ifift'^iiS^-t T23 1922 CORNELL UNIVERSITY LIBRARY HJ9.A5 tm"1922'"'"" ^""'"' "®^llllffiiNKii»Sii,i,';',?,..&'"'"i«ee on Wa' „,,^ 3 1924 030 210 250 The original of tiiis book is in tine Cornell University Library. There are no known copyright restrictions in the United States on the use of the text. http://www.archive.org/details/cu31924030210250 Ma /' HEARINGS 0CT,y,^.^ Q BEFORE THE COMMITTEE ON WAYS AND MEANS HOUSE OF REPRESENTATIVES ON TAX-EXEMPT SECURITIES THE COMMITTEE HAVING UNDER CONSIDERAT''"^^ H.J. RES. 102, 211, 231, and 232 PROPOSING AN AMENDMENT TO THE CONSTITUTION JANUARY 16, 18, 19, and MARCH 7, 1922 INDEXED 93671 WASHINGTON GOVERNMENT PRINTING OFFICE I'J22 COMMITTEE ON WAYS AND MEANS. House of Repbbsentativbs. sixty-seventh congress, second session. JOSEPH W. FORDNEY, Michigan, Chairman. WILLIAM E. GEEEN, Iowa, NICHOLAS LONGWOETH, Ohio."' WILLIS C. HAWLEY, Oregon. ALLEN T. TEEADWAY, Massachusetts. lEA C. COPLEY, IlUnois. LUTHER W. MOTT, New York. GEORGE M. YOUNG, North Dakota, JAMES A. FEEAR, Wisconsin. JOHN Q. TILSON, Connecticut. ISAAC BACHARACH, New Jersey. LINDLEY H. HAD LEY, Washington. OHAELES B. TIMBEBLAKE, Colorado. GEORGE M. BOWEES, West Virguila. HENEY W. WATSON, Pennsylvania. ALANSON B.HOUGHTON, New York. THOMAS A. CHANDLEE, Oklahonja. CLAUDE KITCHIN, North Caroliaa. JOHN N. GAENEE, Texas. JAMES W. COLLIER, Mississippi. WILLIAM A. OLD FIELD, Arkansas. CJ5j\bleS E. CEISP, Georgia. JOHN if. CA.EEW, New York. WHITMELL t. MAETIN, Louisiana. PETEE P. TAGUE, Massachusetts. Clayton F. Mooke, Chfk. ■0»>J ?l? TAX-EXEMPT SEOUEITIES. Committee on Ways and Means, House of Repkesentatives, Monday. January 16, 1922. The committee met at 10.30 o'clock a. m., Hon. Joseph W. Fordney (chairman) presiding. The Chairman. Gentlemen of the committee, Mr. McFadden wants to be heard very briefly, and I think we had better hear him. If agreeable, Mr. Secretary Mellon, we will hear Mr. McFadden for just a few minutes before we hear you. (The following joint resolutions were laid before the committee for in.»<^ition in the record :) [H. J. Res. 102, Sixty-seventh Congress, first session..! JOIN f RESOLUTION Proposing an amendment to the Constitution of the United States. Resolved by the Senate and House of Representatives of the United-States of America in Congress assemhled {ttoo-thirds of each House concurring therein), Tliat the following article be submitted to the legislatures of the several States, which, when ratified by the legislatures of three-fourths of the States, shall be valid and binding as a part of the Constitution of the United States : "Akticle XX. " The Congress shall have power to lay and collect taxes on gains, profits, and incomes, from whatever source derived, which shall include gains, profits, and incomes derived from securities created by the States and their subsidiary governments, issued after the ratification of this article, and salaries of all pub- lic officials. Federal as well as State, elected or appointed to office after the ratifi- cation of this article, without apportionment among the States and without re- gard to any census or enumeration : Provided, That any State having in force a. general income tax under which the gains, profits, and incomes derived from securities created by it or its subsidiary governments and from salaries of public officials thereof are taxable and are actualy taxed, shall, after the ratifi- cation of this article, have the power to lay and collect thereunder taxes on gains, profits, and incomes derived from securities created by the United States and its possessions and Territories, and salaries of all public officials of the United States and such possessions and Territories." [H. J. Res. 211, Sixty-seventh Congress, first session.] JOINT RESOLUTION Proposing an amendment to the Constitution of the United States. Resolved by the Senate and House of Representatives of the United States of America in Congress assembled {two-thirds of each House concurring therein), That the following article be submitted to the legislatures of the several States, which, when ratified by the legislatures of three-fourths of the States, shall be valid and binding as a part of the Constitution of the United States : "Akticle XX. "The United States shall have power to tax incomes derived from securities issued after the ratification of this article by or under the authority of the 4 TAX-EXEMPT SECUKITIES. several States to the saiue extent that incomes derived from securities issued after the ratification of this article by or under the authority of the United States are taxed by the United States. Any State shall have power to tax In- comes derived by residents thereof from securities issued after the ratification of this article by or under the authority of the United States to the same extent that incomes derived by residents of such State from securities Issued after the ratification of this article by or under the authority of such State are taxed by such State." [H. J. Kes. 231, Sixty-seventh Congress, second session.] -JOINT EBSOLTJTION Propoaiug an amendment to the ConstitDtlon of the United States. Resolved by the Senate and House of Representatives of the United States of America in Congress assembled {two-thirds of each Bouse concurring therein), 'That the following article is proposed as an amendment to the Constitution of the United States, which shall be valid to all Intents and purposes as part of the Constitution when ratified by the legislatures of three-fourths of the several -States : "Akticle . ■" The Congress shall have power to lay and collect taxes on incomes derived from obligations issued or created by a State or any political subdivision thereof after the ratification of this article without apportionment among the several States and without r^Kard to any census or enumeration." [H. J. Res. 232, Sixty-soventh Congress, second session.) JOINT RESOLUTION Proposing an amendment to the Constitution of the United States. Resolved hy the Senate and House of Representatives of the United States of America in Congress assembled (tivo-thvrds of each House concurring therein), That the following article is proposed as an. amendment to the Constitution of the United States, which shall be valid to all intents and purposes as part of the Constitution when ratified by the legislatures of three-fourths of the several States : Article — . Sec. — . That from and after the adoption of this amendment as part of the Constitution the provisions of the sixteenth amendment to the Constitution shall apply to and Include Income derived from securities thereafter issued or created by any State or political subdivision thereof, or any dependency of the United States ; but taxes on incomes derived from such securities must be laid without discrimination in favor of income derived from other securities of the same term and general class issued or created after the adoption of this amendment as part of the Constitution. STATEMENT OF HON. lOTJIS T. McEADDEN, A REPBESENTATIVE IN CONGKESS FROM THE STATE OF PENNSYLVANIA. Mr. McFaddbn. I will only detain the committee for a few minutes, Mr. Chair- man. The National Tax Association at its last annual meeting urged considera- tion of the possibility of a repeal of the existing exemptions which created privi- leged classes, or individuals, and In doing so laid down a fundamental principle that I want to call the attention of the committee to : " It is axiomatic that taxation should be universal and that every person in the jurisdiction of a Government should contribute to the support of that Govern- ment in a proper proportion. The exemption of any individual or class, in part or in whole, is favoritism or privileges, and as such is indefensible. *' If the basis of taxation be property, all private property should be taxable ; If the basis be income, all private income should be taxable. Exceptions to this rule should be technical only and should never result in an actual lessenino- of anyone's fair tax burden, " The only ground for absolute exemption from taxation, either of property or of income (revenue), is absolute public use. TAX-EXEMPT SECUKITIES. " Teclmical exemptions, such as those designed to avoid double taxation, or t& graduate the tax burden, or for fiscal administrative reasons may be granted,- but must be safeguarded so as not to result in privilege or favoritism." AVith the purpose in mind of correcting this evil, in December, 1920, I Introduced in Congress an amendment to the Constitution, and in the next session of Congress, on May 3, 1921, I introduced House joint resolution 10^, and on June 23, 1921, I made an extended address in the House, setting forth the evils of tax exemption and calling attention to the resolution which I had introduced to remedy the situation. I submitted a copy of this resolution to the Treasury Department for its analysis and received in reply the text of House joint resolution 211, which I Introduced on October 25, 1921, and which is now before you for consideration. Both of . these resolutions have been designed to accomplish the same purpose, which has since been indorsed by the President in a message to Congress. Since I have made a detailed statement of the necessity for amending the Constitution and for the further reason that there will be many witnesses to appear before your committee dealing with this subject from as many viewpoints, I shall on this occasion have need to make but a very brief state- ment setting forth the fundamental premises upon which this resolution may be considered. ■ It is the opinion of counsel that following the decision of the Suprei^"^ Court in the case of Evans v. Gore, handed down on June 1, 1921, it ■>'''^1 "e necessary to amend the Constitution in order that Congress may nave the power to tax the income from the securities issued by States and tneir political subdivisions and that the States in turn may have the powe^ co tax securities issued by the Government. Witnesses to come before the committee will deal with this subject more in detail from a legal standpoint, and will point out that the necessity for thus amending the Constitution is a direct result of evolution in banking and finance, and that the framers of the Constitution could not have anticipated this condition which now so seriously menaces the financial security and, industrial prosperity of the Nation no less than that of each of the States. Mr. Young. I was going to say that during these hearings I think we could probably save a whole lot of time if it might be understood that the com- mittee is pretty well agreed on the point that it is necessary to amend the Constitution— if that is the fact. The thing that we want to get at is how to do it— the best way to do it, the language and all that. Mr. Green. Mr. Young mentioned that, I suppose, because it was at one time considered — that is, considered by some— that no securities were tax exempt, but I agree with Mr. McFadden that since the decision in Evans against Gore it is quite evident that a constitutional amendment will be required. Mr Garnek. Is not the principal thing that the committee wants to hear— at least I would like to hear it— the logic and reasons why we should submit a constitutional amendment subjecting these securities to taxation? Now, if the gentleman has anything on that I would not mind hearing it. If he has prepared a speech that be wants to go to. the country or wants the committee to consider I will not interrupt him. , Mr. McFiDDEN. I will say on the contrary, gentlemen, I am not going to the country on this speech. It is not a political proposition in any sense whatever. , ,, Mr. Young. I assume Mr. McFadden wants to help the committee, and the reason I made this suggestion was not to embarrass him at all, but to call attention to the thing that I think we are all anxious to have information on. Mr McFadden. AVell, I think I have something here in this statement be- fore i get through that will satisfy the gentlemen, or at least be helpful. The issuance of tax-exempt securities by the Government, the States, and their political subdivisions makes possible the creation of two classes— the wealthy free from the burdens of taxation, and the workers, who are forced to bear 'the burden of which the wealthy are relieved. This constitutes a vio- lation of social justice which is crystallizing in broad public opposition and The Chaiejcan. Mr. McFadden, may I interrupt you there? If there is a tax imposed upon municipal bonds and State securities and the like, will it not increase the rate of interest to be paid by these governments? Mr. McFadden. It might to a slight extent. 6 TAX-EXEMPT SECURITIES. The Ghaikman. Then the taxpayers, rich and poor alike, would be affected, would they not, and would have to pay that bill? Mr. McFadden. Eventually. If the market is affected and the municipali- ties issuing, or the States issuing these securities, should, because of tlie fact of the passage of this amendment or an amendment like this, be compelled to pay a higher rate of interest, it would in that way affect everyone, because the expenses of government, of course, rest eventually on all the people. The Ci-iAiEMAN, Is it not true that whatever rate of tax you impose upon the Income from those bonds will have a tendency to increase the rate of interest that municipalities will have to pay on tbeir bonds? Mr. McFadden. Yes ; but there is an offsetting advantage there. The Chairman. And if that is true, will not the average taxpayer have to pay it? Mr. McFadden. No ; because it will lessen the burden in other ways. BIr. Young. Are they not borrowing too much anyway now? Mr. McFadden. There is that tendency. The whole tendency of this propo- sition is to stop extravagant expenditure. It is one of the reasons why that subsidy should be taken from them. Money should seek more legitimate means of productivity, and thus help in the general rehabilitation of produc- tion in this country. As it is now, the business and industrial interests of yt^e country are at a disadvantage because of the competition and the offer- ing iiv the market of tax-exempt securities. In every daily paper that you pick up i\ow you will notice great offerings of tax-exempt securities. Mr. GAENto. Mr. McFadden, that is an opinion expressed by you and those who are opposed to additional issues of State and county municipal bonds. Do you know of a StatP in the Union that permits the issuance of these bonds, except by a vote of the people, to be taxed? Mr. McFadden. I think, genorally speaking, that is the rule. I am not op- posing their issuance. Mr. Gaknee. Do you not think they are about equailv qualified as to what they should burden themselves with as you or other people — other eminent financial gentlemen— who undertake to say how many of these securities should be issued? The trouble about this proposition is just what you say, if men in Congress believed like you do" they would prohibit the issuance of these bonds by levy- ing a tax on them so that they could not be sold! That is a danger in the proposition that you speak of now. Mr. McFadden. I do not think that would be possible. There would be a general readjustment, Mr. Gkeen. That would not be possible under your amendment or under the amendment proposed, because there is a limitation to the taxation of them. Mr. McFadden. I am not opposed — I am not advocating the discontinuance of the issuance of municipal securities. Mr. Gaenee. Do you want to relieve the ricli fellow that holds Hiem? Mr. McFxiDDEN. No ; I do not want the I'ich man to be relieved of paying his just share of the burdens of taxation ; that is just the reason I want^this amendment to pass. Mr. Gaenee. And you would not by legislation in, • - Mr. McFadden. Yes ; principally. Mr. Garner. If we should adopt a constitutional amendment snbjectftio- all future bonds to taxation and relieving tlie ten billions now outstandinn^vou would increase tlie value of those very materially, would you not? Mr, McFadden, It miglit to some extent, because they would be souglit after- but it affords a means for those people who are best able to participate in the payment of taxes in support of the Government to avoid that. On the one hand you are trying to levy taxes against those people; on the other hand you are furnishing a vehicle wliich will permit them to avoid paying their taxes which you are trying to collect from them, affording them an opportunity to buy tax- exempt securities in which to place their money, and some men of' large wealth TAX-EXEMPT SECUKITaES. 7 f to-day are boasting of the fact that they do not care what Congress does ; that hliey have invested their money in tax-exempt securities and therefore let Congress go and run their wild riot of levying taxes on the rich if they see fit. The Chaieman. Let me ask you— I am asking for information, not opposing this measure— do not understand me as opposed to the measure here ; I am not expressing myself as to that, but we have outstanding Federal bonds bearing 3i per cent interest that are not subject to taxation. Mr. McFadden. Two billions of them, I believe, is there not? The Chairman. Well, whatever there is, they are not subject to taxation, and they sell at par, 3i per cent, and they are selling on the market to-day at par, the same as a bond that draws 4J, 4J-, and 4| and subject to taxation. Where does that difference come in? Is it not because the income from those bonds is subject to taxation, those that bear a higher rate of interest, and, if so, who pays that interest? Mr. McFadden. Well, that is a matter The Chairman (interposing). Let me put it another way. I am asking for information. I am trying to help along here. Every quarter of 1 per cent on $20,000,000,000, for easy figuring, means $50,000,000 a year ; 1 per cent additional interest upon $20,000,000,000 of Govern- ment bonds is $200,000,000 a year that the people must pay to the Government— the Government must pay that extra interest on those bonds. How much of that $200,000,000 does the Government get back in taxes? Now, that is a f<">- crete proposition to be worked out, and a business proposition. If you ^^'iH go to the average amount that the taxpayers pay, the Government gets back in taxes not more than one-fifth of it, and the taxpayer pays $200,ooO,000 for less than $40,000,000 that goes into the Treasury. Mr. McFadden. I intend to point out here a little Ipter something that vvill show what is gained by the State under this proposiclon and how much is lost. If the issuance of tax-exempt securities is allowed to continue, a social up- heaval will occur, which may be so far-renching in its effect as to undermine our constitutional Government. It has been estimated that approximately $15,000,000,000 of tax-exempt se- curities have been issued by the Government, States, and other political sub- divisions. Of this, about half represents the debts of States, cities, school districts, and otlier political subdivisions, while the balance represents the obligations of the Government. In the last few years we have seen the personal wealth of the country so rapidly segregated into the tax-free class that whereas the taxable income of individual taxpayers under the Federal income tax law was $992,972,985 in 1916, the amount decreased to $731,372,053 in 1917, and to $392,247,329 in 1918. It is not to be supposed that the actual income of these taxpayers had thus decreased. On the contrary, it is a reasonable conclusion that they had con- verted their wealth into tax-free securities so rapidly that at a similar rate of conversion they would be practically free of all income tax by 1922. It has been estimated that more than $1,000,000,000 of State and municipal tax-free securities were issued in 1920. I presume from the large amount of offerings that have been made during the past year that probably that many were issued during 1921. Mr. OoLLiEE. How many was that? Mr. McFadden. A billion dollars. In that year, if these securities were held .by the wealthy, whose Federal income tax was 73 per cent of their total income, a total annual loss to the Government in this form of tax alone would be over $35,000,000, if the interest rate on these bonds averaged 5 per cent. That, I think, Mr. Fordney, deals somewhat with your question. Granted that there may have been an apparent saving to the States and other political subdivisions issuing these bonds of one-half of 1 per cent per annum, the saving on $1,000,000,000 of 5 per cent bonds is only $5,000,000 per year, or one-seventh of the annual loss in taxes. If the rates of taxation have not been reduced, the loss of Federal income tax alone would, for the life of this $1,000,000,000 in bonds, extending over a period of 20 years, represent a loss of $700,000,000, against a total saving in interest ofi only $100,000,000. The States would also forego the much larger benefits to be derived from tax income from these securities as compared with the amount they save in interest by issuing tax-exempt securities. The wealthy investor received as much net return under the present tax law from a 5 per cent tax-exempt bond as from a taxable industrial investment 8, TAX-EXEMPT SECURITIES. \ paying over 10 per cent. Railways, public utilities, and other industrials ca» not compete on this basis and are now being deprived of the capital wnicn uiey need for expansion. This is a serious handicap to normal progress of muut, try, which should be terminated. ntinor The issuance of tax-exempt securities by the Government, btates, oi ouier political subdivisions, because of the ease in obtaining funds, encourages aeot, public extravagance, and public inefficiency in funds so raised. , +r, Mr. Gkebn. It also encourages municipal ownership, in order that tney can own these public utilities and issue tax-free obligations. Mr. McFadden. Yes, sir. Apropos of that, the city of Los Angeles, Oalit., is now selling between twenty-five and thirty million dollars worth of tax- exempt securities for the purpose of developing a water power, which is a money earning proposition and is owned entirely by the city. The State of California right now is referring to the people through a referendum asking authority to issue $500,000,000 worth of tax-exempt securities for the purpose of developing natural resources within the State of California. Mr. Gkeen. That is just a business proposition to make money within the State and keep it exempt from taxation? Mr. McFadden. That is the idea. In the State of North Dakota the State, under their peculiar laws, has the right to run grain elevators; they have the right to enter into business ; they have the right to issue and sell tax-exempt SBourities for that purpose. It is a step, and a long step, into socialism, it strikes me, and for that reason alone ought to have the careful consideration of Congress. Furthermore, the bonds for the erection of a schoolhouse or the building of a highway represent capital employed temporarily and therefore unproductive. The same amount of money invested in an industry of permanence and con- tinuous operation is productive in the sense that it insures the permanent employment of labor. AUowea to continue, the issuance of tax-exempt bonds encourages all political units issuing the same to rapidly approach their bond- ing limit, when the burden of taxation thus created may become so heavy as to force confiscation of their property. That is very pertinent at this time, because of the fact that xntinicipaUties are going in the same direction as States — they are issuing securities way be- yond anything that was in contemplation five years ago. As the bonding power of the cities becomes exhausted their credit position also becomes impaired, and to that extent the credit position of the State also becomes impaired. The credit position of a State can not become impaired with- out also impairing the credit position of the Government. This proposition to amend the Constitution places all forms of investment on an equal basis of competition and establishes equality in the assumption of the tax burden by all people. The principles of the Constitution are now being undermined by the inequali- ties of taxation, resulting from the issuance of tax-exempt securities. Under this proposal the Government, States, and all other political subdivisions thereof will have equal rights of taxation upon all securities issued by them after its enactment and ratification by the States. This proposal will not increase taxes in any manner whatsoever. It will merely change the method and equalize the distribution of the burden of taxa- tion. Mr. Hawley. Mr. McFadden, what proportion of these securities issued by ■ States, counties, road districts, school districts, and other so-called municipal organizations are held by the savings banks for investment where small in- vestors or persons having small amounts have placed their funds? Mr. McFadden. I have not the exact figures, but there must be, of course, a large amount of securities held by those institutions. Mr. Young. I would like to ask you how your amendment would affect the Federal farm loan bonds? Mr. McFadden. It would affect future issues of those bonds by taking away the privilege of tax exemption. It would affect the Government bonds the same way. This whole proposition simply taxes the income derived from those securities. Mr. Fbeae. How long would it be before a constitutional amendment could be adopted so as. to put into effect this resolution? I mean under ordinary cir- cumstances if there is no particular opposition — I am assuming that there would be none, for the purpose of illustration. Mr. McFadden. I suppose it would take a matter of two years. All of the legislatures would have to act. TAX-EXEMPT SECXJRITIES. 9 Mr. Febak. What would be the tendency of the various communities — that is, State and municipal, smaller municipalities — in issuing tax-exempt securities during this pending period? I mean what would be the effect on them? Mr. McFadden. The probablities are that many of them, not understanding the proposition, would attempt to issue in large amounts. That is quite a serious matter in connection with this amendment. Mr. Fkeae. These are objections that I have heard raised, and I waht to get your advice. We have between ten and fifteen billion dollars, as you say, in exempt securities — that is an estimate — now outstanding of such securities ; in addition to that we would have whatever , securities will be issued within two or three years to contend with, which will go to add to the accumulation already before us. That is right, is it not? Mr. McFadden. I would think that that matter could be probably fixed in this amendment, to provide that after a certain date this should be retroactive. Mr. Fkeak. Gould you do that, providing they are sold under specific contracts? Mr. McFadden. No ; not if they are sold under contracts, but you could provide in the amendment against the possible issuance with an idea of getting in under it. Mr. Fkeak. After the law goes into effect? Mr. McFadden. Yes. I would not think it was possible to make this retro- active, nor would it be desirable. I think it would be a violation of contract to attempt to do that, but I think it would be a splendid thing in view of «ie possible anticipation on the part of municipalities that there might be a particular advantage which they might consider they would lose, and would thus accelerate the issuance and sale of their securities, to fix a definite date at which this was to become operative. Mr. Feeae. After the constitutional amendment was adopted? Mr. McFadden. Yes. Mr. Feeae. But until that time no liniitation could be placed upon tliem, and we have got all these securities which, as the chairman suggests, will be in- creased or enhanced in value. Mr. Geeen. There would not be anything to prevent doing as Mr. McFadden suggests, providing if it was desired that from and after the date mentioned, "ay from the 1st of June next Mr. TiLSON (interposing). Or, from the passage of the resolution? Mr. Geeen (continuing). Or from the passage of the resolution. Mr. McFadden. If notice were given to the public generally that securities issued after a certain date, say .Tune 1 of this year, would be sub.1ect to this amendment, that would coi'rect the situation, but I would not want to suggest to your committee as to whether that could be done or not. Mr. Feeae. Then this would be the result, would it not, that even after a period of 10 years, if the States refused to ratify the constitutional amendment prior to that time, all bonds issued after the date .fixed in the resolution would be subject to taxation? Is that the alternative? Then it does not require, if that be true, if that is the legal phase of it, if that be true, there is no neces- city of passing the resolution ; all we have got to do is to assert that after a certain date they shall be .subject to taxation. Mr. Geeen. I do not understand that. Mr. Fekae. I can not understand it as a legal proposition. Mr. Geekn. What is the legal difficulty about it? What is the legal diffi- culty about providing — about having the resolution provide that from, and after its passage a,ll securities issued shall be taxable? Mr. Freae. That is, by the Congress? Mr. Geeen. By the Congress. Of course, until the resolution is adopted by the States it has no force and effect. Mr. Feeae. That is the very point I am making. What is the status of these securities so issued? Mr. Geeen. When it is adopted it will take effect from that date specified in the resolution. Mr. Feeae. That is the very point I have in mind. Mr. McFadden. The resolution of Congress, of course, will have to be rati- fied by the States, and if that resolution should contain a provision that all securities issued after June 1, 1922, should be subject to taxation, of course I would think that could be done. Mr. Feeae. But there is a very important question. Action by the States is postponed for 10 years, we will say, before we have it adopted; what is the 10 TAX-EXEMPT SBOUBITIES. character and what is going to be the status of all these bonds that are issued within that 10 years that has elapsed? Mr. McFadden. Well, the matter would be left in an unsettled condition. _ Mr. Feeak. I am in sympathy with your general proposition, but I was just wondering how fixing a specific date would work out. Mr. McFadden. I want to say to the committee that I have not given mature thought to that proposition, and there are many details in connection with this matter which I am sure that the Ways and Means Committee, as they study this proposition, will have to deal with and decide upon. There are many technical points in connection with the working out of this proposition which I am sure will be troublesome to you. Mr. Chandler. What is to become of the taxation of the interests in that interim from now until the 10 years expires — the time that they do adopt? Wouldn't the municipalities and the States pay a higher rate of interest on their bonds with the possibility of its never being adopted by the States for 10 years? Mr. McFadden. Ten years, I will say to the gentleman, is merely, an arbi- trary assumption. There is no assurance of that. This might be adopted right away. There is a widespread public sentiment in favor of action, and as the people understand it and the fallacy of it I believe there will be a general movement in favor of the adoption of such a resolution as I have proposed to you. The Chairman. Let us get along, gentlemen. The Secretary wants to be heard: Mr. Fheae. If this gentleman has given a great deal of study to it, which we know he has, we will be glad to have it. Mr. Chandler. If it was never adopted, would not the rich man refip a harvest, a great harvest of increased interest from tlie taxpayers throughout the country by reason of this pending resolution? Mr. McFadden. Well, he has that right now. He can invest all of his money in tax-exempt securities, and so long as those are not affected or this law is not made retroactive, he can continue to reap benefits under it. ' Mr. Chandler. But by reason of the fact that you would have a retroactive feature in this bill or proposed bill, would not the securities that were offered after the date fixed by the law to go into effect — would they not bring a higher rate of interest, be required to carry a higher I'ate of interest, before they could be marketed; and if it was never adopted, would not the taxpayers pay these rich men this higher rate of interest all during the interim ? Mr. McFadden. Well, the poorer taxpaj'er, the ones the least able to pay, would be getting the little end of the deal all the time. Mr. Chandler. Certainly he would. The taxpayer would be getting the little end of it and the rich man would be getting the benefits of it. Mr. McFadden. Tliat is just the evil that we are trying to correct by this proposed amendment. Blr. Green. That is your interpretation. Mr. McFadden. It is an evil we are trying to correct. Mr. Green. It is said that there will be a large issue of securities pending the adoption of the amendment, if it is adopted. Now, no securities would be issued that would not eventually be issued any way. You can see that, can you not, Mr. McFadden? Mr. McFadden. I should think so, unless some people who are ill advised thought there was a particular advantage and would .lump in and issue a lot of securities thinking they could be protected and their securities would be more attractive. Anyone's guess on that would be as good as mine. Mr. Green. Municipal corporations do not issue securities simply for the fun of issuing them. Mr. McFadden. No, sir. Mr. Green. So that we would eventually have about the same amount of securities in any event; there might be a postponement in the time but there would not be any difference in the amount. Now one question furtlier with reference to the form. Did the Treasury authorities, their legal advisers, go over the form of your resolution? Mr. McFadden. I have a letter from the Treasury Department and the officials are here this morning, Mr. Mellon and Mr. Gilbert. I am sure they can answer any questions you have to propound. I do not want to keep these gentlemen waiting. TAX-EXEMPT SECURITIES. 11 Mr. Gkeen. I asked the question because I consider the form of tlie resolution a very difficult thing. You would be In favor, as I take it, Mr. McFadden, of permitting the States to levy the same amount of tax upon Government securities that they levy upon their own securities? Mr. McFadden. That is embodied in my resolution. I also realize, I will state to the committee frankly, the difficulty of making this entirely equitable. I do not want to go into that phase of it ; I am sure the committee will get into it when they consider it. The President in his message said that in any con- sideration that was given to it you must take into consideration the fact that it must be made equitable with, the States. There are some difficulties there that I am sure you will run into when you get to the consideration of that question, that I hope the wisdom of the committee may be able to solve satis- factorily. Mr. Gbeen. Well, in short, your plan is that the Federal Government should be permitted to levy a tax upon State and municipal securities at the same rate, to the same extent, that a tax is levied upon its own securities? Mr. McFadden. Yes, sir. Mr. Geeen. And also that the same privilege be given to the States? Mr. McFadden. If I was following my own thought in that connection I would not refer to that. I think the question of giving the States the same right is largely a political sop, as you might say, to get them to ratify the whole proposition. - Mr. Gaknee. In connection with Mr. Green's query — have you any c'^nmunl- «ation from the Secretary of the Treasury indorsing your resolution ? Mr. McFadden. Yes; I have a letter from the Secretary referring to H. R. 211, which was drawn by the Treasury Departnient and fl'hich is now before you. I presume, however, that the Secretary will speak for himself on that this morning. Mr. Gaknek. But we had better have that as the foundation put into the record in the beginning. Mr. McFadden. Yes, sir. The Chaikman. If you have the original letter, give it to the clerk and we will have it put into the record. Mr. McFadden. Yes ; I will do that. (The paper referred to follows:) Department of the Tkeasukt, Washington, September S3, 1921. Mt Dear Me. Chairman : I received your letter of August 27, 1921, inclosing a copy of House joint resolution 102, which proposes an amendment to the Constitution of the United States restricting the issue of tax-exempt securities by the Federal Government and States and municipalities, and have noted your request for my opinion with respect to this resolution and the subject in general. As you know, in my letter of April 30, 1921, to the chairman of the Committee ■on Ways and Means, a copy of which I inclose, I recommended to Congress that It consider the advisability of taking action by statute, or constitutional amend- ment where necessary, to restrict further issues of tax-exempt securitie'^. The •ever-increasing volume of tax-exempt securities (issued for the most part by States and municipalities) represents a grave economic evil, not only by reason of the loss of revenue which it entails to the Federal Government, but also because of its tendency to encourage the growth of public indebtedness and to divert capital from productive enterprises. The issue of tax-exempt securities has a direct tendency to make the graduated Federal surtaxes inef- fective and nonproductive because it enables taxpayers subject to surtaxes to reduce the amount of their taxable income by investing it in such securities, and at the same time the result is that a very large class of capital investments escape their just share of taxation. Of course, the voluntary withdrawal of the tax exemptions from securities to be issued by or under the authority of the Federal Government would require no constitutional amendment, but to do this as to Federal securities alone would unjustly discriminate against the National Government and leave a clear field for the State and local governments. In .general, moreover, the policy of the Federal Government has been not to issue its own obligations with exemptions from Federal surtaxes and excess-profits taxes, and the great bulk of the Liberty loans and other war debts have no such exemptions. As to State and municipal securities, I assume it is clear, since the decision in Evans v. Gore (253 U. S., 245), that the sixteenth amendment does not 12 TAX-EXEMPT SECUEITIES. permit the Federal Government to tax income derived from State or municipal securities and tliat the only effective means of restricting the further issue of tax-exempt securities by State or municipal governments would be by constitutional amendment. Such an amendment would doubtless meet with considerable opposition on the part of the States, and for that reason,_ as. well as from considerations of equality and fairness, it is the better view, I should say, that any restrictions on the further issue of tax-exempt securities should be mutual and should apply as well to securities issued by the Federal. Government as to State and municipal securities. It is important, however, not to lose sight of the real basis for the existing constitutional principle- under which securities issued by the State and municipal governments are now held free from taxation by the Federal Government, and Federal securi- ties from taxation by State and local authorities, and at the same time to- provide proper safeguards against any possible discrimination in taxation by the Federal Government against State and municipal securities or by the State governments against Federal securities. It is also important, in order- to avoid any question of bad faith, that the amendment should not apply to- outstanding is.sues which now enjoy tax exemptions. For these reasons I think that some modifications of House joint resolution 102 are desirable. In the first place, I think that the resolution should be so modified as to- niake it perfectly clear that the right of the Federal Government to tax the- inccme derived from State and municipal securities and of any State to tax the income derived from Federal securities, shall exist only to the same- extent that «ach government taxes the income derived from its own securities. This would prevent any discrimination by either government against the- securities issued by the other. In the second place, it is noted that while the- first part of the resolution subjecting the income from securities issued by State and municipal governments to taxation by the United States applies- only to securities issued after the ratification of the amendment, the proviso- subjecting the income from securities issued by the United States, its pos- sessions and TeiTitorles, to taxation by the, .States is not similarly limited. Such a limitation is, of course, necessary. Furthermore, the language of the proviso subjecting income from issues of Federal securities to taxation by the several States is not expressly limited to the income derived from securi- ties held by residents of the State and should be modified so as to avoid any possible interpretation which would allow a State to tax the income derived from Federal securities not held within the State. I might also suggest that the language of the amendment be made broad enough to include all securities issued by or under the authority of the Federal Government or of any State. This would apply, for example, to securities issued by Federal land banks and other so-called instrumentalities; of the Federal and State governments, which might not be considered as- coming within the terms of the resolution as it now stands. In this connection I am taking the liberty of inclosing a draft of- a proposed amendment to the Constitution along the lines of House joint resolution 102,. modified as I have suggested. Very truly, yours, A. W. Mellon, Secretary. Hon. Louis T. McFadden, Chairman Committee on BanJdng and Currency, Souse of Representatives. [Telegram.] Kansas City, Mo., Janiiarii 17, 1922.. Hon. Louis T. McFadden, I-Ioti.se of Representatives, ^Yashington, D. C: At a joint meeting of the real estate loan dealers, southwestern group. In- vestment Bankers of America, and the Real Estate Board of Missouri a reso- lution was unanimously adopted indorsing the proposed constitutional amend- ment removing tax exemption. I was directed by the meeting to advise the AA'ays and Bleans Committee of their desire that a fa\orable report be made upon the resolution, and the hope is that Congress will pass it at an early date. It was the con.sensus of opinion that no measure Congress could enact" would give as great and innnediate relief as to require all property to bear its share of taxation. W. E. Lyons, Secretary. TAX-EXEMPT SEGXJEITIES. 13 The Chaibman. We will now call the Secretary. We will be glad to hear you, Mr. Secretary. STATEMENT OP HON. A. W. MELLON, SECBETAKY OF THE TREASURY. Secretary Mellon. I think you all understand the position of the Treasury in this matter. It has been covered by these letters. TTiere have been several letters written, that which Mr. McFadden referred to, and then a letter to you, , Mr. Fordney, and the matter has been pretty well covered. I think you are familiar in a general way with the matter. Mr. Gabnee. Mr. Secretary, do you intend to put all those letters into the record? Secretary Mellon. Yes, sir. Personally, I think that the main consideration in favor of a constitutional amendment to put an end to the issue of tax-exeriipt securities is the importance of uniformity. It would be desirable to have a gen- eral basis that will work evenly as to all investments, and not have conse- quences which, perhaps, are unfavorable, such as might come through encourag- ing extravagance on the part of municipalities. Naturally, when the money can be gotten by municipalities through the tax exemption at a less rate of interest, there is a tendency to go further with expenditures than those municipalities would go if they were paying the higher rates for money, and naturally t>-i'6 are improvements or undertakings begun that perhaps are not necessar:'" ^^ ^ matter of general principle it would be a great deal better if all investments were subject to the same application of taxation. Mr. ToTJNG. As I understand it, Mr. Secretary, you have approved the wording of the McFadden resolution? Secretary Mellon. Yes. Mr. Young. That is the exact wording that the Treasury Department believes it ought to take? . j v, • Secretary Mellon. It is considered a good basis for discussion, a good basis for a bill There may be matters such as that brought up in relation to the time it should go into effect, or other matters of that kind, but it seemed good to have some general expression in the measure which would authorize the change in the law. -. . . , , , . ^ « . Mr Garneb. Mr. Secretary, speaking about the time it should go into effect, do you take the position that Mr. Green does, that a mere recitation that all bonds issued after the passage of the resolution by Congress and its submission to the States would subject all bonds issued in the interim by municipalities and States to taxation? . , . i, j., Mr Geeen I took that position provided the amendment was subsequently adopted— that is, that after the adoption of the amendment they could be taxed. Mr Gaehee I am speaking now if the amendment should be passed by Con- gress' submitting it to the States for ratification, and had a clause m it which provided that all bonds issued after the passage of this amendment through Congress, and it was afterwards ratified by three-fourths of the States— that all bonds issued in the interim would be subject to taxation. Do you think we ^'''seCTet^ary Mellon. Well, I am not sure, and I doubt whether it could be done ; there would be a period of uncertainty, perhaps, which would be undesirable M? GAENEE. I think, Mr. Secretary, that Mr. Green had m mind Probably the bills that we passed through Congress subjecting certain properties to taxation after the introduction of a bill in Congress; but this is a constitutiona question, and it does nT seem to me that we could amen^ the Constitutioia by mere y declaring that at the time it was amended on a certain day certain things would ^X^Vebn. You are expressing a legal opinion now, are you not? Mr Gabnbb. No, I am not ; I am merely asking him for one. Kry\I'L^'To^^^4\ld^ot'r;i^^ to express a leg.l opinion, but I rath^er doubt whether it would have the effect of making those issues ^'^Afc^GAENEE It will be the first time in the history of this country that you ever amended the Constitution by providing that it should be effective from the date it was submitted to the States. Secretary Mellon. Yes. 14 TAX-EXEMPT SECXJKITIES. Mr. Oldfield. Gould you uot get an opinion from the Attorney General and file it with your remarks, and have it printed in the record? Secretary Mellon. Well, of course, you haven't anything definite to base tnat opinion on. Mr. OLDifiBLD. It is a hypothetical case, but these are hypothetical questions here. . Secretary Mellon. It might be obtained, but that would be var:ed by any change in the bill itself, in the measure that you have before you. Mr. CoLLiEK. Would not the uncertainty, not knowing whether or not the Supreme Court would actually declare that these securities should be taxed, or it might declare that they should not be taxed— would not the uncertamty have a bad effect on it? Secretary Mellon. It would create confusion that would be undesirable; that is certain. The Ghaieman. I should think, Mr. Secretary, that the Attorney General would hesitate very much to render an opinion as to the legality of a measure that has not even been introduced into Gongress and endeavor to tell what its legality would be in the event it is enacted into law. Secretary Mellon. Exactly. Mr. Green. Not even proposed, so far as that is concerned. Nobody has pro- posed anything of that kind. Mr. Houghton. Would you think the Attorney General had cause for action agaiu^f: those who manufactured or sold or transported intoxicating liquors before tn^i eighteenth amendment was adopted? Secretary m^llon. I do not think so. Mr. Ckisp. I wiMicl like to ask you one question that is not a legal proposi- tion. I know you are an able financier, from reputation. Secretary Mellon. You know more than I do. Mr. Ceisp. Well, I am simply going by your general reputation. Of course, if this constitutional amendment )s adopted it will necessarily have the effect of requiring States and municipalities when they sell bonds to have those bonds provide for a higher rate of interest. Secretary Mellon. Yes, sir ; it probably v/ould. Mr. Ceisp. Can you give the committee any Idea of about how much higher rate of interest would be required in State and municipal bonds if this amend- ment was passed and those bonds have to bear their share of taxation? Secretary Mellon. No one could do that, because that depends on the amounts outstanding and the rate of taxation, which changes continually. But that is just the same with all other securities, railroad or industrial bonds that are sold; it depends on what taxes are levied and may be levied in the future. So that no one buying securities knows what he is going to pay on his income. Mr. Ceisp. Do you think, Mr. Secretary, that the full amount of tax would be added to the interest for the selling of State or municipal bonds? Secretary Mellon. It would be .just as it always has been. If all securities bear the general burden of taxation, they all go alike, and there is no discrimi- nation then, and therefore it has no bearing on the securities at tlie time of sale. Mr. Ceisp. The undoubted effect of this amendment, if it is ratified would be to require municipal and State bonds to bear a higher rate of interest would it not? ' Secretary Mellon. But no one could foretell what that rate would be Mr. Gaehee. Mr. Secretary, has your department an estimate on the "number of outstanding State and municipal bonds of all characters' Secretary Mellon. We have ; yes. The experts there have' made an estimate as nearly as they can, as such estimates are made. I have the statement of Mr McCoy giving an estimate. Mr. Gaenee. Is It in your letter? Secretary Mellon. Yes, sir. Mr. Gaknbe. Well, that is all right. Mr. Secretary, would it be possihle if this amendment was adopted, for Congress to levy a different rate on the 'in comes from its own bonds and municipal bonds from other incomes? Secretary Mellon. I suppose that could be done, but, of course without dis crimination between Federal bonds and municipal bonds. ' TAX-EXEMPT SECURITIES. 