Full text of Marriner S. Eccles Papers : Statement of Randolph E. Paul, Tax Adviser to the Secretary of the Treasury, Before the Ways and Means Committee of the House of Representatives on Tax-Exempt Securities, Box 25, Folder 10, Item 2

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Statement of Randolph E. Paul,
Tax Adviser to the Secretary of the Treasury,
Before the Ways and Means Committee
of the House of Representatives
on tax-exempt securities
April 16, 1942
I.

THE ECONOMIC ISSUES

In his statement to your Committee on March
tary of the Treasury recommended the taxation of
standing, as well as future, issues of State and
I should like now to discuss this recommendation
present supporting evidence. 1/

3* 1942, the Secreinterest from outlocal securities.
more fully and to

The present war emergency makes the immediate elimination of
tax-exempt securities an important step in sound war finance. Under
war conditions, the withdrawal of the tax immunity from future issues
alone will not be enough. What is required now is the immediate
removal of tax exemption in all cases in which the Federal Government
is not bound by its own- pledge.
1•

The revenue loss from tax exemption is substantial

The annual loss in revenue from the tax exemption of State and
local securities under the rates proposed by the Treasury is estimated at $275 million 2/, at 1942 levels of business,
2#

The revenue loss from tax exemption will continue to increase

This is a large amount; but the continuance of the existing tax
exemption would not stabilize the revenue loss even at that large
figure. If the tax exemption were removed only from future issues,
a considerably larger revenue loss could result merely from the
shifting of outstanding issues from holders subject to little or
no income taxes to those subject to higher rates.
Of the $20 billion of such securities outstanding on June 30,
1941, $12*2 billions were held by tax-exempt institutions, governments, banks, insurance companies and, to a small extent, other
business corporations. (Table 1 & Chart 1) The securities of these
holders are a huge reservoir from which individuals could increase
their tax-free holdings by as much as 150 percent, even if the tax
exemption privilege were immediately removed from all new issues*
Additional shifts are possible from individuals in low Income groups
to individuals in high income groups.

Some of the detailed evidence is supplied in appendices*

At present rates the loss is estimated at $184 million.

31-19

- 2 -

All such transfers of outstanding; tax exempts to individuals with
large incomes yield nothing by way 'of lower interest rates to State or
local governments* The benefits of such transfers are confined mainly
to the sellers, who obtain windfall capital gains, and to the buyers
who obtain exemption from regular and wartime income taxes.
3#

Tax rate increases stimulate tax avoidance

Even before 1941, the trend toward the concentration of tax-exempt
securities in the hands of individuals in the upper income brackets had
become noticeable. State and local securities have constituted an
increasing percentage of the total assets of large estates, and there
has been a pronounced and consistent tendency for tax-exempt securities
to constitute a greater percentage of the larger than of the smaller
estates. For net estates of $1,100,000 and over, State and local
securities averaged 6*2 percent of the gross estate in 1928 and 15*1
percent in 1940. (Table 2 and Chart 2 )
We may reasonably expect a further increase in the movement of
tax-exempt securities into the hands of those with large incomes
because the recent and anticipated tax rate increases provide new and
powerful motives to individuals with large incomes to use this means
of tax avoidance. Under the 1942 tax rates proposed by the Treasury,
an individual with a surtax net income of $100,000 from other sources
would obtain as large a net return, after taxes, from a 2^ percent
municipal bond as from a taxable investment yielding 20.8 percent.
Other illustrations are presented in Table 3#
U%

The outstanding tax-exempt securities were not purchased in
anticipation of war-time tax rates

The continuance of the tax exemption of interest on State and
local securities enables the holders of these securities to avoid
not only the pre-war scale of income taxes, but also the tax rate
increases necessitated by the war. Most of the outstanding bonds
were issued long before there could have been any serious expectation
of war-time tax rates. Of the $20 billions of State and local securities outstanding, $14«4 billions, or almost three-quarters of the
total, has been outstanding for five years or more, and $10.7 billions,
or over half the total, for ten years or more. (Table 4)
Tax exemption enables the holders of State and local securities
to enjoy an exemption for which few, if any, can be said to have paid
a price at all commensurate with the benefits received. Insofar as

- 3 -

the coupon rates of interest and the market prices of State and local
securities reflected the tax exemption privilege at all, they reflected
exemption fromjuuch lower tax rates than those in prospect, and, in
most cases, than those already in force* A person with income from
other sources of $100,000> who purchased a 4 percent tax-exempt security in 1929, obtained therefrom the equivalent of a taxable return of
5.26 percent under 1929 rates. Under the rates proposed by the
Treasury this individual would derive as much benefit from his 4 percent
tax-free bond as he would from a taxable security yielding 33 1/3 percent.
(Table 5)
59

Holders of tax-exempt securities have enjoyed substantial
vdndfalls during recent years

Because of the rise in tax rates, and also because of the decline
in interest rates, most holders of tax-exempt securities have enjoyed
substantial windfalls during recent years. The most common rates of
interest on State and municipal bonds now outstanding are 4 to 4s percent, whereas the present market yield of such securities is generally
below 3 percent. (Table 6 and Chart 3) For 1941 the average coupon
rate on all outstanding State and local government securities was just
over 4 percent, while the Standard Statistics Company1s index of municipal bond yields for April, 1942, was only 2.49 percent.
6.

