PROCEEDINGS OF

A SYMPOSIUM ON INDUSTRY AND NATIONAL DEFENSE

August 15. 1940

Waldorf-Astoria Hotel

New York City

SponsoredBy The TAX FOUNDATION, INC. 30 Rockefeller Plaza New York. N. Y. s'(\~

TABLE OF CONTENTS

Page

},1orning Session

Introductory Remarks and Address. "Clarif~ring the National Defense Problem." by Lewi s H. Brown ! 1

Addre~s. "A Review of Washington Developments," by Ellswortll C. Alvord 10

Address, "Emergency Taxation; and tl}.e National Econo~," py Dr. Alfred G. Buehler 15

Address, "Appropriate Yardsticks for Determining Normal Profits," by F. P. ~erly 25

Address, "Administrative Problems of an Excess Profits Tax." b~r Robert ~T. Miller 32

Afternoon Session

Address. "Industry's Responsibility and the National ~fense Program." by Philip D. Reed """"""".."'" 44

Address. "Recovery of Costs," by L. C. Weiss , 51

Address. "Administrative Problems Under Prior La'.vs and New Proposals, " bv" L. H. Parlcer , 60

,

==.,,~- ~"~" "",- MORNING SESSION

A Conference on Industry and National Defense. sponsored by the Tax

Foundation. Inc., 3a Rockefeller Plaza, New York City, convened at the Waldorf- Astoria Hotel, New York City, on August 15. 194a, at lO:la a.m,. Mr. Ellsworth C. Alvord presiding. MR. LEWIS H. BROWN (President, Johns..Manville CoI):)orat1on, and Chairman,

The ~ax Foundation, Inc.): Gentlemen: We will call this conference and symposium to order and get stai'ted, so that we can finish, we hope, on schedule.

Let me sB:y' first that this conference started out at the request of some of the officers of the lai'ger corporations of the country, who said that we wore in a tangle and needod to clarify the thiliking of industi'y about some of these national lefenso problems. And we oxpectod to havo about twonty~fivo experts sit around a little tablo and spend a day in discussion of this subject. Now, the matter apparently was of such great interest that one corpora- tion aftor another said they would liko to have representation. and we finally haa over two hundred acceptances and had to enlarge our idea of tho littlo conforencG tab1c discussion and move into a J.argor room, We are very happy, however, to havo so many representatives hero to take part in this diecussion. It is going to bo il1forma1 in nature. There are no roporters present. It is a symposium of industry at \vhich we want you to take part in tho discussion. Wc have ai'ranged for a certain number of spoakers to set the basic outline of the problem, but we are goipg to have diecussion from the floor and wo want you to fecl free to raise questions of anf character tr~t have a bearing on this main point, and to ask the Chairman or any of these oxperts to expross viewpQints that may h~lp to clarify your thinking.

I think it is gonorally undorstood by industry that this problem is of groat importance, and I think as evidence of that is the fact that you men havo come from all O~Ter the country in hot A\~lst weather, a\vay from your vacations in many instances, in order to take part in this important disc1J.ssion and, if possible. to make a contr~bution of tho thinking of the country as to what we should do about it. First I would li1;:e to say just [\, word as to why tho Tax Foundation has cL~led this meeting. !t was at the direct request of many of the Foundation's mcmbcrs, even though it falls some,vhat outside tho scope of the Foundation's p11.rposes. The 'I'!:1.xFoundation has been engaged for tho past two years or mora, as many of you 10lOW, in a rather specialized study of probloms of taxation as

1... I these affect the future of industry and the l~~tional economy. And for the . benefit of those who may not be familiar with its work, let me add that the

approach to these problems on the part of the Tax Foundation is completely objective, non~partisan, and non-politicAl, and is supported as a public service that is intended to bo thoroughly constructive in character.

The Foundation is primarily a coordinating agency. It is striving to bring some kind of order o~t of tho present chaos that has arisen from the taxing

activitics of l75,QQQ d~fforont governmental units which, takon togethor, aro now spending close to 3~ per cent of our entire national income. It is assisting local and state organizations and many different voluntecr citizcns' groups,

helping them to establish, stato by state, co~nty by county, community by community, at the vary grass roots of our national life, more efficient adminis- trativo procedures and sounder fiscal policies \~ich are no\v recognized as being vital in safeguarding America's economic future, With activities spread over this wide front, the Foundation has until

!"'.ow not concerncd itsolf with that other equally important half of the tax problem, Federal financcs. However, during recent weeks, as a result of the national defense crisos, this situation has been profow1dly alterod. Congress is being called upon to make unprecedented appropriEl.tions of morc th~ ton billions to strengthen the national defense. It is estimated that bcfore this

program of IlL'"J.tioMl defense is completed, the original cost of equipping this CO1Ultry and tho cost of ITI.airJ.tenance ",rill, over a period of the ncxt ten years, cost us porhaps fifty billions of dollars. The economic consoquoncos of those huge expcnditures are bo1Uld to have sha~ repercussions upon our national

economy. One of indust~J I s present tasl~s is to ar~yze and pr~are for such

future eventualities. Our main objective is to help this co~ntry prqparo. p~d that is the main problem. Now, those problems appear to me to consist of !I,bout four elements. First, a sudden expansion in the Governrllent' s requirements of indus-

trial products for natioruJl defense. And. this includes the necessity for

determining just what products are wanted, what the specifications of those products DXC. and f.-hat quantities will be required.

$econd, the ilocessi ty for indust~. to co11vcrt or provide with great expedition the nocessary production fa,cilities in order to turn out these requiroments of tho Govornmont.

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-. -- ~- ~ Third. a reasonable and equitable c.ivision of responsibility betwoen Government and industry before the program is undertaken, so that there may result a realistic solution to the huge financing problem imposed by the expenditures required. which concerns both the furnishing of funds and tho control of oxpenditures once the program gets under way. And fourth. the assumption by Government and industry of the responsi- bilities and ri sl:s that properly fall wi thin the area of each. I think in this program thero are certain dangors to industry that neod to be considorod. The new taxes vlhich Congress is now considcring to finance this gigantic roarmarnent program will fall primaril~r upon industry. Mora than ever. it is vital that these taxes should not unduly penalize or : I handicap industry, for the defense bill. huge as it is. can only be paid out of ! an expanding oconomy. out of a greater national income. which in tho last analysis it is up to industry to provide. And it would seam obvious that to expand the economy and to provide this greater national incomc. businoss must bo givon a green light to go ahead. In an oconomic system based 11pon free entcrprise. it now bccomos doubly important to ~'omovc. as far as possible. those dctorrcnts to the profit il~ontivo on ,vhich the system depends for its real motive po,vor. Unfortur~atoly. those who determine tho nation.s fiscal policies too soldom rocognizc that itidustry is already paying in one form or another virtually 75 par cont of tho nation's total tax bill, lodoral. stf'.te and local. And under the nation!1l defonse ffiaorgency thnt percontago is bound to bc ir!creascd.

For cxamplo. the proposal recommended by the SUbcommitteo of tho House Ways and Means Cowilittce. and now being considered by the Joint House and Senate Committee. will take from a corporation's income. once it is subjoct to the 40 per cent excess profits tax, 52 cents out of each additional dollar of profits earned. Thi s moans roughly that if a typical average company i s to oven main~

tain for 1941 the same :-.et profit that it had in 1940, it must increase its incomo before taxos by from 10 to 30 per COtit ovcr its best yoar in tho 1936-1939 poriod-~in other words. the base period to be used in computing excoss or normal profits. In other \vords. what industry is concerned ,\'ith is not the problem of m~ting profits; it is concerned with the problem of avoiding lo3ses. No,v. it is not my purpose to oA~lain how these taxos will affoct industry or tho national economy. for cert~in1y I ~ not a tax expert but mcrely

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- ---~~ ~~= c- - ~ a business man like yourselves, confronted \nth this problem. And I Shall leave

the explanation of these technical points to the experts on tode¥'s program, which I Shall turn o\'er in a raoment to Mr. Ells\vorth Alvord, one of the outstand-

ing experts in this count~r in taxation, who will be Chairman of this meeting for the balance of the day.

What I ~'ould like to do is confine myself to commenting briefly on certain general phases of the present situation which seem to me to be exceed- ingly grave. The first of these is tho possj.bility of inflation. We must avoid at all costs being projected into a ne,v inflationary cycle, for ,~ich there are now at hand all the necessary ingredients. And certainly we remember our experience in the last war, when tho price index of commodities mountcd to 25~, and where we had all the problems of rising prices, rising costs, rising wages, to go through, and then the readjustment that was necessary after the war, We ccrtainly want to avoid that if we possibly can in this poriod that lies ahead.

And yet, there arc on hand at tho present time the elements that might well makc such &~ inflatiol1ary cycle, \vhich would be very serious to the future of this country. In addition to the present deficit financing by the Government, tho armament program e.lone will inject into tho economy additional Federal expendi- tures which for an indefiJ.1ite period will total more than four hundrcd million dollars a month, on top of what we have been spending. And furthermore, many of the taxes which are no\v being leviod upon j.ndustry can .only be rogardod as ta.~es on production. They add to tho industrial costs, and thus they must bc passed on to the conS'U.Iner in tho form of higher prices. Mvancing prices cause manufacturers to hedge contracts and prospective sales by increasing inventories. And lilcewise disrupted end in an uncertain position are raw material supplies dra\vn from belligerent and other foreign countries. Unprecedel1ted ba.llk reserves make possible an unlimited credit ox:pansion based upon Government contracts to industry. And, not,vithstanding the fact that WPA funds are being increased from O11e billion to a billion four hundred million to provide for a prospective risc in unemployment this fall, there is today, particularly in many skilled trades, a gro,ving labor shortage which can quic?~y be translatod into deffir~~ds for higher \vages. l~ot only must 'va recognize the Pl'oscnce of theso factors \vhich tend to~,ards inflation, but equally the important f~.ct that under existing Governmont regulatory controls industr~r is no long~r e.blo to deDI ,v1th those forces

,..~ effectively. Govcrnmont supervi sion over busir..ess activi ti es has already reEl,chad tho point where industry cannot control its own production costs, labor costs, or, in many instances, even the prices of its products, ru1d these are all within tho new orbits of governmental action; while, under the tax meast~es now pending. even thc legitimate profits of industry ara being questioned and are to bo mado to conform to What are nothing less than arbitrary legislative yardsticks. The result is thl.\t our national economy, "hich Wf),Sformerly clastic and flexible in meetj.!Jg rapidly changing conditions, is tending to become more a."ld more rigid and difficult to adjust to the ebb and no" of the business tide. As industry ~s dependence on Government has gro,,'!1, it he,s become mora rather than less vulnerable to influences that are political r[~ther than economic in character. ~he prosent controversy in Washington over the recovery of costs by industry in connection with the establishlllent of emergency .armament plants, and over what shall be the dividing line oetwecn normal and excess profits, illustrates the point that political rather than economic factors are dotcrmining ,'!hat ,...0should do to bring about a proper solution to this defense problom. k~d it should not be political factors. We Should ke~ our mind definitely on thc end result, which is quicl: and adequate defanse. No", these factors. from the standpoint of industry, are t,vo sevarate problems which arc only incidentally related; yet Washington insists on joining thom as if they wore Siamese twins. The quostiO11 of recovery of costs through amortization affects only companies which must expar.d their facilities in order to meet the requirements set ~p by the Defense Advisory Commission. It would scem only common sensa that the cost of tho pla11t built oS!:>ecially to produce war supplies should be just as much a part of tho dofense oxpenditure as tho guns or tanks or other equipment it is designed to manufacture. The excess profits tax, on the other hand, affects all business irrcspective of defense contracts. The vast majority of industrial companies will bonefit only indirectly I:1.Sthe Govornment' s increased spending expands consumor purchas... ing pov,or. We aro naturally concerned over tho delays which have arisen as a rosult of the insistence of Administration officials that thoso two situations be joined in tho pending tax bill. But what is much more serious, in my view, is the possibility that in an election year an attempt may be made to blame industry for this production slo,~down simply because business men have been

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.. -"--~~- - - '" ~,,- ~ ~ _Co" al1Xious that thoir relationships with Government should bo placod upon a practi~ cal, common sense business basis, and bccausc businass non have been dctormined to tr:>T to avoid the economic inflationary tendencies of the last war, ,,:,ith the subsequent dangcr of another dcprossion breakdo\vn that nny \'rall spell the end of the froc privata enterpriso business systcm.

On thoso mattors, which wo are to examino into today, it is important t~~t the position of industry bc made thoroughly cloar to the public. There must bo no room for oithor misundcrstandings or possibly lator recriminations, or for any rovival of that anciont Army practico of "passing the buck." Thcro is no qucstiOll about industry's \villingness to co~eratc. All that industry asks today is a cloar~cut fornulation of the rules under which it can cooporato in the defcnse progra~. Once those are reduced to tangible and practical form, industry will turn in a porformmlce rccord ,'mich will shattor all prcvious precedents. No ousinoss man with an ounco of patriotism \vishas to profiteer at tho oxpense of the nation's necossity. All that businoss soeks in the way of cornponsation is that ninimum of ratum which will produce the maximUM effective functioning of tho ontc~riso systan. Limitations on profits undor contracts awarded by tha ArMY and Navy D~artments havo bean choerfully acceptod by business, and so have the tarns of the Vinson~Tr~.1mell Act. Many business Den may foel that tho profit percontages sot by the Govorn~ont are not comJonsurate vlith tho risks assumed, but they have bean acccptod without protest, for tho simple roason that evory Ai:1crican business man today ra~ards it as his prioary duty to do ovorything in his po?:er to mako America impregnable to any foreign attack, ,vhethor fr~ Europoan dictators or othor quarters. And for these reasons industry today acccpts the nocessity of an excess profits tax, oven though it boliavos that tho principle of such a tt;!,X j.s in i tsalf a dcterrent to full business rocovory. Tho quostion has been magnified, in my opinion, out of all proportion to its true relationship to the defonse progrOCl. This is shown by the fA.ct that one of the ~roasury's leading experts, when tostifying befol"O tho Joint Coml!1ittee hoarings at Washington last weak, conceded that tho 1941 yield from this tax would fall short of throo hundrcd nillions, a ncrc drop in tho bucket against what tho nation is sotting out to spend to achiove ~ilitA.ry and nnval security. If tho tAXation progrD.'!1 ntta-npts to confiscata lU1 o.bnomal portion of profits, there hns boon destroyod the incontivo to lower costs and improved

~~ operatint; efficiencios. And once this incentive has baen lost, ,ve have lost one of tho pl"ime automatic controls of the competitive system, a.nd.have gone a long wa~rin the direction of dostroying the basic elements of tho froo privata enter- prise business s~Tstcm. What is the alternative? Well, '~e hear a lot from the burcaucrate in Washington who threaton that, unloss business will immediately taka contracts ,vithout adeqtk~to provision for ~~ortization or financing, or tako contracts throUf?jl a more latter ,,1 thout even having prices deteminoo. or Any othor of the conditions, Governmcnt ,~ill take over business and operate the plants to mako munitions for defense. No\~, that is the kind of silly, childiSh talk that threatens to hold up indofinitely our defonse program. What we neod is great national unity, with Govor~ent and business each assigned to its taslc to do its part, and m. th an understanding on both sides as to how the system must \,ork in order to get effective results. In othel" words, we must raake the first order of business the bringing about of adequate defense, and eve17thil~ else must move aside in favor of that. :Even Mr. Hitler, the Munich paperhanger, ~"1deretood that first things must come first. He kept his eye on the objective of gettiryg supplies for his army. He certainly had tho po,ver to take over and operate industry over there, but he knew that industry had the "know how" and that his Nazi Party men did not know how. If the Government were to Quild munition plants, the Government would of course have to pay for them. Ins.tead, he got industry to do the job by letting them charge off the cost of the plants as amortization in as short a time as they wished, and then, having quicltly gotten the plants into production and the flo'~ of supplies for his army coming out of thom, he levied increasingly heavy taxes on all but the most nominal of profits. Hel"O in this country, ho,vever, we hold up production for defense for three months, and maybe more. so that \~e can impress everyone with the sad news as to how heavy the excess profits taxes are going to boo and to malce it very clear that there is not going to be any profit incentive in war \~rk, thus effectively removing tho carburotor from our freo private ontorprisc machine. And thus again those petty prejudices agaj.nst business in high places ,vork to prevent tho accompliShment of the main objective, ,vhich is preparodnoss for national defense. Tho rcal bottlenecl~ at Washillgton, as is generally recognizod, arises from the various proposals advanced for amortization of costs of emergency

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i , "-'--'C~ d I I armament plants. Here industry has meroly asked that it be protected against capi tal loss. That \vould certainly seem to be a ree.sonable request. Tho proposal that the cost of plants which have a temporary military value and cannot be convertcd to subsequent industri,~l peacetime use should be charged off within the 'period of their productivc life, \vould appear to be both practical and fair. ~o alternative suggosted, that a company be permitted to reopen its tax returns for preceding years, during which time it may havo had either no profits or subnormal profits, in order to write off unamortized capital inyestmonts, would ~ppoar to set up undue haznrds and penal ties ,mich are hnndicaps to that quick expansion of production ,vhich is no\v SO necessary for national defense. And I think in addition, in the minds of a good many business men that went through the period of the last war, is the recognition that this reopening of returns or trying to deal with Government officials on a matter of this kind after the war, is e. rather sorry oxperience.

Finally, I ,vould like to emphasize tho basic difference botwoen the ordinary commerci~"l business undertaken by the average industrial concern and the type of business undertaken undor the defense program. It is only by a clear undorstanding of these differences that the benefits and economies of the presont froe enterprise system can be utilized. It must be understood that the role of the purchaser, usually performed by hundreds of thousands of individuals throughout the nation, is hero entirely ~~thin the hands of ono agency, the Government. The Governmoot's responsibility essontially is to socure what is wantod in tho most economical way and to assess the costs of tho progrron to tho various p,~rts of the nationDl economy fairlJr and cqui tably.

