1. Financial Management Training Program
University of Liberia
Monrovia-Liberia
Course:
In partial fulfillment of the course requirements for (FIM 506)
Taxation
Assignment # 1
Semester:
2nd Semester, 2013/2014
Topic:
History of Federal Income Taxation
Presented to:
F. Edward Davies
Course Lecturer
Presented by:
Emmanuel S. Nanon
Student
ID#:
43837
Date:
Friday, January 17, 2014

2. TABLE OF CONTENT
I.
Abstract……………………………………………………………………… 3
II.
Introduction……………………………………………………………………4
III.
Legal Basis for authorization to levy taxation…………………………….5-6
a. US Constitution……………………………………………………….6
b. 1895 Tax Law………………………………………………………..6-10
c. 1913 16th Amendments……………………………………………. 10
IV.
US Tax Policy: 1913-1945…………………………………………………. 11
V.
US Tax Policy: 1954 – present……………………………………………. 11-13
VI.
Conclusion…………………………………………………………..………. 14
VII.
References………………………………………………………………….. 15
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3. Abstract
In the United States, a tax is imposed on income by the federal, most state, and many
local, governments. The income tax is determined by applying a tax rate, which may
increase as income increases, to taxable income as defined. This literature presents the
History of Federal Income Taxation in the United States of America taking into
consideration the legal basis for levying taxes by the American Government at different
points in time. The paper highlights various U.S. Tax policies, Tax laws as well as
amendments to those tax laws respectively. After reading this entire document, you are
going to understand how Federal Income Tax in America played very important roles in
the funding of wars in the early 19th century and how it has helped the country in its
development drive since the end of major wars including the two world wars
respectively.
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4. Introduction
The history of taxation in the United States begins with the colonial protest against
British taxation policy in the 1760s, leading to the American Revolution. The
independent nation collected taxes on imports ("tariffs"), whiskey, and (for a while) on
glass windows. The United States imposed income taxes briefly during the Civil War
and the 1890s, and on a permanent basis from 1913. 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. This paper has clearly outlined
the history of Taxation in the United States of America. Highlights of this paper include
the constitutional backing for the imposition of taxes by the American government,
amendments as well as U.S. Tax Policies. In the United States for an example, Taxable
income: is defined in a comprehensive manner in the Internal Revenue Code and
regulationsissued by the Department of Treasury and the Internal Revenue Service.
Taxable income is gross income as adjusted minus tax deductions. Most states and
localities follow this definition at least in part, though some make adjustments to
determine income taxed in that jurisdiction. At the end of this paper, readers will have a
cogent understanding of the Federal Income Taxation in the U.S.
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5. VIII.
Legal Basis for authorization to levy taxation
The first income tax suggested in the United States was during the War of 1812. The
idea for the tax was based on the British Tax Act of 1798. The British tax law applied
progressive rates to income. The British tax rates ranged from 0.833% on income
starting at £60 to 10% on income above £200. The tax proposal was developed in 1814.
Because the treaty of Ghent was signed in 1815, ending hostilities and the need for
additional revenue, the tax was never imposed in the United States.
In order to help pay for its war effort in the American Civil War, Congress imposed its
first personal income tax in 1861. It was part of the Revenue Act of 1861 (3% of all
incomes over US $800). This tax was repealed and replaced by another income tax in
1862.
In 1894, Democrats in Congress passed the Wilson-Gorman tariff, which imposed the
first peacetime income tax. The rate was 2% on income over $4000, which meant fewer
than 10% of households would pay any. The purpose of the income tax was to make up
for revenue that would be lost by tariff reductions.
In 1895 the United States Supreme Court, in its ruling in Pollock v. Farmers' Loan &
Trust Co., held a tax based on receipts from the use of property to be unconstitutional.
The Court held that taxes on rents from real estate, on interest income from personal
property and other income from personal property (which includes dividend income)
were treated as direct taxes on property, and therefore had to be apportioned (divided
among the states based on their populations). Since apportionment of income taxes is
impractical, this had the effect of prohibiting a federal tax on income from property.
