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May 5, 19kl DRAFT OP TESTIMONY BEFORE THE HOUSE WAYS AND MEANS CQLMITTEE Mr. Chairman and Members of the Committee: I particularlywelcome the opportunity to present my views to you, because of my conviction that the effects of the present defense effort upon our national economy will depend greatly upon the tax program now undergoing formulation by t h i s Committee. In appearing before you I speak merely as an individual and not in behalf of the Board of Governors of the Federal Reserve System. One of the most important factors in determining whether economic dislocation w i l l be great or small - - I think we a l l recognize that there must be some dislocation — i s the way in which we raise the great sums we spend for national defense. Not only how much we tax as contrasted with how much we raise by borrowing, but also, after we have decided how much tax revenue we ought to have, the kinds of taxes we use to get i t . The Secretary of the Treasury has recommended that during this emergency two-thirds of our Federal expenditures be covered by taxes. I am completely in accord with this recommendation. Yiewed in the l i g h t of the financial history of this and other countries, this goal may seem an extremely ambitious one. No great nation, to my knowledge, has passed through a period of world disturbance l i k e the present without borrowing a much larger proportion of i t s expenditures than one-third. Viewed, however, in the light of our present and prospective economic situation, the goal i s reasonable and, indeed, a modest one. During the past eight years I have repeatedly expressed the conviction that a large Federal deficit i s appropriate during a period of widespread unemployment and depressed national income, and I have always accompanied that statement by saying that a large Federal d e f i c i t i s inappropriate to a period of v i r t u a l l y f u l l employment• I t i s true that the speed with which unemployment i s l i k e l y to vanish has been g r e a t l y exaggerated by some. I fear that anyone who expects to see unemployment disappear by the summer or f a l l of the present year i s in for a sad disappointment. I t i s much nearer the probabilities to say that by the end of the calendar year 19^2 we may be close to a general condition of having more jobs than people to f i l l them. Even before that time there w i l l be many specific products which we shall have to ask the c i v i l i a n public to forego altogether* or to consume in greatly reduced volume, because those products require the use of s k i l l s , materials, and machines that are needed for defense production. At the present moment we are on the verge of this situation with respect to a wider range of products than i s generally realized and as time goes on the needs of the defense program w i l l increasingly trench upon goods available for c i v i l i a n consumption. Meanwhile the national income, expressed in money terms, i s rising and w i l l continue to r i s e as expenditures are made for the huge volume of defense orders now on the books. As the wages, profits, and other income paid out in connection with this a c t i v i t y begin to be spent, i t w i l l become d i f f i c u l t to provide enough goods for c i v i l i a n use to meet these increasing demands arising out of military expenditures* Such a condition, -when i t prevails for a sustained period in consumer markets generally, brings about price advances and results in inflation. That i s what i s l i k e l y to happen to us unless we do what i s necessary to prevent i t . impose adequate taxes* One of the things to do to prevent i t i s to The Government when i t levies taxes asks i t s citizens to give a part of their money to the tax collector instead of spending i t in the stores or shops. In this way c i v i l i a n competition with the Government for the use of men, materials, and machines can be reduced. In imposing these taxes the guiding principle should be that they be levied in accordance with a b i l i t y to pay. This i s always im- portant, but when taxes begin to require real sacrifices, as they must i f they are to perform their function in the present emergency, when they begin to mean lard instead of butter in the frying pan, a vacation spent on the front porch instead of in the mountains, a college education for only one child and not for a l l the children, i t becomes doubly important that taxes be obtained where they can be spared with the l e a s t sacrifice• That i s why I find myself in general agreement with the main outline of the Treasury proposals. That i s also why I am doubtful whether i t would be prudent, as some suggest, to raise more revenue from excise taxes than the Treasury proposes to raise, especially if these taxes are to f a l l heavily on commodities like coffee, cocoa, tea, and sugar. These -k- commodities may be regarded as proper objects of taxation in a povertystricken country of the Old World where governments must extract revenue from their citizens in any fashion that i s expedient. They are not appropriate taxes in this country where other sources of revenue are ample and the people are prepared to support an equitable tax program by the payment of direct taxes• Consumer expenditure can be restrained either by an increase in income tax applied to the lower brackets of individual income taxpayers, or by a tax on coffee and other foods* The difference l i e s in the f a c t that the individual income tax does this frankly and directly and does i t in a fashion which adjusts the burden to the taxpayers a b i l i t y to bear i t . A tax on coffee or any other |rticle of mass consumption does i t surreptitiously and indirectly and in a fashion that makes the burden proportionately heaviest on those least able to bear it# Indirect taxation i s taxation by autocracies, income taxation i s democratic taxation. Before democratic government came into the world indirect taxation was the only type known. The history of direct taxation, and in particular of the income tax, i s the history of the expansion of democracy. I am therefore in general agreement with the Treasury f s program both in i t s aggregate amount and in the general type of taxation i t provides. It i s my wish, however, to suggest certain changes in emphasis with respect to the sources of revenue on which i t draws. beg permission to describe in same detail the changes that I wish to advocate. I I may state in advance a few of the underlying principles to which in my opinion we should adhere: 1. 2« 3» it-. 