The 16th Amendment: How the U.S. Federal Income Tax Became D.C.’s Favorite Political Weapon

The American Revolution was sparked in part by unjust taxation. After all, the colonists in Boston rebelled against Britain for imposing “taxation without representation,” and summarily tossed English tea into the harbor in protest in 1773.

Nowadays Americans collectively spend more than 6 billion hours each year filling out tax forms, keeping records, and learning new tax rules according to the Office of Management and Budget. Complying with the byzantine U.S. tax code is estimated to cost the American economy hundreds of billions of dollars annually – time and money that could otherwise be used for more productive activities like entrepreneurship and investment, or just more family and leisure time.

The majority of these six billion hours sacrificed by Americans to Washington each year goes to complying with a tax that didn’t even exist until 100 years ago – the federal income tax.

Worse still, this tax has become a political weapon for Washington to incentivize certain activities (homeownership, charitable giving, etc.) and to punish others. It’s a tax that follows Americans wherever they go in the world, and it’s one that was originally sold to the American people by President Woodrow Wilson as a means of “soaking the rich” during the so-called Gilded Age.

How did a country that was founded on the concept of limited government come to embrace such a draconian policy? And what does it say about Washington that tax reform has become synonymous with class warfare and corporate lobbyists?

Read on to learn the history of the 16th Amendment – which authorized the federal collection of an income tax – and how that power has ultimately meant the growth of Washington at the expense of just about everyone else.

Early Attempts to Implement an Income Tax

Could you imagine a time in the U.S. when roads were being paved, there was zero national debt, and the federal government was completely operational – all without income taxes? This may sound like a libertarian fantasy, but it’s actually an image of the America of yesteryear. Before the advent of the income tax, the U.S. government relied exclusively on tariffs and user fees to finance operations.

Unsurprisingly, operations were much smaller compared with today’s extravagant government programs like welfare, social security, and subsidies. But even though spending was more conservative during the Republic’s early years, certain political events motivated the government to consider more direct ways of reaching into the pockets of its citizens.

One of these political events was the War of 1812. This war may have inspired Francis Scott Key to write “The Star-Spangled Banner” as he famously watched the rockets red glare over Fort McHenry, but it was also straining our fiscal resources and the war effort needed to be financed.

Enter the idea of a progressive income tax – based on the British Tax Act of 1798 (which should have been our first warning). Fortunately for the time, the War of 1812 came to a close in 1815, and the discussion of enacting an income tax was tabled for the next few decades.

Ever so stubborn, big-government advocates were hell-bent on enacting income taxes, and they eventually found a way to do this at a local and state level. In time, they would reignite a new movement for the adoption of the federal income tax.

State Versions of the Income Tax

With state governments increasingly embarking on public infrastructure projects and introducing compulsory public education, the money for these programs had to come from somewhere. For the income tax advocates whose hopes were dashed during the War of 1812, state income taxes served as a consolation prize. In turn, income tax supporters immediately got to work and started to chip away at state legislatures.

In the mid-19th century, the fruits of the income tax crowd’s labor began to pay off as several states got the ball rolling. Some of these states included:

• Pennsylvania: 1840 to 1871
• Maryland: 1841 to 1850
• Alabama: 1843 to 1884
• Virginia: 1843 to 1926 (later replaced with a modern individual income tax)
• Florida: 1845 to 1855
• North Carolina: 1849 to 1921 (later replaced with a modern individual income tax)

Slow but sure, income taxes started to make their way from one state legislature to the next. But once the 1860s arrived, income taxes got a tremendous push from one of the most destructive and pivotal events in U.S. history.

Did the income tax supporters finally get their wish?

The Civil War’s Boost for a Federal Income Tax

To say the U.S. was divided during the 1860s would be an understatement.

Ripped apart at the seams by a bloody Civil War (1861-1865), the Union government was desperate for funds to finance its war effort. Like the War of 1812, proposals for income tax were on the menu. Unlike the preceding war period, however, the U.S. was able to successfully enact an income tax.

