Section A: HISTORICAL SURVEY THE FISCAL IMPACT OF FEDERALISM IN THE BY JAMES A. MAXWELL PROLOGUE In contemplating the causes which may disturb our union it occurs as matter of serious concern that any ground should have been furnished for characterizing parties by geographical discriminations— Northern, Southern, Atlantic and Western-whence designing men may endeavor to excite a belief that there is a real difference of local interests and views. . . You cannot shield yourselves too much against the jealousies and heart-burnings which spring from these. Washington's Farewell Address. When the American colonies broke with Great Britain they were not ready for a strong federal union. Their population, scattered over a vast area, was not homogeneous in economic interests, political institutions, or religion. Within regions, as distinct from colonies, there was indeed, more cohesion. The Southern colonies were bound together by slavery and by the importance in their economic life of tobacco and indigo; the Middle Atlantic colonies produced foodstuffs; New England looked to external commerce and to fishing. This economic regionalism stood as a barrier to a national union. Against these elements making for separatism, other influences pulled the colonies together. A common language, law, and tradition were, with minor exceptions, the heritage of all. The growth of intercolonial trade after 1754 was rapid, and the colonies, by building roads ard by improving their postal system, recognized their mutual interests. In time of crisis, they had joined together in protecting their frontiers and after 1754 they drew together in common enmity against Great Britain. How these centripetal and centrifugal forces would have balanced Fad the mother country been prepared to allow the colonies to develop complete self-government, nobody can know. In fact, this course was not followed, and in 1774 the colonies were sufficiently cohesive to join in a loose association. But not until July 1776 did a committee of the second Continental Congress report a scheme of confederation. For a year and a half thereafter Congress debated the scheme, and a farther three and a half years elapsed before the Articles of Confederation were ratified by all the 13 States. When independence had been won, not a few Europeans, and even some Americans, anticipated that the confederation would fall apart. Perhaps this danger was exaggerated, but in any even improvement in the scheme of government was to be very difficult to secure. *printed from The Fiscal Impact of Federalism in the United States, Harvard University Press, Cambridge, Mass., 1946, Chapter I. THE FEDERAL GOVERNMENT SECURES STRONG FISCAL POWERS It was inevitable that the finances of the revolting colonies during the war should fall utterly into disorder. Taxation had always been light, and external commerce, the easiest source of revenue for im mature governments, was dislocated by the war. Revolutionary assemblies were not likely to impose, or a people in revolt against authority to pay, heavy taxes. A Rhode Island protest which said that "taxation, or contribution for the support of the government, ought to be free and voluntary" 1 expressed a typical attitude. Even when taxes were levied, they were inefficiently collected; and people seeing their neighbors escape were provoked to evasion. The ratification in 1781 of the Articles of Confederation, while es tablishing a national government, did not improve the public finances. The functions placed in the hands of the Congress were not inconsiderable; the lack was in the power, particularly the fiscal power, to administer them. For its revenue Congress was left in complete dependence upon the States. The States, at the call of the Congress, were to levy taxes through their own officers "in proportion to the value of all land within each State, granted to or surveyed for any Person, as such land and the buildings and improvements thereon shall be esti mated according to such mode as the United States in Congress assembled, shall from time to time direct and appoint."2 Every schoolboy knows how badly this worked. From 1781 to 1789 Congress ordered the States to pay as requisitions $6,630,000 in specie and $8,733,000 in indents; it received $3,384,000 in specie and $1,542,000 in indents. The public lands were given to the government of the confederation by the Articles, but actual cession was slow. Interest on domestic and foreign debt fell into arrears, and the ability to borrow nearly vanished. So impotent was Congress and so great was the aversion to taxation in the States that the Nation seemed close to an inflation which would wipe out all war debt. 3 The first attempts to strengthen the fiscal power of Congress were blocked. Rhode Island in 1781 refused to give Congress the right to levy a 5 percent duty on imports-and amendment of the Articles required unanimous consent. In 1783 Congress asked for the right to levy a limited range of duties on imports for 25 years, the duties to be collected by State officers and to be used only to pay interest on the public debt. By 1787 12 of the States signified acceptance of this innocuous measure, but New York was recalcitrant. Meanwhile, the States had begun to levy tariff's sometimes to raise a revenue, sometimes to enourage State trade, and sometimes in retaliation for duties imposed by a neighbor. Against these divisive forces all men of property, and all those who desired a strong and united nation, prepared to move. Nothing seemed clearer than that Congress needed the power to levy taxes of its own, but the power actually given by the new Constitution in 1788 went far beyond the proposals mentioned above. Con W. G. Sumner, The Financier and Finances of the American Revolution (New York. 1891). I, 18. 