Global Incident of U.S. Personal Income Tax Revision

By Mirshab, Bahman | Multinational Business Review, Fall 2000 | Go to article overview

Global Incident of U.S. Personal Income Tax Revision


Mirshab, Bahman, Multinational Business Review


To alleviate the burden of the heavy taxation of income in the United States creative solutions have been devised, some of which were introduced by legislation, some of which may be termed" loopholes." For example, the Revenue Act of 1971 introduced a system of tax deferral for a new type of corporation called a Domestic International Sales Corporation (DISC). Under these rules, the DISC's earnings were not taxed, but were taxed to the stockholders when distributed or deemed distributed. The Foreign Sales Corporation Act of 1984 was signed into law on July 18, 1984 as part of the Deficit Reduction Act of 1984. The DISC was considered by major U.S. trading partners as a way to subsidize U.S. companies. This was in violation of the General Agreement on Tariffs and Trade (GATT) which prevents countries from using taxes as a form of subsidy. This law replaced the DISC with the new Foreign Sales Corporation (FSC). Unlike its DISC predecessor, the FSC must satisfy a number of requirements. In the recent past, there was a ruling against the United States because income earned abroad was not fully taxed, thus creating a form of subsidy.

DISTRIBUTION OF TAX BY COUNTRIES

In the United States, the single most important source of tax revenue at the federal level is the personal income tax. A look at Table 1 indicates that almost forty percent of tax revenue is derived from taxes on individual incomes.

Moreover, as seen in table 1, personal income tax as a percentage of total tax in the United States is the highest compared to major industrialized countries. Federal personal income tax has been the subject of various attacks. The origin of most attacks can be traced to the progressive feature of the income tax that makes it complicated, and according to some, unfair. A simple tax system is one that taxes all incomes at the same rate. This paper attempts to demonstrate that attempts to simplify the tax without ignoring the expenditure side of the government budget may lead to a shift of the tax burden to individuals in the middle income category.

THE HISTORY OF INCOME TAXATION IN THE UNITED STATES

The history of income taxation in the United States is relatively short compared to some European countries such as England. The first income tax was introduced by Congress in 1861 for raising revenue to meet high expenditures of the Civil War. The Civil War Act, however, was so poorly drafted that Secretary of the Treasury, Salmon P. Chase, decided not to exercise it. Consequently, the Congress came up with a new act in the following year which, after a series of modifications, served as the first federal income tax until its repeal in 1872.

The first law actually executed, that of July 1, 1862, taxed all income in excess of $600. The tax rate was three percent on incomes from $600 to $10,000, and incomes above $10,000 were taxed at five percent. In 1864, a new law was adopted. Income was divided into three classes. On incomes below $5,000 the rate was five percent on the excess above $600; incomes from $5,000-$10,000 were taxed at seven and a half percent; and incomes above $10,000 paid ten percent. In 1865, Congress omitted one of the classes. Under this law incomes below $5,000 paid five percent on the excess over $600 and incomes above $5,000 were taxed at ten percent. After the Civil War, the tax rates were lowered and became uniform, and the limit of exemption was gradually increased until the tax was abolished in 1872.

As expected, the constitutionality of the tax was challenged in the courts because of its similarity with a direct tax. The United States Federal Constitution requires that direct taxes must be apportioned among the states according to their population. Thus, the opponents of the income tax argued that the tax in question violated the constitutional requirement that direct taxes must be apportioned among the states according to their census. The constitutional controversy over the tax was fought before The Supreme Court in Springer v. …

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