Federal Government Assumes State Debt - History

A View of Wall Street and City Hall in New York

The federal government agreed to redeem the debts of individual states. Debt assumption was supported by Hamilton, but opposed by Madison, who said it rewarded speculators. It was also opposed by a number of key states, such as Virginia, who had repaid all their debts.

In order to put the new Federal government on sound footing, Hamilton felt it necessary to redeem the debt issued by nation before the federal government had begun. He proposed that the federal government take over all of the prior national debt, which totaled $52 million. In addition, Hamilton suggested that the United States also repay the states' debts, which totaled $25 million.

There were substantial objections to Hamilton's proposals. First, Madison and many others claimed that federal repayment of debts would only help the speculators, since much of the original debt had been sold to them below par.An example of that were Continental soldiers who instead of being paid for their service received IOU's. Speculators then would come and offer them 25 cents for each dollar of debt. Madison suggested that the debt be paid in full only to those who had originally issued the debt and that speculators be paid only 50% of face value. Second, many of the Southern states opposed the repayment of states' debts, since they had already repaid their own debts.

A compromise was reached when Hamilton agreed to support the movement of the nation's capital from Philadelphia, which was considered a Northern city, to Washington, D.C., a southern location on the border of Virginia. In return key Southern politician supported Hamilton's debt plan.

U.S. Debt and Foreign Loans, 1775–1795

During the American Revolution, a cash-strapped Continental Congress accepted loans from France. Paying off these and other debts incurred during the Revolution proved one of the major challenges of the post-independence period. The new U.S. Government attempted to pay off these debts in a timely manner, but the debts were at times a source of diplomatic tension.

In order to pay for its significant expenditures during the Revolution, Congress had two options: print more money or obtain loans to meet the budget deficit. In practice it did both, but relied more on the printing of money, which led to hyperinflation. At that time, Congress lacked the authority to levy taxes, and to do so would have risked alienating an American public that had gone to war with the British over the issue of unjust taxation.

The French Government began to secretly ship war materiel to the American revolutionaries in late 1775. This was accomplished by establishing dummy corporations to receive French funds and military supplies. It was unclear whether this aid was a loan or a gift, and disputes over the status of this early assistance caused strong disagreement between American diplomats in Europe. Arthur Lee , one of the American commissioners in France, accused another, Silas Deane , of financial misdealings, while the third member of the commission, Benjamin Franklin , remained aloof. Lee eventually succeeded in convincing Congress to recall Deane. The early French aid would later resurface as one of the disputes behind the 1797 XYZ Affair that led to the Quasi-War with France.

How to Look at Debt by Year

It's best to look at a country's national debt in context. During a recession, expansionary fiscal policy, such as spending and tax cuts, is often used to spur the economy back to health. If it boosts growth enough, it can reduce the debt. A growing economy produces more tax revenues to pay back the debt.

The theory of supply-side economics says the growth from tax cuts is enough to replace the tax revenue lost if the tax rate is above 50% of income. When tax rates are lower, the cuts worsen the national debt without boosting growth enough to replace lost revenue.

Major events, like wars and pandemics, can increase the national debt.

During national threats, the U.S. increases military spending. For example, the U.S. debt grew after the September 11, 2001 attacks as the country increased military spending to launch the War on Terror. Between fiscal years 2001 and 2020, those efforts cost $6.4 trillion, including increases to the Department of Defense and the Veterans Administration.  

The national debt by year should be compared to the size of the economy as measured by the gross domestic product. That gives you the debt-to-GDP ratio. That ratio is important because investors worry about default when the debt-to-GDP ratio is greater than 77%—that's the tipping point.

The World Bank found that if the debt-to-GDP ratio exceeded 77% for an extended period of time, it slowed economic growth. Every percentage point of debt above this level costs the country 0.017 percentage points in economic growth.  

You can also use the debt-to-GDP ratio to compare the national debt to other countries. It gives you an idea of how likely the country is to pay back its debt.

18b. Hamilton's Financial Plan

Alexander Hamilton is one of the few American figures featured on U.S. Currency who was never president. He was killed in 1804 in a duel with Aaron Burr.

