Chapter VII French Fiscal Methods during the War

CHAPTER VII French Fiscal Methods during the War The financial expedients of a state in war time may be listed under five main heads: I. Taxes II. Long time bond issues III. Short time Treasury loans issued in anticipation of receipts from taxes and long time loans IV.' Direct advances to the state by a state bank of issce V. The issue of government paper money Between the last two methods, when specie payment is sus pended by the state bank, the line is often difficult to draw. The issue of government paper money as a means of meeting the cur rent -expenses of the state is generally recognized as the least desirable form of financing; the last resource of financial weak ness. This was a case with the greenback issues of the North during the Civil War, although in that case it represented finan cial inaptitude rather than real weakness, and was held within reasonable limits after a strong tax and loan policy was begun.

It represented much less weakness than the advances by the state banks of Russia and Austria have meant during the present war. During the present war the doctrine that the entire expenses of the state should be met by taxes has occasionally been stated. This is an extreme view which probably today has few if any responsible advocates. It is impossible to carry out. The theory underlying it is that the essential problem is a problem of goods and services; that the amount of goods. and services available is fixed; that the problem is simply to divert goods and services from private to public use; and that the simplest way to accom plish this is for the state to take private incomes and spend them, thus reducing private demand by exactly the same amount that 93 94 EFFECTS OF THE WAR ON MONEY, CREDIT AND BANKING the demand of the state for goods and services increases. The difficulty in applying this plan grows out of the pre-existing fabric of debts and credits which would promptly be thrown into chaos by any such drastic reduction of private incomes as the taxes necessary to carryon a great war would involve. Univer sal bankruptcy would result from it. Instead of private demand falling off in proportion to the increase in the demands of the state, private demand would falloff very much more than state demand increased and the fiscal receipts of the state itself would be very much less than the taxing authorities might anticipate for the very simple reason that bankrupts can not pay taxes. The doctrine is further wrong in its assumption that the volume of goods and services is fixed. It is probable that physical volume of production in the United States, for example, has increased over twenty-five per cent 1 since 1914 under the stimulus of ex panding credit and rising prices. Under ordinary conditions there is a large slack in industry. There is unemployment, there are idle plants. There is, moreover, a large industrial reserve in women and children and retired laborers, and most of the labor force can be induced to give more overtime work than it is ac customed to give in normal times. Rising prices and interest rates connected with an expanding volume of war time demand can, moreover, induce extra saving, especially by active busi ness~s, and increase capital accumulations.

Further, the doctrine that only taxes should be used,ignores the temporal sequence of the cessation of private demand and the beginning of public demand for goods and services. If the state is to rely only on taxes it can not spend its income until it receives it and it can not receive it until the people have given it up. The friction of tax collection makes it certain that a considerable interval will intervene, during which industry slows down and becomes demoralized. A recognition of these difficulties has led Professor O. M. W. Sprague, the leading American advocate of heavy taxation, to insist that the first reliance of the state should be on short time 1 Ct. the present writer's discussion of this point in the " Annual Review" of The Annalist} January 6, 1919, pages 5-6 and 61.

FRANCE 95 loans, issued in anticipation of taxes, to be taken largely by the banks. The advantage of such short time financing is, first, that 'I the state gets its money at once and so may take its time in pass ing tax laws and collecting taxes; and second, that an easy money market is created by the expanding bank credit connected with the larger loans which tends to prevent the collapse of credit and makes the shifting from peace time industrial pursuits to war time industry easier. In practi.ce, however, even a policy of taxation and short time loans has 'proved a counsel of perfection. The periodic paying off of short time loans by receipts derived wholly from taxation would still impose far too heavy a burden on the existing fabric of debts and credits, and long time loans in large volume have pr6ved a fiscal necessity. If the long time loans are taken entirely by the people, individuals surrendering their current income to the state, the difference between loans and taxes is not great.

