CONSTITUTIONAL CONCEPTS AND HISTORICAL BACKGROUND

When the United States of America declared its independence, all 14 governments—one national and 13 state—assumed sovereign powers. In 1790 neither the new national constitution nor the 13 state constitutions said anything about the creation of corporations, limitations on the amount of government debt, or how to borrow, and placed few limits on taxation.²

In the 1840s states adopted general incorporation acts, procedural debt restrictions, and uniform property taxation, each of which is discussed in turn.

LEGISLATIVE CHOICE AND INFRASTRUCTURE INVESTMENT

The problem facing American state governments in the early nineteenth century was how to promote economic development through large-scale public investment, such as a canal. Legislatures are geographically oriented and their electoral incentives force legislators to be concerned about the incidence of state policies on their districts. Although statewide interests matter, it is primarily the effects of policies on his district that determine whether a given legislator favors a policy. Consider an expenditure policy to provide a public good, π(x) = (P₁(x), P₂(x), …, P_n(x)) where n is the number of districts, π(x) is a public policy, and the P_i(x) represent the incidence of the policy on district i.¹⁴

The project is financed through taxes. Let C = Σ_i c_i(x) be the total costs of the project. Let T be the total taxes need to finance the project and assume balanced budgets so that T = C. Further, district i's tax share is t_i, so that its tax share for a particular project is t_iC. District i's legislator's objective function is P_i(x) = b_i(x) − t_iC(x).¹⁵ Legislators consult only their own objective function, ignoring the effects of the project on other districts, and hence the project's social implications. When choosing between two projects, or between building a particular project and not, each legislator supports the alternative that provides her higher net benefits.

Legislatures are constrained in two ways. First, passage of individual legislation is only possible if a majority of legislators benefit from the proposed legislation. This “majority rule” constraint applies to individual pieces of legislation. Logrolling makes it possible to fund individual projects (as opposed to legislation) that benefit a minority of legislators, as long as the project is paired with enough other projects that a majority of legislators receive positive net benefits from the entire package. For simplicity, the majority rule constraint requires that all of the necessary logrolls be bundled into one bill.

The second constraint applies to all of the legislation passed by the legislature. In aggregate, every individual legislator (district, county, or state) must receive positive net benefits from the sum of all legislation passed, or people in that geographic unit will “exit.” The exit constraint requires, for j projects and i legislative districts that

The exit constraint requires that no district is hurt, on balance, by the aggregate actions of the government.

The threat of exit may seem too dramatic for the day to day operation of a legislature, but the constraint did not bind from day to day. The constraint applies to the aggregate of all legislation and the shortest time period it applied to was a legislative session. The implicit threat of exit in early-nineteenth-century America was very real, particularly at the state level, where population movement made the exit constraint bind.¹⁶

The early-nineteenth-century America population was on the move, and states adopting unpopular policies could expect to lose people to out migration. A constant factor in the national debate about public land policy was migration from the east to the west, the desire of eastern states to keep people from moving (and lowering land prices), and the hunger for population in the west (to raise land prices). In 1842 and 1843 Illinois politicians were unwilling to raise taxes to deal with their debt problem because, as then Governor Ford later wrote, “To pay immediately was out of the question. Heavy taxation then would have depopulated the country and the debt would never be paid.”¹⁷

Legislatures made simultaneous decisions about the size of the project, the allocation of expenditures across districts, and the allocation of tax burdens across districts. We can characterize four general ways for states to allocate expenditures and revenues. These are fiscal solutions. The names given to the four policies stress the revenue side, but only for ease of exposition. The four policies are normal taxation, benefit taxation, taxless finance, and something for everyone. The categories are not mutually exclusive, nor are they exhaustive, but they provide a framework to discuss the choice set facing state legislatures in the early nineteenth century.

