1942: Taxation

War Finance.

The problems of war finance are more urgent and more complex and far-reaching than those encountered in any peacetime emergency. Wars are costly experiences in immediate money outlays as well as in terms of the manifold dislocations that they bring about in the economy of a nation. A major war, with its heavy drain on the public purse, is invariably accompanied by abnormally high taxes, extensive borrowing operations, and rising prices. While the national income increases and the exceptional scale of financial operations conveys the impression of prosperity, there is a radical reduction in the employment of men and the use of materials, and a tremendous sacrifice of the arts of peace in order to forge the sinews of war.

Although the United States has been involved in the present world conflict for little more than a year, it has already passed through a series of economic and financial experiences unprecedented in its history. All previous world records in income, in spending, and in borrowing were broken in the year 1942 as the United States became engulfed in the momentum of an all out war. For the first time in history the national income exceeded $115,000,000,000 or almost one-third again as much as the income reported for the peak year of 1929. Federal expenditures approximated $56,000,000,000, net receipts in federal-taxes were $15,000,000,000 (or about double the revenue collected in the preceding year), and the national debt soared to $112,000,000,000. The Victory loan campaign in December 1942 was the most spectacular financing operation in the history of governments resulting, in one month, in bond sales of almost $13,000,000,000.

War expenditures exceeding $50,000,000,000 during 1942 not only outstripped the costs of previous wars but represented an amount equivalent to the combined direct costs of all past wars in which the United States has been engaged since the year 1789. The tempo and magnitude of modern warfare has rapidly stepped up the rate of expenditure for planes, ships, guns, tanks, munitions, and supplies until, in the closing days of 1942, spendings for war purposes alone exceeded $6,000,000,000 per month. Meanwhile Congress approved appropriation bills for financing the war effort at a rate faster than the money could be spent. At the close of the fiscal year 1942, it was estimated that cumulative appropriations and contract authorizations for carrying on the war program were already in excess of $200,000,000,000. Additional appropriation bills added billions more to this total. Actual spending by government departments lagged behind the sums placed at their disposal with the result that by December 1942 approximately $170,000,000,000 remained as unexpended balances in authorized funds.

In view of the staggering costs of the war, an effort was made to reduce non-essential federal expenditures. Toward this end, over $300,000,000,000 were saved by abolishing the CCC and eliminating non-defense activities of the NYA, more than $500,000,000 was whittled off WPA appropriations and another $500,000,000 reduction was made through the curtailment or deferment of various projects, particularly in the Department of Agriculture and the Department of Interior. However, despite these economics, total expenditures for functions not classified as war activities amounted to almost $6,000,000,000.

Federal Revenues.

Revenues to meet these costs continued to be woefully inadequate. Net receipts for the fiscal year 1942 were $13,000,000,000, while for the first six months of fiscal 1943 they amounted to $7,000,000,000, bringing the average for the calendar year to approximately $15,000,000,000. More than half of these sums came from income taxes on individuals and corporations. Miscellaneous internal revenues derived from excises, estate and gift taxes, and the social security taxes, accounted for most of the remainder. As was to be expected, customs duties and Panama Canal tolls declined. Although total revenues reached an all-time high, they fell far short of expenditures, resulting in an addition of $54,000,000,000 to the gross public debt.

Revenue Act of 1942.

In order to meet these increased costs, the Revenue Act of 1942, estimated to yield from $7,000,000,000 to $9,000,000,000 in new revenues, was passed. Out of this total yield, provision was made for a refund of $1,700,000,000 in the form of credits against other taxes during the war, or to be repaid after the war. Personal exemptions in the income tax were cut from $1,500 to $1,200 for married couples and from $750 to $500 for single persons. Credits for dependents were reduced from $400 to $350. No changes were made in allowances for earned income credit. Normal income tax rates were increased from 4 to 6 per cent. Surtaxes, previously ranging from 6 to 77 per cent were increased to range from 13 to 82 per cent, and at a steeper rate of progression in the middle income brackets. Gains and losses from capital assets are taxed as ordinary income, except that long term gains and losses (on assets held longer than six months) are taken into account to the extent of only 50 per cent. Capital losses in excess of gains are allowed a maximum deduction of $1,000 from other income. However, provision is made for a carry-over of losses for five years against all capital gains and against ordinary income to the extent of $1,000 in each of such five years.

