Research Notes & Special Studies by the Historian's Office
Research Note #17:
The Townsend Plan's Pension Scheme
This Research Note discusses in some detail the economic problems with the very popular Old-Age Revolving Pension Plan (aka the Townsend Plan) of the 1930s. Although virtually every establishment economist and political scientist of the era viewed the Townsend Plan as a "crackpot scheme," millions of supporters of the Plan thought it made perfect sense. This Research Note looks at the details of the Plan and tries to explain in an accessible way what the Plan promised and why some of its claims may have been unsound.
THE TOWNSEND PLAN
There were many non-standard economic theories and schemes abroad in the land during the Great Depression. Many of these schemes involved old-age pensions, since this was a area of acute need and a population for which there was a good deal of sympathy. By far the most influential of these alternative pension schemes was the Old Age Revolving Pension Plan, or Townsend Plan, for short.
The basic idea of the Townsend Plan was that the government would provide a pension of $200 per month to every citizen age 60 and older. The pensions would be funded by a 2% national sales tax (more precisely, a "transactions tax"). The Plan provided that a 2% tax would be levied "on the gross value of each business, commercial, and/or financial transaction," to be paid by the seller.
There were three eligibility requirements to received benefits under the Plan:
- the person had to be retired;
- "their past life is free from habitual criminality;"
- the money had to be spent within the U.S. by the pensioner within 30 days of receipt.
Thus, there were no contributions required from the beneficiaries. One did not have to work and pay taxes for a number of years to built up credit under the Plan. In fact, a person who never worked a day in their life would be entitled to a full "retirement" pension under the Townsend Plan. There was no means-test--millionaires and paupers all collected benefits. And the payment was a "flat payment," i.e., everybody got the same amount, regardless of any current or past taxes they may have paid. The final two features were that the person had to be completely retired to collect benefits--there was an absolute "retirement test." And the beneficiary had to spent the entire pension payment each month as it was received--it would be illegal to save even a penny from the benefit. (This last feature was an essential key to the Plan--as we will see.)
The Townsend Plan proved enormously popular. Within two years of the publication of the Plan as a Letter to the Editor in a Long Beach, California newspaper, there were over 7,000 "Townsend Clubs" with over 2.2 million members actively working to make the Townsend Plan the nation's old-age pension system. At one point in 1936 Townsend was able to deliver petitions to Congress containing 10 million signatures in support of the Townsend Plan. Public opinion surveys in 1935 found that 56% of Americans favored adoption of the Townsend Plan.
The Townsend Plan, despite it popularity, had three fundamental flaws that made it an unworkable idea.
THE PROBLEMS WITH THE TOWNSEND PLAN
1. Tax Rate- According to the Townsend Plan, a 2% "transactions tax" would be sufficient to fund the pension scheme. This surprisingly low tax rate was one of the main appeals of the Plan, since it appeared to offer very generous benefits for a very low cost.
The transaction tax would work much like the Value Added Tax (VAT) used today in European countries. At every economic transaction, with some exceptions, a 2% tax on the value of the transaction would be imposed. The reason for this was that the basic idea behind the plan was the supposed stimulative effect on the economy from the spending produced by the requirement that the full amount of the pension must be spent in the month received. From this spending, the Plan assumed, a great deal of new economic activity would be produced, and with each economic transaction a small tax could be levied, and because there would be so many new transactions, the tax could be small and yet generate a large amount of revenue. This was all dependent on Townsend's understanding of the economics of the circulation of money (see the discussion of point 3 below).
The Plan called for a monthly pension of $200 per month to be paid to every American age 60 or older. In 1935 there were approximately 12 million Americans age 60 or older. Virtually all of them would be eligible for the Plan under its very liberal eligibility requirements. Thus, the Plan implicitly promised to raise $2.4 billion in revenue each month from this 2% tax (which would total almost $29 billion annually). To put this in some perspective, the total income of all of the people of the United States in 1933 was only $46 billion. A Plan that would pay $29 billion of that amount to the 9% of the population that was over 60, would thus shift about two-thirds the wealth in the economy from workers to retirees.
| By way of comparison, the Social Security Act as passed in 1935 promised benefits ranging from $10 to $85 per month. To support this level of benefits, required a tax rate of 2% (half paid by the worker and half by the employer) on the first $3,000 of wage income. |
So, the Townsend Plan would require the raising of about $29 billion per year in new taxes. This would be an amount of new taxes that would be more than double the total combined tax revenue of all federal, state and local taxes then being collected! On its face, it seems impossible to generate this much revenue from a 2% tax. Not to mention the political problem of doubling all existing taxes and adding this new tax burden to existing taxes. And of course, this tax burden would grow year to year as the percentage of the population age 60 and older grew, as it was projected to do. So it would start at double the existing taxes and go up from there.
So if we look at the amount of revenue the Townsend Plan would require, it seems implausible to believe that a 2% transactions tax would be sufficient to generate that much revenue. How much revenue, then, was it likely to generate?
It is difficult to calculate the revenue from Townsend's scheme since it involved a transactions tax rather than a straight tax on incomes--and the number of transactions depends both on how many such transactions there are in the economy and on how much the Plan actually stimulates new economic activity (see point 3 below). It was unclear what the real volume of "transactions" subject to the tax would be. The Townsend Plan asserted there was $1,200 billion in annual transactions, but no independent economists could validate this figure, and Townsend himself would repudiate it in a most embarrassing way.
The most revealing moment came on this question when the Congress held hearings on a bill (H.R.3077) to adopt the Townsend Plan. This was in the context of the House hearings on the Administration's Social Security bill. Pressure from the Townsend Plan's many supporters forced the Ways & Means Committee to take testimony on H.R. 3077 in the middle of its hearings on Social Security. At the hearings, Townsend was grilled relentlessly over the revenue assumptions in the Plan. Plan sponsors eventually admitted they had no real idea what the value of transactions were in the economy and that the $1,200 billion figure was made-up. After two days of very embarrassing proceedings, Townsend left with support for his Plan eroding rapidly. He subsequently requested that the Committee reopen it proceedings so he could present a new witness, an economist who could address all the Committee's concerns. At the reopened hearing Dr. Robert R. Doane appeared with Townsend and, to Townsend's disappointment, he told the Committee that a 2% transactions tax could, at its theoretical maximum with no transactions excluded, yield at most between $4 and $9.6 billion annually. This was only about a third (at the top-end) of what Townsend needed. So the real tax rate would have to be somewhere between 6% and 14% in order to pay pensions of $200 per month to everyone over age 60--under the figures of the Townsend Plan's own expert witness. Tax rates of this magnitude did not make the Plan seem like such a bargain after all. [1]
2. Pension Economics - One
of the most breath-taking aspects of the Townsend Plan, and the
heart of its appeal to senior citizens, was the extraordinary
level of benefits it promised. The Townsend Plan promised a retirement
pension of $200 a month to every American age 60 or older. Why
this is so stunning is that the average monthly wage in 1935 was
only about $100 a month. So Townsend was promising retirees a
pension that was twice what workers were earning who were still
at work. It may well have been the most generous retirement pension
promise of all time.
| The Social Security program has traditionally been able to support a replacement rate of about 40% for an average worker. This means that, for an average worker, Social Security pays a benefit that is about 40% of the wage they were making while working. This is a more realistic level for a viable pension. The idea that a retirement pension could be 200% of a worker's pre-retirement income, is very unrealistic. |
3. Macroeconomic Theory - Dr. Townsend was not an economist. He had a kind of home-spun theory of economics, to be sure. But we can easily see that Townsend had one very large unstated economic assumption underlying his Plan, an assumption that was almost certainly not true.
The essence of the Townsend Plan was that by requiring the retirees to spend their entire pension each month the Plan would force a dramatic increase in spending, which would so stimulate the economy that the Depression would lift and the Plan itself would in some sense be "free" since the increased level of economic activity would mean that everybody would have more money under the Plan than they had before the Plan took effect--despite having to pay a new tax.
Townsend's idea took off from a well-known principle in economics--the "multiplier effect" of money. It is a truism in economics that when John Q. Public spends, say $200 to buy a new gizmo, the amount of economic impact this produces is not just $200. The seller of the gizmo will in turn take this $200 and use it to buy groceries, or other gizmos, and this will further stimulate economic activity. So an expenditure of $200 has more than $200 worth of impact on the economy. This much is standard economics. Economists are not in agreement on how large this multiplier effect is, or precisely how to measure it, but its existence is well-known.
So the key dynamic of Townsend's Plan was to rely on this multiplier effect to produce a large increase in economic activity. This is the "revolving" part in the Plan's official name, "The Old-Age Revolving Pension Plan." The idea then was that the forced spending under the Plan would trigger the multipiler effect, increasing economic activity, and at every economic transaction, a 2% tax would be levied. In this fashion, Townsend believed, the necessary funds could be raised to pay for the Plan's benefits, and everybody would be richer than before the Plan took effect.
