STATEMENT OF HARRY KENNETH ALLEN, DEPARTMENT OF ECONOMICS, UNIVERSITY OF ILLINOIS, URBANA

Mr. ALLEN. Mr. Chairman and members of the committee: My name is H. Kenneth Allen. I am a professor of economics at the University of Illinois. I am here today upon the invitation of the committee.

I have prepared a written statement, copies of which I deposited this morning in the main office of the committee.

Before I proceed, I should just like to correct one point in my identification. I am listed here as chairman of the Department of Economics. While I did serve in that capacity for 5 years, since the first of September of last year I have been devoting full time to teaching and research.

I should like to make suggestions pertaining to four topics. The primary suggestion, to which reference has already been made in the discussion this morning, pertains to the case for tax reduction as a counterdeflationary measure, if the unemployment figure shoul reach the level of 5 million.

The second topic has to do with the taxation of interest on Government securities. That is the exemption feature which now applies to the interest on Government securities.

The third topic pertains to the double taxation of corporate dividends.

And the fourth topic pertains to two suggestions pertaining to the Federal estate tax, one of which relates to the extension of the 80 percent credit provision to the additional or supplementary tax, as well as to the basic tax as at present, and the other one pertains to a limitation of the allowance for the exemption of gifts and bequests to nonprofit organizations.

Taking up the first topic, that is, the one which pertains to tax reduction as a counterdeflationary measure, I should like to preface my comments by one or two general statements.

One of these is that I believe that the greatest threat in the long run in this country is inflation, rather than deflation.

The second one is that I do not believe that we can solve all the economic problems of the world through countercyclical fiscal policy. There is, however, at the present time, a rather large dark cloud on the horizon of the economic sky. Whether this cloud is going to develop into a severe economic storm or whether it is going to be a kind of mild flurry, such as those of 1948-49 and 1953-54, remains to be seen. On this point, and without casting any reflections upon the business forecasters, because I do have great respect for them, I think the weather forecasters have a better record than the business forecasters. I do think there is a rather strong possibility, however, that the present recession will degenerate into a deeper, more protracted recession than those of 1948-49 or 1953-54. I think it is highly important, therefore, that the Congress be prepared with a plan of tax reduction to be put promptly into effect when unemployment reaches the 5 million level. In my opinion, if it reaches that level, it will be an indication that we are in for more serious trouble, and that unemployment will probably rise to substantially higher levels if nothing is done.

I should also like to emphasize the desirability of coordinating fiscal controls with monetary controls. In the postwar period we

have placed primary responsibility upon the Federal Reserve system in controlling the supply of money and credit, and I believe that within the limitations of the powers available to them, they have done a very good job. We do know from experience, however, that the Federal Reserve system cannot cope effectively with a deep, protracted depression such as we had in the 1930's.

So, if there is a threat of serious deflation, it is especially important that the Congress be prepared to make use of fiscal controls.

With reference to the details, and these are only of a general character, I should think that the first round of tax reductions should be of the order of an average of 10 percent and with particular reference to the individual income taax and the lower brackets of the individual income tax, because it is in those lower brackets that we have the mass consumer power.

If taxes are reduced in the lower brackets, it is the same thing to those people as an increase in their wages, and we know that they will spend most of that increase.

So, as a kind of tentative suggestion, I would suggest something on the order of a reduction of about 3 percentage points in the first bracket, about 2 percent in the second bracket, and 1 percent in a third bracket, which could be cut off at some particular point, such as, say, $50,000 or even $40,000 of income.

In making these suggestions, I do want also to say that there may be a case for reduction of the rates of the individual income tax and of the corporate rates, aside from countercyclical fiscal purposes. I am concerned today with the latter.

I should also like to say that tax reduction, of course, is also highly desirable to the extent that savings can be made through the application of rigid economy in Government. I am taking that for granted in making the suggestions that I have to make.

I think the case for the reduction of the income tax rates, particularly in the lower brackets, is stronger than that for the corporate rates, for this particular purpose, because a part of the corporation tax, we know, has shifted, and if we should reduce corporate rates, there would probably be some lag in reduction of prices, which reflect the shifting of the tax. To the extent that the tax is not shifted, of course, the benefit accrues to the stockholders, and there probably would be some delay in passing this benefit along to stockholders.

