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SUGGESTED INCOME TAX REVISIONS
Address delivered before the National Tax Association, October 14, 1941, at St. Paul, Minnesota.
By Randolph E* Paul

The program for defense spending has now soared beyond the
mark of $50,000,000,000.

This is considerably more than the

value of all building construction in the United States since
1927. It is twice as much as the total investment in American
railroads.

It is twice as much as the total value of all pas-

senger automobiles produced in this country during the past
fourteen years."1" And there is every Indication that the program has not yet reached its peak*
Mr* Morgenthau announced in his Chicago speech of October
2, 1941, that our tax structure, as modified by the recently
enacted 1941 Act, will yield about $14,000,000,000 in revenue;
he added his opinion that "it still contains many inequalities
and many omissions which will have to be corrected next year."
When taxes reach such startling proportions * the problem of
2
fair distribution becomes highly acute. On the one hand, a
burden escaped by some taxpayers and passed to other taxpayers
!• Morgenthau, Address delivered in Chicago, October 2,
1941.
2# Cf. Frankfurter, Mr« Justice Holmes and the Supreme
Court, p* 42 (1938).



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becomes intolerable, and on the other hand, the -effect of
hard provisions becomes disastrous for taxpayers•

Our revenue

system, founded as it is so largely upon the principle of selfassessment, needs the cooperation of taxpayers.

Indeed, one

may put the matter in the strongest possible terms by saying
that our tax system simply will not work in the emergency if
it breeds widespread dissatisfaction and resentment.

This will

most certainly happen if the tax structure does not distribute
its enormous burden equitably among taxpayers. The people are
willing to pay taxes, but they are unwilling to see some people
avoid taxes.
We have also an important policy problem.

For years our

economy has been running well under capacity. National income
reached a low of $40,000,000,000 in 1932. All this is now reversed. Defense has given a blood transfusion to the economy.
For 1940 our national income was $76,000,000,000; in 1941 it
will probably be in the neighborhood of $87,000,000,000. It
has been estimated that national income in 1942 may be 10 to
15 per cent higher than in 1941.

There was plenty of reason

for a deficit in the lean thirties, but what reason is left
today?

The ugly question must be faced:

If a nation cannot

balance its budget when it has reached the peak of its productive capacity through the utilization of its manpower and
3# Gaskill, Preserving a Willing Attitude among Taxpayers,
16 Tax Mag* 649 (1938).




-2-

facilities, when can it balance its budget?

Mr. Eccles,

Chairman of the Board of Governors of the Federal Reserve
System, while admitting that the drastic tax necessary for
balance would be politically impossible at this time, has
urgently suggested the need of greater effort in this connec4
tion. And the cognate question may be added, why should our
tax system not recapture for the government a large part of
5
the defense expenditures it is making. Are we going to allow
a part of our population to make an inordinate profit out of
war?

The President has repeatedly answered this question in

the negative, but so far his policy remains unfulfilled.
Taxes also enter into the highly complicated problem of
inflation, whatever that word means.

The threat of inflation

is a dark shadow across the immediate future, and taxes are a
principal instrumentality of prevention, for, in the language
of Mr* Eccles, they will "reduce7consumer demand for goods
where the supply is inadequate.11
Here taxes have a function
which may be even more vital than revenue production. The
good effect of Increased governmental revenue will be more
than neutralized if the government must spend in a boom market,
4. Testimony before the Committee on Banking and Currency,
House of Representatives, 77th Cong., 1st Sess., September 29,
1941.
5. Eccles, Price Fixing Is Not Enough, 24 Fortune, No* 2
(1941).
6. See Chase, The Tyranny of Words, p. 291 (1938).
7. Eccles, Price Fixing Is Not Enough, 24 Fortune, No# 2
(1941).



and the public will lose the benefit of an amplified national
income if the purchasing power of that income is reduced in
greater effect than the increase of income. Furthermore, in8
flation is a bubble, which like all bubbles eventually bursts.
Mr. Morgenthau1s point cannot be too strongly emphasized that
every citizen has a "personal stake" in the prevention of the
chaos of inflation.
Mr. Morgenthau promised the bankers assembled in Chicago
a genuinely "all-out" tax bill in 1942, to be levied "upon all
in accordance with their ability to pay." Of course, no one
outside intimate governmental circles knows Mr. Morgenthau1s
exact plans, and I suspect that his mind is far from closed to
what may be revealed by further study Of the immense problem
before him.

