One of the most controversial issues of the First Congress was the debate over the assumption of state debts. Central at heart was the issue of how to establish strong public credit for the new nation.
New Secretary of the Treasury Alexander Hamilton believed that good public credit was essential to the success of the new federal government and critical to maintain national unity. In early 1790 he issued the ~40,000 word document titled the “First Report on the Public Credit.”
In the document Hamilton espoused key elements of his plan which included the assumption of all state debts still outstanding from the Revolutionary War and subsequent period. The plan drew considerable backlash and faced an uncertain outcome in Congress.
Eventually the so-called Funding Act of 1790 prevailed, including the assumption of state debts, and marked a significant highlight of George Washington’s presidency.
What Was the Funding Act of 1790?
The Funding Act of 1790 was a monumental piece of legislation that aimed to address the issue of funding federal and state debts as well as to establish a system to improve the public credit of the United States.
Leaders in the First Congress considered the issue of funding the public debt to be of utmost importance during its legislative sessions. To that end, Secretary of the Treasury Alexander Hamilton issued his “First Report on the Public Credit.”
Hamilton’s report outlined his plan to address all outstanding public debts and thus help improve the public credit of the United States to be on par with other European nations. His plan included the federal assumption of lingering state Revolutionary War debts which was an extremely divisive issue.
The issue largely revolved around “fairness:” some states took on more war debt than others, while still other states had prioritized paying down such debt since the end of the Revolution more so than others.1
Furthermore, final federal accounting of all war debt amongst the states had still not yet been completed. The entire measure appeared in jeopardy, threatening to split the Union over the issue.
Finally, according to traditional accounts, Hamilton, James Madison and Thomas Jefferson struck a bargain in the important Compromise of 1790. The popular musical “Hamilton” portrays this as “The Room Where It Happens.”
In exchange for Jefferson and Madison’s support on assumption, Hamilton would help swing northern votes to accept a site along the Potomac as the new nation’s capital.
Though the clandestine meeting did occur and an agreement no doubt made, its importance in the passage of the two bills is likely overstated. There were too many moving parts and legislators with their own alliances and agendas for the three men to significantly alter the eventual passage.2
After almost half a year of debates and maneuvering, the Funding Act of 1790 finally passed in July 1790. The law took a significant step in establishing strong credit for the nation to utilize for future borrowing.
4 Key Aspects of Hamilton’s Assumption of State Debts Plan
4 key aspects of Alexander Hamilton’s assumption of state debts plan included that the federal government would assume state debt at face value, it would issue bonds that wealthy Americans would buy, establish good public credit, and shift the burden of taxation from state to federal level.
Hamilton’s plan faced fierce opposition primarily from southern states, but also from other states such as Pennsylvania and New York. Negotiations and voting for the plan were a roller coaster, passing in the House twice, then failing a vote in April, before finally passing once again in July 1790.
With its passage came new challenges, but also a boost to the US economy as it benefited from increased creditor confidence in the government’s ability to pay off its debts.
Federal Government Assumed State Debt at Face Value
One of the primary aspects of Hamilton’s financial plan was the ability of the federal government to assume state debts at face value.
Hamilton argued that the states had incurred the debts fighting for a common cause and should therefore assist one another in paying off such debts. Given that some states were overburdened by their debt obligations, such a move would also boost the US economy.1
Most southern states strongly opposed the measure for two primary reasons. First, states like Virginia and Pennsylvania had prioritized paying off their war debt in the intervening years. Only ~$2.2 million in war debt remained in Pennsylvania, about 20% of what it was in 1787 ($11.6 million).3
Second, the federal government had still not completed its final accounting of all states’ war debts, known as “settlement.” Several southern states were convinced that final settlement would show they bore a larger share of war expenses than was just and assumption would not benefit them.1
In addition, southern records of their war debts were largely in disarray. Due to their poor record-keeping regarding damages and expenses the federal government had no choice but to deny many of the debt claims.
As northern records were far more complete, most of their claims would be assumed without issue, a huge grievance in southern eyes. Despite the grievances, assumption of state debts narrowly gained a majority in July and finally passed in the House.4
Under the plan, the federal government assumed $21.5 million in total state debts. In order to help sweeten the deal and turn votes, several middle and southern states were given extra allowances for assumption, including $500,000 for Virginia and $800,000 for North Carolina.2
Of the total, over 50% of assumed state debts came from southern states.
Issue Bonds that Wealthy Americans Would Buy
In order to pay the assumed state debts, the federal government issued bonds that investors—primarily affluent Americans—bought. In addition to the $21.5 million of state debts, the United states also had ~$11.7 million in foreign debts and $42.4 million of other federal domestic debt.5
It was key that wealthy and affluent Americans would buy the new federal bonds. Hamilton wrote that the United States could not be built and maintained on nationalism alone.
Providing interest-bearing bonds to the wealthy would give them a stake in the success of the nation, helping to give “cement of union” in Hamilton’s words. Then as now, the self-interest of affluent citizens reigned supreme above all else.3
With their financial stake tied to the nation’s fate, these affluent and influential citizens could dissuade others from favoring disunion; this was a constant threat in the early days of the nation.1
It is also for this reason that northerners were so in favor of assumption. The nation’s financial centers were all primarily located in northern states. Cities such as Philadelphia, New York City, and Boston all boasted large affluent populations stemming from their mercantile and trade-based economies.
