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D. A tax upon the mutual savings banks would be a tax upon thrift.As shown in exhibit No. 1, the tax which the savings banks would have paid over the 9-year period, had they been subject to the corporate income tax, would have amounted to more than 36 percent of the dividend or interest which they could have paid. This tax would have been paid by the banks out of earnings which otherwise would have been paid to the depositors. At 1948 and 1949 tax rates, a depositor (married with two children) would have had to have an annual net taxable income of $25,000 to have incurred such a tax on the interest had it been paid to him.

This inequitable tax on the depositor would have been a direct tax upon thrift. It would have discouraged savings. Even if the banks, in order to maintain the modest dividend rates they were able to maintain and at the same time pay the tax, had placed a curtailment on new deposits, the tax would still have been a tax upon thrift. The tax would have been the cause of the banks refusing to accept as much savings as depositors wanted to leave with them and as much savings as the banks would have been glad to accept if the tax had left them with sufficient earnings to provide the necessary margin of safety for those new savings.

STATE FRANCHISE TAXES NO PRECEDENT FOR FEDERAL TAX ON BANKS

In all but two of the States in which savings banks are located, the States levy a francise tax upon the banks. In some States the tax is levied upon the deposits as a base and in some it is measured by income. In New York State the basic tax is 2 percent of the earnings disbursed as interest or dividends. In those cases where 442 percent of the undisbursed earnings (after valuation reserve deductions) is in excess of the basic tax, the francise tax is 422 percent of such net earnings.

These franchise taxes are not income taxes, but taxes levied by the States upon their creatures for the privilege of doing business. The taxes are not heavy. There is no more reason for using the State franchise taxes as precedents for & Federal income tax upon the banks than there is for using the real estate taxes upon real estate owned by the banks as precedents for such a levy. All taxes are paid out of income. Many tax-exempt organizations, such as laobr unions, colleges, churches, and charitable organizations, pay real-estate taxes on incomeproducing real estate owned by them as an investment. Yet the Federal Government exempts the income or rents from these properties from the income tax.

Moreover, all of the earnings of the savings banks fairly subject to the Federal income tax are subject to tax in the hands of the depositors who receive those earnings. No earnings of the banks which are properly taxable are escaping Federal income taxation. As pointed out above, the retained earnings are of the nature of a reserve for future losses, and are not properly the subject of taxation to the banks themselves.

ALLEGED COMPETITION WITH COMMERCIAL BANKS

A. No general complaint from commercial banks.—The commercial banks have not generally complained of the exemption of the mutual savings banks from the corporate income tax. Several of the State associations of commercial banks have registered complaints with the House Ways and Means Committee, but their complaints have been aimed primarily at the savings and loan associations. They have included the mutual savings banks in their complaints more as a matter of principle than because they are suffering from the competition offered by those banks. However, we understand that a few commercial banks in the northeastern Atlantic Seaboard States have raised the point that the tax exemption gives mutual savings banks a competitive advantage over commercial banks in the same territory.

B. Competitive advantages enjoyed by the commercial banks.--Actually, the commercial banks enjoy many competitive advantages over the mutual savings banks operating in the same territory. The commercial banks can accept time and thrift deposits virtually without limitation as to the amount on deposit from any one depositor. In general, savings banks are restricted by statute to the acceptance of only a limited sum from any one depositor. Thus the commercial banks have no competition from savings banks for deposits in excess of the statutory limitation applicable to the savings banks.

The commercial banks in general have much wider branch privileges than the savings banks. The commercial banks, therefore, can offer more in the way of convenience of location than can the savings banks. This convenience of location is often as important to the savings depositor as is the differential in interest he may receive by leaving his money with the mutual savings bank.

The commercial banks can offer under one roof a number of banking services. They offer checking-account facilities, trust-department facilities, investmentcounseling facilities-none of which are ordinarily available in savings banks. The convenience to the depositor of being able to do all types of banking business at one location may well offset the differential in the interest rate on his savings &ccount.

While generally commercial banks, because of their large demand deposit liability, are more restricted than savings banks in the making of real-estate loans, they otherwise have much greater latitude in the investment of depositors' money. They can invest the savings and time deposits in whatever fields of loans will yield them the best return at the time. They can make high-yielding personal loans, for example, whereas these loans generally are denied to savings banks.

Commercial banks generally have the bulk of their deposits in the form of demand deposits on which they pay no interest. They receive no competition from the savings.banks in this field.

