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The committee fully appreciates, I am sure, the compelling considerations which require me, as Secretary of the Treasury, to place the protection of the financial integrity of our Government above all other cbjectives. A sound financial structure is the essential cornerstone of the Nation's economy. Wise management of the Government's fiscal affairs will insure a continued contribution to lasting prosperity, to further industrial growth and expansion, and to higher standards of living. This requires that in considering tax reduction and tax revision we never lose sight of the paramount importance of preserving the strength of the revenue system at a level adequate to finance necessary Government services and to provide funds for servicing and reducing the national debt.

I want to stress the importance of gearing any tax bill to the needs of the Government's basic financial policy. The Federal tax system must produce large amounts of revenue if essential domestic governmental services are to be maintained, the public debt reduced, our foreign commitments fulfilled. Premature weakening of our revenue system will involve serious consequences both for our domestic prosperity and for the peace of the world.

I recognize that postponement of tax reduction requires an unusual measure of self-denial. Each of us would welcome relief from the high taxes necessitated by the cost of the war. However, the financial consequences of the war are still with us.

In addition to the normal expenses of running the Government there are heavy demands on the budget for national defense, the care of veterans, the servicing of the war debt, and the rehabilitation of war-torn countries.

The present tax system, in combination with high levels of employment and national income, resulted in a surplus of $754,000,000 during the fiscal year ending June 30, 1947. In the current fiscal year the surplus will for the first time reach substantial proportions. This affords an opportunity to make a significant reduction in our large public debt. In his budget message, the President estimated that in fiscal year 1948 it will be possible to apply 712 billion dollars to debt reduction. During the past 4 months, which included, of course, some of our best tax collection periods, we have used more than $4,000,000 of the surplus to apply to debt reduction. This debt reduction would have been impossible had tax reduction proposed in H. R. 1 become effective last year.

For the fiscal year 1949, the anticipated decline in nontax receipts, coupled with the increased expenditures projected in the President's budget will reduce the surplus available for debt reduction in that year to 4.8 billion dollars. I believe that this amount of debt reduction is desirable under present conditions of full employment and general prosperity. We must ever bear in mind the fact that the public debt of this country is in excess of $250,000,000,000. If we continue to make the very best use of our opportunities, it will still take many years to make an appreciable dent in the size of the public debt. We must make sizable payments on the debt in good years for we know that there may be years in the future when no payments can be made.

Under current economic conditions it is essential to maintain the present level of Government receipts. This, however, does not preclude some readjustment in the distribution of the tax load. On the contrary, the persistence of high prices makes some readjustment imperative. During the second half of 1947 wholesale prices rose at an annual rate of 21 percent and consumers' prices, 13 percent. By the first of this year, wholesale prices were 45 percent and consumers' prices 25 percent higher than in June 1946.

Although the Nation is operating at peak levels and the country is enjoying higher standards of living than ever betore, some groups in the population are suffering real hardship. These include not only families with relatively small fixed incomes but also others whose incomes have not kept pace with the increase in the cost of living. The problem, of course, is most serious for those in the lower income groups who have no appreciable savings to fall back on as a cushion against high prices.

Estimates of what people spend in relation to their incomes graphically illustrate the hardship suffered by low-income groups. It has been estimated that in 1946 about a third of the families with incomes below $3,000 spent more than their income.

I should say that the Secretary's statement includes references to tables which accompany the report. [Reading:]

They financed consumption by dissipating accumulated savings and by going into debt. Under present conditions the taxes paid by the lowest income groups l'educe the already inadequate incomes available for minimum living standards.

Tax reduction alone cannot provide adequate relief to this group. But the right kind of tax adjustment can make some contribution to the relief of the plight of low-income people. Since fiscal and economic considerations preclude any reduction in the over-all strength of our tax system, relief to this group should be provided by appropriate increases in other taxes.

