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Income tax is seen as a part of American life, but this wasn't always the case. Why did Uncle Sam start taking a slice out of citizens' pockets'
A short history of income tax
INCOME tax was introduced by William Pitt the Younger nearly 200 years ago to finance the struggle against Napoleonic France. Subsequent wars have brought big changes in tax.
The schedules of the new tax listed sources of income. The list began with property, moved on to woodlands, through trade, profession or vocation, Crown appointments and ended with a final catch-all for income which did not come within any of the other categories. In a history of the tax system, John Kay wrote: "The idea that employees were people of sufficient standing to be liable for income tax was not conceived of." Yet that catch- all now catches most of us.
In Victorian Britain it caught few people. Aside from the burden of running a blue-water navy, this was the era of the nightwatchman state. There was only one rate of income tax and the highest it reached was 62/3 per cent, during the Crimean War. In the mid-19th century, there were fewer than half-a-million taxpayers.
As Chancellor, William Gladstone described income tax as "an engine of gigantic power for great national purposes" - though he aspired to abolish it. But the engine was running at low power even at the start of the 20th century, when the Inland Revenue still had fewer than a million taxpayers in its trawl. The first step to progressive rates of income tax came with Lloyd George in his "people's budget" of 1909. His "supertax" was only eight per cent - charged on incomes equivalent to more than pounds 200,000 in today's money. But in the First World War top rates rose to over 50 per cent.
On the eve of the Second World War, those paying income tax still amounted to less than one in five of the working population. By the end the number of taxpayers had tripled to 12 million and the pay-as-you-earn system was devised, though the Inland Revenue had insisted that deducting tax before income was paid could not be done.
Today 25,700,000 people pay income tax, which accounts for a quarter of government revenue.
The history behind the taxation of Social Security benefits
The path to taxing Social Security benefits begins all the way back in the 1970s. When the 1970s began, Social Security's trust fund ratio -- a measure of a year's projected costs that could be paid with funds available at the beginning of the year -- stood at a relatively healthy 103%. But things quickly went downhill as demographic changes took shape.
By 1975, the program was expending more than it was bringing in each year, a trend that would continue through 1982. By 1982, the trust fund ratio was down to a meager 15%. In other words, Social Security was running on fumes, and while the program can't go bankrupt, it was very close to a point where across-the-board benefit cuts would have needed to be instituted to maintain solvency. With so many Americans reliant on Social Security income to make ends meet, benefit cuts weren't viewed as a viable solvency option. Thus was introduced the last major bipartisan Social Security overhaul, the Amendments of 1983.
The Amendments of 1983 made a number of changes to the Social Security program, with each political party able to have their core "fix" implemented. For example, Republicans who wanted to see long-term program expenditures reduced were able to include a two-year increase to the full retirement age over the next four decades. By 2022, the full retirement age will peak at age 67 after having been age 65 for many decades. Meanwhile, Democrats were able to include provisions designed to boost revenue collection, including a gradual increase to the payroll tax of all working Americans.
However, one of the more controversial additions to the Amendments of 1983 was the introduction of taxing Social Security benefits, which was officially implemented in 1984. This tax, which was originally designed to only impact upper-income senior households, was introduced to help raise additional revenue and avoid having to cut retired-worker benefits.
Image source: Getty Images.
7 Facts About U.S. Federal Income Taxes You Should Know – History
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The April 15 tax filing deadline (May 17, 2021, for tax year 2020) is one of the most dreaded days of the year for millions of Americans, either because they hate the hassle of preparing their taxes or dread the resulting tax bill.
Yet federal tax dollars fund several crucial programs, including benefits for veterans, Medicare and Medicaid, Social Security, and the Children’s Health Insurance Program. Taxes also support other initiatives you might not consider but rely on in your daily life, such as science and medical research, defense and international security, highways, and mass transit.
And even if you don’t like paying taxes, there are several crucial facts you need to know about them.
Why do Americans pay taxes on April 15?
