Date 5 May 1941
Author D.W. Bell
Title Automatically Balanced Budget: Letter and Response
Description Response to Letter from Senator Millard E. Tydings (D-MD)
Location Box 33; Economy in General; Records of the Office of Tax Analysis/Division of Tax Research; General Records of the Department of the Treasury, Record Group 56; National Archives, College Park, MD.
May 5, 1941

Honorable J. Roy Blough,
Director, Division of Tax Research,
Treasury Department,
Washington, D. C.

Dear Mr. Blough:

You perhaps have note the efforts of the Senate Committee to find ways and means of automatically balancing the Federal budget in times of peace.

I am enclosing herewith a suggested bill and two suggested Constitutional amendments, each of which has been designed as a means to the end desired.

I would appreciate it greatly if, as soon as you find it convenient, you would look over these proposals, as well as examining the questionnaire herewith enclosed. The Committee would be very grateful if you would give us your answers to the questions propounded, and any other data which you feel would contribute to our further study.

It is likely that in the near future we will hold open hearings on this subject and would like to know if you desire to be called as a witness. We would be glad to have you, for we realize you could make a contribution to this subject which would be of value to us and the nation as a whole.

I trust we may hear from you at your early convenience concerning all these matters.

With best wishes, I am,

Sincerely yours,

M. E. Tydings,
Chairman, Special Senate Committee.

[Attachment: Committee Print]

May 24, 1941

To: Messrs. Bartelt [Bartlett?], Blough, Haas

From: Mr. D.W. Bell

There is attached hereto a copy of the list of questions which accompanied Senator Tydings' letter of May 5, 1941, the answers to which he asked to have prepared and submitted to the Senate Committee which has been created to find ways and means of automatically balancing the Federal budget in times of peace.

I should be glad if you three would work together in compiling answers to these questions. It might be a better procedure for one person to be designated to work on them and then get together for a discussion of the proposed answers. I shall be available to help at any time that you want me to.

1. What in your judgment, is the effect of a continuing unbalanced budget which results in an increase in the public debt?

No definite statement, true for all times and places, can be made concerning the effect of a continuing unbalanced budget which results in an increase in the public debt. The effect will depend upon the amount of the increase in the public debt relative to the size of the economy, and the changes in the debt-paying ability of the nation occurring during the period of increase in the debt.

If the objectives for which the debt is incurred increase the income-producing ability of the economy in a greater proportion than they increase the debt charges, the burden of in enhanced public debt may be less than would have been the burden of a smaller one had the income-producing expenditures not been incurred. In this connection, it is interesting to note that the interest on the public debt amounted to 1.59 percent of the produced national income in the calendar year 1932, whereas the corresponding proportion for the calendar year 1940 (including in the letter case interest on the guaranteed debt) amounted to 1.60 percent.

It should be further noted that in the case of the United States substantially the entire debt is an internal one, the charges on which are collected as taxes from some citizens and paid as interest to others. It must be recognized, however, that the servicing even of an internal debt would present problems should the charges thereon come to absorb a disproportionate part of the national income.

Consequently, although the payment of interest on the public debt presents no problem at the present time, it is important that all proposed additions to the debt should be carefully scrutinized, in order to assure a sound long-term balance between the charges on the national debt and the income-producing ability of the economy.

2. While the borrowing power of the federal government must be used to finance part of the national defense expenditures, what, in your opinion, is the safe limit of the public debt?

It is impossible to set any definite figure as the "safe limit of the public debt" which may be incurred for national defense expenditures, except to say that it is high and that no limit will be safe unless the national defense expenditures are themselves adequate. It is interesting to note in the connection, however, that the present debt of the British Government is equivalent, on a per capital basis, to a debt of about $133 billions for the United States, that Britain Government securities of twenty-four years' maturity and a 3 percent coupon are currently being sold at par, and that the apprehensions expressed for the British position are entirely on the military and physical and not on the financial level.

3. What are your views concerning the new principle incorporated in this proposed legislation -- providing machinery for automatically raising revenue to balance the current budgets?

The principle incorporated in the proposed legislation is not acceptable because it would involve raising substantially larger amounts of tax revenue in periods of depression than in periods of property. In periods of depression that tax bases for nearly all revenue sources shrink. The shrinkage is greater in the case of some taxes than others. Per contra, the revenue requirements normally increase during depression years because expenditures for relief, public works, etc. are likely to increase. The increases in such expenditures are for the purpose of counteracting the impact of the depression and alleviating some of the distress from unemployment.

In depression periods when private purchasing power shrinks through lack of employment, low business profits, etc., it becomes desirable and even necessary for the Government to make up this deficiency by maintaining a cash outgo in excess of its cash income. If the principles in the suggested legislation were to be followed, the cash income from taxes would automatically equal the cash outgo, so that the current budget might be balanced. Thus, the private economy would receive no stimulus from public expenditures, except to the limited extent that its revenue might be derived from pools of idle, hoarded funds awaiting more favorable opportunities for investment. The automatic balancing of a budget during periods of serious depression can only contribute to the severity of the depression and unemployment. The economic system would be able to function but weekly, if at all, under the proposed legislation.