Presidents Washington ($1), Lincoln ($5), Jackson ($20), and Grant ($50) all appear on currency. But what about this guy Alexander Hamilton on the ten-spot? How did he get there? A sawbuck says you'll know the answer after reading this piece.

A major problem facing the first federal government was how to deal with the financial chaos created by the American Revolution. States had huge war debts. There was runaway inflation. Almost all areas of the economy looked dismal throughout the 1780s. Economic hard times were a major factor creating the sense of crisis that produced the stronger central government under the new Constitution.

George Washington chose the talented Alexander Hamilton , who had served with him throughout the Revolutionary War, to take on the challenge of directing federal economic policy as the treasury secretary. Hamilton is a fascinating character whose ambition fueled tremendous success as a self-made man. Born in the West Indies to a single mother who was a shopkeeper, he learned his first economic principles from her and went on to apprentice for a large mercantile firm. From these modest origins, Hamilton would become the foremost advocate for a modern capitalist economy in the early national United States.

Hamilton's influential connections were not just with Washington, but included a network of leading New York merchants and financiers. His 1780 marriage to Elizabeth Schuyler , from a wealthy Hudson River valley land holding family, deepened his ties to rich and powerful leaders in New York. His innovative financial policies helped overcome the fiscal problems of the Confederacy , and also benefited an economic elite with which he had close ties.

Alexander Hamilton conceived of the First Bank of the United States as a way to standardize American currency and cope with national Revolutionary War debt. The Bank still stands today on Independence National Park in Philadelphia.

The first issue that Hamilton tackled as Washington's secretary of the treasury concerned the problem of public credit . Governments at all levels had taken on so much debt during the Revolution. The commitment to pay them back was not taken very seriously. By the late 1780s, the value of such public securities had plunged to a small fraction of their face value. In other words, state IOU's &mdash the money borrowed to finance the Revolution &mdash were viewed as nearly worthless.

Hamilton issued a bold proposal. The federal government should pay off all Confederation (state) debts at full value. Such action would dramatically enhance the legitimacy of the new central government. To raise money to pay off the debts, Hamilton would issue new securities bonds). Investors who had purchased these public securities could make enormous profits when the time came for the United States to pay off these new debts.

The spinning jenny was one of several major technological innovations that made British textiles such an economic force.

Hamilton's vision for reshaping the American economy included a federal charter for a national financial institution. He proposed a Bank of the United States . Modeled along the lines of the Bank of England, a central bank would help make the new nation's economy dynamic through a more stable paper currency .

The central bank faced significant opposition. Many feared it would fall under the influence of wealthy, urban northeasterners and speculators from overseas. In the end, with the support of George Washington, the bank was chartered with its first headquarters in Philadelphia.

The third major area of Hamilton's economic plan aimed to make American manufacturers self-sufficient. The American economy had traditionally rested upon large-scale agricultural exports to pay for the import of British manufactured goods . Hamilton rightly thought that this dependence on expensive foreign goods kept the American economy at a limited level, especially when compared to the rapid growth of early industrialization in Great Britain.

Rather than accept this condition, Hamilton wanted the United States to adopt a mercantilist economic policy. This would protect American manufacturers through direct government subsidies (handouts to business) and tariffs (taxes on imported goods). This protectionist policy would help fledgling American producers to compete with inexpensive European imports.

Hamilton possessed a remarkably acute economic vision. His aggressive support for manufacturing, banks, and strong public credit all became central aspects of the modern capitalist economy that would develop in the United States in the century after his death. Nevertheless, his policies were deeply controversial in their day.

Many Americans neither like Hamilton's elitist attitude nor his commitment to a British model of economic development. His pro-British foreign policy was potentially explosive in the wake of the Revolution. Hamilton favored an even stronger central government than the Constitution had created and often linked democratic impulses with potential anarchy. Finally, because the beneficiaries of his innovative economic policies were concentrated in the northeast, they threatened to stimulate divisive geographic differences in the new nation.

