Date 30 November 1942
Author Randolph Paul
Title Fiscal Policy and Inflation
Description Speech text
Location Box 34; Inflation, Depression, Recovery; 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.



(The following address by Randolph E. Paul, General Counsel of the Treasury, before the American Academy of Political and Social Science, Philadelphia, is scheduled for delivery at 8:15 P.M. Eastern War Time, Monday, November 30, 1942, and is for release at that time.)


Stabilization of prices is essential to the efficient working of a war economy. The rising cost of living, which is a sign of instability, has been a source of major concern for many months. Congress has had the problem under consideration almost continuously since the summer of 1941. Its first direct action took the form of the FIRST PRICE CONTROL ACT, under which the Office of Price Administration established price ceilings. The problem of inflation was constantly in the background while the REVENUE ACT of 1942 was taking form. Another frontal attack on inflation was made two months ago by Congress in its passage of the SECOND PRICE CONTROL ACT and by the President in creating the Office of Economic Stabilization.

But the battle against inflation will not be won without the enactment of measures more fundamental then any yet adopted. It will not be won without heavy reliance on fiscal weapons. Price ceilings and wage controls, by themselves, will check, but not halt, the upward course of prices. Price and wage controls will be successful only if they are buttressed by fiscal measures designed to restrict civilian spending and thereby to relieve the tremendous pressure of consumer purchasing power on prices. Such measures are an essential part of a comprehensive anti-inflation program.

What specific measures should be adopted is no longer a hypothetical question to be faced in the dim future. It is an urgent problem which is fully upon us. The vast volume of actual and potential spending being generated by our total war effort threatens to play havoc with price ceilings and economic stability. One of the most pressing problems confronting the new Congress when it convenes a month hence will be that of drafting a fiscal program to meet the needs of war. the problem before Congress will not be merely how to finance the war, but how to do it in equitable and anti-inflationary way. there is no question but what the war WILL be financed. The all- important issue is the WAYS AND MEANS of financing.

Tonight, then, I address my remarks primarily to the fiscal ways and means of coping with inflation. But to set the stage for that discussion, I should like to say a few things about inflation itself. An analysis of the inflation problem requires consideration of the process that produces inflation, of the evils that attend it, of the evidence that inflation exists or threatens, and, finally, of the steps that must be taken to prevent it.

I need not detail the evils of inflation to this audience. Its inequity, its costliness both in conventional monetary and in actual economic terms, and its disorganizing effect on our economy during and after the war, are undoubtedly apparent to all of you. The nature of the inflationary process is equally clear. When an excessive and growing supply of consumer purchasing power rushes to a market having available a shrinking supply of consumer goods and services, inflation is in the making. It may be useful, however, to cite the evidence of that process in order to clarify the nature of the measures that must be adopted to cope with inflation.


The magnitude of the inflationary threat for the future is evidenced not so much by the 19 percent rise in the cost of living that has already taken place during the past two years as it is by the relationship between the flow of purchasing power and the supply the available consumer goods. The most optimistic estimates indicate that not more than $70 billion, at present prices, of consumers' goods and services will be available for purchase in the calendar year 1943. In the same period, consumers will receive incomes totaling $125 billion. Personal taxes of Federal, State and local Governments, including the taxes levied under the Revenue Act of 1942, will take away not more than $15 billion of this amount. Therefore individuals will have about $110 billion at their disposal, or at present prices about $40 billion over and above the supply of goods and services available to meet civilian demands.

That $40 billion is the inflation potential from 1943 income. Unless much of it is withdrawn or immobilized, the rush of spending power to the market will break through price ceilings on a broad front. Black markets will mushroom; evasion and dealer favoritism will become commonplace; and empty shelves and illegitimate profits will become the order of the day. In such a situation distribution of the short supply of the necessities of life will be wasteful and inequitable. Competition to buy the means of living will be reduced to a disorderly, time-consuming scramble, and goods will got not to those who need them most but to those who are least bound by limits of time, money, and scruples. Severe hardships will be suffered, especially by families in the low income groups.

To safeguard against the chaos of inflation, consumers must be induced whether by additional taxation or by other measures, to refrain from spending some $40 billion, or $4 out of every $11 of income at their disposal after payment of existing taxes.

Fiscal measures are indispensable in meeting the threat of inflation, partly because they perform certain functions BETTER than other measures, but, more important, because they do a job that other controls CANNOT do. Taxes and other fiscal instruments which are tax- like in their degree of compulsion strike at the purchasing power root of inflation. The establishment of price ceilings resists the upward pressure of prices by pushing down on them from above. Relief of the upward pressure itself is a vital part of the anti-inflation program. Wage controls and fixed farm prices offer partial relief by preventing the creation of some purchasing power.

But constant wage rates and constant farm prices are not the same thing as constant incomes. Farm income is a function not only of farm prices, but also of the volume of farm goods marketed. Wage income is a function not only of wage rates, but also of the total volume of employment and of the volume at each level. As the volume of farm output responds to military demands, farm income will grow apace regardless of price controls. And the lenthening of working hours, the up-grading of workers into higher-wage jobs, and the employment of more women in industry, will spawn greater total wage payments even in the face of rigid wage rate controls. Direct control of farm prices and wage rates does not prevent the creation of an overflow of farm prices and wage rates does not prevent the creation of an overflow of purchasing power. Taxation and related fiscal measures must step in to impound such spending power before it flows to the market.


Voluntary savings will do part of the job that confronts fiscal policy. Such savings are not being made at an unprecedented rate. During the second quarter of this year they were running at an estimated annual rate of $24 billion, or approximately twice the rate for the same quarter of 1941. This rapid acceleration of savings cannot be attributed solely to the large increase in individual incomes. In considerable part, it is due to maximum price regulations and to the inability to buy automobiles, refrigerators, and certain other consumer goods. The hard facts of war which put many goods out of the reach of civilians provide an almost automatic stimulus to savings. The campaign for reduced spending carried on in connection with the sale of war bonds has been another potent inducement to greater savings.

Increased savings have been expressed in a growing volume of government bond purchase, insurance premium payments, currency and deposits, debt repayments, and the like. Whether this volume can continue to grow during 1943 in the face of heavier taxes and the higher living costs is open to question. Without strong governmental action it is doubtful that the rate of saving in 1943 can be maintained, let alone, increased. Yet, if consumer spendings are to be brought into line with the value of supplies available at present prices, government action must immobilize $16 billion of consumer income in 194 over and above the $24 billion rate of saving. Our fiscal policy must be framed with that end in view.

GROSS savings of $40 billion out of next year's incomes will, of course, not suffice. Those consumer savings must be NET that is, they must total $40 billion after taking account of the fact that some people will eat into their savings to maintain current consumptions. If, for example, some persons draw down their savings to the extent of $10 billion, others will have to save $50 billion to give us net individual savings for the economy as a whole, of $40 billion.

Although a high rate of saving is an effective deterrent to inflation, savings are not an unmixed blessing. The fund of capital assets which represent accumulated savings is itself a dangerous pool of potential consumer purchasing power. The $13 billion of United States Savings Bonds could be presented for redemption on short notice. Billions of dollars of other securities in the hands of individuals might be sold to banks, to business firms, or to other individuals. Bank balances and currency in circulation exceed previous years' holdings by many billions. Additional billions could be borrowed on insurance policies. In consumers undertook a sudden and widespread conversion of their huge fund of capital assets into a flow of purchasing power, the resulting flash flood of spending would quickly demolish the dam of price controls.

Actually, the backlog of savings is not likely to be converted into spendings in so dramatic a fashion. Rather, as more and more income is taken away by taxes or immobilized by forced lending to the Government, the reserves of purchasing power will be increasingly tapped by persons resisting a reduction in their standard of living. As the protective covering of bulging inventories is removed, the shortage of consumer goods which war makes inevitable will become fully apparent. A growing number of consumers will be moved to supplement their current income by drawing on assets in order to get a larger share of the short supply of civilian goods. Price stability will be threatened if capital assets are used to raise consumer spending to a level exceeding the available supply of goods ar present prices.