However, the Court affirmed that the Constitution did not deny Congress the power to
impose a tax on real and personal property, and it affirmed that such would be a direct
tax. 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. Taxation was the subject of
Federalist No. 33 penned secretly by the Federalist Alexander Hamilton under the
pseudonymPublius. 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
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6. 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.
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. The courts have generally
held that direct taxes are limited to taxes on people (variously called "capitation", "poll
tax" or "head tax") and property. All other taxes are commonly referred to as "indirect
taxes".
d. US Constitution
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."
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."
e. 1895 Tax Law
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. To raise revenue to
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7. fund the Civil War, the income tax was introduced in the United States with the Revenue
Act of 1861. It was a flat tax of 3% on annual income above $800 (equal to $21,000 in
2013). The following year, this was replaced with a graduated tax of 3–5% on income
above $600 (equal to $14,000 in 2013) in the Revenue Act of 1862, which specified a
termination of income taxation in 1866. The Socialist Labor Party advocated a
graduated income tax in 1887. The Populist Party "demanded a graduated income tax"
in its 1892 platform. William Jennings Bryan, a Democrat who supported cooperation
with the Populists, was among those Congressional Democrats who advocated the
income tax law passed in 1894. As a three-time Democratic candidate for president,
Bryan advocated an income tax and wrote that advocacy into the Democrats' platform in
1908.
The provisions of the Wilson-Gorman Tariff Act of 1894 required that, for a five-year
period, any "gains, profits and incomes" in excess of $4,000 (equal to $108,000 in 2013)
would be taxed at 2%. So, in compliance with the Act, the New York-based Farmers'
Loan & Trust Company announced to its shareholders that it would not only pay the tax,
but also provide to the collector of internal revenue in the Department of the Treasury
the names of all people for whom the company was acting and thus were liable for
being taxed under the Act.Charles Pollock was a Massachusettscitizen who owned only
ten shares of stock in the Farmers' Loan & Trust Company. He sued the company to
prevent the company from paying the tax. Pollock lost in the lower courts but finally
appealed to the United States Supreme Court, which agreed to hear the case.Arguing
for the plaintiff Pollock was Joseph Choate, one of the most eminent Wall Street lawyers
of his day.
The Court handed down its decision on April 8, 1895, with Chief JusticeMelville Fuller
delivering the opinion of the Court. He ruled in Pollock's favor, stating that certain taxes
levied by the Wilson-Gorman Act, those imposed on income from property, were
unconstitutional. The Court treated the tax on income from property as a direct tax.
Under the provisions of the Constitution of the United States at that time, such direct
taxes were required to be imposed in proportion to states' population. The tax in
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8. question had not been apportioned and, therefore, was invalid. As Chief Justice Fuller
stated:
First. We adhere to the opinion already announced—that, taxes on real estate being
indisputably direct taxes, taxes on the rents or income of real estate are equally direct
taxes.
Second. We are of opinion that taxes on personal property, or on the income of
personal property, are likewise direct taxes.
Third. The tax imposed by sections 27 to 37, inclusive, of the act of 1894, so far as it
falls on the income of real estate, and of personal property, being a direct tax, within the
meaning of the constitution, and therefore unconstitutional and void, because not
apportioned according to representation, all those sections, constituting one entire
scheme of taxation, are necessarily invalid.
The decrees hereinbefore entered in this court will be vacated. The decrees below will
be reversed, and the cases remanded, with instructions to grant the relief prayed.
A separate holding by the Court in Pollock—that federal taxation of interest earned on
certain state bonds violated the doctrine of intergovernmental tax immunity—was
declared by the U.S. Supreme Court in 1988 to have been "effectively overruled by
subsequent case law".
The Supreme Court did not rule that all income taxes were direct taxes. Instead, the
Court held that although generally income taxes are indirect taxes (excises) authorized
by the United States Constitution in Article 1, Section 8, Clause 1, the taxes on interest,
dividends and rents under the 1894 Act had a profound effect on the underlying assets.