5* Raise enough additional taxes to avoid inflation. Raise them in a way to cause a minimum of dislocation in the economy. Raise them in accordance with a b i l i t y to pay. Raise them in a way that w i l l prevent anyone from profiting unduly from the defense effort. Consequently raise them, in so f a r as possible, out of the increase in income caused directly or indirectly by defense expenditures. x We expect the national income to increase sufficiently, so that a third to a half- of the increase would be sufficient to provide the expected revenue. Realization by the public that the Government w i l l take away for defense needs only a part of what the expenditures w i l l add directly and indirectly to the national income and that no one w i l l get rich by supplying the national needs w i l l make the tax program generally acceptable and w i l l prevent discontent and social unrest which would hamper the national effort. I. Excess Profits Tax In my opinion an effective excess profits tax i s not only the keystone of a well balanced tax program; i t i s an essential element in solving the economic d i f f i c u l t i e s which are beginning to confront the nation over a very wide f i e l d . Any tax program that you may frame, whether i t follows the exact lines of the Treasury proposals or not, w i l l have to include a substantial increase in the rates of taxation for corporate incomes in general as well as for individual incomes. At the same time you cannot reasonably ask the great numbers of business concerns of small and moderate size who are not participating in defense contracts to assume the additional tax burden involved in an increased noxml corporation rate (or in the special surtax on corporate net income), - 6 - and ask millions of individual taxpayers to assume the additional burdens involved in increased individual income tax rates until you have given them every reasonable assurance that the funds they are being asked to provide w i l l not go to swell the excessive profits of a j ^ i r corporations which profit handsomely from expenditures on defense. The excess profits tax now on the statute books does not give such assurance. If you allow the idea to take root in Hie public mind that through these vast expenditures a few are being made rich and a few who are already rich considerably richer, the result i s bound to endanger the success of our defense effort. We cannot afford to l e t our citizens remain doubtful on this important point. Many of us believe that in order to prevent an inflationary spiral of price and wage increases we ought to ask I&qt Jxff moderate the demands $or increased pages ^pfnich are now bein^^ftr^ and which w i l l be heard in increasing volume as employment increases and employers find that they a re bidding for labor on a seller 9 s Market. Such a counsel of moderation to labor cannot be wholly effective L4AA/: if employers are permitted to retain huge/profits. Will labor forego wage i increases^if we permit corporate earnings a f t e r normal tax to r i s e during 19*4-1 to jl level 75 V er cent above 1939 and permit many individual corporations to realize, a f t e r payment of taxes, profits vastly higher than at any previous time in their corporate history? I t i s often said that these corporate profits when they are paid out to stockholders are effectively taxed under the individual income tax. If that were s t r i c t l y true they would be effectively reached by the surtax schedules which the Committee has under consideration. But, as you gentle- men who frame our revenue legislation know, i t i s not true that corporate earnings f e e l the f u l l force of our individual income tax rates. Corporate earnings may now be withheld from distribution without penalty; I need not recall the short and unhappy history of the undistributed profits tax. Since we do not have an undistributed profits tax we must have heavier corporate taxation along with heavier taxation of individuals. In the taxation of cor- porations primary emphasis should be placed on the excess profits tax. (Suggested insert on page 10 before l a s t paragraph). I suggest addition of a sentence or two to the effect that WI should also suggest that consideration be given to making taxes heavier for increases in incomes than for stationery incomes. This should apply only to incomes above a stated minimum and below a stated maximum. Sub-standard incomes should be l i g h t l y taxed, even i f they have increased, and high incomes should be heavily taxed whether they have increased or not. This would be in accord with the principle underlying the proposed excess profits tax.* ( i f this suggestion i s adopted - you may wish to modify the proposed schedule of r a t e s . ) Possible substitute for two paragraphs beginning at the end of page 2. Our problem i s to produce enough goods to meet the needs of defense as well as necessary c i v i l i a n needs. Primarily i t i s a problem of production, or of output. We can neither use for defense or consume goods unless they have been manufactured. Consequently, the necessary increase in output for defense can come out of three sources and only three: ( l ) Use of resources, human and material, that have been idle or not f u l l y utilized; (2) Increased efficiency, and (3) Curtailment of non-defense consumption. We shall probably have to use a l l three sources. The problem of financing i s secondary to that of increasing output. In the material and fundamental sense we can pay for defense only out of current production; you cannot f l y a plane, or s a i l a ship, or drive a tank that has not yet been produced. The role of finance i s to help so to distribute the effort as to contribute to maximum efficiency, to maintain justice, and to minimize post-defense readjustments. The money for defense has been appropriated - i t i s merely a question of what is the best way to raise i t . To the extent that we raise i t out of taxes - we do not add to buying power - we merely convert a potential demand for c i v i l i a n goods into a demand for defense goods. Thus we avoid inflation. Inflation arises from an increasing effective demand for a supply of goods that does not increase correspondingly. One way to reduce the danger of inflation i s to increase output by working harder, longer, and more exclusively on necessary things. And another way i s to reduce the demand for unnecessary things and divert i t to the things that we need most. And this i s the role of taxation. Everyone agrees that we should avoid inflation and that in order to accomplish this someone w i l l have to give up something. The disagreement a r i s e s a t a subsequent point. Every group t r i e s to shift the burden on to other groups. Some want to meet the expense by reducing non-defense expenditures - and a sales tax. W U This woulc^put the tUtjitr Wjst burden on the underprivileged and the lowest income brackets. t/ri247 UAAAU relieve the well-to-do. UZL^ / V U ^ X it d^r'-^jL^ I* d-l'y It would/ * Others want a high exemption and no excise taxes This would completely relieve the lower income groups and put the entire burden on the others. I t seems to me that in the present emergency - no group should be completely exempt and a l l groups should bear an equitable share, no more and no less, of the national burden.
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