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Form F. & 131
BOARD OF
GOVERNORS
OF THE
FEDERAL RESERVE
SYSTEM
nDffice Correspondence
D a t e July 2 2 , 19t|0
To_
M r . Despres
Subject; Economic Effects and Estimated
From
M r , Krost
Yields of a Set of Tax Proposals Designed to Raise Revenue without
Restricting Consumption.
List of Proposals
Proposals relating to corporation taxes:
!•
Enactment of an excess profits t a x .
Excess profits should be defined as the excess of profits
in the taxable year over the average of the best two out of the three
years preceding the imposition of the t a x .
I n order to avoid excessive
taxation of corporations making losses or exceptionally small earnings
in the base period the taxpayer should be allowed the option of substituting an amount equivalent to a 5 V
e r
cent return on invested capi-
tal for the base as determined under the general rule.
In order to
prevent corporations having exceptionally high earnings in the base
period from escaping the tax entirely the Government should have the
option of substituting an amount equivalent to some reasonably high rate
of return on invested capital for the base as computed under the general
rule #
The rates of t a x upon excess profits as thus defined should be
high.
Such a tax is needed at the present time in order to impose
upon industry some sacrifice commensurate with the sacrifices that will
be required from the broad masses of the people as a result of the introduction of conscription.
It is needed to prevent the weakening of the
•2'
public morale that w i l l occur if the national defense program becomes
an occasion for conspicuous increases in the number and amount of large
private fortunes.
It is also needed in order to reduce the growth in
the public debt which 'will result from the defense expenditures unless
the public revenues are appreciably increased.
2.
A n increase in the corporate income tax rate from its
present level of approximately 2 1 per cent to 25 per
cent.
The changes in individual income tax rates made by the
Revenue Act of 19i|l have resulted in increases ranging from 25 per cent
to 60 per cent in tax payments of individuals in the income range from
13,000 to §100,000.
The incentive to leave corporate earnings undis-
tributed has been appreciably increased.
M i increase in the corporate
income tax offers the only method of securing an appreciably increased
contribution to our national defense effort from recipients of income
able to take advantage of this method of tax-avoidance.
Moreover, the
corporation income tax provides a simple and effective method of
collecting taxes at the source upon the incomes of the wealthiest 10
per cent of ^American families, a method that minimizes the possibilities
of tax-avoidance and tax-evasion.
She corporation income tax rate is
now 37.5 per cent in the United Kingdom.
It Germany it is now
0 per 6ent.
Proposals relating to the estate and gift taxes;
3.
(a)
Inclusion of gifts during the life of the donor in
the computation of the taxable estate; that i s , assessment of the
estate tax on the total of estate passing at death plus gifts
during life, w i t h a credit for gift taxes previously p a i d .
-3-
Under existing law the initial transfers made under
a tax-avoidance program designed to transfer an appreciable part
of an estate by gift avoid taxation at the highest rate of estate
tax to w h i c h the estate would be subject by incurring taxation at
the lowest rates of gift t a x .
For example, a gift of $10,000 from
an estate that w i l l amount to slightly more than $1,000,000 at the
death of the donor avoids a prospective estate tax of $3,200 by
paying a gift tax of only $150.
The proposal is designed to
equalize the tax treatment of property passing by gift and b y
bequest.
(b)
Substitution for the present specific exemptions
of |1|0,000 under the gift tax and |i|D,000 under the estate tax
of an exemption of #10,000 to be applied to the total of estate
passing at death plus gifts during life.
(c)
Elimination of the insurance exemption.
(d)
Increase of estate tax rates to raise more revenue
from estates of moderate size.
By making use of the |if.0,000 specific exemption under
the gift t a x , the |I{.0,000 specific exemption, and the $lj.0,000 insurance exemption under the estate tax, an estate of f120,000, or
$120,000 of any estate, no matter h o w large, m a y be transferred
to heirs free of t a x .
I n additional f80,000 m a y be transferred
by gift subject to taxes of only f5,100.
Under the British
estate duty, the transfer of §200,000 w o u l d be exempt from tax to
the extent of only fl|.00 and would involve taxes of $2lj.,000.
Proposals relating to the individual income tax:
ij.. Abolition of the privilege enjoyed by husbands and "wives
of filing separate returns, with possible retention of the privilege
for bona fide earned income of wives*
Under existing law a net income of 11,000,000 a year pays
income taxes of $718,000.
If a husband can succeed, by transferring
assets to his w i f e , in giving her a taxable income of $500,000 and reducing his own to $500,000, the taxes payable on the two incomes amount
to only #660,000, a tax saving of #58,000.
For an income of |60,000,
the potential saving attributable to the separate filing privilege amounts
to $8,000.
Income utilized for the maintenance of a common household
should be taxed as a single income, regardless of the fact that it m a y
have nominally separate sources.
The present state of the law repre-
sents serious discrimination, both against single individuals and
1
against married persons with income derived solely from the husband s
earnings.
The practice of filing separate returns is so widely prevalent
among high income families that the effectiveness of the progressive
income tax is substantially impaired.
Of the 5#908 married couples
w i t h incomes of more than |100,000 a year in 1957» 5t58U filed separate
returns and were taxed at considerably lower rates than applied to
equivalent incomes received by couples without property income or received
by single persons.
5«
Substitution for the present system of personal exemptions
and credit for dependents, applied against net income before computation
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of t a x , of a system of flat credits, applied against the tax itself.
The purpose of this proposal is to eliminate the differential subsidy to higher incomes involved in the present system.
