If the American colonists had been more appreciative of the benefits provided by the mother country, today we might be paying tax to the HMRC (Her Majesty’s Revenue and Customs), rather than the IRS. We might also be having our morning “cuppa,” and wondering what the Duke and Duchess of Sussex will get up to next — oh wait, we’re already doing that.
In the beginning, things were very different, according to Mark Luscombe, principal tax analyst at Wolters Kluwer Tax & Accounting.
“When the colonies were first established, Britain used a benign neglect approach,” he said. “They were more interested in promoting trade than in worrying about taxation. In the early colonial period, colonial assemblies and royal governors addressed tax issues for each colony with little involvement by Britain. As they grew toward independence, the colonial assemblies decided how things would run, and they got used to doing it their own way.”
But things changed as a result of the French and Indian War during the period from 1756 to 1776, according to Luscombe. “The war resulted in significant debts for Britain,” he said. “Since the main purpose of the war was to secure the colonies from aggression, it naturally occurred to Britain that the colonies should help pay, but by now the colonies were used to doing their own thing.”
“Britain tried to get the colonies to help pay off these debts through taxes on sugar, stamps for printed materials, and duties on glass, paint, lead, paper, and tea. After growing colonial opposition, many of these taxes were repealed, except the tax on tea,” he explained.
What about “taxation without representation?”
“British parliamentarians thought it odd that the colonies claimed that they were not being represented,” Luscombe said. “They all felt that they represented the entire British Empire, and therefore they represented the colonies as well as other parts of the Empire.”
Although Parliament backed off on a lot of the taxes and duties, it kept the tax on tea, Luscombe observed. “The East India company got Parliament to give them a monopoly on tea by taxing anyone else’s tea, so that tea from the East India Company was the cheapest in town,” he said. “The opposition to the tax on tea was that it was done without any input from the colonies. If you wanted to buy tea from somewhere else you had to pay more for it, which led to the Boston Tea Party in 1773. This resulted in punitive legislation and the stationing of troops in the colonies. It was this punitive response from Britain that helped unify the 13 separate colonies in their push for independence.”
The colonies struggled with their own debt issues after their success in the Revolutionary War.
“The new government had no power to tax,” Luscombe observed. “Under [the Continental Congress and] the Articles of Confederation from 1776 to 1787, the federal government looked to loans or financial support from the new states. In 1787, the Constitution was adopted and granted the national legislature the exclusive power to impose tariffs, along with the flexibility to collect excises and levy taxes on individual citizens.”
The language limiting direct tax was to avoid situations where there could be taxes imposed on slavery, since the Southern colonies were concerned that the tax power could be used to tax slavery out of existence, Luscombe noted.
For 75 years — from 1787 to 1862 — the federal government relied primarily on tariffs to fund expenses, Luscombe indicated. “There were often surpluses during this time,” he said. “The revenue from tariffs got us through the Mexican War and a number of other conflicts, but by the time of the Civil War, it wasn’t viable.”
“Then, in 1862, an income tax was enacted as an emergency measure to help fund the Civil War. It was allowed to lapse in 1872,” he said. “In 1894, a 2% federal income tax was enacted, but was ruled unconstitutional by the Supreme Court in Pollack v. Farmer’s Loan and Trust in 1895.”
Politicians started working on an amendment to change the Constitution, and in 1913, Wyoming was the last state to ratify the 16th Amendment to the Constitution, permitting an income tax. The Revenue Act of 1913 was enacted, imposing a 1% income tax on one out of every 271 citizens, and substantially reducing tariffs.
“We’ve had it ever since,” remarked Luscobe. “And it’s gone from affecting one out of every 271 to closer to everyone. Many people get more in refunds than they pay in, in the form of refundable credits, but over half of citizens now pay some sort of income tax.”
In the meantime, the various revenue statutes were codified in the Internal Revenue Code in 1939, and one out of 32 citizens paid a 4% income tax, he said. Withholding on wages and salaries was introduced in 1943 to help pay for World War II, with one out of every three citizens now owing an income tax. And in 1954, the Internal Revenue Code of 1954 was enacted, overhauling the income tax system with 3,000 changes.
The Tax Reform Act of 1986 represented the first significant effort to simplify the Tax Code, Luscombe said. “But from 1986 to the present, almost every new administration has proposed and has been able to enact significant tax legislation during their first two years in office, resulting in regular changes to U.S. income tax and increasing tax complexity.”
And what about the long-term success of the Boston Tea Party?
“The federal government still imposes tariffs on imported tea,” Luscombe said.
