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Z-549 SPATMEKT OF MAHRIKEl S. ECCLES PRE8PI7TFD BEFORE WAYS AND MEANS COMMITTEE May 7, 1941 Mr. Chairman and members of the Committee: Vfnen I was advised of the Committee1s request that I appear here today, I undertook to prepare as briefly as possible a general statement of my views on the vitally important tax program which you are engaged in formulating. X would appreciate an opportunity tp read the statement first, and then to answer such questions as you may wish to ask. In what I have to say on this subject, 1 speak only for myself and not for the Board of Governors of the Federal Reserve System. At the outset I desire to say that I am fully in accord with the proposal of the Secretary of the Treasury that $3.5 billions of revenue needed for defense be raised from taxation. Likewise, I agree with the objectives of taxation policy sot forth by the Secretary when he appeared before this Committee. As he stated then, the purpose is to design our tax program, first, so that we may pay as we go for a reasonable proportion of our expenditures; secondly, so that all sections of the people shall bear their fair share of the burden; thix*d, so that our resources may be mobilized for defense while reducing the amount of money that the public can spend for comparatively less important things; and finally, so that a general rise in prices may be avoided by keeping the total volume of monetary purchasing power from outrunning production. As a nation we cannot get rich by devoting a large part of our energies and resources to producing the things of war instead of the things of peace. Our standard of living must inevitably suffer. That entails sacri- Z-549 - 2fices which should be borne by all of us. No group should be permitted to profit out of this great national emergency at the expense of other groups. Taxation is the most important instrument of Government in bringing about an equitable distribution of the costs of defense, in preventing profiteering and price inflation. We know that as the national income rises through defense expenditures, the incomes of many corporations and individuals will be greatly increased. Taxes should be levied in such a manner as to bring back to the Treasury as much as possible of the Governments expenditures. In keeping with democracy, taxation for this purpose should be based on income and ability to pay. Only in this way can we avoid inflationary developments. With such general principles we are all likely to agree readily enough. ?fhen it comes to applying the principles, as the members of this Committee know from long experience, there are always some groups that hope to escape, or hope to shift their fair share of taxation to other groups. In the suggestions I have to make I have sought to apply these principles as fairly and equitably as possible. Thus, it is my belief that the first source of defense revenue should be the corporation tax and the excess profits tax because, generally speaking, corporations are the greatest beneficiaries, directly and indirectly, from defense expenditures. The proceeds accruing from the expanding national income tend to become concentrated in the first instance in the possession of business corporations. The most certain way to insure against inflation is for the Government to lev/ on these earnings and divert the proceeds directly Z-549 - 3 into the defense program before they are distributed into the general income stream through higher wages and higher dividend payments. If these surplus funds are not thus collected in the first instance at the source, but are later distributed through large wage increases and large dividend payments to the community, it becomes necessary subsequently for the Government to abstract excess incomes through the personal income tax, excise taxes, and other forms of mass taxation. The problem is not avoided but only delayed and made more difficult by failure to tap the profits at the source. High taxation of personal income and excise taxation will be necessary in any event, but the amount needed from these sources will be reduced by a prior collection at the points where the profits originate, namely, in the business units. If excess profits are not tapped, they will lead to demands for higher wages. Apart from the question of eqtiity and the problem of allaying industrial unrest, is the question of going directly to the source of the increased flow of income and diverting it into the defense program before it spreads out into the community and adds private mass purchasing power on top of the Government's demands springing from the defense program. With increased