Historical economics: U.S. state and local government.

Sylla, Richard ; Wallis, John J. ; Legler, John B. 等

As Americans reconsider the relative sizes and roles of federal, state, and local government in the federal system, there is renewed interest in how the system functioned and changed in past decades. Twentieth-century trends are well documented. At the start of the century, governments at all levels absorbed and disposed of about one-tenth of gross product; now, near the end of the century, the proportion is about one-third.

Government not only grew relative to the economy; it also became more centralized. The federal share of all governmental revenues and expenditures was approximately one-third when the century began; now it is about two-thirds. The state share of the state and local "fisc" (revenues and expenditures) was about one-seventh in 1902; now it is about one-half.(1)

One implication of these trends is that local government, the largest fiscal component (about 60 percent) of the federal system in terms of revenue at the start of the century, is now the smallest - although intergovernmental transfers raise local government to rough parity with state government in terms of expenditures. The reduction in the relative fiscal role of local government was especially rapid in the New Deal years after 1932. Contrary to widespread impressions, government's growth rate did not accelerate in the 1930s; the significant change in that era was a shift of government spending from the local to the federal level.(2)

What about the decades before the twentieth century? Was government in the aggregate increasing its share of the U.S. economic pie? Were centralizing trends already in place? And, in what ways did fiscal and other activities of federal, state, and local governments interact with each other and with the private sector?

Initial approaches to these questions reveal several problems. For example, there was virtually no comprehensive quantitative record of state and local fiscal activity for the first century or more of U.S. history. Further, although the data on revenues, expenditures, and debts needed to construct such a record exist in the voluminous reports of state, county, and municipal authorities, it would be a major task to retrieve, codify, and compile them. Fortunately, each of us independently was interested in the questions, and so we formed a partnership to tackle the job. We have made considerable progress in retrieving and processing the data.(3) Our ultimate goal is to present and analyze a comprehensive quantitative record of U.S. fiscal federalism from 1790 to the present. This research summary reports on some of our findings to date.

Government's Economic Share

Since our work is still in progress, we can only speculate in an informed way on the trends in government's share of gross product and fiscal centralization. Federal revenues and expenditures increased as a proportion of gross product over the course of the nineteenth century, but not much. The federal share was in the 1-2 percent range from 1790 to 1860, rising to more than 3 percent by the beginning of this century.(4) Our findings for several large states (New York, New Jersey, Ohio, and North Carolina), for which our state and local fiscal data for the early decades of U.S. history are most complete, indicate a wide range of variation. Before the Civil War, state and local government in New York raised and spent on a per capita basis well in excess of per capita federal revenues or expenditures. But in North Carolina, at the other extreme, state and local per capita fiscal activity averaged only 30 to 40 percent of federal levels.(5) In New Jersey and Ohio, per capita state and local revenues and expenditures roughly equaled the per capita federal budget at several antebellum dates.

Projecting (very tentatively) on the basis of such partial returns, we think our estimates for the early decades will indicate an overall state and local fiscal share roughly comparable to the federal government's share of the economy. If that turns out to be the case, then there are implications for the issue of how government's aggregate share of the economy changed over time. Government's share increased over the nineteenth century, just as it has in the twentieth. It probably doubled or tripled, from 3-5 percent in the 1790s to 10 percent in 1902.

Fiscal Concentration

Another tentative implication is that, unlike in this century, there was no long-term trend toward fiscal concentration in the nineteenth century. Indeed, it is likely that in the nineteenth century, local government was the fastest growing, and by 1902 the largest fiscal component, of the federal system.

