How the 100-Year Old Income Tax Unleashed the Modern U.S. Economy

The capitalist's case for the income tax: The widely despised and thoroughly misunderstood levy helped the United States move toward a more open economy

800px-Woodrow_Wilson_addressing_Congress_(LOC).jpgPresident Woodrow Wilson addressing Congress in 1913, two months after the ratification of the 16th Amendment (Wikimedia Commons)

One hundred years ago today, Secretary of State Philander Knox certified to Congress that the Sixteenth Amendment had been ratified by Delaware and Wyoming, clinching the required 36 states. Congress was free, once again -- this time without the threat of obstruction from the Supreme Court - to do something that has changed the scope of government for the next century. Washington could tax incomes.

Almost ten years earlier, that Court, alarmed at the willingness of Congress to impose taxes that were only to be paid by the rich, had struck down the tax. Justice Field had declared it an "attack on capital" that was only the opening round of "a war constantly growing in intensity and bitterness." Some populists in Congress had threatened to enact the tax again in defiance of the Court, but in 1909 their energies had been diverted to the ratification effort in the States. Conservatives hoped the push for the income tax would wither in the state ratification process. But less than four years later, the amendment was ratified.

Many political observers rue this day in history. To them, the income tax embodies all that is wrong with the modern federal government. By encouraging some economic activity more than others, they say that the income tax, like much federal regulation, dampens economic growth and stifles entrepreneurial creativity.

Far worse, in their eyes, is that the income tax makes the federal government possible. It funds bloated services and enables all sorts of social and economic meddling in the sacred workings of the free market. But what would the past 100 years have looked like without the Sixteenth Amendment? Certainly not much like a free market--unless something else had come along to get rid of tariffs and tariff politics, which had been restraining the economy.

For much of the 19th century, the federal government had deliberately exercised its taxing power to affect the economy profoundly. The first substantive act of the First Congress--signed into law on July 4, 1789* -- imposed duties on tea, salt, beer, candles, sugar, cider, nails, shoes, soap, and other essentials. Since the country's founding, these fees had not only funded the government, but also had served to protect fledging American industries from foreign competition. Such tariff duties were imposed to ensure high prices--frequently as much as 50 percent higher--for foreign goods and thus to encourage US consumers to buy domestic. By shielding our markets from competition - and by making foreign soap and shoes too expensive for many to buy--these tariffs restrained trade and raised the cost of living for rich and poor alike.

The U.S. federal government had, since its earliest moments, behaved as if it was good to intervene this way in the economy. Battles over which industries deserved how much protection (which frequently amounted to fights over which Congressmen would end up most beloved by their most influential backers) often dominated federal politics. Up until the beginning of the twentieth century, such tariffs had sustained the federal government, except during the Civil War, when warships closed ports and made trade difficult. The knowledge that Congress would impose protective tariffs encouraged lobbyists and drove Washington debates. These lobbyists had always triumphed over those concerned about whether such tariffs hurt consumers without really benefitting the economy. The greed of the lobbyists and their clients was limited only by the fact that if the trade protection they sought was too successful, prices would be raised too high, consumers would refuse to buy, and there would be no imports and thus no federal revenue.

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Charlotte Crane is a professor at the Northwestern University School of Law

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