White House Burning: The Founding Fathers, Our National Debt, and Why It Matters to You - Hardcover

Simon Johnson is Ronald A. Kurtz Professor of Entrepreneurship at MIT’s Sloan School of Management and a senior fellow at the Peterson Institute for International Economics. He is a member of the Congressional Budget Office’s Panel of Economic Advisers and of the Federal Deposit Insurance Corporation’s Systemic Resolution Advisory Committee. He was previously the chief economist of the International Monetary Fund.
 
James Kwak is an associate professor at the University of Connecticut School of Law. He is currently a fellow at the Harvard Law School Program on Corporate Governance. He has also worked as a management consultant and cofounded a software company.

Johnson and Kwak cofounded The Baseline Scenario, a widely cited blog on economics and public policy. They also wrote 13 Bankers: The Wall Street Takeover and the Next Financial Meltdown (Pantheon, 2010), a bestselling analysis of the financial system and the recent financial crisis.
 
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INTRODUCTION
 
Nothing is more important in the face of a war than cutting taxes.
—House majority leader Tom DeLay, 2003
 
On June 1, 1812, President James Madison sent a letter to Congress asking it to consider a declaration of war against Great Britain. The Democratic-Republican majority in Congress was happy to oblige. For the original War Hawks, only military force could avenge repeated British infringements on American sovereignty—“the spectacle of injuries and indignities which have been heaped on our country,” in Madison’s words. The insults to the United States ranged from seizing American ships on the high seas and impressing their sailors into the Royal Navy to supporting Native American attacks along the Western frontier. Attempts to apply economic pressure had backfired, and diplomacy appeared to be leading nowhere; as Madison said, “Our moderation and conciliation have had no other effect than to encourage perseverance and to enlarge pretensions.”
 
With war approaching, it fell to Treasury Secretary Albert Gallatin to pay for it. Gallatin hoped to finance the war with borrowed money, but he wanted to raise taxes enough to cover the interest on new debt. Without those taxes, he worried that bond investors would not be willing to lend large amounts of money to a young country fighting with a European superpower. But the War Hawks were ideologically and politically opposed to taxes—particularly the excise (internal trade) taxes that Gallatin wanted to impose. As the party of small government, the Democratic-Republicans believed that higher tax revenues constituted a threat to individuals’ and states’ rights. Perhaps more importantly, they feared that raising taxes to fight a war could hurt them at the ballot box. Congress did increase some tariffs (taxes on external trade) in the run up to war, but failed to approve the internal taxes that Gallatin had pressed for, instead authorizing the Treasury Department to borrow money. But there were not enough investors willing to lend the amount needed, even before war began, forcing the government to print paper money. On June 18, 1812, the United States declared war against Great Britain. Less than a month later, Congress adjourned.
 
Hampered by Congress’s reluctance to raise taxes, the Treasury Department struggled to pay for soldiers in the field and ships at sea. In 1813, with the government only weeks away from running out of money, Gallatin was forced to rely on Philadelphia banker Stephen Girard to underwrite a massive loan—because, at that point, Girard’s credit was better than the government’s. The United States military could win individual victories, but was unable to achieve any of its major objectives, suffering repeated defeats on the border with Canada, even with Great Britain distracted by the much larger war against Napoleon in Europe. Congress finally agreed to impose excise taxes in 1813, but it was too late to build up a world-class military. After a decade of tight budgets, the U.S. Navy began the war with all of seventeen ships. The Royal Navy commanded over one thousand ships; even with many of them committed elsewhere, it was still able to blockade the Eastern shoreline and raid the coast almost at will. Chesapeake Bay, the broad waterway leading to both Washington and Baltimore, was defended by a collection of barges and gunboats that were outclassed by the British navy and soon trapped in the Patuxent River. The approach to Washington along the Potomac River was guarded by Fort Warburton, completed in 1809, about ten miles downstream from the capital. But when Pierre Charles L’Enfant, the architect and city planner who had designed the city of Washington, inspected the fort, he found it severely deficient and recommended a redesign, more heavy guns, and construction of a second fort nearby. The secretary of the navy added some more guns, but there was no money for further improvements.
 
