HISTORY53 - Taxes Forever

I sometimes have trouble coming up with a new blog topic - something I want to know more about.  On April 18^th, it hit me, duh ….!  It’s taxes!  On Tax Day, I decided that I want to know more about taxes; you figure it out.  Anyway, this blog will cover the history of taxation.

 

After a short introduction, I’ll talk about taxes in ancient times, the Middle Ages, Colonial America, and then cover the history of the myriad of taxes in the United States, leading up to today.  I’ll close with a personal note on paying taxes.

My principal sources include “History of Taxes,” taxfoundation.org; “A Brief History of Taxes in the U.S.,” investopedia.com; “History of Taxation,” britannica.com; “A History of Revolution in U.S. Taxation,” visualcapitalist.com; “Tax” and “History of Taxation in the United States,” Wikipedia; and numerous other online sources.

Introduction

A tax is a compulsory financial charge or some other type of levy imposed on a taxpayer (an individual or legal entity) by a governmental organization in order to fund government spending and various public expenditures (regional, local, or national).

Taxes consist of direct (like income or property) or indirect (like sales) taxes.

Most countries of the world have a tax system in place, in order to pay for public, common, or agreed national needs, and for the functions of government. Some levy a flat percentage rate of taxation on personal annual income, but most income taxes are progressive, based on brackets of annual income amounts.  Most countries charge a tax on an individual's income as well as on corporate income.  Countries or subunits often also impose wealth taxes, inheritance taxes, estate taxes, gift taxes, property taxes, sales taxes, use taxes, payroll taxes, and duties and/or tariffs.

Total revenue from direct and indirect taxes by the countries of the world as a share of GDP, 2017.

  

In economic terms, taxation transfers wealth from households or businesses to the government.  This has effects that can both increase and reduce economic growth and economic welfare.  Consequently, taxation is a highly debated topic.

Ancient Times

Today’s tax codes are extensive and ever-changing, but many of the basic tax types that governments depend on today have been around since early civilization.

About 5,000 years ago, we see the first record of taxation in ancient Egypt, where the Pharaoh collected a tax equivalent to 20% of all grain harvests.  At the time, Egypt was without coined money, so grain represented a tangible store of value that could easily be collected, traded, and redistributed throughout society.

Fun Fact:  The Rosetta Stone - one of the most famous artifacts in archeology – was inscribed in Egypt in 196 BC to secure tax-exempt status for temples.  The stone says the same thing in three languages:  Greek, Egyptian hieroglyphics, and a third Egyptian script called demotic, and was the key to unlocking the mystery of hieroglyphics.  Archeologists used the artifact to understand the countless other Egyptian writings (especially tax documents) that have survived into the present day.  The Rosetta Stone is why we know so much about ancient Egypt.

The tax-policy oriented Rosetta Stone enabled archeologists to decipher Egyptian hieroglyphics.

  

Tariffs have been dated to the 3000s BC on trade of metal and wool between the ancient city of Kanesh in Anatolia (modern-day Turkey) and Assyria (in modern-day Iraq). 

Property taxes were levied in Ancient Egypt, Persia, and China.  Originally, these taxes were based on the production value of the land, or how much the plot was expected to yield in goods, and therefore were typically paid by farmers. 

Ancient Greece, employed a wealth tax on the very rich, but it was levied only when needed - usually in times of war.  Large fortunes were also subject to taxes to support public works.  Taxes were levied on houses, slaves, herds and flocks, wines, and hay, among other things.  

In Ancient Rome, Julius Caesar was the first to implement a sales tax: a 1% flat rate that was applied across the entire Empire.  Under Caesar Augustus, the sales tax was 4%, closer to a rate we see today in many U.S. state sales taxes.  This sales tax proved difficult to operate, and Augustus switched to a direct income tax system.

Depiction of tax collection in the Roman Empire.

 

Inheritance taxes also originated in the Roman Empire, and funded the pensions of military veterans, levied at a rate of 5% on inherited property.

The Roman Empire also levied tariffs, both on goods traded within the Empire, and imported from outside.  Foreign goods were taxed at five to 25 times the rate of internal trades. 

As a means of raising additional funds in time of war, Romans temporarily imposed taxes on property.  Real estate transactions also were taxed.

In Greece free citizens had different tax obligations from slaves, and the tax laws of the Roman Empire distinguished between nationals and residents of conquered territories.

Middle Ages

People have always disliked the idea of paying taxes.  This was especially true in the Middle Ages when most people had little “say” in how taxes should be spent.

