Over the last two days, Federal Reserve Chairman Ben Bernanke has twice expressed "significant concern" about inflation, citing the rapid increase in energy and food prices as well as the general rise in the cost of imports. This is viewed as an important sign that the Fed may view inflation as a greater risk than economic growth.
As we discuss in our book, War and Taxes, this type of concern over rising inflation is a common feature of wars. During the Revolutionary War, reliance on currency finance led to a collapse of the continental currency. It was even worse in the Civil War for the Confederacy, where the government effectively financed the early stages of the war by printing money. Prices for staples like wheat, bacon, and flour rose by as much as 2,800 percent between 1863 and 1865. Indeed, according to economic historian Claudia Golden, “Every major war fought by the United States has been associated with price inflation. In fact, there are no extreme price peaks [between 1775 and 1975] that are not accompanied or preceded by a war.”
By the same token, in almost every war Congress has been urged to adopt war taxes not just for revenue, or to balance the sacrifices on the battlefield (as discussed in my post yesterday on the draft, but to fight inflation. Faced with rampant commodity inflation during the Civil War, Governor Joseph Brown of Georgia pleaded “For God’s sake tax us. Nothing else can save us from ruin.” Similar pleas were raised during World War II and Vietnam. President Roosevelt, during his Annual Budget Message to Congress in 1942, said “a well-balanced tax program must include measures which combat inflation.” In December 1965, Gardner Ackley, chairman of the Council on Economic Advisors, wrote in a memorandum to President Johnson, “there is little question in my mind that a significant tax increase will be needed to prevent an intolerable degree of inflationary pressure.” President Nixon argued for an extension of the tax surcharge in 1969 as an anti-inflationary measure.
So, does that mean we can expect politicians to justify the adoption of war taxes as a response to inflation if the rise in energy and food prices spreads more generally? Highly doubtful. One big change in the past quarter century since Vietnam has been the increased importance of the Federal Reserve Board itself. Ever since Paul Volcker introduced significant changes to the country’s monetary policy in the early 1980s, the Federal Reserve has been the principal soldier in the fight against inflation. And, to a large extent, it has been successful in keeping inflation relatively low even in the face of rising deficits. Tax is now considered too crude an instrument for the job. Nevertheless, it would not be surprising to see at least some anti-inflation rhetoric used in support of tax increases if the Fed falters and to see renewed support for more narrowly-tailored measures such as tax indexing as a general response.