15 tn^^L?^^'^™- '^°n,=i"ess, then, could, if it saw proper, levy a difCerent rate of xrpSr^-nto^rfr^s r^-?^ ^^^-^^ secu7ities%si;.tdot <:;^ do'not?Ck-it?/the\?f°eyo?it"''°"°" °' ^'" ^^^^-l'^-'^ amendn:ent, and I wa^['t^^foUow it^fn'^'T^."' '-l' '''*'^''', f*^**^*^ *''^t that was his guess, and I beino- Seoi-Ptnrv nrth r^ '^'*''^'' " ^^^'^ *° ^'^^'^ ^''^^'^ "^ l^'^self, I am sure, mtad Iimic.L°^i?J;J''?^'^.''y' ^°^ ^^^ undoubtedly knows what Is in his ^L V^? I . ^°^% ''°' "''®^ *"5' suggestions as to his answers. IJow, Mr. Secretary, I am merely leading up to this: If your construction nffp .^f^Pf*^?.^™*^"^™^"* ''^ correct, giving the power to Congress to levy a different rate, if Congress had no occasion-saw probably no occasion-to ilsue dm believfthT-V''""''' °' t^^^,^^«■^' Government, and'^at the same time mey r=li^ / • - It 's^as mimical to the public interest to have a continued large from thn.T?Tf/ Or State bonds. It could levy very heavily against incomis from those, and thereby prohibit the issuance of those bonds by destroying the marJjet, could it not? ^ -i a that^^^'^''^^^' *^'^^'^°'^- ^ ^° ^°^ '^"°'^'^ *^^"'at there would be any legal obstacle to det^rm^^T™" " ^""^"^ only be a matter of public policy that Congress might Secretary Mellon. I should think so, barring any questiofi of discrimination. Mr. CxAENEE. Now, another question, Mr. Secretary. Suppose we had a ""i'' as we recently had, and it was necessary for you as Secretary of the Treasury and financial officer of the Government to raise a great deal of '^loney very quickly, as was the case in the recent war, and you desired t^^ issue a tax-free bond under the provisions of this act, would there not fcc' some difficulty in the States following that procedure? For instance, i" ci^e last issue of L'berty certificates, as I recall, one was tax-free, 3J, anri <-o.e other was subject to tax, 4|, as I recall ; now, would they not have some difficulty in following that pro- cedure in the States in issuing their bonds, if Congress should pass that kind of a law? Secretary Mellon. Well, there is this, that in a war emergency the Govern- ,ment can go a great deal further than it could go legally in normal times. I know that Senator Knox, during the war, made the statement that he believed the Government could tax these tax-exempt securities as a war measure— that is, on the theory of the general powers of the Government in war. Mr. Gaeneb. The power given under the Constitution to levy war? Secretary Mellon. Exactly. There are greater powers in the Government under those circumstances than ordinarily exist. Mr. Gbeen. Just so that no one who reads this hearing will be misled, I want to state that there is not any proposition before the committee to enable the Federal Government to levy a different rate of taxation on State and municipal securities from that which is levied upon its own securities. Secretary Mellon. I take it that the whole object or purpose is just the con- trary ; to endeavor to have it made uniform. Mr. Young. Mr. Secretary, would you mind telling the committee what, in your judgment, the adoption of this resolution — what effect it would have on the sale of Federal farm loan bonds? Secretary Mellon. They would probably have to bear a higher rate of interest' in order to meet the difference in taxation, or to meet the competition in the market from tax-free bonds. Mr. Hawley. Mr. Secretary, that would depend to some extent upon the con- dition of the market at the time they were offered, the scarcity of bonds, and if investment funds were considerable the rate of interest might not be seriously aifected? Secretary Mellon. Certainly it depends on the condition of the money market at the time. Mr. Young. But in a money market that Is rather tight, where money is scarce, you figure that it would alfect the rate and increase it? Mr. Gaenee. The farm loan bonds would have to absorb this tax in an in- creased rate of interest, would they not? Secretary Mellon. They would have to pay an increased rate of interest, undoubtedly. They always would. It might be a lesser or a greater amount of rate of Interest and might not be higher than the rate now prevailing, but it would be somewhat higher if this exemption were not allowed than with the exemption, naturally, and so would all Government issues. 16 , TAX-EXEMPT SECUEITIES. Mr. Oldiield. The object of this would be to try to bring together the lue^es rates ot the State and municipal bonds with the interest rates oi i «■- would it not, to put them on a par — put them togetJier? Secretary Mellon. It would give them all the same standing. Mr. Oldfield. Give them all the same status? Secretary Mellon. Yes, sir. Federal bonds Mr. Oldfield. In that event everybody merely would buy leueidi rathei- than State or municipal bonds? Secretary Mellon. If the rate of interest justified it. nutsf-in.1 Mr. LoNGWOBTH. Do your figures show the amount of these bonds outstand ing before the war? ^, , , ^^^ ^„^ „,„ ,,„,.„ Secretary Mellon. I do not know whether I have that here, but we have furnished that statement I know. i„„ that wo honr no Mr. LoNGWOKTH. There is a great disparity in the estimates that we hear as to the total amount now outstanding and \yhat was outstanding before tne wai, and what the Increase was under the present revenue law. Secretary Mellon. I have a statement here which gives the estimate— a state- ment taken from the census reports of 1913 and also of 1919— ot outstanding tax-exempt securities. ,, j-i, • „„„ Mr. LoNGWOKTH. Roughly speaking, can you tell us how much the increase has been in the last three years? ^ , ^^ ^ .. , ._, Secretary Mellon. I have that somewhere. No ; I do not have that particular ""STvt.teiuent here before me. Mr. -LoNGWOETH. I think that would be very valuable. I have never heard an official ^a.tement of that yet, although I have heard various estimates. I have heard it ebvimated at from three to five or six billion dollars. Secretary MBLLORf j; have here the statement of the increase In indebtedness of the States and muniaT>5iiities in 1913, and then the increase in 1919. Mr. Feeab. What amount is that, Mr. Secretary? Secretary Mellon. The statement is : In 1913 the total indebtedness of count.v and minor civil divisions of the States amounted to $4,075,000,000. Mr. LoNGWOKTH. That does not include municipalities? Mr. Freah. That does not include cities? Mr. LoNGWOETH. It does not include cities? Mr. Oldfield. It includes counties and subdivisions. Secretary Mellon. And at the present time it is $8,142,000,000, for States, counties, and minor subdivisions. Mr. LONGWOETH. Well, that has more than doubled in the six years. Secretary Mellon. It is somewhere near about double. i Mr. Feeae. May I ask you a question in that connection, Mr. Secretary? Have you any information as to where those securities are held — referring now par- ticularly to the municipal securities? Are they held by the smaller banks and the community generally, or do they reacli the hands of these people who are ■ trying to escape payment of taxes? Secretary Mellon. Perhaps half — somewhere near half — of those securities nre held, it is estimatetd, by corporations, such as the large insurance comijanies and banks and other corporations which are required to keep their investments in securities of that nature. There are laws, I believe, requiring them to keep a certain amount of securities, and then there are investments of court funds, etc., that are made in securities of that nature. Mr. Gkeen. And may I add right there, Mr. Secretary, that in some States where the local taxation on moneys and credits is quite heavy, there is con- siderable local investment in tiiese securities. Secretary Mellon. Yes, sir. For instance, in my State the State and municipal securities have exemption from local taxation, and while we may buy the tax- exempt securities of other States, that does not exempt us from our State tax, and therefore the local securities are sought after for the purpose of complete exemption. Mr. Feeae. In your statement before the Senate Finance Committee, as 1 recollect, Mr. Secretary, you said in effect that you knew of few Instance 'where men in commercial life use their funds for investment in tax-exempt securities, which we can readily understand ; they need all funds for their business ; now' what proportion have you — or have you had any estimate from the department as to what proportion is held in tax-exempt securities by those who wish to avoid the payment of taxes? Secretary Mellon. Well, it is difficult lo arrive at any definite estimate. Mr. Geeicn. Not any definite estimate, I understand, but what proportion"' TAX-EXEMPT SECURITIES. 17 Secretary Mellon. It is difficult to arrive at all accurately at it. Mr. McCoy has made an estimate giving it about as near as he could arrive at the amount. The amount ot that investment of that nature and the amount of the cost of that exemption — the amount, you might say, of tax payment that is avoided by that exemption — perhaps this memorandum of Mr. McCoy's would answer those questions. Mr. Feeae. That will be inserted in the record? Secretary Mellon. I will put that into the record. I could read it now. The Ghaieman. We will be glad to have you read it. Mr. Oldtield. I will be glad to have it read. Secretary Mellon. There are several of these statements. I think they would all be enlightening to the committee. Mr. Gaenek. I suggest that you put them all In, so that we can have them for the record. The Chaibman. Leave such of them as you care to leave, Mr. Secretary. Secretary Mellon. This particular memorandum will give you an idea. The estimated total of all tax-free securities issued in the United States, outstanding on January 1, 1922, is $10,660,000,000. Of this amount it is probable that, say, $5,660,000,000 is held by corporations such as the insurance companies, surety and bonding companies, banks and trust companies, etc., which are re- ciuired to retain certain reserves. Many States require tliese reserves held by concerns doing business therein to be in the form of local, State, and municipal securities. Now, .vou see from that these laws requiring investments in municipal securities, etc., seem to account for about half of all the tax-exempt securities outstanding. In other words, of the total amount of $10,660,000,000 which the actuary estimates, $5,660,000,000 are held by these corporations, banks, and trust companies. Those are not in the hands of the individuals — approximately half of the whole amount of those tax-free securities outstand- ing- Mr. Ceisp. Is It your estimate that the total amount of tax-free securities out- standing is about $10,000,000,000? , Secretary Mellon. $10,660,000,000. Mr. Ceisp. We have had several witnesses before us last fall who made it as high as ^15,000,000,000. Secretary Mellon. Well, that may be so. No one can tell, but I think it is nearer $10,660,000,000. Mr. Ceisp. Your .estimate, from the best information you have at the Treas- ury Department, is about $10,000,000,000? - Secretary Mellon. That is what we arrive at, as near as possible. Mr. Feeae. This is a fact, is it not, Mr. Secretary, that the difference be- tween a 32 per cent rate on surtaxes, as embodied in the House bill, would mean a reduction of about $100,000,000 in the taxes of those who were relieved? Now, could anything be ascertained or be determined from that as to the amount of investment of these people? Secretary Mellon. That would be only an estimate. Mr. Feeae. But that is practically the amount of tax receipts that would come in in 1921, is it not? . Secretary Mellon. And even that estimate is changing continually. As time goes on the amount in the higher surtax of differentials is falling off. It is coming to a leveling up right along. Mr. Feeae. Is that not due in part to business conditions which have caused less profits all the way along the line? Secretary Mellon. Yes; but it was going on just at the same rate before there was any change in business conditions — while business was prosperous. Mr. Feeae. Due to investments, do you believe, in tax-exempt securities? Secretary Mellon. No ; not altogether. That is only one factor. There are so many other methods of investments which are better than the investments which incur the heavy surtax. Mr. Feeae. Would you mind telling the committee about what some of those are — just briefly — because I think it is important on this point? Secretary Mellon. In many instances it is not investment at all ; it is merely a method of placing the property or investments where they are not sub.ject to the large surtax. For instance, a man divides his property among his family. Mr. Feeae. That is, by gift, you mean? Secretary Mellon. By gift; and then naturally brings it down to the lower brackets, into lower rates. 93671—22 2 18 TAX-EXEMPT SECURITIES. Mr. Feeae. And by the purchase of property of a speculative nature for the purpose of having- it increase in value, and so on? Secretary Mellon. Yes. And then there are long-time bonds that sell at a very great discount — where, for instance, a railroad bond running a great many years may bear only 3 or 3i per cent, and it sells, say at 60 cents on the dollar or something that way. There are a great many on the market. A man can buy such a security and he makes a large part of the profit there at the end of the period, when he gets par for his security that only cost him 60 cents. Mr. Feeae. May I ask one more question right in that connection? When the New York telephone bonds were sold recently for $50,000,000, the papers stated that the subscriptions reached about $450,000,000, or nine times over- subscribed. Secretary Mellon. Yes. Mr. Feeah-. Those were 6 per cent bonds and they were taxable bonds? Secretary Mellon. Yes. Mr. Feeae. What would be the explanation of that, in view of the oppor- tunity to invest in tax-exempt securities? Secretary Mellon. Well, you see, in a long-time security it is supposed that the tendency of money is toward lower rates, and speculatively a long-time 6 per cent bond of a very sound and substantial company at this period is attractive, when investors are looking for a change to lower rates. People buy them because naturally those bonds will, when money gets to a lower rate, go to a premium ; and then again you can not always say that because a security is subscribed a number of times over it is due to actual demand. People suppose that it is going to be oversubscribed, and they subscribe for several times as much as they want in order to get the amount that will be allotted to them. Mr. Feeae. But that amount of fluid money was to be had for those taxable investments at 6 per cent, provided they could have had them, unquestionably, or the banks would not have offered them. (Secretary Mellon. Yes, sir. Now, if I can finish this — this perhaps goes into figures here which may not be plain just to read to the committee. I can read it if you desire, but there is a good deal of it. The Chairman. I think, Mr. Secretary, if you put it into the record that will be sufficient. If the committee is interested they can get it there and study it. Secretary Mellon. I have a letter prepared which goes into the general proposition, the position of the Treasury ; another letter which covers pretty much the ground of what was said formerly ; and then there are these esti- mates that have been made. I will put those all into the record. (The papers referred to follow:) Teeasltky Depaetment, Washington, January 16, 1922. Dear Me. Chaieman : I am glad, in accordance with the request of the com- mittee, to present the Treasury's views as to the issuance of tax-exempt se- curities and the latest available information as to the amounts now outstand- ing, and their effects upon the revenues and the investment markets. The problem presented by these issues of tax-free securities is of growing impor- tance, and I think that it deserves the most serious attention. The views of the Treasury on the sub,iect and its fniggestions as to possible remedies have already been set forth in my letter to you of April 30, 1921, and in my letter of September 23, 1921, to the chairman of the Committee on Banking and Currency of tlie House of Representatives, a copy of which I sent to you with my letter of September 28, 1921. Copies of these letters are attached for ready reference. The further views of the Treasury have been indicated to some extent in my letter of November 4, 1921, to you and in the undersecretary's letter of November 10 to the chairman of the Committee on Banking and Currency, copies of which arc inclosed. Since these letters the President, in his address to Congress on December G, 1921, has emphasized the importance of action in the matter in the follow- ing words : " There are a full score of topics concerning which it would be becoming to address you, and on which I hope to make report at a later time. 1 have alluded to the things requiring your earlier attention. However, I can not end this limited address without a suggested amendment to the organic law. TAX-EXEMPT SECURITIES. 19 " Many of us belong to (hat school of thought which is hesitant about altering: the fundamental law. I think our tax problems, the tendency of ^vealth to seek nontaxable investment, and tlie menacing increase of public debt, Federal, State, and municipal, all justify a proi)osal to change the Constitution so as to «nd the issue of nontaxable bonds. No action can change the status of the many billions outstanding, but we can guard against future encouragement of capital's paralysis, while a halt in the growth of public indebtedness would be beneficial throughout our whole land. " Such a change in the Constitution must be thoroughly considered before submission. There ought to be known what influence it will have on the in- evitable refunding of our vast national debt, how it will operate on the neces- sary refunding of State and municipal debt, how the advantages of Nation over State and municipality, or the contrary, may be avoided. Clearly the States would not ratify to their own apparent disadvantage. I suggest the considera- tion because the drift of wealth into nontaxable securities is hindering the flow of large capital to our industries, manufacturing, agricultural, and carry- ing, until we are discouraging the very activities which make our wealth." I should also like to call to your attention the statement as to the decline in taxable income, particularly from investments, which appeared in my annual report for 1921, on pages 20-21, as follows : " THE INJUKIOUS EPFECT OF HIGH EATES ON THE REVENUES. " The actual effect of the high surtaxes can readily be seen in the statistics publislied by the Bureau of Internal Revenue. " The following table shows in comparative form, for the years 1916 to 1919, inclusive, the total number of returns of all classes and the returns of incomes over $300,000; the total net income in the same way, and also the investment income. Table fihoicing decline of taxahle incomes over $300,000. Number of returns. Net income. Income from dividends, in- terest, and investments. All classes. Incomes over $300,000. AH classes. Incomes over $300,000. All classes. Incomes over $300,000. 1916 437,036 3,472,890 4,425,114 6,332,760 1,296 1,015 627 679 $6,298,677,620 13,652,383,207 15,924,639,356 19,859,491,448 $992,972,986 731,372,153 401,107,868 440,011,589 $3,217,348,030 3,785,657,955 3,872,234,936 3,954,653,925 $706,945,738 616, 119, 892 1917 1918 344,111,461 1919 314,984,884 " The years under consideration, 1916 to 1919, inclusive, were, on the whole, years of unexampled prosperity, and of earnings and profits beyond those ever known before in any like period in the history of the country. Notwithstanding this, and while the total Income of all classes increased, at the same time there was a striking decrease in taxable incomes of $300,000 and over — the drop being from $992,972,986 in 1916 to $440,011,589 in 1919. " The effect of the high surtaxes in the other brackets is apparent from a brief study of the statistics regarding taxable investment income. " In the bracket ' Incomes of $300,000 and over,' the taxable investment in- come declined from $746,614,591 in 1916 to $828,360,613 in 1919 ; in the bracket ' $100,000 to $300,000,' the decline was from $602,853,543 in 1916 to $427,910,905 in 1919 ; and in the bracket ' $60,000 to $100,000,' the decline was from $366,- 614,917 in 1916 to $323,743,874 in 1919. " If we take the taxable income from Interest, exclusive of interest on Gov- ernment obligations, the decline is still more striking, the figures being as follows : Incomes, $800,000 and over : 1916 $165, 733, 900 1917 111, 468, 127 1918 74, 610, 507 1919 60, 087, 093 '20 TAX-EXEMPT SECURITIES. Incomes, $100,000 to $300,000 : ^,^„ „„ ,„„ iqifl $lo8, 870,428 1917 7- -' 119- 539, 786 iqiQ :_:_' 91, 030, 892 i9i9"iii iiiiriiiiiiiiiiriiriiiiiiiiiiiiiri ' ^^' ^^'^'^ 1^2 Incomes,i6a000To"$i00,000T ]^9]^g »o, 2bU, 08d 1917— _ 75,375,484 1918"— II.IIIIIII 11 - 65,784,062 1919 . 68, 814, 933 " The foregoing brackets represent the incomes subject to surtaxes under the revenue act of 1918, respectively, at 63 to 65 per cent, 52 to 63 per cent, and 29 to 48 per cent. To these figures should be added the normal tax of 8 per cent in order to find the total tax obligation. " In view of these figures is it not clear that these high surtax rates are rapidly ceasing to be productive of revenue to the Government? And is it not equally clear that their effect has been to divert into unproductive channels not merely the income on the old investments, but to force a large part of the old Investment capital into unproductive channels? " I attach for the further information of the committee in this connection the following tables which have been prepared by the Government actuary : 1. Estimate of the total amount of wholly tax-exempt securities outstanding January 1, 1922. 2. Table showing advantage of investing in tax-free securities as compared with a like investment In taxable securities. 3. Estimate of revenue loss to Federal Government through wholly tax- exempt securities outstanding January 1, 1922. According to reports there were issued during the calendar year 1921 fully tax-exempt securities of States and municipalities to the aggregate amount of about $1,100,000,000, and the indications are that further issues will follow during the current year in substantial volume. Fully tax-exempt land-bank bonds. Federal and .loiut stock, to an amount exceeding $100,000,000 were also issued during 1921, and f urtlier issues are in prospect. The Federal Government, on the other hand, has adopted the policy of not issuing fully tax-exempt oblir gations of its own, and its current offerings must be sold in competition with the fully tax-exempt offerin,gs of States and cities. The most important consideration is that the existence of the growing mass of tax-exempt securities, coupled \^dth the extremely high surtax rates still Imposed by law, tends to drive persons of large income more and more to invest in wholly exempt securities issued and still bein,g issued by States and municipalities and heretofore issued by the Federal Government. The result is to impair the re\enues of the Federal Government and t<-i pervert the surtaxes, so that instead of raising revenue they frequently operate rather to encourage investment in wholly tnx-exem)3t securities, and even to encourage the issue of such securities by States and municipalities. This process tends to divert investment funds from the development of productive enterprises, transportation, housing, and the like, into noniiroductlA^e or wasteful State or municipal expenditures, and forces both the Federal Government and those engaged in business and industry to compete with wholly tax-exempt issues, and on that account to pay higher rates of interest. The greatest value of the full exemption fi'om taxation arises, of course, fi-om the exemption it confers in respect to Fedei-al income surtaxes, and the constantly increasing volume of tax-free securities therefore constitutes a real menace to the revenues of the Federal Government. At the same time it makes the high surtaxes operate as inducements to investment in nonproductive public indebtedness and is gradually destroying them as revenue producers. As a consequence the yield of the surtaxes is dwindling and there is a premium on the issue of bonds of States and cities. In the last analysis this is at the expense of the Federal Government, and it is having a most unfortunate and far-reaching effect upon the development of the whole country because of the diversion of wealth from producti\'e enterprise. Tiie problem is one of exceptional diflicnlty, and it is not easy to point to a ])racticable remedy. r>ut the problem is none the less real, and it is important to do whatever can be done to meet it. One angle of approach is through the proposed constitutional amendment; another is through the revision of the surtax rates to remove the heavy premium on tax-free securities. It will be TAX-EXEMPT SECITEinES. 21 helpful to the whole situation If the matter may have eaiiv consideration Ly the conmiittee, with a view to appropriate action. Sincerely, yours, A. W. Mellon, Secretary. Hon. Jo.SEPH W. FOEDNEY, Chuii-Diaii Committee on Ways and Means. Teeasuby Depaktment, Washington, January I4, 1922. Memorandum for Secretary— Loss to Government through tax-free securities- Estimated total of all tax-free securites issued in the United States, out- standing January 1, 1922, $10,660,000,000. Of this amount it is probahle that, say, $5,660,000,000 is held Dy corporations, such as insurance, surety and bonding companies, banks and trust companies, etc., which are required to retain certain reserves. Many States require these reserves held by concerns doing business therein to be in the form of local, State, and municipal securities. A taxable security to yield the same revenue, after paying a tax of 124 per cent, as does a 5 per cent tax-exempt security, must yield 5.714 per cent. That is, on an investment of $100,000 by a corpora- tion, the advantage of a tax-free investment would be $714 per year, as com- pared with a taxable investment. As a large percentage of insurance, banking, and surety companies are required to invest in these tax-free securities, they would still be obliged to invest in them if they were taxable, so it would seem safe to say that, if they were all made taxable, the gain to the Federal Govern- ment in tax from corporation-held tax-exempt securities would be not in excess of $35,000,000 per annum. We must also remember that all commercial stocks are now tax-exempt in the hands of corporations without materially reducing their taxes. Of the remaining $5,000,000,000 in tax-exempt securities held by Individuals, partnerships, and abroad it Is safe to say that upon about $2,500,- 000,000 the gain in tax would be nil, and that upon the remaining $2,500,000,000' about $85,000,000. That is, if all tax-exempt securites outstanding January 1,. 1922, were made taxable the gross increase in revenue to the Government would: be approximately $120,000,000. There is little doubt that under these conditions the future investor in what are now tax-exempt securities would demand that they bear a higher rate of interest or be sold at a discount sufficient at least to meet this tax. Jos. S. McCoy, Government Actuary. Tebasliey Depaetment, Washington, January 12, 1922. Memorandum for Secretary in re tax-exempt securities: The Bureau of the Census reports that for the years 1913 and 1919 the total indebtedness of the States was as follows : 1913 - $422, 796, 525 1919 - - 744, 582, 933 This would Indicate a total indebtedness of the States as of January 1, 1920, of about $775,000,000. The Bureau of the Census reported the total indebtedness of county and minor civil divisions of the States, which includes all cities, towns, etc., as of 1913, at $4,075,152,904. This included $3,475,954,353 exclusive of sinking fund assets. This indebtedness probably increased by January 1, 1920, to about P5,595,000,000. That is, the total indebtedness of the States and their minor 2ivil divisions as of January 1, 1920, was about $6,370,000,000. According to the financial press, about $672,000,000 of new indebtedness was added during the year 1920 and about $1,100,000,000 for the year 1921. This would make the total indebtedness of the States and minor political subdivisions thereof as of January 1, 1922, $8,142,000,000. From this the estimated total tax-free securities outstanding as of January 1, 1922, may be tabulated as follows : State, county, and minor political subdivisions of the States $8, 142, 000, 000 United States tax-free bonds (net outstanding) 2,184,000,000 22 TAX-EXEMPT SBCUEITIES. Federal farm loan bonds (net outstanding) $284,000,000 Bonds of insular possessions (net outstanding)' 50,000,000 Total 10. 660, 000, 000 This estimate may be fairly taken as a maximum, as no allowance is made 1h the computation for any debt maturing since July 1st, 1919. Jos. S. McCoy, Government Actuary. advantage of investing in tax-fkee sbcueities as compared with a like in- vestment in taxable secueities. Januaet 14, 1922. 1. In each case $40,000 is assumed to be invested in a tax-free 5 per cent security and by comparison in a taxable stock bearing the necessary rate of interest so as to yield the same income after paying the income tax of the existing law. Net income of investor, exclusive of that from tbe above investment. Net income of in- vestor from the above invest- ment, after pay- ing income tax on same. Surtax on dividends. Income from taxable stock before paying tax. Neces- ~ sary rate of interest of tax- With tax-free security. With taxable stock. able security. $4 000 $2,000 2,000 2,000 2,000 2,000 2,000 2, 000 2,000 2,000 2,000 $2, 000 2,000 2,000 2,000 2,000 2,000 2,000 2,000 2,000 2,000 SO. 00 105. 26 272. 73 439. 02 777. 78 1, 225. 81 1, 846. 15 2, 000. 00 2,000.00 2, 000. 00 $2, 000. 00 2, 105. 26 2, 272. 73 2,439.02 2, 777. 78 3,225.81 3, 846. 15 4, 000. 00 4,000.00 4, 000. 00 Percent. 6. GO $16 000 5.26 §28,000 5. 68 6.10 S60 000 ■ 6.94 880 000 a06 9.62 S200 000 10. OC S50O,000 10.00 10. 00 2. Advantage of investing in a tax-free security, as compared with any other form of investment, when the income is subject to both normal and surtax, such as a mortgage, commercial bond, etc. In each case $40,000 is assumed to be invested in a tax-free security and by comparison the same amount in the other form of investment yielding the necessary rate of profit so as to give the same income after paying the Income tax of the existing law. The investor is assumed to be married, with- out dependents. Net income of investor, exclu.sive of that from the above investment. J.500 ,$4,000.... S16,000... 828,000. . . 840,000... $60,000. . . .J80,000... 5100,000. . $200,000.. $500,000.. 81.000.000 Net Income of in- vestor from the above invest- ment, alter pay- ing income tax on same. With tax-free security. $2, 000 2,000 2,000 2,000 2,000 2,000 2,000 2,000 2,000 2,000 2,000 With taxable security. 52,000 2,000 2,000 2,000 2,000 2,000 2,000 2,000 2,000 2,000 2,000 Total tax on receipts from above in- vestment. $80.00 265. 26 432. 73 599.02 937.78 1,385.81 2,000.1.') 2,160.00 2, 160. 00 2,160.00 Income from taxable security before pajTOg tax. $2, 000. 00 2,080.00 2,205.26 2, 432. 73 2,599.02 2,937.78 3, 385. 81 4,006.15 4,160.00 4, 160. 00 4,160.00 Neces- sary rate of interest of tax- able security. Fer cetit- 6.00 6.20 6.66 6.08 6.50 7.34 8.46 10.02 10.40 10.40 - 10.40 ' Philippine Islands, Hawaii, and PortoJEtlco.^ TAX-EXEMPT SECUEITIES. 23 From these tables it is observed that there is an advantage to the investor in tax-exempt securities yielding a 5 per cent income as compared with an invest- ment of the same sum in the stock of a corporation where the return from that stock is less than from 5 to 10 per cent, depending upon the taxable net income of the investor. In case of an investment of the same sum in a mort- gage, corporate bond, or other completely taxable form of investment, the ad- vantage exists unless this latter investment yields from 5 to 10.40 per cent, depending upon the net income. Where the amount invested is greater than $40,000, the upper limit will be the same, but the advantage will be somewhat extended where the net income from other sources is small or comparatively small, as is shown in the table below. Investment of $1,000,000 in a 5 per cent tax-exempt security as compared with the investment of the same sum, in commercial stockn. Net income of investor, exclusive of that from the above investment. Net income of in- vestor from the above invest- ment, after pay- ing income tax on same. With tax-free security. With taxable stock. Surtax on dividends. Income from taxable stock before paying tax. Neces- sary rate of interest of tax- able security. 34,000 $16,000.... $28,000 $40,000 $60,000.... «0,000.... «00,000... $200,000... $500,000... $1,000,000. $50, 000 50,000 50, 000 50,000 50, 000 50, 000 50, 000 60, 000 60, 000 50, 000 $50, 000' 60,000 60,000 50, 000 50,000 50, 000 50, 000 60, 000 50, 000 50,000 $7,611.11 13, 111. 11 20, 037. 74 28, 923. 08 38, 076. 92 44, 609. 80 47, 058. 82 60, 000. 00 50, 000. 00 60, 000. 00 $67, 611. 11 63,111.11 70,037.74 78, 923. 08 88, 076. 92 94, 509. 80 97, 068. 82 100, 000. 00 100, 000. 00 100, 000. 00 Per cent, 5.76 6.31 7.00 7.89 8.81 9.46 9.71 10.00 10.00 10.00 J. S. McCoy. EXTRACT FROM LETTER FROM THE SECRETARY OF THE TREASURY TO THE CHAIRMAN OF THE COMMITTEE OK WAYS AND MEANS. Treasury Department, Washington, April 30, 1921. Dear Mr. Chairman : In accordance with your request, as communicated In your letter of April 25, 1921, I am glad to present for your consideration and that of the Committee on Ways and Means, revised estimates of receipts and expenditures for the fiscal shears 1921 and 1922, and to indicate in that con- nection what revenues must be provided for the fiscal years 1922 and 1923 in order to carry on the Government's business and meet its current requirements and fixed debt charges, including interest and sinking fund. Now, that the House of Representatives has passed the emergency tariff legis- lation, I hope that the Congress will soon undertake the revision of the revenue laws, with due regard to the protection of the revenues and at the same time Tvith a view to " the readjustment of internal taxes and the revision or repeal ■of those taxes which have become unproductive and are so artificial and burden- some as to defeat their own purpose." The higher rates of Income surtaxes put constant pressure on taxpayers to reduce their taxable income, interfere with the transaction of business and the free flow of capital into productive enterprise, and are rapidly becoming unproductive. The excess-profits tax is artificial and troublesome. Taxes of this extreme character are clogs upon productive business and should be replaced by other and more equitable taxes upon incomes and profits. An intelligent revision of these taxes should encourage production and In the long run increase rather than diminish the revenues. Early action is necessary, for unless a revision is adopted within a few months it could not in 24 TAX-EXEMPT SECURITIES. fairness apply to income and profits arising from the business of the present calendar year. With these considerations in mind, I venture to make the following principal suggestions with regard to the revision of the internal-tax laws : 1. Repeal the excess-profits tax, and make good the loss of revenue by means' of a modified tax on corporate profits or a flat additional income tax upon cor- porations, and the repeal of the existing $2,000 exemption applicable to cor-, porations, to yield an aggregate revenue of between .i;400,000,000 and .$500,- 000,000. The excess-profits tax is complex and difficult of administration, and is losing its productivity. It is estimated that for the taxable year 1921 it will yield about $4.50,000,000, as against $2,500,000,000 in profits taxes for the taxable year 1918, $1,320,000,000 for the taxable year 1919, and $750,000,000 for the taxable year 1920. In fairness to other taxpayers, and in order to protect the revenues, however, the excess-profits tax must be replaced, not merely repealed, and should be replaced by some other tax upon corporate profits. A flat addi- tional tax on corporate income would avoid determination of invested capital, would be simple of administration, and would be roughly ad.1usted to ability to pay. It is estimated that the combined yield to accrue during the taxable year 1921 from a tax of this character at the rate of 5 per cent and the repeal of the $2,000 exemption would be about $400,000,000. 2. Readjust the income-tax rates to a maximum combined normal tax and sur- tax of 40 per cent for the taxable year 1921, and of about 33 per cent thereafter, with a view to producing aggregate revenues substantially equivalent to the estimated receipts from the income tax under existing law. This read.iustment is recommended not because it will relieve the rich, but because the higher sur- tax rates have already passed the collection point. The higher rates constitute a bar to transactions Involving turnovers of securities and property, which with lower surtax rates would be accomplished and thus yield substantial new reve- nue to the Government. The total net income sub.1eet to the higher rates is rap- idly dwindling, and funds which would otherwise he invested in productive en- terprise are being driven into fields which do not yield taxable income. The total estimated revenue froni the surtaxes under existing law is about $500,000,000 for the taxable year 1921. The estimated yield for. the year from the surtax rates above 32 per cent would be about $100,000,000. The immediate loss in revenue that would result from the repeal of the higher surtax brackets would be relatively small, and the ultimate effect should be an increase in the revenues. 3. Retain the miscellaneous specific-sales taxes and excise taxes, Including the transportation tax, the tobacco taxes, the tax on admissions, and the capital- ■ stock tax, but repeal the minor " nuisance " taxes, such as the taxes on fountain drinks and the miscellaneous taxes levied under section 904 of the revenue act, which are difficult to enforce, relatively unproductive, and unnecessarily vexatious. The repeal of these miscellaneous special taxes would, it is esti- mated, result in a loss of about $50,000,000 in revonue. The transportation tax is objectionable and I wish it were possible to recommend its repeal, but this tax produces revenue in the amount of about $330,000,000 a year and could not safely be repealed or reduced unless Congress Is prepared to provide an accept- able substitute. The Treasury is not prepared to recommend at this time any general-sales tax, particularly if a general-sales tax were designed to supersede the highly productive special-sales taxes now in effect on many relatively non- essential articles. 4. Impose sufficient new or additional taxes of wide application, such as in- creased stamp taxes or a license tax on the use of automobiles, to bring the total revenues from internal taxes after making the changes above suggested to about $4,000,000,000 In the fiscal years 1922 and 1923. The only way "to escape these additional internal taxes, to an aggregate amount of between' $250,000,000 and $350,000,000, will be to make immediate cuts in that amount in current expendi- tures. In the event that this should prove impossible, it might be feasible to provide perhaps as much as $100,000,000 or $150,000,000 of the necessary revenue from new duties on staple articles of import, and the balance by taking more effective steps to realize on back taxes, surplus war supplies, and other salvage- able assets of the Government. 5. Adopt necessary administrative amendments to the revenue act in order to simplify its administration and make It possible, among other things, for the Commissioner of Internal Revenue, with the approval of the Secretary of the Treasury and the consent of the taxpayer, to make final determination and set- tlement of tax cases. In this connection it would be well, in the interest of fairness and "in order to simplify the administrative problem, to provide, under TAX-HXEMPT SECURITIES. 25 proper safeguards, for carrying forward net losses of one year as a deduction from the income of succeeding years. I suggest for the consideration of Congress that it may also be advisable to talce action by statute or by constitutional amendment, where necessary, to re- strict further issues of tax-exempt securities. It is now the policy of the Federal Government not to issue its own obligations with exemptions from Federal sur- taxes and profits taxes, but States and municipalities are issuing fully tax- exempt securities in great volume. It is estimat(^d that there are outstanding, perhaps, $10,000,000,000 of fully tax-exempt securities, -tlie existence of this mass of exempt securities constitutes an economic evil of the first magnitude. The continued issue of tax-exempt securities encourages the growth of public indebtedness and tends to divert capital from productive enterprise. Even though the exemptions of outstanding securities can not be disturbed, it is im- porant that future issues be controlled or prohibited by mutual consent of the State and Federal Governments. I am sending a copy of this letter to Senator Penrose as chairman of the Com- mittee on Finance. I shall, of course, be glad to hold myself and the Treasury experts in readi- ness to answer any call from the committee and to supply such further informa- tion with regard to the condition of the Treasury and the Treasury's revenue recommendations as the committee may desire. Very truly, yours, A. W. Mellon, Secretary. Hon. Joseph W. Fokdney, Chairman Committee on Ways and Means. September 23, 1921. My Deak BIe. Ohaiemah : I am inclosing herewith a copy of my letter of this date to Congressman McFadden in reply to his letter of August 27, 1921, requesting my opinion with respect to House joint resolution 102. I under- stand that this resolution is pending before the Committee on Ways and Means, and I am, therefore, sending you the inclosed copy of my letter to Congressman McFadden for your information. Very truly, yours, A. W. Mellon, Secretary. Hon. Joseph W. Fordney, Chairman Committee on Ways and Means. September 23, 1921. My Dear Me. Chairman : I received your letter of August 27, 1921, inclos- ing a copy of House joint resolution 102, which proposes an amendment to the Constitution of the United States restricting the issue of tax-exempt securities by the Federal Government and States and municipalities, and have noted your request for my opinion with respect to this resolution and the subject in general. As you know, in my letter. of April 30, 1921, to the chairman of the Commit- tee on Ways and Means, a copy of which I inclose, I recommended to Congress that it consider the advisability of taking action by statute, or constitutional amendment where necessary, to restrict further issues of tax-exempt securi- ties. The ever-increasing volume of tax-exempt securities (issued for the most part by States and municipalities) represents a grave economic evil, not only by reason of the loss of revenue which it entails to the Federal Government but also because of its tendency to encourage the growth of public indebted- edness and to divert capital from productive enterprise. The issue of tax- exempt securities has a direct tendency to make the graduated Federal sur- taxes ineffective and nonproductive, because it enables taxpayers subject to surtaxes to reduce the amount of their taxable income by investing it in such securities ; and at the same time the result is that a very large class of capital investments escape their just share of taxation. Of course, the voluntary withdrawal of the tax exemptions from securities to be issued by or under the authority of the Federal Government would require DO constitutional amendment, but to do this as to Federal securities alone would unjustly discriminate against the National Government and leave a clear field for the State and local governments. In general, moreover, the policy of the Federal Government has been not to issue its own obligations with exemptions from Federal surtaxes and excess-profits taxes, and the 26 TAX-EXEMPT SEOUKITTES. great bulk of the Liberty loans and other war debt have no such exemption. As to State and municipal securities, I assume it is clear, since the decision in Evans v. Gore (253 U. S., 245), that the sixteenth amendment does not permit the Federal Government to tax income derived from State or municipal securities and that the only effective means of restricting the further issue of tax-exempt securities by State or municipal governments would be by constitutional amendment. Such an amendment would doubtless meet with considerable opposition on the part of the States, and for that reason, as well as from considerations of equality and fairness, it is the better view, I should say, that any restrictions on the further issue of tax-exempt securities should be mutual and should apply as well to securities issued by the Federal Government as to State and municipal securities. It is important, however, not to lose sight of the real basis for the existing constitutional principle under which securities issued by the State and municipal governments are now held free from taxation by the Federal Government, and Federal securities from taxation by State and local authorities,, and at the same time to provide proper safeguards against any possible discrimination in taxation by the Federal Government against State and municipal securities or by the State governments against Federal securities. It is also important, in order to avoid any question of bad faith, that the amendment should not apply to outstanding issues which now enjoy tax exemptions. For these reasons I think that some modifications of House joint resolution 102 are desirable. In the first place, I think that the resolution should be so modified as to make it perfectly clear that the right of the Federal Government to tax the income derived from State and municipal securities and of any State to tax the income derived from Federal securities shall exist only to the same extent that each government taxes the income derived from its own securities. This would prevent any discrimination by either government against the securities issued by the other. In the second place, it is noted that while the first part of the resolution subjecting the income from securities issued by State and municipal governments to taxation by the United States applies only to securities issued after the ratification of the amendment, the proviso sub- jecting the income from securities issued by the United States, its possessions and Territories, to taxation by the States is not similarly limited. Such a limitation is, of course, necessary. Furtliermore, the language of the proviso subjecting income from issues of Federal securities to taxation by the several States is not expressly limited to the income derived from securities held by residents of the State and should be modified so as to avoid any possible inter- pretation which would allow a State to tax the income derived from Federal securities not held within the State. I might also suggest that the language of the amendment be made broad enough to include all securities issued by or under the authority of the Federal Government or of any State. This would apply, for example, to securities is,sued by Federal land banks and other so-called instrumentalities of the Federal and State governments, which might not be considered as coming within the terms of the resolution as it now stands. In this connection I am taking the liberty of inclosing a draft of a proposed amendment to the Constitution along the lines of House joint resolution 102, modified as I have suggested, Very truly, yours, A. W. Mellon, Secretary. Hon. Louis T. MoFadden, Chairman CoinmiUee on BanJcing and Gurrenci/. JOINT RESOLUTION Propo&ing an aniendment to the Constitution o£ the United States. Resolved by the f^enalc and House of Reprcse^ilatircs of the United States of America in Congress assemhled {two-1hirds of earn House concurring therein), That the following art'cle be submitted to the legislatures of the several States' which, when ratifled by the legislatures of three-fourths of the States shall be valid and binding as n part of the Constitution of the United States: ' " Article XX. "The United States shjill have power to tax incomes derived from securities issued after the ratification of this article by or under the authority of the TAX-EXEMPT SEGTJBITIES. 