America's Fiscal Constitution (36 page)

The tax dispute between the president and congressional leaders in both parties grew bitter by 1944. In February Roosevelt vetoed a tax bill on the grounds that it failed to raise more revenue from corporate taxation. His veto message accused Congress of passing a tax bill “not for the needy, but for the greedy.”
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Irate members of Congress overrode Roosevelt’s veto. By 1944 tax revenues supporting the federal funds budget exceeded 20 percent of national income. Even Doughton, a stalwart supporter of Roosevelt’s New Deal programs, concluded that federal taxation had reached the maximum level that individual taxpayers could take. Doughton—who owed nothing to big business—and a majority in Congress believed that an additional increase in corporate taxation would impair the investment required to support war-related production and to retool factories after the war.

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ORROWING

The scale of wartime borrowing and the desire to avoid inflationary pressures led most of the president’s senior economic advisors to conclude that citizens should be forced to buy bonds. Roosevelt and Morgenthau disagreed. They felt that voluntary bond purchases allowed citizens to take pride in their participation in the war effort. Morgenthau instructed Treasury bond salesmen to forgo “intimidation . . . of any kind to induce people to sign pledges.” He thought the government had to “persuade people to buy . . . willingly and enthusiastically, by bringing them to realize that in doing so they serve[d] their country today and themselves tomorrow.”
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People from a variety of backgrounds, including active duty military personnel, made this pitch during bond drives. The federal government even enlisted allied leaders Winston Churchill and Joseph Stalin in campaigns to market savings bonds. By the end of the war, Americans had purchased savings bonds totaling almost $50 billion, an amount greater than prewar federal debt.
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Almost twenty-eight million workers earmarked some portion of their salaries and wages for the purchase of bonds.
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Morgenthau and Federal Reserve Chairman Marriner Eccles, who had battled over economic policy in the 1930s, worked as a seamless team during World War II. The Federal Reserve directly bought over $20 billion of debt and offered banks credit certificates at low interest rates to support bond purchases.
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The federal government sold vast amounts of debt at extraordinarily low interest rates. Amazingly, the average interest rate on the debt declined from 2.52 percent in 1941 to 1.94 percent in 1945.
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Because of a high rate of national savings, consumer prices rose far less than the expansion of the nation’s money supply.

At the height of the war, in fiscal years 1944 and 1945, debt financed only 56 percent of federal spending, a lower percentage than at the end of World War I (72 percent from 1918 to 1919); the Civil War (72 percent in 1864 to 1865); and the War of 1812 (62 percent in 1814 to 1815).
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Nonetheless, debt rose to record levels. A comparison of debt to federal funds revenues available for debt service provides a reliable measure of how far the nation stretched its debt capacity. At the end of World War II those revenues covered only 15 percent of total debt, the same level as at the end of the Civil War.
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At the end of the War of 1812, when the federal government missed a payment on debt, tax revenues had dropped to 12 percent of outstanding debt.
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Only after the collapse of the American Fiscal Tradition in the twenty-first century would federal funds tax revenues cover a lower share of outstanding debt.

With the war’s conclusion in sight, American political leaders began to consider the scope of future federal responsibilities. Millions of Americans read Secretary of Commerce Henry Wallace’s best-selling book
Sixty Million Jobs
, published shortly after Roosevelt’s death in April 1945. The president had replaced the popular Wallace as his running mate with Senator Harry Truman before the 1944 election. Wallace, who was adept at statistical analysis, concluded that by 1950 the American economy could employ sixty million people—full employment—and maintain an output of $200 billion. At that level of national income, he projected that the United States could cut wartime tax rates and balance a federal budget with spending of $25 billion, and “approach, with a lighter heart and heavier purse, the retirement of national debt.”
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While Wallace embodied the aspirations of many liberals at the conclusion of World War II, Senator Robert Taft shaped the expectations of many conservatives. Both Wallace and Taft assumed that the atomic bomb and America’s geographical distance from Europe and Asia would
allow the federal government to balance its budget by slashing military spending. Americans across the political spectrum wanted life to return to normal after the surrender of Germany and Japan. They hoped that “normal” would not include a permanently high level of military spending and related taxes.

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EBATE OVER
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Harry Truman lacked Roosevelt’s wealth, education, and magic last name. He did, however, reflect the values and attitudes of many middle-class Americans.

Truman disagreed with Senator Taft on many issues, though he respected the fact that there “was nothing devious about him.”
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Taft, in turn, considered Truman to be a “straightforward man” who also had “the quality of decision” necessary for executive leadership.
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The two partisan adversaries shared a commitment to the traditional limits on debt.

After Major Harry Truman returned from World War I, he worked hard for a dozen years to pay off debts from the failure of a retail store he owned in Missouri. As a county executive, he balanced his operating budget. These life experiences and his thorough knowledge of American history shaped his belief that “the pay as you go idea . . . represents the soundest principle of financing that I know.”
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This principle, guided President Truman’s response to the nation’s greatest postwar budget challenge: balancing the desire to reduce wartime tax rates with the goal of maintaining a military capable of meeting commitments to allies. A person at the center of that conflict—Secretary of Defense James Forrestal—noted that Truman was “a hard-money man” who believed that America could not “afford to wreck our economy in the process of trying to fight the ‘cold war.’”
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Congress rapidly cut military spending and a portion of wartime taxes after Japan surrendered in September 1945. The United States could not, however, cut its spending to prewar levels while American troops were still occupying Germany and Japan. The war in Europe ended with Germany’s surrender, not a comprehensive peace treaty. The struggle between communist and democratic forces for power continued within many European nations, and Soviet leader Joseph Stalin refused to withdraw his army from Eastern Europe.

