to be recouped in increasing corporate debt, by sales of stock, and by impairment of the net quick asset position.

As I see it, a gradual substitution of stock dividends for cash dividends will be inevitably required if the corporations are to make their necessary contribution to the country's growth.

For every dollar the Treasury will lose through noncollection of the second tax on dividends, it will gain more than a dollar from other forms of tax revenue generated by corporate expansion. The opposite result will follow, I am convinced, if Congress should interfere with the process of corporate expansion by seeking to force cash dividend payments rather than stock dividends.

If two-class plans are widely adopted they are likely to prove substitutes in part for the present practice of paying cash dividends and then taking back the same money through the sale of new stock to largely the same stockholders.

If this practice does diminish in the future it would not mean that the Treasury would be done out of its just revenue-but on the contrary that the Treasury would lose part of a windfall tax now paid to it entirely unnecessarily by our unperspicacious and tradition-bound shareholders.

For the present practice of paying cash dividends, accompanied by the sale of additional stock, means merely that the owners are given the privilege of paying a dividend tax on money they never really withdraw and retain. Neither Congress nor the Treasury can properly expect that this rather senseless arrangement for paying a gratuitous personal tax will continue unchanged in the future.

This brings me to my second point, which is that Congress will be unable to prevent the development of arrangements similar to the two-class plan, even if it should try to do so.

There are numerous alternatives to the device which the proposed legislation is directed against. The others may not be quite as neat, but they will produce the same result-namely, the limitation of cash dividends to the minority of stockholders who will want them, without impairing the market value of the other shares which do not receive cash.

This committee must recognize, I think, that it will ultimately prove impossible to collect the second or personal tax from shareholders who are not going to receive and retain cash dividends. The only way to compel payment of cash dividends would be by reviving the undistributed profits tax of 20 years ago, a step which would run completely counter to our new philosophy of an expanding economy.

My last point is about the "Dividend election" provision now in section 305B.

The Treasury has claimed that stock dividends paid under a twoclass arrangement are optional dividends, subject to this provision and therefore taxable. But the resemblance is purely superficial. When a company gives each stockholder the right to take a particular dividend either in cash or in an equivalent amount of stock, there is "constructive receipt" of cash by all the holders. Those who elect to take the stock have in essence used a specific amount of cash to buy the new shares, and no doubt that cash is subject to the same tax as the cash received by those who do not take the stock.

In a two-class plan, there is no constructive receipt of cash; those who elect to take the class paying stock dividends have given up all

their rights to receive and retain cash; they have chosen a form of security-paying stock dividends-which is essentially different from electing whether or not to reinvest a particular cash dividend in additional stock.

May I summarize my argument in a few sentences: Since corporations have an inherent right-and perhaps a new duty-to retain profits for needed expansion, they should have a corresponding right to enter upon any arrangement with their stockholders which will make such retention most palatable to them.

If the tax rules are to be changed they should be changed in the direction of encouraging corporate reinvestment and not of placing obstacles in its path. It would be paradoxical if the Congress, through new legislation such as now proposed, compelled corporations needing additional capital for expansion to pay dividends only in stock, rather than to one group in cash and to another in stock. For, by so doing, the Treasury would not only lose its revenue from the cash-dividend group, but at the same time would probably prevent the shares from selling at their full potential market price-with further loss to the Treasury, as well as to everyone else.

The CHAIRMAN. Mr. Graham, we thank you for your appearance and the information given the committee, with respect to this segment of the report of the subchapter C advisory group.

Are there any questions of Mr. Graham?

Mr. Curtis will inquire.

Mr. CURTIS. There would be a taxpayment at the time the security was sold. What would be the basis, original basis?

Mr. GRAHAM. No, sir; the effect of a stock dividend is to readjust the original cost of the shares by dividing the total amount paid by the larger number of shares.

Mr. CURTIS. If you had two types of securities, one that declared dividends in stock and the other in cash, you would have a watering down effect of the other securities, would you not, by the use of the spread here that you are talking about?

Mr. GRAHAM. No, sir; the effect primarily would be to maintain the price of the cash-paying issue unchanged from its original value because it continues to receive its cash dividend.

