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June 16,1944.

Honorable Marriner S. Eccles,
Board of Governors of the Federal Reserve System,
Yi'ashington 25, D. C.
Dear Marriner:
In accordance with what will be my regular
policy of sending you copies of any talks I
might give, I am enclosing herev/ith manuscript
of a talk on Federal taxation which I gave before
the New England Council yesterday.
TiJhile in introducing myself, I said I was
speaking as Chairman of the Research Committee
of C D and not as President of the Federal
Reserve Bank of Boston, s t i l l i t is not possible
to completely dissociate m two capacities.


An Address before t h e Hew England Council
June 1 5 , 1944

The Committee f o r Economic Development has a s a major p r o j e c t t h e
study of t a x p o l i c y for t h e p o s t - w a r p e r i o d .

The problem was a s s i g n e d by t h e

Committee t o our Research D i r e c t o r , Llr. Theodore 0 . Yntema, and h e , i n t u r n ,
engaged Dr. Harold M. Groves, P r o f e s s o r of Economics a t t h e U n i v e r s i t y of
Tiisconsin, t o head t h e s t u d y , w i t h o t h e r t a x e x p e r t s as c o n s u l t a n t s .

The r e -

s u l t s of t h i s r e s e a r c h havo j u s t beon p u b l i s h e d by t h e McGraw-Hill Company i n
a book by Dr. Grovos e n t i t l e d " P r o d u c t i o n , J o b s , and Taxes."

This study i s t h e

foundation of t h e Committee's forthcoming p o l i c y s t a t e m e n t on t h e same s u b j e c t .
While t h e p o l i c y s t a t e m e n t of t h e C o m i t t e o i s based on t h e work of
the research specialists, who tako full responsibility for thoir work, tho
policy statement is the solo responsibility of the business group forming tho

During the long period of discussions between tho economists and

the business group, most of the differences of opinion have been ironed out,
and the final differences will bo coraparativcly unimportant.
Since tho policy statomont is not yet in i t s final form, What I am
saying about i t hero is preliminary and unofficial, but will not, I a sure,
depart very much from the completed statement.

A dangerous dilemma faces the post-war world as a result of tho enormous taxes w shall have to pay.
employment and production?

H w can wo pay theso taxes without choking

H w can wo pay them without destroying tho taxable

income by which alone they can be paid?
The increase in the national debt resulting from tho cost of recovery
measures during tho depression, and the much larger added burden of interest on

tho war debt, will require such heavy outlay that w aro faced with peacetime
federal oxpendituros of unprecedented sizo.

To t h i s vdll bo added the incroased

cost of maintaining an enlarged navy and standing army, and increased benefits
for veterans.


of this adds up to around $20 billion in taxes, including

social security—three times tho amount required before the war and six times
tho amount required in the-twenties.
The government vdll need to raise twice as much as total corporate
profits in a good year*

There is danger that i t s mistakes will more or loss

automatically be big ones.

In fact, unless wo dan doviso a tax system which

permits high production and employment, wo cannot raise the required taxes-thero vdll not be income enough to tax.
Throughout tho history of this country, the increase in job opportunities and tho improvement in tho scale of living has obviously como from the expansion of old businossos and tho establishment and growth of now ones.

Few who

have not studiod the matter or have, not experienced the effects of existing tax


policies realize the ho?«.vy repressive hand that our present taxation has laid
on this normal method of expanding the income of tho wage earner and tho markets
of agriculture*
Business growth is financed in three ways.

First, by the investment of

venture capital in a new, untried but hopeful undertakingj second, by subsequent
growth of tho successful undertaking, financed by plowing back earnings; and
third, by floating new security issues on thu market.
As to new vonturos, our personal taxes are such that, in combination
with our corporate taxes, th.oy direct the funds of tho larger income groups away
from rick-taking, expansive business undertakings into tho gilt-edgod securities


of established companies or, more unfortunately s t i l l , into tax-exempt securities,
Until recontly, the second means of financing, by plowing i t s earnings
back into tho expansion of i t s operations, was tho normal moans of growth of a

well-managed businoss enterprise.

Instead of paying the major part of thoso

earnings back to stockholders, a good share of them was invested In new equipment,
larger supplios of raw materials, and wagos for more men. And, of course, the new
equipmont and the added raw materials, in turn, meant more wages for more men among
the producers of these commodities.
Under our present tax laws and, to a lessor extent, those in the immodiatoly precoding years, so largo a share of the earnings of a growing company wont
into excess profits taxes that little or none was available for expansion, and
increase of employment was thus heavily ponalizcd.
This repression of expansion applied particularly to the small or
middle-sized company which, under existing S.E.C. Regulations, had no effective
access to the third means of raising funds, by new stock issues, even though the
opportunities for profit might bo obviously good. A security issue of $500,000 is
too small for tho complicated and expensive procedure now required.

