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ciation loses its tax exemption but will still be able to escape all or nearly all of its Federal income-tax liability by taking advantage of liberal Treasury rulings and making their profit distributions in the form of patronage dividends rather than dividends to the stockholders.

As of June 30, 1949, there were 503 production credit associations in the United States with combined assets of $660,000,000. Their total capital amounted to $102,000,000, of which $40,000,000 represented investments of the United States Government and $62,000,000 represented stock owned by former members. The associatio in addition to their capital, had $54,000,000 which they had accumulated out of tax-free earnings. In 1948 their earnings amounted to nearly $7,000,000. This sum would provide about $2,937,000 additional tax money for the Treasury.

NATIONAL FARM LOAN ASSOCIATIONS Another source of tax-subsidized competition to the country banker is the national farm loan associations which numbered more than 1,200 at the close of last year. These associations are made exempt from Federal income taxes by section 26 of the Federal Farm Loan Act of 1916. Their combined assets amounted to $92,000,000. Their reserves and surplus approximated $32,000,000. In 1948 their earnings amounted to over $7,000,000 which at present corporation income-tax rates would provide an additional $2,972,000 for the Treasury.

MUTUAL FIRE AND CASUALTY INSURANCE COMPANIES

Another inequity which Congress should remedy at the present time relates to the taxation of mutual fire and casualty insurance companies about which Mr. Webb testified last week. Up until 1942 practically all mutual fire and casualty insurance companies escaped payment of Federal income taxes. The first step toward taxing them on a basis similar to that used for stock fire and casualty insurance companies was taken in that year. At that time your committee and the House passed a bill providing for the taxation of these mutual insurance companies on the same basis as that on which stock companies were taxed. Unfortunately, when the bill got to the Senate the provisions were changed, with the result that at the present time these mutual insurance companies pay smaller taxes per dollar of profit than do the stock companies. In effect, the Senate compromise bill taxed the mutuals upon either of two bases, whichever produced the greater tax. One of these bases is net investment income to which the regular corporation income-tax rates are applied. The other basis is the gross amount of income from interest dividends, rents, and net premiums less dividends to policyholders and tax-exempt interest. A rate of 1 percent, with a notch provision, is applied to this base. The notch provision is necessary because all mutual fire and casualty insurance companies whose gross receipts from interest dividends, rents, and premiums are under $75,000 are still exempt from the payment of all income tax.

There is no rational justification for the special treatment of these companies and the law should be amended so that mutual insurance companies and stock insurance companies should be taxed on their underwriting and investment income in the same way. As long as one segment of the insurance industry is taxed on a gross-income basis and its competition taxed on a net-income basis there can be no competitive tax equality. In 1949 the underwriting profit of 207 mutual fire companies totaled $117,485,000 and their investment income $26,183,000, or a total income of $143,668,000. The income tax they paid amounted to $4,267,000, or 3 percent of their total income. As opposed to this, the stock fire-insurance companies, on a total income of $645,826,000, paid $128,039,000 m Federal income taxes. This amount was 19.8 percent of their total income. In other words, at the 38 percent level for every dollar of net income the stock fire companies paid 500 percent more in income taxes than did their mutual competitors.

For the same year mutual casualty insurance companies numbering 155 had a total income of $162,688,000 on which they paid Federal income taxes of $8,547,000. This income-tax payment was 5.3 percent of their total net income. Figures for 246 stock casualty companies showed a total income of $302,905,000 and a Federal income-tax payment of $60,658,000. This payment was 20.1 percent of their total income at the 38-percent level, a payment of nearly 300 percent niore for each dollar earned than was paid by their mutual competitors. At present rates, if the mutual fire and casualty insurance companies were to pay the same percentage of their net income dollar in Federal income taxes as will their stock insurance competitors, the Federal Treasury would be richer by $60,000,000.

GOVERNMENT IN BUSINESS

At the close of 1949 there were nearly 100 Federal Government corporations competing with private taxpaying business corporations engaged in transpor. tation on land and water, generation and transmission of electrical energy, production of fertilizer and chemicals, rum distilleries, insurance, lumbering, and the extension of credit.

The 1947-48 report of the Secretary of Treasury showed that the assets of these corporations and other Government agencies engaged in business activities totaled more than $23,000,000,000, and that the Government's investment in these institutions exceeded $17,000,000,000. The combined net income of all corporations and agencies amounted to $57,692,000. The net income of the corporations and agencies which operated at a profit was $352,985,000. Had these institutions been taxed at the 38-percent rate like their taxpaying competitors, they would have paid the Federal Treasury $120,000,000. At the present rate of 47 percent they would have paid the Treasury $140,000,000. If they had paid such taxes and if they had been required to pay interest on money borrowed from the Federal Government, they would have been operating in a way similar to their fully taxed competitors and furnishing a valid yardstick as to the efficiency of their business operations.

