Fiscal Policy

Constitutional Conundrums and Fiscal Follies: In Defense of the Articles of Confederation

Leaders of the Continental Congress by Augustus Tholey, c. 1894 (Library of Congress)
Washington spends too much, taxes too much, does too much. That’s because of the Constitution, not in spite of it.

Thinkpieces lamenting the state of constitutional government are a dime a dozen. If only we embraced a correct reading of the Constitution (the various schools of originalist thought seem promising), we could get America back on track: “The Constitution has not failed; the Constitution has never been tried!”

But it has been tried. The Constitution did exactly what some of its most ambitious proponents hoped it would: It laid the foundations for an imperial fiscal-military state. Conservatives and libertarians rightly bemoan excessive centralization under a ravenous Leviathan. If they realized that’s a feature, not a bug, of the constitutional system, perhaps we could finally do something about it.

We recently passed an auspicious day in U.S. history, although almost nobody is aware of it. On March 1, 1781, the 13 states ratified the Articles of Confederation. This was our nation’s first constitution, which prevailed until the ratification of the U.S. Constitution in 1789. The Articles made for a very different government than the Constitution. Acts of the unicameral Congress required concurrence from nine of 13 states. Amendments to the Articles required unanimity. And let’s not forget the powerful words of Article II, which we and many other students of history wish were more explicitly reproduced in the 10th Amendment to the U.S. Constitution: “Each state retains its sovereignty, freedom, and independence, and every power, jurisdiction, and right, which is not by this Confederation expressly delegated to the United States, in Congress assembled.” Talk about a missed opportunity!

To the extent the Articles are discussed at all, it’s usually because of how dysfunctional American government was during those eight tumultuous years. Here’s a sampling of charges: State governments regularly engaged in trade wars with each other, inhibiting commercial development and economic growth; Congress couldn’t pay down the Revolutionary War debt because it lacked the power to tax; America would be helpless before rapacious European powers on the international stage; the unanimity rule for amendment allowed even a single state to hamstring the national government by vetoing efforts to alter the document, and especially the establishment of a national tax authority. But this one-sided picture is deeply inaccurate.

Historians, political scientists, and economists have written dozens of books trying to correct the record on the Articles of Confederation. Alas, their insights have yet to percolate to the public-intellectual sphere. Here’s our modest effort to revitalize our much-ignored, sometimes-maligned governing charter.

We’re going to focus on a single historical impetus for the transition from the Articles to the Constitution: fiscal politics. To set the stage, here’s E. James Ferguson, whose works remain standard in the history of American public finance:

The Articles of Confederation . . . [emphasized] defense of local rights against central authority. The Articles were designed to safeguard liberty; the Union was a league of states, presided over by a dependent Congress. Its authority was limited in many ways, but all the restraints devised to forestall usurpation of power, the denial to Congress of the right to tax was the most fundamental. No maxim of political philosophy was so widely accepted in Revolutionary times as that the “power which holds the purse-strings absolutely must rule.”

The power to tax: In many ways, that’s what it all comes down to. But to appreciate that insight, we need to explore the links between Continental and early Revolutionary money, banking, and finance.

Contrary to goldbug ravings, commodity money isn’t always and everywhere the best money. With a few notable exceptions (e.g., Massachusetts), the American colonies had great successes with paper-money systems, which created an adequately circulating medium of exchange and a relatively simple means of indirect taxation. Colonial governments would issue paper money, often through “land banks” — chartered institutions whose business model relied heavily on short-term mortgages and quasi-mortgages — but sometimes as a direct legislative issuance, too. Those governments would then accept the issued notes to discharge tax obligations. Slow-and-steady increases in the money supply created modest inflation, which functioned as a tax, transferring purchasing power from holders of the money to the legislature. This was by design: Given the immense transaction costs of assessing direct taxes, especially in rural areas, mild inflationary finance was often the best option for getting the public sector the revenue it needed.

American colonists did not regard this system as oppressive, or even suspect. In fact, they regarded it as normal and healthy. Paper-money finance at the state level was a way of maintaining control and oversight over politics. It was not a usurpation of liberty, but a means of its preservation. Again quoting Ferguson:

Nearly all the states carried over from colonial times a predilection for currency finance methods . . . most people regarded specie payment as signifying permanent debts, heavy taxes–in a word, oppression. Liberty in their minds was associated with paper money. . . . The states serviced the public debt, employing currency finance methods and dealing solely with their own citizens.

