The First 1040

On the evening of March 1, 1914, Americans all around the nation inaugurated what has become a spring ritual for millions of us. They raced to file the first Form 1040 at the last minute before the deadline, hurrying by motorcar or trolley or on foot.

In New York City stragglers braved a blizzard to reach the Customs House office of the Bureau of Internal Revenue, which, like district offices everywhere, stayed open until midnight. Their last minute scurrying was front-page news in the Times the next day, and it saved them from being the first Americans to pay penalties for late filing. The weather, no matter how severe, was no excuse, as three men snowbound on a train from New York to Chicago found out. They arrived just after midnight and rushed to file. The tax collector Samuel N. Fitch was unyielding. “If they’re late, they’re late,” he said, “and there is no use in coming in today.”

Some citizens were reluctant to concede that the government had a right to share their income. A tax collector in Chicago was overheard saying into the telephone: “The penalty is up to $2,000 fine and maybe a year in prison. … Yes, a taxi would get you here the quickest.” But amazingly, from today’s perspective, most Americans actually welcomed the tax.

The attitude made considerable sense. Nobody would owe any tax or even, usually, have to file a return if he or she earned less than three thousand dollars (four thousand if married)—and that was the equivalent of more than thirty-five thousand dollars (fortyseven thousand if married) today. In fact, the tax was deliberately designed to affect only the wealthiest one percent of the population, and revenues from it were intended to permit the reduction of crushing protective tariffs and excise taxes that disproportionately burdened the poor and the middle class by adding sharply to the prices of food, clothing, and other necessities.

One Missourian expressed joy in the tax in a note he attached to his return: “I have purposely left out some deductions I could claim, in order to have the privilege and the pleasure of paying at least a small income tax. … I had rather pay twice as much direct and certain tax to and for support of the Federal Government than to pay only half as much indirectly [in tariffs].” And the New York Herald observed the emergence of “the young man who overstates his income in order to be among those who are obliged to pay an income tax.” The paper predicted that “many a $12 to $20 a week clerk will be waving an income tax receipt from the stool of his favorite quick lunch to show his value and standing in the commercial world.”

The new Form 1040 required taxpayers to report income “of whatever kind,” beginning, as we do now, with salaries, wages, and compensation for personal services. Most dividends were exempt, as long as the company issuing them had paid its corporate income tax. Gain on the sale of most types of property would receive no special treatment until 1921; capital losses were not recognized at all.

Only six categories of deductions were allowed: business expenses, interest on personal debt, other taxes paid, casualty losses not covered by insurance, bad debts, and depreciation of business property. Medical expenses and mortgage interest, considered “personal, living, or family expenses,” were not deductible.

The new income tax’s basic levy of 1 percent on incomes between three thousand and twenty thousand dollars was supplemented by a surtax of up to 6 percent on higher incomes. It was estimated that John D. Rockefeller would owe almost two million dollars in annual taxes, Andrew Carnegie almost six hundred thousand, and the extravagant Vanderbilts a mere one hundred thousand. The average worker—a man, woman, or child putting in perhaps twelve hours a day—earned eight hundred dollars per year, slightly more than one-quarter of the lowest taxable wage.

Proponents of the tax had long argued that it would offer the only fair way to shift the burden of taxation toward those with the greatest ability to pay. In an era when everyone knew, for instance, that William K. Vanderbilt had a garage on his Long Island estate with space for one hundred automobiles, the ostentatious wealthy were an irresistible target for reform-minded lawmakers—especially since many of the very rich actually benefited personally from the high tariffs protecting the industries they owned.

Attempts to tap Americans’ earnings to support the government had begun back in the Massachusetts Bay CoIony, which taxed tradesmen, such as tailors, masons, and blacksmiths. The first income tax collected by the United States government was signed into law by Abraham Lincoln in 1862 to finance the Civil War. Most people with incomes of more than six hundred dollars willingly paid their share as long as the war lasted. The tax was repealed in 1872.

The short-lived Civil War tax gave rise to two institutions that are still very much with us. One was progressive rates, introduced not to make the burden equitable but simply to raise revenue. The other was the Internal Revenue Service, then known as the Bureau of Internal Revenue. Taxpayers were assessed by collectors through notices in newspapers and public places, which if not answered were followed up with personal visits. For a time the bureau tried paying commissions to its employees but it abandoned that idea when several agents, pocketing both tax payments and commisions, simply disappeared.

