A Century of the Federal Income Tax

By Cowen, Matthew | Financial History, Fall 2013 | Go to article overview

A Century of the Federal Income Tax


Cowen, Matthew, Financial History


This year marks the centennial anni- versary of the US federal income tax, but its history can be traced as far back as the 18th century. In Federalist Paper No. 12, Alexander Hamilton asserted that the country could make more revenue if taxes were collected at the federal, rather than state, level. The reason, he argued, was that the national government could worry about protecting one border, while the states would have to guard many borders. At the same time, Hamilton stated that the government would make its revenue largely from indirect taxes, such as imports and duties, rather than direct taxes on the income and earnings of its citizens.

In Federalist Paper No. 34, Hamilton maintained that the power to tax Ameri- can citizens should lay more with the federal government than with state gov- ernments. He wrote, "A concurrent juris- diction in the article of taxation was the only admissible substitute for an entire subordination, in respect to this branch of power, of State authority to that of the Union."

In the Constitutional sense, direct taxes are those imposed on income and earnings. Indirect taxes, or excise taxes, are those placed on goods and services, collected by a producer or retailer, and not paid directly to the federal government by a consumer. Following the plan Hamilton laid out in the Federalist Papers, the first Congress would pass, and President George Washington would sign, the Tariff Act on July 4, 1789, which sanctioned the collection of tariff duties on imported goods. Up until the Civil War, tariffs were the source of 80-95% of all federal revenue. In fiscal year 1790, the federal budget was set at $4.6 million, and (per the 1790 US census) the US population was approximately four million. Thus, an income tax of just over $1 on each person in the country would fund the govern- ment's entire budget. However, a federal income tax was unnecessary because the excise taxes covered the federal govern- ment's expenses.

With the outbreak of the Civil War, Congress needed a new way to generate revenues; thus, with the passage of the Revenue Act of 1861, the first iteration of the federal income tax was born - a 3% flat tax on all income greater than $800. Section 49 of the Act states that "From and after the first day of January next, there shall be levied, collected and paid, upon the annual income of every person residing in the United States, whether such income is derived from any kind of property, or from any profession, trade, employment or vocation carried on in the United States or elsewhere, or from any other source whatever, if such annual income exceeds the sum of $800, a tax of three per centum on the amount of such excess of such income above $800."

The following year saw the repeal of the Revenue Act of 1861 and its replace- ment with the Revenue Act of 1862. The new Act replaced the income tax sys- tem with a progressive tax of 3% for individuals whose income was between $600 and $10,000 and 5% for individuals whose income exceeded $10,000. At the same time, the Act created the Office of the Commissioner of Internal Revenue, who was appointed by the President and responsible for "preparing and distribut- ing all the instructions, regulations, direc- tions, licenses and forms pertaining to the assessment and collection of the duties, stamp duties, licenses and taxes, which may be necessary to carry this Act into effect." This office was the predecessor of the Internal Revenue Service (IRS).

Upon the conclusion of the Civil War, there no longer existed such a pressing need for revenue generation, and Congress therefore allowed the income tax law to expire in 1873. The income tax would not be revived until 1894, with the passage of the Wilson-Gorman Tariff Act. …

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