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Employment of Public Credit and Investment Loans


It is the purpose of the present chapter to consider some of those fundamental questions that arise in the employment of public credit. So far as temporary loans are concerned nothing need be added to what has been already suggested in the foregoing chapter. Provided efficient rules have been framed for estimating income and expenditure, and provided the revenue system possess adequate mobility, the financier can answer all questions that arise in connection with a policy of temporary loan financiering by the application of simple business principles. But this is not true of emergency or of investment financiering, and for that reason the employment of public credit to meet an emergency or to provide funds for investment calls for special consideration.

79. Emergency Financiering. There are many sorts of emergencies to which the finances of a nation are exposed, a complete presentation of which would require their defini tion and classification, to be followed by a consideration of the peculiar fiscal necessities of each. This, however, we shall not undertake, but, selecting the most serious of all emer gencies that can occur in the life of a nation, we shall content ourselves with a discussion of the appropriate management of a public treasury in time of war. In a sense the en tire subject will be presented by this method of procedure, for the rules and principles arrived at in studying the necessi ties of war financiering may be applied, though in a modified form, to all classes of fiscal emergencies.

It will be of some advantage to grasp at the outset the magnitude of the operations that may be forced upon the public treasury by the advent of an expensive war. In the War of the Rebellion, for example, it was necessary for the government within the space of four years to increase its revenue from 65.2 millions of dollars to 96o.6 millions of dollars. To express the problem in another way, the expen diture of the government in 1861 was about two per cent of the gross product of the nation; in 1865 it was in excess of twenty-six per cent of the gross product. This is indeed an emergency, and to administer a public treasury under such circumstances so as not to involve the nation in ruin demands a clear policy firmly followed from the beginning to the end of the period of financial distress. Reasons have already been submitted why reliance cannot be placed upon taxes as the exclusive means of procuring funds in time of fiscal emer gency; and were one inclined to question the adequacy of these reasons it would seem that a statement of the magnitude of possible demands ought to be final against the policy which aims to support a war by taxes alone should a financier have the temerity to undertake it. Use must be made of credit, but the financier ought to use it in such a manner as not to destroy it Under no con ditions is the maxim laid down in the Introductory Chapter of this treatise more important than in connection with war financiering. That maxim, it will be remembered, is that a sound fiscal system will not tend to dry no the source of revenue upon which it relies.

If new taxes cannot be used as the basis of war financier ing to the exclusion of credit it is equally true that credit cannot be so used to the exclusion of new taxes. Both reason and experience may be brought to the support of this asser tion. Credit cannot sustain itself. It must be based on revenue, and as the ordinary expenditures of the nation are not materially decreased on account of a war, the income from taxes must at least be increased to cover the interest which accrues on the loans contracted. To do less than this would be to base credit on credit, a procedure which would inevitably lead to financial disaster. It does not, then, seem necessary to consider at length this phase of credit financier ing. It is not approved by business practice, and has never, so far as the writer is aware, been formally put forth as a theory for the financial management of a war.

Admitting, then, that interest p'ayments at least must be drawn from new taxes and not taken from the proceeds of new loans, we come next to inquire if all war expenditures, exclusive of interest payments, should be made through loans? In this form the question is worth serious discussion, for the policy thus brought to notice 'has been a favourite one with financiers. There is, of course, no reason, so far as the mathematical theory of a fiscal policy is concerned, why such a programme might not succeed; but when it is observed that a great wait modi fies the established demand, changes the current of industry, and diverts the course of employment, in short, substitutes a condition of war for a condition of peace, it must be acknowl edged that other elements besides those embraced within a mathematical expression ought to be recognised. In ordinary times when there is no question respecting the stability of the State and no fear of radical measures of any sort it may be adequate for the support of a credit policy that provision is made for interest charges; but in times of excitement and rapid change, no matter what the occasion may be, it is essential for the support of credit that the government show manifest strength. It must resort to taxes with sufficient vigour to prove that in a degree at least it is independent of the money-lender. A financial policy which proposes to rely on credit to the exclusion of taxes shows weakness at the outset and will tend to depress the credit it is designed to use; a financial policy, on the other hand, which proposes to rely on taxes, but to supplement them so far as they may be inadequate by the issue of loans. is an evidence of fiscal vigour and will tend to strengthen credit even before the newly levied taxes have become pro ductive.

