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.

1941: Taxation

Federal Taxation.

Expenditures.

All previous records of public expenditure were destined to be shattered as Congressional appropriations, contract authorizations and Reconstruction Finance Corporation commitments reached a total of $74,440,000,000 in authorized war funds. While such authorizations were not immediately reflected in disbursements of similar size they represented an unmistakable trend toward significantly higher levels of expenditure. Month after month, as the machinery for spending was shifted into higher gear, average daily Treasury payments continued to mount. The effort of the nation to adjust itself to a vast Federal spending program of such astronomical proportions requires a period of time, and the full effect of this Congressional action will not be felt before 1943.

For the 1941 fiscal year ending June 30, 1941, total expenditures were $12,775,000,000, or over $3,000,000,000 greater than the level of expenditures in the previous fiscal year. The increases of approximately $4,500,000,000 in national defense costs and of $70,000,000 in higher interest charges on the public debt more than account for this rise. The War Department, alone, spent almost $3,000,000,000 more than in the 1940 fiscal year. The Navy Department accounted for a further rise of $1,250,000,000. The balance of increased defense funds went for selective service expenses, emergency ship construction, national defense housing, lend-lease defense aid, and miscellaneous defense funds allocated to the President. Substantial reductions in disbursements by the PWA, the WPA, and by various administrative agencies related to agriculture, coupled with the increases in credits from several revolving funds helped to pare this broad expansion in costs.

Expenditures in the first half of the 1942 fiscal year almost equaled the total payments for the entire fiscal year of 1941. By Dec. 31, 1941, a six-month record disbursement of $11,553,000,000 had been made, of which more than $8,000,000,000 was for national defense and lend-lease aid.

Revenues.

Revenues in the 1941-42 fiscal years rose rapidly. In the year ending June 30, 1941, net receipts stood at $7,607,000,000 against $5,925,000,000 in the previous fiscal year. For the first half of the 1942 fiscal year net revenues were $4,166,000,000 or approximately $1,500,000,000 higher than in the corresponding period of the 1941 fiscal year. Important changes that had been made in income tax structure during 1940, combined with the fact that there was a noticeable rise in the level of national income, were chiefly responsible for these increased receipts. The balance of the additional revenue was derived largely from the higher excise tax rates that were imposed upon liquor, tobacco and miscellaneous manufactured goods. Total income taxes (on individuals and corporations) produced almost $3,500,000,000 during the 1941 fiscal year, and miscellaneous internal revenues. including excises, estate and gift taxes accounted for approximately $3,000,000,000 more. Social security taxes amounted to $788,000,000 and customs duties were $392,000,000. Miscellaneous receipts consisting of tolls and seignorage, interest income, and special taxes made up the balance.

Changes In Income Tax Rates.

Despite the significant increases in tax receipts, expenditures continued to exceed revenues by substantial margins. To the cumulative deficit of the preceding decade there was added a $5,000,000,000 excess of expenditures in 1941 and a further deficit of $7,333,000,000 in the first six months of the 1942 fiscal year. This brought the gross public debt of the Federal Government to $58,000,000,000 by Dec. 31, 1941.

The Revenue Act of 1941 was prepared with the avowed purpose of raising from $3,000,000,000 to $3,500,000,000 in new revenues for financing the defense program. The new law, amending the Internal Revenue Code, lowered personal exemptions, provided for an increase in income tax rates, both individual and corporate, and extended the surtax to apply to all incomes. It also imposed higher excess profits taxes, capital stock taxes, and estate and gift taxes, raised existing excise tax rates and introduced many new excises.

The personal exemption in the case of married persons was reduced from $2,000 to $1,500 and for single persons from $800 to $750. By thus broadening the base and requiring that every citizen or resident with gross incomes equal to or greater than these amounts must file a return, whether or not a tax is payable, the law automatically paved the way for a record-breaking number of returns of probably more than 22,000,000 individuals.