He was undoubtedly intending to state policy in

the broadest terms, leaving details to the future. But the
situation calls in the end for a bill of particulars, and I
would like to suggest some points of an increased tax program
for your consideration in the months to come when the Treasury's
"all-out" tax bill is in the process of gestation.

I have to

do so in more or less categorical fashion, for you would not
have time to listen to a detailed discussion of the reasons for
and against each proposed change.

Indeed, the subject is so

vast that I cannot even list the host of technical amendments
our revenue laws demand if they are to be put in condition to
8. Cf. Foreword of Mr. Wickard, Secretary of Agriculture,
to Farmers, Farm Prices, and Inflation, September, 1941.



endure the strain of an emergency. But if you will permit me
to select upon the mixed basis of importance and clarity, I
shall now suggest some points of revenue revision that may soon
be items of tax history.
1. Interest on State and Municipal Obligations*
The subject of the taxation of interest upon the obligations of the states and their political subdivisions was ably
discussed yesterday by Mr# Foley, General Counsel of the U.S#
Treasury, Mr. Epstein, Solicitor General of New York* and Mr.
Seltzer, of the National Bureau of Economic Research<

I may,

therefore, merely register my opinion as to the necessity of
9
taxing the income from future issues of such bonds.
For too
long we have provided a haven from the sweep of the surtax with
the result that a mass of tax-exempt securities is endangering
the system of the progressive income tax.10

I have few doubts

as to the constitutionality of taxing the income from future
issues of state and municipal bonds.11

It might be constitu-

tional to tax the interest from past issues, but such a step
would have elements of unfairness that render it inadvisable.
9. This Involves the elimination of Section 22(b)(4) of
the Internal Revenue Coder
10. Paul, Redesigning Federal Taxation, 19 Harv. Busr Rev.
143, 146 (1941).
11. See Department of Justice Study entitled Taxation of
Government Bondholders and Employees, pp. 21, 43 (1938). Cf.
Chandler, The Case for the Municipalities against Federal Taxation of Municipal Securities, address delivered before the
American Bar Association, September 30, 1941.



The Glass proposal, that the surtax on Income from taxable
sources should take Into aooount the existence of tax-exempt
Income, Is perhaps too Indirect an approach to provide a
satisfactory solution.
2.

Capital Gains.
The maximum rate of capital gain tax has been reduced by
12

the 1941 revenue act from 16.5 per cent to 15 per cent.

Pos-

sibly this reduotion was inadvertent, and we may undoubtedly
expect a revision of the capital gain rate to the level of 1940.
But the capital gain and lose situation must, of course,
be approached from a larger viewpoint. The subject has always
been highly controversial.

We have complete variety of opinion

on the subject from one extreme, which is against all taxation
of capital gains and recognition of capital losses,13 to the
opposite extreme, which thinks that no differentiation at all
14
should be made between capital gains and ordinary income.
12. Section 117 of the Internal Revenue Code remains unchanged by the 1941 Act. Section 101 of the 1941 Act at the
same time integrated the defense tax into the surtax rates.
Section 15 of the Code, imposing the defense tax, was entirely
revamped and no longer deals with the defense tax.
13. Nelson, The Question of Taxing Capital Gains, The
Case against Taxation, 7 Law & Contemp. Prob, 208 (1940); 2 May,
Twenty-five Years of Accounting Responsibility, p. 144 (1936).
14. Simons, Personal Income Taxation, p. 148 (1938);
Kent, The Question of Taxing Capital Gains, The Case for Taxation, 7 Law & Contemp. Prob. 194 (1940). On this subject see
also Haig, Taxation of Capital Gains, Wall Street Journal, March
23, 25, 29, April 2, 8, 13, 1937; Blough and Hewett, Capital
Gains, contained in Studies in Income and Wealth, vol. 2, p. 191
(New York, National Bureau of Economio Researoh, 1938); Colm,
The Revenue Act of 1938, 5 Sooial Research 255 (1938).