We may associate April 15 with the stress and scrambling that comes with knowing that taxes are due, but Tax Day hasn't always landed on that particular date. In fact, there was no such thing as Tax Day in the U.S. before 1913. That was the year that Congress and a three-fourths majority of the states passed the 16th amendment to the Constitution, giving the federal government power to collect income tax on all U.S. citizens. Prior to 1913, the only time the government collected income tax was during the Civil War, when President Abraham Lincoln appointed a commissioner of Internal Revenue to help fund the ongoing war effort, but the tax was repealed soon after the war ended [source: Internal Revenue Service].
The Federal government needs money (revenue) to pay for everything on its budget. Today, the government spends the vast majority of tax dollars (about 80 percent) on five major budget items:
- National defense and security (20 percent)
- Social Security (20 percent)
- Medicare, Medicaid and the Children's Health Insurance Program(CHIP) (21 percent)
- Safety net programs (14 percent)
- Interest on the national debt (6 percent)
The other 20 percent is split among other investments in education, scientific research, roads and bridges, benefits for federal employees and veterans, and international aid [source: Center on Budget and Policy Priorities].
Before 1913, the government generated revenue chiefly through excise taxes (taxes on the sale of particular goods like alcohol and tobacco) and tariffs on imports. But that still left the government in debt, especially in times of war. Many politicians saw a permanent income tax as the solution. Adding to the momentum for the income tax was increasing income inequality between a few super-wealthy industrialists and the common worker [source: Tax History Museum]. Congress passed a bill in 1894 establishing an income tax of 2 percent on income above $4,000, but the law was struck down by the Supreme Court as unconstitutional. It took the 16th Amendment to overcome the Court's opposition.
Before the Income Tax of 1913, and How Tariffs Had No Effect on Imports
The vast majority of the American populace perceive that taxation on wages/income is a usual and regular phenomenon within the history of the United States. The general reason for this is that people wonder how we can pay for our roads, medical healthcare programs, and many other so called “socially beneficial” programs if personal and corporate taxes did not exist. It was not until 1909 when the United States implemented the Business/Corporation Tax, and 1913 when the income tax came into full effect. However, before both the income tax and corporation tax, most of the United States did not have such public welfare programs that exist today. 19 th century welfare programs were so limited as to be non-existent.
How Was the US Government Funded, & What Did It Purchase?
Throughout the 20 th century, the majority of revenue originated from ad valorem taxes which were in the form of tariffs. Tariffs were generally put onto imports no ad valorem taxes (or any significant ones) had been put onto exports. Below is a breakdown of taxes throughout the 19 th century.
What did the tax revenue the government collected put in place throughout the 19 th century? Was it for the statist roads? Attempts of universal health coverage? Public transportation? In fact it was not used for any of what can be described as modern day “utilities” provided by the government the vast majority was used only for defense and military spending.
As a resulrom the inception of the United States, all the way to the advent of income and corporate taxes (from 1789 to 1912), the United States government had accrued a debt of 15.28 billion dollars by running average annual deficits of 125 million USD. The vast majority of such deficits originated from times of war, most notably the American Civil War, when US government spending had reached as high as 15% of GDP! When taking out the crazy amount of spending throughout the Civil War, the sizes of deficit which the US had ran would’ve been lower on many occasions.
As a result, the percentage of revenue obtained by the government over GDP average at 3% prior towards the income tax of 1913.
This can also be noticed with spending as a percentage of GDP.
How Tariffs Did Not Protect US Manufacturers & Had No Effect on Imports
A common misconception is that tariffs had a huge impact on importers throughout the 19 th century, that thanks to tariffs, US manufacturers had the ability to compete against other already established nations. This is far from the truth tariffs did not hurt foreign exporters, but burdened domestic importers, and domestic exporters.
Let’s take for example, the tariffs of abomination. If we look at changes in imports and exports during the tariff of abomination, we can see that before such a tariff was passed, they barely had any effect.
|Year||Imports (USD Million)||Exports (USD Million)|
From above, we can see that imports and exports remained virtually unchanged within the periods of 1828 to 1831. The reason for this is because the US economy was in a business slowdown in this time, and thus all together, imports and exports would have reduced in order to reflect the actual business cycle which had taken place.
Below is a change in GDP and CPI which indicate that the US was already heading into a business slowdown.
This reduction in GDP indicates that an economic slowdown was taking place within the years of 1828 up to 1830. This is also accompanied with deflation, which is the usual trend when during an economic slowdown.
