DEBATE 10/15/08

The history of income taxation in the United States began in the 19th century with the imposition of income taxes to fund war efforts. However, the constitutionality of income taxation was widely held in doubt until 1913 with the ratification of the 16th Amendment.

Article I, Section 8, Clause 1 of the United States Constitution assigns Congress the power to impose "Taxes, Duties, Imposts and Excises," but Article I, Section 8 requires that, "Duties, Imposts and Excises shall be uniform throughout the United States."[12]

In addition, the Constitution specifically limited Congress' ability to impose direct taxes, by requiring it to distribute direct taxes in proportion to each state's census population. It was thought that head taxes and property taxes (slaves could be taxed as either or both) were likely to be abused, and that they bore no relation to the activities in which the federal government had a legitimate interest. The fourth clause of section 9 therefore specifies that, "No Capitation, or other direct, Tax shall be laid, unless in Proportion to the Census or enumeration herein before directed to be taken."

Taxation was also the subject of Federalist No. 33 penned secretly by the Federalist Alexander Hamilton under the pseudonym Publius. In it, he explains that the wording of the "Necessary and Proper" clause should serve as guidelines for the legislation of laws regarding taxation. The legislative branch is to be the judge, but any abuse of those powers of judging can be overturned by the people, whether as states or as a larger group.

The courts have generally held that direct taxes are limited to taxes on people (variously called "capitation", "poll tax" or "head tax") and property[13]. All other taxes are commonly referred to as "indirect taxes," because they tax an event, rather than a person or property per se.[14] What seemed to be a straightforward limitation on the power of the legislature based on the subject of the tax proved inexact and unclear when applied to an income tax, which can be arguably viewed either as a direct or an indirect tax.

In order to help pay for its war effort in the American Civil War, the United States government imposed its first personal income tax, on August 5, 1861, as part of the Revenue Act of 1861 (3% of all incomes over US $800; rescinded in 1872). Congress also enacted the Revenue Act of 1862, which levied a 3% tax on incomes above $600, rising to 5% for incomes above $10,000. Rates were raised in 1864. This income tax was repealed in 1872, but a new income tax statute was enacted as part of the 1894 Tariff Act.[15]

At that time, the United States Constitution specified that Congress could impose a "direct" tax only if the law apportioned that tax among the states according to each state's census population.[16]

In 1895, the United States Supreme Court ruled, in Pollock v. Farmers' Loan & Trust Co., that taxes on rents from real estate, on interest income from personal property and other income from personal property (which includes dividend income) were direct taxes on property and therefore had to be apportioned. Since apportionment of income taxes is impractical, the Pollock rulings had the effect of prohibiting a federal tax on income from property. Due to the political difficulties of taxing individual wages without taxing income from property, a federal income tax was impractical from the time of the Pollock decision until the time of ratification of the Sixteenth Amendment (below).

Amendment XVI in the National Archives

In response to the Supreme Court decision in the Pollock case, Congress proposed the Sixteenth Amendment, which was ratified in 1913,[17] 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.

The Supreme Court in Brushaber v. Union Pacific Railroad, 240 U.S. 1 (1916), indicated that the Sixteenth Amendment did not expand the federal government's existing power to tax income (meaning profit or gain from any source) but rather removed the possibility of classifying an income tax as a direct tax on the basis of the source of the income. The Amendment removed the need for the income tax on interest, dividends and rents to be apportioned among the states on the basis of population. Income taxes are required, however, to abide by the law of geographical uniformity.

A comedic representation by Clifford K. Berryman of the debate to introduce a sales tax in the United States in 1933 and end the income tax

Congress enacted an income tax in October 1913 as part of the Revenue Act of 1913, levying a 1% tax on net personal incomes above $3,000, with a 6% surtax on incomes above $500,000. By 1918, the top rate of the income tax was increased to 77% (on income over $1,000,000) to finance World War I. The top marginal tax rate was reduced to 58% in 1922, to 25% in 1925 and finally to 24% in 1929. In 1932 the top marginal tax rate was increased to 63% during the Great Depression and steadily increased, reaching 94% (on all income over $200,000) in 1945. Top marginal tax rates stayed near or above 90% until 1964 when the top marginal tax rate was lowered to 70%. The top marginal tax rate was lowered to 50% in 1982 and eventually to 28% in 1988. During World War II, Congress introduced payroll withholding and quarterly tax payments.