Regardless, Hamilton's economic philosophies became touchstones of the modern American capitalist economy.

On May 27, 2021, we updated with the numbers from the historical tables in the Budget of the United States Government for Fiscal Year 2022. Actual revenue for FY 2020 and estimated revenue through FY 2026 come from Historical Tables 2.1, 2.4, and 2.5. Actual spending for FY 2020 and estimated spending at the subfunction level through FY 2026 come from Table 3.2. Budget Authority estimates come from Table 5.1, federal debt estimates come from Table 7.1 and GDP estimates come from Table 10.1. Intergovernmental transfers come from Table 12.3.

Here is how headline budget estimates for the upcoming FY 2022 fiscal year have changed since the release of the FY 2021 budget a year ago in Winter 2020.

FY 2021 Federal Budget Changes Since 2020
$ billionEstimate for 2021
in FY2021 Budget
Estimate for 2021
in FY2022 Budget
Federal Outlays$4,829.4$4,789.8+$44.2
Federal Receipts$3,863.3$ 3,706.3 +$61.5
Federal Deficit$966.1$1,083.4-$17.4

Of course, the FY2021 Budget came out pre-COVID and the FY2022 is post-COVID.

You can see line item changes from budget to budget here. You can compare budget estimates with actuals here.

Account level spending estimates through FY 2026 come from the Outlays table in the Public Budget Database and were updated on on May 27, 2021.

Account level budget authority estimates through FY 2026 come from the Budget Authority table in the Public Budget Database and were updated on on May 27, 2021.


The federal debt is the amount of money that the federal government has borrowed and not yet paid back. The government pays for most of its operations by raising money through taxes, but when tax revenues are not enough to cover everything the government wants to do, it borrows the rest. In that sense, it is like a family borrowing something extra each month to pay its bills. The government borrows by selling bonds, notes, and Treasury bills to investors. These debts pay a rate of interest to the lender. As may be expected, the federal debt rises in times of war and other calamities, when the government is borrowing heavily to accomplish its ends. The debt then tends to shrink back down after the crisis passes as the government gradually pays off what it borrowed. Intense public debate has raged in recent decades over how large the federal debt should be. Economists who favor an expansive government role argue that some federal debt is no problem. For example, in times of unemployment the government should borrow more and then spend the money on jobproducing programs. On the other hand, fiscal conservatives maintain that too high a federal debt is bad for the economy. When the government competes for dollars with all other borrowers, interest rates tend to rise dampening economic activity. In the recent history of the United States, the federal debt was very high during World War II (1939 – 1945) it fell in the years after that and rose again in the 1980s during the military build-up during the final stages of the Cold War then it began to fall again during the economic boom of the 1990s.

See also: Keynesian Economic Theory

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When The U.S. Paid Off The Entire National Debt (And Why It Didn't Last)

On Jan. 8, 1835, all the big political names in Washington gathered to celebrate what President Andrew Jackson had just accomplished. A senator rose to make the big announcement: "Gentlemen . the national debt . is PAID."

That was the one time in U.S. history when the country was debt free. It lasted exactly one year.

By 1837, the country would be in panic and headed into a massive depression. We'll get to that, but first let's figure out how Andrew Jackson did the impossible.

It helps to remember that debt was always a choice for America. After the revolution, the founding fathers debated whether or not to just wipe clean all those financial promises made during the war.

Deciding to default "would have ruined our credit and would have left the economy on a very agricultural, subsistence basis," says Robert E. Wright, a professor at Augustana College in South Dakota.

So the U.S. agreed early on to consolidate the debts of all the states — $75 million.

During the good times, the country tried to pay down the debt. Then there would be another war, and the debt would go up again. The politicians never liked the debt.

"What the battle was really about was how quickly to pay off the national debt, not whether to pay it off or not," Wright says.

But, just like today, it wasn't easy for politicians to slash spending — until Andrew Jackson came along.

"For Andrew Jackson, politics was very personal," says H.W. Brands, an Andrew Jackson biographer at the University of Texas. "He hated not just the federal debt. He hated debt at all."

