How did America pay for World War II?

by on September 7, 2010 at 7:25 am in Economics, History | Permalink

Peter Schiff offers some interesting observations, via Interfluidity

But to repeat the impact of World War II today would require a truly massive effort. Replicating the six-fold increase in the federal budget that was seen in the early 1940s would result in a nearly $20 trillion budget today. That equates to $67,000 for every man, woman, and child in the country. Surely, the tremendous GDP growth created by such spending would make short work of the so-called Great Recession.

To a degree that will surprise many, the US funded its World War II effort largely by raising taxes and tapping into Americans' personal savings. Both of those avenues are nowhere near as promising today as they were in 1941 Current tax burdens are now much higher than they were before the War, so raising taxes today would be much more difficult. The "Victory Tax" of 1942 sharply raised income tax rates and allowed, for the first time in our nation's history, taxes to be withheld directly from paychecks. The hikes were originally intended to be temporary but have, of course, far outlasted their purpose. It would be unlikely that Americans would accept higher taxes today to fund a real war, let alone a pretend one.

That leaves savings, which was the War's primary source of funding. During the War, Americans purchased approximately $186 billion worth of war bonds, accounting for nearly three quarters of total federal spending from 1941-1945. Today, we don't have the savings to pay for our current spending, let alone any significant expansions. Even if we could convince the Chinese to loan us a large chunk of the $20 trillion (on top of the $1 trillion we already owe them), how could we ever pay them back?

A related question is whether the American public would consider the offsetting required restrictions on consumption, as documented by Robert Higgs.

File under "Reasons why WWII does not provide a good case for massive fiscal stimulus today."

liberalarts September 7, 2010 at 7:36 am

In the realm of absurd, discussing a government budget that is 50% larger than our GDP is extra absurd. Although not wise in my view, a better comparison would be a thought experiment on increasing the federal budget to the same percentage of GDP that it was during WWII. The ratio of federal budget/GDP peaked in the 36-37% range, so that would equate to about a $5 trillion dollar budget today.

Chuck September 7, 2010 at 8:06 am

I think this is a straw man.

The largest stimulus number I’ve seen is Krugman who specifically wanted 1.5 trillion.

Theo September 7, 2010 at 8:25 am

Always two steps behind: This is just how Keynes himself argued the war should be financed.

The differences between that situation and this are that World War II had to be fought with an eye to the length being open-ended, and that the stimulus was so massive that resources were massively overemployed rather than underemployed. But the stimulus itself, regardless of financing, worked in getting us out of underemployment.

So WWII remains a good case for a smaller-than-WWII-sized (in relative terms) fiscal stimulus today.

Daniel Kuehn September 7, 2010 at 8:46 am

1. I think you have to separate the question of “could we (much less would we want to) increase the federal budget sixfold?”, from “what does WWII imply about the fiscal multiplier”? The first question is completely irrelevant, and the second question is empirically muddier than either Higgs or Schiff or Krugman suggest – but I think it generally points in favor of a higher multiplier.

2. For all that people are down on Krugman for this, it’s Krugman that repeatedly highlights the restrictions on private consumption that you highlight here by attributing to Higgs. It’s pretty transparent when people throw that back at him as if it isn’t something that he’s been saying.

DanC September 7, 2010 at 9:23 am

As Robert mentioned, how many people would tolerate wage and price controls, ration coupons, and placing the modern equivalent of 12,350,000 americans in military uniform (about 8.5% of total population).

Krugman once again let’s politics trump his economic skills.

Seth Halpern September 7, 2010 at 9:43 am

Well of course drafting nearly one quarter of the entire male population reduced unemployment, and redirecting most American wealth toward private industry (put on a war footing) rather than toward government bureaucrats stimulated hiring, production and consumption. Conversely, with public spending around 25% even before today’s Great Recession – some people would call that quite a stimulus – you have to wonder if the thrill is gone .

anonymous September 7, 2010 at 9:57 am

In the aftermath of WWII, America was able to rapidly pay back the debt it took on because the US economy simply had no competition. The economies of Europe and Japan had been bombed to rubble, and China was not yet a factor.

The experience of Britain in the aftermath of the Napoleonic Wars was probably more typical: paying down incurred debt (without resorting to default or experiencing high inflation) took much of the rest of the century, despite being a society in its prime and the leading industrial power of the world.