In the case of the excises, I think there is a strong case for discontinuing some of the excises, for example, such as the transportation tax on freight, but I know that you are not hearing suggestions primarily on excise taxes at these hearings. In any event, the reduction of excise taxes for countercyclical fiscal purposes would not be as effective, in my opinion, as reduction of income tax rates, because there would probably be a lag between the time those taxes would be reduced and the benefits would be passed on to consumers in lower prices. Anyhow, these purchases are scattered and represent such a small percentage of the consumer's outlays that he would probably not be aware of the effects of the reduction.

I should also like to suggest that tax reduction would not result in a decline in revenues to the extent that might be anticipated as a result of reducing the taxes. That is, to the extent that tax reduction would sustain the economy, tax collections would be higher than they would otherwise be.

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This proposal has implications obviously for the public debt. I think it is unfortunate that we did not reduce the public debt substantially in the postwar period. During the period of 1919 to 1929, following World War I, when we ended the war with a debt of $26 billion, we cut the debt $10 billion. Had we had a comparable reduction in the public debt in the post-World War II period, we would have had a reduction of $100 billion.

I am not suggesting that we should have had a reduction in the public debt of $100 billion, but I am submitting that we should have had a reduction in the public debt of something of the range of $30 to $40 billion. That would have provided a valuable cushion for the present situation. But that is water over the dam.

With further reference to the debt implications of the current situation and my suggestion, I would recommend, of course, that the limit on the Federal debt be increased. I think the psychological effect would be valuable of increasing it to not just a mere $280 billion, but I would say to at least $285 billion at the present time.

With reference to supporting the public debt, I should like to suggest that the mere size of the public debt in itself is not of great significance. It is the ability of an economy to support a public debt that is important. We can support a public debt of $325 billion more easily with a gross national product of $400 billion, which would be quite a little below the current level. We can support that kind of debt more easily than we can support a debt of $275 billion, the current level, with a gross national product of $300 billion. And the gross national product may well decline to $300 billion if we go into a deep and protracted business recession.

As a matter of fact, if we should go into such a recession as was had in the 1930's, which I do not think is at all likely, because of the numerous shock absorber which we have in our system at the present time, the gross national product would decline to below $250 billion.

The Congress has at its disposal powerful tools for combating deflation. My suggestion is that a plan of tax reduction be prepared and it be promptly and vigorously put into action when unemployment reaches 5 million. I think the psychological effect of the mere announcement that the Congress is prepared to cope vigorously with this situation will do much to bolster confidence and to support a rise in business activity.

Going now to the next topic, the taxation of interest on Government securities, this topic has been discussed over many years, and I have nothing new to present, except to recommend that the present arrangement whereby the interest on municipal securities is exempt from the Federal income tax and the interest on United States Government securities is exempt from State and municipal income taxes be eliminated.

This present arrangement favors persons in the high-income brackets, and it is those people who have the particular advantage in purchasing and holding tax-exempt municipal securities. It distorts the normal flow of investment funds.

I am not one who is unsympathetic with the problems of municipalities. We have many problems at the municipal level, and I am in sympathy with those problems. But this system confers upon them an advantage in competing for the flow of funds in the capital mar

kets and works to the disadvantage of corporations and other borrowers of such funds.

It is true that it decreases the cost of municipal borrowing, but at an increase in Federal tax rates for all of us who pay Federal taxes. So my proposal is that we remove the exemption on new issues of municipal securities and United States Government securities. I realize that there is a legal problem involved here. I am not a lawyer. I understand from the lawyers that this proposal might take a constitutional amendment to implement it. But I would suggest that it first be tried by statute, and then, if that proves to be impossible, that we resort next to constitutional amendment.

My third topic pertains to the double taxation of corporate dividends. I believe that we are using the wrong approach with our present dividends-received credit approach, and that we ought to change that approach to a dividends-paid credit approach.

