Income tax in the United States has evolved significantly over the past decades. The history of income tax in the United States is, in fact, quite remarkable, while the large changes in taxation regulations have had enormous impact on the public.
Federal income taxes
- Income tax had not been made legal until 1913, while the first attempt to tax income in the United States was in 1643.
- Federal income taxes in the United States have seen tax rates as high as 94%. For example, between 1944 and 1963, marginal taxes for top salaries (over $200,000) were around 91%—94%. This is a huge difference compared to Today, with rates as low as 37% for top incomes over $500,000.
- In fact, on average, income tax rates have decreased from 91% in 1963 to 35% during the George W. Bush administration. Obviously, this has led to an increase in economic inequality in the US from the 1980s.
When did taxation start in the United States?
The first attempt to tax income in the United States was in 1643. Several colonies in the United States introduced a “faculties and abilities” tax on income, which required tax collectors to go door to door to inquire whether people had earned any income over the year. If they had, they were then charged the amount due right away. Although the income tax brought in minimal revenue, it was seen as a supplement to more conventional methods of property taxation.
Taxation in the United States began during the colonial period. This led to protests that later caused the American Revolution. The government was funded through tariffs on imported goods. Local authorities were responsible for collecting property taxes on land and buildings and also poll taxes from voters.
Later, federal inheritance taxes were introduced in 1900, while the income taxes were introduced during the Civil War in the 1890s. The 16th Amendment was ratified in 1913, which made income tax legal.
Taxes during the Colonial Period. During the colonial period, taxes were significantly low at local, colonial and imperial levels. However, a revolution arose due to whether it was fair for the Americans to pay taxes while they were not represented in parliament.
Development of the Modern Income Tax
In 1913, Congress re-adopted the income tax in 1913 at 1% on incomes above $3,000 while income above $500,000 was taxed 6%. However, in 1918, income tax was increased to 77% for all incomes above $1,000,000. The increase in tax was to raise money to finance World War I.
Later in 1922, the marginal taxes fell to 58% and 25% in 1925 and later to 24% in 1929. It was a significant decrease from the tax that was during World War I. Nevertheless, during the Great Depression in 1932, taxes were raised again to 63% and was later followed by a series of increase in income tax.
During World War II, Congress introduced quarterly taxation to achieve equality and not to generate revenue. President Franklin D. Roosevelt was proposing a 100% income tax on all incomes above $25,000, but Congress failed to pass the proposed bill. Instead, Roosevelt introduced a salary cap to achieve similar results on all contracts between the private sector and the federal government. Between 1944 and 1963, marginal taxes for top salaries (over $200,000) were around 91%—94%.
Since 1964 marginal taxes began to drop
Since 1964, marginal taxes for top salaries began to drop, wherein in 1964 they dropped to 77% and 70% in 1965 and up to 1981. Due to inflation, taxes were adjusted in 1978 so that only the rich were taxed highly.
From 1982 to 1986, the tax rate was lowered to 50%. President Ronald Reagan raised gas and payroll taxes in 1984 and closed all loopholes for the businesses. Later, the tax rate was reduced, with the highest marginal tax rate being 38.5% for individuals in 1987. It was then lowered to 28% between 1988 and 1990.
During the reign of George H. W. Bush, the tax was raised to 31% between 1991 and 1992. In 1993, Clinton’s administration proposed an increase in tax marginal rate to 39.6%. The rate lasted up to 2000. However, President George W. Bush lowered the marginal rate to 39.1% in 2001, 38.6% in 2002 and 35% in 2003 up to 2010.
In 2010, Congress passed the Tax Relief, Unemployment Insurance Re-authorization and Job Creation Act and was signed by President Barack Obama on December 17, 2010. This saw an increment in the tax bracket and then later, inflation made people fall into tax brackets that belonged to the rich until they were later adjusted because of inflation. People earning the lowest incomes are exempted from taxation while they receive subsidies from the federal government.
How has Reduction in Income Tax Led to Inequality?
Tax is one of the ways used by the government to create equality in society. Since 1964, there have been radical changes in income taxes, both under the Republican and the Democratic governments. Since the administration of Johnson, marginal income tax rates have decreased from 91% in 1963 to 35% during the George W. Bush administration. It has led to an increase in economic inequality in the US from the 1980s.
Some of the items that lead to inequality in the society are tax expenditures that include deductions, exemptions and preferential tax rates. For example, the 2011 Congressional Research Service report indicated that capital gains and dividends were significant contributors to economic inequality.
There is a negative correlation between economic inequality and economic growth. Societies with a high proportion of citizens with none to little access to resources in the economy, may call for demands in redistribution. Besides, high levels of unemployment may lead to adverse effects on inequality.
Increased inequalities and its impact
Increased inequalities have a significant impact on economic growth, especially in countries with a high level of urbanization. It adds pressure to unemployment, which then adversely affects economic growth due to high demand in the redistribution of resources. Moreover, it strains human capital and drives people into more poverty, conflicts, and unrest in a country.
Therefore, long-term solutions to economic growth are to reduce economic inequalities and controlled unemployment. High-income tax ensures that those with few resources benefit from what the rich have accumulated when wealth is redistributed. It provides that society is intact since there is sufficient redistribution of wealth.