As Congress focuses on tax reform, it might be helpful to look at where we are now and how we got here. Generally, Americans do not like taxes. And taxation without representation is the worst kind. Colonial protests against British taxes led to the American Revolution in 1775. But when that ended and the colonies formed their own central government, we had to determine what that government would do for us, and had to find a way to pay for those services.
Over our country’s history, taxes have come and gone and rates have risen and fallen depending on the needs of the federal government. When we needed money for wars, disasters, or to address infrastructure or social needs, our leaders imposed taxes. When the wars or other needs subsided or ended, or to stimulate the economy, they reduced or repealed the taxes.
When our country was formed in 1781, there were no national taxes. None at all. The States had that power, and used it to support both themselves and the federal government. There were no State income taxes at the time. Instead, States raised money with poll taxes on voters, property taxes, and other levies. They then shared some of their collections with the federal government. The Constitution, adopted in 1789, gave the federal government the power to raise taxes. But most of the money they raised was from tariffs, which also served as a tool for economic and trade policy.
Tranquility ended twenty-three years later, during the War of 1812, when the United States burned Toronto to the ground, and the British retaliated by burning Buffalo and other U.S. cities. We were at war again, and needed money, so individual and business taxes were added to fund the war and save the Nation.
By 1817, after that war ended, all individual and business taxes were repealed, and they were not brought back for more than four decades. How did the federal government pay the bills without taxes? Customs duties and Western Land Sales met our modest needs. But tariffs in the 1820’s and 1830’s also contributed to friction between the North and the South. Tariffs were lowered for a time to meet the demands of the South, but they fluctuated as our leaders tried to influence international trade policies.
Individual and business taxes came back in the 1860’s to fund the Civil War. The very first income tax, at a flat 3 percent rate on income exceeding $800, was added. It lasted twelve years. But was it Constitutional? It wasn’t clear the Congress had the power to impose an income tax, especially one that might have brackets and different rates. The 16th Amendment to the U.S. Constitution addressed that question. It was adopted in 1913 and had a progressive income tax ranging from 1 to 7 percent. The 1040 income tax form that we still use was created at that time. The top rate rose to 77 percent in 1918 during World War I, but only 5 percent of all U.S. people paid any tax. After the war, rates fell from 77 percent to 25 percent in the roaring 20’s before rising again to 79 percent in 1936 as World War II was looming. During the war, President Roosevelt called for a 100 percent tax on all income exceeding $25,000. That never happened, but the top rate rose to 94 percent on all income over $200,000 and the lowest rate was 23 percent. To ensure compliance, payroll withholding and quarterly estimates were added. During the Korean War in the 1950’s the top rate was 87 percent. By 1964 it was 91 percent.
In 1981, when the inflation rate in the U.S. topped 13 percent, Ronald Reagan cut the top rate to 50 percent, and in 1986 he cut it again to 28 percent, with a 35 percent top corporate rate, the same corporate rate we have today. Since then the top individual rate has been between 33 percent and 39.6 percent, which is the current rate. Now Congress is considering lowering the top individual rate to 35 percent and the top corporate to 20 percent.
Federal tax cuts may be coming. Are top income tax rates too high? Are estate taxes too high? As you can see, they have been much higher and much lower in the past 200 years. As they say, when projecting the future of taxation, the only constant is change.
Richard S. Bernstein, CEO of Richard S. Bernstein & Associates, Inc., West Palm Beach, is an insurance advisor for high net worth business leaders, families, businesses, municipalities, and charitable organizations. An insurance advisor to many of America’s wealthiest families, he is a writer, trusted local and national media resource and expert speaker on estate planning and health insurance. Visit his website at www.rbernstein.com. To read more of his reports — Click Here Now.
Paul R. Comeau is a partner and former Chair of Hodgson Russ LLP, a Palm Beach, New York, and Toronto law firm. He is a Florida and New York attorney and heads a group that has handled thousands of residency audits. He focuses on tax, estate planning, and multistate tax issues for high net-worth individuals and businesses. He is listed in Best Lawyers in America and Superlawyers. He can be reached at 561.656.8608 or e-mail firstname.lastname@example.org.
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