IRS at 100: How income taxation built the middle class

By John Buenker and Sam Pizzigati
October 2, 2013

Exactly a century ago, on October 3, 1913, President Woodrow Wilson signed the first modern federal income tax into law. The sky did not fall.

That may have surprised the eminences of the American plutocracy. For years they had predicted the most dire of consequences should the federal government begin taxing the incomes of America’s most comfortable.

Those warnings took a shriller turn in 1909. A flurry of cynical congressional maneuvers sent the states a constitutional amendment, ostensibly designed to allow a federal income tax. Conservatives in Congress felt confident that the amendment had no chance of gaining enough state support to be ratified. To clinch the amendment’s defeat, they unleashed a fierce rhetorical fusillade.

Friends of grand fortune would reserve a special venom for the notion of “progressive” taxation — the idea that high incomes should face the highest tax rates. They characterized a “graduated” tax on the incomes of America’s affluent as “extortion,” a “penalty upon ability and intelligence” and an imposition on a “small class of people powerless to defend itself.” Taxing the wealthy, they contended, would be “killing the goose that laid the golden egg.”

In the Virginia House of Delegates, Speaker Richard Byrd predicted that an income tax would put freedom itself in jeopardy. Any new income tax law, Byrd charged, “will of necessity have inquisitorial features.”

He forecast: “Under it men will be hailed into courts distant from their homes. Heavy fines imposed by distant and unfamiliar tribunals will constantly menace the taxpayer. An army of federal inspectors, spies and detectives will descend upon the state.”

An income tax, Andrew Carnegie summed up, would simply destroy initiative and create a “nation of liars.”

Americans ignored these admonitions. In 1910 and 1912, new progressive state legislative majorities across the nation endorsed the income tax amendment. Early in 1913, final ratification gave Congress a green light to add an income tax to the tax code. Months of congressional debate culminated eight months later with a new revenue act that featured a modest income tax.

How modest? The top tax rate would sit no higher than 7 percent on income higher than $4,000 — the equivalent of slightly more than $94,000 today.

That top rate would soar higher in the decades to come — much higher. In the 1940s, during World War Two, income above $200,000 faced a 94 percent tax rate. America’s top marginal federal income tax rate would hover around 90 percent into the early 1960s.

These high-tax years — for the rich — should have been a time of economic calamity. At least according to the critics of progressive income taxation. But real life proved these critics wrong. Commerce did not cease when the tax code levied steeply graduated rates on U.S. incomes. The wealthy did not flee. The entrepreneurial spirit did not evaporate.

Quite the contrary. The United States thrived throughout the mid-20th century heyday of high taxes on the rich. We became the first mass middle-class nation in the history of the world, the first industrial nation ever where the majority did not live in poverty.

The progressive income tax was a key pillar of this middle class “golden age.” Fiscally, the nation’s steeply graduated tax rates raised the revenue that bankrolled new programs and services that opened doors into middle-class life. Culturally, these same steeply graduated rates sent the message that American society frowned on incomes that towered too high over the nation’s economic and political landscape.

Looking back on those years now, the historical record is clear: America works best when we tax progressively — and significantly so.

History hasn’t been kind to all those who sought to prevent progressive income taxation a century ago. None of their dire predictions have come true.

This is the great irony of federal income taxation’s first 100 years. Our contemporary political movers and shakers go about their business as if history had vindicated those shrill critics of income taxation in the early 20th century. Pols and pundits today have swept off our political center stage any serious consideration of the stiff progressive rates that even moderate Republicans, like President Dwight D. Eisenhower, once accepted as political and economic common sense.

Economists like Emmanuel Saez, the University of California, Berkeley scholar who rates as the leading authority on high incomes, points out that this refusal to revisit stiff top marginal rates makes no sense. Top tax rates today could double, Saez and his colleagues say, without jeopardizing our economic health.

Saez has more than economic theory on his side. He has history. On this anniversary of the first income tax, let’s be sure to remember that history — and the Americans who made it.

In 1909, former Attorney General Wayne MacVeagh asked “Why should the colossal incomes and the colossal accumulations of the possessors of what Mr. Carnegie himself calls surplus wealth continue to be exempted from proper taxation?”

