View original document

The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.



Bear Mr, Chairman:
At the request of Secretary Morgenthau, I am enclosing, in strict confidence, a preliminary draft copy
of a proposed statement to be made before the Senate
Finance Committee regarding the tax bill*
The Secretary has asked me to say that he would
very much appreciate it if you would discuss the
statement with him at his office Wednesday, August 6
at 9 A* M«
Sincerely yours*

Director of Tax Research

Honorable Marriner S* Secies,
Chairman, Board of Governors,
loom 20U6
federal Reserve System
Washington, D. C.



August k,
9 A, M.
Mr, Chairman and members of the Committee:

I am

here today to give my support to the pending tax bill
H. R, $^-17 designed to produce 13,500,000,000 annually
in additional revenue for the defense of our country.
When, on April 2 1 , I made my statement before the
*House Ways and Means Committee on this 6111 the defense
program was about #39 billion Including the lend-lease

Since that time there have been further

authorizations and appropriations so that the total program at the present time has risen to


Of course, not all of this amount is going to

b® spent in the present fiscal year, but as these appropriations are spent the fiscal problems of the
Government and the economic effects of the defense program will both increase.
Our great problem in providing for the defense of
the nation is fundamentally the problem of production;
of actually building planes and tanks, ships and guns
with the labor, management, machinery and raw materials
which we have in our country*

As we increase this

- 2 production we shall find that it will be necessary to
divert to defense production more and more of the resource s now engaged in satisfying our civilian needs
and wants. The pinch of scarce resources and plants
is already being felt and it may be expected to become
more aggravated.
Rising prices.
At the same time as this diversion of production
is taking place, the amount of purchasing power in the
hands of the people of the country will continue to increase due to the large amounts being spent by the
Government and to resultant fuller employment.


result of the pressure of this increased purchasing
power on the limited amounts of goods and services for
which it may be spent threaten, in the absenoe of vigorous action, to sweep us into a spiral of rising prioes.
Apparently we are at the same point in price history as in 1916 —

on the edge of inflation*

The pattern of price rises during the past two
years roughly resembles the price movement during the first
two years of World War I —

little rise in the cost of

living, a moderate rise in the wholesale price index and
a sharp rise in the prices of basic commodities*
Since the beginning of the war, September 1939, the
wholesale price index has risen from 65 to fj or about

- 3 16 percent, fhe greater part of this rise has occurred
during the past five months.
fhe cost of living index has increased 5i percent
since September 19^0. Half of this Increase has occurred
in the past two months.
fhe price index of 2& basic commodities has increased
K$ percent during the same period, despite the fact that
the prices of many basic raw materials have been controlled by the Office of the Price Administration and
Civilian Supply, this increase constitutes a major danger signal of inflation which must not be ignored, fhe
wholesale price index always lags greatly behind the index of basic commodities, while the cost of living index
does not show anything like the full effects of inflation
until long after the seeds of inflation have taken deep
Forces making for price rises.
fhe forces making for further price rise are both
potent and persistent!
(1) fhe Budget estimates defense spending during
the fiscal year 19^2 will be |15 billion or two and one
half times as much as in the fiscal year of 19M-1. fhls
Increased estimate does not take account of extensions
of the defense program made after June 1 and of additional sums needed for 1end-lease.

(2) More Important in its bearing on the danger of
inflation than the figures for expenditures of the coming year are the estimates of deficit spending. The
net deficit for the fiscal year 19^2 as estimated by
the Director of the Budget will be I12.& billion compared with t5»l billion for the previous fiscal year,
fhls assumes the present tax structure*

If the $3,5

billion tax bill which is before you is passed by
Congress at an early date the deficit will be reduced
by about %2 billion (the amount of revenue yield in the
fiscal year 19*1-2 of the $jfr billion total) but it will
still be over $10$ billion. Again this estimated
deficit does not take account of the expansion of the
defense program tffter June 1, 19*1-1»
(3) fhe inflationary force of the Federal deficit
has been supplemented during the past year by an expansion of bank credit. Total bank loans expanded by
an estimated $3 billion or about 20 percent during the
fiscal year Just past. This rise moreover has been proceeding at an accelerated pace*
(4-) Prices will be increasingly stimulated by
(a) the shortage of materials for civilian goods
(b) increased absorption of idle capacity in many industries and (0) further Increases in agricultural