Tax exemption results in inequitable taxation

Tax-exempt securities produce sharp inequalities in tax burdens.
Persons with income from property are in a position to benefit most
from this means of tax avoidance; persons who derive their incomes
from earnings benefit least. Every increase in tax rates increases
the importance of these inequalities.
The discrimination between individuals and between classes of
individuals constitutes, from an equitable standpoint, the most fundamental of all the objections to tax-exempt securities. A survey of
twenty-five actual returns for the taxable year 1940 reveals ho?/
striking are the differences in burden resulting from tax-exempt
securities. If the rate schedule proposed by the Treasury were
applied to the tax-exempt, as well as the taxable, income reported
on these returns, the aggregate tax liability would be almost doubled —
$21 # 4 million, instead cpf $12.5 million. Several of the cases summarized in Table 7 are spectacular. In one case, out of a total
reported income of approximately §974/600, no less than $668,700
came from State and local securities. The taxi'liability under the

~ 4 -

proposed rates would be $254,300, if the tax-exemption privilege were
retained, but $856,100, if the tax-exemption privilege were removed*
In a second case, $817,400 out of a total income of $1,106,300 was
in the form of State and local interest. The tax liability of
$239,600 under proposed rates would be raised to $975,300 if the
entire income were taxable.
7»

The premium paid for tax-exempt securities does not reflect
the value of the tax exemption

The differences between taxes paid by recipients of taxable and
tax-exempt income would be less inequitable if the holders of taxexempt securities had paid a premium that reflected in full the value
of the tax exemption. This is not the case. The price that is set
upon the tax-exemption privilege in the open market differs substantially in most cases, and spectacularly in the extreme cases, from
the value of the exemption privilege to the individual purchaser.
The current market value of the tax-exemption feature of State and
local securities is roughly, 1/2 of 1 percent. This means that an
investor who purchases a municipal bond must content himself with
a yield that is about 1/2 of 1 percent lower, before allowance for
taxes, than the yield he could obtain from a corporate bond, of comparable quality. But to an individual with a surtax not income of
$150,000, under the rates proposed by the Treasury, the tax—exemption
feature of the municipal bond is worth five times as much as he has
to pay for it. A high grade 3 percent corporation bond purchased
at par would yield him only 3/10 of 1 percent after income taxes,
compared with the
percent tax-free yield that he could get from
a municipal bond of at least pomparable quality. The investor pays
a half percent. It would be worth his while to pay as much as
2 # 7 percent.
The value of the tax-exemption privilege varies with the size
of individual incomes. To a person with an income below the personal
exemption, a 3 percent tax-free security is worth no more than a taxable security of comparable cost. To a married man with no dependents, with a net income of $10,000, the same 3 percent tax-free
security is equivalent, under the proposed rates, to a taxable issue
yielding 4.84 percent• To a similar individual with a net income of
$100,000, the 3 percent tax-free security is equivalent to a taxable
security yielding 25*0 percent; and to an individual with a taxable
income of half a million dollars, to a taxable security yielding
30 percent. (Table 3)

- 5 -

If the volume of State and local securities were so small that
the whole amount available was purchased by individuals in the upper
income brackets, the premium paid for these securities in the form
of lower interest rates might reflect roughly the value of the tax
exemption to the purchasers. However, the larger part of the outstanding securities was held by Federal and State trust funds,
banks, insurance companies, and other corporations. (Table 1)
Some of these institutional investors enjoy a tax-free status.
To them the tax exemption feature has no value at all. Others are
subject to effective rates of taxation much lower than the rates
imposed on income received by individuals in the upper income
brackets. Normally, the price paid for a privilege of this sort
in the open market will reflect the importance of that privilege,
not to the most urgent, but to the least urgent of the actual
buyers. That is to say, the premium paid for the tax-exempt security will reflect the importance of the exemption privilege to
those among the buyers to whom the privilege is worth the least.
Purchases to avoid taxes are not the only factors affecting
the yield of State and local securities. Some investors, because
of legal requirements, their desire for greater safety, or ignorance
of superior alternatives, purchase or retain State and local securities even at some sacrifice in interest rates and without any regard
to the tax exemption. Many wealthy individuals do not choose their
investments solely with an eye on net yields after taxes. They are
also influenced by the desire to control particular business enterprises, and reluctance to alter radically the composition of large
bequests or other large holdings, particularly when such an alteration would entail the liquidation of properties with poor markets.
The net balance of these factors has been such that wealthy
individuals have consistently been able to purchase tax exemption
at bargain prices. This fact is reflected in Tables 3 and 9 and
Charts 4 and 5, which show the spread in yield'between corporate
and municipal bonds is small relative to possible tax benefits.
8.

