Senator CONNALLY. That is right.

Senator LUCAS. Mr. Chairman, about 2 years ago I was chairman of a Subcommittee on Foreign Relations that went into this subject pretty thoroughly, and made a report on it.

The CHAIRMAN. This same question?

Senator LUCAS. Yes.

The CHAIRMAN. Senator Lodge, have those transactions been of considerable magnitude?

Senator LODGE. The last figures we have are for 2 years ago. Is that right, Mr. Stam?

Mr. STAM. Right.

Senator LODGE. And almost $4,000,000. Is that right?

Mr. STAM. $3,000,000.

Senator CONNALLY. In tax or business?

Senator LODGE. Amount of revenue lost.

I am not advocating this as a revenue matter. I am advocating it as a matter of morale and justice.

The CHAIRMAN. Mr. Stam, while you were out, we were making in quiry as to what is the practice of nontreaty countries in the treatment of American citizens under similar circumstances.

Mr. STAM. The difficulty with the whole problem of capital gains has generally been that many countries do not levy any tax on capital gains. So they do not have this problem like we have over here. They just do not tax capital gains.

That has been one of the problems that made this question rather difficult.

The CHAIRMAN. Then our citizens would not be hurt in those countries, as far as capital gains are concerned?

Mr. STAM. That is right.

Senator GEORGE. And our conventions, notably with Canada, Great Britain, and so forth, the ones we have concluded, have generally a reciprocal pattern. They not having taxed capital gains in the conventions, we agreed not to here.

Great Britain, of course, does not impose a capital-gains tax, as such, but if it is a regular trade or business in which the taxpayer is engaged, he may be liable for a tax.

Mr. STAM. I think what happened was this: In the 1936 Revenue Act, prior to that time we had a lot of difficulty in collecting any tax from nonresident aliens, and it was thought, after study, that if we could levy some sort of a gross tax on the income going out of the country to the nonresident alien at a little higher rate, say 30 percent, that we might get more revenue from that source than we would under the existing system in effect at that time, which would try to tax them where we could.

As a result of that, there was some concession made to the nonresident aliens by exempting them from the tax on capital gains. In other words, they paid this 30 percent gross tax on their income from dividends, interest, and rents, and so forth, that went out of the country. That rule was generally applied to nonresident aliens who had a gross income of $15.000 or less, around that neighborhood. I think it was a little more than $15,000.

As far as those who had a greater amount of income, they had to pay the full normal and surtax rates which might be beyond the 30

percent rate on their income from sources within the United States, but because of this gross-tax theory that we had, they were still exempted from the capital-gains tax.

That was the system that was adopted in 1936, and when a lot of these tax conventions were entered into, that provision of the 1936 act was incorporated into many of these tax conventions.

That is the way that thing got into the tax conventions. They practically incorporated the 1936 act provisions.

I think it is certainly true that under that system adopted in 1936 we collected a lot more from the nonresident aliens than we did under the old system where we had to go out and see what we could find.

So that is one of the problems which has always confronted the committee.

Senator LUCAS. Mr. Stam, would this amendment violate the treaties we have made?

Mr. STAM. The amendment specifically provides it shall not interfere with those treaties, so it could not violate them.

Senator BARKLEY. Let me ask this: Your amendment applies to all aliens regardless of what countries they come from?

Senator LODGE. Who are not citizens of these countries exempted by treaties.

Senator BARKLEY. Let us take a nonresident alien who has an agent in New York, and he invests in the stock market and makes a profit. That is during the period when the nonresident is not in the United States at all, maybe during 1 of the 9 months which he is not required under your amendment to be in this country. And the agency transmits the profits to him, let us say, in Mexico City.

How would you collect this tax?

Assuming that nonresident alien did come here, a month at a time, three different trips, making 90 days, or six trips of 2 weeks, how would you collect it under your amendment?

Senator LODGE. I suppose you would collect it very much the way you do any other tax on capital gains.

Senator BARKLEY. There is no withholding tax applicable to it now, and assuming the profit was sent to the nonresident in Mexico City, it would be there. You could not go down there and get it.

Senator GEORGE. I think, Mr. Stam, are not all these remittances to nonresident aliens impounded until they show a tax clearance? Mr. STAM. I think at the port they leave the country, they have to show a tax clearance, and at that time the investigation would be made as to whether they had paid the capital-gain tax.

Senator BARKLEY. I am not talking about somebody leaving a port, but somebody who has made a profit during his absence from the United States when it has been sent to him in the country where he lives by his agent, by the broker with whom he is dealing.

The CHAIRMAN. Would not the regulatory powers of the Treasury be sufficient to reach that kind of a transaction?