Abraham Lincoln signed the Revenue Act of 1861 as a means to finance the expensive war effort. This was followed up with other measures like the Revenue Act of 1862 and Revenue Act of 1864, which created the nation’s first progressive income tax system and the precursor to the Internal Revenue Service (IRS).

What seemed like a monumental victory for income tax supporters who hoped for a long-lasting income tax system would vanish into the ether once the Civil War ended. No longer needing a massive army, the U.S. government let Civil War era income taxes expire once Reconstruction was in full swing. The pro-income tax crowd would have to reassess its tactics and look at other avenues for political change.

The American People Push Back

How did the U.S. government go from embracing massive government expansions during the Civil War to later reverting back to its Constitutional roots of limited government during the next decade? Was it benevolent politicians who, in an act of political kindness, decided to hit the reset button and give Americans their cherished rights back? Or was there something else at play?

Upon further inspection, there is reason to believe that taxes in the 19th century tended to be temporary in nature given the American people’s ideological propensities. Most people were still skeptical of government overreach, especially during the Civil War – a time where habeas corpus was suspended, and the first income tax was implemented. Shell-shocked from a horrific experience that laid waste to countless urban centers and left hundreds of thousands of Americans dead, the American populace wanted a return to normalcy. And that meant scaling back government as much as possible.

Even Henry Ward Beecher, the brother of the famous author Harriet Beecher Stowe, was skeptical of the Radical Republicans’ zealous plans to grow government during the Reconstruction period. Historian Tom Woods in The Politically Incorrect Guide to American History exposed Beecher’s thoughts on the matter:

“The federal government is unfit to exercise minor police and local government, and will inevitably blunder when it attempts it…To oblige the central authority to govern half the territory of the Union by federal civil officers and by the army, is a policy not only uncongenial to our ideas and principles, but pre-eminently dangerous to the spirit of our government.”

Many Americans would agree with Stowe’s assessment – above all, members of Congress who sought to reassert Congressional dominance throughout the rest of the 19th century. But with the arrival of the Progressive Era, the rules of the political game began to change. Soon, ideas of expansive government, which were routinely scoffed at by intellectuals, politicians, and the American population at large throughout the first half of the 19th century, made a fierce comeback during the latter half of the 19th century.

This time around, these ideas began to have considerable staying power.

The Income Tax: A Child of the Progressive Era

Decades of legislative pressure and constant hand-wringing finally began to pay off for income tax supporters.The arrival of the Progressive Era was like Christmas for political figures in favor of an activist state. This was a time when reformers actively pushed for an energetic government to solve all of society’s ills, most notably poverty and income inequality.

Although they were shut out from the federal government throughout the Gilded Age, Progressives focused their attention on local and state races. Additionally, academia became more receptive to the technocratic message of Progressivism, as numerous academics like John Dewey gained prominence during this period and made progressive ideas popular in the Ivory Tower circles.

Many will scoff and think that Ivory Tower ideas have no impact in changing, that these ideas are simply too dense and inaccessible to the masses. However, free market economists like Nobel laureate F.A. Hayek understood the indispensable role ideas play in politics. In his work, The Intellectuals and Socialism, Hayek argued that when certain ideas promoting activist government become prominent among the academia and general culture, they eventually consume the political class whole.

The idea of an income tax would have been laughed out the venue in previous decades. But in the 1890s, it was all the rage at universities throughout the U.S. Soon, political winds started to blow in a more favorable direction.

For a brief moment, Progressives got their wish when the Congress introduced an income tax during the mid-1890s. The Wilson-Gorman Tariff Act, which had an income tax provision attached to it, gained the ire of then President Grover Cleveland for its last-minute amendments. Nevertheless, the Wilson-Gorman Act became law without Cleveland’s signature. The Supreme Court would later strike down the income tax provisions of the Wilson-Gorman Act in 1895’s Pollock v. Farmers’ Loan Trust Co. case.

The Supreme Court’s rejection of the income tax was no trivial failure. It was the first step in starting the conversation on the need for an income tax. Progressives now smelled blood in the water and would come back with a vengeance in less than two decades.

