As indicated in the previous section, the most inequitable way of financing the war is inflation; any anti-inflationary tax is more equitable. Thus, if there is a difference in the anti-inflationary effects of a general sales and a withholding tax, this has an indirect bearing on their comparative equity.

For present purposes the doctrine may be accepted that that tax is least equitable which bears most heavily upon recipients of small incomes, and that some degree of progressivity in relation to income is necessary. An inequitably high degree of progressivity could be introduced, but this danger still seems remote. The existing distribution of incomes, the institutions and devices for tax avoidance that are more readily employed by the well-to-do, and the whole complex of taxes making up the revenue system -- all suggest continued need for progressive taxation. It may be assumed that any addition to progressive taxes which at present is likely would be an improvement in the system.

These considerations support the view that the withholding tax is preferable to a general sales tax. It should be kept in mind, however, that the advantage of the income tax from the point of view of equity is lessened by lowering the exemptions and deductions. We concluded earlier that a withholding tax may be somewhat less anti- inflationary than a general sales tax yielding equal revenue. If this is true, one concomitant of a withholding tax is a somewhat greater degree of inflation, with the regressive incidence of inflation. To some extent, then, the difference in anti-inflationary effects of the two types of taxes may lessen the difference in equity which is apparent at first sight.


The problems of price administration cannot be very significantly affected by the choice made between the two methods of taxation. To the extent that the withholding tax permits a lower price level for a given volume of transactions, it might ease the burden of price administration. But the difference between the effects of the taxes on the price level would be small compared with the effect of a large volume of inflationary borrowing that will occur in any event.


To the extent that a general sales tax reduces total consumption more than additional progressive taxes, the sales tax provides greater pressure for conversion of industrial facilities to war production. For either tax, the pressure would be greatest for firms producing goods with the most flexible demand. However, if it is assumed that a larger part of the income tax will be met out of savings than in the case of the general sales tax, the stimulus to business readjustments would be smaller. Expenditure curtailments induced by the additional income tax on taxpayers in the upper brackets may release factors of production not readily adaptable to other uses. (See above, Section I, page 9.) They may, thereby, lead to more frictional underemployment of both resources and manpower than the more diffused sales tax. In this, and probably only in this respect, additional borrowing is the most advantageous form of war finance.

The foregoing conclusion as to the pressure which these two types of taxes would exert toward conversion of industry has its corollary in the readjustments that would be stimulated by a reduction or postwar removal of either tax. If reduction of the income tax would do most to stimulated savings, the reduction or removal of a general sales tax would provide a greater fillip to production of consumer goods. However, it may be assumed that such a reduction or repeal would occur in a period of need for investment or reinvestment in productive facilities for consumer goods, and this may qualify any conclusions as to the relative advantages of the removal of the two taxes.


Increased income taxation involves the establishment of no new administrative organization if, as we have assumed in the present memorandum, the current Treasury proposals are accepted and a withholding tax is established as part of the tax program. The general sales tax, on the other hand, would be an addition to the Federal revenue system assumed here and would require a substantial administrative organization. It could be integrated with the collection of corporate taxes, selective excise, or payroll taxes, but there would be enough differences among the tax bases to present many new problems for the enforcement agencies. It seems probable that more personnel and a greater expenditure would be necessary to obtain a given amount of additional revenue from the general sales tax than from increased income taxes with an already-established withholding device. If the costs to private business of the operation of the withholding device, the examination of the annual return for each worker, and the administration of refunds to individual workers are included in the consideration, the cost of administering a withholding tax on a broadened base may be greater. Without careful investigation, it cannot be stated which revenue source has the advantage with respect to the present availability of experienced personnel.

Despite the possibility of higher direct collection costs and the need for a larger collection force for a given addition to revenues, there are administrative considerations favoring early introduction of a general sales tax. If it appears that such a tax will almost certainly be needed at some time during the war period, there would be considerable advantage in inaugurating it now and training a staff. This problem of staffing, not in itself decisive, reinforces the related consideration that -- if the principle of flexibility is to be introduced in wartime revenue measures -- there would be a great advantage in inaugurating the general sales tax now at a moderate rate and increasing it promptly as developments require.

