ance of its duties, but the compensation so fixed shall not exceed the compensation fixed under the Classification Act of 1923, as amended, for comparable duties. The committee is authorized to request the use of the services, information, facilities, and personnel of the departments and agencies in the executive branch of the Government and of the Joint Committee on Internal Revenue Taxation.

The President's Message of April 25, 1938, is as follows:

TERMINATION OF TAX EXEMPTION-MESSAGE FROM THE PRESIDENT OF THE UNITED STATES TRANSMITTING HEREWITH A RECOMMENDATION FOR APPROPRIATE LEGISLATION ENDING TAX EXEMPTION ON GOVERNMENT SALARIES OF ALL KINDS, CONFERRING POWERS ON THE STATES WITH RESPECT TO FEDERAL SALARIES AND POWERS TO THE FEDERAL GOVERNMENT WITH RESPECT TO STATE AND LOCAL GOVERNMENT SALARIES

To the Congress of the United States:

THE WHITE HOUSE,

April 25, 1938.

The sixteenth amendment to the Constitution of the United States, approved in 1913, expressly authorized the Congress "to lay and collect taxes on incomes, from whatever source derived." That is plain language. Fairly construed this language would seem to authorize taxation of income derived from State and municipal, as well as Federal bonds, and also income derived from State and municipal as well as Federal offices.

This seemingly obvious construction of the sixteenth amendment, however, was not followed in judicial decisions by the courts. Instead a policy of reciprocal tax immunity was read into the sixteenth amendment. This resulted in exempting the income from Federal bonds from State taxation and exempting the income from State bonds from Federal taxation.

Whatever advantages this reciprocal immunity may have had in the early days of this Nation have long ago disappeared. Today it has created a vast reservoir of tax-exempt securities in the hands of the very persons who equitably should not be relieved of taxes on their income. This reservoir now constitutes a serious menace to the fiscal systems of both the States and the Nation because for years both the Federal Government and the States have come to rely increasingly upon graduated income taxes for their revenues.

Both the States and the Nation are deprived of revenues which could be raised from those best able to supply them. Neither the Federal Government nor the States receive any adequate, compensating advantage for the reciprocal tax immunity accorded to income derived from their respective obligations and offices.

A similar problem is created by the exemption from State or Federal taxation of a great army of State and Federal officers and employees. The number of persons on the pay rolls of both State and Federal Government has increased in recent years. Tax exemptions claimed by such officers and employees--once an inequity of relatively slight importance-has become a most serious defect in the fiscal systems of the States and the Nation, for they rely increasingly upon graduated income taxes for their revenues.

It is difficult to defend today the continuation of either of these rapidly expanding areas of tax exemption. Fundamentally, our tax laws are intended to apply to all citizens equally. That does not mean that the same rate of income tax should apply to the very rich man and to the very poor man. Long ago the United States, through the Congress, accepted the principle that citizens should pay in accordance with their ability to pay, and that identical tax rates on the rich and on the poor actually worked an injustice to the poor. Hence the origin of progressive surtaxes on personal incomes as the individual personal income increases.

Tax exemptions through the ownership of Government securities of many kinds-Federal, State, and local-have operated against the fair or effective collection of progressive surtaxes. Indeed, I think it is fair to say that these exemptions have violated the spirit of the tax law itself by actually giving a greater advantage to those with large incomes than to those with small in

comes.

Men with great means best able to assume business risks have been encouraged to lock up substantial portions of their funds in tax-exempt securities. Men with little means who should be encouraged to hold the secure obligations

of the Federal and State Governments have been obliged to pay a relatively higher price for those securities than the very rich because the tax-immunity is of much less value to them than to those whose incomes fall in the higher brackets.

For more than 20 years Secretaries of the Treasury have reported to the Congress the growing evils of these tax exemptions. Economists generally have regarded them as wholly inconsistent with any rational system of progressive taxation.

Therefore, I lay before the Congress the statement that a fair and effective progressive income tax and a huge perpetual reserve of tax-exempt bonds can not exist side by side.

The desirability of this recommendation has been apparent for some time, but heretofore it has been assumed that the Congress was obliged to wait upon that cumbersome and uncertain remedy-a constitutional amendmentbefore taking action. Today, however, expressions in recent judicial opinions lead us to hope that the assumptions underlying these doctrines are being questioned by the court itself and that these tax immunities are not inexorable requirements under the Constitution itself but are the result of judicial decisions. Therefore, it is not unreasonable to hope that judicial decision may find it possible to correct it. The doctrine was originally evolved out of a totally different set of economic circumstances from those which now exist. It is a familiar principle of law that decisions lose their binding force when the reasons supporting them no longer are pertinent.

