Introduction
A Country Born of War and Debt
American history offers many political and economic lessons. But looking back over this nation's more than two hundred years, one central, constant theme emerges: sound national finances have proved to be indispensable to the country's military strength. Without the former, it is difficult over an extended period of time to sustain the latter. Generations of leaders have come to recognize that if the country chronically lives beyond its means or misallocates its financial resources, it risks eroding its economic base and jeopardizes its ability to fund its national security requirements. These considerations are particularly vital today, when terrorists seek to create turmoil in American society and destroy the crucial economic infrastructure and the institutions that underpin U.S. prosperity and stability. Understanding our past can aid us today in putting America's finances on a more sustainable track.
As commander of the Revolutionary army, George Washington pleaded repeatedly with the Continental Congress for the funds to pay and supply his troops. But because that Congress had no taxing power, it was frequently unable to provide the money Washington needed, so the army was deprived of vital provisions and vulnerable to desertions. The desperate Congress turned to Benjamin Franklin and John Adams to seek loans from France and the Netherlands. After considerable coaxing, these nations furnished money critically needed by the army. But this frustrating experience convinced Washington and his young lieutenant Alexander Hamilton that the new American nation required a sound financial system, solidly based government credit, and a predictable flow of tax revenues if it was going to be able to marshal sufficient resources to defend itself in the future.
In January 1790, Hamilton, by then the country's first secretary of the Treasury, confronted the American people with a stark fact: the nation had run up a huge debt fighting the Revolutionary War. This debt, he wrote, was the "price of liberty," and the new government had to repay it. The future creditworthiness of the United States, and ultimately its security and ability to finance future wars, would depend on how successfully and faithfully this was done.
Over the course of the next two centuries, America's wartime leaders have faced challenges similar to those confronted by Washington and Hamilton. Most have recognized that it is not enough to have a large number of troops, sound military strategy, and able generals to fight a war; the country also needed a sound financial strategy and skillful leaders at the Treasury and in Congress to ensure that the money was available to meet extraordinary military expenses. The techniques American officials have employed to generate these funds under the duress of war have produced dramatic innovations in the nation's tax and borrowing policies, innovations that lasted long beyond the conflict during which they were introduced and many of which remain in effect today. America's wars have been fiscally as well as politically transforming events; changes that could not have gained public acceptance in quieter times won support when they answered the urgent requirements of war.
Presidents at War
Americans today tend to take for granted that when the country fights a war, sufficient resources will be forthcoming to provide the troops with pay, weaponry, supplies, and equipment. This was not always the case. After the Revolution, the government's ability to obtain needed financial resources was highly problematic. During the War of 1812, lack of money jeopardized the country's very survival. Prior to the Civil War, there was no national income tax; it was imposed during the war in a desperate attempt to obtain more revenue and demonstrate fiscal fairness, but was allowed to phase out afterward and was not revived for another half century.
As the nation's economic condition and financial institutions strengthened, so did its capacity to mobilize the immense sums necessary for war. In the twentieth century, America's ability to generate colossal amounts of tax revenues, conduct massive bond drives, and produce great volumes of weaponry became critical to its military successes. Without these, the country would not have been able to field large numbers of well-equipped forces to fight the two world wars and to project power into far-flung parts of the globe during the Cold War that followed.
But the story of how the United States has paid for its wars is only partly about money and finance. It is also about the political skills and vision of America's leaders. From Hamilton's time onward, the politics of financing a war has been inextricably tied to the politics of the war itself. Leaders have had to confront fundamental questions about equity: who would pay, how they would pay, and how the needs of war would relate to other national economic priorities. While military battles were being fought between the United States and its enemies, financial battles were being fought among powerful interests and politicians at home.
Toward the end of World War I, President Woodrow Wilson urged Congress to set aside domestic politics in the midst of the hostilities. They never were, during that war or any other war. Methods of paying for a given war have been the subject of contentious debates, featuring vigorous and often acrimonious competition among egos, political parties, ideologies, classes, regional interests, and economic philosophies. In the charged environment that often accompanies war, presidents have found that fiscal policy cannot only be about raising large sums of money, as important as that is. It has also been about finding ways to resolve internal differences in order to unite the country behind the war effort and maximize the productive output of the economy. If the government raises large sums at the cost of dividing the country, the goals that the country is fighting for abroad would be undermined from within. If the methods political leaders employ to secure the funds for a war are seen by large portions of the population—and particularly by low-income groups who supply the majority of troops in a war—as unfair, support for the war effort would suffer. And if the methods chosen to raise money weaken the economy—the foundation of the nation's military power—that, too, would undercut the war effort.