27 [Several States to the same extent that incomes derived from securities issued after the ratification of this article by or under the authority of the United States are taxed by the United States. Any State shall have power to tax incomes derived by residents thereof from secnrties issued after the ratification of this article by er under the authority of the United States to the same extent that incomes derived by residents of such States from securities Issued after the ratification of this article by or under the authority of such State are taxed by such State." NovEMBEB 4, 1921. Deak Me. Chairman : I received your letter of October 27, 1921, with the in- closed copy of the joint resolution Introduced by !\'lr. McFadden (H. .T. lies. 211), proposing an amendment to the Constitution of the United States to re- strict the further Issuance of tax-exempt securities. This amendment is in the form suggested by the Treasury In my letter of September 23, 1921, to Congressman JNIcPadden, a copy of which is Inclosed for your information. This letter outlines the Treasury's general views with regard to the proposed constitutional amendment. I thinlj it would be helpful if the present Congress, as a part of the tax- revision program, would take some action to propose to the States a consti- tutional amendment to restrict future issues of tax-exempt securities, and that •the amendment in the form introduced by Mr. McFadden merits the serious consideration of the Committee on Ways and Means. At the least. It offers the basis for a' thoroughgoing treatment of the tax-exempt security problem. The existence of the present great mass of about $10,000,000,000 of fully tax-exempt securities, with the prospect of continued issues of tax-exempt securities unless some restrictive amendment is adopted, necessarily tends to defeat the surtaxes Imposed by the revenue laws, while the combined effect of the high surtaxes and the unlimited volume of tax-exempt securities is inevitably to divert capital which would otherwise be employed in productive enterprise into rela- tively unproductive public expenditure. I believe that there would be nothing ' in the long run more helpful to the recovery of business and industry in the country, and at the same time nothing better calculated to protect the Govern- ment's own revenues, than a revised system of taxation which not only moderates the surtaxes but also takes steps to stop the diversion of Investment funds into tax-exempt securities. Very truly, yours, A. W. Mellon, Secretary. Hon. Joseph W. Fobdney, Chairman Committee on Ways and Means. NOVEMBEB 10, 1921. My Deab Congressman : I received your letter of November 2, 1921, with the inclosed copy of the joint resolution (H. J. Ses. 211) which you introduced on October 2^, proposing an amendment to the Constitution of the United States to restrict further issues of tax-exempt securities. I had already noted that this joint resolution followed the draft submitted with the Secretary's letter of September 23. In response to the request of the chairman of the Com- mittee on Ways and Means, to which the joint resolution was referred, the Secretary has now expressed his further views in the matter in a letter to the com'mittee dated November 4, 1921, a copy of which Is Inclosed for your Information. I have examined the suggested substitute resolution inclosed with your letter of November 2, and have several comments. I should say that the chief objection to the substitute was a practical one, namely, that it includes provisions with respect to the taxation of salaries of public officials of the several States and of the political subdivisions thereof, which would tend to •create opposition to the constitutional amendment as a whole entirely out of proportion to the benefits to be derived from this particular change. It may be that the salaries of such officials ought to be subject to the Federal income tax, and undoubtedly the present situation results In some discrimination In favor of State and municipal officials as against Federal officials and other indi- viduals It will be exceedingly difficult in any circumstances, however, to get three-fourths of the States to ratify a constitutional amendment to restrict the further Issues of tax-exempt securities, and to add to these difficulties by giving the State and local officials, who are likely to be most active in the 28 TAX-EXEMPT SECURITIES. several States, a definite personal interest against the amendment migM easily defeat the whole proposition. It may also be said that notwithstanding the present discrimination in favor of State and local ofllcials, the tax-exempt status of their salaries results, after all, in only a slight increase in their compensation, «ind that for the most part the State and local ofhcials are not so highly paid as to make this extra compensation any crying evil. In other words, while the proposed sub- stitute may be entirely right in theory as to salaries of State and local offi- cials, and conversely as to Federal officials in respect of State and local taxa- tion, as a practical matter this feature of it would probably endanger the really important part of the amendment. The substitute also inserts in the form of a proviso the condition that iu- comes derived from securities) Issued by or under the authority of the United States must be taxed by the United States before the United States has power to tax incomes from securities issued by or under the authority of the sev- eral States, and makes the same change with respect to the taxation by the States of incomes derived from securities Issued by or under the authority of the United States. The provision as to . taxation by the States has been al- tered, moreover, so as to remove the limitatic^n to " residents thereof " in the two places where it appeared in the Secretary's draft; and under both pro- visos " incomes derived from all securities " issued by themselves after the ratification of the amendment would have to be taxed before there would be power on the part of the Federal taxing authorities, or State and local tax- ing authorities, as tlie case might be, to tax incomes derived from securities issued by the other. The word " all " would seem to be unnecessarily restric- tive, and the omission of the limitation of the taxing power of the States to incomes derived by " residents thereof " might open up securities issued by or under the authority of the Federal Government to double taxation by the States. . I am tlierefore inclined to believe that the phraseology of the- amend- ment proposed by House joint resolution 211 is better, in that it makes more clear the reciprocal character of the change and gives better protection against discrimination. The Intent of the conditions is to insure that there will be mutuality, and this is provided for best by words like " if, when, and as," or " in the same manner and to the same extent that." As a matter of fact, there is much to be said for making even House joint resolution 211 more clear in this respect and using the words " if, when, and as," or " in the same man- ner and to the same extent that," or other similar words. If the condition is stated simply in the form of a proviso, the power to tax might arise in favor of the Federal or State Governments fron; the mere fact of taxation of their own securities, though the taxation we're not in any proper sense mu- tual, or were even discriminatory. It might thus be said, for example, that incomes from 4 and 4J per cent Liberty bonds are now " taxed by the United States," in that the Federal income surtaxes and profits taxes apply to such incomes, subject to certain limited exemptions. Very truly, yours, S. P. GiLBEKT, Jr. Hon. Louis T. McFadden, Chairmam, Committee on Banking and Gnrrencij. The Chairman. Mr. Secretary, I may be fussy on this point, but I want to get an expression from you to see whether I am anywhere near right. I have an idea that it is a mistake to make Federal securities the subject of taxation; that it is an imposition upon the taxpayer, an extreme penalty, and I want to give you an illustration. For instance, in 1919 the total net income of people making tax returns on iflO,000 or more— an income of $10,000 or more— was $5,755,000,000, and the tax collected was $1,004,000,000 — I do not give the lower figures — or 18,2 per cent of the net income. That was paid in taxes to the Federal Government. Mr. Green. The tax collected was how much? The Chairman. The tax collected was $1,049,523,286, from a net income of $5,755,690,649, or 18.2 per cent of the net income was paid to the Federal Gov- ernment in taxes — income taxes. Mr. Green. Are you speaking now of the personal income? The Chaibman. Yes, sir ; of all who paid income tax on $10,000 or more. Now, Mr. Secretary, suppose the man that holds Federal bonds, Government bonds, has a higher rate of income than the average; suppose that the man TAX-EXEMPT SEGUKITTES. 29 •who holds Government bonds lias a higher rate of income than the average above $10,000, then, of course, the percentage would be greater, but for easy figuring let us say 25 per cent — if It were 50 per cent the principle would be •exactly the same. Suppose the people holding Government bonds pay to the Federal Government 25 per cent of their income; Government bonds to-day ■selling upon the market, or quoted upon the market, nontaxable 31 per cent bond, are quoted equally to a 4i or 4i per cent bond, which is subject to taxa- tion. Now, on $20,000,000,000 4i per cent is $850,000,000 a year in interest; at 3J per cent it would be $700,000,000, or a difCerence of $150,000,000 interest that the taxpayer is called upon to pay to the Federal Government, and the Federal Government pays it out to the holder of Government bonds. Of that $150,000,000 extra interest, because the bonds are subject to taxes, the Government gets back, we will say, 25 per cent of that money, or $37,500,- ■000, and the difference, $112,500,000, is the amount that the taxpayer has paid to the Government, to the Federal Government, that goes to the holders of the ■bonds,- and therefore it is a bad financial deal for the taxpayer. Secretary Mellon. It is pretty difficult to tell just exactly what the differ- ence would be as to the cost, but I think your figures are wrong to this extent : That your 18 per cent is based on all securities, tax free and those that are subject to taxation. The Chairman. All incomes, we will say. Secretary Mellon. The percentage is not the same. You are applying that ■same percentage to the tax free alone, whereas it Is not the same at all. The Ghaikman. Let me see, Mr. Secretary, if I understand you. I am apply- ing this to the Incomes of people who made income returns with incomes $10,000 or more. Secretary Mellon. Yes ; and all returns of .$10,000 or more paid taxes upon their average income from every description of securities, tax free or otherwise. The Chairman. The average is 18.2 per cent, but suppose that those holding •Government bonds paid back to the Treasury 50 per cent of what they received in that extra interest above 3.5 per cent ; then they would pay back $75,000,000, and the taxpayer has to pay $150,000,000 in interest. In other words, the hondholder gets one-half that difference between 34 per cent and 4.25 per cent, and the Government gets one-half. There is $75,000,000 loss to the taxpayers of the country over and above what they would pay if those bonds were tax free, all of them. Therefore I am arguing this — the point I am trying to bring out, Mr. Secretary, is this : That if all those public securities, Government bonds, municipal. State, and county, and so on, were tax free the taxpayer would Iiave to pay a great deal less money in interest, because by making it taxable we must certainly add to the rate of interest that must be paid. Now, which would be the best, to have all of them tax free or all of them subject to taxa- tion? The purpose of this bill is to make all bonds subject to taxation. Secretary Mellon. Your argument is that the Government — that the present policy cost the Government or the people less money than it will cost the people if all securities are subject to taxation? The Chairman. Yes, sir. Secretary Mellon. Well, that would be a pretty difficult thing to figure out. Tt does not follow, among other things, that as much as twenty billions of tax- ■exempt securities could be sold at an appreciably lower rate. The Chairman. But it is the real gist of the whole thing, is it not? Secretary Mellon. It is one aspect of the matter. The Chahiman. If we adopt this constitutional amendment and make munici- pal bonds subject to taxation, are we not going to add additional burdens upon the people in taxes? Secretary Mellon. I should say, not, in the long run. Mr. Frear. Does not this question arise there, Mr. Secretary, that there is an assumption that the 3i per cent tax-free security of the Government can be put out at par? Is that true? Secretary Mellon. Probably. Mr. Frear. That is true to-day, that the Government can issue 34 per cent Secretary Mellon. Perhaps. Now, to sell a security at par that is not tax free the Government would have to pay a rate of interest to-day of more than 4 per cent, of course. Mr. Crisp. More than what? Secretary Mellon. More than 4 per cent. I suppose it would depend upon the length of time they would have to run, but it would be somewhere from 41 to perhaps 5 per cent, depending on the length of time they would run. 30 TAX-EXEMPT SECUEITIES. Mr. Feear. Does that have reference, in fixing the market value, to the holding by national banks of the securities on which they issue their currency . Secretary Mellon. No; that is another proposition entirely. That has no bearing on this. Mr. FuEAE. The Government can sell its bonds to-day at 3.5 per cent tax tree/ Secretary Mellon. Yes ; but it would depend upon the terms and the market. Mr. Young. Do you think that any large amount could be sold at that? Secretary Mellon. At what? Mr. Young. At 3.5 per cent, tax free? , Secretary Mellon. That is about what the present issue of Victory notes are, the issue of Government bonds that are entirely tax free. They are selling at not quite that, but approximately that. But generally, whether it is one way or the other, whether it costs the Government or costs the people something more to have all securities of the Government subject to taxation, the same as other securities, or whether it costs them less, it would seem to me to be desirable to have it uniform, to have all incomes treated alike, and then all of these ultimate consequences that sometimes grow out of inequalities such as the encouragement of extravagance in municipal operations, etc. — you avoid any question of that sort. The Ohaieman. That is a strong point, is it not, Mr. Secretary? Secretary Mellon. Yes, sir. Mr. Houghton. If the bonds of the Government, the States and municipalities and the like are made not tax exempt, obviously they must bear a higher rate of interest? Secretary Mellon. Certainly, higher than if exempt. Mr. Houghton. If those bonds must bear a higher rate of interest, what will the effect be on the interest rate of all other securities? Secretary Mellon. I do not think that would make any special difCerence. Mr. Houghton. You do not think that it would tend to increase the rate of all othfer securities? Secretary Mellon. No ; I do not think so. Mr. Young. Would it not probably reduce It a Uttle? Secretary Mellon. I doubt if it would have any effect. There is the quantity of securities existing to-day. Some are tax exempt and some are not. Now there would be practically the same quantity existing if they were all made subject to tax, and I do not think it would have any appreciable bearing on the securities that are existing to-day which are not tax free. The Ohaieman. Is that all, gentlemen? Mr. Secretary, hiave you any other gentlemen from the Treasury Department that wish to be heard? Mr. Feear. I would like to ask the Secretary one question regarding Mr. Green's suggestion, whether or not you would favor having any date fixed here after which time the securities would be subject to taxation? Secretary Mellon. I do not believe I can answer that. That is going into- legal questions. Mr. Feeak. I was wondering if you had considered that. Mr. Geeen. There are some questions that I would like to ask Mr. Gilbert if he is here. The Chairman. We thank you, Mr. Secretary. We will now hear Mr. Gilbert. STATEMENT OF MK. S. P. GILBERT, JR., UNDERSECRETARY OF THE TREASURY. Mr. Geeen. Mr. Gilbert, I presume you have examined the form of the reso- lution introduced by Mr. McFadden pretty carefully? Mr. Gilbert. I have examined it very carefully. Mr. Geeen. Now, in this resolution of Mr. McFadden's, which seems to me to be pretty well worded, and possibly worded in the best manner of any that we can obtain, there was yet in my mind a lingering doubt as to whether some loophole might not be found in it, and when we were discussing it, and in some informal discussions with relation to the matter my attention" was called par- ticularly to this language : " The United States shall have power to tax incomes derived from securities issued after the ratification of this article, by or under the authority of the several States, to the same extent that incomes derived from securities issued after the ratification of this article by or under the authority of the United States are taxed by the United States." What construction do you put on those words " to the same extent"? TAX-EXEMPT SliCUEITIES. 31 Mr. GiLBEBT. Those words are meant to make the taxation entirely recipro- cal or mutual. I am inclined to agree with you, Mr. Green, that those words could be improved upon, and the Treasury has suggested, for Instance, to Mr. McFadden, that they might be made rather more speciiic and be put in the form of " if, as, and to the extent." That would make it completely mutual. Mr. Geeen. Right in that connection, as I understand it then, the Treasury has not definitely concluded just what form this ought to take? Mr. GiLBEBT. This amendment was not drawn as a final draft — was not in- tended to be a final draft ; it was meant to be submitted as a draft in good form for discussion. Mr. Hawley. Mr. Green, in that same connection, how can you have uni- formity in national taxation unless there is uniformity among the States in the taxation they levy? Mr. Green. The amendment intends also in a further provision to provide for that. Mr. GiLBEET. This would mean that a State that taxed Federal securities would have to tax its own securities on exactly the same basis ; if it did not tax its own securities it could not tax Federal securities. Mr. LoNGWOETH. Do you think that would carry exemption of the aiiount under the present law, $165,000? Would that automatically apply to this, to the same extent? Mr. GiLBEKT. That is a different question. Those are already outstanding, Mr. Longworth. Mr. Geeen. I take it, Mr. Gilbert, that this amendment would not apply to anything except securities issued after its ratification, unless otherwise pro- vided. Mr. GiLBEET. I think that would be covered by the provision that only se- curities Issued after the adoption of the amendment would come under it. Mr. Hawley. But the question I have in mind is this : Suppose one State taxes Government securities at one rate ; another State, in order to give an advantage in the market to the sale of its own securities, taxes Government securities at a lower rate, and therefore its own securities at a lower rate, and thereby increases the desirability of its own municipal issues. Mr. Gilbert. Well, that would still be possible under any form of amend- ment, I should thinly. It would be difficult and probably undesirable to make the tax rates in all the States the same. Mr. Hawley. Xou think it would be impossible to secure uniformity of tax rates throughout the United States? Mr. Gilbeet. Oh, yes ; among all the States. Mr. Geeen. Then, as I understand it, the Treasury would like to ha\-e a little further time to consider this form? Mr. Gilbeet. It is not quite so much that as it is that the Treasury does want to submit this form for discussion from all angles, as it is believed to be a good form although it may be susceptible of improvement. The Treasury has no other suggestions to make as to form at this moment. Mr. Geeen. Let me suggest, then, some questions for your consideration with reference to these words : "to the same extent." Under those words would it be possible or practical for the Government to exempt from taxation a portion of its securities and still tax others? Mr. Gilbert. I should say it would be extremely difficult to do it without at the same time exempting from taxation the income from State securities. It would run into that danger. Mr. Geeen. Do these words : " to the^ same extent " apply merely to the rate, or would they apply to differences in terms of maturity and some other differences that might possibly exist? Mr. Gilbeet. I should say they would apply chiefly to the rate. They would also cover special tax exemptions and the fact of taxation of the State's own securities. Mr. Geeen. Let me suggest, Mr. Gilbert, that we have to get this definite enough so that there can be no question of its application. If there is any doubt as to whether this applies simply to the rate or whether it also includes the term " maturity " — that is what we \vant to know. Mr. Gilbeet. I think it clearly would not apply to the maturities of the obligations. It mi.ght apply to special exemptions, for instance, special ex- emption granted to State obligations, so that there would have to be simila- 32 ' TAX-EXEMPT SECUEITaES. exemptions gran ted to Federal obligations, up to corresponding amounts. There are other things than rate that might be made cliscrinnnatory. Mr. Gkeen. That is. If a certain amount of Government securities touici oe held exempt from taxation, then the same amount of the States secuiuies would be held exempt from taxation? Mr. LoNGWoETH. I think that would follow. . • i r Mr. GiLBEKT. Yes ; I think that would follow. The intention is to avoid ois- crlminatlon. It may be that the words ought to be put in the form ot with- out discrimination "—that that ought to be stated specifically. Mr. Gbeen. I am inclined to think so. In the resolution that I prepared I inserted the words " without discrimination." To speak more accurately, I should say that in the first Instance Mr. Beaman prepared it and not being entirely satisfied with It I modified It, but when I got through I was not en- tirely satisfied with my own draft. I think the drafting of this resolution is a very difficult matter. „ tt Mr. Fke.»lE. May I ask a question right there in that connection.' Here, tor instance, tJie city of New York and the city of Buffalo and many large cities in New York issue bonds. What would be the restriction that would be put uporf those bonds in any event? Would it be in amount or simply, as you suggest. In regard to discrimination? What is the meaning of, the words? Mr. GiLBBET. I am not sure I understand. You mean what restriction would such a constitutional amendment put on them? Mr. Feeae. Yes. Mr. Gilbeet. The income from them, if the Federal Government taxes Income from its own securities, would be subject to a similar Federal tax. It would not require the State of New York to tax them Itself, unless it chose to do so. Mr. Freae. In that respect you would reach everything from school bonds up? Mr. GiLEEET. It would reach everything thereafter issued; put them all on the same basis as Federal obligations. Mr. Feeak. It is purely a question of discrimination, then, not a question of amount? Mr. GiLBEET. Yes; there would be no restriction on the amount issued. Thi chief value of these .tax exemptions. It should be added, has arisen from thi exemption they give from surtaxes. The Federal Government itself has not been selling obligations exempt from surtax for about three years, and all the certificates and notes now being issued and most of the Liberty bonds are not exempt from surtax. The exemption from surtax is chiefly at the expense of the Federal Government. Mr. Feeae. That relates, strictly, then, to the question of discrimination, and not to the amount? Mr. Gilbert. Yes. (The following letter from Secretary Mellon to the chairman was received under date of February 9, 1922 : ) Febeuaey 9. 1922. My Deae Me. Chairman : I have received your letter of .lanuary 26, 1922, requesting a statement of the amount collected as income tax from the interest on taxable Government bonds during recent years. The only information available in this department is for the calendar year 1919, in which year the total amount of such interest reported in individual returns of net income was .$63,377,222, and the tax collected, as estimated by the Bureau of Internal Revenue was .$15,28.5,265. This is at least the maximum collected from Individuals for that year. The Bureau of Internal Revenue made this estimate by taking the amount of Interest reported in the various income classes and applying the surtax rate corresponding to each income class. Furthermore, in the year 1919, corporations returned a total income from tax- able Government bonds of $298,436,843, on which it is estimated that the Gov- ernment collected excess-profits taxes of approximately $29,843,684 more than would have been the case had these bonds been entlreiy tax free. It must be remembered that for the time being the taxable Interest on Liberty bonds is relatively small, because of the temporary exemptions from surtaxes which were eoirferred in connection with tlie floating of the Uberty loans. These exemptions, as consolidated in the revenue act of 1921, make It possible for individuals to hold as much as $160,000 face amount of Liberty bonds for limited periods without liability to surtaxes. All interest from the loans Is exempt from the normal tax. Tlie result lias been to reduce the taxable Interest TAX-EXEMPT SEOUKITIES. 33 on Liberty bonds to a comparatively small figure as, for example, the $63,377,222 reported for 1919. It must also be remembered that the amount of tax actually collected on taxable interest gives but one side of the picture, and that even more important is the loss of revenue which arises from the inability to tax the income from fully tax-exempt securities. It is impossible, as a practical matter, to estimate exactly the total amount of loss of income tax to the Federal Government from the diversion of funds into nontaxable Federal or State government bonds during recent years, but some idea of it can be gathered from a comparison of the reports of taxable in- comes over $300,000 a year from 1916 to 1919, inclusive. In 1916 taxable in- comes over $300,000 reported totaled $992,972,986, and in 1917, $731,372,153, as against only $401,107,868 and $440,011,589 in 1918 and 1919, respectively, and this notwithstanding that on the whole these were four years of un- exampled and growing prosperity, during which the total income of all classes reported showed a constant increase. Investment in tax-exempt securi- ties undoubtedly accounts for a large part, though not all, of the shrinkage. Further figures as to the shrinkage in investment income subject to taxation is given on pages 20 and 21 of my annual report for 1921. In this connection I should like to refer to the question which you raised in the course of my testimony before the committee upon the constitutional amendment regarding tax-exempt securities on January 16, 1922, as to whether in case the amendment is adopted the United States Government will not lose more from the higher interest rates on its bonds than it will gain in taxes. I have liad some further investigation made upon the problem, the results of which are briefly set forth below. The case which you propounded was that if the Government could issue $20,000,000,000 worth of 3J per cent tax-exempt bonds at the same price as $20,000,000,000 41 per cent bonds, subject ot surtax, the Government loss in in- terest by issuing the 4i- per cent bonds would be $150,000,000, whereas you suggest that the greatest possible gain in surtaxes would be only one-half of this amount, $75,000,000, assuming that all bondholders were subject to the maxinuim 50 per cent, or only $37,500,000, if they were subject on the average , to a 25 per cent surtax rate. In the first plfice, you will notice that upon the hypothess that the holders were on the average in the 25 per cent class, while it is true that the Gov- ernment would only receive $37,500,000 out of the $150,000,000 additional interest payments, it would also receive 25 per cent of the other Interest i^aid if the bonds were not tax exempt. In other words, the annual interest pay- ment on the $20,000,000,000 of 3* per cent bonds would be $700,000,000, of which the Government would take $175,000,000 on this hypothesis if the bonds were subject to surtax. Accordingly there would be no loss, but on the contrary a gain to Hie Government on this basis from abolishing the tax ex- emption on the $20,000,000,000 of bonds. As against $150,000,000 of additional interest paid there would be taxes collected amounting to $212,500,000, a nel gain of $62,500,000 a year. But the case in favor of the proposed amendment from a revenue standpoint is even stronger, because it would be quite impossible for the Government to float $20,000,000,000 of tax-exempt bonds at a rate of interest three-fourths per cent less than that of taxable bonds. There is only a limited class of people in the United States to whom the exemption from surtax is worth as much as three-fourths of 1 per cent. On November 30, 1921, the amount of Liberty 3i's outstanding was $1,410,074,450, and of Victory 3f's, $497,915,100. These two issues include the great buUc of wholly tax-exempt United States obligations which are held by investors ( as distinguished from circulation bonds held by national banks). If instead of less than $2,000 0000,000 there were ■ $20,000,000,000 of these bonds, the value of the exemption would probably be almost imperceptible in the market quotations. The result of such an extension would be that the Government would have to pay almost the same amount in interest charges as before and would be wholly deprived of the surtaxes which it might otherwise collect. Very truly, yours, A. W. Mellon, f^ea'etari/, Hon. .Joseph W. Foedney, Chairman Committee on Ways and Means. 93671—22 3 34 TAX-EXKMPT SECUIIUIIES. (Mr. McFaddeii siibmitted tlie following imrit'i's:) NovEMnEi! 2, ]921, Mr. S. P. GiLiiERT, Undersecretary of the Treaaury. Deah Me. Gilbeet : Referring to your recent letter to me, regarding my bill on tax exemption, I introduced tlie suggested bill which you sent me, and am inclosing herewith a copy of the House .joint resolution No. 211. The introduction of this resolution has brought forth several opinions from tax experts, the combination of which is embodied in the inclosed copy of a suggested bill. I would be very glad indeed to have your opinion about this suggested bill, and would appreciate an early reply. L. T. McFadden, The United States shall ha^ e power to tax incomes derived from securities issued after the ratification of this article by or under the authority of the sev- ei-al States, and incomes derived from salaries of public officials of the several States and of the political subdivisions thereof elected or appointed to office after the ratification of tins article: Provided, That incomes derived from all securities issued after tlie ratification of this article by or under the authority of the United States, and Incomes derived from salaries of public officials of tlie United States elected or appointed to office after the ratification of this article, are taxed by the United States. Any State shall have power to tax incomes derived from securities issued after the ratification of this article by or under the authority of the United States and incomes derived from salaries of public oflicials of the United States: Provided, Tliat incomes derived from all securities issued after the ratification of this article by or under the authority of such State and from salaries of all public officials of such State and of the political subdivisions thereof elected or appointed to office after the ratification of Ibis article are taxed by such State. Decembek 7, 1921. Hon. -TOSKPH W. FOKDNEY, Chairman Committee on Ways and Means. Deae Mk. Fordney : I desire to call your attention to House .ioint resolu- tion No. 211, introduced by the writer October 25, 1921, proposing a con- stitutional amendment repealing tax-exemption privileges. I am prompted to vlo this by the item in tlie President's message of yesterday, in which he says the following : " Many of us belong to that seluiol of thought which is hesitant about altering the fundamental law. I think our tax problems, the tendency of wealth to seek nontaxable investment, and the menacing increase of public debt — Federal, State, and municipal—all .iustify a proposal to change the Constitution so as to end the issue of nontaxable bonds. No action can change the status of the many billions outstanding, but we can guard against future encouragement of capi- tal's paralysis, while a halt in the growtli of public indebtedness would be beneficial throughout our whole land. " Such a change in the Constitution must be very thoroughlv considered before submission. There ought to be known what influence It will have on the inevitable refunding of our vast national debt; how it will operate on the necessary refundfiig of State and municipal debt; how the advantasres of Nation over State and municipality, or the contrary, may be avoided. Clearly, .the States would not ratify to their own apparent disadvantage. I suggest the consideratifin because the drift of wealth into nontaxable securities is hindering the flow of large capital to our industries — manufacturing, agricultural, and carrying— until we are discouraging the very activities which make our wealth." I would also call your attention to a letter written to you under date of November 4, 1921, by the Secretary of the Treasui-y, A. w". Slellon. in which he says : " I received your letter of October 27, 1921, with the inclosed copy of the joint resolution introduced by Mr. McFadden (H. J. Res. 211), proposing an amendment to the Censtitution of the United States to restrict the further issuance of tax-exempt securities. This amendment is in the form suggested by the Treasury in my letter of September 23, 1921, to Congressman McFadden TAX-EXEMPT SEGUEITIES. 35 a copy of which is inclosed fov your infovuiation. This leftoi- outlines tlie '^l'STwou,^'r;1"; 'r'^ri^ '" ''''■ P'''^^°«*^^' institutional ^unenL,^ I think It would be helpful it the present Congress, as a part of the tax- revision program, would take some action to propose to the States a constitu- tional amendment to restrict future issues of tax-exempt securites and that the amendment in the form introduced by Mr. McFadden merits the serious con sideration of the Committee on Ways and Means. At the least, it offers the basL for a thoroughgoing treatment of the tax-exempt security problem The exist *nce of the present great mass of about $10,000,000,000 of fully tax-exemDt securities, with the prospect of continued issues of tax-exempt securities ulTil ^^T.lf^^''^'' '1™'^"''°?^"* is adopted, necessarily tends to defeat the surtaxes imposed by the revenue laws, while the. combined effect of the high surtaxes ana the unlimited volume of tax-exempt securities is inevitably tS divert capital which would otherwise be employed in productive enterprise into relatively un- productive public expenditure. I believe that there would be nothing in the long run more helpful to the recovery of business and industry in the country and at the same time nothing better calculated to protect the Government's own revenues, than a revised system of taxation which not only moderates the surtaxes but also takes steps to stop the diversion of investment funds into tax-exempt securities." In view of the importance of ths subject and the attention and request of the President and the Secretary of the Treasury for immediate action, I desire to make a request for a hearing at an early date, on this bill, before your com- mittee, and 1 shall be pleased if you will advise nie the date when your com- mittee will take up this important subject. In this connection I might say to you that there are several tax experts and some other interested parties who desire to be heard, and I am hoping that advance notice will be given me so that theSe people may have an opportunity to present their views for the information of your committee. Awaiting your reply, I remain, yours, very truly, L. T. McFadden. The Chaikman. How many gentlemen are there in the room who wish to be ieard on this question? Mr. Mills. Mr. Chairman, I would like to be heard for 5 minutes. The Chaieman. I am try ng to determine whether we should hold a hearing to-morrow or Wednesday. If there are not many here to be heard, we will not have another hearing to-morrow, but will have one at 10 30 Wednesday morning. Mr. McFadden. In that connection, Mr. Chairman, Mr. Philip H. Gadsden, rep- resenting public utilities, is here this morning, and has come here at quite some Inconvenience to himself, and would like to be heard this morning if you can hear him. The Chaieman. Prof. Seligman, of Columbia University, New York, is very desirous of being heard, and has wired through the National Tax Asso- ciation asking if he could be heard to-morrow. We do not want to meet to- morrow for one or two men and have a meeting again Wednesday. Mr. McFadden. I am just submitting a request that came to me that a repre- sentative of the National Tax Association would like to be heard. I am sure he could be heard on Wednesday. The Chaieman. We will hear these gentlemen to-day, and have a meeting on Wednesday morning at 10.30. Mr. McFadden. There is a representative of the Pennsylvania State Chamber of Commerce here also who wants to make a very brief statement. It will not take over a couple of minutes. Mr. TiLSON. Mr. Chairman, could we not hear these gentlemen that wish specially to be heard to-day and then let Mr. Mills and these others be heard more at length on Wednesday? ' Mr. Mills. I only want to be heard for 5 minutes. Mr. TiLSON. We would like to hear you longer. Jlr. Gaenek. You want to be heard for .5 minutes and we want to prod you for 45 minutes. The Chaieman. Will it be agreeable to you to be heard on Wednesday, Mr. Mills? Mr. Mills. Yes, sir. The Chaieman. We will hear this gentleman now for 20 minutes or such a matter, and then recess until 10.30 Wednesday morning. 36 TAX-EXEMPT SECUEITIES. Secretary Mellon. That is all from tlie Treasury, Mr. Chairman? The Chairman. Yes; thank you, Mr. Secretary. We are very grateful to you. Now will you please be as brief as you can, Mr. Gadsden, and we will try not to ask too many questions. Please state your name and whom you rep- resent. STATEMENT OF MR. PHILIP H. GADSDEN, PHILADELPHIA, PA., VICE PRESIDENT OP THE UNITED GAS IMPBOVEMENT CO. Mr. Gadsden. My name is Philip H. Gadsden, vice president of the United Gas Improvement Co. of Philadelphia. I am appearing as chairman of the joint tax committee of the American Gas Association, the American Electric Railway Association, and the National Electric Light Association. We want to direct the attention of this committee for a few minutes to the tremendous importance of this amendment to the public-utility interests of this country. As this committee probably knows, the three associations which I represent comprise in their membership practically all of the gas, electric railway, electric light and power companies in the United States. Those com- panies have an aggregate investment of certainly over $10,000,000,000. Mr. Feeae. What is their attitude on this proposition? Mr. Gadsden. They are in fav.or of the amendment. The public utilities re- quire annually, to keep abreast of the development of the various communities in which they are doing business, about $750,000,000, divided between the electric railways, gas, and electric light and power companies. The difference between the public utilities and the ordinary business enterprise is that in a period of depression such as this country has been experiencing now for 12 months ordinary business shuts up shop ; its employees are either reduced in number or are dismissed entirely. Large numbers of our great indus- tries are closed. They have no need for additional capital. As a matter of fact, their energies are devoted to cashing in their inventories and reducing their outstanding liabilities and getting themselves in as liquid a condition as possible. The public utilities, on the contrary, notwithstanding the period through which we are passing, are every day being required and called upon to invest millions of money. Whether the times are prosperous or whether they are hard, somebody wants an additional gas stove put up in the house ; somebody else wants an electric light in the house ; somebody wants additional street car facilities on a line. So that the interest, the special interest that we have, is that the public utility situation in this country, gentlemen, has boiled itself down to one of economics. It is a matter of common knowledge that they have suffered more than all other enterprises, perhaps, since the war began. Mr. Febar. What variation in rates apply to-day on those companies that you represent from the lowest to the highest in the sale of bonds, if you can tell the rate of interest? Mr. Gadsden. Well, we are selling our securities now on about an 8 per cent ba.sis. Mr. Feeae. They run lower than that and they run higher, I suppose? Mr. Gadsden. There has been a tendency within the last six months to get money at little easier rates. Ever since the war we have been getting money at usurious rates of interest, for the reason that we had to get it. We have paid as high as 12 per cent. Mr. Feeae. On short-time loans? Mr. Ghandlee. Did that not apply to all other business? Mr. Gadsden. Except that all other business had the option to get it or not. The money that we got, we had to get. That is the point I am trying to draw the attention of the committee to. When you consider that the public utilities are annually and daily in the markets of the world to borrow this large amount of new money and to get that money they nuist compete in the financial centers against State and municipal exempt bonds, you can see the tremendous effect upon the public utility interests of this country of the large volume of tax-exempt securities which are now outstanding. IMr. FiiEAE. Are there any large reputable companies that are putting out 8 per cent securities now — that is, for long terms? Mr. Gadsden. They are selling bonds that bear 7 per cent, but they will net the purchaser 8 per oe,nt. TAX-EXEMPT SECUKITIES. 37 Mr. Fkeae. That is, by tlie difference in face value? Mr. Gadsden. Yes, sir. Mr. Chandler. Doesn't tlie 7 per cent bond on the market to-day, of a good reputable company, bring a premium? Mr. Gadsden. No, sir ; not a public utility bond. There has been, of course, within the last 90 days a very gratifying improvement In the money market, but I know of quite a number of companies that are putting out 7 per cent securities, but those securities are sold on a basis which nets the purchaser about 8 per cent. Th Chairman. Let me ask you, What would be a fair average rate of inter- est on the securities of those companies which -have been sold? Mr. Gadsden. To-day, Mr. Chairman? The Chairman. Yes ; gas, electric light, and water power, and so on. Mr. Gadsden. I should say to-day, Mr. Chairman, that the average certainly would not be less than 74 per cent. The Chairman. Those bonds sell for less than par, do they not? Mr. Gadsden. They sell for less than par ; yes, sir. The Chairman. So that they will net the holder more than 7 per cent? Mr. Gadsden. Yes, sir. The Chairman. Now, of course, those securities are not considered as good an investment as those of a State or municipality? Mr. Gadsden. There was before the war a difference, so far as we could figure it out, of about li per cent in preference between the highest grade public-utility bond and a municipal bond, due to the added security of the municipal bond and due to some local exemptions in taxation. So that there was, and probably always will be, in the minds of the investing public a differ- ence of 11 per cent. I have before me — and I will ask permission to submit it hereafter in a little better form as part of my remarks, a study made of this specific problem by Stone & Webster, to show what the effect upon the public-utilities situation of this country is and will be of the continued issuance of tax-exempt securities. The result of that study is that when you consider the original difference of a cent and a quarter in preference between these securities and in view of the high income and surtaxes that an investor to-day would, if advised fully, prefer to invest his money in a 5 per cent municipal bond than in an 8 per cent public utility bond. Mr. Frear. May I ask a question right there that I asked the Secretary a few minutes ago? When the $50,000,000 subscription to the New York tele- phone bonds was put out it was, oversubscribed nine times, at 6 per cent. Now, was that a specially valuable or good security or what was it that would cause that oversubscription? Mr. Gadsden. I can only answer that in a very general way, because I have no special information on it. Blr. Freab. There is no question but what that is the fact. Mr. Gadsden. I know that the telephone companies pay 9 per cent dividends. I happen to know that, that they increased the dividends from, I think, 8 per cent to 9 per cent. But the point I am leading up to, gentlemen, is this : That in a regulated industry we are held down to about a maximum of 8 per cent return on our investment. If we earn more than 8 per cent, as a rule the commissions or courts will say, " You ought to reduce your rates ; 8 per cent is a fair return upon the value of your property. That ought to be sufficient to induce new capital to go into your business." Therefore 8 per cent has come to be prac- tically our deadline. Now, it can be shown mathematically, as will be shown in this report which I am going to submit to your committee, that a man with a large income, a man who is subject to surtax even as low as- 15 per cent, would, if well advised, buy a 5 per cent municipal bond in preference to a public-utility bond at 8 per cent. The Chairman. Let us see if you are correct about that. In other words, his tax then would be 37.5 per cent of his income. The difference between 5 and 8 is 3, and three-eighths would be 37.5 per cent. Mr. Gadsden. I am bearing in mind, Mr. Chairman, all the time that there always was a difference of 11 per cent on these securities. The Chairman. On those particular securities, but not necessarily so on all securities. Mr. Gadsden. Not on unregulated industries, because they presumably can increase the interest of their securities. There is no law limiting their rate 38 TAX-EXEMPT SECURITIES. of return ; tliey can go into the nmrUet and compete for this niouey. J'k^J" have two options: Either to increiise dividends or the interest rates to 9. 