Forget 47%. Only 1 in 7 Would Face Levy With First System

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Photographer: Spencer Platt/Getty Images

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If the U.S. had the same income tax rules it did when the levy started 100 years ago this weekend, 86 percent of households would be exempt from paying it.

That figure, according to data compiled by Bloomberg, far outpaces the 47 percent estimate for nonpayers cited in last year’s presidential campaign. The first levy, adjusted for inflation, would only affect individuals with taxable incomes of more than $69,574 a year -- and then with a bottom rate of just 1 percent and a top marginal rate of 7 percent.

The original income tax, if still in place, would raise about $45 billion, or 3 percent of what today’s individual income tax generates, said Bloomberg Government analyst Patrick Driessen, who generated the estimate by applying the 1913 brackets to today’s income patterns.

“These were really taxes on the rich,” said Carolyn Jones, a law professor at the University of Iowa who studies the history of U.S. taxation.

Today’s debate in Washington over the size of government and how to pay for it can be traced to the enactment of the Sixteenth Amendment, which permitted the tax. Its creation set the U.S. on the path toward a larger central authority and cemented distributional politics, in which the government could fine-tune economic policy to steer tax breaks to favored groups and extract money from others.

Amendment’s Text

The amendment, ratified on Feb. 3, 1913, in the waning days of Republican William Howard Taft’s administration, changed the Constitution for the first time in 43 years. The one-sentence statement gave Congress the “power to lay and collect taxes on incomes, from whatever source derived.”

The amendment was written in response to an 1895 Supreme Court decision that invalidated a prior income tax. The drive to re-create a levy first imposed during the Civil War was propelled by a coalition of economists and populists, Jones said.

“It was significant in terms of moving away from a tariff- based consumption tax and reliance on sin taxes to something that more resembles ability to pay,” she said.

President Woodrow Wilson, a Democrat, signed the modern income tax into law Oct. 3, 1913, combined with a reduction in tariffs. The first 1040 form emerged soon after from what was then known as the Bureau of Internal Revenue, and it applied retroactively to income earned starting on March 1.

Tax Form

That initial tax form is a model of simplicity, weighing in at four pages, including instructions.

It didn’t incorporate many features of today’s tax system. Taxpayers didn’t have preferential rates on capital gains and dividends. They couldn’t deduct charitable contributions. Still, they could deduct all interest “on personal indebtedness of taxpayer.”

The 1913 tax code set a basic 1 percent tax rate on annual income exceeding $3,000 for individuals and $4,000 for married couples. A “super tax” with six 1 percent steps began at $20,000, or about $464,000 in today’s dollars.

The threshold for the top rate -- the 1 percent tax and a 6 percent super tax -- began at $500,000. In nominal dollars, that’s actually higher than the $450,000 starting point for today’s 39.6 percent top bracket for married couples.

In inflation-adjusted dollars, the 1913 tax code would spare everyone from the highest tax rate except those earning more than $11.6 million.

The estimates of the income break points come from using the Bureau of Labor Statistics’ inflation calculator.

World War I

The income tax expanded when the U.S. entered World War I in 1917. Jones said the additional revenue source provided by the levy allowed the government to ban the sale of alcohol and forgo the accompanying tax revenue in 1919.

A mass tax wasn’t needed until World War II, when it was used to fund the war and restrict domestic inflation, Jones said. After the war, President Harry Truman’s administration chose to keep the broad-based tax to ensure financing for a defense buildup for the Cold War.

Attention to the current 47 percent who don’t pay income taxes emerged during the presidential campaign last year with the release of a recording of Republican candidate Mitt Romney talking to donors. Republicans’ low-tax message, he said, doesn’t resonate with nonpayers, who expect benefits from the government.

“And so my job is not to worry about those people,” he said. “I’ll never convince them that they should take personal responsibility and care for their lives.”

Romney Comments

Democrats seized on Romney’s comments -- and pushed tax credits for families and education through Congress on Jan. 1 that will keep more households off the income tax rolls.

The Sixteenth Amendment itself makes occasional entries into contemporary politics. The Republican Party’s 2012 platform said that any value-added tax or national sales tax “must be tied to the simultaneous repeal” of the amendment.

The income tax has caused U.S. economic growth to be slower than it would be otherwise, said Will McBride, chief economist at the Tax Foundation, a Washington-based group that favors a simpler, flatter tax code.

“As a direct result of the burden of the income tax, and the fact that so many people pay it, over the years there’s been an accumulation of ways to take it apart, to carve out loopholes,” he said. “It would be completely unrecognizable and unpredictable. It didn’t evolve in any sort of rational way.”

To contact the reporter on this story: Richard Rubin in Washington at rrubin12@bloomberg.net

To contact the editor responsible for this story: Jodi Schneider at jschneider50@bloomberg.net

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