At first the income tax was incrementally expanded by the Congress of the United States. Inflation automatically raised many persons into tax brackets formerly reserved for the wealthy until Congress began adjusting the income tax brackets for inflation. Income tax now applies to almost ⅔ of the population [1]. The lowest earning workers, especially those with dependents, pay no income taxes as a group and actually get a small subsidy from the federal government because of child credits and the Earned Income Tax Credit.

The federal government is now financed primarily by personal and corporate income taxes. While the government was originally funded via tariffs upon imported goods, tariffs now represent only a minor portion of federal revenues. Non-tax fees are generated to recompense agencies for services or to fill specific trust funds such as the fee placed upon airline tickets for airport expansion and air traffic control. Often the receipts intended to be placed in "trust" funds are used for other purposes, with the government posting an IOU ('I owe you') in the form of a federal bond or other accounting instrument, then spending the money on unrelated current expenditures.

Net long-term capital gains as well as certain types of qualified dividend income are taxed preferentially. The federal government collects several specific taxes in addition to the general income tax. Social Security and Medicare are large social support programs which are funded by taxes on personal earned income (see below).

Tax statutes passed after the ratification of the Sixteenth Amendment in 1913 are sometimes referred to as the "modern" tax statutes. Hundreds of Congressional acts have been passed since 1913, as well as several codifications (i.e., topical reorganizations) of the statutes (see Codification).

The modern interpretation of the Sixteenth Amendment taxation power can be found in Commissioner v. Glenshaw Glass Co. 348 U.S. 426 (1955). In that case, a taxpayer had received an award of punitive damages from a competitor, and sought to avoid paying taxes on that award. The Court observed that Congress, in imposing the income tax, had defined income to include:

gains, profits, and income derived from salaries, wages, or compensation for personal service . . . of whatever kind and in whatever form paid, or from professions, vocations, trades, businesses, commerce, or sales, or dealings in property, whether real or personal, growing out of the ownership or use of or interest in such property; also from interest, rent, dividends, securities, or the transaction of any business carried on for gain or profit, or gains or profits and income derived from any source whatever.[18]

The Court held that "this language was used by Congress to exert in this field the full measure of its taxing power", id., and that "the Court has given a liberal construction to this broad phraseology in recognition of the intention of Congress to tax all gains except those specifically exempted."[19]

The Court then enunciated what is now understood by Congress and the Courts to be the definition of taxable income, "instances of undeniable accessions to wealth, clearly realized, and over which the taxpayers have complete dominion." Id. at 431. The defendant in that case suggested that a 1954 rewording of the tax code had limited the income that could be taxed, a position which the Court rejected, stating:

The definition of gross income has been simplified, but no effect upon its present broad scope was intended. Certainly punitive damages cannot reasonably be classified as gifts, nor do they come under any other exemption provision in the Code. We would do violence to the plain meaning of the statute and restrict a clear legislative attempt to bring the taxing power to bear upon all receipts constitutionally taxable were we to say that the payments in question here are not gross income.[20]

In Conner v. United States[21], a couple had lost their home to a fire, and had received compensation for their loss from the insurance company, partly in the form of hotel costs reimbursed. The court acknowledged the authority of the IRS to assess taxes on all forms of payment, but did not permit taxation on the compensation provided by the insurance company, because unlike a wage or a sale of goods at a profit, this was not a gain. As the court noted, "Congress has taxed income, not compensation".[22] By contrast, at least two other Federal courts have indicated that Congress may constitutionally tax an item as "income," regardless of whether that item is in fact income. See Penn Mutual Indemnity Co. v. Commissioner[23] and Murphy v. Internal Revenue Serv.[24]