The
#2,000 exemption for married persons is worth $1,580 (79 per cent of
#2,000) in tax saving to a person with an income in excess of $5*000,000;
it is worth only |80 (if. per cent of |2,000) to a person w i t h an income
of 15f000.
If subsidies of this type were paid by the Treasury in the
form of cash outlays, the unjustified expense would be generally condemned; in their present form they are as costly and just as little
justified as if they were paid in cash.
A tax credit of #52 might be substituted for the present
personal exemption of $800 for single person; a tax credit of |80
for the present personal exemption of $2,000 for married persons; and
a tax credit of |16 for the tljDO credit for each dependent.
The present
rate of U per cent on surtax net income of tij.,000 to |6,000 might be
lowered to 1 per cent in order to avoid a sharp increase in taxes for
those w h o are now exempt from surtax b y only a small margin and for
those w h o n o w p a y small surtaxes.
6.
Repeal of the provisions restricting the rate of tax on
long-term capital gains to a maximum of 15 per cent.
Under the rates of the Revenue Act of 1940, an income of
150,000 derived wholly from wages or salaries pays income taxes of
|lJ+, 1 2 8 .
Under the existing procedure with respect t o the taxation of
capital gains an income of #50,000 derived wholly from long-term
capital gains need pay income taxes of only $7#500.
The provision
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that only 50 V
e r
cant of capital gains on assets held more than two
years should be taken into account in computing net income constitutes
adequate recognition of the difference between capital gains and other
types of income; the present differentiation in the rate of tax is unnecessary.
7*
Removal of t a x exemption from future issues of Federal,
State and local Government securities.
This proposal is opposed only by the comparatively small
group of wealthy investors in tax-exempt securities and by State financial officers who believe that it would greatly increase the cost of
borrowing to the States.
Consideration should be given to a number of
means of bringing pressure to bear upon the States to discontinue their
opposition to this proposal:
a) repeal of the legislation permitting
the States to levy income taxes on the salaries of Federal employees,
b) less generous allowance of credit for payment of State taxes under
the estate tax and under the unemployment compensation tax, c) less
generous Federal grants to States for public roads, old-age assistance,
w o r k relief and m a n y other purposes.
Estimated Yield of Proposals
The following tables show the estimated yield of the existing t a x structure and of the proposals listed in this memorandum at
varying levels of the national income.
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TABLE 1
ESTIMATES OF YIELD OF THE EXISTING FEDERAL TAX STRUDTHHE (AS MODIFIED BY
THE REVENUE A C T OF 1940) AM? OF THE PROPOSALS ADVANCED IN THIS MEMORANDUM,
A T VARYING LEVELS OF THE NATIONAL INCOME l /
(Billions of dollars)
Tax revenues and other available funds
EXISTING TAX STRUCTURE
Income, estate, and gift taxes
Other budgetary receipts
Total budgetary receipts
Net social security funds
U . S . savings bonds
Total funds available without
open-market borrowing
Additional yield from proposals of this
^ ^ m o r a n d u m 2/
National Income of Preceding Year
w
7 S— i — s c — r
1.1
0.8
5.3
3.2
B.b
1.2
0.8
7.6
3.8
11.1;
2.1
0.9
10.3
4.3
14.6
2.5
0.9
8.2
10.5
1^.4
18.0
l.k
1.8
2.2*
3*0
3.5
2.8
l/
"""
The amounts shown would be collected in the calendar years following the
calendar years in which the national income reached the levels indicated.
Estimates of fiscal year collections would differ only slightly from the
estimates shown. For purposes of estimating transactions which have a predictable
trend over t i m e , the calendar year in which these collections are made are assumed
to be 19I4I (year following |70 billion national income), 19i|2 (year following
|80 billion national income), 19^5 (year following |90 billion national income), and 19b5 (year following $100 billion national income).
2/
Estimates of the yield of each of the proposals are shown in Table 2 .
-S-
TABLE 2
REVENUE YIELD OF SE7ES PROPOSALS AOTAJTCED .IS THIS M M O R A H D I M , A T
VARYING ^ Y E L S OF FATIOKAL INCOME l /
(Millions of dollars)
Fiscal
year
191+1
Excess profits tax
Increase in corporation income tax
Estate and gift t a x changes
Abolition of privilege of filing
separate returns
Substitution of flat tax credit
for personal exemption
Abolition of optional capital gains
tax rate 2 /
Total
3/
300
National income of preceding year
|
80
70
1 90 1 100
600
250
250
700
280
350
1+75
1,000
550
600
120
200
300
1*50
600
60
100
150
225
300
100
150
2,370
3,000
125
—
—
605
—
1,1+00
—
1,780
800
320
l/
"""
The figures shown are estimates of collections in calendar years following the
calendar years during which the national income reaches the indicated levels.
Security prices are assumed to be moving upward without serious break as
national income increases and the general price level is assumed to be moving
slowly upward without serious reversals in t r e n d .
2/
Since the yield of this proposal depends on its effect
on the taking of capital
1
gains, which in turn depends largely on taxpayers views as to whether taxation of capital gains at high rates is to be temporary or permanent, the
estimates of yield shown represent merely an indication that anappreciable
yield is to be expected from this proposal at high levels of national income
if taxpayers do not expect a decrease in the taxes on capital gains for a
considerable number of years.
3/
""
The proposal to eliminate tax-exemption from Government securities applies
only to future issues of such securities, and hence will yield a negligible amount of revenue in the immediate future.
@FedFRASER