It is not necessary to enter upon an extended analysis for the support of such a conclusion, for there are many illus trations in the history of war financiering of the inadequacy of loans when not based on the expectation of clear revenue. The policy of carrying on a war by means of credit was adopted in the United States in 1812 and again in 2861, and in both cases proved to be weak and inefficient. In support of this statement the financial management of the war of 1861 may be very briefly presented. The report in which Secretary Chase presented his plan to Congress was rendered in July, 1861. After calling attention to the large sums required by " the existing emergency," and asserting that deficiencies in the revenue must be supplied from loans, he states that " the problem to be solved is that of apportioning loans and taxes in a proper manner." This is certainly a correct statement of the problem. The view entertained by the Secretary as to the proper apportionment of loans to taxes is suggested by the following quotation from his report: " It will hardly be disputed that in every sound system of finance adequate provision by taxation for the prompt dis charge of all ordinary demands, for the punctual payment of the interest on loans, and for the creation of a gradually in creasing fund for the redemption of the principal is indis pensable. Public credit can only be supported by public faith, and public faith can only be maintained by an economical, energetic, and prudent administration of public affairs, and by the prompt and punctual fulfilment of every public obliga tion." This financial policy may be more clearly apprehended if we notice the estimates presented by the Secretary. He pro posed to raise $8o,000,000 by taxes as against $24o,000,00o by loans. Of this amount of clear revenue $65,800,000 were required to meet the ordinary expenditures of the peace estab lishment. It was believed that existing laws would provide about $6o,000,000, from which it followed that new taxes to the amount of $2o,000,000 were required. Of this sum $9,000,000 were to be devoted to payment of interest upon the new debt, and $5,000,000 to the establishment of a sink ing-fund for its final expungement. Such was the financial plan upon which this great war was begun.

In the December report, 1861, the Secretary declared re newed confidence in the financial plan which he had previously presented. It was found, however, that receipts from customs and from the sale of public lands had fallen off, and there seemed, therefore, just ground for apprehension lest existing taxes should fail to support the peace establishment and the loans which the government chose to place. This fear of a deficit from ordinary sources of revenue impressed itself upon the mind of the Secretary, and, in consequence, he proposed additional duties on tea, coffee, and sugar, a modification of the income tax so as to render it more productive, and a tax on whiskeys, tobaccoes, banknotes, instruments of conveyance, and the like; in short, he proposed the establishment of a system of internal duties. Now all this has the appearance of an abandonment of the loan policy, and the adoption of the policy of carrying through the war by taxes, but this is true in appearance only. The total sum of clear revenue hoped for from all these sources of income was but $9o,000,000, and this, as the Secretary said, was not more than enough to meet " even economized disbursements, and pay the interest on the public debt, and provide a sinking-fund for the gradual reduc tion of its principal." " It will be seen at a glance," says the report in another place, " that the amount to be derived from taxes forms but a small portion of the sums required for the expenses of the war. For the rest reliance must be placed on loans." It was in the latter part of the year 1863 and during the first part of 1864 that the inadequacy of the loan policy as a basis of war financiering forced itself upon the minds of those who managed public affairs. " To check the increase of debt," says the Secretary, " must be, in our circumstances, a prominent object of patriotic solicitude." And again: " Hitherto the expenses of the war have been defrayed by loans to an extent which nothing but the expectation of its speedy termination could fully warrant." The report then re stated the financial policy as adopted in 1861 and continued : " The financial administration of the first fiscal year after the outbreak of the Rebellion was conducted upon these ideas. The Acts of Congress at the extra session of July, 1861, were framed with the intention of supplying the full amount of revenue demanded by them. But receipts disappointed ex pectation, and it soon became obvious that a much larger proportion of the means needed for the fiscal year 1862 than the principle adopted would allow must be derived from loans." But the most interesting expression in this document per tains to the estimates for probable future demands : " These statements," says the Secretary, referring to the estimates, " illustrate the great importance of providing beyond all con tingency for ordinary expenditures and interest on debt, and for the largest possible amount of extraordinary expenditures, by taxation. In proportion to the amount raised above the necessary sums for ordinary demands will be the diminution of debt, the diminution of interest, and the improvement of credit. It is hardly too much—perhaps hardly enough—to say that every dollar raised for extraordinary expenditures or reduction of debt is worth two in the increased value of na tional securities and increased facilities for the negotiation of indispensable loans." Could this truth have been recognised at the beginning of the war, and could it at that time have influenced the treasury policy, subsequent financial history would have been materially modified.

