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o p I July 19, 1946. Dear Captain Clifford: In accordance with your suggestion following the meeting in the Cabinet Room last weeK, I have prepared an informal memorandum outlining my own general opinion on what can most appropriately be done now to deal with the inflation problem. As you know, I feel that whatever the future of GPA may be, it cannot do the job and the only alternative is to present a most vigorous fiscal program coupled with econoiBy and deferment of all needless expenditures, public and private. I am fully aware that Congress will be cold to any tax plan, but if the President should put it up to the Congress, I feel confident that the leadership would be universally approved and the responsibility for failure to act would not be on his shoulders. Anyway, 1 have outlined trds general viewpoint in the informal memorandum which you suggested I send directly to you. Accordingly, enclosed is a brief note to the President as well as the memorandum. Sincerely yours, L S. £ccles, Chairman. Captain Clark M. Clifford, The ihite House. Enclosures c 0 p Y July 19, 1946, Uy dear Mr. President: It was suggested, following a conference in the Cabinet Room last week among your advisers who are particularly concerned with the inflation problem, that I prepare an informal memorandum outlining in a general way the views I expressed at that time. Accordingly, I have ventured to do so and I enclose a memorandum for whatever aid it may possibly be to you in dealing with this ciost pressing and difficult problem. Respectfully yours, M. S. ficcles, Chairman. The President, The White House. Enclosure As a result of the nar, the country Is confronted with an Inflationary danger -which ootild have very grave consequences. War finance, chiefly beoause of heavy reliance oa borrowing from the banking system, expanded public holdings of liquid assets frora about 71? billions in the Middle of 19Ul to xaore than 220 billions by the ead of 19U5» At the sans tine a huge volume of baoklog deaaxtd aooumulated* Inflation was avoided during the war years only because the economy was harnessed in a system of direct controls* Since the war, the pressures of demand have increased s t i l l further* Consumer income: after taxes are above the wartime peak aad the rate of savings has fallen sharply* Corporations are in a highly liquid position and large, amply financed foreign deaands compete with domestic buying* At the same t i n e , direot allocations, building permits, wage and price controls, and rationing have been abandoned or greatly weakened, H adequate fiscal adjustments have beenraadeto compensate for the; O impairment of direot controls* As a result. Inflation pressures haws been rising and prise controls have become increasingly unequal to the task of holding the line* Conditions have thus been created under which no price control measure, much less a weakened b i l l , can now be expected to function effectively* Direot controls, enumerated above, which are; necessary t o reinforce price controls cannot be effectively reestablished* The months of uncertainty preoeding the current legislation, the long delay by Congress in getting the b i l l enacted, aad the drastic cutting of appropriation* to administer such controls as might be tended, all compound the difficulties of continuing offoot ire prioe controls• Unworkable price controls would bo worse than none. Production is the ultirmte a n e w to the inflation problem* That takes tine. It is imperative meanwhile that ways be found to cheek the excessive demand* Since effective direct controls cannot be reestablished, other scans must be found far dealing with the problem. The three most important aret (1) Reduction of public expenditures and raising of taxes to achieve as large a Federal budget surplus as possible, (2) Elimination of unnecessary expenditures* private* state* and looalj (5) Curtailment of credit and disposal of Government surplus* PXSCaL POLICY During t he deflation of the 'thirties, fiscal policy required a budget deficit, putting more purchasing power into the eoonomy through public expenditures than was taken out through taxation* How, under reversed conditions of Inflation pressure, a budget policy is called for which will take more purchasing power out of the eoonomy through taxation than Is returned through public expenditures* A fiscal policy which brings about a substantial budget surplus is by far the most effective means left at our disposal to meet inflation pressures* Unless the Governawnt sets the example in greatly reducing its expenditures and increasing Its savings, the people oannot be -3- expeeted to follow the Government»s admonition to postpone their purohases nod to taaintain thoir savings, (1) Eeduotioo of Expenditures, the expenditure outlook la the budget ha« deteriorated during reo«?nt «a©nfch«. Expenditures for the fiscal /ear 19U7 are now estimated at a l i t t l e over kO billion dollars, without allowance Itor tfc« terminal leave b i l l . 5 billion over the January budget estimate* ?hls la an Increase of Jiearly one-half ef the budget i s for national defense expenditures «hi©h have continued at a Tery high level, despite the faet that the war ended nearly a year ago, that large supplies of every kind were left after '/-J Day, and that the amwd forces have been reduced te about 20 per oent of their wartine strength* Large sums are s t i l l being spent Star construction that oould be postponed and farther supplies whleh are not urgently needed. Searee Material and labor are thus being diverted frwe acutely pressing civilian needs. To remedy tills situation, a l l pro* oureswnt and oonstruotion activities under the national defense pro* gram should be screened* All those which are net of an fcsaedlately urgent character should be postponed. To this end, i t is reessusendod that a committee be appointed, te include proainent representatives of civilian groups, and that this cosa&itte* be Instructed t e reeonmand reduction* or deferments of national defense expend it ires, aggregating net loss than 5 billion dollars. These expenditures should bo deferred for the reminder of ttie current fiscal year or until dangerous inflation pressures no longer exist. While It is evident that mjor budgetary savings will have to coiae la -tii« defence program, other non-urgent Federal expenditures should also be deferred or reduced, especially those on public works. The terminal leave b i l l i f framed to provide for cash pay* raents will bo highly inflationary. 