“Gigantic fortunes,” MacVeagh said, serve as “serious obstacles to the contentment, the peace and the healthy growth of the community as to call for their abatement.”

Let’s stop treating our egalitarian-minded forebears like MacVeagh as crazy old uncles we hide away in the attic. Let’s invite them into our public policy parlors.

They have much to share. We have much to learn.

PHOTO (Top): A general view of the Internal Revenue Service (IRS) Building in Washington, May 14, 2013. REUTERS/Jonathan Ernst

PHOTO (Insert 1): Woodrow Wilson. REUTERS/Woodrow Wilson Presidential Library

PHOTO (Insert 2): President Dwight Eisenhower during a ribbon-cutting ceremony for a new extension to the George Washington Memorial Parkway, November 1959.   REUTERS/Eisenhower Library

21 comments

We welcome comments that advance the story through relevant opinion, anecdotes, links and data. If you see a comment that you believe is irrelevant or inappropriate, you can flag it to our editors by using the report abuse links. Views expressed in the comments do not represent those of Reuters. For more information on our comment policy, see http://blogs.reuters.com/fulldisclosure/2010/09/27/toward-a-more-thoughtful-conversation-on-stories/

All this praise for the income tax as the salvation of the middle class. But that was in the short term. As things have played out, the Federal government’s heavy reliance on the income tax has gradually shifted the burden of government onto the middle class. And it may be reliance on income tax that is the biggest obstacle to middle class grown today. That’s because the rich can pay lobbyists to influence the tax law, while the poor don’t have anything to tax. That leave the middle class caught — well — in the middle.

Before the income tax, the Federal government was financed in large part by import and export duties. That is not actually possible today, because the U.S. has entered into a number of treaties limiting import and export duties as part of what is called “globalization.”

Posted by Bob9999 | Report as abusive

It seems that the Plutocracy has learned how to scam the system with its bogus concepts of Trickle-Down Economics, “job creators” (not profiteers), and too-big-to-fail/too-big-to-prosecute gambling entities whose losses are completely covered by bailouts of the Wall Street Casinos with taxpayer funds. The Federal Reserve System has been creating trillions of cyber-dollars that prop up the stock and bond markets and line the foreign bank vaults with tax-free accounts held by the Plutocrats. Just ask Mitt Romeney why he has most of his ill-gotten gains (saddling massive debt on hapless clients) in tax-free foreign bank accounts. As he says repeatedly, “It’s all legal [for the super rich].”

Posted by ptiffany | Report as abusive

the authors argue that highly progressive taxation, and the government spending it funded, prompted the growth of the middle class. If this is their prescription for future improvements, the authors left out an important statistic. Government spending as a share of GDP has been growing steadily from 7% in 1909 to 40% in 2008 before settling back to around 38% in 2012.

While taxes at the top have dropped since 1960, they have for all income groups. The difference have been made up by government borrowing.

Despite this growth in Federal spending, the middle class has still seen steady erosion of their purchasing power as well paying jobs have evaporated. The authors seemed to have ignored this fact when delivering their opinions.

Posted by Mattnad | Report as abusive

The IRS was created for one purpose…to be the vehicle that guaranteed payment of the interest owed on our national debt to the foreign bankers who comprise our Federal Reserve Banking system. The IRS and the Federal Reserve were both created in 1913, against the will of the people.

Posted by RD137 | Report as abusive

I remember the Eisenhower years as a child, and with my large family. They were great years!

Since then we have had tax reductions based on the promise of job creation.

You would think we would be at zero percent unemployment by now.

The fact is these continued tax reductions have damage needed investment in our nation.

There are both academic and professional documentations that these tax reductions have defunded infrastructure maintenance and development, job training and education, and quality of life issues.

All of which are necessary to attract and promote business.

Tax reductions has damaged and failed our nation.

If you would like this documentation you may contact me at flashwrk22@att.net.

Posted by Flash1022 | Report as abusive

Classic logical fallacy – equating correlation with causation. The unique middle class was the product of a unique historical event – the post-WWII era when the USA was the only country left standing, with no competition, thus permitting artificially inflated incomes. It was not due to the existence of the income tax – BTW, Richard Byrd was correct – the income tax regime unquestionably is Inquisitorial – requiring an annual full disclosure of every aspect of one’s financial (and in some cases, personal) life.