I, therefore, recommend to the Congress that effective action be promptly taken to terminate these tax exemptions for the future. The legislation should confer the same powers on the States with respect to the taxation of Federal bonds hereafter issued as is granted to the Federal Government with respect to State and municipal bonds hereafter issued.

The same principles of just taxation apply to tax exemptions of official salaries. The Federal Government does not now levy income taxes on the hundreds of thousands of State, county, and municipal employees. Nor do the States, under existing decisions, levy income taxes on the salaries of the hundreds of thousands of Federal employees. Justice in a great democracy should treat those who earn their livelihood from government in the same way as it treats those who earn their livelihood in private employ.

I recommend, therefore, that the Congress enact legislation ending tax exemption on Government salaries of all kinds, conferring powers on the States with respect to Federal salaries and powers to the Federal Government with respect to State and local government salaries.

Such legislation can, I believe, be enacted by a short and simple statute. It would subject all future State and local bonds to existing Federal taxes; and it would confer similar powers on States in relation to future Federal issues. At the same time, such a statute would subject State and local employees to existing Federal income taxes and confer on the States the equivalent power to tax the salaries of Federal employees.

The ending of tax exemption, be it of Government securities or of Government salaries, is a matter, not of politics, but of principle.

FRANKLIN D. ROOSEVELT.

The CHAIRMAN. The chairman will make a short preliminary statement.

As we see the inquiry before this committee, it divides itself into two parts: first, should we tax the income from State and municipal bonds, hereafter issued; and, second, the salaries that are paid to employees of the States and the various subdivisions of the States, and at the same time grant to the States the right to levy a tax on income from Federal bonds and on the salaries of employees of the Federal Government.

The next question that comes up, and which the committee would like to hear from the departments of the Government on, is, can this be done by statute, or is a constitutional amendment required, and it seems to me, as a corollary to that proposition, there is a further question. If it can be done by statute, should it be so done, or

should the Congress submit the question to the States for a clearcut expression from them as to what they think should be done. There are many incidental problems to this, but I think those are the main propositions upon which to base our inquiry.

I have asked Mr. Hanes, the Under Secretary of the Treasury, to appear here and present the Treasury's views upon this question. We will now hear from Mr. Hanes.

STATEMENT OF HON. JOHN W. HANES, UNDER SECRETARY OF THE TREASURY

Mr. HANES. The Treasury Department urges approval of the proposal that the issuance of Federal, State, and local governmental securities exempt from income taxes be discontinued. It likewise urges approval of the proposal to tax the salaries and compensation of State and local employees and to consent to the taxation of the salaries of Federal employees by State and local governments. This position is summarized in President Roosevelt's Message to Congress of April 25, 1938, in which he said:

*

I * ** recommend to the Congress that effective action be promptly taken to terminate these tax exemptions for the future Such legislation can, I believe, be enacted by a short and simple statute. It would subject all future State and local bonds to existing Federal taxes; and it would confer similar powers on States in relation to future Federal issues. At the same time, such a statute would subject State and local employees to existing Federal income taxes; and confer on the States the equivalent power to tax the salaries of Federal employees. The ending of tax exemption, be it of government securities or of government salaries, is a matter, not of politics but of principle.

The discontinuance of the issuance of tax-exempt securities by Federal, State, and local governments has been urged consistently by the Treasury Department during many administrations. Condemnation of the inequity resulting from the issuance of such securities has been voiced by former Secretaries Glass, Houston, Mellon, and Mills and by Secretary Morgenthau and my predecessor, former Under Secretary Magill. Almost without exception every spokesman of the Treasury Department since the advent of progressive income taxation has urged the elimination of tax exemption; none has ever spoken in favor of its retention. A typical position was that taken by former Secretary Mellon who, more than 15 years ago, wrote the acting chairman of the Committee on Ways and Means:

* ** it is almost grotesque to permit the present anomalous situation to continue, for as things now stand we have on the one hand a system of highly graduated Federal income surtaxes and on the other a constantly growing volume of securities which are fully exempt from these surtaxes, so that taxpayers have only to buy tax-exempt securities to make the surtaxes ineffective-December 21, 1922.

*

Former Presidents of the United States, including Presidents Harding, Coolidge, and Hoover, have urged the elimination of tax exemption. This position has been endorsed by a great majority of the individuals and civic organizations who have studied the problem. Prof. T. S. Adams, whom some of you will remember from his frequent appearances before congressional committees, stressed

the seriousness of the social problem that is likely to be created if there arises in this country a situation in which the wealthiest men-the men most able to bear taxation-get themselves, by reason of the existence of these tax-free bonds, into an isle of safety, in which they are absolutely sheltered from the burden of supporting government, to which, as Justice Holmes of the Supreme Court has said, they owe their protection and in some senses their lives. National Tax Association Proceedings, 1922.