8very effort should bo nude to provide for payment at suoh tine when deflationary pressures are developing:. This w i l l Help to stabilise the eoonoa^ and w i l l bo in the interest of the veterans who will bo able later on to obtain no re and better goods Jbr their money. Public agencies, finally, should defer for the tis» being a l l food purchases for relief purposes. I understand that foods currently purchased will not add to deliveries to foreign countries prior to their harvest. Accordingly, temporary postponement of purchases until xoro anple supplies are available in the Aasrloan mrket would not impair the relief progran. (2) Inoroase of Taxes, tax reductions provided for in last year* s legislation have produced a revenue loss of about 5 b i l lion dollars. Had rates boom Maintained and expenditures been kept within the limits of the January budget estiraate, a budget star plus possibly of 10 billion dollars oould have boon achieved for the current fisoal year. Instead, no surplus i s in s i g i t and * deficit i s in prospeot. To correct this situation, curtailatent of expenditures will not bo enough. To provide additional revenue, and particularly as a fiwans of reducing pressures for hi^ier price a and increased wages, -5the excess profits tax should be reinstated. In addition, taxation of capital gains should be tightened. (a) Excess Profits Tax* It is now being widely recognised that repeal of the excess profits tax was premature. The repeal came at a time when it was expected that other controls would be continued and when there was widespread fear of impending unemployment and deflation. Since these assumptions have proved to be unfounded and present conditions are entirely different from what was expected, there is every reason for restoring the tax. The annual rate of corporation profits before tax may in the course of this year reach the wartime peak, which would leave profits after tax greatly in excess of the wartime high. As reconversion is completed and as prices continue to rise, profits will increase generally. Since they are essentially wartime profits, they should be subject to excess profits taxation. Based on inflation prices, they are paid for by the publio for whose benefit they should be recaptured through the budget and used for debt reduction, the excess profits tax would not only assist in creating a budgetary surplus but it would exert a powerful influence in discouraging excessive pricing by corporations, and in helping to reduce industrial unrest and demands for increased wages during the inflationary period. -6(b) Capital Gains Taxation* the present tax treatment of capital gains, under the individual income tax, encourages speculation. Gains from assets held for only 6 months are treated as if they were long-term gains, they are taxed at a preferential rate of 25 per cent instead of at the much higher surtax rates applicable to other income. The speculation thus engendered is especially harmful in driving up the prices of homes and farms which are at highly Inflated levels* Accordingly, it is proposed that long-term gains, taxed at the preferential rate, be redefined to mean gains from the sale of assets held for two years or more, the new provision should be made applicable to gains from the sale of assets purchased after July 1, 19U&. This would discour- age speculative purchases for the short-term and would thus reduce demand. As the new provision would not apply to assets acquired prior to this date it would not reduce supply. If inflation pressures continue to increase after curtailment of budget expenditures and application of these tax measures, an increase in excise and personal income tax rates should be considered. In making these tax recommendations, I recognize that there is little likelihood of Congress accepting them at this time, but it is the responsibility of the Administration to recommend what is needed. ELIMINATION OF UNNECESSARY EXPENDITURES Having shown the way by carrying out a drastic retrenchment of its own expenditure program, 12ie Federal Government should appeal to all other spending units—States and localities, businesses, and consumers—to follow suit. State and local governments should be urged to postpone all possible public works and construction projects until the inflationary danger has passed. They should also be urged to maintain State and local taxes at a high level in order to build up a surplus for a later period of need. After the necessary adjustments in the Federal budget are made, the President might call a conference of State Governors to promote cooperative action. Businesses should be called upon to defer capital expenditures wherever this is practicable and to refrain from building up unnecessary inventories. Non-residential construction should be curtailed more vigorously and high-cost residential construction should be deferred altogether. Only if construction expenditures and capital formation are thus curtailed will it be possible to meet the urgent needs for veterans and low-cost housing. Finally, e-rery appeal should be made to consumers to exercise the greatest self-restraint in their purchases, and not to follow prices up. -8- CUSTAILMEKT OF CREDIT Public agencies which extend credit directly, or guarantee or regulate credit, should be requested to do whatever they can to bring about curtailment of credit except as it may be essential to maintain or increase production. At the same time consumer credit controls should be maintained at full strength. In addition, the situation would be further helped by expediting as far as possible disposal of surplus Government property and inventories, this would not only help to relieve shortages but would also bring in revenue to the Government and thus improve the budget situation* X am aware that the program here proposed is drastic and difficult to carry out. The alternative, however, may well be an inflationary spiral which would undermine the basis for prosperity at home and the foundations we have laid for international reconstruction.