C. The basic distinction between commercial and savings banks from the standpoint of retained earnings and Federal income taxation.-Frequently, a particular individual is at the same time a director of a commercial bank and a trustee of a mutual savings bank. We can understand the basic distinction between the two types of institution if we consider the point of view of this individual in his dual capacity. We assume that the commercial bank of which he is a director has a considerable sum of time and savings money on deposit. Therefore, we are considering how he looks at this money as a director of a commercial bank and how he looks at the same kind of money as a trustee of a mutual savings bank.

As a director, he is elected by and is responsible to the stockholders. The stockholders have only one interest in the commercial banks and that is to make a profit for themselves. The director is himself a stockholder and may be a very substantial stockholder. His eye is primarily on what is best for the stockholders. His principal function is to invest the savings and time money on deposit with the commercial bank so as to make a profit for the stockholders.

The same individual as a trustee of a savings bank can have no financial interest whatsoever in any transaction of the bank. His sole interest is that of the depositor. He invests the depositors' money, not with the view primarily of making profits for stockholders, but only for the purpose of earning interest for the depositors and setting up necessary reserves for their protection.

As a director of the commercial bank, our individual would usually retain each year as a part of the capital structure of the bank a substantial part of the earnings. He would do this to increase the lending power of the bank (since loan limitations usually are based upon some percentage of capital and surplus), and to expand the bank's operations—with a view to increasing profits for the stockholders. These retained earnings add to the book value of the stock and may be realized upon by the stockholders through the sale of the stock.

As a trustee of a savings bank, however, our individual would have no motive in retaining earnings other than that of protecting the depositors against loss. He knows that, without this protection, the savings bank could not meet its obligation to pay its deposits at par. As a trustee, he cannot participate in retained earnings. Those earnings do not add to the book value of the depositor's account. Unlike the stockholder of a commercial bank, the depositor cannot realize upon retained earnings.

It is sometimes said that commercial banks and savings banks are on the same level with regard to asset valuation reserves. In fact, however, they are not on the same level at all, and there is justification for treating the two institutions differently with respect to reserves from a tax standpoint.

This arises from the fact that the director of the commercial bank retains earnings for asset valuation reserves, not primarily for the protection of depositors, but for the purpose of preventing an impairment in the capital investment of the stockholders. Should those reserves not be needed, they would belong, not to the depositors, but to the stockholders, and in fact those reserves would in all probability be reflected in the value of the stock and until they were actually absorbed by losses could be realized upon by the stockholder through the sale of his stock.

The trustee of the savings bank, on the other hand, would retain earnings for Asset valuation reserve purposes only for the purpose of protecting the depositor. If it proved that those earnings were not needed, they would in time be paid out as interest to the depositors. They would not belong to a body of stockholders.

Our individual as a director of a commercial bank is working for the stockholder and not primarily for the depositor. His natural and proper point of view is to regard interest paid depositors as an item of expense. His object normally

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would be to hold down this item of expense just as he would hold down any other item of expense in order to increase the return to the stockholder.

As a trustee of a savings bank, however, our individual would not regard the interest paid the depositor as an item of expense to be held to a minimum. His objective here would be to pay out in the form of this item every cent possible consistent with maintaining a safe margin of protection for the depositor.

D. The income tax does not limit the amount of interest the commercial bank car pay on its savings and time deposits. It is only within the past 30 or 40 years that the commercial banks have engaged seriously in soliciting savings accounts, For many of those banks, this type of account is still a relatively small part of their total deposit business. In 1949, for example, time and savings money amounted to only a little more than 25 percent of the total deposits in the insured commercial banks of the country.

As late as 1945, according to a survey made by the savings division of the American Bankers Association, a very substantial number of commercial banks stated that they were actually not encouraging savings accounts. Some 1,276 banks out of 2,813 said that they were not encouraging the opening of savings accounts and 1,431 out of 2,667 said that they were not encouraging the building up of balances in already existing savings accounts--and this, notwithstanding the fact that 1,613 out of 2,942 said that the savings department was showing some profit, and also notwithstanding the fact that 1,295 of the banks said that they were experiencing as much of an increase in their savings account, relatively, as were other types of savings institutions.

As will be shown by the figures which are to follow, there are three principal factors which account for the fact that the commercial bank does not, in general, pay as high a rate of interest on savings and time deposits as the mutual savings bank. The income tax is not one of those factors.

The first and most important of the three factors is the inability of the commercial bank to earn as much on those deposits as does the mutual savings bank. The fact that the commercial bank may pay a Federal income tax has nothing to do with this factor. The average commercial bank with time and savings deposits cannot, because of the necessity of maintaining a higher degree of liquidity, invest as large à proportion of such deposits in mortgages and in bonds of long maturity with their higher yields as can the savings bank. In 1949, the insured commercial banks had in investments of this type an amount which did not exceed 55.3 percent of their time and savings deposits. In contrast the insured mutual savings banks had so invested 93.7 percent of their deposits.

