Date 27 November 1939
Author Roy Blough
Title Thoughts on Increasing Taxes at This Time
Description Memo to file
Location Box 43; Methods of Raising Additional Revenue; 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.
 
November 27, 1939.

THOUGHTS ON INCREASING TAXES AT THIS TIME

Is the proposed increase in taxation really for the purpose of financing additional national defense and thus an emergency levy to be withdrawn as soon as the special expenditure is completed, or is the national defense need merely an opportunity or excuse for introducing needed increases in taxes which would presumably be continued as permanent?

The answer to this question has considerable significance. In the first place, the type of tax to be imposed may differ. If the tax is an emergency one, it should not involve extensive readjustments in prices and costs of business which could be effected only over a period of time. The introduction of such taxes for an emergency would mean disturbance of business both when the tax was introduced and when it was abandoned. Furthermore, if the levy is truly an emergency one, it should not be imposed in a form which will accidentally fall on some taxpayers very much heavier than on others. For example, the estate tax is collected only once every generation. To impose an emergency tax on estates would mean that the burden would fall only on the beneficiaries of those decedents who happen to die during the period the tax was in effect.

In the second place, if the tax is an emergency one, presumably it is desired to have the money come in about as rapidly as it goes out. This calls for a tax which would be collectible quickly. The estate tax may not be collected for ten years and is ordinarily not collected for about fifteen months after the date of death. Thus, there may be very long delay in the collection of any new estate taxes which were imposed. Likewise, the income earned during the previous calendar year. A tax imposed in 1940 on 1939 income would be retroactive in character and probably undesirable for this reason. Most of it, however, would be collected during the calendar year 1940 and practically all of it would be collected during the fiscal years June 30, 1940 and June 30, 1941. An income tax imposed on the income of 1940, however, would not be collected until the fiscal years 1941 and 1942. Quick collection is more readily attainable through taxes on transactions. Such taxes may be collected immediately after the transaction occurs.

It may be that a special income tax imposed in 1940 on 1940 income for which a preliminary payment would be made based on 1939 income, with provision for refund or additional collection when 1940 income became known, would meet the emergency needs without imposing a retroactive tax. It would seem that in view of the condition of the Federal budget there is no great hurry for the collection of the additional. It is not contemplated that the additional taxes will balance the budget and there seems to be no particularly good reason why the collections from a so-called national defense tax should be closely correlated with expenditures for national defense. In view of the condition of the Federal budget it also appears more likely that the so-called national defense tax is really only a general increase in tax burdens and not one of emergency character.

When one turns to the problems of what taxes to impose, other considerations should be borne in mind. The taxes in any event must be paid from someone's income (unless indeed they involve the reduction of saving or capital). Different methods of imposing the tax lay the burden on different incomes and also have different effects on the business community and the production of additional income. If it is desired to place the additional burden for national defense on people in low income groups without being willing to face the political objections to taxing such groups through income taxes, it may be necessary to resort to excises of one type or another. We might increase our special excises on automobiles, gasoline, alcoholic beverages and tobacco. Some of these are already bearing very high rates. Gasoline taxation is a large source of state and local revenue and the states have raised strong objections to the Federal Government's present use of the gasoline tax. They would undoubtedly protest strongly against any increase. Additional taxation of alcoholic beverages might not result in a large amount of new revenue. Its effects might on one hand be a reduction in consumption of alcoholic liquors and on the other hand the encouragement of bootlegging and illicit production and distribution. The tax on tobacco is very high for a product which has become almost a common necessity. Taxes on automobiles would be quite logical if it were desired to reduce the volume of business done by automobile manufacturers. There seems, however, to be no disposition at the present time to discourage the automobile industry and it may be that increases of excises on these products should not be introduced.

We have no import excises on tea or coffee. Many countries desiring to place a substantial burden on the lower income groups have imposed such taxes.

It would seem, however, that under existing circumstances the logical place to get an additional half billion dollars is in the income tax or in a combination of the income tax and the estate tax. The income tax, however, should probably extend to a larger number of persons than it does since the exemptions which we grant are not only substantially above the average income of people all over the country but are also substantially above what the agencies who have studied the matter consider to be a minimum budget for efficiency. It is recognized that considerable political repercussions would result from lowering the personal exemptions. It may be, however, that if the tax were first effective on 1940 incomes and were first collected in 1941, public resentment would be delayed until after the elections. In terms of dollars, however, the bulk of the additional income tax would be collected from persons now paying income taxes even if the exemptions were lowered. Accordingly, substantially the same results could be achieved without lowering the exemptions by changes in the normal rate and in the surtax rates.

It has been suggested that a national defense surtax be imposed in addition to existing income taxes and that this surtax should constitute a percentage of the income tax paid. The percentage of such a tax would have to be very high if it were all to be collected from personal incomes. The rates in the higher brackets would be increased in such a manner as to wipe out practically all and perhaps all of the remaining income. Even an increase of only 10 percent which, if applied to both individuals and corporations would produce over $200,000,000, would reduce the income left in the top brackets from about 21 cents on a dollar of income (leaving out of consideration all state taxes) to about 13 cents on the dollar of income. Thus, over 1/3 of the income remaining in the highest bracket would be taken away by a 10 percent increase. If the increase had to be 26 percent, there would be no income at all left in the highest brackets (still without regard to state taxes which make the situation even worse). While if the increase had to be over 26 percent, the rates theoretically would run about 100 percent at the top brackets. Accordingly, a percentage arrangement of this kind would almost necessarily have to have some upper limits. At least two kinds of upper limits are possible. One would set a maximum effective rate beyond which the tax would not go. Thus, 75 percent might be set as an effective maximum rate. The difficulty with this is that protection from tax increases would be afforded only to an extremely small number of persons. Another method of setting an upper limit would be to provide that the increase in tax should in no event decrease the income after taxes left to the taxpayer be more than a certain percentage, say 10 percent. In this case, assuming an increase in tax of 10 percent of the previous tax and the accompanying provision that the income remaining to the taxpayer should not be reduced by more than 10 percent, the effective top limits would come into operation on all incomes paying an effective rate of more than 50 percent which for a married man with two children would be somewhere close to $250,000.

The increase as a percentage of existing taxes would probably be simpler to put in operation from the political point of view. However, if the tax is anticipated as remaining in the system for any considerable period it would be much more desirable to reconsider the whole schedule of rates and to place the increases where it is thought they can be best borne. This would probably call for some increase in the normal rate and for increases in the surtax rates up to perhaps $50,000 or $75,000

Any tax program anticipating a permanent addition to our tax structure should certainly take into consideration the estate tax. The middle brackets of this tax could be increased substantially and considerable revenue could be derived from this source.