Promptness of impact on income receivers is of great importance for an anti-inflationary measure, but there need be no material difference in this respect between increased income taxes and a general sales tax. The withholding device would require some end- of-year adjustment on the ordinary individual income tax return. It may be that in order to avoid temporary inconvenience to many taxpayers, as well as to reduce the volume of refunds, the current collections under an income tax would have to be a slightly smaller percentage of the final liability than under a general sales tax.


In the conduct of this discussion the conclusion is reached that a general sales tax is probably more anti-inflationary and that an income tax withheld at the source is more equitable when the two taxes are compared.

Preference must be determined by the comparative emphasis put on the anti-inflationary and the equity aspect of the question. The inflationary aspect has in itself an equity aspect. If the practical maximum of revenue has been raised from progressive taxes and if inflationary pressure still remains, the use of a sales tax appears necessary, as stated in the conclusion of section II, both from the point of view of equity and from that of economic desirability.


Although this memorandum has treated general excise and sales taxes in generic terms, it may be helpful to indicate briefly the relative merits of two of the various forms: a value-added business excise tax on the one hand, and a general retail sales tax on the other. Other types of general sales taxes such as selective excises and business excises other than the value-added tax, including the turnover tax and the gross income tax, will not be included in this comparison.

The value-added tax which will be discussed here resembles the general turnover tax which is used as one of the main sources of revenue in most European countries. It differs, however, from the turnover tax in that it permits deduction of all costs of materials and some other items in order to avoid multiple taxation and to eliminate a tax advantage afforded by the crude turnover tax to larger integrated business concerns. (Professor Studenski is preparing a special memorandum dealing with technical and administrative details of a general business excise tax of the "value-added" type.) The retail sales tax discussed here is on sales of tangible commodities not for resale of the type well-known through the experience of many American states and some cities.

Because of the difference in tax base, the retail sales tax must have a higher nominal rate than the value-added tax to yield a given revenue. The following table shows the range of rates for each of these taxes. To the degree that either tax is paid out of business profits, the yields of other taxes on business profits and on upper bracket individual incomes would be lower. There is more likelihood that the value-added tax will impinge on profits. Therefore, this qualification would reduce the difference in rates required of these two taxes.

      (National Income $113 billion; Retail Sales $50 billion)

Tax and related assumptions             Rate of tax (percent)
                                        Depreciation   Depreciation
                                        included in    excluded
Value-added tax                         base           from base
_______________                         ____________   _____________

1. No exemptions                        

     a. Prices paid by government on 
        its purchases not affected 
        by tax                               2.6            2.8

     b. Prices paid by government on
        its purchases increased by
        amount of tax /2/                    4.2            4.5

2. Establishments with annual turnover 
   of $20,000 or less exempted

     a. Prices paid by government on 
        its purchases not affected 
        by tax                               3.1            3.3

     b. Prices paid by government on
        its purchases increased by
        amount of tax /2/                    5.3            5.9

Retail Sales Tax                             Rate of Tax (percent)
________________                             _____________________

1. No exemptions                                   6

2. Food exempted /3/                              10

3. Establishments with annual turnover of 
   $20,000 or less exempted                        7
/1/ Without allowing for probably offsetting reductions in the yield of other taxes, particularly corporation and personal net income taxes.

/2/ Tax receipts resulting from tax-induced price increases paid by the Government are not additions to revenue. Therefore, if the assumption is made that prices paid by the Government are increased by the full amount of the tax, the rate must be higher to yield $3 billion than if prices paid by the Government are not affected by the tax.

/3/ Estimate based on exemption of all sales of food stores and eating and drinking establishments so that tax rate is somewhat overstated.