The removal of the tax exemption will not reduce State and
local sovereignty

The claim is frequently made that the removal of tax exemption
would undermine State and local sovereignty. Some persons have
argued as if the adoption of this proposal would give the Federal
Government the power to levy special or discriminatory taxes upon
any or all operations of State and local governments. Nothing
could be further from the truth. The elimination of tax exemption

» 6 •

would not give the Federal ferernment tkc rigk% to tax State and
local interest at rates any higher than apply to other form3 of
income. It would give the Federal Government no new powers ever
the operations of State and local governments*
The securities ef local governments in Great Britain do not
enioy exemption fr&n the ijieome tax ef the central government, no*
do those of the local governments and provinces of Canada or
Australia. Further, in subjecting interest from State and local
securities to the same tax laws that apply to other kinds of
incomc, the Federal Government would only be doing what all of the
thirty-two States imposing personal income taxes already do themselves with respect to the obligations of ether States and the
subdivisions thereof, (Table 10)
9.

Elimination of tax exemption would only moderately increase
State and local interest costs

The removal of tax exemption it frequently opposed on the
ground that it would greatly increase State and local interest
costs. These fears appear to be exaggerated. Tax exemption is
only one of the many influences affecting the market rate of interest for State and local securities* Some persons mistakenly
ascribe the whole difference betv/cen corporate and municipal bond
yields to the tax exemption privilege» But a large part of the
difference is due to the superior quality or greater safety of
State and local obligations. The differential in yield in favor
of municipal bonds was greater in 1900, before the adoption of the
Federal income tax, than it is today. (Table 9)
Although the precise effect ef the tax-exemption privilege on
the market interest rate is subject to some difference of opinion,
the Treasury believes that i-i is somewhere between one-fourth and
five-eighths of one percent. Hence, it is reasonable to suppose
that the removal of the tax~exemption privilege vrould increase
interest rates on new State and local issues by something less
than one-half of one percent on the average,
The interest costs of outstanding obligations would not be
affected unless and until the obligations were refunded by new
issues. It will be 1970 before 90 percent of the outstanding
State and local obligations have inatured* 1/ (Table 11)
1/

The fact that new plu*-refunding issues have been appearing at
the rate of a billion a year must not be made the basis for tho
expectation
the entire outstanding debt will havo been re-»
funded in twenty years* £ portion of the refunding issues merely
replace securities which ia thenselves were refunding issues*

- 7 -

If other interest rates remained at approximately their present
levels, the refunding of outstanding tax-exempt obligations with
taxable securities would not increase the interest costs of State
and local governments in the vast majority of cases since the removal of the tax exemption would be more than offset by the drastic
decline that has taken place in the general level of interest rates.
In recent years new and refunding State and local issues have
averaged about $1 billion annually. If this volume should continue,
the immediate effect of the elimination of the tax immunity would
be an increase in State and local interest costs of about $5 million
during the first year* Eventually, the annual difference would
reach about $100 millions if the debt of State and local governments
remained at its recent level.
The net cost to State and local governments would be less than
$100 million, since they would obtain increased revenues from the
application of their income taxes to new Federal issues, if Congress
consents to such taxation.
10.

Tax exemption should be appraised as a .joint Federal, State,
and local problem

The individual citizen is not only a citizen and taxpayer of
his city and Statej he is no less a citizen and taxpayer of his
national government. He is subject at one and the same time to
taxes imposed by all governments, — Federal, State,, and local.
The additional burden imposed on the . State and local governments
must be balanced against the now revenue that would be derived from
Federal taxation. The net burden on the taxpayers of the Nation
as a whole will not be increased by the removal of the exemption
privilege. Whereas the immediate difference in Interest costs to
State and local governments would be about
million a year and
the ultimate difference in the neighborhood of $100 million a year,
the Federal Government would, under the proposed rates for 1942,
avoid an immediate annual loss in revenue of $275 million and the
possibility of even larger future losses in revenue. Finally, the
taxpayers of the nation as a whole would be benefited by the elimination of an important source of tax avoidance3 and by a resulting
increase in the equity with which the total tax load is distributed
among our citizens.

II.

