Date 17 March 1942
Author Roy Blough
Title The Sales Tax Controversy
Description Staff memo, Division of tax Research, Treasury Department
Location Box 44; Papers of Roy Blough; Harry S. Truman Presidential Library, Independence, MO.

Tentative Conclusions

1. The magnitude of the war effort implies such a large amount of additional borrowing that sooner or later the choice between a sales tax and additional borrowing will come up even if broadening the income tax base is a first step.

2. Compared with inflationary borrowing, the general sales tax is an effective anti-inflationary instrument. In both cases the price level may rise, but if the Government collects the money corresponding to the price rise, it not only secures revenue but also forestalls secondary effects, such as demands for wage increases. The general sales tax is less inequitable than the inflationary effects of borrowing; it creates less distortion of income and price relations. The major objections levelled against the sales tax do not appear valid if additional borrowing is the alternative.

3. Preference between the general sales tax and a supplementary income tax withheld at source, if that choice should arise, will be determined by the relative importance attributed to anti-inflationary and equity considerations. A general sales tax is probably more anti-inflationary and a supplementary income tax withhold at source is probably more equitable.

4. A general sales tax may take various forms. In comparing a value-added business excise tax with a retail sales tax, judgment as to their desirability depends on relative anti-inflationary effects, relative equity, and relative administrative expediency. The memorandum does not state a preference for one of these two forms of business taxes.



I. The Character of the Controversy

     A. Arguments proposed in opposition to general sales taxes
     B. The nature of the inflationary pressure

          1. The inflationary pressure in general
          2. The specific nature of the inflationary pressure
          3. Conclusions to be drawn from the analysis

     C. The nature of the tax program and threat of inflation
     D. Problem future alternatives for anti-inflationary tax 

II. General Excise on Sales Taxes Compared with Additional Borrowing

     A. Sales taxes in a period of inflationary price rise
     B. Comparative influence on inflation; direct effects
     C. Comparative influence on inflation; indirect effects
     D. Comparative influence on price administration
     E. Comparative equity
     F. Administrative considerations
     G. Postwar considerations
     H. Conclusion

III. The General Sales Tax Compared with an Income Tax

     A. The question
     B. Comparative anti-inflationary effects; direct effects
     C. Comparative influences on inflation; indirect effects
     D. Comparative equity
     E. Comparative influence on price administration
     F. Effects on production
     G. Administrative considerations
     H. Conclusion

IV. The General Business Excise Tax as Compared with a Retail Sales 

     A. Anti-inflationary effect
     B. Comparative equity
     C. Administrative considerations
     D. Conclusions


In his Budget Message of January 1942, the President said, "All through the years of the depression I opposed general excise and sales taxes and I am as convinced as ever that they have no permanent place in the Federal tax system. In the face of the present financial and economic situation, however, we may later be compelled to reconsider the temporary necessity of such measures."

In contrast to the position taken by the President, three administration leaders, Leon Henderson, Marriner Eccles and Henry Morgenthau recently have expressed unqualified opposition to the use of general excise or sales taxes, one in a press interview, the second in a radio address, and the third in a hearing before the House Ways and Means Committee. If they are expressing opposition merely as a tactical device to secure enactment of the highest practicable income and excess profits taxes before recommending other types of taxes, they are not taking a position inconsistent with the President's program. Because of the possibility that they may be opposing general excise and sales taxes on fundamental economic grounds rather than as a move in political strategy, it seems appropriate to re-examine the place of the general excise or sales tax in war finance. This is the purpose of the present memorandum.



Mr. Henderson, Mr. Eccles, and Mr. Morgenthau have suggested tax programs which, they admit, will only reduce, not eliminate inflationary pressure. Their objections to general excise or sales taxes as emergency measures of war finance are:

1. General excise or sales taxes are not effective as anti- inflationary measures.

a. They cause an increase in prices and in that respect are inflationary rather than anti-inflationary.

b. They cause increases in the cost of living and lead to pressure for higher wage rates.

c. They cause an advance in the index of prices paid by farmers and an increase in farm parity prices, raising the minimum level at which price ceilings can be applied to prices of farm products. As a result the cost of living advances further and stimulates additional demands for higher wage rates.

d. They increase the difficulties of price administration by necessitating reconsideration of many of the existing formal and informal ceilings and imposition of new ceilings on uncontrolled prices.

2. General excise or sales taxes impose the heaviest relative burdens on those least able to bear them.

These objections, although raising most of the principal questions, do not include all the considerations pertinent to a choice of revenue measures. For example, Secretary Morgenthau objected to a sales tax partly on the ground that its collection would require much additional administrative machinery at a time when manpower is limited. Accordingly this memorandum will also consider the problems of tax administration as well as the effect of the sales tax on conversion to war production.


The President proposed reconsideration of the sales tax not as a permanent element in the Federal tax system but as an emergency measure in a very specific situation. Therefore, an analysis of the specific situation must serve as a background for an examination of the sales tax controversy.