Victory Tax.

A new 5 per cent Victory Tax was imposed, as part of the new revenue act, on gross income (excluding capital gains) in excess of $624 a year. This tax is collected at source from wages and salaries. Employers deduct it from the pay of employees and remit the tax to the Government on a quarterly basis. Other income is reported in filing a tax return the following year. Post-war refunds of 25 per cent (maximum $500) of the tax are allowable to single persons, and of 40 per cent (maximum $1,000) to married persons. Taxpayers are given the alternative of taking this credit annually against Federal taxes paid, to the extent that they buy bonds, pay debts, or meet life insurance premiums in these amounts. If the credit is not used that way, it will be converted into a non-interest bearing bond to be repaid after the war. This is the first example of a pay-as-you-go income tax in the American tax system. The sweep of sentiment in favor of this method of collection is brought about by the unprecedented tax burdens and the fear of widespread defaults under the older system of making quarterly tax payments against earnings of the previous year.

As a result of these changes, it is estimated that some 50,000,000 individuals will be paying personal income taxes in 1943 compared with 17,000,000 who were previously liable.

Corporation Tax.

Normal tax rates on corporations were unchanged but surtax rates on the larger corporations were raised to 16 per cent, resulting in an effective increase in combined normal and surtaxes on net incomes over $50,000 from 31 to 40 per cent. Excess profits taxes were raised to a flat 90 per cent tax from the previous graduated scale of 35 — 60 per cent. However an over-all tax ceiling of 80 per cent of net income was voted. Corporations are also allowed a post-war credit equal to 10 per cent of their excess profits taxes, payable in non-interest bearing bonds.

Estate and Gift Taxes.

Estate and gift tax rates were left unchanged but basic exemptions were altered. Former estate tax exemptions of $40,000 plus an additional exclusion of $40,000 of insurance, were replaced by a flat specific deduction of $60,000. Gift tax exclusions were lowered from $4,000 per donee to $3,000 and cumulative lifetime exemptions, from $40,000 to $30,000.

Excise Duties.

Heavier excise duties were placed on a long list of articles and services. Taxes were increased on liquors, beer, wines, cigarettes, tobacco, photographic supplies, lubricating oils, telephone and telegraph services, and on train, plane, and bus fares.

It was calculated that with these new revenue measures federal tax collections in 1943 should reach the record breaking rate of $25,000,000,000 to $30,000,000,000 a year. However, 1943 expenditures will probably go to the $80,000,000,000 level. This ever-widening gap between anticipated revenues and expenditures will bring about a further rise in the federal debt. It is freely predicted that even with increased taxation, the public debt will, in another two years exceed $200,000,000,000.

Wartime Fiscal Policy.

However, wartime fiscal policy is concerned with more than raising money, either through taxes or the sale of bonds for financing the war. It seeks to distribute the sacrifices of war in the fairest possible manner while at the same time preserving the vigor of the economy for the prosecution of the war and insuring an orderly post-war period. Among other things, this involves an attack upon the problem of inflation. The real cost of war is not measured in terms of money. It consists of the labor, the resources and equipment used in the production of the instruments of war. This diversion of effort restricts the supply of goods and services ordinarily bought by civilians. Meanwhile, huge government spending for these goods and services causes a great expansion in the flow of income to the consuming public. As money income rises while stocks of available consumers goods decline, the nation is confronted with steadily rising prices and the threat of inflation. Unless this excess spending power is siphoned off, it will result in an upward spiral in prices which will endanger living standards and disorganize the economic process. High taxation in wartime has the effect of discouraging increases in the prices of goods and thus indirectly helps in keeping down the costs of the war. At the same time that it provides revenue to the government, it serves as an instrument to relieve the pressure of consumer spending. The sale of war bonds and stamps to the general public also results in drawing off some of these surplus funds. Fiscal policy is therefore directed during the war toward the reduction in demand for consumer goods, either through the requisitioning of buying power, by means of taxation, or through the encouragement of savings.

Wartime Inflation.

