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J u l y 19, 1946

as a result of the Wc*r, the country is confronted with an in­
flationary danger wnich could have very grave consequences, ftar finance,
chiefly because of heavy reliance on borrowing from the banKing system,
expanded public holdings of liquid assets from about 75 billions in the
middle of 1941 to more than 220 billions by the end of 1945« At the same
time a huge volume of backlog demand accumulated. 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
still furtner. Consumer incomes after taxes are above the wartime peak and
the rate of savings has fallen sharply. Corporations i . e in a highly liquid
*r
position iJid large, amply financed foreign demands compete with domestic
buying. At the same time, direct allocations, building permits, wage and
price c ntrols, and rationing have been abondoned or greatly weakened.
Wo adequate fiscal adjustments have been made to compensate for the impair­
ment of direct controls. As a result, inflation pressures nave been rising
and price controls nave become increasingly unequal to the taax of holding
tne line.
Conditions have tnus been created under wnich no price control
measure, much less a weakened bill, can now be expected to function ef­
fectively. Direct controls, enumerated above, which are necessary to re­
inforce price controls cannot be effectively reestablished. The months
of uncertainty preceding the current legislation, the long delay by Congress
in getting the bill enacted, and tne drastic cutting of appropriations to
administer such controls as might be extended, all compound the difficulties
of continuing effective ¡rice controls. Unworkable price controls would
be worse than none.
Production is tne ultimate answer to the inflation problem.
That taxes time. It is imperative meanwhile that »ays be found to check
the excessive demand. Since effective direct controls cannot be reestab­
lished, other means must be found for dealing with the problem. The three
most important are;
(1) deduction 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 local;
(3) Curtailment of credit and disposal of
Govem&ent surplus.
FISCAL POLICY
During the deflation of the ftnirties, fiscal policy required
a budget deficit, putting more purchasing power into the economy through
public expenditures than was taken out through taxation. Now, under re­
versed conditions of inflation prebsure, a budget policy is called for
which will take more purchasing power out of the economy through taxation
than is returned through public exoenditures. A fiscal policy which brings



—2about a substantial budget surplus is by far the most effective means left
at our disposal to meet inflation pressures* Unless the Government sets
tne example in greatly reducing its expenditures and increasing its savings,
the people cannot be expected to follow the Government^ admonition to
postpone their purchases and to maintain tneir savings.
(1) lieauction of Expenditures* The expenditure outiooK in
the budget has ceteriorated during recent months* Expenditures for the
fiscal year 1947 are now estimated at a little over 40 billion dollars,
without allowance for the terminal leave bill* This is an increase of 5
billion over the January budget estimate* Nearly one-naif of the budget
is for national defense expenditures which have continued at a very high
level, despit3 the fact that the war ended nearly a year ago, that large
supplies of every kind were left after V-J Day, aid that the armed forces
have been reduced to about 20 per cent of their wartime strength. Large
sums are sti-Ll being spent for construction that could be postponed and
further supplies which are not urgently needed. Scarce material and labor
are thus Doing diverted fro® acutely pressing civilian needs. To remedy
this situation, all procurement and construction activities under the national
defense program should be screened. All these which are not of an iinmed- .
iately urgent character should be postponed. To this end, it is recommended
that a committee be appointed, to include prominent representatives of civil­
ian groups, ond that this committee Pe instructed to recommend reductions
or deferments of national defense expenditures, aggregating not less than
5 billion dollars* These expenditures should oe deferred for the remainder
of the current fiscal year or until dangerous inflation pressures no longer
exist.
ihile it is evident that major budgetary savings will have to
come in the defense program, other non-urgent Federal expenditures should
also be deferred or reduced, especially those on public works*
The terminal leave bill if framed to provide for cash payments
will be highly inflationary. R v r y effort snould be made to provide for
payment at such time »»hen deflationary pressures are developing* This will
help to stabilize the economy and will be in the interest of the veterans
who will be able later on to obtain more .nd better goods for their money.
Public agencies, finally, should defer for the time being all
food purchases for relief purposes* 1 understand t lat foods currently
i
purchased will not add to deliveries to foreign countries prior to their
harvest* Accordingly, temporary postponement of purchases until more ample
supplies are available in the American market would not impair the relief
program*
(2) Increase of Taxes. Tax reductions provided for in last
year’s legislation have produced a revenue loss of about 5 billion dollars*
Had rates been maintained and expenditures been icept within the limits of
the January budget estimate, a budget surplus possibly of 10 billion dol­
lars could have been achieved for the current fiscal year. Instead, no
surplus is in sight and a deficit is in prospect. To correct this situation,




-3curt ailment of expenditures will not oe enough. To provide revenue, and
particularly as a means of reducing pressures for higher prices and in­
creased wages, the excess profits tax saouid be reinstated. In addition,
taxation of capital gains should be tightened,
(a) Excess Profits Tax. It is now being widely
recognized that repeal of the excess profits tax was pre­
mature, 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 defla­
tion, ¿ince these assumptions have proved to be unfounded
ana present conditions are entirely different from what was
expected, there is every reason for restoring the tax. The
annual rote of corporation profits before tax may in tne
course of this year reach the wartime peak, waich would
leave profits after tax greatly in excess of tne 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 tax­
ation. Based on inflation prices, they are paid for by the
public 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,
(b) Caoital Gains Taxation, '¡he present tax treat­
ment of capital gains, under tne individual income tax, en­
courages 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 rices of homes
and faros 's&ica are at highly inflated levels* Accordingly, it
is proposed that long-term gains, t-*xed 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, 1946.
This would discourage 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 asking
these tax recommendations, I recognise that there is little likelihood of
Congress accepting them at this time, but it is tne responsibility of the
Administration to recommend shat is needed.




- 4

-

ELIMBi^TIGM OF UiMECESS/dtY EXPENDITURES
Having shown the way by carrying out a drastic retrenchment of
its own expenditure program, the 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 pos­
sible public works and construction projects until the inflationary danger
has pas ed. 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 Gov mo r s 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. Son-residential construction should be curtailed more vigor­
ously 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, every appeal should be made to consumers to exercise the
greatest self-restraint in their purchases, and not to follow prices up.

CURTAILMIM OF CREDIT
Public agencies wiich 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 rev­
enue to the Government and thus improve the budget situation.

I am aware th<^t the orogram here proposed is drastic and diffi­
cult to carry out. The alternative, however, may well be an inflationary
spiral Kiich would undermine the basis for prosperity at home and the
foundations we have laid for international reconstruction.