We have asked why local government increased its fiscal share of all government, as well as its share of the whole economy.(6) Our answer involves urbanization, in particular the growth of cities. In 1850, only 15 percent of Americans lived in urban as opposed to rural places; by 1900 it was 40 percent. The population share of larger cities (25,000 or more people) grew even faster, from 9 percent in 1850 to 26 percent in 1900. Our fiscal data indicate that urban governments raised and spent more per capita in the late nineteenth century than either federal or state governments, and that larger cities spent more per capita than smaller ones. The combination of rapid urban population growth and higher per capita public spending in cities increased the size of local government until it accounted for some 60 percent of all government spending at the start of this century. But this was a late nineteenth-century occurrence, and there are reasons to doubt earlier conjectures that local government before the beginning of this century was always the largest fiscal component in the U.S. federal system.(7)

Banks and State Finances

Some interesting findings of our project relate to the intimate fiscal relationships that developed in the early decades between state governments and the banks they chartered. The Constitution took away the rights of states to engage in "currency finance," that is, funding state expenditures with fiat paper money issues. But the states could and did charter banks that issued paper banknotes backed by specie. Given rapid growth in credit demand and early restrictive practices in granting charters, bank charters had considerable value. Realizing this, the states raised public revenues from banks by investing in them, taxing them, or both. By the 1820s, every one of the original states received some portion of its revenue from banks. In several cases, that proportion was substantial. Massachusetts was the leader; the Bay State often derived half or more of its ordinary operating revenues between 1820 and 1860 from a tax on the capital stock of the state's chartered banks. Reliance on bank revenues allowed the states to minimize traditional property taxation, which was unpopular at the state level, although property taxes were the mainstays of local revenue systems.(8)

The importance of the bank-state revenue nexus led us to ask whether the methods of raising bank revenues - either investments in banks or taxation - affected the behavior of the states in chartering and regulating their banks. If a state's fiscal interest in its banks was an investment interest, with revenues from dividends, interest, and capital gains, then the state could have had an incentive to restrict bank entry by limiting the number of bank charters granted and restricting banking competition. On the other hand, if the state's fiscal interest took the form of a tax on inputs (such as bank capital) or results (such as bank assets or earnings), then the state had an interest in expanding the size of its chartered banking sector.

We found that our distinction of two quite different types of fiscal interest was indeed relevant. States that taxed bank inputs and outputs encouraged rapid banking development; states that invested in banks restricted banking development. Still other states did both, at different times. For example, in the early decades when New York had investments in banks and the Democrats, led by Martin Van Buren, "sold" bank charters, the state restricted bank chartering. When the Democrats were defeated in the 1830s, partly because of their rigid political control of bank chartering, New York introduced liberal chartering under so-called Free Banking. The Empire State's banking system then grew rapidly.(9) Moreover, the states with large investment interests in their chartered banks were in the forefront of passing legislation to restrict unchartered "private" banking, which competed with state-chartered banks.(10)

One interesting implication of these early government-business relationships involves the way we view business taxation. Most economists and business people today would argue that taxation of a business activity tends to put a damper on its development. But our "fiscal interest" concept suggests that governments, through regulation, may act to promote, not restrict, the private business activities that they tax.

Debt Crises and Revenue Structures

During the 1820s and 1830s, large-scale internal improvement programs - canals, railroads, banks - were undertaken by many states, usually by means of debt finance. The states borrowed with the expectation that the projects would pay for themselves through operating revenues. If they would not, it was better to borrow most of the funds initially and then spread the higher taxes required to service the debts over future years (tax smoothing). During the depression of 1839-43, however, nine states defaulted on their debts. Four of these states ultimately repudiated a portion of the debt. Four additional states narrowly avoided default.

Earlier historians saw this debt - default experience of the states as initial carelessness, followed by political cowardice and financial immorality. In recent work, we relate the experience to less judgmental economic and political considerations, namely, the revenue structure of state finances.(11) By revenue structure, we mean the mix of investment income, indirect taxes (excises and other business taxes), and direct taxes (mostly property and poll taxes at the time). The written records of the era point to a pecking order of the political costliness of these revenue sources, with investment income as the least costly and direct taxes the costliest form of revenue.