But practically the people can not make such a complete surrender of their incomes and the difference between loans and taxes lies largely in the fact that a government bond is good collateral at a bank, while a tax receipt is not. The bondholder is thus in a better position to borrow at the bank funds which he needs to continue a certain part of his ordinary expenditure than is the tax payer. It is not true that taxes lead to no borrowings at the' banks. In 1918 in the United States there was a great deal of borrowing, especially on the part of corporations, for paying the excess profits tax, and to a very considerable extent the bonds issued by t~e federal government have been taken up out of the current income of the people, reducing pro tanto popular expendi ture and consumption. But in general the loan policy of the government leads to an increase in governmental expenditure without an exactly corresponding decrease in private expendi- .

tures, which tends to raise commodity prices. This increased expenditure at rising prices tends also, however, to increase aggregate production, and in this fact we have p,erhaps its great est superiority over an all tax policy. An important qualification must be made with reference to the doctrine that rising prices stimulate production. During 1915, 96 EFFECTS OF THE WAR ON MONEY, CREDIT AND BANKING 1916 and 1917 this was clearly true in the lJnited States, as shown by figures for railroad gross receipts, bituminous coal production and other indicia, but by the middle of 1917 progress slowed down decidedly. The country had nearly reached its maximum capacity. Further stimulus of this kind would have its chief .effect in pull and haul among industries competing for a relatively inelastic supply of labor and materials. No doubt there is still some slack, but no amount of further rise in prices or expansion of bank credit could duplicate the increase in production which the first three and a half years of the great war brought the ,United States. The desideratum would prob ably be an increasing substitution of taxes for loans as a country approximates its full industrial capacity and as the shift from peace time industry to war time industry becomes more com pletely accomplished.

TAXES IN FRANCE In France .it was virtually impossible to adopt a strong tax policy at the outset of the war. As we have seen, France was in the midst of a severe crisis before the war. The budget had been delayed for several months by a bitter. struggle over the income tax and the tax on securities, and the opposition of influential elements of the population, the rentiersJ the financial press, bank ing houses and others to heavy taxes, was a matter of long stand ing tradition. There was, moreover, a theory in France that war should be financed by short loans and advances from the Banque (as had been the case in 1870) and that permanent fiscal measures of taxes and loans to retire the short time obligations should.be put into effect only at the end of the w:ar. Further, the invasion of the industrial and mining sections of France . robbed France of her richest sources of current revenue. For a long time after the outbreak of the war the economic demoraliza tion, in no small part caused by the moratorium, made a strong taxing policy impossible, and the political difficulties of taxation persisted for many months more. The French Ministry of Finance had always to reckon with the possibility of aggravating " defeatist" sentiment by vigorous fiscal measures.

FRANCE 97 By the end of 1914 the yield of existing taxes was 38%0 per cent below normal. Monthly figures for many months there after show heavy deficits. September, 1916, was the first month in which the tax yield got above normal. The revenues for September, 1916, were 346,000,000 francs, 49,000,000 above normal in September, and 110,000,000 above September, 1915, but the first eight months of 1916 were still 189,000,000 below normal, although 494,000,000 above the first eight months of 1915. This turn of the tide, however, still represents a deficit in fact, because the aggregate of taxes, other than customs, was still below normal in this month and the customs receipts repre sented in large measure payments by the government in its capacity of importer to the government in its capacity af tax gatherer. It was not until June, 1917, that the tax yield, exclud ing customs, reached the prewar norma1.1 . Later in 1917 the total tax receipts declined somewhat as a consequence of the falling off of customs with a restriction on shipping, but receipts other than from customs have tended on the \vhole to increase pretty steadily. An income tax and an excess war profits tax went into effect during the year 1916 and additjonal tax legislation was passed in December, 1916. The income tax passed just before the war had remained in abeyance.

New taxes on profits, on payments of over ten francs and on luxuries went into effect in 1918. The luxury taxes have pFoved very unpopular and their yield in July, 1918, was less than one third of the yield anticipated, ten millions as against an estimate of thirty-two millions. Their main effect has been in checking luxury. T'he heavy tax on meals costing over five francs, for example, has led enormous numbers of people in Paris to dine at home instead of dining at restaurants. The total tax yield for July, 1918, was 472,000,000 francs. This is 26,000,000 francs below the estimate for that month, the chief deficit being in the tax on luxuries. It is 40,000,000 francs above the receipts of July, 1917, an increase of 9 per cent. On the whole, the tax policy in France has been lamentably lacking in vigor. As compared. with taxation in England or 1 London Economist, October 21, 1916, page 686; July 21, 1917, page 86.

