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On January third, 1936, inrayannual "budget message to the
Congress, I pointed out that without the item for relief the "budget
was in "balance. Since that time an important item of revenue has
been eliminated through a decision of the Supreme Court, and. an
additional annual charge hps been placed on the Treasury through the
enactment of the Adjusted Compensation Payment Act.
I said in my budget messages
t * * * the many legislative Acts creating the
machinery for recovery were all predicated on two interdependent beliefs. First, the measures would immediately
cause a great increase in the annual expenditures of the
Government - many of these expenditures, however, in the
form of loans which would ultimately return to the Treasury.
Second, as a result of the simultaneous attack on the many
fronts I have indicated, the receipts of the Government
would rise definitely and sharply during the following few
years, while greatly increased expenditure for the purposes
stated, .coupled with rising values and the stopping of
losses would, over a period of years, diminish the need
for work relief and. thereby reduce Federal expenditures.
The increase in revenues would ultimately meet and pass
the declining cost of relief.
"This policy adopted in the spring of 1933 has
bben confirmed in actual practice by the Treasury figures
of 1934, of 1935, and by the estimates for the fiscal years
of 1936 and 1937.

There is today no doubt of the fundamental soundness of the policy of 1933. If we proceed along the path
we have followed and with the results attained up-to the
present time we shall continue our successful progress
during the coming years.11
If we are to maintain this clear e i and sound policy, it is
incumbent upon us to make good to the Federal Treasury both the loss
of revenue caused by the Supreme Court decision and the increase in
expenses caused by the Adjusted Compensation Payment Act. I emphasize that adherence to consistent policy calls for such action.
To be specific: The Supreme Court decision adversely affected the budget in an amount of one billion and. seventeen million
dollars during the fiscal year 1936 and the fiscal year 1937. This
figure is arrived at as follows;




Deficit to date (expenditures chargeable to processing taxes less processing taxes collected) in excess of
that contemplated in the 1937 budget ... $


Estimated expenditures to " e made from
supplemental appropriation approved
in the Supplemental Appropriation
Act, 1936".


Estimated expenditures to " e made
under the Soil Conservation and
Domestic Allotment Act


Total additional deficit 1936
and. 1937, due to Supreme
Court decision and adjusted
farm program


For the purposes of clarity, I divide the present total
additional revenue needs of the Government into the -permanent and the
temporary ones.
Permanent Treasury income of five hundred million dollars is
required, to offset expenditures which will " e made annually as a result
of the Soil Conservation and Domestic Allotment Act recently enacted
" y the Congress and approved " y me; and an additional sum recurring
annually for nine years will " e required to amortize the total cost of
the Adjusted Compensation Payment Act.
The net effect of prying the Veterans1 Bonus in 1936, instead of 1945, is to add an annual charge of one hundred and twenty
million dollars p year to the one hundred and sixty million dollars
already in the "budget.
We are called upon, therefore, to raise " y some form of perb
manent taxation an annual amount of six hundred, and twenty million
dollars. It may " e said, truthfully and. correctly, that five hundred
million dollars of this amount represents substitute taxes in place of
the old processing taxes, an^ that only one hundred and twenty million
dollars represents new taxes not hitherto levied.

I leave, of course, to the discretion of the Congress the
formulation of the appropriate taxes for the needed permanent revenue.
I invite your attention, however, to a form of tax which would accomplish an important tax reform, remove two major inequalities in our
tax system, and stop "leaks" in present surtaxes.

