In 1915, forty years since the U.S. had overtaken the UK as the world’s largest economy, a statistician by the name of Willford I. King expressed concern over the fact that approximately 15% of America’s income went to the nation’s richest 1%. A more recent study by Thomas Piketty and Emmanuel Saez estimates that, in 1913, about 18% of income went to the top 1%.
Perhaps, it is no wonder then that America’s current income tax was first introduced in 1913. Being strongly advocated by agrarian and populist parties, the income tax was introduced under the guise of equity, justice, and fairness. One Democrat from Oklahoma, William H. Murray, claimed, “The purpose of this tax is nothing more than to levy a tribute upon that surplus wealth which requires extra expense, and in doing so, it is nothing more than meting out even-handed justice.”
While there was a personal tax exemption of $3,000 included in the income tax bill that passed, ensuring that only the wealthiest would be subject to taxation, the new income tax did little to level the playing field between the rich and poor. There was never any intention of it being used to redistribute wealth; instead, it was used to compensate for the lost revenues of reducing excessively high tariffs, of which the rich were the main beneficiaries. Thus, the income tax was more equitable in the sense that the rich were no longer allowed to receive their free lunch but had to start contributing their fair share to government revenues.
The new income tax did little to put a cap on incomes, evidenced by the low top marginal tax rate of 7% on income over $500,000, which in 2013 inflation-adjusted dollars is $11,595,657. Income inequality continued to rise until 1916, the same year in which the top marginal tax rate was raised to 15%. The top rate was changed subsequently in 1917 and 1918 reaching a high of 73% on incomes over $1,000,000.
Interestingly, after reaching a peak in 1916, the top 1% share of income began to drop reaching a low of just under 15% of total income in 1923. After 1923, income inequality began to rise again reaching a new peak in 1928—just before the crash that would usher in the Great Depression—with the richest 1% possessing 19.6% of all income. Not surprisingly, this rise in income inequality also closely mirrors a reduction in top marginal tax rates starting in 1921 with the top rate falling to 25% on income over $100,000 in 1925.