Fiscal measures must be drafted with an eye not only to inducing saving but also to discouraging DISSAVING. The NET effect of each proposal must be carefully weighed. The goal for 1943 is to prevent $40 billion of excess purchasing power from reaching the market for consumer goods. Some of the $40 billion will probably be removed by tax increases during 1943. The balance must be added to our accumulated individual savings. Although voluntary saving will do a substantial part of the job, we cannot expect it to do the whole job. Some other measure, or measures, such as compulsory saving, compulsory lending, expenditure rationing, and expenditure taxation will be necessary. In using them we must be one guard, however, against against deluding ourselves. It will do no good merely to shift saving already being made from a voluntary to an enforced status. Nor will compulsory lending that comes out of accumulated savings contribute to the solution of the inflation problem. The net effect of such measures would be zero. If we fail to add $40 billion in 1943 to NET individual savings and existing taxes, prices will rise in higher an open or a concealed way.


Net savings and individual taxes are closely related weapons in the battle against inflation. The more taxes we obtain, the less net savings it is necessary to induce or compel. And, in general, the higher the volume of voluntary savings, the smaller the task that confronts taxation and other compulsory measures. Of course, the size of the problem that taxes and related fiscal measures must solve is not measured simply by the difference between the $40 billion of excessive purchasing power and the $24 billion of individual net saving. part of any increase in taxes will merely replace savings. There are a number of reasons why taxes are desirable, even as a mere replacement of savings. But we must avoid weighing the merits of alternative measures in a vacuum. Each must be appraised in full view of its impact on the others and in full view of the $40 billion goal.

In waging fiscal war on inflation, additional taxes can and must play a prominent part. We can hardly have begun to reach the economic limits of taxation and it would be sheer folly to abandon taxes in favor of its alternatives. In the withdrawal of excessive purchasing power taxes have three important advantages over alternative measures.

First, taxation reduces the need for costly administrative controls. It is excessive money in people's hands that occasions many of those controls. Taxes thus reduce the overhead of wartime government and increase the freedom of individuals.

Second, taxes restrict the accumulation of public debt, and thus ease the problem of post-war debt management. By reducing the interest burden, taxes give the Government greater fiscal freedom to cope with the economic problems that will arise in the post-war period.

Third, at the same time that they aid in preventing wartime inflation, taxes strike at the roots of potential post-war inflation. If consumers, especially those in the middle and lower income groups, accumulate great quantities of war bonds and other forms of savings, there may be a dangerous surge of purchasing power immediately after the war. People may redeem their bonds and express their postponed demands in such volume that the rigid controls of wartime may have to be extended into peacetime. Insofar as taxes facilitate the removal of price and rationing controls at the end of the war, they help restore the free economy we are fighting to retain.

Notwithstanding these telling advantages, it would be highly unrealistic to rely on taxation along traditional lines to absorb the ENTIRE excess of civilian spending which threatens runaway inflation. Even a doubling of the present $15 billion of personal taxes would fall far short of the goal, for it anything like the $15 billion of new personal taxes were enacted, the level of voluntary savings would surely fall below the current level of $24 billion annually. Unaided by other fiscal measures, personal taxes would have to be increased by more than $20 billion to complete the absorption of $40 billion of excess spending power. Such a volume of taxes appears not be politically feasible and may not be economically desirable. Other measures must be adopted to restrict spending.

The restriction of spending is, of course, a by-product of price control and specific commodity rationing. But, as we have noted, price controls cannot operate successfully without a diversion of purchasing power from consumer markets. Although eventual adoption of specific rationing on a wide scale may be necessary, the extension of such rationing sufficiently to cover the bulk of consumer spending would be costly and irksome. We must look to other measures to achieve the necessary curtailment of consumer spending.

