History of Taxes
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History of the U.S. Tax System
The federal, state, and local tax systems in the United States shift in response to changing circumstances and role of government. Some of these changes are traceable to specific historical events, such as a war or the passage of new law. Other changes were more gradual, responding to changes in society, the economy, and political situations.
Before the Revolutionary War, the colonial government had only a limited need for revenue within each colony, which they met with different types of taxes. For example, the southern colonies primarily taxed imports and exports, the middle colonies at times imposed a property tax and a "head" or poll tax levied on each adult male, and the New England colonies raised revenue primarily through general real estate taxes, excises taxes, and taxes based on occupation.
England's need to pay for its wars against France led it to impose a series of taxes on the American colonies. In 1765, the English Parliament passed the Stamp Act, which was the first tax imposed directly on the American colonies, and then Parliament imposed a tax on tea. Even though colonists were forced to pay these taxes, they lacked representation in the English Parliament. This led to the American Revolution and established a persistent wariness regarding taxation as part of the American culture.
The Post-Revolutionary Era
The Articles of Confederation, adopted in 1781, reflected the American fear of a strong central government and the national government relied on donations from the States for its revenue.
When the Constitution was adopted in 1789, the Federal Government was granted the authority to raise taxes. The Constitution endowed the Congress with the power to "…lay and collect taxes, duties, imposts, and excises, pay the Debts and provide for the common Defense and general Welfare of the United States.
The citizens now had some proper democratic representation, yet many Americans still opposed and resisted taxes. In 1794, a group of farmers in southwestern Pennsylvania physically opposed the tax on whiskey, forcing President Washington to send Federal troops to suppress the Whiskey Rebellion, establishing the important precedent that the Federal government was determined to enforce its revenue laws. The Whiskey Rebellion also confirmed, however, that the resistance to taxes did not evaporate with the forming of a new, representative government.
During the confrontation with France in the late 1790's, the Federal Government imposed the first direct taxes on the owners of houses, land, slaves, and estates. These taxes are called direct taxes because they are a recurring tax paid directly by the taxpayer to the government based on the value of the item that is the basis for the tax. When Thomas Jefferson was elected President in 1802, direct taxes were abolished and for the next 10 years there were no internal revenue taxes other than excises.
To raise money for the War of 1812, Congress imposed additional excise taxes, raised certain customs duties, and raised money by issuing Treasury notes. In 1817 Congress repealed these taxes, and for the next 44 years the Federal Government collected no internal revenue. Instead, the Government received most of its revenue from high customs duties and through the sale of public land.
The Civil War
When the Civil War erupted, the Congress passed the Revenue Act of 1861, which imposed a tax on personal incomes. The income tax was levied at 3 percent on all incomes higher than $800 a year. This tax on personal income was a new direction for a Federal tax system.
By the spring of 1862 it was clear the war would not end quickly and with the Union's debt growing at the rate of $2 million daily it was clear the Federal government would need additional revenues. On July 1, 1862 the Congress passed new excise taxes.
The need for Federal revenue declined sharply after the war and most taxes were repealed. By 1868, the main source of Government revenue derived from liquor and tobacco taxes. The income tax was abolished in 1872. From 1868 to 1913, almost 90 percent of all revenue was collected from the remaining excises.
The 16th Amendment
Under the Constitution, Congress could impose direct taxes only if they were levied in proportion to each State's population, but the nation was becoming increasingly aware that high tariffs and excise taxes were not sound economic policy.
Eventually, the income tax debate led to a Constitutional amendment to allow the Federal government to impose tax on individuals' lawful incomes without regard to the population of each State.
By 1913, 36 States had ratified the 16th Amendment to the Constitution. Less than 1 percent of the population paid income tax at the time. Form 1040 was introduced as the standard tax reporting form and, though changed in many ways over the years, remains in use today.
Prior to the enactment of the income tax, most citizens were able to pursue their private economic affairs without the direct knowledge of the government. The income tax fundamentally changed this relationship, giving the government the right and the need to know about all manner of an individual or business' economic life. Congress recognized the inherent invasiveness of the income tax and so in 1916 it provided citizens with some degree of protection by requiring that information from tax returns be kept confidential.
World War I and the 1920's
The entry of the United States into World War I greatly increased the need for revenue and Congress responded with greatly increased tax rates. But by 1918, only 5 percent of the population paid income taxes and yet the income tax funded one-third of the cost of the war.
The economy boomed during the 1920's and increasing revenues from the income tax followed, allowing Congress to cut taxes five times.
In October of 1929 the stock market crash marked the beginning of the Great Depression. As the economy shrank, government receipts also fell. In 1931, Congress passed the Tax Act of 1932, which dramatically increased tax rates once again.
The Social Security Tax
The state of the economy during the Great Depression led to passage of the Social Security Act in 1935. This law provided payments known as "unemployment compensation" to workers who lost their jobs. Other sections of the Act gave public aid to the aged, the needy, the handicapped, and to certain minors. These programs were financed by a 2 percent tax, one half of which was subtracted directly from an employee's paycheck and one half collected from employers on the employee's behalf. The tax was levied on the first $3,000 of the employee's salary or wage.
World War II
Increasing military spending led to the passage tax laws that increased individual and corporate taxes and introduced the return to income tax withholding as had been done during the Civil War.
Developments after World War II
Tax cuts following WWII reduced the Federal tax burden. However, the Korean War combined with the extension of Social Security coverage to self-employed persons created a need for additional revenues.
In 1953 the Bureau of Internal Revenue was renamed the Internal Revenue Service (IRS). By 1959, the IRS had become the world's largest accounting, collection, and forms-processing organization. Computers were introduced to automate and streamline its work and to improve service to taxpayers. In 1961, Congress passed a law requiring individual taxpayers to use their Social Security number as a means of tax form identification. Beginning in the late 1960's and continuing through the 1970's the United States experienced persistent and rising inflation rates, ultimately reaching 13.3 percent in 1979. Inflation laid the groundwork for the 1981, 1982, 1984 and 1986 tax changes in the Reagan Era.
Recent Tax Changes
Since the 1990's there has been a shift from hybrid income tax-consumption tax toward consumption tax. For example, Medical Savings Accounts were enacted to facilitate saving for medical expenses.
Despite the higher tax rates, other economic fundamentals such as low inflation and low interest rates, an improved international picture with the collapse of the Soviet Union, and the advent of new information technologies led to a strong economic performance throughout the 1990's.