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BOARD OF GOVERNORS or T H E FEDERAL RESERVE SYSTEM ^ O f f i c e To From C o r r e s p o n d e n c e Chairman Eccles ffmile Date ^ s t Subject: Dgspres In accordance with your request, there i s attached a memorandum by Mr. Krost comparing the excess p r o f i t s tax of the Ways and Means Subcommittee with that proposed by the Treasury. Attachment s o i s , 1940 rotor*. R. 1 1 3 BOARD OF GOVERNORS OP THE FEDERAL RESERVE SYSTEM O f f i c e C o r r e s p o n d e n c e To August r? t 191+0— Subject* Excess-Profits Tax Pro-posed B Y Mr* Despres Frnm Date Martin Krost Ways and Means Subcommittee PI^L On August 8, the Subcommittee on Internal Revenue Taxation of the House Ways and Means Committee submitted an excess-profits tax proposal t o the f u l l committee. The proposal may be outlined as f o l l o w s : 1. The tax i s made applicable t o corporate earnings of 19l|0 and subsequent years* 2m The base period f o r determining standard earnings i s f i x e d as the years 1936 to 1939* inclusive. 3. Optional methods of determining standard earnings, or, i n the language of the proposal i t s e l f , the excessp r o f i t s c r e d i t , are provided. The f i r s t i s simply average earnings during the base period, with no " c e i l i n g " provision. Under t h i s method, average earnings are i n creased by 8 per cent of capital invested a f t e r the base period. The second method provides a f l o o r of 6 per cent of the f i r s t 1500,000 of invested capital plus Ij. per cent on the remainder. I t provides, more generally, that the excessp r o f i t s credit shall be an amount equal t o the percentage of invested capital f o r the taxable year which a corporat i o n ' s earnings during the base period have been to i t s invested capital during the base period, t h i s percentage not to exceed 10 per centi but there i s no c l e a r l y apparent reason why any corporation should use t h i s method, except t o take advantage of the f l o o r provision. I4.. Invested capital i s defined as the sum of equity capital plus varying percentages of borrowed c a p i t a l , depending upon the amount of equity c a p i t a l . Corporations with equity capital of less than §100,000 are allowed t o i n clude 100 per cent of borrowed capital up t o the d i f f e r ence between the equity capital and §100,000; corporations with equitv capital of $1,000,000 or more are allowed t o include 33 V p of borrowed c a p i t a l . 5# Het income subject to excess-profits tax i s defined as net income subject t o normal income tax, disregarding long-term capital gains and losses, minus normal income tax. In addition to these adjustments, i n cases where the percentage on invested capital method of computing the excess-profits credit i s used, dividends received are excluded from net income (since holdings of stock are excluded from invested c a p i t a l ) and the interest deduction from net income i s reduced by the percentage of borrowed capital included in invested capital* A s p e c i f i c exemption of $5#000 i s provided* 6* Excess-profits net income i s divided into brackets f o r the application of tax rates by reference to the excessp r o f i t s credit (standard earnings or the amount equal to a standard percentage of earnings)* For example, an amount of excess-profits net income equal to 10 per cent of the excess-profits credit i s taxed at the lowest rate, 25 per cent* The next bracket of excessp r o f i t s net income, also equal to 10 per cent of the excess-profits c r e d i t , i s taxed at 30 per cent* The remainder i s taxed at J j0 per cent* L. The Subcommittee proposal d i f f e r s from the Treasury proposal in three important respects* 1* I t lacks any " c e i l i n g " provision and thus permits companies with exceptionally high earnings during the base period t o go substantially untaxed. 2* I t imposes rates of 25* 30 and I4.0 per cent, as compared with the Treasury rates of 25* i X and 50 per cent; more|> over i t defines brackets in such a way as t o favor companies with high earnings during the base period. (The Treasury proposal defined brackets i n terms of percentages of invested c a p i t a l . ) 3* I t exempts long-term capital gains from tax, while the Treasury proposed that such gains should be taxed at the highest rate applicable to excess p r o f i t s Excluding capital gains* The Subcommittee proposal does not permit the deduction of long-term capital losses from i n come, while the Treasury proposed that such losses should be recognized in f u l l * In general f the Subcommittee proposes a tax only on increased p r o f i t s ; the Treasury proposed a tax on high, as w e l l as increased profits*
