Date 23 December 1942
Author unknown
Title Revenue Program for 1943: Part 3 -- The Sales Tax and Spending Tax
Description Internal staff memo, Division of Tax Research, U.S. Treasury Department
Location Box 1; General Sales Taxes; 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.
 
REVENUE PROGRAM FOR 1943 -- 3. THE SALES TAX AND THE SPENDING TAX

During the legislative proceedings on the 1942 Revenue Bill, the Treasury (1) opposed flat rate general sales taxes, (2) opposed a progressive retail sales tax, and (3) recommended a spendings tax.

FLAT RATE GENERAL SALES TAXES

The Treasury opposed flat rate sales taxes primarily for two reasons: (1) they fail to protect a basis minimum standard of living, and (2) the administrative machinery needed for any sales tax cannot be established during the war because of the shortages of labor and equipment, if simultaneously the income tax is to be put on a pay-as- you-go basis by instituting a system of collection at source.

Of the flat rate sales taxes, the Treasury prefers the retail sales tax because is would involve lose pyramiding than the manufacturers' or wholesalers' tax and would interferes least with the administration of the price ceilings. Unfortunately, is also the most difficult to administer because of the multitude of retail outlets. /1/

PROGRESSIVE RETAIL SALES TAX

Several independently developed plans for a progressive retail sales tax have recently been suggested. This type of tax would meet one of the Treasury's primary objections to the sales tax -- the minimum standard of living would be protected. Under these plans tax- free coupons would be issued to cover a certain minimums of expenditures. Additional books of coupons would be issued taxable at the initial sales tax rate, and still additional books would be available at successively higher tax rates. /2/

A progressive retail sales tax would constitute an entirely satisfactory source of war-time finance if it could be administered reasonably well without a * * * and costly compliance system. It would not only protect a minimum standard of living, but it would be on efficient anti-inflationary measure since the tax could be collected currently bit by bit as the money is spent. At the same time it would not have the regressivity that is the major disadvantage on grounds of equity of the flat rate sales tax.

The two main weaknesses of a progressive retail sales tax are (1) the difficulties of administration and compliance, and (2) the tax base is too small to permit successful progression.

A progressive retail sales tax would involve all the administrative difficulties of any retail sales tax and others to best. Careful and mostly registration of consumers would be required to prevent persons from obtaining more than one tax-free set of coupons and to prevent persons from purchasing additional coupons at tax rates lover than these provided in the enacted schedule. Some multiple registration and evasion of proper tax payment could not be prevented. More important, it would be element impossible to prevent the transfer on unused stamps -- either unused exemption stamps if exemptions were provided, or unused low-rate stamps. Persons who had no use for the exemption stamps or for low-rate stamps would sell them to persons whose spendings were larger than the exempt amount or whose spendings were in higher rate brackets. Such transfers would be in the mutual interest of both parties. In practice, it would probably be preferable to permit such transfers freely rather than be attempt the impossible task of preventing them. The feasibility of a progressive retail sales tax either with or without exemptions would, therefore, even to hinge very largely on the development of a practical plan for preventing the transfer of coupons.

Less important but will substantial either administration and compliance problems would be noted: (1) The printing and distribution of coupon booklets to individuals in denominations suitable for retail purchases would require substantial additional personnel and equipment even if existing agencies such as banks and post offices were to be utilized. (2) In addition to ration coupons, individuals would nee to have on band at all times sufficient sales tax coupons to cover their retail purchases. This would be a source of considerable inconvenience. (3) Retail purchase made by business concerns would have to be exempted from the graduated tax rates. This exemption would complicate tax administration and would create opportunities for evasion. (4) A continuous check on retailers and auditing of their accounts would be required to insure the collection of the coupons by retailers and to prevent them from selling coupons collected from purchases instead of turning them over the tax- collecting agency.

The second major weakness of the progressive retail sales tax is that the tax base is relatively small, leaving little room for progression under may plan designed to raise substantial amounts of revenue. As with any retail sales tax, it is not feasible to tax certain classes of expenditures such as expenditures on domestic service, professional service, rent, and similar items. With total spending of about $70 billion, this means that the base would be net more than about $50 billion before exemptions. Exemptions would reduce the base still farther. For example, suppose only $300 of free coupons were issued to cover expenditures for each adult and $150 for each child. This would involve the issuance of free coupons covering over $30 billion of expenditures in the aggregate, leaving less than $20 billion in the base. With a base no small, there is little room for progression. Impose the first rate bracket is made $300 for each adult and $150 for each child, or the * * * as the exemptions. This would involve first bracket coupons covering aggregate spendings of over $30 billion -- more than the entire base. The most that would be feasible, if exemptions were permitted, would therefore be a flat rate tax above exemptions.

