FEDERAL-STATE FINANCIAL RELATIONS, 1790-1860*

BY PAUL B. TRESCOTT**

Financial relationships between the Federal Government and the States were a critical matter in the founding and early operations of the Federal Government under the Constitution, with the settlement of the Revolutionary War debt the object of chief concern. When the debt was ultimately secured, other matters arose to keep funds passing from one level of government to another. Some of these were of major political importance, while others involving substantial sums made little political impact, being less controversial. The purpose of this paper is to provide a systematic review of the areas of Federal-State financial contact from 1790 to 1860 and to provide more details on some lesser known areas that are of more than technical interest. Table I lists the various programs that involved transfers of cash or securities between Federal and State governments during this period, with the dates and the sums involved.

TABLE I.-Federal-State financial transactions, 1790-1860

The debt program adopted by Congress in 1790 under Hamilton's influence consisted of three parts, each of which intimately concerned Federal-State relations. Federal assumption of the States' debts was

*Reprinted from The Journal of Economic History, Vol. XV, September 1955, No. 3.

**Kenyon College.

the most controversial part of the debt program. The Funding Act authorized the Federal government to receive certificates of State warincurred debts and to issue Federal securities in exchange. For every $30 (face value) of securities turned in (counting both principal and arrears of interest), the United States was to issue $40 of 6 percent stock, $30 of 3 percent stock, and $20 of stock bearing no interest until 1501, then 6 percent thereafter. No dates were fixed for redemption. A total of $21.5 million of State debts were authorized for assumption, and a quota was assigned to each State. But not all the quotas were filled, so the total assumed was only $18.3 million. Effects of this on individual States are shown in table 2.

Total debt outstanding equals Hamilton's estimate of September 1791 plus debt previously assumed. Det remaining after assumption estimated by taking amount Hamilton estimated outstanding in Septemberel and subtracting debts subsequently assumed.

Figures in parentheses are uncertain.

*Upper column exceeds lower by amount of interest credited.

*C=creditor; D=debtor.

Sources Ratchford, "American State Debts," pp. 60, 63; data on Continental securities funded obtained from sources listed for table 3.

The second important part of the Funding Act provided for the funding of securities issued by the Confederation into new Federal issues. State governments had acquired about $9 million of the $27.5 million (principal) of Confederation debt outstanding in 1789.1 The law provided that for every $90 worth of principal turned in, there should be issued $60 worth of 6 percent stock and $30 of deferred (bearing interest after 1801.) Arrears of interest were funded into 3 percent stock. State governments received a total of about $6 million from this provision, representing $3.5 million principal and $2.6 million arrears of interest, distributed as shown by table 2.2

The third part of the funding program was the settlement of accounts between the States and the National Government, completed in 1793. This was intended to equalize the per capita burden of war expenditures among the States. Each State was credited with sums it spent for the war or related purposes and debited for sums received from the National Government, including debts assuming under the funding program. Each State's net contribution was compared to a quota based on population. The final accounting showed that seven States had contributed more and six less than their quotas. A total of $3.5 million was due from the latter group to the former. In 1794 the Federal Government issued this amount of securities to the creditor States, two-thirds in current 6 percent stock, one-third in deferred stock, plus $0.7 million of accrued interest in 3 percent stock, as shown in table 2. The settlement failed of complete equalization because of the failure of the debtor States to pay up the amount of their deficiency.3

Table 2 summarizes the effects of the funding program on the individual States. The column headed "Net Position" shows the difference between each State's initial debt and the total Federal "aid" it received. For all States combined, Federal aid exceeded initial indebtedness. But the distribution varied widely. Massachusetts and South Carolina, which had the biggest debts to start with, received the most aid but still ended up debtors. Virginia, North Carolina, and Georgia were also substantially net debtors in the end. On the other hand, New York and Pennsylvania emerged with large creditor positions, reflecting their large holdings of Continental securities. The fact that New York's net gain was just about equal to its large unpaid balance due under the

1 Pennsylvania, New York, and Maryland had funded the Continental certificates held by their citizens, issuing State certificates in exchange, and had also accepted Continental securities in payment for lands. They acquired $6.1 million, $2.3 million, and $650,000 respectively. Several other States had acquired lesser amounts in similar fashion. See E. James Ferguson. "State Assumption of the Federal Debt During the Confederation," Mississippi Valley Historical Review, XXXVIII (1951), 416-422.

2 Pennsylvania and New York did not fund all their large holdings, but returned some to the previous owners who funded them.

3 See B. U. Ratchford, American State Debts (Durham: Duke University Press, 1941), pp. 62-66, for subsequent developments: American State Papers: Finance, I, 26, 479, for discussion. A detailed account of the settlement is given in an unpublished doctoral dissertation by Whitney K. Bates, "The Assumption of State Debts" (University of Wisconsin, 1951), pp. 62, 193-231.

settlement of accounts caused considerable criticism. Maryland, New Hampshire, and Connecticut also enjoyed comfortable creditor positions.

