Great piece in today’s WSJ: A Short History of the Income Tax by John Steele Gordon.
Distilled into bullet points:
• After the Civil War, the government relied mostly on the tariff for revenues, which was basically a consumption tax that hit the poor much harder than the rich.
• An income tax on the “rich” was attempted in 1894. The income tax was to be 2% on incomes above $4,000 (less than 1% of the households at the time). It was challenged and eventually struck down 5-4 by the Supreme Court.
• President Taft “…proposed a constitutional ammendment to legalize a personal income tax, while meanwhile imposing a tax on corporate profilts.”
• The 16th Amendment was ratified in 1913 and the income tax was created.
• The new tax was 1% on income above $3,000 and reached 7% on incomes over $500,000.
• There were many deductions, which drastically reduced effect income tax rates.
The author closes out the piece with a couple of interesting points:
Unfortunately the corporate income tax, originally intended as only a stopgap measure, was left in place unchanged. As a result, for the last 98 years we have had two completely separate and uncoordinated income taxes. It’s a bit as if corporations were owned by Martians, otherwise untaxed, instead of by their very earthlyâ€”and taxedâ€”stockholders.
This has had two deeply pernicious effects. One, it allowed the very rich to avoid taxes by playing the two systems against each other. When the top personal income tax rate soared to 75% in World War I, for instance, thousands of the rich simply incorporated their holdings in order to pay the much lower corporate tax rate.
There has since been a sort of evolutionary arms race, as tax lawyers and accountants came up with ever new ways to game the system, and Congress endlessly added to the tax code to forbid or regulate the new strategies. The income tax act of 1913 had been 14 pages long. The Revenue Act of 1942 was 208 pages long, 78% of them devoted to closing or defining loopholes. It has only gotten worse.
Finally, he closes with this, which I totally agree with:
The other pernicious consequence of the separate corporate and personal income taxes has been a field day for demagogues and the misguided to claim that the rich are not paying their “fair share.” Warren Buffett recently claimed that he had paid only $6.9 million in taxes last year. But Berkshire Hathaway, of which Mr. Buffett owns 30%, paid $5.6 billion in corporate income taxes. Were Berkshire Hathaway a Subchapter S corporation and exempt from corporate income taxes, Mr. Buffett’s personal tax bill would have been 231 times higher, at $1.6 billion.