FedralDeficits

Federal Deficits and the National Debt
1791-1929

Part I

What is a Deficit?
A deficit arises when government expenditures exceed the revenues, the government collects mainly through taxes, but customs duties, federal land sales and other fees may also be included. A budget surplus is exactly the opposite, it arises when government revenues exceed expenditures. Our national debt, the debt incurred by the federal government, which is approaching eight trillion dollars, is the accumulation of the annual deficits minus the annual surpluses, since the beginning of the Republic, essentially since 1791.

Fiscal Policy:
Throughout the nineteenth century and up through 1929, the federal government's fiscal policies- the policies of collecting revenues and spending them- were quite different than they have been since. In the period, from 1791 to 1929, the United States government followed, what economic historians refer to as the old fiscal religion. This practice meant that in bad economic times, when government revenues were insufficient, or during periods of war, the government would borrow from the public to cover the shortfall. In times when the government had a surplus, a certain part of the national debt would be retired, i.e., paid off. However, the crash of the stock market in October 1929 and the Great Depression that followed, changed the role of the government in this country.

Government Finance Before 1930:
Prior to 1914, there were no permanent federal income taxes, thus the sources of revenues were essentially limited to customs duties and federal land sales. Excise and property taxes were also imposed, but revenue collections proved insignificant. During the Civil War (1861-1865), Congress approved an income tax on incomes over $5,000 and a inheritance tax. Due to budget surpluses after the war, these taxes were later removed.

As shown in Graph1, between 1791-1861 the government attempted to live within its means. After the War of 1812, the national debt began to fall until in 1835 it reached a mere $33.7 thousand dollars. The following years, the national debt began to rise again, especially during the Mexican American War. In 1862, right after the start of the Civil War, the national debt reached , for the first time, over half a billion dollars. In subsequent Civil War years the debt rose even more sharply and in
1866 it had reached almost $3.0 billion.

Through the 1880s and early 1890s the national debt fell to about $1.6 billion in 1893. However, toward the latter 1890s, increased budget deficits insured that the debt increased again. The Presidents, McKinley, Roosevelt, Taft and Wilson expanded the role of the federal government domestically and internationally. For example, America became involved in a dispute between Spain and Cuba which led to the Spanish American War (1898-1889), at a cost of about $250 million.
Additionally, President Roosevelt initiated the construction of the Panama Canal.

After the passage of the 16th amendment, which made the levying of federal income taxes constitutional, revenues increased sharply. However, they were insufficient to pay for

America

's costs of World War I and government borrowing increased to levels not seen before. By 1919, the national debt had risen to about $27.4 billion. However, Graph2 clearly shows that even after the passage of the income tax amendment, the government essentially followed the old fiscal religion. From the end of WW I to the crash of the market in 1929, $10.0 billion of the outstanding debt was repaid. The country entered the Great Depressions and the era of the New Deal with a debt of $16.9 billion.

The practice of the old fiscal religion had another important benefit. Statistics show that between 1800-1929 the purchasing power of the US dollar, as measured by the price index remained stable. As most readers know, the same cannot be said about the policies since the 1930s.

The period from 1800 to 1929 was characterized by rapid economic expansion, numerous financial crisis and recessions During these periods the price level increased, but it also declined. In the 19th century, the longest period of deflation occurred after the Civil War. Between 1867 to 1879, the economy grew at a rate of 6.8% and the price level fell by 3.8% per year.
In the period from 1879 to 1897, prices fell about 1% per year while the economy grew at rate of about 3.7%.

The last financial crisis prior to the 1929 crash occurred in 1907. The crisis was accompanied by bank failures and a sharp reduction in output and employment. The 1907 panic led to the formation of the Aldrich Commission by Congress. The Commission's task was to study the feasibility of establishing a Central Bank, to be fashioned after the Bank of England. The Commission's recommendation, while generally ignored by Congress, was to establish one Central Bank. However, the passage of the Federal Reserve Act in 1913, provided for the creation of the Federal Reserve System consisting of twelve Federal Reserve Banks, located in different parts of the country. Finally, after 77 years America had established another Central Bank, which opened its doors for the first time January 1, 1914.