called holding period, or the period within which the individual can get his capital back, I think we must extend such a formula to the individual to protect him from the evils of inflation.

So that in our desire to accomplish this very worthwhile objective I hope we can come up with a solution that is more peculiarly adaptable to this limited area and one that will not be interpreted as an excuse for further application, or one in which we will be accused of being discriminatory in not extending to a wider application. That is the thing that has been disturbing me about this suggestion.

Mr. PATON. Well, I sympathize a great deal with what you have said, Mr. Chairman. I won't comment at any length further on it. But I would think we have at the present time in the code a very basic discrimination between the merchandiser and the fellow that has invested in plant.

The CHAIRMAN. I agree with you that LIFO is very favorable treatment for inventory compared to our present depreciation method for plant. I agree with you on that, but there is a distinct difference.

Mr. PATON. And it seems to me that correcting a condition of that kind can hardly be interpreted as moving on into the area of trying to make taxpayers whole. I mean there is a thing that has developed over 15 years or so that has been a blessing, no doubt-at least, many of them feel so-to those who have heavily invested in merchandise and materials. And it has always seemed to me that it was the people who were heavily invested in plant and equipment who were really embarrassed.

Now, I think if I might add this one further affirmative comment along that line. And that is that the changes in the 1954 code permitting a major part at least of the total cost permitted to an installation of equipment to be deducted and recouped if the revenues are big enough early is a step that is useful when it comes to high-risk investment. It may be less appropriate to certain other types of investment. And I understand they have been trying somewhat to deal with the odd capital gains feature on some of this short-lived material-some of these short-lived items-which worked out rather peculiarly when the declining method and some other methods were applied to them. But it doesn't seem to me that it would be an enormous departure, and I think it would go quite a way toward preserving or encouraging the preservation of our stock of capital goods and expansion of capital goods, to apply LIFO to the long-lived assets as well as to the shortlived assets.

I thank you very much.

The CHAIRMAN. Mr. Reed has some questions.

Mr. REED. I think this is a little bit off the beam. But what effect does our type of currency today have on this inflationary question? Mr. PATON. I am a gold-standard man, I might say. I don't think the gold standard solved everything. But I think a convertible gold standard is a peg that is helpful in a monetary system. But it is a pretty complex question as to whether our type of currency has an effect on the inflationary question.

It says on this paper money "payable to the bearer" $10. Of course, that means he can go and get another piece of paper like it. So we have departed in our domestic economy from redeemable currency.

I personally think that it would be an electrifying vote of confidence all over the world if we resumed redemption.

Mr. REED. I agree with you 100 percent. I just figured I would get an answer like that you, because you are a very sound thinker, and it is very fine to have you here to talk with us.

I was always a good follower of Professor Campbell, with whom I know you must have been acquainted.

Mr. PATON. Surely.

Mr. REED. Thank you.

The CHAIRMAN. Are there any further questions of Professor Paton?

If not, we thank you for coming to the committee.

Mr. PATON. Thank you very much.

Mr. REED. Mr. Chairman.

The CHAIRMAN. Mr. Reed of New York is recognized.

Mr. REED. Mr. Chairman, I have received a statement for inclusion in the record at this point which has been submitted to me by a distinguished attorney in western New Work, Frank G. Raichle, Esq., of Buffalo. Mr. Raichle has kindly commented favorably on legislation which our colleague, Mr. Simpson of Pennsylvania, and I have joined in introducing. The bills have the meritorious purpose of amending section 112 (f) of the 1939 code and section 1033 of the 1954 code to provide that if property owned by a public utility is compulsory or involuntarily converted by requisition or condemnation or threat thereof, the purchase by the taxpayer of other public utility property or stock in a utility would qualify as a replacement for taxdeferment treatment. This legislation would treat this situation with respect to public utilities in a manner that is substantially similar to that accorded to other involuntary conversions. This proposed legislation is in my judgment directed toward a true hardship and tax inequity existing under our Federal tax structure in that it would alleviate the present problem confronting owners of privately owned waterworks utilities who have their property condemned. It is not possible for such owners under circumstances of condemnation to find other waterworks companies in which they can invest and present law does not allow for the deferment or present nonrecognition of gain on the proceeds realized from such condemnation.

I commend Mr. Raichle's statement to the attention of the committee not only because of the substance of the statement but also because of Mr. Raichle's oustanding reputation for ability and integrity. It is my hope that during the present session of the 85th Congress we will find favorable action taken on this legislative proposal.

