[Steve Bank, guest-blogging, June 5, 2008 at 11:02am] Trackbacks
Are the Renewed Inflation Fears a Harbinger of War Taxes?

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.

Charlie (Colorado) (mail):
Steve, the thing is that you keep starting these arguments with counterfactuals. Yes, Charlie Rangel suggested a draft; no, we don't have a covert draft through stop-loss by any sensible meaning of the word "draft", and in fact enlistment is invariably at more than 100 percent of goal and the military, when asked, says clearly that they're not interested in a draft: modern warfare is a technical occupation that can't be carried out by cannon fodder.

Similarly, here, Bernanke is indeed worried about inflation, which is at risk of getting up to 3 or 4 percent; undesirable of course, but not Weimar. Nor would we expect it to be Weimar, since neither national debt nor current deficit is at all unusually high in constant dollars and as a percentage of GDP. So you end up with a conditional probability thing: If this counterfactual or hypothetical thing happened, and then this hypothetical thing happened, and then this next hypothetical happened, something bad could happen. But since each of the steps is neither true now nor likely to happen in the foreseeable future, the actual conditional probability is going to be vanishingly small.

I'm sure it's a lovely book, and a good warning not to let all those improbable things happen, but the suggestion that the current situation makes it a probable outcome is just not supportable.
6.5.2008 12:22pm
The thing is, inflation isn't a thing we have a choice to do or not do; it's already happened, via over-valued dollar-denominated mortgages circulating at par. The current round of price increases is just the world catching onto the fact that the dollar buys less than they thought it did.
6.5.2008 12:40pm
K. Dackson (mail):
3-4% inflation! The horror of it!

When you consider that inflation averaged about 3% annually through most of the 20th century, it's about time we did something about it! Like raise taxes!

I guess you forgot the wonderful economy of the Carter years. High taxes, high inflation, and slow economic growth.

Yes, I cannot wait for a return to the good old days.
6.5.2008 1:16pm
jdh (mail) (www):
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.

The Fed is not the principal soldier, it is the principal cause.
6.5.2008 1:27pm
Charlie (Colorado) (mail):

The Fed is not the principal soldier, it is the principal cause.

Then they suck at it.
6.5.2008 2:50pm
Davebo (mail):

Consider the dilemma our troops face. They are approaching their EOAS, but still have time to serve in the IRR.

They can take their discharge, and pray they aren't actived again to deploy as part of the IRR, or they can re-enlist and get a nice bonus.

Given the choices, it's not suprising that many choose to re-enlist. Currently there are over 12,000 members of the Army alone serving under stop loss orders according to Lt. Gen. James D. Thurman, deputy chief of staff for operations and that will continue until at least 2009.
6.5.2008 3:31pm
C. Norris (mail):
"The current round of price increases is just the world catching onto the fact that the dollar buys less than they thought it did."

I agree. I have been involved in the secondary mortgage business, as investments, for over 20 years. I stopped making any new loans in 2002. As the Fed kept lowering their interest rates to keep cash in the mortgage market the Fed was, in effect, lowering the value of the US Dollar. Interest paid on borrowed money is the "rent" paid for the temporary use of another's money, be it for one day or 30 years. The Fed has put the dollar into the "low-rent" financial neighborhood for political reasons, rather than sound financial policy. As the dollar was devalued, house prices increased correspondingly and the Fed responded by devaluing the dollar even further thereby increasing house prices until the bubble finally burst. The evidence of this "Cheap Dollar" policy is now reflected in the price of oil.

Alan Greenspan is no financial "maestro" to me. Chairman Ben Bernanke is still a mystery. He knows the correct thing to do, but does he have the courage to do it? Hold rates until financial stability is attained and then raise the rates until the dollar is worth a "Buck". Wall Street will howl, Main Street will prosper.
6.5.2008 3:56pm
K. Dackson (mail):

You should note that each enlistee knows the requirements of the IRR and that the total obligation is for 8 years (including the IRR component). Just go look at the standard contract.

In addition, note that each of these people volunteer for the chance to get shot at. Death is one of the many occupational hazards of being a soldier, airman, sailor or marine.