-5pricee and wages.
Also making for further price Increases are the
heightened obstacles to imports such as reduced ship
space, higher shipping costs and cutting off of normal
foreign sources of supplies*
Although there are some factors In the situation
operating to check the inflationary trend, such as surplus stocks of some agricultural commodities, unemployed
labor resources and partially employed production facilities! most of these factors were present in the
fiscal year 19^1 in greater degree and yet did not serve
to restrain price rises even though the forces making
for price rises were then much weaker*
Steps already taken to check inflation.
Some Important steps have already been taken or
are being taken to check inflation*

Congress has made

provision for the Treasury to sell Defense Savings Bonds
and Stamps and so to absorb for the defense program funds
which might otherwise be used for civilian purchase of
goods. This very Important program is well under way.
The Treasury Department has also launched a plan
for selling tax anticipation notes which will facilitate
the prepayment of Income taxes and will more promptly
withdraw purchasing power represented by such taxes.

- 6The Office of Price Administration is making every
effort to obtain the cooperation of producers and distributors in limiting price rises.
Additional measures necessary*
These measures to restrain prloe rises, although
they hare unquestionably been helpful, are inadequate to meet
the situation confronting us. We have gone only a small part
of the way It will be necessary to go. We mist attack the
problem on all fronts if we are successfully to check inflation.
My purpose in talking to you today about this subject of inflation is primarily to indicate the ways in
which the tax program can be designed to help minimize
the dangers of inflation, fax legislation, however,
will not, by Itself, solve the problem.

The control of

inflation Is too great a load for fiscal policy alone to
Accordingly before discussing taxation I wish to
refer briefly to other lines along which action should
be taken.
(1) The Office of Price Administration should be
given the statutory power to fix prices where necessary.
The legislation which the President has requested is
essential. Price rises cannot be controlled when inflationary forces are at work without effective power

— 7 —

to Impose price ceilings enforced by direct penalties,
fhe mere possession of such power tends to make its
exercise unnecessary.
fhe attempt to prevent unwanted price increases " y
fiat, however, is bound to "break down here as It has
elsewhere unless it Is accompanied not only by an adequate fiscal program to absorb buying t>ower, but also
by other methods.
(2) Vigorous steps should be taken to Increase the
supply of goods required for military and civilian needs.
Increased output Is in itself a major objective of our
defense program and the most effective and desirable
method of preventing Inflation,

fhere should be fur-

ther exploration of the possibilities of Inducing
expansion of production facilities and labor supplies
where suoh response could not be expected to occur automatically.
{3) fhere should be authority to provide systematic
priorities of scarce supplies among Industries making
divillan goods. In order to obtain a fair distribution
of scarce supplies among consumers it may later prove
necessary to extend the rationing to ultimate consumers.
(k-) Ixtenslan of the general controls over bank
credit may be found desirable.

(5) Establishment of controls over the entire field
of consumer credit will undoubtedly be necessary.
(6) Controls over capital expenditures should be
(7) It may be fofUad desirable to extend the Social
Security Program along lines which would increase the
flow of funds to the Treasury from ourrent incomes during the emergency and would Increase the outflow of funds
when needed in the poet defense period.
(6) There should be a reduction of the Federal
lending and underwriting program, such as nonemergenoy
housing expenditures and mortgage guarantees.
(9) Sonessential Federal expenditures should be
reduced. In my statement before the Ways and Means
Committee I pointed out the desirability of reducing
such expenditures by one billion dollars. An appeal
should also be made for economy in State and local governmental expenditures and for curtailment ©f their
borrowing for nonemergeney expenditures. Such curtailment would not only cut down expenditures during this
period but would build up a back log of desirable projects
for the Dost-defease period when publl® worlts expenditures
may be badly needed to maintain the economy.

-9 fiical policy for Inflation eontrol.
liven with these controls in operation —

and I

urge upon you the necessity of placing them in operation —

a strong fiscal policy for inflation control is


The tax bill before you is an Important

When I appeared before the Ways and Means Ooaaalttee

in April, I recommended a tax bill to yield #3.5 billion of
revenue annually above the yield of the existing tax structur*.

