How War Shaped Modern U.S. Taxation

War Taxes Taxation United States Tax Policy Income

War & Taxes

The idea that war has in some sense impacted tax policy throughout our nation’s history should strike no one as being controversial. War and taxes have always had a close relationship, not only within the United States but across the whole globe. In fact, it is probably the case that taxes have played a role in just about every military conflict in history, though the role may not have always been overt and openly recognized. War is essentially a dispute over power, and since money is often a source of power it should surprise nobody that taxes are frequently looming in the background of such disputes.

What fewer people realize, however, is that war has arguably been the single greatest engine behind the development of U.S. tax structure since the outbreak of the War Between the States. As we will see, without war, our tax structure would likely be radically dissimilar from what it is today. The federal income tax may not have been established, and certainly the size of our government would be much smaller by comparison to what we have now.

The Birth of the Income Tax

The founders of the U.S. wished to limit the taxing power of their government and the Constitution was drafted in a fashion consistent with this desire. Up to 1861, the government of the United States had only collected excise taxes and taxes on foreign imports (tariffs); there was no controversy surrounding the income tax because no such tax had yet been imposed. This state of affairs, a state which had carried on stably for over seven decades after the writing of the Constitution, was disrupted by the War Between the States. Soon after the war broke out the Revenue Act of 1861 was passed and the first income tax was implemented on the American population. Two additional acts were passed subsequent to the act of 1861 which made modifications to the rate structure of the tax.

Though they were (supposedly) only intended as strictly wartime measures, the acts passed during the war produced an indelible precedent, and by 1894 the income tax had reemerged as part of the Wilson-Gorman Tariff Act. Whether the income tax would have been created in the absence of the War Between the States is a matter open to speculation. What is certain is that the war had a tremendous impact on the course of U.S. tax policy.

The First World War

The income tax provision of the Wilson-Gorman Tariff Act of 1894 was ruled unconstitutional by the Supreme Court with its decision in Pollock v. Farmers’ Loan & Trust Co. (1895). That ruling marked the beginning of a near two decade long hiatus during which the income tax disappeared. The income tax made its reappearance with the Revenue Act of 1913 which was developed after the taxing powers of the Congress were expanded through the sixteenth amendment.

Now, it may be untrue that the income tax itself did not reemerge as a direct consequence of the First World War; but there can be no questions of any sort that this war provided the impetus for the massive increases made to the rate structure of the income tax when it did return. When the U.S. entered the war the top rate of the income tax was changed from seven percent to an astounding sixty-seven percent; by the close of the war the top rate had been further increased to seventy-seven percent. Tax rates for individuals fluctuated after the war during the 1920s; by the end of the 1920s the top rate for individuals reached a low of 25 percent.

Rates for individuals were increased following the Great Depression and they would continue to remain high both during and long after the conclusion of the Second World War. The top rate for individuals would not fall below 30 percent until the late 1980s.

Again, we can only speculate about how U.S. tax policy would have developed without war. Was a federal income tax a historical inevitability? Would the rate structure of the income tax look dramatically different if war had not caused us to lean heavily on our wealthiest citizens and corporations? These questions can never be answered given how events have unfolded. One thing which is not open to speculation, however, is that our tax policy looks unrecognizably different than the way it looked at the time of the founding.

Image credit: Helena

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johnAbout john
Seattle CPA+John Huddleston has written extensively on tax related subjects of interest to small business owners. He is a graduate of Washington State University and the University of Washington School of Law.

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