When the United States introduced the modern federal income tax in 1913, fewer than 1% of households paid a dime. The tax rate started at 1% on incomes over $3,000—roughly $90,000 in today’s purchasing power—with a top marginal rate of 7% for those making well over $500,000.
It was an elite levy, designed explicitly to offset tariffs and target massive fortunes accumulated during the Gilded Age.
Then came World War I.
By 1917, the federal government faced an unprecedented funding gap. To finance the war effort, Congress passed the War Revenue Act of 1917, slashing exemptions and pushing top rates to 67%. A year later, the Revenue Act of 1918 boosted the top rate to 77%. The message from Washington was straightforward: these were exceptional levies for an exceptional emergency, designed to fund victory and dissolve once troops returned home.
Governments across the globe ran the exact same playbook. Canada introduced its first income tax in 1917 under the Income War Tax Act, explicitly framed by Finance Minister Sir Thomas White as a temporary wartime necessity. The United Kingdom, which had relied on income tax off and on since the Napoleonic Wars, hiked rates into overdrive to finance the Western Front.
The war ended in November 1918. The tax apparatus stayed behind.
The Ratchet Effect
Economic historian Robert Higgs coined the term “the ratchet effect” to describe how governments expand during crises. In times of war or economic collapse, public expenditure and state power surge upward. When the crisis abates, spending decreases slightly, but it almost never returns to pre-crisis baselines. New administrative machinery has been built, new revenue expectations set, and new interest groups organized around federal spending.
During the 1920s, Treasury Secretary Andrew Mellon fought to pare back the wartime tax rates. Mellon argued that lower rates would boost investment and yield higher tax revenues overall—an early precursor to supply-side economics. Throughout the decade, rates actually fell. By 1925, the top marginal rate dropped back to 25%.
For a brief window, it appeared the temporary measure might fade into background irrelevance.
Then came 1929.
The Great Depression and the Mass Tax Shift
The collapse of trade in the early 1930s destroyed tariff revenue—historically the federal government’s primary income source. To fund the New Deal and balance a hemorrhaging budget, President Herbert Hoover signed the Revenue Act of 1932, spiking the top tax rate back up from 25% to 63%. Franklin D. Roosevelt raised it further to 79% in 1935 and 81% in 1940.
Yet even with these sky-high rates on the wealthy, the income tax remained a “class tax.” In 1939, only 3.9 million Americans filed federal income tax returns.
World War II completely dismantled that dynamic. To finance a global multi-front war, the federal government needed far more capital than wealthy individuals could provide. The Revenue Act of 1942—often called the greatest tax expansion in U.S. history—transformed the income tax from a class tax into a “mass tax.”
The number of taxpayers exploded from 3.9 million in 1939 to 42.6 million by 1945. By the end of the war, roughly 74% of the American workforce was paying federal income tax, with the top rate hitting a staggering 94%.
The Structural Lock-In: Payroll Withholding
High rates alone didn’t guarantee permanent compliance. Collecting large annual lump sums from tens of millions of working-class citizens was an administrative nightmare and politically risky. People often lacked the liquidity to pay a massive tax bill every April.
Enter the Current Tax Payment Act of 1943.
Engineered in part by Beardsley Ruml, chairman of the Federal Reserve Bank of New York, the law established employer payroll withholding. Instead of asking citizens to save money and pay their tax bill once a year, the government took the cash directly out of paychecks before workers ever saw it.
Withholding removed the daily friction of taxation. It automated revenue collection and turned employers into unpaid tax collectors for the state. Once withholding became standard operational procedure, the federal government possessed a friction-free pipeline directly into the nation’s payroll.
Why the Temporary Never Left
When World War II concluded in 1945, rates declined slightly, but the massive administrative machinery remained fully intact.
The Cold War ensured that defense spending never returned to pre-war norms. Meanwhile, peacetime public expectations had shifted: citizens expected expanded government infrastructure, social safety nets, and veterans’ benefits funded during the New Deal and war years.
To scrap the income tax would have meant dismantling the newly built modern state.
What began as a targeted, temporary measure to pay for munitions in 1917 evolved into the structural backbone of Western public finance. Temporary emergency policy rarely dies of natural causes—it simply becomes the baseline for the next budget.