Financing, World War II
FINANCING, WORLD WAR II
World War II was the most expensive war in American history, exceeding all other conflicts in economic impact. Nearly forty million Americans paid income taxes for the first time, and an elaborate price control system touched the life of every consumer. To sell war bonds, the U.S. government made direct and frequent contact with more than 90 percent of the American population. The U.S. government financed a massive expansion of the nation's defense industry, so that by 1945 the government owned billions of dollars worth of factories and machinery.
During the two years before the United States entered the war, the enormity of America's financial burden became apparent. At the war's peak, federal expenditures were twelve times greater than in the last peacetime year. President Franklin D. Roosevelt hoped to pay for half the cost of the war, or more, out of current income, but collecting such a colossal sum was a daunting task. Roosevelt was determined not to rely too heavily on loans, but borrowing was inevitable.
The Japanese attack on Pearl Harbor angered, frightened, and unified the nation, but although the public was eager to contribute to the war effort, Roosevelt's economic policies still faced difficulties. Some members of Congress disliked Roosevelt's political agenda in any form, and others were reluctant to face reelection after raising taxes. Roosevelt's greatest problem, however, was how to tap into the middle and lower income levels. Rampant consumer spending had led to large price increases during World War I.
broadening the income tax
Tax experts generally agreed that the income tax was the fairest, most effective way to draw upon the spending power of the middle class. Some leaders preferred a national sales tax, but against the opposition of the president the idea went nowhere. The treasury proposed a tax on individual spending, but the plan's complexity doomed it as well. The income tax, formerly the domain of the wealthy alone, would have to be broadened to apply to Americans of average income.
In 1941 and again in 1942, Congress lowered income tax exemptions and adopted steeply graduated rates. These ranged from 13 percent on the first $2,000 of individual income up to 82 percent on income above $200,000. Gift and estate taxes were also broadened, and a graduated tax on excess corporate incomes added to the progressive nature of the tax structure, which became the highest in American history. Excise taxes on alcoholic beverages, tobacco, and gasoline rose dramatically as well.
Because the taxpaying public perceived the income tax as a levy that should apply only to the wealthy, the government feared noncompliance. "Suppose we have to go out and try to arrest five million people?" Treasury Secretary Henry Morgenthau said. To keep this from happening, and because most Americans were ignorant of the procedure for filling out an income tax form, the treasury devised a clever and effective public relations campaign, such as The New Spirit. Responding to this and other appeals, most Americans made a good-faith effort to pay their taxes.
collection at the source
The income tax was a bountiful source of income, but it had one great disadvantage: Before 1943, it was paid only quarterly. Since defense spending was producing huge daily deficits, tax collection had to be accelerated. The answer was to put the income tax on a pay-as-you-go basis-in other words, to withhold a sum for tax purposes from every paycheck, with a small reconciliation payment (or refund) due at year's end. The problem with this scheme was that, in the year the change was made, taxpayers would have to pay their taxes twice, once for the previous year and again for the current year. Although this was Roosevelt's preference, many argued that it would be an unfair burden. They demanded that in return for accepting the pay-as-you-go system taxpayers be excused from making the prior year's annual payment. Against Roosevelt's wishes, Congress agreed to forgive three-fourths of a year's tax payments, a compromise that transferred the payment to the shoulders of postwar taxpayers.
The World War I system of marketing war bonds through propaganda posters, pamphlets, and patriotic rallies was resurrected and expanded in World War II. Between the wars, most American families had acquired radios, which simplified the government's work in appealing for funds. Patriotic pleas, presented by performers such as the cowboy star Roy Rogers, flooded the airwaves. The treasury even presented its own variety show, The Treasury Star Parade, to coax the public to purchase war bonds regularly.
To reach people with the lowest incomes, the treasury made the purchase of bonds much easier. Bonds sold for $50 in World War I, but in WWII the treasury sold stamps—which could be used to buy bonds—in denominations ranging from $0.10 to $5. The Series E bond, which sold for $18.75 but could be redeemed for $25 in ten years, was the most popular. (Sixty years later, a modified version, the Series EE, was still available.)
wage and price controls
Taxes and war bonds diverted consumer spending, but if wages rose significantly consumers might bid against the government for scarce resources. To prevent this, and to preserve equity in the economy, in April 1942 the government instituted a system of wage and price controls. Wages and retail prices were restricted according to a fixed schedule, and Roosevelt limited the compensation of business executives to $25,000 after taxes.