The property tax at the state and federal (not local) levels was very unpopular. If it had to be imposed at all, as in the late 1790s when the federal government was concerned with French and British threats, and during the War of 1812 when state governments helped finance defense, it was dispensed with quickly thereafter by the federal government and a number of state governments. In the state debt crises of the early 1840s, two older states, Pennsylvania and Maryland, had investment and business-tax revenues, but chose to default on their debts rather than impose unpopular direct taxes on property. After their defaults, they reluctantly imposed property taxes, though. The other seven defaulting states were newer, frontier states with limited revenues from investments and limited opportunities for taxing banks and other businesses. Of necessity, these states relied mostly on property taxes for state revenue. Per capita property tax collections were often higher there than in the older states, even though per capita incomes were lower. When their improvement investments failed to pay off, the only option for these newer states in a political sense was to default. Had they raised their already high property taxes to higher levels, they would (as they recognized) lose settlers to other states.

The state debt defaults of the 1840s indicate both a widespread antipathy toward property taxes at the state level and the related importance of revenue structure in determining propensities to default on debt. In the aftermath of the crises, many states imposed constitutional limitations on the incurrence of debt. Modern-day debt crises, it seems, have economic and political characteristics similar to those of American states a century and a half ago.

1 For the state shares of the state and local fisc, see J. J. Wallis and W. E. Oates, "Decentralization in the Public Sector: An Empirical Study of State and Local Government," in Fiscal Federalism: Quantitative Studies, H. S. Rosen, ed. Chicago: University of Chicago Press, 1988, pp. 1-28.

2 J. J. Wallis, "The Birth of the Old Federalism: Financing the New Deal, 1932-40, "Journal of Economic History 44 (March 1984), pp. 139-159.

3 Preliminary annual data series on revenues and expenditures for the 48 states, covering the years up to 1917, are available through ICPSR. Data for the twentieth century covering state and local governments for some, but not all, years in which a Census of Governments was taken, as well as data for some 100 cities at decade intervals for 1820-80, are also at ICPSR. Data on local governments in 1880 and 1890 are nearly complete and will be released through ICPSR.

4 P. B. Trescott, "The United States Government and National Income, 1790-1960," in Trends in the American Economy in the Nineteenth Century, Studies in Income and Wealth, Vol. 24, Ann Arbor, MI: University Microfilms for the NBER, 1960, pp. 337-361.

5 R. Sylla, "Long-Term Trends in State and Local Finance: Sources and Uses of Funds in North Carolina, 1800-1977," in Long-Term Factors in American Economic Growth, S. L. Engerman and R. E. Gallman, eds., Chicago: University of Chicago Press, 1986, pp. 819-868; and R. Sylla, "Effects of Local Government on Industrialization: The Case of the Early U.S.A.," paper presented at Session C7 of the Eleventh International Economic History Congress, Milan, Italy, September 1994.

6 J. B. Legler, R. Sylla, and J. J. Wallis, "U.S. City Finances and the Growth of Government, 1850-1902," Journal of Economic History 48 (June 1988), pp. 347-356.

7 L. E. Davis and J. B. Legler, "The Government in the American Economy, 1815-1902: A Quantitative Study," Journal of Economic History 26 (December 1966), pp. 514-552.

8 R. Sylla, J. B. Legler, and J. J. Wallis, "Banks and State Public Finance in the New Republic: The United States, 1790-1860, "Journal of Economic History 47 (June 1987), pp. 391-403.

9 J. J. Wallis, R. Sylla, and J. B. Legler, "The Interaction of Taxation and Regulation in Nineteenth-Century U.S. Banking," in The Regulated Economy: A Historical Approach to Political Economy, C. Goldin and G. Libecap, eds. Chicago: University of Chicago Press, 1994, pp. 121-144.

10 R. Sylla, "Forgotten Men of Money: Private Bankers in Early U.S. History," Journal of Economic History 36 (March 1976), pp. 173-188; and R. Sylla, "The Forgotten Private Banker," The Freeman (April 1995), pp. 212-216.

11 A. Grinath, J. J. Wallis, and R. Sylla, "Debt, Default, and Revenue Structure: The Debt Crisis and American State Governments in the 1840s," paper presented at conference of the All-UC Group in Economic History on Fiscal Crises in Historical Perspective, Oakland, CA, April 1994.