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SOME H IST O R IC A L A SPE C TS O F F E D E R A L F ISC A L
PO LICY , 1790-1956
Paul B. Trescott, associate professor of economics, Kenyon College
Traditional views of fiscal policy tended to treat Government ex
penditures as the means to the performance of Government functions,
and to regard revenue measures as a means to both. Modern income
analysis, by contrast, has tended to stress the money-flow aspects of
aggregate Government financial transactions in relation to national
levels of spending, output, and prices. This paper will deal with both
aspects. I t will describe and analyze briefly the historical develop
ment of Federal expenditures by function and of the attending revenue
structure. The relations between fiscal policy and wartime inflations
will be investigated, also the reciprocal interaction of fiscal policy with
peacetime economic fluctuations. The fiscal ideas underlying such
policies will also be treated. The possible effects of the tax structure
and public debt policy on economic growth will receive some attention.
Discussion of some of the conceptual problems and statistical sources
encountered in a historical treatment of this sort will conclude the
paper.
T h e G r o w t h o f F e d er a l E x p e n d i t u r e s , 1790-1956
During the first full year of its existence, the Federal Government
spent less than $1 million. In fiscal 1956, Federal cash payments to
the public totaled more than $70 billion. Current levels of Federal
spending are about 10,000 times as large as those of the 1790’s and
about 200 times as large as those of the 1890’s.
The pattern of this vast growth over time is shown in the accom
panying chart. A cursory examination will reveal its most striking
feature to be the influence of wars on the pattern of increase. The
large eruptions reflect the W ar of 1812, the Civil W ar, and W orld
W ars I and II. Instead of a gradual, even, upward movement, Fed
eral expenditures have shown a series of plateaus. W ars have pushed
expenditures to high levels. W ith the return of peace, spending has
fallen, but never to prewar levels. Usually the war has left a heritage
of increased expenditures for interest and veterans. Between wars,
expenditures show several long periods of relative stability or even
decline, until the next war forced them to still higher levels. Such
60
ECONOMIC GROWTH AND STABILITY
61
FED ER A L EXPENDITURES, 1 79 0-1956
S ources: 1790-1860, author’s e stim a tes; 1861-1916, au th o r’s prelim inary esti
m ates : pp. 81-83 ; 1917-52, Kendrick, a century and a half of Federal expendi
tures, N ational B ureau of Economic Research, 1955, p. 77; 1953-56, annual
budget volumes for 1955-58.
periods have been lacking in recent years. Since 1900 there has been
a stronger upward tendency in “normal” Federal expenditures, and
since 1945 the earlier distinction between wartime and peacetime
periods has largely evaporated.
Table I summarizes the growth of expenditures in absolute terms
and also gives some information on the composition of expenditures
and their relation to other economic magnitudes. I t shows that ex
penditures for defense and for interest, veterans’ benefits, and other
war-related items have usually dominated Federal spending. In only
one of the selected periods, that of the 1930’s, do the other items ac
count for more than half. This does not obliterate the fact that these
civil expenditures in each period were larger than in the previous one.
In 1956, this civil category accounted for nearly $20 billion of Federal
spending.
97735—57------6
62
ECONOMIC GROWTH AND STABILITY
T able
I.— The growth of Federal expenditures and their relation to other
economic magnitudes, 1790-1956
Average annual expenditures
Period
N u m b er
of years
W arrelated
O ther
T otal
Average
per capita
1926 prices
Average
ratio to
gross
national
product
M illions of dollars
1790-1811............. ..................... .
1812-15..........................................
1816-36___ _________________
1837-61_____________________
1862-65.......................................
1866-90................................... .
1891-1916......................................
22
4
21
24^
4
25
26
6.0
26.7
13.7
27.3
708.0
227.0
357.0
2.0
2.8
6.1
18.4
19.0
66.0
171.0
8.0
29.5
19.8
45.7
727.0
293.0
528.0
1.60
3.25
2.45
2.95
24.40
7.60
10.0
Percen1-2
t
3-5
1-2
1-2
10-14
3-4
2-3
Billions of dollars
1917-19...........................................
1920-29.........................................
1930-41____ _______________ _
1942-45....... ...................................
1946-56.........................................
3
10
12
4
11
10.6
2.8
2.9
70.0
45.0
0.4
.7
4.2
6.0
12.0
11.0
3.5
7.1
76.0
57.0
82.0
28.0
71.0
461.0
225.0
Perce17-18
nt
4
10
40
18
N o t e s . —Figures are for calendar years through 1842, 6 months of 1843, thereafter fiscal
years ending June 30.
War-related expenditures include military, veterans, foreign, and interest.
Averages relative to population are means of annual estimates, as are those for gross
national product since 1861. For earlier years, relation to gross national product indicates
probable range.
Sources: 1790-1916 based on author’s annual estimates, discussed at end. 1917-52,
M. Slade Kendrick, A Century and a Half of Federal Expenditures, National Bureau of
Economic Research, 1955 ; 1953—56, Budget of the United States, annual volumes for
1955-58.
We can better obtain perspective on the magnitudes and growth of
Federal outlays by comparing them with some measures of the size
of the economic system. We should also allow for the fact th at the
value of the dollar has not remained constant. Since 1790, the popula
tion of the United States has increased from about 4 million to about
170 million—more than fortyfold. The purchasing power of the dol
lar, as measured by wholesale prices, has fallen to about one-third of its
1790 value—although such long-run comparisons are virtually mean
ingless because of changes in the composition of output. In our table,
figures showing Federal expenditures per capita, in 1926 prices, take
account of the changes just noted. These show th at the increase in
spending was not great relative to price and population change in the
peacetime periods through 1929.
The type of comparison most dear to the economist is th a t between
Government expenditures and some measure of national income or
output. Precisely what such comparisons show and how they should
be made are questions we will sidestep. We will merely take gross
national product as a measure of the size of the Nation’s economy.
Gross national product (G NP) has grown more rapidly than popula
tion as a result of increased productivity stemming from improved
organization, technological advance, and an increasing stock of capital
goods. O utput per capita in the United States has risen to more than
10 times what it was in the first part of the 19th century. Table I
contains a column of data relating Federal spending to GNP in each
period. This comparison reduces the growth of Federal spending to
ECONOMIC GROWTH AND STABILITY
63
somewhat more modest proportions. I f we concentrate on peacetime
periods, we find an increase in the ratio from something under 2 per
cent before 1812 to something under 20 percent in most recent times.
These statistical relationships do not go very far to explain why the
increases in spending have occurred. Some economists have sug
gested that there is a kind of law of increasing Government activ
ity—that as the living standard of an economy rises, public opinion
will bring about a larger relative amount of Government activity.
Most Government services are not vital for subsistence, but higher
living standards bring more desire for Government services, while in
creasing people’s willingness and ability to pay for them. To use a
modem idiom, Government activities may be purchased out of super
numerary income—income above th at needed for necessities, which
rises faster than total income.
This explanation, usually advanced to account for increases in de
sirable Government activities, may paradoxically help explain the
relative increase in war expenditures. In part the increasing costs
of American wars reflect the higher emotional involvement of the
population in total war. Another contributing factor, as Professor
Kendrick has pointed out, has been changes in military technology.1
But p art of the explanation is that a wealthy, highly productive na
tion can devote a larger proportion of its resources to military pur
poses without infringing on the necessities of life. The high propor
tion of our output devoted to military uses during World W ar I I was
more readily achieved because the economy had been in a period of
depression, which kept people’s accustomed standard of necessity
fairly low, and also permitted a great increase in total output.
But to deal adequately with the peacetime growth of Federal
expenditures, whether war-related or not, one must be more specific
about public attitudes toward Government actions, the political struc
ture, and the revenue base.
Federal expenditure policies in the 19th century
Our figures show that the growth of Federal expenditures in peace
time periods was relatively slow in the 19th century—indeed, down
through the 1920’s—relative to the growth of the economy. Govern
ment spending seemed to approximate a normal level of somewhat
under 5 percent of GNP. The activities on which the Government
spent most of its money showed a remarkable degree of stability
throughout the 19th century. In the years 1789 through 1860, about
five-sixths of Federal expenditures went for defense, general govern
ment, Indian affairs, veterans’ pensions, interest, and postal service
deficits. In 1890 these activities accounted for virtually the identical
percentage, although the relative shares were different. In 1789-1860,
about 5 percent of Federal spending went for aids to commerce and
transportation, chiefly lighthouses and river and harbor improve
ments. In 1890 this percentage was also practically identical. Only
about 10 percent of total spending in each case fell outside these activi
ties, and some of that reflected such common items as surveying and
selling the public lands, and District of Columbia expenditures.
