Taxes and Prohibition of alcohol were related. But ironically, so were taxes and Repeal. Here’s what happened.

I. Background

There were two major sources of federal government revenue for much of U.S. history. One was customs duties on imported products. The other was taxes on alcoholic beverages. About 30 to 40% of the government’s revenue came from alcohol taxes.

This created a serious problem for temperance advocates. Prohibiting  alcoholic beverages would abolish a major source of tax money. Obviously, this was a very powerful argument against National Prohibition.

Nevertheless, nine states had created state-wide prohibition by 1913. And 31 others had local option. Therefore, many counties across the country had their own prohibition. Consequently by that time half the country was dry (under prohibition).¹

Prohibition caused a major drop in federal taxes from alcohol. So the feds then looked for other sources of revenue. Then they found one in 1914 with a federal income tax. And this was a popular solution because the tax effected only a very, very small number of people. In fact, having to pay the tax was a status symbol about which people were often proud.

II. Income Taxes and Prohibition

The income tax enabled the passage of National Prohibition. So the 18th Amendment prohibited the production, importation, or sale of alcoholic beverages. Thus the income tax replaced the lost revenue. And National Prohibition lasted from 1920 through 1933.

The money from the income tax helped the federal government operate during the prosperous 1920s. However, the country went into a severe economic depression after the stock market crash in 1929. Therefore, revenue from the income tax fell. On the other hand, government spending increased. As a result, “Prohibition cost the federal government $11 billion in lost tax revenue. And it cost over $300 million to enforce.”²

By then, ordinary workers were having to pay income taxes. Consequently, labor unions then opposed income taxes. So did many other groups and people. Therefore, they called for another source of tax revenue. Obviously a solution was to tax alcohol. Thus the head of the Democratic National Committee promoted Repeal. And he said it might create alcohol tax revenues high enough to eliminate the need for the federal income tax.³

III. Taxes and Repeal

But producing and selling alcoholic beverages was now illegal. National Prohibition had destroyed the fifth largest industry in the U.S. Illegal production and sale of alcohol had filled the void created by Prohibition. Obviously, moonshiners, bootleggers and gangsters didn’t pay taxes on their illegal alcohol. For example, Al Capone made $60,000,000 in one year.⁴ And it escaped taxes.

In turn, that led to the next logical conclusion. Simply legalize and tax the production and sale of alcohol. Of course, that paved the way to Repeal in 1933.

So that’s how taxes and Prohibition and Repeal were closely connected. Just follow the money. Now you know the story. Remember it next April 15th!

IV. Alcohol Taxes Today

Taxes on distilled spirits are very high today. They account for over half the retail price of a typical bottle of spirits. That is why it’s illegal to distill your own spirits. However, people may brew their own beer and make their own wine. That is because the taxes on beer and wine are much lower.

Thus the very high taxes on spirits is why it’s still profitable to distill and sell them illegally. So reducing the taxes would reduce illegal production. In turn, that could lead to an increase in actual tax revenues.

Reducing taxes to increase revenues can be an effective strategy. For example, Canada had a very tax on cigarettes. And the result was predictable. People counterfeited cigarette tax stamps. They also illegally imported cigarettes. And they did this on a massive scale. Then Canada then reduced the cigarette tax. After the tax was reduced, the total tax revenue exceeded the revenue under the higher tax.

In addition to raising total revenue, there’s another important reason to reduce taxes on spirits. That is, illegally produced spirits (moonshine) often has high lead toxin levels. As a result, these can cause paralysis, seizures, blindness, and even death.

In one recent study, investigators examined moonshine made at 48 different stills.  Over half the samples contained dangerously high lead levels.⁵ So this is a very serious problem. At a result, drinking moonshine causes about 80% of all adult lead poisoning deaths in the U.S.

Increasing revenue and saving lives (and preventing paralysis, seizures, and blindness) would be a win-win situation.

V. Resources on Taxes and Prohibition

Readings

Brown, L. Economics of Prohibition. Boston: Everett, 1916.

Carradine, R. Taxed to Death in Alabama as a Result of [State] Prohibition. NY: U.S. Brewers’ Assn, 1909.

Fernald, J. Economics of Prohibition. Memphis, TN: Rarebooksclub, 2012.

Fisher, I. Economic Benefits of Prohibition. Westerville, OH: Am Issue, 1926.

Gebhart, J. Cost of Prohibition and Your Income Tax. Wash: Assn Against Prohib Amend, 1929.

_______. Does Prohibition Pay? Wash: Assn Against Prohib Amend, 1930.

Miller, H. An Economist Looks at Prohibition. Westerville, OH: Am Issue, 1930.

Thornton, M. The Economics of Prohibition. Salt Lake City: U Utah Press, 1991.

Tillitt, M. The Price of Prohibition. NY: Harcourt, 1932.

Virginia Assn for Local Self-Govt. Your Tax Burdens will be Made Heavier by State-wide Prohibition. Richmond: The Assn, 1914.

Warburton, C. The Economic Results of Prohibition. NY: Columbia U Press, 1932. (Repub 2015)

Weise, C. The Political Economy of Prohibition and Repeal. M.S, thesis, Auburn U., 1998.

References

1  McGrew, J. History of Alcohol Prohibition. Schaeffer Drug Lib.

2  Lerner, M. Prohibition. PBS.

3  Granger, G. Economic Effects of Prohibition Repeal. Wash: CQ Press, 1931.

4  Schlaadt, R. Alcohol Use and Abuse. Guilford, CT: Dushkin, 1992, p.16. Also Fite, G. and Reese, J. Economic History of the US. Boston: Houghton Mifflin, 1959, p. 579.

5  Tsai, M. Why is moonshine against the law? Slate website, Oct. 18, 2007.