THE- LEGAL AND CONSTITUTIONAL ISSUES INVOLVED IN THE PROPOSAL
OF T13E TREASURY MARCH 3, 1942 TO ELIMINATE TIE EXEMPTION OF
INTEREST ON OBLIGATIONS OF STATES AND THEIR POLITICAL SUBDIVISIONS

The Congress possesses the power to levy a tax on incomes.
Interest paid on State and municipal obligations clearly constitutes
income. It would follow, therefore, that such interest is subject to the
Federal income tax. Certainly there is no provision of the Constitution
which prohibits the imposition of a Federal income tax upon the interest
derived from State and municipal obligations. The only possible basis
for questioning the constitutional validity of such a tax is therefore
the assertion that the holders of such obligations are cloaked with an
immunity that may, be implied from the Constitution. In 1895 the
Supreme Court in Pollock v. Farmers Loan & Trust Co., 157 U.S. 429;
158 U.S. 601, stated that such an immunity existed. But the foundations
of this opinion have been so weakened by subsequent decisions that it
cannot withstand a direct attack. With it falls the only barrier to
the validity of a Federal income tax on the interest received by such
bondholders.
A.
The belief that the Pollock decision has no validity today rests
upon these bases: First, it may be argued that the adoption of the
Sixteenth Amendment to the Constitution affirmatively sanctioned taxation of the income from State obligations, through the express grant
of power to the Congress !,to lay and collect taxes on incomes, from
whatever source derived."
Second, every other claim to private immunity from Federal income
taxation, even those formerly recognized by the Court, has now been
rejected. The income derived by Government contractors from their
contracts was denied immunity in Hot calf & Eddy v. Mitchell, 269 U.S.
514 (1926) and James v. Dravo Contracting; Co., 302 U.S. 134 (1937);
the in conic derived by lessees of Government property from their leased
property was denied immunity in Helvering v. Mountain Producers
Corporation, 303 U.S. 376 (1936); the income derived by Federal judges
from their salary was in effect denied immunity in O'Mallcy v. Yfoodrough,
307 U.S. 277 (1939). Most significant of all, State employees, who had
enjoyed under Collector v. Day, 11 Wall-. 113 (1870), an immunity from
Federal income taxation antedating that given to the bondholder by the
Pollock case, were held in Graves v. O'Kcofo, 306 U.S. 466 (1939, to be

- 9 -

subject to Federal incomc taxation on their salaries. Like the State
employee, the bondholder offers services, his capital, to the State at
a price and like the employee that price must pay its contribution to
the Federal revenues.
Third, the theoretical basis of the Pollock decision, that a tax
on the income from State obligations is equivalent to a tax on the
bonds themselves and thus is a tax on the power of the State to borrow
money, has been flatly rejected by the Supreme Court. In Craves v.
0 1 Keef e, Justice Stone said: 11 The theory, which once won a qualified
approval, that a tax on income is legally or economically a tax on its
source, is no longer tenable." In place of that discarded theory there
has been substituted by the Supreme Court the view that a non-discriminatory Federal income tax, directed at all citizcns alike, is valid as
against any claim to constitutional immunity based upon dealings with
State governments. That the economic burden of a State sales tax upon
materials sold to a "cost-plus-a-fixed-fee" contractor with the Federal
Government "is but a normal incident of the organization vdthin the
same territory of two independent taxing sovereignties11 was recently
announced in Alabama v. King; & Boozer, 314 U.S# 1 (1941)* From this
case it would follow that any burden that may be passed on economically
to State governments bccausc of a tax upon the interest derived from
bonds issued by such governments is but the normal incident of the
existence of two governments within the same territory. Such an
indirect and incidental cffcct does not warrant a restriction of the
Federal taxing power.
Fourth, great emphasis is placed by the Supreme Court in its
recent opinions on the duty of all individuals to contribute their
share to the costs of Government. Equally stressed is the recognition
of the dangers inherent in placing restrictions upon the Federal taxing
power. The Court has thus dearly rccognizcd that recognition of any
immunity on the part of the holders of State obligations would relieve
one group of taxpayers from the duty of financial support to the
national Government and curtail the sovereign power of that Government
to maintain its existence. When the issue is so viewed, the urgency of
our present needs for revenue, greater than ever before, compels the
conviction that the Supreme Court rail refuse to exempt the holders of
State bonds from their obligations to the Nation•

