The 16th Amendment and the Federal Reserve Act of 1913

Tax Day raises a question most of us never get a straight answer to: why did the United States need a constitutional amendment just to tax income? We walk through the 16th Amendment with Dr. Sean Beienberg and translate the legal knot it unties in plain language, from Article I’s split between direct and indirect taxes to the Supreme Court’s Pollock decision that made income taxation feel constitutionally fragile.

From there, we connect the amendment to real politics and real numbers. Tariffs were once the federal government’s main revenue engine, so cutting tariffs meant finding a replacement. That’s where figures like William Howard Taft and the 1913 Underwood Tariff come in, and where the first modern income tax shows its surprisingly narrow reach: progressive in structure, but aimed at a small percentage of Americans and set at rates that look tiny by today’s standards. Along the way, we clear up the everyday confusion between tariffs, income taxes, and property taxes, and why state constitutions often carry the detailed tax rules people actually live under.

Then we pivot to the Federal Reserve Act of 1913 and why the country stopped relying on informal rescues by wealthy financiers to survive bank panics. We break down what the Fed is, how its structure balances regional banks with a central board, and how its mission evolves into the modern dual mandate: stable prices (low inflation) and strong employment. We also tackle what changes after the Great Depression, including why institutions like the FDIC end up doing some of the stability work people assume the Fed always handled.

If you like practical civics and the history behind today’s economic fights, subscribe, share this with a friend who loves policy debates, and leave a review. What part of the income tax and Federal Reserve story surprised you most?

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Transcript

SPEAKER_00 0:00

Welcome back to Civics in the Year. Now, the day we are recording this is April 15th, which many Americans know is tax day. So this, even though it will not come out on the 15th, feels very serendipitous that we're talking about the 16th Amendment as well as the Federal Reserve Act. Dr. Sean Breinberg is back with us. Dr. Brynberg, what is the 16th Amendment?

SPEAKER_01 0:25

Right. So as we alluded to in an earlier podcast, the 16th Amendment is part of a sort of populist andor progressive era set of constitutional reforms. And what it does, its text is a little weird, but it's dealing with a sort of specific problem. And so what it says, always a good idea to go back to

Tax Day Setup And Guests

SPEAKER_01 0:46

text when you're doing such things. The Congress shall have power to lay and collect taxes on incomes from whatever source derived without apportionment among the several states and without regard to any census or enumeration. So that sounds very convoluted, but it's dealing with a specific problem, which is to say Congress in Article I has the power to tax, but there is a distinction made between so-called

What The 16th Amendment Changes

SPEAKER_01 1:11

direct and indirect taxes. And direct taxes basically have to be apportioned based on basically on population. And so the question is effectively, what does that mean for the constitutionality of an income tax? In the 1790s, the Supreme Court seemed to suggest that an income tax was probably okay in 1881 in response to the Civil War, or basically in dealing with sort of a civil war tax. The Supreme Court again seemed to suggest that. But as we talked about before, during the populist era, in a case, the Pollock case in 1895, the Supreme Court strikes down an 1894 tax. Now, the opinion is sort of dicey in some situations, but it's also not as wide as people thought it is. It doesn't say that there can't be income taxes per se. What it suggests is if you're basically charging income tax on dividends or rent or whatever from land, you are effectively taxing the land. And so there, so it doesn't say that you can't have like an income tax on wages per se. So it's not as broad as it sounds. But nonetheless, this is sort of seen as freezing, freezing income tax possibility for a while. So there's you know populist pressure on this.

The Pollock Case And The Problem

SPEAKER_01 2:28

You know, William Jennings Bryan and the uh pushes for it in his various iterations from the populist party slash democratic hybrid to just a Democrat. But so this coalition is pushing for it, but it even gets support from other parts of the political aisle. William Howard Taft, again, who I'm will slowly persuade you, is underrated. William Howard Taft is good with this, partly because for a Republican, he's pretty low tariff. So remember, Republicans of this era are like the Republicans of the last couple years in the United States, generally more sympathetic to tariffs than say between you know in the 1920s and like 2012 or whatever. So Taft is a sort of low tariff Republican. So he wants to cut tariffs, but you need to make up revenue. So he thinks basically an income tax is okay. And so Congress proposes an income tax, not too not with too much difficulty. There's a little bit of protest from Northeasterners that they're gonna get hammered paying most of it. And the counterpoint that the Southerners make, particularly, is yes, you make most of the money. Uh so therefore that's proportional. So what the 16th Amendment's text does is basically says, look, whatever this sort of ambiguity about calculating the taxes that's in Article I, like we're just not gonna apply that to income taxes. So Congress can just cleanly have the power to run an income tax. And so that gets uh approved. And obviously, it's but it's obviously not self-executing. It says Congress has the power to tax, but unlike prohibition, we'll talk about a little later, it doesn't say Congress must impose an income tax. So in 1913, the so-called Underwood tariff, that's got after Oscar Underwood, who's a prominent Southern Democrat, he'll come back when we talk about prohibition. He has been pushing for a long time to eliminate to weaken to lower tariffs, which the Democrats have been keen on. So they basically pushed through a major drop in the tariffs. And now to make up for that, they want to do the income tax to make up for the revenue. So maybe it's worth spending a little bit talking about that first income tax. You can sort of choose your own adventure on what you want the lesson to be for contemporary politics. So, in the one sense, it's progressive and graded. So the rich are paying much, much, much more. So if you earned $3,000 in that era, which is about $100,000 today, so it affected about 2% to 3% of all Americans. So very small number, relatively small number. In terms of what the number is, if you earned $3,000, about $100,000 per year today, you paid about 1% of your income. So uh if you earned $500,000 per year, about $17 million today,