The big, es-

tablished company, on tho other hand, has free access to the security market and
can expand, by this third mothod.
and the

Our prosont tax laws restrain the now, the small,

growing organizations, and tend to loave expansion as a porquisite of the

largo, established ones.
Another unfortunate tendency, in companies of all

sizes, has boon in

the direction of financing by debt as against equity; or, in simpler languago, by
borrowing on bonds instead of by the sale of stock.
debt is not taxable as coming out of profit.
coming out of profit.

Interest on bonds or other

Dividends on stock are taxable as

There is, therefore, a tendency toward a typo of corporate

financing which puts hoavy fixed charges on the business, whether timos are good
or bad, whether operations are at a profit or at a loss.

This unfortunate ten-

dency tends toward bankruptcy in depressions and contributes to tho instability
of our economy.

Of course, the extremes of the s i t u a t i o n s described above are made i n evitable by the height of war t a x e s .

But only a small p a r t of the damage i s

inevitable in properly devised peace-time taxes, and i t i s the purpose of our
study to find ways in which we can avoid serious mistakes in going from war to
post-war taxes.
In view of the conditions described above, we make the following recommendations for changes in corporato taxes.


Repeal the excoss p r o f i t s tax.
"While clearly j u s t i f i e d as a war measure, we arc convinced t h a t the rotcntion

of t h i s t a x aftor tho war, evon a t reduced r a t e s , would havo disastrous

effects on national production and employment.

Tho present oxcoss p r o f i t s tax i s

a coiling tax on gross p r o f i t , since v i r t u a l l y a l l p r o f i t s above tho 1939 levels
for most concerns arc appropriated by the government.

What strong incentive i s

thero to do business beyond the 1939 lovolT — Vp( ou
In addition to boing exceedingly repressive for businoss entorprisc as a
whole, we havo soon how i t

places growing cempanios with small c a p i t a l basos and

unsatisfactory past earnings a t a sorious disadvantage compared with old established
businesses which have either a s a t i s f a c t o r y rocord or a largo c a p i t a l baso.


such, i t i s c l e a r l y in opposition to the objective of promoting a dynamic and
expanding economy, with i t s increased markets and employment.
Reduce corporate income taxoi to a level equal to tho
post-war normal withholding tax rate for individual
Tho wage earner, as well as the stockholder, has a definite stake in
those two proposals.

By leaving corporate p r o f i t s l i g h t l y taxed, thoro is not only

an opportunity for more dividends and easy expansion, when expansion i s indicated;
t h a t expansion offers more and b e t t e r job opportunitios.

The tax r e l i e f also w i l l

permit lower prices for the things tho wage oarner buys.

Indood, the case has been

strongly arguod

that corporato taxos arc not paid by tho corporation, but aro

reflected in prices paid by tho customers.

W boliovo this statement to bo too

strong, and arc particularly concerned with tho effect of those taxos on tho expansion of employment.

Yet thorc remains, without question, an opportunity for

favorable uffecta on prices.
Reduce double taxation by frocing from corporate taxation
those profits paid out in dividends, or by leaving the
stookholdor free of the normal tax on dividends on "which
the normal tax has boon paid by tho corporation.
With tho corporato tax and the normal

tax on personal incomes equalized,

this proposal is intendod to avoid tho inequitable and repressive system of double
taxation of dividends which we now have.

Noither of the solutions abovo is per-

From the standpoint of simplicity, we prefer the payment of the normal tax

by the corporation on i t s entire earnings, and tho remission to the stockholder of
the normal tax on the dividends received.
Business income should be allowed to carry forward losses
to apply againirt"subsoquont oaraings for a period of six
years. As a temporary moasuro, w also recQinnond th"at
the existing privilogcTTf applying post-wo.r losses against
current excess p r o f i t s b c o x t e n do d to cover a period of
three years after tho war.

^ •

The theory of taxing income sololy on an annual basis of accrual has
placed a substantial premium on regularity of income.

By failing to make allow-

ance for business incomes which by thoir vory naturo fluctuate from substantial
losses in one year to substantial gains in another, i t has resulted in a heavier
tax burden ovor a five or ten year period for such irrogular inccmos than for
incomes which arc stable.