STATE EXPERIENCE WITH BANK AND INTERNAL-IMPROVEMENT INVESTMENTS

States made substantial investments in early-nineteenth-century banking and transportation. By 1836 the states had chartered over 600 banks, with an authorized capital of $480 million and paid in capital of almost $250 million. State investment was at least $80 million.²³

Between 1790 and 1860 state and local governments spent over $425 million on transportation investments, whereas the federal government spent only $54 million. State governments, by any measure, played a central role in the promotion of financial and transportation investment and development.²⁴

By 1830 states were able to draw on 40 years of experience with bank investments. They had reasonable expectations that “M” was large and positive, and that the probability of a successful investment, “s,” was close to one. Canal investments in New York and Ohio were profitable. Governor Ford spoke directly to the ex ante expectations of Illinois politicians in 1837 when he explained how the state got itself into difficulties: “No scheme was so extravagant as not to appear plausible to some. The most wild expectations were made of the advantages of a system of internal improvements, of the resources of the State to meet all expenditures, and of our final ability to pay all indebtedness without taxation. Mere possibilities appeared to be highly probable, and probabilities wore the livery of certainty itself.”²⁵

In 1841 states owed $198 million on outstanding bonds issued to finance investments in canals, railroads, and banks. In addition, by 1841 New York and Ohio had redeemed $13 million in bonds issued in the 1820s to build early canals. Table 3 breaks down the $211 million in debt by the method used to finance state projects. None of the states documented in the table issued debt and expected it to be paid back through normal taxation, and no state expenditures were allocated within states on the basis of something for everyone type formulas.²⁶

Several states implemented benefit taxation. Opposition to the Erie canal came from farmers on the Hudson and Long Island who faced competition from new lands in western New York, and from New York City commercial interests who feared higher state taxation. New York did not expect the Erie Canal to be as successful as it was, and the bill authorizing the canal set aside three additional sources of revenue for the canal fund. These were a share of the auction duties collected in New York City, revenues from the salt tax levied on the production of salt in (primarily) western New York, and a special property tax surcharge. The surcharge was to be levied on lands within 25 miles of the canal (the initial bill only authorized construction on the middle section of the route) was intended to capture the benefits of canal construction accruing to those geographic areas closest to the canal. The “canal tax” provision was they key element in the compromise between canal supporters and opponents.²⁷

As it happened, the canal tax was never levied, because the Erie returned unexpected revenues to the canal fund and eventually to the general fund of the state. In fact, New York was able to suspend its state property tax entirely in the 1820s as a result of revenues earned from the canal.

Similar taxing arrangements were established in Ohio, Indiana, and Illinois. As in New York, the chief opposition to canals was geographic; opposition came from those areas through which the proposed canals would not pass. In each of these states prior to the authorization of canal construction, land was classified into quality grades and taxed on a per acre basis equally within each classification. In Ohio in 1828, in Indiana in 1836, and Illinois in 1837 and 1839, the key compromise between canal opponents and supporters was the adoption of ad valorem taxation. In each state the passage of a canal bill was tied to the restructuring of state property taxation in order to shift more of the burden of financing canal debt onto those counties whose land values would, presumably, rise with the construction of the canals.²⁸

Expenditures made under these arrangements in New York, Ohio, Indiana, and Illinois came to $53 million dollars between 1817 and 1841 (Table 3).²⁹

Taxless finance required little or no immediate financial commitment from the states. Southern states lent support to banks by purchasing bank stock or by making outright loans to banks.³⁰

For example, Mississippi chartered a number of banks in the 1830s (prior to that Mississippi had only one bank in which the state had a financial interest). The state assisted two of the largest banks, subscribing to $2 million in stock of the Planter's Bank in 1830, and loaning $5 million in state bonds to the Union Bank in 1838. The charters for both banks stipulated the banks would service the bonds.³¹ Although the state was ultimately liable for its debts, Mississippi anticipated the banks would pay dividends to the state, that other taxes would be lower, and that the state would never pay a penny to service its bonds. The state had, after all, been receiving dividends on its bank holdings since the early 1820s. Similar arrangements were made with banks in Florida, Alabama, Louisiana, and Arkansas. State investments in banks in the five states totaled $53 million in the 1820s and 1830s (Table 3).³² Although there were serious sectional debates within states about the establishment of banks, there was no intrastate debate over the allocation of taxation. The states expected that the state bonds issued to these banks would never burden the taxpayers and that bank stocks would pay a net dividend. This contributed to the eventual repudiation of debts, in whole or part, in Florida, Mississippi, Louisiana, and Arkansas.

