Simple Liberty  

 

     
   
     

The American Income Tax

Chapter 1

A Cry For An Income Tax — Introducing the Camel

Written by Darrell Anderson.

Man exists for his own sake and not to add a worker to the State.

Ralph Waldo Emerson, Self Reliance

The modern American income tax has a clouded and often mystical history. As with most taxes, people have been resenting and resisting this tax for decades. Reasons vary from complexity; the progressive, graduated nature of the tax; excessive burdens, intrusiveness, the overwhelming time required to comply with the tax laws, and even constitutionality.

Most Americans today believe that the foundations of the modern income tax are rooted in the 16th Amendment of the Constitution. Although income taxation in the United States precedes that well known event of 1913, the modern income tax swirls around this pivotal period in American history.

Reading the history of the 16th Amendment should convince most researchers that legislators and the typical common person of the period wanted to tax business net income and individual unearned income. Many people in that period wanted to tax profits from organized business activities (incorporated or unincorporated) and from certain forms of renting and selling, and gains derived from passive unearned sources such as monetary investments. Often the terms income and net income were synonymous and often the words gains, profits, and income were used concurrently to convey the same idea. The goal was to tax wealth created from capital investments and monetary gains from similar investments. The agenda of the day was very much “soak the rich.”

There were two noteworthy reasons why people wanted to tax organized business profits and certain unearned monetary gains. First, this is the period of Mark Twain’s Gilded Age. As described in the novel of the same name, this was a period of growing financial speculation, visions, corruption, political manipulation, lobbying, graft, railroads, oil, high society, growing cynicism, hypocrisy, and exaggerated self-appointed importance. This was the age of the legal fictions of trusts and corporations becoming popular; the age of the Rockefellers, Carnegies, and Morgans. These people, a significantly small number, were experiencing a life of wealth never before seen in human history. The concentration of wealth was disproportionately concentrated in these few people and families.[1] Between 1890 and 1910 less than 2 percent of the people had amassed almost 20 percent of the annual income.[2] Many people, through the legal fictions of corporations and trusts, were experiencing the benefits of political protection and privilege but paying little if anything for those protections and privileges.[3]

Second, because the protective tariff was the primary method for collecting taxes, many common workers experienced the impact most because those additional costs were passed to the consumer. Congressional legislators created revenues through land sales and domestic excise taxes, but those methods did not possess an impact on the common worker as did the protective tariffs. The well-to-do and rich could afford to pay this embedded cost of living. Although the wealthy paid more in tariff taxes than common workers simply because they could afford to buy more, the common worker struggled to make ends meet and many people viewed the tax system as inequitable and distorting.[4]

This also is an era complicated by an approximate one-third increase in the cost of living from 1897 to 1913.[5] This was not a unique problem to Americans, but experienced world-wide.[6] A significant reason for this trend was the commercial development at the end of the 19th century of the cyanide extraction process for mining gold, which during this period doubled the global gold production. The cost of mining gold dropped considerably, and coupled with the influx of gold from the Alaska Gold Rush, helped cause an inflation of gold into circulation as currency. Regardless, many people continually blamed the protective tariff for the rise in prices.[7] Reductionism still dominated the way many people tried to analyze complex systems, and through such a process many people tended to focus on single issues as causes rather than multiple issues. The more credible analytical approach of systems theory would not become popular for several more decades.

Many people sought a tax system that would be more predictable, productive, and equitable, spread the load, and help reduce the burden of taxation then obtained through excises and tariffs.[8] Yet, much of this new wealthy class invested in personal property, stocks, bonds, bank accounts, etc. The common worker had only his or her basic skills and labor to invest. The wealthy paid taxes, but when compared to the common worker, had far more disposable income. The issue seemed to be not that the rich were paying fewer taxes than common workers, but that many people simply wanted the wealthy to pay more. The wealthy were already paying more taxes simply because they could and did consume more. The real issue was that the common worker generated his or her income from sweat and toil whereas the wealthy created a revenue stream from passive investments. Most of those passive investments and great wealth often were derived from political privilege. Although jealousy seemed to play a role in the call for an income tax, political privilege also played a role. Said Michigan Representative George Richardson:[9]

I favor the income tax because it is asking a contribution of those citizens of the country who have accumulated great wealth and enjoy large incomes by reason of special privileges afforded by legislation.

