With the committee's permission, I should like to present at this time members of the Treasury technical staff who will discuss various factual questions involved in the testimony presented to the committee. Mr. Blough will discuss the distribution of burdens and benefits among various governmental units and classes of people. Mr. Murphy will discuss the question of differentials in interest rates arising from tax exemption and the probable effects on interest rates of eliminating such exemptions. Mr. O'Donnell will discuss the question of revenues likely to be derived from eliminating tax exemption. So, if the committee is willing, at this time I would like to have you hear from Mr. Blough, director of tax research. The CHAIRMAN. Certainly. STATEMENT OF ROY BLOUGH, DIRECTOR OF TAX RESEARCH, TREASURY DEPARTMENT The CHAIRMAN. Mr. Blough, you may go ahead with your state ment. Mr. BLOUGH. Mr. Chairman and gentlemen of the committee; some very interesting and, no doubt, very impressive fiscal and economic arguments have been presented to the committee by those in opposition to eliminating the tax exemption of interest on future issues of governmental securities. The validity of these arguments depends on the correctness of the facts supporting them. We believe that some of the facts presented to the committee contain serious errors. It is my purpose to point out certain of the more significant of these errors, as well as to bring to the committee's attention certain other important facts that have been overlooked. We believe that the correct factual picture will reveal some of the arguments advanced against eliminating tax exemption to be groundless and others to be of little significance. In his statement to this committee, made on January 18, Mr. Hanes pointed out that one of the most important evils of exempting the interest on governmental securities from taxation is its effect in nullifying the progressive income-tax system. Opponents of taxing governmental interest have contested this position. The most eleborate argument was made by Professor Lutz, who voiced three contentions. First, that "the emphasis on progression and ability to pay" is being overstressed; Second, that progressive taxation has already been departed from in the special taxation of capital gains and in the treatment of charitable contributions; and Third, that not enough people stand to gain from the purchase of tax-exempt securities to make any resulting breach of the progressive income tax significant. The last bears on the point that you mentioned, Mr. Chairman. With regard to the argument that too much emphasis is already given to progressive taxation, it must be agreed that this is fundamentally a matter of opinion. However, it has long been felt by most students of taxation that entirely too little emphasis has been placed on taxes that take into consideration the taxpaying ability of the individual. In the total Federal, State, and local tax system, yielding approximately $13,000,000,000, only 10 percent is derived from progressive taxes imposed on individual incomes. The argument that Congress has already departed from the progressive principle in the taxation of capital gains and the allowance of deductions for charitable contributions overlooks certain facts. Capital gains are not subject to lower rates of taxation if they are derived from assets held for not more than 18 months. It is only when assets are held for a period of years and the imposition of the regular scale of rates would place upon them an unreasonably high tax rate, considering the period of time over which the gain accrued, that lower rates are provided. Thus, one of the purposes of the special treatment of capital gains is to preserve and not to destroy the fair application of the progressive principle. In the case of gifts to charity, it should be noted that the individual does not receive the direct benefit of the income which he gives away. Accordingly, allowing such gifts as a deduction within limits is really an extension of the deductions from income of costs to the individual. Since the individual does not enjoy the direct use of the funds he has given, there is no abrogation of the progressive income tax principle. To support the third argument, namely, that very few persons can gain from the purchase of tax-exempt securities, Professor Lutz introduced a table which purported to show that a person would need to have an income of about $60,000 before he would gain more in taxes saved than he sacrificed in a lower interest yield on tax-exempt securities. He stated that there are only about 13,000 people receiving incomes of that magnitude. The committee will recall that the Under Secretary pointed out that anyone with a surtax net income of more than $18,000, which means a total net income of approximately $20,000, can derive a net tax advantage from buying tax-exempt securities and that in 1936 there were nearly 100,000 such persons. There are two reasons for the disagreement between the figures presented by the Under Secretary and those presented by Professor Lutz. In part, it arises from differences in the interest differential assumed to result from tax exemption. This, however, explains only a minor part of the disagreement, because, even if the interest differential of six-tenths of 1 percent proposed by Professor Lutz is accepted, persons who have incomes of about $35,000 or over would stand to derive a net gain from tax exemption. Senator AUSTIN. How do you account for the difference between Professor Lutz's statement and yours? Mr. BLOUGH. I think that is taken up in the next paragraph, if I may read it. The second and more important difference arises from unreasonable assumptions regarding individual incomes. That is, in the $18,000 figure presented by the Under Secretary, a differential of substantially three-eighths of 1 percent, halfway between one-quarter and one-half, was accepted. The second and more important difference arises from unreasonable assumptions regarding individual incomes. The CHAIRMAN. Before you leave three-eighths and six-tenths percent, what figures do you have to support your figure as against Professor Lutz? Mr. BLOUGH. If it please the committee, Mr. Murphy, who is coming after me, is going into that. The CHAIRMAN. Very well. Mr. BLOUGH. Professor Lutz, in referring to the total income of an individual, ignored the wholly tax-exempt income. In doing so, he eliminated an undetermined but probably quite substantial number of people who had incomes of considerable size, which they derived largely from tax-exempt securities. More important, Professor Lutz based