## Fiscal Politics

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### Background: fiscal collapse and rapid institution building
- About 18 months before the June 20, 1790 dinner, the federal government was bankrupt; the Treasury Department was not created until September 1789, and the first federal revenue had yet to come in.
- By 1792, the administration had:
  - assumed the debt of the states;
  - restructured its own wartime debt;
  - built strong federal tax capacity based on tariffs and an effective customs service;
  - laid the foundations of public credit;
  - created a national bank; and
  - promoted the development of financial markets.
- Hamilton’s program enabled the federal government to carry out an active economic development policy.

### Hamilton’s pragmatic program: five core areas
- Hamilton’s three landmark reports (public credit, national bank, manufactures) addressed five core areas:
  - taxation;
  - public credit;
  - financial markets and organizations;
  - financial stability and crisis management; and
  - trade policy.
- Hamilton was inspired by the post–1688–89 British state model: a state capable of mobilizing resources for war and international competition and actively engaged in economic and financial development.

### Taxation, revenue, and the public debt
- Tariffs were the most expeditious revenue source; direct taxes were harder to collect and deeply unpopular.
- Tariffs contributed about 90 percent of the total federal revenue.
- Hamilton estimated the stock of public debt at $79 million (roughly 40 percent of GDP), of which:
  - $54 million was owed by the federal government, and
  - $25 million by the states.
- Even with that level of debt, debt service costs alone exceeded tax revenues.
- Hamilton proposed a debt conversion offering domestic creditors the choice of swapping existing government notes for new debt to reduce the interest rate from 6 percent to 4 percent, thereby saving about one-third of domestic interest costs.
- The proposal included call protection to limit the government’s ability to redeem the debt early if market interest rates declined.

### Markets, creditors, and political motivations
- Hamilton aimed to:
  - make Treasury securities regarded as safe assets and a reliable source of financing;
  - ensure the allegiance of creditors to the federal government; and
  - foster deep and liquid markets for Treasury securities.
- Politically and institutionally, federal assumption of state debt would diminish the revenue needs of the states and concentrate tax capacity at the federal level.

### Contentious political issues and compromises
- The debt swap at face value implied windfall gains for many current debt holders (speculators) who had purchased original securities at fractions of face value—sometimes as little as 20 percent.
- Hamilton argued against retroactive intervention, emphasizing the government’s willingness to honor financial contracts as the foundation of public credit.
- There was political controversy over federal assumption of states’ debt; Hamilton argued the debt was incurred in pursuit of the common good (financing the War of Independence).
- Location of the national capital became a divisive issue: Hamilton favored New York; Jefferson and Madison favored the Potomac. The June 20, 1790 dinner produced a compromise, and in July 1790 Congress passed the Residence and Assumption bills in quick succession.

### Short-term market effects and political consequences
- Credibility was gained rapidly after passage of Hamilton’s proposals. In 1791, prices rose above par before falling again during the financial crisis of 1792.
- The early policy confrontations between Federalists and Jefferson/Madison supporters led to organized party competition: in 1792 Madison and Jefferson organized their party to rival the Federalist party, marking the beginning of professional, competitive party politics in the United States.
- The shaping of centralized public finances in support of a vigorous executive enabled subsequent policies in financial stability, crisis management, and trade.

*VITOR GASPAR and DAVID AMAGLOBELI, Finance & Development, March 2018.*

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_Source: https://www.imf.org/-/media/files/publications/fandd/article/2018/march/gaspar.pdf_