Taxless finance played an important role in transportation finance as well. The success of the Erie Canal and the Ohio canals led several states to anticipate that they could finance canal investments without raising taxes. This involved the costly requirement of meeting interest payments in the first years of construction out of borrowed funds, increasing the total amount of debt needed to finance the completed project, but obviated the politically costly need to raise current taxes. Canal and railroad investment in New York in the 1830s, Maryland, Pennsylvania, and Massachusetts all proceeded without a concurrent increase in state taxation. State expenditures financed in this manner in these states amounted to $80 million between the late 1820s and the early 1840s (Table 3).³³

This brief review of state financial practices encompasses $186 million in state expenditure for banks, canals, and railroads out of the $211 million of state debt issued before 1841.³⁴

States either addressed the problem of competing geographic interests by tailoring their system of taxation to coordinate benefits and taxes or they made intrastate disputes moot by avoiding the need to raise taxes at all. Voters and legislators were easily convinced that building canals and banks without raising taxes was a good idea.

ELIMINATING TAXLESS FINANCE

In October of 1839 a financial panic swept the country, leading to the suspension of specie payments by banks throughout the south and west, declining prices and land values, and a general economic depression that lasted into 1843. By mid-1840, southern states that had issued bonds on behalf of banks—Florida, Alabama, Mississippi, Louisiana, and Arkansas—found themselves besieged by bond holders who wanted the states to redeem their solemn pledge to honor the bonds with their full faith and credit. In the northwestern states—Indiana, Illinois, and Michigan—construction on state canal and railroad projects came to a halt in late 1839. With construction at a standstill, land values began falling. It was clear by mid-1840 that these states could not service their debts from property taxes. In January of 1841 Indiana and Florida defaulted, followed shortly by other states, culminating in Pennsylvania's default in 1842.

There is no doubt about why states defaulted. As Table 1 shows, nine of the ten states with the largest per capita debts defaulted, and Alabama, Ohio, and New York narrowly avoided default. State legislatures throughout the country were asking “how did we get in to this mess?” and “how can we prevent this from happening again?” Although conditions in every state were unique, the answers given in the 1840s shared a common theme. States got into trouble because they pursued taxless finance and the way to prevent this from happening again was to take taxless finance off the table as a method of financing infrastructure investment. Eliminating taxless finance required procedural debt limitations, general incorporation laws, and general property taxation.

Prohibiting government debt altogether might have been the simplest reaction to the default crisis. Goodrich took his title, “The Revulsion Against Internal Improvements,” from Henry Adams, but the point of his paper was that the wave of constitutional reforms in the 1840s did not stop states, and certainly not local governments, from continuing to pursue internal improvements in the 1850s and after the Civil War. Debt restrictions were procedural, not absolute. States did not close off the possibility of financing internal improvement projects by benefit taxation. Instead, they eliminated taxless finance. To understand why this was, and what the states were doing, we need to examine the constitutional changes in more detail. Table 2 shows whether a state adopted a change in its constitution that regulated debt issue, corporation policy, or taxation, as well as states that wrote new constitutions or amended existing constitutions. (Appendix Tables 1, 2, and 3 provide details for debt restrictions, corporation clauses, and taxation respectively.)

The first complete debt clause was Article 4, Section 6, Part 4 of the New Jersey Constitution of 1844:³⁵

The New Jersey restrictions were repeated, with alterations, in other states. New Jersey limited “casual” debt to $100,000.³⁶

Issue of more debt than that required legislation that specified the purpose of the debt, and the “ways and means,” i.e., the tax revenues, to service the debt within 35 years (such legislation was “irrepealable”). The legislation authorizing the debt issue could not take effect until it was approved by a majority of the voters in a general election. Limits on casual debt varied from a high of $1,000,000 in New York to a low of $50,000 in Rhode Island, but the casual debt limit was only a limit on the debt the legislature could approve without going to the voters. The key element in the procedural restrictions was the requirement that the “ways and means” shall be provided. Legislation authorizing the bond issue had to include new taxes sufficient to service the debt, and the new taxes had to be approved by the voters. In New York and Iowa, “ways and means” was replaced with “direct annual tax,” i.e., a property tax. In most states the property tax would be the tax used to provide revenues. Every state but Virginia adopted procedural restrictions on debt issue.³⁷

Only Indiana absolutely prohibited the issue of new debt.³⁸

The door was left open for any state that wanted to borrow money to do so, as long as a tax increase sufficient to service the debt was approved by the voters before the debt was created. In this way, internal improvement spending was not prohibited, but it had to be financed by benefit taxation.³⁹