The class battle that was growing at that time was not, as some people argue so simply, between “capital” and “labor,” but between people who possessed the political advantage of obtaining the means to capitalize their ventures and those who didn’t. Americans were transitioning rapidly from a predominantly agrarian culture to a highly industrialized society.[10] Through industrialization this was a period where many people were shifting from self-sufficiency to significant dependency upon others. This dependency through trade and exchange for the basic needs and necessities of life was a primary cause of friction for opposing protective tariffs.

There were many bumps and bruises along the way. This is an era when Americans began to think differently about their social and legal system, particularly by trying to treat law in a more scientific and efficient manner. Many people embraced the idea that humans could create perfect, efficient, and self-executing laws. Many people were pushing for codification of common law and simplifying court rules. Statutory law was becoming more important as administrative agencies and political regulation played a more important role.[11] Industrialization was thriving like no other period in human history. This also is an era when the remnants of the generation who lived through the War Among the States were dying and being replaced by the younger generations. Ideas and worldviews were clashing in many ways. This transition affected how Americans thought and acted, and the political and legal arenas were no exception. Words and terms changed meaning during this time. Understanding these transitions help understand the modern income tax.

The written history reveals that the intent of people in pursuing the 16th Amendment was to tax organized business profits and certain gains of the wealthy, and not the wages and salaries of the common worker. In that era of “big business” and trusts, the primary goal of many people was to tax the conversion of capital assets, both directly or indirectly. The goal was not to tax common workers, but to eliminate the political atmosphere of privilege.[12] The goal was to provide tax relief to common workers, tradespeople, and artisans. Two guiding principles in that day were 1) “the ability to pay” and 2) “from whatever source derived.”[13]

The shift away from self-sufficiency toward greater dependency upon others and a greater dependency upon a monetary exchange system gave new life to the “ability to pay” concept. By shifting some of the tax burden away from the protective tariff to an income tax primarily affecting the wealthy, protective tariffs arguably could be reduced. Of course, in reality this seldom happens because the wealthy business owners and managers merely pass the cost of the income tax to consumers in the nature of higher prices in order to recover that particular cost of business. Yet, there was a prevailing attitude at that time that the existing tax system failed to reach the great fortunes being amassed from rapid industrialization and that stocks, bonds, and dividends ought to be taxed.[14] The proposed income tax amendment was sold as a scheme to tax the rich. The great debate was between a tax on incomes and taxes on consumption. Any tax levied was believed and sold as falling only upon the top 3 to 5 percent of the population.[15] Thus, many argued, there was no reason for the common worker to fear this proposal.

Legislators had learned how to tax the profits derived from corporate activities when they enacted the Corporate Excise Tax of 1909.[16] Legislators labeled the tax an excise tax levied on the act of doing business in corporate form. In addition to the political and social climate of the period with people desiring to tax “big business,” as a “creature of the state,” corporations were a prime target for taxation. The tax was not levied directly on incomes, but measured by the net income or profit of the corporation. The 1909 tax rate was a whopping 1 percent of net income, but only on those profits in excess of $5,000. This was the first peacetime tax that did not fall directly upon what economist Edwin R. A. Seligman called “things that men eat and wear.”[17]