There are few (if any) other examples to point to, because historically, countries simply default on or hyperinflate massive wartime debts.

Indy September 7, 2010 at 10:16 am

It’s useful to remember that the post-war and early 50′s high-inflation periods were so high that 10-year war bonds had a negative real yield.

The Nominal Yield was only 2.9% per annum, you put your 75 quarters in the cardboard cutout you got at the post-office ($18.75), and you got a promise for a cool 25 bucks ten years later. If you bought, say, in 1944 and collected in 1954, the accumulated Real yield was -33% – amounting to a large gift of debt-forgiveness to USGOV. This is a big, and often-ignored, component of the Debt-GDP quick ratio decline in the decade following WWII.

The total amount of savings collected in war bonds was massive , amounting to something like $2,000 per household (and most households participated) – which was a huge amount of money back then.

So, let’s see what happened in real terms. The government, essentially, mobilized the entire country. Lots of government money was flowing to lots of people, but almost none of that was available for consumption because of rationing, and so people had no real alternative but to “save”. But instead of mere hoarding or caching, they “invested” in the form of war-bonds.

So, the money the government paid out was, largely, recycled back into war-production. People were therefore willing to work extra-hours for minimal amounts of present consumption with only a promise of the benefit of future consumption from savings once the war ended.

Is this not the equivalent of an internal-devaluation / society-wide real-wage decrease? It is. Then, when those people got their “savings” back, it turned out their purchasing-power was much less than expected becase of unexpected and unforeseen inflation not forecasted in war-time bond rates.

A neat-trick! Now, if only we had that kind of ability to make everyone in the society work full time (and bring in a large number of formerly non-work force women), coerce them forgo all consumption with the promise of future-consumption, and then renege on that promise, after establishing global industrial dominance.

Boy, that’d do wonders for GDP. I don’t think we can do *anything remotely like this* again without a real WW-III on our hands. Maybe not even then.

charlie September 7, 2010 at 10:24 am

Better Title: How we could pay for Iraq and Afghanistan. Amazing idea that we could raise revenue to pay for war!

Double the gas tax, pay for another $100 billion a year in killing Arabs! yeah!

Tony September 7, 2010 at 10:55 am

>redirecting most American wealth toward private industry (put on a war footing)

I call shenanigans. “Put on a war footing” is government spending.

WWII also echoes Keynes’ point about digging holes and burying money. In WWII, all that spending wasn’t put to productive use. It was shipped over to Europe and the Pacific and literally blown up.

Six Ounces September 7, 2010 at 11:49 am

WWII destroyed a lot of resources and diverted a lot of resources from production, so we wouldn’t need equal spending to achieve the same economic effect.

Recall from the movie “Flags of Our Fathers” that heroic efforts were needed to get Americans to part with their money for the war effort. It was patriotism and sacrifice and the will to win that did the trick. Few people today would individually sacrifice just so we could restore an economy to full potency with special interests getting most of the gains.

Also in the movie, they made it clear the US was nearly broke at the end of the war. Without one last push and two atomic bombs, we might have had to negotiate peace with the Japanese which left their government and military intact – a very different world than today.

Jim September 7, 2010 at 1:49 pm

What Robert Speirs said.

Krugman would have you believe that WW2 did not actually happen. To him, a bunch of Government spending happened, and then suddenly things became better for the USA. So clearly, we need more Government spending!

He’s an epic dope. But, you knew that.

Chris Durnell September 7, 2010 at 2:38 pm

A WWII style spending is not possible today for several reasons. First, people were willing to make incredible economic sacrifices because victory was essential. People accepted rationing and limited luxuries to prevent the Nazis from winning. Second, people were already used to sacrifice because of the Great Depression. People today live far better than anyone did back in the 30s and 40s when deprivation was the norm. Third, the need to produce military goods effectively meant there was little civilian goods to buy. Even if people really wanted lots of new cars, rich foods, or silk stockings, they were not going to get them. If they couldn’t spend their money, so why not give it to the government through taxes or war bonds?

Lastly, people accepted these sacrifices because they knew their duration to be limited. When the war was won, things would return to normal. That provided a definite end. People can’t claim the war isn’t over if the Axis surrendered. Today, who would agree on when “victory” was achieved? There is lots of weaseling that could be done. And there will always be those who claim that the minute the stimulus ended, that we would go back to recession, and therefore the high taxes would always need to be kept in place.

mulp September 7, 2010 at 4:46 pm

Let’s see, corporations alone are estimated to be sitting on $2T in cash. Further, investors sitting on the sidelines are estimated to be sitting on at least a trillion in cash. The US Treasuries have been over subscribed multiple times in the past two years.