Speculators that obtained large holdings of old state war debts were also primarily centered in northern states. These interested parties pressured their northern representatives to pass assumption at all costs so they would financially benefit.1
Establish Good Public Credit
One of the main purposes of Hamilton’s financial plan was to establish strong public credit for the United States. If successful, the federal government would be able to borrow from creditors at low rates, boosting the economy in the process.
By giving the federal government responsibility over Revolutionary war debts, creditors of the nation could expect consistent treatment and that obligations would be met.1
Public credit was to be established by paying interest regularly and guaranteeing the payments to creditors. Revenues would be mortgaged in perpetuity and there would be no obligation to repay the principal on the debt at any given time.5
The concept was revolutionary as the government could keep borrowing so long as it could make interest payments without the threat of having to owe the full value of the principal at a given time.5
One of the main issues of the proposal revolved around the proposed interest rates on the new federal debt. Most of the revolutionary war debt was issued at 6% interest, while the new federal debt would be at a lower rate, causing some issues even amongst Hamilton’s supporters.
However, the federal government could not afford a 6% interest rate on all the new debt without significantly raising taxes. A compromise was in order, and different tiers of interest rates between 3-6% appeared in the final bill.
Between the funding bill and the later creation of the first national bank, Hamilton achieved his goal of transforming the nation from weak to strong credit where it could borrow on the same terms as leading European nations.5
Shifted Burden of Taxation from State to Federal
A final aspect of Hamilton’s financial plan was how it shifted the burden of taxation from the state to the federal level. Whereas previously states had levied taxes to pay for Revolutionary war debts, now the federal government would need to.
This ability to tax was in accordance with the new Constitution, though it still made many citizens wary. Federal taxation had the ability to concentrate power among few people, primarily the aristocracy, and could lead the nation down a dangerous path.
Sure enough, Congress passed the Tariff Act of 1790 which implemented duties on imported goods for the primary purpose of raising revenues. The nation needed to not only cover its operating expenses but also the interest payments on its large debts.
As Hamilton predicted, import tariffs would not be enough. Therefore Congress also passed an internal excise tax on consumption (income taxes did not exist in this day).
The so-called “whiskey excise tax” was hated among distillers, primarily those along the frontier. President Washington himself led troops out to western Pennsylvania to put down the Whiskey Rebellion in 1794.
Despite the passage, not all states were satisfied with the result. After the bill’s passage the Virginia legislature sent three resolutions to Congress arguing that assumption was unconstitutional.1
Led by Patrick Henry, the legislature believed that assumption would create a large monied interest and concentrate power among the few. This would particularly threaten liberties among the agrarian population so treasured by the eventual Jeffersonian Democrats.
These resolutions later served as a precedent to James Madison’s Virginia Resolutions of 1798.
To recap, the four key aspects of Hamilton’s assumption of state debts plan included:
- Federal Government assumes state debts
- Issue bonds that wealthy Americans would buy
- Establish good public credit
- Shift taxation from state to federal
Hamilton’s financial plan was an undoubted success and completely changed the trajectory of the nation. Coupled with the creation of a national bank, the United States’ credit skyrocketed to be on par with those of European nations.5
Perhaps most remarkably, his plan succeeded in as little as five years, an unheard of amount of time for an endeavor of such scale.
Even his detractors such as Thomas Jefferson agreed with the fundamental aspects of his financial plan. When Jefferson became president just ten years later after the election of 1800, he kept Hamilton’s system in place, though he prioritized paying down debt principle with the nation’s excess tax surpluses.
Though controversial at the time, the federal assumption of state debts proved to be an extreme boost to the American economy.
To learn more about US history, check out this timeline of the history of the United States.
1) Kuehl, John W. “Justice, Republican Energy, and the Search for Middle Ground: James Madison and the Assumption of State Debts.” The Virginia Magazine of History and Biography, vol. 103, no. 3, 1995, pp. 321–38. JSTOR, http://www.jstor.org/stable/4249521.
2) Cooke, Jacob E. “The Compromise of 1790.” The William and Mary Quarterly, vol. 27, no. 4, 1970, pp. 524–45. JSTOR, https://doi.org/10.2307/1919703.
3) Baumann, Roland M. “‘HEADS I WIN, TAILS YOU LOSE’: THE PUBLIC CREDITORS AND THE ASSUMPTION ISSUE IN PENNSYLVANIA, 1790–1802.” Pennsylvania History: A Journal of Mid-Atlantic Studies, vol. 44, no. 3, 1977, pp. 195–232. JSTOR, http://www.jstor.org/stable/27772464.
4) Bowling, Kenneth R. “Dinner at Jefferson’s: A Note on Jacob E. Cooke’s ‘The Compromise of 1790.’” The William and Mary Quarterly, vol. 28, no. 4, 1971, pp. 629–48. JSTOR, https://doi.org/10.2307/1922191.
5) Swanson, Donald F. “Thomas Jefferson on Establishing Public Credit: The Debt Plans of a Would-Be Secretary of the Treasury?” Presidential Studies Quarterly, vol. 23, no. 3, 1993, pp. 499–508. JSTOR, http://www.jstor.org/stable/27551109.