Financial History Issue 129 (Spring 2019) | Page 25

bankruptcies. It provided an excellent backdrop for the emerging consortium of the disaffected groups noted above to push their congressional representatives to impose a progressive income tax on the wealthy. In addition to reducing tariffs, the Wilson-Gorman Act of August 1894 introduced a 2% federal tax on individual income. Members of both the Populist and Democratic parties supported the reduction in tariffs and the concomitant establishment of a graduated income tax with a relatively high exemption. Tak- ing these actions would not disrupt the level of federal revenue but would shift the balance of revenue-producers from the poor to the rich. The validity of that argument was never tested. In April 1895, the Supreme Court declared the tax to be an unapportioned direct one that violated several clauses of the US Constitution. This particular version of an income tax might have died, but the idea for one certainly did not. Its supporters believed the Supreme Court had been mistaken in its ruling. Moreover, they saw the personal income tax as not only an economic tool to address some fiscal imbalances, but an ethical and moral way to raise govern- ment revenue while limiting the growing concentration of wealth. In the 1896 cam- paign for the presidency, the Democratic standard-bearer William Jennings Bryan supported an income tax aimed primar- ily at the wealthiest Americans to replace the tariffs and excise taxes that were paid largely by the poorest citizens. Even after his defeat, the party leaders continued to push for an income tax. In 1898, House Democrats’ proposal for an income tax of 3% on annual incomes over $2,000 was soundly defeated. In the midst of the emerging debate over the income tax, the federal govern- ment began to report increasingly larger deficits in each year from 1897 to 1899, even with the Dingley tariffs at historically high levels. Restraining federal spending was difficult, largely due to the need to fund programs such as the expansion of the Navy and increases in veterans’ pen- sion benefits. In the first several years of the 20th century, members of the Repub- lican party’s growing progressive wing came to appreciate the need to consider new sources of revenue. Another financial panic in 1907 brought reduced economic activity, more corporate bankruptcies, high unemployment and new strains on the federal budget. By 1909, congressional progressives had become sufficiently pow- erful to add an income tax rider to an early version of the Payne-Aldrich Tariff Act. On separate occasions since winning the White House, President Taft had voiced both support for and opposition to an income tax. He did not want to see another challenge to the Supreme Court over such a fundamental change in fed- eral policy. Instead, he believed Congress should pass a constitutional amendment authorizing a tax on individuals’ income before actually imposing such a levy. Even while wrangling over what was to become the Payne-Aldrich Tarif Act noted ear- lier, in July 1909, Congress sent to the states this language for a proposed 16th Amendment: “The Congress shall have the 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 enu- meration.” Taft persuaded the conference committee crafting the final version of the tariff bill to replace the provision for an income tax on everyone with one tax- ing only the income of corporations. As noted earlier, he signed Payne-Aldrich in August. When the 16th Amendment was pro- posed, conservative lawmakers in Con- gress doubted it would be ratified by the required number of 36 of the country’s 48 states. Many failed to recognize the pub- lic’s dissatisfaction with the complex and always-changing system of tariffs. Farmers in the South and West, and Progressives and Populists in other areas agreed with the traditional Democratic argument that tariffs unfairly taxed the poor and drove up prices for all consumers. President Theo- dore Roosevelt and his progressive Repub- lican followers supported the amendment. Legislators representing manufacturers, bankers and others involved in the coun- try’s expanding foreign trade recognized its role in supporting reductions in tariffs and other trade barriers. And government officials of both parties saw the tax as a way to insure the greater level of federal revenue they believed would be necessary to respond satisfactorily to the growing militarism of Germany and Japan. All three candidates for President in 1912 supported the amendment. It was no sur- prise when Delaware acted in February 1913 to become the 36th state to vote for its ratification. With that amendment now approved, Congress used a provision of the afore- mentioned Underwood-Simmons Act of October 1913 to impose a progressive indi- vidual income tax at rates ranging from 1% to 7%. Tax revenue started to flow to the individual US Treasury within the year. Tariffs generated 95% of the US govern- ment’s revenue in 1790. During the next 120 years, they rarely dipped below 60% of federal receipts. In 1915, following the passage of the 16th Amendment, tariffs contributed only 30% of those receipts. During the subsequent 102 years they declined steadily as important sources of revenue; tariffs now account for less than 2% of all the funds the government receives. Meanwhile, the personal and corporate income taxes formally proposed in 1909 have recently been contributing more than 55% of revenue. The so-called “payroll tax” used to fund the Social Secu- rity and Medicare programs established in 1933 and 1965, respectively, provide another 35%. But that, as they say, is another story.  Michael A. Martorelli is a Director Emeritus at Fairmount Partners and a frequent contributor to Financial His- tory. He earned his MA in History from American Military University. Sources Baack, Bennett D. and Edward John Ray. “Special Interests and the Adoption of the Income Tax in the United States.” The Jour- nal of Economic History. Vol 45, No. 3, pp. 607–625. September 1985. Mehrotra, Ajay K. “More Mighty than the Waves of the Sea: Toilers, Tariffs, and the Income Tax Movement, 1880–1913.” Labor History. Vol 45, No. 2, pp. 165–198. May 2004. Solvick, Stanley D. “William Howard Taft and the Payne-Aldrich Tariff.” The Mississippi Valley Historical Review, Vol 50, No. 3, pp. 424–442. December 1963. Weisman, Steven R. The Great Tax Wars: Lincoln to Wilson—The Fierce Battles Over Money and Power That Transformed the Nation. Simon & Schuster. 2002. www.MoAF.org  |  Spring 2019  |  FINANCIAL HISTORY  23