10, 12, or 15 per cent, or stay out of the uiarl^et. The public utility must go mto the market, must raise the enoi'nious amount of money every year that is necessary, and tlie return on its investment is limited to 8 per cent, so that it presents one of the most anomalous and one of the gravest questions, gentlen}en, before this -country to-day. Here is this gi-eat public utility industry, including the steam railroads, in the market for about !f2,000,OlX),000 a year. Now, they have got to get that money in competition with municipalities who are building municipal warehouses, municipal wharves, municipal schoolhouses, muncipal courthouses; or with counties or States that are building good roads all over the counti-y. The Chairman. In other words, your contention is tliat if this bill passes and makes the municipal bond subject to taxation, it will either make a better market for your securities or lessen the raai'gin between the two? Mr. Gad,sden. Exactly, sir. It will put us in better position to get the monej-, which I want to draw your attention is equally as necessary to the life of these communities as the money derived from these municipal bonds. For instance, I think I might be justified in siiyiug that in a great many cases it is more necessary, because it is notorious that some of the public money, becau.se it has been gotten on easy terms, is used in some cases where it ought not to be used. Now, when you consider, gentlemen, who is benefited by these exemptions, in the last analj'sis who gets the benefit? The Chaikman. That is really the point. Isn't it the man who pays the State, county, and municipal taxes? Mr. Gadsden. Unquestionably, Mr. Chairman. Now, just follow me. Who gets the benefit of what they call this "cheap" money? We will say that a mimicipality wants to build a schoolhouse or some other public improvement. Mr. Feeae. There is oidy one State that pei'uiits the building of warehouses? Mr. Gadsden. Well. I happen to have in mind one that has purchased a terminal for a million dollars — wharves and terminal property. Who gets the benefit of that? They are going to advertise to the world, " We are going to issue a million dollai's of 5 per cent bonds, tax exempt." Of course, they can be sold. Who is going to pay for those bonds? Why, the smaller taxpayer in that community. The man who has been fortunate enough to accumulate a competence and has a little money to invest, he is going to buy those bonds because it is going to save him tlie municipal tax of probably 20, 30, or 35 mills, which added to his 5 per cent is going to give him 8, 9, or 10 per cent on his money. The Chateman. Now. on the other hand, suppose those bonds drew 5 per cent, and by making tliem subject to tax they would have to sell at the rate of S per cent, who gets the benefit? Who pa.vs the bill, rather? Mr. Gadsden. They would not sell as high as that. The Chaieman. That is extreme. I am just classing mimicipa! bonds with your securities. Mr. Gadsden. Mr. Chairman, I will tell you who will pay the bill. The bill will be divided pro rata between the fellow who can best afford to pay and the fellow who can least afford to pay. But if you did not exempt them, then every- body would pay, and, of course, you would get your large proportion from the fellow who had accumulated his money. Apply that to the public utility situa- tion. Here is a street railroad in a community in which the city issues $1,000,000 worth of bonds, tax exempt ; who pays for those bonds ? The Chairman. Who pays the bill with the Federal Government right now? It is paid by the taxpayer. Mr. Gadsden. Of course those taxes, so far as we are concerned, must go into our rates. We have got no cushion to absorb it ; it has got to go into the street car fares. The Chairman. Here is an illustration right here now in the Federal bond. A¥ho pays the bill as between the tax-free bond and the taxable bond? Mr, Gadsden. I would say the little fellow who has got a farm or has got a little house in the city and who can not get away, can not escape taxation? He is the fellow who is paying. And, gentlemen, if we issue enough of them we confiscate the property In this country. We are driving the man with money into these tax-exempts, and the poor fellow who has got his all represented in tangible property has an increasing burden of taxation. Making a bond tax free or taxable will affect the amount of bonds issued ; thev need only a certain amount of money to carry on a certain amo\uit of improvements in a State or in a city. Mr. LoNGWORTH. Even down to actual necessities. TAX-EXEMPT SEOUEITIES. . 39 Mr. Gadsden. Yes. Why, Mr. Chairman, It will make them hesitate and pause whether they are going to issue bonds that are costing them 8 per cent, as you say, or 5 per cent. In my opinion, instead of calling this " cheap " money, from the standpoint of the large capitalist in a community or the man with money. It ought to be called " easy " money, because that is just what it is to him ; it is easy money to him, and the burden is increased and shifted to the small taxpayer. At a convention of the street railway association in Atlantic City in October we had a paper read on financial subjects by one of the leading invest- ment bankers of this country. He was speaking of this particular subject, and he said that whereas before the war, before we had these high Federal taxes, their average sales of public utility bonds were in lots of $10,000, showing that they reached a class of wealthy people, large investors ; that those sales had now gotten down on a basis of .$3,000, which bears out exactly the point I am trying to make, that gradually the public utilities have gotten to look for their money to the smaller and smaller investors. As a matter of fact, what we are doing now, Mr. Chairman, as you probably know, because it has been done a good deal in your State — we are going to our own consumers and selling stock to the little consumer who will buy one share and two shares. Mr. Gkeen. Right there in that connection, I have heard it claimed that it was impossible for the public utility companies to obtain all the money that was needed for necessary — or at least for proper — improvements. Mr. Ga-Dsden. That is unquestionably true, ever since the war started. Mr. Febae. It is the public and the consumer that pays this 8 and 9 per cent eventually. Mr. Gadsden. Unquestionably. They pay it in the gas rates ; they pay it in the street car rates ; they pay it in the electric light and power rates, so that it comes right back to the fact that economically you have transferred the burden from the man of large means, thinking that you are getting cheap money, and the fellow who pays for that is the man who goes back and forth twice a day to the factory to work and rides on the street car. He pays 7 cents instead of 6, or he pays $1.25 for his gas Instead of $1.23. It all comes out in the washing and it is paid for by the public and is reflected eventually, it must be, in our rates. The Ohaieman. How does the thing get out of the washing in the difference between the amount of interest that must be paid by the taxpayer to the munici- pality or the Federal Government by increasing that tax? Who pays that bill? It comes out of the washing exactly in the same way. Mr. Gadsden. But, Mr. Chairman, by cutting out these exemptions you are widening the circle ; you are broadening the class of people upon whom the imposition falls. What is happening to-day is that we are circumscribing this circle ; we are lettihg out more and more one class after the other, until we are going to get down to a very small class of people who are going to pay all the taxes in this country, and it is almost working out a single-tax theory. The Chaieman. It is true that while the Federal Government will reduce its obligations rapidly, the municipalities are going to continue increasing the amount of their securities that are outstanding from time to time, as the population of the country and the wealth of the country increases. That is going to go on and on and on beyond your time and mine, or that of anyone else liere ; whereas, in reference to the Federal securities, that is going to stop by-and-by. Now, if you are going to increase the amount of interest on munici- pal bonds or State bonds — I am trying to get information, that is all; I am not arguing against the bill ; I have always been in favor of taxing tax-free securities if our Federal bonds are to be subject to tax. I have disposed of that, but that tax, if it is Increased, is a tax upon the people for an increased rate of interest that is going to go on for an indefinite time. Mr. Gadsen. Mr. Chairman, do you not think that there is some hope at least that the same arguments which we are discussing here — that I am ad- vancing here — wiU apply with equal force when properly used in a munici- pality? Do you not think it is probable that, as this matter is ventilated and people are educated, the people of a State who have an income tax of their own, will begin to appreciate that by issuing their own tax-exempt se- curities they are letting out the very people who are best able to contribute to the State's expenses, and that they are more and more imposing the bur- den of tatxation on the farm lands and on the little houses in the towns? It is exactly the same argument. Now set the example here by the Federal Government. 40 TAX-EXEMPT SE(JUEIT1ES. The Chairman. According to my estimation, it works riglit tlie _ opposite. Yon are taxing, for Instance, to pay for a tax-free security a municipal bond or State bond which has been sold at a rate of interest much lower than you can hope to sell those bonds if you make them subject to taxation. Now, those taxes are paid right out of your farm-land taxes to the States, the vari- ous States of the Union, and nearly every State in this Union has a tax-free security. The State in which I live in 1892 made all State and municipal bonds free from taxes, and consequently the rate of interest went down im- mediately. Now the little fellow that paid taxes to the State and to the county and township and the city pays less taxes upon his land. Mr. Gadsden. Well, Mr. Chairman, isn't. he paying not only his but a part of mine? Suppose I was in your State and I was worth a million dollars, we will say — which is a violent assumption to make on my part — and you issued these tax-exempt securities and I invested half of my income In tax-exempt se- curities, so that I did not contribute anything to the State government at all. The Chairman. So far as your income from the interest on those investments goes. Mr. Gadsden. Now, does that not necessarily Increase the burden which the small fellow has got to pay? The iChaikman. No ; you have decreased the small fellow. You make him pay 5 per cent where he would pay 4 per cent. Mr. Gadsden. I am talking about the tax-exempt fellow. Mr. Freak. He is escaping taxation on his million dollars. Mr. Gadsden. Yes, sir ; and somebody has got to pay it. Mr. Freab. There is no question about that. Mr. Chandler. But on the other hand. If you have to pay that tax, doesn't this farmer and the little fellows all have to pay the difference between 4 per cent and 5 per cent that you would get on that security? Mr. Gadsden. Yes ; but he prorates it with me. Mr. Chandler. The farmer must pay a' tax to pay the difference in the rate of interest. Mr. Gadsden. Yes, sir. Mr. Green. But he doesn't have to pay it alone. Mr. Gadsden. No ; he has got a lot of company. Mr. Chandler. This man who makes that big investment gets the difference between the cheap rate of interest and the high rate of interest when he does that. The Chairman. Let us not get away from that. I am not in as deep water as the gentlemen think I am in that question, in my opinion — may be I am in error; if so, I want to be put right. Suppo.?e you had a million dollars Income from interest on State bonds in the State in which I live or any other State that has tax-free securities, and you are exempt ; the man, the taxpayer in the State pays now 5 per cent be- cause that bond, is taxable; whereas if it were tax-free he would pay 4 per cent. Now he pays an extra 1 per cent there; how much of that do the people lose by not taxing the income in your hands? ■ The little fellow pays more tax than he would under any other circumstances. That is the case in Govexn- ment bonds right now ; you do not get back the difference between the 3i and the 4i per cent bonds right now. You do not get It back from the holders of those bonds, or anything like it ; you only get back 25 per cent of it, and the bondholder gets the other, and the tax payer pays the bill. Mr. Gadsden. Let me see If I can state the case now. Suppose that the State Issues a million dollars of bonds tax free The Chairman (interposing). Take the Government bond right now. You have got an illustration In that. Mr. Gadsden. Let me give these figures. Suppose thev issue a million dol- lars worth of tax-exempt bonds and they issue them at 4 per cent • whereas If they were subject to taxation they would have to issue them at 5 per cent ' so that the State pays 1 per cent on the million dollars, which is $10,000. Now suppose, instead of exempting those bonds they issue them at 5 per cent- It would cost them $10,000 a year more. They would have the right then— their own income tax, which was probably 2 per cent or 3 per cent or 4 per cent of the income, would be applicable to the fellow who held those bonds Mr. Chandler. You mean to say that 4 per cent upon his Income of $50 000 would be more than the $10,000 that they would save by the difference in 'the rate of Interest? Suppose your tax was 4 per cent upon your Income of $50 000 or 5 per cent of a million dollars; 4 per cent of it would' be $2,000 taxes ■ while TAX-EXEMPT SECURITIES'. 41 on the other hand, if the taxpayer could get his money for 4 per cent instead of 5 per cent he would save $10,000. Mr. Gadsden. Now carry that on Mr. Chandler (interposing). Carry it as far as you please; those are facts and figures. Mr. Green. Oh well, if you carry it to the proper point you will end up in a very dilferent place. Mr. Gadsden. Certainly you would. Mr. Gbeen. That argument is utterly fallacious. Mr. Gadsden. Only a certain class of people would pay the taxes. But permit me to get back to the public utility situation. Mr. Feeak (interposing). May I ask a question right along that line? Sup- pose all of the bonds are tax exempt, and we are going to raise money to run the Government. We get it back eventually if we tax the fellow with a little home, and we put the tax on, the sales tax, or something upon the consumer and that hits the little fellow. Mr. Gadsden. Exactly. You can not escape that course at all. The Ghaieman. May I interrupt you there? This is the way the matter would seem to me, Mr. Frear, if we can get big taxes from the bondholders the additional money will have to come from the taxpayers, and there will be Imposed on the taxpayers an obligation to meet that, which' Is the thing that we do not want to do. You do not get back more than 25 per cent right now on the Federal bonds, and the taxpayer loses three-fourths of that Interest, and not the bondholder nor the Government. Mr. Feeae. What would be your plan? What would you advise, Mr. Chair- man, the exemption of all bonds? The Chairman. No Mr. Gadsden (interposing). Assuming for. the sake of argument The Chairman (continuing). No; I do not agree that they should all be exempt — that all bonds should be tax free. Mr. Gadsden. Mr. Chairman, I promised to be short. I want to conclude by assuring the committee that these principles that we have been discussing apply to the i)ublic-utility situation. The Chairman. Oh, well, it can not apply to the public utilities ; it can not apply to their securities Mr. Gadsden. I do not mean legally, but I mean in effect. The Chaieman. The bonds issued by public utilities are not on a par as an investment with those issued by municipalities. The public-utilities securities are not as secure as those issued by municipalties and States. Mr. Gadsden. Unquestionably that is true.. The Chairman. They are not similar. Mr. Gadsden. I>ut we are practically doing the same class of business witli this money. This money is being devoted to public purposes, just like the city money is. We have got to secure the life of the utilities or they can not go on. Now, they are regulated entirely by law, so that the price of their product is fixed and the rate of return is fixed. The money has got to be procured in some way and somehow, say, $2,000,000,000 a year, and at the same time public utilities are forced to compete for their money with the very municipalities they are serving. Now, I say that it is a hopeless situation, and the result of it, Mr. Chairman, is going to be that they are not going to be able to do it. There is a differential created by this situation of 2i to 3 per cent. Now, as time goes on the ])ublic utilities are going to be more and more unable to meet the necessities du(; to the growth of the cities and provide expansion which the growing communities are demanding. The cities are going to demand that these facilities be increased, and what will be the result of these demands? The public utilities are going to say we can not find this money because you are competing with us and getting the money cheaper. The reply will he, " Welf, if you can not do it, we can," don't you see? " We will take you over and operate you," and the municipality can secure its money for 5 per cent as against the 8 per cent that the utilities have to pay, and you are going to cause a municipalization of the public utilities whether you like it or not, because under the present economic conditions there is no other answer to it. If the city can own its own gas plants and street car lines, they can operate them on money which they can get at 5 per cent, when it is necessary for the 42 TAX-EXEMPT SECURITIES. public utility couip.-iniGs to pay 3 per cent more, so they can not compete with tlie city. The Chaikman. Have you finished? Mr. Gadsden. Yes, sir ; I thank you very much, Mr. Chairman, and appreciate the courtesy of the committee In extending me this time. (The following matter submitted by Mr. Gadsden was ordered printed in the record':) Tax/Wion and Public Utilities. The taxation of public utilities should be considered in the light of public regulation and of the limited return allo^^ed on capital invested in the industry. A study of utility taxation, taking these factors into account, leads to the following conclusions : 1. All taxes levied on public utilities must be borne ultimately by the con- sumer or service will be inadequate. 2. All taxes le\-ied on the incoiue from public utility securities must be borne ultimately by the consumer or service will be Inadequate. 3. The market for public utility securities is seriously restricted by the present income tax. 4. The supply of new capital for public service will be entirely inadequate because of the income tax. 5. Present inadequate and unreliable public service will grow steadily worse until utilities are relieved from the income tax. 6. To correct these conditions, the further Issue of tax-exempt securities should not be p(;rmitted. On the following pages the reasons for the foregoing conclusions are stated briefly. 1. All taxes levied, on public utilities must he borne uUiwately by the con- sumer or service icill he inadequate. — Practically all public utilities are now regulated by Slate commissions or by other governmental authorities. It is the duty of the regulating boily to see that rates are maintained at the lowest point consistent with adequate and reliable service. As n result, service is rendered substantially at cost, including in the term "cost" the following items: .(o) Operating expenses; (h) taxes; (c) the maintenance and upkeep of the property; (d) a return on invested capital .iust sufficient to attract necessary new capital to the industry. These four items an- all necessary expenditures without which the utility can not successfully continue its business and properly serve the public. Under American conditions there is a constantly increasing demand for service year by year, and to meet this demand there must be a continuous flow of new capital to the industry. Under regulation based on this principle of " cost of service," the imposition of a new tax is simply an increase in the cost of conducting the business, and as such must be paid, like any other cost, by the consumer. It can not be deducted from the return on invested capital because this return is already regulated to the lowest rate that will attract the necessary new capital. Any further reduction will cut off the flow of capital, will pre- vent a proper growth of the property, and will cause inadequate and unsatis- factory service to the public. It can not' be deducted from any excess or surplus earnings, as might be possible in other lines of industry, because such earnings are not permitted under public regulation. It .is simply an added cost which the consumer must pay directly or indi- rectly to obtain adequate service. 2. All taxes levied on the income from public utility securities must be borne ultimately hy the consumer or service loill he inadequate. — We have seen that, under public regulation, service is furnished substantially at cost, one element of cost being a return on invested capitfil just sufficient to attract necessary new capital to the Industry. New capital for utilities or for other industries is obtained under keenly competitive conditions. The investor is bound by uo obligations; he is always free to pick and choose and to select the investment which seems to him most attractive. In making his decision he will consider — (a) The risk of loss of capital and of Interest or dividends. (b) The probable net return on his investment. TAX-EXEMPT SECUEITIES. 43 Dnrin.s the period before the war, from 1910 to 1914, the averag^ yleUl to Sijvestors on public-utility bonds aud ou unniicipnl bonds was approximately — Per cent. 3PuWic-utility bonds 5. 50 jNlunic-ipal lionds 4. 25 Dilference L 1. 25 These relative rates of return were maintained because investors believed 'that utility bonds yielding 5.50 per cent and municipal bonds yielding 4.25 per <'ent were substantially equal in value. The dilference in yield measures the rgreater risks and greater prewar tax burdens of the utility investment. The imposition of the Income tax has not clianged the relative risk of loss or relative prewar tax burdens between these two classes of securities, hut it 3ias changed the relative rate of return. For example, if we consider an investor paying a combined normal and -surtax of 30 per cent, the net yield from the two securities will have become — a>ublic-utility bonds: Percent Gross yield 5. 50 Less 30 per cent tax 1. 65 Net yield ' 3. 85 3Iunicipal bonds: Net yield 4. 2o As a result of the income tax the security with the greater risk now yields 41ie lower net return. Obviously an investor offered a choice on these terms ■^\nll select numicipal bonds and will not buy utility bonds. The tax has changed neither the relative risk nor the net yield on municipal *onds: its only effect has been to decrease the net yield on utility bonds. "There is only one way to counteract this effect and restore the former .equilibrium. The gross yield from utility bonds must be increased until -the net yield equals its former figure. When this is done the rate of return -will be — Public-utility bonds : P«'' '^™^- Gross yield 7. 86 Less 30 per cent tax 2. 36 Net yield 5. 50 ."Municipal bonds : Net yield 4. 25 With this read.lustment utility bonds will again sell in competition with anuniclpal bonds, but in making the adjustment and restoring the market for lutility bonds the utility has increased the payment to the investor until it ■«quals the former payment plus the amount of the tax ; in other words, the investor has been relieved from the entire burden of the tax and it has been •transferred to the utility. This result is inevitable and must always occur when by public regulation ■the return, on inAested capital is limited to the minimum rate necessary to .-attract new capital. Tbe tax having been transferred from the investor to the utility must now be treated as a cost for the business and must be passed on to the consumer for ithe reasons already given. 3. The market for puUic-utiHUj securities is seriousHi restricted T>ii the present incn-inr tax. — An examination of security offerings made during the prewar l)eriod, from ]910 to 1914, Shows that municipal bonds and public-utility bonds and prefei-red stocks were sold by bankers to investors during this period at prices to yield on the average about the following rates of return : - Per cent. Municipal bonds 4. 25 Public-utilitv securities : Bonds 5. 50 Preferred stocks 6. 50 Individual cases may be found in which the rate of return differs materially ■ "ifrom the above because of some unusually favorable or unfavorable conditions, 'but this is the exception rather than the rule. In most cases the rate of return -for an individual issue of any of these classes of securities will not dilfer very greatly from the average rate of the class as a whole. 44 TAX-EXEMPT SECTJKITIES. The average rate of return to the investor from utility common stocks is less ,, easily determined. Future prospects and an opportunity for speculative profits as well as the immediate rate of dividends are important factors In determinmg- market price. As a result the rate of return measured by dividends alone fluctu- ates between wide limits. A common stock paying no dividends may have a substantial market value, while another paying 10 per cent dividends or more may sell below par because of some pending menace or threat to the business. Notwithstanding these uncertain elements there is ample evidence to show with, reasonable accuracy the total gain or profit to the investor necessary to make such stocks attractive. An examination of conditions during the prewar period, from 1910 to 1914, shows that for this period an average anticipated gain or profit from such stocks of at least 7.75 per cent per year on the price paid by the investor was neces- sary to create a general market for such securities. Considering the utilities- of the country as a whole, the small and Aveak as well as the large and strong, this figure is probably too low, but to be conservative and avoid anj- possible suggestion of exaggeration it is adopted in the following discussion. We have, then, the following average rates of return necessary to attract capi- tal during the prewar period : Per cent. Municipal bonds 4. 25- Public-utility securities : Bonds 5. 50' Preferred stocks 6. 50 Common stocks , 7. 75 The difference in rate of retirrn between municipal bonds and utility securities and between different classes of utility securities measures the relative risk in- curred through investment in such securities plus any difference in tax burden which may have existed prewar. In other words, a municipal bond yielding 4.25 per cent and a utility preferred stock yielding 6.50 per cent sold for substan- tially the same price, because the investor believed that a higher return of 2.2f> per cent on preferred stock was necessary to equalize any prewar difference in taxes on the two securities and to compensate for the greater risk of loss of capital or income, or both. A public utility selling Its securities to yield the above rates of return and obtaining one-half its capital from the sale of bonds, one-sixth from the sale of preferred stock, and two-sixths from the sale of common stock would pay to investors an average rate of 6.42 per cent on its entire invested capital. This ratio of bonds, preferred and common stocks, is substantially that now existing for the industry as a whole. Interest and dividends paid to investors is not, ho^vever, the total cost to the utility of obtaining capital. The utility must pay the cost of advertising and selling its securities to investoi-s, the legal and other expenses incident to pre- paring mortgages, deeds of trust, bonds, stock certificates, etc., and in some cases a tax based on the amount of securities issued. These exij'enses cause an in- crease of at least 4 per cent in the net cost of capital to the utility. The actual average cost of capital for public utilities during tlie prewar period w&s, therefore, approximately as follows : ^^er cent. Average rate of return paid by investors, at least 6 4'' Costs incident to issue and sale of securities, 4 per cent of 6 42 per cent at least ' or Average cost of capital to public utility during prewar period at least _■___ g gg At the present time (.Tanuarjs 1922) municipal bonds are .selling on a basis to yield an average of about 4.55 per cent to the investor. It is imnossible to say how ong this rate will continue or how it will change in the future but the probable trend is indicated by general industrial and economic conditions It ,s generally recognized that there is now and must be for many years to come an abnormally high demand for capital throughout the world In addi- tion to ordinary demands for future growth, capital must be provided in ^arJf~ amounts to replace that, actually destroyed or otherwise wasted durin- the war and there is and will continue to be for many years a heavy demand for capital tor housing, transportation, public utility, and other forms of construe TAX-EXEMPT SECURITIES. 45 tion postponed during tlie war and now badly needed to provide for immediate requirements. Tlie new capital needed to supply these demands must come in the future, as in the past, from personal and corporate savings, but in the future such savings will be reduced by heavy war taxes, and the net amount available for investment may be materially less than during the prewar period. With heavy demands for new capital and a decreased suppl^^, there seems little probability of any immediate and material decrease in interest rates on municipal bonds. It certainly seems safe to assume that the yield from such t)onds will be at least as high as it is now for some years to come. When municipal bonds sell on a 4.55 per cent basis a corresponding increase must take place in the yield from utility securities, for the relative risks of loss and prewar differences in taxes have not changed and there must be the same differential in rates of return to compensate for these risks and taxes and permit the sale of the securities in competition. To be as attractive as municipal bonds yielding 4.55 per cent, public-utility securities must therefore yield at least the following rates : Per cent. Utility bonds 5. 80 Utility preferred stocks 6. 80 Utility common stocks 8. 05 With these rates of return to the investor, the average cost of capital to the utility, calculated as before, will be 6.98 per cent. So far we have made no allowance for the income tax. Let us now consider an investor who pays a normal tax of 8 per cent and a surtax of 20 per cent. He will pay no tax on income from municipal bonds, a combined normal and surtax of 28 per cent on income from utility bonds, and a surtax of 20 per cent on income from utility preferred and common stocks. To make all classes of securities equally attractive he must receive from each class a gross return sufficient to pay his tax and leave a net return which justifies the risk of the investment. The gross return, rate of tax, and net return in each class to accomplish this %vill be as follows : Gross rate of return before payment of tax. Tax. Net rate of return after payment oitax. Per cent. 4.55 8. 05 8.50 10.05 Per cent. Per cent. Public-utility securities: Bonds 28 20 20 80 Preferred stocks 6 80 With these gross rates of return to the investor, the average cost of capital to the utility calculated as before will be 9.14 per cent. Similar figures may be prepared for other rates of surtax, and this has been done with results shown on a sheet attached hereto and marked Ex- hibit A. From this sheet it appears that the average rate of return a public utility must pay to attract capital in competition with municipal bonds yielding 4.55 per cent varies with the rates of normal and surtax as follows : Hate of normal tax. Bate ol surtax. Average rate of return public utility must pay to attract capital. Rate of normal tax. Bate of surtax. Average rate of return public utility must pay to attract capital. None None 6.98 per cent. 7.25 per cent. 7.49 per cent. 8.09 per cent. 9.14 per cent. 8 per cent Do 30 per cent 40 per cent 50 per cent 65 per cent 10.56 per cent. 8 per cent .do 12.41 per cent. Do 3 per cent 10 per cent 20 per cent Do...- 15.11 per cent. 22.52 per cent. Do.. .. Do Do . 46 TAX-EXEMPT SECXJKIXIES. These rates of return required to attract uew capital may at tlrst glance appear unreasonably high, and it may be said that they do not check witls, similar figures prepared by others. This is true; figures have beeu published purporting to show the relative rates of return necessary to equalize taxable- and nontaxable securities, and these figures in some cases show lower rates of return on taxable securities than those given above. The difference is easily- explained ; the lower rates of return are obtained by overlooking the fact that risk as well as rate of return is an element in determining security values. The lower rates are calculated by assuming that securities have equal value- when they have an equal net rate of return after deducting taxes. This is am error and leads to erroneous conclusions. The risk of loss must be taken into account as in the preceding figures. The maximum rate of return a public utility may earn on its invested capi- tal is controlled by public regulation; in most cases the limit is placed at 8J ■ per cent, in some at 7 per cent, and in a few as low as 6 per cent. With theser rates of return, or even with somewhat higher rates if such sliould be allowed,, the income tax has clearly caused a serious reduction in the amount of ne^v capital available to the industry. With a rate of return limited to 8 per cent; and with municipal bonds yielding 4.55 per cent, an investor subject to a sur- tax of over 10 per cent can not afford to buy utility securities. This meansc- that all new capital obtained by public utilities from private investors uuder- these conditions must come from individuals having a taxable income of .$15,000 or less per year. In the past public utilities have obtained a very large part of their capitaL from individuals having an annual income above this limit. The income tan has, therefore, caiised a very serious restriction of the market for utility secu- rities which, as will be shown, may be very far-reaching and disastrous in its- consequences if the situation is not clearly recognized and promptly corrected^ 4. The supply of neto capital for puhlic service tDill he entirely inndequate- because of the income tax. — Most of the capital invested in public utilities has- come in the past and must continue to come in the future from private in- vestors. The personal income-tax returns compiled by the Government give an ap- proximate indication of the amount of new capital available annually fromj such investors. A sheet attached hereto marked Exhibit B gives an estimate of the amount: of such new capital for the year 1916. The year 1916 is chosen because per- sonal incomes in that year were materially greater than during the prewar- period and yet not as large as during the period of extreme war and postwar- activity in 1917, 1918, and 1919. The year 1916 was also the last year before- the imposition of heavy surtaxes, and therefore represents income condit'ons^ before nontaxable securities had been purchased in large quantit'es and other- methods adopted to reduce the burden of the tax. For these reasons the year- 1916 may be taken as representing more nearly than any other the income con- ditions which may exist in the future. The Government has published a summary of personal income returns for- 1916, dividing the returns into classes, based on the amount of income, and for- each class has given the number of tax returns and the total amount of income- reported. In preparing Exhibit B an estimate was made of the probnble average anuunl expense per family 'u each income doss. From this tho totiil e^-iensc of all families in the class was calculated, iind the difference between this exiiense- and the total income of the class was nssumed to be the savin:;: nvnilahle for- investment. In this wny the estimnted savings fi-om each class and the total' savings from all classes were obtained. The results fire, of course, est^.aates, hut they lire sullieientlv accurate to- be highly instructive and to throw considerable light on the probable new- capital available for public utilities. Fiimilies hiiving an annual income of l(>ss than .$3,000 iier year are not in- cluded, because the savin.gs of such fauiilips are largely deposited in s;ivings-J hanks or invested in homes or life insurance. The savings of such f:im'lies- available foi' investment in corporation securities hiive been negligible' ill the- liiist. nnd it mny be reasonably assumed that th's condition will continue ina the future. TAX-EXEMPT SECURITIES. 47 The total income of all families having au annual income of $3,000 and over is $6,299,000,000, the total savings of tliese families is estimated at $2,106,- 000,000 or a little more than one-third of the total Income. This figure is the gross saving before payment of personal income taxes ; deducting $173,000,000, the total yield from such taxes iu 1916, we have net personal income available for investment of $2,023,000,000. Had the present normal and surtax rates been in effect in 1916 the deduction for Income-tax payments would have been materially greatei- and the net personal income avail- able for investment would have been less. With figures taken from Exhibit A, we have shown that the market for utility securities has been seriously restricted by the income tax combined with public regulation, and that, as a result, all new capital obtained by public util- ities from private investors must come from individuals having a taxable in- come of $15,000 per year or less. Referring now to Exhibit B, we find that the total amount saved, by all, individuals having an annual income of $15,000 or less is $279,400,000 per year. Of this amount approximately $74,900,000 must be paid to the Govern- ment under the present income-tax law, leaving $204,500,000 available for investment. This figure, $204,500,000 is, therefore, the maximum amount of new capital that will be available yearly from private investors for public utilities, and this amount will be available only if individuals with income between $3,000 and $15,000 per year invest all their savings in utilities, A report on the condition of the utility industry was made to officials of the Treasury Department on January 8, 1918, by a committee representing the American Electric Railway Association, the National Electric Light Asso- ciation, the American Gas Institute, and the National Commercial Gas Asso- ciation. Referring to the annual capital requirements of public utilities, the report contains this statement : "We estimate that prior to the war approximately $600,000,000 to $700,- 000.000 new capital was necessary for betterments and extensions." Allowing for inadequate development during the war, and for some permanent increase in costs of labor and materials, it is safe to assume that public utilities will require at least $750,000,000 of new capital per year in the future to pro- vide adequate service. So far there has been considered only the so-called municipal utilities, gas, electric I'ght and power and street railway companies. The situation described applies equally to telephone and telegraph companies and to steam railroads. These industries are subject to public regulations and limitation of earnings, and in obtaining new capital will be sub,iect to the same restrictions because of the income l;ax. The position of steam railroads may be even less favorable than that of municipal utilities, because the railroads are limited under the Esch-Cummins Act to an average return of 6 per cent on invested capital. The new capital requirements of telephone and telegraph companies may be conservatively estimated at $100,000,000 per year, and the requirements of steanivrailroads have been stated by Judge R. S. Lovett, the Hon. John J. Esch and others, to be at least $1,000,000,000 per year. In the past, steam railroads have obtained approximately 30 per cent of their capital from sales of securities to Insurance companies, banks, trust companies, schools, colleges, and other institutions. Telephone and telegraph companies and municipal utilities have also obtained capital from these institutions, although probably to not more than 20 per cent of their total capital require- ments. It may be assumed that these institutions will invest in such securities in the future substantially as In the past. All of these industries retain in reserve and surplus accounts a certain amount of each year's earnings. These reserve funds are retained to provide for future replacements and renewals and for contingencies. Pending use for these purposes any cash in such funds may be temporarily invested in additions to property and so serve for a time In place of new capital. The net increase in such funds per year is, however, not large, and for all of these industries combined will probably not exceed $200,000,000 per year for many years to come. Summarizing the foregoing figures we have the statement following. 48 TAX-EXEMPT SEGUEITIES. Annual new capital requirements. Public utilities (gas, electric light and power and street railway) $J50, 000,000 Telephone and telegraph 100, 000, OOO Steam railways 1,000,000,000 . Total capital requirements 1. 850, 000, 000 New capital available from sale of securities to institutions 500, 000, 000 Balance _' 1, 350, 000, 000 New capital available from reserve and surplus funds 200, 000, 000 Balance - 1, 150, 000, 000 Maximum available capital from private investors restricted by the income tax 204, 500, 000 Deficit (capital required for adequate public service but not available) 945, 500, 000 Here then is the situation : , These three industries, after allowing for all other possible sources of new capital, require annually from private investors new capital to the extent of $1,150,000,000. Without this capital they can not adequately serve the public. Under existing conditions caused by public regulation and the income tax, private investors having an Income in excess of $15,000 per year can not afford to buy securities issued by these industries. The total new capital available from private investors having an income of $15,000 or less probably does not exceed $204,500,000 per year. As a result there will be a deficit of approximately $1,000,000,000 per year in the supply of new capital required by these industries for public service. The size of this deficit suggests immediately the possibility of eri-or in the figures, especially as we are dealing with future conditions which, of necessity, must be a matter of estimate rather than of exact l^nowledge. It is, therefore, well to consider briefly the information available to justify the figures. In exhibits C, D, and E will be found information with reference to past and future new capital requirements of the three industries that we have con- sidered. The amount of capital that may be available from private investors is a matter of much uncertainty. It is clear from exhibit A that individuals having an income of over $15,000 per year can not afford to invest in railway and utility securities if the present income tax is to continue, and that new capital must therefore come from indi- viduals having an annual income of less than $15,000. In preparing exhibit B it has been assumed that the amount saved for invest- ment in securities by individuals having an income of $10,000 or less per year will be 10 per cent of the entire income of all individuals having incomes from $3,000 to $10,000 per year, and that persons receiving from $10,000 to $15,000 per year will save 20 per cent of their income. This is believed to be a liberal estimate of such savings, but suppose it is not and that the actual savings are greater. To take an extreme case, let us assume that one-third (or 33i per cent) of all incomes irom $3,000 to $10,000 per year and one-half (or 50 per cent) of all incomes between $10,000 and $15,000 per year are saved for investment in securities. The total saving after income taxes will be $761,800,000. If this entire amount is available for the three public utilities we are considering, there will still be a deficit of ,$388,200,000 per year, in the required supply of new capital. But this new capital will not all be available for these public utilities ; it will be sought in great volume by other industries, mining, manufacture, agriculture, financial, and mercantile, it will be desired for housing and other nonindustrial construction, and will be bid for by foreign nations. Moreover, a wise investor will wish to diversify his interests, and will not be satisfied to invest all his savings in any one industry or closely allied group of industries. The three puhlc utilities will do well if they obtain one-half of the amount or about $400,000,000. On this basis the capital deficit for the utilities will be $750,000,000 per year. From these figures it appears that we need give but little thought to the accuracy of the estimate of savings ; the exact percentage saved is evidently a TAX-EXEMPT SECURITIES. 