Date 12 May 1942
Author unknown
Title Treasury Anti-inflation Tax Proposals
Description Staff memo, Division of Tax Research, Treasury Department
Location Box 34; Inflation, Depression, Recovery; Records of the Office of Tax Analysis/Division of Tax Research; General Records of the Department of the Treasury, Record Group 56; National Archives, College Park, MD.
 
May 12, 1942

Treasury anti-inflation tax proposals

The record shows that the Treasury in the autumn of 1941 was practically alone, among responsible groups in the executive and legislative branches in urging special anti-inflationary taxes; that other agencies and Congress were apathetic, and the press violently opposed, to the Treasury's program formulated in November, 1941; and that there was no demand for new anti-inflationary taxes on low- income groups until AFTER the Treasury had presented to Congress its proposals to meet the $7 billion dollar revenue goal set by the President in his budget message of January 5, 1942. When an over-all Administration attack on inflation was under consideration in April, 1942, the Treasury again stood practically alone, this time in advocating reliance on voluntary bond purchases rather than further taxes and compulsory savings plans directed at the low-income groups.

THE BOSTON SPEECH

On September 9, 1941, Secretary Morgenthau delivered before the Advertising Clug of Boston an address which was widely hailed in the press as the first clear call from a responsible administration lender for an all-out attack on inflation. He called for heavier taxes in 1942; larger purchases of Defense Bonds; extended controls over bank credit and capital expenditures; expansion of the social security program, with a "separation wage" contribution from workers to set up reserves against the day when they might lose their jobs; reduction of non-essential Federal expenditures; efforts to increase supplies of consumer goods; and release of farm surpluses from storage.

THE CHICAGO SPEECH

Three weeks later, speaking to the American Bankers Association in Chicago, the Secretary again stressed the danger of inflation. "One indispensable method of paying for defense without inflation is 'all-out' taxation, a method that has not yet been tried." The tax bill next year will have to be genuinely 'all-out' bill."

The Secretary's Boston speech was well received in the press, but served editorial writers principally as a springboard for attacks on the farm bloc. Nowhere was there significant support for immediate taxes designed to help check inflation.

The Treasury Department, however, set about formulating a program of special anti-inflationary taxes.

Two plans served as starting points for the Treasury's studies of such taxes -- the Shoup report and the Barnard proposals.

THE SHOUP REPORT

A report prepared under the auspices of the Institute of Public Administration and the Carnegie Corporation by Carl Shoup, Milton Friedman, and Ruth Mack, entitled "Amount of Taxes Needed in June, 1942, to Avert Inflation", recommended a supplementary income tax, to be collected at the source, to raise $5 billion additional revenue and draw off that much excess purchasing power. They estimated that by June, 1942, the Government must be collecting at least $5 billion, perhaps as much as $9 billion, more from consumer incomes than it would collect under existing law, if a substantial rise in prices was to be prevented. They suggested a tax rate of 17 percent on that part of an individual's income in excess of exemptions of $1,000 (married) and $500 (single) and a $300 credit for each dependent. The tax rate, they pointed out, might later have to be increased and exemptions reduced.

THE BARNARD PLAN

On October 16, 1941, Secretary Morgenthau called a conference of his chief fiscal advisers to consider Mr. Chester Barnard's program of "family reserves" and "business stabilization reserves."

The Barnard plan called for: (1) a flat 5% levy on all incomes above an exemption of $1,000; (2) a special graduated levy on the increase in incomes of persons whose incomes had grown larger from one taxable year to another; (3) mandatory purchase, on a graduated scale, of "business stabilization certificates" out of corporate earnings exceeding 6 percent on invested capital, after taxes; (4) tax inducements for establishing irrevocable trust funds for payment of dismissal wages and retirement pay. The additional taxes on individuals would be credited to the taxpayers as "family reserves" and repaid gradually after the emergency, or repaid earlier in case of urgent family need. The "business stabilization reserves" likewise would be repaid after the emergency, or earlier in certain cases.

Secretary Morgenthau expressed great interest in the Barnard plan and ordered that top flight men from various Treasury offices be assigned to study the plan carefully. Out of consideration of the Barnard plan and the Shoup-Friedman-Mack study, the Treasury's program of special anti-inflationary taxes gradually took shape.

THE NOVEMBER PROPOSALS

By October 29, 1941, the Secretary's advisers had come to agree on the main outlines of an anti-inflationary tax program.

