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Form F. R. 131 BOARD OF GOVERNORS or T H E FEDERAL RESERVE O f f i c e C o r r e s p o n d e n c e TO Chairman Eccles Vram Martin Krost finhjert; SYSTEM Date September 21+, 19ig TVia Tte-remne Act of 1Q);! The Revenue Act of 19Ul i s described in the attached memorandum. The act as signed by the President d i f f e r s in the following major respects from the b i l l passed by the House® 1. Personal exemptions under the individual income tax are reduced from #2,000 to #1,500 f o r married persons and from $800 to $750 for single persons. Under the lowered exemptions, from 20 to 25 per cent of a l l income-recipients, -who receive about half of the national income, -will pay Federal income taxes. 2* The 10 per cent defense taxes are integrated with the permanent schedules of individual income, corporation, estate and g i f t , and excise taxes. A simplified individual income tax return i s provided for the optional use of taxpayers with gross income of $3#000 or less. 1+. The rates of corporation surtax are increased from 6 per cent on the f i r s t $25,000 and 7 per cent on the excess, as provided i n the House b i l l , to 7 ami 8 per cent, respectively. 5» The act as passed eliminates 10 per cent special excess p r o f i t s tax imposed by the House b i l l on the difference between average base period earnings and the invested capital credit f o r corporations using the invested capital option. 6. The Senate eliminated the taxes on soft drinks, outdoor advertising, and radio broadcasting, and added a tax on l i g h t bulbs. Of about a b i l l i o n dollars i n additional revenue from excise taxes, the bulk comes from whiskey, automobiles and accessories, amusements, a use tax on automobiles, and a new tax on local telephone b i l l s . 7« The act sets up a committee to investigate the reduction of non-essential Federal expenditures, consisting of three members of the House, three members of the Senate, the Secretary of the Treasury, and the Director of the Bureau of the Budget. The aggregate additional yield of the act i s estimated at about §3,600 million on a f u l l year basis at the 19ipL l e v e l of incomes. Total accruals under the Federal tax structure as modified by the new act . on a f u l l year basis w i l l be i n excess of $15 b i l l i o n . Sept©saber 2J, Igill THE BBVBBOE ACt OF 19i*l lay George Jasai The Bovonue Act o f 19^1 received the signature of the President on September 20» almost f i v e mouths a f t e r hearings on I t started before the House Vfeye and Means Consalttee* Most of t h i s period was occupied by extended public hearings ax*3 consideration of the legislation by the ?/ays end Means Committee and Senate Finance Comittee* Debate on the f l o o r of the House and Senate was b r i e f and related c h i e f l y to ooismittee proposals f o r revising the present isathod o f taxing the incoroe o f married persons* Jh0 present laothod i s l e f t unchanged by the l e g i s l a t i o n as passed, but t h i s problem receive consideration again, together with a number of technical and administrative problems* i n another b i l l upon nhieh the Ways and Means Cwaaittee *?ill begin work i n a f m weeks* I t la also ex- pected that i n the near future the Treasury and other agencies w i l l advance suggestions f o r increasing payroll taxes currently t o provide increased social insurance benefits i n the future* She estimated additional y i e l d o f tho Act* on a f u l l - y e a r basis. I s shown i n the following table* Bstlmated Inoroaad or Peoreaso Q Ovor Yield o f ^roeoxxt Lair I (Millions of dollars) ^ Ineom taxes t Corporation! Soma! tax Surtax Excess p r o f i t s tax ~h93<3 7^3*1 1,112,3 Total corporation incase taxes Individual Total imam taxes 1,302,1 2,526*7 Miscellaneous internal revenue? Capital stock tax Estate tax G i f t tax fatal Maz&facturers sad r e t a i l e r s excise teas©* J&scellaneous taxes Total exeisa and miscellaneous tos 2/ Jotal xaieoellafloouB internal revenue 