49 matter of no great importance in the final result for any estimate falling within the bounds of reason will show a very serious deficit in the required supply of capital. It is clear that the supply of new capital for public service will be entirely inadequate because of the income tax. 5. Present inadequate and unreli-aMe puMio service toill grow steadily loorso until utilities are relieved 'from income tax. — A public utility differs funda- mentally from the ordinary industrial enterprise. A factory, for example, is built and may continue successfully for many years or perhaps forever with no increase in capital ; enlargement of the factory, or ■ its continuation without increase, remains entirely within the control of the owners, and if an increase is to be made this can be done and as the o^vners think best. The normal state of a public utility is constant growth. Most utilities furnish service to a definite territory without competition. The demand for service in the territory grows steadily from year to year because of Increase in popular tion and because of a continually increasing use of the service per capita. The owners of the property have no control over this growing demand for service, but have imposed on their property the obligation to furnish all service reason- ably required. To supply the constantly Increasing demand there must be a corresponding growth in plant and facilities and consequently in the capital invested in the business. If has been found in practice in all utilities that the moment of capital required increases in almost direct proportion to the increase in volume of business transacted. A steady flow of new capital to the industry is, there- fore, a normal condition of utility service. Before the war it was the practice of all utilities to maintain a margin of plant capacity for future growth, and more particularly to secure reliability of service. This margin of safety was thought necessary to insure reliability and prevented interruptions and delays when any part of the plant was temporarily disabled or had to be taken out of service for the time being for inspection and repairs. During the war the demand for utility service increased in nearly all cases at a rate which was above rather -than below normal, but utilities were unable to obtain -capital, materials, and labor necessary to extend and add to their properties. Normal growth could not be maintained, and the situation was met by using up the margin of safety and operating all parts of the property to their full margin of capacity or even under an overload. This resulted in most cases in unreliable and unsatisfactory service, but it is the best that could be done under the circumstances. This situation is generally recognized, and it is a matter of public knowledge that the service of steam railways and public utilities has deteriorated and is to-day inadequate and unreliable. A report has just been made to the United States Senate by the committee on reconstruction and production. Referring to public utilities, this report contains the following statement: " Prior to the war the general rule adopted by street railway companies, gas companies, and electric light and power companies was to have an extra capacity of at least 25 per cent so as to protect service from delays incident to temporary breakdowns, but upon the outbreak of the war this rule had to be abandoned. No additional facilities could be provided owing to embargoes against expendi- tures for construction and owing to inability to finance improvements. The plants were taxed to their capacity to provide war-time facilities. " The public utilities emerged from the war with practically no reserve ca- pacity with increased demand for service, with revenue limited in amount, and the purchasing power of the dollar decreased. The resulting inferior service is directly traceable to the fact that the business of public utilities has outgrown the plants. , , . <. j. " Prior to the war it is estimated that the normal annual requirements of electric railway, gas, and electric-light and power companies for extensions, betterments and improvements was about $500,000,000, proportioned as follows: Electric railways, $250,000,000; gas companies, $125,000,000; electric light and power companies, $125,000,000. ^ .n „ „^„v. "The committee has been informed that for four years not over 40 per cent of such betterments has been made, leaving an accumu^tion of about $1,200,- 93671—22 4 50 TAX-EXEMPT SEGUEITIES. 000,000. If to this sum is added the $700,000,000 required alone for seindce to new residential buildings held in abeyance, a total of approximately $^000,- 000,000 seems necessary for the public utility program in the immediate future. With reference to steam railways, the report contains this statement : '■ Tlie committee has been reliably informed that while the railroads are now in a position to meet average needs, they require an aggregate of 200,000 more freight cars, 10,000 more coaches, and 8,000 more locomotives, and m addition, an expenditure of at least $1,000,000,000 for terminals, tracks, and taalitie^ for maintaining the additional equipment, a maximum total ot !t,b,OUU,0OlJ,uuu for railroad rehabilitation. * * * . i i i i • " If the credit for railroad rehabilitation were available, it would be physi- cally impossible to make the improvements in time to put the railroads m readi- ness to serve a peak load during the coming year." The conditions indicated in these statements can not under any conditions be corrected Immediately. Under the most favorable conditions, it is a proc- ess which must extend over a period. of many years. Possibly the depression in business now existing may relieve the situation somewhat for the time being, but this relief at most will only postpone the day when the work must be done, and from every standpoint it is to be hoped that the depression will be of short duration and that there will shortly lie a return to normal condi- tions. To again supply a proper margin of plant capacity and to restore the service to its prewar character and reliability, it will be necessary to obtain capital for normal growth as in the pa.st, and, in addition, capital necessary to make up the deficit brought about by war conditions. If the capital supply is not sufficient to take care of normal growth, it will no.t only be impossible to make up the war deftcit but the properties will be continuously less able to meet the demand for service and present conditions will go from bad to worse. The exhibits attached hereto and the preceding discussion show that the income tax has so restricted the market for utility securities that the supply of new capital can not be sufficient for normal growth, much less making up the war deficit. Regardless of any improvement which may take place" in general financial and industrial conditions, capital will be diverted from utilities to nontaxable securities until the present income tax is modified. 6. To correct these conditions the hurclrn of the further issue of tax-exempt securities should not be permitted. — One may accept and agree with all of the foregoing and yet feel that some way should be found to ad.iust the situation other than by prohibiting further issues of tax-free securities. Much may be said in favor of this point of view, and every effort should be made to find, if possible, anothei- and more desirable way that offers a practical solution. After considering the matter with some care there seem to be three pos- sible suggestions that should be considered briefly : First. It may be su.ggested that no action is necessary, that the situation will cure itself if left alone, that investors with incomes in exce.ss of $15,000 per year are now buying utility securities, and that such investors will con- tinue to buy in sufficient volume to furnish all needed capital. It is true that there is such buying and this will undoubtedly continue to a limited extent, but its volume will not be sufficient to furnish all or even any considerable part of the required capital. There are two principal causes for this buying : (ft) That utilities are now paying more for capital than the avera.ge rate they are permitted to earn under public regulation. (&) That investors believe that the income tax will he so modified that utility securities will have a future advantage over nontaxables that will more than compensate tor present disadvantages. The first cause is obviously of temporary character. A utility can not con- tinue very long paying more for capital than it is allowed to earn — such a course leads direct to Insolvency. It may adopt this practice as a temporary expedient to tide over an emergency, and this is what is now being done. The .supply of capital is inadequate and every effort is being made to postpone additions and extensions to plant and facilities, but the utility must meet its maturing obligations and must provide for some unavoidable expenditures. Under pressure of necessity it pays an excessive price for capital for these purposes, hoping that some time in the future it may obtain some cheap capital TAX-EXEMPT SECURITIES. 51 to average up. This Is a policy almost of despair and certainly can not be considered as a permanent method to provide for the future development of the industry. The second cause — the purchase of securities for future advantage — is also' based to a considerable extent on the liigh rate of return now being olferecl as an eniergency measure, and to this extent is temporary and can not he con- sidered in any plan for future development. A¥hen the rates paid for capital are reduced to tire limits permitted by public regulation, the incentive to buy securities for future advantage largely disappears. This may be seen by an examination of Exhibit A. The purchase of securities by investors having incomes of over $15,000 per year is, therefore, due in each case to excessive rates of return on capital which can not be maintained permanently. When we reach a basis of return on which the industry may develop, there is little incentive for such investors to buy utility securities and they will furnish but little capital. To rely on these investors is to accomplish nothing. Second. It may be suggested that the Government is planning to reduce the higher surtaxes, and that this will increase the supply of capital available to utilities. The 1921 revenue act approved by the President November 23, 1921, reduces surtaxes in excess of 48 per cent on income earned in the calendar year 1922. This reductiou will not be of the slightest benefit to the utilities. An examina- tion of Exhibit A will show that even a 20 per cent surtax will prohibit invest- ment in utility securities as completely as a 65 per cent surtax. Investment in utility securities requires a reduction of the surtax to 10 per cent or less. Third. It may be suggested that the situation should be cured througlr per- mitting higher rates of return on utility capital rather than by giving relief from the competition of tax-free securities. Let us assume for a moment that this is possible, that Congress and the In- -terstate Commerce Commission will permit steam railroads to earn 8J per cent instead of 6 per cent on invested capital, and that other regnilating authorities will permit a return of 10 per cent instead of 8 per cent on capital invested in utilities, and assume further, that industrial and financial conditions are such that these rates can be earned. As will be seen from Exhibit A, utility securities in competition with non- taxable bonds would, if permitted a 10 per cent return, be attractive to all in- vestors paying a maximum surtax of about 26 per cent or less, or, in other words, to all investors having an annual income of $56,000 or less. The same principle will apply to steam railroad securities. Turning to Exhibit B we find the total savings of all Individuals having an annual income of $56,000 or less is approximately $825,000,000 per year. From this must be deducted income taxes amounting under the present law to ap- proximately $285,000,000 per year, leaving approximately $540,000,000 for in- vestment. Of this amount, one-half, or, at the outside, perhaps, $300,000,000, may be available for steam railroads and other utilities. We have shown that these industries require capital from private investors to the extent of $1,150,- 000,000 per year ; there will, therefore, be an annual deficit in capital supply of approximately $850,000,000. It appears that any increase in the rate of return on utility capital lying within the range of probability will not cure the situation. A further and more complete analysis would only confirm the conclusion that none of these three suggestions can be considered as even an approximate remedy for the situation. Possibly some new and better suggestion may be made, but if not we must conclude that the only procedure that will permit the public utilities to develop and properly perform their duties to the public is to open up to them the widest field for obtaining new capital. This can be done by prohibiting any further issue of tax-exempt securities. 52 TAX-EXEMPT SECURITIES. Exhibit A. , Estimated rates of return necessary to attract freely the investment of new capital. [These flgurea are based on the assumption that public-utility capital is raised one-half on bonds one sLxth on preferred stock:, and two-sixths on common stock, and that costs incident to issue and sale of securities will cause an increase equal to 4 per cent on average rate of leturn to investor.] Pre- war condi- tions ap- proxi- mate- ly. All conditions as at present except variation f Federal Income tax. No in- come tax. Normal tax 8 per cent. Character of security. No sur- tax. Sur- tax 3 per cent. Sur- tax 10 per cent. Sur- tax 20 per cent. Sur- tax 30 per cent. Sur- tax 40 per cent. Sur- tax 50 per cent. Sur- tax 65 per cent Municipal bond (nontaxable) . Utility securities (taxable): Bonds and notes . Per cent. 4.25 5,50 6.50 7.75 6.42 .26 6.68 Per cent. 4.65 6.80 6.80 8.05 6.72 .26 6.98 Per cent. 4.55 6.31 6.80 8.05 6.97 .28 7.26 Per cent. 4.55 6.52 7.01 8.30 7.20 .29 7.49 Per cent. 4.55 7.07 7.56 8.94 7.78 .31 8.09 Per cent. 4.56 8.05 8.50 10-05 8.79 .35 9.14 Per cent. 4.56 9.35 9.72 11.47 10-15 .41 10-56 Per cent. 4-65 11.14 11.32 13-42 11-93 .48 12.41 Per cent. 4.55 13.80 13.60 16.08 14-53 -68 15-11 Per cent. 4.55 21-50 19.40 Common stock . . . 23.00 Average rate of return to in- vestor on all public-utility 21.65 Additional rate of return paid by utility because of costs incident to issue and sale .87 Total average rate of return utility muat pay to attract capital . . 22.52 Exhibit B. An analysis of the personal income and estimated expenses and savings of all families in the Vmted States having an income in excess of $3,000 per year, based on the Federal income tax returns for the year 1916. Income class. Num- ber of families. Total annual income all families, in thou- sands of dollars. Esti- mated annual expenses per family, in thou- ands of dollars. Total annual expenses all fam- iUes, in thousands ofdollars. Total annual savings aH fam- iUes, in thousands ofdollars. Cumu- lative savings, in thousands of dollars Cumu- lative savings, in thousands of dollars, in reverse order. Maxi- mum rate of com- bined normal tax and surtax reached in class. Over 86,000,000 10 9 14 34 42 97 376 245 489 427 726 1,2S4 2,900 1,074 1,422 1,787 2,648 3,621 6,611 10,068 8,055 12,953 22,618 45,309 103,000 40,600 48,400 83,600 71,400 107,300 256,800 109,800 161,800 118,300 163,400 223,400 356,700 102,000 120,900 134,000 165,600 199,200 252, 600 362,400 221,600 291,400 395,800 566,400 1,660,700 1,000 900 770 600 450 390 275 180 145 115 99 79 60 47 44 40 36 32 28 23 19 10 13 10 10,000 8,100 10,800 20,400 18,900 37,800 103,400 44,100 68,000 49,100 71,900 101,400 174,000 60, 600 62,600 71,500 91,700 116,900 167, 100 231,600 153,000 207,200 294,000 463, 100 93,000 32, 500 37,600 63,200 62,500 69,500 153,400 66,700 93,800 69,200 91,600 122,000 182,700 61,500 68,300 02,500 73,900 83,300 85,400 120,800 68,600 84,200 101,800 113,300 1 166,100 93,000 125,600 163,100 226,300 278, 800 348,300 60, 1700 567,400 661,200 730,400 821,900 9'13,900 1,126,600 1,178,100 1,236,400 1,298,900 1,372,800 1,456,100 1,541,500 1,662,300 1,730,800 1,815,000 1,916,800 2,030,100 2, 196, 200 2,196,200 2,103,200 2,070,700 2,033,100 1,969,900 1,917,400 1,847,900 1,694,600 1,628,800 1,436,000 1,465,800 1,374,300 1,252,300 1,069,600 1,018,100 939, 800 897,300 823, 400 740, 100 654,700 633,900 465,400 381,200 279,400 166,100 73 73 73 73 73 73 72 71 71 68 68 64 60 56 51 46 41 36 31 2S 21 19 16 14 11 $4,000,000 to 85,000,000... $3,000,000 to $4,000,000... $2,000,000 to $3,000,000... 81,500,000 to 82,000,000... $1,000,000 to $1,500,000... $500,000 to 81,000,000 $400,000 to $.500,000...... $300,000 to 8400,000 $250,000 to $300,000 $200,000 to $260,000 $150,000 to $200,000 $100,000 to $160,000 $90,000 to $100,000 $80,000 to $90,000 $70,000 to $80,000 $60,000 to $70,000 $50,000 to $60,000 $40,000 to 860,000 830,000 to $40,000 825,000 to $30,000 $20,000 to 825,000 $15,000 to $20,000 $10,000 to $16,000 33,000 to 810,000 1 Assume saving of 10 p er cent. TAX-EXEMPT SECURITIES. 53 Exhibit C. affnual capital ekqumkments of public utilities. It is a well-known fact that for any given type of public utility, the capital investment required increases substantially in proportion to the increase in volume of business transacted. The rate of increase in gross earnings is, therefore, a measure of the rate of increase in capital investment, and , this furnishes a very valuable check on estimates of invested capital. The United States census gives accurate figures, at 5-year intervals, of the gross earnings of street railways, electric light and power companies, and gas companies. From these figures it appears that the combined gross earnings of these utilities increased during the 10-year period from 1902 to 1912 at an a\'erage cumulative rate of 10 per cent per year, and during the 15-year period from 1902 to 1917 at an average cumulative rate of 9 per cent per year. The United States census has published estimates of the national wealth for the years 1900 and 1912. From these estimates it appears that 1;he com- bined value of the property of these utilities has increased during this 12- year period at an average cumulative rate of 10 per cent per year. The actual value of these properties, as given by the census, is, of course, an estimate, but the agreement between the rate of increase in gross earnings and the rate of increase in value is a strong indication that the estimated value is not seriously in error. The total value of these properties in 1917, as indicated by census figures, Is in excess of $10,000,000,000. The total gross earnings at the present time must be at least !i;2,000,000,000. ■ For the average of all of these properties a value equal to five times the gross earnings is not excessive. To be conservative we may safely assume that the present total capital Investment in these utilities is at least $9,000,000,000. If the demand for additional service increases in the future as in the past, this capital investment must be Increased at a rate of at least 9 per cent per year. This would require new capital during the coming year of $810,000,000 and an Increasing amount each year thereafter. On January 8, 1918, a report on public utilities was submitted to the United States Treasury Department by the American Electric Railway Association, the Nation-al Electric Light Association, the American Gas Institute, and the National Commercial Gas Association. In this report the following state- ment is made, referring to the annual capital requirements of the combined electric light and power, street railway, and gas industries : " We estimate that prior to the war approximately $600,000,000 to $700,- 000,000 new capital was necessary for betterments and improvements." All of the foregoing figures relate to pre\yar conditions and make no allow- ance for present increased costs of labor and materials. If such costs should remain 30 per cent higher than during the prewar period, which seems likely, and if the demand for service should increase at the same rate as before the war, new capital requirements would be $1,000,000,000 or more per year. But even this Is not the whole story. During the war utilities were unable to secure an adequate supply of new capital for current requirements. It became necessary to use reserve capacity ordinarily maintained to insure reliability of service, machinery and equipment were in many cases over- loaded and the quality of service deteriorated. This situation is fully dis- cussed on pages 37 and 38 of the recent report of the Senate Committee on Reconstruction and Production, and it is stated in this report that approxi- mately $2,000,000,000 of new capital is required to restore the former char- acter of service and to provide for immediate demands for service. Allowing for present inadequate capacity, as well as for future growth, it is believed that $750,000,000 per year is a very conservative estimate of the new capital requirements of these industries. Exhibit D. NEW CAPITAL BEQUIBEMENTS OF TELEPHONE AND TELEGRAPH COMPANIES. The annual report of the American Telephone & Telegraph Co. for the year ending December 31, 1920, contains a statement of the cost of increases to plant made each year for the 20-year period from 1900 to 1920. 54 TAX-EXEMPT SECURITIES. From this statement it appears that the property of this company has in- creased at an average cumulative rate of 9.72 per cent per year during the past two decades, and has increased at an average cumulative rate of 8 per cent pei year during the past 10 years. „ t* +1 ■ f The present value of the property is given as $1,363,826,327. it this property grows in the future as during the past 10 years, and the costs ot labor and materials return to prewar levels, its annual capital reguirements at 8 per cent of its value will exceed $100,000,000. If the average costs of labor and materials remain 30 per cent in excess of prewar costs, vi'hich seems likely, its annual capital reauirements will exceed $130,000,000 The. property value of independent telephone companies appears from the United States census to have remained practically constant during the past decade. The value of all telegraph property is given by the United States census as $19.5,504,000 in the year 1902, and $363,017,000 in the year 1917, an increase in 15 years of $167,513,000, or an average increase per year of $11,170,000. An estimate of $100,000,000 per year for new capital requirements of all tele- phone and telegraph companies would therefore seem conservative. Exhibit B. annual capital eequieements of steam kaileoads. For Steam railroads, ns for other utilities, the capital investment required Increases substantially in proportion to the increase in volume of business transacted. The reports of the Interstate Commerce Commission show the following aver' age rates of increase for the 12-year period from 1900 to 1912 : Per cent. Passenger-miles increased at an avei'age cumulative rate per year of 6.2 Freight ton-miles increased at an average cumulative rate per year of 5.4 Gross earnings iiicreased at an average cu]nulativo rate per year of 5. 5 These increases in volume of business should call for an increase in capital investment of approximately 5.5 per cent per year. The United States census gives estimated values of steam railroads and rail' road equipment for the years 1900 and 1912. The estimated value increased during this 12-year period at an average cumulative rate per year of 5 per cent. The present value of all steam railroad property, as given recently in a pre- liminary estimate of the Interstate Commerce Commission, is approximately $19,000,000,000. If increased capital is required in the future at the same rate as during the period from 1900 to 1912, the capital increase for the coming year should be 5 per cent of $19,000,000,000, or $950,000,000, and the increase for subsequent years should be a gradually increasing amount. This figure makes no allowance for increased costs of labor and materials. If such costs should continue 30 per cent higher than during the prewar period, which seems likely, the annual capital increase would be approxi- mately $1,250,000,000 for the coming year and a greater amount for subse- quent years. These figures make no allowance for failure to make adequate capital in- creases during the war. The recept report of the Senate Committee on Re- construction and Production says that there is now required "a maximum total of $6,000,000,000 for railroad rehabilitation." A pamphlet published in December, 1919, by Mr. U. S. Lovett chairman of the Union Pacific System, contains the following sentence : ' " Is it conceivable that the money necessary to provide the railroad facilities which this growing country needs— generally estimated at not less than $1,000,000,000 per year— will be obtainable from investors under legislation of this sort?" . An address delivered on December 13, 1920, by the Hon. John J Bsch con- tains the following sentence : ' ' "We therefore were presented with the problem of returning the roads to their owners under such conditions as would enable them to borrow or other wise secure $600,000,000 of new money and compel its expenditure for new TAX-EXEMPT SECURITIES. 55 equipment and facilities and for next year to borrow or secure $1,000,000,000 for lilce purposes and at least an equal amount for subsequent years." It appears that past experience and the known immediate requirements fully confirm the statements of Mr. Lovett and Congressman Esch that new capital will be required in the future at an average rate of at least $1,000,000,000 per year to permit adequate steam railroad service. Mr. McFadden. Mr. Chairman, Mr. Kloss is here as a representative of the Pennsylvanian State Chamber of Commerce and would like to be heard just for a minute on this. It will take but a minute. STATEMENT OF MR. D. S. KLOSS, REPRESENTING THE PENNSYL- VANIA STATE CHAMBER OP COMMERCE. Blr. Kloss. I am appearing here as a representative of the Pennsylvania State Chamber of Commerce. They have asked me to come down here and present some resolutions which they passed unanimously, recording their oppo- sition to the issuance of tax-exempt securities. It will only take a few min utes for me to read them to you. The Chaieman. You can leave the resolutions vcith the clerk and they will be put in the record and we. can read them. Mr. Freak. That resolution is favoring the resolution before us? Mr. Kloss. In favor of the amendment to the Constitution referred to. Mr. Feeau. Yes. Mr. Kloss. In fact, that is the only thing that we had in our hands at that time, and we passed tlie resolution favorable to it, relying upon the wisdom of the committee to correct or evolve any amendment that was necessary. Mr. Fkeak. But it is favorable to the policy? Mr. Kloss. Yes, sir ; it is favorable to the policy. The Pennsylvania State Chamber of Commerce represents 40,000 business and professional men scat- tered over the State of Pennsylvania, and we are very hopeful that some action of this kind will be taken. Mr. Feeae. Have you filed a brief? Mr. Kloss. No ; I did not file a brief. Mr. Feeae, Sir. Chairman, the gentleman might Avell file a brief if he washes to. The Chaiemajy. If you ^^ish to add to your brief, you can do that and hand it to tlie clei'k \Yifliiii a few days: and we will lie very glad to have yon add any- thing that you wish, and we will be glad to have you put the resolution in the record. Mr. McFaddek. This resolut'on. which has been passed by the Pennsylvania State Chamber of Commerce, is similar to one which was proposed by resolu- tion 211, which is the Ti-easury bill. (The resolution above referred to is as follows:) " RESOLUTION UNANIMOtrsLY ADOPTED BY THE PENNSYT.VANTA STATE CHAMHEE OF COirMEECE. " Whereas the exemption from taxation of governmental securities Impairs the equitv and productivity of the Federal income tax ; and "Whereas such exemption hampers private financing of new and established enterprises and subjects them to unfair competition with quasi-govern- mental agencies, thus increasing the tendency toward Government monopoly and ownership ; and " Whereas such exemption facilitates the sale of public securities at less than prevailing Interest rates, and thereby encourages extravagance of govern- mental agenc'es ; and "Whereas the I'Pcent phenomenal increase in the volume of tax-exempt securi- ties is a menace to sound public finance, industrial growth, and national prosperity : Therefore-be it "Resolved, That the Pennsylvania State Chamber of Commerce urge the adoption of the following amendment to the Constitution of the United States, to be entitled Article XX : . , „ . " ' The United States shall have power to tax incomes derived from securi- ties issued after the ratification of this article by or under the authority of the several States to the same extent that income derived from securities issueil after the ratification of this article by or under the authority of the United States are taxed bv the United States. Anv State shall have power to tax 56 TAX-EXEMPT SECUKITIES. inconio tlorivod by residents thereof from securities issues after the ratification of this article by or under the authority of the United States to the_ same extent tlwt income derived by residents of such State from securities issued after tlie ratification of this article by or under the authority of such btate are taxed by such State.' " (Thereupon, at 12.37 o'clock p. m., the committee adjourned.) Committee on Ways and Means, House or Repeesentatives, Wednesday, January 18, 1922. The committee was called to order at 10.35 o'clock a. m. by Hon. Williaiir R. Green. Mr. Gbeen. The first gentleman on the list that I have here is Representative Mills. He is not present. The next is Mr. Chassell. We will hear Mr. Ohassell. STATEMENT OF MB. EDWARD D. CHASSELL, SECRETARY EARM MORTGAGE BANKERS' ASSOCIATION OE AMERICA. Mr. Ohassell. Mr. Chairman, Mr. Mills is just talking on the telephone. He will be here very shortly. Mr. Gkeen. Well, we will hear you first. Give your name to the reporter, and if you represent any particular organization state what it is. Mr. Ohassell. Edward D. Chassel), secretary Farm Mortgage Bankers' Asso- ciation of America. Mr. LoNGWOETH. Did you say farm mortgage? Mr. Ohassell. Yes, sir. We have headquarters at Chicago. Mr. LoNGWOETH. You are not interested in the joint-stock banks or the Fed- eral farm banks? Mr. Ohassell. No, sir ; I am not. Mr. LoNGWOETH. You are independent? Mr. Ohassell, We are independent. We get no subsidy from taxpayers. We are Interested in this amendment for the reason that our clients are farmers and we loan them money. We know what effect the tax exemption of securities has in reducing the supply of money which can be loaned to farmers and in making it necessary to raise the rates on farm mortgages in order that they may be salable and that additional money may be obtained. If you gentlemen will make note of any inquiry that you would like to ask until I finish, I think we can, perhaps, then answer the questions more rapidly and more satisfactorily than if questions are asked along from time to time. Yesterday, I believe. It was the Member from Ohio who asked the question as to how many tax-exempt securities are issued annually, and complete in- formation was not given. I will say that the figures which I quote are from the Daily Bond Buyer, probably the best authority in the United States on that subject. If you will take your pencils and write down a few items, I think you will be astounded at the comparison. In the year 1918 there were issued $262,818,844 of tax-exempt State and municipal securities. In the succeeding year, 1919, after the people began to realize the weight of the income tax and the graduated system and it was making its effect felt, there were issued .f770,195,248. In the year 1920 there were issued .$773,663,986. In the year 1921, just closed, there were issued $1,305,868,916. In the year just closed there were issued, as you will note, five times as many tax-exempt securities as were issued four years ago in 1918. And at no time in the history of the country has there ever been an excess of $500,000,000 issued prior to that time. Mr. Feear. In giving that comparison basis of the tax-exempt securities which were issued you show the amount issued during 1918, which was during the war, and affected by a great many bonds issued by the Federal Government' Mr. Ohassell. I will say that the amount issued in 1918 was small Mr. Feeak. Well, the figures we have, but I am taking your assumption as to the cause. Mr. Ohassell. Yes, sir; these amounts are actually issues, whatever the cause may be, and the point which I desire to make is that taking the issues for the TAX-EXEMPT SEGUEITTES. 57 last two years, for example, 1920 and 1921, at 5 per cent interest, there was added to the tax burdens of the people of the United States more than $38,- 683,000 ; in the year 1921, there was added $65,293,445. That means that the annual direct tax that the property owners of this country are obliged to pay is now $103,976,000 per year more as a result of the exemption from income tax of the bonds issued in those two years. When these tax burdens are Increasing as rapidly as they are, it is certainly time for us to stop, look, and listen as to what is doing before they are still further in- creased. Mr. Feeab. I may be talking on the general subject, but I do not want to misunderstand you as to the issue. We are making appropriations for local purposes and asking the States and communities to make a comparable con- tribution. We are doing that constantly and they are doing the same, and the only way that they can do it is by the issuance of bonds. Mr. Chassell. That is very true. Mr. Feeab. I would like to ask the maximum issue prior to 1918, for any one- year? Mr. Chassell. Less than' $500,000,000 for one year. The largest issue wa.s in 1916 when it was $497,000,000. That was In a preceding 10 years. To make the record complete I will give the issues for the last 10 years : 1912 $399, 046, 083 1918 408, 477, 702 1914 445, 905, 510 1915 492, 590, 441 1916 497, 403, 751 1917 .$444, 9.32, 848 1918 262, 818, 844 1919 L 770, 195, 248 1920 773, 663, 986 1921 1, 305, 868, 916 Mr. LoNGWOETH. Have you the ligures showing the total amount in existence in 1918? Mr. Chassell. No ; I have not that are accurate. They are now estimated at various amounts from $10,000,000,000 to $15,000,000,000, and some estimates are $8,000,000,000 or $9,000,000,000 at that time. Mr. Feeae. You state here that in 1916 there were issued $497,000,000, which is very much less than was issued In 1918, two years afterwards. Mr. Chassell. Yes, sir. Mr. Feeab. So that you took 1918 simply because that appears to be the low figure. Mr. Chassell. Simply because that is the low figure. Mr. Feeae. Two years before it was almost double that. Mr. Chassell. Yes, sir ; two years before it was almost double that amount. I went back four years to show the increase from that period during the last four years. Mr. Gakneb. Your position, as I understand it, is that .Congress should take some action so as to restrict the sums of these bonds and relieve this burden of $50,000,000 or $60,000,000 a year. Is that correct? Mr, Chassell. My position is that the tax exemption of securities at this time enlarges the issue and that it would be well if Congress would take a position so as not to encourage them as they are doing at the present time. Mr. Gaenee. As a matter of fact, none of these bonds, of which you speak, are issued except upon the express command of the people of the various municipalities, counties, and States, are they. Mr. Chassell. Frequently communities make mistakes in investments. Mr. Gabnee. I am not talking about mistakes; I am talking about the fact, It is a fact that these bonds are always issued on the vote of the people? Mr. Chassell. No, sir ; I think you are wrong there. Mr. Gabnee. Well, what percentage of the bonds are issued without a vote of the people? Mr. Chassell. Nearly all of the bonds issued by municipalities and counties, in most States, are Issued by the action of the city council or the board of supervisprs, as the case may be. Mr. Gaknee. Of course, you are familiar with that, or I presume you are. I want to say that in my State, Texas, I think, without any exception, that they are issued only after they are voted on by the people. Within the last two or three years we have issued a lot of bonds for- roads, drainage, irrigation, and similar public improvements, and it requires a vote of the people in every instance. And in most instances it requires a vote of property taxpaying peo- ple before the bonds can be issued. Your proposition is that the people them- 58 TAX-EXEMPT SECURITIES. selves, representing themselves, are l'^™"S„,f ^iXtter^mighfbe V'dfvS trv. Do you not think this is a question on which there ™/'" ';y,i(,^lar prob- Mr. Ohassell. I would not want to express myself on that part cumrp^^^^ lem; but my point-that was an incidental-my mam point, .^hich ddavorUig to^argue, is that these bonds are exempt fronaxation. Mr. Gaknicr. They have been for all time, have they not practice- Mr. Ghassell. These particular ones have not, but it has been tnc piacnce, ■'^Buflet me call your attention to this, tbat^lt is only sinc^ ft^ income tax went into effect that the tax-exempt bonds have become ot mateiuil "Xf'it'is since the time when the issue of bonds was only .$282,000,000 per ve«- that he auiount of the bonds has increased so rapidly, and it has only been stace that time that the exemption from taxation has been of material "Xw'"tht exemption in the past has been from local property taxes. At that time we had no graduated income tax law in effect, and the income tax that was n force was very small ; but at the present time the income tax under the new law will be 50 per cent surtax to the taxpayers whose income brings them into (he higher brackets, plus the normal tax. Last year and year before the total lax ran up as high as 73 per cent and if a man had an Income of a million dollars a year tlie average tax on his income was 6T per cent. That is an enormous proportion. , j. , Now take this increase of tax-exemption securities for the last two years. There is an annual amount of over $103,000,000, or nearly $104,000,000 of income on tax-exempt securities that evades payment of income taxes. The natural tendency of all of these securities is to gravitate into the posses- sion of people having the higher incomes. ^ We will assume that they get into the hands of men whose income tax is 50 per cent per vear upon their income. They might get into the possession of people whose 'taxes are even higher than that, and the annual amount of taxes which the Treasury loses by this exemption would be .1;.51,998,321..5.5. This matter of taxation to pay interest on these tax-exempt securities and the attending burden of tax evasion b,*- the bond owners is a sort of a double- header. We first have a direct tax which the property owners are obliged to pay as interest on bonds and then we have a loss to the National Treasury of income taxes and surtaxes through tlie fact that the wealthier people owning these tax-exempt securities can evade contributing to the National Treasury. The people are now beginning to realize that. I have here a quotation from yesterday morning's press stating that there was a meeting at Staunton, Va., where the taxpayers asked for a 5-year holiday from taxation for building roads. The article goes on to give the names of the officers elected at tlie meet- ing, showing that a permanent organization was effected. Out in Iowa 15 or 20 county meetings liave been held, at whlcli there have been 500 to 2,-500 taxpayers who protested against an increase in taxes. They are holding a State convention in Blontana for the same purpose. These meetings are being held in many States, as tlie public learns of the effect of these tax exemptions, and as protests against them. Pew people realized the effect of the graduated system of income taxes until after they had paid them for a year or two. Mr. Bachaeach. Is it not true, however, that the bonds of the States, coun- ties, or municipalities will have to pay a higher rate of interest if they are not made tax free, and as a result the tax rate will be considerably higher to the communities in the State? Mr. Ghassell. In discussing this tax proposition you must consider two kind of taxes. Every man who has much, if any, tax obligation pays Federal taxes and also State taxes. Now, then, while there might be a slight differ- ence in the increase of the rate which the borrowers would have to pay on the.se municipal bonds if they were sub.iect to taxation, at the same time it would not be so great as you might think, and for several reasons, which the gentlemen who are to follow me will take up. Tlje people of the States are obli.ged to contribute to the Federal revenue as well as the local and State revenues. If it is necessary to contribute a million dollars in money from the State for Federal taxation through taxes on soda water and stamps and notes and through income taxes that are required, and other methods of taxation, in order to exempt bonds from taxation, it does TAX-EXEMPT SECURITIES. 59 isnot correspondingly benefit tlie taxpayers if they save $10,000 or $100 000 a :year on interest on the municipal bonds which they are selling Mr. Bachaeach. WeU, I know, but it is true, however, that the value of the bonds depends on how many bonds have been issued by a community or A State. For mstance, the State of New Jersey sold 5 per cent bonds that ^old as high as $108 bid. Now, if they were not tax exempf those boncfe would probably have to pay 6 per cent and would have been sold probably at par .Mr. Chassell. I do not think that It would make that difference I\Ir. Bachabach. And many other States having issued a great ouantitv •of bonds, probably offering bonds for sale which bear 5 per cent interest tax exempt would be much below par, and it seems to me that the State that has not been issuing bonds— such States as New Jersey— would be somewhat handi- ■capped and injured by the passage of this- legislation. Mr. Chassell. In borrowing money or in loaning money, one of the chief ■elements to be considered is safety of principal. Whether a State has Issued many bonds or a few, tlie effect upon the value of those bonds would depend ' upon the resources of the State back of them. It would not necessarily fol- low that New Jersey could not issue additional bonds and get the same price for them because they had already issued a large number. I can think of many States that might issue the same number of bonds that New Jersey issued and not be able to sell thein nearly so well. It, of course, depends ^ipon their probable payment. That is one of the features. Before this graduated system of income taxes went into effect there was ,a theory, which originated something like a hundred years ago, which was thought to be correct, until careful Investigation demonstrated it not to be -correct, and that was that the benefit to the investor is passed on to the bor- rfower. In order to agree with the position which you have indicated by your ques- tions, it would be necessary to admit that the advantage to the investoi- was Tsassed on to the borrower. Theoretically that might have been true under the old leYel system of taxation, but in practical experience it lia.s been found mot to be true. The National Taxation Association and others investigated sind demonstrated the fallacy of the theory. When the graduated income tax was put into effect and we taxed under that system, it became absolutely im- -possible for it to be true. If you take a man with a small Income and with no Federal taxes to pay, there Is no advantage to him to buy a 5 per cent New Jersey bond that is -exempt from Federal taxation. He had better go and buy a farm mortgage i:hat is subject to Federal income taxes and drawing 6 per cent. But if you take the man who has an income that is sufficient to require him to pay 2.5 ■per cent of his income per year as Income taxes, it would be more advanta- ■geous to him to buy the New Jersey bond at 5 per cent than It would to buy :a farm mortgage at 7 per cent ; and if h's income tax was 50 per cent per yesLT, he could better afford to buy that than to buy one pEiylng 74 or 8 per •cent. The man who buys tax-exempt securities never figures out how much the benefit is to him by buying a bond because it is tax exempt, so as to base a price upon that. Never. He goes into the market and buys as cheap as he ■can. The bonds that have brought 5 per cent, payable in 20 years," to a man ■who had an income of a million dollars a year, under the law which you have ■recently amended, that bond would be worth 1.46 and a fraction to him as •compared with a 5 per cent taxable security, but they are not bringing that price. Some are selling for 102, 103, or 104, or something like that, according to the demand. So that the theory of the advantage to the investor being passed on to the t)orrower is absolutely demolished by the fact that we have a graduated system ■of income taxes. Mr. Watson. You believe that the nontaxable securities are resulting in an increase of municipal, county, and State bonds for the purposes of road build- ang and other improvements? Mr. Chassell. Yes, sir. I think that it vei-y frequently encourages them and it tends to cause communities to increase the issue of bonds. Mr. Watson. Do not all of those improvements increase the value of the I)rope,rty and therefore produce greater returns? Mr. Chassell. Quite frequently. Mr. Watson. Otherwise they would not be improvements. Budding of schoolhouses and roads counterbalance what may be lost in taxable securities. 60 TAX-EXEMPT SECUEITIES. Mr. Chassell. Well, not always. Tliey might frequently be, but that is sa. matter to be left for the judgment of the communities in that respect. We^ will take, for example, roads that are being constructed now. A few years; ago I traveled through the State of New York and investigated their road. systein and discussed the building of roads. They were, building roads at am expense of about $12,000 per mile. The roads that they have built within the- last two or three years have cost all the way of from $2.5,000 to $50,000 per- mile. Mr. Watson. Seventy-five thousand per mile on the road in my section. Mr. Chassell. Yes, sir. A gentleman wrote me the other day from Arkan- sas, and he said as one of the evidences of the mistake of tax-exempt securi- ties that they had built a road from Little Eock out to the country club at am. expense of $90,000 per mile. Mr, Watson. If these bonds were taxable, you believe that the municipal improvements would continue? Mr. Chassell. Yes, sir. I do not think that they would go on quite so» rapidly, for' this reason: The business men of the country are not building- high office buildings and are not engaged in the construction of the expensive- improvements at the present time on account of the great expense attendant, thereto. The.y know that the depreciation in the expense of construction withinsr the next two or three years will rediice the value of those improvements alii of the way of from 25 to 50 per cent. You take these roads that were built last year which were costing $40,00O> per mile. Within two or three years they probablj' can be built for $25,000.- Now, there is going to be a total net loss of interest on $15,000 per mile plus* the payment of that original bond, which could have been put off and would'. probably have been saved. Mr. Watson. The construction of highways will increase the value of the- reat estate ; therefore, greater revenue, Mr. Chassell. No, sir; I do not think to the extent which that would indi- cate. I think that the farm five years from now, or 10 years from now, which' has a $25,0OO-per-mile road built in front of it will be .just as valuable, or more- valuable, than the same farm if it had a $40,000 road in front of it, which wai?-~ built this year, because it will be sub.iect to .lust that much less of a lien ancV the county will be subject to j\ist that much less of a lien on all property for- the future. Mr. Geeen. Mr. Chassell, our time is somewhat limited, and there was one- matter that you spoke of that I think is very important. I would like to have- you take up that and make sure that you do not overlook it. You stated that" the iDresent system that we were pursuing made it more diflicult to get money for farm mortgages. Mr. Chassell. Yes, sir. Mr. Gkeen. I would like to hear you on that. Mr. Chassell. In order that I might not be speaking by guess in anythingr that I say, I will explain that so far as our association is concerned we ha^-e- about 300 members scattered all over the United States. I wrote these mem- bers and asked them about the amount of money which in the past they had?. loaned to farmers that had been diverted from farm loans into tax-exempt: securities. I have a letter here from a gentleman in Illinois. He says thatr his clients have diverted at least $300,000 per year. J-Te says that they could' not afford to take mortgages at a reasonable rate when they' could get 20 to 40» years tax-exempt securities. Here is another letter from one who says that $250,000 was withdrawn by his customers ; that is, his regular customers, large eastern investors, who had?'