An American History Lesson for Europe
Our federal government refused to bail out the states in the 1840s, thus preserving their fiscal independence.
By THOMAS J. SARGENT, WSJ Opinion, February 3, 2012
In 1789, the political price for our federal constitution included a bailout
of the 13 indebted states. But it was by refusing to bail out the states a
second time in the 1840s that the United States preserved its federal system,
with substantial fiscal independence for state governments. Facing a similar
moment, Europe might learn from our experience.
The 1789 bailout was part of a grand bargain designed by Alexander Hamilton
to convert the creditors of the 13 states into advocates of a stronger federal
government—one having the ability to raise all revenues required to service the
large debts that the Continental Congress and the 13 states had both accumulated
to finance that "Glorious Cause," our war of independence.
Hamilton actually served as Gen. Washington's chief of staff during the war. |
Hamilton and George Washington wanted those debts to be paid. They had to
engineer institutional changes to achieve that goal. Under our first
constitution, the Articles of Confederation, the continental government had
virtually no power to tax. For revenues it depended on voluntary contributions
from the 13 states.
About two-thirds of our total debts were owed by the continental government,
the other third by the 13 states. If they had been valued at par, federal and
state debts together would have constituted about 40% of gross domestic product.
But because tax revenues were not big enough to service them, both federal and
state debts traded at very deep discounts, deeper than those we see in Europe
today. From the point of view of the creditors of the states and the United
States, if not our taxpayers, there was a fiscal crisis in the 1780s. Fiscal
crises often end in rearrangements of political institutions designed to sort
out which old promises will be broken and which sustained.
Hamilton's Report on Public Credit from 1790 describes the grand bargain and
his reasons for advocating it. The Articles were replaced by the new U.S.
Constitution, which shifted exclusive authority to levy tariffs from the states
to the federal government. In return, the Congress assumed the states' debts in
August 1790. The federal government immediately imposed a tariff, and it used
about half of the ample revenues that soon rolled in to service its debts. State
and federal debts went from trading at deep discounts to par in the early
1790s.
Why did Hamilton and Washington want to honor our debts? Because they wanted
the U.S. government to build a good reputation vis-a-vis its creditors. Hamilton
reasoned that honoring the existing debts would allow the government to borrow
on good terms in the future. That ability to borrow would generate fiscal
flexibility by creating a prospective source of revenues beyond current taxes,
one that might be used to finance surges in government expenditures associated
with wars and other future difficulties and opportunities.
Why did Hamilton and Washington want the federal government to bail out the
13 states? Because they wanted to realign interests in a way that would induce
voters to support a federal government with ample ability to tax.
They thus built a good reputation for the U.S. by creating another,
potentially troublesome, reputation with the states—the perception that the
federal government would bail them out. Although the trade-off was made mainly
for political reasons, one of Hamilton's stated reasons for bailing out the
states was that most of their debts had been incurred for their contributions to
a national public good: acquiring independence from Great Britain. Was that
reason authentic or was it just a convenient cover, a rationalization for
Hamilton's real goal, which was to convert the creditors of the state
governments into advocates of the central government's ability to tax?
Now fast-forward into the next century. To finance canals and railroads, many
state governments incurred large debts in the 1820s and 1830s. A financial
crisis in the late 1830s pushed many of those state debts into default.
Appealing to the precedent set by the 1789 bailout, state creditors asked the
federal government to bail out the states once again. After an enlightening
debate, in the early 1840s Congress declined, so many states repudiated their
debts.
In the aftermath of those repudiations, many states rewrote their
constitutions to require year-by-year balanced budgets, something they had never
done before. As noted, fiscal crises, like the one in Europe today, often
produce political rearrangements—at best peaceful ones like these.
Did the federal government do the right thing in refusing to bail out the
states in the early 1840s? By doing so, the federal government reset its
reputation vis-a-vis the states, telling them in effect not to expect it to
underwrite their profligacy. In the short run, that cost the federal government
substantially in terms of its reputation with its own creditors. Federal credit
abroad suffered along with state credit. But in the long run, the decision
exposed state governments to continuing market discipline, making future crises
and requests for federal bailouts less likely.
If the federal government had chosen to bail out the states a second time, it
probably would have taken greater control over state taxes and revenues in order
to prevent yet another bailout situation. Refusal to bail out the states was
thus a pivot point in sustaining a federal system in the United States. It led
the states to discipline themselves by rearranging their constitutions in ways
designed to allow them to retain freedom and responsibility for taxing and
spending within their borders.
Europeans today might be tempted to say "yes" to bailouts. Or they might also
recall a time when Americans preserved their own federal system by saying
"no."
Mr. Sargent, winner of the 2011 Nobel Prize in economics, is a professor
of economics and business at New York University and a fellow at Chicago
University's Becker Friedman Institute for Research in Economics and at Stanford
University's Hoover Institution.
No comments:
Post a Comment