A History of U.S. Tax Law Changes

Benjamin Franklin was correct when he said nothing was certain except death and taxes. But while taxes have been eminent, they’ve been far from consistent, especially in the United States. The tax plan has undergone a series of reforms and changes over the years, tracing its roots back to pre-independence America.

Key Takeaways

• Colonists and post-Revolution Americans paid excise taxes on everything from real estate and liquor to sugar and tobacco.
• Income taxes were first introduced to pay for debts incurred from the Civil War.
• New taxes, like Social Security, were introduced with Roosevelt’s New Deal.
• The Tax Cuts and Jobs Act of 2017 aimed to cut individual, corporate, and estate tax rates.

A Tax-Free America

Before a federal government was established, America was tax-free, at least for income taxes. Although they didn’t pay taxes on earnings, American colonists paid the British excise taxes on everything from real estate to tea. The colonists revolted, leading to the infamous Boston Tea Party and an uprising against the British in 1773.

Following the American Revolution, the newly established government was cautious about taxation, and direct taxation was prohibited by the Constitution. Government revenues were collected through tariffs and duties on liquor, tobacco, sugar, and legal documents.

The first challenge came in 1794 with the Whiskey Rebellion when Pennsylvanian farmers burned down tax collectors’ houses. Defending the right to collect indirect taxes, Congress put down the revolt using military force.

Funding War

New Taxes

The sanctity of the Constitution and the ancestral aversion to taxes was tested in the 1790s when conflict with France led to a property tax. The War of 1812 was funded through higher duties and excise taxes. The impact of the Civil War created the income tax.

The American Civil War incurred a massive amount of debt. To help pay for it, Congress passed the Revenue Act of 1861, and tax was levied on incomes exceeding $800 and was not rescinded until 1872. This act created the modern progressive tax system with allowances for deductions. The U.S. Internal Revenue Service (IRS) was founded, originally called The Office of the Commissioner of Internal Revenue.

War, Prosperity, and Depression

World War I led to three acts that raised tax rates and lowered exemption levels. The number of people paying taxes in the U.S. increased to 5%, and separate taxes were introduced for estates and excess business profits.

These taxes were rolled back following the war in five phases, and the economy experienced a huge boom. Government tax receipts reached $3.6 billion in 1918, the last year of the war. Despite lower taxes, the government raised $6.6 billion in 1920. The stock market crash in 1929 and the resulting financial fallout saw these revenues fall to $1.9 billion by 1932.

Important

The U.S. Constitution originally forbade taxes levied in proportion to each state’s population. The 16th Amendment was ratified in 1913, and an income tax was implemented on those with an annual income of over $3,000, affecting less than 1% of Americans.

The New Deal

Roosevelt’s New Deal and WWII saw taxes introduced or increased to boost the economy. The New Deal ran a heavy deficit that required revenue. By 1936, the top tax rate was a staggering 79%, and the economy’s output plummeted. Taxes were raised several more times, except the 1938 Revenue Act contained a corporate tax cut that Roosevelt objected to but nevertheless signed into law.

By 1940, the need for the U.S. to prepare for war and support its allies led to aggressive taxation. By 1944, those with incomes of $500 faced a 23% tax, and the rates climbed to 94%. By 1945, 43 million Americans paid taxes, and the yearly receipts were more than $43 billion, up from $8 billion in 1941.

Note

The Social Security Act of 1935 was part of Roosevelt’s New Deal.

Nixon and Stagflation

The Revenue Act of 1945 rolled back $6 billion in taxes, but the burden of Social Security and an expanded government kept them from going much lower. The highest tax rate was over 80% in the 1950s, and the pay-as-you-go withholding system introduced as a wartime measure was never eliminated.

Rather than rolling back rates, the tax code was being rewritten to allow deductions or to lower rates on private foundations while raising rates on corporate profits. This explosion in loopholes made the tax code difficult to understand.

The 1960s and 1970s were a time of massive inflation, with government deficits growing with the addition of Medicare to the Social Security system. Taxes were not indexed for inflation, and the real value of income decreased. President Richard Nixon was forced to pay over $400,000 in back taxes, but the controversy over the Watergate scandal eclipsed the president’s tax evasion.

Reaganomics

The Economic Recovery Tax Act of 1981 was a temporary turning point for taxation. This Act significantly lowered all the individual tax brackets and changed how companies accounted for capital expenditures, encouraging investment in equipment.

The Reagan administration’s budget was based on an accepted inflation rate, and when the attempts to quash inflation kicked in too quickly, a deficit was created. Consequently, Reagan decreased some of his tax cuts in 1984 to cover the shortfall. In 1986, the IRS claimed that 941,000 Americans were millionaires, partially due to the high-level tax cuts under Reaganomics.

In 1986, another tax reform act lowered the top rate from 50% to 28%, cutting corporate taxes from 50% to 35%. With more Americans now willing to take their wealth in taxable income, the overall tax receipts were relatively unchanged despite the drop.

Negative Income Tax

Under President Bill Clinton, modest tax increases started in 1993, and 1997 saw the expansion of negative income tax. Negative income tax allowed those below certain income thresholds to obtain tax credits.

New Millennium Tax Cuts

The Great Recession

The 2001 tax cut introduced by former President George Bush once again dialed back the trend of tax increases but continued to increase tax credits and negative income tax. Though not intended for it, this long-term tax cut helped shorten the recession following the dot-com market crash, sparing the economy from any specific stimulus measures. The tax cuts expired in 2010 just as baby boomers were leaving the workforce and the world was reeling from the effects of the financial crisis and the Great Recession.

2017 Tax Cuts and Jobs Act

In 2017, Congress passed the Tax Cuts and Jobs Act (TCJA), based on Reagan Administration tax proposals to slash individual, corporate, and estate tax rates. The law made a series of concessions, including cutting tax rates across various income tax brackets. The TCJA lowered tax rates across income levels to reduce Americans’ income tax burden and eliminated popular itemized deductions.

The Tax Cuts and Jobs Act is set to expire at the end of 2025 unless it is extended by Congress, which, if it happens, is expected to cost more than $4 trillion over 10 years.

What Is an Example of a Tax Law?

The Social Security and Medicare withholding are examples of a tax law, as is paying taxes on capital gains.

What Is the $600 Tax Law?

The Internal Revenue Service requires anyone who makes $600 or more to report the income.

What Is US Tax Law?

U.S. tax law dictates how and when people, businesses, and entities must pay taxes. The U.S. Constitution allows the government to receive taxes to fund itself.

The Bottom Line

After the American Revolution, Americans paid excise taxes on liquor and real estate. Income taxes were first introduced during the Civil War. The 16th Amendment of the U.S. Constitution provided the ability to levy taxes on individual states. Taxation provides funds for Social Security, Medicare, education, and military spending.