The Treasury has examined four general measures, any of which could contribute substantially to price stabilization and to an equitable distribution of the short supply of civilian goods. Each would also give substantial direct or indirect assistance to financing the war. These four measures are compulsory lending, compulsory saving, expenditure rationing, and expenditure taxation, which I should like to discuss with you tonight in that order.


There is a marked tendency in current discussion to use the terms "compulsory lending", "compulsory saving", "forced loans", and "minimum savings" as if they were interchangeable. Actually, compulsory LENDING is quite different from compulsory SAVING, both in nature and in effect. The legal obligation to LEND to the Government an amount equalling a specified fraction of income, expenditure, or other base is quite different from the legal obligation to SAVE a specified fraction of income. By drawing on previously accumulated assets, an individual can lend to the Government and yet not save. Or, he might save and yet lend nothing to the Government.

A small-scale example of compulsory lending is the post-war credit under the Victory tax. However, the offsets against such lending for various forms of saving such as the payment of insurance premiums, the repayment of debt, and the voluntary purchase of eligible war bond convert the Victory tax credits very largely into an example of compulsory saving. One should note, perhaps, in citing this example that compulsory saving on so modest a scale is unlikely to do more than replace a part of voluntary saving. Both compulsory lending and compulsory saving can be made progressive in their incidence through the use of exemptions and graduated rates. Assuming that income should be used as the base for either measure, one might, for instance, set up a schedule requiring no lending or, alternatively, no saving, for the first $1,000 of income received by a married person without dependents; an amount equal to 20 percent of the next $1,000, and perhaps 40 percent of the third $1,000, and so on, might be required either as a compulsory loan to the Government, or as some type of savings if compulsory saving were adopted. Special provision for fixed commitments or extraordinary expenses could be made under either measure by allowing offsets for such things as personal taxes, rents, medical expenses, debt repayments, and the like.

Both plans contribute to the control of inflation in much the same way as taxation, namely, by immobilizing the spending power at the disposal of consumers. Compulsory saving is a more effective immobilizer than compulsory lending, as we shall see in a moment, but the two instruments enjoy certain common advantages over taxation.

The advantage most urgently claimed for both compulsory lending and compulsory saving is that, as compared with taxation, they preserve the incentive to work. Workers will be more willing to work harder and longer if they feel that they are only temporarily deprived of the fruits of their labor, and that they may enjoy these fruits after the war when goods are once more abundant. Similarly, the promise of future rewards inherent in compulsory lending or compulsory saving justifies a greater restriction of consumption among the lower income groups than would be justified under outright taxation. A third advantage follows from the first two, namely, that large total levies on all income groups become more acceptable when a promissory note is substituted for a tax receipt. Finally, the compulsory lending and saving schemes would create a reserve of individual purchasing power for the post-war period.

In the immediate job of reducing civilian spending, compulsory lending is likely to be considerably less effective than compulsory saving. This is true because it is directed to only one segment of saving while compulsory saving comprehends all forms of saving. To a considerable extent, especially among upper income groups, the compulsory lending obligation would be met out of accumulated savings or out of current income that would have been saved anyway. Only those persons who did not normally save anything, did not have capital, and could not obtain credit, would be compelled to reduce spending by an amount corresponding to their lending. Since, in general, it is the lowers income groups who save little, have few assets, and have limited credit, it is among those groups that the real impact on consumption would be concentrated. It follows that any compulsory lending schedule would in practice be less progressive in its incidence on consumption than would appear at first glance.

Compulsory saving is more direct and positive in controlling consumer spending than either taxation or compulsory lending. It in effect tells people outright how much they can spend out of a given income, and can even be graduated to a point where the spending of further increments of income would be prohibited. We have noted that compulsory lending requirements can be met by liquidating capital assets or drawing upon normal savings. Taxes can similarly be paid from these sources; however; taxes, unlike forced loans, are not a substitute for other forms of savings; if people want to maintain their customary rate of saving in the face of taxes, they must cut their spending. So taxes will more effectively cut consumer spending than compulsory loans.

