Date 5 December 1944
Author Roy Blough, Director, Division of Tax Research
Title Postwar Tax Structure
Description Staff memo, Division of Tax Research, Treasury Department
Location Box 64; Postwar Planning; 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.

Postwar Tax Structure


Each major way in United States history has left a permanent imprint on the Federal tax structure. The Civil War provided experience in income and estate taxation and added liquor and tobacco excise taxes as a permanent element in the tax system -- an element that rivaled in yield the customs duties which had been the sole revenue source for many years before the war. World War I generated the excess-profits tax and left the income tax on individuals and corporations as the major revenue source. World War II has introduced no important untried taxes but will undoubtedly leave a tax structure differing sharply from the prewar system.

In the fiscal year ended June 30, 1940, internal revenue collections totaled $5,340 millions. /1/ The net budget deficit in that year was $3,611 millions. /2/ The budget estimates for the fiscal year ended June 30, 1945, anticipate internal revenue collections of $43,229 millions /3/ and a net budget deficit of $52,741 millions. /3/

/1/ Annual Report of the Commissioner of Internal Revenue, fiscal year ended June 30, 1943, table 6, p. 113.

/2/ The Budget of the United States Government, for the fiscal year ending June 30, 1942, p. 1046.

/3/ U.S. Treasury Department, Bulletin, November 1944, p.2.

In part the eightfold increase in tax collections represents unprecedented increases in tax rates. In part it reflects the growth in gross national product, under the stimulus of huge war expenditures, from $88.6 billions /1/ in 1939 to an estimated $196.4 billions /2/ in 1944 /3/ and the accompanying growth in income payments.

The operative tax structure has changed radically in the five years from 1939 to 1944. The corporation standard income tax rate has risen from 19 percent for 1939 to 40 percent combined normal tax and surtax for 1944. An excess-profits tax with a gross rate of 95 percent and a net rate of 85-1/2 percent is now in force. Individual surtax exemptions for a married couple with two children have declined from $3,300 to $2,000 /4/ and a 3-percent normal tax applies to income above $500, with not additional exemption for dependent wife or children. The combined normal and surtax rates applicable to the first bracket of income subject to surtax have risen from 8 percent to 23 percent. The former top rate of 79 percent, which was reached at $5 millions, has become 94 percent, reached at $200,000, although its effect is somewhat ameliorated by a 90-percent limit on the total effective rate. The tax on distilled spirits has risen from $2.25 to $9 per proof gallon, the tax on cigarettes, from 6 cents to 7 cents per package of twenty. Most other taxes have gone up at 10 percent. Estate and gift taxes were increased by at least 10 percent in each bracket, with much heavier increases at the lower end of the rate scale. Payroll taxes have remained stationary, the increases scheduled for January 1, 1940, and January 1, 1943, having been postponed by Congressional action.

/1/ U.S. Department of Commerce, Survey of Current Business, April 1944, table 10, p. 13.

/2/ Ibid., table 1, p. 4. This is the seasonally adjusted normal rate for the first half of 1944.

/3/ The calendar years most comparable to fiscal years of collection 1940 and 1945.

/4/ Other variations in the law make this comparison not precisely valid for most taxpayers.

The combination of tax changes and national income changes makes the anticipated internal revenue statement for the fiscal year 1945 something quite different from the statement for the fiscal year 1940, as is shown in the accompanying table.

Significant changes in other aspects of taxation have accompanied the sharp wartime increases in tax rates and bases. The individual income tax has been modernized by the shift from delayed to current collection, by the introduction of withholding, any by drastic simplification. In recognition of the impact of high wartime rates, many tax reliefs to avoid inequity or hardship have been introduced in both corporate and individual income taxes. The introduction of a two-year carryback of business losses has lengthened the period over which business income may be averaged for tax purposes. These and similar changes will inevitably leave their imprint on the postwar tax system.