- in the past invested money in farm mortga.ges. Here is another letter from one who says that one of his customers wrote- that he could not carry 6 per cent loans when they netted l^ini only 2 per cent,- and that he must invest his money in tax-exempt securities in order to avoid?' the income tax. Mr. Fkeae. He had n large income? Mr. Chassell. Yes, sir. The fact of the matter is that the man with a large? income is the man who buys tax-exempt securities, and these people are neces- sarily the ones who furnish the most money for loaning purpo,ses. Mr. Feear. What Avould be his income if he only realized 2 per cent on a 65 per cent bond? ■ ' Mr. Chassell. Well, it would be something like $600,000 a year under the oliS law. TAX-EXEMPT SEGXJEITIES. 61 Mr. Freae. That amount of annual income? Mr. Ohasseh. Yes, sir. And the difference would be more than that in ssome instances, where the investor had a greater income. I think that it is siecessary for you to consider that the law has been changed. But I have here A number of letters. Mr. Bachakach. How many mren in the country are there that would be -■affected by a proposition like that, of getting 6 per cent gross and only have 2 jper cent net left? Mr. Chassell. Well, I can not tell you how many men there would be, lt)Ut it would affect the men who want to borrow money. In the United States there are $8,000,000,000 in farm loans. These men who -owe that $8,000,000,000 of farm loans are the men who would be affected. The Federal census enumerates a trifle over $4,000,000,000 farm loans, libut the Federal census does not pretend to get all of the farm mortgages. The enumerator asks the question of those whom he interviews, and if they own the farm and know, they tell him. The Federal census reports the mortgages in 1920 on 18.6 per cent only of Tthe farms and they have secured data as to somewhere between 40 and 50 3)er cent of the mortgages. If I had greater time to go into details, I could -•demonstrate to you gentlemen that $8,000,000,000 as the amount of existing :farm mortgages to date is, at the present time, a very conservative estimate. Those mortgage debtors are the people who are affected, those that own the :farms and owe the money. They pay more because of competition with the* ^enormous amount of tax-exempt State anil municipal securities. Tax exemption of securities may be of very trifling benefit to those issuing anunicipalities. But who are the chief beneficiaries of these tax-exempt se- icurities? Those who buy the tax-exempt securities are the beneficiaries of ■^anywhere of from 5 to 10 times the amount that it benefits the borrowers. It ibreaks against the interest of the farm borrowers and against the other tax- ipayers of the United States. Mr. Feear. Could you answer this question : What amount of new capital 3s going into new farm mortgages each year? That is, not into renewals, t)ut money into new mortgages? Mr. Chassell. Tes, sir. Mr. Feeae. Can you answer that, not only Avith regard to farm moi'tgages Sbut real estate? Mr, Chassell. I will answer on farm mortgages. I will say, so far as other ■zmortgages are concerned, city mortgages, the interest rates on renewals aver- =age on oflice buildings and other first-class city properties about 1 per cent aiigher over the United States than the rate on farms. I will confine myself to ifarms. Mr. Feeae. I mean new capital. You spoke of $8,000,000,000, for instance, in :rfarm loans. Mr. Chassell. Yes, sir. The Federal census for 1910 estimated on a smaller Siroportion and reported about $1,726,000,000 of farm mortgages on farms re- garding which data was obtained. Private investors and others who investi- igated the indebtedness of the farms that were operated by renters and by hired anen and others not reported by the census, determined the amount of the farm mortgages on all farms was practically $4,000,000,000. Mr. Feeae. That includes land contracts? Contracts are sometimes substan- tially mortgages. Mr. Chassell. No ; it does not include contracts. That only includes mort- igages According to the Federal census, the small amount that was given by ihe Federal census, increased new money as follows. There was $1,726,000,000 "In 1910 and it was increased up to $4,003,767,192 in 1920. These are advance proof sheets of the census report from which I quote these figures, and I am sure that the report is absolutely correct. According to the exact amount reported by the census there was an increase of 132.5 per cent in 10 years, or 13.25 per cent per annum. According to our statement of totals which, of course, is more nearly cor- a-ect than the census report, there has been an increase to $8,000,000,000 of mortgages, or an-addition of $4,000,000 in the last 10 years. That is an enormous amount and shows a consistent increase. ^ u, •+,■„ „„ Mr. Watson. Who will buy taxed securities when nontaxable securities can "°Mr^ SsIli,. It will be the same people, to some extent. As one of^my friends plits it in a letter I hold in my hand, " The Government levies a high 62 TAX-EXEMPT SECURITIES. income tax and then provides a loophole through which taxpayers escape by the purchase of tax-exempt securities." Mr. AVatson. Then, you think that the improvements will not stop. Mr. Chassell. I believe that they will not go on to quite so great an extent. This is the point that I want to emphasize. If these securities were not tax exempt and brought a slightly higher rate of interest they would be purchased more- by people with smaller incomes, who can not afford to buy them now, and greater prudence would be exercised in expending public funds. Mr. Green. Mr. Chassell, you are giving your views on farm matters, and, I would like very much for you to express your views with reference to your' suggestion that the present situation makes it more difficult to get farm loans. Mr. Bachakaoh. Just one other question that I want to ask Mr. Chassell^ if I may. The Government bonds are selling now pretty close to par. If we- enact this new law, as a matter of fact, would we be keeping faith with the- people who bought those bonds? Mr. Chassell. I do not know why not. If you owe a man and pay him and then issue new securities I do not know where there would be any breach of faith. You are not going to change the outstanding bonds. Mr. Bachaeach. I understand that, but the bonds are now gradually working: up to par. I believe some of them are now selling at par. Mr. Chassell. There is barely a possibility and altogether a probability that" the result would be that those bonds would go up somewhat. , Mr. Bachaeach. You think that they would go up? Mr. Chassell. They probably would, but at the same time the Government would be put into a position where it would not be compelled to issue any addi- tional tax-exempt securities. Mr. Gaenbe. May I ask you a question, In connection with Mr. Green's- query which you can answer as you go along? The main objection made by your association is that the money is being diverted from farm mortgages to- tax-exempt securities by the wealthy people? Mr. Chassell. Yes, sir. Mr. Gaenee. And if you remove that tax exemption the money would flow back gradually to these farm-mortgage loans? Mr. Chassell. It would. Mr. Gaenek. And they would get their interest at a less rate, is that it? Mr. Chassell. Yes, sir. Mr. Gaenee. They are now in competition with the farm mortgages? Mr. Chassell. Yes ; very much. Mr. Gaenee. What would you say about the proposition if we could get those- bonds out from under those tax-exempt features as they now exist; wouldi not the money now go into farm loans through the Federal Farm Loan banks^ and would not the farmers thereby secure the money? Mr. Chassell. That Is a very good question and I am glad you asked it. It- Is necessary to take an Involved condition into consideration. ' There is a total of over $8,000,000,000 in farm loans in the United States. The last report of the Federal Farm Loan Board Indicates that both the joint-stock land banks- and the Federal land banks have loaned during the last five years $500,000,000; that IS, about one-sixteenth of the total outstanding farm mortga<'es The- loans have increased $4,000,000 during the last 10 years and these banks have loaned a half of a billion in five years. .nn?^"- Sf^"^™- ^'^^^^ ^^'^'■''' t^e loans last year? Let us have the figures for 1921. Was It not a much larger proportion than it has been heretofore' Mr. Chassell. It was somewhere in the neighborhood of $100 000 000 ■ ves, sir.^ But let me tell you that this is what is being done at the present 'time. It IS easy to divert this money into tax-exempt securities, and it is being done at the rate of not less than $250,000,000 per year. The Federal Farm Loan Board estimates that these banks can loan $150,000,000 to $200,000 000 oer trn''of ^ondf " *° """ ''™*'""* •^"''^''^'^'^ ^1"°™ ag'-icultnre by tax exemp- Tax-exempt, securities are diverting a great deal more money from the farm- loan business than the Federal land banks are loaning. There Is -i mistaten- Idea that the Federal land banks are doing a large part of the loan business of this coun ry. The entire amount they have loaned during the a^t five 4a?^ now equals about 5 per cent of the present existing loans ^ The other farm-mortgage business, amounting to 95 per'cent of the total loaiw is handled by private individuals, loan companies, and fnsuranci compaS TAX-EXEMPT SECURITIES. 63 The Federal land banks are doing the best they can, but it is absolutely impossi- ble for them to encompass the whole thing. The tax-exemption subsidy is economically wrong. You gentlemen could very easily raise Florida oranges up in Maine by making the necessary appropriations for the scheme. All you would have to do would be to build a big greeuhouse and ship coal up there from Virginia and you could raise those oranges, but it would be done at a great expense to the other orange growers and the other tax-paying people of the country Ihey would have to suffer to the extent of paying the cost. It is a good deal the same way with the Federal farm-loan system. It is of slight benefit to a few people who get their loans, but it is a great loss in the aggregate to all of the rest, who do not get them. There are 6,448,000 farms in the United States and only about 152 000 farmers have secured loans through the Federal land banks. Mr. Gaknee. Do you contend that the establishment of the farm-loan bank has not only been of benefit to the borrower of monev, but has been a detriment to those who have not been able to borrow from them ' Mr. CH.4SSELL. Surely. Mr. Gabnek. And, therefore, it represents only 5 per cent who are benefited and is injurious to 95 per cent? Mr. Ghassell. Certainly. It can not be otherwise. Mr. Gakneb. Consequently your association would discontinue the farm-loan banks? Mr. Ghassell. We are not so particular about that. Mr. Gaknek. Naturally, your association would rather serve 95 per cent of the people of America than to serve 5 per cent? Mr. Ghassell. We are serving 25 per cent now, and other people are serving the rest, while 5 per cent are borrowing their money from the Federal farm- loan banks. Mr. Gaknee. Therefore, there is an Injustice being done to those 95 per cent, and you would do away with it because it is only serving 5 per cent? Mr. Ghassell. We think that it would be better to treat all farmers im- partially rather than to subsidize 5 per cent at the expense of the rest. But I am not here to attack the farm-loan banks. That is a small element in this. From these figures which I have already given you you see that the munici- palities and States last year very much exceeded the loans that they had previously made. They issued bonds to an amount about 10 times greater than the Federal land banks. Mr. Geeen. Mr. Ghassell, let me make your position clear, if I can. You are not asking that anything be done with reference to the farm-loan banks? Mr. Ghassell. Why, no. We are not at this time asking that anything be done with regard to the Federal farm-loan banks. And let me make it clear further this amendment does not provide that it shall be illegal to issue tax- free securities in the future, or that tax-free securities shall be prohibited. It does not provide that there shall never be any more tax-free bonds. It is a permissive amendment. It merely provides that Congress in its wisdom may at any time levy taxes, if it so desires, upon future issues of these securi- ties. It leaves the matter entirely in the hands of Congress. This amendment merely leaves it in the hands of Congress to take action in the future, such action as it deems wise. We think that it Is a matter that should be very carefully investigated and that Congress after it has investigated the matter will agree with us. We think that this tax-exemption proposition is very much like one in old times, which caused much worry to Congressmen. Some of you gentlemen have read about, if you do not remember. Then a large portion of all of the merchants in every town got rebates on freight shipped, and'men who did a good deal of shipping rode on free passes and other people paid cash, when it was talked of amend- ing the law so that everybody would have to stand upon a fair basis, so the rich would be obliged to pay for railroad transportation the same as the poor, there was a great turmoil and it was said that business conditions were such that business could not continue if that was done. Discrimination on taxes is very similar to that. We are opposed to tax-exempt securities, and we contend against these special privileges. We contend that if the Constitution were amended, and everybody was put on a fair, even basis, conditions would be far better than they are now. 64 TAX-EXEMPT SECURITIES. Mr. LoNGwoETH. Let me ask your opinion regarding that. Suppose that Con- gress passed this amendment by a two-thirds majority of each House, do you think that three-fourths of the States would ratify it? Mr. Ohassell. I think that they would if they fully understood it. Now, so far as the proposition is now concerned, it depends upon public education. Tou will remember along about 1896 that nine people out of ten did not know the difference between 16 to 1 and something else. At the present time regard- ing tax-exempt securities the same condition prevails, and there is a great num- ber of people that do not realize its importance. I think that if they thoroughly understood it they would ratify it quickly. The problem is one that is not now thoroughly understood. It ought to be thoroughly understod that this amend- ment does not propose to add aja extra dollar of taxes. It may be thus stated to the people of each State, "We propose to pass this amendment so that the taxes paid by your State will be distributed more equitably than they are now, so that a part of your citizens will not be able to evade taxation while the rest of them pay more taxes." Mr. Gkben. Mr. Ohassell, right there, do you know of any business associa- tion or associations that have taken action for the purpose of considering the matter of taxation that have taken any action at all that have not acted in favor of this amendment? Mr. Ohassell. No ; I do not. I know that at one of the first meetings of the National Ohamber of Commerce about four of five years ago they hesitated to take it up. They investigated it along for three or four years and about a year ago a referendum was taken and the proposition was indorsed with the largest majority of any that has been considered. The further this matter is investigated the more people are found to support it. Mr. Watson. Suppose you receive an application for .a loan on two different farms, one situated on a highway, developed, and the other five miles back, and improved the same, on which property would you make the loan? Mr. Ohassell. Of course, I would take into consideration two things. ' If the farms were of equal productive value, and with equal fertility of the soil, naturally, I would prefer the one on the highway. It is not my position that these improvements do not benefit the community. The only point I want to make is that frequently they are built at ill-advised times. I recall that I was in a town down In the Southwest last year and a gentleman pointed out to me a very large building under construction. This was a town of 16,000 people, he said, I' That is our public coliseum." "Is that so? How much is it going to cost"? He said, "We have sold the bonds, and it is going to cost $500,000. We voted $1,000,000." But, the other half a million was to be used for some other purpose. They were going to build this building at an expense of $500,000. I have right here in my hand a letter from a gentleman in Memphis, who says that the taxes are high down there just now and that they are just about to vote a $3,500,000 bond issue to build a coliseum and to make other improve- ments. Those are to be tax-exempt securities and the proceeds are to be ex- pended for something that very probably could be deferred for two or three years and would not cost so much then. Mr. Watson. Then, you are not in favor of high-grade, nontaxable securities? Mr. Ohassell. No ; I am not in favor of high-grade, nontaxable securities. I think that the public securities should be taxed the same as the private secur- ities. Mr. Watson. All public securities? Mr. Ohassell. Yes, sir. Mr. Gaenee. Then you do not think that the people of Memphis should have the right to determine whether they want to tax themselves for these improve- ments or not? Mr. Ohassell. Certainly, I think they ought to have that right, but I think that they ought not to be deluded into the idea that if they Issue tax-exempt se- curities that it will be cheaper than It will be if they issue taxable securities Mr. Garnek. And if Congress should submit this amendment and it should be presented to the State, and the State should ratify it, gentlemen of the same opinion will appear here before this committee asking us in any public policy to pass a tax law against incomes from these securities, making them unsalable, and, therefore, prohibit their use upon the theory you have just mentioned that they are ill advised and had not been thoroughly considered by financiers Mr. Ohassell. I dislike to take up so much of your time while others are waiting to be heard, but I want to say that we can always rely upon the judg- TAX-EXEMPT SEOXJEITIES. 65 ment of Congress not to enact a law that would make that tax so high as to prohibit their sale. I want to call you attention to the fact that in 1836 when the Government had more money in the National Treasury than It knew what to do with Con- gress voted to distribute about $31,000,000 around among the various States to be distributed in four quarterly payments by the Federal Treasury, and the same was to be called back from the States when Congress ordered it collected back, and that money was loaned to the States, and they have it yet. They have never been able to get a Congressman from any State that had any of that money to vote to get that money back. Mr. Gaeneb. Was that a wise provision ; was that a wise act on the part of Congress? Mr. Chassell. I am just showing that it demonstrates the question that you asked, that Congress will never vote for anything. No Congressman will vote for anything that will injure his home State. Mr. Chandlee. Is it not a fact that your position here now is that you want Congress to pass an act that will tax certain loans out of existence? Mr. Ghassbix. Oh, no. Congress has not been asked to pass any such act. Mr. Chandlee. Well, that is practically your position. Mr. Chassell. Oh, no ; Congress has never passed any act of that kind. This is not an act of that kind. I am coming directly to the other question'. I am In favor of a graduated income tax, but I want the act to remove Mr. Chandler (interposing). Is it not your wish that the higher surtax, that the surtaxes be so high that they will put these kind of securities out of the market that you are here complaining about, and do you not want Congress to pass such an act? Mr. Chassell. No, sir. Mr. Geeen. I do not think that Mr. Chassell is advocating anything of the kind. Mr. Chassell. I have not asked for a reduction of the surtaxes at all. And I want to say that at the present time the State of Oklahoma taxes its local securities and all other securities except the State securities. The State securities are not taxed, but the municipal securities are, and I think that the United States ought to have the right to tax municipal and State securities also. They are taxed now by 27 States. There are 27 States in this Union now in which the States themselves individually tax all or a part of their local securities — securities issued by municipalities and counties. The Chahiman. Mr. Chassell, you stated a moment ago that money was dis- tributed among the various States. Was it distributed with the understanding that it should be paid back when Congress said so? Mr. Chassell. Yes, sir. The Chalkman. There is nothing in that act that provided that It should be paid back at any time? Mr. Chassell. No, sir ; but the tax designated it as a loan. I have the act. The Chalrman. I have read that. Mr Chassell. The act states that it shall be paid into the Treasury of the United States at tlie call of the Secretary of the Treasury; and if you will refer to his report of 1837 vou will find that he concluded that they were unable to <'et it back and then the panic came on and Congress voted that the Secretary of the Treasurv should not call it back, but that it should remain in the hands of the State treasuries until Congress voted to have it called back. They took the power awav from the Treasurer of calling it back. The CH4.IBMAN But it was not the intent of the law that it should ever be paid back when it was paid out, because the total amount of money m the United States Treasurv was greater than was necessary to meet the require- ments of the Government, and the expenses of the Government were not so great but that it would have been harmful to the business of the country to have kept that money in the Treasury. .^^ ^^. , j.- Mr. LoNGwoETH. I do not see what that has to do with this resolution. The Chairman. Let me finish the question. Mr. Chassell. The act of .1836 provided as foll-^^^s ^ T,, .tiflcate ghau express the usual and legal obligations and pledge the faith of Wie States receiving the same to pay the said moneys, and every part thereof, fiom time to time whenever the same shall be required by the Secretary of the Treasury." 93671—22 — -5 66 TAX-EXEMPT SEOUEIWES. The Chairman. I understand ; but Cimgress enacted legislation-—- Mr. Chassell (interposing). They passed a law in 1837 which tooit that authority away from the Treasurer and vested it in the Congress. (The document referred to is copied in the record, as follows:) "[Vol. 5, U. S; Stats. D., p. 55. An act to regulate the deposits of the public money.] " Sec. 13. And be it further enacted, That the money which shall be in the Treasury of the United States on the first day of .January, 1837, reserving the sum of $5,000,000, shall be deposited with such of the several States, in propor- tion to their respective representation in the Senate and House of Representa- tives of the United States, as shall, by law, authorize their treasurers, or other competent authorities to receive the. same on the terms hereinafter specified; and the Secretary of the Treasury shall deliver the same to such treasurers, or other competent authorities, on receiving certificates of deposit therefor, signed by such competent authorities, in such form as may be prescribed by the Secretary aforesaid ; which certificates shall express the usual and legal obU- gations, and pledge the faith of the State, for the safe-l^eeping and repayment thereof, and shall pledge the faith of the States receiving the same, to pay the said moneys, and every part thereof, from time to time, whenever the same shall be required, by the Secretary of the Treasury, for the purpose of defray- ing any wants of the public Treasury beyond the amount of the five millions aforesaid: Provided, That If any State declines to receive its proportion of the surplus aforesaid, on the terms before named, the same shall be deposited with the other States, agreeing to accept the same on deposit in the proportion afore- said : And provided further. That when said money, or any part thereof, shall be wanted by said Secretary, to meet appropriations by law, the same shall be called for, in ratable proportions, within one year, as conveniently may be, from the different States, with which the same is deposited, and shall not be called for, in sums exceeding ten thousand dollars, from any one State, in any ■one month, without previous notice of thirty days, for every additional sum of twenty thousand dollars, which may at any time be required. " Sec. 14. And he it further enacted, That the said deposits shall be made with the said States in the following proportions, and at the following times, to wit: One-quarter part on the first day of January, 1837, or as soon thereafter as may be ; one-quarter on the first day of April, one-quarter part on the first day of July, and one-quarter part on the first day of October, all in the same year. "Sec. 15. And be it further enacted. That to enable the Secretary of the Treasury to carry into effect the provisions of this act, he be authorized to appoint three additional clerks for his department, the one at a salary of $1,600 per annum, and the remaining two at a salary of $1,000 each per annum, and to pay the said clerks, quarter yearly, out of any money in the Treasury not otherwise appropriated. "Approved June 23, 1836." ( On page 201 of volume 5 may be found this act : ) " [Chapter 1. An act to postpone the fourth installment of deposits with the States. "Be it enacted by the Sen-ate and House of Representatives of the VniteA States Of America in Congress assembled. That the transfer of the fourth in- stallment of deposits directed to be made with the States, under the thirteenth section of the act of June 28, 1836, be and the same is hereby postponed till the first day of January, 1839 : Provided, That three first installments underthe said act shall remain on deposit with the States, until otherwise directed by Congress. " Approved October 2, 1837." "[Vol. 36 U S. Stat D., p. 776. An act making appropriations to supply deficiencies in IgProPr'ations for the fiscal year 1910, and for other purposes. June 23, 1910 H E " Credit in accounts of the Treasurer : The proper accounting ofHcers of the Treasury Department be, and they are hereby, authorized and directed to credit the general account of the Treasurer of the United States with the amount the public moneys transferred to and deposited with the States under the nro- visions of an act of Congress approved June 23, 1836 : Provided That the credit herein authorteed to be given to the Treasurer of the United' States qhall in nowise affect or discharge the indebtedness of the several States to the Unted TAX-EXEMPT SECURITIES. 67 States as is provided in said act of Congress approved June 23, 1836, and sliall be made in sucla manner as to debit tlie respective States cliargeable therewitli upon tlie books of the Treasury Department, until otherwise directed by Congress." Mr. TiLSON. Mr. Cliairman, I tlilhlj this has nothing to do with the subject. ■ Tlie Chaikman. I want to ask the gentleman this question: If all of the tax- free securities which are primarily State, county, and municipal bonds are made' subject to tax, as they are not now, such tax will result in the necessity, in: order to sell these bonds at par, of having them carry a higher rate of inter- est than they would carry if they were tax free. If that is so, who would pay that tax? Mr. Chassell. They will not sell at enough higher rate so that the loss to the combined local and national treasuries will be equal to the gain which the Government makes by having them taxable. The Chairman. Now, then, let us compare that with the present Federal Gov- ernment bonds outstanding. Does the Federal Treasury get back the difference between the interest upon the tax-free securities that are out to-day and the taxable securities? Does the Federal Government get that difl:erence into the Treasury ? Mr. Chasseur. Well, just take, for example, take the four and a quarters that are taxable, the three and a halfs that are not taxable. Now, if a man's income is subject to the 50 per cent surtax^ The CHAiniMAN (interposing). Well, but now, I said Mr. Chassell (interposing). That is away above the average. The Chairman. You are taking extreme cases. I want to know what would be the case if you would take the average outstanding to-day. Mr. Chassell. Money flows the same way that water does — downhill to the place where there is an attraction for it. If you take the tax-exempt BJ per cent bonds to-day in the hands of persons with large incomes, and if their incomes are large enough and running up to the 50 per cent brackets, the Government will lose If per cent each year on those. The Chairman. Is it not true that the tax-free bonds to-day are 1 per cent below, the riLtes carried by the taxable bonds which are selling at par? There- fore, they are paying an extra 1. per cent on the 44 per cent bonds. The 44 per cent Government bonds outstanding to-day do not sell at as high a rate in the market as the three and a halfs. Mr. Chassell. The three and a halfs, as you know, are not taxable. .The Chairman. How much of this extra 1 per cent is the Government getting, and who pays the money? Mr. Chassell. In the first place there is not a difference of 1 per cent in the rate. The difference is about three-quarters of 1 per cent. The Chairman. No ; it is more than that. We have got 4S per cent bonds outstanding that are taxable. Mr. Chasseix. Well, in the second place, those 31 per cent bonds are en- tirely tax exempt and in the hands of people who pay 26 to 65 per cent taxes on their income, those bonds give a higher return than the others. The average taxpayer has to pay taxes to make up for the income from those tax-exempt bonds. Now, when the railroads were compelled to refund, instead of Mr. Rockefeller or Mr. Morgan and certain other wealthy men buying the taxable bonds, they did not do so. They invest their money in nontaxable securities. The Ch.4irman. How do you know that? Please enlighten us. Mr. Chassell. I got that from evidence presented by J. P. Morgan & Co. before the Interstate Commerce Commission, and they presented that evi- dence when the question was raised as to whether the rate of interest paid by the New York Central and the Pennsylvania was higher than reasonable, and it was demonstrated that it was necessary to sell those bonds to the smaller Investors, people with small incomes. They were not attractive to the people with large incomes. They were not tax exempt, and they were bought by people with $2,000, $3,000, or .$5,000 to invest. Mr. LONGWORTH. Is not this just the point: The question of the interest rates is of very little relative Importance to the rich man, provided the bonds are nontaxable, but to the man with a small Income the interest rate is of im- portance? Mr. Chasseix. Yes, sir. 68 TAX-EXEMPT' SECURITIES. Mr. LoNGwoKTH. Therefore the small man buys the taxable bonds while the rate of interest Is high and the rich man buys the nontaxable Donas wnere the rate of Interest Is low? Mr. Chassell. Yes, sir. Mr. LoNGwoRTH. That follows necessarily? • j. ■ ». i * , Mr. Chassell. That follows necessarily, yes, sir. Tour point is aDsomtely right. If you will carry it a little bit further you wUl establish yonr case, and that is that the rich man to-day is buying tax-exempt bonds. And what does he pay for them? He buys them at whatever he can get them for in the market and the public suffers the difference. The Chairman. Do you mean to say that the small bondholder buys Govern- ment bonds from the Government and turns around and sells them to the rich man at a discount? Mr. Chassell. Certainly. That is the principle of the thing. And the evidence of that is the fact that Mr. Fkeae (interposing). May I ask a question? The tax-exempt feature is of value in the hands of the rich man, while in the hands of the small man it does not make much difference? Mr. Chassell. Yes, sir. Mr. Frbar. That is the point you are trying to answer? Mr. Chassell. Yes, sir. Mr. Fkear. That is true? Mr. Chassell. Yes, sir. Mr. Watson. Do I understand they preferred nontaxable securities? Mr. Chassell. Well, I think they would. Mr. Watson. You know, perhaps, under the present law the exemption lias been raised to $2,500? Mr. Chassell. Yes, sir. Mr. Watson. There are very few who pay taxes on $2,000,000. I do not be- lieve the Government would receive an extra dollar for taxes under your proposi- tion. Mr. Chassell. The man having a $2,500 exemption would not be likely to own tax-exempt bonds. The tax exemption would not benefit him. Mr. Copley, Is it not also a fact that the man who pays taxes to the Govern- ment amounting to 50 per cent of his income and buys bonds which are solfl below par so that the investment nets him 3i per cent nontaxable, is better off or at least as well off as he would have been if he had invested in 7 per cent taxable securities ? Mr. Chassell. Yes, sir. Mr. Copley. And men of this class buy all forms of tax-exempt securities, do they not? Mr. Chassell. Yes, sir. Mr. Copley. And they are taking from the money market, which is just as much a market as the wheat market, the great reservoir of these large income? Mr. Chassell. You are entirely correct. Mr. Copley. And you have to look to other investors, to the smaller incomes, when you go to sell industrials and taxable securities? Mr. Chassell. You are absolutely right. I intended to emphasize that a few minutes ago. Tax exemption is of great importance to a large investor, to a person with a very large income. It is not of so much importance to a man with $2,000 or $3,000 a year to invest, but to the man with a large amount of money to invest it is of great importance. The small investor is attracted by the higher interest rates. There is no question about It, You can question the members of the Investment association which numbers YOO, who sell taxable and nontaxable securities. You can inquire of the mortgage men of the country and you will find that they are obliged to pay a great deal more money to-day for expenses in order to sell their securities in smaller lots to people that do not have tnxable iuconies, these small investors with $2 000 or $3,000 or $4,000 instead of to the investor.? with $10,000 or $20,000 or $50 000, Mr. CoPLEY.1 It costs them more to find the customer, and is a very much ol :an increased expense to the banker. ' Mr. Chassell. Yes, sir. You need not shed any tears about the investment ibankers or the farm mortgage bankers, ^^'p did not come here nskin"- for charity 'or any particular favors, because there is not any question about there being a great demand for money, and It is not at all necessary to ask favors All we have to do is just to raise the rate, just as the merchant does and eo ahead It requires about the same amount of expenses to do business when vou are TAX-EXEMPT SECURITIES. 69 loaning at 54 per cent as it does at 6J. Instead of coming liere to ask for favors, we have come liere to call j'Our attention to the general effect on the income of the country. If we had started In on this movement to make it a selfish proposition all we would have wanted to have said would have been that all money for agricul- tural purposes should be made tax exempt, but we realized that if all in- tangible property was made tax exempt that it would increase the tax on laud and on the earned incomes. We want to do the best that we can for our customers who are farm borrowers paying taxes on their farms ; therefore we are urging that all securities be made taxable instead of ours being made tax exempt. The Chairman. There is just one point in my question that Mr. Copley brought up and that is that the average taxpayer under the 1919 and later statutes would have to pay 18.2 per cent of his income if he owned a 7 per cent bond. According to that it would net him 5.726 per cent, would it not? Mr. Chassell. Yes, sir. The Chaieman. Close to 54 per cent? Mr. Chassell. Yes, sir. The Chairman. Now, then, according to that outline on a 3i per cent bond he would have to have an investment at 7 per cent, on 7 per cent bonds that were taxable to yield him net as much as he would receive under a 34 per cent bond? Mr. Copley. I did not say, Mr. Chairman, an average taxpayer. Mr. Chassell. Let me make that clear. This is not an average taxpayer. The average taxpayer does not pay that much taxes. The man that pays that amount of taxes is the man with a tax which comes within the higher brackets. The Chairman. Certainly, but what I am trying to determine is the per- centage. Suppose that all 34 per cent tax-free bonds were in the hands of men with very large incomes, how are you going to determine it? Suppose that all of 34 per cent bonds outstanding were owned by a man with a very large income. How are you going to determine just how he should invest that money in taxable bonds to yield a like amount? Is not that statement one that is very hard to answer? Mr. Chassell. No, sir. It is just a mere matter of figures. And if you will go to the surrogate's office in the city of New York and look at reports of ' some of the estates that have been settled during the last year you will find that the extremely wealthy people's estates were very largely confined to tax-exempt securities. The Chairman. Mr. Chassell, any man would be a fool if he did not invest his money where it would make the largest income. Mr. Chassell. Naturally, and we want to urge Congress to amend the Con- • stitution and the law to prevent continuing this special privilege. The Chairman. And the laws of the various States and the taxes by the Federal Government are such that men of large incomes certainly do make Investments where they can make the largest amount of income. Mr. Chassell. There is no question about that. The Chairman. The law permits that? Mr. Chassell. Yes. sir ; and we want the law changed. The Chairman. We are trying to correct that thing. If that can be done and a uniform basis of taxation placed upon all securities outstanding now that is one thing. If that can not be done, who pays that tax? That is the point. That is worthy of careful consideration. Mr. Chassell. Well, we want to have an amendment to the law. The Chairman. If we increase the rate of interest and make the income from the bonds taxable, then the people who pay the taxes into the Federal Gov- ernment and to the State, county, and city governments must pay that bill if we increase the rate of interest that must be paid. Mr. Chassell. Well, that is what I am trying to explain. That ,has been demonstrated. The Chairman. Well, it is not a theory. It has been proven to-day upon the Federal bonds. People are buying the 34 per cent tax-free bonds, the taxpayers of this country, and the 44 per cent bonds, and they are paying more for the 34 per cent bonds than they are paying for the 44 per cent bonds. Mr. Chassell. Not enough to make up for the difference that is lost on account of these taxes. 70 TAX-EXEMPT SECUKITIES. The Chaieman. You can not get around that. The taxpayer must pay. Then if they have to pay as much extra as the taxes paid to the Federal Government amount to you are not getting back anything from the bondholder. Mr. Chassell. The Federal Government gets back If cents for every 3i cents paid to a man whose income tax is 50 per cent of his income if those bonds are taxable. Mr. LoNGWOETH. Now, isn't this the proposition, that a large man going to invest some money, a large income, or investing .$5,000,000, Is not the whole question with him what the net earnings will be from the bonds purchased? Mr. Chassell. Yes, sir. Mr. LoNGwoETH. And if lie buys $5,000,000 worth of 3i per cent bonds, his net income is $175,000, because there is no tax. Mr. Chassell. Yes, sir. Mr. LONGWOETi-i. But if he buys 44 per cent bonds his gross income will be $225,000, but he will have to pay, 50 per cent income taxes, so that his net income will be but '$112,500. Is not that the answer to the whole problem? Mr. Chassbll. Yes, sir. Mr. LoNGwoETH. The rich man buys the tax-free low-interest bonds. Mr. Chasseix. Yes, sir; but he would have to pay $112,500 a j'ear taxes on that amount, and the Government would be ahead $62,500! in the case you mention. Mr. Feeae. He could not avoid that. Mr. Chassell. He could not avoid that ; no, sir. Mr. LONGWOETH. The 3J' per cent bonds would be worth a good deal more to him, so that he could buy them at above par. Mr. Chassell. They would be worth about 1.20. Mr. Copley. And, the reason that lie does not pa.y par is that such a large amount of municipal bonds and smaller political unit bonds with a rather bight rate of interest can be bought for less. Mr. Chassell. Yes, sir ; and another reason Is that he goes into the mar- ket .just the same as any other capitalist, and he buys them for just as little as he can. Mr. Copley. And, if this proposed bill becomes a law and this tax is placed upon the securities issued, by municipalities and other political subdivisions, in your opinion, of course, the 3i per cent bonds which are tax-free will imme- diately increase in value? Mr. Chassell. Yes ; they would probably increase, Mr. Gaenee. And all other municipal bonds now exempt from taxation?' Mr. Chassell. Yes, sir. There is one result that is perhaps unfair, and that is that if an amendment is adopted providing that no more municipal or Government bonds shall be issued tax exempt, and that kind of a law is passed, that will contribute to the wealth of the people who now own these bonds. That, of course, is an unfortunate result, but, gentlemen, those bonds will shortly mature and be paid or refunded and the trouble will automatically be cured. If this amendment will do away with tax exempt securities which have increased from $282,000,000 in 191S to $1,305,000,000 this last year, the Federal Government will get income taxes on those incomes. This problem will take carel of itself in about 20 years, if such an amendment becomes effective, and all tax exempt securities will then be out of existence. Mr. Copley. You say that if this bill becomes a law the wealthy people will be made more wealthy. It would be a paper wealth, because" they would have to keep the bonds. If they should sell them to some one else, then they would be compelled to buy something else in their place, and wdiatever they bought would be taxable. Mr. Chassell. Well, that is true. Mr. Copley. It is a paper wealth. It would be something that no one could cash. Mr. Chassell. Of course, there is no denying that their wealth will be in- creased, but this would automatically correct itself in 20 years. Mr. Copley. It would correct itself at once. Mr. Chassell. They might have more wealth for a few years. Mr. Copley. It would correct itself at once, since they could not cash it in. Mr. Chassell. I thank you gentlemen for your patient attention and help- ful questions. TAX-EXEMPT SECURITIES. Yl STATEMENT OP HON. OGDEN L. MILLS, A EEPBESENTATIVE IN CONGRESS FROM THE STATE OP NEW YORK. Mr. Mills. Mr. Chairman, I appear here on behalf of the National Tax Asso- ciation. They have aslied me to present to the committee a resolution adopted by the association at their last annual convention. The National Tax Association, as you gentlemen doubtless know, is made up of tax experts, leading economists, and, in addition to that, tax commis- sioners from the various States. Their convention is attended not only by economists and members of the association but by representatives appointed by the governors of each one of the States, and the adoption of this resolution at least indicates that it is the opinion of the experts and represents the expert opinion of the States. I desire to submit these resolutions for the record which I will not read. (The resolutions referred to are as follows:) " NATIONAL TAX ASSOCIATION — ACTION TAKEN AT ANNUAL CONFEEENCES ON TAX EXEMPTIONS. " Thirteenth conference, Salt Lake City, Utah, 1920, 41 States being repre- sented : " ' Resolved, That this conference is of the opinion that exemptions of pri- vate property or income from taxation should be confined within the narrowest possible limits. " ' Resolved further, That this conference is unalterably opposed to the ex- emption of interest from mortgages from Income taxation, under either Federal or State laws, and that this conference Is of the opinion that salaries of all public officials and the interest on future Issues of Federal, State, or municipal obligations should be subject to income taxation.' " " Fourteenth conference, Bretton Woods, N. H., 1921, 38 States being repre- sented : "'Resolved, That this conference I'eaffirms the position taken by the Thir- teenth Annual Conference on Taxation, held in Salt Lake City, Utah, on Sep- tember 10, 1920, with reference to opposing the exemption from income taxa- tion of the future issues of Federal, State, or municipal obligations, and hereby recommends the submission by the Sixty-seventh Congress and the ratification bythe States of an amendment to the Constitution of the United States which will permit the principle thus stated to be embodied in our national income tax law.' " They do not favor, of course, this particular resolution, but they do favor the principle embodied in this resolution ; that is, that we should perfect the six- teenth amendment by doing away with the inhibition which applies to State aiid municipal securities. Mr. Gbeen. Mr. Mills, do you know who represented your own State? Mr. Mills. I do not know who represented our State at the last convention. Mr. Gkeen. Well, there was a State official from your State? Mr. Mills. Yes ; I think that unquestionably one of our tax commissioners was probably requested to attend. Mr. Fbeae. Tou say that they voted unanimously in favor of It? Mr. Mills. Unanimously in favor, Mr. Frear. I know that the committee does not want me to enter into any extended argument as to this particular proposition. I certainly do not want to rehash all of the arguments which have been made with reference to it, because I think that you understand it perfectly well, understand the fundamental proposition that is Involved here, that we have got to correct the present tax-exempt se- curities feature because the graduated Income tax has created a new situation and has disturbed the normal flow of investment incomes. It has direct effect, of course, on that fund which is available for industrial development. There is no use, of course, of going into that. Then, very nat- urally, the position of the small investor, who formerly Invested In municipal and State securities as being the safest, now can not purchase them, because they have become higlier in price than he can afford to pay. And he, therefore, is driven to invest in the next available securities, and that is public utilities. I think that will largely account, Mr. Frear, for the great success of the issue which you referred to last Monday — that of the New York Telephone Co. I think that that was taken up to a very, very great extent by the small investors, 72 TAX-EXEMPT SECUEITIES. which partially accounts for its success as well as the reason which was ad- vanced by the Secretary of the Treasury. Mr. Gaenbe. Now, Mr. Mills, is it not fair to refer to the phase of this pro- posed amendment which permits States and counties to tax Federal bonds? I have never heard you express yourself on that phase of it. Mr. Mills. Well, I take, it that we have got to consider this proposition as representatives of the National Government. What the States will do with it afterwards is a very different question, and I think my vote in the State legis- lature might be possibly different from my vote in the National Legislature, although I do not want to commit myself on that point. We have got to look at this from the national standpoint. We are giving to the States the privilege, to be sure, of taxing national securities, but in return we are getting the great mass of securities that on the whole are going to constitute a much larger tax base than the Federal securities are. And what is more, we are asking for the benefit — and we are getting the benefit — of taxing them at a much higher rate than the States are likely to do. You are only giving to the States the privilege of taxing income from these bonds. Mr. Gaenek. That is what I was going to call to your attention. Mr. Mills. And there are only four States in the Union to-day that have income taxes. All of the other States, or the great majority of the States, tax securities as property, which they generally classify as the property tax. Mr. Gaenek. We are asking the State in this amendment to surrender their right to issue tax-free securities. Mr. Mills. Yes, sir. Mr. Gaenek. And to vest unlimited power in the Federal Government for tax purposes? Mr. Mills. Yes, sir. Mr. Gaenek. But we are not giving the States the same right that they are ex- tending to the Federal securities. We are limiting it to an income tax. Mr. Mills. You could tax them under an income tax provision. Mr. Gaenee. And the States and counties, of course, levy direct taxes on property. That is the only method they have for collecting taxes. I do not know whether that is the system in your State, but that is the only method we have in Texas. Mr. Mills. No ; we have an income tax. Mr. Gaenee. We have direct taxes. That is the only way they have of col- lecting taxes. For instance, If I give you a note you will have to pay taxes on that note as such. Mr. Mills. You tax it on the same basis as real property. Mr. Gakneb. If we are going to give the States that powex, why limit the States in their privilege of taxing Federal securities? Why not give them the entire right to tax them? Mr. Mnxs. Now, Mr. Garner, I think you are arguing from the standpoint of the State, and I think that when it comes to ratification that the States will be very able to take care of themselves. What we are going to do is to consider it from a national standpoint and from that standpoint which will produce the most revenue and is most economically correct. There is not the slightest question but that this great tax-exemption evil should be done away with. Mr. gaenee. And the only way that the State can remedy that is to pass an income-tax law. Mr. Mnxs. Of course, that brings pressure to bear on them to tax incomes under th*s plan. We have an income-tax law. Massachusetts followed and also Missouri, but there are only four States that tax incomes Mr. OiDFiELD. What States are they? Mr. Mills. Missouri, Massachusetts, New York, and Wisconsin Mr. CoLLiEE. Mississippi has an income tax. Mr. Oldfield. And I believe Oklahoma has an income tax Mr. Mills. But they have not substituted the income tax for their other taxes. Mr. CoLLiEE. No ; they have not done that. Mr. Mills. Let me state that not only from an economic standpoint but from a social standpoint, this point which has been raised Is very true that certain men Invest their money where it will bring the greatest return, and that being true, the very rich men can make more by investing their money In tax-exempt bonds than they can by continuing actively In business. Now, whatever can be said against the large American fortunes, it has got to be admitted that TAX-EXEMPT SECUEITTES. 