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ble laws they will be able to pay fair taxes. If the laws do not discriminate, each sector of the financial community will grow according to the service it renders and according to its operating efficiency.

If the savings banks and savings and loan associations increase their operating efficiency, they will not have to slow down their growth. That they can increase their efficiency is supported by the fact that operating costs vary greatly among institutions of equal size. Those that will not or are unable to lower costs through greater efficiency will lose some of their business to more efficient savings banks or savings and loan associations or to the commercial banks. Since growth and earnings are a prime motive in our society, the effect of exposing the savings banks and savings and loan association to competition without special protection can only benefit the saver. It is the best way of eliminating inefficiency.

There is little danger that taxation will result in lower bad debt reserves for the savings banks and savings and loan associations. The Federal and State laws already provide for the setting aside of such reserves. These institutions will, therefore, have two chances: (1) To grow at the same rate as before and to earn sufficient net income for required reserves and taxes out of increased efficiency and other cost reductions; or (2) to grow at a rate consistent with their ability to absorb the costs of growth under competition. Under existing laws and regulations they will not pay taxes at the expense of reserves. The saver will not suffer a loss because competition will protect him. The savings bank and savings and loan industries will not suffer because they will be compelled to rely on increased efficiency rather than protection from taxation for their

growth. The answers developed in this paper to the four basic questions asked are in summary:

1. Does the present income tax law which, in effect, results in a negligible payment of taxes by the savings banks and savings and loan associations constitute a privilege which, if withheld, would deny the public a useful and necessary service? No. The savings banks and savings and loan associations have about $100 billion in assets. There are now many other outlets for savings and the public would not be denied a useful service if all the financial institutions were exposed to equitable tax treatment and constructive competition.

2. Does the existence of this special privilege employed by the mutual savings banks and savings and loan associations give them an unfair advantage over their competitors? Yes. The majority of commercial banks are small community banks which depend heavily on their ability to attract savings and time deposits, and so important a disadvantage as is inherent in tax discrimination is a great obstacle to their growth and development.

3. Is the tax law pertaining to the mutual financial institutions consistent with this Nation's general objective of economic stability? The present tax law is not necessarily inconsistent with it, but imposing a fair tax on the savings banks and savings and loan associations will not reduce the total flow of savings and is, therefore, not inconsistent with our present overall economic objectives.

4. Will an effective tax collection from mutual financial institu-' tions cause them hardships to which others, similarly taxed, are not subjected ? No. Cost studies show that there is ample room for increased efficiency. Other institutions which are taxed must carefully plan growth, income, and operating expenditures or suffer the consequences. This is how a competitive economy

proves its worth. In view of these conclusions it is recommended that the Federal income tax laws pertaining to savings banks and savings and loan associations should be changed. The Congress had intended to tax these institutions with the enactment of a law in 1951, but loopholes in that law produced no taxes. These loopholes should now be closed.

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FEDERAL INCOME TAXES OF MUTUAL FINANCIAL COMPANIES WITH PARTICULAR REFERENCES TO MUTUAL SAVINGS BANKS

August Ihlefeld

THE TAXATION OF MUTUAL SAVINGS INSTITUTIONS

Few subjects are as vital to a sound economy as a tax system that conforms to the basic criteria laid down by the Committee on Ways and Means in its outline of study of Federal income tax revision.

These basic criteria, set as guides for appraising the present Federal income tax system, are:

1. Equity and fairness.
2. Progression in the distribution of tax burdens.
3. Allowing free play of the market in allocating resources.
4. Providing a climate for economic growth.

5. Ease of taxpayer compliance and administration of the law. The study seeks to determine the extent to which these five basic objectives would be better served by Federal individual and corporation income taxes with broader, more uniform bases and lower rates than those now in effect.

My statement is concerned with Federal individual and corporation income taxes in relation to mutual financial companies with particular reference to mutual savings banks. Mutual savings banks and savings and loan associations, specializing in savings, hold $86 billion, or more than 55 percent of savings of individuals held in all media which provide a savings account service. Commercial banks, credit unions, and postal savings account for the balance.

Mutual savings banks and savings and loan associations, like common trust funds, regulated investment companies, qualified trusteed pension funds and credit unions, are operated for the exclusive benefit of the participants rather than for outside stockholders. The income which they generate is now taxed through taxation of the income received by their beneficiaries.

For the protection of the savings entrusted to them, the mutual savings institutions retain a small part of their income in surplus and reserve accounts to provide a cushion for absorbing possible future losses on their assets. Earnings not paid out by the mutual savings institutions are taxable at the full corporate income tax rate when surplus, undivided profits and reserves exceed 12 percent of deposit liabilities or withdrawable accounts. Thus, the plan of taxation assures that such reserves will be kept within reasonable limits and that income will not be withheld from participants merely to reduce their tax liability.

Deposits of mutual savings banks aggregated $34.6 billion on June 30, 1959, in over 22 million accounts. Interest payments on these deposits, constituting taxable income to the depositors, exceeded $1.1 billion per annum. Share capital of savings and loan associations aggregated $51.4 billion on June 30, 1959. Dividend payments on these funds constituting taxable income to the recipients, approximated $1.7 billion per annum. The 1959 Consumer Finance Survey of the Federal Reserve Board showed that a much higher proportion of spending units with incomes over $5,000 own savings accounts than of spending units with lower incomes. This holds true particularly for the ownership of savings accounts of $500 and more.

The payments made by these two groups of mutual savings institutions into the taxable income stream, now approximately $2.8 billion per annum, will undergo a rapid and persistent expansion so long as these institutions are able to function efficiently and effectively in encouraging and attracting new savings. During the 5 years ended June 30, 1959, these institutions reported an average annual increase in savings held of over 11 percent. The increase in 1958 was 11 percent. Income contributed by mutual savings institutions to the taxable income stream tends to grow at even a faster rate due to the rising trend of interest and dividend rates which they pay on the savings entrusted to them.

So long as they are able to maintain the rate at which they now encourage and attract savings, mutual savings institutions will thus make not only a large but a rapidly growing contribution to the taxable income stream. In fact, at the rate at which savings were entrusted to them during the past 5 years, this contribution would double every 6 years or so.

The current system of taxation of the income generated by mutual savings institutions is analyzed in the following pages in the light of the five criteria laid down by the committee.

1. EQUITY AND FAIRNESS

Equity and fairness require that mutual savings institutions be taxed in the same way as other mutual thrift entities such as common trust funds, regulated investment companies, qualified pension funds, and credit unions. In each instance, Federal income taxation applies primarily to the income received from these mutual entities by the participants.

Common trust funds are taxed exclusively through the taxation of beneficiaries, each of whom includes in his taxable income his share of the income of the fund, whether it is distributed or not. Since common trust funds have no outstanding liabilities, there is no reason for withholding income within the fund except where this serves the convenience of beneficiaries.

Regulated investment companies, paying out at least 90 percent of their income as dividends, are not subject to the corporate income tax except for earnings retained. Since an investment company has no liabilities of consequence, no necessary purpose is served by retaining earnings and so reducing the taxable income of shareholders. As a practical matter, regulated investment companies tend to pay out substantially all income to shareholders.

In a qualified pension trust, income is exempt from Federal income tax. Contributions to a qualified pension trust are fixed at those amounts which, together with the expected income of the trust, will

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