Enter the Wilson Presidency

Not letting the temporary setback of the Pollock v. Farmers’ Loan Trust Co. deter their activism, Progressives continued plowing ahead and making their ideas more palatable to the political class and the masses. Progressivism reached its zenith during the administration of Woodrow Wilson, when progressive reformers finally got their wish as the 16th Amendment was ratified in 1913. This ratification settled any constitutional questions about the legality of this controversial tax. It started out as a relatively limited tax, with individuals making below $20,000 paying a rate of one percent, and the rich – those making making more than $500,000 – paying a seven-percent tax.

Supporters of the income tax sold it as a tax that would only target the filthy rich. But as history has shown, government encroachments have a tendency of growing over time. In 1917, the lowest tax bracket paid two percent, although the highest income earners saw their taxes skyrocket to 67 percent.

At the time, politicians reassured their constituents that those rates would not be permanent and they would eventually be scaled back. Little did taxpayers know what the 1930s and 1940s had in store for them.

The Income Tax: A Normal Part of Public Policy

Since its ratification, the income tax has been a calling card for politicians keen on growing the size of the State. By soaking the rich and redistributing their wealth, politicians can claim to be champions of the common man, all while consolidating their power in D.C. However, economic realities and political backlash have constrained politicians’ abilities to indefinitely raise taxes.

Power-hungry politicians needed a little bit of outside help to make their wildest fantasies become reality. That help usually comes in the form of political crisis, which politicians exploited in its fullest.

The New Deal was the first era that witnessed income taxes rise at astronomical rates. On the eve of the 1929 stock market crash, the highest income earners paid a marginal tax rate of 25 percent. But once the Great Depression was well underway in the mid-1930s, the top tax bracket was paying 63 percent, and the United States’ entrance into World War II catapulted these rates toward 94 percent.

Certain political practices, such as the abandonment of the use of war bonds – debt securities the government issued to finance war efforts – changed certain political realities for the political class. The discontinued use of war bonds made using the income tax and deficit spending a necessity. This was the result of the populace starting to grow skeptical of military action abroad. With war bonds out of the picture, the U.S. relied more on income taxation and central banking to finance military actions and domestic programs after World War II.

Like an annoying chore, the income tax soon became a part of the average American’s life, whether they liked it or not. For some Americans, the rabbit hole of inconveniences and frustration goes even deeper.

Extraterritorial Taxation: The Income Tax’s Worst Kept Secret

Living in foreign lands is one of the most tantalizing experiences for people all over the globe. And after decades of hard work and meticulous saving, many Americans dream of living abroad.

Often times, unsavory political situations like economic collapses, heavy taxation, and even war compel people to search for greener pastures. For many, settling in new lands is a form of wiping the slate clean – disassociating with a tyrannical homeland and starting a new life in a land of opportunities.

But for Americans abroad, the U.S. government still finds a way of sneaking back into their lives. Like an unwanted guest, the income tax has latches on to Americans and follows them all the way to their new place of residency. Thinking that their foreign villa by the beach is a refuge from potential U.S. government meddling, many Americans are caught by surprise when the tax bill comes at their U.S. embassy.

A particularly unique feature of America’s income tax system is its power to tax extraterritorial income. In other words, Americans living abroad are subject to a worldwide tax on their income. One caveat is that American taxpayers enjoy a foreign earned income exclusion that reduces their overall tax burden. As of 2018, the maximum exclusion for taxpayers is $103,900. Nevertheless, the U.S. and Eritrea are unique in their extraterritorial taxation models. Eritrea, however, taxes its citizens living overseas at a flat rate of two percent.

The extraterritorial nature of U.S. taxes has not been without its fair share of legal controversies. George Cook, an American living in Mexico for 20 years, was perturbed by the fact that he had to pay an income tax on his foreign earnings despite no longer having ties with his country of origin. George’s dispute eventually made its way to the Supreme Court in 1924, and the issue was resolved in the Supreme Court case Cook v. Tait.

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