The second of the three factors responsible for the differential in the interest rate which the two types of institution pay on savings and time money is the greater operating expense characteristic of the commercial bank. According to the FDIC 1949 report, the operating expenses of the insured commercial banks, excluding Federal income taxes and interest paid on deposits, amounted to 1.414 percent of the year-end deposits in those banks. The corresponding figure for the insured mutual savings banks was 0.822 percent. In 1949 the insured commercial banks paid out 11.39 percent of their gross operating income as salaries to officers as compared with 3.47 percent for insured mutual savings banks, and 19.41 percent as employees' salaries as compared with 8.2 percent for the savings banks. The commercial banks paid out nearly as large a proportion of gross earnings to officers alone as did the savings banks to officers and employees combined.

The third factor accounting for the differential in the interest paid on time and savings deposits is the profit which the stockholders of the commercial banks retain out of the earnings realized from the investment of those deposits. The income tax paid by the commercial banks on the profit does not hold down the interest. It is the profit itself which holds down the interest. The interest is a deductible item before arriving at the earnings upon which the income tax is levied, and can be increased in the degree to which the stockholder is willing to forego profit. The tax does reduce the profit of the stockholders but it need not in and of itself reduce the interest paid the depositor because such interest is deductible before arriving at the tax base.

The fact that it is the profit for stockholders rather than the Federal income tax which holds down the interest that the commercial banks pay on their time and savings deposits can best be illustrated by concrete figures and examples. Because there is no segregation in cominercial banks of time and savings deposits from other deposits and no segregation of assets as to the type of deposit invested in those assets, it is impossible from official published reports to analyze with absolute accuracy just how profitable savings and time depesits are to commercial banks. Nevertheless, we can make a reasonably accurate analysis and, in the

absence of cost-accounting figures to guide us, we shall give the commercial bank the benefit of the doubt insofar as the argument that the income tax reduces the interest on deposits is concerned.

Exhibit No. 2, which is attached, explains how the published figures for the insured commercial banks in 1949 were broken down so as to develop the earnings, expenses, and profits for stockholders allocable to the time and savings deposits of the commercial banks. As evidence of the fairness of the analysis, it may be said that whereas the time and savings deposits amounted to 25.7 percent of total deposits, they are given credit in the analysis for 30.3 percent of the gross operating income, are charged with only 20.8 percent of the operating expenses (exclusive of interest on deposits), are charged with 27.3 percent of the Federal income tax paid, and are given credit for 27.3 percent of the aggregate profits made by the banks for their stockholders.

In 1949, the interest paid by the commercial banks on their average time and savings deposits was $328,010,000, or 0.92 percent. The insured mutual savings banks in 1949 paid on their average savings deposits $235,800,000, or 1.84 percent-just exactly twice the rate paid by the commercial banks.

The commercial banks, as shown by the analysis in exhibit No. 2, paid $83,140,000 in Federal income taxes allocable to their time and savings deposit operations. Upon the assumption that the Government, in order to remove the income tax as a competitive factor, remitted this amount of tax to the commercial banks and upon the assumption that the commercial banks would have added the tax so remitted to the interest paid on the time and savings deposits, the interest rate on those deposits could have been raised from 0.92 to 1.15 percent. The rate paid by the savings banks would still have been 60 percent in excess of the rate that could have been paid by the commercial banks if there had been no Federal income tax levied on their savings and time deposit operations. This 60-percent differential shows that there are other factors, rather than the Federal income tax, which are responsible for the higher interest rate paid to depositors by the savings banks.

But the assumption that the commercial banks would have passed such a remission of income taxes on to their depositors is questionable. Those taxes represented a part of the profits belonging to the stockholders and any funds representing the remission of such taxes would belong to the stockholders. The directors of the commercial banks, being responsible to the stockholders, would not likely pay out the remitted taxes to the depositors. The proof of this statement is evident from what follows.

Exhibit No. 2 shows that, after paying a Federal income tax of $83, 140,000 allocable to time and savings deposit operations, commercial banks in 1949 earned on those deposits for stockholders $227,085,000. This was equal to 8.51 percent on the capital funds allocable to those deposits. They paid to stockholders & dividend of 11.36 percent on the capital stock allocable to those deposits. Had the directors so desired, they could even without any remission of the income tax have increased the interest to depositors by $83,140,000 (the amount of the income tax) and still have earned nearly 674 percent on the allocated capital funds and could still have paid a dividend of nearly 843 percent on the capital stock so allocated.