In the early Middle Ages, many of the ancient taxes, especially the direct levies, gave way to a variety of obligatory services and a system of “aids,” where taxes were paid by persons or communities to someone in authority.  Aids could be demanded by the crown from its subjects, by a feudal lord from his vassals, or by the lord of a manor from the inhabitants of his domain.

The idea that people should pay a tax called a tithe (10% of the annual produce of land or labor) to support their local minister and parish church was established in the 8^th century.

Middle Ages taxation was based on the ownership of land.  Property taxes continued in Medieval Europe under William the Conqueror in England.  By legend, in the 11^th century, Lady Godiva famously rode naked on a horse through the city streets in protest of the property tax rate her husband was forced to pay.

 

Lady Godiva protesting tax policy in 11^thcentury England.  Painting by John Collier, c. 1897.

 

By the 13^th century, many people had become rich from trade rather than from land.  As these wealthy merchants did not own a great deal of land, kings began to impose taxes on trade, for example on every sack of wool that was exported to other countries.

Taxes were also imposed on personal property, like gold and jewels.  People had to have their property valued by tax officials.  They then had to pay a percentage of it (usually about 10%) to the king.

The revenues from the traditional sources of taxation declined in later medieval England, so in 1377 England instituted a poll tax, a flat-rate tax for all individuals.  By 1381, the unpopularity of these taxes had contributed to a peasants’ revolt.

During the later Middle Ages, some German and Italian cities introduced several direct taxes: head taxes for the poor and net-worth taxes or, occasionally, crude income taxes for the rich.  (The income tax was administered through self-assessment and an oath taken before a civic commission.)  Taxes on land and on houses gradually increased.

The vast majority of Medieval taxes went to military spending. This meant that during wars, taxes were often increased.  People were usually willing to pay these taxes if they believed they would benefit in some way, for example, English farmers being defended from French raiders or traders having their exports protected from enemy ships.

Colonial America

Tax burdens imposed by Great Britain on Colonial America were incredibly light, far lighter than in England, and woefully insufficient to cover the costs of colonial administration.

When the Revolutionary War began, the individual colonies had well-developed tax systems that made a war against the world’s leading military power at least thinkable.  The tax structure varied from colony to colony, but five kinds of taxes were widely used.  Poll taxes were levied at a fixed rate on all adult males and sometimes on slaves.  Property taxes were levied on land - sometimes by total acreage and sometimes by value, the value of houses, the number of swine and sheep, and the value of mills.  Taxes were levied on the earning capacity of persons following certain trades or having certain skills.  Tariffs were levied on goods imported or exported, and excises were levied on consumption goods, especially liquor.  Tobacco taxation funded the plantation economies of Virginia and Maryland.  British subsidies limited the need for taxation in Georgia, the charity colony for debtors.

The tax problem that the American colonies had with Great Britain was not that taxes were too high, but that they were arbitrary, occasionally capricious and punitive, and most importantly, adopted without the consent of the governed.  The American colonists were not represented in the British Parliament.

In Colonial America, there were no income taxes, no corporate taxes, and no payroll taxes.  Taxes primarily existed on imports of goods and services to the colonies, as well as on the sale of particular products.

Tariffs were levied on ships on a per-tonnage basis, slaves, tobacco, and alcoholic beverages.  In all, the average tariff worked out to about 10 percent of the value of imports, with lower rates being imposed on goods from Britain than from elsewhere. 

While American governments were faring well financially, the British government faced debt from many wars worldwide.  This led to the British government turning to the American colonies for additional revenue, and the beginning of the tax struggle we are familiar with that led to the American Revolution.

In 1764, Parliament passed the Sugar Act, imposing a tax on imports to America of molasses and refined sugar.  The Sugar Act also prohibited the importation of all foreign rum.

The Stamp Act of 1765 required all legal documents, permits, commercial contracts, newspapers, wills, pamphlets, and playing cards in the American colonies to carry a tax stamp.  The objective of the stamp tax was to defray the cost of maintaining the military presence protecting the colonies.  Americans rose in strong protest, arguing in terms of "No Taxation without Representation.”   Boycotts forced Britain to repeal the stamp tax, while convincing many British leaders that it was essential to tax the colonists on something to demonstrate the sovereignty of Parliament.

The Townshend Revenue Act were two tax laws passed by Parliament in 1767.  They placed a tax on common products imported into the American Colonies, such as lead, paper, paint, glass, and tea.  In contrast to the Stamp Act of 1765, the laws were not a direct tax that people paid daily, but a tax on imports that was collected from the ship's captain when he unloaded the cargo.  The Townshend Acts also created three new admiralty courts to try Americans who ignored the laws.

