David Stewart: Welcome to the podcast. I'm David Stewart, editor in chief of Worldwide Tax Daily. This week, drunk tax history.
Joe Thorndike: Hi, I'm Joe Thorndike, and I'm going to talk about the intersection of U.S. taxes and alcohol.
David Stewart: Before we get started, I should note for listeners that Joe is not, in fact, drunk. But he is a tax historian. That said, let's get into the history. Joe, I guess we should start out with the story about a bunch of drunks getting into a tax protest.
Joe Thorndike: Right, so this is one of the one of the highlights of American tax history, right? The Boston Tea Party — everybody likes to talk about it. They like to talk about it so much that they named the modern Tea Party after it. It is a story about tea, principally. To some degree about alcohol in the sense that a lot of those guys dressed up as Indians, throwing chests of tea into Boston Harbor, were in fact drunk. And what's confusing about the Boston Tea Party, though, is that it isn't what people think it is, right? It isn't actually a protest against taxes on tea, or taxes on alcohol, for that matter. But it was, in fact, a protest against a tax preference, right? What really drives people crazy is not so much having to pay a tax, it's other people not paying a tax. That is the kind of thing that really gets people angry. And you find that time and again in U.S. history.
So in this very early story, I mean, the deal is that essentially there's a corporate bailout for the East India Company, which isn't doing very well. And Britain creates a tax preference, which allows the East India Company to import tea without having to pay taxes on it like the colonial companies do, the colonial merchants do. So they're angry because, hey, we're bearing this tea tax and the full weight of it over here, and meanwhile, these lucky, well-connected East India Company guys are getting a sweet deal.
That's something that people should remember because we think that we know Americans. Yeah those Americans, they're anti-tax, they hate all taxes. Well, I mean there's some truth to that, except that pretty much people in every country hate taxes. But what I think is distinctive here is that Americans hate taxes, sure, but what they really hate are loopholes, preferences that are given to other people, not to them. They hate people who are not sort of carrying their weight, their fiscal responsibilities.
David Stewart: Okay, let’s move from that to a different story about taxes. This one I know almost nothing about. I remember that it was brought up in seventh grade. I remember hearing about it. But I don't remember almost anything about it. So Joe, can you tell us, tell the listeners about the Whiskey Rebellion?
Joe Thorndike: Alright, so this is actually a really good story, and it begins a few years before there's an actual rebellion. It starts in 1791. We have a very young United States, and for almost all of early American history the federal government paid its bills with tariff duties. Something, you know, Donald Trump would know a little bit about. Taxing imported goods. But it wasn't really enough, at least in the beginning. So in 1791 the federal government is in a lot of debt from having fought the Revolution, and they need to find some way to pay those debts back, to service the debt, and to make some payments on the interest. And a tariff is not doing the job, so they come up with an idea: Hey, let's tax alcohol. This was a reasonable idea because there had been excise taxes on alcohol in Great Britain for a long, long time. And it's also worth noting that excise taxes in Great Britain, including those not on alcohol but on other things too, were incredibly unpopular with the British.
Samuel Johnson, who wrote that 1755 dictionary, he had to define what an excise was, and he called it “a hateful tax upon commodities, and adjudged not by common judges of property, but by wretches hired by those to whom the excise tax is paid.” And that pretty much sums up the way people felt about excises. They hated the idea of taxes on these individual goods. But, there were plenty of them in Britain. And Alexander Hamilton, someone who might be familiar to theatergoers here, actually liked the idea of taxing alcohol among other things, as a way to help pay these Revolutionary War debts. I think the lesson to take from this is about those wretches hired to enforce the tax.