Posted by SayHey | Report as abusive

@ptiffany You are correct, the tax laws are anything but fair, in that only the people on the extremes secure the benefits of legislation. Many have income and do not pay ANY federal taxes (I think the last count was 43%) and some even get a rebate. The “super-rich” have tax attorney’s whose sole existence is to exploit the loopholes Congress builds into legislation (see the President’s BFF Warren Buffet.)

The working guy in the middle covers the costs for both ends under the current system. Thus, the motivation for a flat tax or the consumption based “fair tax” where everyone contributes.

However, if you implement a flat or fair tax (effectively eliminating all deductions–e.g. the real estate special interests, for one, will scream bloody murder) the political aristocracy inside the Beltway have nothing to exchange for campaign contributions. Power, influence and money are what drive our tax system and Congress will not change the system without a fight.

Posted by COindependent | Report as abusive

@SayHey is right. WWII created the American middle class. Proper taxation and governing would have perpetuated it far longer than now. At least it would have made the transition to a global economy less painful on the Americans and other leading economies.

Posted by tmc | Report as abusive

The authors mention the high tax rates for high incomes that prevailed until the 1960s. But there were ways the wealthy could avoid the high rate if they invested the money in productive enterprises or gave it away in charitable contributions.

The tax on high earners also prevented the high earners from buying up the national store as they seem to be able to do now. That preserved middle class opportunity too.

The middle class has become redundant. The country is becoming the country of the cash rich and the debtors. And because the government represents the people, it is a debtor like the rest of them.

Posted by paintcan | Report as abusive

@flash The feds and states have been collecting billions annually in fuel taxes originally designed for building and maintaining infrastructure. The issue is that those funds get thrown into the mass pool of tax collections and then are reallocated (to other “programs”). Thus, the infrastructure does not get maintained and the demand for funds exceeds the available funding–resulting in deficits and debt.

We could easily fund government out of our current tax revenues but their are entrenched interests that need big(ger) government to support their agenda. Go back to the Constitution and look at the limits placed on the federal government. Then look at the programs and funding today that the federal government “manages”.

Look at DOE or the Education departments and see what they were designed to do and what they actually do. Think in terms of the EPA where today only 7% of the employees are considered “essential” during this shutdown. What does a “non-essential employee do, and how much is s/he paid to do it (including benefits and retirement)? But the EPA continues to add employees in spite of the economic downturn (over 17,000 today, not including contractors) and an $8.9 billion budget. That’s $500,000 per employee. Even Google, a for profit company, only generates $1.1 million revenue per employee in revenue.

So the issue is not exclusively tax reductions as the “rich” in the 1950′s had an effective tax rate of 32%. It’s more that Congress is creating programs that are unfunded or underfunded (e.g. ACA) That’s how you end up with trillion dollar deficits and entitlements that are fiscally unsustainable.

Furthermore, take a moment to ask your local school district about the unfunded mandates (special programs each requiring an administrator) from the education department and how they divert funds from the classroom. You will be shocked!

Posted by COindependent | Report as abusive

Multiple millions a year become not income, but only a yardstick. Witness Baltimore Ravens QB Joe Flacco…who said something to the effect that “it’s not the money, it’s the recognition.”

I invite anyone who makes millions or billions in America to move to…oh Somalia…and make those same millions or billions in that country. Won’t happen, becuase that kind of income can’t be generated absent the economy, the culture, and the society of laws that ARE America. And that society deserves to be recognized as a major factor in the incomes of the unconscionably wealthy.

Also resume the high-rate inheritance taxes the founding father’s favored…specifically to prevent the creation of a favored subclass of the super-wealthy who achieve it only by inheritance. Does our country really think Paris Hilton deserves to inherit the billions of dollars she eventually will?

Maybe Warren Buffet’s offspring would make good use of his billions, but he’s smart enough to recognize the evils of such inheritance, and he’s not going to let it happen. Bravo to him, and let’s impose the same good sense on other in similar situations.

