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Summary.-A summary of the various foregoing proposals for changing the income-tax law to place the different types of cooperatives on a basis of tax equality would be as follows:

1. For consumer co-ops, the amounts distributed in cash or allocated as patronage dividends should be included in the taxable net income of the cooperative and made subject to the same corporate-income tax as the return earned for its members on their stock investinent. Similarly, patronage dividends should be regarded as a part of the recipient's personal income and taxed as such.

If these amounts are not genuinely capital returns, the remedy for the consumers' cooperative is simple. The cooperative may reduce its prices in the same way as would a business competitor.

2. For farm-buying cooperatives, similar treatment of patronage dividends and stockholders' earnings would be the fair course. They, too, should pay the corporation-income tax on such amounts of net income as are available for the payment of either patronage or stockholders' dividends. Members are now liable for a personal-income tax on both types of dividends.

3. For farm-marketing cooperatives, the corporation-income tax should be levied upon any balance earned to pay dividends to stockholders and, when the cooperative pays the farmer the market price of his crop at the time of delivery, any further payment, even though called a patronage dividend, should be taxed like stockholder income available for dividends. In instances where the cooperative advances initially only a portion of the value of the farmers' commodities rather than the market price, it would be reasonable that no income-tax liability should attach to funds disbursed within a reasonable period of time after their sale by the cooperative in order to bring the total up to that market figure. However, any additional amounts which represent net earnings from the operations of the cooperative, whether from marketing, processing, or manufacture, should be treated as taxable net income regardless of whether or not they are distributed.

GOVERNMENT-OWNED ELECTRIC UTILITIES

A might be inferred from material already presented, the tax factor is also of first-rate importance in the field of Government-owned utility operations. While direct competition of Government-owned and privately owned utilities is the exception, comparisons, an indirect competition for public favor, are common between the two groups in such a field as electric power where both types of ownership are found. The fairness of such comparisons is an important question. With the publication by the Federal Power Commission of the first volume of its Statistics of Publicly Owned Electric Utilities, data became readily accessible for our study. The figures for 1948 show a gross electric-plant investment amounting to $1,297,000,000 plus $338,000,000 of other utility plant, exclusive of Federal power projects. Gross electric revenues were $283,000,000. The importance of taxes to the showing of these municipal electric utilities can be seen from the ratio of that item to revenues. Their total taxes amounted to 2 percent of gross revenues; similar private companies (classes A and B) reported Federal income taxes amounting to 7.3 percent and other taxes amounting to 9.6 percent, or total taxes of 16.9 percent electric-utility operations in 1948.

If a municipality that does not compete with any private company chooses to give its owned project favored tax treatment, that is its privilege, although it destroys the comparability of its rates with those of neighboring privately owned companies to that extent and increases the amount of revenue which that community will have to raise from other sources. The effect is to shift so much of the local tax burden from one form of levy to another. Escape from the Federal corporation-income tax, however, relieves the community served by a municipal utility of its share of the Federal tax burden as compared with those served by private companies. Since power rates are tailored by regulation to produce a stipulated rate of return on investment, it is apparent that the situation in 1948 was as though consumers using private power from a company subject to the corporation-income tax were paying an excise tax averaging 7 percent which municipal power consumers escaped.

If all of the "savings" from lower taxes were passed along to consumers, tax equality would pose a difficult problem. Actually, the publicly owned electric

& Federal Power Commission. Statistics of Electric Utilities in the United States, 1948, p. 10, and Statistics of Publicly Owned Electric Utilities, p. 8. On the other hand, some allowance should be made for those municipalities which are supplied with power from their own plants without any bill being presented which might be regarded as the equivalent of a tax for some analytical purposes. For similar private utilities, such power use would provide additional gross revenues.

utilities report a substantial net income after their operating expenses and interest charges. Had they paid a 38-percent tax on their combined net income in 1948, it would have totaled $31,464,000, or 11.1 percent of electric revenues. This percent is high because it is related to electric revenues only. The net income from other utility operations is only reported on a net basis. Were total utility revenues assumed to be proportionate to gross plant investment in electric and other utility property, these income taxes would have been but 8.8 percent of revenues or a tigure more nearly comparable to that paid by private companies,

Three other tax factors should also be mentioned: (1) many of these municipal utilities purchase power from Federal hydroelectric projects, which enjoy a special tax position; (2) municipal utilities are financed by the sale of tasexempt bonds; and (3) between June 13, 1933, and June 1, 1939, the Public Works Administration gave some communities 45 percent of the cost of setting up their own electric supply systems and lent them the balance at a very low rate of interest. In this period PWA lent over $96,000,000 and gave over $9.5,600,000 to 477 non-Federal bodies.

