Taxation is the imposition by a government of a compulsory contribution on its citizens for meeting all or part of its expenditures. But taxation can be more than a revenue raiser. Taxes can redistribute income, favor one group of taxpayers at the expense of others, punish or reward, and shape the behavior of taxpayers through incentives and disincentives. The architects of American tax policy have always used taxes for a variety of social purposes: upholding social order, advancing social justice, promoting economic growth, and seeking their own political gain. The need for new revenues has always set the stage for pursuing social goals through taxation, and the need for new revenues has been most intense during America's five great national crises: the political and economic crisis of the 1780s, the Civil War, World War I, the Great Depression, and World War II. In the process of managing each of these crises, the federal government led the way in creating a distinctive tax regime—a tax system with its own characteristic tax base, rate structure, administrative apparatus, and social intention.
In the United States, progressive taxation—taxation that bears proportionately more heavily on individuals, families, and firms with higher incomes—has always enjoyed great popularity. Progressive taxation has offered a way of reconciling the republican or democratic ideals with the high concentrations of wealth characteristic of capitalist economic systems. During national crises, political leaders have been especially intent on rallying popular support. Consequently, the powerful tax regimes associated with great national crises have each had a significant progressive dimension.
The Colonial Era and the American Revolution, 1607–1783
Before the American Revolution, taxation was relatively light in the British colonies that would form the United States. Public services, such as education and roads, were limited in scale, and the British government heavily funded military operations. In 1763, after the expensive Seven Years' War, the British government initiated a program to increase taxes levied on Americans, especially through "internal" taxes such as the Stamp Act (1765) and the Townshend Acts (1767). But colonial resistance forced the British to repeal these taxes quickly, and the overall rate of taxation in America remained low until the outset of the Revolution, at least by contemporary British standards.
Tax rates and types of taxation varied substantially from colony to colony, and even from community to community within particular colonies, depending on modes of political organization and the distribution of economic power. British taxing traditions were diverse, and the various colonies and local communities had a rich array of institutions from which to choose: taxes on imports and exports; property taxes (taxes on the value of real and personal assets); poll taxes (taxes levied on citizens without any regard for their property, income, or any economic characteristic); excise (sales) taxes; and faculty taxes, which were taxes on the implicit incomes of people in trades or businesses. The mix varied, but each colony made use of virtually all of these different modes of taxation.
Fighting the Revolution forced a greater degree of fiscal effort on Americans. At the same time, the democratic forces that the American Revolution unleashed energized reformers throughout America to restructure state taxation. Reformers focused on abandoning deeply unpopular poll taxes and shifting taxes to wealth as measured by the value of property holdings. The reformers embraced "ability to pay"—the notion that the rich ought to contribute disproportionately to government—as a criterion to determine the distribution of taxes. The reformers were aware that the rich of their day spent more of their income on housing than did the poor and that a flat, ad valorem property levy was therefore progressive. Some conservative leaders also supported the reforms as necessary both to raise revenue and to quell social discord. The accomplishments of the reform movements varied widely across the new states; the greatest successes were in New England and the Middle Atlantic states.
During the Revolution, while state government increased taxes and relied more heavily on property taxes, the nascent federal government failed to develop effective taxing authority. The Continental Congress depended on funds requisitioned from the states, which usually ignored calls for funds or responded very slowly. There was little improvement under the Articles of Confederation. States resisted requisitions and vetoed efforts to establish national tariffs.
The Early Republic, 1783–1861
The modern structure of the American tax system emerged from the social crisis that extended from 1783 to the ratification in 1788 of the U.S. Constitution. At the same time that the architects of the federal government forged their constitutional ideas, they struggled with an array of severe fiscal problems. The most pressing were how to finance the revolutionary war debts and how to establish the credit of the nation in a way that won respect in international financial markets. To solve these problems, the Constitution gave the new government the general power, in the words of Article 1, section 8, "To lay and collect Taxes, Duties, Imposts, and Excises."
The Constitution, however, also imposed some restrictions on the taxing power. First, Article 1, section 8, required that "all Duties, Imposts and Excises shall be uniform throughout the United States." This clause prevented Congress from singling out a particular state or group of states for higher rates of taxation on trade, and reflected the hope of the framers that the new Constitution would foster the development of a national market. Second, Article 1, section 9, limited federal taxation of property by specifying that "No Capitation, or other direct, Tax shall be laid, unless in Proportion to the Census." The framers of the Constitution never clearly defined "direct" taxation, but they regarded property taxes and "capitation" or poll taxes as direct taxes. The framers' goals were to protect the dominance of state and local governments in property taxation, and to shield special categories of property, such as slaves, against discriminatory federal taxation.
