Wall Street Journal
February 3, 2012
In 1789, the political price for our federal constitution included a bailout of the 13 indebted states. But it was by refusing to bail out the states a second time in the 1840s that the United States preserved its federal system, with substantial fiscal independence for state governments. Facing a similar moment, Europe might learn from our experience.
The 1789 bailout was part of a grand bargain designed by Alexander Hamilton to convert the creditors of the 13 states into advocates of a stronger federal government—one having the ability to raise all revenues required to service the large debts that the Continental Congress and the 13 states had both accumulated to finance that "Glorious Cause," our war of independence.
Hamilton and George Washington wanted those debts to be paid. They had to engineer institutional changes to achieve that goal. Under our first constitution, the Articles of Confederation, the continental government had virtually no power to tax. For revenues it depended on voluntary contributions from the 13 states.
About two-thirds of our total debts were owed by the continental government, the other third by the 13 states. If they had been valued at par, federal and state debts together would have constituted about 40% of gross domestic product. But because tax revenues were not big enough to service them, both federal and state debts traded at very deep discounts, deeper than those we see in Europe today. From the point of view of the creditors of the states and the United States, if not our taxpayers, there was a fiscal crisis in the 1780s. Fiscal crises often end in rearrangements of political institutions designed to sort out which old promises will be broken and which sustained.
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