Book V, Chapter III, 2

In Great Britain the annual land and malt taxes are regularly anticipated each year under a borrowing clause consistently inserted in the acts imposing them. The bank of England generally advances the sums for which those taxes are granted at interest that has varied since the Revolution from eight to three per cent., and receives repayment as the proceeds gradually come in. Any shortfall, and there is always one, is covered by the next year's supplies. Thus the only substantial part of public revenue not yet mortgaged is regularly spent before it is received. Like an improvident spendthrift whose urgent needs prevent him from waiting for his income to arrive in the usual course, the state continually borrows from its own agents and factors, paying interest to use its own money.

In the reign of king William and through much of queen Anne's, before perpetual funding had become as familiar as it is now, most new taxes were imposed for only a short term (four, five, six, or seven years), and much of each year's grants consisted of loans against anticipated proceeds from those taxes. Because the proceeds frequently fell short of paying principal and interest within the specified term, deficits arose, and the term had to be extended to cover them.

In 1697, under the 8th of William III., c. 20, deficits from several taxes were charged against what was then called the first general mortgage or fund. It consisted of an extension until the first of August 1706 of several different taxes that would otherwise have expired sooner, with their proceeds combined into one general fund. The deficits charged against this extended term amounted to £5,160,459: 14: 9½.

In 1701 those duties, together with some others, were further extended for the same purposes until the first of August 1710, and were called the second general mortgage or fund. The deficits charged against it amounted to £2,055,999: 7: 11½.

In 1707 those duties were extended again, as a fund for new loans, until the first of August 1712, and were called the third general mortgage or fund. The amount borrowed against it was £983,254:11:9¼.

In 1708 all those duties were continued further, as a fund for new loans, until the first of August 1714, and were called the fourth general mortgage or fund. The exceptions were the old subsidy of tonnage and poundage, only half of which entered this fund, and a duty on imported Scotch linen, abolished by the articles of union. The amount borrowed against it was £925,176:9:2¼.

In 1709 all those duties were continued further for the same purpose until the first of August 1716, and were called the fifth general mortgage or fund. The exception was the old subsidy of tonnage and poundage, now excluded from the fund altogether. The amount borrowed against it was £922,029:6s.

In 1710 those duties were extended again until the first of August 1720, and were called the sixth general mortgage or fund. The amount borrowed against it was £1,296,552:9:11¾.

In 1711 the same duties, then subject to four different anticipations, together with several others, were continued forever. They became a fund to pay interest on the capital of the South-sea company, which that year had advanced the government £9,177,967:15:4d to pay debts and cover deficits—the largest loan yet made at that time.

Before then, so far as I can determine, the principal—indeed the only—taxes imposed perpetually to pay interest on a debt were those paying interest on money advanced to the government by the bank and East-India company, and on money expected, but never received, from a proposed land bank. The bank fund then amounted to £3,375,027:17:10½ and paid an annuity or interest of £206,501:15:5d. The East-India fund amounted to £3,200,000 and paid an annuity or interest of £160,000; the bank fund paid six per cent. interest and the East-India fund five per cent.

In 1715, under the first of George I., c. 12, the various taxes mortgaged to pay the bank annuity were combined with several others, likewise made perpetual by this act, into one common fund called the aggregate fund. This fund was charged with paying not only the bank annuity but several other annuities and obligations of various kinds. It was later enlarged under the third of George I., c.8., and the fifth of George I., c. 3; the various duties then added were also made perpetual.

In 1717, under the third of George I., c. 7, several other taxes were made perpetual and combined in another common fund, called the general fund, to pay certain annuities amounting altogether to £724,849:6:10½.

As a result of these various acts, most taxes previously anticipated only for a short term of years became perpetual, forming a fund to pay not the principal but only the interest on money borrowed through successive anticipations against them.