Frequently this situation causes the payment of taxes

out of capital rather than out of actual net income.

There is nothing sacred

about an annual tax basis to justify such inequality.

Moreover, this method

of taxation creates a particular hardship for new small enterprises ifhich, in
gonoral, tond to have considerably greater irregularity of income than those of
largp, well established businesses.

The importance of this fact has boon recognized in current federal taxation which permits the carrying forward of one year's losses to be applied against
the income of the second. Wo believe that considerations of equity and the objoctivo of stimulating venture

capital require a substantial broadening of this

In addition to the proposal that the privilege of carrying forward
losses bo extended for a period of six years, we also recommend that the existing
carry-back provisions of the excess profits tax bo broadened from two years to
cover a period of throe years after the war.

Since the existing privilege is

incorporated in the excess profits tax law, special action will be necessary, if
this tax is repealed after the end of the war.

Since a significant part of re-

convorsion costs end of losses during the transition period will be a direct
effect of the war, we believe such action is desirable to make more equitable the
ovorall burden of wartime taxation on corporations.
The heavy burden of taxation on business expansion which is inherent in
our tax system is mitigated by tho various suggestions just made, but the conditions are still far Ices favorable to an expanding economy than they wore a
generation ago. V r therefore recommend that
Tho present differential taxation of capital gains of
100 per cent subject to tax, on securities hold for
six months and 25 per cent subject "to tax, on those


hold for a longer "period, should be retained^
There has been much theoretical discussion as to whether or not capital
gains are income in the sonso that makes them logically subject to an income tax.
There is the precedent that in England capital gains are not taxed unless it appears
that they are depended upon for income. Without subscribing to tho theoretical
objections to tho capital gains tax, and without depending on tho British precedent,
wo urge rotantion of tho above policy as tho bost point in a modern tax structure
at which to maintain a measure of the old conditions under which risk-taking and •
vonturo capital received the reward necessary to bring them into action.

-7It is true that the very simple form of the proposal will not distinguish
completely between market operations as a source of income and the investment of
money in productive enterprise.

It is true also that it makes no distinction be-

tween the securities of established enterprise and new securities issued for the
establishment of new enterprise or for the expansion of older ones. An endeavor
to draw these distinctions would lead to complications which would not be worth
their cost.

The thing to be desired is to get the liquid wealth of the nation

attracted to the expansion of American production and employment.

This is a

strategic point at which to remove the barriers to the desired result.
After the close of the war, all federal excise taxes
should be repealed, with the exception of those on
tobacco and liquor.
We are opposed in principle to all general sales taxes in the federal
tax structure.

Their impact is particularly severe on low income recipients, and

hence, they have an immediate depressing effect on demand for consumption goods,
whatever stimulation might arise from later expenditures of this tax money by the
Government. They are the source of much annoyance, and are usually costly to administer.
The same general arguments apply against most excise taxes levied on
particular commodities or groups of commodities.

Such taxes are not objection-

able as wartime measures, but are definitely undesirable in times of peace.
We propose, however, that excise taxes be retained on tobacco and liquor.
These taxes are collected at the source and are cheap and easy to administer.
arc not taxes on necessities and, therefore, can be avoided.


They are productive

of an important amount of revenue with highly stable characteristics. I e
believe it desirable to retain such an element in our tax structure in order to
avoid placing too great a reliance on the income tax.
The repeal of other existing excise taxes u8 suggested above will provide
substantial relief after the war for the lower income groups.

simplify the federal tax structure.

In addition, it

-aCongress should pass at once a resolution declaring that
all future issues by state and local governments will be
fully taxable. If a Constitutional amendment should prove
necessary, appropriate steps should be taken.
For many years we have been erecting a federal tax structure which, step
by step, has tended to discourage the assumption of risks by enterprisers, and to
promote a static capitalism.

The refuge from high surtax rates afforded by tax-

exempt securities may well be called the crowning arch of this structure. TThen, as
at present, an individual in the top surtax bracket is forced to obtain a return of
twenty per cent on an equity holding to give him a yield after taxes ecual to that
on a two per-cent tax-exempt bond, the effect on incentives is obvious.
The federal government has finally recognized this anomaly by making all
of its current security issues fully taxable.

