America's Income Tax Law: A Historical Overview

The history of income tax in the United States began with the colonial protest against British taxation policies in the 1760s, which led to the American Revolution. The independent nation collected taxes on imports, whiskey, and glass windows. States and localities collected poll taxes on voters and property taxes on land and commercial buildings. Income tax was imposed briefly during the Civil War in 1861, and the first personal income tax was imposed by Congress to raise revenue for the war effort. The federal income tax that's still in place today was officially enacted in 1913, with less than 1% of the population paying income taxes at a rate of 1% of net income.

The Civil War and income tax

The Civil War, which lasted from 1861 to 1865, was a significant conflict between the Union and the Confederacy, leading to a financial crisis in the United States. The need to fund the Civil War prompted Congress to pass the first federal income tax law in 1861, known as the Revenue Act of 1861. This act included a flat tax of 3% on incomes above $800, which was later modified to include a progressive tax of 3% on annual incomes between $600 and $10,000, and 5% on incomes above $10,000. The tax was designed to be "levied, collected, and paid, upon the annual income of every person residing in the United States", and it applied to various sources of income, including property, professions, trades, and businesses.

The Revenue Act of 1861 was signed into law by President Abraham Lincoln, who played a crucial role in addressing the financial challenges posed by the Civil War. He sent letters to cabinet members to explore the federal government's ability to collect taxes and tariffs, highlighting the imminent threat of secession. On July 4, 1861, President Lincoln opened a special session of Congress to discuss funding for the war, as the Union Army faced significant expenditures in training and arming its troops.

The first income tax was not enough to cover the war expenses, so Congress passed the Internal Revenue Act on July 1, 1862, also known as the Revenue Act of 1862. This act replaced the flat tax with a progressive tax scale, imposing a 3% tax on annual incomes between $600 and $5,000, and a 5% tax on incomes above $5,000. The act also established the Internal Revenue Service (IRS) to oversee the collection of taxes and created complex regulations, instructions, and forms for assessing and collecting taxes. President Lincoln issued executive orders to divide states and territories under Union control into collection districts, each with a collector and assessor appointed by the president.

The Civil War income tax was considered a patriotic contribution to the war effort, and it generated approximately $55 million in government revenue during the conflict. It was levied on residents of all states and territories not in rebellion, and even some states that had seceded were included in the tax base as Union troops established control. The tax applied only to people with incomes above a certain threshold, ensuring that the tax was based on citizens' ability to pay.

After the Civil War ended, the income tax was not immediately repealed and remained in force until 1872, when the Grant administration sponsored the repeal of most "emergency" taxes. However, legal challenges regarding the validity of the Civil War taxes continued until 1881, with the Supreme Court upholding the constitutionality of these taxes. The Populists attempted to revive the income tax in the late 19th century, but it was ultimately declared unconstitutional by the Supreme Court in 1895, leading to the ratification of the 16th Amendment in 1913, which established Congress's right to impose a federal income tax.

The Revenue Act of 1861

The Act imposed a flat tax of 3% on incomes above $800 (equivalent to $27,129 in 2023 and $384,000 in 2021). This tax rate applied to only 3% of the population, as only a small fraction of people had an annual income exceeding the threshold. In addition to the income tax, the Act also included import tariffs on goods such as sugar, tea, nuts, coffee, liquor, and fruits, as well as a direct land tax.

The Act was drafted under the leadership of Senator William Pitt Fessenden of Maine, the chair of the Senate Finance Committee. While the legislation was successful in introducing new revenue streams, it lacked a comprehensive enforcement mechanism, which contributed to its failure to yield the desired level of revenue. As a result, the income tax provision was repealed in 1862 and replaced by the Revenue Act of 1862, which established the Internal Revenue Service and introduced a progressive tax scale.

The 16th Amendment

> The Congress shall have 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.

Prior to the 16th Amendment, the Constitution required direct taxes to be proportionate to each state's population, and most federal revenues came from tariffs and excise taxes. Congress had imposed income taxes prior to the 16th Amendment, including the Revenue Act of 1861, which introduced the first federal income tax to help pay for the Civil War, and the Wilson-Gorman Tariff Act of 1894, which imposed a 2% tax on income over $4,000. However, the 1894 tax was struck down by the Supreme Court in Pollock v. Farmers' Loan & Trust Co.

The Revenue Act of 1913

Income tax in the United States was first introduced under the Revenue Act of 1861 to help pay for the Civil War. The Revenue Act of 1913, also known as the Underwood-Simmons Tariff Act, was a key plank in Woodrow Wilson's 1912 presidential campaign. It was passed by Congress in May 1913 and signed into law by Wilson on October 3, 1913. The Act reintroduced a federal income tax and lowered average tariff rates from about 40% to about 27%.

The Act was a monumental victory for Wilson, hitting about 2% of the population. In 1913, due to generous exemptions and deductions, less than 1% of the population paid income taxes at a rate of only 1% of net income. The Sixteenth Amendment, which granted Congress the authority to issue an income tax without having to determine it based on population, was ratified on February 3, 1913, just one month before Wilson's inauguration.

The Brushaber v. Union Pacific Railroad Company case

Brushaber's argument was that the statute enacting the tax violated the Fifth Amendment's prohibition on the government taking property without due process of law. He also argued that the statute violated due process by exempting certain kinds of income and that, because the tax was not apportioned among the states according to population, it was unconstitutional. The US government filed a brief supporting the validity of the tax.

The Supreme Court, in an 8-0 decision, upheld the validity of the tax statute. The Court held that the Sixteenth Amendment removed the requirement for income taxes to be apportioned among the states according to population. The Court also held that the Revenue Act did not violate the Fifth Amendment's prohibition against the government taking property without due process, nor did it violate the uniformity clause of Article I, Section 8 of the US Constitution.

The Brushaber case was significant because it clarified the taxing authority of Congress and upheld the constitutionality of the federal income tax. The Court's decision reinforced the understanding that income taxes inherently belonged in the "category" of indirect tax, or excise tax, and that the Sixteenth Amendment had removed the need to determine whether an income tax was required to be apportioned among the states.

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