1 M. Slade Kendrick, A Century and a Half of Federal Expenditures, National Bureau
of Economic Research, New York, 1955, pp. 42-48, 57-62.
64
ECONOMIC GROWTH AND STABILITY
By 1910, the share of the first group of activities had fallen below
80 percent. In the category of transportation facilities, expenditures
on rivers arid harbors were exceeded by those on the Panam a Canal,
pushing the total for the category above 10 percent. Coriservationorierited activities in the Interior Department, agricultural expendi
tures (which had been minute in 1890), and the outlays of the newly
formed Department of Commerce and Labor accounted for another
7 percent. Since 1910, the increase in the dollar volume of Federal
expenditures has been accompanied by the proliferation of Federal
activities. We might say that in the 19th century expenditure growth
increased the scale of Federal activities, but th at during the 20th
century, their scope has increased also.
We may be able to throw light on the reasons for these divergent
patterns by adopting an unconventional approach. Instead of asking
why expenditures grew, let us ask why they did not grow more in
both scale and scope before, say, World W ar I. We can dismiss at
the outset one possible explanation—th at there was no pressure from
the public for Government services and actions. Recent research in
economic history has produced a mass of evidence that demands for
Government action were widespread and strong throughout the 19th
century, particularly from businessmen.2 There are a number of
specific factors which account for their slight effect on Federal
spending:
1. The Federal system. The greater p art of the demand for Gov
ernment action involved State and often local governments. State aid,
participation, and regulation were very evident in the development of
roads, canals, railroads, and banks before 1860.
2. The separation of powers in the Federal Government. Members
of Congress have typically been most sensitive to demands for serv
ices from particular constituent groups. The President and other exec
utive officials are, however, more at liberty to pattern their conduct
after a general theory of government. In the 19th century most
Presidents, strong or weak, held pronounced views about the proper
role of the Federal Government relative to the States and to the p ri
vate economy. In particular, they shared a general sense of the limi
tations imposed by the Constitution on Federal activities. Not only
was Presidential leadership lacking on behalf of spending increases,
but strong Presidential pressure was often exerted to keep Federal
activity limited. The history of this can be read in p art in the se
quence of Presidential vetoes, from Madison’s veto of the bonus bill of
1817 through Coolidge’s veto of the McNary-Haugen bills in the
1920’s.3 We will also find evidence of it in the attitude of officials
toward fiscal policy during economic depressions. One might note
that the strong pressures against spending came from the Executive
more than from the judiciary. No Federal spending program of con
sequence fell afoul oi the courts until the 1930’s.
2This literature is excellently summarized in Robert A. Lively, The American System:
3 Other notable items in the series should be Monroe’s veto of a bill to charge tolls on
the Cumberland road, Jackson’s veto of bills to buy stock in the Maysville turnpike and
Louisville and Portland Canal corporations, Polk’s and Arthur’s vetoes of river and harbor
bills, Johnson’s veto of the Freedmen’s Bureau bill, and Cleveland’s vetoes of pension, river
and harbor, and drought-relief bills. Others which involved the scope of Federal activity
were those of Jackson and Tyler on bills to charter a national bank, and those of Pierce
and Buchanan on bills to distribute public lands for certain welfare purposes.
A Review Article, Business History Review, March 1955.
ECONOMIC GROWTH AND STABILITY
65
3. The Federal Government was able to meet demands on it by ac
tions which involved little or no expenditure of money or which even
brought revenue. Major programs which involved little expenditure
would include the national banking and Federal Reserve systems,
antitrust and the Federal Trade Commission, and the regulation of
railways and other industries. In the 19th century, the Government
also was able to take substantial actions with its great nonmonetary
asset, the public lands. In part, the low level of veterans’ pension
payments prior to the Civil W ar reflected the use of land bounties to
servicemen. Federal land grants for aid to railways and education
were vastly more important than the cash expenditures for such pur
poses. And of course in the case of the tariff, the Government was able
to meet demands for assistance to business in a manner which brought
revenue. These factors indicate that a study of expenditure patterns
alone is seriously inadequate for an understanding of the general eco
nomic role of the Federal Government before 1900.
4. Federal expenditures were inhibited at times by the nature of the
tax structure and the abhorrence of debt. Prior to the Civil W ar, the
tariff was the chief source of Federal revenue, but its revenue aspect
was never the sole consideration. During the years 1833-60, the polit
ical power of southern interests made it impossible to increase rates
(except in the face of large depression deficits in 1842), and in fact
created a strong pressure to reduce them as imports grew. Abhor
rence of debt manifested itself in a strong priority for debt retirement
in times when revenues were abundant (1825-36,1850-56), and in de
termination to reduce expenditures in times of depression and low
revenue.
5. Although there emerged in the latter part of the 19th century two
large “underprivileged” groups, the farmers and the industrial work
ing class, the farmers tended to concentrate their attention on such
Government actions as monetary reform, lower tariffs, and antitrust.
The working class was in large measure politically impotent, because
of the high proportion of immigrants, but even the sector of labor with
the highest political potential preferred to seek gains through craft or
ganization and collective bargaining rather than through Government
action.
The increases in Federal expenditures prior to 1900 took place in
well-established channels and at times when the limitations noted were
relatively weak. One major influence toward growth was the terri
torial expansion of the United States under the stimulus of population
increase. A large part of defense expenditure went for frontier pro
tection against Indians, and was greatly in demand especially after
the territorial increases of the 1840’s. Expenditures for Indian affairs,
postal service, and transportation facilities were all linked to terri
torial expansion.
The successive periods of war also tended, to some extent, to create
the revenue necessary for higher subsequent expenditures such as
veterans' benefits. The high tariff rates and belated internal duties of
the W ar of 1812 brought a flood of revenue after the war, and the
tariff was never restored to its prewar level, although the internal
duties were soon repealed.4 The Civil W ar created a revenue base
4 Paradoxically, the large relative increase in pension expenditures after 1816 went
almost entirely to Revolutionary veterans and their survivors. Army veterans of 1812
received no pensions until after the Civil War, nor did those of the Mexican War.
66
ECONOMIC GROWTH AN© STABILITY
of excise taxes on tobacco and alcoholic beverages which were not
removed after the war, and which had a sumptuary aspect which
made reduction unpopular in some quarters. Pension increases after
1865 were also attractive to Republican politicians because of their
geographic distribution. But the big increase in pension payments
came some 25 years after the Civil W ar, when the tariff was bringing
in high revenues at a time when the political pressures for protection
were too high to permit rate reductions.
Federal expenditure policies in the 20th century
The large increase in Federal expenditures relative to GNP has
taken place in the 20th century, particularly the years since 1930. This
has been a growth in both the scale and scope of Federal action, with
an enormous proliferation in the number of Federal activities and
the assumption of responsibilities previously left either to States and
localities or regarded as private concerns.5
This change can be explained to a large degree in terms of modifica
tion in the forces formerly limiting expansion. The economy has
become a national unit, which State and local governments have been
less able to cope with. The Federal Government has tapped phe
nomenal new revenue sources which have completely eclipsed the
relatively cumbersome resources of States and localities and have
increased Federal spending capacity. In addition, during the 1920’s
and 1930’s, these new taxes on personal and corporate incomes were
largely imposed on a wealthy minority, so that they did not have the
political unpopularity which has increasingly attached to the per
sonal tax in its more recent role as a mass levy. By the 1920’s farmers
had become a more effective political power and were demanding
positive Federal action rather than regulation of alleged “exploiters.”
The curbing of immigration in the 1920’s helped pave the way for the
more effective integration of the working class into the political struc
ture. The process of Federal expansion was given considerable im
petus by positive Presidential leadership from Theodore Roosevelt
and Woodrow Wilson.
But the structural and psychological changes just listed took on
effective significance as forces promoting Federal expansion chiefly
under the influence of the economic depression of the 1930’s. Although
President Hoover’s ideological commitment to a limited role of Federal
action was flexible enough to accept the Farm Board and Reconstruc
tion Finance Corporation, he balked at Federal assumption from the
States and localities of responsibility for direct relief. But the de
bility of State and local revenue and credit resources led them to
default on this and other responsibilities. Federal expansion into
this and other areas found a politically effective champion in Franklin
Roosevelt. Hoover’s defeat in the midst of economic chaos repre
sented a thorough discrediting of the traditional ideology of rigidly
limited Federal activity, although some of the worst parts of that
ideology were the last to be discarded.