By themselves, procedural restrictions could and did limit state debt issue (as will be discussed). But procedural restrictions alone could not close the door on taxless finance. To do that required three additional restrictions on state governments. First, states had to close off indirect ways of obligating the state or becoming entangled in the affairs of corporations. Constitutions in every state but Rhode Island and Louisiana required that “nor shall the credit of the State ever be given, or loaned, in aid of any person, association, or corporation.” The prohibition was usually matched with “nor shall the State hereafter become a stockholder in any corporation or association.” (both clauses from Indiana, 1851, Article 11, section 12.) Only New York, New Jersey, and Kentucky failed to prohibit stock ownership.⁴⁰

Second, the states had to close off the possibility that a select group would acquire special corporate privileges in exchange for payments to the state treasury (ala the Camden and Amboy railroad). Constitutional changes in the 1840s tied the requirement that legislatures pass general incorporation acts, with a restriction, and in some cases prohibition, on special incorporation. Most (though not all) states required general incorporation and prohibited special incorporation. In some states special incorporation was explicitly prohibited: “The General Assembly shall pass no special act conferring corporate powers.” (Ohio, 1851, Article 13, section 1). In other states special incorporation was prohibited “except for municipal purposes, and in cases where in the judgment of the Legislature, the objects of the corporation cannot be attained under general laws.” (Wisconsin, 1848, Article 11, section 1). In these states the prohibition on special corporations was implicit. New York initially considered a ban on special incorporation, but in the end adopted language similar to that of Wisconsin because of the need to specify special terms in charters for municipalities and, on occasion, the need to grant specific powers of eminent domain to transportation or communication companies.⁴¹

Banks were inextricably linked with corporations in the constitutions. Although some states banned banks outright, most states required that banks be incorporated under general laws approved by the voters (free banking).⁴²

Finally, states had to close off the option of financing internal improvements through special tax arrangements.⁴³

States required that: “Taxation shall be equal and uniform throughout the commonwealth, and all property other than slaves shall be taxed in proportion to its value, which shall be ascertained in such manner as may be prescribed by law.” (Virginia, 1850, Article 4, section 23, of course, slaves were not an issue in northern states). These clauses required ad valorem taxation for all property (land and whatever wealth was also taxed), with equal tax rates for all types of property, assessed uniformly throughout the state. The New York scheme of levying a special canal tax in the canal counties would not have been constitutional under this type of “general” property tax. The new tax restrictions, in combination with the need to specify in advance what taxes would be collected for debt service, effectively required a majority of voters to gain from any proposed investment to obtain majority support.

WHAT THEY SAID ABOUT CONSTITUTIONAL CHANGE

When Americans tried to understand what had happened in state public finance that caused the crisis in the 1840s, concerns over corruption were prominent in the public debate. Americans inherited a strain of political thought about the proper role and structure of government now called “the republican synthesis.”⁴⁴

American perception that British government had become corrupted was not only a fundamental cause of the American revolution, but fear of corruption, verging on paranoia, became a dominant feature of American politics in the early nineteenth century and remained a central political concern in the 1840s.⁴⁵ States had to come to grips with whether their current fiscal crises were the result of corrupt individuals manipulating the system for their own benefit or whether they were the result of systematically corrupt decisions made by state governments. Did the crises result from bad institutions or from bad individuals? If it was bad institutions, then the appropriate remedy was to alter the institutions. If it was bad individuals, then the appropriate response was to vote the rascals out.⁴⁶ States, in general, decided that bad institutions were the cause of the crisis. States began calling constitutional conventions after 1842.⁴⁷ We first consider constitutional debates about debt policy, then about corporations.

Although internal-improvement legislation was always controversial, it often passed initially by consensus, rather than as the result of partisan majoritarian politics. This limited the ability, ex post, of blaming a party or faction for the failure of a canal or bank.⁴⁸

Indiana provides an example. The Indiana legislature authorized the issue of $10,000,000 in 5-percent bonds when its state budget was only $50,000 a year. Under a binding exit constraint, we should see that substantial consensus was required before a canal bill could pass. The two main canals in Indiana, the Whitewater in the southeast corner of the state and the Wabash and Erie, which ran from the southeast corner of the state to the north and then northeast, were the poles around which the canal interests built their majority. As Indiana historian Logan Esarey points out: “As finally organized, this [canal] party controlled every county in the State but seven—Harrison, Posey, Crawford, Switzerland, Hendricks, Perry, and Spencer; and six of these were on the Ohio. The total voting strength of these [anticanal] counties was always less than ten out of a body of eighty members.”⁴⁹ The internal improvement counties (counties through which a proposed canal, railroad, or turnpike would pass) possessed a clear majority of the votes in the Senate and House as early as 1833, yet fewer than ten of 80 legislators were able to hold up a canal bill for three years. Why? The reason appears to be the exit constraint. Indiana did not proceed with its canal system until the legislature reached a rough consensus that included every region. What brought the southern counties to support the canal system was the adoption of ad valorem taxation in 1836. That is, the adoption of benefit taxation was critical to reaching the political consensus necessary to begin construction.⁵⁰