That same argument was true here. People didn't like the collectors. So I said a little bit ago that what people hate isn't taxes, they hate tax preferences. Now I'm going to add something to that. They also hate tax collectors. They hate people who are walking into their lives and digging around and looking for information and stuff, and that's what excises require. So tariffs are actually kind of easy to collect. You like pull your ship up to the dock and you leave it there and a customs inspector gets on and looks at what you've got and he assesses the tax and it gets paid. It's called a waterfront state because that revenue is all picked up right at the waterfront and there are just a limited number of places where you can do that. But an excise has to be enforced retail. You got to go into every little house and every store and manufacturing facility, whatever, and people hated that. The idea that someone was going to come up and knock on your door and demand to come in and say hey, I heard you have a still in here. How big is the still? How much are you producing? That feels invasive to people and they didn't like it. So that's why people didn't like the excises in Great Britain. It's also why they weren't so wild about the whiskey tax once it was imposed here in 1791. So this is sort of a story about the IRS, or its forerunner.
Anyway, as I said, ample precedent for this sort of tax. Also, it's defended because it's on a luxury item. Nobody really needs whiskey, right? So, who cares. And it's relatively easy to administer compared to some alternatives, but not compared to the tariff. Alexander Hamilton was one who did defend the tax on the grounds that it was taxing an unhealthy and bad-for-you product. A sinful product, if you want. And that's why we call them sin taxes. And Hamilton actually said “the consumption of [ardent] spirits particularly, no doubt very much on account of their cheapness, is carried on to an extreme, which is truly to be regretted, as well in regard to the health and morals as to the economy of the community.”
So you know, you make this case, yeah, well, we're going to tax this stuff because it’s bad for us. What is it, that old line you hear about tax policy all the time? You should tax the things you don't want, and you'll get less of them. You shouldn't tax the things you do want, like income. Well, that's the argument here that's used for alcohol taxes. So they imposed this tax in 1791. It's revised a couple of times. Wildly unpopular, as you might expect, with the people who make whiskey. I mean, they don't like the idea. I think the tax was like 10 cents on a gallon of domestic spirits. They actually taxed things that were made with imported goods, so like rum is made from crops that are not grown in the United States. That was taxed more heavily than things like whiskey, which were made from grain grown right here in Pennsylvania, as was the case here.
So Pennsylvania is the important place if you're talking about the Whiskey Rebellion. This is where the rebellion happened. And it happened there because the farmers on the western frontier, which was right around Pittsburgh at this time, they grew grain, and they had to get their crops into the market somehow and, you know, carrying all that grain over the mountains back into Philadelphia was difficult. What they preferred was to distill it into alcohol. Much easier to transport and bring that into Philadelphia and sell that. And to some degree, that alcohol was actually a sort of currency of sorts. A medium of exchange. It wasn't just something that they sold, but they often used it for barter transactions. And yet the tax was due in hard currency. So this sort of quashed their bartering, their bartering behaviors, and they had to start selling this stuff. They really resented the idea that this tax, imposed on them by these guys back in Washington, or actually in New York and Philadelphia at that point, was falling especially heavily on them and really disrupting their life. As they had been managing to make it work. It was not an easy life out there on the western frontier. They also thought that this was being used as an alternative to property taxes on real estate or personal property, which would have been more progressive, and they didn't like that they were using excise taxes instead.
They also, to get back to those nasty collectors, didn't like the fact that the collection was outsourced to private contractors. We use private contractors today to collect some money for the IRS, and I think that that's not necessarily so popular. Certainly, the use of private collectors for the whiskey tax was extremely unpopular. People just didn't trust them. And these guys were also empowered, as I was saying, to sort of search and seize on private property. That really did not sit well with these western farmers.
So, they rebel. The Whiskey Rebellion of 1794. They say we're not going to pay this, they tar and feather some tax collectors. It's a little bit dramatic. What's a lot more dramatic is the way Washington, President Washington responded, which was by marching an army of some 13,000 soldiers into western Pennsylvania. And really this was driven, again, by Alexander Hamilton, his Treasury secretary, who wanted to make clear that the U.S. federal government had the power to impose this kind of tax. So they marched these guys in. There was no great battle or anything like that. Everybody just sort of folded up immediately and nothing happened. It was sort of a show of force that was necessary, but it's a good image we can put in our mind because there's George Washington, old George Washington at this point, up on his horse leading the troops into what might have been battle but which turned out to be no battle at all.