Local public finance was a point of vigorous contention during the early years following the Revolutionary War. Nationalists, such as Alexander Hamilton, Gouverneur Morris, and George Washington, wanted a stronger fiscal state. They knew that to consolidate the nation, they needed a scheme to pay down the significant debts incurred by the Continental Congress during the War, one that depended on national rather than local initiative. A centralized fiscal authority would facilitate the development of a strong financial sector, a permanent market for government bonds, and specie-backed money. As Ferguson writes, for these men, “the goal of the Revolution was the creation of a national state which would rise to ‘power, consequence, and grandeur.’ This idea was inseparably joined with the conception of a political regime which would foster business enterprise and at the same time leave business free of restrictions.” In other words: crush the rubes, then let the financiers play.

The problem was the Articles of Confederation wouldn’t let them. The concurrence requirement for collective action was too high. Remember, this was intentional. The political theory of our first constitution was that there should be overwhelming agreement on any public issue before the national government acted. But that didn’t stop the states from acting on their own. And when it came to Revolutionary War debts, they did! Ferguson continues:

Meanwhile, since Congress was unable to meet the interest on the public debt, the states themselves began taking over payment — a process which boded disaster to plans for political reform. . . . As the states laid hands on the public debt they undermined the basis for a constitutional enlargement of federal powers.

Now we come to the sticking point. Because some state governments took independent initiative on their debt obligations, a key justification for the nationalist program was quickly losing its force. Edwin J. Perkins, an economic historian, tells us:

Nine states assumed a portion of the federal debt held by residents, and several states began paying the interest due on those securities. Responsibility for sinking the joint war debts incurred by Congress was passing steadily into the hands of state governments by the mid-1780s, and thereby threatening the prospects of securing a stronger central government under the revised Articles of Confederation.

And if Ferguson is to be believed (he is), the states were pretty good at it:

Clearly it [the post-Revolutionary period] was not the era of public bankruptcy and currency depreciation that historians used to predict. The states in varying degrees took care of the interest on the public debt. Congress conducted its internal affairs at a slowly increasing deficit prior to 1789, but the deficit was not serious.

How did the states handle Revolutionary War debt? They adopted the same time-tested finance methods used during the Colonial era. Several states reissued paper money during the 1780s. Some of it was used to honor federal obligations, in addition to state obligations. So much for the claim that national obligations required national finance!

The Nationalists grew worried. Perkins continues:

Morris, Hamilton, Madison, and their political allies realized in the mid-1780s that if the subunits continued their financial programs unimpeded for another five to ten years, the successes in several key states might undermine the nationalist movement. Thus, they wanted not merely to reform the Articles of Confederation in 1787 but to substitute a more centralized form of national government before financial pressures had eased and the states had started to lift the debt burden from congressional shoulders.

James Madison was even more direct in the preface to his notes on the constitutional convention: “It was seen that the public debt rendered so sacred by the cause in which it had been incurred remained without any provision for its payment.” The unanimity rule for amending the Articles presented the main impediment, as “elaborate efforts of Cong. to procure from the States a more adequate power to raise the means of payment had failed.”

Despite the fact that public finance was reasonably orderly during the Articles of Confederation era, the Nationalists would have their day. Shay’s Rebellion shook the nation, persuading many that a stronger central authority was crucial for public order. And the situation with the external public debt was nowhere near as rosy. Congress defaulted on its obligations to Spain and France, and barely avoided defaulting to Holland. There certainly were problems, and visionary statesmanship could have tackled it within existing procedural rules. But that wouldn’t have gotten the consolidation of political power desired by the Nationalist faction.

The Nationalists carried the day in 1787, and with it all but institutionalized a tradition of federally granted power and favors. They extended the newly constituted federal Congress an explicit “Power To lay and collect Taxes, Duties, Imposts and Excises,” the returns of which could then be used “to pay the Debts and provide for the common Defence and general Welfare of the United States.” The Nationalists sought to allay misgivings over these new powers by pledging adherence to restraint. The new taxing authority required uniformity and could only extend to either indirect collection mechanisms or a direct census-apportioned share assessed against each state. The Constitution’s enumeration of congressional powers would constrain the open-ended extension of the legislature’s domain into any and all acts servicing “general welfare,” or so the public was told.

