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B.A.M., October 25, 19143. FINANCIAL POSITION OP CGRPOB&HONS IH POST-WAH PERIOD I. The Facts. Notwithstanding current a r g f b r tax relief, indications are that corporations will emerge from the war in a strong financial position. The following figures support this positions Corporate net income in 19^3 i« three times that of 19^0, ~ §22 billion dollars as against $7 billion dollars* After taxes corporate net income is still twice that of 191*0, — $3.7 billion as against #lu8 billion, — and higher than it has ever been before. (See Sable I.) (b) Retained corporate Income is similarly at a record level. Cumulative retained income since 1939 exceeds $12 billion dollars and is now running about $5 billion a year. (See Table II.) (0) Depreciation reserves are now being accumulated at a rate much in excess of total investment (including plant and inventory ). TSiile investment exceeded depreciation allowances for I9I4.O and 19kl, the excess of depreciation allowances over invest* sent in 19i|2 was $2.2 billion dollars and for the current year is estimated t9 billion. If the war continues for several years, the current rate of reserve accumulation will grow into a very large total. (See liable III). (d) Provisions under the present tax law will help corporations to strengthen their financial position in the post-war period. (1) Under the Excess Profits Tax, corporations are accumulating reserves in the f o m of a 10 per cent refund of tax* amounting to about $1 billion a year. (2) Under the Corporation Income Tax, corpora* tions are permitted a two-year carry-back and two year carry-forward of net operating losses and under the Excess Profits Tax, the same holds for unused excess profits credit. This relief will, of course, be available only to corporations idiich suffer a drop in income after the war and which pay taxes during the war, but the total refunds that may be obtained might be very substantial due to the enormous war-time income against which the carry-backs can be made. On the whole, it appears that the combined effects of the very extensive retention of earnings, accumulation of reserves and possible refunds tinder present tax provisions will be adequate to provide a very substantial base for post-war expansion and growth. - 2 - October 25, 1943 II Policy Conclusions« If war contracts are settled promptly, particularly if corporations receive liberal advance payments on outstanding contracts, corporations by and large trill have sufficient funds to take care of reconversion to divilian production* ?/hile this applies to the bulk of corporations, there are likely to be some marginal concerns which did not have large profits during the war period and thus do not benefit from tax carrybacks* Special provisions might be necessaxy to help such businesses through reconversion loans* So$e corporations will have adequate reserves to take care of reconversion costs, but these reserves may not be in liquid form. Also, claims for tax refunds will not be immediately available* Steps may thus be needed to facilitate rapid liquidation of assets for reconversion purposes* There is no good case for permitting corporations to accumulate large tax-free reserves for purposes of expansion after the -war. Any such provision would simply mean a reduction in corporate tax rates. It would amount to a subsidy paid particularly to high-profit corporations which would be less in need of funds after the war. If corporations want to undertake large and new capital developments in the postwar period, and do not have sufficient funds, it is altogether desirable that they should go to the capital market to obtain funds. This is the more desirable, since investors will have plenty of liquid funds to invest* A reasonable case can be made for permitting certain costs — which are incurred in the postwar period but which are really a reflection of wartime production — to be carried back against wartime income for purposes of computing the final tax burden upon wartime incomes. Costs of this type would be dismissal wages and a part of reconversion costs. It may be con© sidered whether the tax law should be amended to provide for the carryback of such costs* R.A.M., 10-25-1*3* Financial Resources of Corporations j/ (All corporationsi billion dollars) I. Corporate Hot Income Before and After Taxes. 19h0 191*1 191*2 191*3 Net income before taxes Inoome a n d profits taxes 7.3 2.5 14.3 7.2 20.1 11.8 22.2 13.5 Net income after taxes U.8 7.1 8.3 8.7 II. Corporate Net Income Before and After Dividends. Net inoome after taxes Net dividends paid Retained „ inoone Cumulative sinoe 19l;0 III. 191*0 19lfl 191*2 191*3 ii.8 ii.l 7.1 h.5 8.1* h.l 8.7 l*.o .7 .7 2.6 3.3 k.3 7.6 1*.7 12.3 Estimates Business Investment and Depreciation. Net investment^/ Depreciation and related reserves Excess of depreciation on investment 1f Sourcei 0. S. Treasury Department. 2 j In plant and inventory. 