Historical Perspectives on the Federal Income Tax
1913: The Federal Income Tax
Cordell (Judge) Hull, a Representative from Tennessee, was assigned the task of writing the Bill which would ultimately implement the provisions of the Sixteenth Amendment; he is referred to as the "father of the modern income tax". This is important to remember only because he was widely accepted by both the House and the Senate as being the most knowledgeable on income tax legislation.
The Income Tax of 1913, in reality, grew out of the "Corporation Excise Tax of 1909". In fact, the provision of the 1909 Act was extended to "Individuals" under the Act of 1911, although in a very limited way. In the discussions of the "Corporation Excise Tax" it was well recognized that Congress already possessed the power and authority to levy such a tax upon corporate profits, even though those "profits" included "income" derived from sources of real and personal property. In writing the "Income Tax" Law of 1913, the same principles underlying the Corporate Excise Tax were extended to the "gains and profits" derived by businesses, trades, professions, vocations, and all other forms of "employments", including the rental of property and the investing of capital. The provisions of the Law, as written by Judge Hull, are found on pages 505 and 506 of the April 26, 1913 Congressional Record. In a brief explanation of the Law Mr. Hull makes this statement:
"In any event, the proposed tax is measured by net profits or gains, and is not imposed upon gross income nor capital nor other property. If a citizen has not been successful in his efforts to accumulate profits he is not required to pay the tax, but if he has prospered he is required to contribute to his Government, not the scriptural tithe, but a small percentage of his net profits."
Mr. Hull fully explains the proposed Law on page 506:
"The proposed law should be construed as similar laws have been construed by the courts with respect to the application of the tax, and that is that the income in question shall be the measure of the tax and not the specific fund out of which the tax is necessarily payable; the bill takes as the measure of the tax the net income of the proceeding year. Paragraph B defines the net income of a taxable individual or person. Income as thus defined does not embrace capital or principle, but only such gains or profits as may be realized from rent, interest, salaries, trade, commerce, or sales of any kind of property, and so forth, or profits or gains derived from any other source.
It would be impossible here to undertake to explain the application of this provision of the bill to the innumerable transactions arising in this country. The rulings of the Treasury Department and the decisions of the courts of this country with respect to similar provisions of the old income-tax laws, and also the English rules of construction, all essential portions of which will be embraced in the Treasury Regulations, will make clear the distinction between taxable profits or income on the one hand and capital or principle on the other. The proceeds of life insurance policies paid on the death of the person insured are expressly exempted; likewise the return of any part of the principle invested in insurance during life, as distinguished from the earnings upon the same, would not be taxable.
Bequests, devices, and so forth, are not considered as taxable income; an inheritance tax applicable to them would naturally contain rather highly graduated rates, so that this tax would properly be contained in a separate enactment. The second division of paragraph B prescribes the deductions allowed in computing net income for the purpose of the normal tax. Most of these deduction clauses have heretofore been construed both by the Treasury Department and the courts. As to losses, these provisions primarily contemplate allowance for losses growing out of the trade or business from which the taxable income is derived, and generally termed trade losses, as distinguished from losses of capital or principle or losses incurred entirely apart from business transactions from which income is derived. A similar rule governs deductions for expenses. In thus computing net income the taxpayer does not embrace any portion upon which the tax is stopped at the source; but in all cases where taxable income arises from an annual business relationship, but does not exceed $4,000, and so the tax is not withholdable at the source, the same must be embraced in the personal return, and also if such income is uncertain or irregular in the amount or time of its accrual, and so is not derived from a business relationship extending through the year, it likewise shall be embraced in a personal return, and no tax would be withheld at the source. This latter would embrace all taxable profits or income derived from trades, professions, and other businesses embracing promiscuous transactions and the accrual of profits in uncertain amounts and at irregular times, as distinguished from business relationships running through the year and the fixed income therefrom. The amount received by the individual taxpayer from the net earnings of a corporation subject to like tax will not be embraced in his personal return of income for the purpose of the normal tax. The normal tax of 1 per cent that would otherwise accrue against the owners or stockholders of the corporation is paid for them by the corporation upon its net earnings."
A major part of the debates and discussions over the provisions of the Income Tax Law centered on the "personal exemption" deduction. The purpose of the exemption is obvious, in relation to the tax on "net-income", for it provided the separation of the "excise" tax upon business and financial "gains and profits", from the taxable portion attributable to the citizen paying the tax. In other words, the "Income Tax" is an excise tax levied upon business and financial transactions carried on by corporations and "individuals" (business and professional entities), it is not an excise tax levied upon people. The measurement of the tax is "net-income", i.e. "gains and profits". In order for the tax to remain a tax upon "net-income", when the citizen pays the tax, an allowance for "personal living and family expenses" must be made. Otherwise, the tax paid by the citizen would be based upon gross income, not net-income. Again I return to Judge Hull and his synopsis of the revenue bill provided on page 5679 (October 16, 1913). In explaining the Law and its application, he provided two important bits of information outlining the principle behind the Sixteenth Amendment income tax:
"The Treasury Regulations soon to be prepared will make clear to every taxpayer the requirement of the law and its application to income derived from the various kinds of business. To any person who keeps familiar with his business affairs during the year to the extent that at its end he knows with reasonable accuracy the amount of his aggregate annual profits, the matter of executing his tax return would be both simple and convenient.
The statutory exemption of $3,000 is allowed for personal living and family expenses; however, this and other gross income for which special deductions are allowed by the law must be embraced in the return of gross income, and the Commissioner of Internal Revenue will make these deductions when he assesses and computes the tax."
The "income tax" is essentially an excise tax levied upon the privilege of using real and personal property, as well as the different forms of business and professions, to produce gains and profits. The "tax" is then levied in relation to those "gains and profits. In other words, the tax is measured by the net-income or profit derived from business and financial transactions and then assessed upon the natural person owing the tax after the allowance for "personal living and family expenses". In that way the tax remains upon the net-income of the person receiving it.
The intent of the personal exemption, as defined by Congress, is best expressed by Congressman Palmer of Illinois in his speech before the House on May 6, 1913 (page 1250). The personal exemption was set at $3,000 single and $4,000 married:
"The second reason that appeals to me is this, that in levying this direct tax upon incomes we ought to rise above the point where the consumption taxes now bear out of all proportion to the incomes, and we ought to leave free and untaxed as a part of the income of every American citizen a sufficient amount to rear and support his family according to the American standard and to educate his children in the best manner which the educational system of the country affords. I think it safe to say that no man with the average American family of five children can support that family according to the proper American standard and send his children through the high schools and colleges of the land who does not have a gross income of $4,000 per annum. Out of that sum must be paid living expenses, interest on debts and other obligations, improvements to the home, education of children through colleges and universities, many comforts and some luxuries which American demand. And if you would not tax education, if you would not retard the development of our people up to the standard at which Americans ought to live, and if you would not doubly tax the poor upon whom these consumption taxes are now levied, you must make this exemption at about the sum of $4,000."
Congressional Record, Volume 50:
Part 7, INDEX: House Bills, 3269-3329, H.R. 3321
Part 7, INDEX, "Topical History--1913", pgs. 178&182
Part 1, pgs. 421-22, 503-518, 884-85,
Part 2. pgs. 1236-1264, 1299-1311, 1422-24, 1598-99,
Part 3, pgs. 2513-14, 2553, 2557-8,
Part 4, pgs. 3766-76, 3801-22, 3829-90
Part 5, pgs. 4290-92, 4379-81, 4417-19, 4422-28, 5678-81
Part 7, Appendix/Hampton Moore, pgs. 89-90
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