Views substantially similar have been expressed by Professors Seligman and Haig, to mention but two of a long list of scholars. There have been remarkably few dissenting voices. Over the years there may have been some difference in the means advocated but not in the end sought.

For the most part, attention in the past has been directed to the exemption enjoyed by Government securities, but analogous though lesser problems arise with regard to the exemption of Government salaries.

The reasons which have led so many persons with such different social and economic viewpoints to the same conclusion are constantly becoming more pressing and of more and more practical importance. The time for eloquent dissertations on the evils of tax exemptions is over; the time for action has arrived. Unless we act soon the possibilities of removing the evil within our lifetime will become remote because the last of the outstanding tax-exempt debt will not be retired for many years to come.

The elimination of income-tax exemptions is necessitated by three important considerations: First, effects on the distribution of the tax burden; second, effects on the national economy; and third, effects on revenues and costs of government. I shall discuss these three considerations first with respect to securities, leaving treatment of salaries until later.

The first consideration is the effects on the distribution of the tax burden. In his message of last April the President said:

* a fair and effective progressive income tax and a huge perpetual reserve of tax-exempt bonds cannot exist side by side.

Some persons with large incomes are able to escape income taxes entirely, or in large part, through the device of tax-exempt securities. To the extent to which they are able to do this the application of the principle of progressive income taxation by the Federal Government and by the States is nullified.

There would be no unfairness in this if each individual holder of tax-exempt securities had to accept a decrease in his interest return proportionate to the value of the tax-exemption privilege to him. This, however, cannot be the case. The value derived from tax exemption varies with the rate of tax to which the interest would have been subject had it been taxable. Thus, the value of the taxexemption privilege varies widely among different purchasers having different incomes. The cost of acquiring this privilege, on the other hand, is the same to all.

The relative advantage of tax exemption to a person with a large income and to one with a small income may be seen by comparing the positions of a married man with net income from other sources of $500,000 and a married man with similar net income of $5,000. To the man with a net income of $500,000, a 3 percent fully tax-exempt security affords the same return after Federal income tax as a tax

able security yielding 10.71 percent. To put the case the other way round, he would do as well, after Federal income taxes, with a yield of 0.84 of 1 percent on a tax-exempt security as he would with a yield of 3 percent from a taxable security. Contrast this situation with that of the man with an income of $5,000. In his case a 3 percent tax-exempt security is the equivalent of only a 3.2 percent taxable security. If the incomes are also subject to State taxation, the differential in favor of the person with the large income is even greater.

These benefits from tax exemption may be compared to the price paid for them in the form of lower yields. Under present conditions we estimate, upon the basis of an examination of actual market yields. that the differential between the yields of completely taxable and wholly tax-exempt high-grade securities varies from zero, or practically zero, for the shortest maturities up to about one-fourth to one-half of 1 percent for the longest. The yield differential in favor of long-term partially tax-exempt securities, that is, those that are exempt only from normal income tax, as compared with completely taxable securities of equal quality is estimated at from five one-hundredths to fifteen one-hundredths of 1 percent.

The reason for the small differential in interest rates, despite the high preferential value of the tax-exemption privilege is that the interest saving to the Government arising from the issuance of taxexempt securities is measured only by the value of tax exemption to those bondholders who fall in the lowest tax bracket. The differential in interest is relatively small compared to the benefit of the tax exemption to persons in the higher income brackets. Because the outstanding supply of tax-exempt bonds is large it is necessary to sell some of them to investors in the lower tax bracket who will pay for tax exemption only what it is worth to them.

The present volume of tax-exempt securities exceeds $65,000,000,000, including about $15,000,000,000 held by governments and their agencies. We estimate that the remaining $50,000,000,000 is distributed in the chart.

As is indicated in the chart, the outstanding amount of tax-exempt securities is greatly in excess of the demand for such securities on the part of individuals who are subject to the high income-tax rates. In consequence, substantial portions of them have to be disposed of to institutional investors and to individuals to whom the tax-exemption privilege has little or no value. It would follow, considering this factor alone, that there should be no appreciable differential between the yields of taxable and tax-exempt securities.

The interest differential, however, is affected also by another factor. The holding of Government securities has many advantages apart from the privilege of tax exemption. These advantages cannot be duplicated in private securities, whatever the yield. The purchase of governmental securities is mandatory upon seekers after absolute safety. United States Government securities, moreover, afford institutional investors a degree of liquidity which is in practice obtainable in no other way. In addition, public securities as a whole have important legal and psychological advantages which make them extremely attractive to certain classes of holders, for example, banks and trustees, despite wide differentials in yield as compared with taxable securities.