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Ralph E. Burgess, economist, American Cyanamid Co.'


The reform of the Federal tax system is a need which has long been felt and a goal which has actively been pursued by many thoughtful citizens. The current effort of the Committee on Ways and Means in conducting "an extensive inquiry into the opportunities for constructive reform of the Federal tax system," therefore, is to be commended highly and should elicit widespread interest and support.

The immediate objective of tax reform, has been stated by the committee as "reduction in tax rates without sacrificing revenues required for responsible financing of Government.” In an effort to achieve this end, the committee apparently seeks, through appropriate legislation, to broaden the tax base by eliminating, or at least minimizing, differential tax treatment of various sources of income. The increase in revenue thus generated would provide the basis for the proposed reduction in rates.

It is believed that both the immediate objective and the method advanced represent a sane and sound approach to the mounting problem of taxation. For a number of years there has been widespread concern about high and rising levels of taxation and their effect upon the economy. An outstanding economist, John H. Williams, in his presidential address before the American Economic Association in 1951 summed up the problem in the following words:

I have long sympathized with the thesis of Colin Clark, the Australian economist, that a burden of taxation beyond some percentage of gross national product (he puts it at 25 percent) turns upon itself and, instead of having the deflationary effects intended, becomes an engine of inflation, partly through pushing up wages and other costs and thus pushing up prices to the point where the tax burden in real terms has been brought back within the limits of tolerance, and even more through undermining incentives to produce and to save.

In my opinion, the highly progressive and discriminatory rates of the individual income tax do more damage to the economy than the overall heavy burden.

If this committee and the Congress can succeed in lightening the tax load under which the economy is now laboring, you would indeed be performing an incalculable public service, one that would most certainly contribute to economic growth and stability.

The task of establishing a broader tax base by eliminating differentials in the tax treatment of various sources of income, as a practical problem, however, must be handled with extreme care. As the committee can well appreciate, the ability to tax differentially can be, and often is, a powerful stimulant to the production of certain goods and services which, under ordinary market conditions, would not be forthcoming in amounts sufficient to meet the needs of society. Contrariwise, if it is deemed desirable to discourage activity in certain sectors, then differential taxation is a powerful means of achieving that end. One may recognize this situation without abandoning the principle that taxation should be employed primarily for revenue purposes. Obviously, the criterion in judging the efficacy of existing differentials is how well they serve the public interest. But one should not belabor the point, important though it may be. Certainly the members of this committee are well aware of the need for careful study and acute judgment in this matter. In response to the committee's invitation, this paper is devoted to a discussion of differentials involved in the tax treatment of corporation income.

1 The opinions expressed herein do not necessarily reflect the views of American Cyanamid Co.


For more than two decades, the tax treatment of corporate income has left much to be desired. Since passage of the Revenue Act of 1936, it has been the formal intent of tax policy to tax income generated by corporations twice; first, as a separate and distinct levy on such income as earned by the corporation and, then again, to the extent distributed, as personal income in the hands of stockholders.2 Although the Internal Revenue Code of 1954 constituted an important attempt to rectify this undesirable practice, there is still much room for improvement. It is hoped that the work of this committee will result in a significant advance toward the eventual goal of complete elimination of such double taxation of corporate income. The committee has provided the conceptual basis for some immediate further step in this direction. The increase in revenue anticipated by expansion of the tax base should be utilized to alleviate this present practice of double taxation. Not only does this differential treatment of such income result in serious inequities but, more importantly, it constitutes a serious impediment to continued economic growth, through its depressing impact on investment. The opinion is widely held that any short-term loss of revenue involved in correcting the existing inequity will be offset by long-term gains to the Treasury as economic activity is further stimulated. I believe there is justification for this view.


Since a majority of the present committee membership did not participate in the formulation of the crucial tax legislation in this area enacted from 1936 to 1939, it may be of value to recall briefly the development of double taxation in the United States. Under the Revenue Act of 1913, the tax rate on corporate income and the normal tax rate on personal income were equal. The corporation paid tax on its income and dividends received by stockholders were exempted from normal tax. Thus, corporate earnings were subject to a normal tax at the corporate level and to surtax at the stockholders' level. After the period 1918–19, the corporate rate moved ahead of the personal normal rate, resulting in some measure of double taxation. Although the tax rate gap continued to widen until the midthirties, the problem remained of minor importance relative to later developments.

