Hamiltonian Economics: Another Historical Perspective on Approaches to Deficits

Here is a historical perspective that contributes to the current discussion about deficit spending and, unlike many of my posts, this one doesn’t relate to the New Deal. This article by the (now deceased) Harvard business professor, Thomas McCraw, offers a window into debates about taxes and deficits that the country engaged in more than two centuries ago.

During the 1790s, Treasury Secretary Alexander Hamilton faced a deficit that was growing at an alarming rate. At the time, the United States owed significant sums to foreign lenders who had funded the Revolution. Just to put things in perspective, as McCraw’s article points out, the federal government’s debt-to-income ratio at the time was 46 to 1, compared to today’s 6.5 to 1.

Hamilton took a number of important steps moving forward. He refused to use vital resources to pay off existing debts, instead choosing to take out new loans at lower interest rates. This was most likely a good idea. Although McCraw focuses solely on Hamilton, President Andrew Jackson succeeded in paying off the national debt in 1835, but the strategy did not yield terrific results: a government surplus rolled into a land bubble and then a depression. Soon after, the US assumed more debt and has not been debt-free since (for more information on this economic event, see this NPR article).

Most importantly, however, Hamilton created the Bank of the United States, which the author of the article contends was very much in demand. At the turn of the eighteenth century, few banks were available, meaning that those who wished to invest and consume were limited. The creation of this precursor to a central bank served to increase credit. This expanded the tax base and subsequently raised government revenues. Within several decades, the debt-to-income ratio had decreased to 8 to 1.

McCraw contends that Hamilton’s accomplishment is relevant to today’s discussion because Hamilton was able to solve the revenue-debt problem without raising tax rates, but by expanding the tax base, or the “economic pie.” Hamilton understood something that most political leaders would comprehend today: the public is resistant to attempts to change the deficit through tax increases. But they will be less likely to complain if the deficit can be reduced through promoting economic activity.

McCraw’s article is worth a read, as it offers a thought-provoking and relevant historical perspective. However, we should be wary of believing that Hamilton’s solutions will easily work in today’s situation. First of all, the nature of government spending has vastly changed from the time when nearly all debt had been accumulated through one war. Secondly, we have already extended the tax base in the years since Hamilton ran the Treasury, through the establishment and expansion of the federal income tax throughout the twentieth century. What McCraw’s article might be most relevant to (which I would support) is a reform of the current tax code that expands the tax base through the elimination or reduction of many deductions and exclusions for upper-income households.