President Woodrow Wilson succeeded in reducing the tariff rate from 40 % to 25 %. The drop in tariff revenue was to be recouped with a modest income tax .
Senator Reed Smoot of Utah used a “ mathematical calculation ” and arrived at a maximum marginal tax rate of 32 %.
North Carolina Democrat Claude Kitchin , the ranking minority member of the House Ways and Means Committee , defended a system that encouraged investment in municipal bonds .
increased . The ranking minority member of the House Ways and Means Committee , North Carolina Democrat Claude Kitchin , responded during those debates “ that for each year since 1916 … there has been a gradual increase of millions in collection of taxes from income from $ 50,000 upward . In 1919 , $ 586 million more was collected than in 1916 .” He went on to defend a system that encouraged investment in municipal bonds , asking rhetorically , “ Are not the people of the states and counties and municipalities thereby benefitted by getting a higher price for such bonds , and do not the proceeds from these state and municipal bonds go more directly for the benefit of the people than the taxes of the federal government ?”
Congressman Kitchin ’ s choice of $ 50,000 for comparison was no accident . Income taxes on the first $ 50,000 of taxable income were much lower during those years than was the tax rate on income around $ 300,000 . The marginal rate on income of the dollar over $ 50,000 was 36 %, but a single payer with $ 50,000 of taxable income in 1918 was assessed $ 11,690 in taxes , or only 23 % of his income because of the lower rates prevailing on the income below $ 50,000 . Such well-heeled taxpayers were therefore positioned to justify investment in taxable industrial bonds at 8 %, rather than state or municipal bonds at 5 %, and therefore willingly declared such amounts of taxable income .
As with so many other maddeningly complex and seemingly contradictory mathematical facts , both these debating points were true : collections on extremely high incomes of over $ 300,000 / year were decidedly down and probably for the reasons enumerated , but at the same time collections on somewhat lower but still very high incomes were up strongly due to economic and inflationary effects . It is only when the inducements to investment at each of these precise income levels are examined closely — and mathematically — that it becomes clear why both facts could be true .
The translation of these specific historical facts to the present day is imperfect . Things have changed . Marginal rates do not escalate as rapidly and to the levels they did back then . Large numbers of “ middle-class ” Americans now have wage incomes that cause them to be taxed at fairly high rates — especially when their federal tax levy is combined with the state and social insurance taxes they now must pay — and such wage income leaves them few alternatives to reduce their tax burden . Humans have not changed , however , and what may have been glaringly true to policy makers a century ago is probably true today : marginal tax rates of over 50 %
will cause taxpayers subject to those rates to look for alternatives . And alternatives they will find — regardless of whether the passage of time reveals these alternatives to be financially rewarding .
Daniel C . Munson enjoys reading and writing economic and scientific history . His writings have appeared in Barron ’ s , Financial History and other publications .
Sources
Blakey , Roy G . “ The War Revenue Act of 1917 .” American Economic Review , Vol . 7 , No . 4 . December 1917 .
Blakey , Roy G . “ The Revenue Act of 1921 .” American Economic Review , Vol . 12 , No . 1 . March 1922 .
Clements , Kendrick A . The Presidency of Woodrow Wilson . Kansas : University Press of Kansas . 1992 .
Magness , Phillip W . “ The Real History of the American Income Tax .” The American Institute for Economic Research . February 14 , 2019 .
Moskowitz , Dan . “ Are Municipal Bonds a Good Investment ?” Investopedia . January 19 , 2020 .
Piketty , Thomas . “ A Tax on Wealth is Long Overdue .” The Boston Globe . February 11 , 2019 .
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