2 For estimates of the magnitude of such double taxation_see Holland, Daniel M., “The Income Tax Burden on Stockholders," National Bureau of Economic Research, Princeton University Press, 1958.

With the passage of the Revenue Act of 1936, however, the tax treatment of corporate earnings changed radically. On March 3, of that year, President Roosevelt addressed a special message to Congress in which he set forth the administration's proposals for revenue revision. In essence, he suggested repeal of the existing corporate income tax and substitution of a graduated penalty tax on undistributed corporate income. According to this plan, a corporation which paid out its entire income would not be subject to tax. In this case, corporate income would be subject to tax only at the stockholder level. To achieve this result it would be necessary to repeal the existing provision for exemption of dividends from personal normal tax. The revenue bill, as proposed by the House, embodied these provisions. But to make the situation worse, the Senate proposed major and rather disastrous changes. As finally passed, the legislation retained the undistributed corporate profits tax at lower rates and the repeal of the exemption of dividends from personal normal tax, and also provided for a normal tax to be levied against corporate income.

Thus, corporate income would be subject to a normal tax at the corporate level, a graduated penalty tax on undistributed income again at the corporate level and finally, to normal and surtax at the stockholders' level. In the words of one close student of the period, “In contrast to the simple tax structure which the President advocated in March, the compromise bill of June developed into the most complicated income tax measure that Congress ever passed." 3 Under severe and repeated criticism throughout its life this tax monstrosity was repealed in 1939; but the double taxation of dividends continued at sharply increasing rates for well over a decade.

During this period, numerous organizations and tax experts publicly advocated relief from this depressing burden.

A representative listing of such advocates would include: Buehler, Alfred G., professor of public finance, Wharton School, University of

Pennsylvania. Butters, J. K., professor, Graduate School of Business Administration, Harvard

University. Kimmel, Lewis H., Brookings Institution. Magill, Roswell, president, Tax Foundation. Nelson, Godfrey, New York Times. Schram, Emil, president, New York Stock Exchange. Twin Cities plan. Committee on Postwar Tax Policy (1945). CED, “Taxes and the Budget” (1947). Machinery and Allied Products Institute, “Taxes and Economic Progress" (1950). New York Stock Exchange, “Taxes, Equity Capital, and our Economic Chal

lenges" (1953). Special Tax Study Committee Appointed by Ways and Means Committee (1947). Committee on Postwar Tax Policy, "A Tax Program for a Solvent America”

(1947). Chamber of Commerce of United States. National Association of Manufacturers.

* Blakey, Roy G. and Gladys C., "The Federal Income Tax," Longmans, Green & Co., New York, 1940, p. 422.

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National Association of State Chambers of Commerce.
Investors League.
Independent Telephone Company Association.
New York Board of Trade.
American Retail Federation.
National Retail Dry Goods Association.
American Institute of Accountants.

The clamor for relief finally had effect. In his budget message for the fiscal year 1955, President Eisenhower stated :

At present, business income is taxed to both the corporation as it is earned and to the millions of stockholders as it is paid out in dividends. This double taxation is bad from two standpoints. It is unfair and it discourages investment. I recommend that a start be made in the removal of this double taxa. tion by allowing stockholders a credit against their own income taxes as a partial offset for the corporate tax previously paid. This will promote investment which in turn means business expansion and more production and jobs.'

The subsequent course of events is well known. Congress incorporated the principle of relief called for by the President, in the Internal Revenue Code of 1954. According to the 1954 code, every stockholder was henceforth allowed to exclude up to $50 of dividends received from gross income. In the case of joint returns, the allowable exclusion was $100. To provide some small measure of relief in the middle and upper income brackets, taxpayers were permitted a credit equal to 4 percent of taxable dividends received against the income tax otherwise payable.