If at that time I could have foreseen the accelerated

rise in prices and the great increase In the defense program
which have since taken place, I should have asked for mor©
than #3.5 billion.
fhe Ways and Means Committee of the House has labored
long and well on this bill and I am not suggesting that
you increase the total amount of revenue which it provides,
fo Increase its revenue yield substantially might result
in delay, and passage of the bill is important.
When this bill has been passed, however, and you
and the members of the Ways and Means Committee have had
an opportunity to enjoy a well deserved rest from the
arduous labors which it has entailed, I hope you will
undertake, as the Treasury has already undertaken, to
make a new survey of our tax system.

It is now some

- 10 years since the tax system has been examined with respect to the many technical changes which fro® time to
time are found necessary as a result of experience, new
court decisions, and other new situations. Both the
taxpayers and the Government suffer as these uncorrected
faults accumulate.

Such matters have been kept out of

the present bill in order to expedite its passage and
not to complicate the issues which it involves, but they
should be taken up yet this fall.

In addition to cor-

recting the faults in our tax structure, it will again
be necessary in the light of the present program for
defense expenditures and the threat of Inflation to
increase further the revenue power of the tax system
either late this year or early next year»
From present indications, if the control measures
which I have mentioned are placed inti operation, and
if the tax bill is promptly passed providing not le»i
than #3*5 million of new revenue, it is my hope that
the situation will remain fairly healthy until the early
date when another tax bill designed to absorb substantially more purchasing power can be considered and passed*
Excess profits tax.
Within the #3*5 billion revenue scope of the present
tax bill there appear to be several possibilities for

- 11 discouraging Inflationary price rises, the first of
these is In the field of excess profits taxation.


recent months there has been a noticeable tendency for
various groups Including business men, farmers and
laborers, to endeavor to secure higher rates of return
In profits, prices and wages. Such efforts cannot be
criticized in normal times. At the present time, how*
ever, with the existing pressures for inflation,
widespread efforts to increase profits, prices, and
wages will result not only in larger purchasing power
and thus still greater pressure on our limited supplies
of civilian goods, but also In higher coste for the
defense program and for goods which civilians purchase.
These higher costs In turn necessitate increases In
prices and these in turn ive rise to new demands for
higher wages and higher prices. The spiral goes up and

If w« are to expect to stop or prevent this spiral
we must be able to show those who receive modest incomes from their labor or their production that excessive
profits are not being received by great corporations.
The present excess profits tax places special heavy
taxes on profits which are in excess of the profits received during the years prior to the defense program.

- 12 This Is a l l to the good, — i e ind*«d e s s e n t i a l .
temrm$w9 not mmgh.

It Is,

A ©orpor&tloa mf mmk9 50 p«r®nat

profit on i t s Invested eapital and not be subject to the
#3t©t8i profit® tax If th#s T>rofIt i t not In «&©«»» of
95 t>#ro#nt of I t i averag* profit* during t&# ba«« ptriod

1936 t© 1939*

Wil« "bftilo v*akatta l» feuai in the

l«w aaA a l t o 1R tht b i l l b#f©r« you.
t h i s i t aot « a a t t t r of minor l*aortftna«*


numbere of <soinpfini@@ B.r% In the bl^h-orofit

0n« out of flT# pro f i t - a i d i n g oorporntlont
of |l,OOOf0C^ ant ovtr avtrag«d more tiian 10

©tat n t t inooat on t h t l r r®p©rt#& ftquity empltal during
%hM ytar® 1935 to 193S and ©a* out of t%r#nty-flir« ©oatpanics av«r®g#d ®or# tlian 3^ p«ro#at.
ean continue to tarn profits

%#«» eospani««

t virtually theef? rates

without psjlfig ©KOtst profits tax und«r «lth«r the pr#sent lav or tii« Committee's tentntiv© plan*
Fmilurt to &pi>ly •xe#st p r o f i t s ttix^tlon to suoh
profits 1© unfortunatt also bte&itPt of tb« un*
way In vhioh oompttli^ buslnaetft* ar© affnettd.
Concerns which have h&m making high returns in tha
bast period ytar® ar# giv#n m o o a p t t i t l v s mdvnatag*
0"r#r n«vly orgaalxad oonoemi or eonotmt i«iiioh havt
struggling to «fttabllah th«a««lT«it«

