In American History, The National Debt Has Been Largely Ignored -- Until Now

If America's debt burden and the looming risk of a sovereign default look scary, consider this: Huge debt, and deciding not to pay it, have happened before in U.S. history.

After the state of New York completed the Erie Canal in the 1820s and revenues began to pour in, states across the country decided to follow suit, breaking ground on massive infrastructure projects. But rather than raise taxes to pay for them, the states financed the projects by taking on enormous amounts of debt, much of it from foreign investors. They planned to pay off the debt with a projected increase in tax revenue since land values were expected to rise dramatically when the projects were completed. But in 1839, a financial crisis burst the land bubble, credit dried up, infrastructure projects stalled and land values plummeted. By 1842, eight states and the Florida Territory were in default. Four, including Mississippi, repudiated their debt to avoid the political ramifications of raising taxes to pay off a few wealthy lenders.

“It was just a crazy mess that would almost make AIG blush,” said Robert E. Wright, an economics professor at Augustana College in South Dakota, referring to the insurance giant at the heart of the 2008 financial crisis. The defaults led many states to amend their constitutions to proscribe deficit financing.

But that was also the last time in American history when debt was a matter of great popular concern, according to Wright.

Today, a national debt of $16.7 trillion is not just an economic problem but also a political one. Republican presidential nominee Mitt Romney called the debt a “moral issue” last year; Republicans in Congress warn that the United States is heading toward a debt crisis like Greece’s; and corporate America has organized into lobbying groups, like the Campaign to Fix the Debt, to push drastic spending reductions and tax and entitlement reforms. While polls show Americans’ top concerns include jobs and the economy, the national debt has become a topic in Washington, and now it has for many Americans as well, particularly on the conservative side.

While that may be unusual historically, the debt dynamics at play during the country’s earliest years are still at work today.

During the 1780s, the United States was constantly in default because under the Articles of Confederation, the precursor to the Constitution, the national government, such as it was, lacked the ability to tax and therefore couldn’t raise the revenues to pay back all the money it borrowed to fight the Revolutionary War. As the nation’s first Treasury secretary in the 1790s, Alexander Hamilton faced the challenge of getting the nation’s debt under control.

“Hamilton himself sort of got gray hair because he was pressured to reduce the debt,” but lawmakers were unwilling to cut spending or raise taxes, said Richard Sylla, an expert in financial history at New York University’s Stern School of Business. “You see the problem today. The Republicans obviously want to cut the debt; they’re making a big fuss about the debt ceiling,” he said, but they won’t raise taxes to do it, while Democrats push back against spending cuts.

Thomas Jefferson warned about excessive borrowing, Wright said, worrying that because raising taxes can carry political costs, politicians will have an incentive to borrow and spend rather than tax and spend. Ultimately, a rapidly growing economy after the War of 1812 fixed the problem. By the 1830s, President Andrew Jackson had paid off the debt completely.

On the federal level, the national debt has been neither an economic nor a political concern for most of the country’s history. Throughout the 19^th and early 20^th centuries, the debt spiked only during wartime -- and again, economic growth following the wars ultimately cured the problem. Until the federal income tax was established in the early 20^th century, the U.S. government got most of its revenue from taxes on imports, alcohol and tobacco, and Americans were buying, drinking and smoking enough to fund the government. Without entitlements and the other federal programs that the government pays for today, the debt wasn’t an issue.

That changed to an extent after World War II, when the national debt reached an all-time high as a percentage of the size of the economy, at around 110 percent of the gross domestic product or GDP. The postwar boom in the 1950s reduced the debt as a share of the economy, but the actual dollar amount remained fairly steady until the late 1970s. Unlike after previous wars, the debt never came back down, but Americans were generally comfortable with the debt level since, as a percentage of GDP, it steadily decreased until it hit close to 30 percent under President Richard Nixon.

But under President Ronald Reagan, the debt started to rise again, both as a percentage of economic activity and in dollar amount, and by the end of President George H.W. Bush’s term, it had tripled. It rose again under President George W. Bush and jumped again under President Barack Obama.

The rising debt during a time of partisan paralysis led to a 1985 deficit control law known as Gramm-Rudman-Hollings, which set annual deficit targets and called for automatic spending cuts if the targets weren’t met. “It was a big issue in the 1980s, it was discussed on television and in the newspapers,” said John Steele Gordon, who wrote "The Extraordinary Times of Our National Debt," a 1998 history of America’s debt. In the end, the bill led to budgeting gimmicks rather than real deficit reduction.

“Reagan came in, he cut taxes, and borrowed a lot of money,” Sylla said, a pattern repeated in the George W. Bush era. “It’s a bit odd for the Republicans to be the ones complaining about the high debt now,” he added, noting they are doing so “without any admission that they were the ones who pushed the debt up back in the 1980s and under George W. Bush.”

“We had a financial crisis going on when Obama took office, and everybody knows that in a financial crisis, then the government debt tends to go up a lot. Actually that’s part of controlling or managing the crisis,” Sylla added.

And that brings us to the present, where tax cuts, war spending, a recession, and a financial crisis have helped rocket the debt to its current level. But if past is prologue, there won’t be massive spending cuts or tax increases to bring it back down, Sylla predicted. Instead, just as when political interests stymied Alexander Hamilton, the U.S. will just wait for economic growth to get the situation under control. In today’s tepid recovery, that might take a while.