It is somewhat difficult to exhibit accurately the rapid fall of public credit from 1861 to 1866, but I have undertaken in the following statement to approximate such an exhibit by showing the specie price of all the obligations issued dur ing the war. The computation has been made by estimating the value of the total receipts from credit for each quarter at the average price of gold during that quarter. The only source of error in this method arises from the fact that the average price of gold for any three months may not be the actual price at which the proceeds of bonds were covered into the treasury, but any closer computation requires more com plete data than the authorities at Washington have yet given. It is, however, believed that the conclusions may be relied upon as substantially correct.

It seems superfluous to comment on such figures as these. A treasury administration that permits the credit of a wealthy people to decline so that its obligations fall fifty per cent and remain there for a year can hardly be called successful. Yet the results here displayed, as also the forced circulation of treasury notes, follow naturally from the attempt to carry through a war by loans.

What, then, it may be asked, is the correct plan for the administration of a public treasury during the continuance of a war? To answer this question in detail would require the repetition of many principles that have already received consideration, but it may be asserted as a general statement that a sound policy of war financiering is only possible on the basis of a sound revenue system throughout, and it is espe cially important that the taxing system should be so organized as to be capable of rapid and easy expansion in case of an emergency. It may not be necessary to increase the revenue from taxes in any great degree, but some movement in this direction mustbe manliest in order to impress upon the money lender the fact that the revenue machinery of the government is under perfect control. Provided the importance of prepa ration in time of peace for the advent of war is duly appre ciated, the task of making such provision is by no means difficult. It is only necessary that the basis of the established system be so broad, and the rates at which it operates so low, that increased revenue will result from increased rates, and that, provided the exigency continues, new taxes of the old sort may be brought into operation. Applying this to the

situation in the United States, it may be said that elasticity of revenue cannot be expected from customs duties, but that excise duties may be made elastic, provided they are not levied at the maximum revenue rates during years of peace. More over, an internal-revenue system, even though it be narrow during years of peace, as is the case with the internal-revenue system at the present time, can be so easily expanded through the machinery already in existence that a law authorizing such expansion would act upon credit as though the new revenue were already in hand. The Federal Government is not in a very bad condition as matters now stand, and if to the sources of revenue which it already enjoys there is added the taxation of internal commerce, and if the rates imposed are adjusted throughout with due regard to elasticity and control, no ex cuse could be found for a financier who should fail to carry the country successfully through the exigencies of an expen sive war.

It is not possible to state definitely the proportion of loans to taxes acceptable to a sound system of war financiering, for the elements that enter into the situation will be different, or at least present themselves in different ratios, in every special case. We may, however, venture one step in the di rection of formulating a rule for the financial management of a war. At the beginning of hostilities revenue from loans may properly outbalance revenue from taxes, a ratio, how ever, which must be gradually reversed until the chief burden of a long-continued conflict shall rest upon the proceeds of taxes. This will find support in the fact that the necessity for loans is greater at the outset than when the newly levied taxes have been brought into a productive state of activity.