Compulsory saving, however, is not subject to the loophole of liquidation and substitution. it fixes a net savings requirement for each income recipient. That requirement can be met only out of income, not out of the sale or conversion of assets. The form in which the savings are held is immaterial so long as NO form can be converted into current spending. The vital point is that the saved dollars would not be competing for goods in the market. The Government could without fear of inflation spend an amount equal to the income impounded by compulsory saving. War finance would be automatically simplified, since investment in war bonds would be stimulated, and the margin of taxable capacity would be extended.

In principle, then compulsory saving could provide a comprehensive solution to the problem of inflation. The total amount of consumer spending could be pitched to the available supply of consumer goods and services. This would be done by requiring that the difference between total individual income and the value of available supplies be saved in one form or another.

However, compulsory savings is beset with administrative difficulties. Merely to legislate that each person with a given income shall save a specified amount is not sufficient. Nor is a knowledge of each person's income any guarantee of success. It is absolutely crucial to this plan to obtain in addition a snapshot of each individual's capital position at the beginning an at the end of the period in which he was obligated to save. Such balance sheets -- for that is what the snapshots would amount to -- would be the only means of protecting the compulsory saving plan from being undermined by the use of existing balances and credits. The compulsory savings requirement must be in terms of NET savings, and net savings can be determined only by subtracting sales of assets, declines in deposits, and so forth from the gross savings represented by savings credits and purchases of assets. To obtain a picture of changes in capital position would be a new and difficult, though not an impossible, administrative task.

Another complicating factor is that compulsory saving requires a certain amount to be saved out of income CONCURRENTLY with the receipt of that income. It would not, like present income taxes, be a liability that falls due in the year FOLLOWING the receipt of income. Quarterly returns would probably be necessary to keep individuals posted on their savings liabilities. Even then, unanticipated fluctuations in income or in expenditure needs might upset people's calculations. In any case, they would not know for sure that they had complied exactly with the savings requirement until after the event.

One method of enforcing the savings requirement would be to issue each consumer a license to spend only a specified amount on consumer goods and services; in this event, compulsory saving would become expenditure rationing. Or, if a graduated schedule of penalties for spendings above an exempt minimum were utilized, compulsory saving would become a type of expenditure taxation.


Expenditure rationing limits total consumer spendings by fixing the maximum amount that every family or single individual is allowed to SPEND on rationed goods. It may quite properly be thought of as the reciprocal of compulsory saving, which specifies the amount which people must SAVE. If the amount of spending on rationed goods is fixed, saving, in effect, becomes compulsory.

The spending allotment, like the saving requirement, would be fixed on the basis of family status and current income. Retained goods would include almost all consumers' goods and services that have any current cost in labor, materials, or facilities. Rents, tuition, medical care, and a few other selected items might well be placed beyond the pale of the expenditure ration. Except for those items, however, consumers' goods could be bought only with one's ration allowance. Within the allowance the consumer would be free to allocate his expenditures as he pleased. And, of course, people would be free to use income without restriction to make gifts, pay taxes, pay insurance premiums, buy real estate or securities, or to save in other ways. In fact, the very essence of expenditure rationing is to force diversion of income into such non-inflationary channels.

The over-all ration allowance for the entire economy during any given period would be determined by the demands of price stability. The object would be to limit the amount of rationed expenditure to the estimated value of the supply of rationed goods available during that period. In estimating that value, one would apply whatever price level it was desired to maintain. Flexibility would be a cardinal feature of the plan, for it would be relatively easy to change the total expenditure ration as more accurate date became available or as the expected supply position changed.

By its direct attack on the problem of excessive consumer purchasing power through the limitation of expenditure itself, this plan is capable not only of dealing inflation a body blow, but also of allocating the economic sacrifices of war in a fair and precise manner. The allotment of spending power to individuals or income classes cannot be very precise under a program of taxation or compulsory lending. Taking away income by taxes or enforcing loans to the Government does not necessarily force a reduction in consumption expenditure throughout the income scale. But direct limitation of spending facilitates both the over-all reduction in spending that is needed and the distribution of the reduction in the manner that is desired.

