Federal Tax Brackets

What Are Federal Tax Brackets?

The federal tax brackets are overseen by the Internal Revenue Service (IRS) and determine tax rates for individuals, corporations, and trusts. These brackets are adjusted over time, often as a result of differing political philosophies on taxation’s effects on the nation’s overall economy.

Understanding Federal Tax Brackets

Federal tax brackets are generally progressive, meaning that the higher your income, the higher the your tax rate. However, this does not necessarily translate into paying more in tax dollars, because of the large number of deductions and credits that can be applied against the tax that you owe.

When federal tax brackets were created in 1913, the goal was to fairly tax citizens of the United States, in large part to help fund wars. However, as decades went by, special interest groups lobbied for more and more deductions until, in 2019, 91 corporations, including 60 Fortune 500 companies, paid nothing in 2018 taxes.

This was a result of the nation’s most recent tax law, the Tax Cuts and Jobs Act (TCJA), which then-President Donald Trump, with the backing of a Republican House and Senate, signed in December 2017. The TCJA permanently reduced the corporate tax rate while only temporarily reducing individual rates. This was due to concern about how much additional debt these new tax reductions would add to the already large U.S. debt. Estimates at the time of the law’s passing set those debt increases as high as $1.9 trillion over the coming decade.

In reality, the debt increased by nearly $1 trillion each year from 2018 to 2020, and with the advent of the COVID-19 pandemic in March 2020 and the necessary spending to contain it and its negative economic effects, federal budget deficits are rising to levels not seen since World War II.

High-income earners saw the largest reduction in taxation, while low-wage earners, who also had their taxes cut, could conceivably pay more when — and if — the individual tax changes expire as planned in 2025. Given the unpopularity of increasing taxes — as evidenced by the extension of the 2001 Bush tax cuts in 2010, which overrode their sunset provision — the TCJA’s individual rates also could end up continuing past 2025.

The highest tax bracket ever used in the United States, set during World War II.

History of the Federal Tax Brackets

The 16th Amendment was ratified in 1913, and the federal tax bracket was born. In 1913, the top tax bracket was 1% on incomes above $3,000, with a 6% surcharge on incomes above $500,000. However, it didn’t take long for the rate to rise dramatically. By 1918, as the costs of World War I became evident, the top tax rate was as high as 77%. Rates came down again during the prosperity of the 1920s, only to rise during the Great Depression. This became an example of what not to do during difficult times and was cited frequently during the Troubled Asset Relief Program (TARP) debates at the start of the 2008 Great Recession.

By the end of World War II, the top tax bracket reached 94%. The rate remained high in subsequent years, averaging around 70%. Rates have been coming down ever since, starting in the 1980s Reagan administration, and as of 2021, there are seven federal tax brackets: 10%, 12%, 22%, 24%, 32%, 35%, and 37%. It is probably no coincidence that the U.S. debt has ballooned during the modern era, as the country has engaged in several wars while lowering tax rates instead of raising them, as was done during previous wars.