6 A good idea of th is proliferation is conveyed by Solomon Fabricant, The Trend of
Government A ctivity in the United S tates Since 1900, N ational Bureau o f Economic
Research, New York, 1952, pp. 61-72, 242-247. See also P aul Studenski and Herman
Krooss, F inancial H istory of the United States, McGraw-Hill, New York, 1952, pp. 263-270.
ECONOMIC GROWTH AND STABILITY
67
The largest portion of depression-inspired expenditures under the
New Deal went into such straightforward and necessary objectives
as relief (chiefly F E R A and W PA ) and public works.6 I f anything,
these were too small relative to the task. In any case, they were
temporary and went out of existence during the war.
However, the depression was also the occasion for the inception of
programs of farm-price supports and other subsidies, and for the
social-security program. Both of these were originally very badly
designed as part of fiscal policy to relieve depression, but have become,
paradoxically, important parts of the Government’s standby protec
tion against any subsequent depression.
Many of the most controversial expansions of Federal functions in
the 1930’s did not entail great expenditure increases. Monetary and
banking reconstruction, the National Labor Relations Act, the wagehour law, the NRA and its unwholesome progeny—none of these re
quired great financial expense, but each extended Federal influence
drastically. I t is very doubtful if any of them made any appreciable
contribution to recovery, just as it is unlikely that any of them could
have been adopted without the depression as background.
The high level of expenditures in the past decade reflects the assump
tion by the Federal Government of a degree of responsibility for main
taining world peace and order far greater than before 1940. Parallel
ing this has been the continued responsibility assumed during the
1930’s to maintain and increase domestic living standards. The bulk
of Federal spending continues to reflect military outlays. But our
expenditure classification should not cause us to overlook the great
contribution made toward the “welfare state” by the postwar veterans’
program.
W ith these responsibilities, there has developed no philosophy of
the proper role of the Federal Government relative to the States or to
private activity as rigorous or widely accepted as the old. This is
as true in judicial constitutional interpretation as elsewhere. In many
respects, the traditional view was obsolete, particularly in its dedica
tion to an automatic monetary mechanism and its rejection of depres
sion deficit spending. But the lack of some such standard raises
the danger that Federal spending programs will deteriorate into mere
acts of vote buying. There is also the danger that the Government
will exercise its responsibilities toward individual’s living standards
in such a manner as to create a “rich man’s welfare state,” in the phrase
of Blair Bolles. Many Government programs have created vested
interests who were not intended as the beneficiaries but whose welfare
is heavily dependent on the program—the construction and farmimplement industries, for example. A t the same time, as the investi
gations of the Joint Economic Committee have brought out, the pro
grams of the welfare state may be of little benefit to the really de
pressed members of the economy whose needs are most urgent.
The great increases in Federal spending have reflected in p art a
growing role for Government in general relative to private activity
in the economy, and in part a shift in the magnitude of Federal activity
relative to other Government units. These changes are described and
analyzed in detail by Fabricant. We shall do no more than set forth
some of his data which measure them.
6 See Kendrick, op. cit., pp. 31-36.
68
ECONOMIC GROWTH AND STABILITY
T a b l e I I .— Some measures of the changing role of governments since 1900
Expenditures
(billions)
Purchases
(billions)
1949
1903
1903
E m ploym ent
(thousands)
1900
1955
1949
$0.6
1.1
$36.2
23.6
$0.2
.6
$46.7
30.1
312
852
3,608
3,478
1.7
59.8
.8
76.8
1,164
7,086
4
20
4
12
R atio of to tal of to ta l governm ent to to tal
Sources: Solomon F ab rican t, T he T ren d of G overnm ent A ctiv ity in th e U n ite d States Since 1900, N ational
B ureau of Economic Research, 1952; 1955 figures from Economic R eport of the P resident, 1957. F or a sim ilar
a tte m p t a t m easurem ent, see R . A. M usgrave an d J. M . C ulbertson, The G row th of P ublic E xpenditures
in th e U n ited States, 1890-1948, N ational Tax Journal, June 1953.
E
v o l u t io n
of t h e
F
ederal
R
evenue
S tructure,
1790-1956
Table I I I presents the general magnitudes and composition of Fed
eral revenues for the same time periods used for expenditures. Since
revenue growth has roughly paralleled that of expenditures, we will
not devote separate attention to comparisons of tax levels with output,
population, or prices. Our concern will be with some of the influences
on revenue development, and its implications.
T a b l e I I I . — The Federal revenue Structure, 1790-1956
Average annual tax revenue
Period
N um ber
of years
Custom s
Income
and
profits
Land
sales
O ther
O ther
T otal
T otal
M illions of dollars
1790 to
1812 to
1816 to
1837 to
1862 to
1866 to
1891 to
1811________
1815_______
1836________
1861________
1865________
1890________
1916........ ......
22
4
21
24^
4
25
26
9.3
9.5
22.8
35.8
121.0
200.0
235.0
(')
(3)
(3)
522
512
« 15
a 0.4
* 2.9
4.8
71.0
136.0
245.0
9.7
12.4
23.6
35.8
213.0
348.0
495.0
0.3
1.1
4.1
3.5
1.0
6.0
7.0
0.1
.4
.2
1.4
9.0
4.0
15.0
10.1
13.9
27.9
40.6
223.0
358.0
517.0
0.2
.5
.6
1.0
2.0
3.2
4.3
4.8
35.0
Billions of dollars
1917 to
1920 to
1930 to
1942 to
1946 to
1919................
1929___ ____
1941________
1945________
1956......... ...
3
10
12
4
11
0.2
.0
.3
(J)
1.0
1.9
2.3
8 2.7
8 29.0
M6.0
0.9
1.0
1.2
5.0
9.0
3.0
3.8
4.2
34.0
55.0
0)
C)
0)
(7)
(’)
57.0
3 T ax on ban k dividends, 1796-1802—no separate data.
2 Levied 1791-1802 only.
3 Tax on ban k dividends yielded ab o u t $0.1 million annually, 1815-18.
* Levied 1814-17 only.
s Levied 1863-72 only.
* Beginning 1910.
7 Less th a n significant m inim um a t th is level of rounding.
* Includes social-security taxes for old-age an d unem ploym ent insurance.
N otes .—T otals are n et of refunds, b u t custom s an d lan d sales include certain related fees.
Sources; See end of paper.
Choice of Federal revenue sources, within the limits imposed by
the Constitution, has always represented a compromise between the
political problem of distributing the burden, the administrative prob
lem of collection, and the economic problem of the size and stability
ECONOMIC GROWTH AND STABILITY
69
of the revenue source. In the early 19th century the tariff met these
needs to a higher degree than other feasible taxes, and served as the
main, or, in many years, the only source of tax revenue. Hamilton’s
excise program was widely disliked. Objection to the whisky excise
(even then the chief revenue producer) came from the large number
of small western farmers who relied on the still to furnish a readily
marketable cash crop. Thomas Jefferson regarded it as a major
achievement of his presidency that all the internal taxes were term i
nated and exclusive reliance placed on the tariff. This was preferred
because of its relative invisibility to consumers, because some protec
tionist sentiment already existed, and because it was levied at one of
the few points in the economy where transactions in money pre
dominated.
Extensive reliance on the tariff had several important implications.
F irst, because of the waxing and waning of effective protectionist
sentiment, tariff rates were likely to be determined partly for reasons
unrelated to revenues and expenditures. Second, the money-flow
effects of tariff changes were ambiguous. Higher rates would tend to
lower money incomes by diverting more money to the Government
(assuming expenditures unchanged), but this might be offset by a
shift in private expenditures from imported to home products. Third,
the tariff proved a poor revenue source during wars, which usually
interfered with trade. Fourth, revenues from the tariff (and from its
chief supplement before 1860, sales of public lands) were very sensi
tive to economic fluctuations. In periods of recession, imports usually
fell sharply, cutting revenues, and resulting in deficits since expendi
tures were reduced only gradually. This gave the Federal fiscal sys
tem a degree of “built-in flexibility.”