his computations on the assumption that an individual would derive either all or none of his income from tax-exempt securities. However, a person would not ordinarily invest all of his capital in tax-exempt securities. He might be in position to gain by the purchase of only a small amount. On the other hand, he would scarcely purchase them beyond the point where they brought him a net gain. As previously indicated, this point is about $20,000 net income, if an interest differential of three-eighths of 1 percent is assumed, and about $35,000 if a differential of six-tenths of 1 percent is assumed. To show the effects of investing various portions of one's capital in tax-exempt securities, we have prepared a table covering a number of income levels which we should like to have introduced into the record at this point. Senator TOWNSEND. Have you any figures showing how many incomes there were in excess of $1,000,000? Mr. BLOUGH. Yes, sir; the figures for 1936 are right here; a very small number 61. Senator TOWNSEND. Then they have taken account of them with a million dollars income? Mr. BLOUGH. Yes, sir. It has been assumed that if the wholly tax-exempt interest they reported had been taxable, they would have received 15 percent more interest than they received under present conditions. This 15 percent was derived by taking a point halfway between the one-fourth percent differential and the one-half percent differential, and relating it to a tax-exempt interest rate of 2% percent. In other words, it is threeeighths of 1 percent interest differential expressed as a percentage of a 21⁄2 percent interest rate. (The table referred to follows:) EXHIBIT A. INDIVIDUAL INCOME TAX Net income after tax under present law and net income after tax under a proposal that interest on Government obligations be made taxable, for selected levels of net income and according to the relation of interest on Government obligations to total selected net income 1 Assuming that the maximum earned income credit is taken, that no interest is received from partially tax-exempt Government obligations, that no capital gain or loss is sustained, and that, under the proposal, the interest yield on Government obligations will increase 15 percent. Net income after tax under present law and net income after tax under a proposal that interest on Government obligations be made taxable, for selected levels of net income and according to the relation of interest on Government obligations to total selected net income.-Continued. NET INCOME AFTER TAX UNDER THE PROPOSAL THAT INTEREST ON GOVERNMENT OBLIGATIONS BE MADE TAXABLE RELATION OF NET INCOME AFTER TAX UNDER PRESENT LAW TO NET INCOME AFTER TAX UNDER THE PROPOSAL The table shows clearly the advantage or disadvantage of investing various portions of one's assets in tax-exempt securities for persons at different levels of income. It shows that individuals with moderatesize incomes cannot now avail themselves of investments in public securities. Senator TOWNSEND. You begin at $5,000? Mr. BLOUGH. We begin at $5,000 and we go on up. Now, if these men invested some money in tax-exempt securities, how much money would they have left? Take the first man, if he invested nothing in tax-exempts, he would have $4,920 left. But if he invested 50 percent in tax-exempts, he would have all of his $5,000 left. Take the first man with a million, he would have approximately The CHAIRMAN. That is after payment of the tax? Mr. BLOUGH. That is after payment of the income tax. Senator TOWNSEND. You say here, he would have three hundred and twenty-one thousand left. You mean by that that he pays the difference between the million dollars and this sum in tax? Mr. BLOUGH. That is correct. The $679,000 would go in tax. Mr. BLOUGH. Now, suppose he was getting 10 percent of his income from tax-exempt securities and 90 percent from other sources, in the case of the man with a $5,000 income, there is little change. In the case of the man with the million-dollar income, he would have $397,000 left. He would have made a substantial saving there. The CHAIRMAN. A little over $70,000. Mr. BLOUGH. Yes, sir. That does not represent exactly a net saving of this amount. Next, we go over on across here, showing what the amount would be if he received 25 percent, 50 percent, 75 percent, and on to 100 percent of his income from tax-exempt securities. Of course, if he had all of his income from tax-exempt securities, he would have all of it left, and there would be nothing paid in tax; that is, paying no attention to any interest differential. That is just assuming he received a certain portion of his income in tax-exempt securities. Now, shall I go on to the second bank? The CHAIRMAN. Yes. I think I have the first one. Mr. BLOUGH. The second bank says: "Net income after tax under the proposal that interest on Government obligations be made taxable." Now if interest from these tax-exempt public securities became taxable, we would have to give the men some additional interest, and we figured that interest at 15 percent more than he was getting. We are using the three-eights differential on a fully tax-exempt security mentioned in connection with the first table. Mr. Murphy will explain how we arrived at that, and that is about 15 percent of the total interest from totally tax-exempt securities on the first table. We say, if these securities are all taxable, the man would receive some additional interest, and show that at 15 percent interest. Do I make myself clear? The CHAIRMAN. You assume by that that there would be an average rise in cost to the State and local governments of 15 percent over and above the present interest rate that is charged on those securities? Mr. BLOUGH. That is the basis on which this computation is made. The CHAIRMAN. In other words, the 2 percent rate, you figure, would be 2.15? Mr. BLOUGH. No; it would be 2.30. There is some question as to whether that 15 percent should be applied to the 3 and 4 percent, but, to make our aggregate somewhere within the range of simplicity, we have applied that throughout. Senator AUSTIN. Just a moment there. Now, is it correct to interpret that 15 percent in this way, under the proposal that the yield on Government obligations would increase 15 percent? Mr. BLOUGH. That is the basis on which it is computed? Senator TOWNSEND. From what experience do you arrive at that figure? Mr. BLOUGH. I would prefer that you go into that with Mr. Murphy. Senator TowWNSEND. I will not press that question. The CHAIRMAN. We will assume that there will be a 15-percent increase in interest costs. Mr. BLOUGH. Now, we have arranged it this way. |