73- those fortunes were accumulated by men in active business. I thiink that that is known by everybody, and that it is not necessary to discuss that. But through their native ability and their energy they made a distinct contribution to the grovsfth of the country. And, generally speaking, in this country where that wealth has been inherited the nest generation has continued in active business. There is no such a thing existing in this country as a leisure class living on their income. People work in this country, rich and poor. Now, if you drive that wealth from active business you are not only going to create a class living on their income, an Idle class living on their income, but you are going to create an idle class living on tax-exempt Income, and there can be nothing worse than that for any country. So that from the social stand- point we have got to condemn this situation. It is not so serious to-day because these higher rates have only extended over a period of four years, but it is going to last, because there is no immediate prospect of less tax rates in the future. Now, from the standpoint of revenue, the great argument in favor of tax- exempt securities was that it would furnish a better market for the bonds and that they could be sold at better prices, and that the bonds could be sold at a lower interest rate than they could be sold if they were not tax exempt. Mr. Copley. Mr. Mills, if tax-exempt securities force up the interest rates on industrials, they tend to increase the cost of living. Mr. Mills. Unquestionably, because money represents just as much a cost in running a business as the cost of brick and machinery. Mr. Copley. And the cost of money represents just as much a charge as the price of any other commodity? Mr. Mills. Absolutely. Mr. Copley. I think that is where it becomes automatic. Mr. Mills. Mr. Fordney asked a question in which I believe he stated that there was 1 per cent difference. The three and three-quarter bonds were sell- ing at 100.5, or did yesterday, and the Victory four and three-quarters, which pay taxes, were selling at exactly the same figure. And, of course, the Govern- ment is getting a full 1 per cent benefit here on the reduction in the interest rate. I do not know whether it can be demonstrated mathematically that it is losing more in taxes than it is gaining in the interest rate, but the proba- bilities are that it is. Mr. Copley. Which forces the cost of living to rise at the same time? Mr. Mills. I think so. Now, the reason why the rich man prefers the tax-exempt bond at Si per cent at 97 is 'that it yields him a very large income, equivalent to a 12 per cent taxable security, and yet he pays less than par for it. _ ^^ .,„io Now this is what happens : You take a small man, and I am usmg the 191» revenue rates for the purpose of illustration. Of course, it could be figured on - the other Take a man with an income of $10,000 and he buys a taxable bond which nets 4 58 on his return. If he buys a tax-exempt bond and pays 105.17, it yields him 4 58 In other words, he would break even as between those two securities ; but suppose that he bought the security at 106, he is better off if he buys a taxable. So he drops out of the market and that leaves the market open at 106, as you eliminate the $10,000 class at 106. You eliminate the $20,000 class a little higher, and eventually you have this huge accumulation of tax-exempt securities available for people with large incomes, for rich men, and thev get their securities at a much lower rate than they ought to get them by reason of those exemption privileges, and that difCerence Is not gained by the Treasury. The interest is paid by the Treasury, and, of course, while the taxpayer on the one hand gains by a reduction in the interest rate, he pays out more on the other hand by reason of his failure to collect the taxes. Now, I think that at least tends to show that there is a very strong tendency to substantiate the point I am making. Mr Ckisp Mr Mills, I realize the evil of these tax-exempt securities, and, of course, on the other side, certain States and municipalities likewise have to sell bonds to meet the necessary expenditures of the States and mumcipalities If the amendment is adopted it is obvious, of course, that the States and municipalities will have to pay a larger rate of Interest on their bonds to sell them at the prices they are getting now, about par. I know that you are a great student of this subject, and your opinion, I think, is entitled to great weight I would like to have you tell the committee, if you can, assuming that the tax rates remain about like they are now— 50 per cent on the extreme sur- 74 TAX-EXEMPT SECUEITTBS. taxes— about how much higher rates the States and municipalities would have to pay on their bonds to sell them as they are selling them now. _ Mr. Mills. Well, I would not dare to express a definite opinion. It has been estimated that the advantage of tax exemption ranges somewhere between one- half and 1 per cent. The present figure of the 4i bond and 3J Victory notes do not indicate that. They indicate that it amounts to one whole per cent. But you must remember this : That the States sold their bonds before this high rate of taxation and they never found any difliculty in selling their securities. In fact, the municipal and State securities always commanded a better market to the extent of about one-half of 1 per cent than even the best industrials because of their greater safety. They will always have a good market. They will always be relatively safe and always have an advantage over all other securities. You are simply putting them back where they were. Due to an accident, they were given a very distinct advantage, which I do not think it was ever intended to give them, by the sixteenth amendment, and you are re- moving that accident, and you are removing what has been looked upon as a defect in the amendment and in the law. Mr. Copley. May I ask this question, Mr. Mills : Suppose that after the pas- sage of this act State and municipal bonds arp taxable, and the rate of interest is not increased on State and municipal bonds because the rates of interest would not be subject to competition against tax-exempt securities. There will be no more tax-exempt securities issued than those now outstanding, and con- sequently the rate of interest would not have to be increased on municipal bonds? Mr. Mills. They have always enjoyed certain advantages in the market. Mr. Copley. Safety is one feature. Now, in your opinion, would this raise the rate that State and municipal bonds have to pay? Mr. Mills. No ; I should say not. We enjoyed an average of one-half to 1 per cent before and we would probably enjoy that to-day. Mr. Copley. Now, they are being given nothing, no chance to compete against those tax-exempt securities? Mr. Oldfield. Suppose that this amendment is adopted and ratified by the State, will there not be a tendency upon the part of the Federal Government to tax the municipal bonds and the county bonds to such an ex-tent that it would give the Federal Government an advantage? Mr. Mills. No ; because we would only tax those bonds to the same extent that they taxed their own bonds. That is a provision which, I think, hits the Federal Government rather harder than it does the State governments, and I want to call your attention to that feature in this particular resolution. Now, there is a provision in this resolution which provides that the Federal Gov- ernment can only tax the State and municipal securities to the same extent that the Federal Government taxes its own securities. Now, while it does not say so in so many words, in my judgment as a practical matter that deprives the Federal Government practically at all timet! of the privilege of issuing tax-exempt securities, and let me show you why : Suppose that you get out one single issue of tax-exempt securities. During the life of that issue you can not tax a single State or municipal bond ; and the result is, of course, the loss sustained by not being able to levy that tax will be so great that it will practically mean that you never can get out a tax- exempt security. Mr. OLDriELD. Well, it is not the purpose to issue them in the future. Mr. Mills. That is the way I read this particular resolution. But the gen- eral purpose is the proposition that we want to think of and confine our at- tention to and draftsmenship can come later. This is really remedying a de- fect in the sixteenth amendment by permitting the Federal Government to tax State and municipal securities. Now, as I read this you want to give others the privilege of taxing Federal securities. That is another part of speech, but it is something we want to consider. Now, this may be the right thing to do and it may be the right thing to say at all times that we can not issue tax-exempt securities. Per- sonally, I am willing to go that far, but I do think that before the committee reports this resolution that they ought to consider the fact that these words practically preclude the Federal Government from issuing tax-exempt securi- ties even in a great emergency such as war. Mr. 0LUEI15LD. The resolution, of course, could be amended before it is re- ported. TAX-EXEMPT SECURITIES. 75 Mr. Geeen. I might say, Mr. Mills, speaking for myself — and I think that they are the same views as those expressed by Mr. Mellon the other day — 1 think that there is little chance of it being ratified unless it does carry that provision. Mr. Mills. Well, I think that the real question which is of great interest to the Federal Government and is of interest to the Nation from an economic and social standpoint is the basis of this amendment. The amendment here represents the standpoint of the States, and it seems to me that it is our duty to consider this from a national standpoint. And remember all that is de- sired on the part of those who are advocating the passage of this amendment is that they are asking that you give to the State the opportunity to vote on it, and that the interest to the Federal Government certainly seems to be very greatly in favor of the amendment. (Whereupon, at 12.05 o'clock p. m., the committee adjourned to meet at 2 o'clock p. m. of the same day.) AriEE EECESS. The committee reconvened pursuant to the taking of the recess, Hon. Wil- liam R. Green presiding. STATEMENT OF MB. "WILLIAM A. FEBGUSON, BALTIMOKE, MD., REPBESENTING THE NATIONAL ASSOCIATION OF BEAL ESTATE BOABDS. Mr. Fekguson. I represent the National Association of Real Estate Boards, composed of 400 boards throughout the United States and about 20,000 members. I have here a brief from the legislative committee of that association, which embodies in it the resolution passed at the annual convention of the Na- tional Association of Real Estate Boards in Chicago last July. It is very short'and I will just read it, if you have no objection. Prior to the enactment of Federal income tax legislation, the National As- sociation of Real Estate Boards believed exemption of public bond interest from taxation was just and the proper exercise of sovereignty. It is now con- vinced that the income tax law radically changed the conditions pertaining prior to 1913. Doubtless there were few who projected their thought far enough to see the tremendous line-up of sentiment against the opportunity afforded persons of large means, by continuing of exempt features of public bonds, when the Federal income tax law went into effect. In our opinion, there is being erected, to the detriment of the pubUc gen- earlly, and particularly in the matter of home owning and solving the housing problems, a legalized class of nontaxpayers at the very period when the Gov- ernment needs its highest revenue. This situation burdens moderately well-off taxpayers in another direction. As public bonds are a favored investment of those large means, it tends to induce the Government units to borrow and spend money extravagantly. , t^ , , The comfortably fixed taxpayer therefore catches it from both the Federal and local standpoints, and those of large means, who are usually the buyers of municipal and other like bonds, pay no taxes. Because of the high rates of interest being paid on local public bonds, and because of the high cost of improving the officials get but a fraction of the normal value of the money spent all of which is injurious to the ordinary taxpayer. This condition was probably not considered by those who drafted the income-tax law. Our association believes in taking away from those of large means the in- ducements which are afforded by tax-exempt securities, so as to let money flow into the ordinary business channels, including mortgages, the making of which is necessary to promote building and home owning. As long as those of large means can obtain a fuller net return by investing in tax-free securities, they will not invest in other securities, including mortgages (the income of which is not exempt from taxation) bearing the ordinary lawful rate of in- interest, which is generally 6 per cent. ^ ,-,,,. Being a primary source of internal revenue, the tax on income should be equalized and at reasonably low rate, and to do so it is necessary to make the returns on public bonds subject to tax, the same as other securities. " In our opinion the Government should rely upon its own credit, upon the patriotism and desire of the citizens to aid it to get its requirements norma' and exceptional It should not give further special concession or inducement. 76 TAX-EXEMPT SECURITIES. by way of tax exemptions. We believe the day liacl gone by when it is nec- essary or desirable for the Government to continue offering tax-exempt premium on public loans while it retains the income tax. At the annual convention of our association, held last July in Chicago, 111.,, among other things it was — "Resolved, That it is the sense of this association that we advocate the adoption of an amendment to the Constitution of the United States empower- ing on the one hand the Federal taxation of the income from future obligations- of the States and their political subdivisions and on the other hand the taxa- tion of future obligations of the United States by the States and their political subdivisions, in both cases with proper safeguards Mmxting such taxation." There is just a word I want to add to that. Of course, I guess you gentle- men have heard all of the arguments that can possibly be made why this situa- tion should be changed. I am in the real estate business, and of course this association is composed of real estate men, and I can only speak of my own knowledge from the experience of the average real estate man in the big cities- and also throughout the smaller communities who are endeavoring to try to get the housing situation straightened out. We know for an actual fact that the large money loaners, the people of large means who have money to lend on mortgages, that they have been calling that money in and putting it In tax- free securities, for the simple reason that they make more money for their own income by doing it ; and not only has the money market been drained of that s(3urce of investment, but we have difficulty in finding other means to get money to lend on houses. From our own experience we knbw that this is a fact. I thank you. Mr. Copley. What you mean, then, as I understand it, is that, by continuing the issuing of tax-exempt securities, the money that normally would go that has gone in the past and would go in the future, into the building of houses, is going to cost a great deal more in interest rates? Mr. Feeguson. That is true ; yes, sir. Mr. Copley. Which means increased cost to the people who buy those houses or even live in and rent them? Mr. Feegxjson. Yes, sir. Mr. Copley. That is your conclusion? Mr. Ferguson. Yes, sir. There has been no increase in the mortgage money for investment; there has been a decrease in the last two years. It has been taken out of the market. It has been made up to some extent by the loosening up of certain institutions, such as savings banks and building asso- ciations inducing the public to save, the small people ; it has been made up to some extent, in that way, but it is not where it should be at the present time. Mr. Copley. In other words, you have a lessened amount of money to supply a demand which may even be increased as the population of this country increases. Mr. Ferguson. Which is very much increasing all the time. Mr. Gkeen. This has an effect on rents, I suppose? Mr. Ferguson. Undoubtedly. If there are less houses than it will take to comfortably house the people, rents go up. Now what we need to-day in this country is a whole lot of houses to lessen the condition of high rents. Fot Instance, you will find in some of the cities (I think you will probably find Pittsburgh is the worst) that they have 0.8 room per person. In Baltimore we have 1.37 rooms per person. Some of the cities are lower than that and some are higher ; I think Pittsburgh is probably the highest. Mr. Fkeae. What is it in Washington? Mr. Ferguson. I think that is about the same as Baltimore — 1.37. Mr. Frear. It is a pretty hard situation, I recognize, to borrow money. Mr. Ferguson. It is awfully hard to borrow money. Mr. Watson. What is the rate of interest in Baltimore? Mr. Ferguson. Six per cent. Mr. Watson. The, nontaxable securities do not yield over 4-1 or 4| Mr. Copley. Oh, yes ; they do ; they yield 5 J and 6. Mr. Watson. Not in the last six months. Mr. Copley. Yes; I happen to know. I can give you an instance where I invested $7,000 for a certain client of mine ]0 days ago at 5.65 per eenf so I ' know it can. be done. ' TAX-EXEMPT SECUEITTES. 77 Mr. Watson. I went to four different banks, and I could not buy a good non- taxable security tbat would yield over 4i per cent; that is my experience. I -will go to you the next time. Mr. Copley. I know it can be done, because I am doing it right along. Mr. Watson. If you pay 6 per cent, it seems to me you ought to get more money now than you did six months ago. Mr. Feeguson. Of coui'se, the money marlvet to-day is better than it was six months ago. Mr. Copley. I am glad you brought that question up. Is not the real reason for th.e money market being easiej- to-day because less money is being used in industry, and a lot of Industrial organizations, which ordinarily would have their capital in^'ested in their own business, having some idle funds, but not knowing how soon they may have use for them, are ordinarily buying short- term securities? Mr. Feeguson. That is true. Mr. Copley. Which takes that part of the investment supply off of the market and throws more money into the other ; and that is where it has come from, instead of coming from these large incomes ; is not that the fact? Mr. Ferguson. Yes, sir. Mr. Copley. I want to say tliis to the gentleman from Pennsylvania : I will Agree with him that the high-grade gilt-edged municipals are now paying somewhere around 41 to 41 per cent, but you can go out and buy them to yield as high as 5.65 per cent. Mr. Watson. I am speaking only of gilt-edged tax-exempt securities. STATEMENT OE MB. JOHN G. WILLIAMS, PHILADELPHIA, PA., PEESIDENT OE THE PHILADELPHIA REAL ESTATE BOARD. Mr. Williams. Mr. Chairman and gentlemen of the committee, I appear before jou to-day as a member of the legislative committee of the National Associa- tion of Real Estate Boards and alsb as president of the Philadelphia Real Testate Board. The resolution Mr. Ferguson presented comes from an organization of 16,000 realtors and we feel should carry considerable weight, because in our organi- zation we have the real estate men of the country who are really handling the problem of housing. Now, I come here to-day in that capacity, as a real estate l:)roker, and to speak on this bill from that viewpoint. Mr. Feeae. What States do you represent? Mr. Williams. We have representatives from every State in our organization. Mr. Fkeae. From every State? Mr. Williams. It spreads all over the country. We have approximately 450 Tsoards. spread all over this country, and we also take in some in Canada. Mr. Feeae. It takes in the whole country? Mr. Williams. Yes ; we virtually represent the whole country. From a real estate standpoint, there has been a real famine in mortgage money; it has l3een impossible almost to place mortgage loans. I feel that what this country needs to-day is a revival of home construction ; and to have that we must be ;able to finance. We have been passing through a period when it was prac- tically impossible to get money for new construction, and not only for new ■construction but for the replacing of loans on present mortgages — mortgages •created some vears back that were held by people who took advantage of tax- exempt bonds' They have no hesitancy in telling you that ; and they would call these mortgages, and we were forced to get the money somewhere. In many •cases we had to pav bonuses for the money, and, incidentally, such a situation "brings the cost right back on the home owner. If we have to pay more for our morta-age monev, we must get it somewhere. Mr.' Copley. And then ultimately it raises his cost of living? Mr. Williams. Unquestionably; you can not avoid that. The amendment •suggested here will, in effect, make more equitable the distribution of money for the people who have to borrow. If we are all put on a fair competitive "basis we can get money for our home construction, which is so severely needed; and I think you will agree with the real-estate men's viewpoint, which is not a selfish one, that we must have homes. The American Nation is built •on home ownership — I believe we all agree on that— and the more home owners •we can create the better citizens we will have, especially with these foreigners •who come here and accept citizenship ; if we can get them to purchase a home, 78 TAX-EXEMPT SBGXJEITIES. they are going to swear by this country. Any idea of bolshevism is knocked out of a man when he owns a piece of real estate. We feel this amendment will allow us to compete favorably for our money and get the money on terms that will help us to build. As we build we are bound to create a revival of business in all industries, because construction takes in so very many angles of business that it is bound to bring business to those industries. I do not know what more I can add. It strikes me that this is such a broad proposal and so absolutely fair that no broad-minded man could oppose it, and especially when the need for homes is considered. Mr. Hoover, the Secretary of Commerce, at the last convention of the Na- tional Association of Real Estate Boards, held in Chicago, emphasized the need of homes and spoke about the building association plan. You can not get people to save money, even in building associations, when they can go out If they have a little money and buy tax-exempt bonds. So I submit to you, gentlemen, that from any angle the real-estate man views it, it seems to be a very fair measure, if you want to put the country back on a strictly sound economic basis and bring about a revival of con- struction and thus help all lines of industry. Mr. Watson. Are you acquainted with the interest rate on real-estate mort- gages in New York? Mr. Williams. I do not think I can speak about New York. I could probably speak more about Philadelphia, my home town. Mr. Houghton. How far has the high cost of construction interrupted new building development in Philadelphia? Mr. Williams. Considerably, sir. Mr. Houghton. It is not all a question of money, then, but a question al.so of the cost of building, is it not? Mr. Williams. That has to-day a whole lot to do with it, but when you con- sider thelittle money you can borrow and what you have to pay, in many cases, bonuses costing probably 12 to 14 per- cent — I am speaking conservatively now — you can imagine .iust what item of cost that would add to the. entire bill. It was not the whole cost, but it was a large item, and we had to do that ; we could not get the money unless we would go out and offer these un- usual bonuses. Mr. Houghton. Do you figure the lessened amount of money available for construction has more to do in preventing construction than the high cost of construction ? Mr. Williams. I would say yes. We can not get the money unless we pay a high rate for it ; and when we pay a high rate, of course, we go out and let a contract with the material man, the steel man, and the Iron man, and we find they have paid a high rate for their money, and, of course, they will charge us that much more for their commodity. Mr. Houghton. How about wages? Mr. WnxiAMS. Wages, of course, have been high, but I think the wage earner is beginning to see daylight and I know In some cases, speaking of Philadelphia, they are working for less money now than they received a year ago. There has been a reduction in the cost of labor in Philadelphia, and I believe labor is more willing to work to-day. In speaking with builders generally, they have told me- if they could finance they could get plenty of laborers; there was no trouble about getting laborers if they could get the finances. Mr. Watson. Recently New York has sent over $10,000,000 to a certain con- cern in Philadelphia to loan on small houses. That being the case, I thought probably New York had plenty of money. Mr. Williams. I would lil.e to reply to that particular offer, from what I know of it. That was a large life insurance company to which you have refer- ence, was it not? Mr. Watson. Yes. Mr. Williams. Their terms, as I understood them, were that they would only loan on construction already erected. Mr. Watson. No; they will loan on buildings partly constructed, but the mortgage has to be guaranteed. Mr. Williams. As I had it explained to me by the agents who expected to handle the fund, and probably are handling it now, they told me the property must be erected ; it must be new construction and they were only to loan .50 per cent of the cost of construction, and on n plan that carried with it an amortiza- tion feature that the mortgage had to be reduced 3 per cent every six months, or TAX-EXEMPT SEOUBITIES. 79 6 per cent per annum, on the principal. Now, from the Philadelpliian's stand- point Mr. Watson. That far is correct, except as to reducing the amount of the principal. As to that, I do not know. But the proposition has gone through, and I presumed all the $10iOOO,000 would be used in the construction of new properties, especially new homes. Mr. Williams. I made it my business, as representing the Philadelphia Real Estate Board, to inquire into that particular plan, because I thought that if there was to be $10,000,000 available, that was just what we were looking for. Mr. Watson. The offer came from New York to Philadelphia. Mr. Williams. And I was given to understand that it carried with it those features — that it had a reduction clause of 6 per cent per annum, plus only 50 per cent of the cost of construction, and that the building had to be new and had to be finished. Mr. Watson. No ; the buildings are not required to be finished, but their com- pletion is to be guaranteed by a certain company. Mr. Williams. I may be wrong as to that, but from the Philadelphian's standpoint that did not mean much, because in Philadelphia we have always been able to borrow two-thirds of the cost of the building and then had an avenue with the building and loan association to borrow additional money — so much of it on a permanent mortgage and then the additional amount on an installment mortgage, which would give the borrower a chance. And if the 50 per cent had to be an installment mortgage and then we had to get the building and loan association to advance the additional amount on an install- ment basis the overhead would be too large for the buyer of the home to carry. So the proposition was impracticable as far as we were concerned. Mr. Watson. That is all true, except the money may be loaned for the erection of new houses. Mr. Copley. May I ask the gentleman from Pennsylvania a question? He says it is New Tork money? Mr. Watson. Yes. Mr. Copley. That the amount all came from a New York life insurance company? Mr. Watson. Yes. Mr. Copley. Really, that money is money they are collecting from all over the country. Mr. Watson. I do not know, but it came to Philadelphia from New York. Mr. Copley. Now, I would like to ask the witness two or three questions along the line suggested by the gentleman from New York [Mr. Houghton]. He asked you if this halting of building was due, not to the high cost of materials, but to the high cost of labor? Mr. Houghton. No ; I did not ask that ; I said in part. Mr. Copley. In part, and in greater part, for instance, than could be attrib- uted to the high cost of money. As I recall, that is the question you asked? Mr. Houghton. Roughly. Mr. Copley. Now, let me ask you this'- Do you not believe the high cost of money has been responsible in part for the increased cost of building mate- rial and the increased cost of labor? Mr. Williams. I said that in answer to- a question asked by Mr. Houghton. Mr. Copley. In other words, a part of this cost to which Mr. Houghton referred has been caused directly by the high cost of money? Mr. Houghton. There is no question about that. Mr. Copley. And the high cost of money has been caused in great part by having these tax-exempt securities, into which the great investment sums could run? Blr. Williams. Unquestionably that is true. The door had been shut and we could not get it open. - . , . i, ^ Mr Houghton. Did your board ask us, when we were considering the tax bill, to exempt, up to a certain limit, the funds of the building and loan asso- ciations—to make another set of tax-exempt bonds? Mr Williams Our board was in favor, sir, of that amendment. That re- moval of tax-exempt funds was up to a limit of $500. Is that what you mean? Mr. Houghton. Yes. Mr. Williams. We were in favor of that. Mr. Houghton. $500 per annum? _ . Mr Williams Yes ; $500 per annum from building and loan associations. Mr Houghton You were in favor, then, of an increase in the number of tax- exempt bonds? so TAX-EXEMPT SECURITIES. Mr Williams. To that extent ; yes. Mr. Copley. But, may I ask, were not you recommending the removal of the exemption from State and municipal bonds, as serving almost exactly the .same purpose as exempting a small amount of building and loan? Mr. Williams. I think it would do more than that. Mr. Copley. And put this country back in, the same relation in its money rates that we were enjoying prior to the outbreak of the war in Europe ; you would have just about the same money rates and the same relation. The good municipal would sell at a lower rate, of course, than a poor one ; a good municipal would sell at a lower rate than a good utility ; and a good utility would sell at a lower rate than a good industrial? Mr. Williams. Yes ; I think you are right. So far as the building associa- tions are concerned, they have always felt they enjoyed a certain right of exemption from tax. That is inborn in the average building-association man. The building association, of course, works on the theory they are helping the .small man to save money, encouraging him to save money. I suppose they would feel that the exemption of that amount was encouraging the saving of small funds ; and we, as an association, felt we were justified in helping the "building associations, on the same basis that the saving funds of the country will resist any taxation ; and surely if the saving fund is entitled to exemp- tion, the building association stands on pretty much the same principle. Mr. Copley. Now, one more quastion and I will be through. In your opin- ion, if tliis proposed legislation should become accomplished, would the inter- est rates which the States and municipalities and Government subdivisions ware compelled to pay be increasied in the slightest? Mr. Williams. I am inclined to tliink that they might have to pay a little more, but on the other hand, there is another side to that. I feel this way: That after they have borrowed the money, assuming they have paid a trifle more, it goes out and enters in competition with the commodity it is going to purchase. In other words, the dollar is going to go farther. To-day the munici- pality gets the money cheap. Let us agree on that. It goes out in the market to spend the money, and it immediately bumps up against the industry that has paid a big price for its money and consequently has to charge a big price for the commodity. Now, what is the result? From my vievvpoint the munici- pality has increased its indehtedness to buy the commodity that it is after, due to the high cost of that commodity. And I believe, even assuming they would pay a little higher rate of interest, that their money is going farther and they would not have to increase their indebtedness. And to-day, from what I can observe, there is hardly a municipality over the country that is not loading up with indebtedness. It is surprising; it is a question whether it is not a rather serious situation. They are all piling up debt, and the debt has increased, in my opinion, first, because they can borrow cheap ; second, when they go out to spend the money it does not go as far, and, of course, they ..come back and borrow more. Mr. Copley. There is a total sum of money for investment constantly? Mr. Williams. Yes. Mr. Copley. Varying at times — sometimes greater and sometimes less? :Mr. Williams. Yes. Mr. Copley. For instance, if all the bonds and all the securities of every sort ■were taxable, or, rather, the income derived from them was all taxable, why -should interest rates go up? I can not see that they would. For instance, if a man can not get 9 per cent for his money he will take S, and on the same jprinciple, if he can not get 3 he will take 21. He won't let his money lie idle, .and if there is no way he can get securities which are tax exempt, why he is going to raise the rate of his money permanently on any one particular class of investment. Mr. Williams. I can only answer that from an individual viewpoint. Mr. Copley. I do not agree with you that the rates of interest on State bonds would be increased ; as a matter of fact, I think they will hold just ■where they are. Mr. Williams. You may be right. On the other hand, it seems to me that -while we have plenty of money in the country there is going to be quite a demand for money if we get into a proper and sound business revival, and I am of the opinion there might be a slight increase. Maybe I am anticipating some- thing that won't develop. I can remember the day when municipal bonds were selling very cheap and there was always a good market for them because rsome people would not buy anything but a nmnicipal bond ; they are wedded TAX-KXBMPT SEGUEITIBS. 81 to the idea of the security of it, and they always want State bonds and things of that kind. Mr. Oopi-BY. And also because of the nontaxable feature of it? Mr. WiiiiAMS. Just now ; yes. Mr. Copley. I did not refer alone to the Federal income-tax nontaxable fea- ture but to the fact they are free from local taxation. Mr. Williams, Yes, sir. Mr. Houghton. I quite agree with the witness that the tax-exempt bond is undesirable and that houses are pretty badly needed in this country. We have not had many houses built, proportionately, for the last six or eight years. Now, supposing we put out an amendment here to the Constitution which if adopted would stop the Issuing of tax-exempt bonds. Taking the conditions as they are and for a year or two or three years, whatever the time may be, before that amendment would be ratlfled, what would be the situation of the money market during that time in regard to getting money for houses? Would it make the existing situation worse for a few years or would it give some immediate benefit? That, to my mind, is a pretty serious question. Mr. Williams. I do not believe it can be any worse ; it is bad enough now. Mr. Houghton.. I think it might be a great deal worse ; I do not know. Mr. Young. My colleague has this in mind, that there might be a speeding up of loans for municipalities during that time in order to get in under the tax-exempt feature. Mr. Houghton. That might happen or there might be other effects due to uncertainty. And I am not clear in my mind as to the precise effect during that interim of what will happen. Mr. Williams. I think the passage of the amendment would have a whole- some effect on the entire country, and might have this result : The people, know- ing it was ultimately coming, would feel encouraged to go ahead and get into building construction. That is what I am hoping for as a real-estate man — that with the passage of the amendment it is going to open up the way to know just what is ahead of us ; we would know there would not be any more tax-exempt bonds, and we could use that as an argument and go out and do our financing. Mr. Houghton. I do not think you know that. It is entirely conceivable that the amendment may not be ratified by the States. Mr. Caeew. The chances are it won't. Mr. Fbeab. Do you believe your organization represents the sentiment of the various States? Mr. Williams. I feel we do, sir. We have been working on this for some while back ; it is not a new thought with the National Association of Real Estate Boards. When we saw the recommendation of the President in his last message to Congress we began to see that probably it was really taking effect. It has been the thought of the real estate men — and of the thinking men of the country — that this is the remedy. Mr. Green. Do you know of any organization that is not in favor of it? All of the business organizations that have expressed themselves have expressed themselves in favor of it, have they not? Mr. Williams. So far as I have heard here to-day and from what I have read in the various accounts of the hearings they have. I said in beginning my re- marks I felt the thing was so practicable and so fair, on the face of it — and I know the evils of the present arrangement, we see also the seriousness of it— that I can not see how there could be any man, if he sits down and thinks it over carefully and candidly, but who will agree. And I think that applies to our organization ; we have looked it over and see why this thing is in the inter- ests of the country as a whole, and anything that is in the interests of the country as a whole we ought to favor. Mr. Gkeen. With all of the business organizations and all of the farm or- ganizations in baek of it, and the labor organizations, as I understand, in favor of it, it ought to have some chance of ratification? Mr. Williams. Well, one would think so. Mr. Watson. If the Legislature of Pennsylvania would repeal the 4-mills tax law for a tax on mortgages, would not that open the avenue for first-mortgage loans ? Mr. Williams. It would help us there, unquestionably; but, as I said, I am trying to speak for the national situation as a whole. 93671—22 6 , ; 82 TAX-EXEMPT SECTJKITIES. STATEMENT OF MR. KINGMAN N. BOBINS, BOCHESTER, N. Y., PRESIDENT OF THE FARM MORTGAGE BANKERS' ASSOCIATION OP AMERICA AND VICE PRESIDENT OF THE ROCHESTER CHAM- BER OF COMMERCE. Mr. Robins. Gentlemen, I repre-sent, as president, tlie Farm Mortgage Bankers Association of America, Chicago, 111. ; but, Mr. Chassell already having repre- sented that organization before you, I feel perhaps I would appear here In better grace as representing the Rochester Chamber of Commerce as a vice president of that body and as chairman of their tax committee. I do not want to bore you with a repetition of the arguments you have already received, but there are two points, I think, that may be of some value, which I would like to present, without presuming you have not received those also. One of the members of the committee this morning raised the point whether the taxpayers themselves ought not to be left to determine whether they should have the privilege of tax exemption or otherwise — whether it was wise for them to have it. Going back to that same principle of democratic control of the policy, is it not rather interesting to note that practically every representative trade and business body in the United States, which has taken any action on this matter, has taken favorable action on this legislation? Mr. Citisp. I think you do Mr. Garner a little injustice there. Mr. Robins. I apologize if that is the case. Mr. Ckisp. He did not say his community should say whether it should have tax exemption or not ; he said each community should pass on the question whether it desired to issue bonds that were tax exempt. Mr. Robins. I am glad you made the suggestion, because I do not desire to do an injustice to Mr. Garner, especially in his absence. The point I wanted to make was that the feeling of the locality might be otherwise. Mr. Fbeae. Let me make a suggestion right in line with that. Many States provide a limitation on the amount of money that can be assumed in the form of indebtedness by the locality. Now, it is because they feel it is better for the interests of the locality, and even the people of that community have no right to exceed that rate, because it is a constitutional limitation. Many States have that provision? Mr. Robins. That is true. Mr. Fkeae. Of course, this might have a somewhat similar effect. Mr. Robins. I do not think I made my point entirely clear, and I am glad to have these matters suggested to explain what I had in mind. Mr. Hawley. You stated the associations from which you had received replies had acted favorably on the proposition. To what extent have you received re- plies and to what extent have business organizations failed to reply? Mr. Robins. We have not done it so much through our own body as to observe the actions of others. For example, the "United States Chamber of Commerce took this matter up by referendum vote, and they received the largest vote favorable to it that they ever received on any question. The American Farm Bureau Federation has taken similar action by referendum with a similar result. These, of course, are national organizations ; they represent national sentiment, I take it. The National Tax Association is a national organization representing the national sentiment of experts. They have been pioneers in favor of this work. The same is true of the American Economic Association from the standpoint of experts. And the Investment Bankers' Association, after opposing this action for some time, are finally converted to it, in spite of the fact that in their membership they include many who make money out of selling tax-exempt bonds. And the only reason they came to that conclusion, after a considerable light in the executive committee, was on the ground that, in policy, they could not indorse the present situation, and therefore could not act unfavorably on this legislation. I remember asking an investment banker what his viewpoint was a few years ago, and he said : " AVe are merchants ; we do not care how much our customer pays for money ; we get the same margin of protit anyway." I said, " Oh, yes ; you do care, because if your customers are put out of business you won't have any opportunity to put bonds out." Mr. YoUNO. What proportion of your investments do you make in farm loans? Mr. Robins. Why, it is a farm loan organization, engaged solely in making farm mortgage loans. Mr. Young. How did your volume of business compare in 1921, say, with what It was in former years? Let us get some little idea of which direction it is going. Are you making more loans or fewer loans? TAX-EXEMPT SECUKITIES. 