To simplify the collection of the tax, two revised forms of returns were provided. The one, applicable to all persons whose gross income is more than $3,000, is similar to income tax forms previously in use. The other, optional for those with incomes of $3,000 or less which were derived only from salaries, wages and compensation for personal services, dividends, interest, rent, annuities or royalties, permits simplified computation of taxes based upon a rate schedule applicable to gross income. By referring to this table the taxpayer may determine his tax liability with a minimum of calculation and listing of details. On this simplified form tax burdens for single persons range from $1 to $197 for incomes between $750 to $3,000 respectively, and for married persons from $1 to $123 on incomes from $1,500 to $3,000.

The normal tax of 4 per cent on all taxable income remained unchanged. However, the graduated surtax which formerly applied to taxable income in excess of $4,000 was made to apply to the first dollar of income in excess of personal exemptions and credits. Surtax rates in the new act were graduated from 6 per cent on the first $2,000 taxable income to 77 per cent of income in excess of $5,000,000.

Changes in Corporation Tax Rates.

The rates of tax applicable to corporations were graduated from 15 to 19 per cent for corporations having net income of $25,000 or less, and were fixed at 24 per cent for companies with net income above $25,000. In addition, surtaxes of 6 per cent on corporate income up to $25,000 plus 7 per cent of the excess over $25,000 were imposed. The capital stock tax was raised from $1.10 to $1.25 for each $1,000 of adjusted declared value of capital stock. Excess profits tax rates were raised to range from 35 per cent (on excess profits net income up to $20,000), to 60 per cent on amounts over $500,000. A reduction was also made in the credits against the tax allowable under the law. The basic estate tax rates were allowed to remain unchanged but slight increases in rates were made in the additional estate taxes and in the gift tax rate structure. New excise taxes on sales, facilities, occupations and use were added over a broad range of goods and services including: manufacturer's excises of 10 per cent upon business and store machines, commercial washing machines, electric gas and oil appliances, and optical equipment; retailer's excises of 10 per cent upon furs, jewelry and toilet preparations, and a variety of imposts on transportation services, amusements, motor vehicles and boats. Existing rates on admissions, playing cards, alcoholic beverages, tires and tubes, automobiles, refrigerators, radios were increased.

State and Local Taxation.

Education continued to be the largest single item of state and local cost, followed by highways, welfare, health and sanitation and police and fire protective services, in order of financial importance. No substantial changes occurred in the costs of these services and state and local expenditures remained at approximately the $10,000,000,000 level. Modest increases were seen in tax collections, however, resulting in some reductions in deficit financing. This tended to encourage demands voiced in a considerable number of localities that the tax burdens be pared in view of higher Federal taxes. State collections for 1941 amounted to more than $4,000,000,000 compared with $3,877,000,000 in 1940, while local collections were estimated at $4,790,000,000 against a 1940 total of $4,661,000,000. Property taxes supplied the bulk of local revenues, accounting for approximately $4,500,000,000. This source was supplemented by general and selective sales and use taxes, income, motor vehicle taxes, and local administrative charges. State revenues were drawn primarily from gasoline and general sales taxes, and from income, payroll, motor vehicle, property and alcoholic beverage taxes. Utility and franchise taxes, inheritance taxes and miscellaneous excises supplied additional state revenues. During the year a few states adopted new taxes or raised existing tax rates notably on gasoline, liquor, tobacco and utilities, while others repealed certain revenue measures, such as the elimination by New York of its 1 per cent emergency tax on personal incomes, or the South Dakota reduction in income tax burdens. Most of the temporary tax legislation was continued in force.

However, no important changes in tax policy were in evidence. The net effect therefore was that with state and local revenue structures remaining substantially the same, total tax burdens were mainly influenced by and varied directly with the revenue policies of the Federal Government.

War Taxation.