-6-

Without going the full length in either direction one may at
least point out that the present capital gain rate is the most
favorable in our income tax history.

The capital gain rate in

the twenties was 12.5 per cent, but we ended this period with
a highest surtax bracket of 20 per cent. At this time the
capital gain rate was, therefore, five-eigjtiths of our top
surtax bracket. This relative position of the capital gain
rate should be compared with a relationship of a rate of 15
per cent to 77 per cent.

The fraction mentioned has dropped

from five-eighths to one-fifth.
Whatever may be the answer to the capital gains problem,
it seems clear that the present relationship of the capital
gain rate to the surtax brackets involves an inexcusable discrimination against individuals who derive their Income from
personal services and sources other than capital gains. The
capital gain rate should, therefore, be substantially increased.
Perhaps we should go back to the flexible rule established by
the 1934 Act, which at least recognized the period of accrual
of capital gains in a more refined way than does the present
act. At the very least, the tax on capital gains should, in
deference to the principle of ability to pay, take into account
other non-capital gain income of the taxpayer. An increase in
capital gain rates should perhaps be accompanied by a longer
loss carry-over.
3. Pension Trusts.
Pension trusts in their many variations are a growing



menace to governmental revenue.

The Institution of pension

trusts has in its favor many of the arguments put forward on
behalf of social security. But in practice the deferment of
tax granted in the case of pension trusts15 is being grossly
abused by the establishment of trusts in favor of high salaried
16

key employees and stockholders.

Some limiting provisions

should be placed in the revenue act to make the pension trust
exemption applicable only in the case of bona fide trusts with
a valid social, as distinguished from a tax-avoiding, purpose.
The underlying legislative purpose should not be lost sight of
in any further consideration of this problem, because some taxpayers have abused the pension trust provision.

Innocent bene-

ficiaries should not be punished with the guilty when amendments will serve to draw a line between those who deserve a
postponement of the tax and those for whom the benefits of tax
postponement can hardly have been intended.

This is an example

of a problem constantly faced in revenue legislation. One must
find a way of reaching particular cases of avoidance without
striking, like Herod1s massacre, indiscriminately at all cases
17
irrespective of deserts.
15. I.B.C., Sees. 23(p), 165.
16# See Altman, Pension Trusts for Key Men, 15 Tax
Mag# 324 (1937); Paul, The Background of the Revenue Act
of 1937, 5 U. of Chi. L*R. 41, 77 (1937); Hearings before
the Joint Committee on Tax Evasion and Avoidance, 75th Cong#,
1st Sess., p. 294.
17 • Cf. Paul, Studies in Federal Taxation, p. 65
(1937).



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4.

The Interest Deduction.
18
The interest deduction now allowable
for all interest

paid or accrued, except interest on indebtedness incurred or
continued to purchase tax-exempt securities, unduly encourages
corporate financing by borrowing rather than by capital contributions*

The difference between many preferred stock and bond

issues is often more legalistic than real; yet the corporation
issuing the stock does not have the Interest deduction allowed
to the corporation issuing bonds•

Every tax practitioner is

familiar with the process of converting stock Issues into bond
19
Issues in order to reduce taxes•
Some limitation should be
placed on the interest deduction not only to raise revenue, but
also to put equity financing upon a reasonable parity with
financing on a less sound business basis.
5. Percentage Depletion.
Oil and mining companies are granted a special depletion
deduction, or "subsidy," consisting of a percentage of gross
income from depletable property limited to a percentage of
20

the net income from the same property.

This depletion allow-

ance is optionally greater than the ordinary allowances for
loss of wasting assets; it is not restricted to a recovery of
18.

I.R.G., Sec. 23(b).