                    Internal Revenue Collections

         Tax                    Fiscal 1940 /1/     Fiscal 1945  /2/     
                           ____________________   ____________________
                             Amount      Percent    Amount     Percent
                            (millions)  to total  (millions)  to total
Corporation taxes

  Excess profits tax              -          -      $9,096       22.2
  Income Tax                 $1,121       21.0       5,811       14.2 

  Capital stock tax             133        2.5         394        1.0

  Declared value excess
   profit tax                    18         .3         104         .3

       Total                  1,272       23.8      15,404       37.6  

Individual income tax           982       18.4      17,593       43.0 

Estate and gift taxes           360        6.7         520        1.3


  Liquor                        624       11.7       1,482        3.6  

  Tobacco                       609       11.4         974        2.4 

  Other                         660       12.4       1,796        4.4
       Total excises          1,893       35.4       4,252       10.4

Employment taxes                834       15.6       3,169        7.7 
  Total internal revenue     $5,340      100.0     $40,938      100.0
Note: Because of rounding, detail will no necessarily add to totals. 
/1/ Annual report of the Commission of Internal Revenue, Fiscal Year Ended June 30, 1940, Table 5, pp. 100 and 101.

/2/ Estimates based on the Budget of the U.S. Government for the Fiscal Year Ending June 30, 1945, table 4, page A6 ff.

The political conflicts which accompanied the relatively minor increases of the Revenue Act of 1943, passed over the President's veto in February 1944, convinced most people that wartime taxes were at their peak. With the war going well and reconversion problems in the air, various business men's and other organizations prepared postwar tax plans, while many organizations and person with no plans of their own prepared and published comparisons of the most publicized plans. In June 1944, the Congressional Joint Committee on Internal Revenue Taxation passed a resolution calling on its staff and the Treasury tax staff to make a study of postwar tax problems. One effect of the publicity given to postwar taxes in 1944 undoubtedly has been to strengthen the general belief that no additional wartime taxes would be imposed.

The fear that the high wartime corporate and individual taxes rats would be left in force after the war, presumably to help retire the debt, has given strong impetus to postwar tax planning. The various plans emphasize the restrictive effects that wartime taxes would have on peacetime industry and have succeeded in concentrating attention as never before on the relation of taxation to production,income and employment.

If the postwar tax planners /1/ had reached general agreement on just what tax changes would minimize the restrictive effect of taxes on production, income, and employment, a clear outline of the most desirable postwar tax structure might have emerged. But, while there is a surprising amount of agreement on many points, differences of opinion on several basis issues have been revealed. An examination of competing points of view with respect to these issues may be helpful in advancing an understanding of the problems involved in adapting the tax structure to postwar conditions.


Before turning to the specific taxes which constitute the Federal tax structure, let us consider some issues which relate to taxation generally.

On the face of things, the differences of opinion and analysis appear to be predominantly difference in understanding of the economics of taxation rather than differences in objective. The relative effect on economic activity of taxes that reduce consumption and of taxes that reduce "business incentives" are analyzed with great apparent objectivity. But the disagreement on economic forces, and hence on tax policy, which is reflected in such analysis probably springs from a more fundamental source than normal intellectual variation. To a considerable degree it probably grows out of an inevitable conflict of interests. If there were agreement on how the economy operates, a more intelligent effort to reconcile conflicting interest would be possible. The agreement in economic theory might so clarify the implications for governmental policy of a given economic situation as to modify political decisions. If economic theory remains in a constant state of intellectual confusion, special interest groups will have a better tool of political conflict than if harmony in economic analysis is achieved.

/1/ The plethora of postwar tax plans and discussions makes it appropriate to set up the gnus, "tax planners," for convenience of reference.

