The next time a politician tempts you with talk about a temporary tax, you might recall this Forbes article from Amity Shlaes.
Just as they are doing today, lawmakers in the early 20th century were busy casting about for ways to financially help themselves, the government and the economy. Many of them, especially Democrats, recognized that the economy could grow even faster if goods and services moved more freely across borders. But there was a fiscal challenge: Trade tariffs provided most of the government’s revenue.
Lawmakers put forward legislation to achieve their trade goals–the Underwood Tariff, which cut rates on goods from wool to iron and increased the list of items not subject to tariff. To make up for the predicted revenue shortfalls legislators came up with the Sixteenth Amendment, which created that little device, the income tax.
The new levy was presented as a small afterthought, to “take up the deficiency,” as lawmakers put it. It was there to help free trade and the economy, not the other way around. “A feature of the tariff revision programme of the extra session of Congress may include the raising of $100 million from an income tax,” commented the New York Times . In newspapers of the period you’ll find more verbiage about the mohair tariff or Angora goats than you will about the new income tax.
To be sure, people had heard of income taxes abroad and of their efficacy (just as we today hear about VATs in Europe). “Some Democrats Think Proposed New Impost Should Be Mainly Borne by the Wealthy,” the Times suggested delicately. The lawmakers who drew up the amendment crafted the tax schedule as steeply as they could get away with, targeting only the wealthy and selecting a rate higher than their wildest dreams thought would fly: 7%. That rate affected only those earning over $500,000–today’s equivalent of more than $10 million.
But then something happened: The income tax worked–so well, in fact, that even the Treasury was shocked. Officials, pleased with their toy, played with it, raising rates. Within years of its quiet introduction the income tax’s top rate had moved from 7% to more than 70%. In short order the little gizmo was bringing in more money than the old tariff engine. Officials could not contain their glee. “The growth in income tax receipts is one of the marvels of modern finance,” cooed former Treasury Secretary William McAdoo in the 1920s. Except for a too-brief drop in the 1920s the income tax rate remained high. And in the 1940s, during World War II, officials made the class tax a mass tax by introducing withholding and shrinking the exemption. The beast never looked back.