D uring the Civil War, a comprehensive program of excise and
related taxes was reinstituted. Many of these were repealed at the
end of the war, but taxes on tobacco products and alcoholic beverages
were retained, and furnished a large share of Federal revenues down
through World W ar I. The liquor producers were no longer numerous
enough nor able to muster sufficient sympathy to escape taxation.
The Civil W ar also brought the first Federal income tax, but this was
repealed in 1872.
Tariff controversy over protectionism continued in the post-1865
period, with the protectionists generally having more success than
in prewar years. They suffered an embarrassment of riches in the
1880’s, when revenues rose rapidly at a time when it was difficult to
retire much of the Federal debt. The solution, as noted above, was
chiefly a great increase in pension spending.
The revenue pattern of the post-Civil W ar period, with its heavy
reliance on indirect taxation, probably produced a regressive incidence
of burden. However, it was generally favorable to saving and invest
ment while bearing relatively hard on consumption. The excise taxes
demonstrated more stability of yield in economic fluctuations, and
thus reduced the degree of automatic flexibility.
The progressive era and World W ar I worked a revolution in
Federal revenues. A constitutional amendment opened the way for
a personal income-tax law in 1913, while a tax on corporation profits
was imposed in 1910. The war emergency brought drastic increases
in rates, and the income and profits taxes leaped into the dominant
position which they have held ever since. During the war, the
70
ECONOMIC GROWTH AN© STABILITY
personal tax approached the character of a mass tax, but the subse
quent exemptions restored it to the status of a tax on the wealthy
minority, which it remained, with modifications, until W orld W ar II.
D uring the depression, tax rates were drastically increased, in direct
contravention of modern fiscal thinking. The increases offset in con
siderable measure the beneficial effects of increased expenditures.
The principal innovation of permanent significance came in. the socialsecurity program, which imposed wage and payroll taxes. By 1956
these taxes (including State payments into the Federal Treasury)
accounted for more than 10 percent of Federal revenue.
Revenues from personal and corporate income taxes have continued
to dominate the Federal revenue structure during the past decade.
In recent years, the personal tax has alone furnished about two-fifths,
and the corporate tax about one-fourth, of Federal revenue. Excise
taxes have yielded about one-sixth. Public policy toward the tariff
and the public lands has lost any relation to Government revenues.
A number of circumstances influenced the rapid shift from indirect
to direct taxation. Necessary prerequisites were the rise of the cor
poration as the dominant form of business organization, the shift
in the labor force toward occupations paying money incomes for
services, and a relatively high degree of efficiency in administration
and of voluntary compliance by the public. Probably current levels
of personal tax collection would be difficult without withholding at
the source. There have also been changes in effective public opinion
on the subject of proper tax burdens, but these are not as easy to
trace as the development of actual tax policy m ight suggest.7 Prob
ably more important has been the changing political potency of highversus low-income groups.
A t present the Federal tax burden is much more progressive with
respect to income than it was in the latter p art of the 19th century.
This probably also means th at it falls more heavily on sources of
funds for saving and investment (not assumed to be identical), what
ever the effects on incentives. The present system also possesses a
relatively high degree of automatic flexibility in response to economic
fluctuations. This flexibility is more significant than th at of the 19th
century because of the larger absolute level of tax revenues.8
T
he
P
a tter n of
F
is c a l
P
o l ic y a s a
W
hole
Modern income analysis has thrown much more attention on the re
lation between the total money flow into and out of the Government
and the level of national money income. Analysis of fiscal policy
has given particular emphasis to two situations: wars and depressions.
In wartime, Government fiscal policy may be excessively inflationary,
whereas in depressed times an upward influence on incomes and spend
7 There w as considerable sentim ent favoring progressive rate structure in the early 19th
century, and the Federal direct tax of 1798 imposed a progressive rate on real property.
8 Recent attem pts to measure the flexibility of the revenue system indicate th a t the
decrease in Federal cash receipts would range between 20 and 35 percent of any decline in
gross national product. The effect on private spending for consum ption and investm ent
would probably be less, especially where the corporate tax is involved. See E verett E.
H agen, Federal Taxation and Econom ic Stabilization, Federal Tax P olicy for Econom ic
Growth and Stability : Papers Submitted by P anelists, Join t Committee on the Economic
Report, W ashington, 1955, pp. 5 8 -6 0 : papers and comments by David W. Lusher, Samuel
M. Cohn, Gerhard Colm, A. G. H art, Joseph A. Pechman, Richard Goode, Ida C. Merriam,
and K arl A. Fox in P olicies To Combat Depression, N ational Bureau of Econom ic Research,
New York, 1956.
71
ECONOMIC GROWTH AND STABILITY
ing is desired.
historically.
We will examine each of these aspects of fiscal policy
Fiscal policy in wartime—Deficits and infiation
During the period under study, the Federal Government engaged
in four major wars. In table IV are summarized some of the im
portant aspects of aggregate fiscal policy in these periods. The data
indicate that substantial deficits have been the rule, although revenues
as well as expenditures have usually been higher than before the
war. In no case did the Government succeed in covering as much
as half of its expenditures by current revenues. Further, each of
the four wars was a period of substantial price inflation. The figures
suggest some improvement in recent times, but the price figure for
World W ar I I probably overstates the value of the dollar (because
of quality deterioration, shortages, etc.) and does not take account
of continuing price increases after 1945.
T a b l e IV . — Federal fiscal policies and wartime inflation
Expenditures
Period
Average reve
nues
Average
1812 to
1862 to
1917 to
1942 to
1815...
$14,000,000
1865...
223,000,000
1919... 3,200,000,000
1945... 35,000,000,000
$30,000,000
727,000,000
11,000,000,000
76,000,000,000
R atio to R atio to
average of
gross
prew ar 5 national
years
product
300
1,100
1, 570
800
3- 5
10-14
17-18
40
Share of
gross
national
product
taken by
L/nited
States
2- 4
9-11
14-16
38
Increase in prices over
last prew ar year
W holesale
prices
50
100
60
35
Consumer
prices
75
60
30
N ote .—C alendar years 1812-15; fiscal years ending June 30 thereafter.
Price d a ta are those of B ureau of L abor Statistics, including unpublished consumer price da ta for C ivil
W ar. C alculation is based on an n u al averages for calendar year and results are rounded. Published da ta
are from H istorical Statistics of th e U nited States an d Federal Reserve B ulletin.
The four wartime periods have differed considerably in the propor
tion of expenditures covered by revenues, and in the general magnitude
of Federal operations. The Federal Government’s absorption of re
sources during the W ar of 1812 was less than 5 percent of the Nation’s
output, whereas W orld W ar I I required about 40 percent.9 The
Civil W ar appears to have involved a smaller share than W orld W ar
I, but this result is questionable, since our figure compares Federal
(northern) purchases with total national output. As a percentage of
northern output alone, Federal purchases would probably have
amounted to about 15 percent.
_Although abhorrence of debt was a fairly constant factor in peace
time fiscal policy, Government officials were relatively tolerant in their
attitude toward wartime deficits.10 There was no recognition of the
9 The inflation during the War of 1812 w as com pletely out of proportion to the expan
sionary force of Government deficit spending. In part, it reflected additional credit crea
tion by the banks, but chiefly it resulted from the drastic dislocation of international and
interregional trade by both American and B ritish policies. Prices of imported products
rose far more than those produced at home.
10 Albert G allatin’s maxims undoubtedly helped strengthen a tendency in fiscal policy
which would have existed anyway. In 1807 he argued th at “the losses and deprivations
caused by * * * war should not be aggravated by taxes beyond w hat is strictly necessary.”
Loans should be the chief source of funds, w ith increases in taxation only sufficient to
cover “the annual expenses on a peace establishm ent, the interest on the existin g debt, and
the interest on the loans which may be raised” (American State P a p e r s: Finance, II, 248).
H alf a century later Secretary Salmon P. Chase advocated the same program for Civil War
finance.
72
ECONOMIC GROWTH AND STABILITY
function of taxes to curb excessive private spending. The chief ar
gument for them was that they would improve the Government’s
credit standing by assuring a secure basis for interest payments and
debt redemption.11
While 19th century officials ignored the inflationary consequences
of deficits per se, they were not indifferent as to the manner in which
the deficits were financed. Efforts were usually made to cover them
through loans, but these were never sufficient. During the W ar of
1812 the Treasury issued interest-bearing Treasury notes which were
designed to circulate as a close substitute for currency. D uring the
Civil W ar, the Government created the first Federal paper currency
to become a permanent p art of the Nation’s monetary system. H alf a
million dollars of paper currency was issued, which directly covered
about one-fifth of the total deficit, and also made it easier to finance
the rest by borrowing back some of the currency. But in addition to
these actual issues of currency or near-currency, the wTar loans drew
heavily on expanded bank credit in notes and deposits, which also
increased the money supply. Although official understanding of the
inflationary nature of monetary expansion was not lacking, there was
a strong tendency to concentrate on the maintenance or resumption of
convertibility into specie, assuming that prices and other economic
factors would automatically achieve satisfactory levels.