Mr. Chairman, without objection, I ask permission to include Mr. Raichle's statement in the record.

The CHAIRMAN. Without objection, it is so ordered. (The statement referred to is as follows:)

STATEMENT OF FRANK G. RAICHLE, ATTORNEY FOR NEW YORK WATER SERVICE CORP. IN SUPPORT OF H. R. 8563 AND H. R. 8768

H. R. 8563 and H. R. 8768 are identical bills designed to alleviate the special hardship involved in the reinvestment of proceeds received upon a condemnation of the property of a waterworks system.

Under section 112 (f) of the Internal Revenue Code of 1939 and section 1033 of the Internal Revenue Code of 1954, as they now stand, any gain derived in the condemnation of a waterworks system may be postponed if the proceeds of the condemnation are invested in other waterworks property, or in 80 percent of the stock of the company engaged in the waterworks business. The

cost basis of the old property becomes the cost basis of the new property. Hence, gain is only postponed and is realized-gives rise to taxpayment-upon the disposition of the new property.

These sections worked well when there were water properties which could be acquired. However, because, in the last two decades, the acquisition of shareholder-owned systems by municipalities has been an extensive practice, it is practically impossible today to find waterworks systems which can be purchased. Hence, the provision in the code means little for any such company whose properties are or have been taken by condemnation.

The proposed legislation alleviates this hardship and makes the above-mentioned sections meaningful. These bills would permit a deferment of gain if the proceeds of the condemnation of waterworks are invested in the stock of any company whose rates for furnishing service are regulated by a Federal or State utility commission.

There would be no revenue loss to the Government in the enactment of these bills. In the case of a condemnation today, an extension of time is secured within which to invest the proceeds, and subsequent extensions of time are secured in order to find a water company which may be purchased. The Treasury has indicated some objection to these bills, not on their merits, but on the ground that they might lead to other requests for the deferment of the capital-gains tax. However, utility companies owning water properties which are acquired by municipalities are in a uniquely adverse position and present a unique problem. Thus, it is difficult to see how other requests from other taxpayers could be founded on the proposed amendment.

The CHAIRMAN. Our next witness is Prof. Carl S. Shoup.

Professor Shoup, will you identify yourself by giving us your name and address? We recognized you were invited by the committee. Mr. SHOUP. My name is Carl S. Shoup. I am professor of economics at Columbia University.

The CHAIRMAN. You are recognized.

Do you want to use your statement or do you want to speak to us orally and have it included in the record; which way?

Mr. SHOUP. I believe I would prefer to read the statement if I may? The CHAIRMAN. Very well.

STATEMENT OF CARL S. SHOUP, POLITICAL SCIENCE FACULTY, COLUMBIA UNIVERSITY, NEW YORK CITY

Mr. SHOUP. I appreciate the invitation extended to me by the chairman of the Ways and Means Committeee to submit my views on the revenue-revision problems facing the committee and the Congress. The tax system of our National Government must be examined in the light of both the near-term and of the longer term economic forces. For the near term, tax reduction, not a tax increase, is indicated. The present recession in business activity may continue for many months and may go deeper; in either case tax rates should be reduced to stimulate the economy.

I might add parenthetically that perhaps we haven't much more than a month or two to wait before taking action.

Over the longer term, however, the outlook is quite different. This long-term outlook and its implications for our tax system are the chief subjects of my testimony today.

Our Nation appears to be approaching one of the great turning points in history, based again on exploration, this time the exploration of outer space or at least of orbital space. The exploration may be stimulated almost entirely by the need to preserve our existence; alternatively, we can at least hope, it may be based on peace and understanding among nations.

In any case, the program will be costly, and it can scarcely be accomplished except under auspices of the Government.

Moreover, if we do not succeed in halting the new accelerating arms race, the potential Federal budget in the early 1960's may unhappily be of a greater magnitude than any yet mentioned. The increase in expenditures will not be simply in terms of billions for missiles, space platforms, and shelters, and, too, for conventional arms and foreign aid; they will be found also in customary peacetime items, notably in aid to education.