The President recognized that inflation has brought real hardship to millions of families with low incomes and recommended a cost-of-living adjustment in the form of a tax credit of $40 per capita. He recommended also that the revenue loss resulting from this adjustment should be made up by increasing the tax on corporate profits. As I indicated in my statement before the Ways and Means Committee :

“Under existing conditions, the fairest way of levying a tax on corporate prof. its which the President recommended would be to reenact the excess-profits tax, with a few modifications. The small corporations should be exempted by pro viding a specific exemption of $50,000 of excess profits for all corporations. The rate should be reduced from the 85.5 percent in effect for 1945 to 75 percent and the standards for normal profits, both the average earnings and invested capital credits, should be raised by 35 percent. With these modifications the tax would still yield the 3.2 billion dollars needed to cffset the revenue loss resulting from the individual income-tax cost-of-living adjustment. The tax would apply only to 22,000 corporations with the largest excess profits, out of a total of 360,000 taxable corporations. The imposition of a corporate excess-profits tax to compensate in revenue for the cost-of-living tax adjustment is the most equitable way of maintaining the Federal revenues at their present strength and with the least adverse effect on our economy.”

We cannot escape the obligation to find a source of replacement revenue to compensate for that lost by providing tax relief to low-income groups. The President's program accomplishes this through the excess-profits tax. In view of the record earnings of some corporations, this appears to be a sound solution both on equity and economic grounds. I do not know of any other course of replacement revenue that measures up to the required tests.

I now turn to an examination of the principal provisions of H. R. 4790. These provisions can be briefly stated.

The bill would increase personal exemptions from $500 to $600; would permit husbands and wives to divide their incomes equally for tax purposes; and would reduce tax rates by percentages ranging from 30 percent for taxpayers with small incomes to 10 percent for those with large incomes. In addition, the bill would grant a special $600 exemption, and would increase the standard deduction for single persons and married couples filing joint returns with adjusted gross incomes of over $5,000. The bill also would reduce estate and gift taxes. For residents of community-property States the reduction would be achieved by restoring the law in effect prior to 1912. For residents of common-law States comparable reductions are achieved by permitting deductions for transfers of property between husbands and wives.

To assist the members of the committee in their consideration of the bill, I have appended to my statement some statistical materials bearing on its provisions.

H. R. 4790 results in excessive reductions and a deficit for fiscal year 1949. The bill would reduce individual income-tax liabilities by an estimated 6.2 billion dollars in a full year of operation, or by almost 30 percent of the 21.2 billion dollars total individual income tax liability under present law. In addition, estate and gift-tax liabilities would be reduced by $250,000,000, which is also about 30 percent of the estimated $820,000,000 estate and gift tax liabilities under present law.

If H. R. 4790 were enacted the surplus of 7.5 billion dollars estimated in the President's budget for the fiscal year 1948 would be reduced by 1.1 billion dollars. In the fiscal year 1949 receipts would be decreased by 6.6 billion dollars and refunds increased by 400 million dollars. This would convert the estimated surplus of 4.8 billion dollars in fiscal year 1949 into a deficit of 2.2 billion dollars, necessitating an increase in the public debt.

None of the developments which have occurred since the transmission of the President's Budget message, either those in the field of domestic prices or those in the field of international affairs, or otherwise, warrant changing the President's estimates of either receipts or expenditures to show a more favorable budget picture. No one can say with certainty what any future level of income will be. With relatively full employment and with our present production facilities running at virtual capacity, it would not seem prudent to predicate estimates of receipts on a level of personal income higher than the 200-billiondollar level of personal income utilized in preparing the estimates contained in the President's Budget message. The level of personal income in calendar year 1947 was 197 billion dollars.

Members of this committee will undoubtedly agree that there can be no justification for a tax program which would prevent adequate provision for a substantial retirement of the public debt in fiscal year 1949. This alone is sufficient reason for rejecting H. R. 4790.

H. R. 4790 would not increase current production. The proponents of H. R. 4790 claim that it would, by providing substantial individual income-tax reduction, overcome capital shortages and improve business incentives. I would be the first to recommend tax incentives if there were a present need to accelerate capital expansion. The fact is, however, that capital formation is at a high level and the number of businesses is increasing. In 1947, gross private domestic investment accounted for 27.8 billion dollars or 12.1 percent of the gross national product. This rate of investment compares with an average of 11.5 percent for the interwar period from 1919 to 1941. Outlays for producers' durable equipment accounted for almost 8 percent of the gross national product in 1947, a record rate, even including the 1920's. Moreover, the number of businesses has continued to increase since the low point reached during the war. By the end of 1947 they totaled almost 3,900,000, compared with the prewar peak of 3,400,000 and the wartime low of 2,800,000. These figures suggest that under current conditions there is no lack of business incentives.

There are times when tax incentives can play an important role in stimulating production. This fact should be recognized in the revision of the tax system for peacetime needs. Its potentialities should not be dissipated by poor timing. Today tax reduction is almost certain to raise prices by increasing consumer and investor competition for the limited supplies; it holds little promise of increasing production above the 1948 goals set in the President's economic report.

