Confederate
War Financing
The antebellum south
enjoyed one of the lightest tax burdens of all contemporary civilized
societies. Local or state governments assessed all obligations. By contrast,
the hastily assembled Confederate government lacked the bureaucratic
infrastructure to levy or collect internal taxes. Its citizens possessed
neither a tradition of compliance nor a means to remit payment. Land
and slaves comprised the bulk of southern capital; liquid forms of wealth
like specie or paper currency were hard to come by in a predominantly
agrarian region.
Efforts to raise
war revenue through various methods of taxation proved ineffective.
The Confederate Congress enacted a minor tariff in 1861, but it contributed
only $3.5 million in four years. That same year, Congress implemented
a small direct tax (0.5 percent) on real and personal property. But
the government in Richmond was forced to rely on the individual states
to collect the levy. Reprising the scenario played out during the Revolutionary
War, most states did not collect the tax at all, preferring to meet
their quota by borrowing money or printing state notes to cover it.
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A
Confederate bond.
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The Davis administration
turned to loans to finance the initial bulk of war debts. Riding a wave
of patriotic enthusiasm in 1861, the Treasury earned $15 million selling
out their first bond issue. The second issue, however, consisting of
$100 million in 8 percent yield bonds, sold slowly. Few southerners
had the cash to purchase them, but in addition the year-end 12 percent
inflation rate threatened to negate any promise of real financial return.
It fell to investors to buy up the remainder of the 8 percent bonds,
which they purchased with newly minted Confederate Treasury notes.
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A
$100 note issued by the Confederacy.
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By necessity rather
than choice, the South turned to the printing press to pay most of its
bills. In its first year, the Confederate government derived 75 percent
of its total revenue from Treasury notes, less than 25 percent from
bonds (purchased, of course, with the notes), and under 2 percent from
taxes. While the proportion of the latter two would increase slightly
in later years, the foundation of Confederate war financing consisted
of over $1.5 billion in paper dollars that began depreciating before
the ink had a chance to dry. By refusing to establish the notes as compulsory
legal tender, Treasury officials hoped to avoid undermining confidence
in the currency. They preferred that the currency be backed by public
confidence in the Confederacy’s survival (notes were to be redeemable
in specie at face value within two years of the end of the war).
.JPG) |
| A
$2 note issued by the state of Georgia. |
This being the
case, various state, county, and city notes also circulated widely,
diluting the medium further; the fact that these poorly printed bills
were easily counterfeited did not help matters. Ironically, the Confederate
decision to turn to paper money in lieu of a system of internal taxation
abetted the most odious, regressive form of de facto taxation southern
society endured: runaway inflation, appearing in the wake of military
reversals in 1862, and topping 9,000 percent by war’s end.
By the spring of
1863, the crushing burden of inflation motivated Richmond to come up
with an alternative to fiat money. In April, they followed the Union’s
lead and enacted comprehensive legislation that included a progressive
income tax, an 8 percent levy on certain goods held for sale, excise,
and license duties, and a 10 percent profits tax on wholesalers. These
provisions also included a 10 percent tax-in-kind on agricultural products.
The latter burdened yeoman more than the progressive income tax encumbered
urban salaried workers, since laborers could remit depreciated currency
to meet their obligations. Adding to the inequity, the law exempted
some of the most lucrative property owned by wealthy planters their
slaves from assessment. Lawmakers considered a tax on slaves to be
a direct tax, constitutionally permissible only after an apportionment
on the basis of population. Since the war precluded any opportunity
to count heads, they concluded that no direct tax was possible. Accumulating
war debts and heightened condemnation of a "rich man’s war, poor man’s
fight" led to revision of the tax law in February 1864, which suspended
the requirement for a census-based apportionment of direct taxes and
imposed a 5 percent levy on land and slaves. These changes came too
late, however, to have any sustained impact on the Confederate war effort.
Union
War Financing
In addition to its
developed industrial base, the North entered the war with several apparent
institutional advantages, including an established Treasury and tariff
structure. With the exodus of southern representatives, the Republican-dominated
Congress ratcheted up tariff rates throughout the war, beginning in
1862 with the Morill Tariff Act, which reversed the downward
trend instituted by the Democrats between 1846 and 1857. Subsequent
tariff legislation, especially the 1864 act, raised rates further. Protective
tariffs were politically popular among manufacturers, northern laborers,
and even some commercial farmers. But Customs duties amounted to about
$75 million annually, only nominally more, after adjusting for inflation,
than the value of duties collected during the 1850s. Still, the high
rate structure established in the Civil War would remain a hallmark
of the post-war political economy of the Republican party.