A vocal minority “smelled a rat,” to paraphrase Patrick Henry’s assessment of the closed convention. One dissenting delegate, Luther Martin of Maryland, broke the convention’s pledge of silence to alert his state legislature of Nationalist designs “to sluice them at every vein as long as they have a drop of blood” through a federal tax system operating “without any controul, limitation, or restraint.” Dismissed at the time as an alarmist polemic, Martin’s warning now seems like a prescient assessment of the tax power’s trajectory in the two centuries since.

Although little-discussed today, the new Constitution’s fiscal tools also wed its national designs to a corrupting bargain with slavery. The Northwest Ordinance, arguably the most significant act to come out of the national government under the Articles of Confederation, proscribed the importation of this odious institution into new states to the north of the Ohio River. The Constitution, by contrast, punted on the issue of slavery in exchange for securing the national economic powers desired by its proponents.

We remember the notorious “three-fifths compromise” today for its effects on determining the political representation of slave states in the House of Representatives. But it also reflected explicit fiscal goals. “Representatives and direct Taxes shall be apportioned among the several States” according to this formula, reads the clause in full. The bargain accordingly discounted the intended federal tax burden paid by the slave states relative to their true population sizes. To Martin, this deal enabled “the absurdity of increasing the power of a State in making laws for freemen in proportion as that State violated the rights of freedom.” It inverted the Revolution’s core principle of linking representation to taxation, inflating the political influence of states that denied a basic freedom to the enslaved portion of their population while also discounting the same states’ expected contributions to the national treasury by a commensurate amount.

Continuing this pattern of concessions, the Nationalists of the North proved “willing to indulge the southern States, at least with a temporary liberty to prosecute the slave trade, provided the southern States would in their turn gratify them, by laying no restriction on navigation acts.” Here Martin refers to the removal of a clause that would have constrained the regulation of foreign commerce to a two-thirds supermajority as the price for preserving the slave trade until 1808. While the new Constitution’s wording carefully — and intentionally — avoided extending a direct sanction to slavery itself, the terms its framers accepted in order to secure greater fiscal and regulatory powers on the national stage had the effect of bolstering the slave power’s political influence within the very same federal government. No less a source than Alexander Hamilton conceded as much, lamenting to the New York ratifying convention that “without this indulgence, no union could possibly have been formed.”

The objections to the 1787 convention reveal an unsettling implication about our nation’s constitutional design. The men we herald as the Founders never intended the Constitution to enshrine “limited government,” as we now understand that term. (Please do not cite the Federalist Papers to us. Taking political ad copy at face value is a historical solecism.) Whatever else they are, broad taxation powers, the necessary-and-proper and general-welfare clauses, and the implied-powers doctrine are not bulwarks of liberty. Pace Ferguson, the tragedy of the passing of the Articles and the rise of the Constitution is that “somewhere in the course of American democracy the nation at large forgot to distinguish between the government and the people. Individual rights and local privileges were no longer regarded as standing against the authority of the government; they were to be advanced by soliciting its aid and patronage.”

Fiscal politics is not the only thing that explains how we got the Constitution, but it is the major factor. “Constitutional reform had always involved public finance,” Ferguson continues. “The decision to establish a national government entailed federal taxation and the payment of the debt, irrespective of the designs of creditors, who assisted the process, reaped its benefits, but did not create it. Proceeding rigidly by the axiom that related sovereignty with revenue power, the founding fathers crowned the new government with unlimited power of taxation.” If you want to understand the federal behemoth and its crushing tax burden with which we are cursed, look no further than the U.S. Constitution.

Historical understanding and contemporary policy are two very different things. Regardless of the forces that bequeathed it to us, the Constitution isn’t going anywhere. But to use a favorite phrase of ours by economist Frank Knight, unless we grab the bull by the tail and stare the situation square in the face, we won’t make any progress on solving our pressing national problems.

Washington spends too much, taxes too much, does too much. That’s because of the Constitution, not in spite of it.

Phillip W. Magness is a senior research fellow at the American Institute for Economic Research. Alexander William Salter is an associate professor of economics in the Rawls College of Business at Texas Tech University.

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