America's Fiscal Constitution (6 page)

Washington’s election as president was a foregone conclusion. Each state chose electors to cast their ballots for the nation’s first chief executive, and even those electors who had opposed the Constitution cast their votes for the American most responsible for securing their independence from Great Britain. Madison ran for a seat in the House of Representatives, and the ultimate outcome of that election was less clear, as some Virginians had recruited Madison’s neighbor Monroe to run against him. That winter of 1788 the two candidates traveled together frequently on a campaign trail that then, as now, exacted a heavy toll on candidates. One night, on the long ride home after a debate at a small Lutheran church, Madison’s nose became permanently scarred from frostbite. Madison ultimately won by a margin of three hundred votes after a campaign dominated by two issues—taxes and religion—that would become familiar sources of discord in American politics. That election result surely altered US history. Monroe had natural leadership skills, but he lacked Madison’s ability to craft legislation, which was vital for securing passage of the Bill of Rights and various laws organizing the government.

Federal leaders such as Washington and Madison were well aware that every action by the new federal government might establish a precedent. The Constitution itself sketched the federal government in broad strokes, including only essential principles and allowing operating procedures to be filled in later. Even the very first minutes of Washington’s administration established an enduring tradition, in the form of an inaugural address that the president drafted with Madison’s help.

The Constitution made the debt of the Confederation “valid against the United States.” That debt’s size—more than $54 million—was enormous in relation to the scale of a national economy consisting of only four hundred thousand free households, whose principal source of wealth was land.
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The debt was equivalent to the value of over a hundred acres of prime land per family. Total debt far exceeded the value of several millions of dollars of foreign coins circulating as currency. Even citizens considered wealthy by virtue of large land holdings, like George Washington, had little cash. He had to borrow money at 6 percent interest to pay for the cost of his travel to the inauguration. The burden of debt before 1800, measured as a share of national income, would be greater than at any time before national income collapsed at the depths of the Great Depression in 1933.

When Congress first convened, in March 1789, Madison introduced a tax bill he drafted with help from Hamilton. Madison quickly became
the de facto leader of the House of Representatives. Representative Fisher Ames of Massachusetts, who would later become an opponent of the Virginia congressman, offered this description of Madison during the first session of Congress: “He is possessed of a sound judgment, which perceives truth with great clearness, and can trace it through the maze of debate. . . . He is a studious man, devoted to public business, and a thorough master of almost every public question that can arise.”
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On July 4, 1789, the thirteenth anniversary of publication of the Declaration of Independence, Congress passed legislation that taxed imports at 5 percent of their value, with discounts for goods arriving on American vessels. Various luxury items such as lace, carriages, playing cards, and liquors were taxed at higher rates.
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In the early years, these taxes produced enough revenue to pay annual interest but were insufficient to retire principal on outstanding debt.

Madison then managed the passage of a bill creating the Department of the Treasury, despite objections from members of Congress who feared the potential concentration of power in its secretary. Washington’s close friend Robert Morris declined that job and recommended that the president offer the post to Hamilton, who had served as the general’s chief of staff during the Revolution. Madison also believed that Hamilton was best suited for “that species of business.”
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Secretary of the Treasury Hamilton promptly borrowed $50,000 from a bank to pay the federal government’s expenses, including the salaries of the president and members of Congress.

Hamilton faced an enormous task. He would have to calculate the amount of the debt, develop systems for accounting and tax collection, and estimate the level of projected tax revenues. The federal government would have difficulty paying its bills until it had an organization capable of collecting the new import taxes when ships pulled into harbors.

Meanwhile, Madison fulfilled a promise to his constituents and various states when he shepherded through Congress twelve constitutional amendments, ten of which were approved by states and became known as the Bill of Rights. The task took patience, since congressmen who had opposed ratification pressed for more extensive revisions, while strong supporters of ratification saw no need to solve theoretical problems. After passage of the Bill of Rights, Madison believed he had completed, at least for awhile, his labors on the language and structure of the Constitution that he had begun three years earlier with the assistance of books sent from Paris by his
friend Thomas Jefferson. Madison was ready to get on with the practical business of governance. Jefferson, still serving as the country’s minister to France, was not yet satisfied with the Constitution. He pressed Madison to consider another constitutional amendment imposing a limit on federal debt.

Jefferson had focused on the question of public debt when the National Assembly in France debated a plan to deal with the nation’s enormous debts. Some of those debts had resulted from financial support of the American Revolution, which former French finance minister Anne-Robert-Jacques Turgot had unsuccessfully argued France could not afford.

According to Jefferson, some French leaders he consulted treated the US Constitution “like . . . the bible, open to explanation but not to question.”
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Yet Jefferson did question the document’s lack of an explicit limitation on debt. The French monarchy had accumulated large debts, and Jefferson hoped that his nation would not impose similar mortgages on future generations. Throughout his adult life, Jefferson had opposed laws that allowed one generation of free citizens to restrict the freedom of the next, such as the British laws of entail (limiting rights to inherit land to a defined category of descendants, e.g., eldest male heirs) and mortmain (vesting permanent, nontransferable rights in land to a church or corporation). In 1776, he had helped abolish entail in Virginia and viewed independence from Great Britain as an opportunity to rid the New World of feudal legal doctrines.
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Jefferson preferred to write rather than make speeches, as he found it easier to organize his thoughts on paper and desired to conceal a slight lisp. He expressed concerns about federal debt financing in an essay he wrote to Madison, a fellow Virginia planter, in September 1789. Jefferson acknowledged that existing debts would have to be paid as a matter of honor. “But with respect to future debts,” he wrote, “would it not be wise and just for [a] nation to declare, in the constitution they are forming, that neither the legislature, nor the nation itself, can validly contract more debt than they may pay within their own age, or within the term of 19 years?” Jefferson illustrated his point with the hypothetical example of a king who borrowed from foreign bankers an amount equal to the annual income of the kingdom’s economy and then sought favor by distributing the borrowed money to his subjects. If that king allowed interest at 5 percent to compound rather than be paid each year from tax collections, Jefferson
calculated that after nineteen years the debt would be 2.5414 times the amount originally borrowed. He considered placing that type of burden on the next generation “an act of force, and not of right.”
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Jefferson also noted that limits on debt might help place a leash on “the Dog of war.”
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Like Scotch economist Adam Smith, Jefferson believed that financing a war with debt rather than taxes might disguise the war’s true cost. He concluded his letter by asking Madison to consider how to craft a constitutional limitation of debt.