The States are also in business competing against taxpaying corporations. Sixteen States operate alcoholic beverage systems and some have entered the workmen's compensation insurance field. One State owns a steamship pier while another owns and leases the Western & Atlantic Railroad. Two States derive income from power generation and one operates a cement plant, and so it goes. Recent figures of the Department of Commerce show that State governments realize $170.806.000 from such operations. If the 38-percent corporate rate were applied to this income it would produce a revenue of $57,000,000. The present 47-percent corporate rate would yield a revenue of $70,000,000.

Municipalities and local governments operate water, electricity, transit, gas, and port facilities; airports, ferries, railroads, toll bridges, radio stations, and many other facilities. An extensive survey made by the Department of Commerce in 19942 showed these governmental units receiving an indicated profit of $460,000,000. If corporate tax rates of 38 percent were applied to this income, they would have produced revenues of $153,000,000. The 47-percent corporate rate would yield $190,000,000.

COPERATIVE CORPORATIONS

The most important source of additional revenues that remain to be tased hy this committee are the tremendous earnings of cooperative corporations. These business corporations, as you know, are able to escape the payment of Federal income taxes by two separate routes. About half of the farmer mar. keting and purchasing cooperative corporations are granted exemption from the payment of all income taxes by section 101 (12) of the Internal Revenue Code. The other half of the farm cooperatives, the business, manufacturing, and wholesale cooperatives, the city consumer cooperatives, etc., are able to avoid all or nearly all of their Federal income taxes because of liberal Treasury rulings, not based on any statute, which permit them to deduct or exclude from gross income that part of their net earnings which is distributed as dividends on patronage. These nonexempt cooperatives are required to file income-tax returns just like any other corporation. By the use of the patronage dividend device, however, these corporations are able to transfer their profits to their owners without paying a corporation income tax on them.

The Consumers Cooperative Association of Kansas City, Mo., is an example of this type of cooperative. In 1948 it reported earnings of $8,320,206 but indi. cated that its total Federal and State income tax bill would amount to only $415,105. An ordinary corporation making the same profit would have been required to pay $2,000,000 more than the $415,000 that this big cooperative paid to both Federal and State Governments. The basis for this $2.000.000 tar advantage was the patronage dividend device referred to above. The oil business of this cooperative is operated through a wholly owned subsidiary which in turn owns the 4 petroleum refineries, a thousand miles of pipe line, 911 oil wells, 161,000 acres of undeveloped leases, and other similar assets.

Through its retail operations in 10 States it sells not only petroleum products but also tires, tubes, accessories, paint, twine, spray, feed, machinery, wire and steel, lumber, roofing, groceries, household appliances and farm supplies, many of which are produced in its own factories.

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For example, its facilities include grease, paint, and printing plants, à soybean mill, a cannery, a bottling plant, a lumber mill, a feed mill, and several fertilizer plants.

Another example of this type of corporate organization is the cooperative Grange League Federation Exchange which in its 1949–50 fiscal year distributed over a million dollars in patronage dividends, nearly a million dollars in divi. dends to stockholders, paid an estimated income tax of $1,099,000, and added $847,000 to surplus. If it had been taxed on its full earnings it would have paid at the 38-percent rate an income tax of $1,534,000 to the Federal Government and so would still have had $412,000 to add to surplus. It seems clear that paying income taxes would not destroy this cooperative. The Grange League Federation Exchange at the close of its 1948-49 fiscal year sold supplies to its members through 282 GLF-owned service stores, 365 agency stores, 61 bulk petroleum plants, 14 egg stations, and 45 local cooperative associations.

The Farmers Union Grain Terminal Association is a good example of a cooperative association that qualifies for full tax exemption under section 101 (12) of the Internal Revenue Code. This association markets grain in 39 States for more than 150,000 members, handling more than 100,000,000 bushels of country delivered grain a year. In 1946 it owned 150 country elevators. Through an affiliate, the Great Plains Supply Co., it operates 108 lumber yards throughout a six-State area. From 1946 to 1950 its net worth increased 87 percent, or $9,328,173, bringing its net worth to $18,878,745.

This expansion is almost entirely capitalized out of tax-exempt earnings, the corporation distributing patronage dividends in the form of stock and certificates of equity.

Net earnings in 1946 were $3,560,000. In 1950 they were $1,801,755 upon which an ordinary corporation would pay Federal income taxes of nearly $846,824 at present rates of taxation.

Another wholly tax-exempt cooperative is the Southern States Cooperative of Richmond, Va., which has 7 subsidiary corporations, 117 cooperative retail service stores, 10 cooperative freezer plants, and 26 cooperative service stations. It also sells supplies through 46 local cooperative associations and 550 retail stores acting as its agents.

