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Statement by
Stephen S. Gardner
Vice Chairman, Board of Governors of the Federal Reserve System
before the
Subcommittee on Financial Institutions
of the
Committee on Banking, Housing and Urban Affairs
United States Senate

May 11, 1976

I am pleased to appear before this Subcommittee, on behalf
of the Federal Reserve Board, to present the Board's views regarding
the application of State and local "doing business" taxes to out-ofState financial depositories.

In so doing, I will comment on the

recommendations to the Congress of the Advisory Commission on Inter­
governmental Relations, which Committee Print No. 1 seeks to implement.
As the Subcommittee is aware, the ACIR recommendations grew
out of a study, conducted in response to Public Law 93-100, in which
the Congress invited the Commission to submit specific and detailed
proposals relating to the application of State "doing business" taxes
to out-of-State depositories.

This request had been prompted by

certain Federal Reserve recommendations on these matters submitted
to the Congress in 1971, when the Board completed a study requested
earlier by the Congress on the possible economic and financial effects
of a major shift in Congressional policy regarding taxation of national
In 1969, the Congress acted to remove all previous restric­
tions on State and local taxation of national banks and substitute a
simple requirement that these banks be accorded the same tax treatment
as State-chartered banks.

This revision was incorporated in a "permanent

amendment" scheduled to become effective in early 1972.

One of the major

effects of this legislation was to remove the historical requirement
which had confined authority to tax national banks (except for real



property taxes) to the State in which the bank’s principal office
was located.

Because of the umbrella effect of this requirement,

States generally had confined their taxation of State-chartered
banks and other depositories as well to home-State institutions.
In its 1971 report to the Congress, one of the Board’s
principal recommendations was that legislation be enacted before the
"permanent amendment" became effective to "(L)imit the circumstances
in which national banks, State banks, and other depository institutions
may be subject to State and local government taxes on or measured by
net income, gross receipts, or capital stock, or to other "doing
business" taxes in a State other than the State

of the principal

office, and prescribe rules for such taxation."

The Board’s recom­

mendations also covered two related matters--the possibility of dis­
crimination in State and local taxation of out-of-State depositories
and the tax treatment of interest on Federal obligations in a direct
tax on net income.

The areas covered by these recommendations con­

stitute the major focus of the comprehensive staff study incorporated
in the ACIR Report.
Although the "permanent amendment" did take effect on
January 1, 1973, the Congress has acted on two occasions since that
time to provide a moratorium on the exercise of the new authority
for State and local application of "doing business" taxes to Federally




insured out-o£-State depositories.

The last of these extensions,

enacted this past February in Public Law 94-222, extended the
moratorium to September 12, 1976.

The purpose of these extensions

has been to allow time for the ACIR to complete its study and for
the Congress to take whatever legislative action seems desirable
before the authority is made available for States to apply "doing
business" taxes to out-of-State depositories.
The Board believes, as it did when preparing its earlier
recommendations to the Congress, that Federal legislative policy
regarding the taxation of interstate business of banks and other
depository institutions must be carefully formulated to minimize
the emergence of tax and compliance barriers to the free mobility
of credit and monetary flows.

This Nation’s depository institutions

constitute a highly efficient and sensitive mechanism for gathering
available savings from all sectors of the economy and channeling
them to creditworthy users--governments, businesses, and consumers-wherever they may be.

These institutions typically operate on fairly

narrow margins, and their choices as to sources as well as uses of
funds often are influenced by relatively small interest rate and
cost differentials.

Under our present system, vast amounts of funds

have moved across State lines and within and among regions.


vigorous growth of these institutions over the years has contributed




greatly to the efficiency of our economy and to the economic benefit
of both depositors and borrowers.
In providing new authority for State and local governments
to levy income and other "doing business" taxes on out-of-State
national banks--and, in effect, on other depositories--the Board
continues to urge that the Congress establish adequate safeguards
to assure that interstate and interregional mobility of funds not be
put in jeopardy.

Experience over the decades with multistate taxa­

tion of manufacturing, public utility, and mercantile enterprises
suggests that, in the absence of effective safeguards, multistate
taxation as applied to the quite dissimilar interstate operations
of depositories could have damaging economic effects.

