Financing, World War I

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FINANCING, WORLD WAR I

The outbreak of World War I found the United States unprepared for the enormous strains the war would place on its fiscal system. When the guns finally fell silent in 1918, the United States had embraced a significantly different tax system, seen its government assume a dramatically enlarged place in the financial affairs of its citizens, and changed from an international debtor to an international creditor nation.

prewar taxes

Before 1914, the American government had customarily received much of its income from the tariff. After wartime conditions shrank foreign imports, the duties collected on "vices" such as alcohol and tobacco products, cosmetics, and playing cards eclipsed the tariff as the largest source of revenue. The adoption of the Sixteenth Amendment in 1913 had legalized the income tax, but Congress embraced this change without much eagerness. The initial rates were so low and the exemption so high that 98 percent of American families paid no income tax whatsoever.

Such a system could never pay for a major war. The total cost of the war, $33 billion, was forty-two times as large as receipts from all sources in 1916, the last prewar year. The financial decision facing the nation as it confronted

the prospect of mobilization was whether to expand the income tax dramatically or to attempt a substantial broadening of the sin taxes. If duties were imposed on a much wider range of consumer commodities, the effect would be to establish a national sales tax. The issue was highly controversial.

the income tax

Progressives in Congress had long hoped to use Congress's taxing power to reduce economic inequity by taxing the wealthy. In 1916, when President Woodrow Wilson asked for funds to support military preparedness, they saw their chance. Since many Progressives were opponents or only half-hearted supporters of war preparedness, they demanded an expansion of the income tax in return for their support. They contended that since Eastern businessmen were the principal advocates and beneficiaries of preparedness, they should pay for it. As the powerful North Carolina congressman Claude Kitchin put it, if the "New York people" were compelled to pay for preparedness, they would be less disposed to support it (Kennedy, p. 16).

The Revenue Act of 1916 and its companion measures, the War Revenue Acts of 1917 and 1918, differed in detail but not in philosophy. They imposed more steeply graduated income taxes, thus pursuing a redistributive, soak-the-rich policy. Personal exemptions to individual income taxes were reduced to $1,000 for a single person and $2,000 for a married couple, above which a standard tax was imposed—2 percent in 1917 and 12 percent in 1918. To these were added surtaxes ranging from 1 percent for incomes above $5,000 to 65 percent for incomes above $1,000,000.

In addition, businesses were required to pay excess profits taxes on net income exceeding 7 to 9 percent of invested capital as measured during a three-year prewar period. These rates were graduated from 20 to 60 percent in 1917, reaching a theoretical cap of 80 percent in 1918. Taxes on excess corporate profits accounted for more than half of all monies collected in 1918. Between individual and corporate taxes, the Wilson administration was successful in obtaining financial support for the war from America's most affluent families. The richest 22 percent of U.S. taxpayers contributed 96 percent of all individual tax receipts in 1918. Also to tap the assets of the wealthy, Congress introduced a new and steeply graduated estate tax and imposed excise duties on automobiles, jewelry, cameras, motor boats, and yachts.

war bonds

Wilson's policies were less effective in reaching the great resources of the middle classes. Treasury Secretary William G. McAdoo orchestrated an elaborate and innovative campaign intended to prod Americans of average means to furnish financial support to the war effort by emphasizing the voluntary purchase of war bonds. Appealing to what he termed America's "profound impulse called patriotism," McAdoo drummed up support for a series of four Liberty Loans, arranging for celebrities, including the movie stars Douglas Fairbanks and Mary Pickford, to appear at bond rallies (Kennedy, p. 105). The nation's best-known illustrators drew posters entreating the public to contribute, and an army of Four-Minute Men gave patriotic speeches in movie theaters and elsewhere extolling the importance of buying bonds. Even the Boy Scouts turned out as bond salesmen under the slogan "Every Scout to Save a Soldier." In the third Liberty Loan campaign of 1918, at least half of all American families subscribed.

Nevertheless, the bond campaign was flawed. The social pressure compelling citizens to purchase was often heavy handed, echoing Wilson's infringement of freedom of speech and his mistreatment of conscientious objectors. Most significantly, the Federal Reserve System encouraged its member banks to lend money freely for the purchase of war bonds. This was the equivalent of the government printing money, and because of it the Wilson administration failed to meet its goal of financing half the cost of the war through taxes. The increased money supply was also rampantly inflationary and prices doubled by 1918 despite an ill-fated attempt at price control.

WAR BONDS

Bonds are a form of interest-incurring loans and are sold through commercial banks. In 1863 the U.S. Congress created a national banking system in order to raise money to finance the American Civil War, and since then bonds have been used to finance other wars as well. After the United States entered World War I in April of 1917, the U.S. Treasury Department borrowed money using a series of bond issues. Although the first four bond issues were called "liberty loans" or "liberty bonds," the fifth and last was known as the "victory loan." These long-term bonds totaled some $21 billion, of which the liberty bonds accrued interest from 3.5 to 4.5 percent and the victory bonds accrued interest at 3.5 to 4.7 percent. Citizens were strongly encouraged to demonstrate their patriotism by buying these bonds. Posters the with slogan "Beat Back the Huns with Liberty Bonds" were plastered to walls, and speakers canvassed the nation, appearing at churches, rallies, factories, theaters, and other venues.

helping the allies

As the financier of its European allies, Uncle Sam fared much better. Prior to the war, Britain had dominated international trade, but German submarines among other things ensured that this was no longer possible. The United States moved to replace Britain as purveyors to Latin America and as the dominant world shipping power. Whereas in 1914 the United States was a net international debtor in the amount of $3.2 billion, massive British and French purchases soon reversed this situation. American banks and exporters extended long-term loans to their customers, and in 1917 and 1918 the U.S. Treasury extended huge loans to Europe. Britain had originally bankrolled the Allied governments, but its warweakened reserves led to the primacy of the U.S. Treasury as the world's preeminent banker. By the end of the war, the United States had lent more than $10 billion to foreign governments, almost half of it to Britain, and it flexed its financial muscles by requiring that its loan money be spent on U.S. products. This ensured that the United States would be the arsenal and breadbasket of Europe.

By war's end, the United States had become the world's most important trading nation as well as its largest banker. Its tax-collecting arm, the Bureau of Internal Revenue, had quadrupled in size, and the income tax, which now produced thirty-one times as much revenue as it had in 1916, had solidified its position as the most powerful fiscal device of the modern U.S. state. Nearly 23 million Americans, or about 22 percent of the U.S. population, had voluntarily subscribed $7 billion to the Fourth Liberty Loan. By 1918, the United States was spending more on defense each day than any other belligerent, and it had succeeded in raising a greater proportion of its wartime expenditures from its citizens' taxes and loans than had any other nation. These achievements denoted the strength, patriotism, and willingness to sacrifice of an aroused and determined democracy.