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with particular reference to the statement of Senator Borah in the Senate of the United States on February 10, 1910, when the proposed income-tax amendment was under consideration:
To construe the proposed amendment so as to enable us to tax the instrumentalities of the State would do violence to the rule laid down by the Supreme Court for a hundrd years, wrench the whole Constitution from its harmonious proportions, and destroy the object and purpose for which the whole instrument was framed.
The Senate report, upheld by the Senate in 1940, emphasized:
The constitutional doctrine which prevents the States and Federal Government from taxing each other's functions is one of necessity. The structure of the American Government is unparalleled in political history. Our democracy is a successful experiment in a balanced set of dual sovereignties. Our States were independent sovereigns. By the tenth amendment any doubt that they had surrendered their sovereignty was removed. If the Federal system is to continue, the position of each of the partners in this Federal framework demands the continued respect of the other.
Entirely aside from the legal issues just what would be the end result, from the standpoint of the cities, of Federal taxation of municipal bonds? There is complete agreement on the part of all students of the subject, including experts from the Treasury Department, that a Federal tax on municipal bonds will increase the interest rates which cities would have to pay on their borrowings. It is conservatively estimated that this added interest cost will be at least 60 points-and there are many who are of the opinion that the increase will amount to as much as 100 points and perhaps more in the case of many counties, small towns, villages, school districts, irrigation and drainage districts, and so forth. That is to say, that if a city now markets its securities on the basis of a 3-percent interest rate, it may ultimately anticipate that its financial cost will be increased by 20 percent.
If it costs any of our cities 2 percent to borrow money, the annual cost will be increased by 60 points or 33 percent. To my mind, it follows as simply as A, B, C, that this increase in the cost of running local government can only mean one thing to cities-increased realestate taxes. In New York, for example, when this proposal was up in 1939, it was estimated that the additional cost of financing would be in excess of $14 million per year and the tax rate would have to be advanced 87 points. On this same basis it was estimated that tax rates per thousand would rise from $95.20 to $96.93 or $1.73 more in Chicago; from $27.90 to $30 or $2.10 more in Detroit; from $36.18 to $39.15 or $2.97 more in Newark, N. J.; from $43.15 to $44.38 or $1.23 more in Camden, N. J.; and from $52.54 to $54.82 or $2.28 more in Seattle.
When these figures were compiled for the previous hearings before this committee, it was estimated that the States and cities of the Nation would be compelled to pay ultimate tribute in the sum of $113 million annually; in the form of increased interest costs.
Thus, we have this result. Interest rates will increase. Holders of the bonds will get the higher returns—which would take care of their Federal income-tax obligations. City treasurers would have to secure the added revenues to pay the increased interest rates. Local revenues come mainly from property owners. So our real-estate taxpayers in our cities would be the ones who could ultimately foot the bill. Our municipal officials simply cannot understand the logic or wisdom involved in such a proposal.
And for what fiscal gain? A potential immediate Federal revenue of 3 to 5 or possibly 10 millions in the next fiscal year.
Former Senator Adams, of Colorado, realistically pointed out what would be the effect of Federal taxation in his community during Senate consideration in 1940. He said:
* * if a Federal tax be imposed upon the interest upon the bonds issued in our community, it means we will get less for our bonds. The interest money is raised by taxation. In my community there are 12,000 homes which furnish the larger part of the taxation. They are the homes of steel workers, railroad workers, and clerks. The extra tax
would fall upon the moderatecircumstanced people in my community, which is now a highly taxed community.
The tax would not fall upon anybody but the local people. As a matter of fact, taxes for local purposes are paid not by the rich but by the relatively poor.
So my community would have to pay a penalty if this amendment were adopted.
we would have to pay more money to the city, the county, the State, and the school district because the interest on their bonds would go up. I say it will be the homes, it will be the farmers, it will be the little local business that would pay that penalty. It is not fair, it is not just; and I do not think the Congress, whether it has the authority or not, should exercise the authority.
At this point I want to digress a moment to refer to the disastrous effect Federal taxation would have on proposed refunding operations. It is conceded, with what is practically unanimity, that the proposed tax would defeat many contemplated municipal refunding plans. What it would do to much new and necessary capital-improvement borrowing is not pleasant to contemplate. Detroit estimates that on its defense-highway construction project carrying a $100 million bond issue, added interest-rate costs would amount to $24 million. This is for one city, for one project. As many of the committee know, practically every major city of the country is faced with a most serious and critical problem of traffic congestion. A number of cities have established municipal parking authorities for the purpose of proceeding with construction of off-street parking facilities in downtown areas. If the revenue bonds to be issued by the cities and their parking authorities should be subjected to Federal taxation, there is little doubt but that few bonds would be issued because, if these facilities are to pay off, bonds must carry an extremely low interest rate. Some cities have reported to the Conference of Mayors that Federal taxation would effectively prevent going ahead on the development of any proposed parking facilities as well as other improvements.