The part that individual industrial concerns should play is not to assume the trcmendous hazards involved in making plant outlays for a hugo current production, l'ogardless of the continuation of such roquirements. Their part is rather to assumo the risks and hazards involved in raeeting promises to provide the required products on the most economiccl basis from E\, cost sta.YJ.dpoint. There is plenty of hazard and risk in tho latter to challenge tho most alort business man.

~e nation.9l gover11lncnt must determine what manufactured articles arc required and in ,vh~t quantity, in order to assure that individual industrial concerns ,rlll provide the facilities to produce these articlcs. And they should also make certain that the finished articles \vill bo provided at a minimum of cost. Particularly in the latter respect is it dosirable for the Government to

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; I - --7 ---~ - ~- _c, = ~~ ~ crCD.te a procurcmer.t policy th~,t will permit adequate reliance upon the profit motive in kocping down production costs. for the latter is more certain and powcrful than tho relianco upon patriotism alone. This involvos a verJ dolicato bnlancing oetwoen tho safeguards that will koep individual negotiated contract prices within rcasonable limits and. at the same time. that ,rill give tho industrial r.1anager a real incentive to apply his usual peacetime ingenuity and skill in devising tho most e conomic-'ll way of meeting the probler:1. And finally, we come to industry's part. Normally capitRl and manage~ ~ont do trlree things. They provide the necessary capital and facili tics to produco the product. ~noy provide tho talent required to manufacture and soll tho product. And they t~e the risks inhere~t in both the financing and produc- tion of the product. Private capital is undou9tedly ready. in most instances. to furniSh these neccssaIJ' special facilities.if the Gover!"1mentwill take a reasonable position in indic~ting the eoctent to Which it. as the sole purchaser. ~nll utilizo these facilities for a reasonable period. or at any rate permit their costs to be recovered. Industrial managmnent c&~ be d~ended upon to produce tho product oconomicclly and expeditiously. if it can be cllowod to concontrate ~on this problem and socure a nonnal minimum roturn for its f~~ction. As to the risks. there are plenty of risks for the individual enter~ prise to assume in mooting the promis$s inhercnt in the signing of contracts that proDise to prodl.).ce goods at a E,;iv~n price and wi thin a given timc. If ~~~agcment can be assured of a minimum return for this function. plus BODOpart of any cost savings that can be brought c.bout through increased efficiencies. then it se~6 clear thc.t the progr~.1 can go forward on a reasonably expcditious basi s. And. in my jud~ent. there is nothing L1ore important than trJing to make cle~r not only to tho poople in WaShington but to tho Ar,1erican public the fact thn t American business is not 'concerned in thi s r~1attor Moth tho m~ing of profits, it is cor.cernod with the problem of trying to avoid capita.llosses. And. above all, it is trying to get this defGnsGprogr~,1 under way so that wc in this country. in the months or years that lie ahead. will not find ourselves in thE) posi tion of France. inadeqUc"1.tcly prepared to meat the condi tions that may confront us, and as a result lose everything that is precious to the American ~ paoplc and to all of us. ~

And no",. without further words, 1: would lilce to introduce Mr. Ellsworth I!.

-9... I i I Ji.lvord, one of the outstanding tax experts of tho country and a forr:1or a,dviser to tho Government in Washington, who will act as Chair~an of this ~ceting, will introduce the othor speakcrs nnd conduct your progran. Mr. Alvordl (Applause) CHAIRMANALVORD: Gontlomon: I am personally mora concornod with broad probloms than I aJ:l rlith tho provisions of al"1.Yparticular tax measurc, including the one that is no\v pcnding in Washington. A national defenso program, we all l~no\v, is a. very sorious, huge undertaking. Fror.1 tho tochnical l::1ili tary aspcct, I Itnow nothing. From the financial aspcct, I suspect I know nothing. Broadly spcaking, I supposo t~.at a national defonse program rJould 00 classifiod-about as follows: First, \~'e nocd an adoquate military, naval, and air forco, adequately oquipped and fully r,1annod. Second, we neod an industrial production \Wlich \~1ll p'roduce all the requireocnts of the adoquate military, naval, and air forco and maintain it. ~ird--and this problem hasn't been discussed very much, if at all-- \~e need some means by \miCh those not directly ongaged in tho national defense progr~ can carryon in ~:hat we might call peacetime activities, because that is the group that is going to pay. If that group diminishes, payment must be sought from other sources.

From a financial point of vie\v, I would divide our problons about as

follows:

~irst, we f;1USt fin&~co the cost of acquisition of our fully equipped, fully manned array, navy, and air force. Second, we must finance tho cost of r.laint~ining our fully equipped and fully manned army, navy, and air force. Third, we ~ust finance those facilities which will contribute to the national defense progrwu and those facilities \mich ~re not so directly involved in the national dofonse progrwn.

I will meroly givo you a few figures. So far tho Congress has appro- priated $l4,70~,~~~,O~~ in an offort to acquire tho natiol~l defense army, navy. and air force. Thero r.ave boon no official ostirJatos that I havo soen ~!i th respoct to cost of r~aintenance. I havc TJado soma guesses thnt are necessarily rough, but if I have erred, I thinl~ I havo errod on tho side of co:1servatism, \~,nich is probabq on the wrong side. But my guoss is, s,ftor you have R.cquircd your completed army,

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--- ~- ~ -- navy, and air I~orce, and if you continue on \vith YO1~ present Government non- defonse oxpendituros, your annual budgct ,rlll bo about fiftocn billions of dollars. In my fii'teen billion dollar estimate I have done the same thing ,vhich Washington has done in its fourteen billion seven hundred million estimate; I have omitted those matters which we all kno~r ,vil1 come in the future. but Which have not yet been asked for. I moan, for examplo--and this is only ono examplo of many--the $14,700,OOO,~~Oappropriation, or series of ~propriations. calls for twenty...threc thousand airplanos. We havo hoard frequent reforences to an air forco of fifty thousand planes. I don't lcnow whero the rest of the program is or what it is, and I don't know ~:hcre the financial program is or what it is. Of me thing I am very certain, that somo d~ vcry soon somebody must sit down and attompt to plan just how ,vo arc going to finance the national defense program, how \ve are going to finance its maintenance, and how we are going to finance the expansion of private industry. I suggcst that that program might well talre into considGration a threotold ora ,vhich I think wo arc facing. Wo now are certainly facing the first t~,o stages. We soo ourselves being convertod from a poacetimo economy into an armamont econom~r. Then \ve l:now there will be a period of time in \Vhich the armament economy prevails; how long, \VO don't know. Thcn. I hopo t:~crc will come a time \'non wc arc again convcrtcd from an armament economy into a peacetime oconomy. Certainly Whatevor financial program we devi se now ought to be ~:eighed wi th a rcasonably l~cen apprecia ti on of its effect upon o~ch of those throe eras~ Coming more imr.1ediately to the excess profits tax, I suspect that there is no one hero, includil'lg I..1yself. who h~s much of an idea \mat the excess profits tax bill will contain. Wo have a few general statomcnts. We have a few general purposes. Last Friday, a report of the Subco~~ittee of the Co~ittee on Ways and Means was r:1adepublic at 10 0 'clock in the morning. At exactly the same timo the hearings began. The proposals were threefold; (1) A provision for ~~ortization; (2) an excess profits tax; and (3) the suspension of the Vinson- Trammoll Act. The Govcr~~ent officials appoarod on Friday, and I Crol generalize their position. It was about ).ike thi s. 'l'hc Treasury said, "First, \'.'0 !:1ust got rovonue frolJ thi s excess profits tax."

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--~--~-==~~=~ No~', they didnlt say so.publicly, but it has been gonerally rumored in Washington that the Troasury had a progra~ undor which it c~ected to raise

through an excess profits tax a m~imuo of two billion dollars. ~hoir minimum propos?~, according to newspaper roports. was, I thiruc, sovon hundred and fifty I million.

rr'rea6ur.r pronouncQ!:1cnt nu.~ber two: "Wo ::lust not intorfero with r private entorpriso."

This they didn't say: "Whether wa liko it or not, ,vc havc got to roly : upon private entcrpri so to pl~~ a very important part in tho national dofense prograD.1I Nor did thcy sv::{ that "We think that private ontel1Jriso should be financed privatoly." The officials chal'ged ,vi th tho nntional dcfcnse progra~ then ~poarcd. I l~eroly sumuarizo ,vhat I got out of their appoarances; and I ~aJ quote theo inaccurately, in my attoDpt to sUmDarize briefly. Nur.1berone: "\10 cannot go aholld on our nationc~l defense progra~ until industry becoDes advisod spccifically with respoct to aoortization.I' Nuober two: "We thilll~ industry will not go ahoad unless they know with reasonablc certainty beforo thqy ontor into national defonse contracts what their liabilities will be under the proposed excess profits tax." Nuqbor three: "We do not bl~~e Govor~~cnt departments. ,~!Odo not bl&~e industry. we do not blame Qoni,ress fo~ the delays that have been encoun- tered. We are merely stating facts." Certainly they can't blame Congress, at lel:1.st with respect to tho cxcoss profits tax, becausc about eight wcoks ago the Co~ittae on Ways and Mev.ns i announced that there would be e~~excess profits tax enacted at tho noxt session! of Congress ,vhich Di&~t bo appliod rotrollctivOly; wbothor it should be or not, thoy would decido noxt Januar.r, I About sovon ~'eeks ?~O, the Socretllr.r of the Troasury Ilnnouncod that thls. program met ,vi th the approval ~~d the pl~surc of tho Prosidont. i

About six ivoolcsago, the confol'ees on the Rcvcnuo Act of 1940. ,vhich, I

i as you gontlomcn }:now, was dosignod, the TreaS11rY told us, to finance tho nation- I al dcfonso prograr.1 as it had then bean preparod. annou.'1ced that "We havo i i instruc.tod the cxperts of the Cong'J;essf".i1d tho Trcnsury to prepare an e~rcess profits tax and report back to tho Co~itteo on Ways and Moans and tho Co~~itteo on Finance on tl"le first of Octobor." Nov;, that takes care of tho situation eight woclcs ago And six wecl~s

...12-

---", ~-- ago. And then, about five ~Jooks ago, came an announce~ont from the White House saying a stc~ly graduated excess profits tax must be onactod at this session of Congress. ~~t statemont was made noti~ithstanding the fact that just ti~O wcoks before that--my periods of time might not be accurate to tho day--the Secretary of tho Treasury rn1nounced to the Co:mnittee on Finance thc~t he was authorizod to stato that tho progra~ of having tho experts pr~are an excoss profi ts t~~ and rqport back in Janue.ry of noxt year, had ~~o ~residont' s approval and tho frosidont was vory happy about it. So Congress now finds itself~-the reasons for its position haven't been proclaimed~~confronted with the necessity of pr~aring, drafting, consider- ing the intricate policies and problems of an excess profits tax, and completing the impossible tasl{ in probably three weeks I timG. All I Imoiv is that if the job of drafting that excess profits tax devolved in part upon me, I couldn't do that job in three wet;ksl time, even if somebodyhad long before pr~ared all the answors to the innumerable specific questions of policy. r am not going to explain the details of the proposal. I will ,just outline them to you, and I think their dotaiJ.s ivill be revealed as ive proc oed. If they ~.re not revealed sufficiently, it is either because they ~re not known or b~cause the spoaker has not had an opportunity or because you gentlemen have boon too modest. You can shoot all tho quostions at us you want. I alwe.ys reserve the right to confess I don't know. I wil~ give you just a little more history. The original Treasury program, according to tho ncivspapors, was to computc "normal profits" solely with roforencc to invostod capital. You soo, tho big job in an excess profits tax is to detormine ",rhat arc "normal profits." If i'IO can ~roe upon normal profits, then, so far as ! am concorncd, tho tax can talce a torl1ific slico of oxcoss profits, The Treasury proposed to determine normal profits by comp~ting the pre-wl:I-r rata of roturn upon invQstod capital. ! usa tho i~rord "pro...wa:r" ill-advis- edly, I hopo. Thoy callod 1936-37-38-39 a b~so pcriod, i'1ith 1940 bcing tho first tDXablo Y°:1.r. Th~y s,~id, "If your rate of roturn ivas in excess of ton por cont, we inll cut you down to t~1. If it was loss than four, wo i,nll take ~9u up to four. !l.d.' if you fell in between ton ffi1d four, ~!O will let you got wh~t your expert enco provod. !I

-13-

--c-c--c"" = It happened that tho staff of the Joint Committee didn't thirut that that mlS a fair measure of normal profits, and they preparod a plan to determine normal profits substantiEuly as follows: Take tho actu~l c~rnings of the four years 1936~37-38~39; realiZQ that '38 was a substantial loss year, and striko an avor~e of tl'lreo out of tho four yoars. That avorf1,ge will bo considorod normal profits. Further, they s~id, "For those co~orations \vhich in f~ct didn't exist or didn't realizo normal profits during th~t four-year p~riod, we will propare e~ alternate yardstick for normal profits. Wo willlat them compute their invested capital and give them an aight per cent return on it.1t ~e Treasury and the staff of the Joint Committee ~rere deadlockcd for a fow days. I think it is generally known that the Subcommittee report represents ~~in fact, it SO statos~~a compro~iso betwacn those two plans. Under the Sub- committae report it is proposed to use pre-war oarnings as one yardstick, but tho avorago of tr.e ontire four yee.rs 1936~1939, even though '38 was a bad year. Then, as an altcrnative this yardstick has bcen devis~d. We will take those profits in the pr~,var pcriod ~nd find out What return they gave on invested capital, e~d, dospite the fact that this duplicates tho e.varage earnings method,

V!o will take that return if it falls between ton per cent and four per cent of invested capital. We cut them down to ton per cent of invested capitDl if they Darn more than that, although of courso, if they did, they would taka the pre-war aarnlngs basis. We raisa thcm up to four PQr cent (six por cent up to $5~O.~O~ invested capital) if it is less than that, obviously because we think four por cont is a fair roturn.

"So," say the Troasury, "we shall disregard all history, ,vo shall not pay much attention to ,vhat wo learned in tho ~ar yoars, and we shall embark upon the policy of writing a now definition of invost~d capital. We have cloven times in tho last eight yee.rs revamped the dcfinitioA of not incomo, and we shall rovnmp it a li ttlo bit furthor. We shall avoid i~numere.blc p.~~inistrp.tive pl'ob- l~s by taking short-cut ~othods. We shall solve all the criticisms of all the prior excess profits taxes by boiTJog'al'bitrary." I tl'link our bast procodure will be to continuo on through the scheduled program, and then I hope wo Shall have timQ before lm-.ch for you to ask whatever questions you mD;:f ~isl'1 with respoct to tl'le excoss profits tax propos&.

We naturally have throe basic pro~lo~s. One I have reforrod to-- oconomic problQrns. ~o second, yardstick probloos. Tho third, administration. I II -14...

- -~~ c== Our progrom this morning is designed to presont, I suspect, not the answers, but at loast tho probler:1s in those three fields.

~ ~~ vary happy indoGd to present Professor Buehler, of the University of Pennsylv~~ia, as your first expert.

professor BuehlerJ (Applause) DR. ALFRED G. BUEHLER (Professor of Publ ic Finance, Uni versi ty of

Pennsylvania): Mr. Chairman, Gontlemen of the Confere11ce: I find that the remarks made by the two preceding speakers and some of cry remarks may possibly overlap. Taking the langu.'lg'o of the movies, ! might say that ~.ny referencos here to ramarks made by preccding speakers arc purely coincidental; they were not planned that way.

It sQGr:1ad to me, in considering the problem of the conforence, that perhaps I, as an economist, could make my contribution to best advantago if I prosQnted soma of the econor.lic fundamontals. I would like to start out with a briof resUlno~ of recent fin,c;'1.ncial oven ts. The fiscal ar.d oconomic aspects of our or:1orgency a~amont progra~ must be rolated to the prosent fiscal position of the Federal Govcrnmont espocially, and also to tho financial problems of tho state and local gova~~ents. The Sccretary of the ~reas'l;l,rY estimated the other dD:! tha.t FedarE1l expenditures

during the present fiscal ycar ,'fill bo approximatoly t,volve billion dollars. Revenues will be about six billion seven hUl1dred million dollars, f!.nd the dQficit about five 'b~llion three i~undrcd million dollars. By the end of the yoar, the Federal dabt ,nll he.ve climbed to about forty-nine billion dollars. In view of tho unscttled condition of world affairs today, of course, tho estimates are

obviously hi~ly tentativo~ The Federal fina~.cial picture has grown darker yoar by year. Tho fiscal ~rear 1940 closed with a deficit of threo billion six hundred million dolle,rs, ~'nd a debt of forty-four billion dollars. Expondituros were nino and a half billion dolll".rs, and rQvcnues a little under six billion. Yo.'J.r aftor year, since 1931, tho deficits have accumulated and the debt has mo~~ted.

~axes at best havo boon only six billion dollars a year, ~rhile expendi- tures have recently boon around nine billion dollars or more a year. In the new Revenue Act approxirJately a billion dollars in ne~' taxes arc provided. Tho chief sources of the new rovenuo will bc: The corporation income tax increases, about two hundred million dollars; the individual income tax increases~ thl"eO hundred seventy~five million dollars; gasoline and oils, ., \ -15...

= ====-- -- about one hundrcd twolve million; alcoholic bcvoragos, ono hundred twenty-two million.

FundaJnon~~l ~ac~2!:§ As the United States endeavors to recover the ground lost on the economic front during the early nineteen thirties and to advance a program of

social roforms, she finds herself an un,villing participant in the struggle be- tween tho totalitarian and the democratic powers. In attGnpting to evaluate the altornative methods of financing national defense, and their offocts ~pon tho economic organization. it is well to keop certain fundamental factors in mind. 1. The armaJl1ont program is for tho benefit of all, and all of us

~ould sh~re equitably in its cost. The word has gone from onc scction of the country to the othor that tho conscription for defenso must be univorsal, ,~ith man,materials and machines coordinatod in a mighw-cffort to defcnd tho nc'1tion against all aggressors. !n organizing the dofonse program, shall tho nation appeal to our patriotism, to our purses, or to both? War has not yet bccomo a

'business for tho America-,. peoplo. Labor, capital, and entorpriso should be rowarded fairly but not oxccssivcly for their scrvicos. Thoso in activo military scrvice should not be compcllcd to undorgo groater sacrifices tha~ those who engago in non-military pursuits. nor ffilould they be forced to accept lessor rewards.