Posted by dwalexmd | Report as abusive

“… How income taxation built the middle class”

Bwahahahaha! This stupid commentary was written by a couple of Marxist tree-hugging progressives. Pure Marxist ideology that says… you make too much so therefore government is going to steal it from you, (via income tax) calling it fair-share, and then give it to someone else who didn’t earn it by way of big new government staffed entitlement & administration agencies. This is called re-distribution, Marxism.

The Income tax sustains HUGE government welfare programs that are politically motivated to cause dependency on government and insure a perpetual voting block for entitlement and welfare aimed 100% at dependent and subsidized voters, mostly Democrats.

Since the income tax, government has increased 1000 fold! All fueled by the revenue extorted from the wealthy by the progressive income tax and the agency that collects it, IRS.

“Economists like Emmanuel Saez, the University of California, Berkeley scholar who rates as the leading authority on high incomes, points out that this refusal to revisit stiff top marginal rates makes no sense. Top tax rates today could double, Saez and his colleagues say, without jeopardizing our economic health.”

Bwahahahaha!

This clown is a scholar and leading authority??? For who or what? The Communists?
Sure it makes no sense to a progressive, a COMMUNIST scum-bag like Saez!

Hey Saez!! WHY are you in my country puking out your Marxist crap! Get out! You’re in the wrong country, jacka$$! Move to Venezuela, Cuba or North Korea where they do it YOUR way! Keep your Marxist BS out of our universities and this country!

The income tax is a Marxist mechanism to centralize, re-distribute wealth & property, and to empower government as master above its servants & serfs…. the slave-laborer.

According to Marxism… NO ONE is allowed to accumulate its wealth and property above the ruling class, the communists (aka: Progressives).

It’s none of Governments dam business how much a private individual or enterprise accumulates or makes! Government exists at the discretion of the states and its people! Government progressives (Communists, Liberals, Dems, Marxists) are the only ANTI-AMERICAN ideology who believe they should be masters of our nations wealth and economy… to control its banks, earnings, and property accumulation. These clowns are tyrants who want to play God & King over all property, the economy and individuals!

It’s all about THEIR jobs and POWER. And to hold and control this power progressives NEED the IRS and the progressive income tax. It empowers them to provide vote-buying welfare checks, subsidies and anti-economic growth policies (wealth control), regulation & taxes instead of encouraging private sector job creation by de-regulation, lowering taxes and shrinking government. But heaven for bid that the progressives will shrink government and get people off the government welfare-wagon because they will loose power! They know it and that’s why the progressives wont lift a finger for the private sector because the more dependency the more power they have over the voters to keep em voting for “free-stuff”(subsidies, grants, welfare) and bigger government bureaucracy to administer the free stuff. Self-dependency breed’s conservatism and resentment of government sponsored entitlement and free stuff! That’s why progressives HATE conservatism because it teaches self-reliance and hard-work. It will end the progressives if the voters are not kept dependent in some way on Government and brainwashed into believing rich people and greed is bad and that their money and property should be confiscated (taxed) and passed out to those who didn’t earn it!

The sole mechanism the progressives have is the PROGRESSIVE INCOME TAX to carry out this private sector rape and extortion of wealth to enable their welfare vote-buying and continued class war!

This is why the progressives will fight tooth-and-nail to keep the progressive income tax.

But some day the progressives will run out of other peoples money that fuels and buys their power… the economy will collapse and Communism will be the revolution… all deliberately planned and the agenda of the progressives.

Without the income tax the progressives are powerless and dead as a political party and being able to turn us into a oligarchy Communist Utopia State!

Posted by Bellagio551 | Report as abusive

Yes, move away if you don’t like it. No? Of course, because no other nation bows to the wealthy like us. I invite the Koch brothers to get the hell out. They will find that their are plenty of other places where they can torture the poor. They won’t leave unfortunately because there is no better place for them. Billions of dollars and they hate us all. What happy people.

Posted by brotherkenny4 | Report as abusive

@COindependent.

There is no doubt that had we not passed those tax reductions and paid for our wars we would not have the debt problems we have today.

A 90% nominal tax rate down to 32% effective tax rate is questionable, but better than a 30% nominal tax rate down to 0 effective tax rate and receiving subsidies.