surtax rates, especially in the middle income brackets, and in the absence of an undistributed profits tax, there \Till be a tendency on the part of some corporations to hold back disbursements of dividends. This is a further reason for heavy normal and excess profits taxes on corporations. After we have strengthened our corporation taxes to collect a substantial part of the increased national income at its point of origin, we should Z-549 - 4 rely predominantly on the individual income tax and on estate and gift taxes to meet most of our remaining revenue requirements. These taxes are based on the established principle of ability to pay. The normal tax and surtaxes on individual incomes have been moderate, compared with other countries, oxcept in the very highest income groups. They can and must be substantially increased. With expanding employment and payrolls resulting from defense expenditures, it is equitable and necessary that some of the benefits be recovered by the Treasury. Exemptions should be reduced, thereby spreading the base and increasing the number of income taxpayers. This is a more direct and equitable way of raising revenue from the lower income groups than by imposition of indirect excise and sales taxes. To the extent that prices are controlled and wages arc then increased, corporation profits, subject to the excess profits tax, are less than they would be otherwise. Federal revenue from this highly productive source would bo accordingly diminished, and the Government would, in effcct, be paying most of the wage increase. Under these circumstances, it is necessary for the Government to recovor some of this loss of revenue. This can be done by broadening the individual income tax base and increasing the rates. I am opposed to a general sales tax, or to an increase or imposition of excise taxes except where it is necessary to curtail civilian demand for products needed in defense, thus preventing inflation. Sales taxes may have been appropriate in poverty-stricken countries of the Old World where governments must extract revenue from their citizens in any fashion that is expedient. They are not appropriate taxes in this Z-549 - 5country where other sources of revenue are ample and the people are prepared to support an equitable tax program by the payment of direct taxes. Consumer expenditure can be restrained either by an increase in income tax, or by a tax on articles of mass consumption. The difference lies in the fact that the individual income tax does this frankly, directly and on the basis of ability to pay. A tax on articles of mass consumption does it indirectly ahd in a manner that makes the tax proportionately heaviest on those least able to pay. Indirect taxation is taxation by autocracies, income taxation is democratic taxation. Our existing tax structure is already heavily weighted with regressive taxes. According to the estimates furnished to this Committee by earlier witnesses, the income group below #500 paid 22 per cent of its income in taxes of all sorts in 1938-39, while those groups with incomes of from $500 to #10,000 averaged approximately 18 pqr cent. Inasmuch as increases in individual income tax rates will curtail purchase of luxury and semi-luxury goods, it is not advisable at this time to impose further sales taxes on such articles in the interest of defense. The only appropriate role for further excise taxes in our present economic situation consists in limiting the civilian demand for durable goods competing with defense. Selective sales taxes, which would have the cffect of reducing demand for such products as automobiles and other articles that compete with defense production for materials, man power or plant facilities, are justifiable and necessary at this time. Such selective taxes, by curbing demand in specific Z-549 - 6fields, will release facilities needed for defense production. Sales taxes on foodstuffs, clothing and other necessaries of which we have surpluses are entirely unwarranted, however. They would tend to throw out of work in various localities men who could not be absorbed into defense industries, or to make idle facilities that are not needed for defense. While I am, therefore, in general agreement with the Treasury1 s program both in its aggregate amount and in the general type of taxation it provides, I wish to suggest certain changes in emphasis with respect to the sources of revenue on which it draws. Accordingly, I should like to describe in some detail the changes that I believe would more nearly realise the objectives which I have set forth. I. Excess Profits Tax In my opinion an effective excess profits tax is the keystone of a well