Crisis and Leviathan: The Federal Government in the Civil War

When the Civil War broke out in 1861, the federal government, like any government in any situation, had three sources of money: taxing, borrowing, or printing.

Taxing

The federal government was much more successful than its Confederate counterpart in funding the war via taxation.

In August 1861, tariffs were hiked and the first federal income tax in American history was enacted. “The Republican architects of the 1861 income tax made it modestly progressive by imposing the 3 percent tax on annual incomes over $800 only,” historian James M. McPherson notes:

…thereby exempting most wage-earners. This was done, explained Senate Finance Committee Chairman William Pitt Fessenden, because the companion tariff bill was regressive in nature. “Taking both measures together, I believe the burdens will be more equalized on all classes of the community.”

Subsequently, “[t]he Internal Revenue Act of 1862 taxed almost everything but the air northerners breathed,” McPherson writes:

It imposed sin taxes on liquor, tobacco, and playing cards; luxury taxes on cigarettes, yachts, billiard tables, jewelry, and other expensive items; taxes on patent medicines and newspaper advertisements; license taxes on almost every conceivable profession or service except the clergy; stamp taxes, taxes on the gross receipts of corporations, banks, insurance companies, and a tax on the dividends or interest they paid to investors; value-added taxes on manufactured goods and processed meats; an inheritance tax; and an income tax.

It also established a Bureau of Internal Revenue.

“[W]hile the South ultimately obtained only 5 or 6 percent of its funds by actual taxation,” McPherson notes, “the northern government raised 21 percent in this manner.”

Borrowing

With federal government finances on something approaching a firm footing, lenders were more willing to lend to it. “Unlike the Confederacy, which relied on loans for less than two-fifths of its war finances,” McPherson notes, “the Union raised two thirds of its revenues by this means.”

Printing

The federal government’s relative success in financing the war by taxing and borrowing meant that it had less recourse to the printing press.

When the Legal Tender Act of 1862 proposed to issue $150 million of Treasury notes, opponents worried about a repeat of the inflation happening in the Confederacy. “The wit of man has never discovered a means by which paper currency can be kept at par value, except by its speedy, cheap, certain convertibility into gold and silver,” warned Ohio Congressman George Pendleton. If the bill passed, he argued, “prices will be inflated…incomes will depreciate; the savings of the poor will vanish; the hoardings of the widow will melt away; bonds, mortgages, and notes – everything of fixed value – will lose their value.”

This did not happen, at least not to the extent that it did in the Confederacy. The Confederates did not make their notes legal tender, the federal government did, creating a transaction demand absent in the Confederacy. In addition, the increasing success of Union armies on the battlefield reinforced promises of redemption in specie whilst undermining them in the south. The issue of a further $150 million of “greenbacks” in July brought the total roughly into line with the total circulating in the Confederacy. “But,” McPherson notes:

…while the southern price index rose to 686 (February 1861 = 100) by the end of 1862, the northern index then stood at only 114. For the war as a whole the Union experienced inflation of only 80 percent (contrasted with 9,000 percent for the Confederacy), which compares favorably to the 84 percent of World War I (1917-1920) and 70 percent in World War II (1941-1949, including the postwar years after the lifting of wartime price controls).

Crisis and Leviathan

The Republicans were of the Hamiltonian tradition in American politics, which imagined a strong central government, and war presented their opportunity. “Under the emergency of war,” Roger Lowenstein writes,

“…Lincoln’s party formulated a new notion of what the federal government could do. They raised and spent unprecedented sums. They launched the country’s first truly national currency, pushing aside an inchoate system of thousands of disparate bills issued in the states. They created a national banking system and the first credible program for federal taxation. They inserted the government into railroads, education, agriculture, immigration, the sciences, financial regulation. The war government interposed a visible (and at times dubious) hand into industry by enacting a series of high protective tariffs…”

The Bureau of Internal Revenue, for example, “remained a permanent part of the federal government even though most of these taxes (including the income tax) expired several years after the end of the war,” McPherson writes: “The relationship of the American taxpayer to the government was never again the same.”