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FofSiff.K.131

BOARD OF GOVERNORS

F E D E R A L RESERVE SYSTEM

•"Office C o r r e s p o n d e n c e
To

n f i r f n Tfooieg
htrot

From

Alvin H. Hansen




Date Juiy 22,1940
Subject: Som notes on proposals
for increased taxes

1. I should be concerned lest, under cover of financing
the new defense program, we balance the entire Federal budget too
rapidly.
2. I think we should be careful to avoid building up a
tax situation too high in relation to the size of the national
income. The existing tax rates will bring perfectly enormous revenues
at $90 to #100 billion income level. Unfortunately, we are increasing
our consumption taxes as fast as, or faster than, other taxes. We are
educating the public to pay a big tax bill much faster than we are
educating them to make large Government outlays (except for emergency
defense). If this happens (as I fear it may) we shall be sunk with
a tax millstone around our neck.
3. Even so-called nonconsumption taxes are more or less
deflationary, partly because they, at best, fall more or less on the
consumption stream, and partly because all taxes per se are inherently
restrictive, while expenditures are inherently expansionist in their
effect. We need expenditures and expansion, not taxes and restriction.
We have already gone much too far on consumption taxes. Lowering the
income tax exemptions and raising the rates on relatively low incomes
(Revenue Act of 1940) was good, provided we had reduced existing
consumption taxes by a corresponding amount. Instead, we raised
consumption taxes and, in addition, broadened the income tax base.
This was a serious mistake.
4. The defense expenditure in fiscal 1941 will probably be
relatively small (say |2.0 above 1940) and the relatively small expansionist effect may largely be offset by unfavorable trends in foreign
trade and inventories and by a sharp increase in taxes.
5. The steady demand for new Government issues, springing
from (a) takers of Baby Bonds (about |1 billion per annum); (b) savings
banks, life insurance companies, etc. (about fl billion per annum);
and (c) Government trust funds (also about fl billion per annum)
justifies a continuous deficit of about |3 billion per annum from this
standpoint alone. Private thrift in these channels and governmental
loan expenditures are mutually complementary. These savings streams
cannot in any case be tapped to any appreciable extent by high surtax
rates, corporate taxes or excess profits taxes. They ought to be tapped
by Federal borrowing.

Chairman Eeeles

-2-

July 22, 1940

6. For the present, we ought probably not to add to existing taxes except to enact an excess profits tax. While the rates on
the excess profits might be pretty stiff, the "floor" and "ceiling"
from which the excess is calculated ought to be liberal. A liberal
exemption makes it easier to administer, while a liberal exemption
combined with high rates above the base bring the widest possible
popular support. The excess profits tax ought not to be designed to
tax relatively moderate profits. For this, the general corporation
income tax is appropriate. The "ceiling" possibly ought to be about
20 per cent.
7. We should stop some of the loopholes. Family (instead
of separate) returns could at once be recommended. Inclusion of
individual income for tax purposes of accrued earnings in the form of
undistributed corporate profits ought to be pushed as soon as possible.
It is probably not yet possible, owing to the recent undistributed
profits tax debacle.
8. Taxes, as such, perform no useful purpose whatever (loan
expenditures are always to be preferred) except for the considerations
listed below:
a. Taxes designed to tap the savings stream are
useful and necessary as a check on too great inequality of income.
b. Consumption taxes are positively harmful, except
as a means to prevent inflation when full employment is reached. Ihren then they are necessary
only in a situation in which it is not possible
to reduce (as in wartime) governmental expenditures
sufficiently to check inflation.
9. At the moment we ought to rely heavily on borrowing from
the public. Later, when incomes have risen considerably and we have
approached more nearly full employment, we ought to stiffen the excess
profits tax, the estate tax, tbe corporate income tax, and the individual
income tax—all designed to tap the savings stream. Finally, as it becomes
necessary to divert production resources from consumption to defense
expenditures, we shall have to impose consumption taxes.




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