98 EFFECTS OF THE WAR ON MONEY, CREDIT AND BANKING ta:¥:ation in the United States, the showing is very poor. 1 For the first two years of the war a valid defense for it exists in the fact that nothing else was politically or economically possible. Beginning with the summer of 1916, however, it would seem that much heavier taxes could have been imposed. BaNS DE LA DEFENSE NATIONALE Apart from advances by the Banque de France the main reliance of the French Government at the outbreak of the war was short term Treasury bills, the so-called " bons de la defense nationale." These have been purchased steadily and cheerfully by the people. The "great private banks have bought them, most of them placing them in the" portfolio" in their balance sheets. Their commercial discounts have declined heavily and they have bought a considerable amount of bons de la defense. nationale instead. The Banque de France rediscounts them, or makes col lateral loans against them. In England and the United States such short term obligations of the governments have been taken chiefly by the banks, although to some extent large tax payers have bought them in anticipation of tax payments and farge corporate and individual purchasers of long time securities have bought them in anticipation of the long time issues. In general, in England, France and the United States, provision has been made for the government to accept these short time securities in payment of taxes or of subscriptions to the long time loans.

The smallest denominations of these bons de la defense nation ale, those for one hundred francs, passed to some extent into general circulation and all of them represented liquid assets which the people felt safe in taking in exchange for their hoarded gold or hoarded bank notes which they were holding for emergencies. The first· issues were at 5 per cent for three and six months. By December, 1914, the rate on the three months' issues was reduced to 4 per cent. By early December over seven million francs of these had been sold. A later table will show someth.ing of the to~al amounts involved. 1 Even Germany has done better.

FRANCE THE LONG TIME LOANS 99 Early in 1915 provisions were made for the issue of long time "stock," but it was not until the fall of 1915 that long time financing on a large scale was undertaken. In November of that year, a great loan was floated. This was a 5 per cent issue and was marketed at eighty-eight. The receipts at this price were $2,648,600,000/ or nearly 13,250,000,000 francs. There were about 3,000,000 subscribers. As a means of pro tecting the 3 per cent rente} whose price had sagged to sixty-three, sixty-four and sixty-five, the government allowed a certain part of the subscriptions to be paid in the rente per petuelle. The main items received for the loan of November, 1915, were as follows: 2 Cash Fr. 6,360,000,000 Bons de la .Defense Nationale. . . . . . . . . . . . . . . . . 2,228,000,000 Rente Perpetuelle 1,431,000,000 Some savings banks deposits receipts were also taken and some other minor items. The rente was taken at an arbitrary price of 66 as against the bourse price of 64.50 on November 23, but was accepted only for a part of each subscription and had to be accompanied by new money or national defense bonds.

The loan was open only fifteen days and the large subscription was regarded as very gratifying. The position of the Treasury was greatly strengthened thereby. The second loan came in November, 1916. This also was a perpetual rente at 5 per cent and it was issued at 88.65. The total subscription to this loan was somewhat less-about $2, 275,000,000 or about 11,360,000,000 francs. 3 Of this loan 55 per cent was paid in cash, whereas of the previous loan only 47~ per cent had been paid in cash, the balance in each case being paid in various obligations 1 E. L. Bogart: Direct Costs of the Present War, page 19, published by the Carnegie Endowment for International Peace. 2 London Economist, January 22, 1916, page 141. a Bogart, Ope cit., page 19; London Economist, November 25, 1916, page 998.

100 EFFECTS OF THE WAR ON MONEY, CREDIT AND BANKING of the French Government. The next great loan was in Novem ber, 1917. This time a 4 per cent perpetual rente was issued at 68.60. The total subscription was 10,250,000,000 francs or about $2,051,000,000. As before, a substantial part of the loan was paid in other obligations. The government had asked for only 2,000,000,000 francs of fresh money, but in the actual payment about half of the total subscription was in fresh money. 1 In October, 1918, preparations for a fourth great loan are under way. The bill was introduced by M. Klotz, Minister of Finance, on September 18. The loan is to be a 4 per cent tax free loan, unlimited in amount. It is to be issued at 70.80. Subscriptions will be taken between October 20 and November 24. One interesting feature is that Russian coupons will be accepted in payment up to 50 per cent of any given subscrip tion. 2 The French Government, since the collapse of the Russian Government, has been paying the coupons on Russian state securities and this is merely part of its policy of protecting these obligations.