Mr. CURTIS. But the equity is altered. You have another type of security which expands through the stock dividend?

Mr. GRAHAM. That is correct, except that the amount of expansion and the number of shares to the stock dividend is all set by the reinvestment of the additional cash in the company's business so that the equity per share is not reduced by the payment of stock dividends as against a corresponding payment of cash dividend with no increase in the number of shares.

From the practical standpoint there would be two different prices, would there not, on a free market for your dividend, stock dividend type of stock as opposed to your cash?

Mr. GRAHAM. In all probability they would sell at about the same price, but the holder of the stock dividend issue would have a larger number of shares each year because he had not received cash dividends.

Mr. CURTIS. So when he sold any portion then his base would go back to the original purchase of his stock dividend type of stock?

Mr. GRAHAM. The base per share would be reduced proportionately and his profit would be increased in accordance with the present resulations governing the payment of stock dividend.

Mr. CURTIS. That is right, and then we would apply the same laws that we have on capital gains.

Mr. GRAHAM. That is true, sir.

The CHAIRMAN. We thank you, Mr. Graham, for your appearance and the information given the committee.

Our next witness is Philip C. Pendleton.

Mr. Pendleton, we have known you for a long number of years. For the purpose of the record will you identify yourself, giving us your name, address, and the capacity in which you appear.

STATEMENT OF PHILIP C. PENDLETON, COUNSEL FOR THE FAMILY TAX ASSOCIATION

Mr. PENDLETON. Mr. Chairman, members of the House Ways and Means Committee, my name is Philip C. Pendleton. I reside in Bryn Athyn, Pa., and I am an attorney at law.

The CHAIRMAN. Mr. Pendleton, before you begin your statement, let me recognize Mr. Simpson.

Mr. SIMPSON. Mr. Chairman, I would just like to say, for the benefit of the committee, that Mr. Pendleton used to play football at the University of Pennsylvania. He is quite a fellow. He is highly respected in and around Montgomery County and Philadelphia, has been very active in civic affairs in that section of the country, and I know that the message he brings to the committee will be one that merits careful consideration.

Mr. PENDLETON. Mr. Mills, may I say I had the misfortune to play football against Mr. Simpson when Pitt had a very excellent team, much better than we had.

The CHAIRMAN. We are glad to have you here, Mr. Pendleton. You are recognized for 15 minutes.

Mr. PENDLETON. I am appearing before you today as counsel for the Family Tax Association, an unincorporated, nonprofit association, which was recently organized in Philadelphia for the purpose of encouraging and fostering families with children and to that end seeking to reduce or eliminate inequities in the application of the tax laws to those having children.

1. Proposal for children's deductions (sec. 2056, I. R. C.): The association desires to suggest for your consideration that deductions from the gross estate for property passing to each child who survives a decedent be incorporated in the present estate tax, which deductions would be similar in nature to the present marital deduction.

It is further our suggestion that the deduction for each child be limited to 5 percent of the adjusted gross estate as defined in section. 2056, subsection (c) (2) (A), and that it be subject to the same limitations and provisions that are now applicable to the marital deduction. We believe that this could be accomplished either by amending section 2056 of the Internal Revenue Code or by adding a new section to the code immediately following that section.

2. The reasons for the proposal: It is our belief that the present estate tax is unfair to children and is unduly burdensome upon them.

The natural objects of a parent's deepest concern are his spouse and children. It is primarily for them that he toils and sacrifices, and it is their welfare which is ever uppermost in his mind. By enacting the marital deduction, the Congress has done much to protect the surviving spouse, but there is no such protection for surviving children, and it seems to us that the time has come when some remedial legislation is in order.

It was said above that the estate tax is unfair to children and unduly burdensome upon them. In support of this statement, we would call your attention to the following situations:

(a) As between children and other beneficiaries: Under the present law, the share of a parent's estate going to a child bears the same proportionate tax as does the share going to a collateral relative or to a stranger to the blood. It is difficult to conceive of any justification for such a result. Certainly, it runs contrary to the deepest instincts of the human heart, and it should be remedied.

