Taxation - Business in United States of America
Definition: The imposition of charges on the property, income, or activities or citizens or corporations by a government to generate revenue
Significance: Throughout American history, taxation, either through tariffs, excise taxes, property taxes, sales taxes, or income taxes, has taken a large portion of business earnings. Corporations have lobbied legislatures for relief and hired experts to reduce those taxes.
The American colonists rebelled in 1776 because of taxation without representation. Following the rebellion, Americans discovered that even with representation, they did not much like taxes. The Whiskey Act of 1791 assessed an excise tax on the distilling of whiskey; this was the United States’ first internal tax at the federal level. It was promoted as a sin tax and served as the precedent for similar taxes. The objection to the tax, particularly in western Pennsylvania, was so great that a rebellion ensued and President George Washington led troops into the area to quash the insurgents. A 1794 law extended the excise tax to carriages, snuff, sugar, and salt. However, Thomas Jefferson formed a campaign around abolishing internal taxes during his successful presidential run in 1800. By 1802, all but the salt tax had been abolished. Nevertheless, the precedent had been established, and throughout the next two hundred years, Congress periodically introduced other types of luxury or sin taxes. Despite the nuisance excise taxes, the federal government acquired most of its financing during the nineteenth century from tariffs. At the state level, property taxes were the preferred form of raising government funds, although at one time or another almost every form of taxation was used at the state or colony level.
First National Taxes
The U.S. Congress passed the first national tariff law in 1789. From that date until passage of the Underwood Tariff Act of 1913, there were fifty-eight tariff laws. Tariffs provided revenues and protection for domestic companies. The 1789 Tariff Act created the first national tariff, but several states, including Massachusetts and Pennsylvania, had imposed tariffs before that date to protect industries in those states. The 1789 tariff imposed duties on imports such as tea and coffee. The tariff was intended as a revenue-raising measure, and tariff rates ran about 5 percent, with higher rates on luxury items.
The first attempt at a national income tax came in 1813, to fund the War of 1812. This tax was never instituted because the government paid the war debt with high tariffs after the war. This income tax measure did serve as a model for later income tax proposals, particularly the U.S. Civil War and 1894 income taxes. After 1812, tariffs helped the nation begin a transition from agriculture to industry. Although both the Union and the Confederacy had income taxes during the Civil War, these assessments did not apply to a large percentage of the populace. During the 1870’s, congressmen from agricultural states introduced fourteen bills proposing income tax legislation. Capitalists from northeastern states did not allow any congressional votes on these bills. Therefore, the modern era of taxation began in 1909 with the passage of the corporate excise tax and in 1913 with the passage of the Sixteenth Amendment to the U.S. Constitution.
A large body of research exists concerning the development of twentieth century American tax laws. These studies have explained the forces for and against income taxes as partly based on regional, occupational, and class differences. Congressmen from the northeastern section of the country opposed income taxes because their constituents were, on average, the wealthiest in the nation. Congressmen from the South and West preferred the income tax over tariffs because of the undue burden the tariffs placed on their constituents. For example, farmers opposed tariffs as economically detrimental to agriculture because tariffs forced up prices of farm inputs, such as machinery, without protecting farm crops. Farmers complained that prices for their crops fluctuated according to the world market, while input costs were set artificially high to put money in the hands of northeastern manufacturers. The objection to the tariff was based on the feeling that it was class legislation— that it taxed the farmer for the benefit of the manufacturer.
Taxes Collected by the Federal Government, 1990-2005, in Billions of Dollars
Source: Data from the Statistical Abstract of the United States, 2008 (Washington, D.C.: Department of Commerce, Economics and Statistics Administration, Bureau of the Census, Data User Services Division, 2008)
The Sixteenth Amendment
From 1900 to 1909, Congress debated the questions of tariffs and taxes. Federal income tax proposals abounded. Congressmen debated how to frame these proposals in accordance with the U.S. Constitution. Nelson Aldrich, of Rhode Island, chairman of the Senate Finance Committee, was strongly opposed to any income tax provision. Instead he designed a tariff bill that dramatically increased tariff rates. This move caused a severe backlash from Democrats and moderate Republicans. These congressmen lobbied heavily for an income tax. William Howard Taft, the Republican president, and Aldrich proposed submitting a constitutional amendment to the states that would provide Congress the power to levy income taxes. Aldrich did this as a compromise measure and in the hope that the move would ultimately fail, resulting in no income tax law. The Supreme Court had previously ruled that only states had the power to tax individual incomes, but few states had effectively imposed income taxes. Therefore, Republicans did not believe that the states would ratify a constitutional amendment allowing the federal government to tax individual incomes.
Congressmen from agricultural states continued to make income tax proposals in the years leading up to 1909, but all were blocked by Republicans. A division in the power of the Republican Party in 1909, however, provided an opportunity for passage of income tax legislation. Because of a compelling speech by Senator Elihu Root, Congress passed a corporate tax bill, but not an individual income tax bill.
After the elections of 1912, the Democrats held control of both houses of Congress. With this power and subsequent ratification of the Sixteenth Amendment by the needed majority of states in 1913, Democrats quickly submitted a federal income tax law. The first income tax was part of the Underwood Tariff Act of 1913. This income tax law also incorporated the corporate excise tax of 1909. From a American population of 100 million, only 368,000 filed tax returns for 1913. Exemptions were $3,000 for individuals and $4,000 for couples. The tax rates ranged from1 to 6 percent for income over $500,000. The less affluent did not have to file returns or pay income taxes. In total, the federal government collected about $35 million from the income tax in 1913. The number who were subject to taxation increased quickly, particularly as the nation entered World War I. The need for war financing lowered the exemption level and subjected a larger percentage of the population to the filing requirements. Income tax collections in 1918 were seven times greater than in the preceding year and increased more in 1919 and 1920, with the latter year’s collections being more than a hundred times greater than in 1913. Nevertheless, the percentage who had to pay taxes was still minimal until the outbreak of World War II.
With the entry into World War II, the U.S. government became desperate for financing. The defense expenditures alone for 1942 were double the level of federal revenues. To pay for these costs, Congress passed the Victory Tax, which made all income in excess of $624 annually subject to taxation. Moreover, with the passage of the Current Tax Payment Act of 1943, the Victory Tax was withheld from taxpayer wages, rather than letting taxpayers have until the end of the year to pay their taxes. This pay as-you-go basis was passed for two reasons. First, it was designed to meet the needs of wage earners who were accustomed to budgeting on a weekly or monthly basis. With more low-income wage earners on the tax rolls, a budgeting mechanism for taxpayers became important. Second, it allowed the Treasury Department to collect tax revenues at a time when the taxpayers had money. This is known as the wherewithal-to-pay concept of taxation. The greatest impact of World War II on taxation was to broaden the base of taxpayers. Before the war, only 4 million taxpayers filed returns. Almost overnight, that number increased tenfold. The new regime of mass taxation succeeded primarily because of the war effort. Taxpayers on the home front felt they were doing their part in winning the war.
The House Ways and Means Committee
Federal tax laws must originate in the House Ways and Means Committee. Therefore, that committee’s chair is a powerful figure in Congress, and no one was ever more powerful and more effective in that role than was Wilbur Mills of Arkansas, who served in Congress from 1938 to 1977. As chairman of the House Ways and Means Committee, Mills was extremely influential. The general view among congressmen was that Mills was a despot who ruled Congress by giving out favors to those who voted with him and dealing out punishments to those who voted against his views. Given this viewpoint, he was usually able to get tax bills passed without any amendments being added. The addition of floor amendments is often what turns general tax bills into loopholes for special-interest groups. Mills would not give special-interest groups an opportunity to get an amendment added to a bill. Alternatively, another view was that Mills developed a consensus before he would let a bill come to a vote. For example, former Congressman Barber B. Conable, Jr., stated that Mills would not let a bill out of his twenty-five-person committee unless he had at least twenty-three supporting votes. Following the demise of Mills, tax bills that passed did so because they offered tax benefits to everybody—not because they represented sound legislation. The result has been a complex mass of tax laws and a system lacking internal stability.
The greatest impact of Mills’s retirement was the effect that his absence from the House Ways and Means Committee had on U.S. income tax laws. Mills was known for carefully editing every tax bill to be sure that it meshed with existing tax laws. Basically, because of Mills, the Internal Revenue Code was well organized and internally consistent throughout his eighteen-year tenure as chair. Mills’s leadership provided a stabilizing influence on tax laws. However, once he left the chairmanship, his successors lacked either the ability or the motivation to monitor the tax laws. The retirement of Mills led to a loss of a clear source of order and constraint, which had the effect of opening up the tax agenda to special-interest groups. As a result, the tax laws soon became a hodgepodge of miscellaneous provisions that complicated life for taxpayers and tax preparers.
Brownlee, W. Elliot. Federal Taxation in America: A Short History. New York: Woodrow Wilson Center Press, 1996.Anexcellent history of American taxation with explanations of why the tax laws were passed and who influenced them.
Conable, Barber B. Congress and the Income Tax. Norman: University of Oklahoma Press, 1989. This book covers the detailed aspects of how Congress passed tax laws in the twentieth century.
Manley, John F. The Politics of Finance: The House Committee on Ways and Means. Boston: Little, Brown, 1970. This is an excellent history of how Congress works on tax legislation. An entire chapter is devoted to Wilbur Mills, whom the author called one of the “most influential committee chairmen in recent years, if not in history.”
Pechman, Joseph A. Federal Tax Policy. Washington, D.C.: Brookings Institution, 1987. A book widely used in college tax policy classes. Explains why tax bills were passed in the manner that they were.
Ratner, Sidney. American Taxation: Its History as a Social Force in Democracy. New York: W. W. Norton, 1942.Anexcellent history of the class struggles in taxation politics.
Seligman, Edwin R. A. The Income Tax: A Study of the History, Theory, and Practice of Income Taxation at Home and Abroad. New York: Macmillan, 1914. A classic work on income taxation before the passage of the Sixteenth Amendment.
Zelizer, Julian E. Taxing America: Wilbur D. Mills, Congress, and the State, 1945-1975. New York: Cambridge University Press, 2000. This volume analyzes the work of Mills and provides insights into the evolution of income taxation, Social Security, and Medicare during Mills’s tenure as chairman.
See also: Bush tax cuts of 2001; government spending; corporate income tax; personal income tax; Federal monetary policy; Stamp Act of 1765; Tea Act of 1773; Whiskey tax of 1791.