equipment by a money-market bank to a correspondent bank; partnership operation with a correspondent bank in leasing equipment to others or in factoring. In the leasing-factoring instances it has been argued that states other than the domiciliary state of the moneymarket bank might claim that that bank is doing business in those other states through an agency relationship with the correspondent bank. It has also been argued that certain other activities by the money-market bank might attract taxation of the correspondent bank by the home State of the money-market bank: securities handling and safekeeping service, transit service, collections, foreign drawing and remittance service, broker loan participations, factoring and accounts receivable financing, issuance and redemption of commercial paper, and provision of bank facilities and services.10

Duplicate state taxation and gaps in state taxation are of course geographically unneutral; a bank that channels its activities in a certain geographical pattern will minimize its effective combined rate of state income taxes. That pattern may or may not be one of restricting all activity to the home state; a bank may continue to operate outside its home state because of low state tax rates elsewhere, in the face of a certain amount of duplicate taxation on some of its out-ofstate income. Moreover, it may not be easy for a bank to discern accurately the alternative tax patterns, in a complex world of changing tax regulations, court decisions, and other uncertainties.

On balance, then, given the almost certain emergence of duplicate taxation and possible tax gaps under the permanent features of the present bank tax legislation, and given the continuance of the rather low levels of net additional burden imposed by any one state's income tax (see Table 1), the problem may be not so much one of distortion of flow of funds as one of nuisance and social waste of manpower and equipment devoted to the task of complying with, and attempting to minimize tax liabilities under, a number of somewhat differing state income tax laws. To be sure, state tax rates will almost surely rise further, so the distortion problem will become more important. On the other hand, because banks are so closely supervised, the compliance problem is also more important to them than to firms in many other industries.

(c) Technical Neutrality

The technical unneutralities of the corporation income tax are probably not very significant for banks, which, for various reasons, including regulatory restrictions and the nature of their business as a deposit-holding mechanism, cannot respond readily to the pressures that that tax exerts to increase the ratio of borrowed capital to equity capital, or to disincorporate. Or perhaps we should say that since banks are, from one point of view, in the business of borrowing capital (to lend it out), the pressure exerted by the income tax is of relatively secondary consequence.

• These examples are paraphrased from a memorandum by Mayer, Brown, & Platt, Chicago, accompanying & letter from John E. Allen, of this firm), to the Continental Pink, Chirico, November 18, 1970, sad from First National City Bank, New York, Report on the Nations Bank Tax Act as Directed by Congress in Public Law 91-156 (no date), pp. 15-15. Both source documents are in the Federal Reserve Board file for the bank tax study.)

First National City Bank, loc. cit., pp. 16-17.

(d) Supplementary note to Section 2: Derivation of Formula for Net Additional Burden of State Income Tax.11

11

Let f federal statutory rate of corporate income tax.

Let s state statutory rate of corporate income tax.

Let y corporate net income before either federal or state tax. Let t-amount of federal corporation income tax, in dollars, payable by_corporation.

Let t-amount of state corporation income tax, in dollars, payable by corporation.

If the state does not allow the federal income tax as a deduction, we have:

ts=sy;

t=f(y-ts)=f(y-sy)=fy-fsy

ts+ts=sy+fy-fsy

(ts+ts)/y=s+f-fs=rate of two taxes together

(s+f-fs)-f=excess of combined rate over federal statutory rate=s-fs

If the state does allow deduction of the federal corporation income tax, we have:

11 In practice, taxpayers commonly avoid the use of algebra by subtracting last year's tax from this year's income. The results are not quite the same as with instantaneous deduction, but are not capable of being generalized as simply in algebraic formulae.

The excess of (11), combined effective rate of federal tax and state tax, over federal rate alone, is given by:

As of 1968, of 26 states that taxed the income of national banks, 17 also required inclusion of national bank dividends in shareholders' individual income tax returns for the state, along with other dividends.12 Eight states did not require such inclusion, most or all of them because they did not impose an individual income tax. A ninth state, Rhode Island, now (1970) has a personal tax on dividends, interest, and capital gains. Before 1970, no state, apparently, taxed national bank dividends without also taxing national bank income. Of the eleven "double deduction" states that taxed the income of national banks (including Wisconsin in this number), five were among those states that did not impose an individual income tax. Four of the double deduction states did tax bank dividends to stockholders (on two states there is no information available as this is written). On the other hand, of those states that did not allow double deduction, all but one did impose an individual income tax that included dividends. In none of these states, of course, do the facts imply discrimination against or in favor of banks as such, as distinct. from corporations in general.

State "taxation of dividends" to shareholders, like state taxation of corporate income, is softened by the federal income tax deductibility of state income tax in computing the federal tax base for the dividend recipient. The degree of softening depends on the recipient's marginal bracket rate (and lower rates, too, if the dividend is large relative to his total income). Lacking data on ownership of national bank shares by income class, we can only say that the softening is sometimes more, sometimes less, than the softening of the corporation tax rate. If the state allows double deduction to the individual taxpayer, that is, deduction of the federal personal income tax in computing the base for the state personal income tax, the softening is increased, as shown by the analysis above for the corporate income tax.

Taxation of dividends to individual shareholders in banks adds to the industrial unneutrality of the income tax system, since certain industries are largely corporate (including commercial banks) and others not. Such taxation probably does not contribute much to geographical unneutrality, but does exert pressure on the bank to expand its undivided profits in place of raising new equity capital

12 Federation of Tax Administrators, "State Taxes on the Income, Dividends, and Shares of National Banks," RM-411, November 1968. In Mississippi, where State and national banks were exempt from corporate net income tax, dividends from Mississippi national banks became taxable to shareholders January 1, 1970.

or perhaps in place of accepting a lower ratio of equity to debt (technical unneutrality).

