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Left with President 5/11/36 lit 1936 tfeaorandun for the President! Taxation of undistributed earnings of corporations, •feiefa is the underlying principle of the pending tax bill, is in ®& judgaent highly desirable from the fiscal, eeoaoaic* social, <m& monetary points of view* Existing great accumulations of e&sh in the hsnde of large cor- porations are, in fact* <me of the important obstacles to recovery, since they interrupt the flow to •MMNftMift of aoney created by Government l|)Stt4 tng* A tax that would effectively fore© large corporations %C pay out their current earnings would greatly contribute to the progress of recovery• It is because I am confident that the tax in the fora in which it passed the House would not accomplish this purpose that I wish strongly to urge upon you certain modifications !• tb© pending bill* In its present fora th@ tax bill will not achieve the objective specified in your asess&ge to Congress of securing "equality of tax burden on all corporate Incoae, whether distributed or ^ithheid from the beneficial owners'1 • The tax has also beco.ae 30 complicated that instead of effecting s gr<eat simplification in tax procedure, in corporate accounting, and in the uaderstanding of the whole subject by tfee eitiMOi of the nation** it will b« understood by few and will engulf many ssaall corporation® in unnecessary and difficult 'tax procedure* Grave questions hav© also been raised as to the revenue it «111 yield* It seems -.© ae that by thefcftoptiMof a few changes the objeetiveg originally laid A#WB lor the tax will beeose much w i ment* certain of achieve- - 2 - Z« My first proposal is that the present corporate income tax be retained* The argument for repealing this tax rests on the belief that It taxes the rich and the poor stockholders on the same basis regardless of ability to pay* This argument disregards the fact tlmt the in- vestment made by stockholders represents a price for the stock which takes into account the cor orate income tax. Only such present holders as bought their stocks before the present tax was imposed have been unfavorably affected by the tax. Prices paid for stocks reflect net earnings to stockholders and are based on current and expected future earnings after deduction of taxes. To remove this tax now would increase per share earnings for all stockholders anywhere fro® 15 percent, in the case of operating companies with no preferred stock, to a hundred percent or more in the case of certain holding companies• Unless other taxes offset this advantage the elimination of the- tax no® would result ia an unearned increase in the value of the stocks* With corporate profits increasing more rspialy than *ages there is no re-aeon for this unexpected addition to the wealth of stockholders. The purpose of the law should be to cause earnings to be paid oat wherever possible and then be subject to individual income taxes which are graduated in accordance with ability to The retention of the corporate Income tax would assure the continuance of revenue of over a billion dollars from a tax which has been in operation for a long time and is thoroughly accepted, established, and uaderstood, Revenue* from a new tax on undistributed earnings and from income taxes on increased dividend disbursements Mold be over and above the existing tax and «ould be a net gain to the Treasury* Furthermore, the retention of the corporate income tax would make it possible to exempt small corporations and to apply the undistributed earnings tax exclusively to the small group of large corporations whoso holdings of undistributed earnings li the difficulty that the law if designed to correct. ** Adjusted net income up to &1^,000 should be exempt from the .tax on, uadistribu.ted earning* In levying a Its on undistributed earning® it is essential to distinguish between large and small corporations. Scalier corporations have no ready access to the C&, ital market, and also have difficulty in obtaining capital loans from banks* It is to meet their needs that the Government has provided: special facilities through the Reconstruction Finance Cor;-oration arid the Federal Reserve banks for loans for working capital purposes to smaller businesses. It would not be consistent now to iapo$e heavy taxes on such funds as these corporations may acquire la the course of their business. Small corporations, in general, depend on earnings for the development of their business* It would be inequitable and economically undesirable to apply an undistributed earnings taac to these corporations in the sarae manner as to large corporations. On the other hano, it would not be eqaitable to exempt small corporations entirely from taxation on their income, since this would perssit their owners to escape tax-free. Retention of the existing corporate tax sakeg it possible to exempt small corporations without injustice or loss of revenues. The House bill recognizes that small corporations) h&v© far more need of the privilege of retaining earnings than large corporations* That's why it provides lower rate schedules for small corporations* This, however, requires isany small corporations to adjust themselves unnecessarily to new and difficult tax procedure, makes the tax more difficult to administer, and endangers the good will and support of hundreds of thousands of small corporations. If the corporation income tax is retained, the serious difficulties which have arisen in adapting the undistributed earnings tax to the financial problems of sa&all corporations eould be met by exempting earnings up to 115,000 fro® the new tax, and thus altogether exempting from the tax the great numerical a&s of corporations. The existing tax is adequate for these corporations, since it amounts to more than would the total personal income tax that would be paid by aost of the stockholders if all the earnings were distributed* No revenue would be lost and the administration of the tax could be concentrated on the fe» thousand big corporations around which center the abuses of withheld earnings. Over 90 percent of all net income is earned by less than 10 percent of the corporations. Concentration of effort on these 10 percent would be a great help to the administration of the tax plan. 3» Much higher tax rates should auply to undistributed earning^ For the large corporations toward which the tax is directed the tax rates should be high enough to force distribution of earnings. The proposed rates would not accomplish this. From 1923 to 1929 nonfinancial corporations reporting incone paid dividends amounting to —5 ~ 57 percent of their income and retained f25>QOO,QQO,CKX>, Under the House schedules for large corporate incomes corporations co$ld continue to disbars© no larger percentage of their earnings as before in dividends sad yet pay & tax of only 14 1/8 percent of adjusted net income* It would still be profitable for w i t h y stockholders to have the corporations retain a large part of their earnings. Where this was done the purpose of the bill would be defeated* The tax on undistributed earnings, after equitable deductions, should b© high enough to force the distribution of earning® and to make it necessary for corporations to depend for expansion on borrowing or on the issuance of stock in the capital market* presents no difficulty. for big corporations! this This proposal would be the &ogt effective way of checking uneconomic bigness and of preventing important evasion of surtaxes* In essence* ay suggestions are that a heavy earnings tax b® imposed on a fe* thousand big corporations if they did not distribute their earnings in dividends. This tax would be store effective than the tax in the House bill in closing up a loophole in the present lawj it would greatly simplify the form and administration of the proposed taxj and could be easily explained and defended. It would also make the tax more popjtlar and the somber of its opponents much less numerous, because the large number of small companies would be relieved of the tax. A detailed discussion of the;1.-© and other changes is- contained in the acco&psnying wtmwnm&am•
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