As the United States approached its role as an active participant in an all out war against the Axis, it was spending at the rate of $2,000,000,000 a month. This was equivalent to $180 per person, or about one-fourth the national income. To compare these costs on any accurate basis with those of other countries at war, is virtually impossible because of the lack of reliable data, differences in accounting, and variations in price levels, labor costs and other factors. However, on the basis of the best information obtainable it would appear that Great Britain now spends more than $50,000,000 a day, $18,000,000,000 per year, and $350 per capita. Canada is diverting $2,650,000,000 (which is 40 per cent of her national income) for the use of the Federal Government. Of this sum, five-sixths is directly for the war effort. Conservative estimates for Germany and the occupied countries show that $30,000,000,000 per annum is being spent currently for the conduct of the war. This is almost twice the figure estimated for the German nation in 1939-40 and easily represents two-thirds of the total income within Germany and the conquered areas. Japan's budget for the fiscal year starting April 1, 1941, was $3,000,000,000. This was by far the largest expenditure program in Japan's history; yet as a result of the intensification of the war, this budget has probably been materially increased. The greater proportion of these expenditures was financed through borrowing. Russia spent at least $10,000,000,000 in 1941 and as the tempo of the war with Germany increased, it is likely that this level was sharply raised. War expenditures for Italy probably exceeded $2,000,000,000 per annum.

The attack on Pearl Harbor in December 1941 which definitely forced the United States upon an immediate war footing, resulted in drastic upward revisions in financial estimates. In a dramatic budget message to Congress, President Roosevelt stressed the nation's determination to 'pay whatever price we must to preserve our way of life.' His estimates, purely tentative, and subject even to further upward revisions with the changing fortunes of war dwarfed by comparison the unprecedented expenditure level of 1941. It was calculated that for the fiscal year of 1942 defense expenditures would come to $24,000,000,000 and that total costs would amount to more than $30,000,000,000. Revenues were expected to yield $12,000,000,000, leaving a deficit in excess of $18,000,000,000. For the 1943 fiscal year, the President called for a budget with total expenditures of $59,000,000,000, of which $52,000,000,000 would be for war expenditures, including Army, Navy and lend-lease costs. This would involve a speed-up in the rate of war spending to $5,000,000,000 a month by 1943. It is equivalent to $444 per person or more than half the anticipated national income for that period. To meet these expenditures, the President proposed added tax burdens of $9,000,000,000 in social security taxes, income, excess profits, estate, gift, and excise taxes. It was estimated that this increase in taxation combined with existing tax burdens, would bring total receipts to $27,000,000,000. Heavy deficits are expected to accompany even this high level of taxation with the result that the national debt will probably soar to $110,000,000,000 or more, with an annual interest bill of $2,500,000,000. See also BUSINESS; FINANCIAL REVIEW; INCOME TAXATION; BUDGET OF THE UNITED STATES; NATIONAL DEBT; SALES TAX.

1940: Taxation

Federal Taxation.

Defense Authorizations.

The third session of the 76th Congress, primarily devoted to the problems of national defense and foreign affairs, established a new record in United States peacetime preparedness programs. In its unprecedented authorization of defense spending of $13,000,000,000, Congress provided for a two-ocean navy, a mechanized 1,200,000 man army, with reserve equipment for 800,000 more, and an air force of approximately 35,000 planes. In addition, it authorized the Reconstruction Finance Corporation to make loans for plant expansion to munitions makers and other defense industries, and to extend credit through the Export-Import Bank for the stimulation of inter-American trade in the Western Hemisphere. An appropriation of $50,000,000 was also made for the relief of European war sufferers. Commitments for the production of war materials, for which appropriations have not yet been made, ran into several billions more. Despite these enormous allocations of money for a comprehensive program that will require a five-year period for full completion, it was freely predicted by government spokesmen that expenditures for armaments would rise into still higher brackets — perhaps as high as $35,000,000,000 in the aggregate.