In the current emergency when defense expenditures are funning very much in excess of current revenues, the proposed legislation is so obviously impracticable as to require no further comment.

4. Do you see any objection in Congress delegating administrative power to the Secretary of the Treasury to put into effect the flexible tax schedules construed by Congress as provided for in this proposed legislation?

Under the proposal, the Congress would not actually delegate any powers to the Secretary of the Treasury. It would impose upon the Treasury the responsibility for making as accurate an ESTIMATE as practical as to which one of the numerous schedules of taxation enacted would raise the requisite amount of revenue for the succeeding calendar year. Since the proposed legislation does not involve any fundamental delegation of power, it is not necessary here to indicate objections which might be raised to such delegation of the taxing power.

It should be pointed out, however, that it would be practically an impossibility to construct a series of schedules of taxation covering all types of taxes, duties, imposts or excises each of which would raise an amount of revenue with respect to any calendar year, 5 percent greater than the amount that would be raised by the schedule immediately preceding it. The revenue which each of the schedules would yield would vary greatly from year to year and would differ by more or less than 5 percent, depending upon changes in business conditions. Furthermore, the proposed legislation postulates a stereotyped revenue system which, it would seem, except for rate changes, would undergo no other revision. This is itself, if a necessary feature of the proposal, would be highly objectionable, for in practice it has been found desirable to make substantial changes in the base of the various taxes and in the relative importance of the various taxes in accordance with the congressional intent and the administration's over-all policy decisions.

7. Do you think the twenty year period provided for in the proposed legislation is too long or too short a time interval in which emergency expenditures in excess of the budget will have to be liquidated?

It is impossible to say definitely whether twenty years is too long or too short a time interval in which emergency expenditures in excess of the budget should be liquidated. Whether it would prove too long or too short would depend entirely upon economic conditions during the period. As the President stated in his message transmitting the budget for the fiscal year 1941, "Government must have the wisdom to use its credit to sustain economic activity in periods of economic recession and the courage to withhold it and retire debt in periods of economic prosperity." It would appear unwise, therefore, to set in advance any definite period for the liquidation of emergency expenditures.

8. What proportion of the national income, in any given year, do you think can safely be taken by the federal, state, and local governments in taxes? Is there a maximum?

It is not possible to indicate what proportion of the national income can safely be taken by the Federal, State and local government in taxes. The income of the population is spent in part upon goods and services supplied by private agencies and in part upon goods and services supplied by governments and governmental agencies. Some goods and services can be most economically supplied by governments and others by private concerns. Political, as well as economic considerations enter into the determination of what proportion of the needs of the population in any one country can best be supplied by government rather than by private enterprise. Furthermore, changes in the economic life and the maturity of the economy may make it desirable for the population of any one country to spend and increasing portion of its income for governmental goods and services as distinguished from private goods and services. It is not, however, possible to indicate precisely at what point in the percentage scale of national income this optimum efficiency is reached.

9. Do you favor direct taxes or indirect taxes?

In general, we favor direct taxes as against indirect taxes. As the President pointed out in his address before the Retailer's National Forum, May 23, 1939, "it would be bad for business to shift any further burden to consumer taxes. The proportion of consumer taxes to the total is plenty high enough as it is."

Indirect taxes weigh more heavily on individuals with small incomes than on persons with incomes. A revenue system which is overloaded with excise taxes on goods and services in general use, is therefore grossly inequitable, since it does not tax the population according to its ability to pay. Direct taxes on the other hand can be spread among persons with varying capacity to bear taxes more nearly in accord with the principle of ability to pay.

10. If you believe there should be both direct and indirect taxes, what proportion of the federal revenue should come from direct taxes (income) and what proportion should come from indirect taxes (like: (1) customs, (2) taxes on production, manufacturers' excise taxes, process in taxes, etc., (3) taxes on consumption, sale or transfer -- sales taxes, based on venders' returns and sales taxes collected through the sale of stamps, (4) estate and gift taxes, and (5) business privilege taxes).

It is not possible to indicate precisely what portion of the Federal revenue should come from direct taxes and what portion from indirect taxes. It is, however, possible to state that by far the larger portion of the Federal revenue should come from progressive taxes -- income, estate and gift taxes and corporate taxes and that a lesser share of the Federal revenue should come from consumption taxes, sometimes called indirect taxes.

The States and localities raise substantial amounts of tax revenue from indirect taxation. The Federal Government has not control over the types of taxes levied by other governmental jurisdiction, but it patterns its own revenue system in such manner as to recognize the existence of the very substantial indirect taxes imposed by the Senate and the localities. Furthermore, looking at the Federal, State and local system as a whole, the Federal Government with its greater borrowing power is in much better position to rely more heavily on the income, estate and gift taxes with their high variable yields, than are the States and localities. For this reason, as well as for reasons of equity, it is believed that the Federal Government should continue as far as is practicable in the direction of increasing the role of the direct taxes as over against the indirect taxes.