The story by no means is at an end here. The confusion and vacillation which have characterized our treatment of corporate and dividend income has persisted to this day. During June of this year, the Senate actually voted to repeal the 4 percent credit provision of the 1954 code. Only last-minute action by Senate House conferees

averted its passage. Thus, it would seem that the aura of confusion surrounding this crucial aspect of tax policy has not yet been completely dissipated.



(a) Great Britain

It should be of interest to review the tax policy of foreign countries with respect to corporate and dividend income. The procedure followed in the United Kingdom is a classic case often alluded to in this connection. In Great Britain, the standard or normal rate is identical for corporations and individuals. The corporation pays tax on its earnings at the standard rate. In determining income tax liability, the stockholder includes, as part of his income, both the value of his dividend and the value of the tax deducted by the corporation on his dividend. This is the so-called grossing-up method. To such income the taxpayer applies the appropriate surtax rate. The stockholder then deducts from the indicated tax, the value of the tax deducted by the corporation on his dividend. In short, the corporation pays the normal tax on corporate income, both distributed and undistributed, and the individual pays surtax on the distributed portion. Thus, this method eliminates double taxation as far as the stockholder is concerned (but may undertax the undistributed portion for some if the

4 "The Budget of the U.S. Government for the Fiscal Year Ending June 30, 1955," p. 18. Various countries of the world grant preferential treatment to dividend income in any one or more of several ways, to reduce double taxation.


stockholder is thought to have a continuing vested interest in retained earnings).

The rationale behind the British method is straightforward and illuminating

What is essential * * is that all the profits of the company should be taxed and if that is done the revenue is not concerned with what is done with those profits. * * * There is in fact only one profit, no new profit being created from the fact that the shareholder gets his share: the tax is a tax on the profits and not on the dividend. A shareholder is not separately taxable (I disregard surtax) on the dividend, as a profit individual to himself." (6) Canada

The recent Senate action implying dissatisfaction with our present method of granting modest relief to stockholders via the $50 exclusion and the 4 percent credit provisions of the 1954 code seems confusing when viewed in the light of Canadian experience. In 1949, the Canadian Parliament adopted a 10 percent tax credit for dividends. In sharp contrast to our own state of divided opinion on the subject, Canadian experience under this revision of tax policy aroused no great controversy. On the contrary, official evaluation of this step toward greater equity and increased investment was so favorable that the Dominion Government subsequently recommended an increase in the tax credit for dividends from 10 percent to 20 percent. In proposing this move, the Honorable D. C. Abbott, Minister of Finance, in February 1953, made the following statement to the Canadian Parliament.

In 1949 provision was made in the Income Tax Act for a credit against personal income tax of 10 percent of the dividends received from Canadian taxpaying corporations. At that time I said this was a first step in dealing with the situation under our present tax structure where, after taxing corporate profits at a very high rate, the individual is required to pay at graduated rates on the dividends paid out of corporate profits. I now propose a second step of the same length and in the same direction. That is to say, for dividends received in the calendar year 1953 and thereafter, the tax credit will be increased from 10 percent to 20 percent. Canada is fortunate these days in being able to attract enterprising foreign capital. This is desirable and we welcome it. At the same time it would seem to be a good thing if Canadians were encouraged, where they can safely do so, to join in wider participation of equity ownership in the expanding industrial wealth of our country. This dividend credit of 20 percent should, I think, be of considerable assistance in encouraging our people to increase their stake in Canada's future.

Needless to say, this second step along the road of tax reform was adopted by Parliament in 1954. (c) Other countries

The tax policies pursued by Great Britain and Canada do not, of course, represent isolated cases. Numerous other governments afford special treatment to dividend income, ostensibly to alleviate or to eliminate double taxation. In 1956, the New York Stock Exchange completed a study of the tax treatment of corporate dividends in foreign countries. According to this study:

6 Lord Wright, Neumann v. Inland Revenue Commissioner8 (1934) 18 T.C. 332, H.L.

6 Budget speech by Mr. Abbott, Feb. 19, 1953, “House of Commons Debates," session 1952– 53, vol. II, p. 2128.

"Tax Treatment of Corporate Dividends in Foreign countries,” Department of Research and Statistics, New York Stock Exchange 1956 (unpublished).

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