balanced tax program. Any tax program will have to include a substantial increase in the rates of taxation for corporate incomes in general and for individual incomes. You should not impose increased taxes on the great numbers of business concerns of small and moderate size and on millions of individual taxpayers until you have given them every reasonable assurance that the funds thqy are being asked to provide will not go to swell the excessive profits of some corporations. The excess profits tax now ou the statute books does not give any such assurance. If you allow the idea to take root in the public mind that through these vast expenditures a few are being made rich and a few who are already rich considerably richer, the result is bound to endanger the success of Z-549 - 7our defense effort. In order to prevent an inflationary spiral of price and wage increases, labor should be willing to moderate its demands for increased wages, but labor cannot be expected to follow such a course if employers are permitted to retain excessive profits. The Treasury has suggested that an additional $400 millions of revenue be obtained by amending the excess profits tax* I believe $800 millions to $1 billion of additional revenue can and should bo obtained from this source. The revenue-yielding potentialities of an excess profits tax were well demonstrated by our own experience during the World War. The present statute could be made to realize those revenue potentialities by changes in a few important respects. I shall mention three. 1. Restrict the use of the income method of computing the excess profits credit, either by reducing the 95 per cent of past average earnings now allowable to 75 per cent, or by any other method that may recommend itself to the Committee. I agree with Mr. Sullivan's view that all excessive profits, as well as profits directly or indirectly attributable to the defense program, should be subject to special taxation. 2. Increase sharply the rates now applicable to excess profits. In the light of the maximum 80 per cent rate in force in this country during the last World War, a maximum rate of 75 per cent is not too high. It is also important that the tax brackets used in the present law be revised. I recognize the strength of the arguments for graduating the rates according to the percentage of excess profits to invested capital, the method used at the time of the World War, but if the present method is continued, there is no reason why the maximum rate should not apply to excess profits at a very much lower level than #500,000. A corporation with this amount of excess profits cannot fairly claim favored treatment as a small enterprise. Z-549 - 83. Reduce the rate of return allowed under the invested-capital method of computing the excess profits credit from the present figure of 8 per cent to 6 per cent. The figure of 8 per cent was used during the days of the World War. The rate of return that investors could reasonably hope to realize on investment in securities has been materially reduced since that time. We should make a similar adjustment in cur ideas about an appropriate rate of return on equity capital. II. Surtax on Corporation Income If the excess profits tax is revised along the lines I have just indicated, it will then be fair and reasonable to ask American corporate enterprise as a whole to pay the surtax on corporate net income which the Treasury proposes. The argument for enacting a surtax, instead of raising the rate of the corporation normal tax, 3eems to mc to be clear and convincing. Since we have now stopped issuing tax-exempt Federal securities, there is no reason why we should confer additional tax benefits upon holders of outstanding securities by further increasing the normal corporation income tax rate. III. Individual Income Tax If the tax principles to \*rhich most of us adhere are to be effectively implemented, a substantial increase in the individual income tax must play a major part in the tax program now undergoing formulation. I am in accord with the view that the present normal tax and the present oarnod incomc credit be retained, and I agree also v/ith the proposal that the present $4,000 surtax exemption be abolished. I have felt, however, that the Treasury1 s suggested surtax rates impose too abrupt an increase on the middle brackets of individual Z-549 - 9 incomes. I should recommend, instead, a somewhat less drastic revision in the surtax schedule, combined with a reduction in the married persons' exemption to #1,500 and in the credit for dependents to $300. I should like to leave with the Committee a detailed schedule of rates ^vhich I have had prepared along these