On Feb. 3 1913, the financial future of the United States was influenced by an historic and significant event. This revolved around the ratification of the Sixteenth Amendment, which established the right of Congress to impose a federal income tax on American citizens. This also overturned Article I, Section 9 of the U.S. Constitution, which had initially prohibited the government from imposing a general tax on accrued income and earnings. Now in its 101st year, income tax remains a national institution that continues to evolve while inspiring considerable debate among political leaders and citizens alike.
A Brief History of Income Tax in the U.S.
The history of income tax can be traced back to the Civil War, which ended in 1865 after the death of an estimated 620,000 soldiers. The battle between liberal northern states and the Confederate south also represented the costliest conflict ever to be fought in the U.S., and its financial implications prompted Congress to propose the taxation of income. After initially taxing a standard 3% of all earnings over $800 per annum, Congress was forced to introduce a graduated rate of income tax before repealing the legislation completely in 1872 after suggestions that it was unconstitutional.
The concept of income tax remained the source of much discussion, however, and in 1894 Congress attempted to reprise the legislation as a class tax on the nation's highest earners. The decision to enact a 2% income tax rate on citizens who earned more than $4,000 a year was widely criticized, with the Supreme Court almost immediately opposing the legislation as being unconstitutional and an unjustifiable attack on capital. Seemingly at odds with the fundamental principles of capitalism and the American Dream, the concept of income tax looked set to become little more than a footnote in the history of the U.S.
Ratification and the Early Years of Income Tax in the U.S.
The progressive minds in Congress were not to be denied, however, and by 1913 the Sixteenth Amendment to the Constitution had made income tax a permanent fixture of U.S. law. It initially served as little more than a financial sanction on the wealthy, however, with a top tax bracket of 7% and an income of $2 million required to qualify during the first year. As a result of this and a host of generous deductions, less than 1% of the population was required to pay income tax in 1913, while those individuals who did contribute paid just 1% of their accrued earnings.
This had begun to change by 1916, as at this stage all individuals who earned an income were required to pay some form of tax. Even though the majority of taxpayers at this time fell within the lowest bracket, annual internal revenue collections continued to rise and reached the $1 billion mark for the first time in 1918. This had soared to more than $7 billion by the start of World War II, as rising levels of employment also contributed to increased income tax collections. During this time the federal government introduced a graduated income tax system, which facilitated the levy's transition from a class tax on the wealthy to a universal and proportional financial sanction.
Income Tax, its Evolution and the Constitution
While the course of income taxation has been altered according to the demands of individual administrations, certain trends have remained prominent during the last 100 years. To begin with, the number of American citizens grouped within the lowest tax bracket has fallen steadily since 1913, with just 25% earning this distinction before the global recession of 2008. While this can be partially attributed to the fact that the average American wage rose steadily between 1988 and 2008, it also suggests that lower income families are facing an unenviable deal in comparison to high earners and the nations CEOs.
The average CEO salary was just $148,000 in 1988, but 20 years later this had soared to a staggering $582,000. Despite this, however, the average tax rate for high-earning individuals in the U.S. remained largely unchanged during the same period of time. As a result of this, the wealthiest individuals in America have benefited from a relatively relaxed system and subsequently have been able to retain a higher percentage of their earnings. While some may say that this reflects the core principles of capitalism that underpin the American dream, an estimated six in 10 U.S. nationals now feel that the tax system is fundamentally unfair.
While income tax was initially deemed unconstitutional as it reportedly attacked capital and targeted high earners and employers in the U.S., it is opposed for entirely different reasons in 2013. With more than 33% of American families falling close to the poverty line despite their adult members holding full-time employment, a rising number of citizens are being forced to pay a rate of tax that is disproportionate to their earnings and in comparison with the country's wealthiest earners. So while many still consider it be a class tax, the levy applied to income is now more of a burden for the working poor rather than the wealthy.
The Bottom Line
If the 100-year history of income tax has proved one thing, it is that the federal government has been extremely hard-pressed to satisfy both the rich and poor factions of society. While the political incumbents of 1913 were accused of attempting to attack the fabric of capitalism, today's politicians are charged with placing too great a burden on the working poor. The latter represents a more tangible and far-reaching concern, especially when you consider the widening wealth gap in the U.S. and the growing number of households that continue to live beneath the poverty line.