Th$f may

- 13 receiye free from excess profits tax a much higher rate
of return than their new and growing competitors. The
effect is to confirm monopolies In their control and to
protect well established businesses against competition.
Moreover the capaolty of a corporation to pay taxes
Is affected by the rate of Its return on its investment.
The highly prosperous, well established corporation which
has been making 3°» *W» 5° percent or more on Its inTested capital has amuoh larger ability to pay taxes
than a corporation which has been earning only "},ty,or 5
percent on its Invested capital even though the dollar Incomes of the two companies are the same. Heavy
taxes on higksgrates ©f profit will not oause the business receiving them to be liquidated or discontinued
for lack of a minimum necessary profit, which may occur
when heavy taxes are imposed on meager profits. Application to corporations of taxation in accordance with
ability to pay calls for higher taxes on the profits of
those corporations which have the higher rates of return.
Defense excise taxes.
In more normal times excise taxes have little to
recommend them except the fact that they produce revenue.
In a period such as this, however, excise taxes may in
certain oases promote a more positive objective, namely,
to reduce the demand of producers and consumers for

-1* scarce commodities which compete with the defense program and to absorb wind-fall profits which result from
scarcity of supply relative to demand.
The achievement of this objective is not a simple
matter. It would be unwise to Impose numerous excise
taxes at low rates• The result would be to clutter up
the tax system while not effecting the desired control*
It Is not possible to handle In the same manner all commodities which It Is desired to tax. Some may require
one kind of treatment and others another kind.


theless, the further use of excise taxes to divert
consumption and to reduce wind-fall profits should be
seriously considered by your Committee*
For example, the tax on passenger automobiles
might well be made such higher than the 7 percent adopted
by the House, The production of passenger automobiles
will undoubtedly have to be greatly restricted*


tions as great as one-half have been mentioned.

It will

be extremely difficult under such circumstances to prevent retail price rises on automobiles, A high excise
tax will help to prevent these higher prices from giving
unwarranted wind-fall profits to dealers and middlemen.
Such taxes will not likely increase the prices of automobiles to consumers much beyond what they otherwise
would be with the restricted supply; to the extent they

- 15 do increase prices they will reduce the need for rationlag purchases by consumers.
Personal exemptions.
One feature of the bill before you which has received less public attention than It deserves is the
fact that the base has been broadened to add about
2,000,000 new taxpayers, fhls was accomplished by beginning the surtax at the first dollar of surtax net
Income, the 10 percent earned income credit In effect
Increases the exemption fro® normal tax*

Since this

credit Is not applicable In computing the surtax, the
bill has In effect reduced the exemption of single individuals by |SS, of married couples by $222* and of
married couples with 2 children by $311.
In the early stages of this bill the Treasury
Department took the position that in view of this substantial broadening of the base personal exemptions
should not be further lowered. Equitable taxation requires that taxes be placed on ability*

Small incomes

have very little taxpaylng ability, and this little Is
decreased as the cost of living rises*
However, the threat of rising prices has become so
great that a change of policy Is Indicated.

If the

cost of living rises substantially the effect will be
to tax small Incomes much more than would an income tax

- 16 ~
at the rates provided in this bill*

If th© direct

taxation of these incomes will help, as we believe it
will, in preventing inflation it will be a great service to the very groups which would be made newly subject
to the tax.
Accordingly, m the light of the developments of
the past few months It is our recommendation that the
personal exemptions of both single and married persons
be substantially reduced so that the income tax will
reach a much larger percentage of the national income
and will affect a much larger percentage of the persons
of the country than It does at present.
Alternatives to taxation more onerous.
In closing my remarks I desire to point out that
although this Is a very heavy tax bill the alternatives
to heavy taxation are much more onerous. Rising debts
and rising prices would take much more away from
our people both now and in the future than higher taxes
now will take* Our defense program Is an absolute necessity*

It must be paid for. It should be finally

paid for now insofar as possible, thus reducing the
necessity for higher taxes later when they may be harder
to pay and less willingly paid than now*


Statement of Secretary Morgenthau
Before the Senate Finance Committee
August 8, 1941.
Ify purpose in being here today is to
discuss taxation as an essential part of
national defense. Our great problem in
providing for the defense of the nation is
fundamentally the problem of production —
of actually building planes and tanks,
ships and guns with labor, management,
machinery and raw materials• To solve that
problem without impairing our economy or
weakening the structure of democracy, our
fiscal policy must be adapted to the needs
of the times„
On April 24 I discussed with the Ways
and Means Committee of the House the need of
producing $3,500,000,000 annually in additional revenue* The Treasury Department presented a suggested program for raising that
amount of money. As it passed the House, this
bill will produce approximately $3,200,000,000
annually in additional revenue. In my opinion


