Table 4: Direct and indirect tax collections for the fiscal years 1926, 1930-1937 (Collections basis, except customs which are on daily statement basis) (In millions of dollars) 1926 1930 1931 1932 1933 Direct taxes: Income 1,974 2,410 1,860 1,057 747 Excess profits - - - - - Capital stock 97 - - - - Estate 116 65 48 47 30 Gift 3 - - - 5 ------------------------------------------ Total 2,191 2,475 1,908 1,104 781 Indirect taxes: Liquor, including non-intoxicating liquors 26 12 10 9 43 Other internal revenue including AAA taxes 619 553 510 445 796 Customs 579 587 378 328 251 ------------------------------------------ Total 1,225 1,152 898 781 1,089 Grand total internal revenue and customs 3,415 3,627 2,807 1,885 1,871 PERCENTAGES OF INTERNAL REVENUE AND CUSTOMS Direct taxes 64.1 68.2 68.0 58.5 41.7 Liquor, including non-intoxicating liquors .8 .3 .3 .5 2.3 Other indirect taxes 35.1 31.5 31.7 41.0 56.0 PERCENTAGES OF INTERNAL REVENUE AND CUSTOMS EXCLUDING LIQUOR Direct taxes 64.6 68.5 68.2 58.8 42.7 Indirect taxes excluding liquor 35.4 31.5 31.8 41.2 57.3 1934 1935 1936 1937 Direct taxes: Income 817 1,099 1,413 2,149 Excess profits 3 7 15 25 Capital stock 80 92 95 137 Estate 104 140 219 282 Gift 9 72 160 24 ------------------------------------------ Total 1,013 1,409 1,901 2,617 Indirect taxes: Liquor, including non-intoxicating liquors 259 411 505 594 Other internal revenue including AAA taxes 1,400 1,479 1,114 1,442 Customs 313 343 387 486 ------------------------------------------ Total 1,973 2,233 2,006 2,522 Grand total internal revenue and customs 2,986 3,643 3,907 5,139 PERCENTAGES OF INTERNAL REVENUE AND CUSTOMS Direct taxes 33.9 38.7 48.7 50.9 Liquor, including non-intoxicating liquors 8.7 11.3 12.9 11.6 Other indirect taxes 57.4 50.0 38.4 37.5 PERCENTAGES OF INTERNAL REVENUE AND CUSTOMS EXCLUDING LIQUOR Direct taxes 37.1 43.6 55.9 57.6 Indirect taxes excluding liquor 62.9 56.4 44.1 42.4
Another feature of the Federal income tax has been the lack of coordination between its two constituents, the tax on corporations and the tax on individuals. For example, under all the Revenue Acts prior to 1936, dividends received by individuals were credited against the individual income tax base for normal income tax purposes. This procedure would seem to be in accord with the view that the corporation is a conduit through which certain income streams flow to individuals and that these streams of income taxed to the corporation cannot to that extent properly be taxed to the individual. At the same time, however, throughout the period from 1918 to 1936, corporation income tax rates have been consistently in excess of the individual normal tax rate, indicating that at least to the extent of the excess the corporation income tax has been viewed in the nature of a privilege tax for the privilege of doing business in corporate form. Further, the excess of the corporation over the individual normal rate reached a level which made even such an interpretation of the corporation income tax doubtful. It appears that in substantial part the corporation income tax of the past cannot be explained except in terms of the revenue requirements of the Government and in terms of administrative and political convenience. Thus its coordination with the individual income tax was conspicuously lacking.