Anyway, the rebellion such as it was kind of folded immediately. Actually, no one really got punished for it in particular. There were a lot of pardons granted, but it was an important moment in the drunk tax history of the U.S., in the sense that it demonstrated that the federal government could impose taxes on internal goods. You know, we weren't just going to use tariffs on this stuff coming out from overseas. We were going to actually tax things made right here in the U.S. And that was a novelty in the 1790s, and Hamilton wanted to prove that it was possible. The Constitution granted the government the power to tax like that.
The Whiskey Rebellion and the response to it showed that on the ground the federal government was going to make this stick. So, I think that's pretty much the story. It's again, I think, in this case, this is a story about collection, to a great extent, and how people resent intrusive collection. But, also, just how the federal government got its feet on the ground in terms of its taxing capacity.
David Stewart: Alright, so now the U.S. government has asserted its authority to tax internally. Let's move forward to the first time when the government needs a lot more money. The War of 1812.
Joe Thorndike: Right, so that early whiskey tax sticks around for a while, but they repeal it in 1802 because it's so unpopular, and it's especially unpopular with Thomas Jefferson and his party. And they promised to repeal internal taxes. But then they get into war again with Great Britain. The War of 1812. They need to raise a lot of money, and they bring back the alcohol tax, actually in 1813. Again, it taxed liquor made from foreign imports higher than from domestic sources. They promised that it would go away quickly after the war. It was sold explicitly as an emergency tax. And generally speaking, it was pretty well tolerated. Unlike the 1791 tax, which was, sort of after the fact paying for the Revolution, this was paying for the war during the war. And you can find actually that Americans will sort of rise to the occasion in those moments. So it was reasonably well tolerated. And just as they promised, they repealed it pretty quickly after the end of the war. The war ends in 1815. The tax is repealed in 1817 and is gone until the Civil War.
David Stewart: Alright, so at the Civil War I'm guessing more taxes come in because again a lot more money is needed.
Joe Thorndike: Yeah, I mean the story of taxes in America is a story about wars in America for the most part, and yeah, so you get the start of the Civil War. Almost immediately the Union government is in desperate financial straits and they pass a revenue act in 1862 that often is remembered because it imposed the first federal income tax in the United States. But it also brought back this alcohol tax, which had been used in the previous, in the War of 1812 but had been gone for decades, and they imposed this new tax on alcohol as well as a huge number of other items, right? So this whole question of internal taxes, which the U.S. just hadn't really needed to use and had only used selectively in a few moments.
In the Civil War, because the crisis was so bad, they taxed a huge number of items, consumer items and business-to-business items, and it was almost a general sales tax, as the tax historian Elliot Brownlee has pointed out. There were so many of these excises, it was almost like a general sales tax. The alcohol tax was 20 cents a gallon on distilled spirits, which was a reasonably stiff tax but not anything like what it was going to be. Two years later, it was raised to $1.50 and by the end of the war, it was at $2 a gallon. That's 10 times higher than it was at the start of the war. So this became quite a big tax and the federal government got quite dependent on it. The Civil War alcohol tax also introduced the system of taxing alcohol that persisted in this country for many, many decades afterwards with like a system of bonded warehouses, which were overseen by the Bureau of Internal Revenue, which was what they called the IRS back then. They started taxing beer, which was a new thing. And by all accounts the high rates encouraged a lot of cheating. There's an interesting statistic here. After the war ended in 1869, they did not repeal the whiskey tax. They held on to it, but they did cut it from $2 a gallon to 50 cents a gallon. And they actually raised $20 million more that year [LAUGH] than they had under the higher tax, which suggests maybe that more of it was bought, but also that more of it was taxed, that there was less evasion going on.
