Economics and The Public Welfare

Chapter 77

War Taxation and Expenditures

Our Best Fiscal Achievement—Taxation. The best achievement of the Government in World War II in war finance and in the functional control of prices was in the field of taxation.

Wholly Congressional Achievement over Administration Opposition. But this was wholly a Congressional achievement, badly delayed by Administration opposition. It was in large degree the work of the Senate Finance Committee, headed by Senator Walter F. George, although the Ways and Means Committee of the House of Representatives also showed intelligence and vigor in the matter. But the great technical skill and the great fiscal courage were in the Senate Finance Committee. The Administration and the Treasury from the beginning were wholly unrealistic about taxation. They were unwilling to tax the masses of the people, where the bulk of the income was. But they were willing enough to have rates increased in the high income tax brackets where taxation had already passed the point of diminishing returns.

Treasury Discredited. The Treasury itself was rather thoroughly discredited in the eyes of the Congress in the course of the tax legislation, the financial committees of the Congress in time disregarded the Secretary of the Treasury, and the Congress passed its own laws with little concern for his recommendations.

Increases in our national defense expenditures came in the fiscal year 1939. We began real expenditures for national defense after Germany invaded Denmark and Norway on April 9, 1940. In fact the President had declared a partial emergency and ordered an increase in army strength as early as September of 1939. But the tax measures proposed by the Treasury in the summer of 1941 were unrealistic. The Treasury was still trying to get its main revenue out of the small part of national income that came from property ownership and business enterprise, which was already very heavily taxed, and from large salaries, already heavily overtaxed, where taking all that was left would give the Government very little money. There was very little left to be taken by taxation of large incomes.

Eighty Percent of National Income Received by Those Getting Less than $5,000. There was, moreover, evidence enough that the great bulk of the income of the country was received by people having small incomes. A total of 69.10% of all income was received by families and individuals of $3,000 and less, and over 80% of the total income of the country was received by individuals and families with incomes of $5,000 and less. Over 90% of the total income was received by individuals and families with incomes 1 of less than $15,000.

Moreover there was evidence enough that the most rapidly increasing incomes were the incomes of workers. The following table, taken from the Conference Board Economic Record published by the National Industrial Conference Board on July 11, 1941, shows how rapidly these incomes were increasing.

Index Numbers for Payrolls* (Base 1929)
1929	100
1936	77
1937	92.8
1938	71
1939	83
1940: January	90.4
December	110.0
1941: January	109.3
April	122.1
May	128.5

* Ibid., p. 597.

But as Late as October, 1942, Treasury Still Trying to Get Main Revenue from Large Incomes. The Congress was ready to tax and would have applied vigorous taxation had there been any Administration support. The Administration made the reluctant concession in 1941 that exemptions for individuals might be reduced to $750, and that exemptions for married couples without dependents might be lowered to $1500.

As late as September and October of 1942 the Treasury was still fencing, and proposing a “spending tax,” which turned out to be simply an additional tax on the existing body of income tax payers. This was proposed before the Senate Finance Committee on September 3, 1942, by Secretary Morgenthau and General Counselor for the Treasury, Randolph Paul.2 Mr. Paul renewed the proposal on October 7, 1942, in an address before the American Statistical Association in New York.3

Congress Takes Control After Election of 1942—Small Incomes Taxed. Following the Congressional election in 1942, with the strong increase in conservative forces in the Congress which this election brought, the Congress felt strong enough to pass its own tax legislation. The following table will show how slow we were, while preparing for and fighting a great war, in applying real taxation to the smaller incomes.