The considerations that limit progressivity if exemptions are allowed will also limit the possible progression in the absence of exemptions. A rate bracket of $300 for each adult and $150 for each child would account for ever $30 billion of expenditures. With a total base of $50 billion only about two such rate brackets would be feasible. There would be many individuals whose expenditures would be above these two brackets, but most of them would be able to secure coupons at lower bracket rates from persons whose expenditures were less than the sum of the two brackets.

SPENDING TAX

The Treasury recommended a spendings tax to the Senate Finance Committee in a special public hearing which interrupted the Executive Sessions. /3/ The case for the spending tax was stated by the Secretary as follows:

"The legislative which we are proposing has a double purpose. The first purpose is to draw into the Treasury substantial additional funds out of the earnings and savings of the people. The second purpose is even more important. It is to reduce consumer spending directly by withdrawing funds otherwise available for expenditure, and to reduce it also indirectly by creating a strong tax incentive to saving . . . . .

"Revenue is not the sale purpose, nor even the primary purpose . . . . of these proposals. Their main purpose in to restrict consumer spending so that, as far as possible through fiscal means, we may avoid the * * * of inflation in the huge financing program that we have ahead of us . . . . .

"The control of prices is of course not exclusively a fiscal problem. But with full allowance for all that can be done through price regulation, rationing and other devices to control supply. I think that we, who are jointly responsible for tax policy and legislation, shall be doing very much less than our full duty if we do not deal with the problem as effectively as possible in the fiscal field. What I have presented is a method -- and the best method the Treasury has been able to devise -- for accomplishing this result."

The spendings tax is more unitable to the needs of the present situation than the income tax. It also has several advantage over the flat rate sales tax an the progressive retail sales tax.

An advantage of the spendings tax over the income tax is that it makes a more direct attack on consumer spending. The income tax is imposed on spendings that need to be curtailed and on savings that need to be increased. The spendings tax is imposed only on spendings. In the second place it is difficult to extend the income tax indefinitely without imposing undue hardship on persons with large fixed obligations to repay debt, to pay insurance premiums or to make other types of regular savings. Expenditures for these purpose do * * * little, if any, inflationary pressure on prices. The spendings tax can be used beyond the point to which the income tax can be pushed without sacrifice of equity.

The Treasury's recommendation on the spendings tax in 1942 was not intended to reflect that view that the income tax should not be increased beyond the 1942 rates. In increasing the income tax the rate of increase as well as the absolute level of the tax must be takes into account. It is not politic to take away from the people by taking their income, all at one time, the entire amount needed to bring about the readjustment of living standards which the current war situation requires. The spendings tax leaves the income in the hands of the people if they curtail expenditures.

The chief advantages of a spendings tax over a sales tax are as follows: /4/ (1) Under a spendings tax it is feasible to protect a minimum standard of living by exempting a minimum of expenditures; under a sales tax this can be done only partially and loss satisfactorily by exempting classes of goods such as food. (2) A spendings tax, which in a sense is a general expenditure rationing device, can go a long way to substitute for rationing of specific commodities. In conditions of short supply, the liberal purchases of these with high incomes need to be restrained by rationing if those with low incomes are to get the essentials for efficiency and for the maximum war effort. It is impossible to impose a sales tax at sufficiently high rats to discourage luxury spending without imposing an undue burden on the great passes of the people. (3) The sales tax is loss effective than a spendings tax as a brake upon consumer spending and prices, first, because it affects the parity prices of form products and also, because it is administratively difficult to include services in the tax base, it reaches a smaller amount of consumer spending.

The spendings tax also has certain advantages over a progressive rate retail sales tax. Many of the administrative and compliance problems, as, for example, the problem of trafficking in coupons, would be entirely avoided.

But the spendings tax itself in net free from various administrative difficulties of its own. The final liability under the spendings tax would not be determined until after the close of the year. It would be computed at the same time as the regular income tax and on the same form. The spendings tax would, however, be of little immediate value as an anti-inflationary instrument if the actual collection of the tax were delayed this long. Consequently, the tax will have to be collected currently during the year by (1) collection at source from income received in the form of wages and salaries, interest and dividends; and (2) quarterly returns of persons with income from other sources and for persons in the higher spendings tax brackets. The difference between the ultimate liability and the amount collected during the year would be adjusted in the final year- end return. The quarterly returns would involve a serious administrative difficulty. So also would the adjustment at the en of the year. In order to check on the ultimate liability shown on the year-end return, information would be needed that is not now available for income tax purposes, for example, information on bank deposit at the beginning and end of the year, purchases of securities and the like. One source of looseness for the first year or so of operation would be the extreme difficulty, if not impossibility, of checking on the amount of cash, as distinguished from bank accounts, in the hands of individuals at the beginning of the period.