If money had only ever been raised by anticipation, a few years would have freed public revenue from its obligations, provided the government took care not to burden a fund with more debt than it could repay within the term and not to anticipate its proceeds again before the first anticipation expired. But most European governments have been incapable of such care. They have often overburdened the fund even on the first anticipation; when they have not, they have generally made sure to overburden it with a second and third anticipation before the first has expired. Once the fund became wholly insufficient to pay both principal and interest on the money borrowed against it, it became necessary to charge it only with the interest, or with a perpetual annuity equal to the interest. Thus improvident anticipations necessarily gave rise to the still more ruinous practice of perpetual funding. Though this practice necessarily postpones the freeing of public revenue from a fixed date to one so indefinite that it is unlikely ever to arrive, it can always raise more money than the older method of anticipation. Once people have grown accustomed to it, they have therefore universally preferred it in great emergencies of state. Relieving the present emergency is always the main concern of those directly involved in public administration. They leave the future liberation of public revenue to posterity.

During queen Anne's reign, the market rate of interest fell from six to five per cent.; in the twelfth year of her reign, five per cent. was declared the highest lawful rate on money borrowed against private security. Soon after most temporary taxes in Great Britain had been made perpetual and distributed among the aggregate, South-sea, and general funds, public creditors, like private creditors, were persuaded to accept five per cent. interest. This saved one per cent. on the principal of most debts thus perpetually funded, or one-sixth of most annuities paid from those three great funds. The saving left a considerable surplus from the proceeds of the taxes combined in these funds beyond what was needed to pay the annuities now charged against them, laying the foundation for what has since been called the sinking fund. In 1717 it amounted to £523,454:7:7½. In 1727 interest on most public debt was reduced further to four per cent.; in 1753 and 1757 it was reduced to three and a-half and three per cent., respectively, further enlarging the sinking fund.

A sinking fund, though instituted to repay old debts, greatly facilitates the contraction of new ones. It is a supplementary fund always available to be mortgaged in support of another doubtful fund against which money is to be raised in a state emergency. Whether Great Britain's sinking fund has been used more often to repay old debts or to contract new ones will become clear shortly.

Besides these two borrowing methods—anticipation and perpetual funding—two other methods occupy a kind of middle ground: borrowing on annuities for fixed terms of years and borrowing on annuities for lives.

During the reigns of king William and queen Anne, large sums were often borrowed on annuities for terms of years, sometimes longer and sometimes shorter. In 1695 an act authorized a loan of one million against an annuity of fourteen per cent., or £140,000 a-year, for sixteen years. In 1691 an act authorized a loan of a million against annuities for lives on terms that would now seem very favorable; but subscriptions did not fill the loan. The next year the shortfall was made up by borrowing against annuities for lives at fourteen per cent., or a little more than seven years purchase. In 1695 those who had bought these annuities were allowed to exchange them for annuities lasting ninety-six years by paying sixty-three pounds in the hundred into the exchequer: that is, the difference between fourteen per cent. for life and fourteen per cent. for ninety-six years sold for sixty-three pounds, or four and a-half years purchase. So unstable was the government believed to be that even these terms attracted few buyers. During queen Anne's reign, money was borrowed on various occasions against both annuities for lives and annuities lasting thirty-two, eighty-nine, ninety-eight, and ninety-nine years. In 1719 holders of the thirty-two-year annuities were persuaded to accept instead South-sea stock worth eleven and a-half years purchase of the annuities, together with additional stock equal to the arrears then owed on them. In 1720 most of the other fixed-term annuities, long and short, were subscribed into the same fund. At that time the long annuities amounted to £666,821: 8:3½ a-year. On the 5th of January 1775, what remained of them, not having been subscribed at that time, amounted to only £136,453:12:8d.

