February 8, 2023

Guns, Butter, And The Vietnam War Tax Surcharge

The American economy was booming in the mid-1960s. Real GDP growth averaged more than 5% between 1961 and 1967, reaching as high as 6.5% in 1966. Millions of Americans enjoyed the fruits of this prosperity, including rising incomes and plentiful jobs.

Tax cuts got much of the credit for this growth — especially the one enacted in 1964. As the economist Arthur Okun observed: “The best known fact about the Revenue Act of 1964 is that, in the year and a half since it took effect, economic activity has expanded briskly.”

But as Okun also pointed out, a causal relationship can’t be inferred from a sequential one; just because prosperity had followed the tax cut didn’t mean that the tax cut had caused the prosperity. Other fiscal forces were also at work, including robust government spending.

The ambitious social programs of President Lyndon Johnson’s Great Society were part of the story. So, too, were military spending programs driven by the Vietnam War. Combined with the fiscal stimulus of the tax cut, higher spending helped send the economy into overdrive.

Overdrive can be good for an economy, but it can also cause problems, including inflation. And that’s exactly what happened in the mid-1960s.

Between 1961 and 1965, consumer prices rose at an annual rate ranging between 1.3% and 1.6%. In 1966, however, inflation ticked up to 2.4%. After that, things only got worse: 3.6% in 1967, 4.6% in 1968, and 5.8% in 1969.

Economists worry about inflation for many reasons, including its effect on investment and long-term economic growth; both tend to suffer when prices rise too much, too fast. Politicians, meanwhile, have more immediate concerns. They know that inflation raises the cost of living — a salient issue for voters, and not in a good way.

In 1965 Johnson’s economic advisers began nudging him to develop policies that might help slow inflation. Because fiscal stimulus had sparked the rise in prices, fiscal restraint was an obvious way to rein them in — spending cuts, tax hikes, or some combination of the two.

Johnson resisted those entreaties. He worried that fiscal conservatives would use any gesture toward restraint as an excuse to gut his Great Society spending programs. He also worried that unpopular tax increases made necessary by the war in Vietnam might undermine political support for his domestic priorities.

As Kirk Stark, Steven Bank, and I observed in our 2008 book, War and Taxes, “by raising the possibility of a reversal of prior years’ tax cuts, Vietnam threatened the fragile coalition that Johnson had built around the Great Society.”

Instead, Johnson continued to insist that the nation could afford to spend heavily on both national security and social welfare — both guns and butter, as the old saying goes.

“Time may require further sacrifices,” Johnson declared in his 1966 State of the Union address, “and if it does, then we will make them. But we will not heed those who would wring it from the hopes of the unfortunate here in a land of plenty. I believe that we can continue the Great Society while we fight in Vietnam.”

Eventually, the steady pressure of rising inflation was too much for even Johnson to resist. By 1967, he was ready to ask lawmakers for a tax increase.

On January 24 he requested a temporary 6% “surcharge” on personal and corporate income taxes. Scheduled to expire after two years, it would exempt individual taxpayers in the lowest tax brackets. But it would also raise $4.5 billion annually — enough to keep the deficit at manageable levels and help slow inflation.

Congress greeted Johnson’s request with muted enthusiasm. Neither Senate Finance Committee Chair Russell Long, D-La., nor House Ways and Means Chair Wilbur Mills, D-Ark., was eager to take up Johnson’s proposal.

Mills was especially reluctant to embrace the surcharge. Weeks and then months passed, and still Mills did nothing to move the surcharge through the House.

In August 1967 Johnson renewed and formalized his request for a surcharge, now increased to a full 10%. He also raised the rhetorical stakes, invoking the rhetoric of wartime self-denial and shared national purpose.

“Some may hear in this message a call to sacrifice,” he said. “In truth, it is a call to the sense of obligation felt by all Americans. The inconveniences this demand imposes are small when measured against the contribution of a Marine on patrol in a sweltering jungle, or an airman flying through perilous skies, or a soldier 10 thousand miles from home, waiting to join his outfit on the line.”

Mills was unmoved.

Then, in early 1968, the Senate did something that surprised most observers. During floor debate over a separate House-passed bill extending various excise taxes, senators adopted an amendment that included Johnson’s surcharge.

The Senate amendment was happy news for the White House. Less happy were two other provisions that senators also added to the bill: a $6 billion spending cut for fiscal 1969 and a rescission of $8 billion in unspent appropriations from earlier years. Johnson preferred that fiscal restraint be confined to the tax side of the ledger.

House leaders, meanwhile, were aghast at the Senate’s effort to take the lead in crafting tax legislation. Article I, section 7, clause 1 of the Constitution requires that “all bills for raising revenue shall originate in the House of Representatives.” While technically senators had simply amended a preexisting House bill, they had clearly violated the spirit of this provision.