What is more, the Townshend Acts were used to pay the salaries of colonial governors and judges, a duty that previously belonged to the colonies, thus robbing the power of the purse from local governments. 

Colonials vehemently opposed these taxes and started a boycott of British goods.  In 1770, British troops occupied Boston to end the boycott, but on March 5^th, five colonists were killed in the Boston Massacre.  By April, all Townshend duties were repealed except for the one on tea.

In 1773, in the Tea Act, Britain granted the struggling British East India Company a monopoly on tea in America.  While no new taxes were imposed, this angered colonists as it was seen as a thinly veiled plan to gain colonial support for the Townshend tax while threatening local business.

On December 16, 1773, three ships arrived in Boston carrying British East India Company tea.  Colonists refused to allow the unloading of the tea, throwing all 342 chests of tea into Boston Harbor in the infamous Boston Tea Party.  Britain reacted harshly, and the conflict escalated to war in 1775.

 

Colonial protesters, dressed up as Indians, throw boxes of tea into Boston Harbor in the so-called Boston Tea Party, December 16, 1775.

During the American Revolution, On July 4, 1776, the 13 American colonies issued the United States Declaration of Independence, proclaiming themselves as thirteen independent sovereign states, no longer under British rule.  With the Declaration, these new states took a collective first step in forming the United States of America.  The “no taxation without representation” principle was central enough to the Revolution that it was enshrined in the list of grievances against King George III in the Declaration of Independence.

After eight long years, in 1783, Britain officially recognized the independence of the United States of America.

 United States

The issue of “taxation without representation” played a large role in the development of the American legislative system and is seen in Article I, Section 2 of the U.S. Constitution, which granted the elected representatives in Congress the exclusive power to impose taxes on all citizens. States were responsible for collecting taxes, and passing them on to the federal government

Early on, the United States primarily earned revenue from excise taxes - taxes imposed on specific goods or services, like alcohol and tobacco; estate taxes; and tariffs.

Sin Taxes.  The government started taxing tobacco and alcohol to pay back the debts it incurred during the Revolutionary War.  In 1791, Alexander Hamilton, the nation’s first Secretary of Treasury, led the implementation of whiskey and tobacco excise taxes. 

In 1794, whiskey rebels destroyed a tax inspector’s home.  President Washington had to sends in troops to quell the “Whiskey Rebellion.”

Tobacco and alcohol taxes came and went over the years, until 1864, when they were reinstated during the Civil War to provide additional revenue - and these excise taxes continue today.

Social purposes have also long influenced the taxation of these items, because of perceptions that they are harmful to health.  The higher the tax, the more likely Americans are to be discouraged from consuming tobacco and alcohol.

Because tobacco and alcohol taxes are built into the prices of these products, many Americans don't even know they're paying them

Estate and Gift Taxes.  The first estate tax was enacted in 1797 in order to fund the U.S. Navy.  It was repealed, but reinstituted over the years, often in response to the need to finance wars. 

At the beginning of the 20^th century, President Theodore Roosevelt advocated the application of a progressive inheritance tax on the federal level.  In 1916, Congress adopted the present federal estate tax, which taxes the wealth of a donor's estate upon transfer.

Later, Congress passed the Revenue Act of 1924, which imposed a gift tax - a tax on the transfer of valuable assets from one person to another.  Today, the gift tax rate ranges from 18% to 40%, depending on the value of the taxable gift.

In 1948, Congress allowed marital deductions for the estate and the gift tax.  In 1981, Congress expanded this deduction to an unlimited amount for gifts between spouses.

Tariffs.  Tariffs were considered essential and easy to collect at the major ports, and became the original pipeline of tax revenue for the U.S. government.  Tariffs were the largest source of federal revenue from the 1790s to the eve of World War I, until they were surpassed by income taxes. 

Tariffs were the largest source of federal revenue from the 1790s to the eve of World War I.

 

Besides providing income, tariffs protected local industry, but also contributed to sectionalism between the North and the South, leading up to the Civil War.  The Tariff Act of 1824 increased tariffs to protect the American industry in the face of cheaper imported commodities such as iron products, wool, and cotton textiles, and agricultural goods from England.  But this tariff was the first in which the sectional interests of the North and the South truly came into conflict because the South advocated lower tariffs to take advantage of tariff reciprocity from England and other countries that purchased raw agricultural materials from the South.

Since the Civil War, tariff revenues have been up and down - affected by depressions, wars, and especially (political) trade policies.  Since 2000, tariff revenues have been steadily increasing from $20B to $40B per year, but in 2020, amounted to only 2.3% of total U.S. revenue.

