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than 2 percent of eligible loans, including one-half of all banks with no reserves because of abnormally low loss experience or other factors. If all banks were allowed minimum reserves equal to 3 percent of eligible loans at that date, it would involve an increase in allowances of approximately $950 million above those now authorized. This would involve a revenue loss of $450 to $475 million, presumably spread over a period of several years.

Commercial bank capital and reserves, in general, appear to be in relatively sound position. As of mid-1957, total capital accounts and reserves of insured banks aggregated $16.6 billion.32 These amounted to 16.5 percent of all risk assets, including all loans and securities other than U.S. Governments and those guaranteed in whole or in part by the VA, FHA, and the Commodity Credit Corporation.

VI. CONCLUSIONS

1. The favorable Federal tax treatment of savings and loan associations and mutual savings banks is not the most important factor affecting their ability to pay higher rates than commercial banks and to attract savings deposits. The comparatively, greater growth of mutual institutions, rather, is due primarily to their

inherently greater earning power and other special advantages.

2. Bad-debt allowances of mutual savings institutions, as in the case of commercial banks, should be based on their assets at risk rather than on deposits. Only in this way can proper recognition be given to the quality of the assets as a protection against losses to depositors.

3. For tax-allowance purposes it is important to distinguish between reserves for bad debts in the accepted sense and bank capital and surplus. Bank capital is the margin of assets over liabilities believed necessary to protect depositors against unusual declines in the value of assets due to a severe deflation, mismanagement, or other conditions that cannot be predicted with reasonable certainty. Requirements for bank capital based on experience during the great depression fail to take into account significant structural changes in the economy as well as in the banking business itself. These include the greater role of the Government in economic stabilization, deposit insurance, mortgage insurance, and many other factors.

4. Since depositors in mutual savings institutions are also the owners, they can reasonably be expected to provide their bank capital out of earnings after tax rather than as a tax allowance. For this purpose, however, they are at a disadvantage with respect to commercial banks that have access to the capital market.

5. Limitation of mutual savings banks' bad-debt allowances to the commercial bank formula probably would result generally in a reduction in dividend rates to depositors. (It would also induce greater taxexempt investments by mutual savings banks.) This is largely because of the need to meet State and Federal reserve requirements in excess of tax allowances and the provision of adequate capital. (It is to be noted, however, that the 1951 tax provisions greatly stimulated a distribution of earning by mutual savings banks and savings and loan companies.)

Ibid., P. 188. Data are for June 6, 1957, and include stock, $5 billion; surplus, $7.8 billion; bad-debt reserves, $1.5 billion; and other reserves and undivided profits, $2.4 billion,

6. Stock savings and loan associations in some States are not mutual institutions in any meaningful sense and should not be entitled to their tax privileges. When such savings and loan companies are owned and controlled by the stockholders and their dividends are not legally limited to a statutory rate, as in the case of guarantee stock, they should be taxed like commercial banks. These would include savings and loan associations owned by holding companies.

7. The present bad-debt formula for commercial banks, based principally on loss experience during the 20-year period 1927–47, is unrealistic and results in serious inequities arising from an accident of history. Almost half the banks are not on the reserve method, largely because of a low loss ratio, and others have historically high ratios that do not reflect current experience.

8. Some minimum standard-loss ratio, such as 2 to 3 percent of eligible loans, may be justified in recognition of the basic hazards, common to all banks, that arise from business uncertainties and which cannot be anticipated on the basis of past experience. However, provision of such a minimum reserve to all commercial banks would involve substantial revenue loss. A 3-percent reserve, for example, would cost approximately $450-$475 million over several years.

THE CORPORATION INCOME TAX AND ITS APPLICA

TION TO MUTUAL FINANCE COMPANIES

E. Gordon Keith

I. THE CORPORATION INCOME TAX

The corporation income tax has long been one of the Federal Government's principal sources of revenue, and it is one upon which this Government has become increasingly dependent in recent years. Since 1952, when corporate profits first began to be taxed at the present 52-percent rate, the annual yield of this levy has seldom fallen below $20 billion, and it has usually accounted for close to one-third of the Federal Government's total annual budget receipts.

Yet despite the important role which the corporation income tax has played in the Federal tax system since 1913, it has always been a somewhat controversial levy. There have been differences of opinion concerning the rationale of this tax, concerning its incidence and effects, and concerning its fairness. At one time, it was generally assumed that a tax on corporate profits could not be shifted, and that it was therefore borne by the owners of the corporation. Today, the possibility of some shifting is generally admitted, but there is no agreement regarding the extent to which the high wartime and postwar taxes have in fact been shifted.

As for the rationale of the corporation income tax, we have never quite been able to decide whether we should regard this levy as a collection-at-source tax on corporate shareholders, which should be integrated with the individual income tax, or whether we should view it as a direct tax on the corporation as such. From 1913 to 1917, the corporation income tax and the individual income tax were fully integrated by a dividends-received credit provision which had the effect of exempting the dividends received by individual stockholders from the individual income tax. After 1917, this credit was continued only for the purposes of the so-called normal tax on individuals, and after 1936 it was dropped entirely until 1954, when token integration was reintroduced in the form of the present 4-percent tax credit. It was in 1936, however, that we came closest to returning to a fully integrated income tax structure. It will be recalled that in that year the administration proposed to replace the corporation income tax with a new levy that would be imposed on undistributed profits alone. Congress accepted the idea of an undistributed profits tax, but it was unwilling to abandon the corporation income tax as a separate levy. This was a compromise which, as might have been predicted, turned out rather badly, and 2 years later the undistributed profits tax was repealed. Over the years we have continued to talk a lot about the need for more integration; but except for the 1936 episode, and the action taken in 1954, we have not done very much about it.

The difficulty we have had in making up our minds about the kind of a tax we want the corporation income tax to be is, to some extent, a reflection of our uncertainty regarding the relationship of the corporation and its stockholders. It is, of course, well established that the corporation is a legal entity that is quite separate and distinct from its employees and stockholders. But we have found it difficult to decide whether we should regard the legal separateness of the organization and its stockholders as "only a convenient fiction of the legal mind,” and the corporation itself merely a conduit “through which legal and economic relations flow between stockholders and others," or whether we should accept this separateness as a fact, and view the corporation as a separate taxable entity.

One reason for our uncertainty on this point is, perhaps, found in the fact that corporations are not homogeneous. While the conduit theory seems appropriate to apply to the small closely held private corporation, its applicability to the large public corporation is more questionablé. On the other hand, it is much easier to think of the public corporation as an entity that is separate and distinct from its stockholders than it is to view the private corporation in this light. Some of the differences of opinion that exist with respect to the equity of the corporation income tax are also traceable to the lack of homogeneity among corporations. The kind of a tax we now have is probably more inequitable in its application to private corporations than it is to public ones. Frequently, the public corporation is in a better position to shift the tax than the private one is; and partly for this reason, and partly because the owners of most private corporations are persons of moderate income, the inequities of “double taxation” stand out most sharply in the cases of these companies.

In its application to the public corporation, the corporation income tax has been defended both as an instrument for reducing inequalities in income and wealth, and also as a curb on the arbitrary power of management. While this levy is generally held to be less equitable than the individual income tax, it is thought to be better than any other tax we could turn to in seeking diversity for our tax structure. Moreover, it is a tax to which businessmen and investors have become accustomed, and to which they have adjusted their pricing policies. As an old tax, it has in a sense become a good tax.

One complaint that is frequently heard concerning the corporation income tax is that it hits some corporations much harder than it does others. Two corporations with the same operating income may be subject to very different tax liabilities. For example, the corporation which leases a substantial portion of its plant and equipment, or which makes substantial use of borrowed capital, will ordinarily have a smaller tax liability than a corporation which owns all of its facilities, and which is able to finance its operations with little or no debt. The reason for this is found in the fact that payments made for leased or borrowed capital are excluded from the corporation income tax base, whereas payments made to suppliers of equity capital are not. Another example of this kind of “unequal taxation” to which a good deal of attention has been directed in recent years is found in light impact of the corporation tax on nonstock or mutual companies.

Since these corporations have no stockholders, and since they are usually operated solely in the interests of their member-patrons, their

shareholders, or their depositors, the bulk of their operating income can be, and usually is, distributed in a manner which precludes its taxability as corporate income. From the standpoint of the conduit theory, there is nothing wrong with this so long as the income distributed is taxed as personal income in the hands of the individuals who have received it. But from the standpoint of those who think of corporations as competing entities, the fact that nonstock corporations generally pay little if any corporation income tax has been a matter of increasing concern.

II. THE ORGANIZATION

THE

MUTUAL FINANCE

AND OPERATION OF

COMPANIES

Our concern in this panel is with the tax status of two specific types of nonstock or mutual corporations which operate mainly as financial intermediaries in channeling personal savings into mortgage loans and high-grade bonds. These are the mutual savings banks and the savings and loan associations. One question which I shall attempt to answer in this paper is whether the present tax status of these corporations gives them a competitive advantage over commercial banks and other capital stock corporations in seeking to attract personal savings; and another is how these corporations might be made to pay heavier taxes on their income. Before turning to these questions, however, a brief review of the organization and operation of these companies, and of their past and present tax status will be undertaken.

Mutual savings banks were originally organized for the purpose of serving wage earners of moderate means who, during most of the 19th century had no other place where they could safely put their savings. Today there are 519 such institutions doing business in some 17 States and in the Virgin Islands. Although most of these banks were organized before 1900, and although no new banks have been chartered in recent years, these institutions have, as a whole, enjoyed a tremendous growth during the past two decades. At the close of the year 1941, the total assets of the mutual savings banks amounted to $11.8 billion; by the close of the year 1958 they amounted to $38.4 billion.

Mutual savings banks were usually started by groups of civic minded persons who set up boards of trustees to manage their affairs. These boards, the members of which serve without compensation, are generally self-perpetuating. They direct the policies of the banks, subject to the limitations imposed upon them by the laws of the several States in which they operate. The depositors themselves have no voice either in the choice of trustees or in the management of the bank's affairs. Since mutual savings banks are organized with no capital stock, all of their income is either paid out to the depositors, or is held for their protection in surplus or reserve accounts. Furthermore, since the banks cannot go into the capital markets for surplus or guarantee funds, the surplus and reserve accounts have had to be built up out of earnings. It has long been the practice of these institutions to set aside a portion of each year's income for this purpose, with the balance being credited to depositor's accounts.

The amounts actually set aside each year, and the aggregate size of the reserve and surplus accounts, have been largely determined by the

47060—59-pt. 3-17

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