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9 Crucial Eras in U.S. Income Tax History

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If you have followed the presidential campaign at all, you know one major point of contention between President Barack Obama and Mitt Romney is taxes.

With the Bush tax cuts ready to expire, Obama wants to eliminate the cuts for couples making more than $250,000 per year by restoring the 39% top tax rate of the Clinton administration. Romney, on the other hand, advocates an across-the-board cut of 20% and the closing of certain, yet-to-be disclosed, tax loopholes.

The candidates also differ on how to tax capital gains, estate and gift income and other areas as AdvisorOne explored in Obama vs. Romney: 6 Key Differences on Taxes, Regulation.

A look at the history of the income tax in the United States shows that nothing much has changed. Throughout the years, the closing of loopholes and raising and lowering of rates has been met with arguments that would sound familiar in the current crop of campaign commercials. From the first levy, during the Civil War, charges of Wall Street getting out of paying its fair share have been sounded.

Here then are AdvisorOne’s 9 Crucial Eras in U.S. Income Tax History:

Civil War soldiers in front of a medical tent.

1. The Civil War

The need to pay for the Civil War forced Congress to approve a series of taxes. The first, which taxed real estate, drew the ire of those who were looking to protect the interests of farmers. In the agrarian society of the time, that was a much larger interest group than today.

William Wallace, the representative of Washington Territory, even invoked a modern-sounding argument when he decried the fact that “the great stockholders, the money lenders and the princes of Wall Street” would not be taxed. Still, the legislation passed, although many were unhappy about the need for a huge bureaucracy to collect the money.

The $50 million ($1.2 billion today) expected to be raised, though, was not enough. Congress passed a 3% levy on income above $800 ($19,700). Alas, a weak enforcement mechanism rendered the income tax ineffective. A revision of the tax legislation was passed in 1862, including the first inheritance tax (estate tax, or death tax, in modern parlance) and also established the commissioner of internal revenue. In 1866, the government collected a record $310 million ($22 billion). It took more than a half-century for tax receipts to again reach that level.

William Jennings Bryan campaigning in 1896. (Photo: AP)

2. A Constitutional Challenge

The Civil War era income tax was abolished in 1872 only to be reinstituted in 1894. The tax rate was 2% on income above $4,000 ($102,300), but the Supreme Court stepped in a year later and declared it unconstitutional in a 5-4 decision. Farm groups, according to, saw the court’s action as evidence that the court was aligned with business interests against farmers.

The tax issue bubbled below the surface for nearly two decades with the progressive wing of the Republican Party calling for a levy on income. William Jennings Bryan, a three-time Democratic presidential nominee, also supported the idea. In 1909, progressives pushed hard for an income tax. Conservatives hatched a strategy: they proposed an amendment to the Constitution that would enact the income tax. To their amazement, three-quarters of the states ratified the amendment by 1913. The modern income tax was born. In a flip from the narrative of today, just 1% of earners paid any tax. By using generous deductions, the effective rate was just 1% of net income.

World War I recruitment poster for the U.S. Army.3. World War I and Roaring ’20s

As with the income tax’s beginnings during the Civil War, the world wars of the 20th century forced the government to seek more revenue. In 1916, the lowest rate was doubled to 2% and those making $1.5 million ($30 million) paid 15%. More increases (to a top rate of 77%) the next two years raised annual revenue to $3.6 billion ($53 billion) in 1918, a quarter of GDP, to help pay for World War I. Still, 95% of workers paid no income tax.

The economy boomed after the war, giving birth to the Roaring ’20s, which saw tax rates cut five times with the top rate tumbling to 25%. Total tax revenue dived to 13% of GDP. FDR signing Social Security Bill in 1935. (Photo: AP)4. The Great Depression

After the stock market crashed in 1929, tax receipts fell sharply as unemployment spiked. By 1935 the country had stabilized due to many of the New Deal programs pushed by President Franklin Roosevelt. That same year Social Security, unemployment insurance and other programs led to a 2% tax (paid equally by employee and employer) on the first $3,000 ($48,500) of income.

