Fiscal Politics

Author:Vitor Gaspar/David Amaglobeli
n the evening of June 20, 1790, James
Madison and Alexander Hamilton met at
omas Jefferson’s home on Maiden Lane,
in New York. Over a long dinner, the three struck
a historic deal that laid the financial groundwork
for the fledgling nation. Madison agreed to have
the US federal government take over the states’
Revolutionary War debt; in return, Hamilton agreed
to support the move of the nation’s capital to the
banks of the Potomac River, a location favorable to
Madison’s home state of Virginia. e deal is an early
and vivid example of how fiscal politics can shape
history. e episode remains relevant because it
shows that politics plays a crucial role in far-reaching
reforms of public finances. Public finance reform
is fundamentally political, and it has the potential
to shape the political system itself. As this most
famous dinner shows, political negotiation can help
overcome apparently insurmountable obstacles and
become a force for institutional transformation.
Today’s policymakers who disregard political realities
are doomed to be ineffective.
About 18 months before that historic dinner, when
George Washington was elected a s the nation’s first
president, the federal government was bank rupt. e
Treasury Department was not created u ntil September
1789, and the first federal re venue had yet to come in.
Yet by 1792, the new adminis tration would manage
to put its fiscal house in order. In addition to assumi ng
the debt of the states, it restructu red its own wartime
debt, built strong federal ta x capacity based on tariff s
and an effective cu stoms service, laid the foundations
of public credit, created a national bank, a nd pro-
moted the development of financial markets. e se
steps gave the federal government tools to car ry out
a policy of active economic development.
Rarely in the his tory of finance has so much been
achieved in so short a time. Bui lding and shaping
the nation’s capacity to manage public finances
was a profoundly political proces s. It divided the
Founding Fathers into two opposing camps: t he
Federalist Part y of Hamilton and John Adams,
which advocated a strong federal g overnment, and
the Democratic-Republican Part y of Jefferson and
Madison, which favored a decentrali zed government
with limited federal powers.  is partisan split has
been a feature of America n politics ever since.
Pragmatic vision
Hamilton recognized that the Constitution alone
would not make the federal government strong;
it was also necessary to build the infrastructure of
public finance. Guided by a vision that was pragmatic
and concrete rather than abstract and theoretical,
Hamilton laid out his program in three landmark
reports: on public credit (January 1790), a national
bank (December 1790), and manufactures (December
1791). Taken together, these reports addressed five
core areas: taxation, public credit, financial markets
and organizations, financial stability and crisis man-
agement, and trade policy. Hamilton was inspired by
a new kind of state that had emerged from Britain’s
Glorious Revolution of 1688–89: one capable of
mobilizing resources for war and international com-
petition and actively engaged in economic and finan-
cial development. is program of state building
dominated political debate in the United States for
the next decade.
A historic dinner meeting laid the foundations of US finances
Vitor Gaspar and David Amaglobeli

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