Under these

circumstances, multistate taxation would tend not only to impede
credit mobility, but also to divert financing into channels that
would be both less efficient and potentially injurious to many com­
munity interests, particularly in agricultural and other credit
deficit areas.

In certain areas, the availability of many established

interstate financial activities, such as correspondent banking, loan
pooling, and deposit-related services would be reduced, loan rates
increased, and competition weakened.
With such taxation, the tax itself would enter as a considera­
tion to be weighed in every credit, deposit, or service transaction with
a customer in a nondomiciliary taxing State.

Moreover, the wide differences




that exist in tax structures and allocation rules--State to State and
locality to locality--might give rise in many cases to a compliance
burden which, by itself, would render the performance of credit or
other depository services unprofitable, particularly where the
volume of transactions is small.

Depositories would need to acquire

technical knowledge regarding the tax laws and regulations of every
taxing State in which they do business, maintain separate records, and
file separate tax returns.

Under such circumstances, as is frequently

pointed out, the compliance cost could exceed the amount of the tax.
Additional deterrents to out-of-State activity would include the
uncertainty, controversy, and litigation involved in determining
whether or not the depository is subject to taxation in a particular
State and what its tax liability is in that State; the possibility
that more than 100 per cent of the tax base might be subject to taxation;
and the costs and inconvenience of efforts to develop new ways to meet
the financing needs of out-of-State borrowers while avoiding the incidence
of the new taxes.
To minimize these barriers to the interstate mobility of funds
while at the same time recognizing the desire of the Congress to minimize
constraints on State taxing powers, the Board's 1971 Report recommended
that the legislation to govern the application of State and local "doing
business" taxes to out-of-State depositories should address itself to
three major areas.

Such legislation would need to (1) specify the



circumstances and conditions under which a State may assert juris­
diction to tax an out-of-State depository, (2) establish rules and pro­
cedures to govern the division of an institution's tax base among the
various States having jurisdiction to tax, and (3) establish rules to
guide the States in their administrative procedures.

Any rules and

standards in these areas that are developed for State taxation should
be applicable to local government levies as well.

As indicated earlier,

the Board's Report also included recommendations relating to discrimina­
tory taxation and tax treatment of interest on Federal obligations.
With respect to each of these five areas I should now like to outline
the Board's conclusions, as stated in its 1971 Report, and then summarize
and appraise the related ACIR recommendations against that background.
With respect to permissible circumstances for taxation of outof-State depositories, the Board stated that the Federal statute should
establish clearly defined uniform criteria for determining when a State
or its subdivisions may exercise jurisdiction to tax a bank or other
depository which has its principal office or is chartered in another

The intent of such legislation would be to safeguard the

authority of the States to collect taxes in circumstances where an
out-of-State institution has "established a clear relationship to the
taxing State or political subdivision through a physical presence or
pattern of sustained and substantial operations." At the same time,




the Board believed "that the overriding objectives should be to avoid
creation of tax impediments to the continued free flow of credit
across State lines and uneconomic changes in the procedures that now
govern the overwhelming bulk of interstate lending by depository
Like the present Federal statute that applies to income
tax on interstate sales of tangible personal property (Public Law
86-272), the statute relating to depository institutions might
provide that certain activities do

not constitute a sufficient

connection with the State to establish jurisdiction to tax (e.g., mere
solicitation of prospective borrowers by a depository institution or
its representatives, the loans being approved or rejected outside the
State; the holding of security interests in property located in a
State; or enforcement of obligations in the courts of a State).
The related ACIR recommendation, while stated in negative
form, calls for legislation that would deny authority to a State or
local government to impose an income or other "doing business" tax on
an out-of State depository unless that depository has a "substantial
physical presence within the State" in the form of a regular office
location, the regular presence of depository employees or agents, or
the ownership or use of tangible property within the State, including
property involved in lease-financing operations.

The ACIR also recommends




that activities within a State relating to enforcement or protection
of a security interest in case of default should not, by themselves,
provide a basis for imposing a tax.
While the proposed ACIR standard appears broadly consistent
with the Board's.recommendations, we do not believe that the standard
is sufficiently specific to make a definitive judgment.

For example, the

"regular presence of depository employees or agents" could be inter­
preted to include periodic visits by a loan officer from an out-ofState bank or participations by an out-of-State bank in local credits
through a local correspondent bank.

