Policy on Profits

Last week a working subcommittee of six sat down to transact the most important business to come before the House Ways & Means Committee in 1936. On the table before them lay President Roosevelt's tax recommendations (TIME, March 9). In chairs before them were Treasury experts to answer questions. The subcommittee's job was to whip out a tax bill which would give the appearance of balancing the President's regular budget and thereby deflate Republican campaign charges of reckless Democratic spending.

The President asked for about $620,000,000 annual revenue to finance AAA's substitute and the Bonus, plus $500,000,000 of non-recurring requirements to plug the Treasury hole left this year by the invalidation of processing taxes. Less than a week before the President had specifically told the Press that he would propose no specific taxes. Yet his message did contain such a proposal, not only for a new tax but for a new scheme of corporate taxation.

The corporation tax changes proposed by the White House were all correlated: 1) repeal of existing taxes on the income, capital and excess profits of corporations; 2) repeal of the exemption of dividends from the 4% normal tax paid by individuals: 3) a tax of about 35% on each year's undistributed corporation earnings, presumably to begin on 1936 earnings. Thus a corporation would escape Federal taxes if it paid out all its earnings in dividends on which its stockholders would pay nor mal as well as surtaxes. Contrariwise, if it paid out no dividends, 35% of its earnings would go to the Government.

Old Practice, New Idea. Among the experts before the Ways & Means subcommittee last week was dogmatic, large-eyed Herman Oliphant, the Treasury's General Counsel. A onetime professor of Law at Johns Hopkins University, Mr. Oliphant serves Secretary of the Treasury Morgenthau as that gentleman-farmer's No. 1 Idea Man. Washington opinion generally credited Mr. Oliphant with having fathered the new tax plan and transmitting it through Secretary Morgenthau to the spot where it made its startling appearance in the President's message. So great a surprise was that proposal to Franklin Roosevelt's friends and foes that even Ways & Means Chairman Doughton shook his sane, bald dome, clamped his cautious jaw grimly, and solemnly an nounced: "This thing will require study." Mr. Oliphant was well equipped to help the Ways & Means subcommittee see the President's proposal in a favorable light. In logic there is no reason at all for taxing corporations as part of the income tax law. The theory of an income tax is to apportion the burden of Government more heavily on the rich than on the poor. Since stockholders of corporations differ widely in wealth, a corporation tax which hits them share & share alike misses the point. The original idea of a corporation income tax was that it would be a simple means of collecting revenue at its source. On this basis corporations would pay on their earnings a tax equal to the exemption allowed stockholders on their dividends. Early in the history of the U. S. income tax this balance of taxes was forgotten as corporation taxes were run up to their present average of 16%, while stockholders are exempt from only the 4% normal tax when they reckon their dividends on their own tax returns.

The Treasury soon found that it was losing revenue by this arrangement. Wealthy men escaped high surtaxes by leaving part of their income with corporations which reinvested their profits instead of declaring dividends. Heavy taxes on undivided profits, kept by companies beyond their "reasonable" needs, did not prevent a large amount of rich men's incomes from escaping surtaxes because the word "reasonable" was hard to define. And, whatever profits a conservative corporation puts aside for surplus plant expansion or hard times to come, the Government collects only 12% to 15% in corporation income taxes.

The President's proposal would put an end to all this. No longer would small taxpayers have some 16%. of their income from corporate sources taken by the Government in return for only a 4% credit on dividends. Big taxpayers would gain little or nothing by leaving their income to be taxed at 35% in corporation hands rather than taking it in dividends and paying the personal surtax.

Groans. Grim and glum was many a businessman at the idea of a tax that would prevent corporations from putting anything by for a rainy day. "A ruinous tax!" "Breaking the nest egg!" "The breathing spell for business is over!" were some of the things Republicans called the President's plan. Even Ways & Means Committeemen were disturbed. If corporations were not allowed to accumulate surplus what would happen when Depression hit? First question put to General Counsel Oliphant and the Treasury experts was whether corporations could not be allowed to keep as a cushion against Depression a small part of their earnings, say 10% or 20% which would be taxed only 15% or 20%. Mr. Oliphant was firm in his opposition to a corporate cushion, pointing out that the tax plan would not yield the necessary $620,000,000 of taxes requested by the President if such an exemption were allowed.

Questioned by newshawks at a press conference, Franklin Roosevelt was equally firm: no undivided corporation income should be exempt from the full tax, except such ordinary reserves as are already allowed. Suppose, said the President, that he and Correspondent Raymond P. Brandt of St. Louis Post-Dispatch were rich men and owned 51% of the stock of a corporation and the other newshawks were minority stockholders. The majority stock-holders might decide to leave all their profits with the company, to declare no dividends. That would not be fair to the minority who might need money. The undistributed profits tax would force the distribution of the corporation's income in dividends. Then, if the company needed money for expansion or some other purpose, it could offer new stock to its stock-holders and thus get back the necessary amount of cash.*

Still reluctant was the Ways & Means subcommittee. It called on the Treasury for estimates of what other taxes would yield. Some alternatives and their estimated yield:

A manufacturers' sales tax at 5%: $530,000,000. An increase of the normal income tax from 4% to 6% : $121,000,000. Higher surtaxes in $3,000-to-$100,000 brackets: $226,000,000. About 30 excise taxes on farm products at rates lower than the extinct processing taxes: $221,000,000. An increase of the Federal gasoline tax from 1-c- to 1 1/2-c-per gal.: $80,000,000. Louder groans than before rose from the House committee. Compared to these burdensome taxes, with their low yield, the President's tax on undivided profits seemed the least of many evils.

Significance. After several days' cogitation even the gloomiest alarmist felt less anxiety over the enactment of an undivided profits tax. Part of this reassurance came from the fact that the Ways & Means Committee members stuck to their idea that industry must be allowed to build up some reserves as a cushion against Depression.

More reassurance came when men took pencil & paper and found that even a 35% or 40% tax on undivided profits would not in itself burden corporations so much that they would be unable to build up reserves for emergencies. An easy example: a corporation clears $1,000,000 a year. Some $160,000 now goes to the Federal Government in corporation taxes. If $500,000 is declared in dividends $340,000 remains for surplus. Under an undivided profits tax, the corporation might declare the same dividends with the result that it would have to pay 35% on the remaining $500,000. Thus the Government would get $175,000 in taxes and the corporation could still add $325,000 to surplus. Stockholders, on their own account, would have to pay the 4% normal tax on their dividends--$20,000 in taxes. Thus the corporation would be out an additional $15,000, the stockholders an additional $20,000. The Treasury would gain $35,000 in tax revenue which would be the equivalent of an increase of the present average corporation tax of 16% to 19 1/2%.

*The President did not touch on the possibility that he and Mr. Brandt might not be able to subscribe to this new stock. Critics pointed out that Federal surtaxes alone might take up to 75% of their dividends received from the company; after paying Federal and state income taxes they might not have the necessary cash to return to the company.

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