Because Indiana had passed internal improvement legislation by consensus, it was difficult, ex post, for one geographic group to be blamed for the decision to build the canals. Calls for a constitutional convention in the mid-1840s were generally supported by the Democrats and opposed by the Whigs. A constitutional convention, supported by Whigs and Democrats, was not called until 1850 when state finances were back on a sound footing. The voters sent almost equal numbers of Democrat and Whig delegates to the convention.

The convention regarded its main task as fixing the systematic flaws in Indiana government that produced the crisis:

The speaker, Mr. Read, and a majority of his fellow delegates ultimately voted to prohibit borrowing in Indiana completely, the only state to do so.

Surprisingly, there was little in the way of partisan finger pointing over the origins of the crisis. Convention delegates clearly regarded the decisions made in 1836 as the result of flaws in their democratic system rather than malign individuals. Delegates from both parties rose and denounced the policies the state had followed in 1836. So much so that Judge Kilgore, who spoke against the absolute prohibition on state debt, remarked that “I appear to be the last survivor of all the members of the Legislature of 1836 who voted for that bill. I know there are many still living, they seem to have been afflicted—perhaps in judgement for their political sins—with a loss of their memories. [Laughter].”⁵²

Kilgore went on to articulate not only an explanation of what happened in 1836, but how it could be prevented in the future:

Judge Kilgore called for benefit taxation and castigated the perils of taxless finance, and called for a direct tax, which in 1850 meant ad valorem property taxation, before any future debt could be issued. Many delegates laid the blame for the mistake of 1836 at the feet of taxless finance. Mr. Smith of Ripley county: “It was represented to the people of that day [1836], by the political leaders, that they might go on with that gigantic system of internal improvements without incurring any additional tax on themselves: in fact, the proposition was made that the State could borrow money to construct these public works, and never have to pay any taxes thereon out of their own pockets—that the debt would pay itself.”⁵⁴

The new Indiana constitution required the legislature to pass general incorporation laws and banned special incorporation, but these provisions were so generally accepted that no record of a substantive debate was entered in the Debates and Proceedings of the convention. The constitution banned state investment in private corporations. Mr. Morrison of Marion county spoke in support of the ban:

Although Indiana politicians did not use the terms taxless finance and benefit taxation, they used the logic behind the concepts. Their language spoke directly to the evils and dangers of taxless finance. They did not blame the state's fiscal crisis on faction or party, but on the perception that the constitutional organization of the state was “corrupt,” in the nineteenth-century sense that it allowed the state to pursue methods of financing state investments in good faith, that in retrospect turned out to be a disaster. The problems they identified were systematic and the solutions they devised were systematic as well.

The passage of constitutional provisions requiring general incorporation acts can be traced most clearly in New York. New York passed its first general incorporation act, for churches, in 1784. The state adopted a general act for the incorporation of manufacturing companies in 1811, the first law providing for the general incorporation of private business enterprises. In 1827 the Revised Statutes of the states created a general regulatory statute that governed the features that corporation charters could possess, including liability rules, capital limitations, corporation officers, and by laws. The Revised Statutes limited the ability of the state to create special corporations with special features, but a general regulatory statute could not prevent the state legislature from limiting entry. The Albany Regency under Van Buren deliberately limited access to charters for banks in order to garner political support. It was a classic case of systematic corruption.⁵⁶

When the Whigs gained control of the legislature after the election of 1837, they passed the most famous general incorporation act of all, the Free Banking Act, in 1838.