- 3 -

Extended study of methods of improving present taxes on income
from "business warrants the consideration of changes to provide a fairer
distribution of the tax load among all the beneficial owners of business
profits whether derived from unincorporated enterprises or from incorporated businesses and whether distributed to the real owners as earned or
withheld from them. The existing difference between corporate taxes and
those imposed on owners of unincorporated businesses renders incorporation
of small businesses difficult or impossible.
The accumulation of surplus in corporations controlled by taxpayers
with large incomes is encouraged by the present freedom of undistributed
corporate income from surtaxes. Since stockholders are the beneficial
owners of both distributed and undistributed corporate income, the aim,
as a matter of fundamental equity, should be to seek equality of tax
burden on all corporate income whether distributed or withheld from the
beneficial owners. As the law now stands our corporate taxes dip too
deeply into the shares of corporate earnings going to stockholders who
need the disbursement of dividends; while the shares of stockholders who
can afford to leave earnings undistributed escapes current surtaxes
This method of evading existing surtaxes constitutes a problem as
old as the income tax law itself. Repeated attempts by the Congress to
prevent this form of evasion have not been successful. The evil has
been a growing one. It has now reached disturbing proportions from
the standpoint of the inequality it represents and of its serious effect
on the Federal revenue. Thus the Treasury estimates that, during the
calendar year 1936, over four and one-half billion dollars of corporate
income will be withheld from stockholders. If this undistributed
income were distributed, it would be added to the income of stockholders
and there taxed as is other personal income. But, as natters now stand,
it will be withheld from stockholders by those in control of these
corporations. In one year alone, the Government will be deprived of.
revenues amounting to over one billion three hundred million dollars.
A proper tax on corporate income (including dividends from other
corporations), which is not distributed as earned, would correct the
serious two-fold inequality in our taxes on business profits if
accompanied by a repeal of the present corporate income tax, the
capital stock tax, the related excess profits tax and the present exemption
of dividends from the normal tax on individual incomes. The rate on
undistributed corporate income should be graduated and so fixed as to
yield approximately the sane revenue as would be yielded if corporate
profits were distributed and taxed in the hands of stockholders.
Such a revision of our corporate taxes would effect great simplification in tax procedure, in corporate accounting, and in the understanding of the whole subject by the citizens of the nation. It would
constitute distinct progress in tax reform.
The Treasury Department will be glad to submit its estimates to the
Congress showing that this simplification and removal of inequalities can,
without unfairness, be put into practice so as to yield the full amount
of six hundred and twenty million dollars - the amount I have indicated
above as being necessary.

Turning to the temporary revenue needs of the Government, there
is the item of five hundred and seventeen million dollars, which affects
principally the current fiscal year. This amount must in some way he
restored to the Treasury, even though the process of restoration might
" e spread over two years or three years.
In this case also the formulation of taxes lies wholly in the
discretion of the Congress. I venture, however, to call your attention
to two suggestions.
Thg first relates to the taxation of what may well " e termed
a windfall received by certain taxpayers who shifted to others the burden
of processing taxes which were impounded and returned to them or which
otherwise have remained unpaid. In unequal position is that vast
number of other taxpayers who did not resort to such court action and
have paid their taxes to the Government. By far the greater part of
the processing taxes was in the main either passed on to consumers or
taken out of the price paid producers. The Congress recognized this
fact last August and provided in Section 21 (d) of the Agricultural
Adjustment Act that, in the event of the invalidation of the processing
taxes, only those processors who had borne the burden of these taxes
should be permitted to receive refunds. The return of the impounded
funds and failure to pay taxes that were passed on result in unjust
enrichment, contrary to the spirit of that enactment. A tax on the
beneficiaries unfairly enriched by the return or nonpayment of this
Federal excise would take a major part of this windfall income for the
benefit of the public. Much of this revenue would accrue to the
Treasury during the fiscal years 1936 and 1937.
The other suggestion relates to a temporary tax to yield the
portion of five hundred and seventeen million dollars not covered
by the windfall tax. Such a tax coul d be spread over two years or
three years. An excise on the processing of certain agricultural
products is worth considering. By increasing the number of
commodities so taxed, by greatly lowering the rates of the old
processing tax and by spreading the tax over two or three years,
only a relatively light burden would be imposed on the producers,
consumers or processors.

The White House,

March 3, 1936.




The inequalities of present Federal taxes on business profits,
due to certain inequalities in our tax law, but more largely to
methods used by some stockholders to defeat its equitable provisions,
appear from a consideration of the following classification of taxpayers whose incomes are derived from business profits.
Income derived from an unincorporated business (whether individual or partnership) is subject to the individual income tax as earned,
the smaller taxpayer paying the 4$ normal tax thereon and the larger
taxpayer paying 4 t plus whatever surtax our present scale of surtaxes
imposes on the income group to which he belongs, in accordance with
the principle of ability to pay and benefits received.
suggested that this difference represents an inequity.

It is not
Indeed, it

avoids the injustice of treating as equal those who are in fact
To these two classes of taxpayers deriving income from business
profits, must be added the four different classes receiving the earnings of incorporated businesses.