lines. No additional defense tax would be superimposed on the tax resulting from the application of these rates. According to our estimates the changes in rates and in exemptions which I propose would yield #1.2 billions of additional revenue. The middle income groups include many salaried people and others living on relatively fixed incomes who would be especially hard hit by oven a small rise in the cost of living. Too drastic an increase in their tax bill would necessitate many difficult and painful readjustments which it would seem unwise to impose suddenly* It is for this reason that I vur&e some modification of the Treasury's proposed rates in this nm^o of inccacs. At the sane time, I attach sreat importance to the changes in the married persons1 exemption and credit for dependents rhich I have proposed. Without some such broadening of tho individual income tux buso, this tax cannot pcrfoi^ii its full job in financing defense. An important segment of the national income, including tho ineones of Many skilled workers who are receiving substantial wage increases as a result of the defense pro&rua, is now excluded from the individual income tax base. Unless we tax the incomes of the betterpaid wage earners through progressive taxation, we may be unable to resist the pressure for taxing such incomes and our very lowest income groups as well, through the inequitable, shot-gun method of a sales tax. Any tax program which Z-549 - 10 failed to include such a broadening of our tax base would be unbalanced. Should more revenue be required in the future, a further broadening of the income tax base would be preferable to additional sales taxes. IV. Estate and Gift Taxes The strengthening of estate and gift taxes is one of the most needed reforms in our whole tax structure. In a message to Congress in June 1935, the President said: ff The transmission from generation to generation of vast fortunes by will, inheritance or gift, is not consistent with the ideals and sentiments of the American people. Such inherited economic power is as inconsistent with the ideals of this generation as inherited political power was inconsistent with the ideals of the generation which established our government .ff The task, begun in the Revenue Act of 1935, of bringing law into conformity with our American ideals should be completed now. For this reason I am thoroughly in accord with the Treasury proposals, but for this reason I believe also that we should go a great deal farther. Even a lowering of exemptions and a considerable increase in the rates of estate and gift taxation are only a part of the task. Th3 avenues for tax avoidance are both broad and numerous under our existing system of estate and gift taxes, and so long as these avenues are allov/ed to remain open, the task of bringing transfers of wealth within the framework of a progressive tax structure will remain incomplete. A rather extensive redrafting of existing statutes is, therefore, essential. Since detailed recommendations on methods of closing existing loopholes can be furnished only by qualified legal experts, I ahall merely indicate Z-549 - 13. the general principles which, in my judgment, should guide the revision of our estate and gift tax laws. I think there is little disagreement regarding the underlying purpose of estate and gift taxes. It is to subject the passage of wealth — from individual to individual and from generation bo generation — to an effective system of taxation at graduated rates. The amount of tax ought not to depend in any significant degree upon the form in which wealth is transmitted — whether directly or through life insurance or through taxavoidance trusts — nor upon the time of transfer — whether during life or at death. The following proposals are presented with these considerations in mind: 1. For the present exemptions of $40,000 under the gift tax, $40,000 under tho estate tax and an additional $40,000 for life insurance — a total of $120,000 — there should be substituted a single, consolidated exemption of $40,000 applicable to the sum of gifts and estate, including insurance proceeds. 