Madison sympathized with his friend’s goal but had doubts about the use of a constitutional amendment to accomplish it. Debt may be needed for some purposes—like the Revolutionary War itself—that could benefit “posterity.” Furthermore, he cautioned that any principles used to limit debt should be grounded in practical experience rather than theory. Madison placed great faith in the lessons of historical experience and had explained in a Federalist essay that “experience is the oracle of truth.”
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He agreed with the notion that “the living generation” should not impose “unjust or unnecessary burdens on their successors.” He suggested that this truth, based in “Philosophy,” required principles grounded in practical experience in order to be “visible to the naked eye of the ordinary politician.”
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Nonetheless, Jefferson’s warning about the risks of debt, expressed during the Republic’s first year, continued to weigh on Madison. In an essay a few years later, Madison concluded that each generation should pay “its own debts” and that government should be financed with “more palpable” taxation rather than the more “imperceptible mode” of debt. Madison’s essay attempted to distill the proper limits on debt in the form of a Socratic dialogue with a “republican philosopher.” In response to the potential objection that “the benefits of war descend to succeeding generations, and the burdens ought also to descend,” Madison’s philosopher responded that it was better to sacrifice reasonable exceptions to the rule against borrowing than to open the door for “converting exceptions into general rules.”
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Joseph Jones, a member of the Continental Congress and James Monroe’s uncle, used plainer language when counseling Madison on the appropriate budget principle: “Pay as you go is the best policy. The next best is to settle and pay as soon as you can [so] that the interest may not gradually devour the capital.”
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Shortly after Jefferson returned from France to begin serving as Washington’s secretary of state, Treasury Secretary Hamilton gave a report to Congress on the nation’s credit. This report, which contained many practical details, also included Hamilton’s articulation of a principle for avoiding “dangerous abuse” of debt. He posited that it ought to be “a fundamental maxim, in the system of public credit of the United States, that the creation of debt should always be accompanied by the means of extinguishment and principal payments on the debt.”
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In short, Hamilton believed that taxes should always be high enough and spending low enough to allow taxes, rather than additional borrowing, to service both interest and principal payments on debt. Jefferson and Madison had no quarrel with that concept. They were alarmed, however, by one of Hamilton’s specific recommendations: the creation of a national bank.

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Hamilton and Madison had reached an impasse in early 1790 over two issues referred to by Jefferson as “the most irritating questions that ever can be raised . . . funding of the public debt, and . . . fixing on a more central residence [for the federal government].”
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Federal funding of the debts incurred by state governments during the Revolution generated the greatest controversy. Hamilton initially estimated that those debts totaled $25 million.
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The Constitution only obligated the nation to assume the debts of the Continental Congress. Massachusetts adamantly insisted on the federal assumption of debts incurred in the fight for independence; its delegates had ratified the Constitution by a narrow margin, and now the state feared being shortchanged if it remained liable for debt after the Constitution removed its ability to tax imports into its busy Boston port. Its citizens had already rebelled against attempts to retire state war debts with property taxes. Other states, in contrast, worried that federal assumption of state debts would force them to pay more than their fair share.

Apprehensions were heightened by complex accounting.
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Some states contributed financially to the Revolution principally by sending funds to the Continental Congress, while others had borrowed money to pay directly for their militias. Several states, including Virginia, had already repaid their war debts and, along with North Carolina, strongly resisted
the idea of imposing a new federal tax on landowning citizens who had little cash.

Madison surprised Hamilton by abandoning his earlier belief that “justice” required a common responsibility for state debts during the Revolution.
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Madison worried that “an increase of the federal debt” would “prolong the evil” of the debt itself.
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He also objected to paying the full face amount of debt to speculators who had purchased debts at a discount. This concern was not hypothetical, since Madison learned that James Reynolds, an agent for a New York bond dealer, had obtained the Treasury’s confidential list of debts owed to veterans and used that knowledge to buy their claims at a deep discount. Madison brought that fact to Hamilton’s attention, and Hamilton agreed to make public the lists of creditors. (A year later, the unscrupulous Reynolds arranged for his wife to have an affair with Hamilton and then tried to blackmail him.)

Hamilton believed, as Madison once had, that each state incurred Revolutionary War debts for a common benefit and that it was impractical to adjust the payments due to each bondholder based on the price paid for the bond. More significantly, some leaders in Massachusetts threatened to impede the collection of federal import taxes without a commitment from the federal government to pay their state’s war debts. Even before the Constitutional Convention Madison recognized that a state’s refusal to allow collection of federal taxes—which could lead to federal military action against the state—subverted the very rationale of the Union.
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