It began with an earthquake. What hit San Francisco in 1906 was one of the worst natural disasters in American history. Once the water mains broke, there was no way to fight the dozens of fires caused by ruptured gas mains, except by dynamiting buildings in the fire’s path, which made things worse. The fires lasted for days. More than three thousand people died, including the city’s fire chief, who fell two stories after the dome of the California Hotel crashed into the fire station. Most of the city was destroyed. Economic aftershocks were felt as far away as London. Twelve insurance companies went bankrupt, and, after a gold shortage and a doomed scheme to corner the copper market, the Knickerbocker, the second-largest trust in New York, failed, setting off the Panic of 1907. The New York Stock Exchange nearly collapsed. So did the United States Treasury.

Politicians dislike talking about taxes, except to use them as a matador uses a red cape. Illustration by John Brownjohn

The Panic of 1907 contributed to the passage of the Sixteenth Amendment, in 1913, which granted Congress the right to levy an income tax, and to the establishment of a central banking system, the Federal Reserve. Both the Sixteenth Amendment and the Federal Reserve will be a hundred years old in 2013. Hoopla is not anticipated. Not especially controversial a century ago, the tax and the bank lie at the core of a now popular account of American history in which 1913 was the real disaster, the original “fiscal cliff.” This year, the Republican Party platform included a call for the Federal Reserve to be audited—stopping short of Ron Paul’s promise to “end the Fed”—and a provision for the Sixteenth Amendment to be repealed.

It’s possible to think of the election of 2012 as a referendum on the role of government in the economy, and many people do, except that it’s difficult to have a referendum about the future when there’s so much disagreement about the past. This month, the federal government is trying to prevent a disaster of its own making: on January 1, 2013, unless Congress can agree to a plan that the President is willing to sign, the budget will run on austerity autopilot—across the board, taxes will increase and spending will be cut, by seven hundred billion dollars—which, worst case, could trigger a global economic crisis. One reason the situation has come to this is that politicians don’t like to talk about taxes, except to use them the way a matador uses a red cape. Those interested in getting voters to seethe will find no means easier. Read their lips.

Taxes dominate domestic politics. They didn’t always. Since the nineteen-seventies, almost all of that talk has been about cuts, which ought to be surprising, because more than ninety per cent of Americans receive social or economic security benefits from the federal government. Americans, though, find it easier to see what they pay than what they get—not because they aren’t paying attention but because the case for taxation is so seldom made.

Damning taxes is a piece of cake. It’s defending them that’s hard. “Taxes are what we pay for civilized society,” Oliver Wendell Holmes, Jr., said, nearly a century ago. (His words are engraved on the front of the I.R.S. Building in Washington.) No one’s said it better since. And that, right there, is the problem.

Taxes, which date to the beginning of recorded history, are payments made to a ruler in exchange for military protection, public services, and civil order. In the ancient world, taxes were paid in kind: landowners paid in crops or livestock; the landless paid with their labor. Taxing trade made medieval monarchs rich and funded the early-modern state. Then a series of political revolutions began that led to monarchs ceding the power to tax to legislatures.

One of those revolutions lies behind American independence. Early Americans, though, didn’t only deny the king’s right to tax; they questioned the legislature’s. When American colonists challenged Parliament’s right to tax them, Edmund Burke predicted chaos, “a perpetual quarrel.” Meanwhile, another kind of debate had begun. “The expenses of government, having for their object the interests of all, should be borne by every one,” the French minister Anne-Robert-Jacques Turgot remarked, “and the more a man enjoys the advantages of society, the more he ought to hold himself honoured in contributing to these expenses.” Adam Smith expressed much the same view in “The Wealth of Nations,” in 1776: “The subjects of every state ought to contribute towards the support of the government, as nearly as possible, in proportion to their respective abilities.”

In the United States, there existed a kind of property decried in England and France: a property in people. Both liberals like Turgot and conservatives like Samuel Johnson observed that Americans’ ideas about taxation had everything to do with their attachment to slavery. In “Taxation No Tyranny,” Johnson argued that the right to tax had been “considered, by all mankind, as comprising the primary and essential condition of all political society, till it became disputed by those zealots of anarchy, who have denied, to the parliament of Britain the right of taxing the American colonies”—zealots who happened to be “drivers of negroes.”