Such an interpretation clearly

would not satisfy the Board's concern that existing procedures govern­
ing the overwhelming bulk of

interstate lending not be jeopardized

through inadequate restraint on State and local taxation of depositories.
To safeguard such procedures, the legislation might incorporate an
adaptation for depositories of the jurisdictional standard in Public
Law 86-272, as suggested by the Board in 1971.
The lack of specificity of the ACIR standard incurs the
additional risk of creating substantial uncertainty among many deposi­
tories doing business across State lines regarding their potential tax
liability in the various States.

The resulting compliance burden and

risk of confusion and litigation alone could be substantial impediments
to interstate flows of credit and other depository services.


in non-domiciliary States would be placed at a disadvantage not only
through the reduction in competitive alternatives, but also in some




cases due to the resulting higher interest rates on borrowed funds
and higher costs of other depository services.

Smaller films, which

do not have access to the money and capital markets, would be affected
the most.
Regarding interstate division of the tax base, the Board
recommended enactment

of legislation that would prescribe standard

principles and procedures to govern apportionment for each applicable
tax base.

States would not be limited in their choice of tax base,

but a formula for apportioning the base, definitions of the various
factors used in the formula, and rules governing the application of
those factors clearly would be needed.

In the Board’s view, the

legislation should safeguard against the use of inappropriate alloca­
tion factors, provide assurance that the sum of the taxable base on
which two or more States levy

a tax not exceed 100 per cent of the

actual base, and avoid the difficulties of complying with widely
varying procedures and requirements among the various States.
The ACIR recommends, enactment of legislation providing
simply that the applicable tax be applied on a "fairly apportioned
or attributed part of the entire. . . tax base," and that there be
no Congressional action requiring States to adopt a standardized
definition of taxable income for purposes of taxing out-of-State

To limit aggregate tax payments

and provide assurance

that all of the tax base is attributed to an area having jurisdiction
to tax, the ACIR recommends that legislation permit the domiciliary




State to apply its tax to the entire tax base of home-State depositories
but then require the domiciliary State to allow the taxpayer a credit
against such tax liability for similar taxes paid to other States.
However, such credit need not exceed the lesser of the actual tax paid

nondomiciliary jurisdictions or the amount that would be fairly

apportioned to such jurisdictions under the laws and rules of the
domiciliary State.
These recommendations clearly do hot provide the standard
principles and procedures to govern interstate division of the tax
base that the Board recommendation had contemplated.


diversity of practice still exists among the States with respect
to apportionment of taxes on interstate sales of tangible personal
property, notwithstanding extensive efforts by the States to promote
uniformity and reduce compliance burdens.

There is considerable risk

that efforts to adapt these varying nonfinancial business allocation
procedures to the noncomparable interstate operations of depositories,
or to develop new apportionment measures for such institutions, would
be a source of uncertainty and prolonged litigation unless the statutory
guidelines are very specific.

These difficulties, together with compliance

problems associated with the complex and widely varying State and local
apportionment laws, rules, and procedures that likely would develop in
the absence of such guidelines, could cause many depositories to with­
draw from out-of-State markets and seriously impede credit mobility.




Moreover, providing complete discretion for States to
develop and apply their own apportionment formulas would open the
door for adoption of factors that might allocate to an individual
State a share of the tax base determined mainly by the volume of loans
outstanding to, or the volume of deposits received from, customers
in that State.

Such a tax structure could lead to a marked reduction

in the flow of credit to particular States and seriously affect the
local economy, particularly in States where local supplies of credit
are inadequate to meet existing needs.
The ACIR indicates that its proposed requirement for tax
credits, together with its proposed "fair share" apportionment
requirement, would meet the potential problem of overlapping taxation
or taxation of more than 100 per cent of the tax base of an individual

But we do not see how such protection could be assured under

the ACIR apportionment standard, where the States would be free to adopt
varying definitions of the tax base and apportionment formulas that
would allocate that base through what undoubtedly would prove to be
widely varying combinations of factors and averaging procedures.


might be noted also that under this crediting arrangmeent, the taxes
actually paid by a depository on its income apportioned to nondomiciliary
States would not in all cases be governed by the tax rates applicable in
those States as would be the case under a strict apportionment-of-base

If the tax rate in the nondomiciliary State is lower than

in the home State, the credit allowed the depository would be limited




to the actual tax paid in the foreign State.

