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Form F. S. 131

BOARD OF GOVERNORS

• r THE

FEDERAL RESERVE SYSTEM

r 3ice Correspondence
To

Ohairma;a Sccleg

From

Martin KyOSj;

Date September 27, 1941

Subject:

Morgenthmiy s
suggestion for 6 per cent limit
nil oo-rporate profits
saavntaTy

Information from the Tax Research Division of the Treasury
1
and from other sources indicates that the Secretary s proposal was
made without previous consultation or study of the problem, and that
details of the proposal are still in a formulative stage* It was
suggested that unless there were a direct exchange of views with
the Secretary, it might be desirable to say that, since the details
1
of the Secretary s proposal were not available for study, you were
not in a position to comment upon it*
In the event that you wish to state your views on the
issue, however, the following brief notes might serve as a rough
indication of the general nature of the reply. There are also
attached references to the excess profits tax in your testimony
before the Ways and Means Committee, in your speech before the
Chamber of Commerce, and in your FORTUNE article*
,f

I have not had an opportunity to study the Secretary's
proposal in detail* I do not believe that the Secretary meant to
propose a rigid 6 per cent limitation on profits for each individual
corporation. I think his statement reflected a very general feeling
that excess profits ought to be more effectively taxed than they are
under the Revenue Act just passed. Perhaps the Secretary meant to
suggest that industry as a whole should be satisfied with a 6 per
cent rate of return under present conditions, with an appropriate
adjustment of this ratio as between corporations to reflect variations in operating efficiency* /jThat would be a practical effect of
placing a ceiling on the amount of base-period earnings that can be
claimed by a corporation under the present law* Some allowance for
differences in qarning power as reflected in base-period earnings
would be made*
"The Government has not requisitioned industry and placed
corporation executives in a position of hired Government employees*
So long as it has not done this, it must leave some incentive for
corporation management to operate efficiently and to avoid waste
in the use of man power and materials. , If the Government took
everything above 6 per cent this incentive would be gone* That is
why, although I am in favor of very high tax rates on excess profits,
I should be opposed to a rigid and inflexible upper limit on profits."
Attachment




Excerpts from:

Statement before Ways and Means Committee, May 7. 1941:
"In my opinion an effective excess profits tax is the keystone
of a well balanced tax program. Any tax program will have to include
a substantial increase in the rates of taxation for corporate incomes
in general and for individual incomes. You should not impose increased
taxes on the great numbers of business concerns of small and moderate
size and on millions of individual taxpayers until you have given them
every reasonable assurance that the funds they are being asked to
provide will not go to swell the excessive profits of some corporations.
tf

The excess profits tax now on the statute books does not
give 8ny such assurance. If you allow the idea to take root in the
public mind that through these vast expenditures a few are being made
rich and a few who are already rich considerably richer, the result
is bound to endanger the success of our defense effort. In order to
prevent an inflationary spiral of price and wage increases, labor
should be willing to moderate its demands for increased wages, but
labor cannot be expected to follow such a course if employers are
permitted to retain excessive profits.
»* * * The revenue-yielding potentialities of an excess
profits tax were well demonstrated by our own experience during the
World War. The present statute could be made to realize those revenue
potentialities by changes in a few important respects. I shall mention
three:
w

l . Restrict the use of the income method of computing the
excess profits credit, either by reducing the 95 per cent of past
average earnings now allowable to 75 per cent, or by any other method
that may recommend itself to the Committee. I agree with Mr» Sullivan's
view that all excessive profits, as well as profits directly or indirectly attributable to the defense program, should be subject to
special taxation.
w

2 . Increase sharply the rates now applicable to excess
profits. In the light of the maximum 80 per cent rate in force in
this country during the last World War, a maximum rate of 75 per
cent is not too high. It is also important that the tax brackets
used in the present law be revised. I recognize the strength of the
arguments for graduating the rates according to the percentage of
excess profits to invested capital, the method used at the time of
the World War, but if the present method is continued, there is no
reason why the maximum rate should not apply to excess profits at a
very much lower level than f500,000. A corporation with this amount
of excess profits cannot fairly claim favored treatment as a small
enterprise.
w

3 . Reduce the rate of return allowed under the investedcapital method of computing the excess profits credit from the present
figure of 8 per cent to 6 per cent. The figure of 8 per cent was used
during the days of the World War. The rate of return that investors




-2could reasonably hope to realize on investment in securities has been
materially reduced since that time. We should make a similar adjustment in our ideas about an appropriate rate of return on equity capital."
3C a
| p

