A Presidential Look at U.S. Taxes
“…In this world nothing can be said to be certain, except death and taxes.” -Benjamin Franklin 1789
What Benjamin Franklin said so many years ago still stands true today. There is no escaping death and taxes. While the individual tax filing extension date just passed on October 15th and as we gear up for our year-end tax planning strategy, we felt it would be a good opportunity to review the history of income taxes and role of the Internal Revenue Service (IRS).
As we all know, it is our civic duty as Americans to pay our fair share of taxes. Although tax is such a broad category including sales tax, state and local tax, property tax, excise tax, estate tax and much more, for purposes of this blog post we decided to focus our attention on federal income taxes. These taxes carry the majority share of the IRS revenue each year.
The IRS recently released data for the 2017 tax year. Although this was before the passage of the major tax reform bill in late 2017, The Tax Cuts and Jobs Act (TCJA), we wanted to analyze the numbers. Most taxpayers played their part as over 143 million tax returns were filed with individual income tax collections totaling $1.6 trillion dollars. Due to the progressive nature of the tax brackets, the average effective tax rate for 2017 was 14.6%. However, certain US citizens carried the bulk of the tax burden. The top wage earners are often scrutinized for utilizing various tax strategies to lower their amount of taxable income. So, let’s examine the top 1% of taxpayers and their impact on the IRS revenue.
To put things in perspective, to be a top 1% taxpayer, you would need income in excess of $515,371 (as of 2017). Although the top tax bracket for the 2017 year was 39.6%, these top 1% of taxpayers had an average individual effective tax rate of 26.76%. This is partially due to portfolio related income taxed at the preferential qualified dividend/long-term capital gains rates of 20% (highest capital gains tax rate). However, the top 1% of taxpayers accounted for 38.47% of the total income tax revenue collected by the IRS. Furthermore, the amount paid by the top 1% is greater than the amount of tax paid by the bottom 90% of tax payers combined (29.92% of total tax share). As these top earners pay much of the total share of income tax, we wonder if this will change in the future. This largely depends on the state of the economy and political landscape. Before predicting where we are headed with the 2020 election on the horizon, we wanted to look back at how taxes changed through different presidential administrations.
Abraham Lincoln 1861- 1865
Although short lived, the Revenue Act of 1861 imposed the first tax on the American people. The tax was 3% on income over $800 and it was used to pay for the Civil War. To enforce collection, the Internal Revenue Service (IRS) was created on July 1, 1862. This tax was repealed by Congress in 1871.
Grover Cleveland 1885-1889, 1893-1897
In 1894 Congress tried to enact a federal flat rate income tax but the U.S. Supreme Court ruled it unconstitutional because of the varying population in each state. What a time to earn money!
Woodrow Wilson 1913- 1921
In 1913, The IRS created form 1040 for better tax reporting and record keeping. Additionally, the 16th Amendment was changed so taxes did not need to be proportionate to state population. Then a 1% tax was placed on income over $3,000 and 6% on income over $500,000. In 1916, the tax was increased to 2% to aid in World War I expenses. Taxes changed yet again in 1917 by placing the 2% tax on all income over $1,000 and the surtax increased to 63%. By 1920, taxation revenue was up to $6.6 Billion, but fell to $1.9 Billion by 1932 as a result of the Great Depression.
Herbert Hoover 1929-1933
The Revenue Act of 1932 ended up being a major tax reform in US history. The bill caused increased tax rates across the board with the lowest rate starting at 4% and gradually increasing to the highest rate of 63%. This greatly impacted high earners and caused the affluent to explore various tax strategies to reduce income. Corporate taxes also increased by nearly 15%.
Franklin Roosevelt 1933-1945
With the wealthy uncovering several tax loopholes, President Franklin Roosevelt sought out to tax the rich to offset the large deficits created by the New Deal. In 1944, he raised the top marginal tax rate to its highest rate ever, 94%, to help fund the war. And then in 1945, he lowered the rate down to 86.45%. By 1945, yearly tax revenue was $45 billion, up from $9 billion in 1941. Much of this increase was required to fund Social Security which was established in 1935.
Harry Truman 1945-1953
Although Republicans in the Senate and House were able to cut rates in 1948, President Truman increased taxes in 1950 to raise money for the Korean War. The lowest and highest tax brackets increased to 20% and 91%, respectively.
Lyndon B. Johnson 1963-1969
The Revenue Act of 1964 was initially pushed for by President John F. Kennedy but implemented by President Lyndon Johnson. The idea was to cut tax rates to increase job growth. This act cut the top rate to 70%. Furthermore, the standard deduction was initiated and set at $300. Then, in 1965 Medicare was introduced. Similar to other social programs like Social Security, Medicare made it more difficult to lower taxes without running large deficits.