Among the assets of this corporation are 30 wholesale purchasing, processing, manufacturing, distributing, and marketing facilities; it owns 7 seed and farm supply warehouses, 5 feed mills, 4 fertilizer plants, 4 egg-marketing terminals, a seed-processing plant and a river petroleum terminal, as well as 2 oil-blending plants, a paint factory, and an oil refinery in Texas.

The net worth of this cooperative rose from $616,391 in 1937 to $11,430,945 in 1946, to $18,061,000 in 1950. In 1950 the profits of this cooperative exclusive of the profits of affiliated corporations, amounted to $2,411,000. This income was, of course, tax-free. An ordinary corporation would have paid approximately $1,133,000 to the Government in Federal income taxes at present rates.

Cooperative protagonists have constantly attempted to minimize the growth of cooperative business. Before the Senate Finance Committee in 1950, Mr. Karl Loos said: “It is perfectly evident that the cooperatives are not doing any larger share of the farmers' business now than they have been in the past."

All cooperatives, however, have expanded at a greater rate than their competitors. For example, farm marketing cooperatives marketed farm produce valued at $1,638,000,000 in 1940. This had increased to $7,297,000,000 for the year 1949, an increase of 345 percent. Meanwhile, the total cash income of farmers, which represents the total value of all farm produce marketed by both cooperative and taxpaying businesses increased only 236 percent during the same period; namely, from $8,364,000,000 in 1940 to $28,127,000,000 in 1949.

Expansion of cooperative business also took place in the purchase of farm supplies. The Farm Credit Administration reports that this business increased from $448,000,000 in 1940 to $2,022,000,000 in 1949, an increase of 351 percent. On the other hand, the total value of farm supplies purchased as represented by feed, fertilizer, lime, cost of operation of motor vehicles, and expenditures for buildings and machinery, increased from $3,219,000,000 to $10,883,000,000 for the same period, an increase of 238 percent.

The Farm Credit Administration's latest calculation of farmer cooperative business volume for the year 1949 is $9,320,000,000. It is estimated by competent officials that this amount should be increased by 3313 percent to account for wholesale and manufacturing business which is not now reckoned in FCA calculations. That makes a total of $12,400,000,000 for farm cooperatives.

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Now add $1,000,000,000 as the Labor Department's estimate of business done by city consumer cooperatives and $500,000,000 as the volume of business being done by dealer-owned cooperatives and we arrive at a minimum grand total of about $14,000,000,000. Even this omits the large commission business done by cooperatives.

Profits on this volume of business may be assumed to be the same as in the case of most taxpaying corporations in the wholesale and retail fields. Official figures indicate that profit per dollar of sales has varied between slightly more than 4 percent and slightly more than 6 percent. Assuming an average of 5 percent, the taxable income of all cooperative corporations would have amounted to $700 million in 1949. The present corporate income tax rate scales up to 47 percent. Assuming an effective rate of 42 percent as the average on large and small corporations, the tax collection possible from cooperative business is about $294 million and if the corporate rate is increased to 55 percent, as has been pro posed, the collection would exceed $350,000,000 a year.

This, gentlemen, is the figure that you should consider in your deliberations. It is the realistic sum that cooperatives should pay in income tax to the Goverdment. It has not been adjusted for the $2,000,000 to $4,000,000 of income tax presently paid by nonexempt cooperatives that escape full taxation by the patronage-dividend route. The amount involved is small and is more than offset by factors which tend to minimize and understate cooperative profits. Completely exempt cooperatives use abnormally high depreciation rates since they are not bound to keep their books in accordance with statutory practice. Others create capital reserves out of income that would not be recognized by the tax collectors. Still others deduct as expenses amounts spent for capital improvements.

A defense tactic that is frequently used these days by the cooperatives in the effort to retain their full tax exemption is the attempt to direct attention to other loopholes in the tax laws and their suggestion that these should be closed before the section 101 organizations are touched.

The low taxation of life insurance companies is a case in point. But, may I call your attention to the salient fact that no competitive situation is involved. The big life insurance companies, both stock companies and mutuals, are taxed on exactly the same basis—and if the amount is smaller than it should be, as some Members of the Congress have been known to state, it is still true that no one in the life insurance business is being hurt because his competitor has an unfair advantage, as is the case where regular corporations and cooperative corporations are concerned.

Attention is called too by the cooperatives to the amount of revenue that is being lost through the failure of stockholders to report dividends that they receive and to pay tax on those receipts. Last year, when the revenue bill of 1950 was being written, the Treasury reported that some $170,000,000 of new revenue would be collected if the Congress would provide a withholding tax of 10 percent on all dividends paid by corporations to their stockholders, and the Ways and Means Committee wrote into the bill exactly that provision.