19U0 191*1 191)2 191*3 11.1 8.2 18.1 9.1* 8.1 10.3 1.1* 10.1* - 2.9 * 8.7 2.2 9*0 R.JUH., Oct. 25, 19h3 LIQUIDITY AW IHFLAliON IB THE FOSTwAR PBBIOD I. Inorease in liquidity —» the facts Partly as an inevitable consequence of w finance, but also partly due to loose fiscal policy during the war* there will be an enormously high level of liquidity in the postwar period* (1) The interest bearing debt of the TU S. Government* $55 billion in 19^1$ is close to §170 billion now, and will be over $200 billion at the end of this fiscal year. If the war continues for another fiscal year, it -will be around $270 billion by June 19^5* (See Table 1.) (2) So far* much of the increase in the public debt has been taken by banks* — from June 19Ul to June 19^3# cornereial banks and Federal Reserve Banks took $37 billion out of a total increase of |35 billion. Recently, the record in this respect has been somewhat better. Nevertheless* bank purchases have resulted in a vast increase in the total sioney supply* and will result in substantial further increases. The total money supply in June 19U1 was $73 billion and now is $102 billion] by the end of this fiscal year, it will exoeed §120 billion* and* if the war continues for another year* may exceed §ll*0 billion by June 19ij5» (See Table II.) (3) Tb© increase in liquidity is not only in the form of cash and deposits* but also in the form of security holdings. A substantial part of the securities held by the public are* in fact, demand obligations which may be redeemed at fixed prices at any time. Other obligations which are no&inally not demand obligations actually come close to being so* since under present conditions the Federal Reserve System will probably have to maintain the security market should it threaten to break. Total liquid assets in the hands of the public (deposits* currency and U# S. securities) amounted to §139 billion in June of this year as against §60 billion in 1930. (Excluding commercial banks and life insurance companies). Ihe total will be |190 billion by the end of this fiscal year and nay be close to $250 billion by June 19k5p should the war continue that long. Of the total* about onethird is held by business, two-thirds by individuals, (See Table III.) -2- (1;) It is exceedingly difficult to estimate the distribution liquid holdings by individuals between different income groups * Very roughly* it appears that about one-third to one-half of the total is held by people with incomes of under $5#000, constituting about 80^ of income receivers. If this ratio is correct, these people will hold about 150 billion by June out of the estimated total of $122 billion. (See Table IT.) II* Increase in liquidity — the consequences The consequences may be for the good or for the bad, but on balance, the increase in liquidity is more likely to prove a liability. Desirable consequencesi People will have sifteable funds with which to buy and to finance their backlog demand for semi-durables and durables after the war. Also, the fact that they have accumulated some savings may mean that future net savings out of current income may be less (however, the opposite may happen* people may have acquired a savings habit and continue to save more). Undesirable consequencest (1) There is a danger that people will decide to liquidate their holdings at the wrong time, that is, when insufficient civilian supplies are available. Particularly, there is some danger in this respect in the transition period after the war. If this should happen, people will lose their savings in higher prices and considerable inflation might result# (2) M t h a huge volume of public debt outstanding, public policy, most likely, will have to assure that the security market will be maintained* If public holders of securities decide to sell on the net, the Federal Reserve System will have to take up the slack* — and this might happen at a time iki en a tightening of the money market would otherwise be desirable. (3) On the whole, it appears that the large volume of liquid holdings by the publio will make the whole economic mechanism more delicate and sensitive to fluctuations* It will be more difficult to maintain a high level of employment since we must be moro careful hot to risk an inflationary development* We shall be less able to afford making mistakes« R.A.H., 10-25-1+3 POST WAR LIQUID!TT Ownership of U. S. Government Securities I. (In illlions of dollars) Estimates Total Interest-bearing Securities If. S. Government Agencies Federal Reserve Banks Commercial Banks Mutual Savings Banks Insurance Companies Other Investors Marketable Securities Nonmarketable Securities 19i+l 191+3 191+U 191+5 5U.8 s.5" 2.2 20.1 3.1+ 7.0 139.5 11+.2 7.2 52.1 5.3 12.8 206.1 IS.7 11.2 68.1 6.8 17.3 270.6 21+.S 15.2 814.1 8.3 21.8 9.1+ 1+.2 19.1+ 28.U 31+.2 1+9.7 1+7.5 69.1 Total Money Supply II. (In W-llions of dollars) All Banks Deposits Demand 3/ Time Total Currency Outside Banks Total Honey Supply June 30, 19hl June 30, 19*43 June 30, 1914; 37,317 27.879 65,196 55.952 30,328 ( 68,000) 86,280 ( 3U.300) (102,300) 8,201* 15,800 ( 19,800) ( 23,800) 73,1400 102,080 (122,100) June 30, 19U5 ( 80,000) ( 38,300) (118,300) (1142,100) 1/ Estimates by Mr. Piser. Purchases by the Federal Beserve Banks are estimated at billion dollars eaoh fbr the fiscal years I9I4I4 and I9I45, 2{ Purchases of 0. 8* securities by the commercial banks and the Federal Reserve System are estimated at $20 billion dollars each for the fiscal years I9IJ+ and I9I45. 3/ Excludes float. Government deposits,-and interbank deposits. EiA.M., 10-25-l|3 - 2 III. - y Liquid Holdings of Individuals and Businesses (In billions of dollars) Dec.l, 1930 Businesses (except insurance) * total Demand deposits and currency Time deposits U. S. Government securities 15 TJ 1 1 Individuals - total Demand deposits and currency Time deposits 0* S. Government securities "10 26 8 IV. June 3£V June 30, June 30# 19U3 1914* 19U5 53 (71) (90) (122) (158) 1 20 86 2B 28 30 Distribution of Liquid Holdings by Income Groups 2/ (In billions of dollars) All groups Total Individual holdings Demand deposits Currency Government securities Time deposits 86.0 Ik. 5 13.5 30.0 28.0 Estimated Range of Holdings by people with incomes of under $5,000 uver. 15,000 33 - hi 3 6 7-11 8-10 (15 - 20) 39 8.52.520.0(8.0- 53.0 11.5 6.5 22.0 13.0) Choosing billion as the estimated holdings by people with incomes under $5#°00, their share would amount to 1*3 per cent* l/ Estimates for I9I4I1 and 19^5 assume §55 billion dollars borrowed each fiscal year from individuals, non*insurance businesses and banks. On the basis of the past year's experience* one-third of the resulting gross in liquid assets is allocated to businesses and two-thirds to individuals. 