19. We oannot discuss today the question whether such
reorganizations or recapitalizations have the benefit of the
statutory exemption. Cf. Paul, Studies in Federal Taxation,
Third Series, p. 121 (1940).
20. I.R.C., Sees. 23(m), 114(b)(3)(4).



9-

cost or value at March 1, 1913, of the producing property; and
It goes on as long as production continues without relation to
the recovery of cost or value at March 1, 1913.

The elimination

of the deduction was recommended as long ago as 1933 when the
21
Secretary of the Treasury said:
"Our experience shows that the percentage depletion rates set up in the law do not represent reasonable depletion rates in the case of the designated
properties, but are much higher than the true depletion to which the taxpayer is fairly entitled. Moreover, these provisions enable a taxpayer to obtain
annual depletion deductions, notwithstanding the fact
that he has already recovered the full cost of the
property. The deduction is, therefore, a pure subsidy
to a special class of taxpayers. For this reason the
Treasury recommends that these provisions be eliminated, in order to put all taxpayers upon the same
footing."
In 1937 the President recommended the elimination of per22

centage depletion.

Congress has steadfastly failed to act on

this recommendation, but the existence of the emergency may
change legislative attitudes.
6»

Joint Returns.
The subject of Joint returns for husband and wife has re-

ceived much publicity in the last few months. Much of this pub
licity, with its emphasis upon constitutional and moral aspects
of the problem and its effect upon the institution of marriage
21* Testimony of Under Secretary Magill, Hearings before
the Joint Committee on Tax Evasion and Avoidance, 75th Cong.,
1st Sess., p. 33 (1937).
22* Letter of President Roosevelt dated June 1, 1937,
quoted in Report of the Joint Committee on Tax Evasion and
Avoidance, 75th Cong., 1st Sess., p. 1 (1937).



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and women's rights, has established a new record for irrelevance.
Professor Griswold, who has stated the arguments against the
proposal in the strongest possible way, has admitted the
23
speciousness of these arguments,
stating that "he who puts
his trust in unconstitutionality today in matters of this sort
seems to disclose a rather surprising unawareness of the happenings of the past few years."

As to moral grounds, Professor

Griswold calls attention to A. P. Herbert's chapter "Rex v.
Pratt and Merry - The Tax on Virtue" in his "Uncommon Law,"
and says that it would be hard to show that the British institution of marriage has been impaired by the long-standing practice of requiring Joint returns. Along with my partner, Mr.
24
Harry Rudick,

I venture to suggest a reconsideration of this

whole problem for purposes of an "all-out" revenue act, for the
following reasons:
(a) There seems to be no politically practicable method
other than Joint returns of eliminating the unfair advantage
enjoyed by residents of the community property states.pe
23 # Griswold, Letter published in New York Times, July
27, 1941.
24. See letter of Mr* Harry Rudick to Chairman Doughton
of the Ways and Means Committee, July 17, 1941, reprinted in
the Congressional Record, vol. 87, No. 139, p. 6618 (1941).
See also Rudick, The Problem of Personal Income Tax Avoidance,
7 Law & Contemp- Prob. 243, 252-3, 264 (1940), where Mr. Rudick
advocates that Joint returns cover not only spouses, but also
minor children* Cft Shoup, Married Couples Compared with Single
Persons under the Income Tax, 25 National Tax Aesn. Bulletin,
No. 5, pp. 130-135.
25. I have discussed the community problem at length in
forthcoming volumes (Sec* 1.09) on estate and gift taxation, to
be published by Little, Brown & Company.



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Obviously there is no sound foundation for a rule that makes
the federal income tax depend upon where the taxpayer lives,
and which requires a married couple living in New York, for
example, to pay a much higher tax than a married couple living
in California*
(b) There is no convincing reason for a tax disparity
between a family in which the husband is the sole source of
income and a family in whioh the wife contributes to the family
economic unit.

The family, generally speaking, will spend ap-

proximately the same amount for rent, food, support of children,
etc.,whether its income stems entirely from the husband or
derives in part from the wife.