2. Armament expenditures are ossontially an outlay for consumption. War is not productive in itsolf. It m~y protcct a nation's resources and pres0~ its oconomic, political. and social orge.nization, but it tends to cxhaust tho resourcos of tho con1batants. During the ~!ar one nation may rob ar.othor of its lands and its wealth, and the vanquished may be coerced into the payment of opprossive indemnitios, but the we!uth of society is not thercby increascd. In like man.'1cr. mile some of tho makers of armaIaents and certain of the producers of non-mil:itary commodities may exploit the commonwealth, while soma individuals may receive excessive rowards for their scrvices, and war voterans and thoir dependents ml'.Y obtain gonerous bonus and pension p!".yments. the society as a whole does not prosper because of war. l-:ational defensc is, indeed, vitally necossary. Yet it is primarily a con~ptivo, rather than a productive, employ- mont of men and materials.

3. Tod~r's arm~~ont costs must bo t10t from tod.ay's resourcos, so long as national dcfenso is financed intornally. Whethcr wc resort to borrowing, . paper money, forced labor. or to taxation to obtain our a~ancnt. it ,rlll be

-16-

--== ~ -~~_c 1 i

necessary to arm \rlth our present resourcos. We cannot fight today IS battles ?lith tomorrow's soldiers and tomorrow's guns. Ey the resort to expedients other than taxation, it may be possible to conceal the costs of armament and to avert particular taxes upon partic111ar groups. Eut these expedients will not make it possible to arm today with resources not yet created. It is wise, therefore. to face th~ situation intelligently and fra.'11dy and to meat as large a part of tho armamont costs as possible from taxation. 4. The ne,tional income should, if possible, be incroased sufficiently to meet the heavy costs of armament without the sacrifice of our trad.itional necossities and conveniences. America has vast potential productive capacities. If thcsc produ.ctive capacities can be organizod effectivoly, it is conceivablo that wo might carry the additional outlays for national defonse ,rl thout giving up other indispensable commodities and services. Unfortunatoly, the armament program cannot ,vait for increasos in tho national income, if tho lights of damocracy are to burn on through the dark nights of world chaos. We cannot, moreover, be too sanguinc about the possibili- tics of living more luxuriously while we fortify our continent. If, however, armamont production does. initiate a genoral businoss boom and industry in general does prosper, it is to be hoped that the costs of armament ,rill not be so heavy as to compel sacrifices of other essentials. As wo gird oursolvos for tho battle ,vith the foes of democracy, we should strain ovory enorgy to provido an adoquato national dcfense and at the sarno time maintain the health, both physical and mGntal, of tho nation. So far as it bo possible, 'va should increase our productivity and construct a mighty oconomic bulwark for ages to come, '!'he productivity of tho nation, that is, the income produced, is tho result of business enterprises. Since tho taxes ~ust be paid from capital or income, upon business rests the responsibility of croating the resources required for nationn.l dofenso, as well as tho commoditios ncodod for our evcrJday existence. If business is reprosscd by un,visoly choson taxos or othcr gover~~ental rostre.il1ts, the r~~tional income suffors and tho sourcos of taxation disappear. Governments should therefore mako certain that the taxes they impose and the servicos which the taxes fin~~ce \vill bring not gains to society rathor than net 10ssos, Dnd the.t they will not handicap our productivo orga.'1ization. During t4e last sevoral years, tho nation has lived in rele,tive comfort and has watched tho Fodoral deficits accumulate \vithout grave apprehensions. Tho

...17.-

- timo has como, howovor, for us to pAmit tho gravity of our sitUc~tion. Taxes havo already boer~ increasod. They must bo increased still further. When ~rars have been imminent in the past, or have act~~ly brol{en out in their fury, it has "been customary to adopt a fow addj.tional taxos a..'1.dto raisc by fex the greator part of tho funds rcquirod for armamonts"by borrowing. The loan policy postpones the dEIY of unwolcomo taxos ~md scorns to le:;r tho costs of armamont upon futuro genorations. Tr~o disadvantagos of froo a.'1.dunrostrictod borrowing or tho issuc of papor r.10noy sho"lud, howevor, be apparcnt after a Ii ttl() thought. Tho public dobt may pass out of control and tho pri11ting pressos Day flood tho countrysido with worthless paper Doney. Boca.use tho debt ca11not bE) paid off, it may "Do carriod as a pcl~otuaJ" burdon, it may bG repudiated, or it may be cancellod by inflation. The wihoalthy boom of war prosperity \'mich is nourished for a time by inflation, must in time bo followod by jinancial, ocor.oj,1ic, and perhaps poli- tical e.nd social disorganization and collapse. Hoavy taxation ~dll ~ini~ize inflation, indicato to the people the costs of armamont, and pon:1i t thaa to shv.ro equitably in those costs. Tho danger is not that too moch of the expenses of arnrunent will bc !:let by taxes; ratller, it is that too much ,,;ill bG met by borrowing. It is assTh"J1cdrJ.oro that unnecessa~' exporJ.dituros should bo re~oved fror:l Fodoral, state A.I"ldloco]. budgots. The principle \.IJ1ich should be followec.. in sponcling was \visely stL1.tod in the Constit"l1.tion adopter.. by the Common\voalth of pennsylvania in i776, in tho critical days of tho Rovolution, tIThe purposo for \"hich a:'1Y tax is to be raised, n the Constit'ltio11 doclarcd, "ought to appear clearly to the Legislature to 00 of more service to tho coJ:.Ununitythan tho mO11CY",ould bo if not collected." Any public c):pcndituro for armament or othcr purposcs is justifiable only When tho social adva11tagos from thc oxpondi turcs arc groater than tho social costs, At a time when cxpendituros arc bound to soar upward and the tax load bocomos morc ourdonso!:lc, it is imperativo that wasto. incfficiency, and graft 00 eliminatod in tho oxpenditurc of public money. Econor:lios in sponding \vill apparcntly not avcrt hcavior taxation, out thoy \',rill lassen tho emount of new taxation requirod~ At c. timo of natione.l o~orgoncy, tho tax system Ii1ust above all olse bc adcqu~to to providc tho revenuos r0quircd to keep tho budgot in a healthy condi-

tion. Past oxporicncc has shown that it is r.ot cnough to ~qct mcroly tho intcrost

- 18" , on the debt incurred for national dofonso. If futuro credit sources aro to be proservod and if tho budget is to bo kopt within control. a largo part of the costs of aroaI:1ont must bo covered by taxation. In spite of all' tho lossons which might havo bean learned fro~ past Vlars, tho loading nations mot only a Tainor part of their axpenditurasduring tho Wol'ld War by taxation. Taxos in England and the United States ,voro 25 par ccnt of tho total oxponditures during the pariod of conflict, 13 par cant in France, and only 10 por cant in GcrDany. In recent years thoro has boon much discussion of tho probloms pf tho Fodoral tax system and i1oodod rofo~s. It should no" bo possiblo to lay the broad basis of tho tax systeT;'I which could provido incroasod revenuos as tho l1ational ncods DOunt. 'rIle defcnsc program will be hs~stened if a fair and definite tax policy can bo formulated so that taxpayars can ostir;1e.te their tax liabilities with certainty. So far as possible, tho often repeated yet of ton ignored princi- plos of equity, cortainty, simplic~ty, convonioncc, and adequacy, should be observGd. FedorRl. state, and local financial and revenue prograns should be coordinated raoro effectively. Sinco Dll taxes ~ust. in the last analysis, be paid out of current capital or incomo, it should 00 rocognized that now taxes aro only difforont ways of tapping tho old l'QvenUO sources. Many thcorists havc suggestod that marc reliance upon a personal income t~~. to bo collected for the benefit of tho federal and state go,TernDGnts by the formor, ,vould go a long way toward makil1g tax paynents morG direct and obvious. mora simple, and T.lore oquitablQ. The e~igonciqs of war finance may hasten the advent of the day whon tax administration in the United States will be rationally unified for tho gro~tor convoniellce of governments and taxpayers. For tho present, it may be expected that tho Fodoral and state governments, in particular, ,vill follow the principle Which govcrnnents long ago adoptod, tho principle of a diversity of rovonuos. The history of taxation reveals that many of o~r important ta~os originated ill tiQOS of ~lar. During tho World War, individual income and business profits taxos ,'rare extended. General salas taxes were introduced and comoodity taxes ~ultiplicd. Tho hasty search for new revenues wont on with roilowed vigor after tho war, as tho nations vied wj.th oach other in lE1.Yingona tax after ~.nother upon the bacl{s of the groaning taxpv:;:Iors. The outlook of the i;:U;led.iato futm'e in tho United States is that now taxes ,'fill probably be adopted as Congress str'l:lggles with tho worries of national dofenso.