Those of us who have examined this instrument of control realize that the plan would require elaborate administrative machinery. The ration limit could be enforced only through the use of a license to purchase, in either coupon or other form. The coupons would represent that part of income which was expendable on ration goods, and might even be identified with money. Coupon distribution would be an enormous task, but it could probably be accomplished through the active cooperation of employers, ration boards, banks, and other institutions. This brief mention of administration is not intended to do more than indicate that the problem has been under consideration. If Congress wished to adopt a plan for expenditure rationing and the American people were willing to accept it, a tolerable scheme of administration could surely be developed.


A plan which minimizes the administrative problems of direct control by relying largely on inducement rather than on compulsion has been drafted and recommended to the Congress by the Treasury. I refer to the spendings tax which the Treasury submitted to the Senate Finance Committee during consideration of the Revenue Bill of 1942.

The spendings tax base is consumption rather than income. As its name indicates, this tax would be imposed on expenditures for consumer goods and services. It is not imposed on income received, and it specifically exempts income saved. The spendings tax, in fact, looks to the DIFFERENCE between income received and income saved. Its base is arrived at by substracting from each person's income his net savings as evidenced by additions to his capital assets and reduction of his debts. Further deduction, such as rent, medical expenses, and tuition can be allowed if desired, and the regular income tax would, of course, be deductible.

Except for the difference in base, the spendings tax structure strongly resemble that of the income tax and has much in common with that of the compulsory lending and compulsory savings devices were considering a few minutes ago. Exemptions according to family status would be provided, and steeply graduated rates would be applied. For example, the first $1,000 spent on goods and services by a married man without dependents might be spent. A tax penalty of 20 percent might be placed on the second $1,000 of consumption expenditure, 30 percent on the third $1,000, and successively steeper taxes on additional increments of spendings. Rates might rise to 100 percent or more, depending on the desired restriction of spending. Part of the tax could be treated as a post-war rebate, if it were desired to combine compulsory lending with the tax on spending.

The spendings tax would reduce spending not only by directly withdrawing income in the form of taxes, but also by powerfully stimulating saving through its drastic penalty on spending. This penalty would not be levied indiscriminately on all spenders, but rather on those spenders that could best afford to pay and on that segment of spending which could best be reduced or eliminated. The differentiated exemption would enable person with small incomes to obtain basis subsistence needs free of tax, while steep graduation would bring the full weight of the tax to bear on comforts and luxuries rather than on necessities. The highest penalty rates would apply to those who were trying to obtain a disproportionate share of the short supply of civilian goods. The spendings tax serves the interests of equity as it goes about its task of preventing inflation.

At the same time, the spendings tax provides revenue for war finance both by the revenue it collects and by the saving it stimulates. Although the savings induced by the spendings tax would not necessarily be paid over to the Treasury, they nonetheless would be removed from the spending stream and would be added to the pool of unspent income available, directly or indirectly, to finance the war.

The spendings tax would be administered within the framework that exists for the income tax. The taxpayer would fill out a combined income and spendings tax form and would pay the two taxes together. Detailed records of expenditures would not be needed to enforce the tax. The total spendings figure on which the tax is based would be derived indirectly by deducting from the total amount of available funds, the amounts devoted to the purposes other than personal consumption. To the data already required under the income tax would have to be added enough information to determine what changes in capital position take place during the period to which the tax applies. Immediate impact on spending could be assured by collection at source of a substantial part of the tax.

Expenditure taxation is particularly well adapted to the job of coming with inflation. Without imposing irksome administrative controls, and without itself requiring elaborate administrative machinery, it can drastically cut spending and can distribute that cut equitably.


I have outlined this evening a broad complex of fiscal tools with which a forceful anti-inflation program may be fashioned. Each has its shortcomings, but each is vastly superior to inaction. The important issue at stake is to make a choice and to make it now. Swift action is needed to put into effect that measure of that combination of measures which will meet the problem of inflation four-square. "Too late" can be just as disastrous as "too little."