Ronald Reagan 1981- 1989
President Ronald Reagan’s Economic Recovery Tax Act of 1981 greatly reduced the top tax rate from 70% to 50%. The law also indexed tax brackets for inflation. His hope was to encourage savings and investments to stimulate economic growth. Then again in 1986, Ronald Reagan created the Tax Reform Act to further cut taxes and simplify the tax code. The top rate was lowered to 28%, and the standard deduction and personal exemption were increased. This favored many but was extra beneficial to low-income households.
George H.W. Bush 1989- 1993
President George H.W. Bush passed the Omnibus Budget Reconciliation Act of 1990. This raised the top rate to 31% in efforts to reduce the federal deficit.
Bill Clinton 1993-2001
Bill Clinton raised the top tax bracket to 39.6% in 1993. He also increased the taxable portion of Social Security benefits. In 1997, President Bill Clinton signed the Taxpayer Relief Act. The act introduced new tax breaks for families with dependent children and education costs. It lowered the capital gains tax rates to 10-15% to encourage investments. The Roth IRA was born.
George W. Bush 2001-2009
President George W. Bush implemented The Economic Growth and Tax Relief Reconciliation Act of 2001 to lower tax rates and drop the top rate to 35%. A new 10% tax was imposed for the first $6,000 of income for individuals ($12,000 for married couples). Bush also initiated The Jobs and Growth Tax Reconciliation Act of 2003. This act cut taxes again and lowered capital gains rates. This greatly benefited high earners.
Barack Obama 2009-2017
The Obama American Taxpayer Relief Act of 2012 and Obama’s Affordable Care Act of 2010 increased the tax rates with the top rate being 39.6%. It also placed additional taxes relating to health care. The Net Investment Income Tax (NIIT) was also created which imposed a 3.8% surtax intended to tax portfolio income over a certain threshold. Learn more about NIIT here.
Donald Trump 2017- Present
President Trump pushed the Tax Cuts and Jobs Act of 2017 through Congress, with numerous changes to the tax law. To highlight a few, the standard deduction nearly doubled, various tax deductions were eliminated, estate tax exclusion nearly doubled, individual tax rates were lowered, and corporate tax rates dropped significantly to a flat 21%. The top individual rate is currently at 37%. A Sunset provision was also enacted which would cause some of the changes to revert to prior law in 2026.
To review details of the current tax law, please reference our 2019 Key Financial Data Sheet.
When reflecting on our country’s long history of taxes, it is evident that we have come a long way since 1861! As the 2020 election nears, discussions about expanding social programs and health care reform polarize political debates. As we do not have a crystal ball to see into the future, we will reserve judgement on what will happen with the tax code going forward. However, we believe it is important for investors to focus on what they can do today.
Although income taxes are often the highest tax US citizens pay, capital gains tax from investment portfolios can also be costly. As we are in the longest bull market to date, it is becoming more challenging to offset gains. Many investors face a difficult question when seeking to rebalance or de-risk their taxable investment accounts. Do you sell investments to reach your target allocation and incur additional taxes OR pay no taxes (by making no changes) and have a higher risk exposure to equity investments? As this can be a costly question, investors can look to tax strategies in other areas to help limit the total liability.
Some of these tax strategies include-
- Contributions to retirement accounts
- 401Ks and self employed 401Ks (by year end)
- Traditional IRAs and Roth IRAs (by April 15th of 2020)
- SEP IRA (by April 15th or October 15th if filing an extension)
- Donations to Charities
- Qualified Charitable Distribution (QCD) through IRA
- Donations to Donor Advised Fund (DAF)
- Tax Loss Harvesting
- Utilizing Old Tax Loss Carry Forward or Net Operating Losses for businesses (NOL)
As your trusted advisors, we are happy to elaborate on the strategies above and explore potential opportunities. As the bulk of this planning needs to be completed PRIOR to yearend, it is important to take action sooner than later. To allow us ample time to review and make recommendations to your specific situation, please provide us with your 2018 tax return at your earliest convenience.
As opinions vary around the topic of taxes, we hope to find common ground by concluding with a quote from famous historian, Albert Bushnell Hart, – “Taxation is the price which civilized communities pay for the opportunity of remaining civilized.”
** The information provided should not be interpreted as a recommendation, no aspects of your individual financial situation were considered. Always consult a financial professional before implementing any strategies derived from the information above.