Before he was president, Jackson was a land speculator in Tennessee. He learned to hate debt when a land deal went bad and left him with massive debt and some worthless paper notes.

So when Jackson ran for president, he knew his enemy: banks and the national debt. He called it the national curse. People ate it up.

In Jackson's mind, debt was "a moral failing," Brands says. "And the idea you could somehow acquire stuff through debt almost seemed like black magic."

So Jackson decided to pay off the debt.

To do that, he took advantage of a huge real-estate bubble that was raging in the Western U.S. The federal government owned a lot of Western land — and Jackson started selling it off.

He was also ruthless on the budget. He blocked every spending bill he could.

"He vetoed, for example, programs to build national highways," Brands says. "He considered these to be unconstitutional in the first place, but bad policy in the second place."

When Jackson took office, the national debt was about $58 million. Six years later, it was all gone. Paid off. And the government was actually running a surplus, taking in more money than it was spending.

That created a new problem: What to do with all that surplus money?

Jackson had already killed off the national bank (which he hated more than debt). So he couldn't put the money there. He decided to divide the money among the states.

But, according to economic historian John Steele Gordon, the party didn't last for long.

The state banks went a little crazy. They were printing massive amounts of money. The land bubble was out of control.

Andrew Jackson tried to slow everything down by requiring that all government land sales needed to be done with gold or silver. Bad idea.

"It was a huge crash, and the beginning of the longest depression in American history," Gordon says. "It actually lasted six years before the economy began to grow again."

1 Answer 1

The significance of this act was its importance in the Hamilton-Jefferson debate. Basically, Hamilton's idea was that of a large, strong, federal government. Jefferson and his supporters favored a weaker, de-centralized, and (in most cases) a state based government. Hamilton won this round by "federalizing" what had been Revolutionary war (and subsequent) debt.

The assumption of the states' debt meant that there would be one large centralized "national" debt, instead of 13 smaller ones. It was much easier for lenders, foreign as well as domestic, to monitor and deal with one federal debt, which had earlier been incurred by the states mainly to fight the Revolution, and to operate until the "United States" got going.

Yes, the states later incurred their own state debts, but for local matters, (usually) funded by "local" citizens. These debts were much smaller than the "national" debt that had been undertaken to fight the Revolution. By repaying the national debt promptly and in full, America established the credit it needed to fight future wars and to deal with other national emergencies.

There was one other thing. The federal responsibility to pay off the central debt was accompanied its control over most revenue sources, mainly tariffs and excise taxes (income taxes were permanently established in 1913, over a century later).

Controversy with Every Method

To quote Mark Twain, "There are three kinds of lies: lies, damned lies, and statistics." Nowhere is this truer than when it comes to government debt and fiscal policy.

Debt reduction and government policy are incredibly polarizing political topics. Critics of every position take issues with nearly all budget and debt reduction claims, arguing about flawed data, improper methodologies, smoke and mirrors accounting, and countless other issues. For example, while some authors claim that U.S. debt has never gone down since 1961, others claim it has fallen multiple times since then. Similar conflicting arguments and data to support them can be found for nearly every aspect of any discussion about federal debt reduction.

$28.1 Trillion

The record levels of U.S. national debt reached in 2020.

While there are a variety of methods countries have employed at various times and with various degrees of success, there is no magic formula for reducing debt that works equally well for every nation in every instance. Just as spending cuts and tax hikes have demonstrated success, default has worked for more than a few nations (at least if the yardstick of success is debt reduction rather than good relations with the global banking community).

Overall, perhaps the best strategy is one by Polonius from Shakespeare's Hamlet and espoused by Benjamin Franklin when he said: "Neither a borrower nor a lender be."

Federal Government Assumes State Debt - History

The most pressing problems facing the new government were economic. As a result of the revolution, the federal government had acquired a huge debt: $54 million including interest. The states owed another $25 million. Paper money issued under the Continental Congresses and Articles of Confederation was worthless. Foreign credit was unavailable.

