American Taxation


In the first days of the new federal government, the Secretary of the Treasury, Alexander Hamilton, had hoped to accomplish two things with the tariff: First, of course, he wanted to establish a revenue stream that would fund both the operations of the government and the debts acquired in the Revolution, and second, he wanted to protect American industry until it was efficient enough to compete on even terms with the established industrial firms of Europe, especially Britain. This latter intent is a classic example of the second purpose of taxation, one that developed only in modern times: an effort to affect the workings of the national economy rather than to raise revenue—in other words, taxation for the purpose of economic engineering.

THIS IS ONE OF THE RARE INSTANCES IN WHICH HAMIL- ton failed fully to perceive the effect of unchanging human nature on the interaction of politics and economics. Economic engineering is sound in intellectual theory. Now and then it even works in fact. In 1865, for instance, Congress imposed a 10 percent excise tax on bank notes issued by state-chartered banks. The purpose was not to raise revenue—and it didn’t—but to end the economic babel caused by thousands of circulating currencies. This the new tax immediately did, to the great long-term advantage of the American economy.

Far more often, economic engineering requires a benevolent—not to mention objective—despot to succeed. Any time it happens to benefit a particular segment of the population, the way tariffs protect manufacturers, that segment will always work hard to maintain its benefit long after the original purpose of the tax has been served. In the push and shove of democratic politics, meanwhile, economic engineering has also, of course, often served as a splendid refuge for scoundrels, providing cover for political favors to the rich and powerful.

Congress at first ignored Hamilton’s call for protective tariffs because there were few industries to protect and they had little political influence. The people who would have to pay the tariffs—the American population at large—loomed far larger in Congress’s political consciousness. That situation changed radically after the War of 1812. The British blockade during the war and laws such as the Embargo and Non-Intercourse acts that preceded it spurred a large jump in American manufacturing, much of it concentrated in New England. The traditional New England opposition to tariffs began to fade as the new American industries pushed for ones high enough to protect them from renewed foreign competition.

The South, ever more dependent on the export of cotton and the import of manufactured goods from both the North and Europe, fiercely resisted these increased tariffs, but with only limited success. The one passed in 1828—called, with typical Southern genius for political phrasemaking, the Tariff of Abominations—led directly to the nullification crisis of 1832, which threatened the Union itself. Tariffs were lowered in settling that dispute, and were lowered as well in 1857, but they remained far higher than revenue needs normally required. The tariff, then nearly synonymous with federal taxes, was a prime cause of the Civil War.

At the end of 1860 the federal government was spending money at the rate of about $173,000 a day. Three months later the War Department alone was spending $1 million a day. By the end of that year it was up to $1.5 million. A conflict unprecedented in scale in Western, let alone American, history, the Civil War placed wholly unprecedented demands upon the financial resources of the United States and the federal tax system.

THE 1913 income tax was essentially a socialengineering device, to force the rich to pay their “fair share.

Much of the cost of the war for the North was thrown off onto the future by the borrowing of nearly $3 billion from American citizens, many of modest means, in the world’s first bond drives. About $450 million was raised by the printing of greenbacks, legal tender not backed by gold. About $750 million was raised by taxation.

OBVIOUSLY THE OLD TAX system that had relied on the tariff for revenue would not suffice. The first timid steps toward an income tax were taken as early as July 1861, and in 1862 the Bureau of Internal Revenue was established. The ancestor of the IRS, it is by no means the least of the Civil War’s legacies to this country.

The act establishing the Bureau of Internal Revenue also moved to tax nearly everything. Excise taxes were slapped on most commodities; stamp taxes on licenses and legal documents. The gross receipts of railroads, ferries, steamboats, and toll bridges were taxed. Advertisements were taxed. The tariff was sharply raised.

Also imposed was a tax on all income “whether derived from any kind of property, rents, interest, dividends, salaries, or from any trade, employment or vocation carried on in the United States or elsewhere, or from any other source whatever.”