But a more convincing reason in favour of the rule is sug gested by the industrial effect of a long-continued war. The greatest strain to which the industries of a country are sub jected by the advent of a war arises from the necessary ad justment of labour to new lines of demand. This does not seem to be duly appreciated by writers on finance. They do not perceive that the chief strain upon a treasury policy comes at the beginning of a war. A condition of war is not a con dition of peace from any point of view, and the industrial transition from the one to the other is always attended with danger and may prove the occasion of disaster. But if the finan cier can bridge over this chasm and establish business firmly on a basis of war conditions he can extend his taxing system with as much confidence as if the people were living in a state of peace. It is during this period of industrial re adjustment that public credit renders its most significant ser vice to the administration. At no future time during the continuance of a war can such strong reasons be urged in favour of its employment.

It seems, then, that an adequate policy for the management of war finances is a tax policy assisted by credits rather than a credit policy assisted by taxes. It contemplates an increase in the revenue from taxation which shall be gradual and con stant until the war demand is met from the proceeds of estab lished taxes. The service of loans is to enable the financier to bridge over the time between the outbreak of hostilities and the productivity of newly levied taxes.

80. Investment Loans. The character of a loan, as also the rules pertinent to its management, depends in large measure upon the purpose for which the loan is contracted and upon the kind of revenue of which it is an anticipation. This being the case, it is evident that the principles which underlie the act of borrowing to cover a temporary deficit -or to make headway against an emergency demand will not apply, at least without modification, when the government borrows for the purpose of making an industrial investment. The conditions are different; the purpose is different; the marks of successful administration are different. A complete analysis of this important subject would carry us beyond the proper limits of an elementary treatise, but we may venture a few considerations by which such an analysis should be directed.

In the first place, it is necessary to distinguish between an investment designed for an unpaid or an underpaid service and an investment designed for commercial administration. The purchase of grounds for a public park, the construction of canals or the dredging of streams, the material equipment for public schools, and other like services, may be accepted as illustrations of non-commercial or general public invest ments; the building and equipment of a railway, the creation of a system of forestry, the opening of public mines, or the construction of any of the so-called municipal industries for which there is a specific payment for a specific service, are illustrations of commercial investments. This distinction is a fundamental one in determining the character of investment loans, for it shows that non-commercial loans are in antici pation of revenue from taxes, while commercial loans are in anticipation of revenue that accrues from the rendering of a service. The former are a special class under a general cate gory, the latter form a class by themselves.

The defence of.a non-commercial investment loan is found in the engineering necessity of carrying a work once under taken to its completion rapidly and without interruption. Al though the work itself rests on taxes, it should be provided for by a permanent appropriation adequate to the payment of the entire cost within a definite period. The length of time during which this payment should continue, that is to say, the duration of the debt, will of course depend upon the character of the work. If it be of a transitory sort, or sub ject to the deterioration of use or of fashion, the payments must be large and the duration of the payments short; indeed, a work that is to last for a few years only should very rarely be undertaken except with cash in hand, for nothing indicates more surely an abuse of investment loans than the continuance of a debt after the decay of that for which the debt was created. If, on the other hand, the work contemplated be one that is likely to 'remain in use for a long time it is legiti mate that the annual payments should be relatively small and the duration of the debt more extended. It will be safe, how ever, to lay it down as a rule that an investment loan should never take upon itself the form of a " perpetual debt." It is not necessary to follow further the characterization of non-. commercial investment loans. All that is important for our present purpose is to recognise that they form a special class of obligations.

It is a little more difficult to state clearly the character of public credit when employed to secure funds for a com mercial investment. This is in part due to the many forms in which public investments of this sort present themselves; it is in part due to the fact that such an employment of public credit involves all those considerations which separate a special from a general governmental service; but it is more fully explained when one observes that the fundamental dis tinctions between a public and a private industry work their way back to the process of borrowing, which is the first step toward the establishment of any important public work. These considerations and distinctions have already received attention, and the student is at liberty to remind him Self of them and to apply them as general principles to the question in hand. What we are about to suggest is par ticular rather than general in character.