This shows all together that, because imports and exports had virtually remained the same during the slowdown, and that GDP and CPI also showed an indication of an economic slowdown, it further shows that the tariffs of abomination did not protect US manufacturers at all, but rather just increased the price of goods all together. However, who felt the effect of higher import prices the most?
During a slowdown of economic activity, CPI would dramatically decrease. During the 1822/1823 recession, this was noticed with deflation being recorded as -10.00%. However, why was it during the economic slowdown of 1828/1829 that deflation was not as dramatic? The reason for this is because of tariffs affecting consumer goods. Essentially this had hurt consumers more than anyone else by not allowing for the proper adjustment of prices, which furthermore, had most likely prolonged the economic recovery which had happened in 1830/1831. It was most likely that import volume had decreased, however, the value of such imports had increased, which all together had hurt domestic businesses and consumers.
From this we can observe the following:
- Tariffs had no effect on imports, but business cycles and economic preferences is what determines imports
- Due to economic preferences being the main dominant factor towards imports and exports, tariffs do not help exports, but rather just hurt consumers and domestic businesses by making them pay higher prices for imports.
- Imports are vital for trade as domestic manufacturers and industry cannot service all domestic needs, hence why there is a preference to import from abroad to fill in the remainder needs of the economy.
The majority of pre-1913 government revenue was funded by tariffs. Tariffs had little to no impact towards business and imports in the United States, while helping the US government to receive funds, for what can be called, primary services towards the general public (national defense as an example). We can observe that tariffs did not discourage imports and help exports, as economic preferences dominate over what prices are paid for imports, and how much exports are produced by a nation, while at the same-time tariffs in the most extreme case hurt consumers, and domestic businesses rather than helping exports all together.
Who Pays Income Taxes?
Many left-leaning politicians have argued that the tax system is rigged to benefit those at the top and that the wealthy are not paying their &ldquofair share&rdquo of taxes. These claims overlook the starkly progressive nature of America&rsquos income tax code. The code has become increasingly progressive over the past several decades, and despite much political rhetoric to the contrary, the 2017 Tax Cuts and Jobs Act (TCJA) made it even more progressive by shifting a greater share of the income tax burden to the top earners.
New data from the Internal Revenue Service (IRS) for the first tax year under the TCJA confirms that even as the tax reform law reduced top marginal tax rates, the top income earners shouldered a larger share of the income tax burden, far exceeding their adjusted gross income share. Lower income earners are largely spared from income taxes and actually paid a smaller share under the TCJA&rsquos reforms.
For historical information:
New Data Highlights Progressivity of the Income Tax Code under the TCJA
Each fall the IRS&rsquos Statistics of Income division publishes data showing the share of taxes paid by taxpayers across ranges of Adjusted Gross Income (AGI). The most recent release covers Tax Year 2018 (filed in 2019).  This is the first year of reported data under the changes in the TCJA which lowered tax rates, nearly doubled the standard deduction, and expanded the child tax credit.
The new data shows that the top 1 percent of earners (with incomes over $540,009) paid over 40 percent of all income taxes. Despite the tax rate reductions associated with TCJA, this figure is up slightly from the previous tax year&rsquos 38.5 percent share. In fact, NTUF has compiled historical IRS data tracking the distribution of the federal income tax burden back to 1980 and this is the highest share recorded over that period, topping 2007&rsquos 39.8 percent income tax share for the top 1 percent. The amount of taxes paid in this percentile is nearly twice as much their adjusted gross income (AGI) share.
The top 10 percent of earners bore responsibility for over 71 percent of all income taxes paid and the top 25 percent paid 87 percent of all income taxes. Both of those figures represent an increased tax share compared to 2017. The top fifty percent of filers earned 88 percent of all income and were responsible for 97 percent of all income taxes paid in 2018.
The other half of earners (with incomes less than $43,614) took home 11.6 percent of total nation-wide income (a slight increase from 11.3 percent in 2017) and owed 2.9 percent of all income taxes in 2018, compared to 3.1 percent in 2017.
As NTUF reported earlier this year, the number of filers with no income tax liability increased from 2017 to 2018 to 34.7 percent.  The number of nontaxable returns is often related to the economy: as employment decreases and income falls, the number of filers facing no income taxes tends to increase, and vice versa. While 2018 saw a strong economy that would ordinarily increase the number of individuals with income tax burdens, the TCJA removed additional people from income tax rolls by increasing the standard deduction and expanding refundable credits.