Jc
j

Speech before Chamber of Commerce» May 1% 1941>
T,

The first source of defense revenue should be the corporation
tax and the excess profits tax because, in general, corporations are
the greatest beneficiaries, directly and indirectly, from defense
expenditures. In other words, the surplus accruing from the expanding
national income tends to become concentrated in the first instance in
the possession of business corporations. The most certain way to
insure against inflation is for the Government to levy on these earnings and divert the proceeds directly into the defense program before
they are distributed into the general income stream through higher
wages and higher dividend payments.
"Thus, the most direct way to attack the inflation problem
is through heavy corporate income and excess profits taxation. If
these surplus funds are not thus collected in the first instance at
the source, but are later distributed through large wage increases
and large dividend payments to the community, it becomes necessary
subsequently for the Government to abstract excess incomes through
the personal income tax, excise taxes, and other forms of mass taxation. The problem is not avoided but only delayed and made more
difficult by failure to tap the profits at the source.
"High taxation of personal incomes and excise taxation will
be necessary in any event, but the amount needed from these sources will
be reduced by a prior collection at the points where the profits
originate, namely, in the business units. If excess profits are not
tapped, they will lead to demands for higher wages. Apart from the
question of equity and the problem of allaying industrial unrest, is
the question of going directly to the source of the increased flow
of income and diverting it into the defense program before it spreads
out into the community and adds private mass purchasing power on top
of the Government's demands springing from the defense program.
"Tilth greatly increased surtax rates, especially in the middle
income brackets, and in the absence of an undistributed profits tax,
there will be a tendency on the part of some corporations to hold back
disbursements of dividends. This is a further reason for heavy normal
and excess profits taxes on corporations."




* Sfi * *

FORTUNE Magazine« "Price Fixing Not Enough"
"During the emergency we shall have to rely heavily upon the
excess-profits tax and the tax on corporate incomes. This is true
because, generally speaking, business units are the greatest beneficiaries, directly and indirectly, from defense expenditures. The
profits accruing from the expanding national income tend to become
concentrated here in the first instance» Consequently, one of the
surest ways to safeguard against price inflation is for the government
to levy on such profits and divert them directly into the defense
program before they are distributed into the general income stream
through higher wages and increased dividends.
"Perhaps the most compelling reason of all for the imposition
of the excess-profits tax is that, if not taken by the government, such
profits will lead to further demands for higher wages. If wage increases
continue to be freely granted to those who have already received substantial increases, they ?fill swell unduly the volume of private purchasing
power. Labor should certainly be willing to moderate its demands for
increased wages, but it cannot be expected to follow such a course if
employers are permitted to retain excessive profits. Moreover, with
increasing personal income taxes, many corporations may be expected
to leave a large proportion of their profits undistributed. In the
absence of an undistributed-profits tax, therefore, these will be
beyond, the reach of the government, unless recovered through heavy
taxes on corporations.
"The corporate form of ownership is the principal institution
through which capitalism functions. Owners and managers of corporations,
vitally interested as they are in preserving capitalism, have every
reason to favor, not oppose, heavy taxation of their profits, for thereby
they will help to protect the country against the inflationary dangers
that would undermine the foundations of capitalism. They have the
greatest stake in democracy—the most to preserve. They should not
expect those who have the smallest stake to pay an unjust share of
taxation.
"During the emergency the excess-profits tax should in my
opinion, be the keystone of a well balanced program• Increased taxes,
however, should not be imposed on the great numbers of small business
concerns and on millions of individual taxpayers until they have been
given every reasonable assurance that the funds they are being asked
to provide will not go to swell the profits of wealthy individuals and
corporations."




Statement of Secretary Morgenthau
before the Committee on Banking and Currency
of the House of Representatives
Wednesday, September 24, 1941
I am glad to testify in behalf of this Bill not only
because I am in accord with its objectives, but also because
I am convinced of the terrible urgency of the problem which
this Bill would help to solve.
As the President said two months ago in recommending
to Congress a bill to control prices:
"Today we stand, as we did in the closing months of
1915, at the beginning of an upward sweep of the whole price
structure."
In the facts and figures already presented to this
Committee there has been ample demonstration of the accuracy
and timeliness of the President's warning. Almost any part
of the price data presented to this Committee points tc> the
same conclusion, namely, that the pattern of price rises in
the past two years is showing an alarming similarity to the
price movements during the first two years of World War No. 1.
In the last war we waited too long. It was not until
August, 1917, that the first step was taken to check price
rises. The Lever Act empowering the President to control
27-68