The inoome tax should recog-

nize these basic economic realities*
(c) In the vast majority of families in the United
States practically all the family inoome is earned by the husband. If Joint returns are not required, the families of this
vast majority will have to pay a higher tax than the families
in the minority group. Recently increased rate brackets make
this discrimination all the more unworthy of continuance.
Amendments to Eliminate Hardship
At a time when we are considering amendments of the statute
designed to eliminate discriminations, it is certainly not out
of order to consider changes which may reduce revenue. We can
be intelligently generous; we need not raise our revenue by the
hardship method.

Several changes of this sort are dictated by

considerations of equity.



The provision of the last Senate
-12-

bill, allowing the deduction of expenses incurred.in conserving
26

and conducting business affairs, should be passed.

With

rates at their present level a limited deduction for medical
expenses would be no more than a reasonable oonoession to taxpayers. The same is true of the credit for dependents, which
now stops when the dependent reaohes the age of 18 years, unless the27
dependent is physically or mentally incapable of selfsupport.
It need hardly be argued that many dependents are
at the peak of their dependency immediately after the age of
18 years. The treatment of alimony has been a sore spot in
28
our tax system for many years,
and the provision inserted
29
in the last Senate bill
taxing alimony to the wife should
be enacted. The law surrounding the status of mortgage fore30
closure transactions should certainly be clarified.
We could
no doubt afford to legislate away some of the hardship caused
31
by the Supreme Court decision in Helverlng v. Bruun: at least
we might arrange for some postponement of payment where so much
non-liquid income is preoipitated in the hands of a lessor by
26. Senate Bill, 1941 Act, Sec. 119. See Conf. Report
No. — , 77th Cong., 1st Sess., p. 12.
27.

I.R.C., Sec. 25(b)(2).

28. See Paul. Five Years with Douglas v. Willcuts, 53
Harv. L.R. 1 (1939).
29. Senate Bill, 1941 Act, Sec. 117; Sen. Finance Comm.
Report No. 673, 77th Cong., 1st Sess., p. 11.
30. See Helvering v. Hammel, 311 U.S. 504 (1941); Electro-Chemioal Engraving Co., Inc. v. Comm., 311 U.S. 513 (1941).
See also Paul, Studies in Federal Taxation, Third Series, p. 296
(1940).
31. 309 U.S. 461 (1940).



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the termination, cancellation or forfeiture of a lease.
There is real neea for relief from the hardships latent
in Section 42 of the Internal Revenue Code, especially when
the income tax rates have been so sharply increased. The
possibilities of unfairness have been accentuated by the
32
that a
Supreme Court's decision in Helverlng v. Enrlght
partner's share of partnership fees accrues at the date of
death even though partner and partnership have filed returns
on the cash basis. Lawyers will sometimes be flattered at
the high estimates which the Bureau places on the value of
their unfinished legal services under this doctrine.

It would

seem more fair to provide, however, that regardless of accrual
for estate tax purposes, the recipient of the income should
have the privilege of reporting the income as taxable when
received. Any such provision should apply equally to accrued
income arising from personal services or any other type of
33
accrued income.

Consistency would require an amendment to

Section 43 eliminating from the decedent's final return any
accrued deduction in the event that the decedent's estate
availed itself of the option to report income when and as received. The underlying purpose of Section 42 - that no income
32. 312 U.S. 636 (1941). See also Pfaff v. Comm., 312
U.S. 646 (1941).
33. An amendment to this provision might be framed along
the lines of the provisions of Section 44(d), relating to the
transmission of installment obligations at death. In order to
protect the revenue, the government might be empowered to require the filing of a bond as is required under Section 44(d).



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should esoape tax - could thus be accomplished without the
gross inequity of throwing several years' income into one
return.