The crude device of direct currency issues on a large scale has been
rendered obsolete by the establishment of the Federal Reserve System.
During W orld W ar I, sale of Federal securities was facilitated by the
expansion of Federal Reserve credit in rediscounts and loans to banks.
Individuals and business firms wTere encouraged to borrow from banks
in order to buy war bonds, and banks themselves purchased substan
tial amounts. During W orld W ar II, the Federal Reserve itself pur
chased large amounts of securities in the open market, enabling the
banks to purchase a still larger quantity with the resulting reserves.
In every war, except th at of 1812, the Government made substantial
efforts to achieve wide distribution of ownership of wTar securities
among individuals. In general, however, wartime borrowing has
been chiefly a disguise for money creation. I t is not obvious th at the
issue of interest-bearing securities which do not serve to divert funds
out of private spending is really the most rational technique of war
finance.
One of the first fruits of national income analysis wTas the better
recognition during W orld W ar I I of the merits of high taxes in curb
ing inflationary pressures, as well as of the dangers which inflation
might entail. This improved attitude towTard taxation was also very
much in evidence during the Korean emergency.
W artime fiscal policies provide most of the direct historical evi
dence available about the potential effects of Federal deficits in raising
national money incomes. Interpreting the evidence is complicated,
however, by the association of deficits with money creation. One
cannot disprove the arguments of convinced adherents of the quantity
theory of money that it is the latter which really provides the expan
sionary push.
“ See H enry C. Adams, Public Debts, 1888, p. 119.
73
ECONOMIC GROWTH AND STABILITY
Fiscal policy and economic -fluctuations
The history of the American economy from 1790 to 1945 is a his
tory of considerable instability in production, employment, prices, and
incomes. Even in the agrarian days before 1860, wide fluctuations in
farm prices on international markets, combined with the inevitable
burden of farm debt, created widespread periodic farm distress to be
added to the unemployment in the less developed construction and
manufacturing sectors of the economy. Nineteenth century fluctua
tions stemmed in p art from the balance of international payments,
through changes in foreign demands for American goods and in the
flow of foreign capital to this country. To these influences were added
an unsound banking system, which received most of the blame, and a
pattern of investment in fixed capital which was very unstable.
Table V shows in briefest outline the behavior of Federal surpluses
and deficits during seven major business-cycle peaks and recessions.
In each case there is a strong correspondence between fiscal policy and
the phase of the cycle. W ith one exception, the Government shifted
from a position of surplus at or before the peak to one of deficit during
the recession. The one exception was in the high-surplus times of
the 1870‘s, and then the surplus dropped off sharply in recession.
This pattern was largely imposed on the Government by declining
revenues in recession.
T a b l e V.— Federal surpluses and deficits during major cycle peaks and recessions,
18 15 -19 3 2
(Surplus or deficit ( —) e x p re s s e d a s p e r c e n t of a v e ra g e r e v e n u e a n d e x p e n d it u r e d u r in g t h e in c l u d e d cy c le ]
Period
1815-21
1 ________________________
2 ________ ____ ______ __
3____ __________ ______
4 (peak )__ ____
......
D------- ------ -----------------6___________ ____ ________
' ----------------------------------
63
67
40
6
12
-5
-1 0
1834-42
12
65
83
—132
5
12
-1 9
-3 0
-2 3
1854-60
1870-76
1890-96
1904-11
1926-32
32
12
16
3
-4 2
-2 7
-1 5
36
29
34
18
8
5
8
30
13
4
3
-2 0
-1 3
-1 1
-9
-6
4
12
-1 2
-1 7
-3
29
32
27
26
25
-2 9
-8 2
Average revenue and expenditures
M illions cf dollars-.. _____
Fercent of gross national
p ro d u c t________ _______
24.9
29.4
61.8
316
335
589
3,400
1-2
1-2
1-2
4-5
2-3
2-3
4-5
N o t e — D a t a for 1834-37 a r e o n le f t s id e , 1838-42 o n r i g h t s id e o f t h e c o lu m n fo r 1834-42, sin c e b o t h 1837
a n d 1839 a re r e g a r d e d a s p e a k y e a rs .
When deficits resulted, they were usually financed through borrow
ing from banks, drawing on Federal cash balances, or issuing more
currency or near-currency. Consequently .they probably exerted some
cushioning effect during recessions. I t is not certain that surpluses
exerted any check during boom periods, however, since repaying the
public debt often channeled funds into an active capital market where
they were in demand.
The cushioning effect of Federal deficits was limited by the tend
ency to cut Federal expenditures in response to declining revenues
during 19th century recessions. However, expenditures were actually
increased in the recession following 1907, chiefly for naval expansion.
74
ECONOMIC GROWTH AND STABILITY
And in the years following 1929, spending rose through programs
aimed at the economic slump itself.
In all cases except possibly th a t of post 1929, the magnitude of Fed
eral deficits relative to total GNP was so small as to render their pos
sible income effects insignificant.
_
Contemporary official opinion disapproved of depression deficits,
but generally tax rates were not increased to do away with them.
The tariff increase of 1842 is somewhat of an exception, and a clearer
exception was another tariff increase of 1875. In both cases, however,
the increases were desired for protectionist as well as revenue purposes.
Further, their effect on national money income was not necessarily
deflationary. We conclude th at tax increases did not im pair the ex
pansionary effects of Federal deficit spending in pre-1929 depressions.
The case of the recession years following 1929 is drastically differ
ent. Although minor tax reductions were made in 1930, in 1932 a
Democratic House joined a Republican Senate and President Hoover
in enacting the largest peacetime tax increase in history. This meas
ure cut substantially into the beneficial effects of the increased Fed
eral spending. We shall return to this shortly.
Public opinion in and out of the Government has always been
painfully aware of economic depressions and articulate in search of
a cure. But throughout the 19th century and well into the 20th, the
discussion of the causes and possible remedies ran heavily in terms
of money and the banking system. Emphasis in fiscal theory was
placed on the monetary effects of Federal surpluses and deficits,
rather than their direct relation to income flows.12
Nor was Treasury concern with money and banks merely a m atter
of thinking and talking. From the time of Hamilton, Treasury offi
cials used their discretionary authority over the public debt and the
Government’s cash balance as methods of trying to alleviate depres
sions, panics, and stringencies. A fter the Civil W ar the Treasury
was intimately concerned with this at all times, until the formation
of the Federal Reserve System.13 When an occasional insight into
the potential benefits of depression deficits did appear, it was usually
accompanied by constitutional scruples against such action.14
Fiscal policy artd depression, 1929-Jfi
The management of Federal fiscal policy during the depression is
still interesting and relevant to contemporary affairs. Numerous er
roneous views about it still prevail. The student of stabilization pol
icy must be especially concerned with two common assertions. One is
12 Considering the relative m agnitudes Involved, th is w as perhaps the correct em phasis.
In the years 1846-60, for instance, Treasury transactions were carried on chiefly in specie,
and the scale o f absorptions and releases of specie by the T reasury made a much larger
im pact on bank reserves than did fiscal policy on incomes. I have quoted some relatively
sophisticated theories of th is m onetary relationship by contemporary w riters both in and
out of Government in The Idea of “Biuilt-In F lexib ility,” 1837-60, P ublic F in an ce/F in ances
Publiques. X I : 4, 1956.
18 See E sther Rogoff Taus, Central Banking Functions of the United S tates Treasury,
Columbia U niversity P ress, New York, 1943.
14 In face of declining revenues during the panic of 1857, Secretary of the Treasury
H ow ell Cobb wrote, “I t is seriously urged th at our expenditures should be increased for the
purpose of affording relief to the country. Such a policy would undoubtedly furnish
employment to large numbers of w orthy citizens. I t would require the use of large
am ounts of money, to be raised either by a loan or * * * Treasury notes, and would thus
afford temporary relief to the country to an exten t lim ited only by the discretion of the
Government * * *. B ut where shall w e look for the power to do th is in the Constitu
tion ?” Cobb did urge th at expenditures not be reduced, even if deficits had to be incurred.
Annual Report oh the S tate of the Finances, 35th Cong., 1st sess., H. Doc. No. 3, p. 11.
P resident Buchanan endorsed the principle of expenditure m aintenance, and the extent of
reductions w as slight.
75
ECONOMIC GROWTH AND STABILITY
that such New Deal measures as agricultural supports, the NRA, the
National Labor Relations Act, social security, the wage-hour law, and
monetary and banking reforms restored the country to prosperity.
The second, from a different quarter, is that the New Deal was an em
bodiment of Keynesian doctrine, th at it engaged in large-scale deficit
financing, and th at the evident failure to cure the depression proves
that deficit spending won’t work.
Table V I summarizes some of the important economic magnitudes
of the depression years.
T a b l e V I. — S ta tis tic a l background o f th e great depression
Consumption
Calendar year
1929___ ____ _
1930___________
1931..................
1932____ _____
1933___________
1934...___ _____
1935_____ ______
1936___________
1937___________
1938___________
1939___ _______
1940......... .............
Fiscal year
1929...............
1930...............
1931...............
1932...............
1933-............
1934___ ____
Gross
national
product
Output
in 1929
prices
Total
As percent
of dis
posable
incomes
BiUions
Billions
Billions
Percent
$104
91
76
59
56
65
73
83
91
85
91
101
$104
95
88
77
73
80
90
100
108
102
110
120
$79
71
61
49
46
52
56
63
67
65
68
72
Federal
revenues
Federal
expendi
tures
Deficit C— )
or surplus
Billions
Billions
Billions
$3.8
4.0
3.2
2.0
2.1
3.1
$2.9
3.1
4.1
4.8
4.7
6.5
$0.9
.9
-1 .0
-2 .7
—2. 6
—3.3
95
95
96
101
101
100
96
95
95
98
96
94
Fiscal year
1935...............
1936..............
1937...............
1938...............
1939...............
1940—
Gross busi Govern
ness in
ment pur
chases
vestment
Percent
of labor
force un
employed
Billions
Billions
Federal
revenues
Federal
expendi
tures
Deficit (—)
or surplus
Billions
Billions
Billions
$13.0
8.0
4.0
.3
1.0
2.0
5.0
7.0
10.0
5.0
7.0
10.0
$3.8
4.2
5.6
7.0
6.6
6.9
$9
9
9
8
8
10
12
12
12
13
13
14
$6.3
7.6
8.4
7.2
9.4
9.6
Percent
3
9
16
24
25
22
20
17
14
19
17
15
-$2.4
- 3 .5
- 2 .8
-.1
- 2 .9
- 2 .7
Sources: Economic Report of the President, 1956; Department of Commerce, National Income, 1954;
Historical and Descriptive Supplement to Economic Indicators, 1957.
The late 1920’s were years in which, under the influence of the
stock-market boom, industrial capital equipment was built up at a
rate which could only have been sustained if total expenditures for
goods and services increased more rapidly than they could be ex
pected to. Once actual expansion ceased, as it did in the summer of
1929, business needs for additional capital goods fell. And when de
mand for output began to fall, many firms found themselves with ex
cessive capital. The downswing was a reciprocal process in which
business investment and personal consumption spending kept pushing
each other further down. By 1932 business investment had nearly
ceased altogether.
The figures indicate that the decline in consumer spending was
wholly induced by declining incomes—in fact consumers spent a larger
proportion of their incomes than in prosperous times. Much of the
decline in investment can also be regarded as induced by falling de
mand. The reluctance of consumers to cut their spending in proper
76
ECONOMIC GROWTH AND STABILITY
tion to their incomes—in fact, their willingness to spend more than
their disposable incomes in 1932-33—probably did the most to pre
vent the decline from continuing further.
The Hoover administration was not indifferent to the distress
around it. In fact, the President spoke truthfully when he as
serted in 1931 that—
for the first time in history the Federal Government has
taken an extensive and positive part in mitigating the effects
of depression and expediting recovery.13
Emergency agencies were created; innumerable conferences were held.
More important, Federal expenditures were increased substantially,
with particular emphasis on construction. The Government had
started from a position of substantial surplus, and for a time could
spend more without a deficit. In combination with declining rev
enues, however, this increase produced large deficits in fiscal 1932 and
1933—larger on the average, in fact, than those of the 6 subsequent
years of the New Deal. The deficits alarmed the President, and dur
ing the last 2 years of his administration he manifested a concern
for cutting expenditures and increasing tax revenues which amounted
to an obsession. This concern stemmed in part from a conviction
that deficits were economically harm ful .16 Unfortunately for the
Nation’s economy, most respectable opinion shared this view. Con
sequently Congress enacted in 1932 a substantial increase in income and
excise taxes.
Hoover’s defeat and the advent of the NewTDeal in 1933 opened the
way for a drastic reorientation of Federal functions, but this did not
extend to fiscal policy.
Our statistics drive home two important facts: First, the New Deal
did not get the country out of the depression. Average annual ememployment did not fall below 14 percent in the years 1933-40 and
was still 1 0 percent in 1941. Second, the New Deal did not engage
in large-scale deficit spending. Federal expenditures rose substan
tially, but wyere matched by higher taxes. The experience of the
1930’s gives us little evidence of the potential effectiveness of deficits
in depression. The rapid expansion of output and unemployment
under the stimulus of large deficits in World W ar I I are much more
indicative of their potential power.
There is ample evidence that President Roosevelt largely shared the
fiscal views of his predecessor. During the campaign in 1932 he
criticized Hoover for incurring deficits and promised to wipe them
out through economy. Upon inauguration he took steps to reduce
15 W illiam S. Myers and W alter H. Newton, The Hoover Adm inistration : A Documented
N a rra tiv e Charles,Scribner's Sons, New York, 1936, p. 20.
16 In 1932 he stated that “it Is generally agreed th a t the balancing of the Federal budget
and unimpaired national credit is indispensible to the restoration of confidence and to the
very start of economic recovery * *
Quoted In Jam es A. M axwell, F iscal Policy,
Henry Holt, New York, 1955. p. 13. For a history and an alysis of th is and related Ideas,
see Jesse V. Burkhead. The Balanced Budget, Quarterly Journal of Econom ics, May 1954,
reprinted in Arthur Sm ithies and J. K eith Butters, eds., Readings in F iscal Policy, Bichard
1). Irwin, Homewood, 111., 1955; Sidney S. Alexander, Opposition to D eficit Spending for
ih e Prevention of Unemployment in Income, Employment, and Public P o licy : E ssays in
Honor of Alvin Hansen, W. W. Norton, New York, 1948.
ECONOMIC GROWTH AND STABILITY
77
Government salaries and veterans’ pensions. In his budget message
of January 1934, he stated :
we should plan to have a definitely balanced budget for the
third year of recovery and from that time on seek a continuing
reduction of the national debt.
Taxes were increased in every year from 1933 through 1937. The first
agricultural adjustment program was financially based on a wickedly
regressive processing tax, rather than deficits. The social security
system was set up with a strongly deflationary reserve provision and
a regressive tax-rate structure. New Deal deficits were, through 1937,
the inadvertent and undesired result of expenditures undertaken for
their own sake.17
President Roosevelt did not see the depression as a problem of inade
quate spending, but rather of undesirable price declines. In aiming
his recovery measures chiefly at prices, he failed to distinguish be
tween higher prices as a symptom of strong demand and as a symptom
of short supply. His administration also interpreted the depression
largely in terms of the particular problems of particular distressed
sectors, without perceiving their common difficulty. In consequence,
the emphasis of the so-called “recovery” program was on measures
essentially restrictionist in their nature, notably the NRA and the
first AAA. Likewise, the revaluation of the dollar, the National
Labor Relations Act, and the wages and hours law did not bring any
net increase in the total income and spending capacity of the economy
as a whole.
In 1937, expenditure cuts recommended by the President and the
influx of social-security tax revenues reduced the Federal cash deficit
almost to zero. P artly in consequence, the economy fell into a short
but painful and disturbing recession. This finally brought the Presi
dent to accept a positive role for fiscal policy as such, as evidenced by
his “spend-lend” program and budget message of January 1939, and
expenditure increases restored the cash deficit.