The important remaining loophole

still to be closed is that afforded by the exemption from income taxation of securities issued by state and local government agencies. Action should be taken
at once in this connection, and without waiting for the end of the war.
We are not willing to recommend the removal of the tax-exempt privilege
from outstanding securities. Such a step would be inequitable unless compensation
were paid to the holders of existing securities. This would be costly to the
federal government and difficult to administer. Moreover, we do not believe such
drastic action is essential to incentive encouragement.
The present seems a very appropriate time for the action proposed.
Outstanding debts of state and local governments have been substantially reduced
since Pearl Harbor and are likely to undergo further reductions while the war
lasts. After the war, however, public construction needs are almost certain to
cause a considerable expansion of those debts. Furthermore, current low interest
rates provide an excellent opportunity for refunding short-term issues on a
taxable basis.

-9The net effect, in our opinion, would be that the volume of tax-exempt
securities within five years after the war would be small in relation to total
outstanding public debts. Their influence on incentives, therefore, would be relatively unimportant.
As already indicated, the post-war budget, even without provisior for
debt retirement, will run somewhere around $20 billion.

This.will be true whether

we have a Democratic or a Republican administration, and even in the case that the
nation's finances are in the hands of highly conservative legislators and administrators, of whatever party.

The problem of raising money for this unavoidable

budget is going to be painful.
Because it is most favorable to the expansion of profitable, productive
employment, we are proposing to place the principal burden for raising the postwar budget on the personal tax structure of the income tax.


This is logical as

well as desirable, since all taxes are ultimately taxes on persons, whether levied

on corporations, sales, imports, or what not. Putting the burden on personal
taxation is, therefore, realistic, as well as being socially favorable.
The postwar budget cannot be balanced with this main dependence on the
personal income tax unless there are a very great number indeed of highly paid

wage earners to pay their share.

This is a fiscal necessity, as well as a social

The following policies are bused on the above general conclusions:

Present personal exemptions should be raised by repeal
of the Victory tax, but with income tax exemptions
maintained at approximately the present levels. The
present combined withholding tax of 22 per cent should
be replaced with a single normal tax at a moderately
lower rate. Tha level should be raised at which surtaxes begin to apply.

-10As set forth previously, the new normal rate should fix the level
for the corporate income tax. Although it is not now possible to predict exactly
what the postwar normal rate should be, it is clear that it will have to be much
higher than the prewar normal rate, but probably can be somewhat lower than the
present combined rate of 22 per cent. A level of personal exemptions close to
those now applicable for income taxes, other than the Victory tax, will also be
In this connection, it is important to observe that individuals with
incomes of less than $5,000 received in the aggregate $116.7 billions in 1943, or
about 82 per cent of total personal incomes of |142 billions. On the other hand,
total incomes of those who received $5,000 or more amounted to only $25.3 billions.
Although the pattern of income distribution will change in some respects after
the war, no really great changes appear to be in prospect.

Consequently, a

substantial tax contribution will continue to be required from income groups
receiving less than $5,000 a year, if postwar revenue requirements are to be met.
Nevertheless, an adequate withholding rate combined with current personal exemptions, should permit a lifting of the level at which surtaxes begin to
apply. At present, a family of five is exempt from income taxes (except for the
Victory tux) on income up to £>2,25O. Thus, if surtaxes started at a moderately
higher level, the net effect would be that income taxes for the great majority
of all individuu.1 taxpayers would be covered by the normal withholding tax.
Some form of income averaging for tax purposes should be available to
individuals as well as to corporations.
We therefore recomiaand that individuals be granted the
right to obtain tax rebates at the end of every fiveyear period by the use of some averaging device.
We believe that tax relief should be provided for those with widely
fluctuating incomes. Such individuals are frequently required to pay much higher
taxes over a period of years than those- with equivalent stable incomes.

-11One possible method to accomplish this would be to provide for refunds
to individuals to the extent that taxes actually paid during a five-year period
exceeded some given percentage (perhaps 110 per cent) of what such taxes would
have been if the aggregate income had been spread equally throughout the period.
The object of using a figure such as 110 per cent would be to limit refunds to
•those who had been seriously affected by income fluctuations.
Pending a comprehensive study of the problem of business fluctuations,
we are unable at this time to suggest means by which they may be kept under close

Indeed, it is not yet clear to what extent they can be kept under con-

It is clear at this stage, however, that we have certain tools of control

which we must learn to use.

If these tools are misunderstood and misused, or

even if they ore neglected, they may easily become active factors in generating
booms and depressions.
One of these tools, and an essential one — though by no means the only
one —

is the tax system adopted.
A specific tool of control is provided by the volume of money taken out

of the economy for the payment of taxes, particularly if applied to the retirement
of bonds held in the banks.

