Schedule E shows for the year 1953 the revenue consequences of including capital gains in ordinary income. By broad income classes the long-term net capital gain in each class has been taxed at the extra rate applicable to income in that class. The extra revenue in each class is shown in column 5. The net effect is in increase in revenue of $1,056 million spread among the various income classes of taxpayers as shown in column 7 after giving effect to an adjustment for single returns.

SCHEDULE E.-Supporting data for computation of extra revenue from taxing capital gains as ordinary income

Schedule F shows the net income in each of the various classes after the addition of all capital gains to net income. Column 6 shows the net income in each class after adjustment for separate returns.

SCHEDULE F.-Computation by income classes of net income for 1953 including capital gains in full

Schedule G further breaks down the income by classes as shown on the preceding schedules E and F, and allocates such income to the surtax brackets presently effective. The surtax rate is listed in the first column and the income levels to which such rate is applicable is shown in column 2. Column 3 shows the surtax net income for the year 1953 if such income had included capital gains in full. Column 4 shows the added revenue that would be collected in each bracket if capital gains were taxed as ordinary income.

Keeping in mind that capital gains for the year 1953 were the lowest of any during the 1950's and on the assumption that any depressing effect of taxing capital gains in full would not reduce such gains below that reported in 1953, we would apportion the extra revenue collected among the various classes of

taxpayers so as to best achieve equity and render the taxing of capital gains as ordinary income as palatable as possible.

SCHEDULE G.-Comparison of revenue increase by including capital gains in ordinary income, with revenue loss from maximum rate at 50 percent and reduction of certain other brackets by 2 percentage points

We start with the proposition that between the years 1953 and 1954 taxpayers in the very top surtax brackets paid a maximum rate not exceeding 50 percent as a class. If we established a top rate of 50 percent we would be collecting the same amount of revenue, only it would be spread evenly among taxpayers with the same income. Even if we were to establish a top maximum surtax rate of 50 percent, there would be enough extra revenue derived from taxing capital gains at ordinary rates to reduce tax rates 2 percentage points in each of the brackets down through the 26-percent bracket, where capital gains cease to create such great disparity.

It is not of particular significance that the tax reductions and increases in each bracket would not actually coincide in every case. It is important that the total additional revenue does substantially equal total reduction in taxes that would be so achieved, and that the total increased revenue from taxpayers presently above the 50-percent bracket is practically identical with the reduction in tax liability that would be effected with respect to some taxpayers if 50 percent were the maximum surtax rate and capital gains were taxed as ordinary income. This is neither a soak-the-rich nor an aid-the-poor plan. It leaves the tax burden in the same income classes that now bear it, but it does distribute that burden equally among members of the same class.

The right-hand column of schedule G shows the tax rate schedule that could be in effect and still raise the same amount of revenue that is presently raised by the rate schedule in the left-hand column of schedule H, provided capital gains were taxed as ordinary income. With a top effective rate of 50 percent it is believed that taxpayers would undertake business risks not presently feasible and taxpayers would continue to invest in capital assets if their maximum tax liability were 50 percent of income including dividends and realized appreciation in value. Under such a rate schedule and if capital gains were taxed as ordinary income, all taxpayers with the same income would pay the same rate of

tax and our revenue laws would be simplified in a manner that will never be possible so long as we maintain the present discrimination in favor of a certain class of unearned income.

SIMPLIFICATION OF REVENUE LAWS

It is difficult to imagine our Internal Revenue Code absent the complexities brought about by the distinction between ordinary income and capital gains. The capital asset has not been successfully defined after 30 years' effort, and many cases are today pending in the courts on this single question. Without a distinction between ordinary income and capital gains we would no longer worry about sale and lease backs, collapsible corporations, collapsible partnerships, the distinction between redemptions of stock taxed as a dividend and those taxed as a sale or exchange. We could forget about section 306 stock, the allocation of sale price to capital and noncapital assets.

This is not to criticize the present provisions of our code or to suggest that the position taken by the Government in the voluminous litigation in this area is not essential to protect the revenue. These complicated and complicating code provisions cannot be eliminated under our present system of attempting to distinguish the undistinguishable. The worst feature is that the future contains more and more complexities and more and more litigation so long as our tax system provides a windfall on behalf of certain unearned income.

SUMMARY

We can raise the same revenue with a top surtax of 50 percent and a tax reduction in many of the other brackets if we are willing to treat capital gain dollars the same as other dollars. It is difficult to fully appreciate the complexities that would be thus removed from our tax system. We do know that if we now had a system based upon a 50 percent top surtax, we would not listen to anyone who suggested that we complicate it by differentiating between two types of income, and in consequence thereof raising our surtax to 91 percent and adding hundreds of new sections to the code and embarking upon extensive litigation in order to raise the same revenue.