The language used by politicians in the battle over Social Security is echoed today. FDR championed it as a safety net for the elderly, while his opponents vilified it, saying it would lead to job losses. Time magazine quoted Silas Hardy Strawn, a former head of the Chamber of Commerce, as saying it was an effort “to Sovietize America.”

American ships burn during the Japanese attack on Pearl Harbor. (Photo: AP)

5. World War II

Tax changes started in 1940 and ’41, before the U.S. was officially in the war, according to But the biggest changes happened after Dec. 7, 1941, when Japan attacked Pearl Harbor, pushing the U.S. into war.

Besides eliminating many deductions and changing rates (23% on those earning $500, $6,400 today, and a whopping 94% on $1.5 million, $19.2 million today), withholding of taxes from paychecks was introduced for the first time since the Civil War. Receipts equaled 20.4% of GDP in 1945, and the number of taxpayers increased more than 10-fold to 43 million from 1939 to 1945.

President Truman in the White House in 1945. (Photo: AP)

6. The 1950s and the Modern IRS

First proposed by President Harry Truman, the modern Internal Revenue Service was created in 1953 under the presidency of Dwight Eisenhower. Workers now came from the Civil Service, a move designed to instill confidence in the tax system.

Still, the debate over taxes now echoes the one back then. Arguments over closing loopholes, an effort to lower corporate taxes and Truman’s plan to raise inheritance taxes all sparked battles in Congress. The top marginal tax rate, which had “dipped” to 77% (compare that to today’s arguments over raising the rate to 39%), was 90% or 91% every year until 1964 when it was lowered to 77%. That 90% rate in 1954 was applied to individuals making $200,000 and couples earning $400,000 ($3.2 million today). The top rate has dropped ever since, to today’s 35%—temporarily set by the Bush-era tax cuts—for those earning $373,650 or more.

President Reagan after signing a tax bill at his California home in 1981. (Photo: AP)7. The Reagan Years

Ronald Reagan’s name is invoked often when tax policy is debated. Most people remember him as having cut taxes. And that’s true to a point. Taxes were cut 25% in 1981. But when deficits started to appear the following year, some taxes were raised.

Just as now, there was debate about “trickle-down economics.” Would tax cuts for the wealthy help those lower down on the economic ladder? The Reagan cuts do not seem on the face of it to bolster the case. Unemployment rose for 16 months and the economy only started to pick up after taxes were increased and budget deficits were erased. Then in 1986, Reagan signed into law legislation that lowered the top rate on individuals from 50% to 28%. The top rate hadn’t been that low since 1916.

President Clinton giving inaugural address in 1993. (Photo: AP)8. It’s the Economy, Stupid

After President George H.W. Bush was defeated, in no small measure for breaking his “read my lips” pledge to enact “no new taxes,” President Bill Clinton rode into office behind his campaign’s famous “it’s the economy, stupid” mantra.

In 1993, Clinton signed into law tax code changes that followed through on his promise to raise taxes on the affluent. The tax increase, which was among the largest in history, mostly took aim at high earners. A gasoline tax of 4.3 cents a gallon did affect those making less. Of course, the battle over the legacy of those tax increases continues. Democrats say they led to budget surpluses and a roaring economy. Republicans say it was their gaining control of Congress that spurred spending restraints and fed the economic engine of the nation.

President George W. Bush9. The Bush Tax Cuts

President George W. Bush had an eventful presidency, to say the least. But nothing seems to have attached itself to his name more than two simple words: “tax cuts.” Republicans and Democrats are still arguing about them as the recent extension of the Bush era tax cuts, as they’re called, are set to expire at the end of the year.

With two wars and a huge expansion of a Medicare drug benefit to pay for, the budget deficit exploded under Bush. The 2007-09 recession exacerbated the problem, shrinking tax revenue. And, while everyone received a cut in their tax bills, the top 20% received 65% and the top 1% received 38% of the cut—though that’s because these groups paid a larger share of the country’s taxes. The Democrats argue that the highest wage earners can afford to pay more. The Republicans have changed their rhetoric from “trickle down” to helping entrepreneurs, or job creators. By Jan. 1, the era of the temporary Bush era tax cuts will either be extended temporarily—again, end completely or will obtain a different name as Congress enacts a new, permanent version of tax cuts.


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