Because of the lag in getting started on these new national defense measures, full effect will probably not be given to these extensive provisions for Federal disbursements until 1942. While current expenditures for the Navy and War Departments show a sharp rise over the trend for previous periods, they are but conservative forerunners of the levels soon to be established.

Defense and Other Expenditures.

In the fiscal year ending June 30, 1940, Federal expenditures were $9,666,000,000 or approximately $400,000,000 more than was spent in the previous fiscal year. This rise was almost entirely accounted for by the increases of $219,000,000 for the Navy Department, and $178,000,000 for the War Department national defense programs. Disbursements for recovery and relief were pared by $700,000,000 principally in the Work Projects Administration which spent $1,478,000,000 compared with $2,240,000,000 in 1939. This shrinkage in Federal costs was, however, counteracted by a rise of $100,000,000 in interest on the public debt, an increase of $230,000,000 in the cost of the Agricultural Adjustment Program, further capital outlays of $50,000,000 for work on rivers, harbors, the Panama Canal, and reclamation projects, a rise of approximately $100,000,000 in Social Security expenses and Retirement Fund transfers, and by increases in the sinking fund for debt retirement and other capital adjustments. The balance of Federal disbursements remained at relatively constant levels.

In the first half of the 1941 fiscal year this trend was continued. Further reductions were seen in relief appropriations, notably for the Public Works Administration and the Work Projects Administration. Simultaneously, national defense expenditures for the half-year reached a total of more than $1,500,000,000 — a level as high as that for the full year of 1940, and half again as great as that for the 1939 fiscal year.

Federal Revenues.

Revenues lagged behind expenditures in their rate of growth with the result that the 1940 fiscal year again ended with a deficit — the tenth successive deficit since 1930. On June 30, 1940, the Federal debt stood at $43,000,000,000, and by Dec. 31, 1940, it crossed the $45,000,000,000 mark — the maximum debt limit that Congress had originally set, but which was raised to $49,000,000,000 during the 1940 session. The leading sources of revenue in the 1940 fiscal year were the internal revenue taxes on liquor and tobacco, and a long list of miscellaneous excises which yielded $2,344,625,000. Next in rank came the income taxes on individuals and corporations, which yielded $2,125,325,000. Social Security taxes amounted to $712,218,000 and customs duties were $349,000,000. The balance of Federal receipts consisted of special taxes on carriers, interest income, tolls and seigniorage, bringing the total revenues to $5,925,000,000. During the first half of the 1941 fiscal year, revenues were approximately five hundred million dollars greater than in the corresponding period in the previous year. (See also SALES TAX.)

Revenue Acts of 1940.

In order to help finance the defense program, additional Federal tax burdens were provided for in the Revenue Act of 1940 passed in June, and in the Second Revenue Act of 1940, enacted in October. Under the First Revenue Act of 1940, the individual income tax base was broadened by lowering personal exemptions from $1,000 to $800 for single persons, and from $2,500 to $2,000 for married persons or heads of families. The normal tax rate of 4 per cent was retained, but surtax rates were scaled higher in the income brackets up to $100,000. Surtax rates apply to net taxable incomes in excess of $4,000, starting at 4 per cent on incomes between $4,000 and $6,000 and rising progressively to 6, 8, 10 and 12 per cent, respectively, for every increase of $2,000 in the base. As the base becomes larger, the rate of progression increases rapidly so that on surtax net incomes over $50,000 and up to $60,000, the surtax rate is 44 per cent; on blocks of income between $70,000 and $80,000 it is 50 per cent; between $90,000 and $100,000 — 56 per cent, etc. The highest surtax rate is 75 per cent on incomes exceeding $5,000,000 per annum. The graduated rates of tax on incomes of small corporations earning net profits of less than $25,000 per year were raised one per cent to 13½, 15, and 17 per cent, respectively. (See also INCOME TAXATION.)