1. THE INFLATIONARY PRESSURE IN GENERAL. The defense program started at a time when many millions of workers were unemployed and when ample facilities were available for most types of industrial production. The defense program, still mainly in the blueprint stage, could not at once make use of all the available resources. At that time there was no valid reason for limiting the rise in private purchasing power and the demand for civilian goods by a restrictive tax policy. Shortages in specific products were of the "bottleneck" type, which required specific encouragement of production and specific curtailment in demand.

The war program has, however, entered a new phase in which shortages exist in practically all types of products and in most services. In industries where labor and capacities still are available, expansion is limited by the shortage of transportation facilities. In many lines of consumer-goods production increase in supply is limited, and in others, drastic curtailments are necessary. Nominal purchasing power, OF the other hand, is rising rapidly due to the increasing volume of war expenditures.

Calculations made independently in the Office of Price Administration, in the Treasury, in the Bureau of the Budget, and in private research organizations indicate that consumers will have at least $10 billion excess purchasing power seeking outlets in the fiscal year 1943. Those estimates are based on the assumption of additional collections of $7 billion of taxes, approximately half of which would be at the expense of consumption; additional accrual of $2 billion in Social Security funds; a vigorous defense bond campaign; and successful control of wage rates.

In view of the expected upward revision of the estimate of war expenditures and of the movement in wages, these assumption are actually too conservative and the inflationary pressure will probably be larger than estimated. (See the special Memorandum on the "Impact of the War Effort on the Economy.")

2. THE SPECIFIC NATURE OF THE INFLATIONARY PRESSURE. In spite of the general nature of the shortages of goods the DEGREE of the excess of demand over supply varies from product to product. The pressure on specific prices varies with these differences in the excess demand. An analysis of the nature of the inflationary pressure (and of the efficacy of anti-inflationary measures) must take account of these specific situations. The degree of the excess demand for specific products and services is determined:

a. by the development of supply of specific products and services;

b. by the development of demand for these products and services.

If it is true, for instance, that the supply of food for the civilian population can still be increased substantially without impairing the delivery of food for the armed forces and the Allies, then an anti-inflationary policy which curtails the demand for food does not appear necessary. If it is true that an increase in the taxes imposed on people in the upper-income brackets curtails educational, cultural, and charitable expenditures, such curtailments would contribute little to alleviating the inflationary pressure or to converting the peace economy into a war economy.

Data on the basic factors in inflationary pressure are very scanty. Many of the facts are changing rapidly. For many products (even food) in which there appeared to be an abundant supply only recently scarcities have developed because of new military needs, a great increase in civilian demand, or the cut in supply lines.

Our analysis of the development in demand is still based largely on the study of consumers' expenditures in 1935-36. The national income has increased by more than 50 percent since then. Tax rates have increased; the unavailability of motorcars and other durable goods has changed consumers' habits fundamentally with respect to saving and spending. If a product is no longer available no demand can bid its price up. These products should be disregarded in the analysis. But we need to know what extent money that might have been used for these products will now be used for additional purchase of other goods or services which are still available.

Only very unreliable guesses can be found on the distribution of the income increases among the various income brackets of consumer units. More of the increase in incomes in the low income brackets probably would go into spending, less into savings, than is the case in the higher income brackets, in the absence of increased taxes and direct controls on consumption.

The Consumer Income and Demand Section of OPA's Research Division has analyses of these very problems in preparation. The periodic sample studies of urban and rural consumers' spending which are planned by the Bureau of Labor Statistics and the Bureau of Home Economics will be of great help in this respect.

For the time being, we must rely on very inadequate estimates. A few facts, however, can be stated regarding the nature of the inflationary pressure. Due to war expenditures and the increase in civilian demand profits (after taxes) increased by more than 30 percent; wages increased by more than 20 percent in calendar 1941 compared with the preceding year. DISTRIBUTED profits and interest, however, increased only 5 1/2 percent. Farm income increased by about 40 percent. (See the following table.) Thus it seems safe to conclude that farm and wage incomes, the typical low-bracket types of receipts, have increased much more than the typical high-bracket types of receipts (excluding the accrual is undistributed profits to stockholders).

                           Calendar years

                                   In billions of Dollars     Percent
                                  1940     1941   Increase   Increase

National Income                    77.2    94.5     17.3      22.4
  Farm income                       5.3     7.4      2.1      39.6
  Other                            71.9    87.1     15.2      21.1

Income payments                    75.7    89.5     13.8      18.2
  Salaries and wages               49.3    59.9     10.6      21.5
  Dividends and interest            9.1     9.6      0.5       5.5
  Other                            17.3    20.0      2.7      15.6

Corporation profits, /1/ 
 before taxes                       7.9    13.6      5.7      72.2
  Corporation taxes                 2.4     6.4      4.0     166.7
  Corporation profits, /1/
   after taxes                      5.5     7.2      1.7      30.9
/1/ Including distributed and undistributed profits

Families and single consumers in the income brackets below $2,500 comprised probably about three-fourths of all consumer units in 1941; their aggregate income was only 45 percent of the whole; their expenditures were, however, over 55 percent of all expenditures including housing (except for automobiles and other durable consumers' goods now unavailable). It seems a fair guess that about three-fourths of the total increase in income payments, 1941 over 1940, was received by families with an income below $2,500. This explains the presence of inflationary pressure on prices of practically all goods and services bought by all income groups.

