Americans pay many different types of taxes, but this section of DiscoverTheNetworks focuses primarily on income taxes that are imposed on individuals, family units, and corporations.
The United States had few taxes in its early history. From 1791 to 1802, the federal government was supported by internal taxes on distilled spirits, carriages, refined sugar, tobacco and snuff, property sold at auction, corporate bonds, and slaves. The high cost of the War of 1812 brought about the nation's first sales taxes on gold, silverware, jewelry, and watches. In 1817, however, Congress did away with all internal taxes, relying on tariffs on imported goods to provide sufficient funds for running the government.
In 1862, in order to support the Civil War effort, Congress enacted the nation's first income tax law. At that time, a person earning from $600 to $10,000 per year paid tax at the rate of 3 percent. Those with incomes of more than $10,000 paid taxes at a higher rate. Additional sales and excise taxes were added, and an “inheritance” tax also made its debut. In 1866, internal revenue collections reached their highest point in the nation's 90-year history—more than $310 million, an amount not reached again until 1911.
In 1868 Congress again focused its taxation efforts on tobacco and distilled spirits. In 1872 it eliminated the income tax. In 1894 the income tax was revived, but the following year the U.S. Supreme Court ruled that such a tax was unconstitutional because it was not apportioned among the states in conformity with the Constitution.
The federal corporation income tax was adopted in the United States in 1909. Four years later, the 16th Amendment to the Constitution made the income tax a permanent fixture in the U.S. tax system. The Amendment gave Congress legal authority to tax income, and it resulted in a revenue law that taxed incomes of both individuals and corporations. In fiscal year 1918, annual internal revenue collections for the first time passed the billion-dollar mark, and rose to $5.4 billion by 1920.
With the advent of World War II, employment increased, as did tax collections—to $7.3 billion. The withholding tax on wages was introduced in 1943 and was instrumental in increasing the number of taxpayers to 60 million and tax collections to $43 billion by 1945.
In 1981 Congress enacted the largest tax cut in U.S. history, approximately $750 billion over six years. This reduction, however, was partially offset by two tax acts, in 1982 and 1984, that attempted to raise approximately $265 billion.
On October 22, 1986, President Ronald Reagan signed into law the Tax Reform Act of 1986, one of the most far-reaching reforms of the United States tax system since the adoption of the income tax. The top tax rate on individual income was lowered from 50% to 28%, the lowest it had been since 1916.
The Revenue Reconciliation Act of 1990 was signed into law on November 5, 1990, by President George H.W. Bush. It emphasized increased taxes on the wealthy.
On August 10, 1993, President Bill Clinton signed into law the Revenue Reconciliation Act of 1993, a tax hike whose stated purpose was to reduce the federal deficit by approximately $496 billion. Four years later, Clinton, under pressure from the Republican-dominated Congress, signed a bill that cut taxes by $152 billion and included a capital-gains tax reduction for individuals, a $500-per-child tax credit, and tax incentives for education.
President George W. Bush signed a series of tax cuts into law during his administration. The largest was the Economic Growth and Tax Relief Reconciliation Act of 2001, which was projected to save taxpayers $1.3 trillion over ten years, making it the third largest tax cut since World War II. The Bush tax cut created a new lowest tax rate -- 10% for the first several thousand dollars earned. It also cut the top four tax rates (from 28% to 25%; from 31% to 28%; from 36% to 33%; and from 39.6% to 35%).
The Jobs and Growth Tax Relief and Reconciliation Act of 2003 accelerated the tax-rate cuts that had been enacted in 2001, and temporarily reduced the tax rate on capital gains and dividends to 15%. In 2004 Congress passed a cornucopia of tax breaks, which for individuals included an option to deduct the payment of whichever state taxes were higher, sales or income taxes.
Two additional tax bills (signed in 2005 and 2006) extended through 2010 the favorable rates on capital gains and dividends that had been enacted in 2003, raised the exemption levels for the Alternative Minimum Tax, and enacted new tax incentives designed to persuade individuals to save more for retirement.
Currently the largest item in the U.S. budget is Social Security, for which 21 percent of all tax dollars are earmarked. In addition, Medicare funding requires 13 percent of all tax dollars, and Medicaid requires 8 percent. Nonmilitary discretionary spending accounts for 18 percent of the budget; interest on the national debt accounts for 8 percent; military spending accounts for 19 percent; and other items make up the remaining 13 percent.
Like taxes, government regulation -- whose purpose is to create social or economic benefits that presumably would not occur naturally in a pure market economy -- also has a profound effect on the American economy. According to the Institute for Research on the Economics of Taxation (IRET), the "[b]enefits of regulation may be real, as with the prevention of accident, injury, or disease, or the reduction of damage from pollution." But those benefits "are not without costs." For example, says IRET, "Regulation of drugs may prevent the introduction of products with harmful side effects, but it may also delay the release of lifesaving products. Inspection of food may prevent disease, and safety features on cars may prevent injury, but they also raise the price of food and transportation." Federal environmental, safety and health, and economic regulations cost hundreds of billions—perhaps trillions—of dollars each year over and above the costs of official federal outlays.
The RESOURCES column located on the right side of this page contains links to articles, essays, books, and videos that explore such topics as:
- how the tax burden is distributed among various income groups, dispelling the myth that high earners do not pay their "fair share" of taxes;
- why lower taxes tend to increase business activity and thus produce greater revenues for the government, whereas high taxes tend to discourage business activity and therefore lead to lower revenues for the government;
- how excessive public-sector spending harms the economy and leads to mounting debt;
- the theory behind, and the repeated failures of, Keynesian economic policies;
- why monetizing the government's debt is a dangerous practice that inevitably causes hyperinflation;
- the economic counter-productivity of the estate tax, or so-called "death tax";
- government regulation and its costs; and
- the relative benefits and costs of outsourcing jobs overseas.
Adapted mostly from "History of the Income Tax in the United States," by the Tax Foundation (2007).