ships, thus feeling the full impact of the steeply graduated income-tax rates. They have a vital interest, as does the Congress, in the equitable distribution of the heavy burden of Federal taxation and in the prevention of erosion of the tax base.

Mr. GREGORY (presiding). Does that conclude your statement?
Hr. HALL. It does.

Mr. HOLMES. Mr. Hall is a distinguished citizen of the State of Washington, a distinguished individual in his own profession.

I am happy to welcome you before the Ways and Means Committee. I have listened to your statement with a great deal of interest. Do I understand you to say that in the principle that you are bringing up here, you are not only emphasizing the fact that the corporations tend to accumulate their earnings to excess in relation to the penalty provisions that are available, but also, do you not emphasize the point that the individual stockholders sometimes suffer from that type of regulation?

Mr. HALL. I did not indicate the extent to which stockholders, as individual owners of securities might suffer, but it is obvious they do to the extent that earnings are accumulated within the corporation and perhaps during their life they may not share in the profits of prior annual periods.

To the extent that they do not get earnings from these private corporations which do not generally have their securities listed on organized security exchanges and because such securities at best move in a comparatively small volume to a select group of buyers, there is probably little offset in higher prices because of limited capitalization of the retained earnings in terms of higher security prices for these unlisted securities.

The public to which such securities will appeal is so limited that an individual stockholder can have his interest, I think on occasion, rather seriously prejudiced.

Mr. HOLMES. I can see that point because the base of distribution is not large. On the other hand, the minority stockholders in a closely held private corporation sometimes can suffer even though they are small in number.

Mr. HALL. Yes.

Mr. HOLMES. And I have seen that operate in many instances. I think that angle along with it, while it may not have great width in its base or great numbers involved, the principle is there.

Mr. HALL. I would certainly agree with you, Mr. Holmes.

Mr. HOLMES. Thank you very much.

Mr. GREGORY. Mr. Mason.

Mr. MASON. Mr. Hall, am I right in gathering this impression from your statement, that what was wrong with 102 in the old 1939 code was the administration of it by the Revenue Department mostly and we did not correct that when we passed the 1954 code and changed this accumulated earnings section. We may even have weakened the old 102 code or provision; is that right?

Mr. HALL. In my judgment the accumulated earnings tax today is a weaker instrument by far than the former section 102.

Mr. MASON. That is what I gathered from your statement. I also gathered that what was wrong with 102 was mainly wrong with the enforcement of it and the interpretation of it.

20675-58-pt. 2-71

Mr. HALL. To the extent that the allegation has been made, and it has been made on many occasions, that the Internal Revenue Service has used threats of deficiency assessments under section 102 to coerce taxpayers into settling other tax issues we are dealing with an administrative abuse and I think this is one of the more serious charges which has been directed against the Internal Revenue Service. It seems to me the way to correct an administrative abuse of that sort is not by statute but by the Service itself taking such steps as may be necessary to prevent this occurring.

Mr. MASON. Thank you, sir.

Mr. GREGORY. Any further questions?

If not, Mr. Hall, we thank you for your appearance and the information given the committee.

Our next witness is Richard A. Musgrave, professor of economics, University of Michigan, who appears at the invitation of the committee.

For the purpose of the record, will you please give your name, address, and the capacity in which you appear?

STATEMENT OF RICHARD A. MUSGRAVE, PROFESSOR OF ECONOMICS, UNIVERSITY OF MICHIGAN

Mr. MUSGRAVE. My name is Richard A. Musgrave. I am a member of the department of economics of the University of Michigan. Before addressing myself to the problem at hand, let me express my pleasure at being invited to appear before your committee. This pleasure is not only personal. It also extends to the fact that invitations have been issued to a group of professional people to discuss the tax problem with you. I hope that you will find this experiment a useful one. I am sure we shall.

The topic of these hearings has been announced as general tax revision. This is always a good thing to think about. While our tax structure is by no means as bad as some people would have it, there is plenty of room for improvement. Moreover, there is always the problem of setting the general level of tax rates so that taxes provide the appropriate level of yield.