Posted by Flash1022 | Report as abusive

Our tax policies had nothing to do with the growth of the US middle class. The greatest growth came after WW2, and this is due entirely to our winning the war and not having a devastated infrastructure. The rest of the industrialized world was smashed during the war, leaving the US as the sloe provider of goods. As Europe rebuilt, our advantage dissipated to the point that manufacturing in our country was forced to shrink dramatically.

Posted by charliethompto | Report as abusive

Excellent. Love.

Posted by 2Borknot2B | Report as abusive

Cutting back on roads, bridges, and public works, degrades the country you live in. Having defective public health degrades the human capital–and human potential–that creates the culture we live in. We need clean, safe airports; roads; road signs; schools–you name it–public expenses aren’t handouts for the indolent, they’re house and garden expenses for all of us Americans who live here. Mitt said it best–his ilk doesn’t really care about the United States.

Posted by jsmason | Report as abusive

I had though Reuters was not a n extremist web site. This article seem to have brought them out though out both sides.
Every nation in history has paid tax somehow. No one ever likes it. Claiming it built the middle class is foolish. Many, many factors were involved for the American society to grow and shape the way it did. But saying a 90% tax on the wealthy is fair is also foolish.
In fact it’s just spiteful. The US has had a pretty fair tax system for quite some time now. It has been dodged and manipulated and that must stop too.

Posted by tmc | Report as abusive

Classic Rooters slop-inion journalism:

Find two old socialists, get ‘em sloppy drunk, and pay ‘em each $50 to sing that Old-Time Progressive Religion.

What an embarrassing line of reasoning…

Posted by HamsterHerder | Report as abusive

The destruction of the American middle-class has its roots in two macro events. The first was the Sinicization of manufacture(aka destroying the labor unions and working wages by moving manufacturing to communist China) and the second was the systematic dismantling of financial controls.

The first had obvious effects, like destroying the manufacturing base -particularly in vital high-tech fundamentals- that was the core strength of the USA, and preventing growth in real wages. The second performed the task of preventing stagnant wages and loss of steady employment from biting into consumption- by parlaying presumed future earnings or presumed home equity into spendable cash in the present- which would have been the natural consequence. We went from where a line of credit or a credit card was an indication of strong financial standing to where the financial institutions were issuing credit cards to household pets, extending lines of credit to people on welfare and giving home mortgages to people who didn’t earn enough to pay the property taxes. Thus vast new fortunes were made on the backs of vast new public indebtedness in a scheme so grand that it could not but have been deliberate.

The US had a very manageable debt at the start of these two macro events(around 1972), and a generally balanced international trade. In the 40 years since, which coincides with massive increases in the wealth of the extremely rich, public and private debt have rocketed up, and the trade imbalance would have bankrupted a less *influential* country. It has been a carefully choreographed play- which deserves a great deal more space than a comment on an online article- set in motion by the stateless super-rich. I am perpetually amazed that so very few people are able to see what should be quite obvious.

For the USA to return to economic pre-eminence, we need to pull up the drawbridge before it is too late(despite the fallacious claims that there is no going back), and put the interests of the American people ahead of the stateless super-rich. That means doing a quid-pro-quo on countries which block or hinder market access for our goods and services; it means not allowing our tax money to be used to set up overseas businesses which do not bring money back to our coffers or which outsource our jobs(refer the global market reactions to continuation of QE); it means drastic overhaul of financial regulations to reduce the risk to customers; it means using our money to develop our economic and social well-being, not that of China or India or Brazil or the stateless super-rich.

Posted by JohnHolmes65 | Report as abusive

Just a short comment.

If we are to make it fair why not Cut the effective taxes of the middle class to 0-5 percent? Why is it that the lower and middle classes miss out on these obvious benefits to the largest banks or multi-national corporations? Have you seen their PROFITS lately? It seems that low taxes and low regulation does create Some ENORMOUS wealth.

The other post have already covered the selling out of the lower classes of this country. We seem to also have a lack of motivation to even get out and say we’re mad or improve out lives. We’re slacking in my opinion. At least you know in the last 15-30 years we havent totally ruined our “Exceptionalism” cough cough.

We’re all disgusted with it really.

Posted by Burcx | Report as abusive

[…] through another period of rising inequality and social dislocation, history shows there are effective ways to address these […]