Although the federal government had successfully operated without an income tax for 124 years under the Constitution, the American people in 1913 chose to ratify the Sixteenth Amendment, giving Congress the “power to lay and collect taxes on incomes, from whatever source derived.” It is reasonable to expect that the people would not have granted such a broad power to the federal government unless circumstances required it. So what prompted this desperate action? Why was an income tax suddenly necessary in America 100 years ago?
In truth, it wasn’t needed at all. Total federal tax revenue was at an all-time high in 1913, and tax receipts that year were almost 25 percent higher than they were in 1909, the year Congress submitted the Sixteenth Amendment to the states for ratification.
Moreover, there was no debt crisis. In 1909, the national debt was only 8.2 percent of the gross domestic product (GDP). By 1913, the debt-to-GDP ratio had actually dropped to 7.5 percent. In comparison, the nation’s debt-to-GDP ratio in 1791 was 37 percent, which resulted from the federal government’s assumption of all state debts incurred during the Revolutionary War. And despite this large debt, the federal government succeeded in paying it off entirely by 1835, without a tax on income.
Given the manageable national debt and rising tax receipts in 1913, there really was no need for another source of federal revenue, and many proponents of the income tax didn’t even speak of its necessity in that day. They instead argued that the tax might prove useful in some future, unspecified situations. Senator Norris Brown, who was the first to propose the Sixteenth Amendment in Congress, opined that the income tax might be wielded only “in national emergencies” or “when necessary to the life of the republic.” He further said, “Whether the [income-tax] power shall be exercised, when it shall be exercised, or whether it shall be exercised at all, are other questions entirely aside from the question of whether the government shall be vested or stripped of the power.” In essence, many supporters of the income tax viewed it as a tool of convenience for the federal government—a power to be used infrequently, if ever, with a limited impact on the people.
But then there were other progressives who viewed the income tax as essential in transforming the national government into an instrument for social justice. They knew that a controlling centralized government needed the financial backing necessary to achieve their progressive aims of providing for the people and leveling economic conditions. So they encouraged other Americans to support the Sixteenth Amendment as a means to sacrifice their property for the greater good, to government. One such advocate referred to the income tax as a “most just and equitable tax” and urged, “Men should contribute to the needs of the state as God has prospered them.”
It was not long before progressive Democrats began demanding these contributions from the people by law. Two months after the Sixteenth Amendment was ratified, President Woodrow Wilson summoned a special session of Congress to ask for new taxes on income. The country was not at war, and there was no national emergency. Regardless, the Democratic-controlled Congress enacted Wilson’s proposed Revenue Act of 1913, and the first constitutional income tax went into effect that year.
The federal income tax initially had a small impact on most Americans, but this was short-lived. By 1918, the tax exemption level dropped below the median income, so many more individuals were compelled to pay an income tax, and the top income-tax rate jumped to 77 percent.
Similar income-tax expansions occurred under Democratic President Franklin D. Roosevelt. He increased the tax burden on lower-income earners by reducing personal exemptions and by eliminating the earned income tax credit. And he repeatedly raised taxes on higher-income earners—their rates increased from 63 percent in 1932 to 81 percent in 1940 and then up to 90 percent in 1944.
Although the highest tax rates have dropped over time, the collective income tax burden on the American people has only gotten heavier, for over 90 percent of all federal revenue (more than $2 trillion) is now collected under the income tax. There are other costs associated with this tax as well. American businesses and individuals spend approximately $431 billion each year on income tax compliance costs, which include tax preparation, administration, and enforcement costs. In addition, the income tax system often forces businesses and individuals to alter their behavior in ways that result in lower-valued outcomes than would have occurred in the absence of tax-driven decision making. According to a Government Accountability Office study, these economic efficiency costs are estimated to be between 2 and 5 percent of GDP—in a $15 trillion economy, this cost is anywhere between $300 and $750 billion.
Given the income tax’s broad reach, intrusive informational requirements, time-consuming preparation, costly compliance, and coercive control on the people, it is no wonder why our Founding Fathers left it out of the Constitution. They favored consumption taxes instead and gave Congress the power to levy “duties, imposts, and excises” in Article I of the Constitution.
Writing in The Federalist, No. 21, Alexander Hamilton explained why consumption taxes were so desirable. Consumption taxes would maximize economic liberty, he said, because the amount of tax to be paid “by each citizen will in a degree be at his own option, and can be regulated by an attention to his resources. The rich may be extravagant, the poor can be frugal. And private oppression may always be avoided by a judicious selection of objects proper for such impositions.” Hamilton added that consumption taxes were also consistent with the Constitution’s limited design, for any attempt by the national government to overburden the people with taxes would be self-defeating. He wrote:
It is a signal advantage of taxes on articles of consumption that they contain in their own nature a security against excess. They prescribe their own limit; which cannot be exceeded without defeating the end proposed—that is, an extension of the revenue. . . . If duties are too high they lessen the consumption—the collection is eluded; and the product to the treasure is not so great as when they are confined within proper and moderate bounds. This forms a complete barrier against any material oppression of the citizens, by taxes of this class, and is itself a natural limitation of the power of imposing them.
While a natural restraint on federal power is inherent in a consumption tax, no such limit exists with an income tax. As we have seen throughout history, the level of income tax imposed by Congress has been completely arbitrary and virtually unlimited. And because the Sixteenth Amendment is so broad, politicians have been able to use the income tax in ways that exceed its fundamental purpose of raising revenue for government. The income tax has effectively become a tool to implement social policy. Those in power can carve out special tax breaks and subsidies for politically favored groups or industries, and they can create new federal regulations that would otherwise be unconstitutional but for their income tax penalties for noncompliance (e.g., the Affordable Care Act).
It is safe to say that most Americans who voted to ratify the Sixteenth Amendment had no idea what the income tax would become over time. Looking back on 100 years of history, it should be clear to us now that their faith in government to responsibly apply the income tax was grossly misplaced.
So perhaps we should return to the tax system that our founders instituted. Perhaps we should recognize, as they did, that government operates by coercion, not benevolence, and that those who speak of its goodness are only seducing us into submission. Thomas Paine once wrote, “It can only be by blinding the understanding of man, and making him believe that government is some wonderful mysterious thing, that excessive revenues are obtained. . . . It is the popery of government; a thing kept up to amuse the ignorant and quiet them into taxes.” After 100 years of income tax obedience, are we still so easily amused?