Federal Income Tax Rates on Small Incomes, 1939-1946
Single or Married Man with no Dependents
Calendar year	Income $1,000-$1,025		Income $1,500-$1,525		Income $2,000-$2,025
	Single	Married	Single	Married	Single	Married
1939	$0.00	$0.00	$14.45	$0.00	$32.45	$0.00
1940	4.90	0.00	24.70	0.00	44.50	0.00
1941	20.00	0.00	63.00	1.00	106.00	39.00
1942 *	80.00	0.00	167.00	34.00	253.00	120.00
1943	80.00	0.00	167.00	34.00	253.00	120.00
1944	95.00	12.00	198.00	98.00	302.00	202.00
1945	95.00	12.00	198.00	98.00	302.00	202.00
1946	78.00	0.00	164.00	69.00	249.00	154.00

* 1942 tax was forgiven, but 25% of the tax was added to the 1943 tax (except that if the 1942 tax was the greater, it became the 1943 tax with 25% of the originally computed 1943 tax added).

First Impressive Taxation in Fiscal Year 1944. The Revenue Act of 1940 (adopted July 25, 1940) made slight increases in the surtax of the higher brackets (individuals), and the second Revenue Act of 1940 (October 8, 1940) provided for an excess profits tax for corporations. These two Acts together, accompanied by the rising volume of national income, made a modest increase in the revenues for the fiscal year 1941 as compared with the fiscal year 1940. But the effort was inadequate. The fiscal year 1942 brought a real increase in revenues but no adequate increase, and the same was true for the fiscal year 1943. It was not until the fiscal year 1944 that our tax figures look impressive. The deficit of the fiscal year 1943, $55,897,000,000 was the largest deficit of the whole war period. The following table gives the story of war taxation and war deficits, with the perspective of figures running back to the fiscal year 1916. The reader will note that certain captions are changed at the end of the fiscal year 1941.

United States Treasury Receipts, Expenditures, and Surplus or Deficit (Fiscal Years Ending June 30) (in millions of dollars)
Year	Total Receipts	Total Expenditures	Excess of Receipts (+) or Expenditures (-)	National Defense Expenditures	Interest on Debt
1916	783	734	+ 48	337	23
1919	5,152	18,515	- 13,363	11,011	619
1920	6,695	6,403	+ 291	2,358	1,020
1923	4,007	3,295	+ 713	730	1,056
1929	4,033	3,299	+ 734	791	678
1931	3,190	3,652	- 462	832	612
1932	2,006	4,535	- 2,529	753	599
1933	2,080	3,864	- 1,784	680	689
1939	5,668	8,707	- 3,542	1,206	941
1940	5,925	8,998	- 3,611	1,657	1,041
1941	8,269	12,711	- 5,103	6,301	1,111
		Total Budget Expenditures	Deficit	War Activities
1942	13,668	32,397	19,598	26,011	1,260
1943	23,385	78,179	55,897	72,109	1,808
1944	45,408	93,744	49,595	87,039	2,609
1945	47,740	100,405	53,948	90,029	3,617
1946	44,239	65,019	21,981	48,542	4,722

Current Collection of Income Taxes. Of special significance in our war tax programme was the Current Tax Payment Act of 1943, adopted June 9, 1943. This Act, putting taxes on a current basis, was accompanied by withholding taxes on individuals.

It is not certain who originated this tax plan. Beardsley Ruml, Treasurer of R. H. Macy and Company, and Chairman of the Federal Reserve Bank of New York, first offered the proposal to the Senate Finance Committee 4 on July 27, 1942. In informal interviews with the press, Ruml claimed no originality for his plan and said it had been talked about by many others. Ruml is, however, entitled to large credit for the active and effective campaign he made for the measure. The Treasury opposed the plan because it involved forgiving one year’s taxes. Obviously a taxpayer could not be expected to pay two years’ taxes in one year, particularly if he were in the upper brackets where his tax might run 85% to 90% of his income or more. The advantage to the Government of collecting currently the taxes on a rapidly growing national income in wartime was obviously very great, and part of the sharp increase in the revenues of the fiscal year 1944 as compared with the fiscal year 1943 is doubtless due to this factor.5 The Treasury held the view that if a year’s taxes were forgiven, it would be giving up “assets.” But the Treasury did not carry these as yet uncollected taxes as “assets” on its books. The Treasury does not expect to be liquidated. If it had to be liquidated, matching existing assets against existing liabilities, it would, of course, be hopelessly insolvent. The Treasury’s continued solvency rests on future taxes as compared with future outgo.