3. CONCLUSIONS TO BE DRAWN FROM THE ANALYSIS. From such an analysis of the nature of the inflationary pressure the conclusion is often too hastily drawn that the only justifiable tax measures are those which absorb the increase in purchasing power where it accrued. Such a conclusion can be questioned for two reasons:

a. Inflationary pressure is generated, as will be discussed in greater detail later, not only by direct war expenditures but also by increases in wage rates, and in farm prices, and by other indirect effects of war expenditures. It is not reasonable to appeal to labor and farmers for restraint in their demands, and for sacrifices, unless drastic taxation of profits and higher income is imposed when the lower income brackets are called upon to make sacrifices.

b. The increase in the income of wages earners is due mostly to the increase in the active working force and to longer hours. More workers are working longer hours without increasing the supply of consumers' goods. These workers need food, shelter, and clothing. If the total supply of food, shelter, and clothing cannot be increased, the additional goods needed by these workers must be supplied by a curtailment in the demand of other groups in the population. Equity would demand that first of all those groups who have more than a minimum should curtail their demand for food, clothing, and shelter. Greater equality in spending, if not in incomes, is desirable in an emergency situation.

The appropriate conclusions to be drawn from analysis of the inflationary pressure are derived from economic rather than equity considerations. Pressure from increases in income has tended to concentrate more largely on mass-consumption goods. If a person in the higher or middle income brackets is taxed, he may first reduce savings; then cut charity, educational, and cultural expenditures; then shift from fancy to less expensive articles of food, clothing, or move to a less expensive house or apartment. These curtailments will to a limited extent release goods or resources which will enable the low income worker to satisfy more nearly his urgent demand; they will perhaps be more helpful in releasing manpower which may directly or indirectly be diverted to the war effort. Thus, taxes on these groups tend partly to come out of savings, partly to encourage transfer of resources to war industries, partly to cause curtailment of non-necessities. They will, therefore, have a more limited anti- inflationary effect than an equal dollar volume of taxes on lower income groups.


The Treasury has submitted a tax program to Congress that may accomplish the President's request for $7 billion additional collections, in fiscal 1943 if a larger part of income tax payments is required on March 15 and if the authority for collecting a part of the tax currently through the withholding device is granted. The program admittedly will not suffice for "mopping up" excessive purchasing power. Because of its composition, it will contribute very little directly to the anti-inflationary program. The Secretary of the Treasury testified that he recommends "complete rationing" (Revenue Revision of 1942. Hearings Ways and Means Committee March 3, 1942, Unrevised Committee print Part I, page 48). The time is too short, to develop a COMPLETE system of effective rationing which can be the main instrument of price control. A vigourous fiscal policy seems essential for control of the huge amount of excessive purchasing power.

If inflationary price increases are to be limited, it will in all probability become necessary to raise the revenue goal in the course of the next fiscal year over and above the Budget figure. The President recognized such a possibility by recommending a flexible tax policy in his Message. The goal was limited to $9 billion only by the consideration that immediate announcement of a more nearly adequate figure would have decreased the chances for speedy enactment of a revenue bill.

The size of the increase in the revenue goal necessary for the control of inflation depends partly on the types of taxes in the program. The less effective a tax as an anti-inflationary measure, the larger must its revenue be in order to accomplish the purpose.


The general sales tax is not discussed in the present memorandum as a possible substitute for any of the proposals included in the Treasury's present tax program. The present Treasury proposals are in accord with the President's program outlined in his Budget Message. The Treasury program goes a long way in meeting the need for stiff progressive taxation on incomes, estates, and profits. It satisfies the need for equity in the distribution of the tax burden, equity which is essential when all classes of the population are called upon for sacrifices. The program fails, however, to provide a sufficient degree of anti-inflationary influence.

Representatives of the Treasury indicated at the Hearings that they will recommend broadening the income tax base if further anti- inflationary taxes become necessary. Such a proposal was not included in the present program, apparently because it was felt that the political and psychological limits of income taxation would be reached for the time being at the present exemptions if the rates were increased.

In examining the arguments proposed against the use of the general business excise or sales tax two possible situation need to be considered.

1. That the yield from income taxes cannot be increased for the time being beyond the Treasury's proposals and that other anti- inflationary devices are not available or are not sufficient to absorb the excessive purchasing power. (A memorandum on compulsory saving will be submitted shortly). In this situation the alternative to a general business excise or sales tax is additional borrowing, and the effects of the sales tax should be compared with the effects of additional borrowing. This is discussed in section II.

2. That it is still practicable to increase the yield from income taxes by broadening the base and by increasing the rates beyond what the Treasury now proposes. In this case the general sales tax should be compared with such a supplementary income tax. This is discussed in section III.

The first situation is more probable then the second because it seems certain that even by broadening the income tax base the yield will not be increased enough to make additional borrowing unnecessary under the war program. It is is true that more taxes can be collected by including a general business excise or sales tax in a war program than without it, the question of the sales tax versus additional borrowing will be the real issue in the sales tax controversy sooner or later.