But it was not until 1846 that the New York constitution was modified to mandate general incorporation. The arguments for general incorporation revolved around the issue of entry, rather than the powers and privileges given to corporations. At issue was removing from the legislature discretionary power to limit entry into a particular line of business to one or a few firms. William Leggett, a New York newspaper columnist and Loco Foco supporter, wrote extensively about general incorporation:

Advocates of mandatory general incorporation hammered away at the political costs of special legislation. E. P. Hurlbut, a New York lawyer, wrote in 1845, that general incorporation would annihilate “the lobby, or third house, that embodiment of selfishness and gross corruption. The halls of legislation would be cleansed, and the representatives of the people would breathe a purer and freer atmosphere. All ‘logrolling’… would cease.”⁵⁸ As Leggett emphasized, economic benefits would flow from general incorporation, but it was the political arguments that carried the day. Eight states mandated general incorporation in their new constitutions. New York enacted “more than thirty general incorporation statutes between 1846 and 1857.”⁵⁹

Legislatures typically granted charters with truly special corporate privileges only when there was a “great undertaking” with a public purpose involved.⁶⁰

The charter for the Camden and Amboy Railroad, the First and Second Bank of the United States, and the monopoly state banks in Indiana, Illinois, Kentucky, and Missouri all involved the creation of special corporate privileges to serve the greater public good. In this critical sense there was little to distinguish a group of promoters who came to a state legislature with a canal or railroad project funded with state bonds to be repaid with tolls and dividends, than from a group of bankers or railroad promoters who wanted a special charter in return for providing their public service. Both were offering to provide a public good without cost to the state treasury. Because neither type of project involved raising current taxes and both types involved creating privileges for a limited group within the community, citizens and politicians came to suspect that allowing legislatures to consider taxless finance proposals amounted to courting corruption.

WHY STATE DEBT AND CORPORATIONS WERE CONNECTED

At the beginning of the twenty-first century there is no connection between how governments borrow and their policies towards incorporation. The separation is testimony to how effectively the constitutional reforms of the 1840s separated the two issues. In the early nineteenth century, state debt issue and incorporation were closely linked both by a concern over corruption and by the history of state promotion of finance and transportation. Corruption was generally defined as the few benefiting at the expense of the many.⁶¹

Public debts and corporations were different facets of the same problem: how to prevent a democratic republic from being captured by the interests of a narrow political elite. This was a question about the nature of democracy itself, not about the character of a handful of individuals. Promoters had come to state legislatures with proposals to finance banks, canals, turnpikes, bridges, and railroads with variants of taxless finance regularly since the 1790s. They realized that it was extremely difficult ex ante to distinguish the ex post good proposals from the bad proposals. This involved more than public credit. Promoters were not always interested in direct state investment. Often they asked for special privileges that guaranteed them limited competition or favorable access to markets or courts.⁶² State governments and citizens were learning to be suspicious of all forms of taxless finance—any promises to provide valuable public services at no cost to the taxpayers.

The connection between corporation policy and state finances came naturally to early-nineteenth-century politicians. Historically, state finances and corporate charters had been connected in a direct and observable way. Corporate charters were special acts of state legislatures that often included provisions authorizing debt issue in the same piece of legislation. For example, the charter of the Bank of Louisiana, issued in 1824, chartered the bank, authorized state bond issues, and explicitly tied dividends on the state's stock in the bank to interest on the state bonds used to purchase the stock: “That if the dividends on the stock held by the state in the said bank, shall at any time be insufficient to pay the instalments of interest on the principal of said bonds, as the same may become due, that said bank shall supply such deficiency, and charge the same to the account of the state, and for the payment thereof the faith of the state is hereby pledged.”⁶³

Similar arrangements were reached in bank charters throughout the country.⁶⁴ The charters of early New York banks typically reserved a block of stock for the state. In Massachusetts in 1812, the state chartered the Bank of Massachusetts, with a capital of $3 million of which the state subscribed a third.⁶⁵ In Pennsylvania the state regularly negotiated with existing banks over the question of whether new banks should be chartered, effectively auctioning off charters to the highest bidder.⁶⁶

A close relationship existed between chartering and state finances in transportation companies as well. The Gallatin report, issued in 1808, documented the many state connections with transportation corporations. New Jersey aided a turnpike company in 1804. Pennsylvania chartered and contributed to its first turnpike company in 1806. Virginia and Maryland contributed more than $150,000 and purchased 340 of the 701 shares of the Potomac Company. Virginia chartered and invested in the Dismal Swamp Company and the James River Company. New York chartered and invested in the Northern Inland Lock Navigation Company and the Western Inland Lock Navigation Company. Pennsylvania chartered the Schuylkill and Susquehanna canal and stood ready to pay a $300,000 bonus on completion of the canal.⁶⁷