This Act also provided for certain temporary increases in the internal revenue laws for a period of five years, designated as 'defense taxes.' These emergency levies are of the character of a 'supertax' — i.e., a tax on a tax, amounting to an additional 10 per cent of taxes previously payable. This provision applies to individual and corporate income taxes, the capital stock tax, and the estate and gift taxes. Miscellaneous excise taxes were extended for five years and rates were increased. Thus, alcoholic beverage taxes were scaled from 20 to 37½ per cent higher; cigarette taxes were increased from $3 to $3.25 per thousand, and the taxes on a long list of commodities including playing cards, firearms, radios, refrigerators, and toilet preparations, were increased 10 per cent.

The Second Revenue Act of 1940 increased the tax on normal incomes of corporations earning more than $25,000 a year, to 24 per cent. It also imposed a new excess profits tax designed to place particularly heavy burdens upon companies deriving large profits from war and defense activities. According to the law, excess profits are determined by either of two formulas to be selected by the taxpaying corporation: (1) profits in excess of 95 per cent of average earnings for the period 1936-1939; or (2) profits in excess of 8 per cent of taxable invested capital. For all excess profits determined by either method, an exemption of $5,000 is provided. Above this level, a graduated tax rate of 25 to 50 per cent is applied. A further feature of this Act, designed to encourage construction of industrial plants needed for national defense work, is a provision for the amortization of the total cost of such facilities out of tax-free earnings over a period of five years.

State and Local Taxation.

Expenditures.

There was little change in the finances of state and local governments. Aggregate costs stood at the $10,000,000,000 level, with approximately $4,000,000,000 for state and $6,000,000,000 for local expenditures. Education ranked highest among state and local costs, followed in importance by highways, welfare, charity and relief, unemployment insurance compensation, health and sanitation services, and police and fire protection.

State and Local Revenues.

State revenues were derived mainly from general and selective commodity taxes and excises. Heading the list were revenues from gasoline taxes, followed by general sales or gross receipts taxes, taxes on motor vehicles, and liquor and tobacco taxes. The remainder of state revenues was drawn from payroll taxes for unemployment insurance, personal and corporate income taxes, franchise taxes, property taxes, estate and inheritance taxes, and petty administrative fees and tolls. Over 90 per cent of the local revenues were raised by taxes on property, with general and specific sales taxes and local administrative charges accounting for most of the balance.

Changes in State and Local Tax Policy.

State and local legislatures introduced a number of important changes in tax policy. The legalization of pari-mutuel betting in New York and New Jersey provided these states with new revenue sources in the form of horse-racing taxes and licenses. Receipts from this source during the first trial year in New York exceeded $6,000,000. Louisiana enacted a gift tax ranging from 2 to 10 per cent, the rate depending upon the relationship of donor to donee. This raises the number of states having gift taxes to nine. A few states, including Alabama, Louisiana, South Carolina, and Virginia, extended the application of gasoline taxes to Diesel motor fuels. Mississippi and Kentucky adopted chain store taxes with graduated rates ranging from $10 to $300 and $25 to $200, respectively — the rate depending upon the number of stores, wherever located, in the chain. These taxes resemble the Louisiana law enacted in 1934. Liquor taxes were raised on some items in the states of Kentucky, New Jersey, South Carolina, and Virginia. Municipal cigarette taxes were imposed by Denver, Colorado and Kansas City, Missouri. Personal and corporate income taxes were increased in Louisiana and Mississippi. In the latter state, franchise and utility taxes were also raised. Notable among tax reductions or surrender of tax revenue sources were the elimination of the Rhode Island and New York City taxes on cigarettes, the repeal of the general sales and use taxes in Louisiana, and the abandonment of the South Carolina tax on incomes from intangibles.

Summary of 1940-1941 Tax Trends in United States.

