Some of the prominent economists of the day suggested that the war should be paid for entirely through such taxes, but McAdoo disagreed on grounds that the eventual cost of war was unknown at the outset. If the tax generated less money than was required, rates would have to be raised again and perhaps repeatedly. Furthermore, changing tax schedules always requires a controversial, complex, and drawn-out political debate. Indeed, as the estimated cost of the war effort escalated, McAdoo came to the conclusion that, despite the high rates, tax revenues would not cover anything like one-half the cost. Given the commitment to the progressive structure of rates, taxation had reached its acceptable limit. The revised goal was one-third from taxes and two-thirds from borrowing.
Financing a war by borrowing need not be inflationary if the public diverts income away from consumption to purchase bonds. Higher saving web sites as a share of income would necessarily mean lower consumption. A high rate of return on the war bonds would be unlikely to work. High rates might tempt some to take momentary advantage and save more. But there is also an opposite effect. With high interest rates, a household’s wealth would accumulate more rapidly. With that mechanism working on behalf of the saver, less saving from current income would be required to ultimately reach a target level of wealth. The two opposite tendencies would tend to cancel each other. Another problem with offering a high interest rate on the war bonds is that it might divert funding away from investments in physical capital when the war effort warranted an increase in productive capacity.
Indeed, during the bond campaigns, purchasers were given buttons to wear and window stickers to display, thus advertising their patriotism
It is unclear if McAdoo understood that offering high rates of interest would not work. In any case, he was opposed to high rates because that would be a sign of weakness and would reward the rich – the very group the income tax was designed to target. He chose to keep the interest rates competitive with the current return on comparable assets. To many observers, a massive bond sale on these terms seemed to be an imprudent gamble. The worry expressed by bankers and bond dealers at the time was unanimous: the bonds might not sell without the promise of an extra-attractive return. Moreover, the critics pointed out, only a few Americans had any direct knowledge about bonds, and fewer still actually owned any.
Such a change in saving behavior, however, would be difficult to engineer and far from certain
It had three elements. First, the public would be educated about bonds, the causes and objectives of the war, and the financial power of the country. McAdoo chose to call the securities “Liberty Bonds” as part of this educational effort. Second, the government would appeal to patriotism and ask everyone – from schoolchildren to millionaires — to do their part by reducing consumption and purchasing bonds. Third, the entire effort would rely upon volunteer labor, thereby avoiding the money market, brokerage commissions, or a paid sales force. The Federal Reserve Banks would coordinate and manage sales, while the bonds could be purchased at any bank that was a member of the Federal Reserve System.
To the war planners, the appeal of borrowing funds from the public was that it would be good for morale. Individuals could demonstrate their support for the war by purchasing bonds. If bond sales were strong, if the offering was oversubscribed, that would demonstrate American resolve.