The immediate effect of current collection was a big increase in revenue. Over the future years as old men die, the Treasury loses the income taxes which it might otherwise collect from their widows, and as old men lose their jobs, it loses the income taxes which it might otherwise collect on their last year’s incomes. On the other hand, as younger men begin to have large earnings, the Treasury begins to get large revenue from them a year earlier than would otherwise be the case. The Treasury, viewed as a long-time going concern, has no grievance, and the Treasury, financing a great war, had an immediate great gain.

The advantage to the taxpayer of having his income taxes stopped when he lost his income, and to the taxpayer’s widow of not having to use her insurance money to pay taxes on her husband’s last year’s income when he died, was obviously very great.

A further point in favor of the measure 6 was the advantage of current collection of taxes as an anti-inflation measure. The German Government, in the great inflation, 1919-1923, was quite helpless because it relied so largely on income taxes assessed on the incomes of the preceding year. The French Government, with a much less scientific tax system, in its great inflation of the early 1920’s, was greatly helped by the fact that its indirect taxes and its revenues from fiscal monopolies came in currently, and their volume increased currently as the franc fell and prices and governmental expenses rose. This has been discussed in earlier chapters dealing with Germany and France. Putting taxes on a current basis is a vitally necessary, even though inadequate, safeguard against both wartime and postwar inflation.

The Congressional proponents of this measure were obliged to compromise with the Treasury and the President regarding the forgiving of one year’s taxes. The compromise finally was that three-fourths of one year’s taxes would be forgiven, and the year’s taxes that should be forgiven were to be either those of 1942 or of 1943, whichever proved most advantageous to the Treasury. The provision was further made that payment of the 25% of taxes not forgiven should be divided between two years, meaning that 12 of the unforgiven tax was paid in each of two years.

Rates in Calendar Year, 1944
Amount of surtax net income	Rate—%	Total surtax
$0-$2,000	20	$400
2,000-4,000	22	840
4,000-6,000	26	1,360
6,000-8,000	30	1,960
8,000-10,000	34	2,640
10,000-12,000	38	3,400
12,000-14,000	43	4,260
14,000-16,000	47	5,200
16,000-18,000	50	6,200
18,000-20,000	53	7,260
20,000-22,000	56	8,380
22,000-26,000	59	10,740
26,000-32,000	62	14,460
32,000-38,000	65	18,360
38,000-44,000	69	22,500
44,000-50,000	72	26,820
50,000-60,000	75	34,320
60,000-70,000	78	42,120
70,000-80,000	81	50,220
80,000-90,000	84	58,620
90,000-100,000	87	67,320
100,000-150,000	89	111,820
150,000-200,000	90	156,820
Over 200,000	91

For incomes in the lower brackets, this was reasonable enough. For incomes in the highest brackets, it meant that more than 100% of the current income was paid, in a number of cases. It meant in these cases that the income tax actually was in part a tax on capital after taking all of the income.

Taxes on Larger Incomes. In a preceding table we have seen what this war tax legislation did to very small incomes. On larger incomes, the tax rates, applicable to current incomes for the calendar year, 1944, imposed tremendous burdens, not merely on incomes of $100,000 or more, but even on incomes as low as $16,000. During the war the man with a $16,000 income had no legitimate complaint. But the taxpayers have a right to demand, on behalf of the economic future of the country, a drastic curtailment of postwar expenditures, and a drastic reduction of taxes in all the brackets.

The normal tax for the calendar year, 1944, was placed at 3% for all single men with incomes as much as $500, and the surtax rate, beginning at $500, was placed at 20%. The table on page 535 shows the surtaxes on incomes of single men above $500.

To the surtax rates in this table should be added the 3% normal tax, beginning for single men at $500.