Federal power plants represent about one-half of the Government-owned electric capacity of the country and produce a substantially higher fraction of the public power sold. The four hydro giants—Tennessee Valley Authority, Grand Coulee, Hoover (Boulder) Dam, and Bonneville--represent almost a billion-dollar investment in electric plant. They pay no Federal income taxes and make only a small contribution, if any, to local taxes. As for return upon their capital investment, they are under no obligation to earn any stipulated rate or even anything at all. No interest charges may appear in their operating statement. Even when such a property does reach the point where it returns to the Treasury an amount sufficient to equal what the Federal Government pays for its borrowed funds, currently under 242 percent, it has the same general advantages that the municipal utility has over the private utility of very low capital cost and nominal taxes.

Capital costs and income taxes may constitute three-fourths of the total costs of power generated by a similar private hydroelectric development. Here is a very high "saving" for the utility able to buy Federal power. The amount is nin: known and hidden from the casual reader of operating data of the municipal utilities affected. To put the cost of Federal power on a parity with private power, especially if any "yardstick” usage is intended, the Government should not only charge rates sufficient to cover not only a reasonable return on the capital invested in utility property but also an amount equal to the corporate-income taxes lost by supplanting private investment and operation.

Because a municipal utility uses no stocks in financing its needs, its cost of outside funds is represented by the rate paid in its bond issues. For 1948, the interest charges represented an average rate of 3 percent on total debt. This rate is a composite of rates on past financing. Currently lower rates are arailable for such tax-exempt bonds. For example, the Public Utility District No. 1 of Clark County, Wash., recently sold a serial electric revenue-bond issue with yields from 1.20 to 2.35 percent on maturities from 1951 to 1977 and an average cost of approximately 2.25 percent. The Consumers Public Power District of Nebraska sold Western System serial revenue bonds with yields from 1.10 to 2 for maturities of 1953–so.' In contrast, the private utility not only pays a higher yield to borrow with nonexempt bonds but also is obliged to raise a substantial part of its funds by the sale of stock. The over-all average rate of return currently regarded as necessary for a private electric utility to maintain its credit and raise new funds usually runs at the present time from 512 to 6 percent. What this means is that the ability to use tax-exempt bonds instead of taxable stocks and bonds makes it necessary for the private utility to pay from two to three times the rate needed by a municipal utility. Even this statement ignores the net ownership equity of the municipality utilities accumulated from past surplus earnings or a PWA grant upon which it may feel no obligation to earn any return. At the end of 1948, municipal electric utilities had total funded debt of $624 million and ownership equity of $754 million, $98 million representing investment of the municipality and $656 million representing surplus.10

Differences in capital cost become more significant when we recall the point made earlier that the capital-return cost for utilities is a substantial item in the total cost of the service, This total capital return (interest plus return earned

а

8 Abrams, Ernest R., Municipal Ownership of Utilities Declines, Barron's, September 4, 1950. p. 39.

10 Federal Power Commission, Statistics of Publicity Owned Electric Utilities, 1948.

for stockholders) constituted 18.7 percent of revenues for private electric utilities in 1948, 30.6 percent in 1940. If it is assumed that the average municipal utility has a capital cost of one-half that of the private company, it could under comparable operating conditions reduce that cost from 18.7 to 9.3 percent of gross revenues and pay only 2 instead of 16.9 percent for taxes. In effect, these two "savings" would permit rate schedules 24.2 percent lower for the municipal utility operated at the same level of efficiency.11 Or, stated in the reverse fashion, such costs if added to the other necessary costs of a municipal plant would raise its rate structure by 32 percent (24.2 plus 75.8). In practice, the municipal company does not pass along all of these "savings" in lower consumer rates, but uses them to build a net worth or surplus of property investment over debt. Consequently, were municipal companies obliged to pay an income tax, it would not necessarily have to increase existing rates. It might merely reduce the amount available for the expansion of ownership investment. It might even lead to rate reductions by municipalities anxious to avoid the income tax. They would then be obliged to finance more of their expansion by bonds and less by retained earnings.

Clearly, here is a field of business where tax exemption is even more important than in the case of the cooperatives studied above, when comparisons are being made between exempt and taxed business units. Tax equality would, at the least, require :

(1) That municipal utilities be obliged to pay an amount equal to the Federal corporate income-tax rate upon any net income whenever it serves a field in which privately owned companies operate; and

(2) That the interest from all future issues of bonds sold by such municipal utility properties should be fully subject to income taxes for the recipient of such interest.