In some States, holders of eligible State securities were reluctant to turn them in. The terms of exchange were not particularly favorable for every $90 worth of State securities turned in, the creditor received Federal securities worth about $72 in the market. Consequently, several of the States took steps to improve the terms of exchange for their former creditors. Maryland, Pennsylvania, and New York used for this purpose the securities they received from funding Continental certificates.5

Many States were also enabled to deal more generously with their remaining creditors. Pennsylvania, Connecticut, and Maryland redeemed all the State debt they could find either by exchange for U.S. securities or with cash obtained by selling some of their holdings. Rhode Island reduced its debt from $0.5 million to $0.1 million in the

same manner.

Four States did not deal so favorably with their remaining creditors. South Carolina and Massachusetts held on to their Federal securities, using the income from them to service their substantial remaining debts, but redemptions of the latter were made only at figures well below par. North Carolina and Georgia also preferred to retain their smaller holdings of U.S. securities and to continue redeeming their debts below par.

The most controversial aspect of Hamilton's debt program was the large benefits allegedly reaped by speculators-especially by the assumption of State debts. Many States' securities sold in the open market for 10 percent of their face value or less at the time the Funding Act was being debated. This furnished considerable scope for speculative gains. To be sure, Federal assumption did not provide the speculator with the face value of his securities in cash.10 Even so, some securities rose as much as sixfold in value.

Hugh H. Hanna, Financial History of Maryland (Baltimore: The Johns Hopkins Press, 1907), pp. 28-31.

Maryland gave her former creditors current United States 6 percent stock in exchange for the deferred and 3 percent stocks they received.--Ibid. New York gave current 6 percent stock for deferred-Don C. Sowers, Financial History of New York State (New York: Columbia University Press, 1914), pp. 254-257. Pennsylvania issued additional stock to former creditors to cover the depreciation of their claims resulting from the deferred and 3 percent stocks. About $360,000 was issued.-Raymond Walters, Jr., "The Making of a Financier: Albert Gallatin in the Pennsylvania Assembly," Pennsylvania Magazine of History and Biography, LXX (1946), 261-266; reports of the state treasurer appended to Journal of the Pennsylvania State Senate, 1791-1796.

Acts and Resolves of the Rhode Island General Assembly, February 1797, pp. 25-26. Ratchford, American State Debts, pp. 69-70; Charles J. Bullock, Historical Sketch of the Finances and Financial Policy of Massachusetts ("Publications of the American Economic Association," VIII, No. 2, 1907), pp. 20-25.

Ratchford, American State Debts, p. 68.

• See quotations in Nathan Schachner, The Founding Fathers (New York: G. P. Putnam's Sons, 1954), p. 120.

The Federal securities received in exchange for $100 of State securities would have sold in the open market for about $67 in December 1790 and $80 in July 1791. See prices in Jeph S. Davis, Essays in the Earlier History of American Corporations (Cambridge: Harvard University Press, 1917), II, 340.

However, one cannot attribute all of this to Federal assumption, for much of it would have occurred anyway. Low security prices prior to 1790 reflected in part the general economic depression and monetary stringency of the times and the use of paper money by the States for debt service. These causes of depreciation would have been ameliorated after 1790. Furthermore, some of the States would have dealt generously with creditors if no Federal assumption had occurred.12 So not all the rise in security values can be attributed to Federal assumption of the State debts.

Shedding most of their debt burden enabled the States to reduce taxes-but this principally took the form of the shift of the tariff from State to Federal jurisdiction. Some States did reduce internal taxes about this time-New York, Maryland, and Pennsylvania all ceased to levy general property taxes and Virginia and Massachusetts reduced theirs. Pennsylvania and Massachusetts also lowered excise taxes, but this was associated with imposition of similar taxes by the Federal Government.13

However, Hamilton's program furnished many of the States with a substantial source of revenue from the Federal securities which they received in the funding and settlement operations. States held as much as $7.5 million of the Federal debt-about 10 percent of the total-in the 1790's. Income from this source made up nearly one-fifth of total State revenue in 1795-1800, averaging about $225,000 a year-this not counting redemption installments. Table 3 shows the distribution of State holdings for selected years prior to 1834, when all were redeemed. Figures include subsequent open-market purchases by Pennsylvania, Maryland, New Jersey, and others.

11 See Allan Nevins, The American States During and After the Revolution (New York: The Macmillan Co., 1924), pp. 519-522, 534; Merrill Jensen, The New Nation (New York: Alfred A. Knopf, 1950), pp. 319-321; Ferguson, "State Assumption of the Federal Debt pp. 416-419, 421-423.

13 See Albert Gallatin, Sketch of the Finances [1796] in Writings, ed. Henry Adams (Philadelphia, 1879), III, 131. Judging from pre-1789 experience, Massachusetts, Rhode Island, North and South Carolina, and possibly Georgia would have had difficulty with their debts in the absence of Federal assumption. But, of these, all except North Carolina would have been helped by the settlement of accounts. See Ratchford, American State Debts, pp. 42-59; Jensen, The New Nation, pp. 308–309; Bates, "Assumption of State Debts," p. 31.

13 See American State Papers: Finance, I, 425, 427, 431: Bullock, Finance of Massachusetts, pp. 19, 138; Leland D. Baldwin, Whiskey Rebels (Pittsburgh: University of Pittsburgh Press, 1939), p. 78; W. F. Dodd, "The Effect of the Adoption of the Constitution Upon the Finances of Virginia," Virginia Historical Magazine, X, No. 4 (1903), 368.