The question here, however, is at whose expense is the large bondholder taxed. The large taxable bondholder will definitely pay a price for tax exemption; on the other hand if these securities are taxable, it seems only reasonable to assume that this same taxable bondholder will ask the borrower to pay at least the largest portion of tax by way of increased interest rates. The net result being that the local property-tax payers pay the largest part of the bill. The large bondholder has merely transferred a large part of his income-tax load to a large number of property owners. It must be understood that cities continue to receive a large percentage of revenues from the property tax. Therefore, a transfer of additional interest cost to the property owner in itself does not represent an equitable distribution of the tax load, since many residents of large cities are not real property

owners.

In addition, abolition of State and local government immunity from Federal taxation would result in a contest primarily between State and Federal Governments to tax each other's activities and properties. State taxation of Federal vehicle licenses, gasoline consumed, Federal property located in States, etc.; Federal taxation of municipal utilities revenues, etc. The local governments (local taxpayer residents) are in the middle. Sources of revenue, other than property taxes, have largely been already preempted by State and Federal Governments. Local governments will become more and more dependent on Federal and State distribution of revenues, and our experience has been that we get the very short end of these doles. The local citizen loses all control and subsequently community interest.

It has been estimated that abolition of the tax exemption would add 1 percent to the interest cost of local borrowings. If this is true, on the basis of existing Cincinnati debt about 70 cents per thousand of assessed valuation would have to be added to the local citizens' property tax bill. In all probability, cities would extend borrowings over longer periods of time, therefore adding additional cost to the already high cost of improvements. In Ohio this practice would result in large cities reaching, in a short time, the statutory limit of debt which can be incurred by the local government. State laws would have to be amended to provide local governments authority to proceed with needed improvements or cessation of improvement programs by local governments entirely for periods of time, or the Federal and State Governments would have to provide the improvements without local participation.

The net fiscal gain to the public as a whole is very questionable. The statement that taxation of State and municipal bonds will equitably distribute the income-tax burden is even more questionable. The solution on the local level of government of all problems, financial, economic, and social, represents automatic solution to the State and Federal Governments, so why add to the local problem when the results of the alternative are questionable.

Sincerely yours,

W. R. KELLOGG, City Manager.

The CHAIRMAN. Mr. V. H. Hurless, comptroller of Milwaukee, Wis.

STATEMENT OF JOHN E. KALUPA, DEPUTY COMPTROLLER OF THE CITY OF MILWAUKEE, WIS., REPRESENTING VIRGIL H. HURLESS, COMPTROLLER

Mr. KALUPA. My name is John E. Kalupa, deputy comptroller, representing Virgil H. Hurless, comptroller.

The United States Congress in general, and this committee in particular, again has before it the perennial recommendation that the income from future State and municipal bond issues be subjected to the Federal income tax. The many arguments on both sides of this admittedly two-sided question have been considered during many previous sessions. Mr. Lyle C. Fitch of the University of California, in fact, has written in his recent comprehensive work on taxation of municipal bond income that

from 1927 to 1941, 101 resolutions for constitutional amendments to eliminate or modify the exemption were introduced into Congress; these constituted 14 percent of all amendments introduced and more than twice as many as were proposed in connection with any other subject.

Many of you, I know, were Members of Congress when a proposal similar to Secretary Snyder's now before you was considered in 1942. Because of the frequency and regularity with which this question has reappeared, the points made by State and municipal officials will not be new ones, but they will be nonetheless weighty. I contend that the case for exemption of municipal bond income is a strong one and that it is even stronger at this moment than it has been in the past. My positive arguments follow:

A tax on State and local bond income is a tax on the construction of capital improvements that are urgently needed in connection with our national defense program.

This Nation has been and is being forced into an economic program calling for annual defense expenditures in the neighborhood of $40,000,000,000, price and wage controls, and material allocations. This program, which calls for self-discipline and limited austerity, may be with us for a decade or longer. The success of the program and the effect it is to have on the Nation's standard of living and morale depend on our ability to produce more and more. To produce more, we must swell our labor force, work longer workweeks in cases, and just plain work harder. Such intensifying of effort directly intensifies the use of many municipal facilities and requires that industrial cities like Milwaukee move rapidly to plan and finance the construction of certain major facilities and the repair and enlargement of others.