Mr. Bank is using the tired old argument that "since we have always raided taxes during a war, we need to raise them now." The premise is laughable at best. This was costs less than the interest on the national debt each year. More taxes are not required to "pay" for it. I am afraid that Mr. Bank would simply use the money to fund more social programs that will never die.
6.5.2008 4:22pm
Davebo (mail):

Yes, I know how the IRR works and that all enlistments are for a total of 8 years. And yes, I realize enlisting in the military, especially during a time of war, is a risk.

But that wasn't what I was referring to. First, Stop has nothing to do with IRR. A soldier who is stop lossed has completed all of his duty requirements, including IRR. Otherwise they wouldn't need to stop loss them.

Secondly, to claim recruiting is going great when a soldiers choice is to either re-enlist and get a large bonus, or attempt to leave the service and get stop lossed, redeployed anyway, and not get a bonus is just a bit silly to me.

I was IRR from late 1988 until 1991 and fortunately was never called up beyond the five years of active duty I did. But I knew it could feasibly happen.

As to this..

This was costs less than the interest on the national debt each year.

Well, perhaps the current national debt. But if I were you I wouldn't be bringing up the national debt as it's gone from just over 5 trillion in 2000 to almost 10 trillion now.
6.5.2008 4:36pm
Davebo (mail):

" First, Stop [Loss] has nothing to do with IRR."
6.5.2008 4:37pm
K. Dackson (mail):

And your point is? If the debt is climbing, then the interest is also climbing. The war becomes less of a strain on the budget as the debt grows.

The only thing higher taxes will encourage is additional spending by Congress.
6.5.2008 4:52pm

Stop has nothing to do with IRR. A soldier who is stop lossed has completed all of his duty requirements, including IRR. Otherwise they wouldn't need to stop loss them.

I don't think this is correct. The term "stop loss" includes both extension of initial active duty service obligation and (theoretically) extension of IRR time. From what I have read, the most common use is to extend the initial active duty period so as to preserve unit cohesion once deployment orders have been received. Relatively few IRR callups have occurred, see, e.g., here (and sources linked therein), and those have been limited to certain grades and specialties. Note that the authorized number of IRR callups by each service is extremely limited. See here, noting that the USMC is limited to 2,500 involuntary IRR activations at any given time.
6.5.2008 5:12pm
RE: "Stop-Loss" Davbo, you're understanding of it is lacking in some details. Here's an Army Times article form May 5, 2009. One of the important limitations on its use is

"Restrictions under the active-component unit program take effect 90 days before the earliest theater arrival date specified in deployment orders issued by the Joint Chiefs of Staff. The restrictions continue through a unit's deployment to home station, plus a stabilization period of no more than 90 days."

Which units will be deployed is known 6 mos. to a year+ in advance of the notice that triggers the Stop-Loss policy. Any Soldier -- particularly Reserve and National Guard Soldiers -- who cannot figure out how to get out of a unit with that much advance warning isn't in a position to complain (and, personally, I don't know of many complaints, but perhaps you do). Moreover, Commanders and NCOs don't want to take into combat (and have their own lives depend on) people who regard military service as just another way of getting a pay check. There are ways to get rid of people you don't trust.

In any event, the underlying reason for Stop-Loss was that under the Clinton Administration, the size of both the Active and Reserve Components were cut too much in view of needs. As the Active and Reserve Components' strength is brought back up, Stop-Loss will end (except for critical MOSs that take long lead times for training, like Special Ops).

While I've heard it asserted that Soldiers are re-enlisting (&taking the bonuses) because of Stop-Loss, I haven't seen persuasive evidence of that. A Soldier weighing a $5K, $10K, $20K or so bonus (depending on MOS) in addition to other pay and benefits (and considering that his/her fellow Soldiers in his/her unit are facing deployment) as compared with civilian employment opportunites, pay and benefits, can rationally decide to re-up and deploy with the people he/she is closer to than anyone except parents and siblings.

You are correct that Stop-Loss does not directly deal with the Individual Ready Reserve (IRR) since Soldiers in the IRR are subject to re-call to active duty, which isn't Stop-Loss. However, Soldiers on active duty are subject to being retained beyond their ETS (Estimated Termination of Service) date based on needs of the service -- i.e. "Stop-Loss". Further, retirees are also volunteering to be recalled to active duty. This has happened with some IRR and Soldiers drilling Reserve Component units, as well.