Under the Revenue Act of 1936 dividends received by individuals were for the first time subjected to the normal individual income tax. This step was in accord with the view that the corporation income tax was predicated upon corporate privilege. It was, however, in conflict with the conduit view of corporation income taxes, which appears to have governed the simultaneous imposition of the surtax on undistributed profits. Examining 1936 legislation further, it appears that the retention of the corporation normal income tax in that year was in accord with the privilege view of the corporation income tax and in conflict with the conduit view. The conclusion is inescapable that in the light of economic principles the integration of the individual and corporation income tax continues to leave much to be desired. Accordingly, income tax revision must also be directed toward a coordination of the corporation and individual income tax on a consistent principle: To tax corporate income in the hands of the individual income recipients at progressive rates and to tax corporations on a broad basis and at rates sufficiently low to make it possible to view the tax as one on corporation privilege.
Finally, the third objective of income tax revision is the making of those adjustments in the income tax base which are necessary to prevent the income tax from burdening taxpayers inequitably either because existing features of the tax are conducive to tax avoidance or because they provide intentional and unintentional bounties to some taxpayers and not to others.
It is in furtherance of these three objectives, (1) increasing reliance upon progressive taxes, (2) better coordination between the individual and corporate income taxes, and (3) the elimination of existing structural inequities, that the herein contained proposals for revision are recommended.
C. Structural Revisions
1. The Individual Income Tax Schedule
a. Normal And Surtax Rates
It was noted above that one major objective of the proposed revenue revision is the increasing of the role of the individual income tax in the Federal revenue structure. With general agreement that the Federal Government must place increasing reliance upon progressive direct taxes and with the realization that its opportunities for doing so are largely confined to the individual income tax and the less productive estate and gift taxes, the individual income tax looms large in the Federal tax picture. With that view in mind, it is proposed that the surtax rate schedule be revised upward. No change is proposed with respect to the normal tax on individuals. The rate is to remain at 4 percent.
Comparison of the rates in Table 5 with the present schedule will reveal that except in the first two brackets the proposed surtax rates are higher than the present surtax rates for all levels of income of $500,000 and less and are the same as the present rates for all levels of income in excess of $500,000. The proposed bracket rate increases are largest in the case of incomes of $100,000 and less. Further, it is proposed that the surtax rates begin with surtaxable net income in excess of $3,000 instead of the present $4,000 but that the rate for the first $3,000 of surtaxable income be 3 percent, applicable from the $3,000 level instead of the present 4 percent on the first $2,000 of surtaxable income above the $4,000 level. This proposed adjustment of the lowest surtaxable income level is prompted by the desirability of avoiding abrupt differentiation between individuals that have just sufficient income to emerge into the first surtaxable income bracket.
With respect to the normal tax on individuals, it has already been noted that before 1934 it has sometimes been in two or three bracket rates and has sometimes risen to a level as high as 12 percent. The Revenue Act of 1918 imposed a tax of 12 percent on normal income in excess of $4,000. Two questions arise, therefore, with respect to the normal income tax rate: (1) should it be uniform or bracketed, and (2) should it be high or low in relation to the surtax rate schedule?
The graduated normal individual income tax derives its theoretical strength from the desirability of relieving the recipients of small amounts of income from the full impact of a relatively high flat rate normal tax. So long as the normal tax is moderate, such as the proposed 4 percent rate, the need for a graduated normal tax does not arise. Although in 1917 and again in 1929 the rate was actually graduated below this level, these were exceptional occasions for, generally, graduation occurred at higher levels. Thus, the top rate in 1918 was 12 percent, in 1919-23 and again in 1932-33, 8 percent in 1924, 6 percent and in 1925-28 and again in 1930-31, 5 percent.
