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The Revenue Act of 1861, formally cited as Act of August 5, 1861, Chap. XLV, 12 Stat. 292, included the first U.S. Federal income tax statute (see Sec.49). The Act, motivated by the need to fund the Civil War, imposed an income tax to be “levied, collected, and paid, upon the annual income of every person residing in the United States, whether such income is derived from any kind of property, or from any profession, trade, employment, or vocation carried on in the United States or elsewhere, or from any other source whatever [ . . . .]” The tax imposed was a flat tax, with a rate of 3% on incomes above $800. The Revenue Act of 1861 was signed into law by Abraham Lincoln.
The income tax provision (Sections 49, 50 and 51) was repealed by the Revenue Act of 1862. (See Sec.89, which replaced the flat rate with a progressive scale of 3% on annual incomes beyond $600 (which was 3.4 times the 1862 nominal gross domestic product per capita of $177.69; the corresponding income in 2021 is $234K) and 5% on incomes above $10,000 (which is 56 times the 1862 nominal gross domestic product per capita; corresponding to $3.9M of income in 2021) or those living outside the U.S., and perhaps more significantly it was explicitly temporary, specifying termination of income tax in “the year eighteen hundred and sixty-six“).
Prior to the Civil War, the United States faced a financial depression subsequent to the Panic of 1857, an event facilitated by over-expansion of the domestic economy and a European financial meltdown. In the three years preceding the Civil War, the Federal Government incurred a budget deficit exceeding $40 million. Coupled with the threat of secession, the Federal deficit placed the US government under considerable financial strain. In 1860, the US Treasury paid between 8 and 12 percent interest on government bonds in order to raise additional funds and meet public expenditures. In December 1861, the US Treasury attempted to sell five millions of interest-bearing notes at 12 percent but found itself able to dispose of only four millions. The Treasury’s struggles illustrate the precarious nature of the US government’s financial state. As the nation edged closer to war, the need to mobilize a volunteer force placed an additional financial burden upon the Federal government. While treasury notes with enticing interest rates allowed the US government to raise revenue quickly, they also established a need for additional revenue streams with which to pay off interest.
In March 1861, President Lincoln began to explore the federal government’s ability to wage war against the South from a logistical standpoint. He sent letters to cabinet members including Edward Bates, Salmon Chase, and Gideon Welles inquiring whether the president had constitutional authority to collect duties ranging from an import tariff to a property tax. Documents housed at the Library of Congress indicate that Lincoln was concerned with the Federal government’s ability to collect tariffs from ports along the Southeastern seaboard, noting the imminent threat of secession.
On July 4, 1861, President Lincoln opened a special session of Congress with the explicit purpose of addressing the Civil War from a legislative standpoint. One of the primary concerns facing Congress was the question of funding: given a surfeit of volunteers, the Union Army military incurred extraordinary expenditures as they trained and armed a martial force. President Lincoln noted that, “One of the greatest perplexities of the government, is to avoid receiving troops faster than it can provide for them. In a word, the people will save their government, if the government itself, will do its part” To raise revenue by approximately $50 million, legislators adopted a three-pronged approach consisting of an increase in certain import tariffs, a newly instituted property tax, and the first personal income tax.
Under the leadership of Senator William Pitt Fessenden of Maine, chair of the Senate Finance Committee, Congress drafted the Revenue Act of 1861 in a relatively short time-frame. While the legislation effectively introduced import tariffs, property taxes, and a flat rate income tax of 3% on those making above $800, it lacked a comprehensive enforcement mechanism. In Congress, the bill provoked considerable debate: Thaddeus Stevens, chairman of the House Committee of Ways and Means, declared that, “This bill is a most unpleasant one. But we perceive no way in which we can avoid it and sustain the government. The rebels, who are now destroying or attempting to destroy this Government, have thrust upon the country many disagreeable things.” His sentiment reflected the view that the income and property taxes levied by the bill were necessary evils. The bill was eventually passed by Congress and signed into law by President Lincoln. Despite its sweeping reform, the ineffective enforcement mechanism coupled with a 3% flat tax rate failed to yield the desired revenue.
Lincoln’s national income tax was a direct reaction to the military needs of the Civil War, and he could only tax the northern states. He was also able to impose the tax without passing a constitutional amendment.
After asking his cabinet if the income tax was constitutional, Lincoln met with Congress in a special joint session on July 4, 1861, to hammer out the details of the tax law.
Lincoln’s cabinet and fellow Republicans had determined that since it did not tax property directly, the income tax was an indirect tax, and it was not subject to Article I of the Constitution, which said that direct taxes must be apportioned according to the population of each state.
Lincoln signed The Revenue Act of 1861 on August 5, 1861, and it taxed imports, provided for a direct land tax, and imposed a tax of 3 percent on individual incomes over $800 (which, in current dollars, is about $18,000). The bill fell far short of its goals. There wasn’t an effective way to collect the taxes, and the 3 percent income tax only applied, ironically, to 3 percent of the population in the north.
The laws were overhauled in the more-extensive Revenue Act of 1862, which created the agency that later became known as the Internal Revenue Service and levied the first progressive income tax on Americans. The new act also had hefty taxes on alcohol and tobacco products. More income tax
es brackets and higher tax rates were added in 1864, with the tax law expiring during the Reconstruction period after the Civil War.
The Revenue Act of 1864 did survive a Supreme Court challenge when in Springer v. United States a unanimous Court said that the Civil War income tax was constitutional. But when Congress passed a national income tax in 1894, it was ruled unconstitutional the following year by the Supreme Court in Pollock v. Farmers’ Loan & Trust Company.
A divided court in Pollock said it was a direct tax not apportioned according to the population of each state, in violation of Article I, Section 9, of the Constitution. After the Pollock decision, it took Congress and at least 36 states to make the income tax legal via the 16th Amendment. By 1913, when the amendment was ratified, the average income had risen to $800, which was the taxable rate back in 1861.
The Confederacy also had a version of an income tax, which wasn’t as effective as the Union tax system. Its lawmakers approved an income tax measure in 1863 as a graduated income tax. It exempted wages up to $1,000, levied a 1 percent tax on the first $1,500 over the exemption, and 2 percent on all additional income. But the Confederacy didn’t have an established system to collect taxes.