2. Because the gift tax schedule is 75 per cent of the corresponding estate tax rates, many people have inferred that the net saving through transfers by gift is only 25 per cent. This inference is incorrect. At present tax liability at tho highest estate tax rates to which an estate would be subject can be avoided by incurring tax liability at the lowest gift tax rates. This type of avoidance can be prevented only by combining gift and estate taxes into a single tax on transfers of \*ealth. I prefer to leave to lawyers the explanation of the several possible methods of effecting such a consolidation. If consolidation were effected the taxpayer would be free to choose how much cf his property to dispose of during life and how much at death, but his tax liability would not be influenced by his decision. Until this step is taken, the opportunity to save a great deal on estate tax by payment of a small gift tax will remain open. 3. Under existing statutes estate and gift taxes can frequently be either entirely avoided or substantially reduced through the use of various devices invclving long-term trusts. This avenue of avoidance should be closed, so that the estate tax may reach all transfers of property from one generation to anotixer. Z-549 - 12 V. Consumer Taxes For the reasons previously indicated, excise taxes should be imposed only on consumers1 durable goods. The rates should be substantial and should be fixed to achieve the required degree of curtailment in civilian demand. Although revenue should not be the primary consideration in fixing the level of rates, the revenue obtained from this source will be large. Adequately high rates on this range of goods should yield close to one billion dollars. A large part of this revenue can be obtained through taxation of automobiles alone. The automobile industry has already committed itself to curtailing production by 20 per cent in its next model year, at a time when the national income, and the civilian demand for new cars, are rising rapidly. A rise in prices of considerable magnitude is in prospect. The Government should take a much greater share of the increased price people will be paying for both new and used autoiaobiles than the Treasury proposes. A tax of 20 per cent on all automobile sales would be more appropriate than the suggested rate of 7 per cent on new cars only. Increase in the tax on gasoline and other commodities that are in abundant supply will make no significant contribution to our defense effort. The proposed check tax is another case in point. Checks, rather than currency, are used to settle some 80 per cent of our total transactions. There is no more reason to tax checks than currency payments. For many it will be a simple matter to avoid the tax by using currency instead of checks. Depositors of small means, already subject to bank service charges, will be the group most likely to avoid the tax in this way, but they will thus be deprived of a safe and convenient way of making money payments, as well as a record of receipts Z-549 - 13 and payments. The tax will not come out of bank earnings, but will be charged to the individual accounts. VI. Revenue Yield The following table, which I ask permission to insert in the record, summarizes the yields from various revenue sources under the suggestions I have made. There is no significant difference between the aggregate yield of this program and the Treasury proposals. Z—549 - 14 - (Yield in millions of dollars) « * Source Corporation incmes: Excess profits tax (lower credits, raise rates) Surtax as proposed by Treasury Yield 900 534 Individual incomes: Increase in surtax rates, reduction of married personfs exemption and credit for dependents 1,200 Estates and gifts (close loopholes, raise 500 rates) 950 Excise taxes, primarily on durable goods 4,084 Less: Loss to Loss to Gross yield of excess profits revenue due surtax on corporate income of individual income taxes due increases in corporation taxes Net yield 500 150 450 3,634 • 15 - Z-549 EXISTING AND PROPOSED SURTAX RATES t t Existing J^ Proposed ^ < 1 Surtax net income * Rate • Total surtax 1 Rate Total surtax f ($000) (per cent) yon upper limit t (per cent) 'on upper limit 0 1 2 4 6 8 10 12 14 16 18 20 22 26 32 38 44 50 60 70 80 90 100 150 200 250 300 400 500 750 1,000 2.000 5,000 to to to to to to to to to to to to to to to to to to to to to to to to to to to to to to to to and 1 2 4 6 8 10 12 14 16 18 20 22 26 32 38 44 50 60 70 80 90 100 150 200 250 300 400 500 750 1,000 2,000 5,000 over 0 0 0 4 6 8 10 12 15 18 21 24 27 30 33 36 40 44 47 50 53 56 58 60 62 64 66 68 70 72 73 74 75 0 0 0 80 200 360 560 800 1,100 1>460 1,880 2,360 3,440 5,240 7,220 9,380 11,780 16,180 20,880 25,880 31,180 36,780 65,780 95,780 126,780 158.780 224'.780 292,780 467,780 647,780 1,377,780 3,597,780 4 6 10 14 18 21 24 27 29 31 33 35 38 43 47 51 54 58 61 64 66 67 69 70 71 71 72 73 74 74 75 76 76 40 100 300 580 940 1,360 1,840 2,380 2,960 3,580 4,240 4,940 6,460 9,040 11,860 14,920 18,160 23,960 30,060 36,460 43,060 49,760 84,260 119,260 154,760 190,260 262,260 335,260 520^260 705,260 1,455,260 3,735,260 Dear Marriner: At the risk of boring you, may I repeat the arguments in favor of only a reasonable increase in tax rates on income from #2500 to $25,000. 