I. A (very) brief history of income taxation The income tax has been, in the long span of history, a comparatively recent development. Seligman (1970, p. 41) argues that up until the Middle Ages income was not nearly as important an element of revenue as undefined “lucrative prerogatives of the feudal lord.” To the extent that it was used, it was mostly vicariously via taxation on the “faculty” of property, including human capital, corresponding to what economists today would call its present value in exchange. Although nominally a property tax, income earners paid what amounted to a tax of this sort on their productivity in market exchange, with the tax being assessed proportionately to their earned incomes. The first recorded instance of explicit income taxation occurred in several cities in northern Italy during the Renaissance. The increased commercial activity in Florence in particular, combined with the spread of more democratic governance, caused the government there in 1451 to change a portion of its tax assessment from one based on property to one based on income in the modern sense. More presciently than perhaps he knew at the time Seligman, who would without foreseeing the parallel help craft the initial U.S. income-tax laws a few years later, went on to observe:
“From the very outset, however, the political conditions were unfavorable to efficient administration. In the struggle with the Medici the assessment of the income tax became a favorite weapon of whatever party happened to be in power; and at no other time in the world’s history except, perhaps, in the later centuries of the decaying Roman Empire, was there such an orgy of corruption and maladministration. In order to ascertain the business profits, the books of the merchants were open to inspection, and the assessors had practically unlimited scope in deciding upon the amount of the levy. Individuals might compound with the officials in a lump sum, and the frauds were accordingly overwhelming in character. Everything was ruled by what as known as the arbitrio, that is, the arbitrary judgment of the authorities, and the income tax was utilized as the most potent engine of oppression or of favoritism.” (pp. 46-47)
Whether as a consequence of this evolution or not, the Florentine income tax thus lasted, along with all direct taxation on wealthier citizens, only until the return of more autocratic rule in the sixteenth century.
Income taxation was after this largely dormant until the nineteenth century. In the United Kingdom, the first income tax was instituted in 1799, during the Napoleonic Wars. This “temporary” income tax was finally reduced in 1842, but was never repealed. In fact, abetted by the marginalist revolution and the concept of diminishing marginal utility, the U.K. saw fit to introduce a progressive income tax in 1894 to pay for modern battleships. It was, however, sometime after the initial British institution of the tax before it spread permanently to the continent. The tumult of 1848 did lead to public pressure to impose such taxes, but they were all eventually repealed. However, by the end of the century governing sentiment had changed again, and so income taxation was permanently established in Germany in 1891, Holland in 1892, Italy in 1894, Austria in 1896, Sweden in 1897, Denmark in 1903, Norway in 1905, and France in 1909. Among the driving forces in this development were the increased need for arms spending after the Franco-Prussian war and the increased public pressure for state welfare spending (Webber and Wildavsky, 1986). Japan imposed income taxation in 1887, although it would be many years before it was a significant source of revenue.
In the United States, efforts to impose income taxation at the state (or colonial) level predate the Revolution. During the period of the Seven Years’ War, on nine occasions the lower house of the Maryland legislature passed measures taxing incomes. According to the official archives of the State of Maryland, these measures proposed taxation of the earnings of some or all of “public officials and beneficed clergymen, as well as upon the earnings of physicians, lawyers, clerks, and factors.” However, on all nine occasions the upper house of the legislature rejected these measures. A national income tax was first successfully approved at the federal level in 1861, to fund the Civil War effort. Annual incomes over $600 were taxed at a three percent rate, which was adjusted the next year to a five percent rate on incomes over $10,000. The tax was eliminated in 1872, but re-introduced in 1894, with a one percent tax levied on all incomes over $1000 (?), a threshold affecting a very tiny proportion of the U.S. population. However, in 1895, the U.S. Supreme Court, having upheld the Civil War tax in Springer v. United States1, now held it unconstitutional as a direct tax that was not, as Article I, Section 9 of the U.S. constitution required, levied in proportion to population.2To remedy this, the sixteenth amendment to the Constitution was ratified in 1913, and the income tax was permanently instituted in 1916. States had begun introducing income taxation in 1911 (Wisconsin), and it was gradually instituted in most states over much of the twentieth century. (See Table 1.) The Canadian federal income tax has a somewhat similar history. As in the U.S., the income tax was instituted at the central level (in this case for the first time) in 1917 to fund World War I efforts, although income taxation already existed in some provinces.