CONCLUSIONS

1.Study of the latest available date on consumer expenditures indicates that it is possible to protect a minimum standard of living without contributing to inflationary pressure. The figures show, for example, that individuals in the per capita net income class of less than $00 account for less than 8 percent of the total attempted consumption of all individuals estimated for calendar year 1943. (See Table 1 appended). These data substantiate the position which the Treasury took in opposition to a general sales tax in 1942 and indicate that the Treasury should continue in 1943 to oppose all types of sales taxes which unnecessarily impinge upon minimum standards of living.

2. Despite the shortcoming of the spendings tax, the developments in the ration and price control areas since the enactment of the 1942 Revenue Bill indicate than it would be highly desirable for the Treasury to renew its recommendation for a spendings tax in 1943. Public resistance to price ceiling threats the inflation-control program and the stability of our economy. In these circumstances, the spendings tax would seen to have merit as a measure short of general expenditure rationing. This would especially be true if the Congressional resistance to higher taxes and even to compulsory leading were to develop for short of the amounts necessary to control the price situation.


Treasury Department

December 23, 1942

Division of Tax Research

[EDITOR'S NOTE: Footnotes to document are missing]



                               Table 1

                              (PART 1)

        Estimated distribution of individuals, total income,
  net income, state and Federal personal taxes under the 1942 Act,
        consumption, and savings and gifts, by per capita /1/
                net income classes Calendar year 1943

_____________________________________________________________________
     Per capita /1/           Number of           Total 
     net income               equivalent          income
      classes                 adults /2/           /3/

                             (thousands)

      $ 0 -   $400             25,000              6,724        
      400 -    800             37,000             24,935
      800 -  1,200             26,200             29,414
    1,200 -  1,600             10,580             16,842
    1,600 -  2,000              4,690              9,815
    2,000 -  2,500              2,890              7,601
    2,500 -  3,000              1,515              4,930
    3,000 -  4,000              1,456              5,957
    4,000 -  5,000                597              3,164
    5,000 - 10,000                766              6,128
   10,000 and over                306              9,490
        Total                 111,000            125,000

                     CONTINUATION TABLE 1 PART 2
___________________________________________________________________
         Net       Personal       Total       Attempted     Savings
       income       taxes        income        consump-       and  
         /4/          /5/      after taxes      tion        gifts
___________________________________________________________________
                          Aggregate amounts
                        (million of dollars)
         5,924           5          6,719       6,034           685
        22,083         583         24,352      20,535         3,817
        25,642       2,114         27,300      22,129         5,171
        14,485       1,630         15,212      11,974         3,238
         8,328       1,121          8,694       6,656         2,038
         6,393         971          6,630       4,871         1,759
         4,125         690          4,240       2,993         1,247
         4,984         925          5,032       3,438         1,594
         2,641         508          2,656       1,722           934
         5,132       1,273          4,855       3,003         1,852
         7,918       4,480          5,010       2,717         2,293
Total  107,655      14,300        110,700      86,072        24,628

                       AVERAGE PER CAPITA /1/

   $ 0 -   $400     1    $269    $237     /6/    $269    $241     $28      
   400 -    800     1     674     597     $16     658     555     103
   800 -  1,200     1   1,123     979      81   1,042     845     197
 1,200 -  1,600     1   1,592   1,369     154   1,438   1,132     306
 1,600 -  2,000     1   2,093   1,776     239   1,854   1,419     435
 2,000 -  2,500     1   2,630   2,212     336   2,294   1,685     609
 2,500 -  3,000     1   3,254   2,723     455   2,799   1,976     823
 3,000 -  4,000     1   4,091   4,423     635   3,456   2,361   1,095
 4,000 -  5,000     1   5,300   4,424     851   4,449   2,884   1,565
 5,000 - 10,000     1   8,000   6,700   1,662   6,338   3,920   2,418
10,000 and over     1  31,013  25,876  14,641  16,372   8,879   7,493
FOOTNOTES TO TABLE
/1/ In computing per capita net income, spendings, savings, etc., each dependent is counted as one-half and adult, e.g., a family of husband and wife and two dependents is counted as three equivalent adults. If the family income is $1,800, the per capita income is $600.

/2/ Number of potential taxpaying units if there were no exemptions and if the present advantage to filing separate returns were retained.

/3/ Corresponds to income payments.

/4/ Total income less tax-exempt income and deductible items: taxes, interest paid, contributions, etc.

/5/ Includes Federal and State personal income taxes and estate and gift taxes; excludes post-war credit part of Victory tax.

/6/ Less than $.50.