1 TABLE VIII.-Cash flow 1 annual rate of change: 1951–76 The annual increase in cash flow to corporations was faster in the 1970's than in the previous two decades. Investment in Producers Durable Equipment 1930 52 54 56 58 60 62 64 66 68 70 72 74 76 Source: U.S. Department of Commerce, Bureau of Economic Analysis. Corporate cash flow, i.e. profits after taxes and depreciation allowances, grew very rapidly in the 1970's. Depreciation allowances increased swiftly as a result of the new depreciation rules of 1971. Hon. HARRY F. BYRD, Jr., AMERICAN BANKERS ASSOCIATION, Chairman, Subcommittee on Taxation and Debt Management, Committee on Finance, U.S. Senate, Washington, D.C. DEAR SENATOR BYRD: This letter is being written as a followup to the testimony of Leif Olsen on behalf of the American Bankers Association before the Subcommittee on Taxation and Debt Management of the Committee on Finance of the United States Senate on May 17, 1977. At that time you requested our views on the integration of corporate and personal income taxes. This subject was considered very carefully by a special task force on tax reform that has been assembled by our Association. This task force includes members of our Association's Economic Advisory Committee, Bank Taxation Committee, and the Executive Committee of the Trust Division. We discussed three methods of integration. First, full integration through the elimination of the corporate income tax, and the treatment of all corporate income as if it were earned income of the shareholders. This proposal has too many problems and should not be considered at this time. Partial integration was discussed in terms of two other proposals. The first would be to allow corporations to deduct dividends paid from their gross income in their determination of taxable income. This deduction would be allowed for dividends paid to domestic tax exempt organizations, but not for these paid to foreign shareholders unless reciprocal treatment were afforded by treaty. The second method would be to allow shareholders to use corporate tax payments on income paid out as dividends as a tax credit against their personal tax liability, after these tax payments have been included or "grossed up" in their personal income. At the current time, our Association cannot take an official position on any of these methods because we do not know what other proposals will be involved in tax reform legislation. Subject to this qualification, our task force reached a tentative consensus in favor of the dividend deduction method for the following reasons: 1. Simplicity of administration There would be no need to estimate taxes at the time dividends are paid. Shareholders would not have to be re-educated to include the gross-up in income and take the credit. No problems arise from audit adjustments for past years, partial-year shareholders, or the variations between current and deferred taxes. There would be no necessity of elaborate record keeping to ensure the correct treatment of the credit. The records on foreign shareholders are substantially the same as those that must now be kept for withholding tax purposes. 2. Incentive to increase dividends The dividend deduction approach would provide managers and shareholders with an incentive to increase dividends, thus passing on the tax savings to the shareholders for reinvestment. With a shareholder credit approach, in order for the dividend-paying corporation to retain any benefit directly the dividend must be cut, although the shareholder may still receive a higher gross dividend than formerly. 3. Ease of Phase-in Under a dividend deduction alternative the phase-in is simple, with the burden of keeping up with the phase-in changes falling on professional managers rather than individual shareholders. It would also provide time for a corporation to change its business mix as necessary to accommodate the increasing deduction. 4. Preservation of existing incentives Congress has provided a variety of tax incentives to corporations for purposes seen to be of economic or social benefit to the national interest. With a dividend deduction, these incentives are more likely to be preserved than with a shareholder credit, which might be structured in such a way as to destroy the efficacy of present or future incentives to the extent of dividend payouts. 5. Enhancement of capital formation The dividend deduction approach would generate more capital formation for two reasons. First, the deduction guarantees a tax savings at the marginal or statutory rate, rather than at some lesser gross-up factor, as might be the case under some forms of shareholder credit. Second, the capital thus formed is auto matically reinvested unless dividends are increased; it is likely that somewhat more earnings would be retained than under a shareholder credit system, and thus less would be lost by any propensity of shareholders to spend rather than reinvest dividend income. In general, we see many advantages to a dividend deduction system although we would not be opposed to a carefully constructed shareholder credit system which took account of the reservations listed above. We share the concern expressed by many observers about the effects of these proposals on Treasury revenues. Indeed, economic stability will be a crucial element in any program to enhance capital formation. On balance however, capital formation will only be enhanced if the net tax burden on the corporate sector is lightened, and tax incentives are altered to favor capital investment. To accomplish this we urge the Committee to also consider other forms of tax incentives. Areas for consideration might be the investment tax credit, accelerated depreciation, lowering corporate tax rates, and indexing tax rates to account for inflation. Sincerely, GERALD M. LOWRIE. STATEMENT OF ALAN S. DONNAHOE, PRESIDENT AND CHIEF EXECUTIVE OFFICER, MEDIA GENERAL, INC., RICHMOND, VA. RECOMMENDATIONS 1. Establish a tax ceiling of 50 percent on all income, whether earned or unearned The present maximum of 70 percent on unearned income is absolutely punitive, and strongly discourages any investment that yields income in the form of either interest or dividends. 