The Global Debt Clock at The Economist website indicates the debt of sovereign governments will exceed $50 trillion by the end of 2012. That’s nearly double what it was just five or six years ago. The welfare state is on a collision course with fiscal reality.

One of the benefits of historical knowledge is that it brings perspective. Things that seem obvious look quite different when you realize that they are of recent origin. Things that seem inevitable do not appear so when you look at their past. One of the best examples of this is the size of modern government.

Today in the “developed” world, governments spend on average between 40 and 60 percent of the national income. Most people take this for granted. This is where the first element of historical perspective comes in. Government spending on this scale is historically recent. In 1900 the average share of national income taken by government was about 10 percent. Government spending rose as a proportion of national income throughout the twentieth century. The two critical episodes in most countries were the two world wars. Government spending soared during the conflicts. Afterward, although it declined, it never went back to its pre-war level.

All this is well known. There is an extensive scholarly literature on the reasons for this growth of government since 1900.1 The common conclusion is that the growth of government was unavoidable and is irreversible. However, taking a longer view than one that stops in 1900 leads to a different conclusion. Government grew, apparently inexorably, before and then was sharply cut back.

Modern public finance was invented in 1696, with the creation of the Bank of England. Before then rulers raised most of their income through direct loans from private bankers. This was a risky business as kings frequently found themselves unable to meet their obligations and resolved their difficulties by defaulting on their debts. The English government solved this problem by inventing the national debt, in which governments raise money by borrowing from the public through the issuing of bonds. The Bank of England had the responsibility of managing the government’s borrowing. However, as contemporary critics pointed out, the consequences were disastrous.

The invention of national debt enabled the governments of eighteenth-century Britain to spend money while putting the burden of paying for it on future generations. Until the 1820s most current spending was paid for by debt. The income from taxation was used primarily to service the debt. As a result, between 1702 and 1783 interest payments to debt holders accounted for 33 percent of government spending. Repeated wars and other spending led to a steady rise in both debt and taxes. By 1815 the level of taxation was 18 times what it had been in 1660. In 1660 government spending came to 3.4 percent of national income. By 1720 it had reached 10.8 percent, and by 1815 it had reached 19 percent. Given the nature of the economy at the time, the impact was as significant as the 40 percent of national income spent by governments today.2

All of this was sharply attacked by critics such as Thomas Paine. By 1781 the burden had reached an unsupportable level. The result was a program of “economical reform” launched by the new Prime Minister, William Pitt the Younger. This meant reducing the level of debt, abolishing many government posts and sinecures, and raising a larger proportion of current spending by taxation. With these measures Pitt was able to stabilize the public finances. However the level of national income taken by the government remained constant, despite Pitt’s efforts to reduce it. In 1791 war broke out with France and would continue with only a short intermission until 1815. As a result the rise of government spending began again and it reached its peak in 1815. To read the full article: click here.