16th Amendment

There was a lengthly political debate in the 1800's about establishing an income tax in the US. There was an income tax during the Civil War, but it was repealed when the war was over. After much debate, an income tax law was passed in 1894, but it was declared unconstitutional by the Supreme Court. To remedy that, the 16th Amendment to the Constitution was ratified in 1913. It specifically authorizes Congress to tax income. It is only one sentence long: "The Congress shall have 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." It is certainly amazing that one sentence could give birth to what must now be billions of words, millions of pages and trillions of dollars changing hands. You might say it was the Big Bang of taxes.

Dividends

Dividends were exempt from personal income tax until 1936. (See previous post for the reason why.) From 1936 through 1939 they were fully taxable. Then from 1940 through 1953 they were exempt again. From 1954 through 1984 they were mostly taxable, with small exempt amounts--$50 till 1964, going eventually up to $1500 for a married couple if the dividends were from utilities. They were fully taxable from 1985 through 2002. Since then they have been taxed at a top rate of 15%, but for people in the two lowest tax brackets, dividends are not taxed at all. They are scheduled to become fully taxable in 2013 unless Congress decides otherwise before then.

1040 1913

The first tax form, the 1040 for 1913, already had some complexity to it, but most of the details were laid out right on the form. It was three pages long, plus another page for instructions. That's right, just one page of instructions. The 2011 1040 instructions are about 100 pages long, not including the instructions for the additional schedules such as Itemized Deductions. In 1913 there were no additional schedules. The General Deductions, forerunner of today's Itemized Deductions, took up about 1/3 of page 3. The instructions say that people who made less than $3,000 did not need to file at all. Since the average salary that year was about $750 per year, that meant that most people were not bothered by income tax. Another interesting side note is that dividends of corporations subject to income tax were subtracted from taxable income on this form 1040. Nowadays dividends are subject to what is famously called "double taxation." The dividends are paid from corporate profits that have already been taxed at the corporate level. Then when the dividends are received by individuals, they are taxed again. This was not the case in 1913.

Average incomes

An interesting website at visualizingeconomics.com has lots of graphs of historical average incomes in the US, historical tax brackets, etc. Strangely, I don't see anywhere on it whether the historical incomes are adjusted for inflation, though it seems obvious they must be. Average income in 1913 was around $14,000 according to the graph. The top of the lowest tax bracket that year was an inflation-adjusted $453,292. That was the last time the gap was anywhere near that big. In 2006 the graph of income shows an average of about $50,000 per year. The top of the lowest tax bracket was an inflation adjusted $16,806 for a married couple and $8,403 for a single person. The tax rate for the lowest bracket in 1913 was 1% (one percent). In 2006 it was 10% and still is today, at least until the end of this year.

The way it was

The Tax Foundation (a nonpartisan tax research group based in Washington, DC) has posted a list of all income tax rates and brackets since the beginning of the modern income tax in 1913. The lowest tax bracket in 1913 covered taxable income from zero to $20,000. The top tax bracket of 7% covered all income above $500,000. Adjusted for inflation, that 1% bracket would cover taxable income from zero to $453,292 in 2012 dollars. The top tax bracket of 7% would cover all income above $11,332,304 (in 2012 dollars). There was no differentiation between married, single, head of household, etc. There was only one set of rates and brackets. By 1918 the top rate had skyrocketed to 77% for income above $1,000,000 ($14,859,578 adjusted for inflation). The lowest rate had jumped from 1% to 6%, and it was good only up to $4,000 of taxable income ($59,438 in 2012 dollars). Above $4,000 the rate doubled to 12%. No doubt World War One was to blame for the big jump in taxes. The rates went down in the 1920's, but back up beginning in 1932. (Higher taxes probably did not help the economy recover from the Depression.) By 1936 the top rate was up to 79%, but the lowest rate of 4% covered a bracket that, adjusted for inflation, went up to $64,570. Taxes went sky-high in World War Two, with a top bracket of 94% and a low bracket of 23% that went from zero to only $2,000 (which would be $24,931 today). Tax rates declined only slightly in the 1950s, and then a little more in the 1960s. However in 1964 the top of the bottom bracket went down to only $1,000 ($7,238 in 2012 dollars). The other brackets also became similarly squashed in ensuing years. The rates themselves stayed about the same through the 1970's. Tax rates began declining in the early 1980's.

Phew

Tax season is over. Finally! I'm sure everyone missed me and has been wondering why I have not been blogging for a while. Hopefully in the coming weeks and months we will take a look at the tax picture for 2012 and maybe a little bit beyond that. We know pretty much what the tax picture is for 2012, because it has been officially established (for the most part). It will be basically the same as 2011. Beyond 2012, no one really knows. A lot will depend of the election in November. So... Vote! If popular demand demands it, we may take a look at some general theories of taxation. Like, what the heck is Congress thinking when it passes certain tax laws? And why? Also maybe some of the "intellectual foundations" if any such exist. Be sure to make known your comments, suggestions and questions. Thank you.

Gift tax crackdown, Part 2

As we posted on 5/31/11, the IRS wants to crack down on people who transfer assets to family members with little or no consideration without filing a gift tax return. At that time a court had decided that the state of California was not required to give the IRS the names of such people, because the records existed at the county, not the state level. Now the court has changed its mind and told California to give the information to the IRS. The IRS is seeking such information from several other states as well.