How today’s budget woes owe their debt to the financing of recent wars

December 4, 2013

This is a guest post by Gustavo Flores-Macías (Assistant Professor of Government, Cornell University) and Sarah Kreps (Assistant Professor of Government, Cornell University; Stanton Fellow, Council on Foreign Relations).  

–Erik Voeten.

Public Enemy #1 for the American military is not a country, per se.  It’s “sequestration.” The across-the-board, automatic spending cuts in the military — applied to all “programs, projects, and activities” — had its origins in the 2011 debt ceiling crisis.  Those who were reluctant to raise the debt ceiling were assuaged by the prospect of spending cuts, a deal that became incorporated into the Budget Control Act. The problem from the military’s standpoint is that the reductions will likely affect military readiness.  More problematically though, is that sequestration, with its automated, across-the-board nature, is a blunt rather than nuanced instrument for cutting spending, an axe rather than a scalpel.

Those problems are potentially about to get worse.  With Congress reconvening after the Thanksgiving break, budget issues will be back on the table.  Unless a deal is made to the contrary, a second round of automatic spending cuts will hit in 2014.

The question is how we got here.  It’s a long, tangled road but part of the answer has to do with the way we financed the last wars.  The wars in Iraq and Afghanistan added between $1.3 trillion and as much as $6 trillion to the national debt.  Some leaders such as Harry Truman instituted a “pay as you go” rule and financed 100 percent of the Korean War through a special war tax that left no additional debt after the war.  Even the enormously costly World Wars I and II generated considerable sums of revenue from taxes, 30 percent and 49 percent respectively. President Wilson urged war taxes as a way to fund the war because “borrowing money is short-sighted finance.  We should pay as we go.  The industry of this generation should pay the bills of this generation.” And during the Civil War, the Union introduced the first income tax, paying for 20 percent of the costs of the war through taxes. Even smaller wars such as the Spanish-American War had war taxes, proposed several weeks before the first shots were fired.

But others, such as the Mexican-American War were financed through debt rather than taxes.  As were the Iraq and Afghanistan wars.

Why has the United States turned to war taxes to finance some wars and not others?

An obvious answer is economic.  Big wars need big sources of revenue, including taxation. As The New York Times summarized the conventional wisdom in 1861, “battles are won by ‘the last dollar.”

However, the economic case for war taxes is not entirely obvious.  States can raise revenues in a number of ways, and economists have made arguments both in favor of tax smoothing as a way to avoid the economic shock of high wartime taxes, and taxes as a way to distribute the burdens of war.  Given this relative economic indeterminacy, the story also becomes about politics.

Indeed, as we argue in a recent American Political Science Review article (gated and ungated), even in times of war, partisan bickering is a prominent feature of the political landscape.  The reason is that the revenues required for wars are enormous, so the distributional consequences of those decisions are lasting. World War II, for example, created an unprecedented growth of the tax base, which burgeoned by 1,000 percent in a five-year period, in order to accommodate federal outlays that had increased from $8.8 billion annually in 1940 to $98.3 billion in 1945.

Source: Gustavo A. Flores-Macías and Sarah E. Kreps. 2013. “Political Parties at War: A Study of American War Finance, 1789–2010.” American Political Science Review 107, 4 (November), 835.
Source: Gustavo A. Flores-Macías and Sarah E. Kreps. 2013. “Political Parties at War: A Study of American War Finance, 1789–2010.” American Political Science Review 107, 4 (November), 835.

As David Mayhew writes, wars become “policy windows” during which leaders can implement drastic peacetime policies that would be untenable during peacetime.  Far from politics stopping at the water’s edge, leaders very much act by the view that they should not waste a crisis, advocating fiscal policies that will help their constituencies.

When examining the historical record of war taxes in the United States, we find that partisanship has been a key factor explaining the adoption of war taxes. Republicans were more likely to vote in favor of and adopt war taxes before 1913, when the 16th amendment was passed, while Democrats have been more likely to do so since. Drawing on Richard Bensel’s argument about the effect of American sectionalism on industrialization to wartime political economy, we suggest that northeast Republicans who represented manufacturing interests favored tariffs as a way to protect against foreign competition.  Wartime then became a policy window through which to pass major tariff legislation that would likely have lasting favorable consequences for their constituencies.   Democrats were loath to finance wars through taxes, since their constituencies were more likely to include agriculture, which opposed tariffs that made their exports less attractive.

This all changed after 1913, when the 16th Amendment meant income taxes, and Democrats, representing labor, favored the redistributive elements of progressive taxation, and Republicans were more likely to represent business that opposed income taxes.  We show these stark partisan differences in war finance hold for wartime presidents and members of Congress, and that those partisan differences help account for the differences in wartime finance between the Union and Confederacy in the Civil War. This complements other work that has highlighted how partisanship shapes the strengthening of states and military expenditures.

Thus, differences in parties’ fiscal views not only do not fall silent during war but actually intensify because of the sheer magnitude of resources involved.

The question is how this all matters for today’s debates about budgets and sequestration.  One implication is obvious, which is that rather than paying as we went for the last wars, President Bush used the policy window of war to push through tax cuts.

A second is more indirect but also bears mentioning. David Ricardo observed the following about war taxes: “When the pressure of war is felt at once, without mitigation, we shall be less disposed wantonly to engage in an expensive contest.” War taxes create a palpable connection with the conflict that will give the populace pause in terms of engaging in costly military endeavors.  Without such reminders, individuals have few incentives to put restraints on leaders, costly wars drag on, and the budget pressures intensify.  We end up with policies such as the Sequester that elicits rare bipartisan agreement:  that it was an outcome that no one wanted.

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