Corporation and Other Taxes. Total revenues, as indicated in our table above for the fiscal year ending June 30, 1945, were $47,740,000,000. Of this, internal revenue collections, as reported, account for $43,800,000,000, divided as follows:

Internal Revenue Collections, Fiscal Year 1945 * (In thousands)
Corporation Income Taxes			Individual Income Taxes	Miscellaneous Internal Revenue Taxes	Employment Taxes, including Carriers Taxes	Total Collections
Normal and Surtaxes	Excess Profits Taxes	Unjust Enrichment Taxes
$4,879,715	$11,147,317	$180	$19,034,313	$6,959,634	$1,779,177	$43,800,338

* I have taken these figures from the Washington Close-Up, issued by the Citizens National Commitee, Inc., for the month of August, 1946, p. 7. They give as their source, the Annual Report of the Secretary of the Treasury for the fiscal year ending June 30, 1945. These figures are more comprehensive than the figures for internal revenue collections given in the August, 1946, Federal Reserve Bulletin, p. 907, which account for a total of only $35,062,000,000.

The “miscellaneous” internal revenue has, as it largest single items,7 the tax on alcoholic beverages, amounting to $2,310,000,000; the tobacco taxes, amounting to $932,000,000; and the manufacturers’ and retailers’ excise taxes, amounting to $1,207,000,000.

Of the individual income taxes for 1945, $10,263,000,000 came from the withholding tax and $8,567,000,000 from the current tax payments. (These two figures for individual income taxes do not quite aggregate the $19,034,000,000 given in our table above.)

The effect of war taxes, as compared with prewar taxes, on corporation profits appears in the following table taken from Washington Close-Up of July, 1946, which in turn has taken it from the Survey of Current Business, April, 1946.

Corporation Profits Before and After Taxes, (1929-1945)
Year	Profits in millions of dollars
	Before taxes	After taxes	Percentage of reduction due to taxes
1929	9,770	8,337	- 15
1930	3,225	2,348	- 27
1931	- 846	- 1,365	- 61
1932	- 3,100	- 3,489	- 13
1933	99	- 444	- 548
1934	1,640	866	- 47
1935	3,141	2,188	- 30
1936	5,597	4,150	- 26
1937	6,126	4,575	- 25
1938	3,151	2,069	- 34
1939	6,374	4,868	- 24
1940	9,185	6,248	- 32
1941	17,050	9,141	- 46
1942	20,969	9,179	- 56
1943	24,908	9,945	- 60
1944	24,077	9,757	- 59
1945	20,875	9,080	- 57

Postwar Tax Rates in Revenue Act of 1945. The Revenue Act of 1945, passed in November after the war was over, repealed the excess profits tax on corporations, though leaving the benefits of past excess profits taxes paid as offsets to future losses.

It reduced the individual surtax rates shown above by 3%. It then reduced the total of individual normal tax and surtax as thus computed by 5%. Taxes for 1946 remained appallingly high, and remained so high in brackets above $16,000 that they greatly inhibited the employment of venture capital, except for the very inadequate mitigating circumstance that capital gains on assets held over six months were taxed only at the rate of 25%.

Vast Postwar Spending. Meanwhile, despite the high rates and the enormous revenues which continued in 1946, Government expenditures continued on so high a level that budget balancing could not confidently be predicted.

Civil Service—Harry Byrd. For one thing, despite the heroic efforts of Senator Harry F. Byrd and his Joint Committee on Reduction of Nonessential Federal Expenditures, the Federal executive employees, apart from those in the War and Navy Departments, show a net increase of 205,535 between June of 1945 and June of 1946. The Navy Department and the War Department decreased their civilian employees radically during that same period, but we had at the end of June, 1946, a civil service of 2,748,545. Abolishment of some war agencies and cutbacks in others, meant merely that many of the “displaced persons” went as refugees to other agencies apart from the War Department and Navy Department.8

Congressional action in the Pay Act of 1945, designed to reduce the Civil Service, proved entirely inadequate and was supplemented by the Pay Act of 1946. Both of these acts set personnel ceilings, and the second placed definite numerical limitations on the number of classified employees in most departments and agencies, with penalties for violations of the law. Senator Byrd was quoted as saying that “responsible government officials have professed that these provisions are ‘just a gesture on the part of Congress.’ It is my intention to see that future violators find that flouting the laws of Congress is a gesture involving penalties.”

