tariff was another major political issue during the late 1800s and early 1900s. Westerners and southerners continued to blame tariffs for high finished-goods prices, thereby making eastern capitalists wealthy at their expense. At the same time, many Americans, regardless of where they lived, believed that corporations and wealthy Americans should pay income taxes. President Theodore Roosevelt, who occupied the White House from 1901 to 1909, never advocated tariff reform, but in 1906 he did come out in support of an income tax.
Three years later, incoming president William Howard Taft pressed the Republican Congress to modify the tariff law, and the result was the 1909 Payne-Aldrich Tariff Act. Passed after a frenzy of lobbying by various manufacturing groups, the bill lowered tariff rates on some items, but in many cases they were goods that were not imported, or imported only in small quantities. Meanwhile, well over half the tariffs were raised. Congress had hardly “reformed” the law, and everyone knew it. In disgust, a group of congressional Republicans split from their party and aligned themselves with the Democrats. President Taft tried to defuse the party revolt by coming out in support of a corporate profits tax and recommending that Congress approve a constitutional amendment making an income tax possible. These bills passed Congress, apparently because many Republicans in the House and Senate viewed them as the political cost of keeping the protective tariff in place (Carson 1977, 78–80).6
The proposed amendment would give Congress the authority to impose an income tax that was not apportioned among the states according to population. In 1909, Congress approved the following and sent it to the states for ratification:
The Congress shall have the power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration.
Many have speculated about whether the Republicans actually wanted the states to ratify the amendment, contending that it was political cover for the upcoming 1910 congressional elections. If so, the strategy failed miserably, because the Republicans lost the House in 1910 and the Senate in 1912. Also in 1912, Theodore Roosevelt ran for president as a third-party candidate, which split the Republican vote and allowed Democrat Woodrow Wilson to emerge victorious. Once again, the Democrats controlled both the federal executive and legislative branches.
The Amendment Passes
Garnering considerably more support in the East than contemporary observers predicted, the Sixteenth Amendment was ratified on February 3, 1913. President Wilson was inaugurated in March, and during the summer Congress debated an income tax law that was ultimately included in the Underwood Tariff Act. Tariff rates were dropped to their lowest levels since before the Civil War. The new income tax was supposed to make up for the lost tariff revenue, and this part of the bill was short and simple, taking up only 14 pages of U.S. law. The four-page tax form (including instructions) defined income as coming from several sources, including wages, dividends, interest, business profits, and capital gains. It allowed deductions for expenses, including interest, taxes, casualty losses, depreciation, and uncollectible debt. All information was self-reported, and after determining net income, the following tax table applied for married couples:
| Income | Tax Rate |
| $0–$3,999 | 0% |
| $4,000–$20,000 | 1% |
| $20,001–$50,000 | 2% |
| $50,001–$75,000 | 3% |
| $75,001–$100,000 | 4% |
| $100,001–$250,000 | 5% |
| $250,001–$500,000 | 6% |
| Greater than $500,000 | 7% |
Source: www.irs.gov/pub/irs-utl/1913.pdf.
At the time, a middle-class family earned an annual income of around $500–$700 per year, so the vast majority of Americans were exempt from the tax.7 Largely for this reason, the arrival of the personal income tax was greeted with little public fanfare.
More Revenue Needed
The first tax returns were filed in the spring of 1914, and just a few months later World War I began in Europe. Initially, most Americans wanted no part of the conflict, but attitudes changed in 1915 when the German navy torpedoed the passenger ship Lusitania, killing 1,198 people, of whom 139 were Americans. This event inflamed anti-German feelings in the United States, and the U.S. federal government responded by increasing expenditures on defense goods. By 1916, higher defense spending combined with falling revenue from customs duties (due to fewer imports from war-torn Europe) caused the government to incur a sizable budget deficit. More revenue was needed, and the income tax was suddenly, conveniently available.
The Emergency Revenue Act of 1916 raised the tax rate on incomes above $4,000 from 1 percent to 2 percent, and pushed the top rate to 13 percent on incomes above $2 million. Several other taxes were also raised, including excise taxes on alcohol and tobacco and taxes on the profits of war munitions manufacturers. In addition, a federal inheritance tax was imposed. However, the deficit continued to expand because of the ongoing military buildup. So Congress raised rates again in 1917, just months before the United States finally declared war. The War Revenue Act of 1917 lowered the tax-exempt income level from $4,000 to $2,000 for a married couple and established tax brackets that ranged from a tax rate of 2 percent to 50 percent on incomes over $1 million. In addition, tax rates were increased on corporate profits and inheritances, and several excise taxes were raised.
The 1917 War Revenue Act was a significant event because, as Witte notes, “the crucial result was the discovery of how easily and quickly large sums of revenue could be raised through the income taxes” (1985, 81). The next year another Revenue Act (1918) was passed that returned the exempt income amount back to $4,000, but elevated the bottom tax rate to 12 percent and the top rate to 77 percent on incomes above $1 million. Higher tax rates in conjunction with the booming war economy caused federal revenue to soar. Here are federal revenue data from 1915 to 1920:
| Year | Revenue (millions) |
| 1915 | $683 |
| 1916 | $761 |
| 1917 | $1,100 |
| 1918 | $3,645 |
| 1919 | $5,130 |
| 1920 | $6,648 |
Source: U.S. Bureau of the Census (1975, 1106).
During these years, taxes on individual incomes and corporate profits accounted for about two-thirds of total revenue (Faulkner 1960, 598). The top rates were now punitive, a fact recognized by both President Wilson and Treasury Secretary Carter Glass. They believed that high tax rates could have an adverse affect on economic activity by reducing the incentive to earn income (Witte 1985, 88).
In summary, World War I was a very important event in the history of the U.S. income tax because it starkly demonstrated the income tax’s ability to raise major amounts of revenue quickly. In addition, it marked the first time