~ 10 -

B.
Some individuals have asserted that while the Federal Government may possess the power to tax the interest on future issues of
State and municipal obligations, such power does not extend to the
interest on the outstanding obligations* They support this assertion
by claiming that a contract of exemption exists between the Federal
Government and the holders of such outstanding obligations*
However, no such contract exists. Although the various revenue
acts have excluded from gross income the interest upon such obligations, the exemption provisions in these acts cannot be regarded
as contracts between the Federal Government and the States or the
bondholders. This exemption, like any other exemption, is simply
an expression of legislative policy which may be changed at any time*
If such a provision were said to be a contract, on like grounds a
salaried taxpayer might claim he had a binding contract right to the
earned income credit, a father to the credit for dependent children
and so on. In short, to the^e taxpayers, and to the taxpayer who
possesses State and local obligations, the Federal Government has
made no promises that existing laws would not be changed*
But, it has been asserted, while no contract exists, at least
there is a moral obligation upon the Federal Government not to tax
such interest in view of the exemption existing at the time of their
issuance. But here again the granting of an exemption does not carry
with it the understanding that it will be forever continued. Ho doubt
many investors expected a continued tax-free yield when they purchased
the obligations. But it has been pointed out previously that such
expectation did not extend to the high rates necessitated by emergency
conditions. And every taxpayer takes the chance that the rates of tax
and the exemptions thereunder will change* Any other view of the
situation would turn the tax laws into static rules and by thus straitjacketing revenue legislation make it impossible for the Congress to
adapt its tax policies to changing conditions.

Finally, it has been contended that the history of the ratification of the Sixteenth Amendment proves that at that time it was the
understanding that the words !tfrom whatever source derived" did not
give to the Congress the power to levy a tax upon interest from State
and local obligations, ffhe communications and speeches of Senators Borah
of Idaho and Root of New York have been cited in an effort to show that

- 11 -

Congress did not intend to tax the interest on State and municipal
obligations. It should be noted that this issue was not raised until
after the Amendment had "been submitted to the States for ratification.
In fact, there is nothing that was said in the course of the debate in
the Congress from which it may be inferred that a single Member expected
or intended that the income from State and municipal bonds and the
salaries of State and municipal officers and employees should be constitutionally immune under the proposed amendment.
When the Sixteenth Amendment was before the New York State Legislature for ratification, Governor Hughes recommended its rejection on
the ground that the Amendment gave to the Federal Government the right
to tax the interest on State and municipal securities. Senator Root
took the position that the Amendment merely dealt with the problem of
apportionment and did not affect the inherent power of the Federal
Government to tax incomes. In other words, the Sixteenth Amendment
simply permitted Congress to levy an income tax without apportionment
among the several States, and that therefore the Amendment did not give
to the Congress any power that it did not previously have, so that the
rule of the Pollock case was unaffected by its passage. This was also
Senator Borah1s position. While the Hew York Legislature rejected
the Amendment on Governor Hughes1 advice, it was ratified by that State
after his departure from office. It is thus apparent that at the time
of the ratification of the Sixteenth Amendment by the several States
there was reputable authority on both sides of the question with respect
to the taxability of interest upon State and local obligations.
There is, however, a stronger answer to this contention. As
indicated above, the observations of Senators Borah and Hoot amount to
the assertion that the Pollock case was unaffected by the adoption of
the Sixteenth Amendment. But the rule of the Pollock case has since
been rejected by the Supreme Oourt, so that there is no immunity afforded
by the Constitution to the interest on these obligations. In this light
the references to the Sixteenth Amendment become wholly irrelevant.

Table 1

Tax-exempt State and local securities,
by classes of holder, June 30, 1941 1/

Class of holder

[

Individuals 2/
Commercial banks
Insurance companies
Corporations other than banks
and insurance companies
Tax-exempt holders:
Federal funds
State and local government
funds J/
Mutual savings banks
Other tax-exempt institutions

Estimated amounts
at par value
(in billions of
dollars)
7.8
3.7
2.1
.5
.7
4*1
.5
.6

All tax-exempt holders
All holders

Source:

5.9
20.0

Treasury Bulletin, February 1942 and Annual
Report of the Secretary of the Treasury, 194-1.

Including securities of Territories and insular possessions.
2/ Including estates and trusts.
_2/ Including trust, investment, and sinking funds, and
holdings of Territorial and insular governmental funds.

Table 2
State and local government, securities as a percent
of gross estate, by size' classes of net estate,
estate tax returns filed in 1928-1940.

Filing
year

: Net estate. 1/
:
100 :
200
: under : under
200 :
300
:

(in thousands of dollars)
: 300 :
500
: 1,100
: under 5 under :
and
: 500 : 1.100 2/ :
over

(State and local government securities as percent
of gross estate)
1928
1929
1930
1931
1932
1933
1934
1935
1936
1937
1938
1939
1940

Source:
1/
2/

1.6
1.4
1.9
2.2
2.9
3.4
3.6
3.0
3.1
2.9
3.2
3.1

2,3$
i.a
2«4
2.5
2.6
5.1
4*4
5.7
5.4
5.3
4*4
4#4
3.6

2.1%
2.2
3.0
4.2
5.0
6.6
5.8
6.7
6.3
5.7
5.3
7.1
6.2.

4.3$
4.5
3.6
4.8
8.3
11.2
10.0
11,0
8.2
9.2
8.0
11.6
8.8

6,2%
6.0
7.3
9.2
13.3
21.9
23.9
14.4
12.5
11.4
16,1
22.7
15.1

Compiled from Statistics of Income•

Before specific exemption*
Includes securities of Territories and insular
possessions.
j3/ Gross estate includes tax-exempt insurance.