Table 5: Proposed surtax schedule Amount of surtax net income Rate of tax Total surtax (in thousands) (percent) (cumulative) 0 - 3 - - 3 - 6 3 90 6 - 8 5 190 8 - 10 7 330 10 - 12 10 530 12 - 14 13 790 14 - 16 16 1,110 16 - 18 20 1,510 18 - 20 24 1,990 20 - 22 28 2,550 22 - 24 32 3,190 24 - 28 36 4,630 28 - 34 40 7,030 34 - 40 44 9,670 40 - 48 48 13,510 48 - 56 51 17,590 56 - 64 53 21,830 64 - 72 55 26,230 72 - 80 57 30,790 80 - 90 59 36,690 90 - 100 61 42,750 100 - 150 63 74,290 150 - 200 65 106,790 200 - 250 66 139,790 250 - 300 67 173,290 300 - 400 68 241,290 400 - 500 69 310,290 500 - 750 70 485,290 750 - 1,000 72 665,290 1,000 - 2,000 73 1,395,290 2,000 - 5,000 74 3,615,290 5,000 up 75
There are two disadvantages in keeping the normal tax high in relation to the surtax rates: FIRST, the use of a high normal rate in lieu of a high surtax rate schedule enables certain recipients of income from tax-exempt bonds to escape their proper share of the tax burden; and SECOND, the use of a high normal tax rate renders the combined income tax scale less flexible for purposes of maintaining some desired standard of progressiveness under varying business conditions. Sharply rising prices and inflated money incomes tend to make a progressive rate scale more progressive than initially contemplated. Similarly, declining prices and a deflation of income sources tend to make the originally established progressive rate scale less progressive. In order to maintain the same degree of progressiveness during years of different business conditions it is necessary to adjust the surtax rate scale as well as the normal tax. If the normal tax is high in relation to the surtax rate scale, it becomes more difficult to adjust the combined rates and thus retain the desired standard degree of progression.
Great Britain furnishes the outstanding example of a country that has attempted to adjust a high flat standard rate in order to meet governmental revenue requirements. The surtax rates have been maintained practically unchanged since enactment. There is much to be said for this procedure on grounds of simplicity but the procedure is one which sacrifices consideration of equity. Too much stress cannot be placed upon the inability of the British procedure to maintain any standard of progressiveness during periods of fluctuating prices, although it should be noted that the maintenance of such a standard by surtax rate schedule adjustments is extremely difficult, so difficult, in fact, that the British apparently do not believe the attempt to be worthwhile.
Increasing recognition of the interdependence of business conditions and fiscal policy, however, tends to substantiate the American as opposed to the British procedure. The adjustment of rate scale progression to business fluctuations is at least recognized as theoretically desirable if not practically possible. For that reason it is recommended that the present continuation of low and stable normal rates with high and variable surtax rates be retained.
A comparison of the effective normal and surtax rates under the existing and proposed surtax schedule is presented in Table 6 and in the accompanying chart. For purposes of the comparison, recognition is given to the proposed changes in personal exemptions and in earned income credit discussed in the following section.
Table 6: Effective Normal and Surtax Rates Under Existing and Proposed Individual Income Tax Schedule Net income Present Schedule Proposed Schedule before Single Married Single Married exemption /1/ Person Person Person Person $ 1,000 - - .2 - 2,000 1.6 - 1.8 - 2,500 2.0 - 2.1 .2 3,000 2.3 .3 2.3 .7 6,000 3.6 1.9 4.0 2.6 8,000 4.7 3.1 4.9 3.5 10,000 5.6 4.2 5.9 4.5 12,000 6.4 5.0 6.9 5.5 14,000 7.0 5.8 8.1 6.6 16,000 7.7 6.5 9.4 7.9 18,000 8.4 7.2 10.9 9.3 20,000 9.2 7.9 12.4 10.7 22,000 10.0 8.7 14.0 12.3 24,000 10.8 9.5 15.7 13.9 28,000 12.3 11.1 19.1 17.4 34,000 14.3 13.2 23.4 21.9 40,000 16.0 14.9 27.0 25.6 48,000 18.2 17.2 31.1 29.8 56,000 20.3 19.4 34.5 33.3 64,000 22.7 21.7 37.3 36.2 72,000 25.1 24.1 39.7 38.7 80,000 27.5 26.6 41.8 40.9 90,000 30.5 29.6 44.1 43.3 100,000 33.4 32.5 46.2 45.4 150,000 42.9 42.3 53.1 52.6 200,000 48.2 47.7 57.1 56.7 250,000 51.7 51.3 59.7 59.3 300,000 54.4 54.1 61.5 61.3 400,000 58.3 58.0 64.2 63.9 500,000 61.0 60.8 65.9 65.7 750,000 65.4 65.2 68.6 68.5 1,000,000 68.0 67.9 70.5 70.4 2,000,000 72.5 72.5 73.7 73.7 5,000,000 75.8 75.8 76.3 76.3 FOOTNOTE TO TABLE /1/ All income is assumed earned; basis of computations: for present rate schedule earned income credit 10 percent, personal exemptions $1,000 for single person and $2,500 for married person, and for proposed rate schedule earned income credit 15 percent, personal exemptions $800 and $2,000, respectively. END OF FOOTNOTE