2 Article VIII. 3 C. J. Bullock, Finances of the United States, 1775-1789 (Madison, 1895), p. 162. gress received the power "to levy and collect taxes, duties, imposts and excises ... ," which meant that, besides the exclusive control over customs, it was to have a concurrent jurisdiction with the States in practically all fields of taxation. To many contemporaries this seemed excessive, and the advocate of the plan, while insisting that such a broad Federal power was desirable, protested that there was no practical likelihood of its extended use. Thus Hamilton argued that "the sense of the people, the extreme hazard of provoking the resentment of the State governments, and a conviction of the utility and necessity of local administration for local purposes, would be a complete barrier against the oppressive use of such a power." He went on to affirm that, with the sole exception of duties on foreign trade, the States would retain an independent right to raise revenue "in the most absolute and unqualified sense; and that an attempt on the part of the National Government to abridge them in the exercise of it would be a violent assumption of power, unwarranted by any article or clause of its Constitution." Why, then, was it needful to give the National Government such a broad power? Because upon it fell the duty of defense. Wars and rebellions were the "two most mortal diseases of society." The expenditures of the National Government, if it were blessed by peace, would be small. But since the danger of war was incalculable, the Federal power of taxation should not be limited. Even to separate out and divide Federal and State sources of revenue would be to sacrifice "the great interests of the Union to the power of the individual States."" 6 Hamilton had his way, and certainly he was right. But the forecast has been fulfilled of those who declared that, given this extended power of taxation, Federal exercise would follow. For 60 years any extension of the Federal revenue beyond customs was gingerly handled. Then, under stress of emergency, came a great surge forward with no reversion to the former position. The other fiscal provisions of the Constitution can be passed over lightly. Congress was given the power to levy "direct" taxes, but only by apportioning them among the States "according to their respective numbers." What was a direct tax? The Constitution did not say. When, by judicial interpretation, it turned out that important taxesnotably the income tax-were direct, this provision limited the Federal taxing power. The reason was that apportionment according to population placed an undue burden upon the States with a low per capita. wealth. Another provision of the Constitution prohibited levy of export duties. Behind this lay the fear of the South that its staple exports might be taxed. In a few other features the Constitution bears evidence of sectional apprehensions, but these need not be discussed here. Art. 1. Sec. 9. No. 4. Federalist, edited by Henry Cabot Lodge (New York, 1888), p. 185. Pid., p. 186. 154, p. 200, Hamilton's opinion of what should be State functions is given in the wing quotation: "The expenses arising from those institutions which are relative to the mere domestic policy of a State, to the support of its legislative, executive and judicial destments, with their different appendages, and to the encouragement of agriculture and ufactures (which will comprehend almost all the objects of State expenditure), are frant in comparison with those which relate to the national defence." Ibid., p. 197. 'Tile was a carryover from the Articles of Confederation by which Congress could impose taxes upon the States according to the value of their lands and buildings. 67--vol. 1-2 CONSOLIDATION OF FEDERAL POWER DURING THE FIRST When at last the United States had a national government with adequate fiscal power, everyone watched eagerly to see how that power would be used. Urgent tasks had to be undertaken at once, but any solu tion of them was bound to raise up latent regional animosities. At no time in the history of the United States was governmental debt-Federal and State-so serious a problem as in 1789. The Federal debt, foreign and domestic, was estimated at $54,124,500, of which $14,670,300 was arrears of interest. About the proper method for handling the foreign portion of the debt ($11,710,400) there was little dispute: it should be settled according to the letter of the contract. About the domestic debt, however, no such unanimity prevailed. Many people felt that some distinction should be drawn between original holders of the securities and the speculators who had acquired them by recent purchase. Against the proposal of discrimination Hamilton took a forthright position. The securities had been issued as negotiable so that the holder could sell them in the market and the buyer could be safe in his purchase. That contract should not be broken. Hamilton stressed also the practical difficulties in the way of effective discrimination. How trace back the various holders of a security and how ascer tain the motives behind sale and purchase? His own simple plan of outright Federal assumption would, he conceded, permit some individuals to make speculative profits; but this damage was irreparable. and to strive after would not be to secure a more exact justice. Here again Hamilton had his way." Even more controversial was the question of State debts, amounting to $18,271,800.10 These also were war debts-they were "the price of liberty"—and Hamilton argued for Federal assumption. All public creditors, in his opinion, should be treated alike, as they would not be if the States were left to their own resources. The States were unequal in the debts which they had amassed and in their ability to carry these debts. All of them, however, had been deprived of customs, and, therefore, of their chief source of revenue. The Federal Government, equipped with this revenue, could assume the debts without great inconvenience. For weeks the question was savagely debated. On several occasions assumption was voted down only to be revived in another form. At this same time Congress was deadlocked also on the issue of the permanent location of the national capital; and finally the two chief antagonists, Hamilton and Jefferson, made a bargain. Hamilton secured a few votes in support of the new city of Washington; Jeffer son secured a few in favor of assumption. And although speculation in the State debts was even more greedy and deplorable than that in the Federal debt, assumption was a wise step.11 But some alteration in the contract was made by funding. Upon the U.S. domestic debt. interest at 6 percent was paid only upon two-thirds of the principal; upon the remaining one-third of the principal interest began after 10 years. Upon arrears of interest. interest was paid at the rate of 3 percent. 10 Hamilton estimated them at $21,500,000, but this amount was not assumed. By the terms of the funding, interest upon four-ninths of the total principal was to begin at once, upon two-ninths after 10 years, and upon three-ninths the rate was to be 3 percent. A. S. Bolles, Financial History of the United States, 1789-1860 (New York. 1885), II, 28. |