Table 3
Gross annual yields from a taxable security equivalent to specified yields from a wholly
tax-exempt security if

Net income :
from other :
sources
:
2/

Gross
2a
191+1
rates

2.50
2.77
2.87
3.33

1,000
2,500
5,000
10,000
20,000
50,000
100,000
500,000
1,000,000

6.10
7 . 81

10.42
11.36

annual yield from a taxable security equivalent to a tax-exempt yield of
percent
:
3i percent
:
4 percent
3 percent
1941 :; proposed ; 1941 : proposed : 1941 : proposed
:; proposed
rates : rates 3/ : rates : rates 3/ : rates : rates 3/
:: rates 3/
2.50
3.21
3.^7
4.03
5.56
10.42
20.83
25.00
25.00

3.00
3.32
3-^5
4.00
5.17
7.32
9.3?
12.50
13.64

3.00
3.85
^.17
4.84
6.67

12,50
25.00
30.00

30.00

3.50
3.87
4.02
4.67
6.03
8.54
10.94
14.58
15.91

3.50
4.49
4.86
5.65
7.7S
14.58
29.17
35-00
35-00

4.00
4.42
4.60
5.33
6.9O

9.76
12.50
16.67

18.18

4.00
5.13
5.56
6.45
8.89
16.67

33-33
40.00
40.00

It is assumed that both the taxable and the tax-exempt security are bought at par; and that
the income from additional investments, if taxable, would not be large enough to become
subject to a higher rate than that applicable to the first dollar of the additional income*
The calculations apply to a married person with no dependents, and take into account variations in the personal exemption and earned income credit as well as in tax rates. The
earned income credit is assumed to be unaffected by the additional taxable income except in
those cases where by statutory definition all net income is deemed earned.

2./ Before personal exempt ion*
j/

As presented by Secretary Morgenthau to the Ways and Means Committee, March 3, 19^2.

Table 4

State and local government securities, by
length of time outstanding, 1/
June 30, 1941

Length of
time outstanding

Estimated amount
(in billions of dollars)

Less than 1 year
11

" 3
" 4
,f
5
« 6

»
i«

t»

t»
"

i»

4.2
4.9
5.6
6.5

i»

Total amount outstanding

3.1

"
"
»

it
"

Source:

2.3

2 years

7#3
7>9

8.4
9.3

20.0

Compiled from data supplied by the Bureau of the Census,
Division of State and Local Government.

Interest-bearing securities only, including those of
territories and insular possessions.

Table 5

Gross annual yield from a taxable security equivalent to
a b percent yield from a wholly tax-exempt security,
under tax rates in effect in 1929• 1935• and 19^1 > and
proposed for I9U2 1/

Net income
from
other sources 2/
$

•
:
*

1941

1942
(proposed
rates 3/)

1929

1935

•

:
•
•

1,500

4.00$

2,500

4.00

4.42

5-13

5,000

4.02

4.17

4.60

5.56

10,000

4.12

4.37

5.33

6.45

20,000

4.1+0

4.71

6.90

8.89

50,000

4.g2

5.^0

9.76

16.67

100,000

5.26

S.70

12.50

33.33

500,000

5.26

10,00

16.67

40.00

1,000,000

5.26

10.53

18.18

40.00

1/ It is assumed that both the taxable and the tax-exempt security
are bought at par; and that the income from additional investments, if taxable, would not be large enough to become subject
to a higher rate than that applicable to the first dollar of
the additional income. The calculations apply to a married
person with no dependents, and take into account variations
in the personal exemption and earned income credit as well as
in tax rates. The earned income credit is assumed to be unaffected by the additional taxable income except in those cases
where by statutory definition all net income is deemed earned.
2/ Before personal exemption.
3/ As presented by Secretary Morgenthau to the Ways and Means
Committee, March 3»

Table 6

Securities of States, and of cities with more than 100,000 population, by interest rate, 1939 l/
(Amounts in thousands of dollars)

Interest :
rate
:
(Percent) :
1.50
1.75
2.00
2.25
2.50
2.75
3.00
3.25
3-50
3.75
4.00
4. 2 5
U.50

Securities out standing, at par value
States, and cities over
States
:
:
: Amount
: Percent :
100,000 population
: of total :
Amount
:Percent of total :
75.980
43,388
131,814
233.516

149,174
177,907
713,118

402,4n
848,107
230,617
2,267,29s

1,580,990
1,730,479

4.75

294,902

5.00

706,704
15,809

5.25
5.50
5.75
6.00
Total
Other rates
Rates not
reported

81,963

14,764
120,871

9,819,812

.8
.4
1.3
2.4
1.5
1.8
7-3
4.1
8.6
2.4
23.1
16.1
17.6
3.0
7.2

.2
.8
.2

75,980
43,388
65,153
140,570
50,188
72,600
300,121
136,839
195,681
117,483
782,670

