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:
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.
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 ourdocuments.gov, 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.
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. 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.