A Brief History of Taxes in the United States

Estimate Read Time: 5 minutes

Key Takeaways:

• In the US, the tax system that we have today is roughly one hundred years old, with income and capital gains taxes established in 1913.
• The payroll tax, known as the Federal Insurance Contributions Act (FICA), followed in 1935 as part of the establishment of Social Security.

Although the US’s current system of taxation is only about a hundred years old, taxes of varying types have been utilized globally for thousands of years. There is truth to Ben Franklin’s adage: “in this world nothing can be said to be certain, except death and taxes.”

While Fisher Investments monitors tax policies as a potential driver of market returns, in this article we’ll look at taxes simply from a historical perspective.

Taxation, an Age-Old Nuisance

Taxes have been around for a very long time and in some ways they haven’t  changed much: They’re about collecting revenue for a society’s governing body, typically with the intent of providing some benefit to that society.

A Little Tax History

The story of taxes in America began while the territory was still a British colony. Outrage and protests over tariffs helped drive the American Revolution and independence from Great Britain. Tariffs continued to be the largest source of federal revenue until World War I. In the late 19^th century, America temporarily imposed an income tax to help fund the Civil War. Early in the 20^th century, Congress also came up with a federal estate tax, capital gains tax, and in 1935, the payroll tax.

Tariffs

Why did Britain’s Stamp Act (1765), Sugar Act (1764), and Tea Act (1773)—all tariffs—enrage colonists to the point of overthrowing their British rulers? It probably wasn’t the costs themselves, but the colonists’ lack of political power. “No taxation without representation” was their fighting slogan.^[i]

Income Tax

The first tax on income—the Revenue Act of 1861—was imposed during the Civil War and repealed in 1872. It came back 22 years later as the Income Tax Act of 1894. This time, income received through interest, dividends and rents was taxable. The following year (Pollock v. Farmers’ Loan & Trust Co.), this federal tax was ruled unconstitutional as taxes weren’t evenly apportioned to states based on population. ^[ii]

In 1913, the Sixteenth Amendment to the US Constitution allowed Congress to impose an income tax without apportioning that tax among states based on population. This made the income tax permanent.

Over the years income tax rates have gone up and down:

• During World War I, the top marginal tax rate jumped from 15% (1916) to 77% (1918).^[iii]
• During the Great Depression in 1932, Congress raised the income tax from 25% to 63% for top earners.ⁱ
• In 1944 during World War II, income tax peaked at 94%.ⁱⁱⁱ
• From the 1950s through the 1970s, the income tax for top earners stayed above 70%.ⁱⁱⁱ
• In the 1980s, top earners saw their rates fall from as high as 70% down to 28%.ⁱⁱⁱ
• From the 1990s to the 2000s, the top tax rate rose to 39.6% and then fell to 35%.ⁱⁱⁱ

Capital Gains Tax

Along with the income tax, 1913 also saw the establishment of a capital gains tax. Capital gains refers to a profit from the sale of any capital asset (stock, bond, real estate, etc.). Today, capital gains are taxed in two categories: long-term capital gains, for assets held for over one year, and short-term capital gains, for assets held for less than a year. Short-term capital gains are taxed as ordinary income, while long-term capital gains are taxed at lower rates: 0%, 15% or 20% depending on your income.

Capital gains tax rates have also had their ups and downs. Here is a synopsis of capital gains’ tax history.

• From 1913 through 1934 capital gains tax jumped from 7% to 12.5%.^[iv]
• From the 1940s through 1979, these taxes ranged from 25% to 35%, depending on individual circumstance.^[v]
• From the 1980s to 2010, capital gains tax ranged from 15% to 35%.^v

Since 1998 capital gains tax rates have been keyed to tax brackets for ordinary income. For investors and retirees, capital gains tax rate may be lower than ordinary income tax rate. Keep in mind the difference between short-term and long-term capital gains.

Estate Tax

Adopted by Congress in 1916 and sometimes referred to as the “death tax,” estate tax is levied on the portion of an estate inherited by heirs. Taxes are applied to any portion of an estate that exceeds “exclusion limits.” This tax applies to assets transferred to heirs, and doesn’t apply to assets left to a surviving spouse. In 2018, the exclusion limit doubled to $11,180,000.^[vi]

Payroll Tax

Social Security, established in 1935 to provide benefits to the elderly, disabled, veterans and widows, included the Federal Insurance Contributions Act (FICA) tax to provide funding for Social Security and Medicare.

Employers and employees pay this tax, though their shares have varied through the years. Like every tax mentioned so far, payroll tax has undergone fluctuations, starting under 3% in 1935 and rising to over 15% in 2019 (depending on whether you file as an employer, employee or self-employed taxpayer).^[vii]

Tax rates have changed over time and they continue to change. Many taxpayers and investors are still getting used to the changes made by 2017’s Tax Cuts and Jobs Act (TCJA). And whether you’re happy or outraged by the latest changes to America’s tax code, it is always worth remembering the long history of tax policy.

^[i] Tindall, George Brown, and David Emory Shi. America: a Narrative History. Norton, 2018.

^[ii] Brownlee, W. Elliot. Federal Taxation in America: a Short History. Cambridge University Press, 2016.

^[iii] Federal Income Tax Rates History. Accessed 3/5/2019. https://files.taxfoundation.org/legacy/docs/fed_individual_rate_history_nominal.pdf

^[iv] Capital Gains Taxation. From the Encyclopedia of Taxation and Tax Policy. Accessed 3/5/2019. http://webarchive.urban.org/publications/1000519.html

^[v] How are capital gains taxed? Tax Policy Center. Accessed 3/5/2019. https://www.taxpolicycenter.org/briefing-book/how-are-capital-gains-taxed

^[vi] Estate Tax. Accessed 3/5/2019. https://www.irs.gov/businesses/small-businesses-self-employed/estate-tax

^[vii] Social Security and Medicare Withholding Rates. Accessed 3/5/2019. https://www.irs.gov/taxtopics/tc751