Mr. STAM. If he was not physically present in the United States. London would not apply, but just using it as an example, suppose he was dealing on the London Stock Exchange in American securities. If he was not present in the United States, he would not be taxable on his capital gain that he made on that American stock on the London exchange.

So they can deal abroad in American securities, and I think that is one reason why it was thought maybe the 90-day rule was a little better protection than no rule at all, because, you see, to some extent, when they do deal on the American exchanges we do collect taxes in the form of stamp taxes, and things like that, which, had they dealt on our own exchanges in the same type of security, we would get no tax from.

So this amendment, as Senator Lodge has pointed out, I think, has attempted to meet the practical problem of people doing business side by side in this country, and one paying no capital gains tax and the other paying a capital gains tax.

Where they transact the business abroad, being a nonresident alien, that income would not be from sources within the United States.

The CHAIRMAN. I am still not clear as far as Senator Barkley's point is concerned. If he does his business here through an agent, in one aspect it would be as though he were here himself. How are you going to keep the funds the agent will pay to him? He will get the funds over there before he pays the tax. Is that not your point, Senator Barkley?

Senator BARKLEY. Yes.

I can see that if the man were here 90 days and transacting business, and during those 90 days, he made a profit and took the money back with him, when he left you could hold him up at the port and make him clear it.

But suppose that money is made during the 9 months he is not in this country and transmitted to him in his own country. The fact he might come over here and stay for 90 days on two or three different trips would not enable you to collect it from him if it has already been sent to the country of his residence.

Mr. STAM. Of course, when a nonresident alien owes taxes, generally speaking, and he is abroad, usually the diplomatic repreesntatives of the United States would contact the other country to see whether or not they could make an arrangement to collect this tax.

It is handled through diplomatic channels in the case of nonresident aliens where the property is abroad. So there would be some effort to proceed through diplomatic channels if we could not collect it in this country.

The CHAIRMAN. Is this bill limited to nonresident aliens who are residents here for 90 days? Is that right?

Senator LODGE. That is right.

Senator BARKLEY. I do not know of anybody who regards the col`lection of a tax a diplomatic procedure.

The CHAIRMAN. Are there any other questions?

If not, thank you very much, Senator Lodge.

Senator LODGE. Thank you, gentlemen.

The CHAIRMAN. Senator Kem is next.

Senator Kem, we are very glad to have you here.

STATEMENT OF HON. JAMES P. KEM, A UNITED STATES SENATOR FROM THE STATE OF MISSOURI

Senator KEM. Thank you very much, Mr. Chairman, and gentlemen of the committee.

I would like to bring the attention of the committee to two points. The first is this:

A person who earns his living as the result of special training and education is subject to discrimination under the present income tax laws.

Secondly, that a school teacher is now not permitted to deduct as a business expense an essential expense incurred in holding his or her job. Senator LUCAS. Do you have a copy of your amendment?

Senator KEM. The amendments have been requested from the legislative service and are now being prepared. They are not yet available. Senator LUCAS. Thank you.

Senator KEM. I have a written statement which has been distributed, and which I should like to have in the record, Mr. Chairman. The CHAIRMAN. It will be inserted in the record.

(The statement is as follows:)

STATEMENT OF SENATOR JAMES P. KEM BEFORE SENATE FINANCE COMMITTEE MARCH 3, 1948

I should like to invite the attention of the committee to two matters which I believe are worthy of its consideration. The ideas are not original with me. They have been presented to this committee before, and undoubtedly have been considered in previous years by the committee. Whatever the reasons, relief is not accorded under the existing laws. I urge that favorable consideration be given by this committee this year.

My reason for appearing here may be briefly stated. Last fall I spoke on these matters at a meeting of the Lawyers Association of Kansas City. The mail that I received from all over the country indicated a widespread interest in the subjects discussed. I claim no special competence except as one having some recent first-hand personal experience with the tax burden upon one of the so-called learned professions. I have felt the shoe pinch until it hurt.

The two points I have in mind are: (1) A person who earns his living as the result of special training and education is subject to discrimination in the payment of Federal income taxes. (2) The school teacher is now not being permitted to deduct, as a business expense, the cost of certain essential training required in order to keep a job in the teaching profession.

I. EARNED INCOME IS ENTITLED TO SPECIAL CONSIDERATION

The Federal income tax, as its name indicates, is intended to be a tax on income, not a tax on capital. There are three forms of income: (a) investment returns, (b) capital gain, and (c) earned income.

