Wall Street Journal Guide to Understanding Your Taxes: An Easy-to-Understand, Easy-to-Use Primer That Takes the Mystery Out of Your Taxes - Softcover

Chapter 1

THE TAX SYSTEM

History of Taxes

"Taxes are what we pay for civilized society."
Oliver Wendell Holmes Jr., 1904

Taxes figure in many of the oldest written records of civilization. Clay cones found in what is now Iraq indicate that there were heavy taxes there more than 4,000 years ago. Inscriptions made on the Rosetta Stone about 200 B.C. tell of tax immunity for Egyptian temples. Two centuries later came the biblical admonition of Jesus Christ during the Roman era: "Render therefore unto Caesar the things which are Caesar's, and unto God the things that are God's."

References to taxation pop up frequently in early art, literature and legend. Lady Godiva's legendary ride on horseback was part of a successful appeal for tax relief for medieval Coventry. William the Conqueror's Domesday Book of 1086 was a census of England designed to ensure accurate taxation. A fresco on a wall in the Brancacci Chapel in Florence, Italy, pictures a divine blessing for the income and property-tax system enacted by the Florentine Republic in 1427.

ANCIENT METHODS OF TAXATION

The rulers of cities and nations throughout history have demanded that their subjects pay tribute in a number of ways. There were taxes on property, income, status and occupation. Many taxes were paid in kind, with part of the grain, cattle or other wealth that someone raised or produced.

Taxes were used to pay for wars of expansion, to enrich kings and aristocrats, to control imports and exports and to crush conquered peoples. Some rulers striving to maintain power used tax cuts to win favor. Others levied to make their states strong militarily, while encouraging trade and individual enterprise.

TAXATION IN GREECE

The first graduated income tax was recorded in Greece 2,600 years ago. It imposed the highest rates on citizens with the greatest honors and wealth. Solon, the ruler at the time, also legalized and taxed prostitution and used the proceeds to erect a temple.

About 150 years later, under the statesman Pericles, democratic Athens had traffic tolls, harbor dues, import and export tariffs, per-head taxes (called poll taxes) on freemen and slaves, a sales tax, license fees and a levy on property with rates rising according to wealth.

The Ptolemy dynasty, the Greek dynasty that ruled Egypt after the death of Alexander the Great, set standards for efficient government and taxation. The rulers protected their own products, such as olive oil, with high tariffs on imports. Peasants paid fees to keep cattle and graze them on common land. Farmers gave as much as half their produce to the state.

There were tolls and poll taxes as well as taxes on salt, catches of fish, legal documents, legacies and the sale and rental of goods. An army of scribes registered private property and kept track of taxable products and transactions. The government hired tax collectors and held their possessions as security until they delivered the taxes they were responsible for collecting.

TAXATION IN ROME

Rome's senate and later its emperors were adept at draining the resources of its vast domains. As the empire tottered toward collapse in the 4th and 5th centuries A.D., Rome became infected with an epidemic of tax evasion.

In the 4th century, a special police force was created to examine every man's property. Wives and children were tortured to make them reveal hidden wealth. Eventually, aristocrats refused to accept positions and honors simply to avoid the taxes the positions would bring. Skilled artisans left their trades and ordinary citizens abandoned their homes and found refuge among the so-called barbarians.

In the end, according to Will Durant in Caesar and Christ, Rome fell because of decaying morals, failing trade, bureaucratic despotism, consuming wars, declining population and "stifling taxes."

War and Taxes

Taxes were a cause of the American Revolution and the Civil War. They also helped pay for them.

The idea of paying for wars with income taxes came from British Prime Minister William Pitt, who instituted a tax on income in 1799 to pay for Britain's prolonged war with Napoleon. The British income tax remained in force until 1816, a year after Napoleon's defeat at Waterloo. A peacetime economic crisis in 1842 restored the income tax in Britain for good.

TAXATION IN THE NEW WORLD

The colonies in America spent little for public purposes. Colonial government got most of the modest revenue it needed from per-head taxes (called poll taxes), property taxes and taxes on products.

In 1643, the colonists of New Plymouth, Massachusetts, adopted a forerunner of the income tax called a faculty tax. It was applied to people according to their "faculties," or their property and ability to earn income from commerce or a skilled trade. During the American Revolution, from 1775 to 1783, most of the 13 states levied faculty taxes.

The distant British Parliament's efforts to dominate the colonies through import taxes on molasses, sugar and tea intensified the misunderstandings between the New World and the Old and led directly to the Revolution. "Taxation without representation is tyranny" became the watchwords of independent thinkers in the 1760s.

When the two-million-plus American colonists protested against taxation without representation, the British responded with more colonial taxes and sent more troops to the colonies to crack down on resisters. Until then, the colonies had been rivals only of each other.

THE FIRST U.S. TAXES

There was no national U.S. tax system until several years after the Revolution. To pay for freedom from Britain, the Continental Congress printed paper money and borrowed money from France -- Britain's age-old enemy. When the war for liberty was won, the bankrupt national government defaulted on its debts.

The Constitution of 1789 gave taxation powers to the new federal government. The states agreed to a strong central government with ample power to collect taxes "to pay the debts and provide for the common defense and general welfare of the United States."

Under George Washington and John Adams, Congress enacted a broad system of taxes on carriages, liquor, salt, sugar, snuff, legal documents, bonds and auction sales. A tax on homes, land and slaves was added in 1798.

The third president, Thomas Jefferson, championed the common man and opposed the domestic taxes of his predecessors. He saw to it that many of their taxes were repealed.

In the 19th century, war brought new tax burdens to the American people. Various taxes were revived during the war of 1812 against the British. Still, until Abraham Lincoln's inauguration in 1861, taxes on American property and goods played only a small role in government revenues. Even in 1862, the second year of the Civil War, taxes on imported goods accounted for $49 million of the federal government's total receipts of $52 million.

Taxes on imported goods -- also called customs duties or tariffs -- were a bone of contention between the North and the South. Northern manufacturers wanted high tariffs to protect their products against lower-priced imports. Southern planters wanted low tariffs to keep their imported goods cheap.

To help pay for the Civil War, Lincoln approved a three percent tax on annual incomes between $600 and $10,000 and a five percent tax on higher incomes. The rates soon increased to 10 percent on income over $5,000.

Less than 1 percent of the population paid income tax during the Civil War, and income-tax revenues made only a small contribution to the war effort. The Civil War income tax was repealed in 1872.

The Constitutional Debate

The pros and cons of an income tax continued to divide the country after the Ci