- 2 it is very important that the revenue yield be
raised to at least the original $3*5 billion level.
It is also important that the bill be passed as
promptly as possible. Income taxpayers and excess
profits taxpayers should know as quickly as possible what their taxes on 1941 income and profits
are going to be, since more than seven months of
the year have already elapsed. The excise taxes
and the estate tax cannot be imposed retroactively
and every day's delay in the passage of this tax
bill costs the Treasury several million dollars in
revenue from those sources*
The rapid developments of the last few months
have made this bill inadequate even before it is
passed. Since my statement before the Ways and Means
Committee, many things have happened*

Two and one

half months ago the President proclaimed the existence of an unlimited national emergency. He called
upon "all loyal citizens to place the nation's needs
first in mind and in action to the end that we
may mobilize and have ready for instant defensive


- 3 use all of the physical power, all of the
moral strength and all of the natural resources of this nation/1
Since I appeared before the Ways and
Means Committee, the amount of appropriations,
authorizations and recommendations over and
above the Budget has increased by about
$14,000,000,000, thus completely changing
the fiscal picture and greatly increasing the
need for revenue*
Since I appeared before the Ways and
Means Committee, prices and the cost of
living have increased at an accelerated rate,
thereby accentuating the need for a strong
fiscal programo
In the light of these and other developments resulting from "all out" defense, I
should like to point out what, in my opinion,
will be necessary in "all out" taxation to
support such a program.


- 4 First of all, we shall need more revenue —
much more revenue. The defense program is
an absolute necessity. It must be paid for.
Insofar as possible, it should be paid for
now. Borrowing should be kept to a minimum to
maintain our fiscal strength,, The rise in
the Federal debt means merely that the
taxpayer's burden is being postponed—that
both principal and interest must be paid
later out of higher taxes collected at a time
when they may be harder to pay and less
willingly paid than now0
Along with increased taxation should go
the maximum reduction in the ordinary non-defense
expenditures of Government. The burden of
paying for defense is so heavy that it should
be relieved at every possible point*
Increased taxation is needed also to
maintain economic stability. Rising purchasing
power is exerting increasing pressure on the
prices of many kinds of goods, while at the
same time production of these goods is being


- 5 increasingly curtailed by the necessity
of diverting our resources to defense uses.
This complication of increased demand and
restricted output is causing inflationary price
rises which threaten to increase the cost of
the defense program, unbalance family budgets
and seriously disturb our economic life.
This larger needed revenue should come
from all sources where there is ability to
pay — that!s what an "all outtf tax program
means. The people of this country have never
been more ready to make sacrifices for the
common good. Our tax program has not kept
pace with the defense program. HVe are still
thinking too much of helping this group or
that to escape its share of the burden.
We have now come to the point where it is
a matter not merely of fundamental equity,
but of the utmost necessity that all exemptions
from taxation be reduced to the absolute
minimum c


- 6 An "all out" tax program for defense
should reach ability to pay at several points
not now fully tapped;
1. In my opinion such a tax program
might well involve a substantial lowering of
personal exemptions and a consequent broadening of the base of the income tax, if simultaneously we take immediate steps to remedy
defects in the application of the principle
of ability to pay in other parts of the tax
structure. Under the bill before you, the
base has been broadened to add about two million
new taxpayers, but even so there will remain a
relatively large proportion of the population
in the lower income groups which will not be
directly affected by the income tax. A
further lowering of the exemptions would produce some additional revenue and in addition
it would give millions of Americans an opportunity — a welcome opportunity — to make a
direct contribution through taxes to the


- 7 defense of their country. It would enable them
to feel that they were participating personally
and directly in the defense program. As the
President wrote to Chairman Doughton on July 31,
"Most Americans who are in the lowest income
brackets are willing and proud to chip in directly even if their individual contributions
are very small in terms of dollars/1
But I believe this Committee will agree
with me that we ought not to accept such
sacrifices, even though willing sacrifices,
from millions of people with low incomes on
whom the burden of other types of taxes falls
most heavily, unless we reach in other places
ability to pay which is escaping its fair
share of taxes« Among these are the following:
2. The excess profits tax exempts profits
of even the most prosperous corporation, except
to the extent that such profits are in excess
of its average profits for the years 1936-1939„
Surely Congress will not wish to impose


