Date 20 September 1934
Author J. Wilner Sundelson
Title The Federal Revenue System: Taxation During Inflation
Description A report to the Secretary of the Treasury
Location Box 62; Tax Reform Programs and Studies; 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.



I   Probable Effects of a Rapid Rise in Prices on Revenues,
    Expenditures and Credit

     Definition of Inflation
     Analysis of Rising Prices during Inflation

          Need of Effective Federal Tax System
          Increased Governmental Expenditures
          Government Financing During Inflation

II  Extent to Which the Tax System May Be Effective in Preventing or
    Combating an Inflation

     Flexibility of Tax Yields

          Tax Base

     Criteria for Maximum Revenue Yields
     Behavior of Tax System During in Inflation

          Personal Income Tax
          Capital Gains
          Corporate Income Tax
          Excess Profits Tax
          Estate and Gift Taxes
          Liquor and Tobacco Taxes
          Manufacturers' Excise Taxes
          Stamp Taxes
          Miscellaneous Taxes
          Customs Duties


III Policies to be Pursued in Coping with Unfavorable Reactions to
    an Inflation in the Fiscal System

     American Inflation Experience
     German Taxation Policies During Inflation

          Reasons for Failure

          1. Failure to Comprehend Gravity of Situation
          2. Over-concern for Misfortunes of Taxpayers
          3. Attempts to Lower Some Prices Through Legislation
          4. Difficulty of Measuring Real Values
          5. Disowning of Currency

    French Taxation Policies During Inflation
    Tax Policies to be Employed to Combat Inflation

          1. General Rate Insurance on Existing Levies
          2. New Taxes
          3. New Taxes Responsive to Price Rise
          4. Modifications of Existing Levies to Ad Valorem Basis
          5. Taxes Collectable in Kind
          6. Use of Estimated or "Forfait" Basis for Fixing Tax Debt
          7. Prepayment of Taxes
          8. Moving Tax Closer to Revenue Source
          9. Partial Abandonment of Currency
         10. Complete Abandonment of Currency

     Policies for General Fiscal Legislation and Administration to
     Combat Inflation


Taxation During Inflations

J. Wilner Sundelson

Part I

There is a strong belief prevalent that a continuation of the present fiscal and monetary program of the Government will lead to an inflationary boom. Others feel that the conditions and trends in finance, commerce, and industry may well be considered as pointing to a growing clamor for, if not an actual, inflation. In addition to this there is the possibility that advocates of monetary expansion in one form or another may gain the upper hand in the conduct of Government. It is not necessary to weigh the merits or soundness of these views. The fact that they are held and discussed makes a study of the fiscal aspects of an inflationary price rise not without value at this time. The study should show

(a) the probable effects of a rapid rise in prices on revenues, expenditures, and credit.

(b) the policies to be pursued in coping with the unfavorable reactions of an inflation on the fiscal system.

(c) the extent to which the tax system may be effective in preventing or combating an inflation.

It will be necessary to reduce to a minimum the discussion of any other than the taxation problem.

Inflation for the purpose of this memorandum may be defined as a sharp increase in prices unaccompanied by a related change in the quantity of goods and services. In other words a depreciation of the standard of payments is considered as synonymous with a rising price level. A definition of this type (Rogers, /1/ p. 337) is limited in its scope and does not attempt to deal with underlying causal factors. The monetary deterioration is merely a superficial symptom of inflation, but it measures the sole feature that is universal enough for purposes of definition. Some students of the problem (Willis, p. 325) offer definition that are in no sense contradictory but which attempt to associate the term inflation with a state of business affairs that will eventually culminate in in the rapidly rising price movement. Definitions of this type even go beyond the price feature and deal with the final deflationary chapter. Our concern with the behaviour of taxes during the rising price period rather than with the events leading up to, or following an inflation, enables us to disregard the more basic type of explanation.