But the whole disposition of the Federal Government, money-drunk after living on the proceeds of bank expansion for thirteen years, was to spend, spend, spend.

It is interesting to contrast the figures above for Civil Service before, during and after World War I, and the years following 1929, with the present war and postwar figures.

Employees in Federal Executive Civil Service, Including War and Navy Departments
1916
June 30	480,327
1918
November 11 (Armistice)	917,760
1920	691,116
1921
July 31	562,252
1923	515,772
1929	559,579
1932	583,196
1934	673,095
1936	824,259
1938
December 31	861,914
1939
June 30	920,310
December 31	932,305
1940
June 30	1,002,820
December 31	1,119,641
1945
June 30	3,543,326
1946
June 30	2,748,545

Perspective host. But the spending ran far beyond the salaries for the enormously multiplied Federal civil servants. Perspective had been lost. We had been urged to adopt the Bretton Woods programme because it would cost us only what the war was costing us in a very short period of time, and the argument had great weight. We were pouring out vast sums to our veterans whom we love and cherish, but who are so very numerous, and who are so much an integral part of the country, that unless they themselves learn to think of themselves as citizens first rather than as a special class, they can easily wreck the finances of the country, ruining the dollar and bringing disaster upon themselves and their loved ones. We were entertaining gigantic proposals for further great taxes and further great expenditures for “social security” when there can be no social security in a country whose finances and currency are wrecked. We were paying out vast sums for unemployment relief in a tight labor market when employment was very easy to get. We had lost perspective.

• 1This point will be discussed at length in Chap. 34.
• 2I have not been able to find that this article was ever published. However, the reader will find much of it in two books by Veblen: Imperial Germany and the Industrial Revolution, New York, 1915; and The Nature of Peace and the Terms of Its Perpetuation, New York, 1917.
• 3See my book The Effects of the War on Money, Credit and Banking in France and the United States, published by the Carnegie Endowment for International Peace, Oxford University Press, New York, 1919. For London, see the interesting articles by Mr. J. M. Keynes in the British Economic Journal in late 1914.
• 4O. M. W. Sprague: “Crisis of 1914 in the United States,” American Economic Review, September, 1915; H. G. S. Noble: “The New York Stock Exchange in the Crisis of 1914,” Garden City, N. Y., Country Life Press, 1915. These two papers are classics of permanent value.
• 5The figures of all the State and National banks and trust companies appear only once a year in the Comptroller’s report as of approximately June 30. For dates other than June 30, it is necessary to make estimates. During the war period these estimates are made on the basis of variation in the National Bank figures.
• 6War Industries Board Price Bulletin No. 3, Government Control Over Prices, by Paul Willard Garrett, assisted by Isador Lubin and Stella Stewart, Washington, Government Printing Office, 1920, p. 550.
• 7Mr. Herbert Hoover, in particular, did a superb job in bringing the grain and milling interests into the service of the country. I shall later find occasion to criticize his policies as President, but I wish to pay high tribute to his work in feeding the Belgians before we entered the war, to his work in food control at home during the war, to his postwar work in feeding stricken countries, and to his work under President Truman along similar lines after World War II.
• 8See my “Value and Price Theory in Relation to Price-fixing and War Finance,” an address before the American Economic Association, printed in papers and proceedings, American Economic Review Supplement, March, 1918. Reprinted in the Economic Bulletin issued by the Capital Research Company of Los Angeles, Vol. II, No. 2, Dec. 6, 1940, and reprinted in the hearings of the Senate Committee on Banking and Currency on the Price Control Bill Dec. 16, 1941. See also my testimony of Dec. 16, 1941, before this Committee.