(b) As between an only child and children: Generally speaking, the estate of a parent of an only child goes to the child undiminished by anything but debts, taxes, and bequests. On the other hand, the parent who dies leaving two or more children divides it equally among the children, subject to the same deductions, so that at the very outset his children receive far less than does the only child. If the estates are of equal size, the same proportionate tax is levied upon both of them, but the unfairness arises from the fact that this method ignores the amount that each child receives.

Consider, for example, two estates, each having a taxable value of $500,000. In one case an only child is the sole heir; the other estate is equally divided between five children. The only child receives $354,300, but each of the five children receives only $70,860. This could not be called taxation according to the ability to pay by the wildest stretch of the imagination.

How much worse the situation can be under the present law than that outlined above is illustrated by another example. Assume that A dies, leaving one child and a taxable estate of $500,000, and B dies at the same time, leaving five children and a taxable estate of $1 million. After the estate taxes are paid, A's child receives $354,300, but each of B's five children receives only $135,860. Although B's estate was twice as large as A's estate, each of B's children receives only 38 percent of the amount received by A's child, and the share of each of B's children is diminished by a tax of $65,140, which is 45 percent of the amount of the tax of $145,700 taken from the share of A's child. This is taxation according to the ability to pay in reverse, and with a vengeance.

(c) Multichildren families effectuate the social purpose of the estate tax: Much has been written as to the purpose of the estate tax, but certainly one of its prime objectives was and is the breaking up of substantial accumulations of wealth. Assuming for the sake of discussion that this is a desirable objective, what method is there of achieving this purpose that is more effective than the equal division of an estate between a number of children, a division that is almost automatic in its operation? Surely, the man who voluntarily contributes to this result should not see his children penalized by the further and excessive eroding of the estate he accumulated or preserved. We realize that mathematical justice is impossible of attainment

What we seek is some measure of approximate justice, and we believe that this would be attained by the provision of a modest deduction for each child along the lines suggested above.

3. The effect of the proposal on the Nation's economy.

(a) Encouragement of savings: The estate tax is a tax on savings and as such admittedly acts as a deterrent upon the savings which are so necessary to our economy. Much of our national welfare depends upon the capital which results from past savings, and its replacement and expansion are matters of concern. Any measure which will increase rather than diminish future savings should be seriously and affirmatively considered. That our proposal would result in increased savings which could be used for business expansion seems beyond doubt.

(b) Increase in venture capital: Much of our current savings is used to finance those new ventures which are so important to the progress and well-being, if not the survival, of our Nation. Despite this fact, there is a very real need for more venture capital. We believe that the adoption of our proposal would materially increase the supply of such capital, not only because of the increased flow of savings discussed above but also for the following reasons:

(i) Decrease in capital held in long-term trusts: By its very nature, the children's deduction would be limited to outright bequests or to one-generation testamentary trusts. If our proposal should be adopted, these would increase, and long-term trusts covering 2 or 3 generations should decrease, both in number and in size. The result of this would be the reduction in the amount of capital which is subject to the extremely conservative investment policies that characterize long-term trusts, and the corresponding increase in the amount of capital in the hands of heirs who seek a higher return on the money controlled by them, and who are willing to take more risks than are trustees who are subject to legal restrictions and to surcharges.

(ii) Decrease in capital reserved for payment of the estate tax: Since the children's deductions would result in some lowering of the amounts required to pay the estate tax, individuals would not have to invest in such a high proportion of liquid, low-return assets as they now do. This would mean that they would have more money to invest in ventures which involve risk.

(c) Encouragement of small, closely held businesses: One of the most discouraging features of our present economy is the difficulties which face such businesses. A man who has built up his own business is faced with the problem of trying to accumulate enough to insure payment of the estate tax. To do this, he must either divert needed capital from the business to a reserve to be used to pay the tax, or he must sell the business during his lifetime to acquire the necessary funds for that purpose. If he follows the first course, his business runs a real risk of disaster from lack of capital; if the second, one more small business disappears.

Should the children's deductions be enacted into law, the pressure either to divert capital into a tax reserve or to sell the business would be lessened in the case of a man who has children, and usually it is such men who are most concerned with the future of the businesses they have built up, since they hope to pass them on to their children. 4. Offsets to loss of revenue: Although there would be some loss of revenue to the Federal Government as a result of the children's de