EFFECTIVE NORMAL AND SURTAX RATES UNDER PRESENT AND PROPOSED INDIVIDUAL INCOME TAX SCHEDULE
b. Personal Exemptions And Earned Income Credit
It is proposed to lower the personal exemptions from $1,000 to $800 for single persons and from $2,500 to $2,000 for married persons, and to simultaneously raise the earned income credit from 10 to 15 percent.
As shown previously, relatively high personal exemptions have been characteristic of the Federal income tax. The personal exemptions were lowest during the period 1917-20, when they were $1,000 and $2,000 for single and married persons, respectively. These cannot be compared, however, with the existing $1,000 and $2,500 and with the proposed $800 and $2,000 exemptions insofar as concerns individuals subject to the surtax. Whereas the present personal exemption and credit for dependents are allowable for both normal and surtax purposes, the 1917-20 levels were restricted to normal tax purposes. For the majority of persons, however, those that do not reach into the surtaxable levels, the proposed personal exemptions are comparable with those of 1917-20.
However, the personal exemptions and credit for dependents cannot be evaluated except in combination with the earned income credit.
The present personal exemptions together with the existing 10 percent earned income credit affords complete freedom of Federal income tax liability to a single person without dependents and with income of $1,111 and to a married person without dependents and with income of $2,778. In combination with the proposed 15 percent earned income credit, the proposed personal exemptions mean that single persons with income of $941 and married persons with income of $2,353 are free of the Federal income tax.
The proposed lowering of the personal exemptions would broaden the individual income tax base so that many more individuals would file Federal income tax returns. Such direct taxation of a larger number of individuals would have the tendency of making the population more keenly alert with respect to governmental problems and would yield some additional revenue.
The recommended reduction in personal exemptions serves to broaden the individual income tax base in two respects: (1) By reducing the lower limit, it reaches individuals with smaller net incomes than those at present taxable; and (2) by enlarging the tax base of individuals at present subject to tax it increases their tax liability. On both counts, this proposal would result in increased revenue and consequently make possible the relinquishment of less desirable and regressive types of taxes.
The portion of the income tax base cut away even by the lowest of personal exemptions and credit for dependents, that of the period 1917-20, is shown in the following table:
Personal exemptions and credit for dependents and net income, for calendar years 1917-1920 (In millions of dollars) Personal exemptions Personal exemptions and credit for dependents and credit for dependents as a Year dependents Net income percentage of net income 1917 $ 3,773 $11,191 33.7 1918 8,097 15,925 50.8 1919 9,424 19,859 47.5 1920 12,835 23,736 54.1
One of the chief objections to lower personal exemptions and lower credit for dependents is that the greatly increased number of returns aggravate the problems of income tax administration. If such returns are to be audited even in the most cursory manner it will require a substantial increase in personnel. Some indication of the increase in the number of returns which is likely to result from the lower personal exemptions may be derived by reference to the data for the period 1917-20. These are shown in Table 9.
