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Forjtt F.«R. 181

BOARD OF G O V E R N O R S
or THE
FEDERAL RESERVE SYSTEM

"Office C o r r e s p o n d e n c e
To

nhfijrm^n

From

Date

Lauchlin Gnrrie

-i^,

Subject:
„
* *0

Attached are statements of the proposed amendments* and the arguments
against depression reserves* It is very difficult to estimate the
revenue that would result from the adoption of these amendments, owing
in large part to the uncertainty both as to the amount of debt that
will be retired, and the amount of earnings that will be retained, but
Miss Burr puts it very tentatively at between four and five hundred
millions* I have modified the proposal to require joint returns from
all husbands and wives by making it apply only to husbands and wives
who are living together and are not maintaining separate establishments.
Daiger pointed out to me that the whole proposal would be ridiculed if
we made husbands and wives who are living apart and who are not on speaking terms get together to prepare their income tax.
By the way, I checked up on Glass 1 railroads,
of 1934 they comprised 95 percent of the total
of the total gross revenues, and 94 percent of
property, although they were only 9 percent of




and find that at the end
mileage, operated 97 percent
the investment in railway
the total number*

_
1—5
682

Harch 24, 1956.

s g is f d umwsms
pG-tj

to the tax program

It should be clearly understood that the following proposals do
not Indicate any lack of sympathy with the objectives of the recent
tax proposals.

On the? contrary* they are suggested as a means of

strengthening the proposals against attack and of enabling them to
achieve their objectives acre surely. They have been designed to nest
the major objections and difficulties that have arisen since the program
was made public.
The broad objectives of the program are (a) to raise additional
revenue* (b) to close up a loophole through which the wealthy have
evaded surtaxes on the income left undistributed with corporations, and
(c) to do this, so far as it is practicable and equitable* by forcing
the distribution of corporate earnings and thus diminishing the monetary*
social and economic abuses associated with the practice of withholding
earnings*
The tax program, as modified to date by the House Sub-Committee,
appears at present to be along the following lines*
1, Removal of the present corporate income, excess profits, and
capital stock taxes*
2*

The imposition of a tax on undistributed corporate earnings,

graduated by percentages undistributed, and by the sise of the net earnings*
5*

Removal of the exemption of dividends from the normal individual

income tax*
4*

The imposition of a flat 15 percent tax on the income of fiduciary

corporations, —




banks, Insurance companies, etc*, —

in place of a tax

on undivided earnings.
5*

the imposition of a tax of 55 1/5 percent on dividends paid

foreigners*
6*

In cases where corporations are forbidden to pay dividends

when their capital is impaired or when earnings fail to reach a certain
percentage of bond interest requirements, or preferred dividend requirements, tile exemption of earnings from the graduated scale and the imposition
of a flat

percent^

7* The imposition of taxes on a range of commodities*
8*

The imposition of taxes on windfall profits resulting from

the abolition of the processing taxes*
Suggested Amendments
1*

Retain a corporate Income tax but at a flat 12 percent on all

corporations* including fiduciary corporations.
2*

Exempt from taxation $15,000 of earnings after corporate income

taxes and preferred stock dividends*
5* Allow a deduction for repayment of contractual obligations on
the payment of a tax of 10 percent on the amount so deducted*

Contractual

obligations are to be understood as sinking fund requirements, annual
amounts not more than sufficient to retire debt at maturity* legal requirements to retire preferred stock, and additions to surplus in caaes where
there are legal prohibitions on the payment of dividends under certain
conditions*




4* Iarpose & steeply graduated tax on undietributed earnings after
the above deductions and credit**

Xt ia auggested that the scale of

graduation be along the following lineal
Percent of

Rate of
yax

Less than SOJt

40*

More % b m 50$

60*

It is also suggested that, following British practice in levying
estate taxes* the highest rate applicable shall apply to all; the undistributed earnings*

For example, if 55 percent of earnings Here undistrib-

uted, the 60 percent tax would apply to all undistributed earning* rather
than a rate of 40 percent on the first SO% undistributed and a rate of
60$ only on the balance,
5*

Exempt earnings of banks from a tax on undivided earnings,

provided the capital and surplus together are less than 20 percent of
deposits*
6*