22*3 ll&*6 16*0 179.9 &7»7 1 aU6#8 1,026,7 GRASD S O m 2 / Cuing t o increased estimates o f defense expenditures* the Revenue Act *&11 f a l l short o f the freasury f s original objective o f financing twothirds o f expenditures, exclusive o f expenditures under the Lease-lend Act, out o f taxation, On a f u l l year basis l e s s than 60 per cent w i l l be so financed and in the current f i s c a l year only about 50 par cent, r e f l e c t i n g the lag I n c o l l e c t i o n o f income taxes and the f a c t that increased excise i/ Treasury Xtepartaaent, Division o f Hesearch afcd Statistics* A l l estimates she* f u l l year e f f e c t s * Estimates f o r corporation and individual income taxes aire based on l e v e l s o f ineoas estimated f o r calendar year 19Ulf e l l other estimates are based on incoiae l e v e l s estimated f o r f i s c a l year 1$£*2, 2 / Excluding $1*7*5 m i l l i o n mn^recurring floor~stock taxes* taxes w i l l be in e f f e c t only f o r threo-fourths of the f i s c a l year. Addi- tional collections in f i s c a l 19^2 may yiold about 02*0 b i l l i o n , instead of the f u l l S3.6 b i l l i o n . The budgetary d e f i c i t on the basis of the latost available o f f i c i a l estimates -will thus* be reduced from $12.6 b i l l i o n to about OH b i l l i o n , about twice the d e f i c i t f o r the f i s c a l year 19l*l. Met Federal expenditures have been running since the end of Juno at a rate of about $900 million a month, as compared vdth about £300 n i l l i o n a year ago# Further expansion i s expected to occur between now and next March, vfiwn collections of income taxes on 19^1 incomes w i l l begin to be received. Betvreen l!arch and the end of the f i s c a l year, increased revenues attributable to the new act and to increased business a c t i v i t y m i l reduce net expenditures to currently prevailing l e v e l s , unless the expansion of defense expenditures exceeds present expectations. Ket Federal expenditures at their current rate, together v/ith a large volume of private capital expenditure on plant, equipment, and inventories and heavy buying of consuner durable goods, have raised ogcrogate consuiser income and expenditures to levels at vMch the cost of l i v i n g has begun to r i s e . I t seens unlikely that the supply of goods available for private purchase con continue to increase at the rate that has characterised the period since Kay, 19l;0i Under these circumstances, although prices w i l l rise less than i f taxes had not been increased, prices cannot be expected to stop rising or to rice appreciably less rapidly than in recent ^eelis, unless e f f e c t i v e l y checked by price c e i l i n g s , p r i o r i t i e s * rationing, restrictions on consumer credit, and other direct governxnental controls* Excise Taxes The act xaakes permanent the excise taxes imposed by the Revenue Act of 1952 and certain excise taxes iisposed by the Revenue Act of 19^1 i t increases the rat00 of soise existing esciso taxesj and i t irtpococ nor/ excises on a nuxaber of itens* In the writing of the excise tax sections of the act two opposing ideas \7ero at work* Ono view was that excise taxes ehould bo spread as evenly as possible over the "whole of commodities, so that no product should bo unduly handicapped i n relation t o others in competing: concussers* dollar* the The other tme that excise taxes should be restricted to these commodities usin£ resources needed f o r national defense, in order to curtail their c i v i l i a n consumption* represent a cortproirlre» The ercicee actually imposed Increased taxes ore imposed on a number of £Ocde that compete vdth the defense procran, Hie rates on autcnobilos, trucks, etc* # on radio receiving sets, refrigerators and air conditioners, t i r e s end tubes are appropriately doubled, n w excise taxes are imposed on phonograph records, rmsicol instruments, e l o e t r i c , gas and o i l appliances, photographic apparatus, e l e c t r i c siens, business and store machines, rubber