This article first appeared in the St. Louis Beacon, Jan. 28, 2013 - Warning: This article contains information on the federal income tax. It may cause drowsiness in non CPAs. Do not read while operating heavy machinery.
One hundred years ago on Feb. 3, 1913 - another day that lives in infamy for some - the United States suddenly and deliberately attacked the wealthy with the passage of the 16th amendment. This amendment to the Constitution gave the federal government the power to collect taxes on income.
At least that is what some would have you believe.
In actuality the federal government has always had the power to tax its citizens. Article 1, Section 8, Clause 1 says “The Congress shall have power to lay and collect taxes, duties, imposts, and excises, to pay the debts and provide for the common defense and general welfare of the United States; but all duties, imposts and excises shall be uniform throughout the United States.” Thus, the original Constitution gave the government the power to tax, not the 16th amendment. And the government had imposed a Federal income tax on its citizens long before 1913.
The U.S. income tax had its start at the beginning of the Civil War when Congress passed the Revenue Act of 1861 to finance the Northern war effort. This act levied a flat tax of 3 percent on income above $800 (nearly $20,000 in today’s dollars). Then in 1862, as the cost of the conflict grew, Congress passed the first progressive tax which had a top rate of 5 percent on income above $10,000 ($222,000 in current dollars). A progressive tax, which is what we have today, has a higher tax rate on higher incomes. After the war, as the economy got back on track, rates were gradually lowered. In 1872, the income tax was eliminated and the government went back to financing its expenditures with tariffs and excise taxes.
However, in 1894 Congress struck again and adopted a 2 percent flat tax on incomes over $4,000 ($102,000 in current dollars). Although the Supreme Court had upheld the earlier tax, the high court now struck it down as unconstitutional, saying the income tax was forbidden by Article1, Section 9 of the Constitution. That, it said prohibits direct taxes on individuals unless apportioned on the basis of population. A direct tax is imposed upon an individual or on property (such as a real estate property tax); an indirect tax is imposed on a transaction.
The Supreme Court didn’t rule that the federal government couldn’t tax its citizens. It said that the section of the tax that related to income from property was unconstitutional. The court decided that a tax on income from property should be treated as a tax on property by reason of its ownership and so that portion was a direct tax and should be required to be apportioned. And that was enough to kill the entire Federal income tax ... at least for a while.
The economic Panic of 1907 (they used to call them panics, now we call them crises) renewed the push for an income tax. Many Americans believed that the high tariffs enacted during the McKinley administration had been inflationary and had contributed to the Panic.
By the election of 1908 both the Republican candidate, William Howard Taft, and his Democratic opponent, William Jennings Bryan, backed an income tax. Outgoing Republican President Teddy Roosevelt did as well. The “plus size” Taft, who is remembered for getting stuck in the White House bathtub, won the election and declared the need for an income tax in his acceptance speech. By 1909, Congress had passed a resolution proposing the 16th Amendment, which was then submitted to the states for ratification. But not until the Democrats and their Republican pro-tax allies won landslide victories in the national and state midterm elections did state legislatures take up the cause in earnest. And not until Feb. 3, 1913, when Delaware became the 36th state to ratify this constitutional amendment, did it become official.
The new amendment says that “the congress shall have the power to lay and collect taxes on income from whatever source derived, without apportionment among the several states and without regard to any census or enumeration.”
Newly elected President Woodrow Wilson, a Democrat, quickly took advantage of the amendment and pushed for a progressive income tax with a top marginal rate of 7 percent, with hefty exemptions. And although the amount of revenue initially derived from the new tax was rather small, it was important in that it began the change of the federal tax system from a consumption-based system, which tends to be regressive (meaning it hits those with lower incomes proportionately harder), to a system that imposed taxes based on a citizen’s ability to pay.
It didn’t take long for rates to rise. By 1918, the top rate had soared to 77 percent to help finance World War I; and by the end of World War II, the top rate had climbed to 94 percent on incomes over $200,000 ($2.5 million in current dollars). Ouch.
Last month, after much heated debate, the highest federal income tax rate was increased to 39.6 percent from 35 percent. But even this higher rate is low compared to historic rates. In the 70 years between 1917 and 1987, when President Reagan lowered the top rate to 38.5 percent, the highest rate was higher than 50 percent for 62 of the 70 years. In the 100 years since the enactment of the 16th Amendment the highest rate has only been lower than the current rate in 26 years.
Now a full century after the passage of the 16th Amendment, the debate continues with many Conservatives including Ron Paul, Rick Perry and George Will arguing for the repeal of the unpopular amendment and asking for it to be replaced with a regressive tax on consumption such as a sales tax. Perhaps they need to re-read the famous economist Adam Smith, the “Father of Capitalism.” As Smith wrote in “The Wealth of Nations,” “The subjects of every state ought to contribute towards the support of the government, as nearly as possible, in proportion to their respective abilities.” Yes, Smith wrote that not Marx.
I’m afraid the 16th Amendment is here to stay. To be honest it wouldn’t be surprising if tax rates continued to climb because, despite the drought, according to an old Jewish proverb, “Taxes grow without rain.”