If this volume is heavy during an inflationary period,

it tends to restrain inflation and thus acts favorably.

If it is heavy during a

deflationary period, it tends still further to deepen' the depths of deflation.
If, therefore, a tax system were designed solely from the standpoint of controlling
the business cycle, it would doubtless provide for variations in rate which would
apply drastically high taxes as inflation appeared, and decrease taxation during
the deflationary period.

This latter v/ould not merely decrease the liquidation,

but would, as well, allow larger margins for spending and'business revival, both
on the part of individuals and businesses.

The difficulty with using the tax system positively as a means of controlling the business cycle is most obvious at the time when it most needs to be
applied: namely, when an inflationary curb is needed.

In the first place, the

increased taxation must be applied more quickly than is possible by legislative
enactment; and in the second placej if it is left by law to administrative discretion, the extreme unpopularity of the required moves would make the process
politically unfeasible.
We are, therefore, making the following recommendation in advance of a
thorough study of the other tools of control, and with the knowledge that the results of that study may lead to putting more dependence on variable taxation. In
such case, we may have to accept the variable rate (or, alternatively, the variable base) in spite of the great difficulties in administration.
Wo propose that the federal tax system be revised
to provide a balanced budget at an average high
level of employment and national production.
The level at which the budget should be balanced will require careful

It must be neither too high nor too low.

If the point of budget balance

is set too low, taxation will tend to have a repressive effect before our desired
level of production and employment is reached.

If it is set too high, the budget

will not be balanced over the business cycle, and we trill have a continuously
increasing debt. We desire neither the ono condition nor the othor, but an intermediate position which will maintain us at the required high levels, on a selfliquidating basis, rather than on the basis of indefinite and cumulative deficit
At this point we run head-on into our dilemma.

If tho kinds «nd rates

of taxes are to be low enough to oncourago business expansion and employment, they
can only balance the budget if the national income is high.

From tho best figures

as to postwar budget, tax rates and tax returns, applied to the tax program we have

been describing, it would seem the only safe rate of net national income we can
plan for in the postwar world will be around $140 billion*

Several independent

calculations which have been made indicate that at the 1943 price level, this
income will be achieved with 55 million peoplo gainfully employed at 40 hours a

Above and below this level we may expect our economy to alternate but with-

out destructively serious fluctuations.
We recommend to Congress and the Treasury the
establishment of a stable income tax structure^
within which rates may bo adjusted without re^~"
quiring radical new legislation*
It is recognized that one Congress cannot bind another*

If, however, a

tax law is drawn up, having a coordinated structure directed toward high employment and production in addition to a raising of the required revenue; and if,
furthermore, such a tax structure is comparatively simple and equitable, there will
be less temptation for successive Congresses to change the structure itself*
Tax legislation has become a serious burden on Congress and its committees*

Anything which lightens that burden should be appreciated by successive


As suggested, we do urge that rates bo stabilized eventually, so that

this element of the conditions affecting business and employment will become
established, so that in turn business confidence can support business enterprise*
Business confidence needs to be defined*

It is often considered to bo

a psychological factor affecting businessmen and keeping them vibrating between
jubilant optimism and blank despair. This is a better definition of the psychology of speculation in securities and commodities than it is of productive business*
Business confidence, in the lattor field, can be simply defined as a reasonable
hope of profit*

As such, business confidence is absolutely essential to the ex-

pansion of productive employment, and the various proposals of this document are
directed to that end*

This group of tax proposals is not complete. Other items will
require attention to make a well-rounded federal tax policy.

But those are the

most important proposals so far as concerns business confidence and expansion
and a high level of productive employment.

Let us revert once more and finally to the difficulties of the
balanced budget in the postwar world.

It is confidently believed that the pro-

posals made will balance the budgot, and it is also confidently believed that
they will permit business enterprise and high employment. Permit is the word to

they will not guarantee those blessings.
At the outset of this talk the dilemma was stated: that unless wo set

our mark high in employment and production, we would have to have a tax system
which would prevent us from reaching high employment and production on a balanced

The solution of the dilemma lies in attaining and maintaining that high

level of national income of around $140 billion. Those tax proposals pernit
reaching this goal, but the actual attainment will have to be made by the
individually vase activity and enterprise of the whole mass of American businessmen, employees and farmers. The postwar world can be a success only as it is
supported by the cooperation of all of us.

Ralph E. Flanders
30 Pearl Street
Boston, Massachusetts