The importance of this phase of the issue was dramatically stated by a former Speaker of the House, John Garner, in the course of the 1922 debate. Mr. Garner said: The people pay this in the long run.
The people pay for it after all.
I have got the statement from the Secretary of the Treasury that undoubtedly the adoption of this amendment will increase the rate of interest on all bonds—State, county, and municipal. Why, I go further than that and say it will stop the issue. It will so cripple the market for these county and State bonds that you cannot sell them.
I can go before a joint session of the Legislature of the State of Texas and say, "Gentlemen, here is what Mr. Mills (referring to Mr. Ogden L. Mills] sent down to you. He wants you to surrender the right of the people over in your district to issue bonds by giving power to the Federal Government to levy whatever taxes it sees fit against them, and what are you going to do about it?” And I have no doubt that they will say, "To the lower regions with such a proposition.” They will say that they are not going to give up their right to reclaim the desert lands by a bond issue for irrigation, their right to protect the people of the cities and their health by the issue of bonds for sewerage, and their right to build roads in this country by bond issues.
And now, I would like to comment on the political effects of the Secretary's recommendation. I want to be perfectly frank with the committee. City officials are fearful and apprehensive that if taxation of future issues can be enacted and upheld, resulting in no substantial Federal revenue, the second step would simply be for the Treasury Department to propose and recommend taxation of outstanding issues as a source of immediate revenue. The facts clearly show that in the past there was no real intention on the part of the Treasury Department to stop at taxation of future issues for the very logical reason from their standpoint that it means little or no revenues to the United States Treasury for many years to come.
I am not questioning the position of the present Secretary of the Treasury or the present administration. I simply want to recite facts concerning which the chairman and some of the older members of this committee are well aware.
During the period 1939–42, when the Treasury Department's recommendations were being given consideration by both the Senate and the House, there followed this sequence of events:
1. On June 28, 1939, Under Secretary of the Treasury John W. Hanes told the committee before which I now have the privilege of testifying:
It is not suggested that interest on outstanding issues be taxed.
2. On January 18 of the same year, Mr. Hanes had given the special Senate committee similar assurances:
Senator Brown. In other words, there is no disposition on the part of the Treasury to attempt to tax the income on the State and municipal bonds that have heretofore been issued?
Mr. HANES. None whatsoever.
Senator BROWN. I am glad to have that made clear for there has been considerable talk about that question. That is the policy of the administration?
Mr. Hanes. Yes, sir. That is certainly the Treasury's position.
3. On February 20, 1941, Assistant Secretary of the Treasury John L. Sullivan stated: I would like to add that the proposal to discontinue reciprocal tax exemption
concerns only interest received from such bonds as will be issued in the future. It is not proposed to violate the moral obligations implicit in securities previously sold. I mention these facts because failure to keep them in mind has sometimes resulted in misunderstanding.
4. On March 14, 1941, when certain test cases were initiated against Port of New York Authority bondholders, an official press release of the Department reiterated that there was not "any reason to fear the imposition of taxes on obligations now outstanding."
5. On January 13, 1942, the Chairman of the Federal Reserve Board, Mr. Eccles, told the mayors of the country meeting in Washington:
I do not see how taxation can be levied in good faith on the tar. exempts already issued.
6. With all these official statements, from early January of 1939 up to early January of 1942, is it not clear why city and State officials in all parts of the Nation were amazed to read the statement by the Secretary of the Treasury, Mr. Morgenthau, in Cleveland, on January 24, 1942, that it was now the intention of the Treasury to request
Congress to enact legislation imposing a tax on outstanding State and municipal bonds as well as on future issues. And on March 3 of 1942, when Mr. Morgenthau presented the administration's tax program to this committee that is exactly what was recommended. Repudiating previous statements the Secretary bluntly said:
Unfortunately, tax-exemption clauses appear in many of the outstanding issues of Federal securities and these promises must not be violated. In the case of State and local securities, however, there has never been any contract or moral commitment between the Federal Government and the security holders or the State and local governmental authorities regarding Federal taxation,
Thank God, from the standpoint of our dual system of constitutional government, this committee stood firm and rejected the views and recommendations then expressed and submitted.
What assurance is there that exactly the same pattern might not be forthcoming in coming weeks and months? Since the pending proposal has practically no immediate revenue significance or importance, city officials believe that their conclusious as to the possible real intent are justified on the basis of past experience.