The discussion during recent weeks, statements by the administration, by Chairman Mills and others, suggests that it is the level of yield which is of most immediate concern to this committee; and it is here that the tax problem extends beyond providing for the cost of public services in an equitable fashion. Tax policy comes to be related closely to the broader problem of economic stabilization.

SHOULD TAXES BE CUT?

Should the Congress at this time provide for a change in the general level of tax rates? As I see it, the answer depends on (1) the budget outlook, (2) the business outlook, and (3) the required level of defense expenditures.

The budget outlook, as presented in the President's message, shows an increase in expenditures of $1.8 billion and an increase in receipts of $2.2 billion. As a result, the surplus is estimated to rise from $200 million in the fiscal year 1958 to $600 million in the fiscal year 1959. These figures refer to the consolidated cash budget, which is the more

significant one in dealing with the economic impact of the budget, but the picture in the administrative budget is essentially the same.

I understand that the revenue estimates are based on the assumption of a personal income for calendar 1958 of $352 billion, with corporation profits remaining at 1957 levels. This would seem to imply an annual rate of gross national product for the last quarter of 1958 of about $460 billion, or $25 billion above the fourth quarter of 1957.

My guess is that this is too optimistic a view, and that receipts may well fall $2 billion below the official estimate.

I may add, in connection with Mr. Smithies' statement this morning, that it does not seem at all appropriate to me that the Treasury should estimate the yield on the assumption that there will be a fullemployment income. I think it is one thing to argue in line with the Treasury Department philosophy, which I do not entirely share; nevertheless, in line with this philosophy, you may argue that you should set tax rates so that the budget is balanced at full employment; but it does not follow on this that, in estimating yield, you should not estimate the actual yield which will be obtained under the likely income at such rates as prevail.

At the same time, it seems likely that the Congress will provide for a somewhat higher level of expenditures than is recommended in the budget message. Assuming present tax rates to be continued, including extension of excise and corporation rates as recommended by the President, we may well have a deficit of, say, $3 billion.

Turning now to the economic outlook, I am again doubtful that the second half of this year will produce the decisive upturn which the administration anticipates. While I am not looking at this point for a sharp decline, there is a distinct possibility that we are in for a more sustained recession.

The deficit which I anticipate will help to meet this situation, but conditions may become more serious, and a reduction in tax rates may be called for. Note that this reduction will be called for if income is low and the deficit is larger than anticipated, and not, as some have been suggesting in recent years, if an unexpected surplus should develop.

Moreover, note that tax reduction as an anti-recession device involves an increase in the deficit, and not a contraction. There is little merit, at least in the short run, to the pleasant notion that the way to raise tax yields is to cut rates. Recent statements by the President and members of the administration are reassuring on an understanding of these points.

While it is not too difficult to say what should be done if economic conditions take this or that course, there remains the difficult matter of timing. If you could wave a magic wand and wish that tax rates had been reduced as of the beginning of this year, you might well want to do so. But this cannot be done.

It will be difficult to provide for a reduction prior to July 1, and by then conditions may have changed. If the administration's expectations of a sharp upturn in business are fulfilled, as I hope they will be, tax reduction will not only be unnecessary, it will be quite undesirable. But I fear that this will not be the case. Assuming the expenditure level as recommended in the budget, a tax cut is likely to be in order.

However, it remains to be seen what the level of budget expenditures will be. A higher level of expenditures will obviously require a higher level of tax rates or a lesser rate of reduction. I do not mean to imply that this will be needed because it is always desirable to balance the budget.

Rather, I am referring to the level of tax rates which is required to maintain high employment and price level stability. Everyone knows that if expenditures are increased, tax rates must be raised lest the net expansionary effect of the budget is increased. Therefore, the case for or against tax reduction will depend greatly on what is done about the expenditure side of the budget.

If the Congress should decide to raise national security expenditures by $3 billion per annum as recommended in the Rockefeller report, a reduction in tax rates, though it might have been needed otherwise, would then become undesirable. Since I personally believe that this additional contribution to our national security is probably needed, I am hesitant to recommend a tax reduction which would be justified only if this expansion in the defense program was not forthcoming.

