History of Taxation in the United States

Tax season is just around the corner, and no other name incites more fear in people's hearts than that of the Internal Revenue Service. America has long been funded by its citizen's hard earned tax dollars. It has been the main source of funding for several wars and government-funded programs. Taxes affect every person, business, and property. This environment of constant change is a challenge for most accountants or anyone for that matter. This paper seeks to explore the history of the Federal Income Tax System, the Internal Revenue Code, the Internal Revenue Service, and guidelines and improvement of the tax system.

History of Taxation in the United States

The history of taxation in the United States commenced when the British, French and Spanish Empires ruled the individual colonies established in the US. This was back in the 1790's after World War I. After their independence from Europe, the taxation system continued by collection of poll taxes, tariffs, and excise taxes. There were various acts passed by parliament which imposed taxation of various items such as lead, paper, paint, glass, stamps, sugar, and tea as a means of tax collection. From these come the Sugar Act, the Stamp Act, and the Townshend Revenue Act. The Boston Tea Party was the insurgency against the British colonists by the American colonists to not pay the tea tax levied upon them.

Federal Government Income Tax History

The taxation system in the United States is governed by different levels of government. There are different methods of taxation as well. The tariffs imposed were the largest source of federal revenue from 1790 to the eve of World War I. This was the largest source of income until the collection of income taxes. Congress adopted federal statutes imposing legal obligation to pay federal income taxes in 1861 and 1862 to pay for the Civil War. The law levied in 1862 stated that income over $800 was to pay 3%, above $10,000 was to pay 5%. These rates were raised in 1864. In 1872, this income tax was repealed and a new statute Wilson-Gorman Tariff Act was enacted in 1894 (Wikipedia.org, Taxation history of the United States). It was named by West Virginia's representative William L. Wilson and Maryland's Senator Arthur P. Gorman. This tariff act to some extent reduced the US tariff rates from the 1890 McKinley tariff and forced a 2% income tax to wages over $4,000. This meant that less than 10% of the households would have to pay anything. The purpose of the income tax was to supplement for lost revenues from reduced tariffs.

In Article I, Section 8, Clause 1 of the United States Constitution you will find that it assigns the United States Congress the power to impose "Taxes, Duties, Imposts and Excises" and but the article states it must be uniformed throughout the US. The United States Constitution limited Congress' ability to impose a direct tax only to the extent of the law apportioning the tax amongst each state according to their census population. This all changed when the United States Supreme Court ruled in 1895 in Pollock v. Farmer's Loan & Trust Co. case that taxes on the rents of real estate, interest income from personal property and other income from personal property were direct taxes on property therefore* ruling they had to be apportioned. Prior to the Pollack case Congress was prohibited from apportioning income taxes on property. "In response to the Supreme Court decision in the Pollock case, Congress proposed the Sixteenth Amendment, which was ratified in 1913,[15] and which states:

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." [Wikipedia.org, Taxation history of the United States (http://en.wikipedia.org/wiki/Taxation_history_of_the_United_States#Income_for_federal_government) ]

The Sixteenth Amendment only removed the classifying of income tax as a direct tax from the collection of income from the federal government's existing power. It also removed the collection of income tax from interest, dividends and rents that was apportioned amongst each state according to their census population. Many modifications were enacted by Congress on income tax levying taxes on personal incomes. Each time there was war, the rates would increase (Treasury.gov, United States Department of the Treasury, Fact sheets: Taxes, 2009). The highest rates were imposed during the Great Depression and reached as high as 94% in 1945. Congress introduced payroll withholding taxes and quarterly tax payments during World War II. Rates started to decline in 1964 reaching its lowest to 28% in 1988. It increased to 39.6% in 2000 and decreased again in 2003-2010 to 35%.

Modern Income Tax

Inflation caused people to get into tax brackets that were reserved primarily for the wealthy until Congress adjusted the tax brackets accordingly. Two thirds of today's populations pay income taxes. The lower earning groups pay little to no taxes and some get subsidies from the federal government with federal credits. Figure 2 chart below demonstrates historical table percentages of the sources of Federal Revenue for the United States government.

(The Tax Policy Briefing Group, Historical Percentage of Revenue by Source, 1934-2013, Author: Roberton Williams, Updated: April 22, 2009, http://www.taxpolicycenter.org/briefing-book/background/numbers/revenue.cfm)

The modern day federal government is financed by personal and corporate income taxes. Although the government was funded by tariffs originally, now in day, tariffs imposed on imported good only represent a minor portion of federal tax revenues. Qualified dividend income and net long term capital gains are other types of income taxes collected and taxed preferentially. Social Security and Medicare are also another source of tax revenue that the federal government imposes on personal earned incomes. Changes in the different taxes are reflected in the historical chart in Figure 2 above.

Americans were faced with a great dilemma prior to the Great Depression with economic problems to the working-class Americans. This is when the Federal Insurance Contributions Act (FICA) tax was imposed by the federal government known as payroll tax or employment tax. Both employees and employers fund this federal program that provides benefits to the working- class American [From Wikipedia, the free encyclopedia, Federal Insurance Contributions Act Tax). Social Security was introduced in 1930 to fix the three problems the federal government had with retirement, injury induced disability and congenital disability. And Medicare was introduced in 1960 to