The federal income tax is a surprisingly recent innovation. The modern income tax was only introduced in 1913. From 1866 to 1893, the federal government ran surpluses, thanks to revenues from tariffs and excise taxes.
Republicans defended protective tariffs as a positive good. They claimed that a high tariff encouraged industrialization and urbanization, generated high wages and profits, and created a rich home market for farmers and manufacturers. Beginning in 1887, the Democrats, led by Grover Cleveland, argued that the tariff was a tax on consumers for the benefit of rich industrialists. They claimed that the tariff raised prices, encouraged foreign countries to retaliate against American farm exports, and encouraged the growth of economic trusts. In fact, there is little evidence that the tariff had much economic significance. Its major beneficiaries were the producers of raw material, especially sugar, wool, hides, and timber.
By the end of the 1890s, revenue from the tariff was declining (since the United States was mainly importing raw materials), as was revenue from federal land sales. Meanwhile, government spending was increasing. By 1905, the expanding U.S. Navy was receiving 20 percent of the federal budget. At the same time, Congress expanded pensions for Civil War veterans.
In 1894, the government ran the first deficit since the Civil War and enacted a short-lived income tax, which was declared unconstitutional in 1895. The Supreme Court ruled that it violated a constitutional provision that taxes had to be apportioned among the states. The court reached this decision even though it had earlier upheld an income tax levied during the Civil War.
In April 1909, Southern and Western congressmen sponsored another income tax bill, hopeful that the Supreme Court with a new membership might approve it. Their opponents responded by sponsoring a constitutional amendment that would authorize an income tax, which they thought could not be ratified by three-fourths of the states. Congress approved the amendment overwhelmingly. The Senate vote was 77 to 0 votes; the House vote was 318 to 14 votes.
By the end of 1911, a total of 31 states (including New York and Maryland as well as many Southern and Western states) had approved the amendment--five short of the required number to pass. It appeared that the amendment had failed since no previous amendment had taken so long to be ratified.
But during the 1912 election, Democrat Woodrow Wilson and third-party candidate Theodore Roosevelt rekindled support for the amendment. The amendment eventually passed and went into effect when Wyoming became the 36th state to ratify in February 1913.
The new federal income tax was modest and affected only about one-half of one percent of the population. It taxed personal income at one percent and exempted married couples earning less than $4,001. A graduated surtax, beginning on incomes of $20,000, rose to six percent on incomes of more than $500,000. The $4,000 exemption expressed Congress' conclusion that such a sum was necessary to "maintain an American family according to the American standard and send the children through college." It was about six times the average male's income. State officials were exempt from paying any taxes, as were federal judges and the president of the United States.
American involvement in World War I caused government expenditures to soar and international trade (and tariff revenues) to shrink. By 1919, the minimum taxable income had been reduced to $1,000, and the top tax rate was 77 percent. As late as 1939, only 3.9 million Americans had to file taxes. But just six years later, 42.6 million Americans filed. Tax withholding was introduced in congressional legislation in 1943. President Franklin Roosevelt vetoed this provision, but Congress overrode his veto.
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