The retail sales tax has a more direct and immediate impact on consumers than the value-added tax, and in this respect it acts as a more immediate brake upon consumption. This fact may make the control of secondary effects more difficult than with a value-added tax. It may lead workers to exert pressure more immediately for wage increases and to do more postponing of debt repayment or to forego more of their savings in order to minimize readjustments in current consumption. The value-added tax, being imposed at all stages and in all branches of the productive process, affects consumers' prices more gradually and thereby avoids the shock effect of the retail sales tax.

Because of its more scattered impact, the value-added tax may be absorbed, initially at least, by increased resistance of management generally to wage demands, or by some contraction of realized business profits, compared with what would occur in the absence of the tax. But if the initial impact of the tax on consumers were less than that of a retail sales tax, the wage-increase demands attributable to the tax would also be less and consumers would have less incentive to forego savings or defer debt repayments. It seems likely that in wartime, frictions would operate over even an extended period to compel somewhat greater absorption of profits by the value- added than the retail sales tax.

Thus it seems that the retail sales tax is more effective as an anti-inflationary device with respect to the immediate impact on consumption, while there probably would be less increase of wages attributable to the tax under a value-added tax. It is difficult to judge whether, weighing both factors, the value-added tax or the sales tax is the more effective on the whole as an anti-inflationary device. The answer will depend largely on the relative weight given to the direct curtailment of consumption and the (indirect) brake on compensating income increases.

From the point of view of price administration the business excise tax presents more difficulties because it affects prices at every stage of the productive process and not at the retail level only. Other unavoidable pressures upon prices are so great, however, that additional difficulties caused in administration of prices by either tax are not of greater significance.


From the point of view of equity to the consumer, the general business excise tax has a definite advantage as compared with the retail sales tax because it is likely that a greater part of the value-added tax will be absorbed by business.

A retail sales tax, on the other hand, has the advantage from the social point of view that with it necessities of life can be exempted more easily. If great complications in tax administration are to be avoided, the exemptions from a value-added tax can be only for certain types or sizes of business; it would be quite difficult to base exemptions on products. From one point of view, this may be an advantage, however. In the enactment of a retail sales tax, it might be somewhat easier for pressure groups to urge exemption for their product, whereas in the interest of yield the number of exemptions should be kept to a minimum. Furthermore, no system of exemptions can really allow escape for "life necessities" and catch "luxuries". Food is a necessity for life but many items of food are luxuries.


Either the value-added tax or the retail sales tax would be new in Federal taxation, although the problems of the retail sales tax are not materially different from those involved in administering many of the present selective excise taxes. The possible difficulty in administering a general business excise tax is substantially reduced by a list in the possession of the Bureau of Internal Revenue which was built upon the administration of the Social Security taxes, giving the names of practically all business concerns.

The costs of administration and size of staff required for either type of tax depend mainly on (a) the number of taxpayers subjected to the tax; (b) the goal of administration in terms of the percentage of legal liabilities that will actually be collected; (c) the legal definition of the base - its complexity or simplicity as an accounting concept; and (d) the extent to which exemptions are allowed.

The value-added tax as proposed in Professor Studenski's memorandum could be collected currently on the basis of a certain percentage of total sales established for each industry for a tentative tax computation. In that case, the initial collection is not substantially different from the collection of a tax on total retail sales. For the larger establishments, however, the filing of annual returns should be required and this implies additional work for the enforcement agency and the taxpayer. If small taxpayers are given the right to claim adjustments when overtaxed on the presumptive basis, this would add to the administrative costs for the Government and to taxpayers' expenses for compliance.

The number of taxpayers under an all-inclusive retail sales tax might go as high as 2.6 million, including nearly 1.8 million retail establishments and some 0.8 million wholesale, manufacturing, service, and professional businesses engaging only incidentally in retail trade. Frequency and intensity audits would, of course, be less for enterprises that are not primarily in the retail field, but some further cost would be involved in verifying that businesses not licensed or registered for retail sales actually do not have taxable sales.