-19.-

~ The Excess Profits Tax- At the moment, the most discussed tax proposal calls for a new impost

upon the excess profits of corporations. SUC11 a tax is s1~ggested ~r the experi- ence of the United States and other nations during the World War, when war and excess profits taxes were rapidly developed to provide handsome revenues. Recently

there has been a revival of the excess profits tax in various countries. The mushroom growth of the tax during the World War must be attributed to its rela-

tively large revenues during the war boom, \WlOn the administrativo difficulties of the tax wore moro or loss disregarded in the patriotic fervor attcndant upon \vaging a war. After tho war, the tax collapsed as its yield fell off because of

depression conditions, administrative complexities, inequalities in burden, and evasion and avoidance. The tax was accepted as a wartime emergency and \~as sub-

sequently rejected shortly after the cessation of hostilities. That was a general worldwide movement~ There ~~s much discussion of the excess profits tax as a normal peace revenue after the World "ar and during the nineteen thirties, but the tax was generally considered to be impracticable as an ordinary revenu~. The recent discussion of the tax is to be related to the memories of its role during the World War. It is admitted in many quarters that an excess profits tax m~y be

tolerated in wartime, even though its inherent administrative weaknesses may rule it out in times of peace. The tax has been favored as a method of striking at monopoly profits and as an instrument of indirect price control. Some observers also feel th~t tho rate of the return upon business investments is the most logical guidc to the capacity of business enterprises to pay taxcs. To be sure, the profit ratio ~~ll not indicate the economic status of the individual stockholders of corporations, and a tax \~hich may seem fair when it is levied impersonaJ.1y upon business ma;;T prove to be inequitable when it is related to the personal status of the owners of the bu5iness corporFttions.

The theory of a heavy tax upon excess profits, especially in war periods, has proved most alluring to malllf persons, some of whom mffY feol that it is ~'dcked to earn any profits and that it is pnrticularly sinful to obtain high profi ts. It is also believed ~J many persons that ~ excess profi ts t~x coulcl yield l8.rgo\rovenues, although the returns of the prescnt ml:\keshift excess profits tax were only twenty~scvcn million dollars in 1939, ~en tho r~tes were six and t,relve per cant on tho corporate profits in excess of ten per cent of the value of the capital stock as declared by corpol'ations.

-20- The war and excess profits taxes of the World War period were more productive tmln tr.is. since the rates were very high and quite substantial profits were obtained in many industries during the war boom. One must keep in mind. however. that the rates of the personal income tax and the normal profits tax are now higher than the rates of these taxes in the ekl.rlier period. The aggregate tax collections are also greater, and a higher percentage of the national income is being taken in tnxos todaijr than during the era of the World War. Thus. in 1919 Federal taxcs wore four and a half billion dollars and the total Federal. state and local taxes were seven and a half billion dollars. or 11 per cent of the national income. while 1ederal taxes in 1938 were six billion dollars, the total Federal. state ~~d local taxes '~ere about fourteen billion dollars. and the tax load was equivalent to 22 per cent of the national income. just twice the percentage of 1919. It is difficUlt to estimate the present possibilities of the excess profits tax as a source of revenue, bec'BUse of the uncertainties concerning future profits and the features which might be enacted in the tax law. The estimates of the Secreta~J of the Treasury for one of the proposals now being considered are that three hundred million dollars might be obtained in the first year and five hundred million dollars thereafter. iVithout disputing his estimates, which have alrea~r been questioned, one may agree that important revenues could be obtained without admitting that these revenues muld be ample to finance an armament program involving outl~s of five billion dollars a year or a sum even much larger than this.

;',' An inherent and as yet insuperable difficulty in excess profits

taxation under present administrative limitations. is that of separating excess l from ordinary profits. If the rate oi tl~ return upon business investments t" " llIIlSt be determined. how shall those investments be valued with reasonable

, accuracy and at a reasonable cost of appraisal? If the profits of one year or :: a period of years are taken as normal profits, as the period 1936-39 inclusive,

in order to expedite the administration. it will always remain a question, were the profits during that period norroDl profits? A given base period may ., be quite fn.voraole to some corporations .'1Jld very unfavorable for other

coI1Joro.tions. During tho WorJ.dWt1.r. tho English plfill of excess profits taxation

':' was essentially one of comparing; the total profits in tho taxable yer',r \'lith those in the base period. Qpinion was quite general in England after the war

-21- .

that the fairer and more logical method of ascertaining excess profits was

qy determining the rate of return upon the investment. While the principle of comparing profits in the tax year with those in the base period is followed

in the 1939 English 1 a,., , investments of new corporations are to be valued to discover whether profits exceed the rate of return permitted. In this country, we are proposing to abandon our previous theory of a tax levied according to

the rate of return for a tax Which may be related to the income earned in the base period. A true excess profits tax can be imposed only if business invest- ments are .valued yearly, unless the value of investments, which,is seldom the

case, remains constant. The rates of return upon investments fluctuate con-

siderably for many concerns and also very greatly among concerns at a given time. Unless a period of several ~'ears is taken as the basis for determining the profit ratio to the inve$tmen.t, an excess profits tax ~nll penalize concerns

with variable earnings and will be especially onerous upon rigl~ ventures ~here

investments mB::! return losses or only uncertain profits in many years.

The highly perplexing problem of amortizing investments when plant e~~ansion is demanded qy a government to produce war materials and the type of armaments is changing and the quantity needed is uncertain, must also be faced.

This problem is not altogether peculiar to excess profits taxation, however, since it may also be found in the application of other profits taxeg~ Here

again, as in the valuation of investments and in the definition of excess profits, a decision which may be fair for one corpor.!iion may be quite unfair for another,

if allowances are not made for particular circumstances in each caBO. The

adjustment of an cxcoss profits tax to each individual case, however, renders the administration most difficult, if not i~racticable.

An excess profits tax is essentially an emergency device to raise needed tax revenues quickly in a boom period. Even in an emergency, however, the long run effects of tax policies should be weighed carefuJ.ly. Excess

profits may arise during the prosperity of peace as well as during a war boom. '~hey are not peculiar to war industries, but may be found here and there throu&10ut the field of industry. m1ile they may be the fruits of monopoly

prices, they mB::! also arise when the fortunes of a business alternate from failure to success, and they mB::! follow vent~resome investment at high rates of

risk. The long continued excess profits of a monopoly should be distinguished from the occasional high profits of a corporation with unstable earnings. If i

i a government is to pl~ the game fairly? its excess profits tax at a high rate !

-22- should be imposed only upon the excess of profits over costs and lassos over a

period of several years. Assuming that an excess profit s tax is employed ,vi th due moderation,

that it is as fairly administered as possible, and that it reaches only true excess profits, it may bo justified as a wartime revenue, and it may also

have some advantages in curbing monopoly profits and in liruiting tho gains of the profiteers. Until its baffling problems can be solved satisfactorily, however, tho excess profj,ts tax can be defended only as a revenue makeshift.

If the tax is adopted, it should appliT to the whole field of industry and should not be confined simply to armament making. In view of the high rates of the personal income tB~ which apply to the undistributed as well as

to the distributed income of non~corporative enterprises, the excess profits tax should apply only to corporations~ One may suggest here that if it were possible to treat the undistributed as well as the distributed earnings of

corporations as individual income and to tax them in that manner, an excess profits tax would be uncalled for as long as the individual income tax were levied at steeply graduated rates.

An excess profits tax will obviously not provide cnough revenue to financo an armament program~ But it may be employed as an emergency impost to supplement the basic 110rmal profits tax.

Othor Taxo$

Tho present systom of graduatod rates in tho normal profits tax is arbitrary and illogical, and it should give \vay to a flat rate tax at a rata consistent with rovenue rcquireraonts and tho eff~cts of tho tax. Rate

graduation according to tho total not incomo indicates confusion concerning

tho assumed ability of corporations to p~ taxes. Ability to PD;)' is an attribute of the individual rather than of the corporation. If one wishes to

ass~~e that corporations ~~ve a c~paci t~r to PB¥ taxes, it would probably be

measured best by the rate of return upon the investme.nt if it could be de- termined, rather than by the total pro!"'i ts~

The individual inco~ tax is also indispensable in the Federal tax

system. We may anticipate the further lowering of the personal exemptions, the lowering of the credits, and the advancement of the rate$ upon the lower and the middle incomes. The tax rates on the higher brackets should be raised only if it is

found probable that higher tax rates would produce more revenues, Which many

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I of course vrould deny. Commodity taxes m~r ~so be expected to supply greater revenues. The demand for gasoline. tobacco. alcohol. coffee. sugar. And other commodities. is rather inelastic. nnd high rate taxes may be collected to advantnge if bootlegging can be kept under co~trol. ~he exemptions of the death and gift t~~es [md advances in rates in some of the brackets would provide additional

revenues. A most important revenue ,i1ich was developed during and after the

World War Vias the general sales tax. In one form or another, it has been

imposed in many countries and also in many of our states. England. a count~J

Which had long held out against a general sales tax. has apparently capitulr.ted and is reported to be initiating joining this relatively regressive and much

! criticized impost. l It has recently been estimated that a Federal manuf,~cturers' sales tax at a rate of 2 pel' cent. \vith exemptions for food. clothing. and drugs. would produce eight hundred million dollars annually; without exemptions, still more revenue could 00 obtained. The tax outlook in the United States is indeed gloomw. The heavy I

: spending during the nineteen ~1irties and the still heavier spending which will apparently accompany the ninetee~l forties. in view of the present armament requirement9 and the demands of the iwnediate future. call for an increasing stream of taxes for an indefinite period. We should plan now for the tax requirements of the nation. for both the iDmediate and the more distant fu~ure. The crushing burdens of taxation may bo alleviated by a judicial selection of tho sources of revenue and the proper methods of administration. even if increasingly heavy taxation msv not be averted,

(Applause) CHAlm,~ ALVORD: Thank you very much. Dr. Buehler. You certainly have given us a very accurate picture of our economic and financial situation. But since what you have suggested is based on common sense. the chances are your remarks will not be hcoded. Professor Buehler has also indicated several rather important issues. I trust that Bome time in the courso of the day we may hRve a discussion as to what is tho truc pu~ose of an excess profits ta:(. Professor Buchler says the rLLising of revenue. In ~ opinion. the loss revonuo raised. the Dotter your economic condition.

