For much of the 19th century, the United States lacked the institutional capacity to mount ambitious federal programs. Regressive tariffs and excise taxes on alcohol and tobacco were the main sources of federal revenue. Those revenues supported limited federal spending—on average only about 3% of gross domestic product compared to 23% today—for a few grudging investments in infrastructure. So-called “internal improvements” were mostly the domain of state governments. And with the exception of the Civil War, the military was tiny by comparison to those of the European powers.
In those early years, the tariff was not intended to raise significant revenue. It was principally meant to protect the country’s “infant industries” from foreign competition. Success in that endeavor meant, by definition, that tariffs would generate little revenue. Goods kept out of the U.S. market never generated duty payments at U.S. ports.
Moreover, American protectionism soon began to diverge from its aims. Lawmakers increasingly used the protective tariff to pick winners in the marketplace, deciding which firms and which regions would benefit from duties placed on foreign rivals. The duty list became a tool for corruption and party self-dealing, a device for rewarding favorites and punishing enemies.
The protective tariff also facilitated corporate consolidations. Vast holding companies arose at the end of the 19th century, shielded from foreign competition and run by industrialists who boasted previously unknown riches. Because import duties raised the prices of everyday goods while protecting the industrialist class, ordinary Americans rightly came to associate the tariff with rising inequality and with the gross concentrations of wealth that typified the first Gilded Age—and now plague our own.
And so, a combination of agricultural interests, organized labor, and Progressive Era intellectuals demanded a new system of taxation to rein-in galloping inequality and support an expanded federal budget. Such pressure worked. Congress adopted its first peacetime income tax in 1894. When the U.S. Supreme Court struck it down a year later as unconstitutional, Americans responded by creating a social movement for what eventually, in 1913, became the 16th Amendment to the U.S. Constitution, authorizing Congress to lay and collect taxes on incomes. President Woodrow Wilson signed a new income tax into law later that same year, and the income tax has been with us ever since.