products, conaiorcial washinc Bachinos, e l e c t r i c l i g h t bulbs end optical instmaents. But the rates of tax inposed — not exceeding, in general 10 per cent of the price of the a r t i c l e s appear to be inadequate to reduce consumer den&nd t o the curtailed supply that w i l l be available. Unless e f f e c t i v e l y clicked by direct controls, prices can be expected t o r i s e by considerably sore than the anount of the increased tax, and the resulting increase of p r o f i t margins w i l l increase the reluctance t o la&ke the drastic changes in the patterns of production that nust be nade i f the present schedules of defense production are t o be Bet, Horecver, no taxes, or no additional taxes, M*ere inposed on e number o f a r t i c l e s using scarce xmteri&le, f o r cxsnplo f I reams, clocks and watches, xo&tol furniture, alundnuia ware, jute products, o i l cloth, linoleum, and paints end varnishes. And a number of taxes -wore inpocod that w i l l make f o r curtailment of consumption not called for by the defense progress, such as taxes on d i s t i l l e d s p i r i t s , wines, anusomonts, telephone, telegraph, and radio coa&unicat 1 on&, sporting goods, luggage, joivelry* and the transportation of parsons * Corporation Taxes The act imposes a surtax on corporations; re vinos the excess p r o f i t s t a x j increases the rates o f capital stock tax; and integrates the 10 per oont defense tax; inpocod by the Ilovonuo l o t of l$hO into the regular rate structures* 13t0 near surtax on corporate p r o f i t s i s inposod at the rate of 6 per cent on the f i r s t 025#000 of net income and 7 i n excess of that arsount# cent on not incoiae I t d i f f e r s i n i t s e f f e c t from an equivalent increase in the noma! tax because i t applies to incorao from p a r t i a l l y tax oxenpt securities* Conoereial banks aro more seriously affected by this feature of the new tax than any other corporate group. Ho change i s made i n the general fraaev/ork of the excess p r o f i t s tax under which corporations are allowed to calculate the "normal p r o f i t s " credit from which excess p r o f i t s arc noacured m t h reference either t o base period earnings or t o invested capital. During the fomulation of the act, the Administration objected to the unrestricted use of base period earninge as a taeasuro of noraal p r o f i t s on the ground that I t exempts corporations who have earned excessive p r o f i t s in tho past fron excess p r o f i t s tax on 95 por cent of an equivalent cnount of currorrfc p r o f i t s . The rates of exccsc p r o f i t s tax arc increased by 10 porcontnce points in each brackot as ohovra in the following table* Kates (per cent) TOT isajr /.mount of Excess P r o f i t s First £20,000 Kerb 30,000 n 50,000 11 n ovor 25 50 35 ho 150,000 250,000 500,000 b5 50 h5 50 55 60 The rato of l^eturn allowed on statutory invoetod capital i s loworod from i t s present l e v e l of 0 par cent t o 7 P®r cant with respect to invested capital in excess o f 05 million* The change has limited signi- ficance, since i t w i l l not a f f c c t corporations v/ho alroady find i t nore advantage dug to e l e c t the base period earnings ncthod of determining nornal p r o f i t s , and v/ill not f u l l y a f f e c t corporations who w i l l s h i f t to that Esothod as a result of the current revisions of the lasr* the sequence o f determining corporation inccnc ta£ and oztcosc p r o f i t s tax l i a b i l i t y i s reversed. Under the esd sting law corporation normal tax was computed f i r s t and was allo^od as a doduction both in coxaput ing base period oamines and current p r o f i t s subject to excess p r o f i t s tax* Under the Bevonue Act of 19kl this cequonce i s reversed* Corporate normal tax and surtax i s not allowed as a deduction i n excess p r o f i t s tax computations but excess p r o f i t s tazos are allowed as a deduction i n determining incoiue f o r normal and surtax purposes* IThile part of the increased -7- yield of the excess p r o f i t s tax under tho now schetse i s o f f s e t by corresponding loss in the yield of tho corporation Income tax* tho rover sol of deductions results in a substantial increase of the conbinod tax chare©* For corporations electing tho invested capital option this reversal producos the ceino e f f e c t on corabinod income and oxoess p r o f i t s tax l i a b i l i t y as would be produced i f the reversal of deductions had not boon made and tho "normal p r o f i t s * deduction had boon lowered by about JO per cent* For cor- porations eolocting tho base period earnings method, tho equivalent lowering of the deduction for "noraal p r o f i t s " vrould bo only about 15 por cent, sine© f o r those corporations tho disallowance of income toxoB as a deduction produces a higher figure f o r base period earnings that partly o f f s e t s tho increase in current earnings attributable to tho same factor* Hie not o f f o c t on combined tax l i a b i l i t y of reversing tho order of deductions could have boon approximated, i f the present order had boon l o f t unchanged, by reducing "aoraal p r o f i t s " under tho invested capital option from 8 por cent of invested capital to about per cent, and undor the earnings option fron 95 por cent of base period earnings to about 60 per cent. Thus, v/hilo this particular change increases the conbinod ineons and excess p r o f i t s tax burden of a l l corporations, i t increases tho relative advantage of corporations that have had high base period earnings and are therefore able to ©loot the earnings option* Por corporations choosing the invested capital nsthod, the i c t provides that, vAth rertain restrictions, 125 per cent of equity capital invested since December 31, 19^1, shall be counted in determining invested capital* The .Act also terminates the exemption from excess p r o f i t s tax of excess p r o f i t s derived frora the uiuiiig of certain strategic netalo i n the United States. Individual Incom Taxes She act reduces personal oxer^ptionsj increases the rates of surtax* provides f o r a s t o p l i f i o d xaethod of f i l i n g incoxae tax returns f o r persons vrhOBo ^ross incono does not oxcood £3*000 and i s derivod T r o l l y from specified sourcos} i t disallows tlio credit f o r one dopendent i n cases \?hore tho taxpayer 1 s status as head of f o u l l y i s occasioned s o l e l y by the existence of one or iaore such dependents* and i t integrates tho 10 per cent defense tax i n t o the structure of surtax rates* Personal exe&ptione are reduced from 02,000 t o §1,500 f o r head© of families and f r o n $000 t o §750 f o r single individuals. Koraal tax i s l e f t unchanged at i t s present l e v e l of 1* par cent i n order t o avoid increasing the value of the tea exemption p r i v i l e g e attaching t o p a r t i a l l y tax exempt securities. But rate© of surtax are raised; and surtax isinpoeed on a l l ixicouo i n excess of personal exemption and c r e d i t f o r dependents, instead o f exempting, as heretofore, the f i r s t Ci;,000 of such incGoe. Under tho Revenue Act of 19^0 parried persons earning i n excess o f §2,222, and single persons earning i n excess of £3G9 bocisao taxable at a rate of h*h per cent (noraal tax plus defense t a x ) on the f i r s t dollar i n excess of these suns. Under tho current act they m i l be taxable at a rat© o f 6 per cent on the f i r s t d o l l a r i n excess o f $1,500 and 1750, respectively and taxable at a rate of 10 per cent on the f i r s t d o l l a r i n excess of 01*667 &nd respectively* The follcnvinj table shovrs inccno taxes m & percentage of net income at various income levels under last year's Revenue jict and under the Revenue Act of l?ljL, and c o l o r a b l e current figures for the United Eir^dom raid Canada, Effective 3gfcoc of Individual Income Tctz (Uarrioci tazpoyer, no dependents) Ir.cono § 2,000 5,000 10,000 20,000 50,000 100,000 United States Kovonuo Act l9ko — 1 r"er cemt 2,2 5*2 11,7 20,3 1&.5 19U1 2,1 7.5 13.1 23.1 ho.O 52.7 United