2/ The estimates in this table are extremely speculative and should only be taken as an indication of the general magnitudes of holdings by people with incomes below and above I5#000. With respect to time deposits, there are no indications at all upon which to base an estimate, so that the figures given in the table are not much more than a guess. KM October 25, 1943 POSTWAR MANPOWER At the end of the war, we will have a total labor force of 66 million, 9 million more than in mid-1940. The labor force increases normally by 700,000 a year, or over 1 per cent. About 6 million of the,increase are extras not normally in the labor force. If these are forcea back to school, kitchens, aad retirement, we will have 60 million left. Armed forces will be demobilised fast after Japan is defeated. Probably have about 2.0 in the services one year after victory. About 2C# million will bo unemployed for frictional and seasonal reasons, even with full employment. war, This leaves a minimum of 56 million jobs to be provided after the more than were employed in July I940. 8 million Output per xaanhour for all employed increases 2-3 per cent a year. War stimulus to productivity has been tremendous. Return to peace will find productivity about 20 per cent above 1940. A return to 1940 production ($97 billion gross national product) at 1940 hours of work (about 39 for nonagriculture as a whole) with a 20 per cent war stimulated increase in productivity, aid 3 million normal increase in labor force would leave 20 million unemployed at end of war. To obtain full employment, it would require a gross national product of around $140 billion (at 1940 prices, $165 billion at 1942 prices) at the end of the war. The employment pattern indicates the great difficulty of providing full employment by increasing industrial jobs. Service jobs must increase. Prewar End of War July 1940 July 1945 (In millions) Civil Employment 48 54 12 Agriculture 11 16 Industry 23 Manufacturing 10 17 Mining 1 1 2 Construction 1 Transportation & Public Utilities 3 4 21 Service 19 Government 6 4 Trade, Finance, Etc. 11 9 Self-Employed & Doaestics 6 4 - 2 - October 25, 1943 Agriculture trill end the war with a labor surplus. Manufacturing will hare to decline substantially^ Automobiles will not employ as as aircraft^ Mining will not increase. Transportation and public utilities are likely to contract. Construction is only industry which will increase materially. Government will contract substantially^ trade, finance, and service will increase and must* Self-employed and domestics will increase. R. A. If. October 26, 1943 POSTWAR BUSINESS AND FISCAL POLICY For the Duration of the War, Present taxes are estimated to yield $40 billion in the current fiscal year, as against $104 billion of expenditures. Higher taxes are imperative in order to (1) assure continued success of the stabilization program (the excess of income payments after personal taxes over available consumer goods is estimated at &40 billion for the present fiscal year), and (2) to assure a sound postwar economy (if present methods of finance continue, liquid assets in the hands of the public may amount to $200 billion at the end of the present fiscal year and f250 billion by June 1945) • ?/hereas Britain covers one-half of its expenditures by taxes, we cover only about one-third] while the United Kingdom and Canada respectively collect 42 per cent and 36 per cent of their -national income in taxes, we are collecting but 32 per cent* Host of the additional taxes must be collected ?&ere the bulk of the purchasing power is found, that is, from taxpayers with incomes of less than $5* 000, and much of it must be collected from taxpayers with incomes of under $3,000. But this does not establish a case for a general sales tax. (Ratter, a sales tax now *ouLd induce a tremendous pressure for wage increases*) On the contrary, equity in taxation becomes the more important the lower are the income groups which have to be reached* Exemptions, to be sure, should be lowered, but the principle of granting exemptions should not be discarded. Hence, the general approach must be along the line of the income tax, together with higher excises on non-essential products. A good part of the additional taxes should be refundable. This is desirable (l) as a matter of equity (refunds should be applied particularly to the lower in cone groups), arid (2) because refundable taxes (or compulsory savings) are much safer from the point of view of inflation control, particularly in the postwar period, than the bonds purchased under the voluntary plan* The latter point is vexy important* TTe must begin to place more enqphasis on the postwar implications of current war finance* (See special statement on postwar liquidity*) It goes without saying that the Government should make the utmost effort to avoid wasteful expenditures* At this point, however, it is better to have an all-out war effort, even though this may involve a billion or two of outlays not absolutely essential, than to cut war expenditures drastically and to