The Evolution of Taxation in America: From Tariffs to Income Tax and the Growing Inequality

The Origins of U.S. Taxation: From Tariffs to Income Tax

Before the establishment of income tax, the United States government primarily relied on tariffs—taxes imposed on imported goods—as its main source of revenue. From the late 18th century through the 19th century, tariffs were considered the most efficient way to fund the government without directly taxing citizens. These import duties were used to support infrastructure, military expenses, and government operations. However, as the country expanded and industrialized, this system became increasingly insufficient.

The first federal income tax was introduced during the Civil War with the Revenue Act of 1861 to help finance the Union Army. This was a temporary measure, and the tax was repealed in 1872. However, by the early 20th century, as the economy grew and the government needed a more stable revenue stream, the 16th Amendment was ratified in 1913, granting Congress the authority to levy income taxes permanently.

Why Was the Income Tax Necessary?

As the United States transitioned from an agrarian society to an industrialized economy, tariffs alone could no longer generate enough revenue. Additionally, tariffs disproportionately affected lower-income citizens, as they raised the cost of goods. The shift to income tax was designed to create a fairer system where wealthier individuals contributed more to government funding based on their ability to pay.

The original intent of the income tax system was progressive taxation, meaning higher earners would pay a higher percentage of their income, ensuring a more equitable contribution across different economic classes. This was meant to reduce the economic burden on the working and middle classes while ensuring that the wealthiest citizens and businesses paid their fair share.

How the Tax System Became Unfair

While income tax was initially designed to be equitable, wealthy individuals and corporations soon found ways to manipulate the system through lobbying efforts and legislative changes. Over time, tax laws were rewritten to include loopholes, deductions, and corporate tax benefits that disproportionately favored the wealthy. Some key moments in history when this shift occurred include:

• 1920s: The Mellon Tax Cuts – Treasury Secretary Andrew Mellon pushed for major tax reductions on the wealthy, arguing it would stimulate economic growth. This set a precedent for tax cuts benefiting the highest earners.
• 1980s: Reagan’s Tax Reforms – The Economic Recovery Tax Act of 1981 and the Tax Reform Act of 1986 significantly reduced top income tax rates while also closing some loopholes. However, corporate tax burdens were reduced, leading to a greater tax shift onto individuals.
• 2000s: Bush Tax Cuts – The 2001 and 2003 tax cuts disproportionately benefited high-income earners and were extended for several years, increasing the national deficit while reducing government revenue.
• 2017: Trump’s Tax Cuts – The Tax Cuts and Jobs Act of 2017 lowered corporate tax rates significantly and provided significant benefits to high-income earners while offering minimal relief to the middle class.

The Middle-Class Tax Burden

As a result of these legislative changes, the middle class has borne a disproportionate share of the tax burden compared to wealthy individuals and corporations.

• The top 1% of earners often pay a lower effective tax rate than many middle-class workers due to capital gains tax advantages and loopholes.
• Many large corporations pay little to no federal income tax due to deductions, tax credits, and offshore tax shelters.
• Payroll taxes (which fund Social Security and Medicare) place a greater proportional burden on middle-class workers, while the wealthy benefit from income caps on Social Security taxation.

How to Fix the Tax Disparity

To restore fairness in the tax system, the government could implement several reforms:

1. Close Corporate Loopholes – Eliminate offshore tax havens and loopholes that allow large corporations to avoid paying federal taxes.
2. Increase Capital Gains Tax – Currently, long-term investment income is taxed at lower rates than wages. Equalizing these rates would ensure high earners pay their fair share.
3. Implement a True Progressive Tax System – Higher tax brackets for the ultra-wealthy, similar to what existed in the mid-20th century, could reduce income inequality.
4. Strengthen IRS Enforcement – Increase funding for the IRS to audit and enforce tax laws on the wealthiest individuals and corporations.
5. Eliminate Payroll Tax Caps – Currently, Social Security taxes only apply to income up to a certain limit ($168,600 in 2024). Removing this cap would ensure higher earners contribute more.

Conclusion

The income tax system was originally designed to create fairness by ensuring those with the most resources contributed more. However, decades of tax cuts, loopholes, and lobbying have shifted the burden onto the middle class, exacerbating income inequality. By implementing targeted reforms, the government can restore fair taxation, ensuring all citizens contribute equitably to the nation’s financial well-being.