Wartime inflation was already well under way early in 1942. Price indexes stood at levels substantially higher than the year before, and in spite of efforts to establish price ceilings, living costs continued to rise. The OPA estimated that excess purchasing power would amount to approximately $17,000,000,000. The enactment of the new tax measure and the campaigns to sell war bonds, including the formation of voluntary bond purchase 'minute-man' clubs, were directed, in part, to the reduction of surplus spending power. However, at the close of the year prices were still rising and the inflationary gap between spendable income and volume of goods and services available continued to be larger than ever. The Treasury Department calculated that still higher taxes and extensive borrowing, possibly through the medium of compulsory loans, would be necessary to check inflation.

State and Local Finance.

The war produced varied effects upon state and local finances. The inflationary tendencies in prices and incomes was accompanied, in most states, by increased collections from income taxes, general sales taxes and selective commodity taxes such as tobacco and liquor excises. On the other hand, the rationing of gasoline and rubber and the restriction of the use of automobiles resulted in declines in revenue among those states that had relied heavily upon gasoline and motor vehicle taxes. Improved tax collections in some states gave rise to sizable surpluses with resulting demands for tax reductions as an offset to rising federal tax burdens. Few important changes were made in the tax laws. Louisiana introduced a new sales and use tax of one per cent imposed on all sales at retail and on the consumption, distribution, and storage of tangible personal property. Rhode Island enacted a bank tax, a new gift tax, and a tax upon unincorporated business. Massachusetts imposed a surtax on all legacy and succession taxes, to be used for old age assistance. Numerous changes were effected in tax rates. The most important reduction was in New York, where personal income taxes were cut 25 per cent.

In general, local finances showed signs of improvement during 1942. Except in those communities where the impact of the war caused a serious exodus of population or a shut-down in industrial plants, property tax collections rose and there was a noticeable drop in delinquencies. Several cities reported the best collection experience on record. However, serious problems have developed in some communities either because of increased local costs due to the influx of war workers and the demand for local services, or because of the narrowing of the tax base through the decline in local business, or the establishment of large members of tax exempt defense housing projects, federal military zones and camps, hospitals, shipyards, and war industries plants. Another problem arises from the fact that constitutional and statutory limits upon tax rates threaten to become severely restrictive as inflation results in further rises in costs of materials and services. Meanwhile, aggregate state and local revenues and expenditures remained at a rather constant level of from $9,000,000,000 to $10,000,000,000. Education continued at the head of the list of state and local costs, followed, in order of financial importance, by highways, welfare, health and sanitation, and protective services.

United States Taxation Compared With That of Allied Nations.

As the United States plays its role as the 'arsenal of democracy,' some interest naturally focuses upon the question of relative burdens of taxation among the Allied powers. Comparison is difficult, because of differences in price levels, living costs, methods of accounting, and inadequacy of data. However, according to the most reliable reports, Great Britain spent in the fiscal year 1942 $16,000,000,000 toward paying for the war, or 55 per cent of her national income, Canada, $2,200,000,000, or 40 per cent of the national income. Australia was reported to be appropriating 50 per cent of national income for defense, while in New Zealand the 1942 budget called for war expenditures of £133,000,000 out of a total national income of only £220,000,000 — roughly 60 per cent. In the United States, war costs in 1942 were about $50,000,000,000, or 43 per cent of the national income.

In absolute amounts, the United States is unquestionably spending more for the conduct of the war than any other nation in the world. Because of the higher levels of wealth and income of its people, these expenditures have thus far probably involved less sacrifice and privation than that encountered in other lands. However, as the war program is still further accelerated and the American people are called upon to equip our fighting forces and those of the Allies with a steady stream of matériel and supplies, the full burdens of the war will be realized. In his budget message in January 1943, President Roosevelt outlined some of the demands that would be made of the American citizen during the 1944 fiscal year. His 'maximum program for total war' called for a budget of $109,000,000,000, taxes and enforced savings of $50,000,000,000, and a public debt of $210,000,000,000. These enormous sums dwarf, by comparison, the estimated 1944 war budgets of $21,000,000,000 for Great Britain, $15,000,000,000 for Russia and $3,500,000,000 for Canada.