On the whole, New Deal fiscal policies made no strong contribution
to recovery.18 Their shortcomings are measured by the slow and
tortuous rise in consumption. Tax increases prevented the rise of
Federal expenditures from p r o d u c i n g any substantial increase in
consumer disposable incomes. Had the latter risen, consumer spend
ing would undoubtedly have gone higher and helped restore business
investment.
Several relevant lessons may be derived from New Deal experience.
Adherents of fiscal conservatism may note that public opinion will not
tolerate Government inaction in the face of depression. Consequently,
if the Government does not do the right things (increasing total
spending), it will probably do the wrong things—things which in
17 “There is no evidence th at the adm inistration, as distinct from some persons w ithin
it and some econom ists offering advice from outside, ever had a conscious interest in fiscal
policy as an instrum ent of recovery prior to the new depression in 1938. Government
spending w as primarily for relief and was regarded only as the unavoidable accompani
ment of unemployment until recovery could be achieved by other m eans.” John H. W il
liams. The Im plications of F iscal P olicy for Monetary Policy and the Banking System,
Papers and Proceedings of the American Economic System March 1942, reprinted in
Rf'-idines in F iscal Policy, pp. 190-191.
18 This is the conclusion reached by E. Cary Brown, F iscal Policy in the Thirties : A
Reappraisal, American Economic Review, December 1956. Compare the more favorable
view reached by Gerhard Colm, Public Spending and Recovery in the United States,
abridged from Social Research, May 1936, in his E ssays in Public Finance and Fiscal
Policy, Oxford University Press, New York, 1955.
97735— 57-------7
78
ECONOMIC GROWTH AND STABILITY
crease Government intervention in detailed production, price, and
income decisions, or which give favored groups protection from the
rigors of competition and change. Deficit spending may appear more
attractive as an alternative to these. Latter-day liberals may be re
minded that good intentions are not sufficient to produce good policies,
even if wrapped in the finest rhetoric. And one should not accept
uncritically the whole panoply of New Deal measures on the assump
tion that they really restored the economy to a prosperous condition.
However, in all fairness, we must point out that many New Deal meas
ures, while ineffectual in curing the depression of the 1930’s, have
become im portant parts of our defense against any future depression.
This refers particularly to the structural reforms of the banking and
financial system and to the automatic flexibility latent in the social
security and agricultural programs.
Recent developments and contemporary problems
Fiscal policy since 1940 has been marked by a much higher degree
of rationality than before, particularly since the Employment Act of
1946. The performance of fiscal policy, as measured by the mainte
nance of high production and employment, has been good. Recessions
have been mild and have been met with appropriate responses in tax
and spending policies. Closer examination may leave us uncertain as
to what this experience proves, however.
F irst, high levels of demand in recent years have reflected continued
high Federal defense spending and a relatively unflagging rate of
business-capital formation. There has been no practical demonstra
tion of what fiscal policy could do to reduce the adverse effects should
either of these decline substantially.
Second, the good performance of fiscal policy in offsetting recessions
has been partly good luck. This is notoriously evident in the case of
the tax reduction of 1948, passed over a Presidential veto in the last
stages of inflation, to go into effect just as the economy was sliding into
unforeseen recession. More favorable in appearance was the willing
ness of the Republican administration to reduce taxes and incur
deficits during the recession of 1953—but the recession itself stemmed
largely from cuts in defense spending.
Third, fiscal policy has shown much less capacity for curbing infla
tion. This partly reflects the political difficulty th at counterinflation
measures reduce people’s access to money and are therefore likely to
be unpopular. B ut there are other limitations. I t would have been
undesirable to increase taxes in World W ar I I sufficiently to drain
off inflationary demands, although more could probably have been
done safely than was. The Korean emergency indicated th at fiscal
policy probably cannot cope with a sudden outburst of private scare
buying, although the flexible tax structure undoubtedly absorbed some
of the pressure, and tax-rate increases were admirably strong.
Most recently, the outbreak of the “new inflation” in the last 18
months has raised the disturbing possibility th at some inflation may
come from costs rather than excessive demand. The actual importance
of the Federal budget itself as an inflationary force in this period
remains unclear, although it is easy to find fault with the view that
the cash budget cannot be inflationary unless it shows a deficit. The
proper role of fiscal policy in such an inflation is also unclear—can
price increases be prevented by curtailing demand without producing
ECONOMIC GROWTH AND STABILITY
79
too much unemployment and loss of output ? The contemporary chal
lenge to fiscal policy seems to lie in the problem of inflation controlj
and particularly in controlling the expansion of Federal spending in
the face of many legitimate demands and needs for increases.19
F
is c a l
P
o l ic y
and
E
c o n o m ic
G
row th
The relation between fiscal policy and economic growth takes many
forms. Obviously Government functions and activities such as re
search, public capital formation, health and education programs, etc.,
can actively promote growth. This discussion will deal only with
aspects which pertain to fiscal policy as a whole. Two chief types of
influence can be distinguished. On one hand, a fiscal policy which pro
motes economic stability, high incomes and demands, and relatively
full employment will undoubtedly help to stimulate the incentives of
business firms to invest and to innovate .20 But we have no real his
torical evidence on this as yet.
Fiscal policy can also influence the availability of funds for invest
ment. Historically the important influences have been the tax struc
ture and public-debt policy. The tariff-excise combination of the
19th century probably placed the burden prim arily on consumption.
The shift to personal and corporate income and profits taxes has un
doubtedly increased the relative burden on saving, and through it, on
investment. Probably the most serious aspect of this has been the dis
advantage imposed on the investment capacity of small, growing firms.
One’s judgment on the relative loss to aggregate investment must cer
tainly be conditioned by the enormous volume of capital formation
whicla the economy has generated in the past decade.21
Public-debt policy may also exert a substantial influence on the
volume of investable funds. Historically, Federal borrowing lias
generally occurred during periods of war or depression and has in
variably drawn to a large extent on newly created money or idle
balances, instead of diverting funds from private capital formation.
Debt retirement, however, has generally occurred in prosperous times,
when the demand for funds has been high for capital formation. Debt
retirement has commonly placed funds in the hands of wealthy in
dividuals and financial institutions, so that they were likely to move
into other investments rather than consumption.
Together, the revenue and public-debt policies of the 19th century
probably exerted an influence in the direction of “forced saving,”
diverting funds out of consumption into investment. However, the
Government’s revenues from land sales removed some funds from the
capital market.
A rough estimate, making allowance for issue and redemption of
currency and near-money, suggests that Federal finance shifted about
19 An excellent brief review of the period since 1930 is given in Gerhard Colm, Fiscal
Policy and the Federal Budget, in Max M illikan, ed., Income Stabilization for a Developing
Democracy, Yale University P ress, New Haven, 1953, pp. 214-227. On the postwar period,
see also A lvin H. Hansen, The American Economy, McGraw-Hill, New York, 1957, pp.
90-131.
20 One m ust beware of the fallacy in the often-encountered argument that the Govern
ment must promote high consumption (e. g., through taxes which bear more on saving) in
order to stim ulate (induced) investm ent. Any kind of spending for the products of a
capital-using firm can stim ulate induced investm ent, and consumption may actually do
so less than some other possible types. A high-consumption economy may be desirable, but
hardl^ because it w ill produce a high rate of output growth. I t is a high-demand, fullem ployment economy generally which is desired.
21 On these m atters, see papers by R. A. Musgrave, J. K . Butters, and P aul W. McCracken
in Federal Tax P olicy for Economic Growth and Stability.
80
ECONOMIC GROWTH AND STABILITY
$80 millions into the capital market from consumption in 1790-1860,
most of it representing redemption of securities for which the Govern
ment received no money originally. During the period of heavy
postwar debt retirement in 1866-90, about $600 million was so shifted,
but in the period 1891-1916, the Government was a net borrower of
about $250 million.
During the 1920’s, the Government poured some $9 billion into debt
retirement, but the reduction in saving through progressive taxation
may have been equally large. A fter W orld W ar II , net cash debt
retirements in 1947-52 totaled about $30 billion. Most of this passed
through commercial banks and insurance companies (directly, or in
directly through shifts in remaining debt) into other financial assets
and thus into the capital market .22 Again, the adverse effect of taxa
tion on saving may nave offset this. But one should certainly not look
merely at that adverse effect without noting th at the debt retirement
may have offset it.
