Taxation in The United States - History

History

Before 1776, the American Colonies were subject to taxation by the United Kingdom, and also imposed local taxes. Property taxes were imposed in the Colonies as early as 1634. In 1673, the UK Parliament imposed a tax on exports from the American Colonies, and with it created the first tax administration in what would become the United States. Other tariffs and taxes were imposed by Parliament. Most of the colonies and many localities adopted property taxes.

Under Article VIII of the Articles of Confederation, the United States Federal government did not have the power to tax. All such power lay with the states. The United States Constitution, adopted in 1787, authorized the Federal government to lay and collect taxes, but required that some types of tax revenues be given to the states in proportion to population. Tariffs were the principal Federal tax through the 1800s.

By 1796, state and local governments in fourteen of the 15 states taxed land. Delaware taxed the income from property. By the American Civil War, the principle of taxation of property at a uniform rate had developed, and many of the states relied on property taxes as a major source of revenue. However, the increasing importance of intangible property, such as corporate stock, caused the states to shift to other forms of taxation in the 1900s.

Income taxes in the form of "faculty" taxes were imposed by the colonies. These combined income and property tax characteristics, and the income element persisted after 1776 in a few states. Several states adopted income taxes in 1837. Wisconsin adopted a corporate and individual income tax in 1911, and was the first to administer the tax with a state tax administration.

The first Federal income tax was adopted as part of the Revenue Act of 1861. The tax lapsed after the American Civil War. Subsequently enacted income taxes were held to be unconstitutional by the Supreme Court because they were not given to the states. In 1913, the Sixteenth Amendment was ratified, permitting the Federal government to levy an income tax without giving all of it to the states.

The Federal income tax enacted in 1913 included corporate and individual income taxes. It defined income using language from prior laws, incorporated in the Sixteenth Amendment, as “all income from whatever source derived.” The tax allowed deductions for business expenses, but few non-business deductions. In 1918 the income tax law was expanded to include a foreign tax credit and more comprehensive definitions of income and deduction items. Various aspects of the present system of definitions were expanded through 1926, when U.S. law was organized as the United States Code. Income, estate, gift, and excise tax provisions, plus provisions relating to tax returns and enforcement, were codified as Title 26, also known as the Internal Revenue Code. This was reorganized and somewhat expanded in 1954, and remains in the same general form.

Federal taxes were expanded greatly during World War I. In 1921, wealthy industrialist and then Treasury Secretary Andrew Mellon engineered a series of significant income tax cuts under three presidents. Mellon argued that tax cuts would spur growth. The last such cut in 1928 was followed by the Great Depression in 1929. Taxes were raised again in the latter part of the Depression, and during World War II. Income tax rates were reduced significantly during the Johnson, Nixon, and Reagan Presidencies. Significant tax cuts for corporations and upper income individuals were enacted during the second Bush Presidency.

In 1986, Congress adopted, with little modification, a major expansion of the income tax portion of the Internal Revenue Code proposed in 1985 by the U.S. Treasury Department under President Reagan. The thousand page Tax Reform Act of 1986 significantly lowered tax rates, adopted sweeping expansions of international rules, eliminated the lower individual tax rate for capital gains, added significant inventory accounting rules, and made substantial other expansions of the law.

Federal income tax rates have been modified frequently. Tax rates were changed in 34 of the 97 years between 1913 and 2010. The rate structure has been graduated since the 1913 act.

The first individual income tax return Form 1040 under the 1913 law was four pages long. In 1915, some Congressmen complained about the complexity of the form. In 1921, Congress considered but did not enact replacement of the income tax with a national sales tax.

By the 1920s, many states had adopted income taxes on individuals and corporations. Many of the state taxes were simply based on the Federal definitions. The states generally taxed residents on all of their income, including income earned in other states, as well as income of nonresidents earned in the state. This led to a long line of Supreme Court cases limiting the ability of states to tax income of nonresidents.

The states had also come to rely heavily on retail sales taxes. However, as of the beginning of World War II, only two cities (New York and New Orleans) had local sales taxes.

The Federal Estate Tax was introduced in 1916, and Gift Tax in 1924. Unlike many inheritance taxes, the Gift and Estate taxes were imposed on the transferor rather than the recipient. Many states adopted either inheritance taxes or estate and gift taxes, often computed as the amount allowed as a deduction for Federal purposes. These taxes remained under 1% of government revenues through the 1990s.

All governments within the United States provide tax exemption for some income, property, or persons. These exemptions have their roots both in tax theory, Federal and state legislative history, and the United States Constitution.