Eia^doia 25.2 57.1 1*5.0 56.1 72.9 Canada 0,0 20,0 30, Q ia.7 55.9 61,9 "Soto: Owinc to diiloronce's cowaon the throe countries i n saethode of tcxfng capital gains and corporate income the porcontr£e f i b r e s given are less comparable in the hi^xor incase ranges, t?hero incone derived fron cor~ porate source© forms an important part of t o t a l incoxao* Figures roughly adjusted for these differences indicate that for very large i n c o g s the gap between tases i n the United States end tho United Kingdom i s rauch sn&ller than shewn by the tablet TThile the increase in tax harden under th$ zuw rcvonuo act i s drastic at levole of Incom up to 0100,000, the incwie te^os paid on such incomes are s t i l l lovr relative to tazes i n those najor countries ?/here the proportion of military expenditures to the national incase i s l i t t l e higher than Trill soon be reached in the United States* The contrast between our rates end rates in foreign countries i s especially marked f o r Incosses of less than £20,000* Estate and G i f t Taxes Hie g i f t and estate tax rates are increased, and as in the case of other taxes, the 10 per cent defense tax imposed by the Revenue Act of -10- 19U0 i s incorporated i n the regular rate structure* Usenptions and deduc- tions f o r estate and g i f t tex purposes are l o f t unchanged. Estates of §120,000 or loss continue to be able to escape the estate tax entirely provided taz-freo g i f t s are jsade to the isaxinua allowed by 1 mr and part of the estate i s l e f t in the forss of te£-froe insurance* Estates of considerably larger sise continue to be comparatively l i g h t l y afiectod by these taxes* Bio following table shows e f f e c t i v e rates of tvx paid by estates of varying cisos undor existing t a r rates and under the rates of the 19^1 act* Net estate before e^erapticn V ;,evonue i x t 19^0 1$ 50,000 100,000 200,000 1400,000 000,000 Ii*6 10*8 15*9 20*9 100,000,000 72*5 1,000,000 10,000,000 22*9 53*2 1*0 s# 5 I9.h £5*2 29*6 51.1 60*6 75*U Iflscellaneous Provisions geo»P on Non-resident Aliens and Foreign Corporations The Act increases the t s z on non-resident aliens and foreign corporations, and the rates of -withholding tas at source, by msnn of vdiioh these tases are l a r g e l y collected. United States incase taxes on those taxpayers operate only i f special treaties reducing then are not i n force* Authorisation i s extended t o conclude such t r e a t i e s with countries of the Vfestem Hemisphere* the United States* Hitherto i t was confined t o countries contiguous to -11- Treataaont of Certain Securities for Inco&o Tor, jccountirg Tho Act provides that a tcospayor reporting on a cash oasis, viio ovms non-intorest hearing obligations issued at a discount and rodoenablo f o r f i x e d amounts increasing at stated intervals, nay report cuch incronentc of value as incoao on cxi accrual basis* xhic soction i s designed to bono- f i t holders of non-intorost bccrinc dofonco bonds* TTith rospoct to short- term obligations issued on a discount basis by tho Federal, State, or local governments, the act provides that the issuing discount shall not be accounted on an accrual basis and that such obligations shall not bo treated as capital assets* The main e f f e c t of these provisions i s to simplify incosae tax accounting* Hon-essential Federal Expenditures The Act establishes a coisaittee composed of throe xaenbers each of the Senate Finance Comitteo, tho Senate Comittee on Appropriations, the House Ways and iiosixs Coianittee and the House Comitteo on Appropriations, and the Secretary of tho Treasury and the Director of tho Bureau of tho Budget, to study tho p o s s i b i l i t y of reducing non-essential Federal escpenditures* In lino with t h i s provision of the i c t the Senate Finance Coxaaittee has called upon the Director o f tho Budget to submit a report showing how non-defence and non-essential budget items may be reduced by alternative t o t a l s of (1) §1,000,000,000$ (2) $1,500,000,000$ f j ) $2,000,000,000*