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the use of invcstod capital figures for tho base period--which ought to be

quite a help to us accountants. (LaUghtcr)

There arc a number of rather important things on which tho Subcommit- tee report is silent, and others on which it seems to be either cunbiguous or

defective. I had the opportun~ty this week to appear before the Committee on iVays and ~leans and put in a statement calling attention to a few of those points, and I think my remarks no~v might be largely the same a~ there, as th~J related

chiefly to the topic which had been assigned to me. I believe that perhaps the most ir.1portant thing to submit as a

criticism of this Subcommittee report in proposing an excess profits tax is the failure of the S11bcommittee to include any recommendation regarding con-

solidated accounts. The history of the Vlar profits taxes tvronty yeal'S or ~ore ago is that consolidc'ltion was then compulsor~r, and I understand thore was some rather hectic discussion on that subject in \Vas~lington along in late 1917 and

early 1918, whon the 1917 Act was being completed and regulations framed. The authorities in Washington were then convinced. after the Act itself had been

passed, that consolidatiol~ should be required for computation of excess profits taxes and therefore by regulation so rcq,uired. although the Act had nothing on the point. The 1918 Act, as you probably cuI recall, included it in mandatory

form. Then we had a series of post-w~lr years Whore it was to soma extent optional. The '34 Act ,u thdre\v the privilege of consolidated returns for most

companies. I believe, ml1king an exception with respect to railroads. , rf Xhe Xreasury Department in the past has been ver~r much convinced of the desirability of consolidated returns, not si~ly in the interests of fair-

ness, but to plinimize or reduce possibilities of evasion. There are certain sorts of cases, with Which you are probably all familiar or which you can

readily imagine, where special inter-colnI)a!ly arrangements might be made of a somewhat artificial nature which would serve to reduce excess profits taxes. if the Treasury Dopartment couldn't have them thr01~ out as simply devices or

artifices Which the courts wouldn't r~cognize.

From the point of vie~l of tho ta~ayer, tho obvious advantage of con- solidation is tho avel'~\ging of profits ancl losses of tho ,vhole business and

determining a rolationship bct~leen income and capital that '70uld have some

economic significanco for tho enterprise as a 11hole.

Another point that I might mention is tl~t the Subcommittee report

...26.. . / fails to provide for the inclusion of predecessor earnings. If a company, say, between tl~ beginning of the base period, Janua~J 1.1936. and the beginning of the excess profits taxable year, 1940, acquired some other going concern

through some form of tax-free merger or reorganization, or possibly ~J liquidation of a subsidiary, the earnings from that newly acquired business

would presumably be reflected in the 1940 earnings. and therefore they would not be fairly comparable with the base period earnings of the ta~8lfer cor~ poration alone. If a provision for inclusion of such predecessor earnings is

written into the bill, of course a parallel provision should go in with respect to invested capital of the base period in sir~ilar cases. There is some lack of clari tJ7 in the Sl.1bcommi ttee 1s report as to

whether, in arriving at the average earnings of the base period. the loss of aJoss year or years would 'be deducted; that is. whether you would take the algebraic

sum of the income account, s~, for the four base years and divide by four, or whether you would do as provided in the Canadian law recently enacted. take the total number of base years but add up onl~' the profits, ignore the losses, if any, and divide the sum bJ' the number of base~period yee.rs.

As to Method T,~ of the Subcommittee report. ~hich is the one de- pendent on invested capital (under which you get a percentage of earnings of the base period on the invested capital of the base period, then apply that percentage, within limits, to the taXable year invested capital to determine the normal earnings for that year), the report provides that deficits in earnings should be deducted in the base period co~utation. They don't seem to have a similar provision where you are using Method One, simply base period earni11gs without regard to tho base period invested c~pi tal. It is not entirely clear whether this apparent difference was intentional.

Tl1ere is a fUl'ther complication in interpreting how loss years ,vould work out in detail. 'becaU.se excess profits income is recommended to 'be based upon normal tax net income, presumably as defined in the 1939 Act or in the Code as amended by tl~t Act; and that Act. as ~rou lQ1ow, contained a provision for net loss carryovers. Now, it doesn't seem conceivable that if in the base period a comp~'1Y had losses, say, in 1936 and 1937. but larger profits in 1938 and 1939, it would have to car~r those losses forvrard and di~inish the 1938 and 1939 excess profits inCOlfiC and also, on top of that, deduct the losses

of the years 1936 and 1937 as such. Incidentally, the net loss car~Jover

...27~

-- - ~~~. deduction provision l1as some rather tricky foatures in it, and it is not a

simple calculation in itsclf, whereby you merely car~/ forward the net loss, but the net loss deduction is net losses of previous years diminished by a

number of othor factors that may have to be brought into account.

However, such questions as that will no doubt be "1orked out by the legislative draftsmen when a bill is actually framed. It is really more a matter of detail and not the sort of thing you would. expect the Subcommittee to go into in the prelimina~ report.

I think I might proceed now to read (or pa.raphrase) certain portions 01~ the statements that I made before the Ways and llieans Comrnittee.

As to the determination of base period earnings to be used as a measure for normal earnings of the taxable year, whether you are using };!ethod One or I~ethod Two, it is obvious that the bill should provide that the earn- ings of the base period and of the taxable yea,r should be so computed as to blo fairl:' comparablo. The Subcommi tteo roport proposes to eliminate from tho

determination of excess profj.ts income for both the base period and the taxable year, any realized long-term capital gains or long-term capital losoes upon sale or exchange of depreciable or nondepreciable assets. But there are in many cases a number of other extraordinary iteL1S of the sort commonly described as non-recurring. INon-recurrin~;" I of course, does not mean items of a nature

that may never recur, but items of ruajor irnportance which do not recur annually or at longer intervaJ.s with some regul.-:irity. Exampl,;~s of such items are: 1. SubstarJ.tial gains or losses realized from sale or exchange of capital s.ssets, incl'Llding depreciable C..S~lcts,that ma;)'have been held for not I!lOre th.'}.n ei gh teen months (the S11.bcom:.m.t 'tee rep ort al re aa.y having propose d to eliminate such gains and losses with J:'espcct to items held for more than eighteen months). 2. Losses on abandonment or destruction of property. 3. Taxable profit realized upon the purchase at a discount by a corporation of its o~ bonds or other outstanding evidences of indebtedness.

4. Doductible loss incurred ~T a corporation upon the purchaso at a premi\lm (or at an amO\L~tin excess of the principal amount less the related balance of unamortized discount B.t the time of purchase) by a corporation of its own bonds or other outstanding eviue11ces of indebtedness.

Those last t~~ items of extraordina~r gain or loss are usually sub- stantial when a corporation has carried through a refunding operation, and

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", might not call for ~r special adjustment in the case of acquisition of bonds

simply from time to time through some sinking fund or similar routine operation.

j It is my recommendation tl1.""t such extraordinary profits and losses I of substantial amount, if any, realized by a corporation during the base period

or the excess profits taxable year, should be eliminated in determining the excess profits credit and the excess profits income, but need not be eliminated

for normal tax purposes. On the subject of consolidated returns, I just made these remarks: "The business of a number of corporations is conducted on such a

scale tl1at it is often necessa~r or desirable, because of state la\'Ts, tomporary exigencies of financing, and so~etimes for other special reasons, to have Bome of the departments, operations, or geographical divisions of the business con- ducted by subsidia~T corporations. From the economic standpoint, howevor, the entorprise is a unit, and the interest of the investing public is wholly or

" principally in the securities issued by the paront COMpany.