From the point of view of the licarawar it is not neces sary to distinguish between a commercial and a non-commer cial loan. The credit upon which he relies is the same in either case. He does not feel called upon to investigate the probable success of the enterprise to be undertaken, since for him it is sufficient to know that the State is jealous of its credit, and that the resources of the government are ample to meet all obligations. It is not surprising, therefore, that the lender does not insist upon a classification of public obliga tions according to the purpose for which they are incurred.

From the point of view of the government, however, it is believed that such a classification is important. A non commercial loan differs from a commercial loan in that the former rests on taxes, while the latter rests on earnings. The one appeals to the conditions of general prosperity, the other to the prosperity of a particular industry. Not a little harm has been done by the failure of governments to maintain this distinction between commercial and non-commercial loans, for it has encouraged legislators to neglect that careful investiga tion into the probable success of the enterprise to be estab lished by the proceeds of 'the loan. It is not claimed that a should always refrain from an investment that fails to promise commercial success, but that, if it choose to make such an investment, it should deceive neither itself nor the public by proceeding as though the obligations sold were commercial obligations. Good judgment of course cannot be guaranteed, but it would be of assistance in arriving at a con servative forecast of the future should there be an absolute separation in accounts and in rules of administration between commercial and non-commercial loans. Every enterprise should have its own account and its own administration; in no other way can responsibility for financial embarrass ment be traced or the benefits from financial success be as signed.

A second reason for the separation of commercial from non-commercial loans springs from the accepted theory of governmental functions. The services rendered by a govern ment are either special or general in their character. Price is the means by which a government covers the cost of the former, while a tax is the means by which it covers the cost of the latter. It will of course be admitted that interest pay ments upon money borrowed for the establishment of a plant is one element in the cost of a commercial service, from which it follows that the debt must be assigned for support to the industry created. This cannot be done except the investment be personalized and its accounts specialized. In so far, there fore, as it is desired to maintain the distinction between special and general governmental services it is important to maintain the distinction between commercial and non-commercial ob ligations. In the case of temporary or emergency loans there is no need of remembering the purposes for which the money was borrowed, for there is no administrative or legislative decision that can in any way be affected by such knowledge; but when a government enters upon the policy of investment loans, especially commercial investment loans, it comes within the influence of considerations that cannot be appreciated ex cept the accounts of the government conform to business principles.

This view of the case receives collateral support when one observes that the employment of public credit for a com mercial purpose differs from the commercial employment of private credit in that the former creates a debt while the latter creates a property. It is the nature of a debt to be extin guished by the prosperity of the enterprise for which it was created; it is the nature of commercial property, as, for ex ample, the stock of a corporation, to be increased either in amount or in value by the prosperity of the enterprise which it represents. It must, then, be held as sound policy when a government issues a commercial loan to clear the investment of its obligations as quickly as may be done by applying the earnings of the business to the payment of the debt. This is true because an industry established through loans is not the property of the public until it exists as an unincumbered in dustry, and until that time the general property of citizens is liable for its support. Or, should one regard this as a dog matical statement, the same thought may be presented by saying that the dangers incident to the employment of public credit for industrial investments are so great when taken in connection with the fact that the liability in case of failure extends beyond the industry in question, that a wise credit policy will insist that each industry clear up its own obliga tions before any of the ulterior advantages of the investment can be judiciously considered. We may, then, conclude that commercial credits form a class of obligations by themselves and should be recognised as such by the financier.

It is not possible to press further the analysis of invest ment loans without passing from the point of view of the finan cier to that of the administrator. It is, for example, a financial question which inquires whether public credit when employed to further industrial development shall be loaned to private corporations by guaranteeing the stocks and bonds, or the government should assume the direction of all enterprises of which it assumes the risk. But while this ques tion is one to which the financier must make reply, the con clusion is one which involves so many political, social, and administrative interests that the analysis may properly be dropped from a cursory treatment of the general subject. This conclusion is typical of many other questions suggested by the subject in hand, and for this reason we may bring to a close at this point our consideration of investment finan tiering.

war, taxes, revenue, policy and commercial