- 8 additional taxes on millions more of our low
income group, unless it also imposes the excess profits tax on the exempt excess profits
of such corporations,
3. Families pay lower Federal income
taxes when both husband and wife receive income than when the same total amount of income
is received by only one of thenu

This is a

discrimination of which many wealthy people
have taken advantage by large gifts of incomeproducing property between husband and wife.
Furthermore, in at least eight States of the
Union, Federal income taxes are made substantially lower than in the remaining States because the local law permits the splitting of
income between husbands and wives 0 Here are
discriminations against the rest of the taxpayers which, I believe your Committee will
agree, must be eliminated if we are to extend
the income tax downward to include millions of
persons with low incomes. The discriminations
can be eliminated by requiring husband and





wife to file a single joint return with appropriate relief granted only where both husband
and wife work outside the home*
4. For years, the concerns engaged in extracting certain of our natural resources, notably oil, have been granted far greater allowances for depletion than can be justified on any
reasonable basis of tax equity. If the income
tax is to be extended to lower incomes, this
privilege of tax escape should simultaneously
be removed.
5* A few months ago, the Congress eliminated
the tax-exemption privilege from new issues of
Federal securities. The purchasers of new State
and local securities still enjoy this exemption.
The exemption was inequitable and expensive even
in more normal times. It cannot be borne longer
in a time like this, and especially if we are to
increase the direct tax burdens of persons with.,
small incomes.


- 10 6. In its suggestions to the Ways and
Means Committee, the Treasury recommended substantial increases in estate and gift taxes,
and lower exemptions. In part, this recommendation was followed, but, in my opinion, the estate
and gift taxes should reach more estates and provide more revenue if we are going to tax smaller
Those are some of the things that I mean
when I say that an "all out" tax program for defense must go far beyond the present bill.
There is another condition which I would
attach to lowering the personal exemptions. I
think we ought not to take into the income tax
system millions of new taxpayers with small incomes without simplifying the way in which their
tax is computedo
Take, for example, a person with a $900

Under the present law, he first figures

out what deductions he has — taxes paid, interest
paid, contributions and so on. Then he computes


- 11 his earned income credit„ Then he subtracts
his personal exemptions from his income after
deductions. On the balance, under rates of
the bill before you, he computes a surtax at
5 percent. Then he goes back to the income
and deducts his earned income credit. On the
balance, he computes a normal tax at 4 percent.
He then adds the normal tax and the surtax and
takes 10 percent of the total for defense tax.
He adds the defense tax to the normal tax and
surtax and finally arrives at his income tax.
When he started to fill out his return,
he may have been full of patriotic enthusiasm
to pay his share toward the defense program,
but by the time he has finished his last computation his cheerfulness may well have collapsed under the strain,, It is difficult
enough for persons with substantial incomes
who are used to dealing with financial papers
and who can afford high-priced lawyers and
accountants to make their computations for them*


- 12 The person with a small income should not be
put to this annoyance and possible expense,,
Furthermore, the checking of these tax
computations by the administrative authorities
takes time. Frequent errors are found which
must be rectified, requiring correspondence
and further annoyance of the taxpayer as well
as expense to the Government. We in the
Treasury do not enjoy pestering the taxpayer
any more than he enjoys being pestered by us.
For taxpayers with relatively large incomes, refinements in determining income and
computing taxes are troublesome but are necessary in the interest of equity. For small taxpayers, however, especially those now taxed for
the first time, these refinements are cumbersome and confusing without serving any important
purpose. The income taxes of millions of people
can be determined with acceptable accuracy by
less involved methodse


- 13 As the President suggested to Chairman
Doughton, there should be a provision in the
case of the small taxpayer "for a straight,
simple payment of some small contribution to
the national tax income through a simple agency
and on a simple form."
For such taxpayers a plain and easily
understood table could be provided with the
aid of which the small taxpayer could compute
his tax bill in a very few moments * He would
be spared time, trouble and annoyance and the
Government would be spared expense.
To indicate more clearly what I have in
mind, I have had prepared a sample table showing
how this might be worked out in practice for
incomes up to $3,000«