This program placed major reliance on taxation rather than compulsory savings and on individual income taxes rather than corporate taxes. Emphasis was placed on taxation because compulsory savings are, dollar for dollar, less effective in reducing inflationary pressure than taxes, involve an increase in the public debt and post-war commitments under conditions that cannot be clearly foreseen in advance, and make additional levies in the form of taxes rather than compulsory savings more difficult. Further, it was felt that the amount of taxes required was not yet sufficiently large so that compulsory saving was essential to soften they blow and to provide incentive for increased effort. Emphasis was placed on individual rather than corporate taxes because the inflationary pressure was arising primarily from increased individual incomes and because direct measures were available and were being taken to curtail non-essential corporation expenditures on capital expansion.

The major points of the anti-inflationary program were:

1. The control of inflation required that by June, 1942, tax collections out of consumer income be increased by from $6 billion to $9-1/2 billion.

This estimate represented a revision of that contained in the Shoup-Friedman-Mack report based on a series of technical conferences with representatives from other Washington agencies. More than 20 persons participated in these conferences and eight agencies other than the Treasury Department were represented, among them the Office of Price Administration, the Office of Production Management, the Federal Reserve Board, and the Bureau of the Budget.

2. There was general support for the Social Security Board's proposed expansion of the social security program, with increases in payroll taxes (1% increase in tax on employees for unemployment insurance).

3. There was general agreement that there should be some form of flat tax on incomes above minimum exemptions, to be withheld at source of payment, and to go into effect January 1, 1942. Opinions differed as to the the rate of the special withholding tax and the amount which should be credited to the taxpayers as compulsory savings. A plan representing a median among the various proposals called for a tax rate of 12-1/2% with exemptions of $1,000 for married persons and $500 for single persons, and a $300 credit for dependents. About $0.5 billion of the revenue received form low- income groups should be credited to taxpayers for return after the emergency.

4. The impact of these special anti-inflationary taxes should be balanced by changes in the income tax in the higher brackets, increased corporation taxes, and the closing of loopholes in the present law. These additional measures were to be presented along with the special anti-inflationary taxation, but with the expectation that they would be embodied in a separate bill to be enacted at a later date.

This was substantially the program informally presented by Secretary Morgenthau to the Ways and Mean Committee on November 5, 1941. By that time the Treasury had decided upon a supplementary net income tax of 15 percent, to be withheld at source, with personal exemptions fixed at $1,500 and $750, and with a $400 credit for dependents, plus the social security tax increases already mentioned. The plan called for no compulsory savings.

CONGRESSIONAL ATTITUDE

Secretary Morgenthau invited Senator George and Chairman Doughton to confer with him concerning the Treasury proposals. They met on November 5, 1941, and the Secretary presented the results of the Treasury studies, pointing out that an inflationary gap of from $5 to $10 billion could be expected in 1942 and recommending a tax bill to raise about $5 billions. He then outlined how the Treasury proposed to raise this amount. Both chairmen thought the request for increases in social security taxes would bring on a long and heated Congressional debate. Both felt that Congress had no appetite for a new tax bill. Congress, they said, was tired and wanted a vacation. Chairman Doughton added that he thought Congress would be more interested in getting more tax revenue than in trying to block inflation through taxes.

It was arranged that Secretary Morgenthau should informally discuss his proposals with the Ways and Means Committee. This he did in the afternoon of November 5, 1941. Considerable hostility to the social security proposals was apparent, and it was generally thought that any revision of the social security system would involve a long period of discussion and consideration. Mr. Robertson indicated approval of social security tax increases, but wanted an assurance from the White House that there would be no social security reform message while the tax bill was under consideration.

The Secretary again met with Senator George and Chairman Doughton on the morning of November 6, 1941. Earlier in the morning the Secretary had seen the President, and he reported that the President had approved the Treasury proposals. He further reported that the President had agreed not to send the social security message to Congress until after Christmas, provided Congress would immediately start to consider the Treasury's tax proposals. The Secretary added that the President said he would be obliged to send a letter to Chairman Doughton asking for immediate consideration of the Treasury program in case the Committee decided to turn it down.

Chairman Doughton was not pleased with these remarks and proceeded to outline his own ideas of a proper time-table for considering tax measures. First, loopholes in the present law should be closed. Reduction on non-essential Government spending should then be effected. After these steps had been taken a tax bill, in his opinion, could be taken up and put through with much less delay and opposition. He thought the withholding tax would meet with strong opposition -- solid among Republicans, considerable among democrats. Senator George agreed that the program would be strongly opposed in Congress. Chairman Doughton repeated that he thought the way to keep prices down was through the price control bill, not through taxes. He again alluded to restiveness in Congress and the desire of members to have a vacation.