2. For capital gains of more than one year, deduct the gain due to inflation, and tax the remainder as ordinary income Prices in this country, for example, have risen by about 75 percent in the past decade. Thus a home worth $40,000 10 years ago will have risen to $70,000 today due to inflation alone. Only the profit beyond $70,000 should be taxed. It is grossly unfair and inequitable to make people pay a tax on inflation itself, which is the cruel hoax inflicted, in effect by our present system. 3. Permit corporations to deduct dividends as a business expense The typical corporation now pays 48 percent of its income in federal income taxes. If it pays out the remaining 52 cents per dollar in dividends, the taxpayer can pay up to 70 percent of this in taxes, or 36.4 cents per dollar. Thus he is left with 15.6 cents of the original corporate income dollar; and the federal government has taken the other 84.4 cents in taxes. And the situation is even worse, of course, when state taxes are included as well. With such a negative tax system as this, it is not surprising that the United States is a laggard in investment among industrialized nations, and that we are constantly plagued with high unemployment and inflation. It is significant that the median price/earnings ratio of all listed stocks on the New York and American Exchanges, along with principal OTC companies, is now 7.8. This means that the typical company, selling stock to get additional capital, must earn an after-tax return of 12.8 percent on that capital just to break even in terms of earnings per share. Taking account of the federal income tax, this must be doubled to a return of 25 percent on a before-tax basis, just to break even. Is it surprising, in view of this, that capital investment is being severely retarded in the United States? If dividends could be treated as a business expense, it is reasonable to assume that most corporations would double their dividends immediately. As a result, it is a virtual certainty that stock prices would rise sharply, thus providing all companies with far greater inducement to increase their capital spending. This effect would be even stronger, of course, if my other two recommendations were also adopted-a 50 percent maximum tax on income, and deduction of inflation before any tax on capital gains. 4. Revise the ERISA law to stop the discrimination that it has created against medium and smaller-size companies among institutional investors A miserable by-product of ERISA has been to give pension and other fund managers a ready excuse for not investing in anything other than giant companies. They claim, under ERISA, that they can be held guilty of negligence for investing in any company with, say, less than $100 million in annual revenue, on the theory that there is greater risk in any smaller company of this type. The effect of this is to further limit the access of these smaller companies to the capital market, and thus sharply reduce their growth potential. In many and perhaps most instances, over time, about all they can look forward to is being gobbled up by some larger, acquisition-minded company. So legislation intended for another purpose entirely has had the effect of putting these smaller companies at a huge disadvantage in competing with larger firms for available capital. Clearly, this inequity should be eliminated by an appropriate amendment to the ERISA legislation as quickly as possible. SUMMARY These simple changes would provide an enormous stimulus to capital investment in this country, and go a long way towards redressing the present imbalance in our tax system which strongly favors consumption versus savings, through the heavy penalties imposed on investment income. With normal taxes on the additional investment and income thus generated, the federal government should more than recoup any initial losses in tax revenue in a relatively short period. Thus, properly viewed, these are revenueproducing measures which in time should lead to a balanced budget, along with additional funds to meet other needs of the country. And, most importantly, these simple changes would set this country on the road to full employment and reduced inflation. The only real argument against the recommended program is that it runs counter to the soak-the-rich philosophy that seems to have great popular appeal. But all of this is utterly spurious because the people really hurt by our tax system are not the rich but rather the middle class, professional people, corporate executives, and entrepreneurs. Precisely the people, in other words, who can contribute most to the vigor of our economic system. And when these people are harassed and their incentive is reduced, then everyone in the nation suffers accordingly. The revenue from excessive taxes on this group is utterly trivial in terms of the economic damage that is wrought thereby. The clearest example of this, of course, is England, where punitive taxes and related policies have created economic stagnation, growing unemployment, high inflation, and ever-increasing social conflict. POSTSCRIPT Media General has been a public company, chartered in Virginia, since 1966. In its relatively short history as a public company, it has grown in assets from less than $14 million to more than $191 million, in revenue from $18 million to $199 million, and in stockholders' equity from $11 million to $116 million. Media General today owns daily and Sunday newspapers in Richmond, Virginia; Winston-Salem, N.C.; and Tampa, Fla.; along with broadcast, printing, and related subsidiaries. It also owns the Garden State Paper Company which produces about 12 percent of all the newsprint manufactured in the United States through a unique recycling process which utilizes old newspapers as the basic raw material without the need for any virgin fibre. I have been president and chief executive officer of Media General throughout its history as a public company and I have personally approved and recommended more than $100 million in capital expenditures throughout this period-a substantial investment for a company our size. This background is provided simply to indicate that I have had some personal experience in the area of capital investment, and the decision-making process that is involved therein. ALAN S. DONNAHOE. STATEMENT OF THE FINANCIAL EXECUTIVES INSTITUTE TAX SYSTEM CHANGES FOR CAPITAL FORMATION AND ECONOMIC GROWTH Financial Executives Institute is the recognized professional association of 9,000 senior financial and administrative executives of more than 5,000 business organizations, representing a broad cross section of American national and international industry. |