operate on a, say, $75 billion — or 75$I— war effort! The Transition Period. The problem will depend altogether on hoer gradually the war terminates, that is, on the length of the Pacific war after Germany is defeated* Demobilisation of military personnel should be gradual if possible# But industrial reconversion to peace time production should be as rapid as possible. Contract cancellation should be speedy, and should be left in the hands of the contracting agencies. $hore necessary, financial assistance trill have to be given to expedite reconversion, but by and large, the financial position of corporations will bo strong. (See special statement.) It will be to everyone's interest in the transition period to maintain wartime controls* For industry, a prematura relaxation of controls and sharply rising prices would clean an enormous increase in reconversion costs. For labor, a rapid increase in living costs would be equally disastrous. However, industry should not attoiapt to break wage scales in this period; ~ the active support of labor is needed to avoid postwar inflation and industry itself will need high wage rates after reconversion to be able to produce to capacity. The role of fiscal policy in the transition period will be to cut expenditures rather than taxes. Every effort will have to be made to reduce the deficit to a minimum, so as not to aggravate the inflationary pressure. Postwar Period. In the postwar period, industry will be faced with a tremendous task. It will have to employ at least 56 million people, that is, 3 million more than were employed in July 1940. As a result of the enormous increase in productivity during the war years, this will mean a gross national product of at leastf 160 billion at 1942 prices. The future of private enterprise will depend on its success in meeting this goal. Policies will be required which in many respects will differ drastically from those accepted in thef2Qfs and f30fs: (1) Industry must show an aggressive spirit of expansion. Individual savings at the indicated level of income are estimated at about $20 billion, and corporate savings may amount to 010 to tl2 billion. Depending upon the level of corporate savings, industry will thus have to make investments amounting to $20 or $30 billion per year — a volume vastly in excess of anything experienced in previous peace years. Certainly, industry will not succeed in this task should it continue to retain large portions of its income. More reliance must be placed on equity financing and the bulk of funds not actually spent for investment must be distributed to the stockholders. If full employment is to be achieved , there trill also have to be a vast increase in consumption — say, $110 billion as against $70 billion in 1939 — much of which will be directed to the services, health, education, etc* (2) Industry must be flexible and competitive. The technological advance umich has been so enormous during the past years must be reflected promptly either in higher wages or lower prices. Vigorous competition must assure the expansion of our economic frontiers and the development of now products. Only if industry lives up to these basic mores of our economic system can it hope to succeed to provide full employment at a level of peacetime production of §160 billion or more. (3) The role of fiscal policy in the postwar period will be to encourage full employment under private enterprise. (a) Taxes will have to be revised to encourage consumer speeding and not to discourage enterprise. In particular, we shall have to cut consumption taxes and income taxes paid by the 1cmer income groups which are the bulk of business* customers. We shall have to raise exemptions and again reduce the number of income taxpayers to a smaller group. The corporation income tax should be abolished (with the exception, perhaps, of a small franchise tax) and corporate income should be taxed to the owners of the corporation. However, provision should be made to make it impossible for stockholders to evade individual income taxes through non-dis tribution of corporate income. (b) Jnablic expenditures should be economical. If industry does the Job of providing full employment, the Government should limit itself to essential expenditures which do not interfere with but strengthen the activity of enterprise. Even under these considerations, however, the Federal Budget in the postwar period may well approach $20 billion. (c) Economic freedom requires that no citizen should suffer unnecessary want. To assure this freedom, Social Security should be expanded greatly as proposed under the Wagner Bill. Also, an expansion of Social Security will make it possible for individuals to accumulate less savings and to consume more, thereby assuring a higher level of employment and income. (d) If industry and government work hand in hand in the task of providing full employment under private - u - enterprise, they will jointly develop a flexible fiscal policy which in times of need will take up the temporary slack in business activity and at other times apply curbs against inflationary spirals. For such a policy to succeed, it is absolutely essential that the business community should participate and have full confidence in the formulation of fiscal policy. International Trade. To take its place in world commerce> the basic task confronting the United States is the maintenance of full employment and a high level of income at home. If this condition is met, Americans will be able to buy abroad, and African industry will be in a position to compete with other countries.