The net result of the tax legislation in 1940 was an unmistakable upward trend in the tax burdens imposed by Federal, state and local governments. Tax collections in 1940 for all three branches of government were from $14,000,000,000 to $15,000,000,000, or slightly more than 20 per cent of the national income. Total expenditures were close to $20,000,000,000. Of this sum, only $1,500,000,000 was for direct payments for national defense. With defense costs in 1941 and 1942 conservatively estimated at $5,000,000,000 and $10,000,000,000, respectively, aggregate public expenditures may jump to $25,000,000,000 or even $30,000,000,000. Reductions in non-defense items may help to offset the larger amounts required for defense, but not sufficiently to prevent the need for heavier taxes. The 1940 crop of Federal taxes, coupled with a rising national income, will provide more revenue in the 1941 fiscal year. New taxes, further increases in existing rates, and the consideration of another extension in the debt limit are on the 1941 agenda for Congress.

Taxation in Leading Foreign Nations.

With substantial increases in the cost of government in the United States virtually assured for some time to come, it becomes pertinent to consider comparative expenditures and tax burdens in other leading nations. Such an inquiry is naturally limited in view of the paucity of data emanating from the warring world powers.

Although France and Italy had per capita taxes much lower than those for the other countries listed, or than the American level of taxes, the percentage that these taxes bore to the national income was higher, because of the limited resources of these nations. In most instances public expenditures for this period were considerably in excess of tax revenues, resulting in deficits and increases in the national debts. Since 1938, tremendous expansion has occurred in the military disbursements of these nations. On the basis of present standards, a European army, thoroughly trained and mechanized, costs $10,000 per man, per year, if guns, motors, planes, and supplies are included. For an army of 1,000,000 men, this involves an expenditure of $10,000,000,000 per year, not including the heavy outlays for capital ships, which may run into many billions more.

Great Britain.

These staggering costs are dramatically illustrated in the British budget for 1940-41 amounting to $10,668,000,000 — the largest budget on record in the nation's history (equivalent to almost half of the national income) and involving an estimated war cost of $21,000,000 per day. Of this sum, $5,732,000,000 was borrowed; the remainder being financed by increased taxation. The basic rate of the British income tax was raised to 42.5 per cent. A purchase tax was imposed on the sales of many classes of commodities. The rates are 16 2/3 per cent and 33 1/3 per cent, depending upon the kind of merchandise. The government-owned telephone and telegraph service raised its rates from 15 to 25 per cent and postage rates were boosted 66 2/3 per cent. Liquor and tobacco taxes, business, and excess profits taxes were increased. Estimates of the costs of the war are constantly being revised upward. Sir Frederick Phillips, British Under-Secretary of the Treasury, indicated in December, 1940, that the costs were running as high as $45,000,000 a day. The Economist of London estimated that 1941-42 expenses might reach £4,000,000,000, or roughly $16,000,000,000. This would amount to a per capita cost of more than $300 a year.

Canada.

See CANADA: Appropriations.

Germany.

Conservative estimates place Germany's war expenditures at $14,000,000,000-$17,000,000,000 per annum. This is equivalent to about 50 per cent of the national income. According to other estimates, recent wartime expenditures of the Reich have mounted to a monthly average of from $1,500,000,000 to $2,000,000,000, or in the neighborhood of $20,000,000,000 per annum. More than one-half of this money is obtained through borrowing: the balance is met from tax revenues. Chief reliance is placed upon income and property taxes, but heavy increases have been made in excises, general sales taxes and business taxes. Industry is strictly regulated and controlled in the national interest. Some of the cost is probably borne by the people in the conquered areas. No official data are available to show actual distribution of these tax burdens.

Italy.

In Italy, the budget for 1940-41 was $1,850,000,000, of which 31 per cent was for military needs. Revenues from fiscal monopolies, together with excise, income, business and property tax receipts (including a new turnover tax and a capital levy), were expected to amount to $1,500,000,000 — the balance to be raised by a domestic bond issue. Debt service on the national debt is the largest item in the budget, and amounts to approximately $700,000,000 per annum. Since Italy entered the war, appropriations have undoubtedly exceeded budgetary allowances.