The Court ruled that the tax on dividends, interest and rent should be viewed as a direct
tax falling on the property itself rather than as an indirect tax. As direct taxes, these
taxes were required to follow the rule of apportionment found in Article 1, Section 2,
Clause 3.
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9. The rule of apportionment requires the amount of a direct tax collected to be divided by
the number of Representatives in the United States House of Representatives, the
quotient is then multiplied by the number of representatives each State has to determine
each State's share of the tax which it then needs to lay and collect through its own
taxing authority.
Congress has had the power to lay and collect an indirect tax on incomes (such as
wages and salaries) from the beginning of the American Government under the United
States Constitution of 1787. The purpose of the Sixteenth Amendment was to prevent
the tax on income from property, which Pollock had ruled was direct, from therefore
having to be apportioned. It achieved this by declaring that Congress could tax income
from any source without apportionment.
In his dissent to the Pollock decision, Justice Harlan stated:
When, therefore, this court adjudges, as it does now adjudge, that Congress cannot
impose a duty or tax upon personal property, or upon income arising either from rents of
real estate or from personal property, including invested personal property, bonds,
stocks, and investments of all kinds, except by apportioning the sum to be so raised
among the States according to population, it practically decides that, without an
amendment of the Constitution—two-thirds of both Houses of Congress and threefourths of the States concurring—such property and incomes can never be made to
contribute to the support of the national government.
In a nation where the Federal government was beginning its battle against monopolies
and trusts, where the great bulk of wealth was concentrated in the hands of a few, the
decision in Pollock was unpopular, much like the decision in United States v. E. C.
Knight Co., 156 U.S. 1 (1895) of the same year. The following year, the Democratic
Party, which had grabbed hold of the Populist movement, included an income tax plank
in its election platform.
Nebraska Republican Senator Norris Brown publicly decried the Court's decision, and
instead proposed specific language to remove the Pollock requirement that certain
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10. income taxes be apportioned among the states by population. The proposal was later
incorporated into the Sixteenth Amendment. Fourteen years would pass, however,
before the Amendment was finally passed by Congress in 1909. Upon ratification in
1913, the Amendment effectively made the Pollock decision moot, removing any
requirement that taxes on incomes derived from property be apportioned by population.
f. 1913 16th Amendments
In 1913, the 16th Amendment to the Constitution made the income tax a permanent
fixture in the U.S. tax system. The amendment gave Congress legal authority to tax
income and resulted in a revenue law that taxed incomes of both individuals and
corporations. The Sixteenth Amendment (ratified by the requisite number of states in
1913), states that:
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 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 to be
apportioned among the states on the basis of population. Income taxes are required,
however, to abide by the law of geographical uniformity.
In order to help pay for its war effort in the American Civil War, Congress imposed its
first personal income tax in 1861. It was 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.
A new income tax statute was enacted as part of the 1894 Tariff Act. 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.
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11. I.
US Tax Policy: 1913-1945
Following World War II tax increases, top marginal individual tax rates stayed near or
above 90%, and the effective tax rate at 70% for the highest incomes (few paid the top
rate), until 1964 when the top marginal tax rate was lowered to 70%. Kennedy explicitly
called for a top rate of 65 percent, but added that it should be set at 70 percent if certain
deductions weren't phased out at the top of the income scale. The top marginal tax rate
was lowered to 50% in 1982 and eventually to 28% in 1988. It slowly increased to
39.6% in 2000, then was reduced to 35% for the period 2003 through 2012. Corporate
tax rates were lowered from 48% to 46% in 1981 (PL 97-34), then to 34% in 1986 (PL
99-514), and increased to 35% in 1993.
IX.
US Tax Policy: 1954 – present
Congress re-adopted the income tax in 1916, 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.
During World War II, Congress introduced payroll withholding and quarterly tax
payments. In pursuit of equality (rather than revenue) President Franklin D. Roosevelt
proposed a 100% tax on all incomes over $25,000. When Congress did not enact that
proposal, Roosevelt issued an executive order attempting to achieve a similar result
through a salary cap on certain salaries in connection with contracts between the
private sector and the federal government. For tax years 1944 through 1951, the
highest marginal tax rate for individuals was 91%, increasing to 92% for 1952 and 1953,
and reverting to 91% for tax years 1954 through 1963.