Adam Smith in his Wealth of Nations, considered that all income should be taxed alike. He asked but one question in determining ability to pay: “How much is your income?" This test, however, is not followed in every case in our income-tax laws. We have gone far afield in affording, for one reason or another, special treatment to various groups or classes. My thesis is that earned income, particularly in the case of a professional man and the skilled worker, is entitled to special consideration.

When a businessman spends a sum of money in order to obtain machinery, equipment, or buildings, necessary in his business, he acquires what is called for tax purposes a capital investment. He may allocate the cost, so much per year, over a number of years, and deduct for Federal income-tax purposes a yearly percentage of the cost. In this manner, he is permitted to deduct from his income, free from income tax, the cost of the necessary equipment to engage in his business. By use of this method of calculating his tax, the businessman does not pay a Federal income tax on that portion of his capital which, theoretically at least, he uses up year by year. This is referred to as an allowance for depreciation, or depletion.

The reason for this deduction is obvious. If it were not allowed, money would not readily be invested in enterprises, sometimes financially hazardous, which are essential to industrial development and progress. Production, so necessary for the country's well-being, would be adversely affected.

Now let us examine this situation as it is applied to the skilled laborer and the professional person. Before he can engage in his chosen calling, he is schooled for several years at a considerable cost in order to obtain the specialized knowledge and skill required to engage in his work. Sometimes a license is required, and not infrequently the requirements to qualify for the license include a specified number of years in an approved technical school. This specialized training corresponds to the machinery and equipment of the businessman. It is the skilled man's capital investment. However, a deduction for depreciation or depletion is not allowed as a means of recovering funds that have been invested in acquiring the skill and knowledge so necessary to engage in the work.

The engineer who develops a patentable process or machine cannot charge off against his taxable income the cost of acquiring the knowledge which was basic to the invention. However, the businessman who purchases that machine or process can, over a period of time, charge off the cost to him of the purchase. The skilled mechanic cannot charge off the cost of obtaining the skill with which he earns his wages, but the cost of those wages to a business can be deducted as a business expense. The physician, the accountant, the teacher, the registered nurse, the machinist, the mechanic, the watchmaker, and the other skilled people find themselves in a similar predicament under the present tax laws.

If the skilled craftsman is to be given the same treatment with respect to income tax as is given to the businessman, he should be permitted to recover through the equivalent of a depreciation charge against taxable income the basic capital he has invested in purchasing an essential item of equipment in order to engage in his work. In the case of the skilled worker the need to use this method is greater than in the case of the businessman, because skill and knowledge, unlike machinery, buildings, and other tangible capital, have no resale value and no salvage value.

The case for special treatment

Several cogent reasons may be assigned for special treatment for tax purposes of incomes of the skilled workers and members of the professions. I shall summarize them.

1. The professional man and craftsman is entitled to something in the nature of a depreciation or depletion allowance.-A lawyer's intellect, a doctor's skill, a nurse's special care, a teacher's instruction, a mechanic's special ability, are not fixed or indestructible capital, capable of producing an income forever. Yet the income they produce is taxed more severely than that from capital because capital is permitted to replenish its loss tax free by dipping into income through depreciation, obsolescence, and depletion.

2. The professional man and skilled craftsman are put to much incidental expense. The individual with earned income has expenses not borne by the individual with investment income. The former must live near his place of employment and maintain a standard of living in keeping with his position. On the other hand, the investor may elect to reside wherever he pleases, thus avoiding the extra expenses required in a particular community, and his standard of living does not necessarily have an effect on the return derived from his investment. Inasmuch as the major portion of these extra expenses borne by the individual with earned income is not deductible for tax purposes, such as going back and forth between home and place of work, it results that earned income is taxed to some extent on a gross basis, while investment income is taxed on a net basis.

3. Earned income is uncertain.-Earned income is more uncertain than income derived from capital. If an investor is not too much lured by the possibility of an extravagant return, he may assure himself of a reasonably stable income. On the other hand, the individual with earned income is always confronted with the possibility of illness or accident, either of which may temporarily or permanently suspend his income, thus creating the necessity of savings to protect himself and his family from the possibility of that time when earned income ceases or is substantially reduced. The earned income stops short at the death of the earner. 4. Capital gains are accorded special treatment.-As has been said, the present law recognizes the need of special treatment for income derived from certain sources, particularly capital gains. The Revenue Code imposes a tax of not over 25 percent on the gain from the sale or conversion of capital assets held for a period of more than 6 months. There appears to be no reason why earned income arising from personal endeavor should not receive at least as much consideration as capital gains occurring in many cases without effort on the part of the taxpayer. 5. An incentive should be provided for work and effort.-Considerations of public policy are involved. Lightening the burden on income derived from personal