The year 1913, alongside the establishment of the Federal Reserve System, marks another monumental shift in American governance and economic policy: the introduction of the federal income tax. This was a transformative moment, fundamentally altering how the United States government would finance itself and its burgeoning role in national life.
For much of American history prior to this, the federal government largely relied on customs duties and excise taxes for revenue. In fact, in 1792, 87 percent of federal revenues were dedicated just to interest payments, underscoring the early government’s reliance on trade to manage its debts. The Civil War era saw a temporary income tax, but it was unpopular and considered a violation of the Constitution at the time. By 1913, customs revenues still accounted for a significant portion—45 percent—of federal receipts. The new income tax would dramatically change this, with customs’ share falling to 28 percent by 1916, and eventually less than 5 percent after World War I. This shift allowed the United States to potentially cut tariffs without fearing unacceptable fiscal costs.
The pathway to a permanent income tax was paved by the ratification of the Sixteenth Amendment earlier in 1913, which granted the federal government the explicit power “to lay and collect taxes on incomes”. This was a direct response to a Supreme Court ruling in 1895 (Pollock v. Farmers’ Loan and Trust Co.) that had previously deemed a modest income tax passed in 1894 unconstitutional. The widespread agitation for relief—especially monetary, economic, and social—following the “Bankers’ Panic of 1907” created a ripe environment for such reforms.
The introduction of the income tax was deeply intertwined with the Progressive Era’s political and economic currents. Leaders like President Woodrow Wilson, who took office in 1913, coupled calls for fairness and reformed government with a long-standing Democratic Southern opposition to high tariffs. Wilson prioritized both lower tariffs and antitrust measures upon entering the presidency. The income tax, as part of the Underwood-Simmons bill, was instrumental in allowing for tariff reductions.
This tax was also seen as a tool to address wealth inequality and concentration of financial power. Earlier in the 20th century, economist Edwin R.A. Seligman, from a prominent Wall Street investment banking family, had envisioned the “new industrial order” where economic knowledge would grant power to “control and mold” material forces. While this might sound like a consolidation of power, the income tax itself was intended to be progressive, aiming for “more equality of wealth and of income than would result from economic forces working alone”. Theodore Roosevelt, Wilson’s distant cousin and a notable progressive figure, had years prior promoted the idea of a social insurance program and advocated for public funding of elections, bans on corporate contributions, and full disclosure of campaign sources to combat corruption, successfully pushing for the Tillman Act of 1907 to bar corporate contributions. The 1913 income tax, with its graduated rates and later the first federal inheritance tax, further reflected these progressive ideals. The principle of using taxation to achieve greater equality was explicitly stated: “These taxes should be defended and attacked in terms of their effect on the character of American life, not as revenue measures”.
Compared to European nations, the U.S. was somewhat behind in adopting a modern income tax. By 1900, income tax supplied roughly 12 percent of government revenue in Italy and the United Kingdom, and about 20 percent in Germany and the Netherlands. France also established a modern income tax in 1913, though with a top marginal rate of only 2 percent. The U.S. income tax, therefore, brought the American system more in line with the fiscal policies of other industrialized nations.
Ultimately, the income tax, along with the Federal Reserve Act passed in the same year, provided the U.S. government with newfound financial tools and a more active role in managing the nation’s economy. It allowed the country to fund large-scale endeavors, notably World War I, with a significant portion of the cost paid by this new form of taxation rather than traditional methods like borrowing from banks or issuing “printing-press money” which had previously led to massive inflation. The introduction of the income tax was a clear indication that the federal government was expanding its functions and intended to influence the distribution of wealth, moving towards a more centralized and coordinated state.