The Civil War tax forcefully demonstrated the revenue-raising power of an income tax, and the lesson was never forgotten. Between 1873 and 1879 fourteen income tax bills were introduced by congressmen from the South and Midwest, where income was lowest and the impact of tariffs greatest. A bill finally was passed in 1894 that would have put a flat 2 percent tax on incomes of more than four thousand dollars. It made Rep. David De Armond of Missouri nearly delirious: “The passage of the bill will mark the dawn of a brighter day, with more of sunshine, more of the songs of birds, more of that sweetest music, the laughter of children well fed, well clothed, well housed.” Stockholders of several companies saw things differently and filed suits to challenge the tax’s constitutionality. One of the cases, Pollock v. Farmers’ Loan and Trust Company, ended in one of the most questionable Supreme Court decisions of all time.

The Court had to decide whether the tax was an indirect one, permitted by the Constitution, or a direct one, forbidden by Article I unless apportioned on the basis of population. The plaintiffs argued passionately that the Founding Fathers had considered any taxes on rents and personal property direct. The record of the Constitutional Convention gives no indication of this, but in May 1895 the Court declared the entire income tax legislation invalid, even though it had retroactively upheld the Civil War tax fifteen years before. Justice Stephen J. Field, who had voted with the majority in that case, was still sitting in 1895, but he had changed his mind. “The present assault upon capital is but the beginning,” he wrote in his concurring opinion, and if it continues, “our political contests will become a war of the poor afiainst the rich.”

Justice Edward D. White’s dissent seemed to support speculation that the Court was acting in self-interest: “If the permanency of its conclusions is to depend upon the personal opinions of those who from time to time may make up its membership, it will inevitably become a theatre of political strife and its action will be without coherence or consistency.”

Despite the ruling, the income tax idea would not die. Between 1895 and 1909 forty-two more income tax bills were introduced, exclusively by Democrats and Populists from the South and West. Even President Theodore Roosevelt came out for a tax during a 1906 speech. To the immense relief of fellow Republicans, he did not pursue the idea further.

One Democrat in the Tennessee legislature watched the development and demise of the 1894 tax especially closely. Cordell Hull, later Franklin Roosevelt’s Secretary of State, represented a poor, rural district and was convinced that “wealth was shirking its share of the tax burdens.” He was elected to Congress in 1906 and promoted the income tax idea almost to the point of obsession throughout the 60th Congress.

“I talked to some Congressmen so often they were no longer willing to listen,” he later recalled. “House leaders … strongly favoring an income tax, would turn and walk in another direction when they saw me approaching.” Unfortunately for Hull, the House was still dominated by Republican “standpatters,” who supported the tariff as a means of keeping wages (not to mention profits) high. He would not be deterred.

In 1909 Hull managed to get a bill considered as an amendment to the Republican-sponsored Payne Tariff Bill, but it was promptly defeated, and the tariff was approved and sent to the Senate, seemingly out of Hull’s reach. Then, in a quirk of fate with lasting reverberations, Hull had the good fortune to share a sleeping car with Sen. Joseph W. Bailey of Texas, a strong advocate of the 1894 tax. By the time the train reached Tennessee, Hull had persuaded Bailey to sponsor an income tax amendment in the Senate.

Meanwhile a bipartisan alliance was emerging in the Senate among those who opposed increased tariffs and thus supported an income tax. To counter this movement, President Taft secretly worked out a compromise during golf games at Chevy Chase and clandestine evening carriage rides. If the Democrats and pretax Republicans would drop the tax from the tariff bill, the administration and regular Republicans would back a resolution authorizing an income tax amendment to the Constitution— an amendment they doubted would ever be ratified.

The deal was struck. The Republicans got their tariff, but with prices soaring, the vast majority of Americans continued to blame the tariff for the high cost of living. The income tax amendment began to pass in state after state.

On February 3, 1913, the Sixteenth Amendment was approved by Wyoming, the thirty-sixth state to do so and the last required. Only Connecticut, Florida, Rhode Island, and Utah had voted no. The amendment gave Congress the power to “lay and collect taxes on incomes, from whatever sources derived, without apportionment among the several States and without regard to any census or enumeration.” A permanent income tax was now possible.

Congress went to work. Cordell Hull got the job of drafting a law and took on the task with relish, poring through a mountain of statistics on the economy and making a detailed study of income tax laws around the world. According to Hull’s biographer, Harold B. Hinton, the congressman based the system on the government’s need for revenue and the individual’s ability to pay, with no thought of redistributing income. It soon became apparent, though, that the law’s effect was to use the income of the rich to pay for services for the disadvantaged.

Debate on the House floor lasted just two days. More than a few representatives—particularly those who wanted to see the provision fail—suggested changes. Several proposals for higher rates, including one with a top level of 68 percent, were defeated. President Wilson urged that the exemption be fixed at three thousand dollars, to “burden as small a number of persons with … what will at best be an unpopular law”; the House settled on a more generous four-thousand-dollar exemption because, according to one representative, that was the amount required to “maintain an American family according to the American standard and send the children through college.”