As the framers of the Constitution intended, property taxation flourished at the state and local levels during the early years of the Republic. Most of the nation's fiscal effort was at these levels of government, rather than at the federal level, and the property tax provided most of the funding muscle.
Differences persisted among states regarding the extent and form of property taxation. Southern states remained leery of property taxation as a threat to the land and slaves owned by powerful planters. These states also had the most modest governments because of limited programs of education and internal improvements. One southern state, Georgia, abandoned taxation altogether and financed its state programs through land sales.
Northern states, in contrast, generally expanded their revenue systems, both at the state and local levels, and developed ambitious new property taxes. The reformers who created these new property taxes sought to tax not just real estate but all forms of wealth. They described the taxes that would do this as general property taxes. These were comprehensive taxes on wealth that would reach not only tangible property such as real estate, tools, equipment, and furnishings but also intangible personal property such as cash, credits, notes, stocks, bonds, and mortgages. Between the 1820s and the Civil War, as industrialization picked up steam and created new concentrations of wealth, tax reformers tried to compel the new wealth to contribute its fair share to promoting communal welfare. By the 1860s, the general property tax had, in fact, significantly increased the contributions of the wealthiest Americans to government.
At the federal level, a new tax regime developed under the financial leadership of the first secretary of the Treasury, Alexander Hamilton. His regime featured tariffs—customs duties on goods imported into the United States—as its flagship. Tariffs remained the dominant source of the government's revenue until the Civil War.
To establish precedents for future fiscal crises, Hamilton wanted to exercise all the taxing powers provided by Congress, including the power to levy "internal" taxes. So, from 1791 to 1802, Congress experimented with excise taxes on all distilled spirits (1791); on carriages, snuff manufacturing, and sugar refining (1794); and with stamp duties on legal transactions, including a duty on probates for wills (1797)—a first step in the development of the federal estate tax. In addition, in 1798 Congress imposed a temporary property tax, apportioned according to the Constitution, on all dwelling houses, lands, and large slave holdings.
Excise taxes proved especially unpopular, and the tax on spirits touched off the Whiskey Rebellion of 1794. President George Washington had to raise 15,000 troops to discourage the Pennsylvania farmers who had protested, waving banners denouncing tyranny and proclaiming "Liberty, Equality, and Fraternity."
In 1802, the administration of President Thomas Jefferson abolished the Federalist system of internal taxation, but during the War of 1812, Congress restored such taxation on an emergency basis. In 1813, 1815, and 1816, Congress enacted direct taxes on houses, lands, and slaves, and apportioned them to the states on the basis of the 1810 census. Congress also enacted duties on liquor licenses, carriages, refined sugar, and even distilled spirits. At the very end of the war, President James Madison's secretary of the Treasury, Alexander J. Dallas, proposed adopting an inheritance tax and a tax on incomes. But the war ended before Congress acted.
The Era of Civil War and Modern Industrialization, 1861–1913
The dependence of the federal government on tariff revenue might have lasted for at least another generation. But a great national emergency intervened. The Civil War created such enormous requirements for capital that the Union government had to return to the precedents set during the administrations of Washington and Madison and enact a program of emergency taxation. The program was unprecedented in scale, scope, and complexity.
During the Civil War, the Union government placed excise taxes on virtually all consumer goods, license taxes on a wide variety of activities (including every profession except the ministry), special taxes on corporations, stamp taxes on legal documents, and taxes on inheritances. Each wartime Congress also raised the tariffs on foreign goods, doubling the average tariff rate by the end of the war. And, for the first time, the government levied an income tax.
Republicans came to the income tax as they searched for a way to hold popular confidence in their party in the face of the adoption of the new regressive levies—taxes that taxed lower income people at higher rates than the wealthy. Republicans looked for a tax that bore a closer relationship to "ability to pay" than did the tariffs and excises. They considered a federal property tax but rejected it because the allocation formula that the Constitution imposed meant taxing property in wealthy, more urban states at lower rates than in poorer, more rural states. The Republican leadership then took note of how the British Liberals had used income taxation in financing the Crimean War as a substitute for heavier taxation of property. They settled on this approach, and the result was not only an income tax but a graduated, progressive tax—one that reached a maximum rate of 10 percent. This was the first time that the federal government discriminated among taxpayers by virtue of their income. The rates imposed significantly higher taxes on the wealthy—perhaps twice as much as the wealthy were used to paying under the general property tax. By the end of the war, more than 15 percent of all Union households in the northeastern states paid an income tax.
