<P> On the founding of the United States, the financial affairs of the new federation were in disarray, exacerbated by an economic crisis in urban commercial centers . In 1790, Secretary of the Treasury Alexander Hamilton pushed for Congress to pass a financial plan, called the First Report on the Public Credit, a controversial part of which involved the federal government assuming state debts incurred during the Revolutionary War . Northern states had accumulated a huge amount of debt during the war, amounting to $21.5 million, and wanted the federal government to assume their burden . The Southern states, which had lower or no debts, whose citizens would effectively pay a portion of this debt if the federal government assumed it, were disinclined to accept the proposal . Some states, including Virginia, had already paid off almost half of their debts, and felt that their taxpayers should not be assessed again to bail out the less provident, and further argued that the plan was beyond the constitutional power of the new government . James Madison, then a representative from Virginia, led a group of legislators from the South in blocking the provision and prevent the plan from gaining approval . Jefferson supported Madison The plan was finally adopted as part of the Compromise of 1790, as the Funding Act of 1790 . The compromise meant that the state debts were all picked up by the federal Treasury, and the permanent national capital would be located in the South, along the Virginia - Maryland border in what became the District of Colombia . </P> <P> Historian Max M. Edling has explained how assumption worked . It was the critical issue; the location of the capital was a bargaining ploy. Hamilton proposed that the federal Treasury take over and pay off all the debt that states had incurred to pay for the American Revolution . The Treasury would issue bonds that rich people would buy, thereby giving the rich a tangible stake in the success of the national government . Hamilton proposed to pay off the new bonds with revenue from a new tariff on imports . Jefferson originally approved the scheme, but Madison had turned him around by arguing that federal control of debt would consolidate too much power in the national government . Edling points out that after its passage in 1790, the assumption was accepted . Madison did try to pay speculators below 100%, but they were paid the face value of the state debts they held regardless of how little they paid for them . When Jefferson became president he continued the system . The credit of the U.S. was solidly established at home and abroad, and Hamilton was successful in signing up many of the bondholders in his new Federalist Party . Good credit allowed Jefferson's Treasury Secretary Albert Gallatin to borrow in Europe to finance the Louisiana Purchase in 1803, as well as to borrow to finance the War of 1812 . </P> <P> The Southern states extracted a major concession from Hamilton in the recalculation of their debt under the fiscal plan . For example, in the case of Virginia, a zero - sum arrangement was contrived, in which Virginia paid $3.4 million to the federal government, and received exactly that amount in federal compensation . The revision of Virginia's debt, coupled with Potomac residence issue, ultimately netted it over $13 million . Another result of federal assumption of state debts was to give the federal government much more power by placing the country's most serious financial obligation in the hands of the federal government rather than the state governments . The federal government was able to avoid competing in interest with the States . </P> <P> The debts of the federal government on January 1, 1791 amounted to $75,463,476.52, of which about $40 million was domestic debt, $12 million was foreign debt, and $18.3 million were state debts assumed by the federal government, of the $21.5 million that had been authorized . </P>

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