The First Modern Income Tax

SPEAKER_01 5:14

you paid 7%. So on the one hand, it's very graded in terms of the rich are paying a much higher percentage. On the other hand, I think people, I think even the most ardent democratic socialist progressive would probably think it not sufficient if the richest are paying a 7% income tax, right? So the actual quantity is much, much lower because again, the federal government isn't doing the right. So again, you can look into this first tax as hey, the principle was taxes shouldn't be that high. On the other hand, you can look at it and say, but a very progressive income tax is okay. So choose your own adventure with whatever the lessons are from that first tax. Those get massively increased during World War I. So that's sort of the 16th Amendment and the income tax and in its implementing tax.

SPEAKER_00 6:02

Can I ask really quick for listeners who you talked about tariffs and taxes? What are the differences between tariffs and taxes?

SPEAKER_01 6:10

I should have said, yeah. So tariffs are in some sense a subset of taxes. They are taxes that are applied on the importation of goods. The some kinds called imposts or excises is the old timey constitutional language. But uh, this is why, if you ever read old 19th century political history, I know you've been reading about Garfield of late. And like, why is Chester Arthur the customs collector for New York? Why do we care about that office? But we do when tariffs are your basically primary income source. Yes. So tariffs are basically what you're paying. We we see, you know, we we we see this debate today, but tariffs are effectively you're paying a tax, it's

Tariffs Versus Income Taxes

SPEAKER_01 6:49

an importation fee, versus an income tax is paying a percentage of your income, you know, not related to this. Property taxes are what you pay local. That's certainly something that the constitution would make hard for the feds to do. Like that is a direct tax. You know, there's other sales tax, et cetera. But the feds have constitutional authority. I mean, the feds theoretically have constitutional authority for any kind of tax, but property taxes or something like that would get a lot more complicated based on that, like based on that language. So that's yeah, great, great clarification. Thank you. Thank you for that.

SPEAKER_00 7:23

And then this is just talking about the federal government, right? Like states do their own taxing system, just for clarity. So where does that right?

SPEAKER_01 7:31

So the states generally, states and local general, generally property tax is their primary one for local particular, but property and sales, some income. And so taxing is something income tax is what's called a concurrent power that both the federal government and the state governments could do it. But the federal, the states, so states under the you know, the federal constitution can set whatever taxes they want. Part of why state constitutions are so long is people have gone through and said you can tax this, you can't tax this, you can set this amount on my property tax or whatever. So if you care about taxes at

Federal And State Tax Powers

SPEAKER_01 8:09

the state and local level, which you might want to, your state constitution is basically what sets the protocols for that. The U.S. constitution, again, generally is sparser and more or less at this point says the feds can run tariffs, the feds can run income taxes without too much trouble. The other kinds of taxes are much more constrained, which creates kind of a specialization of labor because the states can do those kinds of taxes.

SPEAKER_00 8:32

Which I did learn last night on Jeopardy that Alabama has one of the longest constitutions. So if you're a listener from Alabama, it might take you a little while, but state constitutions are still very important.

SPEAKER_01 8:43

And they're trying to get they're trying to clean that one up, actually. Really? So yeah, we we I could do an entire podcast on Alabama's constitution. But it's the longest. It's the it's the long, it's it's the longest. That also was at one point the most racist, which is why people have been tried to take it out. So they just had a commission that basically said, all right, we're gonna pull out all the racist parts, and then next step is we're going to try to clean it up. Because it is, I think it's after India, the longest constitution in the world. It's got like 600 amendments. They have sections on like bull weevil taxes, bull weevil regulation and gym

Alabama Constitution Detour

SPEAKER_01 9:19

trophies and all kinds of fun stuff. It's because basically the short version is they tried to write the Alabama Constitution like the federal one, where it's one of enumerated powers. But if your state government is supposed to do most things, anytime you want the state government to do a new thing, you've got to go back and get an amendment. So it's yeah, it's an interesting thing.