The measure passed the House on May 8, 1913, substantially unchanged. In the Senate the debate lasted through a steamy summer. A demand for an increase in the surtax on very large incomes led to a compromise that set the maximum surtax at 6 percent on incomes of more than five hundred thousand dollars. An exemption of five hundred dollars for each child of a married couple was rejected; the final bill lowered the personal exemption to three thousand dollars for individuals and kept it at four thousand dollars for married taxpayers. Since then Congress has never stopped struggling with the problem of equalizing the tax burden on people in different family circumstances.

The Underwood-Simmons Tariff Act, with the income tax amendment attached, was approved by the Senate on September 9, 1913. It went to the President for his signature less than a month later and became law on October 3, effective retroactively to March 1, 1913.

By far the most controversial aspect of the final bill turned out to be “collection at the source,” which had been tucked away in Hull’s original proposal. Based on a system then in use in England, this required that any entity paying anyone three thousand dollars or more in income withhold 1 percent of it and pay it directly to the Treasury. Withholding on salaries has since become a routine part of our lives, but the original version meant, for instance, that tenants would have to ensure the payment of taxes by their landlords. Corporations and banks were asked to collect taxes on interest earned, exempting only those who filed certificates declaring their income to be less than three thousand dollars a year. And the certificates weren’t immediately available, even though withholding was supposed to begin November 1, 1913.

Collection at the source proved unworkable and was repealed in 1916; simple salary withholding was not introduced until 1943. The penalties for late filing in 1913 ranged from twenty dollars to one thousand dollars, depending on the amount owed. A fraudulent return could cost two thousand dollars or a year in prison or both.

Despite the simplicity of the form, it perplexed thousands. Very few regulations had been issued, and no tax rulings had yet been made. As Leslie’s Illustrated Weekly predicted, the birth of Form 1040 had to mean “a rich harvest for lawyers.” Sen. Elihu Root reportedly warned a friend who couldn’t master the form: “I guess you will have to go to jail. If that is the result of not understanding the Income Tax law I shall meet you there. We will have a merry, merry time, for all of our friends will be there. It will be an intellectual center, for no one understands the Income Tax law except persons who have not sufficient intelligence to understand the questions that arise under it.”

How-to articles appeared in all sorts of publications. “Don’t get excited,” counseled The New York Times. “Look Blank 1040 squarely in the face.” In 1915 the newspaper observed that many House members were going to the office of the sergeant at arms for help in completing their own returns. Ordinary taxpayers could get assistance too. Local district offices of the Bureau of Internal Revenue offered help both in person and by telephone.

The bureau’s Washington staff of 277 had only several weeks in late 1913 to create and distribute Form 1040, whose name simply indicated the next in an old series of bureau form numbers. The bureau had survived the repeal of the Civil War tax and all the years since but had been doing little more than enforcing the payment of excise taxes. With the passage of the new law, 477 new field agents were taken on, each at eight dollars per day, to examine returns.

No money had to be sent in with any return that first year. Instead each taxpayer’s computation of his liability was verified by the bureau’s field agents, who then sent out bills. A New York Times editorial complained that this gave the taxpayer “the same option that the eel has about being skinned.” Nonetheless, the process proceeded amazingly smoothly. By June 1, 1914, the tax bills were ready to be sent out, payable by the end of the month. When the receipts were tallied, more than twenty-eight million dollars had been collected. That was far less than the seventy million dollars Hull had predicted, but it was enough to prove to most members of Congress that a great resource had been discovered for raising revenue without grave consequences at the polls.

In fact the new tax created political capital for most of those involved. The average tariff rate had been lowered from a high of more than 40 percent to about 29 percent. There were, of course, court challenges. But in 1916 the Supreme Court, led by Justice White, the chief dissenter in the Pollock case, found the tax constitutional on all counts. Hull immediately declared, “We are now free to go ahead to revise the law to meet new needs.” Later that year he proposed augmenting the tax to raise an additional seventy-five million dollars “without making it burdensome.”

As everybody knows, taxes would never be that low—or that popular—again. The assassination of Archduke Franz Ferdinand in Sarajevo on June 28, 1914, changed everything. By 1919 the maximum tax rate had risen from 7 percent to 77 percent, and the Revenue Act of 1917 had lowered the minimum taxable income to one thousand dollars. As Hull had observed in a 1910 speech to the House, “We cannot expect always to be at peace. If this nation were tomorrow plunged into a war with a great commercial country … we would be helpless to prosecute [it] without taxing the wealth of the country in the form of incomes.” It would take just one more great war, less than three decades later, to transform Hull’s gentlemanly “class tax” into the mass tax we know today.