Virginia established a Board of Public Works in 1816. The board administered a Fund for Internal Improvements, which was based on dividends on state stock in the Bank of Virginia, the Farmers Bank of Virginia, the James River Company, the Appomattox Company, the Dismal Swamp Canal Company, the Potomac Company, and the Little River Turnpike Company. The state stood ready to subscribe up to two-fifths of the paid in stock of approved internal improvement projects.⁶⁸

It would have seemed odd to a knowledgeable American in 1840 to suggest that state debt policy, state finances, and corporate chartering were independent from one another. The entire history of corporate chartering in banking and finance up to 1840 was intimately connected to state investment and finance. The constitutional changes made in the 1840s deliberately separated corporate chartering from state debt issue, and the distance between the two policies today is a measure of the success of the institutions put in place in the 1840s.

PARTY POLITICS

Despite their central importance in the evolution of American economic institutions, there is no general history of state constitutional change in the 1840s. An alternative to the hypothesis presented here is that the new constitutions were the work of the Democratic Party. The Whigs opposed writing new constitutions in several states: “The adamant, politically costly, and ultimately unsuccessful opposition by Whig leaders to constitutional revision in Maryland, Kentucky, North Carolina, Ohio, and Indiana is one such instance were Whigs undoubtedly suffered from ‘too much respectability,’ where innate conservatism put them on the losing side of an issue.”⁶⁹

Carmony's history of Indiana talks about the “Democratic” constitution of 1851. But as we have seen, the constitutional provisions that we are concerned about were not the result of partisan battles between Democrats and Whigs, nor were the conventions themselves generally partisan contests.

This does not mean that partisan issues did not intrude into the conventions. In Indiana, Democrats' proposal to exclude corporation officers from holding seats in the state legislature was defeated on almost a straight party vote. Part of the reason Whigs were reluctant to hold conventions in some states was the unequal apportionment of legislative representation across districts. In several states, new constitutions adopted more equal apportionment schemes that hurt the Whigs.

Yet, in many states party issues were not important. The New York legislature took up the issue of a constitutional amendment to limit state debt in 1842. The amendment did not pass that year, but ultimately the debate led to a constitutional convention and the New York constitution of 1846. The battle over calling the constitutional was not a party issue. The major split over the convention was within the Democratic party, not between the Democrats and the Whigs.⁷⁰

In Louisiana, the state adopted a new constitution in 1845 when the state was controlled by the Whigs, and again in 1851 when the state was controlled by the Democrats. The two constitutions had similar provisions with regard to debt restrictions, general incorporations laws, and restrictions on special incorporation. These were not party issues. Everywhere the issue was concern about the growing corruption of politicians: “The growing populistic rebellion against the regular parties and the politicians who led them as corrupt, selfish wire pullers was hardly confined to Maryland. It also helped fuel movements to revise and ratify constitutions in Ohio, Indiana, and Kentucky.” “Nonetheless, the constitution seemed so popular, especially its provisions reflecting the rising tide of antipolitician, antiofficeholder sentiment in Indiana and elsewhere …”⁷¹

In his history of the Whig Party, Michael Holt divided states in the 1840s into three groups: solidly Whig states, competitive states, and solidly Democratic states.⁷²

Only two of the eight solidly Democratic states wrote new constitutions, Illinois and Michigan. They were both states traumatized by the debt crisis. Five of the six states where Democrats and Whigs competed on equal terms adopted new constitutions or amendments: Louisiana, Pennsylvania, Indiana, New York, and Virginia. Five of the 11 solidly Whig states adopted new constitutions: Maryland, Kentucky, Ohio, New Jersey, and Rhode Island. States where political parties competed equally were more likely to adopt constitutional changes. Constitutional changes were otherwise not connected to partisan politics.

EFFECTS AND IMPLICATIONS

If the constitutional changes were important, then they should have large and lasting effects. This section quantifies the easy-to-measure effects, and draws implications for several areas of American economic development. Table 4 shows the relationship between total debt in 1841, per capita debt in 1841, whether a state defaulted, whether a state restricted debt, and the change in debt between 1841 and 1880. States that defaulted had, on average, $13 million in total debt and $35 in per capita debt in 1841, whereas states that did not default had only $4 million in total debt and $4 in per capita debt.⁷³

