Our Constitution was not a proclamation written by a convention. It was a negotiated contract for uniting thirteen sovereign independent states. Nothing like that had ever been done voluntarily, and few nations have matched it in two hundred years, even with the use of force.
At first glance, the Articles of the Constitution today seem entirely descriptive, but they originally identified power and, only after protracted debate, the decision where it should best be assigned. The Constitution primarily speaks of separation of powers, not so much balance of powers, as in 19th century British foreign relations. Separating powers weakens them; balancing weakens them further. Sometimes, the original intent was flexibility. The notion of separating Kings from Parliaments, and both of them from the Courts, dates back at least to the Magna Carta. To Americans, a preference for bicameral Legislative branches is most plausibly traceable to the Pennsylvania Legislature in 1787, with Robert Morris doing battle against a headstrong unicameral body. The vertical division of power among federal, state and local lines occasionally provoked difficulties, but mainly eases confusion. Even when separation fails to quiet matters, clearer lines of separation usually prove to be required, not clever methods of balancing. Separating rather than balancing powers has been our preferred system, and for us, it often proves sufficient.
However, short little James Madison had also cast about for resources to bestow on weak states and weak government departments as protection against bullying by big ones. His life displayed an instinctive avoidance of systems requiring the weak to appeal to the strong for protection, only to find they had acquired a new master. He reasoned that state governments are able to modify state laws to the disadvantage of neighbors, and should retain that ability. He employed the concept that sovereignty began with the states and should remain there. Resulting interface friction is now seen in sales taxes at border crossings, or varying income and estate taxes. But all fifty states are restrained from laying unreasonable burdens on their own citizens by the threat those citizens might then move to another state. Although it is counter-intuitive, abusive tax systems collect less tax revenue by raising rates than by leaving them alone. In extreme cases, whole industries shift location. The outcome is that state governments have less scope for legislation that if they had no peers able to retaliate. James Madison has every right to be pleased with state legislatures slowly responding to the reality he created. Not merely that states must match taxes with neighbor states, but that fairness is the best policy.
To return briefly to comparison with the present debates of the European Union, speculate what advantage might be found in taking Madison literally on treating states as sovereign nations. Europe in 2012 struggles with the same problem America faced in 1787, made more difficult by diversity of languages and folklore of national sovereignty, made urgent by the failure of alternatives. The European leaders reasoned it was easier to unify nations piecemeal; start with monetary policy and work out more difficult problems later. That may seem to point to the same final result, but it does not teach the same lesson. Behind this dubious assessment of relative difficulty was the clear determination in Brussels to use a heavy hand with nationalists; pay no attention to referenda, avoid them if possible. A seeming advantage of first unifying monetary policy is that no one seems to understand it, thus transferring power to those who gruffly pretend they do. Unfortunately for this approach, it is the citizens' nation to do with as they please; they will eventually remind you of it. There is consequently little choice but to educate them to the advantages of Madison's self-disciplining systems. Essentially, keep it simple and don't hide the problems. Half the world probably does not believe honesty is the best policy, maybe even half of Europe. But we adhere to it, not because of Washington's Farewell Address, but because it seems to work.
A practical example of cross-border discipline concerns monetary policy itself, in 1913 when the American Federal Reserve system was created. The Governor of the Texas Fed soon decided to lower local interest rates to the advantage of Texas, just as he had always done. Within days, interstate bank deposits and loan originations switched direction, with everyone looking for Texas loans and no one willing to keep deposits in Texas banks; the independence of Texas banking simply vanished. What emerges is a general principle: there exists hidden pressure for inter-state prices to be uniform, despite constant overt pressure to respond to local conditions. Freed of state regulation, trade moves in the international direction. If both forces happen to pull in the same direction all will be well, but if they go in opposite directions the whole state or nation will be made to suffer for it, usually by blocking other features of bilateral trade.
At the moment, corporation taxes provide the sharpest focus for the power of uniform sovereignty. The nation to get the attention of the world was not 1787 America, but 2001 Ireland, historically a bit leftish. The Irish abruptly lowered their corporate taxes to 12.5%, attracting a sudden massive migration of Swedish, German and English corporations to headquarter in Ireland. Since Ireland is primarily agricultural, the new corporations prompted a sudden migration from the countryside to Dublin, thus generating an urban housing boom. When the boom collapsed there was alarmed commentary, but the observers who really noticed were the world's other finance ministers. Although the boom did get out of hand, the finance ministers mostly noticed that lower corporate taxes attracted business to Ireland. In spite of massive national deficits, England has since lowered corporate tax rates from 28% to 26% and proposes to lower them to 24% in 2012. (Including state taxes, the USA imposes a 40% rate). A century of theorizing that corporations are unfairly doubly-taxed had not provoked any comparable gold rush to match the Irish experience. Other nations will soon follow, and ultimately corporate taxes may go to 0%. But finance ministers are mindful of the ensuing Irish housing crash from going too fast, and therefore may take a decade to get to the end of cutting. They will surely cut until corporate taxes are uniform among major trading nations, as they probably should have been for a century. Those who are slow will now be punished for it by the markets. James Madison the main visionary of this theory, deserves a statue in the main square of Europe, right away.
Originally published: Friday, March 30, 2012; most-recently modified: Wednesday, June 05, 2019