Today in 1913: The Revenue Act of 1913 establishes the modern-day federal income tax system

October 3, 2014

Today in Legal HistoryToday, we mark a milestone that is somewhat ignominious, at least to some: the birth of our modern day federal income tax system.

Our current system is based on the original tax code of 1913, which consisted of the Sixteenth Amendment – which effectively overruled an 1895 Supreme Court ruling that declared a previous attempt at a federal income tax system to be unconstitutional – and the Revenue Act of 1913, which was signed into law 101 years ago today, on October 3, 1913.

The original impetus for the Revenue Act, also known as the Underwood-Simmons Act, wasn’t to create a vast new infrastructure for collecting individual and corporate income taxes because the government sorely needed the money.  Rather, the institution of the new income tax was meant to offset the expected lost income from reducing the tariff rates on certain goods entering the United States.

And this is also where the act had a major impact on the structure of the U.S. government: this act marked a shift in its primary revenue source from tariffs to income tax.  Indeed, it was only a few years later that income taxation replaced tariffs in this role for the government.  This is noteworthy, since the income tax provisions of the Revenue Act were mostly a secondary addition to the bill to offset the reduction in tariff income.  In other words, despite how significant the establishment of the income tax system seems to us today, back then, the issue was dwarfed by the issue of tariff reform.

In fact, the issue of tariff reform was one of the newly inaugurated President Woodrow Wilson’s goals coming into office.  President Wilson convened a special session of Congress to address this and other goals, which were directed at remedying the country’s economic downturn.  Attempts to lower tariffs in the past had been largely unsuccessful, and some even had negative political consequences.

Fighting against tariff reductions were, naturally, domestic businesses that would face increased price competition from foreign products if tariff reforms were successful.  With this in mind, President Wilson took a populist approach, seeking to generate public support for tariff reform by warning of the massive influence of business lobbyists fighting against it, even though it would mean lower prices for consumers.

Wilson’s strategy was successful, and constituents from across the nation wrote to their congressmen demanding tariff reform.  And with this public support, the act passed successfully.

As far as the income tax portion is concerned, the system was progressive with a 1% tax imposed on individual incomes starting at $3,000 (around $72,000 in 2014 dollars) and married incomes starting at $4,000 (about $96,000 in 2014 dollars).  Starting at annual incomes above $20,000 ($480,500 in 2014 dollars), there was an additional 1% tax.  There was an additional 1% tax for annual incomes exceeding $50,000 ($1.2 million in 2014), $75,000 ($1.8 million in 2014 dollars), $100,000 ($2.4 million in 2014 dollars), $250,000 ($6 million in 2014 dollars), and $500,000 ($12 million in 2014 dollars).

Clearly, the income brackets and the rates in today’s tax code are quite a bit different than those in the tax code that started it all: the income brackets reach much lower incomes nowadays, and tax rates are higher (although not nearly as high as they were in 1980, when incomes over $300,088 ($866,000 in 2014 dollars) were taxed at a rate of 70%.  Nevertheless, the ratio of the top marginal rate to the bottom marginal rate of the 1913 tax brackets (7:1) was the highest it has ever been.

Since the 1913 act, the issue of federal income taxation has become one of the most significant political issues facing the nation, and if the current political climate is any indicator, it will remain so for the foreseeable future.  Meanwhile, the majority of Americans probably wouldn’t even know what a “tariff” is.