During the next several years, Milwaukee plans to spend millions to build expressways and to widen and repair streets so as to facilitate travel to and from its many plants; to add to its harbor facilities so as to expedite the movement of raw materials and processed articles; to provide streets, sewers, and water installations so as to service new industrial plants and residential areas; and possibly to build shelters, control centers; and other facilities so as to protect its citizens, utilities, and other services from possible enemy bombing attacks. City officials everywhere recognize that priority must be given to projects tied in with defense and that almost all recreational and cultural projects must be postponed for lack of funds, materials, and labor. Municipal officials have been helped to this decision by the recent National Production Authority bans on certain types construction.

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That the Federal Government is much interested in promoting the construction of the very projects that we want most to build is probably best evidenced by the fact that Federal aids for highways, hospitals, airports, harbors, housing, and advance planning now total substantially more than $1 billion per year. Why then should the Congress, when promoting construction of the very projects that we need most and exercising control over what may be built, legislate to tax the construction of our projects? Subjecting municipal bond income to income taxation might raise the interest rates on future issues as much as one percent. Milwaukee's 1951 borrowing program calls for the issuance of $12,650,000 worth of 20-year serial general obligation bonds. Increasing the interest rate on these bonds

by 1 percent would increase the cost of borrowing $1,000,000 by $105,000 and would increase the cost of our 1951 borrowing program by $1,328,250. Said simply, taxation of municipal bond income means a sizable increase in the cost of financing construction; increasing financing costs will simultaneously decrease the ability of cities to construct the many projects they need to maximize their contribution to the national product.

The United States tax system as a whole is rendered less equitable by Federal taxation of municipal bond income because the increased cost of borrowing will force municipalities to raise their already high property tax levies.

Public finance economists the world over are quite well agreed that two of the best taxes available to a predominantly industrial nation are the personal and corporate income taxes now used extensively by the Federal Government and that one of the worst is the general property tax. The income taxes have their support primarily because income, which is both the subject and the measure of these taxes, is the most rational indication of ability to pay. All taxes, it is said, are in the last analysis paid from income, and a tax is most equitable if paid by a person with ability to pay when he has that ability. On the other hand, telling criticisms are leveled against the general property tax because it hits those less able to pay harder than it hits those more able to pay and because it discourages investment in badly needed housing.

Each time that Milwaukee officials stop to consider that the smallest and least pretentious home that can be built in the city draws a property tax bill of about $20 per month, and that the property tax in a measure causes slums and necessitates the building of publicity subsidized housing for low-income families, they are spurred into searching for substitute taxes. Each such search leads them to the conclusion that the productive and otherwise desirable substitute taxes have been preempted by the State and Federal Governments. The import of the foregoing thoughts is merely this. This committee, faced with the task of increasing Federal revenues, can raise X dollars by taxing municipal bond income which thereby indirectly increases municipal property tax levies or it can raise the same number of dollars by increasing its income taxes or others of its relatively equitable taxes. Justice can only be served by choosing the latter alternative.

The dollar loss that will be suffered by State and local governments if their cost of borrowing is increased by a Federal income tax on their bonds' interest may exceed the revenue collected from that tax by the Federal Government.

I am fully aware that this contention is hotly debated, but I urge that the committee give careful consideration to this possibility for the following reasons:

First, much income from both bonds and stocks evades the Federal tax collector. I will not develop this point because the Congress heard much testimony on it last year when a withholding tax on dividends was being discussed.

Secondly, economists who claim that the Federal Government loses more in taxes by exempting State and local bond income than the State and local governments save in interest tacitly assume that most tax-exempt securities are held by persons whose tax liabilities

are so high that they can earn significantly more by holding exempt municipal bonds than by holding taxable bonds of similar risk and maturity. Available studies on municipal bond ownership are less than comprehensive, but they do give us good reason to believe that the quantitative amount of exempt bonds held by the very wealthy is small. These studies also show, on the other hand, that many individuals hold exempt municipal bonds when they would be better off to hold taxable bonds of similar risk and maturity. This seemingly unexplainable appeal of municipal bonds must be due partly to safety and liquidity considerations and partly to investor irrationality. Whatever the reason, the loss in these cases is at the expense of the investor and not the Federal Government.