A growing national income will allow part of these added expenditures to be met without raising tax rates, but only a part. A Federal budget of $100 billion by 1963 would not be surprising. This is to say that we shall probably decide, in the course of the next 5 or 10 years, to devote to Government use a somewhat larger fraction of our national output than at present. Unless we are to divert resources to Government by the process of inflation, or by an extensive system of direct controls, we must be prepared to operate under a somewhat higher average level of taxation.

That a higher level of taxation can be supported, if we choose that path, there can be little doubt. Experience of the past two decades shows how the private-enterprise system can function under tax rates thought impracticable not long ago. The fact is, higher taxation puts pressure on us from two directions at once: to work more, because our standard of living is threatened; and to work less, because the reward for working more is reduced somewhat by the higher tax rates. At least this is so if the tax moneys are spent on defense or on other things that do not make us feel better off immediately, hence less inclined to work.

The net result of these two forces seems to be about zero, or perhaps even a somewhat heightened level of work. With respect to investment, to be sure, a higher level of taxation may well prove more restrictive than desired. Even here, our experience and that of Britain, France, and Germany suggests that the degree of investment we need for a stable price level in a growing economy would not be appreciably endangered by a somewhat higher average level of taxation.

We may decide not to undertake the additional expenditures; and if we do undertake them, we may choose inflation or direct controls as the method of diverting the resources to Government. But in any of these cases, if the consequences turn out to be unfortunate-the consequences of not spending, of spending by inflation, or of imposing a network of direct controls-we cannot then absolve ourselves from blame by saying, "No; we had to act that way because more taxation was unthinkable." We hypnotized ourselves by that specious argument in World War I, and then again in World War II, and paid for it in both instances by a more or less delayed inflation; we shrank from courageous action by convincing ourselves that we could stand no more taxation.

If, on the other hand, we do turn to higher taxation, it is the income tax on which we shall doubtless attempt to rely. This tax seems to suit us better than any other on a comparable scale. We use the income tax to a greater degree even than Great Britain; their National Government obtains less than half of its current revenue from its income-tax system; ours, nearly four-fifths.

In France the proportion is only one-third. The reasons for these differences in reliance on the income tax are many, and complex, but three stand out:

First, we spend a smaller proportion of our national income through Government than do Britain and France, and at the same time we have a higher income per head. If those two countries tried to finance three-quarters or four-fifths of their National Government expenditures from income taxation, the rates would have to be more steeply progressive, and with personal exemptions of a smaller amount, than anything experienced so far, even in wartime.

Second, the income tax does appeal to us with perhaps somewhat more force than in other countries, as the most just form of taxation, despite all its shortcomings.

Third, much of what we finance outside the National Government, through our State and local tax systems is in Britain and France covered by national taxes.

If it is true that the income tax is the one to which we have recourse in a time of need, anything that impairs the operation of that tax is even more serious for us than for other countries. We need to be as certain as we can that our income-tax system is in good condition, as insurance against the times ahead.

But the fact is, it is not in good condition. It is not dangerously defective; it does not face imminent collapse; but it may not be able to respond to further calls upon it as it should, unless we admit the existence of, and do something about, what I shall here call the "deadlock."

This is a deadlock between two groups of proponents of income tax reform. One group, looking to a lightening of the income tax, seeks a lowering of the top bracket rates that now go as high as 91 percent in the United States and 92.5 percent in Britain.

The other group, believing that many taxpayers of substantial income contribute less than their fair share because of loopholes, urge a tightening of the tax base. Both groups are in the right, but neither, seemingly, will agree that the other one is. Meanwhile, each of those two defects in the tax law tends to perpetuate the other. Loopholes are driven in the law because the high rates make for hard cases, and arouse understandable sympathy in the minds of legislators. But some of the loopholes, when publicized, arouse resentment and envy in taxpayers, usually large in number, who are not in a position to take advantage of those provisions. These feelings in turn create a formidable barrier to the lowering of the top surtax rates. Those rates are only slightly lower now, in real terms, than they were in 1945. This is so, even for married couples, despite the introduction of income splitting in 1948, and some lowering of the rate schedule itself.

The countervailing factor has been the fall in the value of the dollar. An income of $200,000 for example, is of much less real value than was an income of $200,000 in 1945, and hence should be compared with a smaller number of 1945 dollars. If we allow for this fact by using the consumer cost of living index to put the 1945 and 1957 dollars on a comparable basis, we find that the marginal income tax rate on a married couple with $200,000 income in 1957 dollars has dropped only from 92 percent in 1945 to 89 percent in 1957.