I "Under an excess profits tax, whereby the tax is detennined in part

i by reference to invested capital, artificial duplications of invostod capital r i may exist to the injury of the revenue in a group of affiliated companies if the accounts are not made up on a consolidated basis~ In consolidated accounts

I the investment of the parent comp~ in the stock and securities of the

subsidiary companies is eliminated, but in the absence of consolid£~tion no such elimination occurs, and the same net operating assets mau be represented

in the equity securities of two or more corporations of tho group, subsidiary and parent. The provision in the Subcomr;u ttee I s report for an ac.justment

in respect to inadmissible assets would not necessarily serve to cure such

duplication, since that adjustment is reduced by application of the ratio which

the equit~r or invested capital bears to the total assets~ "Consolidated accounts are more equitable to taxpayers in that the

operating results of the whole enterprise are combined in arriving at the

amount of net income. "On the basis of consolidated accounts, the ratio of income to in-

vested capital is a weighted average for all the separate corporations crthe

affiliated group, and the artificial pe~cs and valleys that muv exist in such rc"tios for the separate corporation divisions are leveled off. Under the

system of a separate return for each corporation, it would be quite possible for the effective tax rate on one enterprise to be more than a hundred per

-29- cent under a law which asserted a maximcuunoLunal rate of only forty per cent. or even lower. "Without consolidation ambiguities would often be encountered as to the status of inter-company open accounts. The question would arise as to Whether such accounts represented indebtedness or capital and how they should be treated in determining statutory invested capital." Although the Subcommittee. you recall. made some allowance for in- debtedness to be included in invested capital. their recommendation is limited to debt represented b~r outstanding evidences of indebtedness and apparently vrould not have any application to an opon book account such as we often find in inter-compa~v records. "Such complications, II I concluded, "might put taxpaycrs under temptation to rearrange their corporate structures and relationships so as to minimize duplication of taxes and thus might tend to retard progress in tho direction of simplification of corporate structures." There was another point not quite 30 obvious as some of those I have mentioned, vVhich cama to the attention of somo of us t\VO or three aays ago, that mi~1t in some cases seem to bo unfair to taxpewers. The Subcommittee report concludes \'lith a short recommendation tha.t tho Internal Rovenuc Code be clarified in order that t11c unrecognized gain or loss upon the sale or exchange of property bjr a corporation not be reflected in its earnings and profits. If that recommendation were adopted. it wotud presumably be applicable in aetermining earnings or profits in the computation of invested capital, and also for computations of earnings and profits to ascertain the tax status of corporate distributions or dividends. In this connection the tax lavi regarding liquidations of subsidiaries might work out unfairly if that was not specifically excepted. In a sup- plementary statement filed with the 'Vays and lAeans Committee. I said: "The tax law. commencing with the Revenue Act of 1936. has provided that under specific conditions the complete liquidation of a subsidiary compa~r does not result in recognized gain or loss to the parent company. A parallel provision of the law states that the basis of assets so acquired by a parent company shall be the same as the basis to the subsidiary. The Sub- committee report recommends a general rule that assets be included in inv~sted capital at their income t~~ basis. In conformit~r viith this principle. it should be made clear in the bill that tr.is general rule applies to assets

-30- acquired by a p~rent company upon liquidation of a subsidiary comproiy under Section 112 (b)-(6), regardless of whether such liquidation resulted in an ,..II unrecognized gain or loss. "Supplementa~.r to such a provision, the rule to be included in the bill ~~th respect to the deterr.unation of earnings or profits for purposes of invested capital should explicitly recognize the principle established by the Sansome decision (CCA-2, 1932--certiorari denied) and applied ~ince that time in the administration of the income tax lavIs, viz., that the earnings and profits of a corporation should include the amount of the earnings or profits of a predecessor company acquired by a reorganization, merger, or liquidation ,"hi ch was a tax~free transaction under the income tax la,v effective for the year in which it occurred." It seems to me that such a provision as that and as the one recommen- ded with respect to 112 (b)-(6), vlould be entirely consistent in principle ! with a requirement or permission for filing returns on a consolidated account~ ing basis. Consolidated accounts, properly made up and carried through for the base period and the taxab~~ period both--and, let me say, recognizing consoli- dation accounting even in interpreting, for purposes of invested capital of the base period or the tax period, transactions that may have occurred in prior years when possibl~r the corporatiorJ. did not or could not file consoli- dated returns--would in lr.3.n.}rcases eliminate co~licated problems of inter- company situations and transactions that would certai~r arise and be very difficult to deal with on [t separate corporntion return basis. ~hank you, (Applause) CHAIRl'.iANALVORD: Thanl~ you, l.~r. 3yerl;}r. In twenty minutes' time he has ,~iven you innumerable reasons why an excess profits tax can't be drafted in two weeks or four weeks or six weeks or eight weeks. 3ear in mind that ,'{hat 1Iveare tt"Jing to do is to deterJ;line excess profits. What are they? I start out by saying, let us first decide what are normal profits. I suppose excess profits are something in addition to normal. One question I would ask in considel'ing normal profits is, what have been your profits in the past? As I indicated to you, there are two cases where normal profits in the past aloe clearly inadequate. One case is

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- --- where your corporation didn't exist in tl~ past, The second is \mere your corporation has earned admittedly abnormally low profits, in the past. Other yardsticl:s have to bo dovised to take care of those two situations and past history, trends, rislcs, and nature of business are probably important factors. The complications can be piled on top of each endlessly, We are going to givc ~rou time to express your vieV1S. I think you will find basicalljr thc differonce between the views e~ressed by Professor Buehler and rnwself is this. What is it you are trying to do? Arc you t~Jing to get revenue, or arc you trying to promote, permit, protect normal profits and prevont excess profits? That seems to me to be the basic issue. But, regardless of the objective, regardless of the purpose of the tax, it has to be administered. It might seem strange that we should call upon a la~~rer to discuss administrative pl'oblems, But Bob I~iller was on the firing line during the war; he merel~r changed camps after the war, and staJred on the firing line. I kno,v of no one better qualified to discuss administrative problems than Robert N. Miller, of Wa.Shington. (Applause)

1,m. ROBERT N. l£II,LER (Former Solicitor of Internal Revenue and past Chairman, Committee on Taxation of the American Bar Association); I~r. Chairman, Gentlemen: What we have all heard is so apt and so comprehensive that I would feel vel"y much embarrassed if I were going to talk about the same phase of taxation, but, as you have heal'd, my assignment is something different~-that is, the administrative phases of excess profits tax laws. I have tried to put nyself in the place of the Govennment and see what aclministrativ'e considerations the Congress should be giving weight to in drafting the law, in the Government's own interest, and especially in the Government's interest of getting a workable law. It is, of course, true that taxpayers want a \vorkable law; but the Gov(!r'nment needs a workable la,v even more tha..'l taxpayers do. 1'lv remarks will havE) to do Iilainl~r "vi th the past, that is, the more eorious difficulties vihich the Bureau of Ir.ternal Rcvenue acually met with in afu~inistoring the World War high rate taxes based on income, imposed by tho '17 Act, the '18 Act, and t:l0 121 Act. Of the hundreds of lLard problems mich wore of vital importance to some gro1;jps of taxp~yers, and hence to the 'Bureau, tho ones I am about to speal: of appeal to mo as the !!lost important just now, ,lhen we are dra!'ting a bill. !

1

"'32~ Pure!y Adminisgativ~ Diffic~!~ies

Before I speak of any single technical problem or difficulty of that period. let me say that there has graduallJr developed in me over the years the conviction that. however n~~erous and serious were the problems of determining questior.s of law and of fact in connection with those World War taxes--that is, the problems that would exist with an ideal personnel, ideally directed and free from fear of criticism--there were other causes. probably more important, interfering with reasonably prompt and satisfactory administration of these taxes--causes which had little to do with the detailed text of the law as

wri tten ~J Congre ss. I am convinced~ indeed, that the greatest difficulties of administra-

tion which the Government meets in getting its money, and getting it promptly, were then and will be under the new law, if it has hi&~ rates, not these very

real difficulties involved in the Government's task of making an audit and

writing a deficiency letter. but the difficulties involved in so h~~dling each

tax case that the Government and the taxpayer come with reasonable promptness to a condition of equilibrium as to tl.e amount of tax involved in the controversy.

instead of taking years to roach that condition of equilibrium. In other words. real tax administration demands a great deal more tl.an getting up a deficiency

letter which embodies the Government.s position on the various topics or problems of the case in hand; more, even. than inviting the taxp~er to whittle aw~y according to the taxp~er's abilitJ' at each one of the many points of the

case where the Government's position mew be subject to attack. The Government's

real job is to get the case actually finished~ In other words. the Treasury has a selling job as well as a deciding job, and Congreas has a job of giving

the TreasurJr something that the Treas"U-r'J can sell °wi thout being ashamed of it. An official study, in which I have great confidence because our Cl~airman participated in it when he \~as in the Government mill. was made in 1927--dealing only with taxes for the four years 1917.1918, 1919 and 1920-- to see how many of the cases were still in the administrative phases. and how much tax they involved. It shovled that there were still in administrative controversy morc than $160,000.000 of taxes. That amount seems worth con- sidering. v'ohen\'Ie hear how re1ativelJ' 10v1 the probable yiold of this neil tax is expected to be. The survey showed tl.at more than three thousand cases of a substantial character involving the years mentioned '~re still pending near the end of 1927~

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