A Brief Lesson on the History of Income Tax

The history of income tax in America is older than the nation itself. Taxation has evolved over time, moving from property to income, from individuals to businesses. So as tax season begins, we look back to our history and the competing views associated with the public purpose of acquiring private wealth.

The Colonial Era

While colonists were toasting to the health of King George III, their governments were collecting “faculty” taxes on property and some forms of income. Named after an old sense of the word, meaning “capabilities,” property was taxed on the income it produced (mostly from farming), not on its resale value, which was a later development.

As Plymouth Colony began taxing the sale of crops, other colonies quickly followed suit. Most relied on tax money for government spending until the Revolution. Property taxes were refocused on the value of the land, while states paid closer attention to other forms of income, such as bank dividends.

The Civil War

When the Civil War heightened financial demands on both the Union and the Confederacy, both governments turned to new taxes on income. According to The Civil War Trust, the Union began in 1862 with a 3 percent tax on incomes between $600 and $10,000, and a 5 percent tax on wages higher than that. The tax was later amended to a higher percentage to help pay for war efforts. The next year, the Confederacy also started taxing income, but at a lower percentage.

It was the U.S. Supreme Court’s ruling in 1895 that the federal income tax was unconstitutional (because it wasn’t apportioned by state populations), that led several states that didn’t have income taxes to finally adopt them. This was partly because the federal burden had been lifted and there was “untaxed income” lying around for the taking.

The Progressive Movement

The advent of the Progressive Movement at the turn of the century also had an impact on the history of income tax, as it spread the general belief that those who gained wealth had a moral obligation to share it with the less fortunate. Thus, higher percentages of income were demanded from those who could afford to pay more.

New techniques of mass production created many new industries, which allowed governments to tax their stock dividends as a new form of income. At the same time, tax codes were drafted to include withholding taxes well before they were due, taxing corporate income instead of capital assets, and creating centralized bureaucracies to administer the system instead of leaving it in the hands of local elected officials.

The 16th Amendment

When the United States adopted the 16th Amendment in 1913, federal, corporate, and personal income taxes were legalized. By the 1920s, many states had implemented income taxes on individuals and corporations. A resident’s full income, including interstate income earned, were taxed by their home states. However, attempts to tax nonresidents were generally rebuffed by the courts.

State income tax systems were expanded at the end of the Great Depression, leaving only nine states today that do not tax personal income: Alaska, Washington, Nevada, South Dakota, Texas, Wyoming, Florida, Tennessee and New Hampshire (although the latter two do tax dividend and interest income).

Today, while states with income taxes generally justify them as promoting public services, those without them are among the nation’s fastest-growing and most prosperous jurisdictions.

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