The Revenue Act of 1921: A Turning Point in Tax Policy

The Revenue Act of 1921, signed into law on November 23, 1921, marked a shift in American fiscal policy following World War I. Facing substantial war debt and the economic downturn of 1920-1921, the nation was receptive to a change from the high tax rates that had financed the war. This legislation was a part of President Warren G. Harding’s “return to normalcy” platform, which focused on domestic prosperity.

The intellectual force behind the act was Secretary of the Treasury Andrew Mellon. Mellon advocated for what would later be recognized as supply-side economic principles, arguing that high taxes stifled economic activity and that lowering rates would spur growth. He contended that the steep rates established by the Revenue Act of 1918 were counterproductive, discouraging investment. The 1921 Act was the first legislative effort to put this philosophy into practice.

Modifications to Individual Income Tax

The Revenue Act of 1921 introduced direct changes for individual taxpayers, primarily by targeting the highest income brackets. The most prominent modification was the reduction of the top marginal income tax rate. Under the preceding 1918 Act, the highest earners faced a combined rate of 73 percent, which the 1921 legislation lowered to 58 percent for the 1922 tax year. This reduction applied to income levels exceeding $200,000.

The act also provided relief to a broader base of taxpayers by increasing personal exemption amounts. For a single individual, the exemption was raised from its previous level. A married couple or the head of a family saw their personal exemption increase to $2,500, and the law also maintained the $400 exemption for each dependent. Under current law, the personal exemption is $0, and taxpayers instead claim a much larger standard deduction—for 2025, this is $15,000 for single filers and $30,000 for married couples filing jointly.

A more targeted provision was the creation of a new tax exemption designed to encourage personal savings. Taxpayers could now exclude the first $300 of interest earned from deposits or investments in domestic building and loan associations. This measure was intended to stimulate the flow of capital into these institutions, which were important for financing home construction.

Creation of the Capital Gains Tax

A key feature of the Revenue Act of 1921 was the formal creation of a preferential tax rate for capital gains. A capital gain is the profit realized from the sale of a capital asset, such as stocks, bonds, or real estate. Before this act, any profit from the sale of such assets was treated as ordinary income and taxed at the same graduated rates, which could reach as high as 73 percent. This high tax liability was seen by policymakers as a deterrent to selling assets, effectively “locking in” capital.

The 1921 Act addressed this by establishing a new category for gains on assets held for more than two years, defining them as long-term capital gains. The law introduced an alternative tax rate of 12.5 percent for these specific gains. This meant a taxpayer could choose to pay either their normal income tax rate on the gain or the flat 12.5 percent rate, whichever was lower. This provision offered a substantial tax reduction on investment profits for high-income individuals.

This was the first time in U.S. tax history that income from long-term capital investment was given preferential treatment over income from wages and salaries. The rationale was to encourage the sale of appreciated assets and unlock capital for reinvestment. This principle of a lower tax rate for long-term capital gains persists in the tax code. For 2025, these gains are taxed at 0%, 15%, or 20% depending on income, while short-term gains are taxed at ordinary income rates.

Revisions to Corporate Taxation

The Revenue Act of 1921 also brought changes to the taxation of businesses, aligning with the goal of transitioning to a peacetime economic footing. The most impactful of these changes was the repeal of the wartime excess profits tax, effective January 1, 1922. This tax was designed to capture what were considered unusually high profits earned by industries during World War I, with rates as high as 80 percent on profits deemed above a “normal” pre-war level.

The excess profits tax was complex and unpopular among businesses in the post-war era. Its repeal was a central objective of the Harding administration and Secretary Mellon, who argued it was a major impediment to business investment. By eliminating this tax, the 1921 Act removed a significant liability from corporate balance sheets, freeing up capital for other uses.

While repealing one tax, the act simultaneously adjusted the primary corporate income tax rate. To partially offset the revenue loss from the excess profits tax repeal, the general corporate income tax rate was increased from 10 percent to 12.5 percent. Current federal law applies a flat 21% tax rate to corporate income.

The Act’s Role in Shaping Tax Philosophy

The Revenue Act of 1921 represented a fundamental shift in the guiding philosophy of American tax policy. It was the first major legislative victory for the economic theory championed by Treasury Secretary Andrew Mellon. This theory held that high tax rates on the wealthy and on capital were economically inefficient, as they discouraged the investment that created jobs and prosperity. By lowering these rates, Mellon argued, the government would actually collect more revenue in the long run by stimulating a larger, more dynamic economy.

This legislation put that idea into practice, marking a clear pivot from the redistributive focus that had characterized wartime tax policy. The act’s provisions, particularly the reduction in the top marginal rate and the introduction of a preferential capital gains tax, were direct applications of Mellon’s belief that freeing up capital at the top would lead to investments that benefited all levels of society. This approach laid the groundwork for what would later be known as “supply-side” economics.

The act cemented the principle of preferential treatment for capital income into the U.S. tax code. The creation of the 12.5 percent capital gains rate established a lasting distinction between income earned from labor and income earned from investments. This legislative package served as the definitive break from the high-tax policies of World War I, establishing a new peacetime framework for federal finance that prioritized private investment.