After the Civil War, Republican Congresses responded to the complaints of the affluent citizens who had accepted the tax only as an emergency measure. In 1872, Congress allowed the income tax to expire. And, during the late 1860s and early 1870s, Republican Congresses phased out the excise taxes, except for the taxes on alcohol and tobacco.
Republicans, however, kept the high tariffs, and these constituted a new federal tax regime. Until the Under-wood-Simmons Tariff Act of 1913 significantly reduced the Civil War rates, the ratio between duties and the value of dutiable goods rarely dropped below 40 percent and was frequently close to 50 percent. On many manufactured items the rate of taxation reached 100 percent. The system of high tariffs came to symbolize the commitment of the federal government to creating a powerful national market and to protecting capitalists and workers within that market. The nationalistic symbolism of the tariff in turn reinforced the political strength of the Republican Party.
After the Civil War, continuing industrialization and the associated rise of both modern corporations and financial capitalism increased Democratic pressure to reform the tariff. Many Americans, especially in the South and West, came to regard the tariff as a tax that was not only regressive but also protective of corporate monopolies. One result was the enactment, in 1894, of a progressive income tax. But in 1895 the Supreme Court, in Pollock v. Farmers' Loan and Trust Company, claimed, with little historical justification, that the architects of the Constitution regarded an income tax as a direct tax. Since Congress had not allocated the 1894 tax to the states on the basis of population, the tax was, in the Court's view, unconstitutional. Another result of reform pressure was the adoption in 1898, during the Spanish-American War, of the first federal taxation of estates. This tax was graduated according to both the size of the estate and the degree of relationship to the deceased. The Supreme Court upheld the tax in Knowlton v. Moore (1900), but in 1902 a Republican Congress repealed it.
State and local tax policy also began to change under the pressure of industrialization. The demand of urban governments for the funds required for new parks, schools, hospitals, transit systems, waterworks, and sewers crushed the general property tax. In particular, traditional self-assessment of property values proved inadequate to expose and determine the value of intangible property such as corporate stocks and bonds. Rather than adopt rigorous and intrusive new administrative systems to assess the value of such, most local governments focused property taxation on real estate, which they believed they could assess accurately at relatively low cost. Some states considered following the advice of the reformer Henry George and replacing the property tax with a "single tax" on the monopoly profits embedded in the price of land. Farm lobbies, however, invariably blocked such initiatives. Instead, after 1900, state governments began replacing property taxation with special taxes, such as income taxes, inheritance taxes, and special corporate taxes. Beginning in the 1920s, state governments would continue this trend by adding vehicle registration fees, gasoline taxes, and general sales taxes.
The Establishment of Progressive Income Taxation, 1913–1929
Popular support for progressive income taxation continued to grow, and in 1909 reform leaders in Congress from both parties finally united to send the Sixteenth Amendment, legalizing a federal income tax, to the states for ratification. It prevailed in 1913 and in that same year Congress passed a modest income tax. That tax, however, might well have remained a largely symbolic element in the federal tax system had World War I not intervened.
World War I accelerated the pace of reform. The revenue demands of the war effort were enormous, and the leadership of the Democratic Party, which had taken power in 1912, was more strongly committed to progressive income taxes and more opposed to general sales taxes than was the Republican Party. In order to persuade Americans to make the financial and human sacrifices for World War I, President Woodrow Wilson and the Democratic leadership of Congress introduced progressive income taxation on a grand scale.
The World War I income tax, which the Revenue Act of 1916 established as a preparedness measure, was an explicit "soak-the-rich" instrument. It imposed the first significant taxation of corporate profits and personal incomes and rejected moving toward a "mass-based" income tax—one falling most heavily on wages and salaries. The act also reintroduced the progressive taxation of estates. Further, it adopted the concept of taxing corporate excess profits. Among the World War I belligerents, only the United States and Canada placed excess-profits taxation—a graduated tax on all business profits above a "normal" rate of return—at the center of wartime finance. Excess-profits taxation turned out to generate most of the tax revenues raised by the federal government during the war. Thus, wartime public finance depended heavily on the taxation of income that leading Democrats, including President Wilson, regarded as monopoly profits and therefore ill-gotten and socially hurtful.