Legislators previously tried in 1894 to tax individual profits and gains of the wealthy. The revenue act of 1894 included wages and salaries in calculating total receipts.[18] Through the 1894 act, legislators had imposed a flat 2 percent tax on corporate and individual incomes in excess of $4,000. There were no graduated rates — just the one flat 2 percent rate and only on net profits and gains. Income in the form of gifts and inheritances were considered potential net gains. Unlike the 1913 income tax, the 1894 act was not a wealth redistribution effort or a class tax but a revenue reform effort. But legislators were stymied by the Supreme Court justices in Pollock v. Farmers’ Loan and Trust Company.[19] To avoid the rule of law derived in Pollock, which treated taxes imposed on certain types of income as a direct tax subject to apportionment, and after being encouraged by the Pollock justices, many people and legislators began to push for a constitutional amendment to more easily tax incomes. Many people of the times believed that a constitutional amendment was the only way to tax the gains, profits, and incomes derived by wealthy individuals and “big business” while avoiding the Pollock rule. Taxing gifts and inheritances, as well as the wages and salaries of the wealthy was a goal, but at no time was there any noticeable discussion or desire in taxing the wages and salaries of the common worker. Indeed, similar to the 1909 $5,000 exemption threshold for the corporation tax, the hefty $4,000 exemption — approximately 3 to 6 times greater than the typical annual salary — indicated a desire to avoid such taxation.

The original promises of the 16th Amendment affecting only the rich seemed fulfilled after enacting the first modern income tax act in 1913. While the most affluent 5 percent of the people received only 17 percent of the total wages and salaries, they received 79 percent of all income derived from dividends, 53 percent from interest, and one-third from rents. The 97 percent who failed to receive at least $3,000 annually received less than 1 percent of the unearned income being received.[20] After the income tax act was law, nearly 80 percent of the tax returns filed were from people engaged in business. Most of that number were bankers, brokers, manufacturers, merchants, or corporate officials. As a group, these people accounted for 85 percent of the income reported and almost 90 percent of the taxes paid.[21]

This long-term debate was one of the top issues of that era and should not be underestimated. Both proponents and opponents argued and fought bitterly about the issue. That the problem required several decades to resolve, or the equivalent of at least one generation, is evidence of the challenge and emotions involved for both sides. Taking time to understand the history and background of the modern income tax helps explain why so many people today still oppose this tax and explains why this tax is so confusing to understand.

Finis.

Terms of Use

Next: Chapter 2: Definitions — Approaching the Camel

Table of Contents

Bibliography

Endnotes

[1] Johnson, The United States Since 1865, pp. 209–210.

[2] Carson, “The Income Tax and How It Grew,” http://www.americanheritage.com.

[3] Wilson, “The Income Tax on Corporations,” p. 7.

[4] Crane, “The Income Tax and the Burden of Perfection,” p. 180.

[5] Ekirch, “The Sixteenth Amendment,” p. 172.

[6] Buenker, “The Ratification of the Income Tax Amendment,” p. 186.

[7] Buenker, “The Ratification of the Income Tax Amendment,” p. 186, citing Studenski and Krooss, Financial History, pp. 270–271.

[8] Buenker, “The Ratification of the Income Tax Amendment,” p. 183.

[9] Jensen, “The Taxing Power, the Sixteenth Amendment, and the Meaning of ‘Incomes’,” citing Congressional Record, 53rd Congress Session II, app. 271, Jan. 31, 1894.

[10] Buenker, “The Ratification of the Income Tax Amendment,” p. 183.

[11] Howard, The Death of Common Sense, pp. 24–26.

[12] Johnson, The United States Since 1865, p. 246.

[13] Buenker, “The Ratification of the Income Tax Amendment,” p. 183.

[14] Buenker, “The Ratification of the Income Tax Amendment,” pp. 183, 185.

[15] Buenker, “The Ratification of the Income Tax Amendment,” p. 183.

[16] Volume 36 Statutes at Large, 61st Congress Session I, Chapter 6, section 38, p. 112, enacted August 5, 1909.

[17] Buenker, “The Ratification of the Income Tax Amendment,” p. 185, citing E. R. A. Seligman, The Income Tax, (New York: Macmillan, 1911), p. 498.

[18] Volume 28 Statutes at Large, 53rd Congress Session II, Chapter 349, sections 27–36, pp. 509, 553–560, enacted August 27, 1894.

[19] 157 U.S. 429 (1895), 158 U.S. 601 (1895). The case was reheard because in the original hearing one of the judges was ill and the final vote was 4–4.

[20] Buenker, “The Ratification of the Income Tax Amendment,” p. 185.

[21] Buenker, “The Ratification of the Income Tax Amendment,” p. 188.