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Free Rider Problems Under the Articles of Confederation

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A Free Rider Problem Under
the Articles of Confederation
“The check is in the mail”
Lots of Debts after the War
• The United States had about $35 million in
debt after the Revolutionary War.
• $25 million owed to the American people.
– Soldiers waiting for back pay.
– Businesses which had supplied troops
wanting payment.
• $10 million owed to foreign governments.
– This needed to be repaid before commercial
relations could be normal.
Collective Interest in Paying Debt
• The national government – as well as all of
the state governments – had an incentive
to pay the debt.
– The country faced internal legitimacy.
problems if it could not pay the former troops
and suppliers.
– Disgruntled soldiers could be a threat….
– Normalized foreign trade was critical to both
the national and state economies.
How to address this collective
action problem?
Articles of Confederation
• Congress was responsible for paying the
debt.
• However, Congress had no taxation
powers.
• Congress gave each of the states an
annual amount it must pay for its share of
the debt.
• State legislatures had to determine how to
raise the funds for these annual payments.
How to raise the money?
• In order to raise the money for their annual
payment, state legislatures typically had to
raise taxes on its citizens.
• Then as now, politicians despised raising
taxes!
• Plus, local economies were still very
fragile after the War.
What are the states’ options?
Option #1: Raise Taxes
• Pros
– Will have enough funds to pay share of debt.
• Cons
– Will have to take unpopular step of raising
taxes.
– May further damage already weakened
state/local economies.
Option #2: Keep Taxes the Same
• Pros
– Can keep the tax rate the same.
– Be more popular with electorate.
• Cons
– Can’t pay allocated share of national debt.
Which option is a politician,
primarily concerned about his
local interests, going to choose?
“Option 2!” says
State Legislator Smith
• Legislator Smith would like to do what he
can to avoid raising taxes on the people of
his state.
• Members of his state’s congressional
delegation contend that such an attitude
would mean that the state would shirk its
national responsibility!
• Legislator Smith asks, “What are the
ramifications of not paying Congress?”
Enforcement mechanism?
• The Articles of Confederation had no
enforcement mechanism to compel states to
make their payments.
• Thus, only concern for the collective good of
paying down the debt was the motivation for
payment.
• Those collective goods are compelling, but
wouldn’t they be achieved anyway as long as all
the other states (except us!) paid their share?
The Free Rider Problem
• Without an enforcement mechanism, states had
an incentive not to pay their allocation of the
national debt and hope that other states would
pay enough of the debt to provide most if not all
of the collective benefits.
• In other words, the “shirking” states had an
incentive to “free ride” on the backs of the states
that were willing to do what it took to pay their
allocation.
The Domino Effect
• Once some states decided to not pay their
allocation, other states had extra incentive not to
pay their own allocation.
– Why should the citizens of only some states bear the
national debt burden?
– This results in a Prisoner's Dilemma situation.
• With this free rider problem, it became clear that
the national debt was not going to be paid, and
that the collective benefits of doing so were not
going to be realized.
How the free rider
problem was addressed
The Constitution
• Article I, Section 8 gave Congress the
power to raise taxes directly.
– States would no longer have to raise funds for
the national government.
• The national government in return would
assume any of the states’ outstanding debt
related to the War.
This free rider problem is solved
by centralizing the ability to raise
funds with the national
government rather than relying
on states to collect the money
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