This present credit system of double taxation of dividends, whereby a corporation pays taxes on its earnings before dividends and individuals are required, except for the modest allowances, to pay individual income taxes on corporate dividends, discriminates as between the corporate form of organization and the unincorporated form of busiIt discriminates between firms that are financed largely from borrowed capital, in which case their interest is deductible in computing taxable net income, and firms that are financed largely by stockholders' capital. The present arrangement favors the high income groups.

ness.

As for the remedy, it is to permit the deduction of dividends in computing corporate net income, and to include the dividends in individual income. Except for the differences in rates between the corporate income tax and individual income tax, this plan would achieve the highly valuable goal of the integration of the corporation and individual income taxes.

I realize that because of revenue considerations, this plan could probably not be adopted in a single year, and I would suggest that a plan be worked out whereby it could be accomplished over a period of 5 to 10 years; that is, by allowing at first a certain percentage of the dividends to be deducted at the corporate level, and then increasing that percentage each year until it is 100 percent.

The final topic has to do with the Federal estate tax and the extension of the 80 percent credit against the additional or supplementary tax, as well as the basic tax, at present.

The Federal estate tax is, of course, an important source of revenue to the Federal Government, but if this credit were extended as I have proposed, it would produce a substantial amount of revenue for the State governments.

For reasons which we cannot avoid and which I certainly am not proposing to change, the Federal Government pretty well has a monopoly on the income tax, the fact being that the rates of the Federal taxes are so high that the States cannot use more than very moderate rates. But it is not essential or desirable, in my opinion, that the Federal Government maintain a monopoly on the Federal estate tax. I think there is an added reason for giving the States this extended credit. That is, that the estates, the laws of inheritance, transmission of profit at death, are governed by State laws. The machinery for

the probation of the States is provided by State and local govern

ments.

So I suggest that the 80 percent credit be extended to the additional or supplementary tax of the Federal estate tax law.

I have been concerned for a few years, and this concern has been growing, relative to the present allowance for gifts or bequests to nonprofit organizations. I am impressed that in my opinion the main objective in many cases, particularly where there are not direct heirs, in planning the disposition of property at death or before death, has been to avoid Federal estate-tax liability, rather than to see to it that the property is channeled into the courses where it can best promote the social interests.

Here I do not mean to reflect unfavorably upon many highly desirable programs which are financed by nonprofit organizations, but I do believe that there would be a better prospect of avoiding the misallocation of resources if the allowance for such gifts and bequests were reduced. I should like to recommend that the allowance for gifts and bequests to nonprofit organizations be reduced to 50 percent of the amount involved. I believe that this would submit these arrangements to what I call more of a test of the market, in which people who are disposing of property would give greater care to how their property is to be disposed of.

Also, I believe it would put greater pressure upon the recipients to see to it that these properties, these moneys, are used in a manner that will best promote the social welfare.

Thank you very much, Mr. Chairman.

The CHAIRMAN. Dr. Allen, we thank you for a very fine paper and a most interesting statement. We appreciate greatly your coming to the committee this morning.

Mr. Reed is recognized, Dr. Allen.

Mr. REED. Dr. Allen, I have been very deeply impressed with your presentation here.

Mr. ALLEN. Thank you, sir.

Mr. REED. I think you have made a very good, constructive statement, and one of great value to this committee.

The CHAIRMAN. Are there any questions?

Mr. Kean will inquire, Dr. Allen.

Mr. KEAN. I noticed from your statement that you would automatically kick off a tax reduction when there were 5 million unemployed. Is it not true that the depth of unemployment will come just before the recovery, so that that might not be a good automatic figure! It might be that there were all sorts of other signs that the recovery was on the way, when we had reached the low point. Is now the low point always just before recovery?

Mr. ALLEN. That is certainly true, Mr. Kean, and I would not quarrel with the question as to whether or not, say, 5 million or 6 million would be the better figure. Perhaps 6 million would be a better one. I happen to think that 5 million is one that we might use. Mr. KEAN. But even 6 million might be at the very bottom, with all signs pointing to recovery.

Mr. ALLEN. Mr. Kean, I would like to make a point here. Just as we heard the saying that inflation feeds on inflation, and it is a vicious inflationary cycle, so does deflation starve on deflation, and it is an even more vicious inflationary spiral. The deflationary tailspin is