Property Taxes.  It’s a peculiar note of history that the founding fathers, who spoke often of abolishing the feudal system, kept a remnant of the Old World:  property taxes.  But their rationale was very simple: They needed the money, particularly in times of war.  In fact, the federal government levied a national property tax in 1798, 1814, 1815, 1816, and 1861.  The tax in 1798, for example, charged households for their slaves, houses, and land.  It reportedly raised $2 million. 

Federal taxation on land was particularly unfavorable among citizens, and national property taxes were discontinued after the Civil War. 

A system of local governments collecting property taxes, based on the property’s value, has replaced federal levies.  The money is spent locally on projects to fund water and sewer improvements, provide law enforcement, fire protection, education, road and highway construction, libraries, and other services that benefit the community.

Income Taxes.  To help pay for the Civil War, Congress imposed its first personal income tax.  The Revenue Act of 1862 levied a 3% tax on incomes above $600, rising to 5% for incomes above $10,000.  Rates were raised in 1864, but the income tax was repealed in 1872.  (Excise taxes were also added to almost every commodity possible - alcohol, tobacco, gunpowder, tea.)

The Civil War also led to the creation of the first version of the Office of the Commissioner of Internal Revenue - the earlier version of what we now call the Internal Revenue Service (IRS).  This office took over the responsibility of collecting taxes from individual states.

As World War I loomed, with a decline in tariff revenues, and a desire to shift tax burdens to the wealthy, the idea of a tax on income was brought back in the 16^th Amendment to the Constitution, which established Congress' right to impose a federal income tax.  The amendment was passed by Congress in 1909, ratified by the states, and took effect on February 25, 1913.  That first year, less than 1% of the population paid income taxes at the rate of only 1% of net income.  The income tax was permanently introduced for both individuals and corporations, and the first Form 1040 was created.

The World Wars led to the expansion of the federal income tax to boost the national budget and further increase progressivity in the federal tax code.  Today, the income tax is the top stream of government revenue.

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 get a small subsidy from the federal government because of child credits and the Earned Income Tax Credit.

When the federal income tax was implemented in 1913, the 16^th Amendment introduced marginal tax rates, a progressive tax structure where the tax liability of an individual increases with the increase in the amount of income earned during a financial year.  Initially these marginal tax rates were 1% on income of $0 to $20,000, 2% on income of $20,000 to $50,000, 3% on income of $50,000 to $75,000, 4% on income of $75,000 to $100,000, 5% on income of $100,000 to $250,000, 6% on income of $250,000 to $500,000, and 7% on income of $500,000 and up.

Tax rates were the same for everyone, and there was no filing status.  This meant everyone paid the same rate whether they were single, married, or heads of households.  But all that changed over time.  Tax rates increased considerably, with the highest marginal tax rate currently at 37%. (The highest U.S. marginal tax rate ever was 94% in 1944 and 1945, as the chart below demonstrates.)  Modern tax rates also depend on filing status.

 

Personal income tax rates have changed over the years.

Taxes on investments were enacted in 1913 with Capital Gains Taxes as part of the income tax.  Dividend taxes were enacted in 1936, but only lasted through 1939.  They reappeared in 1954, and have persisted ever since.

The initial income tax on gains from capital assets did not distinguish capital gains from ordinary income.  From 1913 to 1921, income from capital gains was taxed at ordinary rates.  Congress began to distinguish the taxation of capital gains from the taxation of ordinary income according to the holding period of the asset with the Revenue Act of 1921, which allowed reduced tax rates for assets held at least two years.

Today, net long-term capital gains, as well as certain types of qualified dividend income, are taxed preferentially.

The Alternative Minimum Tax (AMT) was enacted in 1978 to ensure that taxpayers who earn above a certain threshold, pay their fair share of taxes.  This parallel system uses a separate set of rules to calculate taxable income.  The effect of the AMT is to place a floor on the percentage of taxes that a filer must pay to the government, no matter how many deductions or credits they may claim.

Here are a few milestones for taxpayer payments of income tax:

a.      1943:  It becomes mandatory for employers to withhold taxes from employee’s wages.

b.  1961: The National Computer Center at Martinsburg West Virginia is formally dedicated to     assisting the IRS in its shift to computer data processing.

c.      1992:  Taxpayers who owe money are given the option to file electronically.

Corporate Taxes.  In 1909, Congress enacted an excise tax on corporations based on income.  After ratification of the Sixteenth Amendment to the U.S. Constitution in 1913, this became the corporate provision of the federal income tax.  Amendments to various provisions affecting corporations have been in most, or all, revenue acts since.  