States that enacted constitutional restrictions on procedures for issuing debt had $12 million in total debt and $18 in per capita debt, whereas states that did not restrict debt had only $3 million in total debt and $11 in per capita debt.⁷⁴ Between 1841 and 1880, aggregate nominal state debt grew slightly, from $198 million to $236 million. In states that adopted debt restrictions, total debt fell by $5 million per state, whereas in states that did not adopt debt restrictions total debt rose by $6 million. In states that defaulted, total debt fell by $6 million per state, whereas in states that did not default rose by $5 million per state. Both constitutional restrictions and default experience mattered, and procedural debt restrictions had a significant effect on the subsequent fiscal behavior of state governments.⁷⁵

The effect of debt restrictions and the general property tax had a profound effect on the structure of state and local governments. In 1840, local government debt was one-eighth of state government debt; in 1902, local government debt was eight times state government debt. In 1840, state government revenues were 75 percent of local government revenues; in 1902 state government revenues were 20 percent of local government revenues.⁷⁶

The requirement that governments use benefit taxation (or something approaching it) shifted borrowing and spending to smaller, more homogeneous geographic units. Cities, counties, and special districts took the lead in providing basic social infrastructure investments in public utilities (water, sewage, gas, and electric), public health, and education. In aggregate these investments were enormous, but their scale was well suited for local governments. As Werner Troesken shows, America was successful at providing critical urban infrastructure in the late nineteenth century, and an important element in how well it did that was the relationship between state and local governments. Constitutional changes played a role in the decentralization of nineteenth-century American government, but how much of the change is due to changing constitutional provisions still remains to be determined.⁷⁷

Despite a few landmark Supreme Court decisions, corporate law in the United States continues to be a state, not a national, matter. In the 1840s, states deliberately altered the way they chartered corporations to encourage entry and to limit flexibility in corporate form. General incorporation acts were intended to limit all corporations to the same rights and governance structures. Special corporations and flexible charter privileges were a source of corruption. Although strict corporate forms limited flexibility, it increased transparency, and it certainly encouraged entry. We cannot compare numbers of corporations in the 1830s to the 1880s, because there are no counts of corporations, reliable or otherwise, until the IRS began collecting statistics in 1916. In 1920 there were 314,000 corporations operating within the United States. Between 1807 and 1867, however, France chartered 642 corporations. By comparison, in New England alone, 6,700 corporations were chartered between 1800 and 1862.⁷⁸

We know that the adoption of a free banking law, a general incorporation law for banks, usually resulted in a substantial increase in the number of banks. So, for example, when New York adopted its free banking law in 1838, 93 free banks were created in a state with only 95 banks on 1 January 1837. Similar increases occurred in Michigan, Indiana, and Ohio.⁷⁹

In her study of special incorporation, Susan Hamill finds that “From 1875 through 1996, the states issued 19,998 total special charters.”⁸⁰

This suggests a very small share of corporate charters were issued to special corporations in the late nineteenth and twentieth centuries (in 1996, 4,474,167 corporations filed tax returns). But in absolute terms 19,998 is not a small number. If general incorporation acts were intended to limit special incorporation, why were so many special charters given after 1875? The answer lies in the definition of a special charter. Any charter that is issued by a legislature is a special charter, no matter what its content. Some states were reluctant to ban special charters completely because they realized the necessity of including specific and unique conditions into the charters of municipalities and other local governments, as well as in cases where eminent domain was involved. Of Hamill's 19,998 special charters, 10,685 were issued to public corporations.⁸¹ Transportation and communication companies account for another 3,933 charters. These charters typically involved questions of eminent domain, and so had to be taken on a case-by-case basis. Banking and financial institutions make up another 3,030 charters, and these charters were typically special charters because of general incorporation act limits on capitalization.⁸² In total, 17,648 of 19,998 special charters were special because of well-understood difficulties in implementing general laws for these types of corporations.

Of the remaining 2,350 special charters, issued to companies in a wide variety of industries. “Only 153, or seven percent, of the almost 2,200 special charters issued to private business corporations contained evidence of providing benefits not available under the applicable general law.” In other words, there was nothing special about these special incorporations. “By far the greatest number of these [153] special charters, seventy-nine, were issued to relax the capital limitations imposed by the applicable general law.”⁸³

Another 40 charters were special because of technicalities in stock issues or company duration. In short, of the 19,998 corporations receiving special charters, at most 34 charters really conferred special privileges, such as tax exemptions, not available to all corporations. The shift to mandatory general incorporation was equally successful at increasing the number of corporations in the United States and limiting the number of corporations with truly special privileges.⁸⁴