They may be either small taxpayers

or large taxpayers, and each of these two classes in turn must be
subdivided into those to whom business profits are distributed as
earned and those whose business profits are retained by, or left in,
the corporations earning them.

Serious inequities appear, when the

tax position of each of these four classes of stockholders is compared
with that of the other three and with that of the taxpayers deriving
income from unincorporated business.

(a) The stockholder who has a small total income
and who receives corporate profits as earned does not pay

the 4$ normal tax thereon, "but the corporation has already
paid out of his share of corporate earnings the corporate
income tax, ranging from

to 15$, and also the capital

stock and excess profits taxes, while a man of equal total
income receiving an equal amount from an unincorporated
business pays only the 4$ normal tax,
(b) The stockholder with a large total income who
receives corporate profits as earned does not pay the
normal tax of

thereon, but hoshad deducted therefrom

by the corporation the three taxes just mentioned and is
subject to the surtaxes applicable to the income group to
which he belongs. His tax position is to be contrasted
with that of the large taxpayer deriving income from an
individual business or a partnership who does not have
subtracted the corporation income, capital stock, and
excess profits taxes.

On the other hand, his tax position

is to be contrasted with that of the large taxpayer who
leaves corporate earnings in the corporation, thereby
avoiding or postponing surtaxes to which the other two
classes of large taxpayers are subjected.
Thesp are the inequalities removed by the reduction of all
corporation taxes to a tax on undistributed corporate income. Under
it, business income of whatever kind and by whomever received is
treated alike and treated like all other kinds of income.

Taxes on Corporation Stockholders

Stockholders in low
income groups
: Proposed


Stockholders in high
income groups
: Proposed


Corporation net income:
Portion distributed

i a | - 15^


Portion undistributed

1 2 j - 15*


Capital stock tax

$1.U0 per $1,000
capital stock

Excess profits tax

6 - v4>


( 1 4 - 15;*

( 1 2 | - 155S

$1.H0 per $1,000



capital stock

6 - 12 -jb



Taxes on Owners of Unincorporated Businesses
Business net profits

Owners in low
inc ome groups
l Proposed




Owners in high
income groups
: Proposed
+ surtax

4- surtax

Advantages of the Proposal to Substitute a Tax on Withheld
Corporate Earnings for the Present Corporation Income,
Capital Stock, and Excess Profits Taxes.

The primary purposes of this proposal are to eliminate an

important source of unfair discrimination, tax avoidance, and unjust
duplication of taxation in our income tax law; and thereby to increase
the Federal revenues.

It is proposed to do this by repealing the existing corpora.-

tion income, excess profits, and capital stock taxes, and substituting
therefore a tax: averaging about 33-1/3 per cent on that portion of any
corporation's earnings that is not currently distributed to its stockholders.

The exemption of dividends from normal tax would be repealed

since its basis is the present taxation of corporate earnings whether
distributed or not.
3. When distributed to stockholders, corporate earnings are
subject to surtaxes ranging up to 75 per cent.

Corporate earnings

which are not currently distributed in dividends escape these surtaxes
for long periods or altogether, thereby creating an unfair discrimination.
All the earnings of a partnership or of an enterprise owned by a single
individual, whether reinvested or not, are now subject to our income

The present proposal would tend to Place all business,

whether incorporated or not, on the same basis for income tax purposes.

The present law also discriminates against corporate stock-

holders with small incomes.

The corporate earnings are subject to the

1 - , to 15 per cent corporation income tax. As against these rates
of 12^ to 15 per cent taken out of the earnings, the stockholder's




dividend receipts are exempted only from the 4 per cent normal tax..
Under the proposal, there would " e no corporation taxes to reduce the
amount distributed as dividends, and the small stockholder would pay
no tax at all, enly the normal tax, or only that tax plus a moderate
surtax, according to his total income.

Further, the present ability of corporations and of their

contidling stockholders to choose the timing of dividend distributions,
without any effect in the corporation^ tax liability and without
reference to current earnings, often results in a loss of revenue to
the Federal Government and an unjust avoidance of taxation by stockholders of large personal incomes.

The earnings withheld by a cor-

poration would often, if distributed, raise the surtax brackets of
many stockholders, thereby subjecting such earnings to the higher surtax rates.

When withheld for a time and then paid out in years when

the other income of important stockholders is smaller, such earnings
escape the higher rates to which they would have been subject.


dividual businessmen and partnerships possess no corresponding choice
for the timing of the distribution of earnings for income tax purposes.