During the 1920s, three Republican administrations, under the financial leadership of Secretary of the Treasury Andrew Mellon, modified the wartime tax system. In 1921 they abolished the excess-profits tax, dashing Democratic hopes that the tax would become permanent. In addition, they made the rate structure of the income tax less progressive so that it would be less burdensome on the wealthy. Also in 1921, they began to install a wide range of special tax exemptions and deductions, which the highly progressive rates of the income tax had made extremely valuable to wealthy taxpayers and to their surrogates in Congress. The Revenue Acts during the 1920s introduced the preferential taxation of capital gains and a variety of deductions that favored particular industries, deductions such as oil- and gas-depletion allowances.
The tax system nonetheless retained its "soak-the-rich" character. Secretary Mellon led a struggle within the Republican Party to protect income and estate taxes from those who wanted to replace them with a national sales tax. Mellon helped persuade corporations and the wealthiest individuals to accept some progressive income taxation and the principle of "ability to pay." This approach would, Mellon told them, demonstrate their civic responsibility and help block radical attacks on capital.
The Great Depression and New Deal, 1929–1941
The Great Depression—the nation's worst economic collapse—produced a new tax regime. Until 1935, however, depression-driven changes in tax policy were ad hoc measures to promote economic recovery and budget balancing rather than efforts to seek comprehensive tax reform. In 1932, to reduce the federal deficit and reduce upward pressure on interest rates, the Republican administration of President Herbert Hoover engineered across-the-board increases in both income and estate taxes. These were the largest peacetime tax increases in the nation's history. They were so large that President Franklin D. Roosevelt did not have to recommend any significant tax hikes until 1935.
Beginning in 1935, however, Roosevelt led in the creation of major new taxes. In that year, Congress adopted taxes on wages and the payrolls of employers to fund the new social security system. The rates of these taxes were flat, and the tax on wages provided an exemption of wages over $3,000. Thus, social security taxation was regressive, taxing lower incomes more heavily than higher incomes. Partly to offset this regressive effect on federal taxation, Congress subsequently enacted an undistributed profits tax. This was a progressive tax on retained earnings—the profits that corporations did not distribute to their stockholders.
This measure, more than any other enactment of the New Deal, aroused fear and hostility on the part of large corporations. Quite correctly, they viewed Roosevelt's tax program as a threat to their control over capital and their latitude for financial planning. In 1938, a coalition of Republicans and conservative Democrats took advantage of the Roosevelt administration's embarrassment over the recession of 1937–1938 to gut and then repeal the tax on undistributed profits.
World War II, 1941–1945: from "class" to "mass" Taxation
President Roosevelt's most dramatic reform of taxation came during World War II. During the early phases of mobilization, he hoped to be able to follow the example of Wilson by financing the war with taxes that bore heavily on corporations and upper-income groups. "In time of this grave national danger, when all excess income should go to win the war," Roosevelt told a joint session of Congress in 1942, "no American citizen ought to have a net income, after he has paid his taxes, of more than $25,000." But doubts about radical war-tax proposals grew in the face of the revenue requirements of full mobilization. Roosevelt's military and economic planners, and Roosevelt himself, came to recognize the need to mobilize greater resources than during World War I. This need required a general sales tax or a mass-based income tax.
In October of 1942, Roosevelt and Congress agreed on a plan: dropping the general sales tax, as Roosevelt wished, and adopting a mass-based income tax that was highly progressive, although less progressive than Roosevelt desired. The act made major reductions in personal exemptions, thereby establishing the means for the federal government to acquire huge revenues from the taxation of middle-class wages and salaries. Just as important, the rates on individuals' incomes—rates that included a surtax graduated from 13 percent on the first $2,000 to 82 percent on taxable income over $200,000—made the personal income tax more progressive than at any other time in its history.
Under the new tax system, the number of individual taxpayers grew from 3.9 million in 1939 to 42.6 million in 1945, and federal income tax collections leaped from $2.2 billion to $35.1 billion. By the end of the war, nearly 90 percent of the members of the labor force submitted income tax returns, and about 60 percent of the labor force paid income taxes, usually in the form of withheld wages and salaries.
In making the new individual income tax work, the Roosevelt administration and Congress relied heavily on payroll withholding, the information collection procedures provided by the social security system, deductions that sweetened the new tax system for the middle class, the progressive rate structure, and the popularity of the war effort. Americans concluded that their nation's security was at stake and that victory required both personal sacrifice through taxation and indulgence of the corporate profits that helped fuel the war machine. The Roosevelt administration reinforced this spirit of patriotism and sacrifice by invoking the extensive propaganda machinery at their command. The Treasury, its Bureau of Internal Revenue, and the Office of War Information made elaborate calls for civic responsibility and patriotic sacrifice.