This is only a prelimi-

nary table, and improvements and changes will no
doubt be desirable, but it will illustrate how
the proposal can be applied,,
The taxes imposed by the bill before you
are very heavy; the taxes of an all-out program
would be even heaviero

I am convinced that the


- 14 people ape not opposed to neavy taxes, that
in fact they favor neavy taxes because they
know that tne alternatives are much more onerous „
kt a time when expanding incomes are operating
to force prices, upward many kinds of measures
must be employed if prices are to be kept under

without heavy taxation, the other

measures have little chance to succeed*
Rising prices would take much more away
from our people now and in the future than higher
taxes now vuli take* Under the tax bill in its
present form, a married couple with no dependents,
having a net income of $6,000 a year, will have
its Federal income tax increased by $198, or
4 percent of its income0

JLssuming that two-thirds

of the family's income is spent on items affected
by a. changing cost of living, an increase in tne
cost of living of 6 percent would impose as
great an additional burden on this family as
would tne proposed income taxo

The cost of living

index has increased 5-1/2 percent since September,

It is clear from tnis simple illustration


- 15 that rising prices tax the family income just
as surely as do income taxes. Although, as
prices rise, the incomes of some families will
increase, many incomes will not increase and
most incomes will not increase as fast or as
much as prices*,
If, in an attempt to protect the incomes
of our people, we hold down taxes and as a
result the cost of living rises, we shall have
taxed them just as surely as if we had levied
on them directly — and we shall still have
the inflated costs of defense to pay later
from taxes•
An all-out tax program will build public
morale in an all-out defense program. By
reducing the necessity for borrowing, it will
strengthen confidence in the impregnable fiscal
position of the Government,, By contributing
to the control of prices, it will help prevent
the demoralization which would result from inflation. By distributing the defense burden
fairly, it will help unite the nation. It will
make all the people equal partners in sharing
the cost of the defense of our country*

Form V.K. 131



Office Correspondence

Chairman Bccles


Martin Krost

Date August 5, 191*
Subjecti Proposed Statement before the
Senate Finance Committee

I am returning the proposed statement by Secretary Morgenthau,
with the Terbal suggestions you made over the phone written up on a
separate sheet,
I should like to call your attention to the fact that the section of the statement dealing with the excess profits tax, beginning on
page 10, suggests no alternative to the old Treasury proposal involving
the elimination of the average earnings method. In view of the continuing reluctance of Congress to eliminate the average earnings option, you
may wish to revive at this time the suggestion made in your Ways and Means
Committee statement to restrict the use of the average earnings method
by reducing the percentage of average earnings allowed in computing normal
profits from the present 95 per cent. The reduction might be parallel to
the reduction already made in the invested capital credit on capital over
$5#000,000, that is 12 l/2 per cent (from an eight to a seven per cent
rate of return.) This would mean reducing the present 95 per cent of
average earnings allowed to about 83 per cent.
With respect to the effect of lowering the personal exemptions,
the argument often made that the bulk of the increased revenue would
come from existing rather than new taxpayers does not imply, as it seems
to, that this measure is not an effective means of curtailing mass purchas
ing power. Families subject to income tax under the exemptions of the
bill passed by the House make about l. per cent of all consumer expendij0
ture. Most of the revenue would come from the taxpayers of lowest income
within this group. Such taxpayers are comparatively lightly taxed at
present. Married persons with incomes of as much as $8,000 pay an
effective rate of less than 10 per cent under the proposed bill. This
percentage seems especially low when it is considered that total governmental expenditures may soon amount to as much as a third of the national

August 5, 19hX

Suggestions on Proposed Statement
before the Senate Finance Committee

Page 7» numbered paragraph ( j ) — Instead of the present
language, "Present limitations on the powers of the Board of Governors
of the Federal Reserve System to define and increase reserve requirements should be removed,"
Page 8, numbered paragraph (5) — Instead of the present
language, "it will undoubtedly be necessary to control all installment
credit covering the sale of consumer durable goods, including housing."
Page 12, middle paragraph — Would it be possible to give
the proportion or profits made by these high-profit corporations, as
well as the proportion of the total number of companies that they