ATTITUDE OF OTHER ADMINISTRATIVE AGENCIES

On the same day that the Secretary first met with the Chairman of the Congressional Committees (November 5) Mr. Eccles and Mr. Paul conferred. Mr. Eccles felt there would be no serious inflation problem for about a year. In his opinion, the shift to war industries, temporary lack of employment, and the impact of existing taxes, should take care of the situation until about November, 1942. He doubted the effectiveness of a withholding tax, pointing out it would lead to demands for wage increases and higher farm prices. To control inflation, he said, it was necessary to control prices of important commodities and to impose effective controls on wages and farm prices. A withholding tax, he thought, would be politically impracticable until taxes on higher brackets had been stiffened.

On November 5, 1941, Mr. Henderson addressed a memorandum to the Supply, Priorities and Allocation Board entitled "How Fiscal Policy Can Aid the Work of the SPAB." Having estimated that there would be a considerable inflationary gap in 1942, he said that chief reliance must be placed on taxation to close the gap. His suggested tax program included (1) closing loopholes, (2) advancing income-tax payment dates, (3) collection of income tax at source, starting at a rate of 5 percent, (4) small increase in social security taxes, (5) stiffer excess profits taxes, and (6) selective excises to complement price control and curtailment of production for civilian use. He expressed opposition to compulsory savings for the time being. These proposals were much milder as anti-inflationary measures than the proposals then being developed by the Treasury.

A few days later, November 12, 1941, Secretary Morgenthau met with Messrs. Eccles and Henderson. Mr. Henderson felt that no accurate estimate of the inflationary gap could be made without information from the O.P.A. concerning plans for converting production to war purposes. In his opinion it seemed likely that ordinary production would be so curtailed that there would be, for a time, less rather than more purchasing power in the nation until the adjustment had been made and the adjustment might be a slow process. Mr. Eccles thought enactment of a withholding tax would not be politically feasible until loopholes in the present tax law had been closed, individual surtaxes raised, and the excess profits tax stiffened. It was arranged that the technical staffs of the Treasury, O.P.A., and Federal Reserve Board should meet to work out details of a tax program.

PRESS REACTION

The Secretary had presented his tax proposals to the Ways and Means Committee in confidence, to learn whether they were interested in holding hearings to consider such a tax program. The proposals, however, leaked out and were widely reported in the press. The proposals were in general misunderstood, the 15 percent withholding tax being regarded as a tax on gross income rather than on income above exemptions and as a payroll tax rather than an income tax. Editorial denunciation was prompt and vigorous. The press assailed the withholding tax as an indefensible burden on incomes which had not increased as a result of the defense program, scoffed at the idea that there was an excess of purchasing power which needed to be mopped up, and accused the Administration of turning to taxation as a politically easier way of doing a job which could only be done by an effective price control bill.

When the President wrote to Chairman Doughton, November 8, 1941, to urge immediate consideration of the Treasury proposals, the press said that the first job of the Administration was to pass a strict price control law, restraining wages and farm prices as well as prices of other commodities. Next in order, the Administration should cut non-essential expenditures. Then, and only then, should new taxes be considered as a complementary measure to check inflation.

The press reiterated its strong opposition t using social security tax increases as a method of emergency financing. Changes in the social security system should be considered quite apart from any program to combat inflation or raise revenue.

On December 11, 1941, a conference on taxes was held at the home of Assistant Secretary Sullivan. Budget Director Smith, Price Administrator Henderson, Federal Reserve Chairman Eccles, and Mr. Lauchlin Currie were present from outside the Treasury. In the face of Congressional lack of interest in special anti-inflationary taxes, the lack of support for such program from other Administration leaders, and the strong press reaction against the Treasury proposals, the plans for a special withholding tax had been shelved. The Treasury was still concerned, however, over the problem of speeding up tax collections to divert purchasing power from the hands of consumers as quickly as possible. Should an immediate request be made for authority to withhold some part of the income tax at source of payment?

Mr. Mr. Henderson thought that due to dislocation in industry, the pressure of income on prices would not be resumed until March, 1942. Beginning in March, he said, the pressure of income would increase and larger withdrawals of purchasing power would be necessary. A plan for speeding up tax collections might be included in the regular tax bill and then enacted separately if the bill were delayed. Mr. Eccles seemed to agree with Mr. Henderson's position. Mr. Currie likewise agreed. He thought the case for a strong tax bill might be weakened if there was a prior request for discretion to advance the date of collection before the regular tax bill was presented. Mr. Smith took the same position.