There is the usual argument that taxation should be for revenue only. [The "maximum revenue" test is used to make this argument consistent with simultaneous emphasis on the economic effects of tax changes. According to this test, concern over the economic effects of taxation is merely concern over the removal of restrictions to maximum revenue. Although it would be improper to seek through tax changes such economic goals as maximum production, income and employment PER SE, they become proper objectives of tax policy if they are identified with achievement of maximum revenue. Thus stimulus to business incentives becomes a legitimate goal on the grounds that increased business activity produces higher tax yields. The argument is a handy one, since, though it, desired changes can be defended as promoting maximum revenue and undesired changes condemned as interfering with maximum revenue.]

In current discussions there seems to be great awareness of the inevitable repercussions of taxes on economic life and of the importance of producing the least undesirable, i.e., the most desirable, repercussions. Recognition that tax rates would not be raised in periods of declining business activity -- a view not widely held a decade or so ago -- is now fairly general. This recognition does not necessarily represent a conversion to the economic tenets of compensatory fiscal policy. In some cases recognition has been forced by the logic that if low tax rates are necessary to maintain and encourage business activity after the war, an increase in rates can hardly be justified in a period of declining business activity. The intellectual and emotional clash between budget balancing and the logic of compensatory fiscal policy is probably severe for some people. The view that budgets should be balanced annually rarely appears, but there is some cleavage as to longer periods. The most prevalent view seems to be that over the business cycle expenditures should be matched by revenues and at least token progress should be made toward reducing the accumulated debt.

A few planners advocate flexible tax rates which rise in boom times and decline with the approach of depression. In view of the political and practical difficulty of applying flexibility, however, this proposal has in this country thus far remained largely in the academic realm.

The postwar tax plans and accompanying discussions have created a general awareness that government expenditures in the postwar years will be several times as high as before the war and that, notwithstanding a much higher national income than in prewar years, taxes will not revert to prewar levels. Some reduction from wartime rates is demanded and expected. However, failure to distinguish whether "cutting taxes" means cutting rates or reducing yields has led to some confusion. A reduction in yield, of course, involves the combined results of lower rates and lower national income.

The economic theories developed over the past decade or two are being used by some tax planners to eliminate conflict that has appeared to exist between the equity of tax distribution and the effects of taxes on the level of production. The orthodox emphasis on a large volume of saving and investment as the basis requirement of expansion casts an economic doubt on progressive taxation because of its alleged dampening effect on saving. The new emphasis on the maintenance of consumption as the foundation of investment and maximum production points to progressive taxation as both equitable and economically sound. Maintenance of consumption is thus deemed to overshadow direct incentives to invest as a means of stimulating business activity. Needles to say, this view does not meet universal acceptance, especially among spokesmen for the business community.

Little support has developed for the use of special tax incentives to stimulate economic activity. Specified tax concessions for such economically desirable activities as expansion of investment or employment have gained few advocates. In part this is merely an extension of the principle of using taxation for revenue alone. But is goes beyond this. Some people oppose such incentives because they fear that in practice the incentives would become special privileges and tax loopholes far removed from the underlying purpose of economic stimulation. For example, special tax treatment of new businesses is frequently opposed on the ground that such an incentive device might be perverted to result in tax reduction for old businesses for which it was never intended.

Simplification receives a share of attention in the formal tax plans, but less than might be expected in view of the public pressure for simplification in the winter of 1943-44. That pressure, of course, was primarily for individual income tax simplification and was heightened by the fact that great numbers of new taxpayers faced the complexities of the 1943 return which stemmed from the Victory tax and the Current Tax Payment Act of 1943. Most of the postwar tax plans proposed would add new complexities to the law while removing some of the old ones.


In the postwar tax plans under discussion, modifications have been proposed for every important tax that was changed during the war. Some of the more important issues involved in these proposals are discussed in the following paragraphs.


