To understand the financial polices enacted by Republican leaders during the American Civil War, one needs to appreciate the limitations created by the system of fiscal federalism that developed during the antebellum era. Throughout this period in American history, the fiscal powers of the national government remained constrained. State governments had more flexibility in raising revenue and more control over banking policy. The national government sustained itself primarily through import duties. Collecting tariffs emerged as the most efficient and cost-effective means of providing revenue for the central authority. Internal taxes remained the revenue device used primarily by state and local governments; the federal government levied these taxes only in times of war or the threat of war.

Taxing citizens through imports complemented the federalist structure of government. States assumed responsibility for ‘lives, liberties, and property’ of citizens, maintaining control of the laws and activities within their boundaries. Concurrently, the national government depended on indirect taxes on consumption through tariff duties. Since the tax became incorporated into the price of the good, the consumer paid the levy in small increments (through each purchase), and remained insensible of the actual amount contributed to the Treasury. The tax gatherer did not touch citizens individually. Collected through an intermediary, such as a customs officer at a distant port or a merchant, indirect taxes provided steady revenue when trade was good and the economy functioning properly. However, when any economic disruptions occurred and trade slowed, this diminished the revenue stream to the government. In matters of financial policy, this emerged as the governing paradigm of the pre-Civil War era. States, rather than the federal government, held primary responsibility for regulating banks, investing in internal improvements, and collecting taxes from citizens. This became a fundamental challenge in early American finance during recessions or wars.

This system reflected the vision of government James Madison articulated at the Philadelphia Constitutional Convention. During the proceedings, Madison told the delegates that the national government needed ‘vast’ powers within its sphere; however this authority would not be exercised on the citizens of the country ‘individually’.