ciency of the cooperative and other competing business units. Consumers could make direct comparisons of the prices paid when dealing with the two types of organization. Under the present system, the cooperative member never knows the exact price he is paying at the time of purchase because the patronage dividend is in the future and, of course, it may actually never materialize. This element of doubt comes very close to an unfair trade practice in that it holds out uncertain future patronage dividends as a lure for business. Direct price reductions by cooperatives will make for clear-cut competition.

Such price reductions will also make for fair treatment of large and small members and of nonmembers trading with the cooperative. Some small members and nonmembers neglect to collect patronage dividends which results in swelling the profits distributable to those who do collect. For example, a nonmember drives up to a cooperative filling station, he purchases gas and oil or a tire but may receive no evidence of his purchase. He is sometimes ignorant af the fact that he is dealing with a cooperative, and, in any case, he does not know whether he is dealing with an exempt or a nonexempt cooperative, or, indeed, whether the cooperative is one which pays patronage dividends. The result is that the profit on this business makes possible so much more in patronage dividends for those members who do collect them. This possibility exists as between two cooperative members both receiving patronage refunds if one gets a wholesale price, as on the purchase of a carload of fertilizer, while the other pays a higher price on smaller lots.

Federal taxation should neither favor nor discriminate against the cooperative on the one hand or the business corporation on the other but give equal treatment to each so that in their competition for the public favor the more efficient units of either class may survive as a result of their giving the ultimate consumer the benefit of the best service at the lowest prices.

Since the patronage dividends of the consumers' cooperatives and the farm buying cooperatives, when they exist, are derived from the same source as the business profits of the ordinary corporation, they should be taxed as income to the recipient in the same manner whether the membership chooses to take them as patronage dividends or as dividends upon their stock.

Farm marketing co-ops.-There remains the question of the treatment of the third class of cooperatives, namely, the farm marketing cooperatives. The dividends which are paid on the stock of these organizations are as clearly a return for the use of capital as the return paid by any of the other forms of cooperatives, and should be consequently taxed as such. The income which makes such dividends possible should be taxed as such at the same rates as paid by the business corporation. Under the present law, however, this form of cooperative pays no income tax on the income earned for either stockholders' or patronage dividends if it qualifies for exemption under the law."

Most marketing cooperatives pay their members the going market price for their crops at the time they are delivered to them. Then, at a later date, an additional distribution, usually called a patronage dividend or refund, is paid. This extra distribution arises from business operations, such as marketing, processing, or manufacturing. Profits from such business operations are not a return for the farm crop, but an ordinary business profit, which should be subject to the same corporate income taxes as that paid by noncooperative competitors.

A further point to note is that some marketing cooperatives do not distribute full proceeds to their members, but retain a portion for a number of months, or even years, after the crop season is over. Such retention is clearly an attempt to obtain the use of additional capital without paying any stock dividends or interest for the use of capital.

Farm marketing cooperatives are able with the aid of Government agencies to borrow an unusually large proportion of the capital which they need to conduct their operations at a very low interest cost. Consequently, their need for capital from their farmer members is relatively small in relation to the volume of marketing operations which they carry on. Yet, in order to obtain such ownership capital as they do need, frequently for supplementary operations, elaborate schemes such as the revolving fund are frequently resorted to to obtain the needed stockholders' investment. Discussion of such a revolving-fund

For the qualifications required for exemption, see ibid.

Where the cooperative makes only a partial payment for the crop upon receipt, the amount paid at a later time may include an element of capital return. The cooperative has had the use of the funds while the crop was being sold and sometimes it pays a subnormal dividend on its stock. However, it is doubtful if any practical analysis can be made to determine the amount of the profit or capital return element when it is merely a part of the ordinary crop proceeds.

arrangement may be found in Government bulletins, such as the Bulletin of the Farm Credit Administration on Legal Phases of Cooperative Associations (No. 50, May 1942, p. 276, etc.). The author of this bulletin believes that this retention of funds to operate the business is equitable because it solves the problem of how "to capitalize a cooperative so that the capital furnished by a particular member will bear a direct relation to his patronage." Clearly the raising of capital from members by this method reduces the need for selling shares upon which stock dividends will be paid and so members can receive all of their capital return in their patronage dividends. Unless patronage-dividend income is taxed like corporate income, so much capital return is given an exemption.

As the writer of this bulletin says: "It cannot be overemphasized that it takes money to go into business. Farmers, when they form and operate a cooperaitve. are in business and should supply the required capital." When farmers go into a business which is not farming, it is difficult to understand why they should expect to be free from the taxes paid by other operators in that field. Furthermore, it would be unfair to permit them to create a form of ownership investment that will make it unnecessary to show much of their profits for dividends on stock and enable them to avoid the corporate income tax by distributing such profits as patronage dividends. One of the reasons that these cooperatives have to resort to these schemes for retaining proceeds to provide ownership capital is their failure to pay dividends on their stock adequate enough to attract investment by members. The deficient capital return is then paid out as patronage dividends. This device for avoiding the payment of dividends shows how ineffectual a change in the tax law would be that only taxed the income available for dividends on stock and why many farm cooperatives even now do not claim the exemption from this tax. They pay little or no dividends at all on stock and make most or all of their profit distributions as patronage refunds. The possibility that all of the owners' investment may consist of retained earnings was illustrated earlier. Such balance sheets as have been examined show a preponderance of capital from that source.

Where the marketing cooperative pays its members the going market price upon delivery of the crop, it would appear equitable, then, to require the cooperative to report all further net income over and above that price as business profits earned for its members and to make them subject to the same corporate income taxes as are paid by other business concerns. Where the farmer member is only paid as the crop is sold by the cooperative it may not be possible to apply this method of determining the business profits, if any. The basic principle should be to segregate the amount representing the crop return from the revenues produced by the off-the-farm activities. The cooperative should be obliged to distribute the crop return within a reasonably short period after sale. Any amounts not distributed promptly should be treated as corporate earnings and taxed as such. Such taxation would put pressure upon the cooperatives in the future to obtain their capital needs, other than that which is borrowed, by selling stock and paying a reasonable dividend upon the same in order to induce such investment on a voluntary basis. When, and if. cooperatives paid an income tax as other business corporations do, their retention of earnings would arouse no more objection than the similar practice of other corporations.

Before concluding, it should be emphasized that such equal tax treatment is in no sense a hostile measure directed against this form of business organization. They have played a useful part in the American economy, especially in the field of agriculture. They have made a valuable economic contribution. However, many of them are no longer small struggling institutions but vigorous mature business units. On the basis of Farm Credit Administration reports of farm cooperative business at the local level of $8,635,000,000 for the marketing year 1947-48, one estimate, after allowing for nonreporting organizations, wholesaling and manufacturing and commission operations, arrives at a total in excess of $15,000,000,000. The economic contribution which private profit-seeking enterprises have also made to the American standard of living should not be overlooked. They, too, have brought improved productive technology and mass marketing methods to the service of the consumer.

National Tax Equality Association, Facts and Figures, p. 47. A statement to the Committee on Ways and Means of the House of Representatives, 81st Cong. (Chicago: The Association, 1950). In this source, a net income of approximately 2 percent is esti mated, and the income taxes escaped at $318 million (p. 35).

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 investment. 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 of 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 com munity 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 figure 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 taxexempt 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 $95,600,000 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 21⁄2 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 unknown 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 available 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 1953-80. 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 5%1⁄2 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

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." 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.