Future Defense Financing in United States.

The rapid spread of world conflict, accompanied by an increasing tempo of expenditure for armaments among the nations of the world, has forced upon the United States a major problem of defense financing. To the record-breaking budgets and deficit spending of the depression years must now be added extra billions if the United States is to be raised to a level of preparedness comparable to, or surpassing that of the aggressor powers of the world. Early in January 1941, President Roosevelt notified Congress that the budget for the 1942 fiscal year would probably come to $17,500,000,000, exclusive of funds that may be needed to finance aid to the warring democracies. Of this total, from $10,000,000,000 to $11,000,000,000 would be for the armament program. A budget of this size will no doubt lead to heavier income and excise tax burdens. Nevertheless, in spite of increased taxes, a deficit of from $8,000,000,000 to $9,000,000,000 is almost certain to arise. At this pace, the national debt would eclipse the $60,000,000,000 level within two years. See also EDUCATION; LAW AND LEGISLATION.

1939: Taxation

Federal Taxation.

Federal expenditures for the fiscal year 1939 amounted to $9,268,000,000. This is the highest level of expenditures the nation has seen, with the exception of the World War period when more than thirty billions were spent during the two years 1918-19. Compared with the previous fiscal year, 1939 expenditures represented a rise of approximately $1,500,000,000, or more than a 20 per cent increase. On the other hand, total revenues were only $5,668,000,000 — a drop of over $500,000,000 from the previous year. This amounted to an excess of expenditures of approximately $3,600,000,000 — the ninth successive deficit since 1930. As a result, the public debt rose to the unprecedented level of more than $40,000,000,000.

Chiefly responsible for the increased costs of the Federal Government were the larger appropriations for recovery and relief projects, for agricultural adjustment and farm tenancy programs, and for national defense. Total disbursements for recovery and relief were $3,105,000,000, or more than one-third of the national budget. Of this sum, $2,500,000,000 were allocated to the Works Progress Administration, the National Youth Administration, and the Public Works Administration. The balance was distributed for the construction of other public works, for credit aids to farmers and home owners, and for miscellaneous relief measures. The agricultural adjustment and farm tenancy programs cost $815,000,000, the Civilian Conservation Corps, $290,000,000, and an additional $500,000,000 were spent for rivers and harbors, public buildings, highways, flood control, reclamation, and rural electrification work. Direct appropriations for the national defense were approximately $1,000,000,000, while $552,000,000 more were allotted to the Veterans Administration. Another billion went for debt service (including payments for interest and a slight reduction in the public debt). General departmental expenditures were $645,000,000. Social Security and Railroad Retirement Act expenses amounted to 345 millions, plus an additional $610,000,000 which were added to old-age reserve and retirement accounts. The balance of federal disbursements was for postal deficiencies, loans and grants to states, the Panama Canal, the Tennessee Valley Authority, and miscellaneous charges.

The leading sources of revenue to meet these expenditures were income taxes of $2,182,300,000 and miscellaneous internal revenue taxes of $2,231,983,000. Income taxes were collected from individuals and corporations, each group contributing approximately one-half of the receipts. Internal revenue taxes consisted primarily of excises on liquor and tobacco which yielded about half the total. The balance came from estate and gift taxes, capital stock taxes, and a long list of excises on miscellaneous manufactured products and services. Social security taxes returned gross revenues of $631,000,000 and railroad retirement taxes, $109,000,000. Customs receipts amounted to $319,000,000. Additional revenues of $187,000,000 were obtained from Panama Canal tolls, government seignorage charges, proceeds from government-owned securities, and miscellaneous fees and charges.

State and Local Taxations.

Expenditures.

State and local government expenditures continued to be greatest for education, highways, welfare, relief and unemployment insurance, conservation of public health, police and fire protection, sanitation, and the maintenance of institutions of charity and correction. Increased activity was seen in some jurisdictions in the clearance of slums and in the construction of public housing projects. Total disbursements by the states exceeded $4,000,000,000, while aggregate local expenditures were estimated at $6,000,000,000.

