What Tax Experts Can Contribute: Lessons from World War II

Taxes

The United States is facing an immense human tragedy. According to one influential analysis, up to 2 million Americans could die from COVID-19 in the next few months without drastic nationwide measures to halt its spread. The resulting economic downturn will cause additional hardship and suffering. We tax experts can do little to prevent this other than the actions we take as individuals to practice physical distancing and contribute to charitable organizations that relieve distress.

But we can begin to think of the time after the pandemic passes and how government should respond to massive increases in the public debt, and the new tax increases that Congress will need to enact to fund them. And, for that, we can look to lessons from World War II and its aftermath.  

Congress just approved a massive $2 trillion bill – part relief, part economic stimulus, and part corporate giveaway. We can debate the effectiveness of this legislation and will no doubt see critiques of individual provisions in the coming years. But it is too late to change it. That train already has left the station.

The US experience during and after World War II, however, provides two important lessons for fiscal policy going forward.

First, just as the unchecked rise of aggressor nations revealed the folly of America’s pre-war isolationism, so too did the unchecked spread of COVID-19 reveal the folly of the nation’s neglect of public health and, more generally, policymakers’ long-term denigration of the public sector.

And, just as after World War II, when the United States led both in post-war recovery efforts and in developing international institutions intended to prevent future wars and promote global economic cooperation, we will now need to rebuild our own public institutions that have atrophied over the past 40 years.

This means investment in public health, public infrastructure, education, scientific research, environmental protection, and many other activities grouped under the budgetary label “domestic discretionary” spending. It also means finally following all other advanced nations and adopting a system that provides all Americans with access to affordable health care.

Second, just as the cost of fighting World War II necessitated large increases in taxes, so too will these public investments as well as the large increase in debt service costs from the short-term surge in spending and tax cuts. And just as in World War II, we likely will need both increased taxes on the highest-income individuals and a new broad-based tax on the general public.  

During the Second World War, the top individual tax rate rose to 94 percent and remained at 91 percent for nearly two decades—until 1964. World War II was also the time when Congress converted the income tax from a “class” tax that applied mostly to those with high incomes to a “mass tax” that most Americans paid, enabled by a system of wage withholding developed by the Treasury Department.

New taxes post-coronavirus probably will take very different forms than those enacted during World War II. Instead of raising the top individual rate to a confiscatory level, we might consider other options, including a moderate increase in the top individual income tax rate, higher taxes on long-term capital gains and dividends, new taxes on unrealized capital gains or wealth, increased taxes on corporate profits, and measures to curb international tax avoidance by individuals and corporations. 

Instead of increasing individual income tax liability for more people, the new mass tax may take the form of a value-added tax now in use by over 150 countries throughout the world.

It may seem strange to recommend studying how to impose new taxes just as we are entering a period of substantial unemployment and economic misery. But with strong public health measures and—perhaps—a new vaccine, the epidemic eventually will wind down. More fiscal stimulus may be needed then to restart the economy, but there will also be pent-up demand for consumer goods and services that have been unavailable.

Just as the end of World War II led to an economic boom after a short period of re-adjustment, rather than a renewal of the Great Depression, as some feared, the end of the epidemic could lead to a rapid economic turnaround. At that time, we will need to develop plans for how to design tax increases to fund rebuilding of the public sector and a restoration of the government’s fiscal position. And it would be advantageous to develop those plans ahead of time.

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