I have just written a new section for Chapter 4 of my North American history, telling how Americans paid for the Civil War, with special emphasis on the Union solutions. Read and enjoy!
Before the Civil War, the federal government got most of its money from tariffs and a few other taxes, and issued various bonds and notes when it did not raise enough revenue this way. Federal spending was kept low, because most administrations, from Jefferson to Pierce, thought accumulating debt was bad in the long run. The Buchanan administration allowed an exception to this rule, because the financial panic of 1857 had reduced normal income from tariffs and duties. In 1857 the national debt was $28 million, not enough to scare anybody, and by issuing bonds and notes to cover the shortfall in revenue, Washington added $76 million to the debt by 1861. Then came the Civil War, and the calls to recruit hundreds of thousands of new soldiers. All those troops needed to be paid, and they also needed uniforms, guns, ammunition and food, so the Civil War was not only bigger than any previous war in North America — it was also more expensive. And because both sides had originally expected the war would be short, Lincoln’s Treasury Secretary (Salmon P. Chase), and his Confederate counterpart (Christopher Gustavus Memminger) did not think they would have to raise billions of dollars for the war effort, but that is what they eventually did.
To find new sources of revenue, President Lincoln called a special session of Congress in July 1861. The ideas considered at this session included the sale of government bonds, increased tariffs, new taxes or duties, and the sale of public lands. Congress approved a $240 million bond sale, and the introduction of an income tax; the latter was a flat tax of 3% on everyone making more than $800 a year. Before the new tax was collected, though, Congress passed a new Revenue Act (in mid-1862), to replace the Revenue Act of 1861. This modified the income tax, so that it collected 3% on annual incomes above $600, and 5% on incomes above $10,000 or on US citizens living abroad. Most important of all, the income tax was declared temporary; collection of it would end in 1866. After that, Americans would not be saddled with an income tax again for almost fifty years.
The 1861 bond sale raised only $150 million, so a $500 million bond sale was authorized in February 1862. Since bonds were bought mostly by banks and brokers, Secretary Chase gave the responsibility of selling the bonds to one of the buyers, a banker named Jay Cooke. This was a roaring success; Cooke did it by running newspaper advertisements, using a network of 2,500 salesmen spread out across the country, and by writing editorials promoting the bonds. Some of the bonds had a face value as low as $50, making them affordable to private citizens, and Cooke declared that buying a bond was a patriotic act, that should be considered by anyone who wanted to preserve the Union. Because Cooke did so well, Congress authorized an $830 million bond issue in early 1865, and this time Cooke sold them all by the summer of the same year. Altogether, bond sales paid two-thirds of the $3.4 billion that the Civil War cost the Union government.
Finally, the Civil War saw the introduction of paper money as present-day Americans know it. At the beginning of the war, the money supply in circulation was $200 million worth of banknotes. Each state authorized a few banks to print the money, and from state to state the bills looked different, and were in different denominations. To reduce the confusion this understandably caused, Treasury Secretary Chase suggested that the federal government print $150 million worth of a new paper currency not backed by gold, but still considered an obligation of the USA. Printed on green paper, these "greenbacks" would be convertible into an equal amount of government bonds and considered legal tender for all public and private debts. After two months of heated deliberation, Congress approved his plan, through the Legal Tender Act of 1862. Ironically, the first dollar bills printed had Chase’s picture on them. Still, the new standard currency was soon accepted by both merchants and consumers, so in July 1862, Congress authorized another $150 million greenback issue, and urged that about 25% of the notes be issued in denominations of one to five dollars. Then it approved the third greenback issue, worth $150 million, in early 1863. By the end of the war, approximately $450 million worth of the new paper money was in circulation.