For the year 1920, for example, 72.2 percent of the total number of returns were made by persons having incomes of $3,000 or less; this large percentage of the total number of returns, however, supplied only 7.6 percent of the total individual income tax revenue. It should be noted, however, that the absolute net amount of revenue, after offsetting administrative costs, which will result from the enactment of the lower personal exemptions will by no means be inconsequential.
Personal exemptions and credit for dependents are granted in the nature of reliefs from income tax burden in recognition of the fact that a certain amount of tax-free income is essential for the maintenance of a decent standard of living. This relief granted under the income tax does not effectively accrue to the individual taxpayer unless the amount of income thus free from income tax is also free from other types of taxation. If the level of personal exemptions and credit for dependents is high, it is practically impossible for the Federal Government to pursue a tax policy which will leave the individual taxpayer with a large amount of income free from all taxation. The distribution of the burden of taxes other than the individual income tax is less rational and more regressive than the distribution of the burden of the income tax. One of the main purposes of the proposal to lower personal exemptions is not to raise additional revenue but to raise substitute revenue; to substitute income tax revenue for other tax revenue, with a view to making the aggregate distribution of the Federal tax burden more equitable.
Table 9 Individual income tax returns and taxes paid, 1917-20. Ratio of $1,000 - $3,000 income class to total A. Number of returns (In millions) Taxable returns Nontaxable returns ------------------------- ------------------------- Net income class Net income class $1,000 - $3,000 $1,000 - $3,000 ----------------- ----------------- Year Total Number Percent Total Number Percent ---------------------------------------------------------------- 1917 3.232 2.265 70.1 .241 .214 89.0 1918 3.393 2.018 59.5 1.032 .996 96.4 1919 4.231 2.429 57.4 1.102 1.065 96.7 1920 5.518 3.549 64.3 1.742 1.693 97.2 ------------------------------------------------------------------- Total returns --------------------------- Net income class $1,000 - $3,000 ------------------ Year Total Number Percent ----------------------------------- 1917 3.473 2.479 71.4 1918 4.425 3.014 68.1 1919 5.333 3.495 65.5 1920 7.260 5.241 72.2 ----------------------------------- B. Taxes paid (Amounts in millions of dollars) Net income class $1,000 to $3,000 --------------------------------- Year Total Amount Percent of total ---------------------------------------------------------- 1917 675 9 /1/ 1.3 1918 1,128 62 5.5 1919 1,270 53 4.2 1920 1,075 82 7.6 FOOTNOTE TO TABLE /1/ Tax returned by incomes of $2,000-$3,000. No tabulation was made of the tax returned by incomes under $2,000. END OF FOOTNOTE
c. Earned Income Credit
If personal exemptions were lowered without the simultaneous increase in the earned income credit, it is possible that the tax falling on small incomes would result in too great a burden. The increase in the earned income credit serves to bring additional relief to the small taxpayer.
The principle of differentiation between earned and unearned income under income tax laws is recognized in other countries. Thus, in Great Britain the earned income credit is at the rate of 20 percent, except that all income in excess of $7,500 is considered unearned instead of all income in excess of $14,000, as in our law. In Canada, instead of giving some relief to the recipients of earned income, the principle of differentiation is recognized by imposing an additional tax on unearned income, graduated from 2 to 10 percent; in Australia the principle is recognized through the use of a separate and higher progressive rate scale applicable to unearned income as against earned income.