“Ordinarily amendments of this magnitude are not accepted by the House because it guards closely its prerogative of initiating tax legislation,” explained Laurence Woodworth, chief of staff for the Joint Committee on Internal Revenue Taxation, during a review of the 1968 legislation. “Ordinarily it would insist on major amendments of this type originating in the House and being considered by the Committee on Ways and Means.”

But House leaders felt compelled to acquiesce to the Senate maneuver, at least partially. Relevant House committees eventually signed off on the Senate changes, and when the bill went to a conference committee, the Senate provisions emerged more or less intact.

Key Provisions

The most important tax provision of the 1968 law was the 10% temporary surcharge — larger in size than the one Johnson proposed but slated for quicker expiration. The surcharge applied to both individual and corporate taxpayers and was scheduled to disappear on June 30, 1969, unless extended. The effective date differed for the two sets of taxpayers: January 1, 1968, for corporations and April 1, 1968, for individuals.

Low-income individual taxpayers were entirely exempt from the surcharge. Johnson’s signing statement noted that a family of four earning less than $5,000 (about $38,900 in 2023 dollars) would pay nothing extra. A family making $10,000 (about $77,900 in 2023 dollars) would pay just $2 more per week (about $15.60 in 2023 dollars).

In operation, the surcharge was straightforward. Individual taxpayers completed their returns as they always had. But the 1968 Form 1040 got a new line.

After entering regular tax due on line 12a, taxpayers were instructed to consult a special surcharge table and enter the appropriate addition on line 12b. For tax year 1968, the surcharge amounted to 7.5% of a taxpayer’s regular tax liability. (The 10% levy was prorated since it was in place for only nine months of the calendar year.)

For corporations, the process was similar: A new line on Schedule J of Form 1120 instructed companies to add 10% to their regular tax bills (or a prorated amount, depending on the corporation’s tax year).

Together, the individual and corporate surcharges were expected to raise $12 billion during their first year of operation.

In addition to the income tax surcharge, the 1968 revenue act featured an extension of various excise taxes that would otherwise have disappeared, including levies on automobiles and telephone calls. Extending these taxes would raise another $3 billion annually. A temporary acceleration of corporate tax payments would yield another $1 billion.

The law included several other minor tax provisions, but one seems prophetic in retrospect: a requirement that the administration submit a plan for comprehensive tax reform no later than December 31, 1968.

Debate over the Tax Reform Act of 1969 was just a few months away.

Driving the Economy

On June 29, 1968, Johnson signed the Revenue and Expenditure Control Act of 1968, casting the measure as a necessary counterpoint to the 1964 tax cut. To underscore his point, he developed a driving metaphor about brakes and accelerators.

“Four and a half years ago — just a few months after becoming President — I signed the biggest tax cut in the Nation’s history,” Johnson said in his signing statement. “The economy was dragging. Five and a half percent of the labor force was out of work. We were underachievers — falling almost $30 billion short of our productive capacity.”

Tax cuts were the obvious response to a sluggish economy. “We had to put our foot on the accelerator,” he explained. “The income tax reduction and the later excise tax cuts brought new vigor and health to America’s economy.”

But times had changed, and tax policy had to change with it. “The special costs of supporting our fighting men in Vietnam and the costs of launching and supporting comprehensive education, health, city, job, and conservation programs in our society have added many billions to our budget,” Johnson acknowledged.

New conditions required a new sort of economic driving technique. “The nation’s economy is moving too fast because of an unacceptable budgetary deficit,” Johnson said. “We must now apply the fiscal brakes.”

Left to his own devices, Johnson would have applied those brakes solely on the tax side of the budget, and he was explicit about his distaste for the law’s spending cuts.

“The Congress — as a condition of its approval for the tax bill — has imposed a deep reduction” in spending levels suggested by the administration, he said. “I have accepted this decision of the Congress because the tax bill is so imperative to the economic health of the Nation,” he added.

Assessing the Law

Looking back on the legislative odyssey of the 1968 tax surcharge law, Woodworth judged it “a most unusual history for a tax measure,” thanks chiefly to the Senate’s outsize role.

But the real question about the law is whether it actually performed as advertised. Did it actually slow inflation?

The law successfully transformed the federal deficit into a (short-lived) surplus. But economists are dubious about its effect on inflation. At the time, critics predicted that the surcharge would do little to slow the rise in consumer prices.

And in a 1971 article, economist Robert Eisner argued that temporary taxes were generally ineffective curbs on consumer spending. He noted that inflation had continued to rise after the enactment of the 1968 surcharge, and indeed, inflation continued to rise into 1969. It dropped significantly in 1970 and 1971, before starting to rise again. But by then the surcharge was gone.

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