1« The heavy taxes proposed by the Treasury will seriously impair the defense baby bond campaign, since those earning from #2500 to $25,000 are probably the largest group of baby bond purchasers* 2. Such heavy rates as proposed by the Treasury will unfairly penalize all professional groups such as teachers, doctors, engineers and business executives of small and mediumsized concerns. 3# To heavily increase taxes suddenly on this same group may not only restrict consumer purchasing power but temporarily bring about a real measure of deflation. It is true that this class are responsible for only 1-1/2 to 2 billions of purchasing power. But to drastically cut down this purchasing power is to cut down the last 10$ of from 15 to 20 billions of general sales. In other words, manufacturers and merchants selling 15 to 20 trillions of goods or merchandise will run the risk of encountering a drastic sell-off of from 5 to 10$ which, in mary cases, means the difference between a profit and a loss. The economic dislocation, as a result of such action, might be serious, even though only temporary. 4* If it is said that the above arguments are fallacious, and the income derived from these brackets is so relatively small as to not affect the total income picture seriously, then that fact in itself is all the more reason why we should be careful to act equitably toward a class who are the real backbone of our intellectual and commercial economy. 5* All these arguments point toward (1) A scaling off of the Treasury rates on income from |2500 to $25,000. (2) A scaling up of corporation Excess profits rates to compensate for the deductions under (1). (3) A total tax increase of the same amount as mentioned by the Treasury. May 6, 1941 May 8, 1941. STATEMENT BEFORE WAYS AMD MEANS COMMITTEE Ways and Means Committee Treasury Press Room ... . • ••• National Press Club Federal Reserve Press Table . Mr. Krost .•... Dr. Goldenweiser Automobile Manufacturers Association, Washington, D. C. . Independent Petroleum Association, Washington, D. C. ... Board Members .... Bureau of National Affairs, Washington, D. C .... Ellsworth Alvord, Washington, D. C. .....•.•..•.•••...•. Harold R. Young, Washington, D* C. . .... Walter Lippmann Professor Hansen John H. Rumbaugh, New York City William R. Kuhns, Editor, Banking Magazine, New York City Dr. Walter E. Spahr, New York City ..... American Bankers Association, Washington, D. C. ........ Clerk, Ways and Means Committee ....... H. L. Merillat, Treasury Department Mr* Krost American Automobile Association, Washington, D. C. ..... United Typothetae of America, Washington, D. C Federal Reserve Banks and branches Board Mailing List , Circulation in building .............. Federal Reserve Press Table Joseph 1. Davies, Washington, D. C. Wayne C. Taylor Dr. Currie Leon Henderson •..........•.«•.....••»... Daniel W. Bell Herbert 1. Gaston Treasury Press Relations Miss Donald, Securities and Exchange Commission National Automobile Dealers Association, Washington, D.C. B. Frank Coe, Treasury Department Total 75 30 25 '15 2 2 3 1 4 2 2 2 1 2 1 1 1 15 25 2 12 3 1 400 100 100 15 1 1 1 2 1 1 2 6 1 2 860 May 13, 1941. WAYS AND MEANS COMMITTEE CTATMEMT Copies previously sent ...... ......•••••.860 A. C. Oliphant, Washington, D. C. (Publishes a news letter for utility concerns; requested copies for distribution to clients who have expressed desire to see full text) C. H. Mann, Washington, D. C. ••••.••.••••••••••••••••••.. T. R. Goldsmith, Washington, D. C. Automobile Manufacturers Association, Washington, D. C. .. Harold Rosen, Brookings Institution Idison Electric Institute, New York City Miss Burgess, Federal Reserve Library ...... Robert H. Hinckley . . Bureau of National Affairs, Washington, D. C D. L. Tiely, President, Brooklyn Chamber of Commerce Commander Walter F. Chappell, Navy Department ••••••• Mr. Despres ...» John Oudine, Time Magazine, Washington, D. C .. Mr* Ransom ..••••..... Mr* Draper Total 50 1 1 5 2 10 5 1 60 1 2 3 1 1 1 1004 May 29, 19Ul* WAYS AND MEANS COMMITTEE STATEMENT Copies previously sent look Mr* Hutson Mr. Love Ur« Monroe William R. Kuhns, New York City John H. Rumbaugh, New York City •••••••• Bland Roland, Washington, D* C* ••••••••••• Arthur Carley, American Automobile Assn., Wash* • • James S. Taylor, Federal Housing Administration •• B. J. Reis, New York City . .. Samuel Sharpe, New York City Federal Reserve Bank of Minneapolis ••»•«»•••••«•• £• W. Schietinger, Pittsburgh, Pennsylvania W» F. Harbranft, Jersey City Heights, N# J. Congressional Intelligence, Washington, D# C. Total 15 10 6
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