Cumulatively, the two world wars revolutionized public finance at the federal level. Policy architects had seized the opportunity to modernize the tax system, in the sense of adapting it to new economic and organizational conditions and thereby making it a more efficient producer of revenue. The income tax enabled the federal government to capitalize on the financial apparatus associated with the rise of the modern corporation to monitor income flows and collect taxes on those flows. In the process, progressive income taxation gathered greater popular support as an equitable means for financing government. Taxation, Americans increasingly believed, ought to redistribute income according to ideals of social justice and thus express the democratic ideals of the nation.
The Era of Easy Finance, 1945 to the Present
The tax regime established during World War II proved to have extraordinary vitality. Its elasticity—its ability to produce new revenues during periods of economic growth or inflation—enabled the federal government to enact new programs while only rarely enacting politically damaging tax increases. Consequently, the World War II tax regime was still in place at the beginning of the twenty-first century. During the 1970s and the early 1980s, however, the regime weakened. Stagnant economic productivity slowed the growth of tax revenues, and the administration of President Ronald Reagan sponsored the Emergency Tax Relief Act of 1981, which slashed income tax rates and indexed the new rates for inflation. But the World War II regime regained strength after the Tax Reform Act of 1986, which broadened the base of income taxation; the tax increases led by Presidents George H. W. Bush and William J. Clinton in 1991 and 1993; the prolonged economic expansion of the 1990s; and the increasing concentration of incomes received by the nation's wealthiest citizens during the buoyant stock market of 1995–2000. Renewed revenue growth first produced significant budgetary surpluses and then, in 2001, it enabled the administration of president George W. Bush to cut taxes dramatically. Meanwhile, talk of adopting a new tax regime, in the form of a "flat tax" or a national sales tax, nearly vanished. At the beginning of the twenty-first century, the overall rate of taxation, by all levels of government, was about the same in the United States as in the world's other modern economies. But the United States relied less heavily on consumption taxes, especially value-added taxes and gasoline taxes, and more heavily on social security payroll taxes and the progressive income tax.
Bibliography
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Brownlee, W. Elliot. Federal Taxation in America: A Short History. Washington, D.C., and Cambridge, U.K.: Wilson Center Press and Cambridge University Press, 1996. Includes a historiographical essay.
Brownlee, W. Elliot, ed. Funding the Modern American State, 1941–1995:The Rise and Fall of the Era of Easy Finance. Washington, D.C., and Cambridge, U.K.: Cambridge University Press, 1996.
Fischer, Glenn W. The Worst Tax? A History of the Property Tax in America. Lawrence: University Press of Kansas, 1996. The best single volume on the history of property taxation.
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Leff, Mark. The Limits of Symbolic Reform: The New Deal and Taxation, 1933–1939. Cambridge, U.K.: Cambridge University Press, 1984. Interprets President Franklin Roosevelt's interest in progressive taxation as symbolic rather than substantive.
Ratner, Sidney. Taxation and Democracy in America. New York: Wiley, 1967. The classic interpretation of the expansion of income taxation as a great victory for American democracy.
Stanley, Robert. Dimensions of Law in the Service of Order: Origins of the Federal Income Tax, 1861–1913. New York: Oxford University Press, 1993. Regards the income tax as an effort to preserve the capitalist status quo.
Stein, Herbert. The Fiscal Revolution in America. Rev. ed. Washington, D.C.: AEI Press, 1990. Explores the influence of "domesticated Keynesianism" on fiscal policy, including the Kennedy-Johnson tax cut of 1964.
Steinmo, Sven. Taxation and Democracy: Swedish, British, and American Approaches to Financing the Modern State. New Haven, Conn.: Yale University Press, 1993. A model study in comparative political economy applied to international tax policy.
Steuerle, C. Eugene. The Tax Decade: How Taxes Came to Dominate the Public Agenda. Washington: Urban Institute, 1992. The best history of the "Reagan Revolution" in tax policy.
Wallenstein, Peter. From Slave South to New South: Public Policy in Nineteenth-Century Georgia. Chapel Hill: University of North Carolina Press, 1987. The best fiscal history of a single state.
Witte, John F. The Politics and Development of the Federal Income Tax. Madison: University of Wisconsin Press, 1985. The leading history of the income tax from a pluralist point of view.
Zelizer, Julian E. Taxing America: Wilbur D. Mills, Congress, and the State, 1945–1975. Cambridge, U.K.: Cambridge University Press, 1998. Interprets the powerful chair of the House Ways and Means Committee as a reformer.