Some further general remarks about the type of situation envisaged by the writer as surrounding this particular concept of inflation may aid in classifying the subsequent discussion. The rising price of an inflation are characterized by unevenness, lack universality, and are subject to irregular lags and geographical dislocations. The violent disturbances in existing money expressions and exchange relations make it utterly impossible to think in terms of uniform price levels. Certainly whatever doubt exists regarding the validity of the price level concept in general surely the use of different value standards, the breakdown of elderly exchange, the widespread prevalence of "distress" selling and "panic" buying, and rapid turnovers must assure the reader that the price level notion must be revalued. The existence of "levels" would rob inflations of many of their objectionable features and would make such booms less difficult to cope with. (It is not improbable that even under more normal circumstances the relation of the fiscal system to prices is obscure. The emphasis in fiscal science literature has been on business conditions rather than prices. The existing body of price data furthermore, is unsuited for public finance purposes.)

An inflationary price rise is unbalanced. Certainly it does not follow any known historical sequence. Nor is a theoretical analysis satisfying; for whatever may be said about the backward state of scientific knowledge of dynamic economics, it is clear that the probable progress of an inflation is not comprehendable. No weight of authority can be assembled to sanction any one particular view. Continental post-war experience tends to indicate that the usual course of events is a fall in foreign exchange rates, a rise in prices, and an increase in the quantity of the circulating medium of payment. (It should be noted that foreign experience is limited to countries in which the use of bank-deposit currency was generally undeveloped. Nevertheless, conclusions can hardly be expected to differ because of this.)

It is not without some hesitation that the writer has chosen the "internal capital flight" type of inflation as the basis for the subsequent discussion, yet it is not at all improbable that the World War expansion period in this country might offer a more advantageous historical analogy for our purposes.

The element in the European post-war inflation models that gives them a unique character absent in the War boom is the self-accelerating progress of the cycle. An inflation, regardless of the causal background, is more likely to be accompanied by a wild rise in prices if it starts where there is no unemployment when industry is running at full plant capacity, and when there is a shortage of durable goods. On the other hand, when an inflation follows a severe depression, as will be the case in this country if we have one, it will meet with the unemployment, the idle plant capacity, and the excess inventories that a depression leaves in its wake, and will not necessarily mean a rise in prices. In the latter case a period of prosperity may be enjoyed before the vicious self-accelerating phases with their panic fluctuations get under way. Rather than consider this factor as one eliminating the dangers of our having a runaway inflation, the writer has preferred to assume that it will merely extend the early and less excited stages of the currency depreciation and postpone the more dangerous phases.

This memorandum should not convey the impression that the writer feels that we are necessarily going to suffer a violent inflation. There is, however, sufficient evidence pointing to the possibility of our having a boom of the more spectacular type, and the writer has chosen to treat the problem from this approach.

The conclusion is reached that the Federal tax system is not in a position to cope effectively with the demands of a rapidly rising price period. Unless the tax measures associated with the extreme phases are adopted, a breakdown of Government functions or an orgy of borrowing will follow. Furthermore, unless a drastic tax program is introduced at the beginning of the boom, we are apt to go far beyond the initial impulses of a pump-priming credit expansions or monetary devaluation. It is not without a specific purpose that the tax problems associated with the extreme types of inflation are discussed.

The course of the French and German inflation processes is well established, though causal relationships are still subject to debate.

Two representative views of the course of typical inflations are as follows:

Rogers,- p. 197 (France): "This (the) gradual decline of the franc in terms of foreign currency led to increased foreign buying of French goods, to a gradual but lagging rise in prices and finally, as it became necessary to make the larger payments, to an increase in the currency supply".

Graham,- p. 48 (Germany): "Rising foreign exchange rates, rising domestic prices, increase of governmental expense, larger budgetary deficits and increase both in the absolute volume and the rate of acceleration of government discounting of Treasury bills, diminished public demand for such bills, increase in the absolute amount and in the rate and issue of Reichsbank notes, larger cash and credit volume of circulating medium, further rise in exchange rates and prices, and so on in indefinite repetition."

In following these general patterns we may be entitled to ascribe a certain reasonableness to what may otherwise appear as an irrational guess.

Since an upward movement of money prices is the outstanding feature of an inflation, there need be no difficulty in pointing out the rapid growth of Governmental expenditure outlay. Additional purchasing power is needed to defray the cost and carry out a constant amount of activities. This is coupled with the fact that inflations are usually ushered in with excessive Governmental loan expenditures and outlays are at a high level immediately preceding a recognition of the inflation itself. (The public finances will hardly emerge without blame in the tracing of the responsibility for inflations. This aspect of the problem, important as it is for this country at present, goes beyond the confines of this study). There are some further reasons for the expected growth of Government expenditures during a period of rapidly rising prices.

(a) In addition to increase arising out of the need for purchasing goods and services in the open market, the Government will find itself expending additional sums on what now appear to be contractually fixed prices. In a sincere effort to defeat the progress of an inflation one might assume that the Government would avoid voluntary increase. The state, however, is not impersonal enough to stand behind the protecting wall of contracts when human hardships are involved. Wages and salaries paid by the Treasury are certain to follow, even if with lags, the rising cost of living or come vague increase related to it. The present depression has shown that we must revise our notions regarding "fixed" expenditures. Political pressure and expediency have definitely replaced legal obligation as a realistic criterion for fixity. This will probably be the case during a boom, since foreign experience points to the conclusion that even a conscious effort cannot prevent the state from being unable to exert pressure to stop the incidence of rising prices from falling upon itself.

It can be noted that the general impression gained from studies of inflationary finance is that Government expenditures as a whole tend to follow wholesale prices. This can be nothing more than a coincidental relation since a wide variety of prices (cost of living, foreign exchange, etc.) enter into the make-up of the Government expenditure total and actual wholesale commodity purchase play only a minor role in Government outlay.

(b) Exchange depreciation places a severe burden on all payments to be made abroad or in a non-depreciated standard. Apart from external debt (this Government is not faced with this problem), consular and diplomatic, defense and import outlays make up this bulk of these payments. The German inflation, in particular, was greatly influenced by this feature. It is estimated (Lotz, p. 11) that in 1922 and 1923 almost a billion gold marks, exclusive of reparations and other postponable items, had to be paid by the Treasury of the Reich.

It is not unreasonable to assume that an inflation in this country will be accompanied by a competitive devaluation abroad. England, and subsequently the gold bloc, may not stand by idly during a currency depreciation in the United States. In that case certain of the incidences, e.g., foreign trade, need not be feared in a purely individualistic fall in the national monetary unit.

(c) The breakdown of many normal economic activities during an inflation brings in its wake a series of social misfortunes. Welfare, relief, and even subsidy expenditures will increase as the Governments undertake these added functions and activities. Two influences will affect the Federal finances:

1. Expenditures based on spheres of activity engaged in at present by the Federal Government will expand.

2. The breakdown of local finances will shift an abnormal share of the burden to the Federal Government. The discussion below of the monetary depreciation sensitivity of taxes should indicated that the finances of the localities, and to a lesser extent those of the States, will be severely hit by an inflation. There is sufficient precedent established during the current emergency to support the prophecy that the Federal Government will step in and relieve the political subdivisions. Inflations have their origin in federal finances or monetary policy and there will be efforts to have the Federal Government bear the incidence of the trouble it starts itself.

A compensating influence on the growing cost of government will appear in relation to the expenditures linked to the Government's role as a debtor. The public clamor for revalorization will strike this group last. The expenditures will in monetary terms remain equal and will not be much of an equalizing influence on total expenditures. The conclusion must remain that Federal outlays will reach, regardless of attempted control, new and growing heights during a period of rapidly rising price levels.

The growth of expenditures will never be a problem PER SE if the financing offers no difficulties. Unfortunately, inflationary finances are troublesome because of the hardships that the fisc will find in meeting the increasing outlay without adding to the further progress of the inflation. That is the reason the usual discussions of taxation or pay-as-you-go financing VERSUS borrowing find no place in this memorandum. The ability of a Government really to borrow, that is to tap actual accumulation of savings at reasonable prices is a sure indication that there is no inflation. The empty notions of a nation engaged in exchanging its won unmarketable paper for that of the depreciating currency printed by the central bank or some other fiscal agent do not deserve the connotation of borrowing. Particularly short term borrowing, which has a recognized place in a normal fiscal system, is vicious. It was via the short term debt route that Continental inflations travelled.

Between borrowing and taxation there is a narrow strip of activity that might offer, at first blush, a solution of the financing problem. The Treasury will be tempted, just as it is during depression, to liquidate hidden reserves. A probable field for Federal action is to attempt to force payments on outstanding foreign debt. Perhaps foreign nations will not object to pay dollar debts in a devalued dollar.

The Administration has recently shown that it places considerable emphasis on the capital assets held by the Government. In addition to specie and foreign-owed debts the assets consists chiefly of bank, farm, and mortgage loans, and the self-liquidating portfolios of some of the spending agencies. These are all fixed income obligations with little or no equity ownership elements, and their marketability during an inflation is questionable. Equally, repayments of outstanding Government loans will be made in depreciated currencies.

Some of the so-called "windfall" resources might be available but should be strenuously avoided since their tapping is usually a further step along inflationary excesses. Our handsome increment from the reduction in the weight of the gold dollar and the silver seignorage represent the type of resource that will not be available if a consistent anti-inflationary policy is pursued. It is definitely a case of taxation or greenbackism. We turn to a survey of the tax aspects of an inflation with the thought that taxation is the sole financing and contracting device.

German writers have been the leaders in the study of the behavior of tax yields under various different periods of economic conditions. Their contributions to the knowledge of business cycle sensitivity of taxes (Konjunkturempfindlichkeit) has been a valuable addition to public finance literature. Unfortunately, only the depression phase of the cycle has attracted their attention. These authors have also developed the concept of monetary depreciation sensitivity (Geldentwertungsempfindlichkeit) but have, to the writer's knowledge, done very little in measuring and classifying revenues in terms of the inflation criterion. The term sensitivity, when used here, implies the ability of the tax yield to react to changes in the tax base. It suggests also that the base will follow the general course of events. The cycle sensitivity criterion, on the other hand, ranks levies on the basis of their power to yield revenues regardless of the shrinkage of the more common indices of economic well-being. It is really a measure of insensitivity. A simple capitation tax is the best cycle tax (giving no consideration to the non-fiscal stabilization or recovery influences), while it is one of the worst inflation levies. It will readily be seen that the classifications made with the cycle approach are worthless with respect to our own problem.

An attempt to measure revenues with respect to their inflation effectiveness can derive no benefit from the usual classification of direct and indirect taxes. Some direct taxes such as the capital gain of excess profits levies are well adapted to inflation, others such as the inheritance and succession taxes are not. Similarly, consumption taxes, according to their varying provisions, are often on opposite ends of the sensitivity scale. Other classifications of revenues are equally unsuited for our purposes and no attempt will be made to work with any known grouping of taxes.

The most important factor in the yields of a tax is the behavior of the tax base. The fluctuations in the magnitudes of the taxable objects must immediately present or restrict opportunities for increased yields. The base being given, the ability of the revenue yield to keep pace with its changes depends on the tax measure and rate and on the mode of collection. (The inclusion of the collection method among the inflation norms indicates that the problem is not solved with the more ascertainment of the tax liability. The progressive deterioration of the currency, supposedly the essence of the inflation tax problem, necessitates giving attention to the rapidity with which the tax law and its administration call for actual payment of the tax debt).

In measuring the effects of inflation on tax bases, it can be noted that quantitative increases in certain measures of economic activity are not significant since they merely express changes in the manner of stating exchange relations. There are frequently no basic increases in taxable magnitudes. For example, money sales volume figures might indicate a growth in excise tax bases. Actually, quantity sales figures may decrease or remain stable. Unless the actual behavior of each tax is analyzed, one is led to believe that a rapid turnover of goods, an acceleration of certain economic processes, reduction of unemployment, and an increase in money income, profits, and wages would serve to widen the logical field for taxes. There is a first impression that the boom factors add to the accumulation of taxable sources. The ability of the Treasury to extract purchasing power from these phenomena, if they mirror true conditions, is an entirely different matter.

The brief enumeration of the features of a boom in the above paragraph represents the optimistic view of inflation. They are the so-called advantages and are considered favorable from the point of view of economic welfare in general and tax bases in particular. A number of other aspects may have no direct influence on broadening the scope of taxation. For example, the disappearance of metallic currency from circulation, losses to foreigners due to the cumulative depreciation of the currency, and profits to the inflated economy from the sales of paper money abroad are some of the factors of this type. These, along with several other items which Graham points out, may be influential in determining the course of economic developments but are extremely difficult to trace with respect to their effect on tax yields. Unless the measured phenomenon is directly associated with some specific tax, its influence can only be realized in conjunction with some of the of the direct taxes on economic surpluses. The traces of the individual factors are easily lost. It will not be possible, for instance, to trace the influences arising out of the fact that new title-holders acquire property in the rapid turnover of wealth without high cost burdens, that profits of middlemen tend to diminish, or that the disenfranchised rentier class and other participants in fixed income distribution must engage in productive labor in order to live.

It may be advisable to digress from the study of tax base influences to consider the question of the demands to be imposed upon the fiscal structures; for on the ability of the tax system to cope with the situation hinges the success of the anti-printing press forces. The tax system is faced with an unsurmountable obstacle in attempting to cope with the inflation leakage. It is our conclusion that the Treasury, even with radically revised policies, will hardly be able to tap enough of the increments created by inflation to compensate for the losses on real tax bases. The tax system is, however, expected to go beyond merely covering current expenditure. It must fight by means of currency contraction through taxation, the excess amount or the too rapid circulation of the media of payment. Contraction of the currency is not a goal in itself, but through it, confidence that the price rise has run its course can perhaps be restored. Views have been specifically expressed to the effect that a tax policy can hinder the development of an internal depreciation in spite of an unavoidable external decline in the exchange value of the currency. Both Graham and Cohen, who are quoted below, present the belief rather than the proof that the tax system can win. They have their ideas on German experience.

"The hard fact of external pressure was, in itself, enough to ruin the exchange value of the currency, though a more Spartan tax policy might perhaps have preserved its interval value" (Graham, p. 76).

"Wahrungsfragen und steuerwesen hangen aufs innigste zusammen. Dean die Grundlage der ungunstigen Wahrungsverhaltnisse, die Inflation kann nur durch Anderungen im Steuerwesen wirksem bekcamoft werden. Die steuern bieten die noglichkeit, einer weiteren Inflation au entgehen. Sie sind aber such ein Heilmittel bestehender Inflation. Die beste Art der eanierung einer Wahrung ist Kontraktion: Einziehrung vorhandenen Geldes aus bereiten Mitteln des Staatsfonds. Als solche kommen in Betracht: Anleihen und Steuern."

"(Problems of currency and taxation are intimately connected. The basis of the unfavorable currency condition (the inflation) can be successfully combatted solely by means of changes in the tax system. Taxes alone offer the best means of preventing the progress of an inflation. They are also the means of getting an existing inflation under control. The best method to stabilise a currency is contraction. The State should obtain control of all outstanding currency and the best means of so doing is the use of loans and taxes," (Cohen, p. 21).

The contraction of the amounts of outstanding circulating media by means of taxation is definitely a form of non-fiscal motivation in taxation. However, unlike most other cases of non-fiscal taxation the goal in this instance, namely the collection of more funds, is the same as that is the desired and in ordinary revenue considerations. This aspect supports the impression that the taxing power is a suitable medium for counter-inflationary Government intervention.

We turn again to the specific problem of tax bases and their behavior during inflations.

In the final analysis it is difficult to convince a same person that general improvement takes place in the tone and progress of business affairs. The reduction of a nation to a panicky state of poverty hardly can be achieved by an amelioration in general conditions. On the other hand, security transfer activity, advances in export business, and foreign exchange speculation may lend themselves to bigger tax revenues. It is just these individual phenomena which relate to specific taxes and which may exercise beneficial influences on revenue yields, though the power of these factors to enhance general economic welfare is doubtful. A discussion of individual taxes will bring out further points with regard to the tax yields from specific boom features.

Let us for a moment disregard the illusory aspects of the money measures employed by those who see any advantages accruing from an inflation. There are other features that point to a shrinkage of tax bases. Unlike depressions, where tax reactions are all stable or downwards, inflations offer a wide range of experiences that taxes may undergo. There are ample instances where declining yields in face of rising prices are to be expected.

The redistribution of wealth which some claim to be a feature of inflations, may mean a general leveling off of the top levels of certain direct taxes. The existence of a progressive rate structure may not offset this. There is, however, no possibility of making quantitative studies of the factors involved. The opposite of every claim made for the favorable aspects of an inflation might be a closer approximation to the actual state of affairs than the original contention. Business may recede, profits may give way to losses, unemployment may increase, and sales may fall off. The German experience, and to a lesser degree the French, shows waves of recession and improvement during the course of the inflation. The fact that these are different phases in an inflation may mean that at times tax returns will be subject to more favorable or less harmful influences than at others.

Prices that are rising too rapidly can cause panics, receiverships, bank closings, and the other symptoms of a super-excited business community to appear. These make it easy to see the loss favorable aspects of an inflation on tax yields. Certainly, there will be fear and uncertainty, depreciation and shrinkage of some property values, labor and social unrest, and the renaissance of barter; these must all hurt the Treasury like everything else.

If a decline in foreign trade occasion a setback in our general economic well-being, it will certainly act unfavorably on tax yields. Since exports are discussed elsewhere, comments at this point are restricted to imports. The general European inflation pattern calls for a decrease in imports. In addition to a direct decline in custom duties, corporate income and other taxes will reflect losses from industries that are deprived of essential raw materials. In this country, however, the great bulk of commodities (rubber and tin, coffee, tea and cocoa, and to a lesser degree wool and silk) that are imported are considered indispensable and most of them are allowed to come in free of custom duties.

The ability to purchase these raw materials and foodstuffs is strengthened by the fact that we possess some eight billions of gold and over one half billions of silver. Certainly we will be able to purchase if we are willing to part with some of our bullion all the imports wee need even though our paper currency will be worth very little. Our imports may fall off during an inflation but hardly to the same relative extent as that for countries that could not part with their last few ounces of specie. In devaluing our currency first in the face of huge specie reserves and at a time when the devaluation profits are not the sole source of available funds, we are establishing a new pattern for inflations.

Suggestive ideas about business during inflation are presented by a study of the time element in business. It becomes more attractive during inflation to engage in entrepreneur activities and in what is called unproductive employment. Industry and finance certainly do not wish to embark upon the time-consuming, "roundabout" processes that are characteristic of the capitalistic economy. Business becomes more speculative, loss constructive. Security issues for entrepreneur activities are relatively easy to float. Most of the new issues represent increased valuations of the basis of rising prices and are merely capital dilutions (Kapitalverwasserung). Other long-term investment in the shape of either stocks or bonds, is not attractive. Solely claims to ownership of existing or immediately available tangible elements of wealth are capitalized. The falling off of other capital market activities can offset the gain from speculative investment and equity pursuits.

Another feature that will introduce unfavorable repercussions in this country is the breakdown of fiduciary business institutions. For example, the life insurance business, a source of livelihood for many thousands, is one of the many types of business activities based on a more stable business outlook that will suffer. Specifically the loss will first hit the Federal and State treasuries in the form of decreased revenues from insurance taxes. This feature in independent of the decreases in purchasing power that the recipient of insurance benefits must suffers.

We have a habit of discounting future possibilities, and it is not unlikely that some of the possible advantages that are associated with inflations, like the rise of common stocks, will have already taken place, by the time the latter stages arrive. This feature, however, could exert an influence during only the initial phases of an inflation and must soon lose its significance.

The discussion of possible tax base influences can well go on ad infinitum as each guess and its opposite claim is offered. In general the impression gained is not a favorable one. Inflation is not a healthy tax background. The levies that meet with our approval as "good" taxes are to suited to the peculiar situation, of inflation. No tax system can be expected to live up to the various demands imposed on it by a fluctuating economic system. It must therefore be kept in mind that no attempt is made here to set up new standards for sound taxes. It is, however, impossible to neglect the inflation problems. In the case of depression financing the conclusion has been reached by many writers that it is wrong to attempt to make a tax system cycle-proof. A tax system base on the commonly accepted norms can be trusted to respond to the up-swing of the cycle in such a manner as to warrant deficit-financing during the depression. Myrdal, Colm and other writers advise against attempting to reduce the cycle-sensitivity of the tax system. (Fiscal Aspects of Planned Public Works an unpublished manuscript prepared by the writer for the National Planning Board). Unlike the depression problem, the inflation financing crisis offers no way out except through tampering with the tax system. Although steps backward to inefficient and inequitable tax types will be recommended, such a policy is justified since the very stability of government is at stake.

It is difficult to state dogmatically that revenue yields alone become the sole criterion for the acceptability of taxes; still the attempt to save the fisc from collapse supersedes all other considerations. Inflation demands a subordination of justice and equity concepts base on the former relations of the individual to the state and to his own economic status.

Inflationary taxation will call for attempts to bring into the tax systems levies that will insure against the nullification of legislative intent by unforeseen price movements. A study (by Viner) has clearly shown that even small price level rises increase and redistribute burdens in a highly unjust manner. The present writer is interested solely in maximizing revenue yields during the rising price period. Consideration will be given to equity principles only at the point where failure to pay attention to gross injustices causes the Treasury to defeat its own purposes. A hostile spirit among taxpayers against the Treasury or a strong incentive to universal evasion (tax strikes, etc.) will serve to decrease revenue yields. Although the Germans at times paid too much attention to the particular misfortunes of individual taxpayer, they occasionally failed to take into account excessive burdens imposed by the vagaries of the inflation and at such times met with the organized and militant opposition of taxpayers.

These principles that we have set up and accepted interfere with the policies that must be pursued by the Treasury during inflation. To the reader interested in preserving the "soundness" of the tax system, some of the conclusions of this memorandum will be shocking.

Failure to take into consideration the incidence and shifting of taxes may mean that the state will be armed with a number of theoretically lucrative but actually uncollectable levies. The burdens must fall on sources that have the means to make payments. Actual payment demands against persons who are in no position to pay will result if the Treasury does not remember that an economic status achieved at some stage of the inflation is at time not capable of oven a short preservation. For example, our progressive income taxes will mean that an ordinary wag earner will find himself in the higher brackets. If the rise in prices has gone ahead of his increased earnings, as it usually does, the new income tax subject will not be able to meet his minimum expenses, still loss pay taxes. Or the tax may be levied at a time when the lag has been absent. Subsequently the delay may wipe out money profits that available for taxation at an earlier period. We should profit from our depression tax policy mistakes. We levied higher rates against disappearing tax bases. Such a policy help to reenforce confidence in Government obligations, since it indicates a desire to tax high incomes when they eventually return, but it does not bring in any current revenues.

Before continuing the survey of the factors affecting monetary depreciation sensitivity, a few further comments on tax bases and types will be made. It is essential that inflation taxes strike immediately at taxable capacity. It is fatal to wait for a diffusion of the various improvements throughout the economic system. The time element is the crux of the entire tax problem, and the Treasury should recognize its importance. The Government must anticipate rather than wait for the emergence of likely tax sources. A system geared to economic surpluses will not fare well as a tax philosophy aiming at turnover at the stages of production, exchange and consumption.

We are assuming throughout a continuing depreciation so that it will be necessary to receive funds from a source as close as possible to the actual event giving rise to the tax liability. Revenues from sales taxes, from taxes on transfers and turnover, and from taxes that pay no attention to the subsequent developments in the economic status of the taxpayer are best suited. The profits during and inflation are largely illusory, and currency contraction through taxation will not take place unless taxes are levied and collected before the mirage disappears. It is when goods are sold above cost that a profit appears. But if distrust in the medium of payments encourages an internal capital flight, manufacturer will be anxious to replace goods sold. The replacement cost will be higher than the previous sale price, and over a period of time business will show no profits. Individual transactions will not, however, fail to offer a tax target.

The value of the tax, then, as an inflation device, will be determined by the proximity of the tax source to the basic phenomenon giving rise to it, the absence of time lags between the appearance of taxable capacity and the tax levy, the exclusion of provisions that may give taxpayers recourse to the true economic status, and wherever possible a link to non-depreciated values.

Tax measures are important since they determine the manner of linking the tax liability to a given factor. The cruder measures, such as gross incomes and gross sales, are desirable since they preserve the Treasury having to acknowledge the shrinkage in real incomes and in the quantity of goods sold. Ad valorem rates automatically keep pace with price increase, as well as turnover, whereas specific taxes will benefit only from turnover. What happens to prices during inflation is well known, but turnover indices are less likely to run true to predicted form. A price link rather than a quantity link should be preferred. The measure criterion is applicable more to excise and sales levies than it is to the commoner direct taxes. The nature of the tax changes when the levy is made on a gross instead of a net basis * * *. This falls under the heading tax type or base. Furthermore, direct taxes are invariably expressed in percentages and do not present the problems associated with taxes that do not move in any proportional relation to changes in the base.

The payment problem is one that is peculiar to inflation or any other condition where borrowing in any form is impossible or undesirable. No other type of approach except one from an administrative point of view, to the question of taxation concerns itself with the collection of the tax debt after the determination of the liability. During inflation the collection problem, the case of time element, is perhaps the most important. It presents itself in two forms. First, the tax should call for payment as soon as possible after fixing the taxable status. We know at one extreme, of estate taxes and capital levies payable years after their imposition at the other, stamp taxes that involve pre- if not immediate payment. The growing European trend towards taxes based on estimated or presumptive indices frequently involves prepayment features. It is hardly necessary to repeat that the slightest lag will hinder budget balancing and will defeat the currency contracting possibilities. If the tax system is to be disrupted on account of the adoption counter-inflation devices, it would be unfortunate if the Treasury were not consistent enough to see that it derived the benefits of its actions. A collection lag is inexcusable. (It should be noted that prepayment must not be confused with tax anticipation financing. Tax warrants of this type are limited in their usefulness for us since they represent borrowing).

The second feature of the collection problem concerns itself with the means of payment. The simple term "payment" calls for redefinition in connection with inflation taxation. It is known that some taxes are payable in Government securities. Our own estate tax provisions allow these under limited circumstances. The Treasury will hardly welcome payment in depreciated obligations, which it cannot resell and which will probably not obviate the need for making certain expenditures. Attempt to liberalize the security-payment provisions with the though of bolstering the market for such securities or for any other reason, should not be made without a realization of what the effects of much provisions will be if the supporting effort is unsuccessful.

Another feature is payment in kind. Our early finances contained provisions of this sort, and service payments are not unknown in local finances today. In our present Federal tax system non-monetary payments are unknown. Still this type of levy will not appear strange during a period or rapidly rising prices.

More immediate is the question of the type of exchange medium in which tax returns are acceptable. During this recession we have removed from the statutes regulations regarding payment of customs and certain other levies in specific kinds of our many currency types. The Treasury must now accept them all. It will be sure to get the worst if any difference exist with respect to redeemability or acceptability.

A brief survey of the Federal taxes with respect to their monetary depreciation sensitivity will be made. The purpose of this survey is to indicate the extent to which policy changes will become necessary if we are faced with an inflation and a desire to combat it. It is indeed unfortunate that it is impossible to reach any tenable conclusion about the behaviour of income taxes. They are not linked to any definite factors in the economics life of the community. The yield of the income taxes mirror the result of many activities and conditions. The period for which income is measured in a year, and during that time a wide variety of influences can make themselves felt. The writer's opinion, based on his knowledge of what happened to income taxes in European inflations, is that income taxes, both individual and corporate, will yield increased revenues for the initial stages of an inflation. But regardless of the yields, the payment lags will put the income taxes out of the running if the inflation progresses for more than a year.

For personal income taxes there are a number of possible influences that can be cited to support the contention that yields will increase. In general, if the boom and general stimulation of business that has been promised by the advocates of inflation of materialize taxable profits should appear. Our liberal exemptions may lose their effectiveness at the same time that the progressive rate structure will take care of existing income taxpayers who are moving up in the brackets. Furthermore, we have not in our Federal income tax any averaging of income over a period of years. This would reduce the yield of the tax for a sufficient time to eliminate the influences of the pre-inflation years. The British and Wisconsin taxes, which benefited during the past few years of falling profits, would benefit less from an inflationary boom.

The biggest element in the possible growth of income tax yields are the capital gains. The so-called unearned incomes of "schedular" taxes would also yield more revenue, in addition to the capital gains, if the proportion of unearned income growing out of fixed returns were not too great. On the whole it is problematical whether our capital gains provisions, even in their 1934 revisions, will really be so fruitful since they are effective solely in taxing realized gains. (A capital levy is one of the few means for getting at unrealized gains, in addition to being an excellent deflationary and contractive tax). People do not dispose of assets unless they have to or unless they see a chance to get a better store of value. Since we allow for deduction of capital losses, chiefly to offset capital gains, the influence of this provision should be considered. The fixed income security, which does not represent a valid ownership element, will depreciate in value. The declines will probably lag behind appreciation in speculative and equity shares and will act as an additional reason for the ability of the yield of the personal income taxes to show gains in the early periods of an inflation during which these lags are operative. The Treasury uses forecasts of security prices to estimate personal income tax receipts. This indicates the fact that the inflation behaviour of the tax may be influenced to a large extent by stock and bond market activity.