The person assigned to the task of resolving these problems was 32-year-old Alexander Hamilton. Born out-of-wedlock in the West Indies in 1757, he was sent to New York at the age of 15 for schooling. One of New York's most influential attorneys, he played a leading role in the Constitutional Convention and wrote 51 of the 85 Federalist Papers, urging support for the new Constitution. As Treasury Secretary, Hamilton designed a financial system that made the United States the best credit risk in the western world.

The paramount problem facing Hamilton was a huge national debt. He proposed that the government assume the entire debt of the federal government and the states. His plan was to retire the old depreciated obligations by borrowing new money at a lower interest rate.

States like Maryland, Pennsylvania, North Carolina, and Virginia, which had already paid off their debts, saw no reason why they should be taxed by the federal government to pay off the debts of other states like Massachusetts and South Carolina. Hamilton's critics claimed that his scheme would provide enormous profits to speculators who had bought bonds from Revolutionary War veterans for as little as 10 or 15 cents on the dollar.

For six months, a bitter debate raged in Congress, until James Madison and Thomas Jefferson engineered a compromise. In exchange for southern votes, Hamilton promised to support locating the national capital on the banks of the Potomac River, the border between two southern states, Virginia and Maryland.

Hamilton's debt program was a remarkable success. By demonstrating Americans' willingness to repay their debts, he made the United States attractive to foreign investors. European investment capital poured into the new nation in large amounts.

Hamilton's next objective was to create a Bank of the United States, modeled after the Bank of England. A national bank would collect taxes, hold government funds, and make loans to the government and borrowers. One criticism directed against the bank was "unrepublican"--it would encourage speculation and corruption. The bank was also opposed on constitutional grounds. Adopting a position known as "strict constructionism," Thomas Jefferson and James Madison charged that a national bank was unconstitutional since the Constitution did not specifically give Congress the power to create a bank.

Hamilton responded to the charge that a bank was unconstitutional by formulating the doctrine of "implied powers." He argued that Congress had the power to create a bank because the Constitution granted the federal government authority to do anything "necessary and proper" to carry out its constitutional functions (in this case its fiscal duties).

In 1791, Congress passed a bill creating a national bank for a term of 20 years, leaving the question of the bank's constitutionality up to President Washington. The president reluctantly decided to sign the measure out of a conviction that a bank was necessary for the nation's financial well-being.

Finally, Hamilton proposed to aid the nation's infant industries. Through high tariffs designed to protect American industry from foreign competition, government subsidies, and government-financed transportation improvements, he hoped to break Britain's manufacturing hold on America.

The most eloquent opposition to Hamilton's proposals came from Thomas Jefferson, who believed that manufacturing threatened the values of an agrarian way of life. Hamilton's vision of America's future challenged Jefferson's ideal of a nation of farmers, tilling the fields, communing with nature, and maintaining personal freedom by virtue of land ownership.

Alexander Hamilton offered a remarkably modern economic vision based on investment, industry, and expanded commerce. Most strikingly, it was an economic vision that had no place for slavery. Before the 1790s, the American economy--North and South--was intimately tied to a trans-Atlantic system of slavery. States south of Pennsylvania depended on slave labor to produce tobacco, rice, indigo, and cotton. The northern states conducted their most profitable trade with the slave colonies of the West Indies. A member of New York's first antislavery society, Hamilton wanted to reorient the American economy away from slavery and colonial trade.

Although Hamilton's economic vision more closely anticipated America's future, by 1800 Jefferson and his vision had triumphed. Jefferson's success resulted from many factors, but one of the most important was his ability to paint Hamilton as an elitist defender of deferential social order and an admirer of monarchical Britain, while picturing himself as an ardent proponent of republicanism, equality, and economic opportunity. Unlike Jefferson, Hamilton doubted the capacity of common people to govern themselves.

Jefferson's vision of an egalitarian republic of small producers--of farmers, craftsmen, and small manufacturers--had powerful appeal for subsistence farmers and urban artisans fearful of factories and foreign competition. In increasing numbers, these voters began to join a new political party led by Jefferson.

Watch the video: Assume or Presume? (December 2021).