349.750
435,485
124,284
227,626

2.4
1.4
2.1
4.4
1.6
2.3
9-5
4.3
6.2

3-7
24.7
11.0
13.7
3.9
7-2

Cities over 100 , 0 0 0
population
Amount
:Percent of total

1.0

66,66l
92,946
98,986
105,307

1.4
1.5
1.6

412,997

6.2

265,572
652,426

4.0
9.8
1.7

113.134
1,484,628
1,231,240
1,294,994
170,618

479.078
15,809

22.3

18.5
19.5
2.6
7-2
•3

81,963

1.2

1.0

100.0

1.2

52,328

1.6

14,764
68,543

100.0

3,170,146

100.0

6,649,666

1,086,476

166,795

919.6si

6,999

1,087

5.912

Source: Bureau of the Census, Division of State and Local Government.
1/ Securities outstanding at close of fiscal years ended in 1939* Debt with original maturity
of less than one year is not included.

Table 7
Tax liability assuming interest from State and local government securities (a) tax-exempt and (b) taxable,
under present and proposed individual income tax rates, for 25 selected individuals.
State
and
Case ;
local
interest
1
2

3
4
5
6

7
8
9
10
11

12
13
11+
15

221,9
236.2
260.4
230.9
226.9
215.0
349,5
820.7
162.7
351.7
330.7
773-0

305.9

8i7.it
394.6

288.9
376.6
603.0
160.1
915.1
27s. 7

296.5

17
18
19

404.3

21
22

23"
24
25
Total

373.6
765.1

66s. 7

: Taxable
: net income : Total
: income
:
from
:
other
: sources l/
b01.9
823-8
444.1
207.9
1^8.9
409.3
1,568.4
1,337.5
1,081.0
1.307.9
147.8
362.8
144.2
493.7
835.6
1,656.3
249.8
412.5
626. 8
275-1

316.3

313-4
356.5
1,083.7
172.6
226.2

314.8
424.8
9,969. 4

135. ^

4,321.4
170.7
166.9

331.7
218.9
Ik,441.7

704.3

1,538.1
974.6
1,106.3

771.2
899-5
564.4
1,231.4
592.1
491.9
5,405.1
343.3
393.1
646.5
643.7
24,411.1

(In thousands of dollars)
Present rates
Tax liability
Interest : Interest
: taxable
exempt
424.2
595.7
126.4
301.2
87.0
276.8
1,181.6
999.2
796.6
975.8
83.8
241.8
82.6
339.6
605.0
1,251.6
158.1
279.2
442.7
175.9
503.0
249.9
549.4
1.157.7
19s. 6

712.S
817.2
553.2
653.0

186.6
250.7
423.2
94.8
666.8
179.2
75-1
3.380.3

4i6.6
336.9
4,251.3

102.2

227.2

395.3
915..8

: Revenue loss
from tax
:
exemption
;
171.5
174.8
189.8
182.4
179.2
158.0
257.0
646.6
121.1
266.8
253-1
60S. 3

514.2
630.6

302.5
229.8
300.5
249,0
237.4
261.8
871.0
125.0

264.5

165.O

136,2

457.3
366.3

239.8
230.1

10,348,8

17,914.1

7,565.3

99*5
217.5

Proposed rates 2/
:
:

Tax liability
* Revenue loss
Interest : Interest
from tax
exempt : taxable i
exemption
521.4
721.0
199. b
164.6
212.6
377.2
113.6
348.0
234.4
207.8
1,182.7
1.390.5
1,156.0
204.1
951.9
110.2
303.7
193.5
422.4
314.6
107.8
738.6
1,470.3
731.7
204.4
146.5
350.9
543.0

316.5

613.5
1,363.2
856.1

297.7

975.3
672.0

735.7
355.2

787.0

266. S

176.6

487.6
1,087.8
512.5
^19.7
4,844.2
288.6
333.^
560.1
558.9

363.9
284.7
282.1
320,8
975.4
155.4
203.6
283.2
382.3

12,470.5

21,442.9

8^972.4

226.5
315.8
667.6
254.3
239.6
316.8
520.2
123.7
803.1
230.4

98.9
3,868.8
133.2
129.8
276.9

Source: Income items from returns on JForm lOHO for I9U0.
1/ Exclusive of net long-term capital gains and losses.
2f As presented by Secretary Morgenthau to the Ways and Means Committeet March 3, 19^2..

695.6
601.8

Table 8
Comparison of the Yields *f High-G-rade Corporate and Municipal Bonds

Month

1939-January.
February
March...