Yet all its income,

including the amount apportioned to the foreign State, would be subject
to taxation in the home State at its higher rate.
In its 1971 recommendations, the Board also expressed concern
about the burden on out-of-State taxpayers associated with the need
to comply with widely varying administrative procedures among the

Accordingly, the Board recommended enactment of legislation

to establish rules that would guide the States in their administrative
procedures, such as the application of a unitary business concept,
requirements regarding use of consolidated or combined tax returns
from related or affiliated corporations, and audits of out-of-State


Board also suggested the designation of a Federal

administrative agency to provide regulations and interpretations.
The ACIR, in recommending against Federal prescription of
a standardized definition of taxable income for

taxation of out-of-

State depositories, in effect is recommending also that the States be
free to apply their own administrative, accounting, and reporting
procedures in apportioning and collecting the tax.

Moreover, the ACIR

proposes that Federal legislation concerning the application of "doing
business" taxes to out-of-State depositories omit reference to procedures
and mechanisms for adjudication of disagreements between States and tax­

This would leave the resolution of such problems to customary

administrative agencies and procedures established by the States and
to applicable judicial proceedings in State and Federal courts.




The Board remains concerned about the barriers to credit
flows that could be associated with the need to comply with widely
varying and complex administrative procedures in the various States.
Because the application of "doing business" taxes to out-of-State
banks and other depositories opens a new area in interstate taxation
for which established or customary procedures do not now exist, wide
differences in treatment are likely.

There would appear to be signifi­

cant advantages, to the tax collector as well as the taxpayer, if
such taxation were introduced on the basis of uniform administrative
procedures to be provided for by Federal statute.

We believe that the

Congress should designate a Federal administrative agency, such as
the Treasury Department, to develop appropriate regulations and issue
I can be very brief regarding the remaining two issues on
which the Board and the ACIR recommendations overlap--those dealing
with discriminatory taxation and taxation of interest on Federal
obligations--since the recommendations contained in both reports are
essentially identical.

Because of uncertainties regarding the possi­

bility that States might discriminate against out-of-State depositories
in favor of those within the State, the Commission recommends enactment
of legislation specifying that out-of-State depositories shall not be
subject to heavier taxes than would be imposed if they were domestic




corporations chartered or domiciled in the taxing State.

The Commission

also recommends that the Federal public debt statute be amended to
authorize States to include, in the measure of otherwise valid direct
net income taxes, the interest income realized by financial depositories
from Federal government obligations.

States now may tax such interest

only through a franchise or excise tax "according to or measured by"
net income, not by a direct income tax, although the two types of taxes
are identical in all other essential characteristics.

The recommended

legislation would enable some States to simplify their tax structures and
provide additional flexibility for States in adapting their choice of
tax to their individual needs.

The Board recommends enactment of both

In concluding my statement, I should like to remind the Sub­
committee that the issues before you in these legislative recommendations
are of substantial economic importance to the Nation.

To meet the needs

of governments, businesses, and individuals for an efficient monetary and
credit system, and to promote effective utilization of the Nation's
resources, a very large and complex system of interstate and inter­
regional flows of funds through depository institutions has developed.
It is essential that these flows not be placed in jeopardy as the outof-State activities of these depositories are exposed, in many cases for
the first time, to non-domiciliary State and local taxation.


the Board's 1971 study concluded that the grant of authority to tax must
be accompanied by certain safeguards, a conclusion to which we still subscribe.




lt is the Board's view, based onthis study and on the later
ACIR study, and my own view, influenced in part by my banking experience,
that the bill in Committee Print No. 1 now before you does not provide
adequate safeguards.

We, therefore, recommend that the Congress develop

a legislative approach that will establish appropriate

and uniform

jurisdictional, apportionment, and administrative guidelines and pro­
cedures and thus avoid the risks of damage to our economy that might
otherwise arise.
The Board appreciates that this is a difficult and complex
undertaking and that viable answers might not be found quickly.


the necessary legislative and administrative action cannot be completed
before the present moratorium expires on September 12, the Board reluc­
tantly concludes that the moratorium should be further extended.