Something approaching tax equality is necessary if discrimination between taxpayers who buy from municipal and private utilities is to be our objective. Furthermore, any comparisons between rates of municipal and private utilities are meaningless in the absence of more equal tax treatment.

A corporate income tax could be avoided by a municipal utility willing to pass all “savings” along to consumers through reduced rates. This possibility poses the question as to whether a more equitable arrangement would not be to exempt all regulated utilities from the income tax, whether public or private, and levy a common excise tax upon the revenues of both that would yield the desired total revenues from this sector of the consuming public.

Conclusion.Cooperatives and Government-owned utilities have been selected for discussion because they were deemed the most important to the problem of tax exemption as a competitive business factor. The problem in the case of certain financial institutions, notably insurance companies, involves more complex and technical matters. Whatever tax burden is laid upon such institutions, the same general principle developed here would seem applicable. The objective should be to produce an equality of tax burden within a given competitive field so as to avoid favoring one corporate form of organization over another. To achieve that end, ecnomic analysis is essential to avoid inequity growing out of legalistic differences. Fundamental economic similarities should be emphasized. Thus, if mutual savings banks were to be regarded as competitive with commercial banks, it would appear equitable to permit them to deduct payments to depositors that are the equivalent of interest in arriving at their net taxable income even though such a payment is legally called a "dividend" under their mutual form of organization.

Because the weight of taxation has become so heavy, the greatest care is essential that it be not used to handicap some business organizations at the expense of others. Failure to exercise such care might so blight the competitive process that it will cease to bring about the survival of those units which serve the community with the greatest economy of resources. As between its own and private enterprise, the Government can readily discredit private operation, especially in the utility field, if it chooses to tip the scales in its own favor with discriminatory taxation as it does at the present time.

11 This comparison omits the greater advantage previously referred to from both lower capital cost and tax exemption where hydroelectric power is employed. This advantage arises from the large part these two elements play in hydro as compared with steam power. While municipal utilities are given preference in the sale of Federal power, some private utilities are able to purchase it where municipal plants are unable to absorb the total avalable.

The CHAIRMAN. Without objection, the committee will adjourn until 10:30 Monday morning in this committee room.

(The following statements are submitted for the record :)

STATEMENT OF Wm. L. CLAYTON, OF ANDERSON, CLAYTON & CO., HOUSTON, TEI, AT

THE HEARINGS ON REVENUE LEGISLATION OF THE COMMITTEE ON WAYS AND MEANS OF THE HOUSE OF REPRESENTATIVES

I am Wm. L. Clayton, associated with Anderson, Clayton & Co., of Houston, Tex. I wish to address my comments solely to the exemption from corporate income taxes presently accorded to cooperatives.

This exemption has, as I understand it, been a specific part of the Internal Revenue Code since 1921. The code provisions assuring this exemption eren in the case of earnings retained by stock-issuing cooperatives were, I am informed, added in 1926.

I refer to these dates not because I intend now to argue the considerations which originally prompted the exemptions but because I wish to question whether those considerations are applicable in this year 1951.

I assume that the Congress originally had two different sorts of consideration in mind when granting such exemption. It is, I think, worth while to give separate thought to them.

The first consideration was presumably the idea that cooperatives were mutual societies of active members and that any “income” involved in their operations belonged to the members rather than the societies as such. It is, in this connection, interesting to recall that the Code section beginning, then as now, with the words "Farmers', fruit growers', or like associations," originally went on as follows: “organized and operated as sales agents.” The present wording is “organized and operated on a cooperative basis.”

The difference in wording is, I think, significant. The typical modern coopera. tive is not a "sales agent” operating only for the separate account of the individual producer according to the established laws of agency. It is instead an entity, separate and apart from its members. It is usually organized as a corporation, and as such is possessed of the power to hold property, to incor debt, to contract, to sue and be sued--all in its own name. Its corporate attributes include limited liability. Its management is responsible not to the individual members but to a board, which is elected periodically. This board has the power, among other things, to decide, wholly without reference to the individual members, what part of net earnings shall be paid out as dividends and what part shall be retained in the business.

These are the very aspects of separate identity which distinguish an ordinars commercial corporation from its shareholders. They are regarded as justifying the imposition of one tax upon the income of the corporation itself and of another tax upon the same income when received by the shareholder as dividends. In the eyes of the law two parties—the corporation and the body of shareholdersare involved.

If, now, the logic of two taxes holds for the ordinary commercial corporation it must, the evidence being the same, hold for the cooperative also. Nor is the logic denied in this latter case by the assertion that the cooperative is a "non-profit" organization-that it works not for itself but for its members. It can equally be said that the ordinary commercial corporation works not for itself but for its shareholders. What is truth in the one case is truth in the other also; what is legal fiction for one is legal fiction for both.