The corporate tax rate in the United States averaged 32.4% from 1909 until 2021, reaching an all-time high of 52.8 percent in 1968, and a record low of 1 percent in 1910.  Under the "Tax Cuts and Jobs Act" of 2017, the rate adjusted to 21%.

In 2017, corporate tax revenue constituted about 6.6% of all federal revenues. 

Sales Taxes.  Sales taxes in the United States are taxes placed on the sale or lease of goods and services and are governed at the state level.  No national general sales tax exists.

The retail sales tax was first introduced just prior to, and during, the Great Depression.  The first state to enact a sales tax was West Virginia in 1921.  Eleven other states followed suit in 1933.  By 1940, 18 more states had a sales tax in place, and today sales taxes are employed in 45 states, the District of Columbia, and the territories of Puerto Rico and Guam.  Alaska, Delaware, Montana, New Hampshire, and Oregon are the only states currently without a sales tax.

Sales taxes became the largest source of tax revenue for states in 1947.  Across the 45 states with a current retail sales tax, sales tax revenue made up on average 34% of all state tax revenues in 2016.

The items and services included in the sales tax, and the rate of taxation, vary across the states.  For example, Arizona does not have a sales tax on groceries, prescription medicine and medical devices, and machinery and chemicals used in research and development, while some other states do; the Arizona state sales tax rate is 5.6%.  (State sales tax rates range from 4-7%.)  States may also grant local governments the authority to impose additional sales taxes (those existing range between 0.6 - 8.3%).  I pay a local Pima County (Tucson area) sales tax rate of 0.5%.

Gasoline Taxes.  Federal excise taxes on gasoline were implemented in June 1932 under President Herbert Hoover as part of the Revenue Act of 1932.  As its name implies, this act was designed to increase the amount of money the government had at its disposal.

In 1932, gas was taxed at a rate of $0.01 per gallon.  By 2022, the tax had increased to $0.18 per gallon.  State gasoline taxes and fees tack on an additional cost, averaging $0.39 per gallon.  Today, the lowest gas tax is $0.15 per gallon in Alaska; the highest is $0.68 cents per gallon in California.

Social Support Taxes.  In reaction to the Great Depression, President Franklin Roosevelt signed the Social Security Act in 1935, introducing an old age pension program, unemployment insurance, and funding for health and welfare programs. 

To fund the program, a 2% tax on earned income was imposed, shared equally by an employee and their employer.  Social Security taxes are collected through payroll taxes according to the Federal Insurance Contributions Act (FICA), enacted in 1935 as a tax provision of the Social Security Act.  The government first collected Social Security taxes in January 1937, although no benefits were paid until January 1940

In July 1965, under President Lyndon Johnson, Congress enacted the Medicare program under the Social Security Administration, and now administered by the Centers for Medicare and Medicaid Services, to provide health insurance to people age 65 and older, regardless of income or medical history.

The payroll FICA tax was increased to pay for this expense.  Federal payroll taxes are deducted directly from the employee's earnings, to collect Social Security and Medicare taxes, and paid to the IRS.

As of 2021, employees pay 6.2% of income into Social Security for the first $142,800 of earnings and another 1.45% into Medicare on all wages.

Federal Revenue by Tax Type.  The figure below shows the total U.S. federal revenue, by percentage for each tax type, from 1934 through 2017.  This is a “layer cake” figure, where the annual amount of each tax type is layered atop another to show its contribution to the total of 100%

 

Federal revenue by tax type from 1934 to 2017.

 

Note the steady contribution of income tax at 40-50%, the gradual decline of corporate tax from about 30% to 10%, the steady increase of the payroll tax to pay for Social Security and Medicare from about 10% to 30%; and the decline of excise taxes from about 30% to less than 5%.  Note also the relatively small percentage, from 5-10%, of “other” taxes, including tariffs, and taxes on estates, gifts, and gasoline.

Personal Note

I’ll close with a personal note on paying taxes.  For reasons I can’t quite explain, I figure my own taxes, and fill out the forms by hand without using any of tax paying tools like Turbo Tax.  To make it worse, I pay almost every kind of taxes I’ve talked about in this blog.  And most years, I have post-submittal issues with the IRS, from forgetting to copy a key number on my 1040 form, to not providing enough supporting data (like the appropriate third-level form) to justify my deductions. The instructions for some of those forms are almost criminally complex!  One year, the IRS misread my social security number; that took quite a while to sort out! 

I guess it must be the challenge.  I typically am doing my taxes on off-action days of the NCAA March Madness basketball tournament in March.  And, unbelievably, I actually enjoy the process.  However, I suspect the real reason for my stubborn personal income tax prep is captured in the cartoon below.

The bravest stupidest man in the world.