The fact that some states give preferential treatment to dividends received from domestic corporations does tend to inhibit interstate flows of capital, and thus makes for geographical unneutrality.

In general, then, the taxation of dividends creates unneutrality, not against banks as such, but, when coupled with corporate income taxation, against the corporate sector, in which commercial banks, as a rule, find themselves."

(b) Under Corporation Income Taxes

If state income taxes apply to dividends received by corporations from subsidiaries, the corporate form of organization is further penalized relative to unincorporated business. This would have an unfavorable, but presumably rather weak, effect on the flow of capital and labor into the banking sector, which with rare exceptions is incorporated and has recently experienced a rapid expansion in the creation of holding companies.

The facts on this score for corporations in general, as of November 1963, are given in column 5 of Table 2 above, and in the footnotes to that table. For the most part, intercorporate dividends paid by United States (domestic) corporations are exempted or included only as to 15 per cent (the federal provision), but most of these instances are coupled with a requirement that the paying corporation be subject to the state's corporation income tax to some degree. Only seven states follow the federal provision without exception. A few states specify an exemption for banks that is not entirely available to oth corporations (see footnotes 7 and 24 to Table 2).

The parent corporation pays federal income tax on only 15 per cent of dividends. Hence the impact of a state or local income tax on dividends received from a subsidiary is cushioned much less by deductibility of that tax than is the impact of a tax on profits. In other words, for a given increment of state revenue, a state tax on intercorporate dividends is relatively damaging, and is correspondingly more likely to check the formation of holding companies.

4. FRANCHISE TAXES ON CAPITAL EMPLOYED IN TAXING STATES

A low-rate annual franchise tax on capital, or capital stock, employed in the state is imposed by some 35 states, as Table 3 indicates. In a few of these states the maximum tax is so low that it might almost be lumped with the mostly flat-rate license fees charged for the same privilege, not shown in Table 3.

These taxes seem to pose no threat of unneutrality against banks under the permanent provisions of Public Law 91-156. Where the tax applies only to capital stock, banks would be favored, since they commonly have a low ratio of capital stock, or even total equity, to total assets. On the other hand, these taxes are unneutral against industries that turn their capital over slowly (such industries must raise the prices of their products by a larger percentage than the fast-turnover industries to recover the tax), and if bank assets turn over relatively slowly, a matter on which the present writer is not well informed, there is unneutrality against banks.

The franchise tax on out of state (foreign") corporations generally applies to that part of the capital stock that is employed in the state, as measured by selected apportionment factors. This has significant implications for post-1971 taxation under P.L. 91-156, insofar as banks qualify in "foreign" states.

TABLE 3.-FRANCHISE TAXES BASED ON CAPITAL EMPLOYED IN THE TAXING STATE, AS OF OCTOBER 1, 1970

[Numbers in parentheses refer to pages of source: Commerce Clearing House, State Tax Handbook, as of October 1, 1970 (New York)]

Alabama. Franchise tax: (Prorated on a half-yearly basis.) Domestic-$2.50 per $1,000 of capital stock. Foreign-$2.50 per $1,000, measured by actual amount of capital employed in the state less loans secured by real estate mortgages on which Alabama recording tax has been paid. No par stock valued at $100 per share unless a different value is shown. (461)

Arkansas. Corporation franchise tax: Domestic-11/100 of 1% of proportion of subscribed capital stock employed in the state. Doing no business in state, $5. Foreign-11/100 of 1% of proportion of capital stock representing property owned and used in business transacted in the state. No par stock valued at $25 per share. Minimum, $11.

Colorado.-Franchise tax: Domestic corporations-less than $50,000 of authorized capital stock, $10; $50,000 but not exceeding $150,000, $20; $150,001 but not exceeding $250,000, $40; $250,001 but not exceeding $500,000, $65; $500,001 but not exceeding $1,000,000, $100; $1,000,000 or more, $250. Foreign corporations-$100 annual license fee in lieu of franchise tax. (480)

Delaware.-Franchise tax: Up to and including 1,000 authorized shares, $20; 1,001-3,000, $24.20; 3,001-5,000, $30.25; 5,001-10,000, $60.50; over 10,000, $60.50 plus $30.25 per each additional 10,000 shares or fraction. Alternative rate, $121 per $1,000,000 of assumed par value capital based on average asset value, but not less than par 50% reduction for inactive corporations. Maximum-$110,000 ($55,000 for regulated investment companies). Minimum-$20. (486) Florida-Corporation franchise tax: Graduated from $20 for $10,000 or less, on domestic issued capital stock not including treasury stock, and on foreign outstanding capital stock representing capital allocated for use in Florida, to $2,000 for over $2,000,000. No-par stock valued at $100 per share unless a different value is shown. Financial corporations, if qualified, may elect to pay a $1,000 annual franchise tax in lieu of intangibles taxes. (492)

Georgia.-Corporation franchise tax: Graduated from $10 for $10,000 or less, based on net worth, including capital stock and paid in and earned surplus of domestic corporations, and on the proportion of issued capital stock and surplus employed in the state of foreign corporations, to $5,000 for over $22,000,000. (496)

Idaho.-Corporation franchise tax: $20 for $5,000 stock or less based on domestic and foreign authorized capital stock, to $300 for stock over $2,000,000. No par stock valued at $100 per share. (501)