Interpret •undistributed* aa meaning uadietribated by March let

of the succeeding year*
?#

Abandon the proposal to levy further excise taxes and in ita

place require joint income tax returns by all husbands and wivea*
living together.
Retention of a flat corporate income tax of 12 percent*
The reasons for recommending the retention of the corporate income
tax are the assurance of a eource of revenue of upimrde of a billion




dollars, and the fact that business men end Investors have adjusted
themselves to this tax*

The tax is treated as an expense and per

share earnings are calculated aftey taxes*

Stock prices have become

adjusted to this tax and to remove it now would constitute a windfall
gain to holders of stocks*

Already Wall Street statisticians are

calculating the increase in the per share earnings of various corporations if the tax were removed*

the increase will be particularly

large in the case of holding companies with bonds and preferred stock
outstanding*

In such eases, due to the leverage factor, a small

percentage increase in per share earnings of operating companies re*
suits in imv&ry large percentage increase in the per share earnings
of the top holding companies*

Similarly* common stockholders in cor-

porations having preferred stock outstanding will receive a larger
windfall gain than stockholders in corporations with no preferred stock*
This is true because in corporations with preferred stock outstanding
the whole of any increase in net earnings (with certain exceptions)
will go to the common stockholders who provide only part of the capital*
Even In the ease of privately owned companies the remission of the
corporate income tax would increase the sale value of the property*
In view of the fact that earnings available for common stock have
been increasing rapidly (Standard Statistics gives a compilation showing
an increase of S5 percent for a large number of companies in 1935), and
are expected to Increase substantially in 1956, and in view of the fact
that although common stockholders have lost money in the depression
they are still as a class the wealthiest in the community, there appears




-in-

to be no possible justification for conferring upon this class at this
time a substantial windfall gain*

the fact that some persons would

pay higher taxes by reason of the windfall ia no justification for
conferring a windfall*

The purpose of the proposed tax is not to

Increase incomes but to make the present individual income tax rates
effective in reaching existing incomes*

The most they are entitled to

is a reduction in the rate of the tax and the abolition of the excess
profits and capital stock taxes in compensation for the removal of the
present exemption of dividends from the normal income tax*
Since the removal of the present exemption of dividends from the
4 percent normal tax applies also to dividends of fiduciary corporations*
it appears only fair to make the corporate income tax levied on their
net earnings 12 percent instead of the proposed IS percent*

Unless

this is done, bank stockholders will be penalised in comparison with
stockholders of other types of corporations*

JfrWHrtfoitf
1*

It is suggested that net earnings up to $15*000* calculated

after the payment of the corporate income tax and preferred dividends*
be exempt from the tax on undivided profits*
for this recommendation*

There are two main reasons

In the first place* it is equitable* and* in

the second, it would greatly weaken the opposition to the proposed tax
without diminishing the effectiveness of the tax.




A corporation with earnings as low as $15,000 available for
common is at a serious disadvantage in contrast with large corpora*
tions in raising money for expansion*

The small corporation has

no access to the capital market and local banks are naturally reluctant to make capital loans*

It relies, therefore, mainly on

retaining earnings for the purpose of expansion*

Moreover, it is,

generally speaking, tho small corporations as a class whose position
has been severely strained by the depression and which are most in
need of financial rehabilitation*

Finally, if the corporate income

tax of IS percent is retained, the small corporation will pay as much
in taxes
as its owners would if this tax were removed and all earnings
were disbursed in dividends*

Xt appears equitable, therefore, to

exempt undivided profits of small corporations from the proposed tax*
This exemption would remove most of the opposition, since it
would exempt over ninety percent of all corporations*

In 1935 only

10*000 corporate returns out of 450,000 showed statutory net incomes
of over $25,000*

At present the financial press and the campaign

organised ty the large corporations Is playing up the injustice involved
to the smaller corporations*

It is constantly said that the present

proposals will favor the large corporations with large surpluses and
easy access to the Sfpital markets and will prevent the development
of small corporations*