('Yield on first day of
month
High-grade High-grade Spread
municipal
corporate
bonds 2/
bonds l/
3.01
2.36
3 T
2.94
.61
2.33
2.86
.48
2.38

April.
May...
June..

2.93
2.90
2.82

July
August..
September

2.78
2.74

October.
November
December
1940-J anuary.
February
March..
April.
May...
June..
July...
August.
September

2.98
3.28
3.00
2.90

2.83
2.83
2.80
2.73
2.7^
2.99

2.88
2.82
2.78

2.32

.61

2.37

• 53
.56

2.26

Month

1940-0ctober.
November
December
1941-J anuary.
February
March...

2.79

• 52
.47
• 19

April.
May...
June..

2.94
2.55
2.35

•3^
• 45
• 55

July...
August.
September

2.24

• 59
• 55

2.27

2.28

2.35
2.27

2.21

2.66

2.34
2.17
2.17

.46
• 53
•33

2.69

.68
.76
.79

2.76

1.80
1.97
2.13

• 77
.64
.63

2.72

2.02

.70

2-75
2.74

1.92

.83

1.77

•97

1*69
1.70
1.71

.96

2.57

2.61

2.65

2.64
2.$5

2.62

1942-January..
February.
March....

2.71
2.80

2.58
2.59

2.81

.65
.61

April.

2.01

Spread

1.9^
1.82

2.70
2.61

October..
November.
December.

1/ Treasury Department average of high-grade corporate bonds.
2/ B«nd Buyer average, 11 first grade cities.

Yield on first day of
month
High-grade High-grade
municipal
corporate
bonds 2/
bonds 1I

2.77

1.65
1.57

• 94
• 94

• 97
1.01

1.60

• 99

1.91
2.04

,80
,76

2.19
2.06

,62

.71

Table 9
Yields of Corporate and Municipal Bonds, Spread, and Federal individual Income Tax Rates, 1900-4-2

Year

1900.

Annual average yield
High-grade Municipal
corporate bonds 2/
"bonds if

1901.

4*05
3.90

1902.

3.86

1903.
1904.
1905.

1906.

1907;

190S.

1909^
1910.
1911.
1912.
1913 <
1914.
1915....

1916

1917-..1918.;•i.
1919

3*12

Spread

0.93
.66

4.07
4.03

3.32

.69

3.89

3.40
3-57

3.99
^.27
4.22
4i06
4.16
4.17
4.21
4.42
4.46
4.64
4.49
4.79
5; 20
5.49 1/

3.86

3-93
3.7s
3.97
3.98
4.02
4,22

.58
.49

.42
,41
,29
.28
.19
.19
•19
.20

4.12

4.16
3.94
4.20

,48

.55
.59

0
0
0
0
0
0
0
0
0
0
0
0
0
5
.5
5
7
31

Annual average yield
High-grade Municipal
corporate bonds 2/ Spread
bonds if

1922.

5.10

1923.
1924.

5.12

0.87

5.00

4.23
4.25
4,20

1925.
1926.
1927.
192s.
1929.

4; 88
^73
4.57
4.55
4.73

4.09
4.08
3.9S
4.05
4,27

•79
.65
•59

1930,...4.*

4.55
4.58

4.07

,48
• 57
.36

193 1
193 2
1933-......
193^
1935.
1936.
19371938.
1939.

5.01

4.49
4.00
3.60

3.24
3.26

3.19
3.01

4,01
4.65
4.71

.87
.80

.50

.46

Tax rate
on bracket
immediately
above
$100.000
56
42

25
25
25
25
24
25
25
56

-.22
-.03

56
56

3.41
3.07
3.10

.19

.17

2.91
2.76

.28
.25

62
62
62
62

4,03

. 16

.70
64
4.46
1940
2,84
60
2.50
66
1-03 If
1920;....
6.12
194 1
4.98
2.77
1.14
60
2.10
.67
69
.88
1942 4/.
2.84
1921
5.09
60
2.49
5.97
.35
through 1918* Standard Statistics Co* average for 15 high-grade railroad "bonds; other years
1/ JTrom 1900
Moody 1 s Investors Service average for high-grade corporate (Aaa) bonds*
Standard Statistics Co» average.
1 1 Standard Statistics Co. average of yields of high-grade railroad bonis was 5*29 percent for 1919, and the
spread based upon this average was 0*83 percent;
April
1, I3k2.
y

4.50

Year

$100,000

3.13
3.20

3.^5

Tax rate
on bracket
immediatelyabove

Table 10
Treatment of interest from Federal, State and local Government
obligations "under State individual income taxes,
as of January 1, 1942

State

:
:

Home
State

Interest from obligations of the
Political subFederal
divisions of the
Government
: Other
: States
and its
Home
: Other
agencies
State : States

Alabama
Arizona
Arkansas
California
Colorado
Delaware

Exempt
Exempt 2/
Exempt
Exempt k/
Taxed
Exempt