America's Fiscal Constitution (20 page)

At the war’s conclusion Congress resolved—with only one dissenting vote—that “the public debt created during the late rebellion was contracted upon the faith and honor of the Nation; that it is sacred and inviolate, and must and ought to be paid, principal and interest.”
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In explaining his determination to pay down the debt, President Lincoln’s last treasury secretary, former Indiana banker Hugh McCulloch, evoked the American Fiscal Tradition’s most powerful, underlying value: “As all true men desire to leave to their heirs unencumbered estates, so should it be the ambition of the people of the United States to relieve their descendants of this national mortgage.” Anticipating the argument that the debt was too high to pay off within a generation and that “future generations [should] be asked to share the burden,” McCulloch observed that “wars are not at an end, and posterity will have enough to do to take care of the debts of their own creation.”
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The emergence of the Republican Party marked the advent of a stable two-party system that soon became embedded in the nation’s unwritten constitution. That system would be incorporated in a variety of practices and laws that governed primary elections, campaign financing, and the organization of the legislative branches of state governments. The Civil War itself interrupted the evolution of a Republican consensus concerning the proper size and scope of the federal government. However, two decisions made by Republican leaders during the war—on railroad subsidies and political activities by federal employees—would shape the party’s attitude toward the breadth of federal activities until the 1920s.

The Republican platforms of 1856 and 1860 had promised to expand economic opportunity by providing federal aid for railroad construction. Since the war absorbed all tax revenues, Congress subsidized rail lines with exclusive licenses and grants of public lands to corporations that committed to raise private dollars to build them. The Pacific Railway Act of 1862 also authorized loans to build the intercontinental Union Pacific line. Agents for railroad promoters in Washington pressed members of Congress to obtain more land and loan guarantees. In meetings in the lobbies of the Capitol and nearby hotels, this outpouring of “lobbyists” gave cash, stock, and campaign contributions to members of Congress they referred to as “friends.”
Congress granted to railroads the rights to over 130 million Western acres, a total area about the size of Ohio, Illinois, New York, and Michigan combined. The Union Pacific’s linking of the East and West Coasts, completed in 1869, opened the country’s vast interior for settlement. The warm relationship between politicians and rail owners marked the beginning of a new era of greater influence of corporate money on federal politics.

Public land grants also served as a means of “off balance sheet” financing for other wartime domestic initiatives. Ultimately seventy million acres would be granted to homesteaders while seventeen million helped sustain state colleges.
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Though today some Republicans question the federal government’s role in education or support of home ownership, the party’s founders viewed support for expanded opportunity as consistent with their values of “free soil, free men.”

The Republican campaign in 1864 planted another seed that would later blossom into both corruption and support for a larger federal government. Until General William T. Sherman’s capture of Atlanta in September 1864, the outcome of the presidential election was uncertain. Lincoln ran as a “National Union” candidate rather than as a Republican in hopes of wooing support from pro-war Democrats. His running mate, Andrew Johnson of Tennessee, was an old-school Jacksonian Democrat. Lincoln’s bipartisan campaign required Republican candidates down ballot to scramble to put together their own state organizations capable of competing with the established structure of the Democratic Party.

Senator Zachariah Chandler of Michigan, a gruff pragmatist, took charge of the Republican congressional campaign. For the next dozen years, Chandler effectively divided up campaign assignments among party members. At the time most of the Republican Party’s natural leaders labored as soldiers or civilians in public office. Many held jobs that depended on appointments by their patrons in Congress. Chandler directed members of Congress to assign fundraising and get-out-the-vote goals to federal employees. After Lincoln’s death, Congress stripped President Andrew Johnson of much his executive authority and exercised even more control over federal employees. Incumbent Republican leaders began to identify their party with the federal government that employed much of the rank-and-file party organization.

Military veterans emerged as a major new force in the Republican politics after the war. They favored the presidential nomination of a former Democrat with no political experience, General Ulysses Grant. He won
the popular vote in 1868 by a surprisingly small margin. Senator Sherman naively hoped “that our candidate Grant should be so independent of party politics as to be a guarantee of peace and quiet.”
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As a field commander Grant quickly assimilated information and issued clear orders, a style of leadership not suited for the White House. In September 1869 congressional leaders and members of Grant’s cabinet were startled to learn that the president’s personal secretary had negotiated—with the help of cash and federal gunboats—a treaty to annex the Dominican Republic. Congress refused to go along with this plan, and afterwards, Grant gave more control over federal appointments to key senators in return for their cooperation with other White House initiatives. Senators Simon Cameron of Pennsylvania and Roscoe Conkling of New York, among others, exploited this system to build their own powerful political machines. Many of the late president Lincoln’s friends and cabinet secretaries began drifting to the minority Liberal Republican faction or the Democratic Party.

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EBT

While some Republicans worked to reconstruct Confederate states, John Sherman and Justin Morrill were more concerned with the reconstruction of precarious federal finances. They easily rebuffed President Johnson’s idea that enormous debt could not be paid in full and that the interest paid each year should “be applied to the reduction of the principal in semi-annual installments”—in effect defaulting on at least part of the principal.
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To no one’s surprise, the Fourteenth Amendment to the Constitution voided obligations to repay Confederate debt. That amendment also sought to reassure creditors that the “validity of the public debt . . . shall not be questioned.”