All of these loans have been essentially funding operations. The government has gone as far as safety permitted in the issue of national defense bonds and in direct borrowings from the Banque de France. It has then issued a long time loan with which it has somewhat reduced its debt to the Banque and with which it has retired a large part of the short time obligations. It will be most convenient to treat the advances by the Banque de France to the government for war purpos'es in our chapter on the Banque de France. The tables which follow will show the proportion which such advances bear to the total revenue and receipts from loans of the French Government. It is interesting to note that following the first great loan in November, 1915, the state reduced its borrowings from the Banque from 7,500,000,000 to 5,000,000,000 francs, and that the note issue of the Banque declined about 250,000,000 at the same time.

1 Bogart, op. cit., page 20. London Economist, January 5, 1918, page 13. z New York Times, September 19 and 27, 1918.

FRANCE 101 Following the loan of November, 1916, the advances to the state in the Banque's balance sheet were reduced from 8,600, 000,000 to 6,600,000 and notes were also somewhat reduced. The effect 'of the loan in the fall of 1917 upon the Banque's balance sheet was less clearly marked, but there was as a result of that loan a substantial temporary retardation in the rate of increase, both of advances to the state and notes. By August 29, 1918, advances to the state had reached 19,150,000,000, while note issue had reached 29,434,000,000. Since about November, 1916, these two items have kept a close parallelism, remaining just about 10JOOO,OOO francs apart. The state pays the Banque 1 per cent on these advances. The rate is to be 3 per cent after the war, 2 per cent of which, however, is to be counted as a sinking fund for the ultimate extinction of the principal of the debt.l There is theoretically a legal limit to the state's borrowings from the Banque, but practically this limit has been raised by successive steps whenever it has been approached. Commonly, the legal limits on the advances to the state and note issues have been raised at about the same time. Of the total borrowings of the state something less than 20 per cent had been borrowed from the Banque de France and the Banque de I'Algerie by December 31,1917, as will appear in the tables below. At the outbreak of the war, however, the main reliance was on the Banque de France. From August 1, 1914, to December 31, the state borrowed twice as much from the Banque as it was able to borrow from all other sources. From January 1, 1915, to May 15 of that year, however, the tide turned and the borrowings from other sources were about three times as great as the borrowings from the Banque. 2 It is in no sense true that the main reliance of the French Government has been the Banque de France. During the first six months of 1918 the growth of the advances by the Banque to the state was very rapid. It is probable that this had some connection with the expenditures of the American Government In France.

1 London Economist, December 21, 1914, page 1112. 2 Ibid., June 5, 1915, page 1166.

102 EFFECTS OF THE WAR ON MONEY, CREDIT AND BANKING The following tables, prepared by Professor E. L. Bogart,! are the most authoritative summary the writer can find of the main elements of French war financial history: EXPENDITURES IN FRANCE, AUGUST 1, 1914-DECEM·BER 31, 1917 (In millions of francs) Social Other Expenrii-Expenditures tures Strictly Military Period Expenditures Aug. I-Dec. 31, 1914.. 5,867 Jan. I-Dec. 31, 1915.. 15,765 Jan. I-Dec. 31, 1916.. 23,673 Jan. I-Dec. 31, 1917.. 29,100 Total 74,405 Charges on Debt 60 1,900 3,267 4,500 9,727 494 2,711 3,291 4,200 10,696 167 2,428 2,402 3,200 8,197 Total 6,589 22,805 32,633 41,163 103,190 RECEIPTS AND EXPENDITURES OF FRANCE AUGUST 1, 1914-DECEMBER 31, 1917 (In millions of francs) Period Expendi tures Aug. I-Dec. 31, 1914............ 6,589 Jan. I-Dec. 31, 1915............ 22,805 Jan. I-Dec. 31, 1916....... . . . . . 32,633 Jan. I-Dec. 31, 1917............ 41,163 Total '1 •••••103,190 Revenue Receipts 1,000 3,884 4,667 4,730 14,281 Loans 6,365 19,856 27,429 35,230 88,880 TOTAL BORROWINGS, AUGUST 1, 1914-DECEMBER 31, 1917 Treasury bills, etc Fr. 21,700,000,000 5% loan of 1915..................................... 13,243,000,000 5% loan of 1916..................................... 11,375,000,000 4% loan of 1917..................................... 10,256,000,000 National defense obligations......................... 840,000,000 Bills sold in England, etc............................ 7,340,000,000 Loans in the United States........................... 3,000,000,000 Advance by United States Government. . . .. ... . .. ... . 6,425,000,000' Advances from banks of France 'and Algeria......... 12,200,000,000 Additional borrowings, unclassified................... 2,500,000,000 Total Fr. 88,879,000,000 This is an enormous war debt for a country whose total annual income before the war was estimated at 30,000,000,000 francs or $6,000,000,000. How can France ever pay it? The 1 0", rif .. pages 20-21. Professor Bogart's figures are given in dollars.