To those who discount the effect of proposed Federal taxation I want to read a letter that was transmitted to this committee during the earlier hearings by the city just across the river from Washington, D. C.-Alexandria-when all of the above incidents were occurring. It serves as a graphic example of just why the States, cities, and county governments are united in opposition to this continued and persistent effort on the part of the Treasury Department. The letter was directed to the distinguished chairman 5 days after Secretary Morgenthau's Cleveland statement:
CITY OF ALEXANDRIA, VIRGINIA,
January 29, 1942. Hon. ROBERT L. DOUGHTON,
House of Representatives, Washington, D. C. MY DEAR CONGRESSMAN: For some time past the cities of this country have been protesting, particularly to the Ways and Means Committee, against any attempts to impose Federal taxation on our local securities. Time and again the serious consequences that such an extension of the Federal tax powers must inevitably vest upon the taxpayers of the local communities have been foretold. On the other hand the Treasury Department has of recent years been prone to suggest that these fears were unfounded or exaggerated.
On Monday, January 26, the City of Alexandria was faced with the grim reality of what had heretofore been in the realm of surmise. For on that date and on the mere threat of a Federal tax on outstanding local securities the people of this city sustained a loss of approximately $52,500 on a comparatively small bond offering of $750,000.
These bonds, Congressman, were being issued by us to pay for schools, streets, and sewers that faced us as the part that our community must take in cooperating with the Federal Government in the expanding needs of the defense program. $100,000 of them were to pay a temporary loan, the proceeds of which were used in the construction of a trunk-line sewer to serve Federal housing projects. Our city council had determined to offer these bonds at a fixed rate of 272 percent and we were assured of bids substantially above par.
However, on Saturday afternoon, January 24, 1942, the Secretary of the Treasury saw fit to issue a public statement that the Treasury proposed the taxation not only of future but also of outstanding issues of municipal securities. have read in the newspapers, the consequence of this unfortunate proposal was that, on the following Monday morning, the municipal bond market practically collapsed. After prime New York City bonds had crashed three points in the opening hour, trading in them was virtually suspended on the Exchange. The municipal market crashed in all the exchanges in the country, and the city of Alexandria with an issue set for sale on that morning, was faced with a loss which for å city of our size was a real disaster.
Of 25 municipal investment firms which had announced their intention of competing for these bonds, we are advised by our New York correspondent, 11 withdrew altogether, 1 asked permission to withdraw their bid after it had already been submitted on Monday morning, and 9 put in revised bids. The high bidder was Goldman Sachs & Co. with a bid of 101.289 which reflects a 2.42 basis. The representative of the concern advised me his firm had originally prepared a bid of 108.2 prior to Mr. Morgenthau's statement of Saturday afternoon. I know of many other bidders who were prepared to bid 106 and 107. The net result was a loss of a cold $52,500 to the citizens of this community.
The Council of Alexandria, on the same day rejected all bids, which results in delay and additional expense to us. We did this because we Virginians are un. willing to believe that the Congress of the United States would seriously entertain such an unmoral proposal as is involved in the announced plan of the Treasury Department, and we earnestly hope that your committee will promptly repudiate it.
I think that it is my dutv as city manager of Alexandria to place before you, as a member of the Ways and Means Committee, the cold facts in the light of our sad experience as to what will happen to every State and municipality and local district in this country if the Treasury Department ever succeeds in its effort to bring State and local securities within the taxing power of the Federal Government. We trust that the next time the so-called Treasury experts come before your committee and blandly assure you that this proposal would involve little or no loss to the local communities, you will ask them: “What happened to Alexandria on January 26?” Respectfully yours,
Carl BUDWESKY, City Manager. There is a further fear on the part of city and State officials. If outstanding State and municipal bonds can be taxed what is there to stand in the way of ultimate Federal taxation of municipal earnings or even revenues? If a solemn contract between a city and its bondholder can be nullified by Federal taxation, cannot the earnings of municipal water plants, light plants, sewerage-disposal systems, gas plants, trolley, bus, and subway systems, ferry systems, toll bridges and toll expressways and all other similar public enterprises be subjected to Federal taxation? Should this occur, there is, of course, complete destruction of the sovereignty of the 48 States and their political subdivisions.
These fears that I have mentioned have not only been voiced by city and State officials but they have been repeatedly expressed by members of both the House and Senate during the past 30 years.
There are many city officials who hold that the ultimate issue presented is not taxation, or municipal costs, or even Federal control of municipal securities. The method by which it is proposed to tax State securities--enactment of a simple statute-involves grave political consequences. Those consequences must be apparent to all schooled in our fundamental law, and they have been completely admitted in prior years by the Treasury and Justice Departments. When it is asserted that this statute must find its support in the proposition that the Federal Government has supreme power to tax the States, then, we submit that they have marked out the course of the most direct march to centralized power that has ever been attempted in our political history. For whether or not the power to tax is the power to destroy the States, it is most definitely and certainly the power to control them.
I shall conclude by quoting from the well-known message which Governor Charles Evans Hughes submitted to the New York Legislature: