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January 19, 2001
CRS Report on History of Federal Taxes
Louis Alan Talley

FEDERAL TAXATION: AN ABBREVIATED HISTORY



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CRS REPORT FOR CONGRESS
Received through the CRS Web

January 19, 2001

Louis Alan Talley
Specialist in Taxation
Government and Finance Division

SUMMARY

[1] The present federal income tax dates from the act signed by President Wilson on October 3, 1913. That act was made possible by the ratification of the Sixteenth Amendment to the Constitution adopted on February 3, 1913. Earlier federal income tax laws had been repealed or held unconstitutional. The income tax first became a significant source of revenue during World War I.

[2] Four tax reductions were enacted during the prosperous decade of the 1920s. Despite rate increases and new taxes in the 1930s, revenues declined with falling levels of income. Seventeen internal revenue acts passed from 1913 until they were first codified in 1939. The decade of the 1940s saw the income tax become a mass tax covering a large portion of the population. The withholding provisions of today stem from the Current Tax Payment Act of 1943. The deduction for medical and dental expenses, along with marital income splitting, were all enacted in the 1940s. The early 1950s saw an increase in individual and corporate rates due to financing needs of the Korean War. The second codification of the tax laws took place during 1954. The Highway Trust Fund was set up in 1956 which increased excise taxes on vehicles and products connected with the use of public highways.

[3] The 1960s saw the introduction of the investment tax credit and the enactment of income-averaging provisions. A major tax reduction was provided by the Revenue Act of 1964. Surcharges were enacted in 1968 and 1969, because of the Vietnam War. A major reform of the tax laws was provided in the Tax Reform Act of 1969. The decade of the 1970s was one of reform and simplification, with major tax acts passed in nearly every year. The Tax Reform Act of 1976 provided numerous reform measures, particularly with regard to syndicates and limited partnerships as well as estate and girt taxes.

[4] The theme of the 1980s and 90s was primarily one of reducing the federal government's budget deficits. A comprehensive revision of the federal tax system with a view to fairness, efficiency, and simplicity was enacted as the Tax Reform Act of 1986. The 1990S found a Congress concerned with the administrative structure of the Internal Revenue Service and involved in protecting taxpayer rights.

INTRODUCTION

[5] The present composition of the federal tax system represents a relatively recent development in the fiscal history of the United States government. Customs duties were the primary source of receipts prior to the Civil War. Additional revenues were generated through the sale of public lands and temporary excise taxes. 1 During the period between the Civil War and World War I, customs duties continued to be an important source of revenue -- accounting for more tax revenues than other federal taxes combined in most of those years. Financing government operations through tariffs had the disadvantage of varying revenue yields according to business conditions of the time, rather than the needs of government.

EARLY HISTORY

[6] The nation's first income tax and a direct apportioned tax on land were levied as part of the Act of 1861. The income tax resulted from a determination primarily by the western areas that the eastern portion of the country should pay a fairer share of taxes. In particular, the western areas resented the imposition of a direct tax on land since the western areas had an abundant amount of land but a sparse and poor population. Before the collection machinery was set up, the Act of 1861 was passed. The 1862 act superseded the 1861 income tax which was a flat rate tax. The first income tax revenues thus were collected under the graduated rates of the 1862 act (other provisions of this act suspended for two years the direct tax on land and provided for a new Commissioner of Internal Revenue). The 1862 tax was revised in 1864 to meet the revenue needs of the government and to make its provisions more definite, was amended in 1865 and 1866, and was rewritten in 1867 and 1870 when the country's revenue needs were not as pressing. The tax was allowed to expire in 1872. These acts always contained an expiration date and the income tax was considered to be a war-time expedient.

[7] Also during the Civil War period, excise and stamp taxes were revived and, under the Act of 1862, an inheritance tax was imposed. Excise taxes were imposed on a long list of commodities, including alcoholic beverages and tobacco. During the postwar period, most of the excise taxes and the inheritance tax were repealed. The taxes on alcoholic beverages and tobacco continued in effect and increased in importance.

[8] In 1894, another federal income tax was enacted, but it was declared unconstitutional by the Supreme Court in 1895, on the ground that it was a direct tax not apportioned among the states by population.

[9] Excise tax rates were increased and new excises 2 imposed along with the imposition of an inheritance tax to help finance the Spanish-American War. These excise taxes were mostly repealed by 1902. The low revenue-yielding inheritance tax continued a few years longer.

[10] The Act of 1909 imposed a corporate excise tax of 1% on corporate net income over $5,000. Four years later, the Sixteenth Amendment (ratified on February 25, 1913) provided that "Congress shall have the power to lay and collect taxes on incomes, from whatever source derived without apportionment among the several states and without regard to any census or enumeration." The Sixteenth Amendment paved the way for the introduction of the modern income tax, first enacted as part of the Tariff Act of 1913 and signed into law by President Wilson on October 3, 1913. This act applied both to corporations and to individuals. It superseded the 1909 corporate excise tax act and provided for progressive tax rates on the income of individuals.

