Wisdom and Rubies
Ah, April. Some believe the month is named for Aphrodite, the Greek goddess of love, while others contend its name derived from the Latin verb aperio, “I open.” The poet Ovid wrote that “April was named from the open season, because spring opens all things.” His expectant reference to the first flowers of the season from which bees and butterflies begin to gather nectar is lost on this tax lawyer whose thoughts of something opening in April go no further than to a checkbook. I know Jesus teaches us to render to Caesar the things that are Caesar’s but making an income tax payment on or about April 15 each year (April 17 is the 2023 payment date) misdirects my rubies and brings me no joy.
Article 1, Section 8, Clause 1 of the U.S. Constitution authorizes Congress “to lay and collect taxes, duties, imposts, and excises, to pay the debts and provide for the common defense and general welfare of the United States,” but an amendment (the 16th) was required for the federal government to collect taxes on income. Delaware became the 36th state to ratify the amendment on February 3, 1913, and the federal income tax became the law of the land.
It is interesting to note that our government had imposed an income tax on its citizenry many years before 1913. Congress passed the Revenue Act of 1861 to underwrite the cost of the North’s war effort in the War Between the States, and the federal income tax was born. Imposing a tax of 3% on individual incomes over $800 ($27,200 in today’s dollars), the Act did not provide for an enforcement mechanism and generated little added revenue. But with the expense of war increasing and the fresh taste of tax still on its palate, Congress passed the Revenue Act of 1862 creating the first progressive tax, levying higher tax rates on higher incomes. A maximum rate of 5% was charged on income exceeding $10,000 ($296,200 in today’s dollars), and the Office of Commissioner of Internal Revenue was established to aid in collection. As the economy improved after the war, tax rates were gradually reduced and Congress returned to financing government through the assessment of excise taxes and tariffs, ending the federal income tax in 1872.
Congress struck again in 1894 and enacted the first peacetime income tax of 2% on income over $4,000 ($139,150 in today’s dollars). The tax was almost immediately struck down by a five-to-four decision of the Supreme Court despite its prior finding that the income tax earlier imposed was constitutional. This time the Court ruled that the income tax was prohibited by Article 1, Section 9, Clause 4 of the Constitution forbidding direct taxes on individuals not apportioned on the basis of population. The decision did not say citizens could not be taxed by the federal government, but that any direct tax on persons or property had to be based on a census. This meant Congress would set the total amount to be raised by a direct tax, then divide that amount among the states according to each state’s population. A state with one-tenth of the country’s population would be responsible for one-tenth of the total amount of direct tax, without regard to that state’s income or wealth levels. For example, if the government wanted to raise $20 million and 10 percent of the country’s population lived in one state, say, New York, then New York would be required to raise $2 million. If New York had 1 million residents, each resident would owe $2 in taxes. With individuals earning different amounts of income, a tax based on income could never achieve the proportionality demanded by the Constitution.
By the presidential election of 1908, the federal government’s appetite for revenue had grown to the degree that both William Howard Taft, the Republican candidate, and his Democratic opponent, William Jennings Bryan, supported an income tax. Taft won the election and declared the need for an income tax in his inaugural address. On July 2, 1909, Congress obliged, adopting a resolution proposing the 16th Amendment, which was then submitted to the states for ratification:
“The Congress shall have the power to lay and collect taxes on income from whatever source derived, without apportionment among the several States and without regard to any census or enumeration.”
With landslide victories by the Democrats and their Republican pro-tax allies in the 1910 national and state midterm elections, state legislatures pursued the cause in earnest, and Delaware’s ratification on February 3, 1913, sealed the deal—and our fates. The federal income tax was here to stay.
Taking quick advantage of the revenue-generating opportunity, newly elected President Woodrow Wilson, a Democrat, pushed for a progressive income tax with a top marginal rate of 7%. While the revenue initially collected from the new tax was rather small, the significance of Wilson’s tax policy was its transition from a regressive, consumption-based system (proportionally harsher on those with lower incomes) to a system that imposed taxes based on a person’s ability to pay.
When it comes to revenue consumption, Congress can be insatiable, and it did not take long for tax rates to skyrocket. The highest marginal bracket climbed to 77% in 1918 to pay for World War I, and by the time World War II concluded, the top bracket soared to 94% on incomes exceeding $200,000 ($3.32 million in today’s dollars). Pass the Pepto-Bismol!
In March, President Biden proposed increasing the highest federal income tax bracket of 37% to 39.6%, but even his higher rate is low when compared to historic rates. President Reagan lowered the top tax rate in 1987 to 38.5%, but for 62 of the 70 years between 1917 and 1987, the highest tax rate exceeded 50%. It would not be surprising if tax rates continued to rise, but the greatest gift of divided government (where one party controls the White House and the other controls Congress) is gridlock and the requirement of compromise.
Today, approximately 50% percent of Americans pay no income tax. They have no “skin in the game” and, accordingly, no motivation to preserve and guard their rubies from those elected officials who would take and spend them. If all of us were subject to having to part with some rubies to pay for government—if we all had some of our rubies at risk—participating citizenship might become more of a priority and politician accountability more of a practice.
Fred is an Assistant Professor of Accounting at Texas A&M University-Texarkana and an attorney Board Certified in Tax Law and in Estate Planning and Probate Law by the Texas Board of Legal Specialization. His practice is limited to matters of federal and state taxation, wealth transfer and asset protection planning, elder law, probate and the administration of estates, and the formation and operation of business, professional and nonprofit entities. You may find him at www.nortonandwood.com.