The present law provides that there shall be allowed for purposes of the normal tax only a credit for earned income to the extent of 10 percent of earned net income. If the taxpayer's net income is not more than $3,000 his entire net income is considered to be earned net income and if his net income is more than $3,000 his earned net income is considered to be no less than $3,000. In no case, however, shall the earned net income be considered to be more than $14,000. Recognition of the fact that earned income should be given preferential treatment is first found in the Revenue Act of 1924 and was continued through the Revenue Act of 1928. It was discontinued under the Revenue Act of 1932 but reimposed under the Revenue Act of 1934. The rates and allowances during this period are shown in the following table:
Credit on earned net income Earned net income subject Revenue Income Kind of to tax for computation of Act year credit credit Limit of credit ------------------------------------------------------------------- 1924 1924 Against All net income up to 25 percent of tax $5,000 whether earned or normal tax on not, and up to $10,000, earned net if earned income. (Cannot exceed 25 percent of normal tax on ordinary net income.) 1926 1925, do All net income up to 25 percent of 1926, $5,000, whether earned or total tax on 1927 not, and up to $20,000, on earned net if earned. income. (Cannot exceed the sum of 25 percent of normal tax on ordinary net income and 25 percent of surtax on earned net income.) 1928 1928, do All net income up to Do 1929, $5,000, whether earned 1930, or not, and up to $30,000, 1931 if earned 1932 1932, 1933 1934- 1934, Against All net income up to 10 percent of 1936 1935, net $3,000 whether earned or the earned net 1936 income. not, and up to $14,000, income, but not if earned. in excess of 10 percent of the entire net income.
It will be noted that under the present law the earned income credit is allowed on amounts of income of $3,000 and less irrespective of whether earned or not. This is justified on the grounds that recipients of small amounts of income are entitled to relief from the rate scales otherwise in effect. Further, it should be noted that irrespective of whether earned or not, incomes in excess of $14,000 are considered unearned. This procedure is justified on similar grounds, namely, that it is not essential to afford recipients of large amounts of income relief from the rate scales otherwise in effect.
In the present law there is a little understood limitation upon the amount of earned net income credit, namely, that it must not be in excess of 10 percent of net income. It is proposed that this limitation be repealed so as to allow an unconditional credit to the extent of 15 percent of earned net income, that is, irrespective of the amount of the net income; subject to the exception, however, that incomes in excess of $14,000 shall be considered to be unearned.
2. Taxation Of Corporations
In line with the previously indicated objectives of revenue revision this section examines the inequitable features of the existing complement of Federal corporation taxes and describes a more acceptable method of corporation taxation. The proposed revision is predicated upon the hypothesis that the corporations themselves should be taxed solely for the privilege of doing business in the corporate form and that the profits of corporations be taxed in the hands of the individual dividend recipient. This, it will be observed, is but the next stage of the individual-corporate inter-relationship in taxation initiated by the Revenue Act of 1936.
a. The Existing Corporation Taxes
The Federal Government at present, in addition to the undistributed profits tax, levies three taxes on corporations, a normal income tax, a capital stock tax and an excess profits tax. The most important of these from a point of view of productivity is the normal tax, now imposed at rates ranging from 8 percent on the first $2,000 of normal tax net income to 15 percent on normal tax net income in excess of $40,000. The yield from the corporate normal income tax, it is estimated, amounted roughly to $950,000,000 during the fiscal year 1937 and is estimated at approximately $1,200,000,000 for the fiscal year 1938. While collections during no recent year approached the present level, they were, nevertheless, consistently in excess of collections from individual income tax in all but two of the last thirteen years and on occasions have supplied fully one-third of Federal revenues.
Prior to the Revenue Act of 1936 the corporation income tax was in part a tax on corporate privilege and in part a tax at source, in lieu of the normal individual income tax, dividends being exempted from normal individual income taxes. However, the corporate income taxes have generally been higher than those imposed under the normal individual income tax on dividends and a portion of them were therefore in fact taxes on corporate privileges. The subjection of dividends to the individual normal income tax under the Revenue Act of 1936 rendered the entire corporate income tax one predicated upon corporate privilege. In view of that circumstance the present corporation tax must be appraised in the light of its qualifications as a privilege levy. Such an appraisal, as will be noted later, leads to the conclusion that the tax is both excessive and defective.
The corporation income tax is an unsatisfactory measure of the corporate privilege. Being based on net income it does not apply to a corporation which conducts a business which runs into millions of dollars annually for several years, as long as it produces no statutory net income.