If small corporations are exempted this effective

argument will not be able to be used*




The advantages of the corporate

form of enterprise will not be weakened for the small business man*
Finally, the purposes of the tax will not be impaired* little, if
any, revenue will be lost. It is really the enormous undistributed
earnings of the few thousand big corporations around which abuses
have centered and which it is desired to force out in dividends.
Around 90 percent of corporate net income is earned hy 10 percent of
the corporations*
It is recommended that corporations be permitted to devote
earnings in excess of $15,000 to the payment of contractual obligations upon the payment of a 10 percent tax. In view of the fact
that up to this time there has been no tax un undivided profits,
•any corporations have either entered into contractual obligations
to retire debt out of earnings or have contracted debt upon the obvious
and reasonable assumption that it could be retired out of earnings*
Creditors have laftt on this basis, even to the extent, in some cases,
of requiring that the debt be retired before any dividends are declared*
This has been done to seme extent even by Government lending agencies*
In other cases there are legal prohibitions against the payment of
dividends when capital is impaired, or when earnings fail to exceed
interest payments or preferred stock dividends by a certain amount*
If such contractual obligations or legitimate assumptions are disregarded, not only will grave injustices be done, resulting in certain
cases in bankruptcy, but in addition the opposition to the principle
of the tax will be strengthened*
particular, willfewmentioned*




The plight of the railroads, in
The citation of a few hard cases may

sometimes wreck a good bill*
The purpose of the 10 percent tax Is to prevent abuse of this
exemption*

The tax is high enough to prevent most corporations

from taking advantage of the exemption unless they really have to,
and yet Is not too high to impose a burden on those to whom the
exemption is a practical necessity*

With this rate most corporations

would find it more economical to issue stock to retire debt if they
can, rather than retain earnings*

This is not true in the case of

large corporations dominated by wealthy individuals, but in most
cases such corporations have no contractual obligations which would
permit them to take advantage of the exemption*
The 10 percent tax is equitable, since the net worth of the
corporation is increased by the repayment of debt out of earnings
and th equity of the common stockholders is correspondingly increased*
Moreover, If th' earnings were disbursed in dividends most of these
dividends would be subject to at least a 10 percent income tax*

The calculation of earnings undistributed after Preferred stock
dividendsy
While preferred stock is called stock, it resembles a junior debenture such more closely than it does an equity*

With few exceptions

preferred stockholders do not share in increased earnings* Preferred
stockholders, therefore

do not have income on which they evade

taxation by leaving It with corporations*




Common stockholders may

point to a 60 percent distribution of their corporation earnings
when actually only some 50 percent of their earnings (i*e*, net
available for common) is distributed*

the Government should, of

course, direct its tax toward the realities of the situation and
not allow Itself to be circumvented in its objectives by the legal
usage which confers the name stock on both preferred and common*
In this particular case the reality of the situation is the evasion
of taxation by common stockholders*

By imposing the tax on earnings

available for the equity holders and undistributed to them, equality
of treatment would be assured stockholders of corporations having
preferred stock outstanding and those not having preferred stock
outstanding,

If a corporation has participating preferred stock

outstanding, undistributed earnings could be interpreted as earnings
undistributed before preferred stock dividends*
For the purposes of the proposed tax, undistributed income
should be Income of the calendar year undistributed between February 28th of that year and larch 1st of the succeeding year*

Corpor-

ations do not know what their earnings have been until after the end
of the year*

Adequate time should be allowed for the declaration

of a final dividend after the result of the year* g operations is
known*
If these amendments are adopted, the objections to the new tax
proposals will be greatly lessened and the purposes of the proposals
more surely achieved*




Additional revenue will be raised} windfall

-00*

gains will be minimized; there will be more assurance t'xit the wealthy
will pay their share of taxation than under the present proposals;
and, finally, there will be more assurance that money will actually
be forced out of corporations, either in the form of debt repayment,
or in dividends, or in taxes*

A proposal to require joint tax returns for husbands and wives not
actuallyseparated and maintaining separate establlshmentsf
If husbands and wives were required to file Joint individual
income tax returns, between $150,000*000 and $200,000,000 of additional
revenue might be raised in the calendar year 1957. This revenue would
come almost entirely from individuals with net incomes In excess of
110*000, and the bulk of it would come froa individuals with net incomes
of $50*000 and over. The more effective the tax on undivided profits
is in forcing out dividends, the more will this proposal yield in revenue.
This imsseaaftlto revenues would not require an upward revision
in normal and surtax rates applied to individual incogs nor a chrnge
in personal exemptions and credits*

Unless there are special legal

difficulties, this eo^ld be accomplished by en appropriate change in the
law affecting the administration of returns, either by eliminating the
option now given husbands and wives of filing separate returns, or by
making use of the privilege subject to special penalty tax rates.