And so as I said, after the war they didn't repeal this tax, they kept this one. They kept the ones on tobacco as well. Sin taxes, sinful things are easy to tax. But these remained a fixture of federal finance for the decades after the Civil War, despite the fact that they were regressive because they were at this point pretty well tolerated. So I mean, this is again, brought back as a war tax, it becomes a peacetime tax.
David Stewart: Alright, let's move forward into the 20th century and talk about a period when alcohol taxes weren't that readily available to the government.
Joe Thorndike: Yeah, so this is Prohibition, right? The question that always strikes me about Prohibition, I've wondered about for decades, was, what were they thinking? [LAUGH] How did this ever happen? It seems like such a tragedy. And it's hard to imagine that voters ever signed on for this. And it's a good question to ask, and the answer is, grass-roots organizing. It was the forces of dry America were just a lot more organized and well put together than the forces who wanted to keep drinking. So the Woman's Christian Temperance Union and the Anti-Saloon League, I mean, these were sort of single-issue political action groups and you should think of them as sort of the equivalent of today's NRA. Very powerfully connected with their constituents, able to get people out on the street and into the voting booth. And so they had been arguing for temperance, or ultimately Prohibition, for decades, and they were much better organized than the forces on the other side, which were dominated by the German-American Alliance. This is an official German government agency very closely tied to the brewers in this country, who were also many of whom of German descent. And the German-American Alliance ran into some big problems during World War I, as you might expect, when we were fighting the Germans. They were regarded with deep suspicion, and in 1916, before the U.S. actually enters the war, there's a wave election in which all these dry candidates actually make it into office and they are ready to vote in Prohibition. So they take a vote and it happens. They actually make drinking alcohol illegal in the U.S. and in the process give up a lot of tax revenue because they had been taxing alcohol in the years after the Civil War. And in 1914, they added to them because they were in need of some cash, so they raised some of these taxes, and when they voted for Prohibition, they willingly decided we're going to give up all of that alcohol tax revenue that's become such a staple of American public finance. And one reason they can do that is because they had the income tax now. The income tax had finally been ratified by the states, and in 1913 they had imposed the first federal income tax, and there was a source, an alternative source of federal revenue that could make up for this this gap created by Prohibition and demise of alcohol taxes.
Judged by almost any standard, Prohibition was a total failure. People kept drinking and they just did it in secret. It also turned the market for alcohol over to mobsters, who are famous in pop culture for all the bootlegging that went on in the 1920s. And there was a ton of official corruption that surrounded that as well. So it was a disaster in the sense that it was a widely flouted law, both by regular people who kept drinking and by criminals who made the most of a criminalized activity and enabled them to profit off of it. The most famous one here, Al Capone, right? And there's a famous IRS recruiting poster that was trying to get people to come work for the IRS, and it said only an accountant could catch Al Capone. And that's because Al Capone was indicted for income tax evasion. He did not pay his income taxes on the money he made from his criminal activities, and in particular, from his bootlegging and from his dealings in illegal alcohol.
So Prohibition is a tax story in those two ways. It's a story about the demise of alcohol tax revenues during the period of Prohibition. And it's also a story about tax evasion by the criminals who made the most out of Prohibition. The other side of the Prohibition story is about repeal of Prohibition, right? A lot of people want Prohibition repealed because they want to drink legally again. But one group of people who are particularly excited about repealing Prohibition are politicians who want the money from that alcohol tax revenue back again. In the early 1930s, after the Depression begins, federal tax revenues drop through the floor, and they're looking all over for money. And along come the Democrats who are by and large, the wet party, arguing for repeal of Prohibition. And they say, hey look, we're going to repeal this crazy constitutional amendment. We're going to allow people to drink, and that's going to raise all sorts of revenue from those alcohol taxes, which are still on the books. And actually the argument that the Democrats put forward was phrased this way: If only given a chance, Americans might drink themselves into a balanced budget. Which is not what happened. The budget wasn't balanced, but alcohol taxes, once Prohibition was repealed, did begin to make a huge contribution to federal revenues. And in fact, for the first half of the New Deal, say from 1932 through about 1935 or 36, excise taxes on alcohol and to some extent, tobacco, were providing the largest chunk of federal revenue. We think of the New Deal as this period when we were soaking the rich with high income taxes and taxes on big estates and everything, which we were, but for a long time, it was regular people paying alcohol taxes and tobacco taxes that were actually footing most of the bill for the federal government.