It is clear from these figures that it was not the $83,140,000 of income taxes which held down the interest paid time and savings depositors, but the fact that the directors wanted to retain for the stockholders from the earnings on those deposits $227,085,000, an amount equal to nearly 234 times the sum paid as Federal income tax.

In addition to the very important part played by the profit factor (not the income tax factor) in holding down the interest paid depositors, there were also the two other factors we have discussed: the gross earnings on the time and savings deposits and the operating expenses allocable to those deposits. Exhibit No. 2 shows that the insured commercial banks had gross operating income of 3.07 percent on average time and savings deposits, assuming for this purpose that all of the earnings from high yield, long term securities are attributable to such deposits. Contrast this with 3.40 percent for the insured savings banks. The exhibit also shows that the operating expenses (exclusive of interest) of the commercial banks amounted to 1.144 percent of average time and savings deposits as compared with 0.811 percent for the savings banks.

Further proof that the Federal income tax is not the cause of the lower interest paid by commercial banks on the time and savings deposits may be found in a 1948 survey made by the American Bankers Association covering operations in the year 1947. The survey covered 21 mutual savings banks with $10,000,000 of deposits or less and 26 commercial banks with $10,000,000 or less in savings deposits; 23 mutual savings banks with deposits between $10,000,000 and $30,000,000 and 10 commercial banks with savings deposits between $10,000,000 and $25,000,000; and 11 savings banks with deposits between $30,000,000 and $100,000,000 and 12 commercial banks with savings deposits over $25,000,000.

The survey is an attempt to determine how profitable the savings deposits were to the commercial banks. In general, the survey shows that the three factors already discussed are responsible for the higher interest paid by the savings banks, those factors being the higher gross earnings, the lower operating expenses, and the absence of profit for stockholders, characteristic of the savings banks. The survey also shows that, with few exceptions, the diversion of the entire net profit in the case of the commercial banks as an addition to the interest paid depositors would not have covered the gap between the interest rate paid by the commercial banks and the interest rate paid by the savings banks. Clearly the full remission of the income tax on those profits would have fallen far short of closing

Exhibit No. 3 which is attached, sets out for comparative purposes the median banks (with respect to gross earnings) in each deposit-size group with comparable amounts of savings deposits. The exhibit also sets out similarly the banks with the highest amounts of gross earnings.

E. The commercial banks are not losing ground relative to the savings banks in the growth of their time and savings deposits.For the 8-year period ended December 31, 1949, the relative growth in the three most important savings bank States, New York, Massachusetts, and Connecticut, of time and savings deposits was as follows:

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1 Source: The figures for 1941 and 1945 are from the Annual Reports of the Comptroller of the Currency. The figure for 1949 is from the 1949 Annual Report of the FDIC.

2 Source: The figures sor 1941 and 1945 are from the Annual Reports of the Superintendents of Banks. The figure for 1949 is from the National Association of Mutual Savings Banks.

It will be seen from the foregoing figures that whereas the savings deposits in the savings banks in the three States in question increased by 84.4 percent from 1941 to 1949 and 28 percent from 1945 to 1949, the relative increases for those periods in the case of the commercial banks in those three States were, respectively, 144.6 percent and 43.7 percent. It is, therefore, clear that the commercial banks as a whole in the three States are easily holding their own against the savings banks.

RISK ASSETS HELD BY THE SAVINGS BANKS ARE INCREASING

It has been stated that the savings banks do not need as much of a margin of protection for depositors at the present time as they needed in former years, because their assets, in large measure, are composed of Government bonds and Government guaranteed or insured mortgages and because most of the savings banks have their deposits insured with the FDIC or with some self-constituted insurance fund.

During the war, the ratio of Government bonds to total assets expanded rapidly. This was due to the fact that war conditions made for a short supply of other types of investment and created a large supply of Government bonds growing out of the need for financing the war. Also, by virtue of war conditions, savings deposits expanded rapidly. This increase in deposits grew out of the greatly expanded money supply due to the Government's own deficit financing and out of the fact that rationing and controls made it more difficult for people to spend their increased money incomes. These same factors led to a rapid liquidation of conventional mortgages and to a relative decrease in the supply of corporate securities. The savings banks did their part in assisting the Government by buying heavily of the bonds that were issued and have assisted the whole economy by absorbing large amounts of the people's increased incomes by encouraging them to save rather than spend. Spending under those conditions would have added greatly to the forces of inflation.

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