As noted above, NTUF has compiled historical IRS data tracking the distribution of the federal income tax burden back to 1980. In that year, the income tax share of the top one percent of filers was 19 percent &ndash less than half of what it is now (40 percent). This is despite the fact that the top marginal income tax rate was 70 percent in 1980 and has since fallen to 37 percent in 2018. 
On the other side of the income spectrum, the bottom 50 percent&rsquos income tax burden has been significantly reduced over the past forty years. In 1980, it stood at 7 percent. That dropped to a low of 2.4 percent in 2010 during the recession. As the economy gradually improved after the recession, the tax share of this income group gradually increased to 3.1 percent in 2017. Although the economy remained strong in 2018, this group's tax share fell from the previous year. This can be attributable in part to the lower rates and higher standard deduction enacted in the TCJA along with its additional provisions designed to ease burdens low-income earners such as the increased child tax credit.
The trends are clear: the code has become increasingly progressive, and when people are allowed to keep more of their own money, they prosper, move up the economic ladder, and pay a bigger part of the income tax bill for those who aren&rsquot.
Tax Cuts and Tax Fairness
Democratic party leaders have taken rhetorical shots against tax reform bill since it was introduced back in 2017. During the debate, Speaker of the House Nancy Pelosi (D-CA) went so far as to call the TCJA the &ldquoworst bill in the history of the United States Congress.&rdquo  Senate Minority Leader Chuck Schumer (D-NY) also disparaged the bill as a &ldquoproduct that no one can be proud of and everyone should be ashamed of.&rdquo 
Progressives continue to assail the TCJA in the years since its passage. A few days before the election, the Center for American Progress, a self-described &ldquoprogressive&rdquo policy institute, called the tax system &ldquounfair&rdquo and said the results of the TCJA were a &ldquohugely regressive tax cut.&rdquo 
This ignores that most taxpayers paid less thanks to the TCJA. In fact, the Tax Policy Center estimated that nearly two-thirds of households paid less income taxes in 2018 than they would have under the pre-TCJA code, while 6 percent paid more (mostly due to the new cap on the state and local tax deduction impacting residents of high-tax states). 
With the income tax burden concentrated largely among a small percentage of filers, the total dollar value of tax reductions is naturally highest among those with very high incomes paying high effective rates, but the benefits are felt across income levels. A reputable dynamic analysis from the Tax Foundation shows that tax reductions as a percentage of income ranged between 2.0 and 2.8 percent for each of the five income quintiles by the end of a 10-year scoring window (assuming that the individual provisions are extended beyond their scheduled expiration after 2025).  While the top quintile does see the largest reduction, all quintiles benefit from the economic growth spurred by the TCJA and its tax reductions. The second largest comes in the lowest quintile, where tax burdens were already very low. This illustrates the broad-based nature of TCJA&rsquos benefits.
Low-income households having very little tax burden to cut in the first place, in dollar terms, is also why &ldquotax cut&rdquo proposals targeted at lower-income households rely heavily on &ldquorefundable credits.&rdquo Like other tax credits, these reduce a filer&rsquos income tax liability. But unlike nonrefundable credits, any remaining credits are paid to the filer. The refundable portion manifests as direct spending through the tax code.
Lower tax rates allow Americans to keep more of their earned income, whereas refundable tax credits provide subsidies. For example, the IRS reports that filers claimed $109.4 billion in refundable credits in 2018.  Of this amount, $4 billion was applied toward reducing income tax burdens and $10.9 billion against other federal taxes. The remaining $94.6 billion ($10 billion higher than in 2017) was essentially converted into subsidy checks. Nearly 96 percent of the refundable credit portions were from two credits: the Earned Income Credit ($56.2 billion, down slightly from $56.8 billion in 2017) and the Additional Child Tax Credit (34.2 billion &ndash an increase of 46.8 percent from 2017).