S
ome
C
onceptual
P
roblem s
U
n d e r l y in g
H
is t o r ic a l
A
n a l y s is
The characteristic analysis of fiscal policy runs in terms of such
aggregates as revenues, expenditures, surpluses and deficits. Defini
tions and computations of these have traditionally been determined
by the information needs of government officials, which have not al
ways coincided with the interests of economists.
One approach to fiscal data would follow the conventions of national
income accounting. Government revenues and expenditures would
be those included in the income and product accounts as computed by
the Department of Commerce.23 This particular compilation has sev
eral possible drawbacks. I t gives taxes on the basis of accruals rather
than collections, and it omits certain transactions which seem to fall
economically in between income and product at one extreme and pub
lic debt at the other. These are mainly Government lending and re
payment, and in the past, transactions in land. These drawbacks do
not exist in the cash consolidated statement of receipts from and pay
ments to the public which currently appears in the annual budget
document. The figures used in this paper come closer to the latter
basis of calculation.
Use of the term “cash” in the latter case is somewhat misleading—
“current account” would be more nearly correct. A genuine cashconsolidated account for the Government is found in the money-flow
analysis developed by Morris Copeland and now published by the
Federal Reserve Board of Governors.24 This approach has the advan
tage of incorporating public-debt policy, which may be significant
even for short-term fiscal interpretations. I t is generally assumed,
for example, th at a cash surplus is deflationary, but if the funds are
used to repay publicly held debt in prosperous times, when the funds
find their way promptly into private spending, the conclusion may be
unwarranted.
31 See data In Federal Reserve Bulletin. August 1953, pp. 857, 865, 874.
28 See N ational Income, 1954, pp. 170-173, for figures on this basis.
*
See particularly their Flow of Funds in the United States, 1939-53, 1955. I have com
puted a set of money-flow accounts for the Federal Government for 1790-1860 which are
In process o f publication by the N ational Bureau of Econom ic Research in a volume of
papers on 19th century economic growth.
ECONOMIC GROWTH AND STABILITY
81
As a rule, added refinements, with their costs in compiling and
complications in using, are only as valuable as the uniformities of
behavior on which they rest. W hat one really wants to know to
analyze fiscal policy is, first, from whom did the money come and
what would those people have done with it otherwise; and second, to
whom did the Government pay it, and what did the recipients do with
it? Variations in the response to one tax or one spending program
may create a degree of indeterminacy which swamps added refinements
in classification.
S t a t is t ic a l S ou rces
and
M
ethods
The “official” figures on Federal receipts and expenditures as pub
lished in numerous Treasury and other documents contain certain de
ficiencies for the economist. In p art these stem from the classifica
tions, which are administrative rather than either functional or eco
nomic. In p art they stem from capricious patterns of inclusion and
exclusion. F or the years since World W ar I, the official figures have
been badly inadequate because of the existence of Government corpo
rations and trust funds whose activities are not accurately reflected by
summary data on receipts and expenditures in traditional form. F or
recent years, the problems have been recognized and met to some ex
tent by the statistical devices noted above. They give data back as
far as 1929, usually. Professor Kendrick has computed cash-consoli
dated expenditures data for earlier years, but they are not ideal for
pre-1900 dates.
The defects in the official data exist for figures all the way back to the
1790’s. One systematic distortion, more important before 1870, was
the lack of conformity between the accounts of the Treasury, which
the official data summarize, and the accounts of the collecting and dis
bursing officers who actually dealt with the public. During the Civil
W ar, for instance, more than $ 1 0 0 million shown by Treasury figures
as spent was actually accumulated in disbursing officers’ balances from
which most of it was disgorged in 1866.
The transactions of the Post Office were also outside the ordinary
Treasury summaries, and while this paper adheres to the convention
of netting postal transactions, it does not imply unqualified approval.
There have also been trust funds and/or Government corporations as
far back as 1796. The security-holding trust fund was extensively
used prior to 1860, with considerable investments being made in State
government bonds. A fter the Civil W ar, this practice largely gave
way to the use of bookkeeping trust funds not involving segregated
accounts, but these gave rise to fictitious transactions in the summary
accounts.
Treasury summary figures make some unsatisfactory inclusions and
exclusions. Their totals for ordinary receipts sometimes include
seigniorage charges and premiums on sale of gold or securities. E x
penditure totals may include debt premiums paid, trust fund or other
security transactions, and tax refunds. They do not showTthe pay
ment of $28 million surplus revenue to States in 1837.
The statistics on receipts and expenditures used in this paper were
compiled in an effort to overcome these shortcomings. They consist
of completed estimates for 1789-1860, fairly close preliminary esti
mates for 1861-90, and a relatively sloppy first approximation for
8 2
ECONOMIC GROWTH AND STABILITY
1891-1916. From th at point I have used Kendrick’s data, which
merge into the contemporary official publications. F or receipts, my
approximations go to 1929.
Estimates through 1890 were constructed on the basis of the annual
Account of Receipts and Expenditures of the United States, published
by the Register of the Treasury. These present in vast detail the data
which are the basis for the summary totals appearing in the Treasury
annual reports. The detail is generally adequate to classify the items
and remove undesirable ones.25
F or the period through 1860, separate financial accounts were com
piled for all Federal agencies carrying on financial transactions.
These were derived chiefly from the annual or other published re
ports of executive departments appearing in the series of American
State Papers or the executive documents of Congress. From all these
was computed a consolidated money-flow account of all transactions
with the public.
F or the period 1861-90, a sampling of sources indicated that the
discrepancies arising out of collecting officers’ accounts were negli
gible. The time lag in expenditures, reflected in changing levels of
disbursing officers’ balances was occasionally important, however.
F or the war period, these balances were ascertained as much as pos
sible from detailed reports. F or the peacetime periods, however,
they were estimated to be a relatively constant and in the long run
declining fraction of transactions.
One major adjustment was imposed on the data for 1862-79. D ur
ing this period the Treasury conducted part of its transactions in
com and part in currency which was substantially depreciated relative
to coin. In order to show all transactions in a common unit, customs
revenues and interest payments (which were made in coin) were con
verted to currency values by multiplying them by the average gold
premium of the year.
F or the years after 1890, estimates were constructed from Treasury
annual reports. F or the entire period 1790-1916, data were adjusted
to exclude tax refunds, interest receipts, sales of Government prop
erty, and certain fictitious trust-fund transactions from both receipts
and expenditures. Revenues from seigniorage and securities issues
were excluded, as were expenditures for securities. The postal ac
count was modified to contain the actual difference between revenues
and expenditures, rather than the payment to or from the Treasury.
The “official” cash-revenue figures for 1929—47 do not show the com
position of revenues. I estimated these to be the same proportion of
totals as the accrual data in National Income, 1954, pages 170-171.
F or the 1948-58 data were obtained from the annual budget documents
for 1950-58. Refunds were excluded, their distribution being roughly
estimated. I doubt that my revenue series is exactly commensurable
with that for expenditures, particularly for 1920-29.
25 Incidentally, it is clear th at the data in Receipts and Expenditures, and therefore in
the Treasury summary tables, reflect w arrants actually paid by the Treasurer (through
1890, a t le a s t), and not m erely w arrants issued, as alleged in the explanations of the
Treasury summary tables. For an explanation, see Secretary B ristow ’s statem ent in 44th
Con?.. 1st sess., Senate Reports, No. 371 (1876), pp. 36-37.
ECONOMIC GROWTH AND STABILITY
83
Other data used in table I were assembled in the following manner.
G N P figures for 1790-1865 were based on my own estimates (expressed
as a range). These were derived by adjusting the estimates of K,. F.
M artin to meet certain conditions suggested by Kuznets .28 F o r pre1861, Federal expenditures are so small that a wide range of inde
terminacy in GNP figures does not change the percentage very much.
F or the Civil W ar period, I made annual range estimates, adjusting
1860 estimates with price data.
For all the data on per capita expenditures in 1926 prices, and for
G N P comparisons after 1865, I adjusted Kendrick’s figures in pro
portion to the discrepancy between them and mine. This somewhat
piratical technique saved me a vast amount of work, and I am most
grateful to the National Bureau of Economic Research for permitting
the use of this material.
*
M artin’s estim ates are given in Studies in Enterprise and Social Progress, National
Industrial Conference Board, New York, 1939, p. 79. See Simon Kuznets, N ational Income
E stim ates for the United S tates Prior to 1870, Journal of Economic H istory, June 1952.
I figured GNP to be 10 to 15 percent above national income.
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