Financial History 141 Spring 2022 - Page 35

money in 1913 ), the top rate went to 15 % in 1916 , then jumped dramatically to 67 % in 1917 ( the year the United States entered the war ) and finally to 77 % in 1918 ( the year of the armistice ).
These martial matters are easily forgotten by the financially minded . Thoroughly modern French economist Thomas Piketty recently suggested that it was growing income inequality that drove the adoption of the income tax in the United States all those years ago . “ Between 1880 and 1910 ,” he wrote , “ while the concentration of industrial and financial wealth was gaining momentum in the United States and the country was threatening to become almost as unequal as old Europe , a powerful political movement in favor of an improved distribution in wealth was developing . This led to the creation of a federal tax on income in 1913 and on inheritances in 1916 .”
Not exactly . The 1913 income tax — at roughly 1 % for most high-income people and increasing to a mere 7 % only on very , very high incomes — wasn ’ t very re-distributional . Additionally , the inheritance tax of 1916 was not new , and the version passed in 1898 to finance the Spanish- American War was arguably stiffer
More importantly , the real drive to institute the 1913 income tax stemmed not from a desire to re-distribute income but to simply make up the revenue lost from a reduction in tariff rates . Woodrow Wilson scholar Kendrick Clements states flatly : “ Tariff reduction was Wilson ’ s first concern .” Wilson had campaigned in 1912 on the idea that tariffs had been “ a method of fostering special privilege ” and needed to be trimmed back or even eliminated . Wilson believed that import tariffs favored certain commercial interests — American sugar and wool producers were very visible beneficiaries — and corrupted members of Congress while unfairly raising prices to all American consumers .
Wilson succeeded , and tariff rates were reduced from roughly 40 % to around 25 %. The drop in tariff revenue was to be recouped with a modest income tax . Under the new income tax law passed in early October 1913 , a single taxpayer making $ 5,000 / year — a very comfortable income in 1913 — was asked to pay a 1 % tax on their income exceeding a $ 3,000
National Archives and Records Administration
The 16th Amendment to the United States Constitution , which allows Congress to levy an income tax without apportioning it among the states on the basis of population .
personal exemption , or a mere $ 20 that year .
It was the Revenue Act of 1917 , passed in October of 1917 as the US government was spending money hand-over-fist in prosecuting a war it had joined the previous April , that sent rates on higher incomes rocketing upwards : from 15 % to as high as 67 %. The increase was so dramatic that tax expert Roy Blakey worried at the time that taxpayers were “ not yet psychologically prepared to pay what they should .” ( Politicians later figured out that “ their fair share ” sounded better than “ what they should .”) The shock was greatest on high income earners , but even the $ 5,000 / year taxpayer would be asked to pay $ 240 — a 6 % rate on their income above a reduced $ 1,000 personal exemption — or a 12-fold increase on the amount owed in 1913 .
Another central fact of those years was the general inflation fueled by the war spending , which resulted in an increase in wages for most workers . This rise in wages is clearly visible in the treasury data : In 1913 , a $ 5,000 taxpayer would have been one of only about 400,000 American “ households ” required to file a return because not many Americans had yearly income greater than the personal exemptions of $ 3,000 for single people and $ 4,000 for what we today call “ joint filers .”
By 1918 , however , the number of such households required to file had increased more than 10-fold to over 4 million . The comfortable $ 5,000 / year taxpayer of 1913 would probably have been disappointed to earn no more in 1918 than in 1913 . Had that person ’ s income grown to , say , $ 8,000 in 1918 , the income tax would have risen to $ 630 — about 30 times the 1913 bill . Such a hypothetical may more accurately reflect the extent to which the burden of paying for the war was shared in ways not captured by the tax rate tables .
These same years reveal quite dramatically a little kernel of taxing wisdom that is with us , both substantively and rhetorically , to this day . It is seen in the behavior of those very wealthy taxpayers who were suddenly faced in October 1917 with 60 +% marginal rates and whose income derived principally from investments and not from wages . The capital of these very wealthy taxpayers was somewhat mobile , their income therefore somewhat flexible as to how it was generated , and in their behavior we see for the first time in US history the difficulty , the “ goose-hissing ,” of taxing income at extremely high marginal rates . And they were indeed high marginal rates : by 1918 the income of single persons exceeding $ 100,000 / year was taxed at 64 %, that over $ 300,000 / year at 75 %.
People subject to these 60 +% rates were undeniably wealthy . Legendary 1920s baseball player Babe Ruth made headlines when his wage income increased from $ 52,000 to $ 80,000 / year , a salary that readers of the sports pages in those days found almost stratospheric .
Instituting these extremely high marginal rates , however , resulted in a sharp drop in the number of returns declaring income subject to these rates . For example , there were some 1,296 tax returns that declared income of over $ 300,000 in 1916 when such income was taxed at 15 %. In 1918 , when such income was taxed at 71 – 77 % ( depending on filing status ), the number of such taxpayers declined by over half , to 627 .
The income tax was only five years old in 1918 , and these very high rates were newer still , so it is quite stunning to observe the speed with which the wealthy and their advisors reacted to these changes . Whether it was because they were not
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