Cyclopædia of Political Science, Political Economy, and the Political History of the United States
SINKING FUND. This fund may be defined as a financial arrangement intended to redeem or extinguish the public debt upon certain determined conditions, by means of a sum to be annually set aside from the produce of taxes, and to be used in sinking or paying a part of the debt through the purchase of a portion of the public indebtedness. Historically, this is not a strictly accurate definition, but it is generally correct when applied to the financial methods of the present day. The sinking fund has ever been regarded as an instrument for reducing the public indebtedness, but through false systems it has sometimes proved fallacious, and has often even increased the debt. The simplest method of creating such a fund would be by economizing in the expenditures of government, and setting apart the sum saved for the purchase and the cancellation of the state's securities or certificates of indebtedness. But the more common method is to create a special fund, to be controlled and managed by a special board or commission, and to be supplied out of the receipts of taxes.
—Before the beginning of the eighteenth century the general practice in England was to provide a special tax for each new loan, so that the particular loan was said to be "funded," or provided for by a tax. In 1716, however, on the suggestion of the earl of Stanhope, Sir Robert Walpole carried a measure which rendered the taxes formerly distributed among the South sea aggregate and general funds perpetual, and consolidated whatever surplus might be collected by these taxes into a sinking fund, that was to be applied to the discharge of the national debt, and to no other purpose. This fund was still further augmented by what had been saved through successive reductions in the interest of the debt, and between the period of its formation and 1733 discharged £11,648,000 of the debt. Soon after, however, what should properly have gone into the sinking fund was applied to other purpose, and this practice became general. So that, according to the figures of Dr. Price, the amount of debt canceled by this fund between 1733 and 1775 was only £8,500,000. "On the whole," says Hamilton, in his "Inquiry concerning the National Debt of Great Britain," "this fund did little in time of peace, and nothing in time of war, to the discharge of the national debt. The purpose of its inviolable application was abandoned, and the hopes entertained of its powerful efficacy entirely abandoned. "This fund was, in 1786, superseded by Mr. Pitt's new fund.
—The rapid increase in the amount of the debt during the eighteenth century had directed attention to the burden, and not a few predicted national bankruptcy as a result. In 1713 the total debt, funded and unfunded, was nearly £35,000,000. The Spanish, the seven years' and the American wars ran the debt up to a total of £245,300,000. On the proposal of Dr. Price, a parliamentary inquiry into the national finances was instituted, and, as a result, a sinking fund was established, but on a different system from that embodied in the fund 1716. Under this new system the sum of £1,000,000. was to be annually appropriated by parliament to the fund, and this amount was to be expended, either in the redemption of stock, if at par, or, if under par, in the purchase of it in the open market at the current rate. The interest arising from all stock so redeemed was to be added to the principal, and laid out in the same manner, until, by their joint accumulation at compound interest, they should amount to the annual sum of £4,000,000, when this fund should thenceforth continue to be laid out at simple interest only, leaving the amount of interest annually redeemed at the disposal of parliament. (26 Geo. III., cap. 31. See Speech of Mr. Huskisson, March, 1813.) The most extravagant expectations were formed of this law, and the writings of Dr. Price, which had wide circulation, tended to foster such beliefs. "The smallest fund of this kind," he wrote, "is, indeed, omnipotent, if it is allowed time to operate." In order to secure the inviolability of this fund, its management was intrusted to a commission composed of the speaker of the house of commons, the chancellor of the exchequer, the master of the rolls, the accountant general of the court of chancery, and the governor and the deputy governor of the bank of England. In 1792 a change was made in the manner of accumulating this fund, and at the same time a permanent provision was made for future debts by the framing of a permanent system of a sinking fund. "It was enacted," says Ricardo, "that, besides a provision for the interest of any loan which should thenceforward be contracted, taxes should also be imposed for a 1 per cent. sinking fund on the capital stock created by it, which should be exclusively employed in the liquidation of such particular loan; and