H. R. 4790 gives inadequate tax relief for the lowest income taxpayers; the relief is inequitably distributed. Another argument advanced in support of H. R. 4790 is that it gives adequate and correctly distributed relief. Under this bill, personal exemptions are increased by $100 to compensate for a calculated $100 decline in the purchasing power of the average income after taxes during the past 2 years.

These calculations do not provide an adequate measure of the need for tax relief in the lower income groups. Under the stress of war needs, personal exemntions were reduced to emergency levels. It was then recognized that the $500 per capita exemption system would endanger the health and living standards of large segments of the population if retained for many years. Fiscal and economic considerations do not yet permit exemptions to be raised to a level compatible with long-term living standards, just as they preclude general tax reduction at this time. The national interest nonetheless requires sufficient immediate relief for those in greatest need to help tide them over this difficult period. In this respect H. R. 4790 stands in sharp contrast with the President's cost-of-living adjustment plan.

H. R. 4790 would exempt 6.3 million from income taxation in comparison with the 10.3 million exempted under the President's program. Moreover 13 million additional taxpayers with the lowest income would receive more tax reduction under the President's program than under H. R. 4790. These are the groups most urgently in need of relief from the high cost of living.

Under the President's program, 93 percent of the income-tax reduction would go to individuals with net incomes under $5,000. This compares with 66.3 percent under H. R. 4790.

The pending bill would reduce the taxes of those with net incomes in excess of $5,000 by $2,100,000,000 as against $225.000,000 under the President's plan. It is my belief that we cannot go beyond a cost-of-living adjustment at this time. The $2,100,000,000 tax reduction provided high-income taxpayers under H. R. 4790 goes far beyond this requirement.

The pending bill would also provide additional relief to the aged and the blind in the form of special exemptions. These and other low-income groups and disabled persons are hard-pressed by high prices. The cost-of-living adjustment recommended by the President is the most equitable way of providing tax relief to all these groups.

H. R. 4790 equalizes income taxes in community-property and common-law States at the cost of substantial revenue but does not equalize estate and gift

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taxes. The bill under consideration contains proposals designed to equalize income, estate, and gift-tax liabilities among taxpayers in community-property and common-law States.

With reference to the personal-income tax, the bill contains a provision which would permit married couples filing joint returns to divide their combined incomes equally in computing their income taxes. This is designed to eliminate a longstanding tax discrimination against married couples residing in noncommunityproperty States.

This provision is addressed to a problem which has acquired importance in recent years.

Several common-law States have adopted community-property laws designed primarily to give their residents tax advantages previously enjoyed only in the original community-property States. As you know, I believe that this subject should be given a high priority among the structural changes in the Federal-tax system. In the current situation, however, it would be unwise to make this or other major structural changes which would result in substantial revenue losses. Splitting the incomes of husbands and wives would result in a loss of $803.500,000, 97.5 percent of which would go to individuals with net incomes in excess of $5,000.

With reference to the State and gift taxes, the bill would repeal the 1942 estate and gift tax community-property amendments. This would d crease the liabilities of married residents of those States by a relatively substantial amount. However, it is also proposed to provide similar relief for residents of common-law States, by amendments which it is hoped will produce relatively equal treatment with community-property States.

Prior to 1942, residents of community-property States paid relatively less estate and gift taxes than residents of other States. The 1942 act, in recognition of fundamental similarities in the family ownership of property in all the States, sought to correct this discriminating situation by equalizing the effects of the law under the different concepts of property ownership. It increased the transfer tax liabilities of community-property residents to approximately the level paid by residents of other States and generally succeeded in equalizing transfer tax liabilities among residents of all States.

This bill would replace the plan adopted in 1942 with a system which is apparently intended to establish equality by reducing the transfer-tax liabilities of all persons to the level paid by community-property residents before 1942. It is my view that there is no valid basis for this change. While some differences in the impact of transfer taxes on residents of different States remain, these do not appear to be of major significance. However, they could be further narrowed by relatively simple amendments within the framework of the present structure. The proposal, on the other hand, would create new areas of inequality and administrative problems that outweigh those remaining under present law.

The estate- and gift-tax provision, it has been said, is related to the splitincome plan considered for purposes of income taxation. Any such relationship, if it exists at all, is superficial. The problems are not analogous or comparable.

