What Congress can learn from the general store owner who crafted U.S. borrowing limits

Photo by Karen Bleier/AFP/Getty Images

Photo by Karen Bleier/AFP/Getty Images

Editor’s Note: Several months ago, the debt ceiling was big news. Would Congress vote to raise America’s borrowing limit or let America default on expenses already incurred? The House finally approved a “clean” debt ceiling raise in February – until March 2015, which means, before long, we’ll be going through the whole process again.

In the meantime, Bill White, former Democratic mayor of Houston and U.S. deputy secretary of energy, wants to change the way America handles its borrowing. He’s the author of a new book out this spring, “America’s Fiscal Constitution: Its Triumph and Collapse,” which the New York Times Book Review called “music to the ears of budget hawks everywhere.” He describes America’s original track record of fiscal discipline, introducing readers to the general store owner who help craft the first limits on debt sustained by both parties through two centuries.

So where’d America go wrong? Unified budgets that muddled income and liabilities, for Social Security and Medicare, for example, and overall debt ceilings that didn’t make clear the purpose of specific borrowing have led us astray. Balancing the budget makes for a great political talking point, White argues, but recently, that’s all it’s been. White ends with prescriptions not unlike those that general store owner Albert Gallatin carried to Congress in 1793 to get America’s finances back on track.

Simone Pathe, Making Sen$e Editor

In 1787 citizens from 12 states gathered to decide how best to pay past due debts from the War of Independence. They solved that problem by creating a new nation, the United States of America. The architect of the written Constitution, James Madison, hoped that the nation’s leaders would limit any additional debt by applying principles clearly “visible to the eye of the ordinary politician.” For almost two centuries, ordinary politicians relied on well-defined rules to maintain extraordinary fiscal discipline.

The size and nature of federal borrowing changed when traditional limits on debt collapsed in the 21st century. For only the second time in the nation’s history, total federal debt now exceeds annual national income. When that first occurred — after World War II — the federal government quickly balanced its budget in order to restrain the burden of debt service. This year, in contrast, the federal government will borrow an additional $5,000 per household, though its annual interest expense is projected to double by 2020.

No wonder so many in Congress, as well as the public, refer to a “broken” budget process. It is worth considering just how it once worked.

The owner of a general store, Albert Gallatin, helped craft the nation’s traditional limits on debt. His rough-hewn neighbors on the new nation’s far western frontier sent him to the Congress in 1793. Though other federal leaders at that time had difficulty understanding his heavily accented English, they learned to listen carefully whenever he addressed budget issues. He reviewed the ledgers of the federal government, and seemed to effortlessly absorb the details of federal finances.

No one was better prepared to develop budget principles. Gallatin had graduated at the top of his class in Geneva, the financial center that was home to the world’s finest schools. While educated New World leaders viewed Voltaire as the intellectual giant of the age, the modest Gallatin remembered him simply as a family friend. The Swiss immigrant urged Americans to learn from the experiences of other nations that had been hobbled by excessive debt. And no one surpassed his knowledge of the details of taxation, public spending and the American economy.

For 13 years Gallatin crafted the nation’s first budgets while serving as Treasury secretary in the Jefferson and Madison administrations. He began those “pay as you go budgets” by estimating annual revenues, subtracting required debt service, and allocating the balance to various spending programs. Most years he retired debt that had been inherited from the Revolutionary War. When taxes were raised for naval protection against pirates, Gallatin placed those revenues in a trust for that purpose to assure voters that their use would be limited to that defined purpose. His budget accounting satisfied Jefferson’s goal of being as “clear and intelligible as merchants’ books.”

The Founding Fathers expected Congress to authorize debt only in specific amounts for four defined purposes: to prevent states from leaving the Union (assumption of state debts in 1790), to extend and secure the nation’s territory (the Louisiana Purchase in 1803), to wage war (the War of 1812), and to plug holes during a downturn (following the Panic of 1819). For the next century and a half, the federal government borrowed only for purposes grounded in those early precedents.

Voters throughout American history have viewed limits on debt as a means of preserving the financial future of their children and their nation’s economic independence. They realized that government would cost more with an added burden of interest.

Gallatin’s budget practices began to erode in the 20th century, even though virtually all mainstream political leaders embraced the goal of balanced budgets. Congress permitted Depression-related borrowing under the ceiling for debt authorized for World War I. That action seemed innocent enough at the time, but by late in the century, the use of an overall debt ceiling made it difficult for voters to identify the purpose for additional borrowing. Clear federal accounting — another of Gallatin’s practices — was compromised in 1968 when “unified” budgets incorporated income but not accrued liabilities for the Social Security and Medicare trust funds. That misleading accounting greatly exaggerated the size of the surplus in 2000.

After 2000, federal officials no longer planned spending based on estimates of available revenues. They severed the traditional and common sense link between tax and spending policies. A flood of red ink filled the gap between federal outlays and tax collections. Only half of debt incurred after 2001 resulted from borrowing for traditional purposes, such as financing two wars and responding to a severe recession.

Incumbents recast their ideologies to rationalize chronic borrowing. Conservatives claimed they limited the size of government by substituting debt for taxation, while progressives acquiesced to the unsustainable use of debt to finance medical services. Today leaders in each party publicly profess a commitment to the ultimate goal of balancing the budget, so long as that balance occurs only in the distant future. One recalls the prayer of the young St. Augustine: “Lord make me chaste, but not today.”

Traditional budget practices once helped the nation balance its commitments and resources. People are free to devise their own personal budget priorities, but not their own rules of math. So it should come as no surprise that the time-tested budget practices that once limited the temptation to borrow offer the clearest roadmap for needed budget reforms today.

Congress could initiate those reforms with more honest accounting, which requires a separation of trust funds from the rest of the budget. And those trust fund budgets should be brought into balance. Medicare would be a good place to start, since all members of Congress in both parties publicly support that program. Democrats and Republicans ought to agree on that goal even while they debate how best to accomplish it. A similar framework led to the heated debate and hard choices that yielded needed reform of Social Security in 1983 and Medicare in 1997.

The existing congressional practice of voting to spend more than available tax revenues, and afterwards arguing over the debt ceiling, rewards posturing rather than fiscal progress. Instead, Congress should restore the historical procedure of voting to authorize specific debt for defined purposes when it appropriates more than available revenues.

Congress can divide annual appropriations (spending) bills into portions funded with taxes and any portion financed with debt. That change is hardly radical: state and local governments vote separately on tax and debt-financed appropriations. (No wonder their debt has increased at half the rate of federal debt for the last four decades.) Members of Congress who support only the tax-funded spending could vote against the amount funded with debt. The tradeoff between tax and spending policies would become more explicit. Voters would have a record, which they lack today, of the amount and purpose of borrowing voted for by each of their elected representatives. Who can object to that?

In 2012, Paul Solman interviewed former International Monetary Fund chief economist and MIT Sloan School of Management professor Simon Johnson about America’s historical struggle with debt.