From the point of view of ability to pay taxes, there is no
reason why this change should not be made*

The ability of married

individuals living together to pay taxes depends on their combined
net income rather than on the fact that income may coiae from sources
belonging legally to ttio individuals*
To raise additional revenue by means of this proposed additional
charge would impose little restraining effect on recovery since it
would affect mainly the wealthy whose inco&es, at the present time^
are not all spent on consumers* goods or the making of producers1
goods*

To cut down savings at the present time, in other words, is

no impediment to recovery since there is a superabundance of idle
funds seeking investment*
There appears to be much more to be said for this proposal on
the grounds of recovery, equity, and popularity, than for new or
additional taxes on commodities*




BALAHCE SHEET rmis. ALL H H K i f C A CORPORATIONS.
O-lAllL

DECEMBER 1929.DECFHBKR 1985

(In Millions of Dollars)
Ceoh
7,901
7,806
6,495
6,557

yeny;
1929
19S0
19S.
1952
1955

1929 - 1955 -1,917

£,958
2,616
2,607
2,755
£.840
- 118

pttysr friyeptqcfltp
21,824
£9,£86
24,755
£7,418

+2,868

guraluq
40,005
58,722
52,185
25,481

«14,87S

Botes end Accts. Receivable
Bonded Debt
less Botes and Accts. Payable and Mortgages

inventory

1,885
1,267
1,175
-21
64

20,205
57,101
3?,816
57,250

20,990
18,510
14,891
12,222
15.457

1929 - 1955 -1,819

• 723

-7,655

1929
1950
19351
1952
1955

pms

FBQy

IHCOHE STATHBSHTS. ALL N H F H H I i CORPORATIONS.
O-IACiL

Year
1950
1951
1952
1955

J M Debts,
650
695
752
222

1950 - 1955

2*817

Source*

United States Statistics of Incoae




Depreciation
and Depletion
4,108
5,916
5,657
?.449
15,110

1930 - 1955.

Loss, Sale of
Cooitcl Assets
855
614
601
m

INCOME AND DIVIDENDS OF HOS-FI&ftitCIAL CORPORATIONS RBPORTIHG HET IBCOIIE

(In Millions of Dollars)
Total Income
.year
less Taxes
1925 » . . . 7,506
1924 . . . . 6,489
1925 . . . . 7,944
1926
1927
1928
1929

,
.
.
.

.
.
.
.

.
.
.
.

1930
1931
1952
1955

.
„
.
.

.
.
.
.

Dividend^
3, HI 5
5,406
4,059

Income
Undistributed
5,991
5,084
5,685

Percentage
Undistributed
55
48
51

, 8,325
. 7,552
. 8,975
.10,145

4,690
4,859
5,427
6,582

S,6M
*,6fi£
5,848
©,825

44
56
40
38

. . 6,135
. . 3,515
. . 1,997
.

5,756
8,571

379
144
-71
582

6

2,068
W 8

Total for
years 1925
to 1929,
inclusive. .56,736

32,079

15.554

II

24,657

Total for
years 1930
to 1935, 4 j
inclusive* .14,587

&4*

ItOSj

Total for
the period
1925 to
1933, inclusive.

71fl«S

.25*221

Ohcarned Dividends Paid fSon-ftnsnelal Corporations Reporting Ho He-t Income
1925-1955)(In Millions of Dollars)
1923 - 221
1926 - 276
1929 - 271
1932- 1051
1924 - 259
1927 - 495
1950 - 799
1955- 594
1925 - 254
1928 - 555
1931 -1524
Total for the years 1925 - 1929, inclusive. . . 2,068
Total for the years 1930 - 1955, inclusive. . . 5,76>
Total for the period 1925-1955, inclusive . . . 5,857