It was Justice Brandeis who said "If we would guide by the light of reason, we must let our minds be bold." All reason dictates that we can have a far simpler tax system to raise the same revenue, with the burden spread more evenly among those with equal ability to pay. The question is whether there are those with minds bold enough to make this system available to our people.

The CHAIRMAN. For the purpose of information, may I ask, isn't it true that out of all the taxable returns in 1954, only 3.4 percent reflected any net captial gain?

Mr. MILLER. I am not familiar with that figure.

The CHAIRMAN. That is a fact; 3.4 percent of all of the taxablè réturns filed in 1954 reflected net capital gain.

Mr. MILLER. I might say that this subject came to me not in the order in which I have presented it; it did not come to me as a matter that had great inequity. It come to me sitting in sessions of the American Law Institute prior to the 1954 code.

As I listened to all of our efforts to try to achieve equity with the capital gains tax, and I realized all we were doing really was trying to keep the little man from getting the same benefit that the fellow has now in the stock market who owns his stock and can change any time he wants to. All we were doing was hedging around, and I could see no reason to it.

The CHAIRMAN. Are there any questions?

Mr. Miller, we certainly appreciate your coming to the committee and your very informative testimony you have given the committee. Mr. MILLER. Thank you.

The CHAIRMAN. Our final witness is Mr. Charles O. Galvin. Please identify yourself for the record by giving us your name, address, and the capacity in which you appear.

STATEMENT OF CHARLES 0. GALVIN, PROFESSOR OF LAW, SOUTHERN METHODIST UNIVERSITY SCHOOL OF LAW, DALLAS, TEX.

Mr. GALVIN. Thank you, Mr. Chairman. My names is Charles O. Galvin. I am professor of law at Southern Methodist University, and I am here at the invitation of the committee.

Mr. Chairman, several weeks ago I submitted a statement to the committee containing the specific recommendations which I have proposed, and I do not here propose to read that statement in full.

The CHAIRMAN. Without objection, the entire statement will appear in the record.

Mr. GALVIN. I would appreciate the entire statement being inserted in the record.

(The statement referred to follows:)

RATE STRUCTURE, CAPITAL GAINS, AND AVERAGING OF INCOME CHARLES O. GALVIN, PROFESSOR OF LAW, SOUTHERN METHODIST UNIVERSITY SCHOOL OF LAW, DALLAS, TEX.

SUMMARY OF RECOMMENDATIONS

My recommendations relating to tax policy are first submitted below in outline form followed by an analysis of each proposal.

1. Ordinary income tax rates should be reduced.

(a) The present rate structure applicable to ordinary income progresses from 20 percent to 91 percent. I recommend a scale of rates from 15 percent to 65 percent.

(b) The present income brackets increase in size as the rates increase. I recommend that the income brackets be equal in size.

2. The treatment of capital gains should be revised. At present the effective tax on net long-term capital gains is 50 percent of the ordinary income tax rates up to the point at which the tax on such capital gains is 25 percent. At this point the progression ceases. I recommend that 75 percent of net long-term capital gains be includible in income. This would result in effective rates on capital gains graduating from 11.25 percent to 48.75 percent.

3. Correlative to the foregoing two proposals I recommend that:

(a) Appreciation in property values not previously recognized for tax purposes be recognized at death; and

(b) A 5-year averaging device be used to mitigate the inequities that result in the case of taxpayers whose income fluctuates from year to year.

The foregoing proposals are integral parts of a common pattern, and I believe that the acceptance of this pattern in principle will yield the same revenue to the Government as under the present law and provide for simplicity and increased efficiency in administration.

PRESENT TAX POLICY

So much has been said and written about the inequities of our present income tax law that even the most cursory treatment of the criticisms that have been made would be an unnecessary encroachment on the time of this committee.' All would agree that a complex tax structure is the consequence of a complex economic system. All would equally agree, however, that a complex tax structure must nevertheless be compatible with certain canons of taxation; that is, that the tax (1) be broad based, (2) be intelligible to those subject to it, (3) possess the characteristics of certainty and predictability, and (4) be easily administered. Our present system falls so far short of these practical objec tives that there is a very real danger of its disintegration because of its inherent structural weakness. There are those who wistfully hope that each major overhaul of the revenue laws will be the last, that the unclear will be clarified,

