What are Federal Tax Brackets?

All modern industrialized nations tax their citizens’ income. Most vary their tax rates according to the amount of income that is being taxed. In the United States, these rate variations are codified, applied by the Internal Revenue Service (IRS) and are commonly referred to as federal tax brackets.

Constitutional responsibility to raise revenue for the operation of the US government lies with the United States Congress, and they have the responsibility for setting federal tax brackets. Prior to 1895, the United States Congress levied income taxes with federal tax brackets somewhat similar to modern practice. The constitutionality of the law was challenged in a case entitled Pollock v. Farmers’ Loan Trust. In 1895, the US Supreme Court held that the constitution forbids that particular approach to taxation and all tax brackets were eliminated from consideration. The sixteenth amendment to the constitution was ratified by the states in 1913, making possible the modern approach to taxation, including the use of federal tax brackets.

The top US federal tax bracket has varied from a 7% tax rate, exacted on incomes over $500,000 US Dollars (USD) in 1913, to a rate of 92% exacted on income in excess of $400,000 USD in the post World War II era. By 2011, the highest federal tax bracket had been reduced to a 35% rate, applicable to income in excess of $379,150 USD. According to the US Bureau of Labor Statistics, $500,000 USD in 1913 had the same buying power as more than $10,700,000 dollars USD in 2009.

US tax rates are not comparable across time due to many factors, including in regards to tax deductions. There were very few tax deductions allowed in the early years of US tax law, although the personal exemption deduction was set at an amount that could support a household for a full year. The practice of employing high federal tax brackets set to pay the costs the government incurred in World War II spawned a new industry: lobbying for tax benefits for various corporate interests. These tax benefits, which became so-called tax shelters, made it entirely possible, even as late as 1988, to earn more than $1 million USD annually yet pay almost no income tax. Many of the tax shelters of that era are no longer in the US tax code, a situation heartily endorsed by most economists who believe tax shelters result in a misallocation of resources.