11. What are you views as to the federal government spending part of its funds by way of grants-in-aid to the states (as, for instance, relief appropriations, unemployment insurance, education, public roads, etc.)?

Provision for Federal aid to States in connection with certain governmental problems which are of national, as well as State and local concern, has become an accepted feature of Federal fiscal policy. The grant-in-aid device makes it possible for the Federal Government to assist the States in financing these functions, while retaining many of the advantages of our traditional system of local self-government. In many instances, because of limited resources, unequal financial capacity or emergency conditions, the State or local governments are unable to undertake or to provide adequately services which they clearly recognize as desirable. It would appear to be proper for the Federal Government to contribute a portion of the cost of such services.

12. While expenditures for national defense are rising in the face of large defense appropriations, do you believe we ought to continue or reduce non-defense expenditures, including those for public works?

It is my belief that in view of the large expenditures necessary for national defense purposes, we should reduce non-defense expenditures, including those for public works, as far as possible. I consider this a matter of great importance, not merely because of the purely fiscal considerations involved, but because many such expenditures compete for labor and materials needed for our defense effort. I have emphasized this view on several previous occasions. On January 29 of this year, I said to the Ways and Means Committee of the House of Representatives:

"At this time our whole economy and effort should be concentrated on national defense. One step which the Government should take is economy in Federal expenditures. I believe, therefore, that all Federal nondefense expenditures should be re-examined with a magnifying glass to make certain that no more funds are granted than are absolutely essential in the existing circumstances."

and again on April 24, to the same Committee:

"There must, of course, be no stinting of our defense expenditures. But there is another set of expenditures which, as I suggested to this Committee on January 29, we should now re-examine with a magnifying glass.' These are the government expenditures which are neither for purposes of defense nor for purposes of relief and security from want. We are continuing to spend in these nondefense and nonrelief fields as if we had no emergency defense program, as if we could super-impose our have rearmament effort upon government as usual and business as usual. This was all right before the existing emergency and while there continued to be a large volume of available unemployed resources. But we simply cannot carry on business as usual and government as usual from now on and still take adequate care of our defense needs. It would be a tragic error to assume that we can expand our defense production on a colossal scale and still go our usual ways, whether as a Government or as individuals. It would be folly to assume that we can continue to spend now as we did in normal times.

"In the past twelve months, we have completely revised our thinking on defense expenditures, as this Committee known. We are no awake to the need for expenditures on the enlarged scale required to make this country safe an strong. We have remained curiously static in our conceptions of what to spend on those things not directly connected with defense. Ordinary traffic must now get to one side to let planes and tanks and guns have the right of way. Other traffic can be permitted only if it does not obstruct the National purpose."

13. Do you think the prospect of inflation is hastened by virtue of an increasing unbalanced budget?

I do not believe that an excess of Federal expenditures over Federal revenues during the defense emergency will itself bring about an inflation as long as it is properly financed. The President said in his budget message for the fiscal year 1942, "A substantial part of the defense program must, or course, be financed through borrowing. Individual investors will be gives increased opportunities to contribute their share toward defense through the purchase of Government securities. Such borrowing is not hazardous as long as it is accompanied by tax measures which assure a sufficient tax yield in the future."

As you know, in furtherance of this program of the President, I have recommended to the Ways and Means Committee of the House of Representatives that taxes be increased at the present time by an amount sufficient to yield as additional $3.5 billions of annual revenue. I consider such an increase adequate for the present time. The financing of the remainder of our expenditures by borrowing will not in itself be inflationary if as much of the excess of expenditures as cannot be covered by an increase in physical production is obtained from real savings -- i.e., is substitutionary for rather than additional to private spending. Our borrowing policy is now being directed to this goal.

14. What are your views as to the theory which has been propounded that there is no need to worry about the public debt since public expenditures increase the national income and promote the public welfare!

I do not believe that the theory as stated has ever been held by responsible officials of this Government. Increases in the public debt should always be a cause of concern, and should be carefully weighed against the advantages expected to be derived from them. It is equally important, however, that the Government should not refrain from incurring debt when the national welfare demands it. As the President stated in a passage which I have already quoted from his 1941 budget message, "Government must have the wisdom to use its credit to sustain economic activity in periods of economic recession and the courage to withhold it an retire debt in periods of economic prosperity."

15. What part will the proposed procedure for a balanced budget play in a period of post-war reconstruction?

The period of post-war reconstruction is bound to present many problems, the exact nature of which it is difficult to foresee despite our best efforts in planning, such, for example, as that embodied in the Report of the National Resources Planning Board, submitted to Congress by the President on March 17, 1941. One thing seems clear, however, and that is that we ought to retain the greatest possible degree of flexibility in order to meet these problems as they occur. For this reason, I believe that the rigid procedure for an automatically balanced budget, proposed in the bill and constitutional amendments under consideration by your Committee, would make more, rather than less, difficult the solution of the problems which will inevitably confront us at the conclusion of the war.