During the two wars that began in 1739 and 1755, little money was borrowed against either fixed-term or life annuities. Yet an annuity lasting ninety-eight or ninety-nine years is worth almost as much as a perpetual one and might therefore be expected to support nearly as much borrowing. People who buy public stocks to make family settlements and provide for the distant future, however, would not wish to purchase an asset steadily declining in value; such people constitute a considerable share of both stockholders and stock purchasers. Thus a long fixed-term annuity, though almost equal in intrinsic value to a perpetual one, attracts far fewer buyers. Subscribers to a new loan, who generally intend to sell their subscriptions as soon as possible, strongly prefer a perpetual annuity redeemable by parliament to a nonredeemable annuity for a long term of years paying only the same amount. The former may be assumed always to retain the same value, or very nearly so, and is consequently more convenient as transferable stock than the latter.

During those last two wars, annuities for terms of years or for lives were seldom granted except as premiums to subscribers to a new loan, in addition to the redeemable annuity or interest on the strength of which the loan was supposed to be made. They were granted not as the actual fund against which the money was borrowed, but as an added incentive to the lender.

Life annuities have sometimes been granted in two ways: on separate lives or on groups of lives, called tontines in French after their inventor. With separate lives, each annuitant's death frees public revenue of the burden of that person's annuity. With tontines, public revenue begins to be freed only after every annuitant in a group has died. A group may contain twenty or thirty people, with the survivors succeeding to the annuities of all who die before them, and the last survivor succeeding to the annuities of the whole group. Tontines can always raise more money against the same revenue than separate life annuities. An annuity carrying survivorship rights is genuinely worth more than an equal annuity on a separate life; and because everyone naturally trusts in their own good fortune—the principle behind the success of all lotteries—such an annuity generally sells for more than it is worth. Consequently, in countries where governments commonly raise money by granting annuities, tontines are generally preferred to separate life annuities. The device that raises the most money is nearly always preferred to the one most likely to free public revenue soonest.

In France, life annuities account for a much larger share of public debt than in England. According to a memoir presented to the king by the parliament of Bourdeaux in 1764, France's entire public debt was estimated at twenty-four hundred millions of livres. Of this, the principal on which life annuities had been granted was thought to amount to three hundred millions, or an eighth of the whole public debt. The annuities themselves were estimated at thirty millions a-year, a fourth of the one hundred and twenty millions taken as interest on the whole debt. I know perfectly well these estimates are not exact; but, as a highly respected body presented them as approximations to the truth, I think we may regard them as such. This difference in how the French and English governments borrow does not arise from different degrees of concern to free public revenue from its obligations; it arises entirely from the differing aims and interests of their lenders.

In Great Britain, the government regularly spends the proceeds of the annual land and malt taxes in advance. Each year the laws imposing them include a clause allowing borrowing. The bank of England generally advances the amounts expected from those taxes, charging interest that has ranged from eight to three per cent. since the Revolution. It gets repaid as the tax money comes in. Any shortfall—and there is always one—is covered by the following year's funds. Thus the only substantial part of public revenue not yet mortgaged is regularly spent before it is collected. Like a reckless spender who cannot wait for income when bills come due, the state constantly borrows from its own agents and pays interest to use its own money.

During king William's reign and much of queen Anne's, before perpetual funding became as familiar as it is now, most new taxes lasted only a short time: four, five, six, or seven years. Much of each year's funding came from loans made against the expected receipts of those taxes. The receipts often failed to cover the principal and interest before the deadline, leaving shortfalls that required an extension.

In 1697, under the 8th of William III., c. 20, shortfalls from several taxes were charged against what was then called the first general mortgage or fund. It extended various taxes, due to expire sooner, to the first of August 1706, and combined their receipts in one general fund. The shortfalls assigned to this extension came to £5,160,459: 14: 9½.

In 1701, these duties and some others were extended again for the same purpose, until the first of August 1710. This was called the second general mortgage or fund. The shortfalls assigned to it came to £2,055,999: 7: 11½.

In 1707, the duties were extended again until the first of August 1712 to support new loans. This was called the third general mortgage or fund. Borrowing against it came to £983,254:11:9¼.

In 1708, all these duties were extended again, to back new loans until the first of August 1714. This was called the fourth general mortgage or fund. There were two exceptions: only half the old subsidy of tonnage and poundage was included, and a duty on imported Scotch linen had been removed by the articles of union. Borrowing against the fund came to £925,176:9:2¼.

In 1709, the duties were extended once more for the same purpose, until the first of August 1716. This fifth general mortgage or fund now excluded the old subsidy of tonnage and poundage entirely. Borrowing against it came to £922,029:6s.

In 1710, the duties were extended again to the first of August 1720. This was called the sixth general mortgage or fund. Borrowing against it came to £1,296,552:9:11¾.

In 1711, those same duties, already pledged four separate times in advance, were made permanent along with several others. They became a fund for paying interest on the capital of the South-sea company. That year the company advanced £9,177,967:15:4d to the government to pay debts and cover shortfalls. It was the largest loan ever made up to then.

Before this time, as far as I can tell, only the taxes to pay interest on loans from the bank and East-India company, and on a planned loan from a land bank that never actually lent the money, had been made permanent for paying interest on a debt. The bank fund then totaled £3,375,027:17:10½, with an annual payment or interest of £206,501:15:5d. The East-India fund totaled £3,200,000, with an annual payment or interest of £160,000. Interest was six per cent. on the bank fund and five per cent. on the East-India fund.

In 1715, under the first of George I., c. 12, the various taxes mortgaged for the bank's annual payment were combined with several others, which this act also made permanent. Together they formed one common fund, the aggregate fund, responsible not only for the bank payment but for several other yearly payments and obligations. The third of George I., c.8., and the fifth of George I., c. 3 later enlarged it and also made the added duties permanent.

In 1717, under the third of George I., c. 7, several other taxes were made permanent and pooled in another common fund. This general fund was to pay yearly amounts totaling £724,849:6:10½.

As a result of these acts, most taxes previously pledged in advance for only a few years became permanent. They supported payment not of the principal, but only of the interest, on money borrowed through repeated pledges of their future receipts.

If governments had raised money only by borrowing against future tax receipts for fixed periods, public revenue would have been freed of debt within a few years. The government would only have needed to avoid pledging more than the revenue could pay within the period and to avoid pledging it again before the first pledge expired. But most European governments have not managed that. They have often burdened a fund too heavily on its first use. If not, they have usually done so by pledging it a second and third time before the first pledge expired. Once the fund could no longer pay both principal and interest, it became necessary to charge it only with interest or a permanent annual payment equal to interest. Reckless borrowing against future receipts thus led inevitably to the still more damaging practice of perpetual funding. That practice changes the date when public revenue becomes free of debt from a fixed date to an indefinite one unlikely ever to arrive. Still, governments can raise more money by perpetual funding than by borrowing against limited future receipts. Once officials become used to it, they always prefer it during major emergencies. Those running public affairs chiefly care about meeting the present emergency. They leave freeing future public revenue to later generations.

During queen Anne's reign, the market interest rate fell from six to five per cent. In her twelfth year, five per cent. was declared the maximum legal rate on loans secured by private property. Soon afterward, most temporary taxes in Great Britain became permanent and were assigned to the aggregate, South-sea, and general funds. Public creditors, like private creditors, were persuaded to accept five per cent. interest. That saved one per cent. on the principal of most debts funded permanently in this way, or one-sixth of most yearly payments made from those three large funds. The savings left substantial tax revenue in the funds after their annual obligations were paid. That surplus became the basis of what was later called the sinking fund. In 1717, it amounted to £523,454:7:7½. The interest on most public debt was reduced again to four per cent. in 1727, then to three and a-half in 1753 and three per cent. in 1757. These reductions further enlarged the sinking fund.

A sinking fund may be established to pay old debts, but it makes taking on new debt much easier. It is a reserve always ready to be pledged alongside another fund of uncertain value when the state needs to borrow. We will soon see whether Great Britain's sinking fund has more often been used to repay old debts or support new ones.

Besides borrowing against future receipts and by permanent funding, there are two methods between them: borrowing in return for yearly payments for a fixed number of years, and borrowing in return for yearly payments for people's lifetimes.

Under king William and queen Anne, the government often borrowed large sums in return for yearly payments over periods of varying length. In 1695, an act authorized borrowing one million in exchange for an annual payment of fourteen per cent., or £140,000 a-year, for sixteen years. In 1691, an act authorized borrowing a million with payments lasting for people's lifetimes on terms that would seem very favorable today, but the full amount was not subscribed. The shortfall was made up the following year through lifetime payments at fourteen per cent., or a little more than seven years purchase. In 1695, buyers of those payments could exchange them for payments lasting ninety-six years by paying sixty-three pounds in the hundred into the exchequer. In other words, the difference between fourteen per cent. for life and fourteen per cent. for ninety-six years was sold for sixty-three pounds, or for four and a-half years purchase. Even these terms attracted few buyers because people thought the government unstable. During queen Anne's reign, the government borrowed at different times through both lifetime payments and payments lasting thirty-two, eighty-nine, ninety-eight, and ninety-nine years. In 1719, holders of the thirty-two-year payments were persuaded to exchange them for South-sea stock worth eleven and a-half years purchase of their payments, plus additional stock equal to the unpaid payments then owed. In 1720, most of the other fixed-term payments, both long and short, were subscribed into the same fund. At that time, the long-term payments amounted to £666,821: 8:3½ a-year. By the 5th of January 1775, those not exchanged then amounted to just £136,453:12:8d.

During the two wars that began in 1739 and 1755, little money was borrowed through payments for fixed terms or lifetimes. A payment lasting ninety-eight or ninety-nine years is worth almost as much as one lasting forever. You might therefore expect it to support nearly as much borrowing. But people buying public stock to arrange family settlements and provide for the distant future do not want an investment that steadily loses value. They account for a substantial share of stock owners and buyers. A long-term payment therefore finds far fewer buyers than a permanent one, even if its inherent value is nearly the same. Subscribers to a new loan generally plan to sell their shares soon. They greatly prefer a permanent payment that parliament can redeem to an equally large fixed-term payment that cannot be redeemed. The permanent payment can be expected to retain the same, or nearly the same, value. That makes it a more convenient investment to transfer.

In those two wars, yearly payments lasting for fixed terms or lifetimes were rarely offered except as bonuses to new-loan subscribers. They came on top of the redeemable yearly payment or interest that actually backed the loan. Their purpose was to give lenders an extra reason to participate, not to provide the main basis for borrowing.

Lifetime payments have sometimes been offered in two forms: payments on individual lives and payments on groups of lives. The latter are called tontines in French, after their inventor. With separate lives, each person's death releases public revenue from that person's payment. With a tontine, revenue is not released until every person in a group has died. A group may include twenty or thirty people. Survivors inherit the payments of those who die before them, until the last survivor receives the whole group's payments. A given revenue can always support more borrowing through tontines than through payments on separate lives. A payment with a right of survivorship is worth more than an equal payment tied to one life. Because people naturally trust their own luck—the principle behind the success of every lottery—it generally sells for even more than it is worth. In countries that often borrow by offering yearly payments, governments therefore generally prefer tontines to payments on separate lives. They almost always choose the method that raises most money over the one likely to free public revenue fastest.

Lifetime payments make up a much larger share of France's public debt than England's. According to a report the parliament of Bourdeaux presented to the king in 1764, France's total public debt was estimated at twenty-four hundred millions of livres. The principal borrowed in exchange for lifetime payments was estimated at three hundred millions, one-eighth of the total. Those payments were estimated at thirty millions a-year, a quarter of the one hundred and twenty millions estimated as the interest on the entire debt. I know these figures are not exact. Still, a very respected body presented them as approximate, and I think we may treat them that way. The difference between France's and England's borrowing methods does not reflect different levels of concern about freeing public revenue. It comes entirely from the different aims and interests of the lenders.