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BOARD OF GOVERNORS
• F THE

FEDERAL RESERVE SYSTEM

Office Correspondence
To.

Chairman E c c l e s

Frpm

Thomas Lee Smith,

Date

Subject;

October 21«

19hl

E f f e c t o f income t a x on net

i n t e r e s t income o f commercial "banks

V
Several persons have r a i s e d t h e q u e s t i o n o f t h e e f f e c t o f i n come taxes and the t a x s t a t u s o f commercial bank holdings upon net i n t e r e s t
income r e c e i v e d by commercial banks• The q u e s t i o n i s r a i s e d i n c o n n e c t i o n
w i t h the estimates o f the r e d u c t i o n i n i n t e r e s t paid t o the banks under
various r e f u n d i n g p o l i c i e s o u t l i n e d i n t h e memorandum t o you dated October
10, 1947 and t a b l e dated October li*, I9i|7# which made no allowance f o r the
corresponding changes i n tax l i a b i l i t i e s o f commercial banks•
The r e d u c t i o n i n bank earnings might b e o n l y t w o - t h i r d s as great
as t h e r e d u c t i o n i n i n t e r e s t paid t o t h e banks * That i s , t h e r a t e o f t a x
on i n t e r e s t r e c e i v e d by commercial banks on Treasury s e c u r i t i e s which w i l l
nature between October y i 9 19^7
October 31* 1952 i s estimated a t 32-33
per cent* This i n c l u d e s b i l l s and c e r t i f i c a t e s and makes adjustments f o r
t h e Treasury 1 s f i n a n c i n g program through October 191+7 •
However, the e f f e c t i v e r a t e o f tax on i n t e r e s t r e c e i v e d b y comm e r c i a l banks would b e c l o s e t o 38 P©r cent were i t n o t f o r t h e s i z e a b l e
bank h o l d i n g s o f p a r t i a l l y tax-exempt s e c u r i t i e s .
Banks now hold an e s t i mated lij. b i l l i o n d o l l a r s o f a t o t a l o f a l i t t l e over 17 b i l l i o n o f Treasury
bonds p a r t i a l l y exempt from Federal income t a x e s • Commercial bank h o l d i n g s
o f f u l l y exempt bonds amount o n l y t o about 15 m i l l i o n d o l l a r s o f P o s t a l
Savings and Panama Canal bonds®
Commercial banks own an estimated t o t a l o f about ij6 b i l l i o n d o l l a r s o f marketable p u b l i c s e c u r i t i e s maturing between October 31*
^uad
October 31* 1952, o f which 8 b i l l i o n are p a r t i a l l y tax-exempt s e c u r i t i e s
and I4.O b i l l i o n are f u l l y t a x a b l e s e c u r i t i e s • The i n t e r e s t from the 8 b i l l i o n d o l l a r s o f p a r t i a l l y tax-exempt bonds i s taxed a t s u b s t a n t i a l l y II4.
per cent and the remaining i n t e r e s t i s taxed a t 38 per cent* The e f f e c t i v e
t a x r a t e works out a t approximately 32-33 V e r cent* The exemption from
normal tax o f the i n t e r e s t from the 8 b i l l i o n d o l l a r s o f p a r t i a l l y t a x exempt bonds i s worth about I4.5 m i l l i o n d o l l a r s t o commercial banks•
The nature o f t h e p a r t i a l t a x exemption i s as f o l l o w s • The
i n t e r e s t on p a r t i a l l y tax-exempt bonds i s e n t i r e l y exempt from t h e normal




To:

Chairman Eocles

-

2

-

tax rat© which f o r most banks would b© 2lj. p©r cent*-^ The interest
which i s derived from th© f i r s t #5*000 of principal amount owned by any
on© holder i s exempt from the surtax r a t e , which i s generally ll*. per
c e n t , - / but the interest on principal in excess of $5*000 i s subject t o
surtax* (The former excess p r o f i t s tax applied in the same way as the
surtax, but p r a c t i c a l l y no banks incurred excess p r o f i t s tax l i a b i l i t y * )
Practically a l l of the interest exempt from normal tax i s subject t o
surtax*

l / I f the normal tax net income exceeds $50*000, the normal tax rate i s
2lj. per cent, and i f the surtax net income exceeds $50*000, the surtax
rate i s llj. per cent making a combined rate of 38
cent* Normal tax
net income i s less than surtax net income primarily by reason of the
credit f o r p a r t i a l l y tax-exempt
S* interest+
The rates, however, are progressive f o r corporations with less than
$50*000 net income* Corporations with net incomes of $25*000 or less pay
at a surtax rate of 6 per cent and pay at normal tax rates as follows:
Up t o $5,000, 15 per cent; over 15,000 to $20,000, 17 per cent; and over
$20,000, 19 per cent* Corporations with net incomes over $25,000 but not
over $50,000 pay a surtax of $1,500 plus 22 per cent of the surtax net
income i n excess of $25,000 and pay a normal tax of $14,250 plus 31 per
cent of the normal tax net income in excess of $25,000*
2 / Ibid*