From the military's point of view, Stop-Loss shows that the military actually learned something from Vietnam. In Iraq and Afghanistan units are moved in and out, instead of sending in individual replacements when individuals' tours ended. You may have read "We Were Soldiers Once, and Young" or seen the movie. A significant problem 7th Cav (and all other units deployed to Vietnam) faced was that shortly before it deployed, it lost about 1/3 of its Officers and Enlisted whose terms of service ended, and many of those people lost were the most experienced and trained at their respective ranks. This resulted in a much less cohesive and well-trained unit (and personnel) being deployed to combat. The current Stop-Loss/Stop-Move policies means that Soldiers know they are going to be deployed, and that is strong motivation to train hard and well, and ensure that all their equipment is squared away.

Although I don't like seeing Soldiers retained under Stop-Loss/Stop-Move policies, those policies are better than the Charlie Foxtrot policies of the Vietnam era. And, as noted, today Soldiers are all volunteers who generally believe they are doing something a lot more important than merely a job that lets them draw a pay check. Considering that only about 28% of High School age Americans meet the minimun standards to enlist in the Army -- which 28% includes a lot of those considered good college and skilled crafts material -- what I consider remarkable is that the military is having so few problems attracting and retaining the people it is. This is especially true given that there are combat deployments, the Army is rapidly increasing in size and undergoing complete reorganization, and these young people have other opportunities. When you served, it was a garrison Army, so things may have looked a lot different.

Stop-loss likely to last into fall 2009
By Michelle Tan - Staff writer
Posted : Monday May 5, 2008 11:41:24 EDT

Last year's surge of five combat brigades into Iraq helped drive a 43-percent increase in soldiers being barred from leaving the service under stop-loss orders, and Army leaders predict the policy will remain in place at least through next year. However, they expressed optimism that the numbers will ebb as surge forces redeploy.
More than 12,230 soldiers are under stop-loss orders, compared to 8,540 in May 2007, during the surge. But the 30,000 combat troops that were part of the surge are in the process of coming home, and the Army is returning to 12-month deployments Aug. 1. Because soldiers are placed under stop-loss as members of deploying units, reducing the numbers sent to war reduces the numbers involuntarily held.
"As the [war zone] demand comes down, we should be able to get us weaned off stop-loss," said Lt. Gen. James Thurman, the Army G-3.
Under stop-loss policies, active-duty soldiers within 90 days of retirement or obligated service are barred from leaving the Army if they are in units alerted for deployment. Reservists and National Guard members are barred from leaving if their units have been alerted for mobilization.
Thurman said he hoped the Army could end stop-loss by fall 2009. In March 2005, 15,758 soldiers fell under stop-loss orders, the most for any month between November 2004 and March 2008, according to Army data. The numbers stayed between 10,000 and 13,000 for about two years after that and fell to an all-time low of 8,540 in May 2007. But the trend reversed the next month as the last of the five surge brigades flowed into Iraq and soldiers settled into 15-month tours.
At the end of March, the most recent month for which data are available, 6,868 active Army soldiers, 3,879 Army National Guard and 1,488 Army Reserve soldiers were affected by stop-loss.
Until then, the number of active Army troops forced to stay beyond their initial enlistments had remained relatively consistent since September, ranging from 6,322 to 7,690.
Much of the increase in March can be attributed to a spike among Guard soldiers — the 3,879 soldiers stop-lossed during that month make up the largest group of Guardsmen affected by the policy since November 2004.
Overall, about 58,000 soldiers, about 1 percent of the active force and activated Guard and Reserve soldiers, have been affected by the stop-loss policy since 2002, said Lt. Col. Anne Edgecomb, an Army spokeswoman.
The move to reduce and eventually eliminate stop-loss is tied to the Army's efforts to return to 12-month deployments and increase dwell time for soldiers, Thurman said.
"Reducing the deployment time to no more than 12 months is going to help us restore the balance and strategic depth [of the Army]," he said.
President Bush announced April 10 that active Army soldiers serving in the Central Command area of operations, which includes Iraq and Afghanistan, will return to 12-month tours beginning Aug. 1.
Soldiers deployed now should expect to be deployed for 15 months.
With time, if conditions in the war zone permit it and the Army meets its growth goals, dwell time for soldiers should increase, Thurman said.
"Ideally, we want to push dwell to 15 to 18 months," he said.
Soldiers now get an average of 12 months at home. Thurman estimated that dwell time could grow to 18 months by the end of fiscal 2009 and 24 months by the end of fiscal 2011.
The ability to keep soldiers home will allow them to train for full-spectrum operations, Thurman said.
"We don't have enough time back home," he said. "You get into what I call atrophy of skills."
The ultimate goal for active-duty soldiers is one year deployed, three years at home, but that won't be possible for several years, Thurman said. The goal for the reserve component is one year deployed, five years at home, he said.
When the surge in Iraq ends this summer, the Army has been told its requirement for Iraq and Afghanistan is 15 active Army brigade combat teams, Thurman said.
There are 17 BCTs in Iraq and two in Afghanistan. At the height of the surge, 20 active Army BCTs were deployed in the two theaters.
The Army also will need support from four or five Guard BCTs, he said.
By the end of fiscal 2010, Army leaders hope to have an active-duty end strength of 547,000. The Guard is growing to more than 358,000 and the Army Reserve is planning for 205,000, Thurman said.
Plans include adding six BCTs in the active component for a total of 48, plus 28 in the Guard, by the end of fiscal 2011. There will be 223 support brigades by that time, Thurman said.
If the service meets its goals, 21 BCTs — 16 active, four or five Guard — will be ready to go at any time, Thurman said.
And the Army continues to provide other troops to Iraq and Afghanistan. The demand for these troops is not coming down, Thurman said.
About 53 percent of deployed soldiers is assigned to BCTs, but the rest belong to units such as division headquarters, sustainment brigades, engineer brigades, combat aviation brigades, military police brigades and military transition teams, according to information provided by the G-3 staff.
Critical military occupational specialties include special operations, infantry, aviation, military intelligence, engineers, civil affairs and military police, Thurman said, and the Army is focused on growing those jobs.
The nation will continue to be engaged in persistent conflict, and even though soldiers are resilient, it is critical for the Army to return to 12-month tours and meet its goals for growth, Thurman said.
Stop-loss and stop-move policies that bar the reassignment, voluntary separation and retirement of soldiers in deployed and mobilized units have been in effect since November 2002 for reservists and June 2004 for active-duty soldiers.
Here are highlights of the program:
• Stop-loss and stop-move policies will remain in effect until lifted by the secretary of defense and the assistant secretary of the Army for manpower and reserve affairs.
• Restrictions under the active-component unit program take effect 90 days before the earliest theater arrival date specified in deployment orders issued by the Joint Chiefs of Staff. The restrictions continue through a unit's deployment to home station, plus a stabilization period of no more than 90 days.
• The active-component restrictions apply to all soldiers in units that are alerted to deploy in support of operations Iraqi Freedom and Enduring Freedom. Included are deployable and nondeployable soldiers assigned to a unit's rear detachment.
• National Guard and Army Reserve restrictions apply to all reserve call-ups for the war on terrorism (including homeland defense) and Central Command operations. They apply to mobilized units and all their soldiers, regardless of specialty.
Soldiers are placed in stop-loss status when the unit is alerted for mobilization and until 90 days after demobilization.
• Stop-move does not apply to soldiers in units performing homeland defense missions.
6.5.2008 6:49pm
Inflation is way more than 3%, if you measure inflation by the increase of the money supply minus the increase in GNP.

The FedRes has been fudging things on behalf of their stock holders and whatever administration is in power at the time.

The rest of us peons just scratch our heads and see the continual loss of the abiltiy to "make ends meet" (us who stay away from getting into debt) while the court historians and jesters claim that the standard of living has improved.

We began to cut back on driving last year, when the cost of filling my commuter car's tank increased 200%. I work for a small company and the downward spiral in my purchasing power has been evident for several years now. We have made adjustments and continue to make them but, darn it, it is becomeing harder and harder.

Low inflation my asss!
6.5.2008 11:01pm
Oh, yeah. I forgot. Are not war taxes supposed to tax companies that directly profit from war? After all, no wars no profit above what is normally procured when there are no wars!
6.5.2008 11:03pm
Duncan Frissell (mail):
(last year) the cost of filling my commuter car's tank increased 200%.

3/24/02 1.46/gal
10/27/06 2.14
6/5/08 3.84

Hasn't doubled yet for me since '06 more like the end of '04.

Meanwhile the cost of housing is declining. I could make an offer on a house that would have been $150K more in '05. Cheap. Rents are stable or falling too with all the houses for rent.

Meanwhile a pocket video camera is $82 and a pay-as-you-go cellphone $9.99.

My e-books are free.
6.6.2008 1:16am
MarkM (www):
The standard treatment of wartime finance in economic history is that there are three ways to finance a war:

1. Raise taxes (central planning and rationing arguable fit into this category also)
2. Borrow by issuing bonds
3. Print money (inflation)

For there to be a connection between 1 and 3, as you argue and as seems to be the case in previous wars, option 2 has to be exhausted. As long as there are enough investors to buy up all the bonds the government can issue without real yields shooting up, a war can be financed without a monetary expansion. So far, that appears to be the case today as sovereign wealth funds and foreign central banks -- including those run by governments hostile to the Iraq war -- continue to pile into U.S. Treasury bonds.
6.6.2008 2:53am
cubanbob (mail):
Why is the obvious solution of cutting other non military spending never considered? Eliminate farm subsidies and we can finance the war indefinitely and have 50 plus billion left over. And that is just a start.
6.6.2008 3:58am
It used to cost me around $14 to fill up. Last year it was up to $24. Now it costs me around $32. Yeah, I am using round numbers. My bad, it more like 125% We have had to cut back on some activites for the kids and do not take a car trip unless we can combine purposes or the trip has to be made. All this at the time that I have a son going to college and begining to drive. And a second son graduating from High School next year. What has been the increase in college tuition &books?

What about electricity? I used to pay about $150/month in the summer. Now I have seen bills of over $300. And we keep our thermostat around 75F ... in Houston.

And we do use pay-as-you cell phones and we continue to cut back on groceries.

On housing. That depends where you live. If you do not have a job to buy one of those cheap houses, it is of no help. If I sell my house, what exactly can I buy for the same money I sell mine? And here in Texas property taxes increase almost 10% annually. And wait until the new marginal tax dead line arrives. It is going to be ugly.

Inflation is NOT 3%. My guess is that the real inflation number has been around 8% for a number of years. CPI is a rigged formula.

It all adds up to a lowering of my living standards and it has.
6.6.2008 9:21am

Why is the obvious solution of cutting other non military spending never considered?

It was. Remember the "Peace Dividend"? Due to the collapse of the USSR, it was possible to reduce the military's size -- essentially reversing the Reagan build up. This was approved and the implimentation was begun under Bush 41 and GEN Powell, and further carried out (to an extent even greater than originally planned for) under the Clinton 42 Administration. The second part of the plan, to be implemented during the Bush 41 2d term, was to implement the Grace Commission recommendations that were developed under the Reagan administration.

However, this did not occur during the Clinton 42 administration. The Peace Dividend reduced spending enough to turn the deficits into a supposed surplus (if you included Social Security and Medicaid taxes as revenues, but didn't fund the trusts -- an accounting sleight of hand). Congress being Congress when it comes to money -- the parent of any 3 year old who's taken the child to a store understanding that behavior -- seeing "extra" money found ways to spend it on non-military programs. First the Democrats controlled Congress, and increased social welfare, environmental and other populist programs. When the Republicans took control, things didn't change (and probably got worse).

So, while the "obvious solution" has been recognized and there was a plan developed, lack of political will trumped. It's only "pork barrel" if the money is going to some else's voters.
6.6.2008 9:22am
Borrow by issuing bonds is also inflationary.

The increase in spending, due to the interest to pay borrowed money, has to come from somehwere.

And Federal government borrowing, in the end, results, in an increase of the money supply. Borrowing/printing monay is a tax on future generations ... unless it is paid for matching spenditure cuts in other areas or by concurrent tax increases.
6.6.2008 11:46am