- 2 food and fuel prices was not introduced until June 11, 1917,
and did not become law until August of that year.
By that time the damage had already been done. The
general price level had risen more than 75 per cent and the
forces making for further price raises had become so powerful
that they could not be stopped•
Are we again to wait until prices have risen 75 per cent
before we take bold and effective action?
The wholesale prices of farm products have risen 37
per cent in the past year, and of that rise, 6 per cent has
occurred in the last, month*

All commodities have risen 18

per cent in the last year and 2 per cent in the last month
alone. Similarly down the line:

foods are up 25 per cent;

hides and leather up 13 per cent; textiles up 23 per cent;
building materials up 12 per cent; and chemicals up 14 per
cento
The public is amply aware of what is happening. The
housewife knows that pork chops that were 29 cents a pound
in January were 30 in February, 31 in April, 32 in May, 35
in June, 37 in July, 38 in August and 41 at the moment, a
total rise of 40 per cent in those nine months. The housewife knows that eggs have risen more than a third since




- 3 January, that coffee is up about one-fourth in the same period,
and that sugar and flour are up almost a fifth in the same
period, respectively. The housewife, the business man, the
wage-earner, and the Government employee all know from their
daily experiences that prices are rising.
The forces at work today are the same as those that
brought our inflations in previous periods of war or rearmament.
Yet there is fortunately one difference in the situation
which, I believe, can save us from the disaster of inflation
now. This time the public and the Government.are aware of
what happened before and what is happening now. All of us are
able, if we choose, to take positive, effective, preventive
measures in time.
That is what the Congress is being asked to do today.
Passage of this Bill would be one additional step forward in
the war against inflation, the war on our home front, the
war that must be fought and won if we are to preserve our
American heritage.
It is true, of course, that price control alone will not
conquer inflation. This Bill alone cannot stop price rises.
Every government that has attempted to check inflation has




- 4 found that direct price controls alone cannot hold down the
lid when the income of the consuming public is increasing
and the amount of goods available to the consumer is decreasing. Additional steps are necessary.
Our Government has already taken some of them:
(1) The Congress has passed, and the President has
just approved, a tax bill designed to raise more than 3-1/2
billion dollars of additional revenue. This is a major
accomplishment in the anti-inflation effort, for it will
absorb a substantial portion of the increased incomes that
are initially responsible for price rises.
(2) Secondly, the Treasury is engaged in a borrowing
program designed to absorb still more of this excess income.
Through the sale of Defense Savings Bonds and Stamps the
Treasury is trying to borrow a large proportion of its funds
from current consumer incomes, rather than from banks. In
the past four months 1-1/4 billion dollars of Defense Savings
Bonds and Stamps have been sold.
(3) Thirdly, a new form of borrowing - the tax anticipa- ,
tion note - has been introduced, with the object of absorbing
consumer incomes before the date at which income taxes fall




- 5 due„

During the month of August more than $1 billion of

these notes were sold, absorbing income that might otherwise
be pushing up prices in the market place.
(4) Fourthly, the Board of Governors of the Federal
Reserve System has recently been given the authority to
control consumer installment credit and has just increased
reserve requirements of member banks as a further check against
inflation.
(5) Finally, the Office of Price Administration has been
exerting every effort to control prices through the cooperation
of producers and consumers.
Those are the more important steps that the Government
is now taking to check price rises. But they are not enough.
If we are to be sure of victory in the fight against
inflation, we must prepare further to increase taxes. We
may have to extend the general controls over bank credits.
We shall certainly have to reduce capital expenditures for
non-defense needs, and widen the sale of Defense Savings
Bonds and Stamps.
It would be wise to extend the social security program
to absorb purchasing power now and pave the way for increased
purchasing power after the emergency.