This brings me to what I regard as the heart of the matter. I said in beginning that the Congress, in its first grant of tax exemption to cooperatives, was pre sumably moved by two different sorts of consideration. The first was, I am supposing, the legal theory I have just discussed. The second, I am again supposing, was a matter of public policy-a sense that here was a type of activity which should, in the public interest, be encouraged by according favorable tax treatment.

The formulation-and the review-of public policy in matters like this must, I take it, have regard for two different considerations, namely, the present state or condition of the activity to be encouraged, and the cost of such encouragement. One might, for example, well conclude after examination and study of some type of activity that encouragement, while desirable or even necessary for the activity's survival, was just too costly to be given serious consideration. In this present matter, my own examination and study has persuaded me that tax exemption

for cooperatives fails to meet either test: it is, whatever may originally have been the case, no longer necessary or even desirable, and it has become prohibitively costly.

First, the cooperative movement in this country is no longer a struggling, experimental movement standing in permanent need of support. A press release of the Farm Credit Administration dated October 2, 1950, reported for the 1948–49 marketing season an aggregate business volume of some $9.3 billion on the part of 10,075 farmers' cooperatives. Whatever the reason, whether it be tax exemption in the past or a natural development in the changing circumstances of our Nation, cooperatives are now a well-established and a substantial part of the economy. The movement has experience, "know-how," and organization; it has had ample opportunity to “shake down” and to perfect any distinctive contribution it has to make to our productive or distributive system. If it has such a contribution to make, as it may, the cooperative movement should now be able to meet the test imposed upon all he rest of us: the ability to compete upon an equal basis.

I, for one, do not question that ability. My complaint is not that tax exemption permits cooperatives to survive where otherwise they would not, but rather, that it places them in a position where they can be, and increasingly are, predatory.

Ours is a growing economy, and it is my hope and contident belief that it will continue to be so. This means that it is a proper function of the individual enterprise-whether private or cooperative-to expand. From the viewpoint of the economic system as a whole, having regard for efficiency of operations and therefore for our future standard of living, this expansion should be in some manner proportioned to proven competence in the use of materials, labor and capital. Such is not the case as matters now stand.

The firm with which I have been associated during my business life has been built up, as has the greater part of American industry, by the accumulation and reinvestment of earnings. It owns and operates, among other things, oil mills, and it continues to expand in that field. This is a field in which farmers' cooperatives are likewise active and in which they also expand through the reinvestment of earnings. Let me illustrate one of the consequences of tax exemption by a hypothetical reference to this industry.

Let us say that we operate a mill in an area of increasing cottonseed production. There is also a cooperative mill there. Let us suppose that at the end of a crop year our mill shows somewhat the better results: it has earned $125,000 as against the cooperative's $100,000, both figures being before taxes and before dividends of any character. Let us suppose, further, that each pays a dividend equal to 30 percent of its earnings, namely, $37,500 in our case, $30,000 in the other. The cooperative, being tax exempt, is left with $70,000, which is available for expansion. We, on the other hand, are left with $28,750, for we are subject to a 47 percent tax not on the amount after the dividend but on the full $125,000 earned. In short, with just one difference between us apart from our own greater efficiency, namely, tax status, the cooperative is able to expand 2.4 times as rapidly as we are. With a corporate tax rate of 55 percent the figure would be 3.7.

I do not assert that private enterprise is inevitably more efficient than a cooperative undertaking, though my own experience leaves me quite prepared for competition on even terms. I do assert that a tax provision which permits a situation such as that just described is not only inequitable but bad economic policy. It permits an industry to be preempted by those who, by the test of comparative efficiency, are least able to make effective use of the national resources devoted to the industry.

The word “preempted” may seem too strong, for it may appear that tax exemption would at most permit the cooperatives to acquire an increasing proportion of an industry but never the whole of it. In the literal sense this is, of course, true; but the tax advantage of which I have spoken does more than permit rapid expansion through the construction of new plant facilities. It also provides cooperatives with the funds to purchase existing private enterprises. For example, the March 10 issue of the Cotton Digest reports the sale of the Pinedale Compress & Warehouse Co., of Pinedale, Calif., to the California Cooperative Association. This is not an isolated case; its like is happening constantly, and most frequently the seller is a small, independent businessman.

I particularly wish to point out that, in cases such as this, tax exemption affords the cooperatives two advantages. The first lies, of course, in the tax-free accumulation of investment funds to which I have just referred. The second advan

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