In August 1814, British forces sailed into the Patuxent, an inlet of Chesapeake Bay that points toward Washington. They cornered the overmatched defensive flotilla, forcing the Americans to scuttle their ships, and landed ground forces in Benedict, Maryland, less than forty miles from the U.S. capital. The soldiers marched overland from Benedict, defeated an American militia at the Battle of Bladensburg, and eventually reached Washington, where they encountered little resistance. On the night of August 24, they burned the Capitol, the Treasury Building, and the White House—after eating the dinner that had been set for that evening. Another British squadron sailed up the Potomac and bombarded Fort Warburton, whose defenders quickly abandoned their positions. From there, they continued upriver to capture the city of Alexandria, which was commercially more important than Washington at the time, seizing twenty-one merchant ships and their cargo.
 
For the Americans, the burning of the White House was the low point of the war, a moment of national humiliation that remains an iconic image in U.S. history. Despite the symbolism, it was not a decisive moment in the conflict; the two sides negotiated a peace later that year after deciding the war was no longer worth fighting. But the vulnerability of America’s capital highlighted the danger of going to war against one of the world’s superpowers unprepared. As Admiral George Cockburn supervised the destruction of official Washington, someone called out to him, “If General Washington had been alive, you would not have gotten into this city so easily.” “No,” Cockburn replied, “If George Washington had been president we should never have thought of coming here.” But Washington, who had been forced to fight the Revolutionary War with an under-equipped, underpaid army, knew as well as anyone that any military was only as strong as the treasury that backed it. What the British had, more than anything else, was money—money to outfit and equip hundreds of ships and to fight simultaneous land wars in Europe and North America. By contrast, without a stable source of tax revenue, the United States struggled to attract lenders willing to bet on the country’s unproven armed forces. Right up until the end of the war, military operations were hampered by failures to pay troops and contractors.
 
This deep fiscal crisis was the product of one of the most bitter, divisive political struggles in American history. Beginning in 1790, Treasury Secretary Alexander Hamilton pushed through a controversial series of fiscal policies that included restructuring the national debt, federal government assumption of state debts, a national bank, and excise taxes. Opposition to Hamilton’s policies led Thomas Jefferson and James Madison to found the Democratic-Republican Party (often known simply as the Republican Party), which faced off against Hamilton’s Federalists. The small-government, antitax Republicans swept the elections of 1800, with Jefferson defeating Federalist incumbent president John Adams, and proceeded to reverse some of Hamilton’s policies, repealing the excise taxes in 1802. To pay for these tax cuts, the Republicans cut defense spending, which was one reason for the military’s unpreparedness in 1812. The elimination of internal taxes also made government revenues dependent on tariffs, which were gutted first by an embargo against Great Britain and then by war. It was this battle over taxes and spending that led to the country’s fiscal weakness in 1812.
 
Ironically, the Republicans, who voted for war but not for the taxes to pay for it, were the political victors of the War of 1812. The Federalists’ opposition to the war—which, in some cases, extended to attempts to undermine the Treasury Department’s efforts to raise money—made the party appear unpatriotic, and it never again gained power on the national level. In a sense, however, the war also vindicated the principles laid out by Hamilton two decades before. Both Federalists and Republicans had always been “fiscally responsible” in the shallow sense that they believed the country should make required payments on its debts. But there is a deeper meaning of fiscal responsibility: the recognition that if you want something, you have to pay for it, either now or in the future. If a government cannot demonstrate that type of fiscal responsibility—through the willingness and capacity to levy and collect taxes when necessary—it will have trouble borrowing money in a time of crisis. This was missing in the Congress of 1812. As Representative John Randolph (an antiwar Republican) said sarcastically to his pro-war colleagues, “Go to war without money, without a military, without a navy!” By 1813 and 1814, however, it was Republican majorities in Congress that voted to reinstate and then raise the internal taxes originally imposed by the hated Federalists. Some things, everyone agreed, were worth paying for.
 
Fast forward to 2011. Once again, Washington is embroiled in a bitter partisan fight over taxes, spending, and debt. This time, unlike two centuries before, it is not primarily about war, although troops are still on the ground in the Middle East. The United States is the world’s only true superpower, with the largest military and the largest economy on the planet, and its national survival is not in question. Nor does the Treasury have any trouble borrowing money. The dollar is the backstop currency of the global economy, and Treasury bonds are used in financial markets as the very definition of a safe asset. Although the national debt is over $10 trillion, interest on that debt is barely $200 billion per year—less than 10 percent of the tax revenues that the federal government brings in. Investors around the world, seeking safety from economic problems elsewhere, are hungry to lend money to the United States: interest rates on ...