Congressional leaders in each party also resolved to reduce debt using tax revenues rather than perpetually rolling it over, as would become the practice in the twenty-first century. In his annual report to Congress in 1865, Treasury Secretary McCulloch forcefully asserted the advantage of retiring debt while taxpayers remembered clearly why it had been incurred: “The people of the United States will never be so willing to be taxed for the purpose of reducing the debt as at the present time. . . . Now, it is regarded by a large majority of taxpayers as a . . . sacred debt.”
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A member of the
British embassy in Washington reported with admiration that “the majority of Americans would appear disposed to endure any amount of sacrifice rather than bequeath a portion of their debt to future generations.”
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John Sherman, chairman of the Senate Finance Committee, and Justin Morrill, chairman of the House Republican Caucus and the Ways and Means Committee, shared those sentiments. They also understood reducing the debt required a careful balance between monetary and fiscal policy. In general, monetary policy concerns the regulation of credit markets and currency, while fiscal policy refers to the level and nature of spending and revenues. (The term “fiscal policy” was used sparingly to refer to federal budgets until the 1940s.) In order to reduce debt, Sherman, Morrill, and their allies sought to lower interest rates in order to free more tax revenues for principal reduction and to promote the long-term economic growth on which debt reduction depended. Creditors might refinance Civil War debt at lower rates of interest if they felt the Treasury would make timely payments for debt service using dollars that had retained their purchasing power. The alternative of higher interest rates—and the corresponding decline in the value of outstanding bonds—posed a threat to the nation’s banking and credit system that held federal debt as its principal reserve.

Since the Treasury lacked large gold reserves, an immediate return to the gold standard was impractical. An eventual return, however, was more than an ideological obsession. Since early in the war people struggled to cope with a dual set of pricing for many goods: a gold dollar could purchase more than a greenback dollar. In addition, international trade required credit that could be converted to gold at fixed rates for various currencies. A firm deadline for returning to the gold standard might stabilize prices; that deadline had to be soon enough to comfort bondholders and late enough to allow the Treasury to accumulate gold reserves.

Secretary of the Treasury Hugh McCulloch unintentionally jeopardized an orderly restoration of the gold standard when he tried to rapidly eliminate the greenbacks issued in 1862 and 1863. In 1866 Congress authorized the Treasury to exchange new interest-bearing Treasury debt for paper money. Sherman was able to repeal that measure by arguing that some amount of paper money was needed to sustain commercial activity and avoid deflation. Furthermore, currency—which did not bear interest—encumbered federal tax revenue less than interest-bearing bonds.

In 1867 to 1869 Secretary McCulloch refinanced Civil War bonds at lower interest rates based on a promise of payment in gold.
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McCulloch
noted that the United States needed to bring down its trade deficit through productivity growth and steadily retire its debt through an estimated annual debt service of $200 million a year over three decades.
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Several corrupt Wall Street speculators tried to force the Treasury to hoard excessive amounts of gold in the postwar period. Financier Jay Gould, President Grant’s brother-in-law Abel Corbin, and a senior Treasury official were part of a group that attempted to corner the gold market in 1869. Grant ordered the Treasury to sell gold and squeeze the speculators once he discovered their scheme.

Congress slowly dismantled wartime levels of internal taxation but retained taxes high enough to service the debt.
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When taxes on whiskey fell from $2 per gallon to 50 cents per gallon, revenues skyrocketed from $18 million to $55 million in two years, a stark reminder that excessive taxation can lead to tax evasion.
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In 1870 Sherman fought hard to retain the personal income tax, arguing that it broadened the federal tax base and provided a source of revenues for retiring the debt. That year, when the Senate voted to allow the income tax to expire, Sherman forced consideration of a bill to offset the loss of income tax revenues by raising taxes on sugar and the gross receipts of businesses. In response, the Senate reversed its position and agreed to extend the income tax—though at lower rates—until 1872. The majority of senators were not swayed by Sherman’s early Republican idealism, which led him to argue that Congress should “retain the income tax on all incomes above one thousand dollars . . . and then throw off these taxes on consumption that oppress the poor.”
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Justin Morrill’s system of import taxes remained largely intact after the war. Frank Taussig, the preeminent historian of import taxation, noted that if immediately after the war “the question had been put to almost any public man, whether the tariff system of the war was to be continued, the answer would certainly have been in the negative, that in due time the import duties were to be lowered.” Nonetheless, wartime levels of import fees persisted because “the country [had] adapted itself more closely to the tariff as it was.”
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Congress did not, however, extend high taxation to growing new categories of imported goods, which kept import tax revenues at a fairly steady level in the decades following the war, even though the size of the economy and the value of imports rose steadily. Textiles and sugar, the two workhorses of federal import tax revenues, declined as a share of all imports.

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URRENCY

Many Americans blamed the long recession following the Panic of 1873 on the collapse in the market value of railroad stocks and bonds.
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Investors had speculated on the economic potential of railroads, even though railroad income did not keep up with railroad investment, in a manner similar to the Internet bubble in the late 1990s. Jay Cooke’s business collapsed when the Northern Pacific Railroad defaulted on bond payments in 1873. Cooke blamed the downturn on the federal government’s tight money policies, while many Americans blamed Cooke and Wall Street. Banks failed and credit contracted—first in the United States and then in Europe.
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The federal government balanced its budget throughout the downturn despite the heavy burden of interest payments. In 1874, for example, the federal government collected $163.1 million in import duties, $102.2 million in sales taxes, and $39.4 million in other taxes and proceeds from public land sales.
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It used those revenues to pay for $107 million in interest on the debt, $73 million in military expenses, $29 million in military pensions, and $93 million for everything else.
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Often commentators on the post-2000 debt crisis treat formula-based “entitlement” expenses as a recent innovation, but in the era following the Civil War—as during much of the nation’s history—most federal spending consisted of interest payments fixed by contract, military salaries, and pensions for veterans set by statute.