Under an all-inclusive tax on value-added, there would be about 11 million taxpayers. Exemption of all establishments with gross income of $20,000 or less would reduce the number of taxpaying enterprises to about 1 million. Such exemptions would reduce the administrative load very materially, through not in proportion to the numbers exempted, since it would be necessary to verify claims to exemption and the size of the average taxable business would be substantially larger, thereby requiring more staff work for a given number of actual taxpayers.

A tax exemption for small businesses would be much less feasible in the case of a retail sales tax than in the case of a value-added tax, although low exemptions have been allowed in the Indiana and Michigan state taxes. In the case of a retail sales tax the entire tax is imposed on the final stage of the productive process. Exemption for small retail traders might distort the competitive situation in the retail trade and would require a higher rate for a given yield. The value-added tax collected from retail traders as from all types of business would be small in relation to the retail price. (For example, a 3 or 4 percent value-added tax imposed on retail business would probably amount to less than 1 percent of the retail price of products.) If all small businesses and therefore small retail traders were exempted under a value-added tax, the incentive to shift retail trade to smaller units or to divide businesses into small portions would be substantially less than under a retail sales tax. The exemption under the value-added tax would, however, be a factor favorable to small-sized business units in all lines. (Problems involved in a tax-exempt limit under the value-added tax will be discussed in detail in Professor Studenski's report.)

Even if some portion of retail trade under a value-added tax should escape the portion of the tax imposed on the retail trade, the products still would be taxed on their earlier stages of production. Moreover, a tax imposed entirely at the final stage in the productive process is more conducive to tax evasion than a tax which has an equal yield and is spread over all stages of production. This is partly counter-balanced by the fact that the retail sales tax has a simpler base.

Neither in this country nor abroad has there been experience from which a direct comparison might be made of the administrative aspects of retail sales and value-added taxes. Experience of many American states and a few cities over the past decade testifies to the administrative feasibility of a retail sales tax. Collection costs to the governments and compliance costs to the taxpayers appear to be low compared with most other forms of American taxes. Because collections are made at short intervals, delinquencies have not been an important problem even in the depression. An important administrative consideration favoring this type of tax is the fact that approximately half of the states, including some of the largest, have personnel and taxpayers who are experienced in handling retail sales taxes. It would be possible to draw a nucleus of experienced personnel from the states, and a majority of retail establishments would be familiar with the concepts involved in the new tax.

On the other hand, states may be opposed to the use of the general retail sales tax by the Federal Government because they may regard this as an intrusion into their domain.

The general turnover taxes of European countries offer the nearest parallels to the value-added tax. These taxes have demonstrated few administrative difficulties compared with most other taxes in the same countries. Collection and compliance costs, as well as the volume of delinquencies, appear to be low. The favorable European experience with these taxes suggests that a value-added tax would be feasible administratively, particularly since it avoids the enforcement difficulties which are raised for a general turnover tax by variations in the extent to which industrial processes are concentrated within an individual concern.


In the comparison between a retail sales tax and a value-added tax it was not possible to arrive at a clear-cut preference for one of these two forms of business taxes. From the point of view of equity among consumers, the value-added tax appears preferable unless a retail sales tax with exemptions for life necessities is considered. In the latter case, however, the nominal rate on the remaining retail sales must be higher than the rate of a value-added tax yielding the same revenue. Judgment about relative anti- inflationary effects depends on the relative weight given to the direct curtailment of consumption and the indirect effects on wages and other consumer income. Differences of opinion exist with respect to the comparative administrative expediency of the two taxes. Exemption of small business units would be more feasible under the value-added than under the retail sales tax. Experience with state sales taxes provides a nucleus of experienced personnel and has familiarized retail businesses with this type of tax base, but reliance of many states upon such taxes might lead them to oppose its use by the Federal Government. Less consumer resistance may be expected to the value-added than to the retail sales tax, partly because the value-added tax is a "hidden tax."