No one can state dogmatically that the imposition of a Federal income tax on State and local bond income would result in a net dollar loss to governments as a group, but this committee must reckon with the fact that there is good reason for believing that such would be the result.

Federal taxation of State and local bond income involves an extension of Federal power over the finances of our sovereign States and their subdivisions that is probably unconstitutional and certainly unwarranted.

Although it has been asserted by opponents of the exemption of municipal bond income that recent Supreme Court decisions indicate the possibility that the exemption can be abolished without a constitutional amendment, I have every reason to believe that a constitutional amendment would be required. The Pollock decisions which established the unconstitutionality of Federal taxation of State and local bond interest have never been overruled. Furthermore, in a Supreme Court case decided as recently as 1946 (State of New York and forty-five other States as amici curiae v. U. S.), four Justices expressed themselves as feeling that a tax which "unduly interfered with the performance of the States' functions of government" is unconstitutional, and two other justices sharply condemned the trend toward narrowing State and local immunities. They, in fact, even questioned the wisdom and constitutionality of the line between governmental and proprietary functions that had been drawn in earlier decisions.

More important than the constitutionality today, however, is the fact that the 40 legislatures that approved the sixteenth amendment and thereby allowed the Federal Government to "lay and collect taxes on incomes" did so at a time when it was undisputed that Federal taxation of State and local bond income was unconstitutional. Any attempt to eliminate the exemption by other than constitutional amendment would be an infamous breaking of faith.

The delicate balance of powers between the various levels of government is also very much involved in this whole question of tax exemption. Our founding fathers wisely restricted the Federal Government to a small group of expressed powers and gave the residual powers to the sovereign States so as to allow those States and their subdivisions much latitude for independent and direct action. The fact that the Constitution has progressively been interpreted more liberally in favor of the Federal powers is a contradiction of the obvious fact that those governments on the scene, the "grass roots" governments, are best able to judge and to handle

local needs and should be allowed to do so without outside interference. As has been stated before, a Federal tax on municipal bond incorne would force cities to raise their property tax levies or to cut back on basic services and badly needed improvement construction; and would also force them to carefully watch and to try to influence Federal tax developments so as to plan and to time their borrowing activities. In other words, a Federal tax on municipal bond income unduly interferes with the essence and the functioning of self-government and is therefore intolerable.

I believe that all of the arguments presented are compelling. The common council of the city of Milwaukee and I, therefore, officially urge that you expeditiously defeat any and all proposals that would have the effect of taxing State or municipal obligations or the interest paid thereon.

The CHAIRMAN. We thank you, Mr. Kalupa, for your appearance and the information given the committee.

Mr. KALUPA. Thank you very much, Mr. Chairman.

The CHAIRMAN. Mr. Northcutt Ely, general counsel of the American Public Power Association.

Will you give your name and address to the reporter and the capacity in which you appear?

STATEMENT OF NORTHCUTT ELY, GENERAL COUNSEL, AMERICAN PUBLIC POWER ASSOCIATION, WASHINGTON, D. C., ACCOMPANIED BY CARLTON L. NAU, GENERAL MANAGER OF THE ASSOCIATION

Mr. ELY. My name is Northcutt Ely. I am an attorney in general. practice with offices in the Tower Building, Washington, D. C. I appear as general counsel of the American Public Power Association, and am accompanied by Carlton L. Nau, general manager of the association.

The American Public Power Association is a nonprofit service organization comprised of publicly owned electric systems in 32 States, including the major municipally owned systems. It was organized in 1940.

We are here in opposition to the proposal of the Treasury Department, presented to this committee on February 5, that the exemption of the interest on State and municipal securities from Federal income taxation, now appearing as section 22 (b) of the Internal Revenue Code, be repealed.

This question arises at a time when the Treasury Department and the Federal Reserve Board are engaged in a public disagreement over the interest rate on Federal bonds. The Treasury is understood to be opposed to any increase in the cost of money to the Federal Government, by even a fraction of 1 percent, on the ground that it would increase taxes. But simultaneously, in the proposal before you, the Treasury champions a change in the tax laws which, if constitutional, would require a rise in interest rates on municipal bonds of probably about 1 percent, which would be an increase of about 50 percent in the average cost of money to local governments, and substantially all of its would be reflected directly in increased local taxes and rates for municipal services.