There were probably lots of detailed problems in Townsend's notions of how the economy works--including the question of whether the multipiler effect is large enough to produce the kind of revenues Townsend's Plan required. But it is is easy to see a very large problem that does not depend on the details of how to calculate the multiplier effect. There was an assumption implicit in Townsend's vision--an assumption that was almost certainly false.
In order for this dynamic to work, Townsend had to assume that the money being spent by the Plan's retirees was not already being spent in the economy. In other words, merely shifting $200 in spending from a worker to a retiree would have precisely zero effect on economic activity. It would only have an effect if the worker was not himself/herself spending that money in their own current consumption. In order for Townsend's Plan to really stimulate the economy in the way he imagined, he had to assume that all the spending produced by the Plan would be new spending. In macroeconomic terms, he had to assume that the money taken in by the tax would come from savings, rather than from someone else's current consumption. And it would have to be non-productive savings--not money saved in a bank, for example, which might be lent-out for new investment. So, if Jill J. Worker saves $200 every month by sticking it under her mattress, then taking this $200 from Jill and giving it to Robert R. Retiree, and requiring Robert to spend it, would indeed stimulate the economy through new spending. But if Jill is already spending her $200 every month on clothes and food and her own gizmos, then merely taking money from Jill and giving it to Robert would have no effect whatever on the overall level of economic activity. So Townsend had to assume, in effect, that there was $2.4 billion a month being shoved under mattresses all over the country. Of course, this was not the case. Most people during the Depression were spending whatever money they could get their hands on just to try and maintain some semblance of their pre-Depression standard of living. [2]
Not only that, but since the Townsend Plan's tax was a tax on transactions and not on assets, it only applied to money already in circulation in the economy. So it could not reach any of that money hidden under the nation's mattresses which it had to reach in order for the Plan to work. Townsend was dimly aware of this problem and so he proposed that the start-up payments under the Plan would be out of a federal subsidy for the first month of the Plan's operation. Townsend was banking on the idea of having the federal government pay the first month's payment of $2.4 billion out of existing tax revenue and expecting this to "prime the pump" thereby stimulating the mattress-savers to retrieve their stashes and toss them into circulation. After that, he assured everyone, the Plan would become self-supporting.
Again, the point is that a Townsend scheme could only work to the extent that there was a large volume of money not currently in circulation, and that this money could be disgorged by the sudden provision of a a retirement pension to 12 million retirees. If these two assumptions were not true, then Townsend's Plan could not work.
CONCLUSION
Despite it dubious chances of success, the Townsend Plan was without question the single most-popular scheme for old-age pensions in America during the 1930s. Literally millions of senior citizens fervently believed the Townsend Plan was their economic salvation. There is even some evidence that President Roosevelt introduced his Social Security proposals when he did in order to stave off pressure from the Townsend Plan and related alternative pension schemes. FDR's Secretary of Labor quotes the President as saying: "The Congress can't stand the pressure of the Townsend Plan unless we are studying social security, a solid plan which will give some assurance to old people of systematic assistance upon retirement." [3]
The fact that a scheme with such unlikely prospects could be so influential in the making of public policy, suggests the depth of the unmet social need that the Social Security Act of 1935 was attempting to address. And it was only with the passage of the Social Security Act that schemes like those of the good Dr. Francis E. Townsend would finally pass into history.
FOOTNOTES:
[1] The most thorough study of the Townsend Plan can be found in, "The Townsend Movement: A Political Study," by Abraham Holtzman; Bookman Associates. 1963.
The full text of the House hearings on the Townsend Plan are available as part the Legislative History section of this web site.
[2] There was a wide-spread and accepted view of the economy during the Depression which held that the problem in the economy was a depressed level of aggregate demand. This was probably correct, as far as it goes. But the low level of aggregate demand was not due to people saving too much money from current incomes. It was rather that current incomes, in the aggregate, were too low and hence there was too little money in the economy. Whatever the proper economic cure for this condition might be, it should be obvious that merely moving current incomes from one cohort in the economy to another would not have any effect on current incomes or aggregate demand. Again, it would only have an effect if one assumes that most all of that income is not being currently consumed.
[3] Quoted in "The Roosevelt I Knew," by Frances Perkins. Harper & Row, 1964 edition, pg. 294.
Larry DeWitt
SSA Historian's Office
December 2001