1 See Surrey, The Congress and the Tax Lobbyist-How Special Tax Provisions Get Enacted, 70 Harvard Law Review 1145 (1957); Paul, Erosion of the Tax Base and Rate Structure, Joint Committee on the Economic Report. Federal Tax Policy for Economic Growth and Stability, 297 (84th Cong., 1st sess.. November 9, 1958); Cary, Pressure Groups and the Revenue Code: A Requiem in Honor of the Department Uniformity of the Tax Laws, 68 Harvard Law Review 745 (1955); Riehm, Federal Taxation: Perspective During the Fifth Decade, 52 Michigan Law Review 941 (1954).

the areas of uncertainty reduced to a minimum, the rules made sufficiently definite so that all know how to play the game. Such, however, has not been the case. Tinkering with the Internal Revenue Code is a national pastime promoted by almost every business and professional organization. Amendments are tacked on amendments so that even the knowledgeable are confounded and the sophisticated find their way with great difficulty. Moreover, investors and managers of industry have become so single minded about tax consequences that there has ceased to be a real freedom of choice in decision making and policy formulation. "Tax" planning has been substituted for sound business and economic planning; even within the intimacy of family arrangements individual choices are subordinated to the pervasive influence of the tax system.

Attempts at escape from high ordinary income tax rates appear in a multiplicity of measures which have been and continue to be urged insistently, sometimes irresistibly, upon the Congress. For convenience of discussion these measures, whether proposed or enacted, may be classified as follows:

(1) Those which transfer income from taxable status to exempt status.

(2) Those which reduce the income subject to tax by deductions of expenditures that would otherwise be personal or capital in nature or by deductions for amortization of capital expenditures over a shorter period of time than would otherwise be the case.

(3) Those which downgrade the income from that subject to ordinary rates to that subject to capital gains rates.

(4) Those which defer the recognition of income to some later taxable period. The principal thesis of my statement is that the rate structure is in large part responsible for the continuous pressures which are exerted on the Congress to enact ameliorating legislation for particular taxpayer groups. The consequence is an Internal Revenue Code that becomes ever more compendious and more complicated.

ORDINARY INCOME TAX RATES

Ordinary income tax rates now progress from a rate of 20 percent on the first $2,000 of taxable income in the case of a single person, or $4,000 in the case of married persons filing joint returns, to a rate of 91 percent on taxable income in excess of $200,000 in the case of a single person, or $400,000 in the case of married persons. In the middle and upper brackets the percentage point increases are reduced and the size of the brackets increased. The effect is a more accelerated progression at the lower brackets than at the middle and upper brackets. For example, at $10,000 of taxable income the effective rate is approximately 26 percent, at $20,000, 36 percent; at $30,000, 44 percent; and at $40,000 49 percent. Therefore, the effective rate increases 10 percentage points on the $10,000 increment between $10,000 and $20,000 of taxable income, 8 percentage points between $20,000 and $30,000, and 5 percentage points between $30,000 and $40,000, or a total of 23 percentage points on $30,000 of increment between $10,000 and $40,000 of taxable income. On $50,000 of taxable income the effective rate is approximately 54 percent, at $800,000, 63 per cent, and at $110,000, 70 percent. Thus, on the $60,000 of increment between $50,000 and $110,00 of taxable income, the effective rate increases 16 percentage points contrasted with 23 percentage points on $30,000 of increment at the lower end of the scale. When the slower progression at the upper brackets is considered in connection with the regressive effect of the capital gains rates in the same brackets, the need for some sort of adjustment in both the ordinary and capital gain rate structures seems demonstrably clear.

2

The rates are too high, and if they were literally applied as they appear, they could seriously impede the growth of the economy. The difficulty is, however, that the rate scale is deceptive. It has become only a theoretical base to which a myriad of exceptions and modifications apply. The report of the Treasury recently released entitled "Preliminary Statistics of Income for 1955" reflects that taxable income reported by individuals was about $128 billion, on which taxes of about $29.6 billion were paid. This is an effective rate of 23.1 percent, or about 3.1 percent above the effective rate at the first bracket of 20 percent. Since various forms of tax exempt income do not appear in the figure of taxable income, we may assume that the effective rate on all individual taxpayers' real income was about 20 percent, the rate at the first bracket. Of 58.25 million individual returns filed, 57.718 million, or 99.8 percent, reflected adjusted gross

2 Statistics of Income, 1955, Preliminary, Individual Income Tax Returns, U. S. Treasury Department, Internal Revenue Service Publication 198 (1957).

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