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|
Secretary
of the Treasury Salmon P. Chase
|
Ideological reservations
tempered some of the Treasury’s supposed institutional advantages. Secretary
of the Treasury Salmon Chase, like many northern policymakers, generally
distrusted any form of exchange other than specie. They preferred to
pay government debts by physically moving gold out of the Treasury instead
of transferring funds from demand deposits via check. They also refused
to utilize established private banks in New York, Boston, and Philadelphia
as repositories for federal funds, further complicating financial transactions.
Chase hoped to follow Albert Gallatin’s model of financing the War of
1812, which (initially) emphasized borrowing over taxation. Ultimately,
however, mounting debts, a shortage of specie, and the threat of inflation
led the Union to adopt innovative plans for both borrowing and internal
taxation.
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In contrast to the
Confederacy, which relied on loans for about 35 percent of its war finances,
the Union raised over 65 percent of its revenue this way. Having little
personal experience, Chase turned to Philadelphia Banker Jay Cooke to
administer the sale of war bonds. Although he expected banks and wealthy
citizens to purchase most of them, Cooke employed a sophisticated propaganda
campaign to market the bonds to the middling classes as well. Patriotic
newspaper advertisements and an army of 2,500 agents persuaded almost
one million northerners (about 25 percent of ordinary families) to invest
in the war effort; bond sales topped $3 billion. In this way, Cooke
previewed the techniques with which governments in the 20thcentury would
fund modern wars.
In order for the
bond program to be successful, the North needed an unrestricted currency
supply for citizens to pay for them and a source of income to guarantee
the interest. The Legal Tender Act filled the first requirement. Passed
in February 1862, the act authorized the issue of $150 million in Treasury
notes, known as Greenbacks. In contrast to Confederate paper, however,
Congress required citizens, banks, and governments to accept Greenbacks
as legal tender for public and private debts, except for interest on
federal bonds and customs duties. This policy allowed buyers to purchase
bonds with greenbacks while the interest accrued to them was paid in
gold (funded, in part, by specie payments of customs duties). Investors
enjoyed a bountiful windfall, since government securities purchased
with depreciated currency were redeemed with gold valued at the prewar
level. Taxpayers essentially made up the difference. Because most bonds
were acquired by the wealthy or by financial institutions, the program
concentrated investment capital in the hands of those likely to use
it, much as Alexander Hamilton’s debt plan had sought to do.
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The Union government’s
decision to implement a broad system of internal taxation not only insured
a valuable source of income, but shielded the northern economy from
the sort of ruinous inflation experienced by the South. Despite another
$150 million Greenback issue, the overall northern inflation rate reached
only 80 percent, comparable with the domestic rates during World Wars
I and II. The Internal Revenue Act of 1862, enacted by Congress
in July, 1862, soaked up much of the inflationary pressure produced
by Greenbacks. It did so because the Act placed excise taxes on just
about everything, including sin and luxury items like liquor, tobacco,
playing cards, carriages, yachts, billiard tables, and jewelry. It taxed
patent medicines and newspaper advertisements. It imposed license taxes
on practically every profession or service except the clergy. It instituted
stamp taxes, value added taxes on manufactured goods and processed meats,
inheritance taxes, taxes on the gross receipts of corporations, banks,
and insurance companies, as well as taxes on dividends or interest they
paid to investors. To administer these excise taxes, along with the
tariff system, the Internal Revenue Act also created a Bureau of
Internal Revenue, whose first commissioner, George Boutwell, described
it as "the largest Government department ever organized."
.jpg) |
| Receipt
for Civil War excise tax on a Jersey wagon, 1863. (larger
image) |
The majority of
internal taxes and tariffs duties were regressive, consumption-oriented
measures that affected lower income Americans more severely than higher-income
Americans. In response, Republicans looked to reinforce the system’s
fairness by implementing a supplementary system of taxation that more
accurately reflected taxpayers’ "ability to pay." The income tax addressed
this need.
The first federal
income tax in American history actually preceded the Internal Revenue
Act of 1862. Passed in August 1861, it had helped assure the financial
community that the government would have a reliable source of income
to pay the interest on war bonds. Initially, Salmon Chase and Thaddeus
Stevens, Chairman of the House Ways and Means Committee, wanted to implement
an emergency property tax similar to the one adopted during the War
of 1812. This way, the government could adapt the administrative system
that state and local governments had developed for their own property
taxes. But legislators understood such a property tax as a direct tax.
Article 1, Section 9 of the Constitution required the federal government
to apportion the burden among states on the basis of population rather
than property values. Emphasizing population over property value would
actually render the tax quite regressive. Residents of lower-density
western states, border states, and poor northeastern states stood to
bear a greater burden than those of highly-populated urban states, despite
the latter’s valued real estate. Their representatives also complained
that a property tax would not touch substantial "intangible" property
like stocks, bonds, mortgages, or cash.