The IRS 2018 data shows that filers with AGI under $30,000 had an average income tax rate that was negative, thanks to the refundable credits. As filers&rsquo income increases, the average tax generally increases. Those in a range from below to just above the income of the middle-class, with AGIs in from $50,000 to $200,000, paid an average income tax rate of 9.3 percent.  The top one percent (incomes above $540,009) paid an average income tax rate of nearly 27 percent.
Compared to 2017, the data shows that those earning from $1 to $10,000 received, on average, fewer refundable credit subsidies, but otherwise taxpayers up and down the income groups either paid lower average tax rates, or saw increased negative tax rates.
These attacks on not just the TCJA but any tax reduction are used to justify tax increases. As a presidential candidate, Joe Biden released a tax plan that would increase the top rate back to 39.6 percent and hike corporate tax rates, capital gains and payroll taxes. Other Democrats like Rep. Alexandria Ocasio-Cortez (D-NY) advocate for top income tax rates of 70 percent or more and Sen. Elizabeth Warren (D-MA) and Sen. Bernie Sanders (I-VT) introducing steep new wealth taxes as well.
Tax hikes would be a threat to the economic recovery. The Tax Foundation projects that Biden&rsquos tax plan would reduce GDP and lead to about a 1.9 percent decline in after-tax income for all taxpayers on average.  Wealth taxes would impose immense compliance and administrative burdens on an already complicated tax system. Wealth taxes would also negatively impact private charitable foundations and entrepreneurs.
The distribution of the tax burden is an important issue impacting the debate surrounding fiscal and economic policies as the new Congress convenes next January. When looking at the income tax alone, the federal government&rsquos largest source of revenue, data from the IRS shows that America&rsquos code remains very progressive. Lower-income households face negative tax burdens, with effective rates rising steadily as income increases.
Despite heated political rhetoric suggesting that the 2017 Tax Cuts and Jobs Act was a regressive plan that accrued primarily to the benefit of the wealthy, this new IRS data makes clear that it was in fact a significant overall reduction in tax burdens that in fact made the code more progressive, not less. Congress would be wise to remember that when discussing future tax reform efforts.
History Shorts: Why We Pay Income Taxes - HISTORY
Four Things That Everyone Should Know About New Deal Taxation
Joseph J. Thorndike is a contributing editor with Tax Analysts. E-mail: [email protected].
But much of today's New Deal nostalgia is deeply ahistorical. Liberals have engaged in more than a little romantic recollection, while conservatives have waged a dubious rearguard action to discredit New Deal achievements.
So let's set the record straight on at least one key element of the New Deal: taxation. Here are four things that everyone should know about New Deal taxes.
1. The New Deal made liberal use of conservative taxes. Some of the most important elements of the New Deal tax regime were engineered by Herbert Hoover. Congress passed the Revenue Act of 1932 five months before Franklin Roosevelt won his bid for the White House. But key elements of the law -- including an array of regressive consumption taxes -- remained a cornerstone of federal finance throughout the 1930s.
The 1932 act imposed the largest peacetime tax increase in American history. Congress expected it to raise roughly $1.1 billion in new revenue, much of it from the rich. Lawmakers raised income tax rates across the board, with the top marginal rate jumping from 25 percent to 63 percent overall effective rates on the richest 1 percent doubled, according to economic historian Elliot Brownlee. Meanwhile, estate tax rates also climbed sharply, while the exemption was cut by half.
For all its progressive features, Hoover's revenue swan song -- which passed with strong support from the Democratic majority in Congress -- also included an array of regressive excise taxes. The law created new levies (including taxes on gasoline and electricity), while raising rates for old ones. As a group, most of these consumption taxes fell squarely on the shoulders of Roosevelt's famous Forgotten Man. Yet once in office, the new president did nothing to reduce them. Indeed, excise taxes provided anywhere from a third to half of federal revenue throughout the 1930s.
2. Most New Dealers were not Keynesians -- at least not initially and not when it came to taxes. Why did Roosevelt tolerate regressive taxation? Because he needed the money. The president -- and most of his economic advisers -- believed that unchecked borrowing posed a threat to recovery. While English economist John Maynard Keynes was urging the president to embrace an aggressive program of debt-financed spending, many New Dealers clung to more orthodox notions of public finance.