For the 1964 tax year, the top marginal tax rate for individuals was lowered to 77%, and
then to 70% for tax years 1965 through 1981. In 1978 income brackets were adjusted
for inflation, so fewer people were taxed at high rates. The top marginal tax rate was
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12. lowered to 50% for tax years 1982 through 1986. Reagan undid 40% of his 1981 tax
cut, in 1983 he hiked gas and payroll taxes, and in 1984 he raised tax revenue by
closing loopholes for businesses. According to historian and domestic policy adviser
Bruce Bartlett, Reagan's 12 tax increases over the course of his presidency took back
half of the 1981 tax cut.
For tax year 1987, the highest marginal tax rate was 38.5% for individuals. It was
lowered to 28% in revenue neutral fashion, eliminating many loopholes and shelters,
along with in corporate taxes, (with a 33% "bubble rate") for tax years 1988 through
1990. Ultimately, the combination of base broadening and rate reduction raised revenue
equal to about 4% of existing tax revenue
For the 1991 and 1992 tax years, the top marginal rate was increased to 31% in a
budget deal President George H. W. Bush made with the Congress.
In 1993 the Clinton administration proposed and the Congress accepted (with no
Republican support) an increase in the top marginal rate to 39.6% for the 1993 tax year,
where it remained through tax year 2000.
In 2001, President George W. Bush proposed and the Congress accepted an eventual
lowering of the top marginal rate to 35%. However, this was done in stages: with a
highest marginal rate of 39.1% for 2001, then 38.6% for 2002 and finally 35% for years
2003 through 2010. This measure had a sunset provision and was scheduled to expire
for the 2011 tax year, when rates would have returned to those adopted during the
Clinton years unless Congress changed the law; Congress did so by passing the Tax
Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010, signed
by President Barack Obama on December 17, 2010.
At first the income tax was incrementally expanded by the Congress of the United
States, and then inflation automatically raised most persons into tax brackets formerly
reserved for the wealthy until income tax brackets were adjusted for inflation. Income
tax now applies to almost two-thirds of the population. The lowest earning workers,
especially those with dependents, pay no income taxes as a group and actually get a
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13. small subsidy from the federal government because of child credits and the Earned
Income Tax Credit.
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.
From 2003 through 2011, individuals were eligible for a reduced rate of federal income
tax on capital gains and qualifying dividends. The tax rate and some deductions are
different for individuals depending on filing status. Married individuals may compute tax
as a couple or separately. Single individuals may be eligible for reduced tax rates if they
are head of a household in which they live with a dependent.
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14. Conclusion
The federal, state, and local tax systems in the United States have been marked by
significant changes over the years in response to changing circumstances and changes
in the role of government. The types of taxes collected, their relative proportions, and
the magnitudes of the revenues collected are all far different than they were 50 or 100
years ago. Some of these changes are traceable to specific historical events, such as a
war or the passage of the 16th Amendment to the Constitution that granted the
Congress the power to levy a tax on personal income. Other changes were more
gradual, responding to changes in society, in our economy, and in the roles and
responsibilities that government has taken unto itself. As increasing numbers of U.S.
firms expand their operations across territorial boundaries, jurisdictional tax planning
becomes crucial. Managers must determine which tax systems result in favorable
business climates and which systems are inhospitable to foreign investors. They must
be aware of crucial differences between competing tax regimes and how those
differences can be exploited to the firm’s advantage.
The rate of tax at the federal level is graduated; that is, the tax rates of higher amounts
of income are higher than on lower amounts. Some states and localities impose an
income tax at a graduated rate, and some at a flat rate on all taxable income. Federal
tax rates in 2009 varied from 10% to 35%.
Income taxes are essential for the provision of basic social services for national
government.
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15. References:
I.
http://www.infoplease.com/ipa
II.
http://www.policyalmanac.org/economic/archive/tax_history.
III.
www.wikipedia.com
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