SPEAKER_00 9:39

It is the longest. It is the longest. It is twice as long as India's. Longer than India. Okay. That's okay. See, now we're going off on side tangent. So let's go back. The Federal Reserve. So where does the Federal Reserve come in? Because the Federal Reserve, to me, I know like there's Federal Reserve banks. I've heard the term the Federal Reserve Chair. Who are they and why do they matter?

SPEAKER_01 10:05

Yeah. So the Federal Reserve is in some ways a successor to the, you know, the first and second banks of the United States that were we've talked about at great length with Hamilton and Madison and Jackson and all that. So there is no, there is no sort of bank to that extent for decades in American history. And so what tends to happen when there are bank failures is that the federal government will either ask or get volunteers from really, really, really rich

Why The Federal Reserve Was Created

SPEAKER_01 10:36

people like JP Morgan, who will call up their banker buddies and say, like, loan out some more money, I'll guarantee it or whatever, in order to basically deal with credit crunches. And eventually they decide maybe it's not the best policy to like hope there's a friendly billionaire who, a friendly and patriotic billionaire willing to float stupid amounts of money. And so the Federal Reserve is effectively an effort to create a sort of more stable, initially banking system. The goal is really more to deal with sort of bank failures. Its current iteration is a little different, but I'll come to that. So originally it's proposed by Republicans in the Northeast, a senator named Nelson Aldrich, who's a very powerful Rhode Island senator. He is the father-in-law of John Rockefeller Jr. So, like they are he's got it. So he's proposing basically what looks in some ways more like one of the old banks of the United States, much more centralized. More of the Democrats want to have a more decentralized kind of regional version where there's like different banks that are sort of backstops for regions. Wilson, Wilson, as we've talked about, tries to push this vision of decentralization on the campaign stump, but in practice, his president looks a little more kind of Theodore Roosevelt-y. So he fights with some of his allies and insists on a central board of presidential appointees. So in that sense, it looks more like what the Republicans had initially adopted, proposed their commission. And so effectively, what it is is it uses a few techniques. Certainly today, it uses basically it has power to sort of set the reserve ratio. So how much the banks have to keep on reserves is a percentage. So that if there's a bank run, you know, they've only loaned out, you know, they think they can guarantee like in cash, basically, whatever, like 20% of what they've loaned out. I mean the number changes, but you know, they have a basically a ratio. They also think they eventually can set the rates of when those banks then loan to you know other banks. So that's you hear about the interest rate. That's usually what that one uh is about. But basically speaking, the Federal Reserve is supposed to be originally sort of a kind of a hedge or a backstop.

How The Fed Uses Its Tools

SPEAKER_01 12:53

Over time, that mandate shifts toward what we think of now as the sort of dual mandates from the 1970s, in which the Federal Reserve's two primary jobs are now a stable currency and unemployment. Stable currency meaning basically low inflation, not necessarily zero inflation, but low inflation. This is unusual compared to other central banks in, like say Europe, which more or less have the single mandate of just keep inflation sort of predictable and smooth. So if you know, if if there's uh you know, if there's a contraction or you know, a infl high inflation tweak your interest rates to correct for that, if it's low inflation, right? So

The Dual Mandate And Inflation

SPEAKER_01 13:41

so the the US having that kind of dual mandate is unusual. And it's you know, the Federal Reserve people themselves will say, like, these are harmonized. But many people will say, well, no, like if you're fighting inflation, you know, you you took your economics, right? Inflation and unemployment often sort of track you know in a way that makes that dual mandate kind of hard to do. So I could get into the arcana of the Federal Reserve and you know, all the gold standard stuff or whatever, but that actually is one reason that why the Federal Reserve originally wasn't an inflation fighter because they were still on the gold standard. So they thought the gold standard would do sort of the inflation hedge work. So that obviously that obviously changes. But so Federal Reserve, for our purposes today, is somewhat different than its original in terms of what its mandate is. Institutionally, it still looks pretty similar.

SPEAKER_00 14:32

Okay. One more quick question. So the Federal Reserve was created prior to the Great Depression. Does the Great Depression kind of shift the the mandate and the powers of the Federal Reserve, or no?

SPEAKER_01 14:45

Less so the Fed less so the Federal Reserve and other things that get bolted onto it, like the FDIC, right, is a product of depression, which in some sense is doing kind of some of the work that the original Federal Reserve was supposed to. So the answer is kind of, but not as much as just building new institutions. They do pass in 40 46, basically. So kind of in the wake of, like in the wake of the like, what would that be? Like even past the second new deal, but the sort of emphasis to be cautious about the employment

Depression Era Changes And Add-Ons

SPEAKER_01 15:19

issue. So the inflation piece comes later, largely after off the gold standard, and you know, the 70s is an era of very high inflation as a result. Or not, well, as a result or not, but like it's a period of very high inflation in that period.

SPEAKER_00 15:36

So perfect. Okay, thank you, Dr. Weinberg.