What the cooperatives conveniently forget is that your committee provided that the 10 percent withholding tax should apply also to the patronage dividends paid by cooperatives to members and patrons, and that this part of the tax would produce some $30,000,000.

Cooperative spokesmien fought the withholding tax vigorously in the Senate Finance Committee. I have seen no recent suggestion from them that it be instituted now along with the tax on corporate dividends. It seems that the shoe pinches on thąt foot.

There are other so-called loopholes that have recently been widely advertised and discussed in the cooperative press, but I think I have given you sufficient examples to demonstrate clearly that they are brought up at this particular time in an effort to take the attention of your committee off this problem of competitive tax exemption and steer it into less controversial directions. It is likely that in the natural course of these hearings you will look into all such extraneous matters, but I ask you not to be diverted from this important matter of tax-exempt business income and the billion dollars of new revenue that can be had by closing the loopholes which I have discussed with you.

Cooperatives escaped taxes on $32,600,000,000 of business volume during World War II, and in those 4 years avoided taxes amounting to nearly $1 billion, while other businesses were paying up to 80 percept. That gave the cooperatives the ability to expand on tax-free income during wartime and gave the cooperative corporations an overwhelming advantage with respect to growth possibilities.

Since World War II, cooperatives have gone into a multitude of new businesses and have expanded their operations all down the line. The tremendous tax advantage that they have is a continuous incentive for them to gradually take over more and more business, taking more and more corporations off the income taxpaying rolls, and making the tax burden to be carried by the rest of us all the more difficult to bear.

The three cooperative corporations I have discussed would, if fully taxed under present rates, have paid nearly $413 million more than they did pay in Federal income taxes. Then there is the case of the Union Equ Cooperative Grain Exchange of Enid, Okla., which announced last summer that it would voluntarily pay an income tax of $1 million on the profits it earned in its dealings with the Commodity Credit Corporation. The amount of income taxes to be gained by fully taxing all of the 10,000 or more farmer marketing and purchasing cooperatives, the city consumer cooperatives, the dealer-owned wholesale cooperatives, etc., would amount to a sum which this committee cannot overlook in its search for additional revenue. Our figure of $294 million for the revenue to be gained by taxing all cooperatives may be compared with the $25,000,000 which was suggested by Secretary Snyder. The discrepancies between these figures is based on the fact that different types of taxes are under consideration. Our figure is based on the assumption that cooperative corporations are to be taxed in the same manner and on the same basis as other, corporations are and that the passage of a “mere token tax" is not worth while considering.

If the type of law recommended by the Treasury were to be enacted, it would not raise any substantial amount of income the Treasury says so, cooperative spokesmen say so, and we agree.

For example, a law which, instead of attempting to plug this loophole, would create a new loophole by allowing corporate income distributed as a cash patronage dividend to be excluded or deducted from gross income, would merely make clear how cooperatives must act to avoid income taxes and would not make them pay income taxes. Such inadequate compromise legislation woull, according to the Division of Tax Research of the Treasury Department, continue to permit cooperatives to expand on taxfree income. The revenue it would raise would be negligible and the tax-subsidized competition that businessmen are objecting to would continue. Such legislation would not in any way satisfy the hundreds of business organizations and their members who are asking for full tax equality. In view of these facts, it would be of little use for the committee to consider legislation of that type.

Cooperative spokesmen have long claimed that taxing the income of their corporations before the distribution of patronage dividends would be unconstitutional. They have claimed that such corporations act as mere agents and when the agency theory has been refuted, they have claimed that the distribution of dividends on patronage constituted a price adjustment. These various cooperative contentions have now been completely and finally refuted by the experts who have studied the matter.

You have heard Mr. Joseph J. O'Connell, Jr., who was general counsel of the Treasury Department, take up the principle contentions of the co-op and demonstrate the fallacies on which they are based. He has also filed a complete and fully documented legal opinion which takes up the various cooperative contentions in detail. He stated, "In view of the fact that the cooperative, as a distinct entity, earns the profits distributed in patronage, dividends just as it earns profits distributed as dividends on capital stock, the amounts of patronage dividends should be included in its income.”

An article on the taxable income of cooperatives, whose coauthor is Roswell Magill, has been published in the Michigan Law Review. Mr. Magill is probably one of the foremost authorities on the nature of taxable income in the United States today. He has written several books on the subject and was appointed chairman of

he special Tax Study Committee, which was constituted by your committee in June 1947. He was Under Secretary of the United States Treasury in 1937-38.

In his article, Mr. Magill traces the history of cooperative tax exemption from the beginning in 1916, and points out that from these modest beginnings modern giant co-ops have sprung up, branching into every conceivable form of enterprise, strangling competitive taxpaying corporations out of existence, and, to use his Own words, "leaving the State with no support” from their fast-growing

businesses.

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