Read America's Fiscal Constitution Online
Authors: Bill White
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The urban economy flourished in the 1920s. The share of households with cars rose from about a quarter to three-fifths; households with electric lighting rose from a third to two-thirds; and households with radios rose from very few to two-fifths.
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This progress, along with the expanded use of telephones, flush toilets, central heating, and washing machines, defined a new middle-class standard of living. Private debt—which grew from 119 percent of national income in 1920 to 157 percent in 1930—helped finance this growth in consumption.
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Americans on farms borrowed simply to try to preserve a minimum standard of living. Farm income declined in the 1920s. Farm productivity rose faster than the demand for farm products, thereby driving down commodity prices and the value of farm land. In 1920 the value of all manufactured products was triple the $21.4 billion produced from farming and ranching activities. A decade later the value of manufactured products had increased, but the value of agricultural products had fallen by $11.8 billion.
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Farm foreclosures surged, and hundreds of rural banks failed throughout the 1920s.
Many farmers looked to the federal government for help. A strong congressional Farm Bloc included both Republicans and Democrats. Secretary of Agriculture Harry C. Wallace, a Republican from Iowa, publicly supported federal assistance to deal with chronic overproduction. He and his Farm Bureau allies proposed that the federal government buy farm products, export them at lower prices, and pay for the export subsidy with a tax on domestic farm sales. They viewed this program, embodied in the McNary-Haugen bill, as the equivalent of nurturing domestic industries with protective import taxation.
Calvin Coolidge, who became president after Warren Harding’s death in 1923, defied the Farm Bloc. Coolidge was obsessed with the efficient use of tax dollars. In his first inaugural address he identified spending discipline as the “soundest method” of restraining taxes.
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He embraced Mellon’s approach to scientific taxation and the Bureau of the Budget’s push for spending discipline. Coolidge would become an icon for later twentieth-century Republican conservatives, though he remained distant from the Senate’s traditional Republican leadership. He identified more with the independent-minded Idaho senator William Borah, a self-described liberal, whom Coolidge tried to recruit as his running mate in 1924. Coolidge and Borah
both loathed wasteful spending while unequivocally embracing Prohibition, the most intrusive of all progressive initiatives. Dawes, considered a moderate, joined the Coolidge ticket after Borah declined.
Coolidge twice vetoed the McNary-Haugen farm bill. Mellon strongly supported those vetoes, as did Secretary of Commerce Hoover, who helped Coolidge draft a veto message explaining that other nations would not sit idly by while subsidized farm exports were dumped in their domestic markets. Even if the bill temporarily raised farm prices, Coolidge and Hoover argued that higher prices would spur higher production. Lower prices would eventually follow, leading to demands for even higher subsidies and taxation. Coolidge and Hoover encouraged farmers to join cooperatives in order to become more efficient. That recommendation did not satisfy the Farm Bloc, and the plight of agriculture created an unstable fault line in American politics.
Another fierce budget divide arose from the attempt of a bipartisan congressional majority to raise pensions for World War I veterans. Citing the need to maintain budget discipline, Presidents Harding, Coolidge, and Hoover opposed bills raising benefits for veterans, especially those without service-related disabilities. Many of the three million Americans who had served in the military sometime during World War I had earned little more than a dollar a day as soldiers, a small fraction of civilian wage levels. Like Vietnam veterans in a later generation, they felt unappreciated by a nation whose citizens just wanted to forget the war. President Coolidge shared the attitude of an earlier generation of reformers who had considered escalating Civil War pensions to be a form of political corruption. Progressives, particularly strong in Coolidge’s Massachusetts, instead favored pension systems in which employees contributed alongside employers.
In 1924 Congress overrode Coolidge’s veto of legislation that promised World War I veterans a bonus, which would be paid in 1945 (or sooner to the surviving family of a veteran who died earlier). By delaying payment until 1945, Congress sought to avoid interfering with the planned retirement of World War I debt. In fact, the obligation could be considered a form of “off the balance sheet” financing. Payment was based on a formula—$1 per day of service and $1.25 per foreign deployment, minus discharge payment, plus 4 percent interest until payment—that was estimated to yield approximately $1,000 per veteran.
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Coolidge, Mellon, and Hoover were of one mind in opposition to farm subsidies and bonuses for veterans, but Coolidge and Mellon were wary of
Hoover’s approach to reducing unemployment that would inevitably accompany future economic downturns. Laid-off industrial workers lacked the historical safety net of a subsistence farm. The National Conference on Unemployment in 1921, convened by Hoover, had recommended the creation of a trust fund—financed with some amount of annual tax revenues—that could pay for large-scale public works during severe downturns. Neither the White House nor Congress embraced that idea. Federal debt reduction during the 1920s, however, accomplished much the same purpose by freeing debt capacity to support future extraordinary spending during downturns. Put another way, Mellon’s policy of debt reduction was the economic equivalent of designating a reserve fund to purchase and hold Treasury debt that could be sold back into the market in an emergency. The notion of balancing a budget across a business cycle became a refinement to traditional “pay as you go” budget planning only in the late twentieth century.
Republicans nominated Hoover for the presidency when Coolidge declined to seek reelection in 1928. Hoover had never held elected office or been a military general, unlike prior presidents except Taft. He did, however, represent the 1920s ideal of a pragmatic progressive interested in results rather than rhetoric. Both business organizations and labor unions backed the corporate executive known for his humanitarian relief efforts during World War I and the severe flooding of the Mississippi River in 1927. Hoover’s inaugural address, which identified problems and listed solutions, read like a business briefing.