Forging wartime fiscal policy in America has been far from simple. Presidents have frequently faced congressional resistance to their massive tax and borrowing requests, occasionally even from those in their own party. As the War of 1812 began, James Madison's request for appropriations was blocked by a faction within his own Jeffersonian Republican Party; there was also aggressive resistance from the Federalists, who opposed the war and sought to undermine Madison's military strategy by preventing the government from borrowing the money it needed. Early in Abraham Lincoln's administration, influential congressional Republicans balked at creating a federal bureaucracy to collect the Civil War income tax. Woodrow Wilson's World War I tax requests were frequently opposed by congressional Republicans and significantly altered by congressional Democrats. At the height of World War II, legislators on both sides of the aisle combined to slash Franklin D. Roosevelt's revenue requests. During the Vietnam War, Lyndon B. Johnson was forced by a resolute coalition of Democrats and Republicans to alter his tax and spending proposals. During the mid-1980s military buildup, Ronald Reagan encountered opposition from both parties to his fiscal policies. And prior to the first Gulf War, George H. W. Bush was bitterly attacked by Republicans when he supported a budget-cutting compromise that included a tax increase. For the most part, however, all sides in these often bruising confrontations eventually were willing to put aside parochial interests to ensure that the military was well supplied and well armed. And in the heat of these battles, each generation of wartime leaders learned valuable lessons and developed innovative fund-raising techniques that were instructive for their successors.
The Tradition of Paying Down Wartime Debt
A central feature of U.S. fiscal policy for the first century and a half of its history was a bipartisan tradition of paying down wartime debt as rapidly as possible. For many decades, it was a national compulsion. The Founding Fathers established a principle of avoiding debt when there was no war or other national emergency and quickly reducing the debt that was accumulated during such times.
In his farewell address, President Washington emphasized the need for "vigorous exertion in time of peace to discharge the debts which unavoidable wars may have occasioned, not ungenerously throwing upon posterity the burdens we ourselves ought to bear." Posterity was a compelling preoccupation of the Founding Fathers. They spoke of it often, seeing themselves as representing the interests of future generations of Americans as well as their own. In his second inaugural address, Jefferson echoed Washington's sentiments, emphasizing the need to avoid "encroaching on the right of future generations by burdening them with the debts of the past." In later years, populists and progressives who shared the Jeffersonian philosophy sought to prevent the accumulation of large amounts of debt. They feared that the wealthy holders of government bonds would force Congress to impose high duties and excise taxes on the goods purchased by the working class to enable the Treasury to service the interest due on the bonds.
Over the next century and a half, the principle of paying down debt was almost religiously adhered to. During the War of 1812, the national debt nearly tripled but then was sharply reduced as military spending was cut and a booming economy produced increased customs and excise tax revenues. In eighteen of the twenty years that followed, the government recorded budget surpluses, and during the 1830s the national debt was eliminated during Andrew Jackson's administration. By the end of the Civil War, Union debt had exploded to roughly forty times its 1860 level. After the war, the nation recorded twenty-eight years of budget surpluses, reducing that debt by two-thirds. During World War I, the nation's debt increased over twentyfold, but surpluses during the next eleven years reduced it by more than a third before the Great Depression caused it to climb again. World War II saw the national debt rise sixfold, to a record 110 percent of the gross domestic product (GDP). However, from the war's end through 1960, the government recorded surpluses half the time, even though it faced the high cost of financing postwar reconstruction in Europe and countering the new Soviet threat. Prudent fiscal policy during that period, coupled with a thriving economy, brought the debt down to 60 percent of GDP at the end of the Eisenhower administration.
The Cold War, which began in the late 1940s and ended in the early 1990s, presented a new financial challenge for the United States. In the past, there had been a sharp line of demarcation between periods of war and periods of peace, between mobilization and demobilization. The nation did not have a tradition of a large peacetime military. In the post-Revolutionary period, Americans were deeply suspicious of the very notion of a peacetime standing army, fearing a powerful individual or cabal could potentially use it to seize power, and perhaps even restore a monarchy. The vast majority at the time believed that citizen militias should primarily be relied upon for the nation's security.
During the Cold War, however, a large standing army was needed because of the constant threat to American and Allied security posed by the Soviet Union and its client nations. That required consistently large defense budgets relative to past periods when the country was not engaged in a major shooting war. The Cold War was also punctuated by two "hot wars," in Korea and in Vietnam, during which mobilization and military expenses spiked. The costly nuclear arms race, along with enormous expenditures on conventional weapons, required the appropriation of trillions of dollars from the 1950s through the 1980s at a time when escalating social spending imposed heavy demands on the budget. A substantial portion of the cost of these defense and social programs was met through borrowing. In the face of these requirements, the historic commitment to avoid accumulating debt except in times of national threat faded away; Keynesians as well as advocates of supply-side economic policy, at varying times, used deficit spending as a technique for boosting economic growth.
The Challenge Ahead
In the early years of the twenty-first century, the United States is confronted with the challenge of financing a new type of war—the war on terrorism. In the words of a 2006 Pentagon report, it is likely to be a "Long War" and is being fought in parallel with prolonged ground wars in Iraq and Afghanistan. Moreover, the country faces additional security threats, including increased nuclear proliferation, a collapse of moderate governments in the Middle East, a broadening of military conflicts in that region, and instability among major oil suppliers.
