General Revenue Revision

(Advisory Group Reports on Subchapter C (Corporate Distributions and Adjustments); Tax Treatment of Dividends of Companies, Etc., Holding State and Local Securities; General Discussion)

FRIDAY, JANUARY 31, 1958

HOUSE OF REPRESENTATIVES, COMMITTEE ON WAYS AND MEANS, Washington, D. C.

The committee met at 10 a. m., pursuant to recess, in the Ways and Means Committee hearing room, Hon. Wilbur D. Mills, Chairman, presiding.

The CHAIRMAN. The committee will please come to order.

The first witness this morning is Mortimer M. Caplin.

Mr. Caplin, will you please come forward and identify yourself for the record by giving your name and address? We know you come as an invited witness of the committee.

STATEMENT OF MORTIMER M. CAPLIN, ESQ., PERKINS, BATTLE & MINOR, CHARLOTTESVILLE, VA.

Mr. CAPLIN. Yes, sir. Thank you, sir.

My name is Mortimer M. Caplin, of Charlottesville, Va. I am a professor of law at the University of Virginia Law School. Also I am counsel to the law firm of Perkins, Battle & Minor.

The CHAIRMAN. You are recognized, sir, to proceed in your own

way.

Mr. CAPLIN. First, I would like to thank this committee very much for the kind invitation for me to come here to express my views amicus curiae as to the need for revenue revision and the direction which we should take.

I will read from certain excerpts from my statement and will be able to answer any questions that the committee might have.

It is often pointed out that ours is a self-assessing tax system, and that the soundness of such a system depends upon the good faith of our people and their continued willingness to report their income and assess themselves in a fair and honest manner. To this there is usually added that Americans are trustworthy and that this facet of our internal revenue system is working effectively.

I do not question the inherent honesty of our people, nor do I have the facts to dispute the assertion that most of them report their income fully and fairly. But there are disturbing signs: There seems to be a current lack of confidence in our tax laws, marks of disrespect for

the administration of these laws, and increased tendencies toward tax avoidance and even dishonesty.

People also appear to be developing a lethargy over tax enforcement, reminiscent of the former widespread attitude under the Volstead Act. Not that fraudulent tax evasion is currently accepted or approved by any large segment of our society; rather, the evidence is that of indifference and sometimes sympathy when a member of the community is charged violations, criminal or civil.

Now, these attitudes constitute, in my opinion, a serious threat to the integrity of our tax system. At a crucial moment in our history, when this system is being strained by an indefinite period of high taxation, it seems imperative that firm steps be taken to reverse these trends.

Before considering possible remedies, I would like to examine briefly some of the causes of our present plight.

First, the rates are extremely high at all levels of our graduated income tax.

High rates have made us a tax-conscious people. Taxes are a major part of the family budget, and a controlling force in the way we conduct our businesses. Many of us have developed an acute sensitivity to the importance of tax deductions and the costliness of nondeductible expenditures. This has led to increased interest of tax planning, in means for arranging one's affairs to minimize taxation and even tax avoidance.

It should also be recognized that there is a growing awareness of the artificiality of our highest brackets. Individuals frequently hear of expense accounts, fringe benefits, and persons earning huge sums, but paying little taxes. The remarks made the other day by a salaried employee is typical: "Why does everyone have a loophole but me? Why shouldn't I have a window to crawl out of?" And that is verbatim.

Along with increased rates, our tax laws have become unbelievably complex.

To attempt to comprehend the tax laws is an extremely difficult task. Accountants and lawyers, in small communities, complain about the complexity of the law as it applies to the small-business man and the average client. Income tax returns are detailed and involved, and the people approach April 15 with frustration and dread.

Laws should be understandable to the great bulk of society. When they materially affect individuals, and yet are not reasonably comprehensive to them, we are inviting widespread disregard of the laws, leading to innocent as well as calculated violations.

Another contributing force to the lack of confidence in our tax laws is the undue emphasis and publicity given to "tax gadgets" or "tax gimmicks." I refer here not to the expected use of various provisions of the Internal Revenue Code, based upon normal business or family motivations. Instead, my reference is to the wide variety of proposed transactions often entirely unrelated to the usual activities of the individual, but which are being peddled by a type of tax broker, plans which are sold solely on the basis of tax advantages to be derived from them with only secondary consideration to their economic soundness.

Many such proposals have been defeated by the ingenuity of our courts: The "business purpose" rule, the "step transaction" doctrine, the substance versus form approach, are all judicial replies to these artificial plans. But the judicial process alone is not sufficient to prevent this type of trafficking in tax schemes.

A fourth factor to be taken into account is the sentiment that our tax laws discriminate in favor of our particular industries or groups. Certainly when we examine the legislative history of the Internal Revenue Code, it is difficult to answer the charge that a large portion of the law has been enacted in direct response to the demands of particular individuals or groups.

Under a fiscal program geared to a high budget, a tax favor granted to one group inevitably results in a tax burden to another. Whether it be an extension of percentage depletion or the creation of new types of capital gain, the resulting loss in revenue must be borne by less-favored taxpayers.

Frequently these tax preferences have been granted to provide incentives to different groups or industries. But is our tax law the proper vehicle for providing these special incentives or subsidies? Does such a legislative policy not result in continuing inequities to other taxpayers?

I doubt whether the average man is conversant with the refinements of these tax favors. But I do gain the impression that many are of the view that certain groups are not "paying their way." Local personal property tax systems have suffered greatly because of beliefs in the community that neighbors understate their values. On a much larger scale, our national tax system would be grievously damaged if the sentiment was widespread that our laws were discriminatory or inequitable. People will declare their full tax liabilities only if they feel sure that the other fellow is paying his full share.

Now, a final consideration, I feel, is the sporadic enforcement of our internal revenue laws. The development of the Internal Revenue Service has fallen behind the vast increase in the taxpaying body. Whether it is a question of size or lack of top-quality personnel, the service is not adequately exercising its auditing functions. For the fiscal year ended June 30, 1956, almost 58 million individual income tax returns were filed, yet hardly 2 million individual tax returns were examined through contact with the taxpayer.

Not that we have need for a high-powered police force of Treasury men, but a broad exercise of the auditing procedure on a reasonable basis has a salutary effect. Knowledge among taxpayers that their returns will probably be examined by an agent serves to check possible abuses. Too often we encounter the taxpayer willing to "take a chance" on the gamble that his returns will not be scrutinized. His information that acquaintances similarly situated have not been questioned contributes to his engaging in this new game of roulette.

If our self-assessing tax system is to be preserved, this trend must be reversed and a spirit of tax law compliance promoted. Our tax laws must earn the respect of the public; and to do this they must be understandable and they must be aimed at taxing persons of equal income, regardless of source, on an equal basis.

Now, I would like to turn briefly to certain basic policy decisions, which I think we must confront.

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General Revenue Revision: Hearings Before the Committee on Ways and Means ...