Clearly, the ability to fund $2 trillion in infrastructure investment over the next decade is easily funded out of savings.

Sure, the stock market prices won’t be bid up to reduce the return on investment, but instead the prices will remain lower while earning from the construction projects boost revenues and profits. That anyone think that returning to the kinds of dividend returns of the 50s and 60s is a bad idea is odd, clearly reflecting the desire to profit from pump and dump which generates lots of trading fees and other derivatives opportunities.

As for raising taxes, simply returning to the tax rates of the 90s would go a long way toward making the costs of infrastructure investment manageable. After all, job creation was higher when taxes were higher. At no time did the Bush tax cuts produce job growth that matched the growth after Clinton hiked taxes. And most of the growth after the Bush tax cuts resulted from Bush administration government spending projects, building cities and infrastructure in Iraq that Iraqis didn’t want and can’t use, and then cleaning up the mess in the Gulf Coast region that resulted from a failure to invest in cleaning up the environmental disaster that resulted from infrastructure projects begun in the 17th century and that continued after the Army Corp of Engineers was put in charge of the Mississippi in mid 19th century.

So, lots of cash is flooding into the US Treasury today from savings and the higher Clinton taxes delivered better job growth than the Bush tax cuts, and let’s remember the road use taxes on gasoline have been reduced by both inflation the higher fuel efficiency, so those road use taxes are lower as well.

ziel September 7, 2010 at 7:17 pm

“Let’s see, corporations alone are estimated to be sitting on $2T in cash.”

Not really, those are assets in the form of cash, but there’s no evidence this represents a cash surplus.

“Further, investors sitting on the sidelines are estimated to be sitting on at least a trillion in cash. The US Treasuries have been over subscribed multiple times in the past two years. Clearly, the ability to fund $2 trillion in infrastructure investment over the next decade is easily funded out of savings.”

Unless you’re advocating confiscating those savings, then you’re talking about funding it via debt – which is apparently what is happening now anyway.

“As for raising taxes, simply returning to the tax rates of the 90s would go a long way toward making the costs of infrastructure investment manageable.”

I think that’s a good point – there’s still plenty of room to raise taxes on higher incomes.

Cobb Knobbler September 7, 2010 at 9:36 pm

Benny Lava calling someone else a liar? Now that’s rich.

Jon September 8, 2010 at 12:56 am

Re: the only reason WWII helped the American economy was that after it ended all of our major economic competitors were devastated and produced almost nothing for ten years. We were the last man standing.

This is simply not correct.
Canada, Australia, and Sweden were also major economies that survived the war with little or no damage.
The UK had only marginal damage.
Outside the Soviet block (where Communism not war damage was the big problem) the rest of the world was back up and running in less than a decade.

a September 8, 2010 at 4:52 am

“This is simply not correct.
Canada, Australia, and Sweden were also major economies that survived the war with little or no damage.
The UK had only marginal damage.
Outside the Soviet block (where Communism not war damage was the big problem) the rest of the world was back up and running in less than a decade.”

Canada, Australia, and Sweden were hardly comparable to France, Germany, and Japan. And even if they were, if only half your competition is standing, that’s still pretty good from a business point of view. As to the UK, it was on a downward course in any case, and was in such poor shape that it did not finish with rationing until the mid-1950s.

As to “back up and running in less than a decade,” a decade is an enormous amount of time.

Paul September 9, 2010 at 1:45 pm

I don’t see why raising taxes cannot work. We borrowed a lot of money during WWII (the war bonds). How did we pay those bonds back to get GDP back in line during the 1950s? High marginal tax rates.

Eddie September 14, 2010 at 6:23 pm

Whelp, Schiff’s still an idiot. Surprising.

Taxes and bond offerings are simply measures to control inflation — which operated in conjunction with outright price controls during the Second World War, because the following process was terribly inflationary. People were paid wages to build bombs; the wages were saved in banks because there wasn’t much to spend it on; the banks bought bonds because there wasn’t much else to invest in; the government spent the bond revenues on contracts for bombs; people were paid wages to build bombs…

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