Whiskey and War: A Brief Look At The Origin of US Taxes

In America's early days (1760s -1770s), citizens rallied and fought back against various British taxes. The British-imposed Stamp Act, Sugar Act, Tea Act, and Townshend Revenue Act all culminated in 1775 when the Boston tea party famously rebelled by dumping imported tea in the Boston harbor. This, of course, set off the Revolutionary War. “No Taxation without Representation” was the battle cry.

Unfortunately, debts from the Revolutionary War added up, and couldn’t be privately funded. Shortly after the war, Alexander Hamilton helped impose tariffs on imported goods- this proved a popular way to raise revenue for the newly-created government, and support American businesses.

In 1791 Alexander Hamilton proposed America’s first Excise Tax on an American product; a 7-cent per-gallon tax on distillers; known as the Whiskey Tax. The tax hurt small producers- usually farm families who had turned to distilling and bottling their excess corn, rye, and grain. American’s had just won the Revolutionary war fueled by a hatred of tax, and now an excise tax was levied in order to pay for it!

A growing number of citizens refused to pay the tax collectors, some citizens assaulted them and broke into their homes; one tax collector was even tarred and feathered. George Washington ended up sending troops to the frontier, thereby ending the “Whiskey Rebellion”. Thomas Jefferson eventually won the Presidency in 1801, in part by campaigning to end the Whiskey tax.

Fast forward to 1861, Abraham Lincoln was concerned with financing the recently started Civil War. In August, Congress passed the Revenue Act of 1861, which was the first income tax in US history. The value was 3% on incomes over $800, (which is said to be around $16,000 in today’s dollars). The Revenue Act’s language was broadly written to define income as gain “derived from any kind of property, or from any professional trade, employment, or vocation carried on in the United States or elsewhere or from any source whatever.”

The civil war ended in 1865, and Congress repealed Lincoln’s tax law in 1871. But the precedent for income taxes had been set. In 1909 the 16th Amendment passed (ratified in 1913) which set the modern federal income tax system in place.

At that time, due to exemptions and deductions, only 1% of the population paid income tax, and the effective rate was around 1% of income. That quickly changed as another War needed financing: World War I brought about a top marginal tax rate of 77% (1918), and World War II pushed the marginal rate to over 90%.

Though taxes have long been a feature of our society, they’ve never been a reason to avoid investing. The tax rate has been used as a political ping pong ball for hundreds of years. It’s hard to be optimistic about the stock market under high tax rates; thankfully there’s more to the story for stock returns. After all, the S&P 500 averaged over 10% annually from 1926-2019, despite the average top tax rate being over 60% during that same time.