After the United States declared its independence and fought the Revolutionary War, the U.S. Congress relied on excise taxes on alcohol, tobacco and a few other products for revenue to pay off its war debts. These taxes were not popular and led to the Whiskey Rebellion during the administration of George Washington. The U.S. instituted direct taxes on real property, estates, and slaves, taxes which Thomas Jefferson abolished in 1802. The U.S. relied solely on excise taxes for a few more years until they were repealed in 1817. At that point the U.S. had plenty of public land to sell and it relied on the sale of land and on customs duties for its revenue until the Civil War.
The cost of the Civil War prompted Congress to restore the excise taxes and to impose a tax on personal income. The tax rate at that time was 3% and proved inadequate for the war needs, so Congress passed new excise taxes on a broader range of items and began taxing licenses, professions, and trades. Following the Civil War the need for revenue declined and Congress abolished the income tax in 1872. For the next 30 years nearly all revenue was collected from the various excise taxes.
Congress passed a flat rate income tax of 2% in 1894, but the Supreme Court ruled that the new tax was a direct tax and that it was not apportioned according to each state’s population, as required by Article 1 of the Constitution. The Spanish-American War forced the U.S. to increase tariffs and excise taxes, but it was vigorously debated that the U.S. could not continue to sustain itself with high tariffs and excise taxes and that those taxes were disproportionately burdensome to the less affluent.
The ensuing debates about excise taxes, tariffs, property taxes, and income taxes led to the 16th Amendment to the Constitution in 1909 which allowed the Federal government to levy a tax on individual lawful incomes. The amendment clarified the earlier Supreme Court ruling by essentially saying that the tax on income was not a direct tax and that it could be levied without regard to the population of each State. Ironically, the amendment was proposed by conservatives in Congress who believed that the amendment would never be ratified and who hoped that the failed amendment would defeat the idea of a tax on income forever. However, in 1913 the amendment was ratified by 36 of the 48 States, the necessary three-fourths majority, and then ratified by 6 more States.
The new income tax law passed by Congress established tax rates of 1% to 7% and included generous exemptions and deductions. As a result, only 1% of the population paid income tax during the first year following the passage of the tax law.
When the U.S. entered into World War I the need for revenue greatly increased. Over the next few years the tax on incomes was increased several times, starting with the 1916 Revenue Act. The War Revenue Act of 1917 reduced exemptions and raised the tax rate again. The 1918 tax act raised the bottom tax rate to 6% and the upper rate to 77%.
Since the end of World War I the tax rate has changed many times, reflecting the needs of the Federal government at the time of the change. For example, during the prosperity of the 1920’s, the tax rate was reduced to a minimum rate of 1% and a maximum rate of 25%. As the United States’ economy has grown in strength and the Federal government has grown in size, the income tax has become an increasingly important segment of the government’s revenue. As a result, tax laws and the tax code have been revised and refined constantly in an effort to meet the changing revenue needs of the Federal government.