In the income-tax field, residents of community-property and common-law States are not treated equally. The income-splitting plan is designed to remedy this situation by providing a single system of taxation applicable to all married residents of every State without exception. Moreover, it is also intended to go beyond removing the discrimination between community-property and commonlaw States by equalizing the now unequal tax treatment of family income from earnings and investments in all States.

An entirely different situation prevails in the estate- and gift-tax field. Present law already achieves substantial equality of treatment between common-law and community-property States.

This bill would reduce the revenue yield of the estate and gift taxes by as much as $250,000,000. Economic and fiscal requirements compel us to postpone urgently needed reductions in many sectors of our tax system. It is also necessary to require a large segment of the population to bear tax burdens which impinge upon their living standards. Under these conditions the transfer-tax provisions of H. R. 4790 conflict with fairness and sound fiscal policy. Any structural revision in the system to remove inequities should be accomplished in a way calculated not to weaken or further complicate the transfer taxes.

In view of the technical complexity of the estate- and gift-tax provision of H. R. 4790, I am submitting for the use of the committee a memorandum discussing the problems involved in greater detail.

H. R. 4790 would prejudice much needed tax revision. It is clear that many of the tax revisions required to modernize the American tax system will result

in a reduction of revenue. If the revenue system is prematurely weakened, our opportunities to improve it would be dissipated.

In his state of the Union message, the President said:

"When the present danger of inflation has passed, we should consider tax reduction based upon a revision of our entire tax structure.”

On several occasions I have outlined the basic principles of taxation as follows: “I believe that a sound tax system should meet the following essential tests. The tax system should produce adequate revenue. It should be equitable in its treatment of different groups. It should interfere as little as possible with incentives to work and to invest. It should help maintain the broad consumer markets that are essential for high-level production and employment. Taxes should be as simple to administer and as easy to comply with as possible. While the tax system should be flexible and change with changing economic conditions, it should be possible to achieve this flexibility without frequent revisions of the basic tax structure. A stable tax structure, with necessary flexibility confined largely to changes in tax rates and exemptions, will make it easier for business and Government to plan for the future.”

While we cannot safely undertake this year the basic structural changes that will ultimately be desirable due to the large losses in revenue that are entailed, we can adopt many technical revisions which would move in the direction of an improved tax system. I urge upon the committee the desirability of undertaking the steps necessary to make such administrative and technical revisions as will clarify present tax laws and correct some of the existing inequities without any substantial loss of revenue. This can and should be done at an early date. Specific proposals along these lines have already been submitted by the Treasury Department to the House Committee on Ways and Means.

I am confident that sound tax policy can contribute in an important measure to the continued prosperity of this country. I am also confident that your committee will give full consideration to the financial requirements and obligations of this Government. These considerations counsel against the adoption of H. R. 4790.

Following that statement, the Secretary has an analysis of the estate- and gift-tax provisions of H. R. 4790 and a series of exhibits.

(They are as follows:)


Enactment of the estate and gift tax provisions of H. R. 4790 would be undesirable. Apart from causing unjustified revenue losses (involving a large portion of the total revenues from these taxes), these provisions would not establish the equality of transfer tax treatment of community property and noncommunity property which is said to justify the revenue loss; they would open the door to tax avoidance; they would create new administrative problems and complexities; and they would lead to disruption and distortion of well-established methods of property disposition in common-law States. Moreover, these amendments are not required as the counterpart of the proposed income splitting provisions for husbands and wives under the income tax. The following discussion will amplify these objections, Discrimination

It is the prinicipal purpose of the estate and gift tax amendments in the bill to restore the pre-1942 treatment of community property under which each spouse is recognized as owning one-half of the community property regardless of its source.

Since mere repeal of the 1942 amendments governing the estate and gift tax treatment of community property would revive the former discrimination existing in favor of such property and against noncommunity property, the highly complicated provisions of sections 361 and 372 of the bill have been added in an attempt to provide equality of treatment for both types of property; i. e., it is intended to permit husbands and wives in common law States to divide their property equally with equivalent estate and gift tax results. To accomplish this, section 361 provides, in general, that there may be deducted from the gross estate of a deceased spouse the value of certain interests in property passing to the surviving spouse, but not to exceed one-half of the gross estate reduced by claims and similar deductions. Where, however, the estate of a spouse includes only his one-half interest in community property, no marital de


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