that no relief should be afforded to the public from the taxes which constituted the 1 per cent. sinking fund, until a sum of capital stock, equal in amount to that created by the loan, had been purchased by it." The wisdom of this provision can not be questioned, as it tended to maintain confidence in the credit of the government, which was then at a low point. It made the government not only a seller of securities (while issuing loans), but also a buyer (while purchasing with the sinking fund). And while the expectation was, that every loan would, under the operations of a 1 per cent. sinking fund, be redeemed in about forty-five years, yet the lower the price of the securities fell, the more efficient would the fund become, so that in proportion to the depression existing at the time, would this sinking fund operate as a check to prevent a further fall, and as a lever to produce, at no distant period, a probable rise in the market. Mr. Huskisson said of Mr. Pitt's plan, that it was "framed with the specific view of holding out to the public a guarantee, that any future debts which the states might have occasion to contract, should from the moment of their being incurred, be placed in a course of liquidation, uniform and unalterable. This plan contained within itself a principle of permanency, which being applied to every loan at the time of making the contract, could not, from that moment, be varied or departed from, without a breach of such contract. * * That every future loan should, from the moment of its creation, carry with it the seeds of its destruction; and that the course of its reimbursement should, from that moment, be placed beyond the discretion and the control of parliament." From 1786 to 1793 the fund effected some reduction in the debt; but in the following years, when through the war the expenditures of government greatly exceeded the income, it was attempted to maintain the annual reductions, it became a wretched piece of jugglery, although the form and machinery were continued.
—It remained for Dr. Hamilton to expose the fallacies of such a sinking fund, and he showed that so far from reducing the debt it had really increased it. "The extent of the sinking fund is artificial, and may be brought, by a mere change in the arrangement of the public accounts, to bear any proportion to the amount of debt, without the slightest advantage, or any tendency to promote its discharge. In time of war we raise a certain sum by taxes for the expense of the year, and borrow what further is wanted. If a sinking fund be maintained, the sums appropriated are deducted from what would have otherwise been expended on the war, and a greater loan is required. We may throw into the sinking fund any share of the revenue we please. We have only to add as much to the loan, and we shall raise a larger sum in the form of loan with the same facility, by the effect of the sums thrown into the money market for the stock purchased by the commissioners. In time of war the sinking fund is nominal; in time of peace a large sinking fund will discharge the debt more quickly; but this amounts to no more than that a continuance of the taxes which we paid in war, after peace is restored, will be attended with a speedier reduction of debt than what would take place if a large part of these taxes were repealed." Hence he was led to assert that the excess of revenue over expenditure was the only fund by which any part of the public debt could be discharged. "The increase of revenue, or the diminution of expense, are the only means by which this fund (sinking) can be enlarged, and its operations rendered more effectual; and all schemes for discharging the national debt, by sinking funds operating at compound interest, or in any other manner, unless in so far as they are founded upon this principle, are completely illusory."
—Dr Hamilton's work was first published in 1813, the very year in which important changes were made in the fund under the administration of the finances by Mr. Vansittart. But the farce of borrowing to supply the requirement of the fund continued. In 1819 Dr. Hamilton's views were so far recognized as to induce the house of commons to resolve, that to provide for the exigencies of the public service, to make such progress in reductions of the national debt as may adequately support public credit, and to afford to the country a prospect of future relief from a part of its present burdens, it is absolutely necessary that there should be a clear surplus of the income of the country over the expenditure, of not less than £5,000,000. In 1822 the committee of public accounts recommended that the annual sinking fund loans be discontinued, and that the whole of the redeemed capital stock of funded debt remaining in the name of the commissioners be canceled. In the following year their recommendation was carried into effect, but the last remnant of the fund was not abolished before 1828.
—This sinking fund had proved an unfortunate and costly experiment: but how costly it had been was not proved until 1869, when it was made the subject of parliamentary investigation. "During the whole period, from Jan. 5, 1793, when the French war broke out, up to 1829, there was only one year (1817) in which money was not raised by loan, in order to aid the sinking fund, besides what was required for war expenditure. After excluding the period from Aug. 5, 1786, to Jan. 5, 1793, during which £8,147,631 was applied to redeem £10,241,100 of 3 per cent. stock, bearing an interest of £307,263 per annum, there remains £321,902,824, which was applied between 1793 and 1829 to redeem £472,942,703 capital stock, carrying £14,488,388 annual interest, the mean rate on the sum paid being almost exactly 4½ per cent. per annum. During the same period the total sum of £702,163,075 was raised by loans, for which £1,052,536,700 capital stock of funded debt was created, carrying £35,301,392 annual interest, or a mean rate of about 5 per cent. per annum. The actual result of all these sinking fund operations, therefore, was, that the total amount of £330,050,455 was raised at 5 per cent. to pay off a debt carrying 4½ per cent. The difference in these two rates amounted, upon the total capital sum of £330,050,455, to £1,627,765 per annum, which may be set down as the increased annual charge of our funded debt, and a real loss to the public from this deceptive sinking fund system; without taking into account the expenses of the management of the sinking fund, and the increased amount of capital of debt consequent upon the practice of borrowing on less advantageous terms for larger sums than were required to meet the actual public expenditure."
—I have described somewhat at length the English sinking fund, because the principles which governed its formation were early adopted in this country, under the leadership of Alexander Hamilton. In December, 1782, he introduced into the congress of the confederation the following resolution. "Whereas, It is essential to justice and to the preservation of public credit, that whenever a nation is obliged, by the exigencies of public affairs, to contract a debt, proper funds should be established, not only for paying the annual value or interest of the same, but for discharging the principal within a reasonable period, by which a nation may avoid the evils of an excessive accumulation of debt; therefore, Resolved, That whenever the net product of any funds, recommended by congress and granted by the states, for funding the debt already contracted, or for procuring further loans for the support of the war, shall exceed the sum requisite for paying the interest of the whole amount of the national debt, which these states may owe at the termination of the present war, the surplus of such grants shall form a sinking fund, and be inviolably appropriated to the payment of the principal of the said debt, and shall on no account be diverted to any other purpose." Thus, four years before Mr. Pitt accepted the plan of Dr. Price, and ten years before he laid down the sound rules of finance embodied in the English act of 1792, the two important principles, that with the creation of a debt measures should be taken to insure its extinguishment, and that debt reduction is efficient only when made with surplus revenue, were clearly enunciated by Mr. Hamilton in the congress of the confederation. Circumstances, however, which chiefly arose from the weakness of the confederation, prevented any attempt to put into practice this resolution, and in the disordered condition of the finances little could be done before the return of peace. Even then the jealousy among the states prevented action, and it was not until the constitution was adopted and the national government formed, that a settlement of the debt question could be looked for. In his report on public credit, Hamilton proposed to apply the revenues arising from the postal service to the purposes of a sinking fund, and he again lays down as a vital principle the necessity of such a fund. "Persuaded, as the secretary is, that the proper funding of the present debt will render it a national blessing; yet he is so far from acceding to the position, in the latitude in which it is sometimes laid down, that 'public debts are public benefits,' a position inviting to prodigality, and liable to dangerous abuse, that he ardently wishes to see it incorporated, as a fundamental maxim, in the system of public credit in the United States, that the creation of debt should always be accompanied with the means of extinguishment. This he regards as the true secret for rendering public credit immortal. And he presumes that it is difficult to conceive a situation in which there may not be an adherence to the maxim." He recommended, as commissioners to administer this fund, the vice-president of the United States, the speaker of the house of representatives, the chief justice, secretary of the treasury and the attorney general. His propositions respecting the postal revenues were not accepted; but congress appropriated to the sinking fund the surplus revenues of the current year, and authorized the president to borrow $2,000,000 with which to purchase stock at its then low value. There was a considerable surplus revenue in 1790, which was applied to debt reduction, and in 1791 the sinking fund had already reached the sum of $1,000,000. The act of Aug. 12, 1790, which constituted this fund, provided, 1, that the surplus of the duties on imports and tonnage to the end of the year 1790 should be applied to the purchase of the debt of the United States, at its market price, if not exceeding par or true value thereof—said purchases to be made openly, and with due regard to the equal benefit of the several states; and 2, that, in addition to this fund, the president should be authorized to borrow any sum or sums, not exceeding $2,000,000, at an interest not exceeding 5 per cent., to be applied to purchases of public debt; provided that, out of the interest of the debt to be purchased, there should be appropriated, annually, a sum not exceeding 8 per cent. of the sums borrowed, toward paying the interest and reimbursing the principal of these sums. It will be seen that the compound interest scheme, which was so eagerly taken up in England, was not embodied in the plan of 1790, which was little more than a direct appropriation of surplus revenue to debt reduction. In 1792, however, an important change was introduced, and a permanent sinking fund was established, to be composed, 1, of the interest of the public debt, purchased, redeemed, or paid into the treasury, in satisfaction of any debt or demand; and 2, of the surplus, if any, which should remain of moneys appropriated for paying the interest of the public debt, after paying that interest. This fund was to be applied, first, to purchases of the debt, till the annual amount of the fund shall be equal to 2 per centum of the whole amount of the outstanding funded stock, bearing a present interest of 6 per centum; second, to the redemption of that stock; and lastly, to purchases of any unredeemed residue of the public debt. To January, 1795, the purchases of stock had amounted to $2,268,022.
—The operations of this and of subsequent sinking funds are fully described in Elliot's "The Funding System of the United States" (28th Congress, 1st Session, Exec. Doc.) The principles so clearly laid down by Alexander Hamilton have been generally applied in this country both with respect to national and to local indebtedness, but the manner of constituting the sinking fund has varied greatly according to circumstances. In every instance, however, the main object was to provide for the extinction of the debt, and, by setting aside a stated sum which was to be inviolably applied to this purpose, to maintain confidence in the credit of the state or borrowing power. Whatever errors, either in the composition of the fund or in its administration, have been made, it has come to be recognized that debt can be canceled only when a state's income exceeds its expenditure. The surplus may with profit be applied to debt reduction. Some of the state constitutions specify the number of years in which a debt is to be redeemed. For example, that of Illinois says: "Any county, city, school district, or other municipal corporation, incurring any indebtedness as aforesaid, shall, before or at the time of doing so, provide for the collection of a direct annual tax sufficient to pay the interest on such debt, as it falls due, and also to pay and discharge the principal thereof within twenty years from the time of contracting the same." (Constitution, 1870, Art. IX., § 12.) This would practically involve the maintenance of a sinking fund. The constitutions of other states are more particular. Thus, that of Pennsylvania (1873) recites, that, "to provide for the payment of the present state debt, and any additional debt contracted as aforesaid, the general assembly shall continue and maintain the sinking fund, sufficient to pay the accruing interest on such debt, and annually to reduce the principal thereof by a sum not less than $250,000; the said sinking fund shall consist of the proceeds of the sales of the public works, or any part thereof, and of the income or proceeds of the sales of any stocks owned by the commonwealth, together with other funds and resources that may be designated by law, and shall be increased from time to time by assigning to it any part of the taxes or other revenues of the state not required for the ordinary and current expenses of government; and, unless in case of war, invasion or insurrection, no part of the said sinking fund shall be used or applied otherwise than in the extinguishment of the public debt. The moneys of the state, over and above the necessary reserve, shall be used in the payment of the debt of the state, either directly or through the sinking fund, and the moneys of the sinking fund shall never be invested in or loaned upon the security of anything, except the bonds of the United States or of this state." (Art. IX., §§ 11, 12.) And again, "Every city shall create a sinking fund, which shall be inviolably pledged for the payment of its funded debt." (Art. XV., § 3.)
—In addition to the writings mentioned in the course of the article, the following may be consulted: M'Culloch, Treatise on the Principles and Practical Influence of Taxation and the Funding System; Reports of the Secretary of the Treasury; American State Papers, Finance; State Constitutions; and Congressional Debates.
WORTHINGTON C. FORD.
Return to top