The approach taken by the administration and Congress to financing the U.S. role in these conflicts has been a substantial departure from past practices. The terrorist attacks of 9/11 appropriately triggered big increases in military and homeland-security appropriations. These were accompanied, however, by a wave of nonsecurity-related spending, including billions of dollars for items of low national priority. Two years after 9/11, Congress also enacted a large tax cut to stimulate a sluggish economy, but it did so with relatively little consideration of its significant long-term revenue costs and whether it was appropriate during a period of elevated national security spending.
Past wartime administrations and Congresses had eliminated, postponed, or reduced funding for low-priority domestic projects in order to make room in the budget for additional high-priority military spending. They also raised taxes to generate more resources for their war effort. Congress had never before increased nonsecurity spending and cut taxes while also appropriating large sums to fight a war. By supporting and signing expensive spending and tax legislation, President George W. Bush broke with a tradition that had extended from Madison through Lincoln, Wilson, Franklin Roosevelt, Truman, and, eventually, Johnson and Reagan. All of them insisted on, or at least acquiesced in, wartime tax increases, cuts in civilian programs, and sometimes both, as they devoted more resources to the nation's military requirements.
The chapters that follow describe how past generations have marshalled the financial resources to meet the security needs of the nation during periods of war, tracing and describing how earlier administrations and Congresses have reconciled competing political agendas to assemble massive amounts of financial resources in support of the nation's armed forces. This tale is as much a part of the history of the nation as the conflicts themselves.
These issues take on a new urgency today. The war on terrorism—against enemies seeking nuclear, chemical, and biological weapons to kill large numbers of Americans and seriously damage the U.S. economy—poses a unique financial challenge. Like the Cold War, it will require constant and elevated military, intelligence, and foreign-policy-related spending and is likely to be punctuated by periods of high alert, dangerous threats, and perhaps severe crises. But the financial challenge of this war goes beyond that of the Cold War.
Osama Bin Laden has made clear his desire to disrupt and destabilize the American economy. He has boasted that the attacks of 9/11 struck the U.S. economy "in the heart"—claiming that Al Qaeda spent only $500,000 while the United States lost over $500 billion. Experts believe that in the future, Al Qaeda or other groups of global terrorists spawned or inspired by it intend to deploy weapons of mass economic disruption. The U.S. government will have to spend large sums on all facets of homeland security to prevent another attack. In addition, it will have to win the battle for the hearts and minds of large numbers of people who might be attracted to radical terrorist movements. And it must also be able to mobilize resources for recovery in the event another attack should occur—and the amounts required in that event would likely be far greater than after 9/11.
America's leaders have to find ways to meet these critical security needs while addressing another long-term financial challenge: the rapidly rising retirement and health-care costs of an aging population. Other generations have faced significant defense spending requirements, but none has confronted them along with such an imposing combination of nondefense budgetary demands. Social Security, Medicare, and Medicaid will place unprecedented financial burdens on the budget for decades to come. Ultimately, their costs and those of protecting America's national security will clash unless a long-term fiscal strategy can be found for meeting both priorities. It must include a more rigorous prioritization of resource allocation, curbs on nonessential spending, tax policy that avoids chronic deficits, and matching payouts under entitlement programs more closely to the money flowing in.
Further, America's heavy dependence on foreign capital exacerbates the financial threat facing the country. These early years of the twenty-first century mark the first time since the Revolutionary War period that the U.S. government has been so dependent on funds from abroad during wartime. In 2006, foreign private investors and governments bought over half of all newly issued Treasury securities, which means that foreigners financed over half of the U.S. budget deficit. Central banks abroad keep over 70 percent of their reserves in dollar assets. Another terrorist attack could precipitate a dramatic reduction of capital inflows or even an exodus of funds. With the country's high dependence on overseas capital, these developments could trigger a spike in U.S. interest rates and a collapse in the value of the dollar, further disrupting an already damaged economy.
The new century presents the country with new kinds of security threats, new demographic challenges, new health-care demands, and new external pressures from global trade and finance. An extensive reexamination of fiscal policy has taken place at the outset of most major wars in U.S. history. Yet today the United States is living in a post-9/11 world with a pre-9/11 fiscal policy. These new circumstances require a realignment of policies and priorities to meet the unique financial challenges posed by the global war on terrorism in the face of the equally unprecedented requirements posed by America's aging population and the rising heath-care needs of its society. Although U.S. leaders have warned that the war against terrorism could last for decades, the country lacks a multidecade financial strategy to address that challenge. With such large sums of money committed by past legislation and such large deficits on the horizon, the flexibility to respond to new dangers is badly constrained. The current long-term direction of U.S. fiscal policy is inconsistent with, and could ultimately undermine, America's national security. A heavily debt-laden, overobligated, revenue-squeezed government, highly dependent on foreign capital, creates major security vulnerabilities. The long war on terrorism requires a sound long-term financial strategy.
Copyright © 2007 by Robert D. Hormats. All rights reserved.