Perhaps at the same time the estate should be re-

quired to report the income on the same basis - cash or accrual - as the decedent used prior to death, and perhaps it
3
should also be required to use the same aooounting period.
Further Questions for Consideration
The foregoing suggestions are not intended to be all
inclusive. Many possible amendments of the statute should be
canvassed in order to determine whether changes are advisable.
34. Cf. Estate of Cyrus H. K. Curtis, 36 BTA 899.
35. Two clearly advisable amendments may be mentioned in
a footnote. The statute has a flagrant defect in its provision permitting value at date of death as a basis even in cases
in which an executor has eleoted under Section 811(J) of the
Internal Revenue Code to report assets of the estate at their
value a year after the death of the decedent. To illustrate
the point: A decedent may leave assets having a value of
#1,000,000 at the date of his death which a year after death
have dropped in value to #500,000. In such a case an executor
paying estate tax on only #500,000 secures a basis of #1,000,000. Obviously the statute should insert a new subdivision in
Section 113 to the effect that where the optional valuation
privilege is exercised, the basis of property shall be the
value as used in the estate tax return.
In the case of contributions in the form of property the
law now permits deduction to the extent of the value of the
property transferred at the date of the gift. Thus, where a
taxpayer has transferred securities costing #1,000, but having
a value at the date of the gift of #5,000, he is allowed a deduction of the latter amount without any tax on the appreciation in value of #4,000. Although the donor may have received
income under the doctrine of vicarious satisfaction established
by Helverlng v. Horst, 311 U.S. 112 (1940), some provision
should be inserted in the statute to settle this question. A
possible provision would be to allow a deduction only in the
amount of the adjusted cost basis of the property to the donor
or its value at the date of the gift, whichever is lower.



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It is a serious question whether we should allow the basis of
value at the date of death for the purpose of determining gain
or loss on the sale or exchange of property transmitted at
death. Our system of taxing nonresident alien Individuals and
foreign corporations involves a marked discrimination in their
vg
favor.
It should not be taken for granted that we ought to
37
allow as a deduction non-business casualty losses,
non38
39
business interest,
non-business bad debts,
and non-business
40
taxes.
For example, the deduction for taxes on residential
property could well be eliminated.

It is well worth consider-

ation whether we should return to the principle of consolidated
returns in the case of affiliated corporations.
41
intercorporate dividends is far from solved.

The problem of
Perhaps we

should frankly admit the impossibility of preventing the avoidance of the regular surtax on gains from preferred stock re-

42
demptions, and apply the capital gain rate to such redemptions.
The Chandler Act in its relationship to the basis provision

36. This discrimination was only partly corrected in 1937,
See Paul, The Background of the Revenue Act of 1937, 5 U« of
Chi. L.R. 41, 86-7 (1937).
37»

I.R.C., Sec. 23(e)(3).

38. I.R.C., Sec. 23(b),
39.

I.R.C., Bec. 23(k).

40*

I.R.C., Sec. 23(c).

41. I.R.C., Sec. 26(b).
42. Cf. John D. McKee, 35 BTA 239.




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18
should again be revised.

Dividends on fully paid-up life

insurance or endowment policies should be taxable, as proposed
in 1938, regardless of whether the consideration paid has been
recovered.

Finally, without attempting to exhaust the list,
44
one may recall the perennial inadequacy of Section 102.
For

years corporate taxpayers have successfully argued that they
may pile up surpluses for the mythical rainy day of the unpredictable future, or that they may in the same sort of future
go into a new business in the manner of the White Knight, who
kept a bee-hive on his horse because he might someday wish to
45
keep bees.

Both of these arguments have acquired new vitality

in the uncertainty of our post-war future.
The Excess Profits Tax
I have left for the end the controversial excess profits
tax, and X shall leave most of that subject to tomorrow morning's session. But since the excess profits tax is a corporate
income tax, it is relevant to mention the subject in this session
under the heading "Evaluation and Suggested Revision in View of
Present and Prospective Needs."
The excess profits tax, as it is now constituted, is designed to recapture a part of the excess profits of the emer43. See Paul, Debt and Basis Reduction under the Chandler
Act, 15 Tulane L.R. 1 (1940).
44. Rudick, Section 102 and Personal Holding Company Provisions of the Internal Revenue Code, 49 Yale L.J. 171 (1939).
45. Paul, Redesigning Federal Taxation, 19 Harv. Bus.
Rev. 143, 145 (1941).



17-

gency.

It is not intended to take any part of what might be

called ordinary excess profits not attributable to the present
emergency.