The American Fiscal Tradition had become deeply ingrained as part of the unwritten constitution. Political leaders in each party helped retire wartime debt. They had adapted an old tradition to a modern age.
A political figure with the most appealing family pedigree in politics, Franklin Roosevelt, feared that his Democratic Party had neglected other values of the party’s founders. After disastrous Democratic losses in the 1924 election, the former vice presidential candidate wrote a letter to Democratic leaders and newspaper publishers urging them to revive the party by attacking the alignment of business with political power. Roosevelt’s advice, inspired by his reading of Jefferson’s collected works, was largely ignored. As most of Theodore Roosevelt’s old Bull Moose Progressives returned to the Republican fold, those who still clung to the minor Progressive Party commanded little attention when they called for a “new deal” in 1928.
For 130 years federal leaders had confined the use of planned debt to only four purposes. The limits of borrowing for one of those purposes would soon be tested when the progressive tax system, designed by Kitchin and reformed by Mellon, failed to produce revenues covering even minimal federal expenses during the Great Depression.
1929–1940: Years when deficits exceeded debt service = 10 (1931–1940, Great Depression)
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British political leader Winston Churchill expected to observe the mechanics of the world’s most robust financial market when he arrived at the New York Stock Exchange on October 24, 1929. He witnessed instead the chaos of panicked selling. The Exchange closed its public galleries to hide the disaster called “Black Thursday.”
The stock market crash in the last months of 1929 eliminated $26 billion in paper wealth, approximately 40 percent of the value of public stocks.
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Stocks appear overvalued in hindsight; unsold inventories of goods had begun to rise months earlier. Yet the future had once seemed boundless for technology-driven companies such as General Motors, American Telephone & Telegraph, Radio Corporation of America, and General Electric.
By early 1930, four million American workers—out of a total workforce of fifty million—were unemployed.
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Farm foreclosures and bank failures climbed to record highs each successive month. Construction ground to a halt. The world’s other industrial leaders, Great Britain and Germany, also staggered.
Recessions, of course, had always been part of the economic cycle. Civic and business leaders hoped this one would be relatively brief, like the
two that began in 1907 and 1920. They looked for signs that the economy had bottomed out. President Hoover tried to inspire confidence; he told the US Chamber of Commerce in May 1930 that the country had “passed the worst.”
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Yet local charities and governments still struggled to provide food and shelter to a vast number of families of unemployed workers.
Banks failed when borrowers could not make their payments. Surviving banks preserved their capital by curtailing new lending. The collapse of prominent regional banks precipitated other bank failures when depositors raced to withdraw funds. Runs on deposits resulted in four distinct waves of bank failures over several years, culminating with the most severe convulsion in early 1933.
It was impossible to accurately estimate federal revenue after 1929. Since income taxes were paid the year after income was earned, a surplus persisted well into the downturn. In December 1930 Americans paid quarterly income taxes of nearly half a billion dollars, an amount greater than they had paid in December 1928. A year later, in December 1931, income receipts fell by half.
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The president and Congress were unprepared for the speed and size of the drop in revenues. Writing in 1934, the first great historian of the federal budget, Davis Dewey, described the budget disaster:
The fiscal year ending June 30, 1931 marked a turn in the fortunes of federal finance. For eleven years, the Treasury had enjoyed a surplus averaging annually $760,000,000. . . . Writing on November 20, 1930, Secretary Mellon declared that “the finances of the Federal Government for the fiscal year 1930 continued the favorable record of recent years.” . . . Six months later, in June 1931, the deficit for the year amounted to $903,000,000.
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Most Americans had supported the federal shift toward reliance on income taxation. Yet that very dependence exacerbated the decline in federal revenues. In fiscal year 1930 the United States collected $2.9 billion from personal and corporate income taxes and import duties. Three years later, revenues from those sources fell to just less than $1 billion, even after Congress raised tax rates.
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Federal tobacco taxes, which produced a fifth the revenue of income taxes in 1930, generated more revenue than either personal or corporate income taxation three years later. The New Deal would soon be celebrated by progressives, but New Deal budgets relied more heavily on more stable revenues from regressive sales taxes.
Secretary of the Treasury Mellon, who was once treated as a financial genius, became a symbol of callous wealth. The seventy-one-year-old industrialist told President Hoover that the downturn served as a needed reminder of the virtues of hard work and thrift. He blamed the downturn on debtors who borrowed too much and the banks that extended too much credit.
President Hoover was quite willing to innovate in order to revive the economy. He reassured Congress, in December 1930, that the nation could balance the budget across an economic cycle: “We can confidently look forward to the restoration of . . . surpluses with the general recovery of the economic situation, and thus the absorption of any temporary borrowing that may be necessary.”
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Hoover directed federal departments to accelerate planned public works projects and assigned priority to those that could produce future revenues, like hydroelectric dams. The president also pleaded with business leaders to maintain capital spending and wage levels.
The economy appeared to bottom out in early 1931. By then output had declined by 40 percent from the all-time high reached in July 1929.
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Hopes faded that spring in the wake of another bank panic. More than eight million Americans still could not find work.
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Many families exhausted their savings.
Economists, bankers, and business leaders searched for ways to end the pervasive gloom. A chorus of economists and business leaders urged President Hoover to boost confidence by reducing the budget deficit. Hoover, who had cut taxes modestly at the outset of the downturn in order to demonstrate such confidence, tried to follow their advice. In an attempt to balance the budget, he asked Congress to raise taxes, including a national sales tax, higher estate taxes (“the most economically and socially desirable—or even necessary—of all taxes”), and personal income taxes (on “upper brackets . . . to 45 percent as compared to the present 23 percent”).
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Mellon also supported a reversal of the cuts in income tax rates.