Devvy Kidd

Declassified (Confidential Committee Print)
Withholding Tax Hearing Before A Subcommittee of The Committee on Finance, 
United States Senate, 77th Congress, Second Session on: 
Data Relative to Withholding Provisions of the 1942 Revenue Act, August 21 and 22, 1942 
(Printed for the use of the Committee on Finance) 
United States Government Printing Office, Washington 1942 
SUMMARY/Contents Statement of: 
Friedman, Milton, Division of Tax Research, Treasury Department 
Hardy, Charles O., of Brookings Institution 
Jacobstein, Meyer, of Brookings Institution 
Paul, Randolph E., Treasury Department

Overview

Because the war effort resulted in increased production and employment, which caused a sudden large influx of money into circulation, the Federal Government and Federal Reserve System had to find a method of "mopping up excess purchasing power" thereby control inflation and obtain immediate funds for the Treasury. Several plans were put forth before the House, Ways & Means Committee and the Senate Committee on Finance to accomplish this purpose.

The following points were made by the Senators and those testifying before the committee:

1. The overall purpose was to obtain immediate money for the war effort, to control inflation and to get the income tax on a current basis instead of being one year behind.

2. To accomplish this goal, it was recognized that a scheme was needed to reach the largest number of people.

3. That the scheme, regardless of whether it was a "coupon," "stamp" or "withholding of income tax at source," would constitute a "forced loan" to the Federal Government and it would apply to taxpayers and nontaxpayers alike, with exceptions.

4. Where an individual had money withheld and ultimately no tax liability, the individual would file an income tax return and that income tax return would constitute an automatic claim for refund.

5. The proposed plan was an emergency war time measure.

Hearing Experts, Beginning Page 99

"It is obvious that it is necessary to mop up the excess purchasing power of the community, not only because of it's effect on the price situation but because the Treasury needs the money and needs it quickly.

Obviously the Treasury can collect from the consumers as the purchases are made and the Treasury has the use of those funds long before it would obtain them by the income-tax method.

Now, there are many ways, of course, of mopping up this surplus purchasing power...
Now, there is the withholding tax at the source based on payrolls."

Senator Clark: "Doctor, what this plan is, it is essentially a compulsory savings plan based on sales tax methods, is it not?"

Mr. Jacobstein: "I should say that is a fair description of it, yes. It is the use of a sales tax method without being a tax."

Senator Clark: "So far as the impact on the public is concerned, it is precisely the same as a sales tax, except you give the money back sometimes."

Mr. Jacobstein: "That is right. That is a very fair statement, I think. Senator Danaher used the word "self-assessment." If I buy a dollar necktie I pay $1.10 under his plan. A withholding tax is usually withheld at the source. Here you withhold it not at the manufacturer's end but at the retailer's end. You are using the retailer instead of the manufacturer to siphon off several billion dollars, depending on the rate of the assessment of a tax.

It may be that several systems can be used. Any one of them might be very useful to the Treasury in accomplishing this purpose. But...for siphoning off purchasing power into the Treasury from day to day, or week to week, or month to month; and it has that advantage.

Now, there is an aspect to this question which was not brought out in the original memorandum which would make the scheme perhaps a little more palatable if certain deductions were made by any method, either by the withholding tax method or direct sales tax method or by Senator Danaher's proposal...."

Mr. Hardy: "First...mainly for the purpose of providing an exemption from the tax or forced loan, either one. Now, as has been stated a moment ago, this is a forced loan. It should be pointed out, I think, that you can do the same thing with the mechanics of any other tax, that is, under the income tax you can give out bonds or coupons redeemable in bonds instead of giving receipts for the income tax. You can do that, as far as I can see, with any tax, for the whole schedule of taxes.

I would like to say...that we have to bring about a readjustment of consumption in the country to the amount of consumers goods and services that we can spare the resources to produce under war conditions. First, we have got to devote our productive energies to the war.

Or, you can use the mechanism of the sales tax, as far as I can see, by mopping up the increased purchasing power that is created by the rising amount they receive in their paychecks. On the other hand, if the money is stored up, whether it is in the form of these stamps or in the form where people haven't spent it because they have had no way to spend it, in either case if it is too large a proportion you are going to have the problem, whenever you do turn it loose, that you have now in the other case, namely of having a lot more purchasing power than you have goods and services to make it good with.

That is the answer, I think, to the question that might be raised as to why not carry this principle through and apply it to income tax, corporation tax, and everything else. Obviously, this has the advantage that this definitely sews up the purchasing power in such a way that it cannot be released until we discover the proper way to release it.

I think it has a great advantage over the deficient spending program. This program just postpones the problem of administration, in deciding how much purchasing power is available to release and to what extent it will create the old wartime inflation over again."

Senator Danaher: "Let me ask you this question: Considering the withholding tax, simply the treasury withholds it currently and applies the proceeds against the tax due in a given year..."

Mr. Hardy: "The deduction from salaries and interest, and so on, at the source?"

Senator Danaher: "Yes."

Mr. Hardy: "Yes."

Senator Danaher: "That is a currently applied method of withholding so much of the consumer purchasing power as is represented by the tax collected or withheld."

Mr. Hardy: "That is right."

Senator Danaher: "And the applied as against the tax due."

Mr. Hardy: "Yes. The withholding tax provision has the effect of withholding purchasing power at the time the income is realized rather than a year hence through the income tax structure."

Senator Danaher: "And if it were in effect for 1 year it would apply only 1 year?"

Mr. Hardy: "I assume so."

Senator Danaher: "Yes. Whereas this proposal is a continuing thing."

Mr. Hardy: "It seems to me the essential difference is that the withholding tax plan applies at the point of receipt of income, and this applies at the point of expenditure of income."

Senator Danaher: "Of course, you withhold not only from taxpayers but nontaxpayers."

Mr. Hardy: "Yes. Some people that I talked to about this plan, Federal Reserve people, have been rather favorable to the idea."

Mr. Jacobstein: "Don't you want to add that Mr. Selko pointed out that such difficulties as are encountered in the States are, partially at least, overcome when you have a uniform Federal tax? Where you have a uniform tax all over the country by one administration, the Federal Government, it is easier to administer than a sum total of 48 states. Now that was Mr. Selko's conclusion."

Senator Danaher: "I have only one other thought on that point. In the event of withholding from the owner of stock and no taxes due ultimately, where does he get his refund?"

Mr. Friedman: "You thinking of a corporation or an individual?"

Senator Danaher: "I am talking about an individual."

Mr. Friedman: "An individual will file an income tax return, and that income tax return will constitute an automatic claim for refund." End of document excerpts.