David R. Henderson  

The Hoover/Mellon Tax on Checks

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It's heartening to see that virtually everyone who has blogged on the proposed tax on bank accounts in Cyprus has pointed out that this is a set-up for a run on Cyprus banks. I have little to add to that discussion.

What I do have to add, though, is that we've seen something like this in U.S. economic history. William D. Lastrapes and George Selgin laid out the details in "The Check Tax: Fiscal Folly and the Great Monetary Contraction," Journal of Economic History, Vol. 57, No. 4, (Dec., 1997), pp. 859-878. In June 1932, the Revenue Act that Herbert Hoover signed imposed a 2-cent tax on each check. Treasury Secretary Andrew Mellon, one of my erstwhile heroes, pushed for it. Two cents per check is trivial today, but remember how much inflation we've had since then. To see how important the tax was, you need to know the size of the average check. Lastrapes and Selgin write:

The Treasury's own position had been based on its $175 estimate of the mean value of a bank check. A two-cent tax was, of course, unlikely to cause any significant switch to currency for such large transactions. But the Treasury's figure came from data that included some very large financial transactions. The figure therefore hid the fact that the vast majority of checks, including checks for family expenditures, wage payments, and purchases by agricultural cooperatives, were written for much smaller amounts. For instance, according to the National Cooperative Milk Producers' Federation, as of 1932 dairy farmers had been receiving approximately 150 million checks annually, with a mean value per check of only $2.15. The proposed tax applied to such checks would therefore have been approximately equivalent to a one-percent tax on dairy products at a time when dairy industry profits were exceedingly slim or nonexistent. Similar circumstances prevailed, though on a smaller scale, in the poultry and egg industries. The [Ways and Means] committee was convinced that a check tax might sponsor a large scale switch to currency-based payments in these industries, at the expense of banks serving them.

Critics of the check tax pointed out the worrisome implication for banks the money supply:
The ensuing reduction of credit would in turn do further damage to the economy as a whole. In the end the committee concurred with a New Jersey banker's testimony that "if there ever was a time when money should be kept in the banks as distinguished from pockets and money tills, it is now.

And, sure enough, here was the effect:
The check tax therefore accounts for about 26 percent of the actual increase [in the currency/deposit ratio]. As for M1, the check tax accounts for 35 percent of its overall decline (from $25 billion to $19 billion) between October 1930 and March 1933.

In short, the tax on checks contributed to the severity of the Great Depression.

Comments and Sharing

CATEGORIES: Monetary Policy , Money , Taxation

COMMENTS (9 to date)
John Hall writes:

Fantastic post.

Richard A. writes:

I must admit, this is the first time I have heard of this tax. Glad you called attention to it.

David R. Henderson writes:

Thanks, John Hall and Richard A.

Andrei writes:

David. In light of what's happening in Cyprus would you change anything in the analysis you provided here: http://econlog.econlib.org/archives/2013/02/must_default_be.html ?

David R. Henderson writes:

No. But you've got me curious: are you seeing a reason, in light of Cyprus, that I should?

Andrei writes:

@David. I see the 2 situations (US and Cyprus potential defaults) as somewhat similar. I liked the moral argument that you made in the previous post: "Really? It's worse to default on creditors who took a risk than to forcibly take money from taxpayers who have no choice?" and I think the same argument is applicable to Cyprus bank customers as well. And yet Cyprus government chose the (morally) worse option. What's the probability in you view that the US government will choose a similar path of not (formally) defaulting?

George Selgin writes:

It's funny, David, but when I learned of the Cypriot runs I thought, not of Hoover's check tax, but of the bank holidays enacted in Michigan and elsewhere later in 1932, which caused runs elsewhere as depositors in still-operating banking systems worried that their own banks might also be closed. In fact, the ECB and IMF managed to come up with a more effective means for triggering bank runs than was ever tried even in those bad old times in the U.S.!

BigEd writes:

Very informative post.

I recently re-read Uncle Miltie's "A Monetary History of the US . . . . . " and I don't believe he mentions this. His numbers and charts of all the components of the money supply are so elaborate it is hard to fathom how he could overlook such a deflationary action by the USG.

muirgeo writes:

How does the Check tax act signed June 1932 effect currency/deposit ratios and M1 between October 1930 and March 1933?

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