A History of Fiscal Policy in the United States

The history of American fiscal policy begins before the Constitution. The Continental Congress's inability to tax under the Articles of Confederation -- it could only request contributions from states -- produced the fiscal crisis of the 1780s that helped motivate the Constitutional Convention. Hamilton's financial program of the 1790s, which assumed state war debts, established a national bank, and used tariff revenues to encourage manufacturing, was the first systematic exercise of federal fiscal power. It was immediately contested: Jefferson and Madison argued it concentrated economic power unconstitutionally in commercial interests at the expense of agrarian ones. This tension between active and passive federal fiscal roles has structured American political economy ever since.

The nineteenth century federal government was a limited fiscal actor by design. Its primary revenue was the tariff, which served trade policy purposes as much as revenue ones; its primary expenditures were military and the disposal of public lands. The income tax did not exist until the Civil War emergency, and it was repealed afterward. The Gilded Age federal government ran budget surpluses to retire the Civil War debt, imposing deflation on an economy in which most debtors were farmers and most creditors were financiers -- a distributional consequence that fueled the Populist movement's demand for monetary and fiscal reform.

The Progressive Era established the institutional foundations for active fiscal policy. The Sixteenth Amendment (1913) permanently authorized the income tax, providing a revenue source that could grow with the economy and be made progressive. World War I demonstrated the federal government's capacity for rapid fiscal mobilization: top rates reached 77% by 1918. The interwar period saw the first systematic attempt to manage the business cycle through fiscal means -- the Hoover administration's catastrophic effort to balance the budget in 1932, which deepened the Depression, and Roosevelt's New Deal, which used deficit spending for relief and recovery though not at the Keynesian scale theory prescribed (Stein, 1969).

World War II ended the Great Depression absolutely. Federal spending reached 43% of GDP by 1944, unemployment fell to 1.2%, and output grew faster than at any other time in American history. It was the most successful fiscal experiment ever conducted, and its lesson -- that government spending can employ the unemployed -- was immediately contested once the emergency passed.Adapted from Hugh Rockoff, America's Economic Way of War (2012)

The postwar Employment Act of 1946 formalized the federal government's commitment to using fiscal policy for economic stabilization. The Kennedy-Johnson tax cut of 1964 was the first explicitly Keynesian fiscal intervention in American history -- a deliberate demand stimulus at a time when the economy was not in recession -- and it produced the predicted expansion. The simultaneous demands of the Vietnam War and Great Society programs in the late 1960s pushed fiscal policy beyond the economy's capacity, contributing to the inflationary pressures of the 1970s. The stagflation crisis discredited not only Keynesian economics but the activist fiscal posture associated with it.

Reagan's 1981 tax cuts initiated a new fiscal paradigm: supply-side economics, which held that reducing taxes on high-income households and corporations would stimulate growth sufficient to raise revenues despite lower rates. The empirical record has been consistently negative -- the 1981 cuts tripled the deficit, and no subsequent supply-side tax cut has produced the promised revenue increase. But the political paradigm has proven durable: the framework that reduced government expenditure requires immediate fiscal offset has constrained discretionary fiscal policy for four decades. The post-2008 austerity, the 2013 sequester, and the repeated debt ceiling crises are all downstream effects of this shift in fiscal norms (Brownlee, 2004).

The COVID-19 pandemic broke the austerity consensus temporarily. Five trillion dollars in emergency fiscal support -- the CARES Act, the Consolidated Appropriations Act, and the American Rescue Plan -- produced a faster economic recovery than the Great Recession's inadequate stimulus had managed. It also produced the highest inflation since the early 1980s, reigniting the debate about fiscal policy's inflationary potential and the conditions under which large deficits generate price instability. The episode illustrated both what fiscal policy can accomplish when deployed at adequate scale and the risks of overdeployment when the economy is already operating near capacity (Summers, 2021).