- 6 It will also be essential for Federal, State and local
governments to reduce non-defense spending as much as
possible.
I am looking forward now to an early meeting of the
joint committee of the taxing and appropriating agencies of
Congress, a committee that has just been created to study
the whole problem of non-essential Federal expenditures.
I hope that this committee will receive constant support
from Congress and the country at large, for it can make a
vital contribution in the anti-inflationary struggle.
We must do much more than cut down purchasing power,
we must attack the problem from the other side. Rising
prices can also be retarded by increasing the supplies of
goods which do not compete with defense needs.
We are in a position to do just that. The Government
has in its warehouses vast quantities of cotton, wheat, and
corn. Our granary doors should now be opened, enough at
least to prevent unreasonable price rises. Such a step
would be in agreement with our established agricultural policy
the ever-normal granary. Having accumulated stocks in times
of low prices, they should be distributed in times of high




- 7 prices. Now is the time to draw on these supplies, both as
an anti-inflationary measure and as a preparation for
replenishing them if that should again become necessary«
The concept of an ever-normal granary, which calls
for a control of falling farm prices, seems to me to call
equally for control over rising farm prices*

This Bill,

however, specifically restricts the authority of the price
control administration over farm prices*
the major defect of the Bill*

That is, I believe,

I strongly recommend that

this inflexibility be removed - in the interest of the
attack upon inflation, in the interest of the standard of
living of our people and in the long-run interests of farmers
as well*
I am not disturbed by the general level of agricultural
prices now prevailing, but I am deeply concerned about the
danger that agricultural prices will continue to rise as
they did in the World War«

Such a rise would hasten general

inflation, would restrict the standard of living, and would
even interfere with the health and morale of our people*
And it cannot be repeated too often that in the long-run
the worst sufferers from inflation are farmers themselves*




- 8 After the First World War inflation, agriculture was the
hardest hit and the slowest to recovero
It has been suggested during these hearings that this
price-control bill should include a ceiling over wages•
I should like to go on record as not sharing this view.
In free countries labor is not a commodity, human beings
are not property; and they should not be treated as such»
I fully appreciate that wages affect the cost of
production and the general level of prices. However, I
feel very definitely that if we can on the one hand keep
the cost of living from rising, and on the other hand impose
adequate taxes on excessive profits, then we will have
removed the major causes for demands for general wage
increases•

Furthermore, it is worth noting that the major

portion of our defense industries today is covered by
collective bargaining contracts, and only a sharp rise in
the cost of living is likely to upset those contracts0
Two weeks ago I said at Boston that it was folly for
labor leaders to seek continual increases in wages every
few months, and that it was equally shortsighted for farmers,
businessmen, landlords or bankers to seek to exploit the
present abnormal situation for selfish gain«




- 9 If we provide effective price control and adequate
excess profits taxation, and if it should later develop that
wage rates are not being kept within bounds, we shall have
to consider other measures0

As yet, however, I see no

/

necessity for them.
Before closing, I feel it my particular responsibility
as Secretary of the Treasury to point out to you the special
interests of the Government and the Treasury in stopping
prices from rising further.
1

As the nation s largest purchaser, the Government is
concerned with the problem in a very direct way. Congress
has already appropriated more than 50 billion dollars for
defense, and the end is not yet in sight. The rise in
prices which has already taken place will cost us billions
of dollarso

If prices are allowed to behave as they did

during the World War, we may find that our defense program
will cost us double without giving us a single additional
gun or plane for that extra expenditure.
1

We not only are the nation s largest purchaser of
1

goods, but we are the nation s largest employer. The
Government now employs nearly one and a half million civilians
in the Executive Departments, with a payroll now running at




- 10 the rate of 2-1/2 billion dollars a year. A substantial rise
in the cost of living will raise for us as an employer a
choice of evils:

to permit the real incomes of our employees

to be unjustly reduced, or to increase still further the
payroll that we must meeto
I fully appreciate that it requires courage on the part
of Congress to pass this Bill*

It always requires courage

to put brakes on rising prices. But if any lesson is to be
learned from the record of the past, it should be that inflation is inevitable in times like these unless all of us Congress, the Executive Departments, and the people - fight
it on all fronts and with all the strength and courage at
our commando
We should gain courage from the*knowledge that inflation is not only accompanied by serious evils but is
followed by even greater evils. We should never lose sight
of the fact that inflation is always followed by deflation
and that the ride down is a lot longer and a lot harder and
a lot more painful than the short intoxicating ride up.
After all, this question of inflation is one that goes
to the very heart of the social aspirations of the American
peopleo




An uncontrolled price rise now would endanger the

- 11 fruits of our hard-won progress of many years. If we lack
the necessary realism and courage now, we shall place
multitudes of American farmers, workers and Government
employees at the mercy of those whom I have called "the
three horsemen —

the speculator, the profiteer and the

hoarder."
Every hardworking and thrifty man and woman in the
United States has a direct personal stake in the success
of the battle against inflation.

I regard it as vitally

important for Congress to pass this bill and pass it
promptly.




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