1924: Earned Income Credit

The "earned income credit" provisions that we have to day, began in the debates over the first "Income Tax Act" implemented under the Sixteenth Amendment in 1913. However, there is no relationship between what was implemented in 1924, and the "earned income credit" provisions we have in today’s Tax Code. There was no need for such provisions as we have today. Employees, that is, workers employed by businesses, professions, and corporations, who were not paid large salaries and or "wages" for operating the business or corporation for its owners, were exempt from the provisions of the "net-income" tax Law. Whether you consider that such "employees" were exempt by reason of the "net-income" provision, or the fact that the "personal exemption" generally exceeded their "wages", makes no difference, they still were exempt as far as payment of the tax was concerned. The provisions of the "earned income credit" were directly related to, and based upon, the distinct difference between "gains and profits" derived from human effort and "gains and profits" derived solely from capital. The House Ways and Means Committee Report, Number 179, provided this introduction into the provision for earned income credit:

"The bill proposes a reduction of 25 per cent in the tax on earned income not in excess of $20,000. The fairness of taxing more lightly the income received as personal compensation for services rendered than income from investments has long been recognized, and seems to be generally admitted without regard to political divisions. Such a distinction has been made for many years in the income-tax laws of Great Britain, but at a much lower rate. The soundness of such a distinction is shown by testing it under the principle of ability to pay, which is the principle underlying the entire system of progressive income taxation in effect in this country. The taxpayer who receives salaries, wages, and other earned income must each year save and set aside a portion of his income in order to protect him in case of sickness and in his old age, and in order to provide for his family upon his death. On the other hand, the person whose income is derived from investments already has his capital and is relieved of the necessity of saving to establish it. He may spend each year his entire income, and at the same time have sufficient capital to protect him in his old age and to provide for his family upon his death. In most cases the person whose income is derived from investments is able to pay a greater tax that the one whose income is the result of personal effort.

Congress has long been inclined to insert a provision in our revenue laws which would carry out the principles above stated, but has found difficulty when an attempt was made to make a definition of earned income which is theoretically correct. As to a large part of the income of taxpayers, there is no difficulty in classification as between earned and unearned. Wages, salaries, and professional fees are clearly earned income, and interest, dividends, and rents are clearly unearned."

Congress clearly defined "earned income" as being: "wages, salaries, professional fees, and other amounts received in compensation for personal services actually rendered". What they did not define was the meaning of the term "personal services actually rendered". However, that term is most often used to identify those who provide "personal services" such as doctors, lawyers, dentists, barbers, hairdressers, tailors, etc. who personally perform some form of service for their customers in exchange for compensation. It also applied to corporate and business managers who actually rendered services to their customers for the corporation or business and were paid large salaries, or wages, to do so. The term was rarely, if ever, used to identify a common law employee solely performing labor for his employer. Why? Because the common laborer did not "render" personal services to their employer’s customers, they may have provided specific types of labor for their employer, in relation to the customer, but they did not render their labors to the customer for pay. In addition, common employees barely earned enough to keep their family fed, the rent and utilities paid, and a few comforts they deserved. Whereas, those earning large salaries or "wages" not only were able to cover those expenses but could buy stocks, bonds and other property from which to earn dividends, interest, rents, and other forms of profits or income. The "earned income credit" amounted to 25 percent of the tax owed on $5,000 of earned income, and was allowed up to a maximum of $10,000 of earned income. Common law employees, on the other hand, were generally paid less than $2,000 per year, most, however, earned less than $1,500 per year.

One of the major objections to the earned income provisions was that in its original form it excluded farmers and small business proprietors because their income included profits derived from the investment of capital. The definition was admittedly not a scientific one, but its purpose was to reduce the tax burden placed upon those who derived the substantial part of their "income" from physical and mental labor. The House bill provided that up to 20% of the business net-income, so derived, would be considered earned income. The final objection was removed by allowing the first $5,000 of income, partially attributed capital as well as labor, to be consider earned income for purposes of the credit.

The Senate reduced the maximum earned income credit allowed, as proposed by the House, from $20,000 to $10,000, feeling that the $10,000 was a more appropriate amount based upon the "net-income" reported by the majority of "taxpayers". These provisions remained in the Tax Code up until 1944, when Congress decided to repeal the "earned income credit" and replace it with the "standard deduction".

Congressional Record, Volume 65:

Part 12, INDEX : House Bills, 6704-6756, H.R. 6715,

House Ways and Means Report Number 179, Serial Set 8226, H.R. 6715

House Conference Report Number 844, Serial Set 8229

Senate Finance Committee Report Number 398 (I&II), Serial Set 8220