Keynesians were a rare breed in the early 1930s. (Indeed, the word "Keynesian" didn't enter popular usage until 1938, when countercyclical fiscal policy began to attract a broader following.) Most policymakers believed that government spending could help spur recovery, but few endorsed wholesale fiscal intervention. "Despite enormous, if not profligate spending, the New Deal has never achieved the volume or kind of pump-priming expenditure which Keynes insists is necessary to start private enterprise going," The Washington Post observed in 1934.
Keynes himself said as much in a December 1933 letter to FDR. "The set-back which American recovery experienced this autumn was the predictable consequence of the failure of your administration to organise any material increase in new Loan expenditure during your first six months of office," he scolded the president. "The position six months hence will entirely depend on whether you have been laying the foundations for larger expenditures in the near future."
Pump priming did accelerate toward the middle of the 1930s, but it was never adequate to the task. As economist E. Cary Brown later concluded, stimulatory fiscal policy failed to end the Depression, "not because it did not work, but because it was not tried."
Spending never had a chance to spur recovery because taxes kept going up. Both parties worshiped at the altar of fiscal responsibility. In 1932 they had competed to see who could inflict more pain on the American taxpayer, with Democratic leaders even sponsoring a manufacturers' sales tax (ultimately defeated by a rank-and-file rebellion). With revenue in a free fall, policymakers across the political spectrum felt compelled to raise taxes.
FDR, for his part, remained deeply conflicted when it came to fiscal stimulus. On one hand, he was genuinely committed to the notion that budgets should be balanced -- someday, at least. His close friend and Treasury secretary, Henry Morgenthau, was even more averse to red ink. But Roosevelt also wanted to spend. So he embraced regressive elements of the 1932 tax act, convinced that consumption tax revenue was indispensable. Later he championed a series of additional tax hikes in 1935, 1936, and 1937.
Most New Deal economists -- at least those working in the Treasury Department -- shared Roosevelt's orthodox inclinations. They worried about unchecked borrowing, even when it was used to finance expansionary spending. "The situation calls for more than merely drifting with the tide of expenditure on the assumption that no grave problems would be presented by a large increase in the present Federal debt," they warned in a key 1934 report.
Treasury economists remained deeply suspicious of countercyclical tax policy. "Talk of more ambitious attempts to use the Federal revenue system as a regulatory mechanism has been heard," they noted with some disdain. "The tax system, so the argument runs, may be employed to eliminate business cycles or at least to lessen their severity, by penalizing 'over-saving' and encouraging consumption, by checking speculation, by favoring certain geographical or social classes at the expense of others, by encouraging business initiative, by discouraging 'unwise' business expansion, and so on."
All of which struck these sober minds as more than a little dangerous. "The use of taxes for other than revenue purposes is not necessarily an evil," they concluded, "but in all such cases great care should be taken to consider all possible effects, some of which may be undesirable and contrary to the ultimate goal originally contemplated."
Eventually, most New Deal economists hopped aboard the Keynesian Express. But it would take the better part of a decade. In the meantime, they were more than willing to contemplate substantial tax hikes -- at least on some people.
3. New Dealers believed that heavy taxes on the rich were a moral imperative. Roosevelt was a vigorous champion of progressive tax reform, especially when it came to raising taxes on the rich. Since 1934, Treasury economists had repeatedly urged the president to lower taxes on the poor they wanted to expand the income tax and use resulting revenue to pay for excise tax repeal. But the president cast his lot with a different group of advisers: Treasury lawyers more interested in soaking the rich than saving the poor.
FDR embraced this approach in 1935, driven by a keen instinct for political opportunism. The New Deal faced a challenge from the left, particularly in the colorful person of Sen. Huey Long. The Louisiana populist was making headlines with his tax plans to share the wealth, and Roosevelt was determined to steal his thunder.
But FDR was also motivated by moral outrage over tax avoidance. He considered taxpaying a pillar of citizenship, a civic responsibility that transcended narrow questions of legality. But in 1935, Treasury lawyers gave Roosevelt detailed evidence that rich Americans were successfully avoiding much of their ostensible tax burden.
This was hardly news, but Roosevelt used it to justify a series of dramatic soak-the-rich measures. Some, like the Revenue Act of 1935, were designed simply to raise statutory rates. Others, like the Revenue Act of 1937, tried to close egregious loopholes. And one, the Revenue Act of 1936, imposed a new tax on undistributed corporate profits, which supporters believed would curb tax avoidance among wealthy shareholders.