It is true that corporations float in and out of the profitable group so that over a long stretch of time all corporations, except those that pass out through bankruptcy or are otherwise liquidated, become subject to income tax. Nevertheless such a tax is not a satisfactory corporate privilege tax because it would seem that the privilege of doing business under the corporate form must have some annual value irrespective of the corporation's ability to make profits. Further, differences in corporate capitalization affect the income tax base in a way which is altogether incongruous with the view that the normal income tax is in fact a satisfactory corporate privilege tax. Two corporations each doing the same amount of gross business and each with the same profit ratio will under the present procedure pay different amounts of normal income tax if one of the corporations operates entirely with capital derived from issues of stock and the other operates with capital derived partly from stock and partly from bond issues.
The capital stock tax is at present imposed at the rate of $1.00 per $1,000 of adjusted declared value of capital stock. It is in substance a privilege tax distinct from the normal income tax and was originally imposed under the Revenue Act of 1916. After ten years it was repealed under the Revenue Act of 1926, only to be reimposed by the National Industrial Recovery Act in 1933.
In order to prevent the avoidance of this privilege tax through understatements of capital value, Congress imposed an excess profits tax which applies to corporations reporting profits in excess of 10 percent of declared capital value. The tax is imposed at a 6 percent rate on a corporation's net income in excess of 10 percent and not in excess of 15 percent of the adjusted declared value of its capital stock and at a rate of 12 percent on a corporation's net income in excess of 15 percent of the adjusted declared value of its capital stock.
The capital stock tax has proved to be no more satisfactory as a measure of corporate privilege than the corporation normal tax. The base upon which it is imposed, as will be noted later, is incapable of exact, uniform determination with the result that the tax is frequently discriminatory as between different taxpayers.
Upon the reimposition of the capital stock tax under the National Recovery Act, the taxpayer was permitted to declare any value for the capital stock, and as a protection against tax avoidance, the excess-profits tax was also reimposed so that if capital stock were undervalued the corporation would become subject to the excess-profits tax. A re-declaration of value was permitted under the Revenue Acts of 1934-36 but since this valuation is based primarily upon taxpayer's judgment it bears no necessary relationship to book value, market value or capitalized income. Tax liability continues to be determined by an arbitrarily valued capital stock base unrelated to the privilege of doing business. Consequently the tax is devoid of certainty and results in substantially inequitable taxation as between different corporations operating under substantially identical circumstances. It cannot be emphasized too strongly that this deficiency lies not only in the base now utilized for the capital stock tax but that it was also inherent in the bases used during all past efforts at imposing capital stock taxes.
To the preceding conclusion that neither the corporate normal income tax nor the capital stock tax constitutes a satisfactory tax upon corporate privilege should be added the observation that a combination of the two taxes, as is done under the present law, is also unsatisfactory, because corporations with net income pay both taxes whereas corporations without net income pay only the capital stock tax. Even if the view is taken that this corporate normal income tax in the long run will burden all corporations as they float into the profitable group, the two taxes combined would appear to be excessive for the purpose of taxing corporate privilege and nothing else. Apparently the two taxes were originally imposed for revenue purposes without much consideration given to their economic justification and certainly without much reference to the extent to which they collectively constitute a proper tax on corporate privilege per se.
While all recognize that a corporate privilege exists, the measure of that privilege is subject to conjecture. The corporation has perpetual life, has facilities for assembling large aggregates of capital from diverse sources and gives its proprietors immunity from unlimited liability. These are tangible but not specifically measurable attributes. Because it is not possible to measure the value of corporate privilege per se, the tax imposed in large part is likely to be determined by revenue considerations but the tax should not be at a level which would make reference to the privilege basis obviously irrelevant. Further, it would seem highly desirable for this purpose to impose one tax with a base more closely related to operating profits which would result in taxing corporations according to the scope of their economic activities, than two taxes, such as the present corporate normal income tax and the capital stock tax, which are not closely related to the scope of corporate economic activity.
b. Interrelationship Of Capital Stock And Excess-Profits Tax
The view is sometimes taken that the existing combination of capital stock and excess-profits taxes can serve as a foundation for a future real excess-profits tax. If this claim were true, it would not be worthwhile to reexamine the corporate normal income tax base in order to make of it a more satisfactory corporate privilege tax. It is important, therefore, to examine the interrelationship of the present capital stock and excess-profits taxes.