[11] The income tax became important as a source of revenue during the First World War. The traditional 19th century revenue sources were inadequate to finance the greatly expanded federal defense and war expenditures needs of the period. The maximum rate of the individual income tax, which was 7% in the year 1913-1915, increased to 77% by 1918. The corporate income rate also rose sharply during the war, rising from an initial level of 1% in 1913-1915, to 12% by 1918. The income tax soon became the government's most significant source of revenue. By 1917, income tax collections surpassed customs revenues. Additional wartime revenues were derived from newly imposed estate, capital stock, and excess profits taxes on corporate net income.

TAXATION BETWEEN THE WARS

[12] During the 1920s, four tax reduction acts were enacted, with the Revenue Act of 1924 providing tax rebates to individuals for 1923. The corporate income tax rate was slightly higher at the end of the decade than at the beginning, but the overall corporate burden was reduced as a result of the increase in the surtax exemption and the repeal of the war-excess profits and capital stock taxes. Although annual income tax receipts during the decade were below the 1920 level, the income tax retained its significant position as a revenue source and represented the major part of the total tax receipts. Income and profit taxes in 1920 were nearly $4 billion and declined to $1.7 billion in 1923. For the rest of the decade there was an upward trend in their yield; they reached about $2.4 billion in 1930.

[13] Most of the excise taxes were either repealed or greatly reduced during the 1920s. The only important excise tax existing by the end of the decade was the tax on tobacco, which yielded $434 million in 1929. The alcoholic beverage tax, which produced $483 million in 1919, yielded little during the 1920s because of prohibition. While dollar receipts from custom duties increased during the 1920s, they never regained their pre-1900 importance as a percentage of total federal government receipts.

[14] In 1926, the Joint Committee on internal Revenue Taxation (now called the Joint Tax Committee) was established.

[15] During the Great Depression of the 1930s, in an attempt to maintain federal revenues in the face of falling income levels, various existing taxes were increased and some taxes were newly imposed. In spite of the income tax rate increases and lower personal exemption amounts, revenues from individual and corporate income taxes fell both absolutely and relative to total tax collections during this decade. Revenues from these taxes combined declined from a level of $2.4 billion in 1930 -- which represented about two-thirds of total tax revenues -- to less than $750 million by 1933. In 1940, they amounted to about $2.1 billion, which was less than two-fifths of total taxes.

[16] Total tax revenues declined in the first half of the decade of the 1930s, but rose in the latter half and, by 1940, reached $5.3 billion, or about $2.3 billion over the 1930 level. A significant part of the increase was due to increased excise tax revenues, particularly from alcoholic beverage taxes collected after repeal of prohibition. The estate tax and the gift tax were important during this decade, accounting for nearly 10% of total federal taxes in several of the years. A capital stock tax and supplementary declared value excess profits tax were imposed. In the late 1930s, employment taxes were introduced to finance the old-age social security, unemployment insurance, and railroad retirement programs. During this decade, several short-lived taxes were also imposed; they were levied under the undistributed profits and agricultural adjustment acts. The 17 revenue acts passed since 1913 were first codified in 1939. Prior to this codification, each new revenue act had superseded the continuing portions of previous acts. The codification was seen as the first important step in simplifying tax administration.

WORLD WAR II AND AFTER

[17] Increasing demands for additional revenues to finance World War II programs established the overriding importance of the individual and corporate income taxes in our federal structure. The sharp increases in tax rates, the reductions in personal exemptions, and the levying of the excess profits tax raised income (and profits) tax revenues from a 1940 level of $2 billion to over $35 billion in 1945.

[18] The individual income tax, which had applied to only a small percentage of the population until the early 1940s, was levied on most of the working population by the end of the war. With the tax applying to the masses, the withholding system was introduced in the Current Tax Payment Act of 1943 to facilitate the payment and collection of personal income taxes. In addition, quarterly estimated tax payments were introduced for those individuals whose income was from sources not covered by the withholding system. For the years 1944-45, individual income rates ranged from 23% to 94% -- the highest rates ever imposed in the entire history of the federal income tax.

[19] The deduction for medical and dental expenses was first included in the Revenue Act of 1942. Major tax reductions were enacted in 1945 and 1948. The 1945 act reduced individual income tax rates, repealed the excess profits tax, capital stock and declared value excess profits taxes, and reduced the corporate income tax slightly. The 1948 act reduced individual rates further and introduced marital income-splitting. With income splitting, married couples filing a joint return computed their tax such that the tax was equal to twice the tax liability on one-half of the couple's combined income. By the end of the decade, individual and corporate income tax revenues had declined to $29.5 billion from the $35 billion level of 1945.