PREPARATION OF 1942 TAX PROGRAM

The Treasury then set about preparing its proposals for a 1942 tax bill. Guided by to reactions of other agencies to its earlier plans, the Treasury decided to present a single bill rather than urging the adoption of special anti-inflationary taxes prior to the enactment of other changes. The President set a revenue goal of about $7 billion (plus $2 billion in social security taxes) in his budget message of January 5 and the Treasury Plan was designed to raise this amount. In the course of its preparation during January and February, Mr. Paul conferred constantly with Mr. Eccles of the Federal Reserve Board, Mr. Gilbert of the O.P.A., Mr. Colm of the Bureau of the Budget, as well as with representatives of other interested agencies. Until the first of March, when the Treasury proposals were about to be submitted to the Ways an Means Committee, there were no demands, from agencies concerned with inflation control, for a higher tax yield than that proposed by the President and by the Treasury.

On January 12, 1942, a meeting was held in Mr. Paul's office to consider a proposal by the Bureau of the Budget for a tax on value added. This meeting was attended by representatives of the Bureau of the Budget, and a number of other agencies outside of the Treasury. Most of the persons present agreed with the Treasury representatives in opposing the proposed tax.

From January 25 to February 17, 1942, an Excise Tax Committee met frequently to consider what excises Congress should be asked to impose. The Treasury, O.P.A., Federal Reserve Board, W.P.B., Bureau of the Budget, and Staff of the Joint Committee on Internal Revenue Taxation, were represented on this committee. Deliberations proceeded on the assumption that a number of selective excise taxes, rather than a general sales tax, would be included in the tax program.

ANTI-INFLATION PROGRAM SINCE MARCH 1, 1942

On March 3, 1942, Secretary Morgenthau and Mr. Paul presented to the Ways and Means Committee the Treasury's proposals for taxes to raise $7.6 billion.

One day earlier, March 2, Mr. Henderson wrote a letter to the Secretary, urging the institution of a compulsory savings plan to raise 5 or 6 billion dollars more than the revenue goal of the Treasury's tax program.

Mr. Henderson estimated that under the most favorable circumstances the excess of consumers demand over supply would be at least $12 billion, even AFTER the increase in taxes proposed by the Treasury. He expressed fears that price control and rationing would not be effective to keep prices down unless a large part of these $12 billion was diverted from consumers. Accordingly, he recommended a compulsory savings plan, with exemptions lower than those granted under the present income tax law.

This marked the beginning of efforts on the part of several agencies -- Treasury, O.P.A., Bureau of the Budget, Department of Agriculture, and W.P.B. -- to formulate an over-all inflation program. Agencies other than the Treasury insisted on the need of taxes much heavier, and more directly aimed at low incomes, than those suggested by the Treasury. After a period of intensive consideration of various anti-inflation measures, the program of these various agencies took definite shape.

Until April 6 there was disagreement on details among all the agencies. For example, April 3 the representatives of O.P.A. insisted that the O.P.A. was strongly opposed to a general sales tax and lower income tax exemptions which were being urged by some other agencies. April 6 the O.P.A. united with the other agencies in recommending a sales tax, lower exemptions, and compulsory savings.

April 6, 1942, Budget, O.P.A., W.P.B. and Agriculture informed the Treasury that they were agreed on a tax and compulsory savings program to yield about $6-1/4 billion more during the fiscal year 1943 than the Treasury's program. Their tax program was to supplement an anti-inflation program calling for freezing of prices, rents, and wages; drastic restrictions of consumer credit; and specific rationing. Their tax proposals consisted of:

1. Lowering personal income tax exemptions to $500 for single persons and $1,000 for married persons, and a $250 credit for each dependent. Estimated yield - $2 billion.

2. Compulsory savings at the rate of 5 percent on income, excluding single income earners of $500 or less and married earners of $1,000 or less. Estimated yield -- $3 billion.

3. A war consumption (sales) tax of 5 percent to take effect January 1, 1943, which would raise $1-1/4 billion in the second half of fiscal 1943.

4. An excess profits tax rate of 100 percent (No estimate on yield).

5. Confiscation of all income above $50,000 or $100,000 (No estimate on yield).

This group insisted that such a tax and compulsory savings plan would be more equitable and effective than an intensified drive to sell War Savings Bonds. Such a drive, they said, would not raise the required sums of money unless coercive sales methods were used.

The Treasury stood alone in urging reliance on voluntary War Bond purchases and in opposing compulsory savings, a general sales tax, lower income tax exemptions, and freezing of wages.