Crisis and Leviathan: The Federal Government in the Civil War

As the Civil War erupted in 1861, the federal government, much like any organization facing a fiscal crisis, had three primary avenues to secure funding: taxation, borrowing, or printing currency.

Taxing

The federal government outperformed its Confederate rivals in financing the war through taxation.

In August 1861, tariffs were increased, and the first federal income tax in the United States was introduced. “The Republican drafters of the 1861 income tax designed it to be mildly progressive by implementing a 3 percent tax on annual incomes exceeding $800,” historian James M. McPherson observes:

“…thereby exempting the majority of wage earners. This was justified by Senate Finance Committee Chairman William Pitt Fessenden, who noted that the accompanying tariff was regressive. “Considering both measures together, I believe the burden will be more equitably distributed across all social classes.”

Following this, “[t]he Internal Revenue Act of 1862 taxed nearly everything except the air that northerners breathed,” McPherson notes:

It introduced sin taxes on alcohol, tobacco, and playing cards; luxury taxes on items like cigarettes, yachts, billiard tables, and jewelry; taxes on patent medicines and newspaper ads; license taxes on almost every profession or service except clergy; stamp taxes; taxes on corporate, bank, and insurance company gross receipts; value-added taxes on manufactured goods and processed meats; an inheritance tax; and a comprehensive income tax.

It also established a Bureau of Internal Revenue.

“In contrast, the South managed to gather only 5 or 6 percent of its war funds through actual taxation,” McPherson points out, “while the Union raised 21 percent through similar measures.”

Borrowing

With the federal government’s finances stabilizing, lenders were more inclined to offer loans. “Unlike the Confederacy, which relied on loans for less than two-fifths of its war financing,” McPherson states, “the Union generated two-thirds of its revenue through borrowing.”

Printing

The federal government’s relative success in financing through taxation and borrowing reduced its reliance on the printing press.

When the Legal Tender Act of 1862 proposed the issuance of $150 million in Treasury notes, opponents expressed concerns over potential inflation akin to that faced by the Confederacy. “Human ingenuity has yet to devise a method by which paper currency can maintain its value, except through prompt, affordable, and reliable conversion to gold and silver,” warned Ohio Congressman George Pendleton. Should the bill pass, he cautioned, “prices will soar… incomes will diminish; the savings of the less fortunate will evaporate; the reserves of widows will dissipate; bonds, mortgages, and promissory notes—everything with fixed value—will depreciate.”

Fortunately, this outcome was mitigated, at least to a degree, compared to the Confederacy. The Confederate notes were not made legal tender by their government, while the federal government did so, creating a demand for transactions that was absent in the South. Moreover, the Union’s military victories bolstered confidence in the currency’s convertibility into gold, while Southern prospects diminished. The issuance of an additional $150 million in “greenbacks” in July brought the total of circulating currency roughly in line with the Confederate total. “However,” McPherson highlights:

…while the price index in the South soared to 686 (with February 1861 as the baseline of 100) by the conclusion of 1862, the Northern index remained at just 114. Over the course of the war, the Union experienced an inflation rate of merely 80 percent, in stark contrast to the staggering 9,000 percent in the Confederacy, and favorably comparable to the 84 percent inflation during World War I (1917-1920) and 70 percent during World War II (1941-1949, including the postwar period after wartime price controls were lifted).

Crisis and Leviathan

The Republicans were aligned with the Hamiltonian tradition in American governance, envisioning a robust central government, and war provided them with a golden opportunity. “Amid the exigencies of war,” Roger Lowenstein explains,

“…Lincoln’s administration conceptualized a new role for the federal government. They raised and allocated unprecedented sums of money. They introduced the nation’s first cohesive currency, eclipsing a fragmented system of thousands of differing state bills. They established a national banking framework and the first credible federal taxation program. They intervened in railroads, education, agriculture, immigration, scientific endeavors, and financial regulation. The war government exerted a visible (and sometimes questionable) influence on industry by instituting a series of high protective tariffs…”

The Bureau of Internal Revenue, for instance, “remained a permanent fixture of the federal government even though most of these taxes (including the income tax) lapsed several years post-war,” McPherson notes: “The connection between the American taxpayer and the government would never again be the same.”