[20] Faced with financing the Korean War, Congress enacted three major revenue acts between September 1950 and October 1951. As a result of these acts, individual and corporate income tax rates were increased and an excess profits tax was reimposed. By 1953, individual and corporate income tax revenues amounted to $54 billion.

[21] As of the beginning of 1954, individual income tax rates were reduced to the levels existing prior to the Revenue Act of 1951, and the excess profits tax was allowed to expire. An excise tax reduction act in 1954 provided for reductions in many of the excise tax rates. In the same year, the Internal Revenue Code of 1954, which recodified numerous changes, was enacted.

[22] Between 1955 and the end of 1963, various tax legislation was enacted, but the income tax rates remained unchanged. Some excise taxes were repealed or reduced, while others were increased or newly imposed. Particularly noteworthy in this respect is the federal-aid highway construction program, inaugurated in 1956, and which earmarked increased or new taxes on certain vehicles and products connected with the use of public highways. The method of taxation for life insurance companies was revised in 1959.

[23] The role of tax policy was recognized as a primary fiscal tool with which to prod economic activity. The 1960s saw the introduction of the investment tax credit with the passage of the Revenue Act of 1962, intended to spur business investment. The Revenue Act of 1964 provided major income tax reductions. Both individual and corporate income tax rates were reduced in two stages. The individual rates which ranged between 20% and 91%, were reduced to 14% to 70% in 1965 when the reductions were fully effective. Corporate tax rates which were 30% on the first $25,000 of taxable income and 52% on income over $25,000 ended in the range of 22% and 48% in 1965. Other structural reforms were made, such as the minimum standard deduction designed to provide relief for low income persons, the adoption of a moving expense deduction and the five-year income- averaging system. However, the major revenue effects resulted from the rate reductions. The Excise Tax Reduction Act of 1965 reduced excise taxes to help sustain the economic expansion then underway. A surcharge went into effect in 1963 and 1969, to help finance the Vietnam War. Major reform of the income tax laws was provided in the Tax Reform Act of 1969.

[24] The decade of the 1970s saw reform and simplification of the tax laws with the passage of a number of major acts. In the early 1970s, a number of excise taxes, such as those on automobiles and telephone service were extended and their expiration postponed. Additional excise taxes were imposed on air passengers and property transported by air; these taxes were dedicated to a new trust fund designed to modernize the Nation's air transport system. The Tax Reduction Act of 1975 was designed to provide stimulus for recovery from an economic recession. Major tax reforms suggested during hearings held in the early l970s were modified in the Tax Reform Act of 1976, which provided numerous reform provisions, particularly with regard to syndicates and limited partnerships as well as estate and gift taxes. Other major acts included the Tax Reduction and Simplification Act of 1977 and the Revenue Act of 1978.

[25] The beginning of the 1980s witnessed the passage of the Crude Oil Windfall Profits Tax Act and the Economic Recovery Tax Act of 1981, the latter intended to stimulate economic growth. The theme of the 1980s, however, was primarily one of reducing the federal government's large budget deficits. Deficit reduction laws included the Deficit Reduction Act of 1984, the Omnibus Budget Reconciliation Act of 1987, the Technical and Miscellaneous Revenue Act of 1988, and the Revenue Reconciliation Act of 1989. A comprehensive revision of the federal tax system, with a goal of fairness, efficiency, and simplicity, was enacted as the Tax Reform Act of 1986. This act reduced tax rates, eliminated certain deductions, and broadened the tax base as well as recodified the code.

[26] Like the previous decade, the 1990s continued the theme of reducing the budget deficits with passage of the Omnibus Budget Reconciliation Act of 1990 and 1993. Legislation passed during the mid and late portion of the 1990s showed a Congress concerned with the operations of the Internal Revenue Service and a concern for taxpayer rights. The IRS was restructured in the Internal Revenue Service Restructuring and Reform Act of 1997 with several acts passed which provided taxpayer rights. Other concerns have been health and retirement with the introduction of Roth IRAs and medical savings accounts (MSAs). In the area of excise taxes, tax rates on tobacco and alcohol products have been increased along with extension and reexamination of the Airport and Airway Trust Fund and the Highway Trust Fund.

[27] As we enter the new millennium with a surplus in tax revenues it is expected that themes in tax reform may involve a reduction in income tax rates, reform of the estate and gift taxes, a reduction in the marriage tax penalty, and simplification.


FOOTNOTES

1 Excise taxes were imposed during two periods, from 1791-1802 (the salt tax was repealed in 1807), and during the emergency surrounding the War of 1812. Excise taxes reimposed because of the War of 1812 were repealed in 1817.

2 An excise tax was first imposed on telecommunication services. For a complete legislative history see The Federal Excise Tax on Telephone Service: A History (RL30553) by Louis Alan Talley.


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