The previous article discussed the 1st US income tax with the Revenue Act of 1861 and its repeal in 1872. During the time after that, the nation’s financial system was being strengthened, and there was a growing recognition that the government needed a more consistent and reliable source of revenue to fund its operations. These debates and discussions led to the creation and ratification of the 16th amendment. This constitutional amendment is the basis for our current federal income tax.

The 16th Amendment to the United States Constitution, ratified in 1913, established the federal income tax as we know it today. The text of the amendment states:

“The Congress shall have 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 enumeration.”

This amendment gave Congress the power to levy taxes on income without the need to apportion the tax among the states and without regard to population. It effectively overrode the Supreme Court’s 1895 ruling in Pollock v. Farmers’ Loan & Trust Co., which had declared a federal income tax unconstitutional because it was a direct tax that had to be apportioned among the states according to population.

The process of ratification of the 16th amendment was controversial. Many states, particularly Southern states, resisted the amendment’s passage, arguing that it would infringe on states’ rights and disproportionately affect the South. Despite the objections, the amendment was ratified by the necessary number of states in 1913 and created the federal income tax as we know it today.

The US was not the first sovereign nation to impose an income or progressive tax. The idea is rooted in the writings of Adam Smith, John Stuart Mill, and Henry George. Adam Smith, in his 1776 book “The Wealth of Nations” described the benefits of a graduated tax system where those that could pay more, did. This was the prevailing thought at the time. In recent years, there have been arguments against economists such as Milton Friedman and Arthur Laffer. Both argue that a progressive tax is inherently unfair because it punishes hard work and success. They also argued that it discourages economic growth by reducing incentives to work and invest.

In his annual message to Congress in 1909, President William Howard Taft called for the passage of a federal income tax, arguing that it would be a more “just and equitable” form of taxation, as it would be based on the ability to pay. Similarly, in a speech on the Senate floor in 1909, Senator Joseph Bailey [insert It’s a Wonderful Life Joke Here] argued that an income tax would be fairer than the existing tariffs and excise system he said disproportionately affected the poor. In congressional hearings and debates, lawmakers and experts argued that an income tax would provide a more stable source of revenue for the government and would be more efficient to collect. This is what eventually won out.

The 16th amendment allowed the government to fund operations more consistently and provided what most people considered a fair and efficient way to fund the government at the time. It also allowed the government to have more control over the nation’s finances, giving more power to the federal government over the state government. The income tax became a key instrument for government policies and social programs, such as providing funding for defense, education, infrastructure, and social security.

It’s worth noting that the tax debate from 1913 has never stopped. There have been discussions about a flat tax or a nationwide sales or Value Added Tax (VAT) that would tax based on spending rather than income. As recently as this month, a 30% national sales tax was proposed to replace the income tax. These continue to be discussed though their promoters have made no significant progress. We have seen exemptions and credits being allocated to specific groups and individuals to make it fairer or to stimulate certain groups to help the economy. This manipulation has led to thousands of pages of internal revenue code or tax law.

16th Amendment and the BIR

The 16th amendment only empowered the government to impose an income tax. It did not specify the tax amounts or how they would be collected. Congress passed the Underwood Tariff Act of 1913 and the Revenue Act of 1913 later that same year.

The Underwood Tariff Act of 1913 established the first federal income tax since the Civil War, a 1% tax on incomes above $3,000 for individuals and $4,000 for married couples. It also lowered tariffs on imported goods to increase economic growth and reduce the cost of goods for consumers.

The Revenue Act of 1913 established the Bureau of Internal Revenue (BIR) as the agency responsible for collecting federal income taxes and establishing a 1% tax on corporate incomes above $5,000. The BIR was established within the Department of the Treasury and is responsible for administering and enforcing the new federal income tax laws. The BIR collected taxes, enforced tax laws, and assisted taxpayers. The BIR was responsible for implementing the income tax on a national level for the first time.

Specifically, the Revenue Act of 1913 empowered the BIR to:

• Assess and Collect taxes imposed by the Act
• Make regulations, examinations, and inspections necessary for the enforcement of the Act
• Compel the attendance of witnesses, the production of books and papers, and the giving of testimony
• Issue summons and subpoenas
• Make arrests and seizures

Section 32 of the 1913 Revenue Act also established the Commissioner of Internal Revenue as the head of the BIR. The Commissioner was authorized to “prescribe all needful rules and regulations for the enforcement of the act.”

There was great power ceded to the BIR for tax regulations and collections. Several of the regulations were challenged up to the Supreme Court with cases such as Bowles v. Seminole Rock & Sand Co., 325 U.S. 410 (1945) where the Supreme Court of the United States held that regulations issued by the BIR had the “force of law”, and that the BIR is entitled to “great weight” in interpreting the tax laws. Additionally, in the case of United States v. Correll, 389 U.S. 299 (1967), the Supreme Court held that the regulations issued by the BIR are entitled to deference by the courts as long as they are not arbitrary, capricious, or manifestly contrary to the statute.

The BIR was the agency in charge of Income tax until its name was changed in 1953 to the Internal Revenue Service (IRS). More on that in the next article.