When the existing combination of capital stock and excess-profits taxes was enacted it was not expected that the excess-profits tax would yield much revenue. Its chief function was to make the capital stock tax effective. That it is "merely an adjunct to a corporation capital stock tax" is clear from the following table which shows the yield from these taxes for the fiscal years 1933-1937:
Collections from capital stock and excess-profits taxes for fiscal years 1933-37 (In thousands of dollars) Fiscal year Capital Excess ending June 30 stock profits Total 1933 - - - 1934 80,168 2,631 82,799 1935 91,508 6,560 98,068 1936 94,943 14,509 109,452 1937 137,499 25,105 162,604 ------------------------------------- Total 404,118 48,805 452,923
The taxpayer on each of three different occasions was given the privilege to declare whatever "initial" value of the capital stock he might choose. The last "initial" value was selected for the taxable year ended June 30, 1936, and as reflected in the collections for the fiscal year 1937 was substantially higher than the preceding ones.
The declared value hinges primarily upon the taxpayer's judgment and may not be very closely related to either book value, market value or the capitalization of income basis. Once the declaration is made, it is not recallable by the taxpayer and is not subject to review by the Bureau of Internal Revenue. Subsequent to the "initial" declaration, certain adjustments of capital inflow and outgo are provided for. These adjustments are subject to review.
Formally the two taxes are distinct. Actually they are linked together by a common base, the adjusted declared value of the capital stock, which serves both as the base for the capital stock tax and the base from which excess profits are measured. Thus, in the present law no excess profits emerge if the net income of the corporation fails to exceed 10 percent of the adjusted declared value.
By linking the two taxes together in this way the Government has imposed on the taxpayer a peculiar and perplexing valuation problem. If he declares a low capital stock value the taxpayer exposes himself to the excess-profits tax. If, on the other hand, he declares a high capital stock value he escapes the excess-profits tax but exposes himself to a higher capital stock tax. Thus, the taxpayer is enticed to strive not merely for an accurate valuation (which in itself is difficult enough to determine) but for that valuation which will result in the minimum liability for both taxes taken in combination, which is much more difficult because it involves the taxpayer in an estimate of the profits of his business over its life or else over the period that he estimates that the existing combination of the two taxes will remain in force.
The task for those taxpayers that attempt to report the true value of their capital stock is not an easy one; however, it is not human nature to resist the temptation to capitalize the future earnings of a business in such a way as will result in the least possible combined tax load. It is within the law for the taxpayers to try their skill at economic and legislative prognostication and it may be assumed that they have in large numbers done so.
Taxpayer A, who predicts a two-year life for the capital stock and excess-profits taxes and little or no profits from his business in the two income-tax taxable years ending after June 30, 1936, will have had no fear of the excess-profits tax and will have declared a very low value of his capital stock for the taxable year ending June 30, 1936. Taxpayer B, with a similar forecast of profits but with a different view relating to the permanency of the taxes will be reluctant to declare a value as low as A did lest the excess-profits tax become burdensome in the third and subsequent taxable years.
If the permanency of the taxes is taken for granted, then in declaring the value of the capital stock for the taxable year ending June 30, 1936, the taxpayers should have declared it at ten times the estimated average annual earnings for in this way they are most likely to escape the burden of the excess-profits tax. The extent to which they will escape it will depend upon the fluctuations in the profits of their business.
To illustrate these points: