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Throughout the fall of 1942, Congress was hard at work on a tax bill to fund the American war effort. The eventual fruit of these labors, the Revenue Act of 1942, made important changes in federal taxation. In particular, it continued the legislative trend toward a broader income tax, further lowering exemption levels to create millions of new taxpayers. Indeed, the 1942 act is often cited as a milestone in the transformation of the income tax from a "class tax" to a "mass tax."
The 1942 act, however, was also notable for what it did not contain. Specifically, the law did not include a trace of the Treasury Department's innovative proposal for a personal spendings tax. Derided by opponents as overly complex, the spendings tax enjoyed little support on Capitol Hill. Indeed, its brief career came to a screeching halt before the Senate Finance Committee, which dealt the proposal a swift and ignoble defeat.
The spendings tax made scarcely a ripple in its own time, slipping beneath the turbulent waters of a busy legislative season. But the idea merits something more than a footnote in the history of federal taxation if only because it briefly raised the possibility of a major change in the federal revenue system. In addition, today's growing interest in a consumption-based federal tax gives new salience to this innovative proposal.
Treasury Secretary Robert Morgenthau Jr. offered his plan for a spendings tax on September 3, 1942, while Congress was midway through its work on the revenue bill. His motives were two-fold. First, he faced an urgent need for additional money. Expenditures for fiscal 1942 were expected to exceed $80 billion, while revenue projections for the 1942 act were running at only $24 billion.
Second, Treasury officials were determined to head off the threat of inflation. Indeed, Morgenthau stressed such concerns in his presentation to the Finance Committee. Uncontrolled price increases, he warned, posed a serious threat to America's wartime economy. "The Treasury," he asserted, "is seeking in these proposals to attack the problem at its roots and to attack it drastically."
The spendings tax, in conjunction with a proposed reduction in income tax exemptions, was projected to raise $6.5 billion, simultaneously siphoning funds out of the consumer economy and helping fund the war effort. Of this amount, however, $4.5 billion was to be refunded after the war without interest.
The spendings tax was designed to supplement -- rather than replace -- the individual income tax. Indeed, Treasury proposed that the two taxes be administered jointly, with taxpayers filing a combined return and sending in a single payment. Individuals would calculate their total spending indirectly, subtracting savings from the total amount of available funds (including current income and draws on capital). Savings were defined to include debt repayment, life insurance premiums, purchases of capital assets, gifts and contributions, tax payments, and increases in bank balances.
Using this base, the spendings tax would then be imposed in two parts: a flat rate tax of 10 percent to be refunded after the war, and a progressive surtax. The refundable portion, which would have applied to all individuals already paying the income tax, assessed a flat tax on all spending; the proposal made no provision for any deductions, nor did it exempt any minimum level of spending.
The surtax, by contrast, was to be imposed at progressive rates -- ranging from 10 percent to 75 percent -- on expenditures in excess of certain exemption levels. Treasury left open the possibility that various "extraordinary expenditures" might be made deductible.
The Treasury proposal drew on earlier studies of spendings taxation, such as the system proposed by Ogden Mills in 1921 and later advocated by Professor Irving Fisher of Yale University. Unlike these proposals, however, the Treasury version was never conceived as a replacement for the income tax. Rather, it was viewed as a temporary device for achieving pragmatic, not theoretical, goals.
Treasury officials developed the spendings tax with a close eye on its alternatives, principally a further increase in income tax rates or the enactment of a general sales tax. The spendings tax enjoyed several advantages over further income tax hikes, according to internal Treasury studies. First, it would more effectively curtail consumer spending, and that made it a better weapon for fighting inflation. Second, its progressive rate structure, if sufficiently steep, might permit fairly close regulation of individual spending levels. Third, the spendings tax was thought to be more politically palatable; because individuals had considerable discretion in determining their spending patterns, Treasury officials argued, they could largely determine their own tax liability.
Treasury officials also believed the spendings tax enjoyed several advantages over a general sales tax. First, it allowed for a much more efficient means of granting personal exemptions. Second, it would be less inflationary than a sales tax. Third, it would not upset wartime price controls, then in their early stages and already under considerable strain. Sales taxes, by contrast, were thought to involve such problems, given their tendency to raise the cost of production. Finally, sales taxes were considered more administratively burdensome, demanding an entirely new collection structure. Treasury officials did concede, however, that the spendings tax would be less effective than a sales tax as an anti-inflationary device.
A Speedy Demise
Following Morgenthau's brief presentation to the Finance Committee, Treasury General Counsel Randolph Paul filled in the details. He was careful to stress the dual objectives of the new levy. "The spendings tax," he said, "will raise very substantial amounts of revenue, and will accordingly be valuable in financing the war." Even more important, he continued, the tax would help fight inflation by reducing consumer purchasing power and providing a strong incentive to save.
Paul acknowledged that the spendings tax involved new administrative burdens. He maintained, however, that the tax's compatibility with the existing income tax system made these burdens manageable. Moreover, he warned, "in time of war, administrative difficulties cannot be allowed to stand in the way of measures vital to the Nation's welfare."
The Finance Committee was unimpressed. Complaining that the plan was too complex, panel members voted unanimously to reject it. The episode, Paul later recalled, illustrated the perennial dilemma facing would-be tax reformers.
When a new revenue proposal is presented in general terms, lawmakers want to know how it will be implemented. When the particulars of a proposal are immediately offered, the mass of detail makes it seem too complicated. The spendings tax was impaled on the latter horn.
Few lamented the defeat of the spendings tax. It had only a handful of supporters on Capitol Hill, and even the administration seemed rather lukewarm toward the idea. It died quickly and permanently. Perhaps the best epitaph was offered by Robert C. Albright of The Washington Post. The spendings tax, he quipped, was "Morgenthau's morning glory. It opened Tuesday morning and it folded before noon."
The full texts of the following documents are available from Tax Analysts:
o Statement of Treasury Secretary Henry Morgenthau before the
Senate Finance Committee, Sept. 3, 1942. Doc 96-9366 (5 pages)
o Statement of Randolph E. Paul, Treasury General Counsel,
before the Senate Finance Committee, Sept. 3, 1942. Doc 96-
9367 (22 pages)
o Supplement to Paul's statement. Doc 96-9368 (2 pages)
o Memorandum for the Secretary of the Treasury, Aug. 27, 1942.
Doc 96-9371 (2 pages)
o Spendings tax proposal, internal memo, Treasury Division of
Tax Research, Sept. 1, 1942. Doc 96-9372 (4 pages)
o Proposal for a "consumption expenditure tax," internal memo,
Treasury Division of Tax Research, Sept. 9, 1942. Doc 96-9369
o Comments on the proposal for a spendings tax, internal memo,
Treasury Division of Tax Research, undated. Doc 96-9370 (9
o The spendings tax, internal memo, Treasury Division of Tax
Research, Nov. 21, 1942. Doc 96-9373 (9 pages)