Evolution of Federal Taxation in the United States - Research Paper Example

Evolution of Federal Taxation in the United States Taxation in the United States has evolved over the years into a comprehensive system supporting the government’s revenue stream. The government needs to generate its own revenue in order to support critical services such as Social Security. Without support from taxation, it would not be possible for the federal government to support its own structure and its expenses. The tax system in the United States spans a number of different channels that include taxes on income, estates, gifts, employment, and miscellaneous excise taxes as well as taxes on alcohol, tobacco and related products. These taxes are levied at various levels including local, state and federal levels. The taxes are aimed at both individuals and enterprises of all sizes and also include Americans living abroad. Tax rates tend to differ from one state to the other based on factors such as allowable reduction in taxable income through contributions to charities and other such means. The current taxation system in the United States has evolved based on a number of different circumstances over time. This paper will look into the evolution of the United State’s taxation system by tracing its historical development and its current application to taxable entities. Introduction Taxation regimes existed in colonial America under the auspices of the British Empire. Essentially the colonies revolted against the existing dominion governmental setup due to differences in taxation rates and the manner in which taxes were applied. The Boston Tea Party was a watershed for the American independence struggle that occurred due to British taxation methods[Car10]. Once independent, the new nation required taxation in order to generate the kind of revenue required to build the nation. Taxation was commonly applied in the late eighteenth century on imported items by the federal government. The major taxable imported items included glass and whiskey. In contrast, the states had their own tax collection mechanisms that depended on property taxes. These property taxes were levied by the local governments on residential as well as commercial property. In the earliest years of the independence struggle, the American federation revoked its power to tax the various states forming the union. The constitution of the United States existed at this point in time but it had not been ratified as yet. Alternatively, the Articles of Confederation were being utilized in these early years to manage the federal government. Article VIII of the Articles of Confederation dealt with taxation and declared that the federal government was devoid of any power to tax the people. Under the same article, the local and state governments were authorized to collect taxes [Sta98]. In these early years, it was agreed that the states would collect taxes and submit them to the federation based on the overall wealth of the state and the discretion of the state legislature. This revenue generation was required in the early years to pay off the national debt that had accrued as a result of the struggle against the British[Rab08]. However, states were recalcitrant in paying taxes to the federation under the agreed principles. This situation continued shortly until 1788 when the Constitution of the United States was adopted unanimously. The Constitution allowed the federal government wide powers to collect revenue though direct taxation was still not allowed. Instead, the federal government could levy taxes indirectly by taxing items consumed by people. This would tend to have notable consequences for future tax regimes created by the federal government [Bro96]. In the immediate aftermath of the constitutional provision allowing the federal government to tax people, the federal government levied taxes on imported items. In many ways this method of taxation was similar to the British taxation regime that relied largely on taxing imported items. The federal government had little need to tax people and enterprises directly in the early years since import taxes were enough to pay for the government’s expenditures. In addition to taxing imported goods, the federal government began to tax specific products and transactions in the form of excise taxes as the burgeoning expenditure increased to new levels. However, the increases in taxation were not significant enough to warrant the use of more diversified taxation methods such as direct taxes [Bec80]. The nascent taxation structure relied on the thinking that the federation should not be allowed to manipulate revenue in its favor. In order to discourage the British model of taxation, the nascent taxation regime was fashioned to allow localized taxation and revenue spending[Bro96]. This state of affairs continued uninterrupted until the onset of the Civil War. The massive costs associated with the Civil War were too much for the federal government to bear. The situation was exacerbated by the cessation of the Southern states that took away their tax contribution to the federal Northern government. Till this point in time, the federal government had relied on taxing imported items and taxing the sales of certain goods and transactions only. Local governments and the state governments relied on property taxes to generate their revenue streams. This was the case throughout the continental United States until the 1860’s when the Civil War prompted the federal government