Unlike the Constitution, income tax hasn’t been part of our republic since the beginning.
This year marks the sesquicentennial of not only the Civil War, but also the first U.S. federal income tax to help finance it.
That wartime measure was repealed 10 years later, but Congress passed another income tax in 1894 that the Supreme Court ruled unconstitutional as a direct tax the following year. To settle the matter, Congress proposed the 16th Amendment in 1909. It was ratified in early 1913.
The new income tax law Congress passed later that year bears little resemblance, in terms of simplicity and equity and principle, to our modern code. The original tax rates ranged from 1 to 7 percent, with a tax bracket corresponding to each whole percentage point. Payers of the top rate, presumed to be the wealthiest earners, had to have incomes of $500,000 or more-in 1913 dollars. Adjusted for inflation, that translates into a whopping $11 million today.
Obviously, few people earn that much. The dollar cutoff for the top one-10th percent of taxpayers nowadays is just over $1.8 million, which was reported by only 140,000 tax return filers in 2008. The number of filers with $11 million in income would be smaller still.
Clearly, as envisioned in its original construction, the federal income tax was a progressive program that placed taxation squarely on the shoulders of those most able to pay.
The political consensus at the time was that excise taxes were an undue burden on the working class’s consumption, and the advent of sophisticated trusts and such was creating an inequitable system. Thus, the lowest rate of 1 percent applied to incomes all the way up to $20,000 in 1913 dollars, or $445,000 today.
The income tax was aptly named. It was meant for people with disposable income above their living expenses.
Now let’s examine today’s income tax brackets.
The top rate is 35 percent, which kicks in for married filing jointly households with $373,650 in income or more. The lowest rate is 10 percent, which applies to income under $17,050.
Adjusting backward for inflation, our entire bracket span today is compressed beneath the first, lowest income threshold in 1913. Using our figures, the top bracket would have started at a mere $16,800 in 1913, with the bottom bracket capped at incomes as low as $766.
It’s safe to say that our government has turned the spirit of the 16th Amendment on its head.
The road from progressive tax structure as envisioned in 1913 to today’s ridiculously condensed “soak the middle class” bracketry was shaped mostly by wartime opportunism.
When World War I broke out, the government needed money so it tapped both ends of the income tax, raising rates and expanding the brackets. Rates soared from 7 percent to 77 percent on the top earners, who were defined as those making $2 million per year ($40 million today). At the lowest level, rates were boosted from 1 to 6 percent, and the lowest bracket ceiling was reduced to $2,000 ($44,500 today).
Even so, with generous exemptions—the $4,000 married exemption then is equivalent to $80,000 today—only 5 percent of Americans paid income taxes at that time.
It wasn’t until the Second World War that the income tax began shifting to everyman’s tax.
Between 1939 and 1945 the number of payers had risen tenfold, from 4 million to 43 million, thanks to suffocating surcharge taxes and slashed exemptions. When the war ended, the taxes didn’t. Congress had tasted the addictive nectar of mass taxation. In 16 of the income tax’s first 28 years, the top bracket had started at $1 million or more, echoing the 16th Amendment’s progressive intent.
Inexplicably, after the U.S. entry into World War II in late 1941, the top bracket was reduced from $5 million to $200,000. It would never again exceed $500,000.
At the other end of the tax equation, exemptions would never again approach pre-war levels. The result is a badly skewed income tax system today that ludicrously lumps brackets in a regressively weighted heap at the bottom of the income scale.
Picture the whole range of income as a skyscraper, with low-wage earners crowding the ground floor and those few earning fortunes each year scattered on the observation deck near the building’s peak.
The early tax codes, when the ink was still damp on the 16th Amendment, spread the brackets and their graduated rates across every single floor, from the first to the top. But today’s brackets start on the first floor and go up just a few flights of stairs to the $400,000 mark. Above that, the rate never changes all the way up the express elevator to where the incomes reach $40 million and more.
A lot of tax areas warrant reform, but the first ought to be a reconsideration of the 16th Amendment’s original intent, from which we’ve wandered far.