In this respect the tax seems to me to go on the

false premise that it is possible ever to make & clear-cut
differentiation between emergency profits and non-emergency
profits*

No one can tell what part of the profits of any par-

ticular concern in 1941 are attributable to the emergency and
what part of such profits are the natural culmination of previous years of effort.

The tax should discard this ephemeral dis-

tinction and frankly exact a contribution from corporate profits
not attributable to the emergency, as well as corporate profits
which are undoubtedly the result of governmental defense
expenditures.
It will be unhealthy for all of us if the large corporations, which are being given the bulk of the emergency orders,
are permitted to keep for their own such a share of emergency
profits that small business is put at a further disadvantage.
Corporations as well as individuals must carry their part of
the load, and a stiffer excess profits tax than we now have is
essential for that purpose. For the theory of that tax I go
along with Mr. Eccles in the belief that we should return to
the original scheme of the Treasury, making a flexible invested
capital determinative of the exemption of excess profits*

That

formula provided an exemption from the tax, dependent upon the
previous earnings of the corporation, of at least 5 per cent




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arid at most 10 per cent of the invested capital.

Such a

formula serves the double function of recapturing emergency
profits and of collecting a share of defense cost from corporations which were highly prosperous in the depression period.
47
The income credit in the present bill
gives an undue advantage to corporations with established records, and puts new
corporations and corporations without high depression earnings
at an undue disadvantage.

If the income credit is retained,

it might be subordinated in Importance by making the excess
profits tax consist of one-half of the tax oomputed on the
basis of the income credit plus one-half of the tax computed
on the basis of invested capital.
With all my belief in the principle of the excess profits
tax, as compared with the crude Instrumentality of the straight
corporate income tax, I must confess to misgivings as to the
treatment of concerns in which capital is a relatively minor
income-producing factor. We may as well admit that we are far
from a solution of this problem. The personal service corporation provision48 does not afford a complete solution; neither
49
do the so-called relief provisions.
I cannot but feel that
46. H.R. Rep. No. 2894, 76th Cong., 3d Sess., pp. 4, 22
(CB 1940-2, pp. 498, 512). The floor percentage recommended by
the subcommittee was 4 per cent. Hearings before Ways and Means
Committee and Finance Committee on Excess Profits Taxation, 76th
Cong», 3d Sess., pp. 4, 12 (1940).
47. I.R.C., Sec. 713.
48. I.R.C., Sec. 725.
49. I.R.C., Sees. 721, 722, 723.



-19-

there Is some solution of this problem which we have all missed.
Perhaps we could optionally exempt from the tax certain types
of corporations on the condition that they would accept some
fair substitute tax.
A final word may be said with respect to the much advertised difficulty of computing invested capital. On this point
one hears much defeatism.

In view of better records and a

more efficient Treasury personnel, the Job Is relatively easy
compared with what it was in 1917 and 1918, particularly with
the adoption of the unadjusted basis for loss as the measure
of the inclusion in invested capital of property paid for
with stock.

Invested capital is not the esoteric concept many

try to make it appear to be. It is simply the capital, surplus,
and undivided profits, or net worth of the corporation without
taking into account any unrealized appreciation or depreciation
in value of assets.

It is true that stock dividends, liquida-

tions, and reorganizations raise problems, but they are far
from insuperable. We could afford a little greater degree of
optimism about the possibility of computing invested capital.
Conclusion
There will be some who think some or all of the proposals
50
made in this paper are drastic and even confiscatory.
The
answer is, first, that times are extraordinary.

The old for-

mulae of postponement and evasion are inadequate in the face
50% Cf. Lawrence, High Court "Captured" in Tax Cases,
The Evening Star, Washington, D.C., October 9, 1940.



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of three Imperative necessities, (1) unprecedented demands for
revenue, (2) the control of price inflation, and (3) the elimination of profit from war.

It would be fatuous at such a

time to soft-pedal our policy. And it may be an expensive
luxury to neglect the thorough-going reconstruction Job so
sorely needed by our revenue systenu




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Tomorrow may be too late.