to raise more revenue[Jon99]. Revenue collection for war efforts had been escalated before the Civil War on one occasion only. The War of 1812 led to a massive decrease in imports and hence the federation’s collected revenue. Congress authorized excise taxation, direct taxes on residential property and slaves based on the state’s population levels as per the census of 1810. The popularity of the war meant that little political backlash occurred. Taxation rates on imported goods were increased once again during the 1820’s to allow emerging industry in the United States to take foot. Imported goods such as iron, steel, wool etc. was heavily taxed to make local products more attractive. Permanent changes to the federal taxation structure were deemed necessary but were never applied since the war ended before political will could be gathered for this cause [Bro96]. Income Taxes Over time, the federal government reduced tax rates once again such as through the Walker Tariff of 1846. Costs for the Mexican war were covered in large part by tax revenues and customs collection. The federal government was able to pay off its debts from the war by the time that the Civil War took place. The onset of the Civil War produced the first major and noticeable changes to the existing federal tax regime. The federation was quick to realize that tariffs and excise taxes were insufficient to conduct the war effort. The cessation of the Southern states and the loss of their revenue also hastened decisions on Capitol Hill. For the first time the federal government levied direct taxes on people in the form of income tax. The very first measure came through in 1861 in the form of the Revenue Act of 1861 that placed a tax of 3% on all people who earned more than $800. The very next year seeing fiscal problems, the federal government decided to increase the amount of people in the tax bracket by declaring the entry slab income to be $600 instead of the previous $800. However, the taxation rate remained steady at 3% under the new Revenue Act of 1862. This new act placed another stipulation – all people earning $10,000 or more would be taxed at 5% instead of 3%. The fiscal constraints of running a war and a government at the same time strained the federal government’s coffers till the taxation rates were raised in 1864[Hil94]. By 1865, the tax rate had gone up to 5% for incomes between $600 and $5,000 while it had risen to 10% on personal incomes greater than $5,000[Bro96]. However, the end of the war did not see an immediate end to the taxation by the federal government. Money was constantly required for the massive rebuilding and repatriation effort after the war. Congress finally repealed the Revenue Acts in 1872 when the federal government’s expenditure finally began to decrease. The federal government moved to create a new income tax under the Tariff Act of 1894 under protection of the Constitution. However, the action of the federal government was challenged in court in the decisive Pollock v Farmers’ Loan & Trust Co.1 that led the court to declare apportionment for taxes on rents, interest based income and any other income from personal property holdings based on census data from each state. At that point in time it was not practical to apportion income tax in this fashion and as a result such individual incomes were exempted from tax [Dun94]. This practice continued into the early part of the twentieth century but was revoked by the 16th amendment to the Constitution. The 16th amendment provided the federal government the possibility to levy personal income taxes without regard to any apportionment or without regard to any source of the income. Following this change, Congress passed the Revenue Act of 1913 that placed a 1% income tax on incomes greater than $3,000 and a 6% income tax rate on incomes greater than $500,000. However, the onset of the First World War escalated the income tax rates to some 77% for incomes over one million dollars in order to finance the war effort. For the same period, the average tax rate was 15% for personal income. Tax rates were finally decreased at the onset of the Great Depression but had to be escalated in wake of the Second World War. These manipulations in tax rates produced a stable taxation system that levied taxes on people based on their levels of income instead of taxing them at a flat rate. Following the Second World War, the income tax rate has been in steady decrease to the modern day. The only major change to the taxation system has been the introduction of multiple income slabs to judge for tax limits. Moreover, the definition of income sources has expanded over the years to include any forms of income that affect an individual directly [Bro96]. Estate and Gift Taxes Before the 16th amendment, local and state governments charged people for inheritance based taxes. The origin of these taxes can be traced back to the 1880’s when certain states allowed the imposition of inheritance taxes. The turn of the twentieth century saw support for progressive inheritance taxes implemented by the federal government. Congress brought forward its first estate tax in 1916. This law required that a person had to pay tax on estate when the estate was transferred for any reason including ownership, inheritance or gift. The compass of federal taxation was updated in 1924 with the passage of the Revenue Act that required taxation on gifts. Under the new law, the donor had to pay taxes on gifting any item to another person. Marital