To be sure, an expansion in the expenditure program as suggested in the Rockefeller report, cannot be accomplished at once. Even if accepted, the adoption of such a program might have little bearing on the economic outlook for this year and the possible need for lower taxes during this period.

I am aware of this, but I cannot overlook the likelihood that tax reduction, once undertaken, would make it more difficult to attain the needed defense effort. Such will tend to be the case, be it for fear of deficit or because of disinclination to return to a higher level of tax rates.

This consideration gains in weight if we suspect that the need for expansionary action will be more or less short lived, while increased requirements for national security will be of a sustained sort.

In all, I would be hesitant to recommend tax reduction before assuring myself that all efforts have been made toward achieving the necessary level of defense expenditures. Again, this introduces difficulties of timing which frustrate a reasonable plan of action.

A PLAN FOR FLEXIBLE ADJUSTMENTS IN TAX RATES

Caught in this maze of uncertainties and pressed by the need for legislative action, a Congressman's prayer-especially if serving on the Ways and Means Committee- may well be for a device to provide greater flexibility in acting on changes in the level of tax rates. Such a device has been discussed at times by economists, but it has not been given the public attention which it deserves. I propose therefore, to consider such a plan.

Under this plan, the Congress would continue, on an annual basis. to review the tax structure as has been customary in the past. The purpose of this review would remain that of dividing the cost of public services equitably between various groups of taxpayers, and of setting the overall level of yield as required by the prospective level of budget expenditures and the likely economic outlook for the coming

year.

Moreover, there is the additional task of using tax policy as a shortrun stabilization device. This involves adjustments in the level of tax rates, such as may be required in the course of the year to maintain a high level of employment and stable prices. This second aspect of tax policy demands a high degree of flexibility. It cannot be provided for effectively by annual adjustments.

The problem, as it were, is one of driving the car while it moves along and of making the turn when the bend in the road appears. The impasse of the current situation well illustrates the difficulty of doing this job under present arrangements.

To make such adjustments possible, I suggest that each year you provide for a margin of flexibility in tax rates and instruct the President to raise or lower rates within this margin, when needed to check inflation or deflation in line with his functions under section 2 of the Employment Act.

This delegation of authority would be very specific, both as to the type and the range of adjustment. Thus, the Congress might authorize the President to raise or lower income tax exemptions by $100; or, he might be authorized to increase or reduce bracket rates by a flat 5 percent.

Still other types of adjustments may be chosen, such as a change in the first 2 bracket rates by 3 percentage points. My present concern is not with the specific terms of the adjustments which the President would be authorized to make, but with the principle of the matter. This authorization would be subject to annual review by Congress, in connection with the general review of the tax structure, and changes in its terms would be made as the situation requires.

This plan may seem new and drastic, but I believe that it could be applied without much difficulty, and that it would greatly add to the Government's ability to deal promptly with emerging elements of instability. Without going into detail, let me atnicipate several objcetions which will be raised.

To begin with, I am aware that the power to tax is vested in the Congress, as it should be, and that a delegation of this power to the Executive is not permissible under the Constitution. While I am not competent to discuss the legal question involved, it would seem that the proposed measure does not constitute such a delegation.

It does not in any way negate the congressional control over the Nation's purse strings, and it has no effect whatever on the need for legislative authorization of expenditure programs. The only authority which would be delegated is that of making short-run changes in the level of tax rates; and these changes would be held within limits and forms prescribed by Congress. They could be applied only as needed to carry out a congressional mandate-the executive rspeonsibility for full employment and price level stability as spelled out in the Employment Act.

Still, it might be asked whether this function may not be performed equally well by Congress. While I felt that this cannot be done effectively through the annual process of revenue legislation, it may be possible to place responsibility for current rate adjustments with a congressional committee, say the Joint Committee on Internal Revenue, or the Joint Economic Committee. This may serve the same purpose,