As an alternative,
policy makers sought to follow the example of British Liberals, who
had turned to income taxation in order to finance the Crimean War without
heavy property taxation. Justin Morrill, (R-VT), Chairman of the Ways
and Means Subcommittee on Taxation and the architect of the regressive
tariff structure, introduced a proposal for the first federal income
tax. Because it did not tax property directly, congressional leaders
viewed the income tax as indirect, and thus immune from constitutional
strictures.
.jpg) |
| Drawing
of taxpayers lining up at a collector's office to pay the 1862 income
tax. (larger image) |
The first income
tax was moderately progressive and ungraduated, imposing a 3 percent
tax on annual incomes over $800 that exempted most wage earners. These
taxes were not even collected until 1862, making alternative financing
schemes like the Legal Tender Act critical in the interim. The Internal
Revenue Act of 1862 expanded the progressive nature of the earlier act
while adding graduations: It exempted the first $600, imposed a 3 percent
rate on incomes between $600 and $10,000, and a 5 percent rate on those
over $10,000. The act exempted businesses worth less than $600 from
value added and receipts taxes. Taxes were withheld from the salaries
of government employees as well as from dividends paid to corporations
(the same method of collection later employed during World War II).
In addition, the "sin" excise taxes imposed in the 1862 act were designed
to fall most heavily on products purchased by the affluent. Thaddeus
Stevens lauded the progressivity of the tax system:
"While the rich
and the thrifty will be obliged to contribute largely from the abundance
of their means . . . no burdens have been imposed on the industrious
laborer and mechanic . . . The food of the poor is untaxed; and no one
will be affected by the provisions of this bill whose living depends
solely on his manual labor."
 |
| Justin
Morrill, chairman of the House Ways and Means Subcommittee on Taxation
and crafter of the Union's Civil War tax and tariff legislation. |
But the war grew
increasingly costly (topping $2 million per day in its latter stages)
and difficult to finance. The government’s ability to borrow fluctuated
with battlefield fortunes. The Confederate navy harassed northern shipping,
reducing customs receipts. And inevitable administrative problems reduced
the expected receipts from income and excise tax collection.
In response, Congress
approved two new laws in 1864 that increased tax rates and expanded
the progressivity of income taxation. The first bill passed in June
upped inheritance, excise, license, and gross receipts business taxes,
along with stamp duties and ad valorem manufacturing taxes. The same
act proceeded to assess incomes between $600 and $5,000 at 5 percent,
those between $5,000 and $10,000 at 7.5 percent, and established a maximum
rate of 10 percent. Despite protest by certain legislators regarding
the unfairness of graduated rates, the 1864 act affirmed this method
of taxing income according to "ability to pay." An emergency income
tax bill passed in July imposed an additional tax of 5 percent on all
incomes in excess of $600, on top of the rates set by previous income
tax bills. Congress had discovered that the income tax, in addition
to its rhetorical value, also provided a flexible and lucrative source
of revenue. Receipts increased from over $20 million in 1864 (when collections
were made under the 1862 income tax) to almost $61 million in 1865 (when
collections were made under the 1864 act and emergency supplement).
 |
A
Union "greenback," authorized by the Legal Tender Act
of 1862; note portrait of Salmon P. Chase in left. (larger
image)
|
The affluent upper
middle classes of the nation’s commercial and industrial centers complied
widely with the income tax. 10 percent of all Union households had paid
some form of income tax by war’s end; residents of the northeast comprised
15 percent of that total. In fact, the northeast, a sector of American
society that owned 70 percent of the nation’s wealth in 1860, provided
the most critical tax base, remitting 75 percent of the revenues. In
total, the North raised 21 percent of its war revenue through taxation,
as opposed to the South, which raised just 5 percent this way.
Federal taxes were
also instrumental in instituting a system of national banking during
the war. The National Banking Acts of 1863 and 1864 imposed a system
of "free banking" — banks established by general incorporation
as opposed to specific charters — on a national level. State banks
were granted national charters and allowed to issue national bank notes
(these notes were separate from Greenbacks). One third of a national
bank’s capital had to consist of federal bonds, since the new national
notes were to be backed by federal bonds. The National Banking Acts
thus served as another means to induce bankers to purchase bonds. In
an attempt to avoid increased regulation, however, many state banks
declined to seek national charters. To remedy this problem, the 1864
act imposed a 10 percent tax on state bank notes to drive them out of
existence. As a result of this tax, the number of national banks tripled
by the war’s end, while their purchase of U.S. bonds nearly quadrupled.
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