deductions were allowed for the gift tax and the estate tax in 1948. The only other change introduced into these laws came in 1981 when Congress increased the amount of gifts between spouses to be unlimited. On the other hand, the estate tax has become applicable to any transfers of estate for a living or a deceased person. A person could circumvent the estate tax by using the gift methodology; however, it could only be used by a living person. In the case of intestacy, the gift methodology is not possible so the estate tax applies. Moreover, if the estate is left to a spouse or is donated to a charitable cause, the transaction is exempt of estate tax [Bro96]. Employment Taxes The onset of the Great Depression modified the existing taxation structure on a permanent basis. Before the Great Depression there was little coverage for working class people in the United States. The working class was exposed to harm both during and after their working years without any form of protection. The major problems confronting workers included no retirement plan schemes, no coverage against on the job fatality or injury that might cause permanent disability, no disability support program and no health insurance for anyone in the working class[Way11]. Given the situation, the federal government embarked on a program to offer the working class coverage by creating programs such as the Social Security program. President Roosevelt, under the New Deal, began the ambitious move towards a Social Security program. Initially, the program was voluntary and participants were taxed on the first $1400 of the total annual income. The tax rate was only 1% which meant that over time more and more people joined up for the program. Over time, the Social Security program was complemented with the Medicare program that was initiated in the 1960’s to provide medical coverage to the working classes. President Johnson’s administration changed the nature of Social Security from a trust fund to a general fund. On the other hand, the Carter administration allowed immigrants to be eligible for Social Security benefits[Bro96]. President Reagan required annuities to become taxable for Social Security purposes[Soc12]. Miscellaneous Excise Taxes A number of alternative taxation schemes have been authorized by the federal government to retain income disparity and to generate additional revenue. One of these schemes is the alternative minimum taxation (AMT) scheme that tends to tax individuals and entities earning above a certain threshold. AMT was authorized under the Tax Reform Act of 1969 to target high income households only. This was expanded under the Tax Reform Act of 1986 to target more high income households in high income states[Pra11]. The lack of revision for the AMT has meant that more and more middle class households are finding themselves eligible for the AMT since inflation based adjustment has not been performed[Wil10]. Another similar tax is the capital gains tax (CGT). Initially after the 16th amendment, ordinary income and capital income were considered on equal footing and were taxed at a maximum rate of 7%. The Revenue Act of 1921 redefined this policy to allow for taxation of assets held for two years at 12.5%. Over time new holding times and applicable tax rates were introduced to expand the CGT umbrella. This practice continued into the eighties but was reversed in the nineties and the early twenty first century[Bur12]. The Economic Growth and Tax Relief Reconciliation Act of 2001 saw the federal government cutting down $1.35 trillion in taxation from capital gains[Wil01]. Additionally, corporate tax is also enforced by the federal government in the United States which has seen a constant 35% rate since 1993[Cai11]. Alcohol, Tobacco, and Certain Other Excise Taxes Excise tax is levied on consumable items such as alcohol, tobacco, utilities, food items etc. The taxation rates for all such items tend to vary from state to state except for tobacco and alcohol. The federal government places a fixed one dollar tax on a twenty cigarette pack while each state government chooses to tax cigarettes differently. The tobacco control policy of each state determines such leverage but the federation does not interfere in any such decisions [Nat10]. The case of alcohol is similar although it has a checkered history. The passage of the 18th amendment saw a prohibition of alcoholic beverages. The envisioned dry America only led to more problems in the form of boot legging and rise of criminal syndicates[Ham95]. The move was meant to curtail the use of alcoholic beverages but the fallout caused more problems than solutions. In order to deal with this dilemma, the federal government enacted the 21st amendment to legalize alcohol beverages once again. In order to discourage the use of such products, the federal government taxes such products at high rates[Tho91]. Conclusion The taxation structure of the federal government in the United States has evolved from a small governmental artery to a pervasive revenue system. It must be noticed that the federal taxation structure has taken shape depending on the contours of circumstances facing the nation. Innovations such as Social Security and Medicare are attributable to a burgeoning tax structure but there are still areas for improvement such as the AMT. The progressive nature of the American federal tax structure means that these adjustments could be expected to take place over time. 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