As a group, the New Deal revenue acts of the mid-1930s substantially boosted the tax burden on rich Americans. According to Brownlee, the income tax changes alone raised the effective rate on the top 1 percent from 6.8 percent in 1932 to 15.7 percent in 1937.
Some New Deal critics have questioned whether such changes were meaningful. High taxes on the rich didn't really compensate for regressive taxes on the poor. They were, in the words of historian Mark Leff, largely symbolic.
Leff is right: New Deal tax reform was largely symbolic (although it felt real enough for those facing higher tax burdens). But symbols can be important. Sometimes they even change the world.
4. To understand New Deal taxation, we have to understand World War II taxation. The New Deal experiment with soak-the-rich taxation ended with a whimper. In 1938, business leaders, Republicans, and conservative Democrats united to destroy the undistributed profits tax, Roosevelt's most ambitious but least durable tax innovation. For a moment, it looked as though progressive taxation had reached its high-water mark.
In fact, the tide was still coming. World War II changed the politics of taxation forever -- or at least for the next 50 years or so. Driven by staggering revenue needs, lawmakers in both parties agreed to raise taxes on everyone: rich, poor, and -- especially -- the middle class. Treasury economists got the broad-based income tax they'd been seeking since 1934 the number of people paying the levy increased sevenfold in just a few years. But New Deal lawyers got their high rates on the rich, too. The top marginal rate for individual income tax payers reached 94 percent in 1944, and effective rates on the top 1 percent reached nearly 60 percent the same year.
After the war, effective rates dropped substantially. But the income tax retained both its breadth and its steep nominal rate structure. What changed was the focus on loopholes. High rates made loopholes valuable, and lawmakers in both parties tacitly embraced them. As long as rates stayed high, members of Congress could do a brisk business selling tax preferences. Narrow ones could be marketed to well-heeled contributors. Broader ones could be used to assuage the worries of middle-class voters. It was a good deal for everyone - - at least for a while.
Are there lessons to be gleaned from the history of New Deal taxation? Today's pundits seem to think so, and they're probably right. But the lessons may not be the ones they expect.
Lesson #1: Progressive taxation can be its own worst enemy. Roosevelt's support for a steep nominal rate structure eventually undermined the apparent fairness of the tax system. The bipartisan tax consensus that followed World War II proved unstable. Tax preferences drew scrutiny from influential lawmakers, and voters began to suspect that some taxpayers were getting a better deal than others. By the mid-1970s, confidence in the fairness of the tax system had eroded. By the 1990s, it had all but vanished. If proposals to scrap the income tax, including its progressive rate structure, ever succeed, a good share of the blame will belong to FDR.
Steep rates may have advanced the cause of progressive tax reform in the 1930s they almost certainly ensured that wartime taxes were more broadly progressive than they otherwise would have been. But the Roosevelt rates had a pernicious effect in the out years. Sustainable taxation is moderate taxation -- something New Deal economists understood -- but New Deal lawyers did not.
Lesson #2: Sometimes regressive taxation can be an element of progressive reform. Roosevelt's tolerance for excise taxation was almost certainly unwise by almost any calculation, the 1932 revenue act slowed recovery at the worst possible moment. But Roosevelt understood that regressive taxes had a role to play. In the early years of the New Deal, he accepted them as a fiscal necessity. Later he chose them deliberately to finance the New Deal's most important innovation: Social Security.
That being said, Roosevelt also managed to poison the well against other forms of consumption taxation -- forms that might have financed an even more ambitious welfare state. His vigorous opposition to a general sales tax made it hard for the United States to consider other forms of broad-based consumption taxation (like a VAT), even while the rest of the world was discovering their utility.
Lesson #3: If you want progressive tax reform, talk a lot about tax avoidance. FDR sometimes frankly made the case for the redistribution of wealth (although he usually framed it as an attempt to thwart the concentration of wealth -- a subtle but crucial difference). More often, however, he focused instead on the evils of tax avoidance. Americans respond well to the suggestion that everyone should pay their fair share. Demonstrate that some people are not, and voters will rally to your cause.