The writer has reconverted them to francs. counting five francs to the dol lar, in order to make them comparable with the other figures given in the discussion of France.

FRANCE 103 interest charge alone would make up a large fraction of the pre war national income while a rapid reduction of the principal would seem to be an impossibility. We have ~ere presented in the case of France a problem that all the belligerents and many of the neutrals are considering very solemnly today: "How can such debts be paid?" I f the interest on the war debt had to be paid out of the national income as it existed before the war, the problem would be indeed a serious one, perhaps a hopeless one. But consider-the interest paid on the war debt, to the extent that it is receiyed by French holders of the debt, is an addition to their incomes. What the government takes out .of their pockets in taxes to pay the interest on its bonds it returns to their pockets in the interest that it pays them. Figures for the income of the people and figures for the budget of the state are thus swollen by what is after all merely a transfer of funds.

Abstracting from foreign debts and abstracting from the fact that people who receive the interest on the war loans are not exactly identical with the people who pay the taxes, the trans action becomes merely a bookkeeping transaction. The burden of the war is after all borne during the period of the war. It can not be thrown on future generations. The future genera tions are of course poorer to the extent that the {>hysical wealth of the country has been depleted. They are poorer to the extent that the labor force is depleted by deaths and sickness and wounds. They are poorer to the extent that the social organiza tion has been demoralized; that family life has been interrupted; that the education of the child:::enhas been interfered with; to the extent that the children have been undernourished and be come weaker men and women as a result. But the mere exist ence of a huge war debt owed by the state to its own people , does not constitute in itself an additional burden upon the coun try as a whole.

It is not safe, of course, to abstract from debts held abroad. France has probably been changed from a creditor nation to a debtor nation as a. result of the war, or at all events will so be changed if the war lasts another year and its borrowings from the United States continue at theiT present. rate. The loans 104 EFFECTS OF THE WAR ON MONEY, CREDIT AND BANKING made by France during the war to her allies are much less than her borrowings in other countries unless it should develop that French advances to the United States Government in 1918 and 1919 turn the scale. It is far from safe of course to abstract from the fact that the people who pay taxes are not identical with the people who receive interest or who receive payments of the principal of the loans. In the past it has often happened that a war debt has been a crushing burden on labor. The rich have lent money to the state and the poor have paid the taxes with which the loan was paid off. This need not be. With the growing political strength of labor; with the growth of income taxes, inheritance taxes and other forms of taxes aimed chiefly at the rich, it is more likely to be true that the flow of funds from the pocket of the tax payer through the Treasury to the pocket of the bondholder will tend to redistribute wealth in the interests of· the poor, rather than the other way.

Nor need it be true that th~ taxes required to pay the interest on these loans and ultimately to amortize them will be a handi cap to business men in competition with the business men of other countries where the tax burdens are lighter. Not all taxes are a burden to industry and trade. Some taxes effect prices, others do not. Some taxes check production, others do not. Taxes on incomes without reference to their source, taxes on inheritances without reference to their manner of accumulation and, within limits, taxes on land, need not check production or handicap trade. If France does not become insolvent during the war there is little reason to suppose that she will become insolvent after the \var, and to the present writer there seems little or no indica tion of any real danger of insolvency either of the French Gov ernment or the French banks during the war. It may be added that even insolvency on the part of the state need not interfere with its continuance as a fighting power if only the state is strong enough to seize by direct methods the physical goods and services needed for the continued prosecution of the war. The Southern Confederacy was virtually bankrupt for two years or more before Appomattox" If vigorous taxes are applied, the"

problem is manageable.