In the minds of people who are considering the postwar tax structure the problem of what to do with the excess-profits tax seems to command first attention. The name "excess-profits tax" does not describe the tax accurately, for it is more nearly a war profits tax. [However "excessive" in relation to invested capital, profits are not subject to excess-profits tax unless they are above the prewar earnings level, which is measured as 95 percent of the average earnings in a base period of prewar years, 1936-1939. On the other hand, even though profits exceed the prewar earnings level, they are not subject to excess-profits tax unless they also exceed a percentage of invested capital varying from 8 percent to 5 percent according to the size of invested capital. In both cases only the amount of the excess is taxed as excess profits. A series of provisions has been placed in the law to relieve hardships which might arise from an abnormal element in current income or from an abnormally low earnings record in the base period years. Excess profits are not subject to the corporate normal income tax and surtax.]

The excess-profits tax was brought into the tax structure in 1940 partly to raise revenue but chiefly to prevent profiteering from the war. The postwar tax planners with rare exceptions have approved or accepted the excess-profits tax as a wartime measure. [The view is sometimes expressed that the high rates have probably operated to restrict production in some areas during the war but have not significantly impeded our total productive effort in view of the strong counter-balancing impact of patriotism and governmental war powers. Limiting civilian production during the was is probably desirable in that it releases labor and resources for war production.] But the consensus is that the restrictions of the excess-profits tax on business reconversion and expansion would be unreservedly bad in the postwar period. Prompt repeal at the close of hostilities is generally urged, although there is some sentiment for retaining the tax at a lower rate until controls on wages and prices can be safely abandoned and perhaps even until war-caused high profits cease to exist.

Quite apart from the understandable desire of those subject to the excess-profits tax to get rid of it, the reasons for discarding this tax in peacetime are persuasive. A rough, although by no means fully achieved, effect of the tax is to maintain during the war a relative position among corporations similar to that which existed before the war. This tie to the prewar period makes the excess- profits tax unsuitable in any event after war excess profits have come to an end. For example,in the postwar period it is desirable that small corporations and new corporations be in position, unfettered by tax disadvantages, to grow and compete with established corporations. The present from of excess-profits tax would interfere with that competition.

It has been strongly urged that if, despite the objections, the excess-profits tax is retained for a year or so in the reconversion period, the rates should be substantially lowered. Proposals have been made to increase the excess-profits credits and, as an aid to small corporations, to increase the present specific exemption of $10,000.

The excess-profits tax presents many complications to the taxpayer and to the administrator. But suggested changes to simplify the tax are, in general, opposed by postwar tax planners. At this point, change itself constitutes a complication,since it would introduce a new set of rules applicable to some years, while the old rules would continue to apply to other years still under consideration.

A few voices advocate retention of some sort of excess-profits tax in the postwar period. They justify such a tax on the grounds that the higher ranges of profits relative to investment are less necessary to achieve a high level of production than are moderate profits, and that consistently high profits commonly flow from monopoly control. They agree, however, that the existing excess- profits tax, because of its emphasis on the excess over prewar profits, is not fitted to play such a role. [The difficulties of devising an excess-profits tax capable of reaching the desired profits in a peacetime system are impressive and have thus far seemed conceptually and practically insurmountable. Among the problems are: the determination of invested capital; the treatment of intangibles, which may or may not reflect an investment of capital (even where they do, it is often impossible to measure the amount of the investment): allowances for risk appropriate to different industries; and the treatment of income which is essentially derived from personal service rather than capital.]

While calling for early repeal of the excess-profits tax, a large majority of the postwar tax planners believe that the carryback of unused excess-profits credits and the carryback of losses should remain effective until corporations have had the tax benefits of the expenses and losses which are caused by the war but not incurred until after the war. There is some difference of opinion as to how long a period will be necessary to achieve this end, but in general a full two years after the repeal of the tax has been urged, and an even longer period has occasionally been suggested.

Some have pointed out, however, that the longer the carrybacks are maintained, the greater will be the offsets against wartime income of losses and expenses not connected with the war as contrasted with those that are war-connected. This not only operates to nullify the effectiveness of the excess-profits tax in taxing high war profits, but will also necessitate higher tax rates than would be required if there were not carryback refunds to finance.

Sentiment appears unanimously in favor of speeding up the use of the carrybacks by allowing them to be credited currently against income taxes due the Government.