The Constitution grants Congress the power “to lay and collect taxes, duties, imposts and excises, to pay the debts and provide for the common defence and general welfare,” except not “direct taxes,” unless levied in proportion to population, as assessments on states. The Constitutional Convention nearly fell apart over this. For purposes of representation, Southerners wanted their slaves counted as people. Northerners objected. By way of compromise, Pennsylvania’s Gouverneur Morris moved that “taxation shall be in proportion to Representation”: the South could have its slaves counted in exchange for an increased tax burden. After Southerners balked, Morris proposed “restraining the rule to direct taxation.” When the Massachusetts delegate Rufus King “asked what was the precise meaning of direct taxation? No one answd.”

No one answered Rufus King because, on this point, there was little agreement. The term was, and remains, disputed: one kind of direct tax is a head tax, another is a tax on certain kinds of wealth; an indirect tax extracts payments for exchanges made in a market. A real-estate tax is direct, a sales tax indirect.

In the early republic, Congress briefly experimented with taxes on carriages and whiskey, but, before the Civil War, raised revenue almost exclusively through tariffs—duties on imports. “We are all the more reconciled to the tax on importations,” Jefferson explained, “because it falls exclusively on the rich.” But the tariff was uncontroversial, the historian Robin Einhorn has argued, because it skirted the question of human bondage: the American antitax tradition, she insists, has its roots not in democracy but in slavery.

By the eighteen-sixties, most states taxed property. The Union, faced with paying for the war against the Confederacy, borrowed from banks and, when money ran short, printed the first federal paper currency since the Revolution, the greenback. When the House Ways and Means Committee considered levying a tax on land, Schuyler Colfax, a Republican from Indiana, objected: “I cannot go home and tell my constituents that I voted for a bill that would allow a man, a millionaire, who has put his entire property into stock, to be exempt from taxation, while a farmer who lives by his side must pay a tax.”

There was another option. The British had funded the Crimean War by taxing income. Unlike a tax on real estate, an income tax was not obviously a direct tax. Income also included earnings from stocks; it didn’t exempt millionaires. In 1862, Lincoln signed a law establishing a Bureau of Internal Revenue, charged with administering a graduated tax that taxed incomes of more than six hundred dollars at three per cent—at the time, the average income was about three hundred dollars—and incomes of more than ten thousand dollars at five per cent. The Confederacy, reluctant to press the issue, was never able to raise enough money to pay for the war, which may be one reason the rebellion proved to be a lost cause.

After the war, the federal income tax was allowed to expire, over the protests of John Sherman, a Republican from Ohio who went on to craft the Sherman Antitrust Act and who, countering Jefferson, pointed out that tariffs unfairly burdened the poor. “We tax the tea, the coffee, the sugar, the spices the poor man uses,” Sherman said. “Everything that he consumes we call a luxury and tax it; yet we are afraid to touch the income of Mr. Astor. Is there any justice in that? Is there any propriety in it? Why, sir, the income tax is the only one that tends to equalize these burdens between rich and poor.”

In the eighteen-eighties, Democrats opposed high tariffs, Republicans favored them, and Populists advocated an income tax instead, believing that it was essential to the survival of a democracy undermined by economic inequality. In the aftermath of the Panic of 1893, the Populists prevailed. By then, income taxes had become commonplace in Europe. Responding to the suggestion that, if Congress passed an income tax, rich Americans would flee to Europe, William Jennings Bryan asked where they would possibly go. “In London, they will find a tax of more than 2 per cent assessed on income. If they seek refuge in Prussia, they will find an income tax of 4 per cent.” In 1894, a two-per-cent federal income tax passed that applied only to Americans who earned more than four thousand dollars. But the Populist victory didn’t last long. The next year, in Pollock v. Farmers’ Loan & Trust Company, the Supreme Court ruled, 5-4, that the tax was a direct tax, and unconstitutional. Justice John Harlan, dissenting a year before his more famous dissent in Plessy v. Ferguson, said that the ruling had turned provisions “originally designed to protect the slave property” into “privileges and immunities never contemplated by the founders.” It was, he said, a “disaster.”