Initially, the price control system worked well. But as rising production demands placed pressure on scarce resources, flaws began to appear. The first was in the price of steel, which was vital to warships and tanks. Controlling the price of gasoline was an even thornier problem, and a shortage of rubber arose due to the Japanese capture of Southeast Asia. Driving was restricted: the government rationed gasoline, imposed a nationwide speed limit, and attempted to prohibit all motoring for pleasure. No wartime measure was more unpopular or difficult to enforce. A lively market for illegal, or black market gasoline developed, but in spite of the black market inflation during World War II was comparatively modest. Whereas the cost of living doubled during World War I, inflation was held to about 28 percent during World War II.
The Roosevelt administration was skittish about making loans to foreign governments. Many Americans believed that during the 1930s America's World War I allies had improperly suspended payments on their debts, and they were leery of lending money again. To address this difficulty, Roosevelt proposed to lend only military equipment, all of which was to be returned after the war. The lend-lease program adroitly avoided the issue of whether debts would be repaid after the war.
THE NEW SPIRIT
More than two-thirds of the American population attended at least one movie each week during World War II, offering an ideal opportunity for a patriotic appeal. Early in 1942, the treasury department asked the Disney studio to produce The New Spirit, a short animated film featuring Donald Duck paying his income taxes. Arming himself with an aspirin bottle and aided by an animated ink bottle and pen, Donald finds that filling out his tax form is surprisingly painless. With three deductions for his dependents Huey, Dewey, and Louie, Donald's tax is only $13 on his actor's income of $2,501. More than thirty-two million people saw the film, which was shown on twelve thousand screens, and 37 percent of the moviegoers reported that it had a positive effect on their willingness to pay their taxes.
In wartime, the United States had traditionally relied on converting existing factories to defense production. In World War II, to encourage plant conversion and expansion, the government again offered liberal tax incentives and paid attractive, high-incentive prices. In return, contractors agreed to a system of price renegotiation that was intended to prevent swollen profits. But the existing manufacturing facilities could not produce the immense
quantities of planes and tanks that World War II required. New plants had to be built, and only the government could supply the capital necessary to finance them.
In 1940, Congress created the Defense Plant Corporation, which could build an entire factory and then lease it to a contractor. This firm financed about 30 percent of the new facilities that were built during the war, and the government came to own major portions of the synthetic rubber, aircraft, magnesium, and aluminum businesses. By the war's end, the government had invested billions of dollars in factories and machinery and owned about one-sixth of the nation's industrial capacity. Since there was little postwar need for many of these facilities, the government sold them to the highest bidder in an auction popularly known as Uncle Sam's garage sale. Some contractors realized excellent bargains, purchasing equipment or even whole factories at a fraction of their cost.
When the war ended, America's financial strength was unrivaled. The United States possessed the most powerful revenue source ever devised, the mass-collected personal income tax. It had claim to billions of dollars in military equipment that was in the possession of its wartime allies, and it owned a significant portion of the nation's manufacturing capacity. It had successfully limited the wages and salaries of the nation's workers and managers, and it had restricted the prices of nearly all consumer products. About 40 percent of the cost of World War II was financed out of current revenue, an improvement on the Civil War (28 percent) and World War I (36 percent). The nation could be rightfully proud of a job well done.
Brandes, Stuart D. Warhogs: A History of War Profits in America. Lexington: University Press of Kentucky, 1997.
Jones, Carolyn C. "Mass-Based Income Taxation: Creating a Taxpaying Culture, 1940–1952." In Funding the Modern American State, 1941–1995: The Rise and Fall of Easy Finance, edited by W. Elliot Brownlee. Washington, DC: Woodrow Wilson Center Press; New York: Cambridge University Press, 1996.
Perrett, Geoffrey. Days of Sadness, Years of Triumph: The American People, 1939–1945. New York: Coward, McCann & Geoghegan, 1973.
Winkler, Allan M. Home Front U.S.A.: America during World War II. Wheeling, IL: Harlan Davidson, 2000.
Thorndike, Joseph J. "Historical Perspective: Wartime Tax Legislation and the Politics of Policymaking." Tax History Project. Available from <http://www.taxhistory.org>.
Stuart D. Brandes
See also:Financing, World War I.