The earnings withheld by corporations add no less to the

wealth and taxpaying ability of the shareholders than the earnings
distributed in dividends; for the reinvestment of corporate earnings
becomes reflected in the market prices of the stock, and in the increased earning power of the corporation.

Shareholders in corporations

that pursue liberal dividend policies are discriminated against because
they are not permitted to reinvest tax-free the corporate earnings
received a s dividends; whereas stockholders in corporations pursuing




niggardly dividend policies, under the present law, in effect reinvest
their share of the corporate earnings without payment of individual
income taxes thereon,
7. A discrimination in favor of incorporated business in the
present law is to be found in the fact that an individual who reinvests
in his business the large profits of one year, and subsequently experiences losses, is nevertheless subject in full to the income taxes
on the profits of his good year; whereas the stockholders of a corporation that similarly reinvests the large earnings of one year, and
subsequently suffers losses, escape individual income taxes on the
profits of good years which are so wiped out.

It is estimated that a tax averaging p^bout 33-1/3 per cent

on undistributed corporate earnings would approximately equalize the
individual surtaxes escaped by the undistributed earnings.

With such

a tax in effect, the Federal revenues would not be dependent on the
dividend.policies adopted by corporate management,

If the corporation income, capital stock, and excess profits

taxes were repealed, it is estimated that the net income available for

distribution in the calendar year 1936 would approximate

$6,909 millions.

The anticipated dividend disbursements to individuals

by corporations during 1936 amounts to $2,131 millions; therebygleaving
$4,778 millions available for additional dividend disbursements.


by reason of the proposed tax, this additional amount were distributed,
and all dividends were made subject to the 4 per cent normal tax, it is
estimated that the Treasury1s collections under the individual income

tax would " e increased " y approximately $1,608 millions.

The repeal of

the corporation income, capital stock, and excess profits taxes would
reduce the net gain in Federal revenue to about $640 millions.

If, on the other hand, corporations decided to withhold from

their stockholders the $4,778 millions of earnings available for distribution, and paid an average tax thereon of 33-1/3 percent, the net
increase in Federal revenues, inclusive of the 4 per cent normal tax on
such dividends as were declared, would approximate $676 millions.


other words, the proposed rate of 33-1/3 per cent on withheld corporate
earnirgs would approximately equalize the loss in Federal revenues
occasioned by the withholding from the personal income tax of reinvested
corporate earnings.

It is clear that this proposal, far from imposing any new

taxes on business, actually removes the largest single tax paid by
business enterprises.

The tax on withheld corporate earnings could

not be passed on to consumers nor passed back to workers.
tion need pay this tax.

No corpora-

To avoid it, the corporation need only pass

on to its stockholders, as earned, the earnings that belong to them

Nor does the proposal involve any increase in the individual

income tax rates.

Its primary result would be to make effective the

present income tax rates on a very large volume of income that now
escapes, an important part of ordinary income taxation.

The effect of this plan of taxation of business profits

would be to unshackle business in important respects, among which

is the effect of the proposed repeal of the capital stock tax and
the excess profits tax.

Such repeal would leave "business executives

entirely free to set up or alter their capital structures wholly on
the basis of what sound business administration requires.

They would

not need to consider the possible effect of changes in their capital
set-ups on the taxes which corporations would pay to the Federal

This would give latitude for any changes in capital

set-up designed to reduce fixed charges.

It may be objected that the proposed tax and the resulting

liberal dividend policies would tend to limit the expansion of business
enterprises by removing a present source of additional capital,
clear that this is not the case.

It is

Corporations that desire additional

capital for expansion, or additional liquid funds as reserves against
future plans or other contingencies, could obtain such capital, as many
of them regularly do now, by the sale of additional shares to their
stockholders or the latters1 nominees.

To take an extreme case, let

us assume a corporation that desired to reinvest in its business the
entire earnings of $5 per share, but that, nevertheless, decided to
pay out dividends of $5 per share in order to avoid the proposed

Such a corporation could easily obtain the reinvestment in its

business of this $5 per share by offering to its stockholders rights
to purchase additional capital stock at prices well below the prevailing
market prices.

The rights themselves would constitute a valuable market-

able instrument which could be sold by any shareholder who was not
disposed to reinvest his dividend check in additional stock of the
issuing corporation*