Pollock caused an uproar. In 1896, the Democratic Party platform for the first time endorsed an income tax, “so that the burdens of taxations may be equally and impartially laid, to the end that wealth may bear its due proportion of the expenses of the Government.” Between 1897 and 1906, constitutional amendments to defeat Pollock were introduced in Congress twenty-seven times.

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In 1906, the day the earthquake hit and the fires began, people raced to the San Francisco Bay and boarded ferries to escape the flames. A handful of men rushed to the banks, but before long all that was left of the city’s deposit and lending institutions, aside from rubble and ashes, were their fireproof steel vaults: red hot, smoking, and locked.

During the recession that followed the panic that followed the earthquake, the number of people applying for poor relief in New York tripled; in Philadelphia, it increased nearly fivefold. A purpose of a federal reserve was to allow the government to halt a panic by shoring up faltering banks. A purpose of a federal income tax was to undergird the Treasury with a stable source of revenue. But it had another purpose, too. The richest one per cent of households, which had held about a quarter of the nation’s wealth in 1890, now held more than a third. The tax was intended to answer populist rage at the growing divide between the rich and the poor. In the election of 1908, both parties favored an income tax—Democrats hoping to close that gap, Republicans hoping to quiet that rage.

Republicans won. The new President, William Howard Taft, who had been a federal judge (and who went on to serve as Chief Justice), wanted to avoid signing a law that would end up going back to the Supreme Court. “Nothing has ever injured the prestige of the Supreme Court more than that last decision,” he said, referring to Pollock. He decided to support a constitutional amendment. It went to the states for ratification in 1909.

Constitutional amendments are notoriously difficult to ratify. The Sixteenth Amendment was not. Once it got out of Congress, it passed, handily, in forty-two of forty-eight states, six more than required, and took effect on February 25, 1913. The House voted on an income-tax bill in May; Woodrow Wilson signed it in October. Its highest rate was seven per cent. The next year, the Bureau of Internal Revenue printed its first 1040. The form was three pages, the instructions just one.

Taxes have got a lot hairier since. The Revenue Act of 1916, anticipating the United States’ entry into the war in Europe, raised taxes on incomes, doubled a tax on corporate earnings, eliminated an exemption for dividend income, and introduced an estate tax and a tax on excess profits. Rates on the wealthiest Americans began to skyrocket, from seven per cent to seventy-seven, but most people paid no tax at all. By 1918, as W. Elliot Brownlee writes in “Federal Taxation in America: A Short History,” “only about 15 per cent of American families had to pay personal income taxes, and the tax payments of the wealthiest 1 per cent of American families accounted for about 80 per cent of the revenues.”

Business interests fought back. Wilson’s tax policies were one reason that his party lost Congress in 1918, and the Presidency in 1920. In 1921, Wilson’s successor appointed Andrew W. Mellon, the industrialist and philanthropist, as his Secretary of the Treasury. Mellon held the office under three Republican Presidents: Harding, Coolidge, and Hoover. The American Bankers League renamed itself the American Taxpayers League, and began sponsoring, providing literature to, and paying the expenses of state “tax clubs,” whose members then testified before Congress, urging tax cuts. During Mellon’s tenure, and at his recommendation, the excess-profits tax was abolished, the estate tax was cut, capital gains were exempted from income, and the top tax rate was capped at twenty-five per cent. In 1924, Mellon published a manifesto, “Taxation: The People’s Business,” in which he argued that high taxes kill “the spirit of business adventure.” Cutting taxes, Mellon insisted, would lower the cost of housing, reduce prices, raise the standard of living, create jobs, and “advance general prosperity.”

Whether Mellon’s tax policy was responsible for the Roaring Twenties or for the stock-market crash in 1929, or for neither, or both, is an argument whose implications Americans are still living with. It’s worth noting that the terms of this debate were set by a man of staggering wealth: in 1924, the only Americans who paid more in taxes than Mellon were John D. Rockefeller, Jr., Henry Ford, and Edsel Ford. In 1929, a Senate investigation found that members of the Mellon family had helped bankroll the American Taxpayers League.