State and Local Revenues.

Gasoline taxes, estimated at roughly $800,000,000, headed the list of state revenues. Payroll taxes earmarked for unemployment insurance yielded between $700,000,000 and $800,000,000. Next in rank came various types of general sales or gross receipts taxes aggregating $500,000,000. Income taxes upon individuals and corporations yielded $400,000,000; motor vehicle taxes, another $400,000,000; liquor taxes or profits from liquor stores, $300,000,000; and general property taxes, $200,000,000. The balance of state revenues was derived from estate and inheritance taxes, franchise and license taxes, miscellaneous selective sales taxes on tobacco, soft drinks and amusements, stock transfer taxes, and a long list of fines, fees, rents, interest and earnings of general departments. Substantial Federal loans and grants supplemented these receipts. This list of revenues reveals a strong reliance among the states upon indirect consumption taxes as a source of public income. Considerably more than half of state tax receipts are of this description. The trend has been increasing in this direction within recent years.

Among the local governments, the chief source of revenue, as in the past, was the property tax, mainly upon real estate. However, aggregate receipts from supplementary sources such as sales taxes, fees, fines, tolls, license charges, and from state-shared taxes and grants-in-aid, continued to mount.

Revenue Act of 1939.

The Revenue Act of 1939 introduced several modifications in the national tax system. Undistributed profits taxes on corporations earning more than $25,000 were eliminated, thus ending a lengthy controversy over this question between business and government. A flat tax of 18 per cent on the entire net income of these corporations was substituted for former rate structures. More liberal provisions were also introduced for the deduction of losses of bad years from profits of good years in computing gross income. A rather significant change in the taxable status of public employees was effected through the Public Salary Tax Act of 1939 which provided that salaries for 1939 and thereafter paid by the state and local governments would be subject to the Federal income tax. It also opened the way for state and local governments to tax the salaries of Federal employees. Amendments to the Social Security Act limited the application of the unemployment insurance tax to the first $3,000 paid to each employee, instead of making the total payroll the basis of the tax as heretofore. The 1 per cent tax rate on employers and employees for old age pensions was retained for the years 1940-42 instead of being allowed to rise to 1½ per cent as the law originally provided. (See also SOCIAL SECURITY.)

New State Tax Laws.

Among the states several hundred laws were passed introducing new taxes, and modifying, extending or abolishing old ones. Most significant as a trend were the actions by seventeen states to amend their income tax laws to tax Federal salaries. New taxes on cigarettes were introduced in several states. Two states raised the gasoline taxes, and five states increased their taxes on liquor. Real estate taxes were abolished as a state levy in New Hampshire, and Delaware abandoned all taxes upon personal property. Several states relaxed their penalties against delinquent property taxpayers.

National and State Indebtedness.

As the nation crossed the half-way mark of the 1940 fiscal year it faced the problem of an ever-widening gulf between revenues and expenditures. Federal indebtedness at roughly $42,000,000,000 came dangerously close to the maximum debt limit of $45,000,000,000 previously set by Congress. State and local indebtedness stood at $20,000,000,000.

Although present taxes are expected to yield somewhat higher revenues, there is little chance that the Federal budget can be balanced, unless expenditures are drastically cut, or new revenue measures are introduced. The continuation by the 76th Congress of heavy allocations for relief and for agricultural aids, coupled with a doubling of the national defense budget, has resulted in appropriations which will send total national expenditures to still higher levels. Meanwhile, state and local governments, constantly on the lookout for new tax measures in order to keep their budgets in balance, are drifting further away from the all-important goal of simplification and coordination of fiscal systems. See also BUDGET; BUSINESS; FINANCIAL REVIEW, UNITED STATES; LAW AND LEGISLATION; NATIONAL DEBT; SALES TAX; UNITED STATES: Supreme Court Decisions.