History of the standard deduction, a tax lesson

Your Guide to State, Local, Federal, Estate + International Taxation

standard deduction, taxAs a tax accountant, I feel like over the last several months all that I have read and heard about is tax reform. Over that time, there have been significant changes here and there, but one thing that seemingly never wavered was the proposal to significantly increase the standard deduction and eliminate personal exemptions.

Recently, I began to wonder what the history of the standard deduction was like. After researching the subject, I was surprised to find out that it has changed quite a bit through the years. While the standard deduction was not in the original tax code, let’s start at the beginning so that we can get a bigger picture.

The Federal Income Tax was created in 1913; however, at the time, only a small number of wealthy individuals actually paid it. In the beginning, personal exemptions were very large. This kept the average joe from having to pay. At the time, the exemption for single filers was $3,000 and $4,000 for married couples. I’m not sure how that would compare to today’s dollar, but for comparison, the personal exemption amount was $4,050 for 2016. The original Form 1040 was rather simple. There was an area for your “gross income” and another area for “general deductions.” (If you are interested, you can see it here.)

Once the United States entered World War I, exemptions were lowered significantly to pay for the war. Exemptions were reduced to $1,000 for single individuals and $2,000 for married couples and a new credit for dependents was created. After the war ended and the federal government began to have large surpluses in the 1920’s, exemptions were raised to reduce the number of taxpayers. Then the Great Depression hit. The Federal Government attempted to make up for the decreased tax revenue by reducing exemption amounts.

Once the United States entered World War II, exemptions were once again reduced to raise money for the war efforts. This time so significantly that around 70% of individuals now had a filing requirement. It was now that the standard deduction was born. The theory behind it was a need to simplify the tax code so that the average joe could prepare their own tax return without the assistance of an accountant. It was sold on the idea of simplicity. The phrase “painless extraction” was the aim. While the standard deduction was created then, it wasn’t quite in the same format as we have today. At that time, the standard deduction was 10% of your income up to $500 for single individuals and $1,000 for married couples. As a result, only 17% of taxpayers itemized on their returns in 1945.

The next significant change came in 1964, in the form of what was called the “minimum standard deduction.” The minimum standard deduction was calculated as $300 + $100 per exemption with a maximum of $1,000. Taxpayers were then able to take the larger of either the new minimum standard deduction or the percentage standard deduction. In 1969, Congress renamed it the “Low-Income Allowance.” The goal here was to have the low-income allowance be precisely the poverty line of income.

Then in the 1970’s as inflation began to be a problem, Congress began to increase the standard deduction from 10% with a max of $1,000 to 15% with a max of $2,000. Finally, in 1977, the standard deduction became a flat dollar amount like we have today. Congress initially set it at $2,200 for single filers and $3,200 for married filers. It remained that amount until tax reform under Ronald Reagan. Starting in 1985, the standard deduction began to increase each year, with the largest jump coming in 1988 when the standard deduction went from $2,540 for single filers to $3,000 and from $3,760 for married filers to $5,000. Since that time, the standard deduction has mostly just increased a little each year for inflation.

Now under President Trump, we have a new chapter in the history of the standard deduction. Personal exemptions will be eliminated and the standard deduction will be increased to $24,000 for married filing joint, $18,000 for head of household, and $12,000 for all other taxpayers. Time will only tell what the next chapter will look like.

Richard Christensen