This year marks the sesquicentennial of the Civil War -- much to the delight of battle reenactors and military historians everywhere. But tax geeks should be celebrating, too, because 1861 was also a milestone in fiscal history. As the fractured American nation plunged into a fratricidal abyss, Union political leaders made time to open a new chapter in the annals of American taxation: They imposed the country's first income tax.
In isolation, the income tax of 1861 was an abject failure. Mired in controversy, it languished on the law books when Treasury Secretary Salmon Chase refused to enforce it. But the political discourse surrounding its enactment -- and subsequent income levies enacted during the war -- can teach us a thing or two about the dynamics of tax reform. In particular, it drives home the role of balance and shared sacrifice in the making of tax policy.
Congress designed the Civil War income tax to balance the scales of fiscal justice. In the early stages of the war, lawmakers raised almost every tax they could, including tariffs and excises. Those consumption levies were the traditional mainstay of federal finance, funding the national government for its first 60 years.
Tariffs in particular were the principal source of federal funds, providing more than 90 percent of total revenue. They were also a key source of sectional tension, as Southerners complained that high tariffs protected Northern manufacturers from foreign competition at the expense of Southern farmers who had to pay more for manufactured goods.
More generally, tariffs were understood to be regressive in every region, burdening the poor more than the rich. Excise taxes, too, suffered from a similar problem, especially when wartime exigency forced lawmakers to dramatically expand the number of taxed items. But as the Union girded for war, lawmakers believed both revenue tools were necessary.
To help compensate for the regressive incidence of existing levies, Congress began searching for something new: a tax that would fall primarily on the rich. Some excises were designed to do the same thing. Levies on luxury were always the extraordinary tax of first resort, both during the Civil War and earlier revenue crises.
But Union lawmakers wanted a tax that would accomplish that progressive aim more directly, while also producing much-needed revenue. At first they considered a federal property tax, which Congress had used to help pay for the War of 1812. But federal property taxes were unwieldy and unpopular. Farmers objected that, as with the tariff, a property tax would spare the nation's economic elite while soaking its agrarian yeomen. "I cannot go home and tell my constituents that I voted for a bill that would allow a man, a millionaire, who has put his entire property into stock, to be exempt from taxation, while a farmer who lives by his side must pay a tax," insisted Indiana Rep. Schuyler Colfax.
Those complaints proved persuasive, and Congress eventually turned to the income tax. The levy was unprecedented in the United States, although Treasury officials had vaguely considered one during the War of 1812. But in Great Britain, the tax was already a proven revenue tool, and American political leaders were intrigued by its possibilities.
Champions of the income tax generally defended it as an adjunct to existing, more familiar levies. In conjunction with tried-and-true taxes on consumption, the new tax would yield a balanced revenue system. "I am inclined very much to favor the idea of a tax upon incomes for the reason that, taking both measures together, I believe the burdens will be more equalized on all classes of the community, more especially on those who are able to bear them," said Sen. William Fessenden.
Debates over Civil War tax reform (and tax innovation) returned to the issue of balance repeatedly. As the war continued, taxes and tariffs continued to rise, burdening almost everyone. But lawmakers consistently turned to the income tax as a means to balance the overall incidence of the tax system.
Of course, the income tax has proven to be a fine revenue tool, raising considerable money for a cash-strapped government. By 1865, it was producing more than 20 percent of total revenue. According to estimates by historian W. Elliot Brownlee, the tax eventually fell on roughly 10 percent of Union households; in the Northeast, where the Bureau of Internal Revenue collected 75 percent of its income tax revenues, the figure was probably closer to 15 percent.
The impressive yield of the fledgling levy stemmed, at least in part, from its rising rates. What began as a flat rate tax of 3 percent on incomes over $800 eventually became a two-rate levy on incomes over $600, with rates ranging from 5 to 10 percent.
Throughout the war, the income tax was reasonably well tolerated, and it enjoyed broad support in Congress. But the introduction of graduated rates raised the hackles of some lawmakers, who insisted that the move was fundamentally un-American. As Rep. Justin Morrill said:
This provision goes upon the principle of taxing a man more because he is richer than another. The very theory of our institutions is entire equality; that we make no distinction between the rich man and the poor man. . . . [This law] is seizing property of men for the crime of having too much.
Morrill had some sympathetic colleagues, but a large majority of the House voted to approve the new rate structure. The Senate soon followed suit.
Over the course of the war, new and higher taxes were always defended in terms of shared sacrifice. The war itself was the most obvious sacrifice, claiming lives on the battlefield. But economic sacrifice was real, too, as Congress raised tax burdens for every American. In the context of that broad-based fiscal sacrifice, the income tax -- and its graduated rates -- seemed a reasonable tool for allocating burdens according to ability (then, as now, always vaguely defined).
Sacrifice Without Balance
What can the Civil War tell us about today's debate over deficit and debt reduction? It's the notion of sacrifice that links the two eras. Then, as now, the nation faced a serious fiscal crisis. And then, as now, lawmakers struggled over how to allocate the pain incurred while solving it.
Differences abound, of course. An entitlement-driven fiscal crunch is not the same thing as a war, no matter how severe it might become. Mortal sacrifice on the battlefield is not the same as economic sacrifice from a paycheck.
Still, the notion of shared sacrifice unites those episodes. Clearly, solving today's fiscal problems will be painful, requiring higher taxes and lower spending. The necessary changes won't be pleasant for anyone -- and they will be deeply painful for some, especially those who depend on key social programs.
But today's lawmakers have failed to acknowledge that broad-based sacrifice will be necessary to solve the nation's fiscal problems. No one in either party is willing to talk about meaningful entitlement reform.
Lawmakers are also not being honest about taxes. If higher revenues are going to be part of the solution, then the extra burden will almost certainly fall on everyone. But so far, the champions of higher revenues have been unwilling to acknowledge that everyone will end up paying more. Instead, they have focused narrowly on raising taxes on those with high incomes.
For the time being, Democrats are doing OK with their focus on taxing the rich. Polls suggest that most Americans support that approach. But that's a function of our painful economic moment. When the current crisis eases, progressive taxes will be vulnerable again -- as they always are in American politics.
Civil War leaders knew that raising taxes on the rich was important. But they also knew that it was best done as part of a broader tax increase. Only then could progressive taxes avoid being tagged as discriminatory and un-American. That's something today's progressive leaders might want to consider.