President Truman’s first budget message, delivered in January 1946, declared that the federal government should retire debt with planned surpluses. The president urged “a continuation of our present policy, which is to maintain the existing tax structure for the present, and to avoid nonessential expenditures.”
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There was no clear benchmark for estimating normal federal budgets after the sixteen years spanning the Great Depression and World War II. Truman used basic rules of thumb as part of traditional “pay as you go” budget planning. His Budget Bureau began by estimating revenues from existing taxes, apart from those dedicated to trust funds. It then subtracted debt service and devoted a third of the remaining revenues to the military. The remaining funds were allocated to cover all other expenses, including substantial sums for veterans and military assistance to allies.

International affairs, however, did not abide by White House budget priorites. In the words of historian John Gaddis, “the period of late February and early March, 1946, marked a decisive turning point in American policy toward the Soviet Union.”
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In February 1946 an official at the US embassy in Moscow, George Kennan, gave senior Washington officials a thoughtful analysis of a belligerent speech delivered by Stalin. Kennan predicted that the Soviet regime would attempt to dominate other nations in order to preserve its own ideological authority and only American military strength could check that tendency.

Senator Arthur Vandenberg called for American preparations to protect Europe from Soviet aggression. Secretary of State James Byrnes expressed alarm at the Soviet Union’s “unilateral gnawing away at the status quo.”
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In Truman’s home state of Missouri, former British prime minister Churchill likened the Soviet police state to an “Iron Curtain” descending over Eastern Europe. In April 1946 Truman told Americans that it would be “a tragic breach of national duty” if the United States declined to accept its responsibility as “the world’s strongest nation.”
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Fierce debates occurred within each of the two major parties concerning the appropriate level of postwar military spending and taxes. Secretary of Commerce Henry Wallace, a potential Truman rival for the 1948 Democratic presidential nomination, thought that the United States could avoid costly military competition if it simply recognized the inevitable reality of a Soviet sphere of influence. The president disagreed and asked Wallace to leave the cabinet in September 1946.

The congressional budget debate following the 1946 midterm elections exposed a parallel conflict within the Republican Party. Senator Taft and Representative Harold Knutson, ranking member of the House Ways and Means Committee, had crafted a GOP election platform that promised a 20 percent tax cut. Republicans believed they had a mandate for that tax cut after winning a majority in the Senate and House for the first time since 1928.

The Legislative Reorganization Act of 1946 tried to institutionalize “pay as you go” budget planning by requiring Congress to vote on spending limits and revenues before each new fiscal year. The new Republican-led Congress, in February 1947, adopted a budget that cut taxes and limited spending to $31.5 billion for fiscal year 1948. Truman had proposed a budget with higher military spending, a surplus, and $37.7 billion in revenues without a tax cut.
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Despite the significant difference of opinion concerning the overall level of federal spending and taxes, Truman and congressional Republicans agreed on the need for an orderly reduction in debt. On March 3, 1947, with Truman’s support, the Senate voted to use the surplus in the existing fiscal year to retire at least $2.6 billion of the national debt.
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Events in Europe gave a sense of urgency to the debate over military spending in the budget for the fiscal year beginning on July 1, 1947. After the House cut spending to far less than the Truman administration had requested, congressional leaders from both parties met at the White House with George Marshall, the nation’s ranking general since the beginning of World War II. The respected soldier asked for military assistance for Turkey and Greece in order to counter imminent communist takeovers. Heavily indebted Great Britain could no longer afford to maintain an armed presence in those countries. Deputy Secretary of State Dean Acheson starkly described the potential isolation of the United States in a world dominated by communist dictatorships.

The nation’s unwritten fiscal constitution did not allow Congress to evade a hard budget choice by opting to use debt to fund security-related spending. Senator Vandenberg, who chaired the Senate Foreign Relations Committee, agreed to help the administration raise defense spending. He insisted, however, that Truman clearly express to the public the threat posed by Soviet expansion.

The president then urged a joint session of Congress “to support free people who are resisting attempted subjugation by armed minorities or by
outside pressures.”
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After Truman’s appeal, Vandenberg restored some defense cuts made by the House. Like many Americans, Vandenberg had no trouble reconciling his former isolationism with his new internationalism. He explained why his views had changed: modern aviation and new weapons dramatically reduced the effectiveness of the buffer once provided by the Atlantic and Pacific Oceans.

The United States was then the only nation that had the economic capacity to pay for the defense of Western Europe. At the conclusion of the war, the United States produced half of the world’s industrial output. It had the world’s only large grain surpluses and its only strong gold-backed currency and banking system.

At the beginning of 1946—as in 2013, for example—most economists worried that a sharp contraction of debt-financed federal spending would harm economic growth. They were mistaken. Though federal outlays dropped from the wartime high of $98 billion in 1945 to $34.5 billion in 1947, federal tax collections fell only 10 percent from their wartime peak even after the enactment of modest reductions from wartime tax rates.
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By 1947 the nation was experiencing strong economic growth.

Despite the robust economy, in 1947 Truman vetoed tax cuts that he thought would endanger the nation’s ability to retire debt. By late 1947, halfway through fiscal year 1948, the White House announced a projected surplus of approximately $7 billion.
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By the end of that fiscal year, the federal funds budget was running a surplus amounting to an unprecedented quarter of all revenues. The size of the surplus moved Congressman Robert Doughton to join Republicans in passing legislation to cut tax rates and then overriding the president’s subsequent veto of the bill.