David Stewart: Now, this sounds, this argument about repealing Prohibition, sounds quite familiar to the modern ear as the way some are arguing in favor of legalizing marijuana as a way of raising additional tax revenue. Do you see parallels?
Joe Thorndike: Absolutely. I think on the state level right now you do see a lot of states looking at taxes on marijuana as a very appealing revenue source. As in so many cases like, it seems like a great thing to tax because it's optional. Nobody has to be smoking marijuana. So if they choose to do that and pay the tax, hey that's up to them. It's a regressive tax because all these consumption taxes, all these narrow excise taxes tend to be quite regressive. But that regressivity, at least in the popular discussion about tax fairness, regressivity tends to be balanced out by choice, by the optional quality of these sin taxes. So you do, I think, in the states right now see a lot of people saying, look, we can make a lot of money off of these marijuana taxes if we legalize marijuana and just tax it at a reasonable rate. That's exactly the case they made in the 1930s for alcohol, and it proved quite successful. Now, there was a long tradition of legal alcohol in the U.S., and that doesn't hold true for marijuana, but I think that the real question is the social acceptance there was, and in the 1930s alcohol was still quite widely socially acceptable. And increasingly I think that's the case with marijuana. So I would expect that we're going to see an exact replay here of what happened in the 1930s.
David Stewart: Well, Joe this has been fascinating. Where can listeners find you online?
Joe Thorndike: Well, they can come take a look at the Tax History Project's website, which you can find conveniently at http://www.taxhistory.org.
You can also follow me on Twitter. I'm @jthorndike, just jthorndike, all one word. And I do a little alcohol tax commentary there from time to time.
David Stewart: Excellent. Cheers. Thank you for being here.
Joe Thorndike: My pleasure.
David Stewart: And now, Coming Attractions. Each episode we feature one magazine to give you a preview of what's coming in the next edition. This week's featured magazine is Tax Notes, the leading source of federal tax analysis and commentary. We're joined by Tax Notes editor in chief Ariel Greenblum. Ariel, what can listeners look forward to in the next edition?
Ariel Greenblum: So much! Commentary highlights include a description of how and why special purpose acquisition corporations are used in IPOs, by Victor Hollender of Skadden. In another article, Lee Reams, editor in chief of the CPA reference book, Big Book of Taxes, examines the deduction for home mortgage interest. Then, long live the estate tax! Jay Soled, a professor at Rutgers Business School, explains how the estate tax should be viewed as a way of balancing out the code's favorable treatment of capital. Rounding it out, partnership practitioners will enjoy reading about how the Tax Cuts and Jobs Act altered the rules for some profits interests, written by Blake Rubin, Andrea Macintosh Whiteway, and Maximilian Pakaluk, all of EY. And how Jennifer Ray points out how the TCJA might've made it more beneficial for a partner to contribute capital to a partnership as opposed to making a loan to one.
All that in the April 2nd issue of Tax Notes, as well as our annual April Fools’ humor.
David Stewart: Be sure to check that out, along with all of our great news and commentary on taxnotes.com. That's it for this week. You can follow me on Twitter at @TaxsStew, that's S-T-E-W. If you have any comments, questions, or suggestions for a future episode, you can email us at firstname.lastname@example.org. Be sure to subscribe to us on iTunes or Google Play to make sure you get the next episode of Tax Notes Talk.
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