83 Mr. Robins. We have outstanding now, I sliould say, about $2,000,000,000 on our books. Mr. Young. How does that compare with what it was in former years? Mr. EoBiNs. I should say it was about double what it was 10 years ago. Mr. Young. How does it compare with the time the Federal farm loan banks began running? Mr. Robins. Considerably more. It Is a little difficult for us to know .just how much we loaned last year, but we do probably 75 per cent of the lending for the insurance companies, who loaned $250,000,000 last year on farms. Mr. Young. So the joint stock land banks and the farm loan land banks have not cut down your business? Mr. Robins. No ; I do not think they have in the gross. It is a little difficult to say, relatively, what they have done, because that would be a matter of guess- work. But ill the gross we are doing more than we ever did before. ■ Mr. Young. Are you doing any loaning on city property? Mr. Robins. No ; farm loans strictly. Inasmuch as Mr. Ghassell made clear that the total of farm land bank loans, both Federal and joint stock, is only about 5 per cent, it seems, of course, the private agencies must still be doing a very large proportion. Mr. Young. We have received some letters from time to time I think from your organization and from members of it, protesting against the exemption of the bonds of the farm-land bank and joint-stock land banks, and I gather from what you say you are able to compete with them? Mr. Robins. That is a protest on principle, sir. With conditions as they are to-day, the farmer needs more money than he can get from any one source. I think if agriculture is to continue to prosper, possibly he will continue to need more. I think it has been stated here in one of the committee's hearings by a member of the Federal Farm Loan Board that probably they would not expect to do more than $200,000,000 a year. Mr. Young. That is more than they have done. They expect to loan about $150,000,000 a year. M*. Robins. That is their maximum. We figure over $1,000,000,000, perhaps a billion and a half a year, as representing the annual farm loans on first mort- gages. That is apart from contracts. Mr. Young. Do you believe that if the exemption were removed from the bonds of what you might call your competitors, say Government competitors, that that would make more plentiful for farm loans_ or not? Mr. Robins. Yes. But here is the point. The exemption of the Federal farm loan bonds does not do us the damage, but the total exemption of public securities does it, in' this way : Iwill illustrate in my own business. I am in Rochester, N. Y. I am the director of a trust company there, which I asked to act as trustee to secure a bond issue of about $300,000 just prior to the act of 1917. One of the directors examined the proposition and the executive com- mittee took more than half of that issue before It left the room, in blocks of $25,000 and over apiece. Not a single one of those gentlemen has bought a single farm mortgage since that time ; the passage of the act of 1917 completely put them out of the farm-loan mortgage market. Mr. Young. You figure some of those gentlemen would come back if this amendment were passed? Mr. Robins. They have openly said they would. Their disposition is such that they will put their maids and their stenographers and their children into farm-1'oan mortgages. And what is the result? We now have to sell in blocks of a thousand and two thousand dollars in the average sale where we sold in blocks of $25,000 and $50,000 before, and the consequence is the cost to us of dis- tributing those mortgages is comparatively very much more, and naturally that cost has to be paid by the borrower. Mr. Young. You mean you have to sell now to people of relatively small In- comes? Mr. Robins. Yes. There is a sort of general principle apparently among in- vestors now who have incomes of $30,000 or more that they will not buy any- thing but tax-exempt securities. There are, however, many exceptions to that. Mr. Oldfield. The people -who buy tax-exempt securities are the very rich — • that is, the men who have incomes of $1,000,000? Mr. Robins. That is the point I am trying to make. I find the average investor, with an income of $30,000 or more per annum, is the man who stops buying taxables. I can not go with any hope of success to the man who has an income of $30,000 or over with a taxable mortgage. 84 TAX-EXEMPT SECURITIES. Mr. Oldfield. How would this operate, to increase the inheritance tax to a sufficient amount on tax-exempt securities? You could do that, constitutionally, without a constitutional amendment? Mr. Robins. It undoubtedly would have a detrimental effect on the market for tax-exempt securities ; it is problematical to know just how much effect it would have. Mr. Oldfield. Then that would be to your advantage? Mr. Robins. I would say not only ours, but to the advantage of all dealers in taxable securities. Mr. Olbfield. Then you would be in favor of such a law? Mr. Robins. I would favor it from that angle. I have not studied it suf- ficiently to pass upon it as a matter of general public policy. Mr. Oldfield. While this proposed amendment is being ratified, which necessarily mil take some years, and might take 10 years or might take 25, and might never be ratified, to overcome the hiatus Mr. Houghton was talking about a while ago, we might write this kind of a provision in the inheritance- tax law? Mr. Robins. I remember the debate on that question when it came up. I should not want to pass on the policy of that without some more study, but it would not seem to me, in principle, to take the place of broadening the basis of taxation of the income tax. Mr. Oldfield. It would make some of these rich fellows buy something else except tax-exempt securities? Mr. Robins. It would work that way, of course. Mr. Cmsp. You referred a few moments ago to the fact that the Federal land banks and joint stock land banks only made about 5 per cent of the farm loans? Mr. Robins. I was quoting Mr. Chassell's figures. Mr. Cbisp. I think that is accurate. Is not this true, however, that when the Government loaned that 5 per cent and opened these institutions, that the effect of it was to force these farm loan associations to reduce their rate of interest and the commission they had been charging the farmers for those loans before these farm-loan acts were passed? Mr. Robins. My own feeling would be that theoretically that should be so. Mr. Crisp. I know.it is so. Mr. Robins. There are certain particular instances where it would seem to be so, yet the census figures do not seem to bear it out. Mr. Geisp. I know in my community it had that efCect. Mr. Robins. What is your particular section? Mr. Cmsp. Georgia. Mr. Robins. I would say yes; and, for instance, in certain parts of Mon- tana I think it is so. Mr. Geisp. I know in south Georgia after those banks were established— of course, these private concerns still got the bulk of the loans — the rate of interest and the commission of the agents who were negotiating loans were • reduced. Mr. Robins. I should be inclined to say yes, but in that connection I would not want to be understood as opposing the Federal farm loan system. Blr. Chassell made that disclaimer as well. Mr. Gkisp. I wanted to bring that out on account of your minimizing the effect of the Federal farm loan banks only loaning 5 per cent of the loans Mr. Robins. I did not want to do that. Mr. Gkisp. I wanted to put in the record that not only were they loaning 5 per cent, but it had the good effect of reducing these other rates on the private loans. Blr. Robins. Mr. Chassell made the point,, of course, that the Federal Farm Loan Board itself has recently had to raise the rate from 5* to 6 per cent and better. The point I was trying to emphasize was not the unimportance of the farm land ban]{;s, but to emphasize tlie importance of the other a^-encies Mr. Houghton. What really is the trouble here, Mr. Robins • is it the non- taxable securities or is it the upper ranges of the income tax? ' Mr. Robins. You mean which is driving out the investment funds from mortgages? Mr. Houghton. We are speaking hero as if the whole trouble were due to tax-exempt securities. Now, the trouble really came after the income tax and its high range, did it not? Mr. Robins. Yes ; in 1917. TAX-EXEMPT SECURITIES. 85 Mr. Houghton. Now, if a reduction in the uijper ranges of the income tax were possible, and were made, say, to 20 per cent, as I think the Secretary of the Treasury once suggested, would your market be satisfactory? Mr. Robins. It would help, but not fully solve, the problem. Of course, any reduction of the surtax would gradually let more and more funds into those brackets which would not be heavily taxed, and the lower they go the more the money that would be released. Of course, the farm mortgage, like the municipal bond, is the type of security which finds its place in the strong box of the most conservative man, the man who is not seeking to make a high rate ; and, tha result is he is the- first one to leave the market when you penalize it, and that point will be covered in a brief which we will file later. The point I want to make now is the question asked so many times — What would be the effect on the rate of interest on public securities and other securi- ties that are now tax exempt if the privilege of tax exemption were removed? I had occasion last week to buy some bonds for an institution with which I am connected and looked to the Canadian market. We bought about $200,000 of Canadian city and provincial bonds to yield an average return of 5J per cent in New York funds, which would be about 5 per cent, as the ex- change is to-day, in Canadian funds. I got, in connection with this matter, a list of their utility and industrial bonds. I was interested to see what would be the interest return. The interest return ranges from one-half to li per cent higher on those bonds, apparently on the basis of risk. Everything is taxable there except the 1937 issue of war bonds. The point I wish to make is that the preferred position of the public security is main- tained, even where there is no tax exemption. In Canada there is no tax exemption of public securities, and the public securities command the market over everything else. Mr. TiLsoN. What is the rate of exchange? Mr. Robins. About 6 per cent when I left. Mr. Copley. In your opinion, would the removal of the exemption from State and municipal securities increase the interest? Mr. Robins. I was going to come to that question. My feeling would be, since supply and demand must, of course, control the rate, that the true interest rate would be determined by supply and demand and that it would not be increased by this elimination. We have an illustration of that in connection with the best rail bonds to-day. As you know, the highest grade of rail bonds to-day yield about 4.70. That is very close to the yield of a tax-exempt high-grade bond, merely because it is sold on a money basis and regarded as so safe that there is no risk. I found we could not get any such, as we wanted to buy at more than 5.15 to 5.25. Of course, those bonds are for the most part shut up in strong boxes. New issues to refund the railways must be junior securities and will yield very much more. Mr. Houghton. Were those guaranteed bonds? Mr Robins. No. I am quoting you what it would be on the underlying bonds of organizations like the Chicago and North Western. Those bonds can not be had except in a very small quantity, brought out by a high bid, because they are so safe. But the Interesting point there is that money seems to command the rate there, rather than any extraneous consideration. And I do not feel that the removal of the tax exemption would materially increase the rate for that reason, . . -, i, ^ i, Mr Gbeen. In answer to one of Mr. Houghton's questions you said that the reduction of the surtaxes would throw the various incomes back into the lower Mr Robins It is a little difficult for me to explain that except in this way : If a man's income is made up of two classes, one of the class which he has in his business which is taxable and the other of tax-exempt securities, with the present rates he would pay more and would be more inclined to buy tax-exempts than he would be if the surtax rate were reduced. For example, if his income to-day is $30,000, payable on taxable securities, his tax is so much, whereas if part of that security which yields that income is tax exempt, then he could go up into a higher a'ncome before he would have to buy tax-exempts. Mr.- Gbeen. That is very true. I thought you were speaking of a totally different matter For instance, in preparing the House and Senate bills, the surtax limit of the House bill was 32 per cent and the surtax limit of the S^enate bill was 50 per cent, which wns the one finally adopted. Of course, that does not mean any income, necessarily, pays as high as 50 per cent, on account 86 TAX-EXEMPT SECUEITIES. of the matters which you have just mentioned and other matters. Bat the- proposal in the House bill was not to reduce the intermediate brackets at all, and to reduce the limit of the surtaxes to 32 per cent. It did not affect tlie intermediate brackets. Mr. Robins. I see your point on that. Yes. Mr. Gbebn. Now, if that had been carried out, do you think it would have made very much difference? Mr. Robins. There is a curious thing in this connection. For instance, I went to a friend who is disposed to buy our mortgages; he is of that curious temperament where he won't even investigate or use his pencil to find out at what point he can stop buying tax exempts. He says he knows he ought to have a certain amount of tax exempts, and therefore that is all he will buy and he does not stop to calculate to the last dollar. I wLsh he did, because I could sell him more taxable securities. Mr. Frbae. The difference between the 32 per cent and 50 per cent rate amounts to only $40,000,000 tax income and that $40,000,000 would have been spread over the whole field of liquid money — a very small element in regard to loans placed on real estate mortgages. Secretary Mellon, day before yesterday, said it was true ; he testified before the Finance Committee of the Senate that in industrials only a small portion of the money was put in tax-exempt securi- ties by the people engaged in them, because they needed it in their business. Mr. Robins. That is true. Mr. Feeae. He said, beyond that, as I remember, investments were made in real estate and in other ways to avoid, of course, the payment of taxes, and also gifts that were made. Mr. RoiiiNs. I did not go into that at the time it was proposed to see what the effect would be. It is a technical question I would not like to pass on. Mr. Green. I am inclined to think the reduction to 32 per cent would not have made any very great difference, because the purchaser would have just simply figured on the interest return in each case and nothing else, and if he was one of those who paid the limit of the taxes, why he would still find the taxable bond out of his reach. Mr. Robins. Yes. I do not know what was in the Secretary's mind. My thought would be that the reduction to that rate would have helped the invest- ment in new enterprises by the very wealthy. I do not think it would have increased the market for this type of security very markedly. Mr. Copley. Let me, if I may, answer the gentleman from Wisconsin : The difference between the House rate and the Senate rate means that the tax- exempt security, granting you can buy a good one for 5 per cent, which you could not when that bill was under discussion — the tax-exempt security, realizing 5 per cent, would have to come into competition with the industrial that yielded 7.4 per cent ; whereas under the Senate bill it has to come in com- petition with an industrial yielding 10 per cent. In other words, wliere a man is up in the higher brackets, if he is going to pay 50 per cent he must get 10 per cent in order to leave him 5. per cent net ; whereas at 32 per cent he would only have to get 7.4 per cent. Mr. Freak. I am giving the actual result furnished to us at the time the discussion was had. Mr. Robins. That would be on the actual figures. Mr. Copley. The real trouble is that amount, the difEerence of $40,000,000 that would be collected in taxes, prevented the investment in the 7.4 per cent. In other words, the $40,000,000 was only a very small proportion of the total. Mr. Robins. Only a small coefficient. Mr. Copley. The difference would be several times $40,000,000? Mr. Robins. That is true. Mr. Frear. Here is the fact, as stated by very many witnesses : The reduction would have to come to 20 per cent if you were going to have any relief. Mr. Robins. I think that is true. Mr. Copley. I have drawn this conclusion from your testimony — and, frankly, I think it has been very excellent — and I want to see if I am correct: That you do not think this bill would increase the interest rates on the State and municipal bonds, but on the other hand you do think it would decrease the rates of interest on industrials? Mr. Robins. Yes ; I think it would. Of course, the reasoning of that is a little involved, but you will have to come to that conclusion, I think, if you go all the way through it. TAX-EXEMPT SECURITIES. 87 Mr. Copley. That must be the Inevitable conclusion. For instance, on this present tax law, where you are compelled to raise 10 per cent in order to net the investor 5 per cent, in comparison with the municipal bond, if we tax those municipal bonds we are putting this money into the entire pool from which the demand is going to draw its supply? Mr. Robins. That is true. Mr. Copley. If we agree on that, let me ask this further question : In your opinion, who paid in the past, who pays at present, and in the future who will pay the increased interest rates, ultimately? In the last analysis, who pays it? Mr. Robins. The taxpayer, of course. Mr. Copley. The ultimate consumer? Mr. Robins. Of course. Mr. Copley. In other words, it Increases the cost of living and will continue to increase the cost of living as long as it is on the sta<-ute books? Mr. Robins. Yes; I am very glad you brought that out. The committeemen are more helpful than I am. Mr. Houghton. What is your opinion as to the effect on the market of our framing an amendment and sending it out for ratification, taking the condition the country is in now, for the next two or three or four or five years? Mr. Robins. Of course, it would stimulate the man who wanted tax-exempt securities to buy all the tax-exempt securities that were issued, so far as his funds would permit. But it is interesting to check up, from the Treasury re- ports, how far the present wealth of those who have large incomes, is already segregated in tax-exempt securities. In other words, the market for tax-exempt securities is up to the limit. I doubt whether a rush to produce public securi- ties, would actually occur, therefore, because the market would not absorb them, and because I do not think the communities would authorize any amount simply because they could get a better rate to-day. They might do it to some extent, but they would not to that extent. Mr. Houghton. Leaving that out of the question altogether, what would be the effect of putting an element of doubt In your money market as to whether or not tax-exempt bonds would hereafter be issued? Mr. Robins. I have not reasoned it all the way through, except, of course, it might put some premium on present Issues of tax-exempt securities. Mr. Houghton. Do you think your money market would be easier if such an element of doubt were created or would money be harder to obtain? Mr. Robins. It would depend, I think, on the individual, what his opinion wa>. as to whether It would be ratified. Mr. Houghton. What in your opinion would be the result? You are an ex- pert on such matters ; you have come here to talk with the committee and give us your expert opinion. Would a more or less chaotic situation be produced or not? Mr. Robins. I have not seen the evidence to make me believe it would. I have only one other request and that is that I may file a brief a little later, embodying some of my arguments in detail. (The matter referred to is as follows :) SUPPLEMENTAL STATEMENT OF KINGMAN N. EOBINS, PKESIDENT FAKM MOKTGAGE BANKEES' ASSOCIATION OF AMERICA AND VICE PKESIDENT KOCHESTEE (N. Y.) CHAMBER OF COMMEECE. The following statement is an attempt to summarize the considerations affect- ing the proposal to perfect the sixteenth amendment by a further constitutional amendment permitting the taxation under the income tax of the income from public securities. ' At the present time the income from securities issued by the States and their political subdivisions is exempt from taxation by the Federal Government under the Federal income tax, and the income from tax-exempt Federal securi- ties is exempt from taxation by the States under their income taxes. The main question is one affecting our system of taxation and not one affect- ing the respective .iurisdietions of the Federal Government and the States. Tax- exemptions, which are steadily undermining and destroying the income tax as a form of taxation calculated to tax in accordance with " ability to pay," are a menace alike to our State and local governments and to the Federal Government, for the destruction of the income tax will throw back the burden of the support of Federal, State, and local governments onto their citizens in such a way as to perpetuate the old inequalities in a form much more acute, because of the extent 88 TAX-EXEMPT SECURITIES. of present-day taxation, than was the case when the sixteenth amendment was first passed to remedy these Inequalities. Questions of reciprocity between Federal and State Governments, of possible infringements by one on the rights of the other, no matter how pertinent tliey seerii, are relatively unimportant as compared with the cxuestion vital to every citizen as to whether we shall destroy the income tax or preserve it. This question is the all-important one tor State and local authorities as much as. for Federal, for the income tax is rapidly being adopted by State governments as the best solution of the pressing problem of raising needed revenue. It may well be of equal importance to city governments by some of which it has been proposed. At all event, it must be evident that what concerns every citizen and every taxing authority is the establishment of the income tax wherever and whenever administered, on the broadest and most equitable base possible in order that it may remain a socially and economically sound and fair method of taxing in accordance with " ability to pay," instead of, as at present, a system of transferring the burden almost wholly to the shoulders of those least able to bear it. As administered at present, permitting income from over ten billions of secuii- ties to be exempt from tax, the income tax, both Federal and State, transfers the burden of taxation from the wealthy to those of small means, from so-called unearned incomes to salaries and wages, from accumulated wealth to enterprise. The result is a crying social wrong and an economic monstrosity. From this standpoint, therefore, the arguments which have been presented, and which are briefly summarized below, are, we believe, without rebuttal from any quarter. On the contrary, .they have been urged and indorsed by public sentiment in every section of the country and by citizens of every calling. The movement against tax exemption is not only universal from experts and econo- mists ; it is universal politically and without class distinction. The truth of this is proved by favorable action on the principle of the proposed legislation and specifically by constitutional amendment taken by the following organiza- tions representative of universal and national sentiment in their respective spheres : American Farm Bureau Federation (representing the farmers' sentiment by national referendum). The Chamber of Commerce of the United States (representing business and professional sentiment by national referendum). The National Tax Association (representing tax experts and public taxing officials throughout the country). The American Bankers' Association (representing the financial sentiment of the entire country). The Investment Bankers' Association of America (representing the sentiment of those concerned with the distribution of securities throughout the country). Farm Mortgage Bankers' Association of America (representing the major proportion of the agricultural financing of the country). National Association of Real Estate Boards (representing the business of real estate and housing throughout the country). American Gas Association, American Electric Railway Association, National Electric Light Association (representing the public-utility business throughout the country). In addition to these and other national bodies, various local organizations have taken similar action, as for example : The Oregon State Chamber of Commerce, tJie Rochester (N Y ) Chamber of Commerce, the Kansas State Bankers' Association, the Illinois Implement and Vehicle Dealers, the board of directors of the Illinois Manufacturing Associa- tion, New York State Tax Conference, et al Reco^ition of the evil and the need for a remedy has been recognized bv public officials of every shade of political belief for years, and among those who tioned"-" "'^"'^^'''''' °" '"'''°'-''^ ^'^ ^^^oi" of i-emedial legislation may be men- President Harding, formej Secretaries of the Treasury Houston and Glass Secretary of the Treastiry Mellon, Undersecretary of he^reasurv lXS gt„:- ^rots^orGsr""" °' ""'^ ^^™^^'^*'^^' «°^^- ^--^-'^ ^^^ To summarize the arguments in favor of the legislation therefor • . H^ ^®''*''?'ii*•'" °^ T^'"''' securities from income taxation enables the wealthy to put their wealth beyond the reach of the tax collectors, thus creat' TAX-EXEMPT SECURITIES. 89 ing a privileged tax-free class at the expense of their fellows. One man was heard to boast that with an income of $1,000,000 a year he had totally escaped taxation for many years. The rapidity with which this tax-exempt class is being created is indicated by the reports of the United States Treasury show- ing that taxes paid by persons with incomes of $300,000 per annum and over dropped from $992,972,685 In 1916 to $392,247,329 in 1918. The potentialities of this process of tax immunization are suggested by the fact that during 1921 more than $1,250,000,000 of new tax-free securities were created, and already Mr. Kahn estimates that there are enough outstanding tax-exempt securities to absorb the entire personal wealth of those in the United States having an- nual incomes of $100,000 and over. 2. When the Government provides its wealthier citizens a tax-free refuge and invites them to fly to it to escape paying half or more of their revenue over to that same Government in taxes, blame can hardly attach to those who accept the invitation. ■ Furthermore, when these same wealthy citizens can assure themselves of a tax-free income of 4 to 5 per cent on their capital, whereas to get the same net income from a taxable security the wealthiest of them would have to receive 17 per cent dividends, it is not surprising that agriculture, business, and new enterprises languish for want of capital. It is a rare business that will pay 17 per cent dividends, even after years of effort. No borrower can afford to pay that rate on mortgages or bonds. The supply of capital for agriculture, business, the railways must, therefore, come from the small savings of the country in the hands either of institutions or individuals. Fortunately, these have grown enormously, but it costs too much to find them and enlist their interest in a particular investment. Obviously a bond or mortgage house having to sell its securities in $1,000 units, as against $10,000 units, on the average, as before the graduated income tax went into effect, must meet selling costs much higher than ever before. These costs are, of course, paid by the borrower, in addition to what would be a higher interest rate in any case owing to the competition of the tax-exempt securities. The effect of tax exemption is well illustrated in farm financing. About 5 per cent of the total is furnished by the tax-exempt Federal farm loan bank bonds. The other 95 per cent must be furnished by small investors and insti- tutions without any aid from the wealthy investor who used to take millions of dollars of these farm mortgages in large blocks, thus keeping the distrib- uting cost low. What benefit comes to the borrower from the Federal land banks on tax-exempt bonds is offset many times by the heavier burden resting on all other farm borrowers by reason of tax exemption in general. It was natural, therefore, that the American Farm Bureau Federation should take favorable action on the elimination of all exemptions. 3. Perhaps even more detrimental to the general welfare, however, is the destruction of the spirit and motive of new enterprise which the coexistence of high surtaxes and tax-exempt securities brings about. No inducement re- mains for the wealthy to finance new transportation, industrial, or other un- dertakings, or to develop our natural resources. The inventiveness and pioneering spirit which have made this country what it is are destroyed at the root. We fall back into a stagnant condition of getting along with what we have, paying more and more in taxes to keep it going instead of creating new wealth to offset the load. We can not stand still. Either we must go forward or we shall slip back- ward in this country, and there is much of truth in Dr. H. Parker Willis's remark : , . , " The tremendous overload of tax-exempt Federal and State securities which had resulted from the war made it hard for legitimate business enterprises to get proper access to credit and threw nearly all business into confusion." 4. A corollary of tax exemption is the shifting of the burden from the ac- cumulated wealth of the rich to the current earnings of the small business man, farmer, doctor, lawyer, and clergyman. Salaries, wages, and fees for professional services are heavily tax.e.d, while accumulated fortunes go scot free, an Intolerable situation in this country which, as Congressman Ogden L. Mills has well said, has little toleration for a leisure class, and can have none for a " tax-free leLsure class " ! , . ^, ^ 5 We have mentioned the social effect of tax exemption and m that con- nection something of the economic effect. The chief economic fallacy in tax exemption, however, is in the belief that it saves something— that it confers a benefit on the community or taxpayer. On the contrary, there is good basis for believing that with tax exemption eliminated, the Governments could hor- 90 TAX-EXEMPT SBCXJRITaES. row at approximately tlie same interest rates as at present. The experience of Canada, wliere tiiere is practicaily no tax exemption, shows that pnbhc securities enjoy a preferred position in the investment market corresponding to the position of State and municipal bonds in our own market. Canadian provincial and city bonds command a rate of interest from one-half of 1 per cent to one and one-half per cent lower than utility, industrial and mortgage securities. The same was true of our Federal, State and municipal bond.s before the graduated income taxes made tax exemption a much sought for factor in United States investments. But even granting that the elimination of tax exemption would raise the interest rate even as much as one-half of 1 per cent — a liberal allowance- that would be a saving in interest of only $5,000,000 per annum on every billion dollars outstanding of tax-exempt bonds, whereas the loss in Federal income tax alone owing to the tax-free status of that same billion dollars of bonds at an average interest rate of 5 per cent would amount to $25,000,000 if the bonds were in the hands of investors paying surtaxes averaging 50 per cent. In other words tax exemption under tliose condition.? — a fair assump- tion — costs live times what it is worth! And that five times is paid by the poor man in every State and city. State rights are not saving him now— they are not a valid argument against the only remedy that is oifered. As President Howard of the American Farm Bureau Federation remarks : " When the amount of tax-exempt bonds equals the value of the farms of the nation, it means that every acre of farm land will be carrying approximately a double taxation." In otlier words, to emphasize another argument against exemptions from the income tax, they virtually enact " the single tax." Our summary ends here for reasons of space and not because the field of argument has been covered. In closing we would particularly emphasize the fact that the amendment, if enacted, would be permissive, not mandatory, and does not of itself bind Congress to anything. Surely, with the weight of all this argument behind the amendment, and in view of the fact that it is per- missive only, there can be no valid reason for neglecting at this time to give the States an opportunity to pass on it. $TATEM:ENT of MR. EDWARD a. HARRIMAN, WASHINGTON, D. C, MEMBER OF THE NATIONAL TAX ASSOCIATION. Mr. Hakeiman. Mr. Chairman and gentlemen, I am a member of the National Tax Association and of the committee on jurisprudence and law reform of the American Bar Association, but I appear to-day in a very humble capacity, merely as a citizen and taxpayer. And my reason for doing so is the request of one member of the committee. I am in sympathy with all the economic and financial arguments that have been advanced in favor of the proposed amendment. I shall confine myself to the legal and political situation involved. I wish to emphasize the point brought out by Mr. Mills this morning as to the social and political eifect of the creation of a class of privileged citizens. We think. of England as a country of privilege, hut there is uo power in England that can confer on the English citizen the privileges conferred on American citizens by the purchase of tax-exempt securities. If England issues a tax-exempt bond to-day, the exemption from taxation may be repealed to- morrow by Parliament. Why is the situation different in this country? It is due to a decision of John Marshall, which has become the settled law of this country, a decision which, to my mind, was the only legal mistake that Marshall ever made. He held, when the question came before him in New Jersey v. Wilson, that the con- tract for tax exemption could not be impaired by legislative action. Now the rule is well settled that no contract is beyond the" control of the police power of the State, because the police power is essential for the protection of the health and the security of. the people. You may have property in a brewery in Kansas, and if Kansas chooses to pass a prohibition law, that brewery cease's to be valu- able property for the purpose for which it was intended, and of that property you may be deprived. Mr. Fkeab. That is in a peculiar class. Mr. I-lAEMMAN. That is under the police power, so called ; yes. But the prop- erty contained in a tax exemption you may not be deprived of. Now, the health and security of the people rest, ultimately, on the power of the State to protect them. For their protection it is necessary to raise taxes; but the State and TAX-EXEMPT SECURITIES. 91 the United States may now contract to exempt a citizen froni the snpport of his ■Government. It is true that he paj's a consideration for the exemption ; but a man might be willing to pay a valuable consideration for exemption from the draft, and yet no such exemption to-day would be allowed. We do, however, allow a. man to contract that he shall be exempt from further duties as a citizen to support the Government, so far as his income from the tax-exempt security is concerned. The Wall Street Journal, the other day, said that a man with a fortune of $75,000,000 bragged that he had paid no income tax for sevei-al years. Now, the Wall Street Journal is not a radical sheet ; but if you will take that same state- ment and put it in a radical newspaper, what effect does it produce? It pro- •duces the effect that there is a class of people in this country who are exempt from the duty to support the Government and that, to my mind, is, in effect, a very serious political consequence which, in the long run, will be fully as im- portant as the economic consequences which flow from it. Now, as regards these particular resolutions, I have three of them liere — 102, 211, and 232. On the whole, 211, which, I understand, Is the Treasury resolution, seems to me the most satisfactory. The effect of resolution 211 is 'that while it does not prohibit the further issue of tax-exempt securities by the United States, it will practically prohibit such issue, because if a tax-exempt •security is issued by the United States the United States will lose its privi- lege of taxing the income from such securities. That resolution contains also a provision giving the State the right to tax the income of its residents from securities issued, after the ratiiication of this .article, by or under the authority of the United States, to the same extent that '.the incomes derived by residents of such State from securities issued after the ratification of this article by or under the authority of such State are taxed by •such State. I think that is a desirable provision and one that would tend to .secure the ratification by the States. Mr. Ceisp. You heard Mr. Mellon? Mr. Haekiman. Yes. Mr. Ceisp. As a law proposition, what do you think of his suggestion -with that provision in here, if it were possible, for the Government to be denied the privilege of hereafter issuing any tax-exempt securities? Mr. Haehiman. I think the effect of that will be to prevent the future issue . of tax-exempt securities by the United States. ^ Mr. Geeen. That is, as a practical matter? Mr. Hareiman. Yes ; as a practical matter. Mr. Geeen. Although not absolutely prohibited? Mr. Hakeiman. Not prohibited ; but the practical effect will be to prevent that ' issue. Mr. Feeae. What will be the objection to the refusal to issue tax-exempt • securities? Is not that what we are aiming to do now? Mr. Haeeiman. What would be the effect? - Mr. Feeae. No ; what is the objection to Mr. Mellon's statement that we should not issue tax-exempt securities? Mr. Haeeiman. I see no objection to it. Personally I think no tax-exempt • securities should be issued, with this exception — and this is very important — and I do not think this amendment as drawn quite takes c^re of this point: " The securitv should not be tax exempt in the hands of a citizen or of a resident alien ; but the United States should not be deprived of the power of issuing an external loan free from taxation in the hands of foreigners. At the present time we are a creditor nation, but we have not always been, and in the future we may wish to borrow abroad. Now, in external loans it is essential that the ' loan shall provide in its own terms that the Government issuing the loan shall not impair the obligation of that loan by taxing it in the hands of the foreigner who owns it. The objection to tax exemption is that it relieves the citizen of his obligation to his Government ; there is no objection — in fact, it is essential that the ex- ternal loan should be tax exempt in the hands of a foreigner. And I think, therefore, that the amendment as finally drawn should expressly provide for that, so that in case of need we may borrow abroad on tax-exempt secairities • without affecting our domestic situation. Mr. Feeae. That we may sell our bonds abroad, you mean? Mr. Haeeiman. That we may sell our bonds abroad. Mr. Feeae. Tax exempt? 92 TAX-EXEMPT SBOUEITIES. Mr. Haeeiman. Tax exempt while in tlie hands of a nonresident alien ;' not tax exempt in the hands of an American citizen, hut m the hands ot a non- resident alien. That is essential for the protection of any external loTin. ■ Mr. TiLsoN. The resident alien you would tax? Mr. Haeeiman. Yes; I would tax the resident alien. Mr. Fkbab. Why does not that adjust Itself in the market value of the bond, that technical question of the tax-exempt feature, as to the alien? He picks up the bond and determines its proportional value at par ; that is what interests him. Mr. Haeeiman. It may, but here is an element that enters into it: If you issue a bond which is taxable to the foreigner, he does not know but what you may turn around the next day and put a tax on him and cut down his income so much. Mr. TitsoN. Or take it entirely away from him? Mr. Haeeiman. Or take it entirely away from him ; yes. Mr. OopLET. What control would the United States Government have over a nonresident alien? Mr. Geeen. It would not have any, but it might withhold a portion of the Interest. Mr. Haeeiman. It might withhold, exactly; it might withhold any income that has to be sent abroad. Mr. Feeee. Do you not give the foreigner a large advantage over the people of this country In such an event? Mr. Haeeiman. Certainly you give the foreigner an advantage over the people of this country, and that is the way in which you sell your external loans. The external loans of Great Britain, for example, the external loans of France, I think all the external loans of European countries that have been floated in this country have contained that provision, that they are exempt from any deduction by taxation of the Government issuing them. Mr. Feeae. But subject to taxation of the people in those countries? Mr. Haeeiman. I think they are subject to taxation in their own country; yes. Mr. Copley. It Is a rather interesting proposition to me to know how this Government, for Instance, could assess a tax against a nonresident alien? Mr. Houghton. It is a question of selling the bonds at all. Mr. Copley. I am trying to determine how you are going to take it away from him. Mr. Haeeiman. Ton may tax a nonresident on Income derived in this country, and if his income is derived from income derived from Interest on the bonds of this country. Mr. Copley. On the Government bonds of this country? Mr. Haeeiman. You may tax his Interest and collect an Income tax on that and thereby diminish the amount which you have promised to pay him by the act of the debtor itself; and of course there would be every reason for doing that. Mr. TiLSON. And if we could put a greater tax on him, we might take away , entirely the value of his bond ? Mr. Haeeiman. We might put on a tax of 95 per cent and destroy the interest and therefore destroy the bond. So that as to the external loan, I think it is well to provide it shall not be subject to reduction while In the hands of the foreign holder. It Is an advantage to the foreign holder and Is essential to secure the loan of foreign capital. Mr. Copley. It might be absolutely necessary to do it sometimes to stabilize the rate of exchange? Mr. Haeeiman. To stabilize the rate of exchange in order to float an ex- ternal loan ; and at some time we may flnd we must get money abroad as all the European countries have found. Mr. TILSON. I would like to Interject another matter and that Is this, that if It should be provided in this resolution that bonds Issued after this resolu- tion passes the two houses, for instance, no bonds issued after that time should be exempt from taxes; what would be the diflicultles,- if any in such a nro- vislon? ^ Mr. Haeeiman. You mean with the exception of an external loani' Mr. TiLSON. No; another matter entirely. What would be the obiectlon to providing In the resolution itself that all bonds issued after this resolution passes the two Houses of Congress shall not be exempt from taxation ■? TAX-EXEMPT SECURITIES. 93 Mr. Haeeiman. I should approve of that, with the exception of the external loan. Mr. Young. Do you think that would be given legal effect? Mr. T11.SON. What would be the objection from the legal or constitutional viewpoint? Mr. Geeen. It would not go into effect until final adoption by the States. Mr. HAiaiiMAN. Oh, exactly. I think the adoption of such an amendment would have legal efCect, so far as the Federal tax is concerned. Mr. Feeae. The proposition, as I understood it, which was discussed the other day was to put this resolution into effect when it passes the two Houses of Congress and before it has been ratified by the States. . Mr. TotnsTG. Oh, no. Mr. Haeeiman. Oh, no ; that is impossible. Mr. Feeab. No ; the proposition was that it shall contain a provision that all bonds issued after the date on which this resolution passed the two Houses of Congress, but prior to ratification by the States, shall not thereafter be subject to exemption from taxation. Mr. Haeeiman. I think that is perfectly possible. Mr. Feeae. What would be the effect, then, in the event the resolution was never ratified? Mr. Haeeiman. If the resolution was never ratified, it would have no effect. Mr. Feeae. What is the effect on the bonds in the market, in the meantime ; where do they stand — what is their status? Mr. TiLsoN. I am. simply asking him as to the legal effect. Mr. Haeeiman. This resolution, of course, has no effect until its ratification by three-fourths of the States ; but if it contained that provision, then the rati- fication by three-fourths of the States would render all bonds issued from the date fixed in the resolution taxable, after its ratification by the States. Mr. Feeae. Even if 10 years elapsed? Mr. Haeeiman. Yes, sir. Mr. Feeae. And in that interim what happened to those bonds? Mr. Haeeiman. In that interim any man who buys a tax-exempt bond buys it with the knowledge that that tax exemption may be ended at any time by the ratification of this amendment. Mr. Oldi-ield. You mean to say this : Suppose this Congress should pass this resolution to-day — this is the 18th of January ; suppose 10 years from to-day the States should complete the ratification of it ; then could you write an act, a law here which would be legal making it retroactive back to .January 18, 1922? Mr. Haeeiman. That would depend on the form of the amendment. Mr. Oldfield. The form of the resolution? Mr. Haeeiman. The form of the resolution, yes ; entirely. Mr. Oldfield. You could put language into the resolution so that yon could make it retroactive back to now? Mr. Haeeiman. Oh, certainly. It could be incorporated in the resolution that any bonds issued after the 18th of January, 1922, shall not be exempt from income tax after the ratification of this amendment. I think that is per- fectly possible if it is desired to do so. Whether that is worth while or not is a practical question which I have not considered fully from the practical side, but from the legal standpoint there is no question about it. Mr. Ceisi*. In other words, when the States ratify it they ratify it with all the conditions and terms of the resolution submitted to them? Mr. Haeeiman. Exactly. Mr. Oldfield. But you could not do it without those terms being written into the resolution, could you? Mr. Haeeiman. That depends on the future composition of the Supreme Court. [Laughter.] My own view, if I may state it, is that when the sixteenth amendment was adopted the intention was to render income from all sources taxable. The Supreme Court, however, has put a very different construction on that amendment — the majority of the Supreme Court. Mr. Justice Holmes and Mr. .Justice Brandeis dissented, but the majority of the court has held that the words " from whatever source derived " do not mean what most people supposed they did mean. Mr. Oldfield. That it meant stock dividends, for one thing. Mr. Haeeiman. Yes, sir. Mr. Oldfield. Now, of course, if they had held what we ordinarily understand the language to actually mean, as you said, we could tax these incomes? 94 TAX-EXEMPT SECTJRITIES. I Mr. Haebiman. Yes ; if the Supreme Court had put a different construction on the sixteenth amendment this would be unnecessary. Mr. Geeen. I wantetd to ask Mr. Robins a question that I overloolved m his testimony. Mr. Robins, in the course of your investigation of Canadian securities did' you come to any conclusion as to what difference in the rate the privilege of tax exemption made in Canada? Mr. Robins, Well, there was an interesting point on that. They have only one tax-exempt security, that is the 1937 maturity of their war loans, which I think was their third. At that time they had a debate as to whether their war- loans should be issued tax exempt or otherwise, and by about a 50-50 vote on that issue they made it totally tax exempt in Canada. A protest arose, and the next issue, with many misgivings on the part of the minister of finance was made totally taxable and was tremendously overscribed, and after that Canada said she thought her policy had been established in favor of the taxable security. Mr. Gbeen. Was the rate the same? Mr. Robins. The rate was practically the same, as I remember it — I think 54 in both cases. The 1937 maturity went to a premium of about 110. I know we had some holdings that sold at that rate — a premium of 10 points difference in the market. Mr. Copley. One brought 5 per cent and the other brought 5J? Mr. Robins. Of course the criticism that aro.se was on the part of the subscribers, the small subscribers who had subscribed for patriotic motives, whereas he claimed the wealthy man had subscribed for other motives, and he had to take the same rate and made no profit. Mr. Copley. That would make a difference, for instance, of more than the difference between 5 and 5J per cent. It would make a difference between 5 and 5i plus a sixteenth. It would make a difference of almost 1.1 per cent. Mr. Robins. Well, of course, I have no amortization tables with me. That is the only test of your question, Mr. Green, as to what the effect of tax exemption in Canada has been. That is the only issue, and, of course, there was not enough of them to absorb all their personal wealth. I suppose the bidding, though, for that was much more keen in Canada, as well as for all other securities, than it was for ours. Mr. Geeen. Do you remember how much that tax-exempt issue was? Mr. Robins. The bond issue? Mr. Geeen. Yes. Mr. Robins. I wish I did know. I can not give it. I will be glad to send those figures — to insert those in the brief. Mr. Ceisp. I read in one of the Canada papers when I was up there that the total indebtedness of Canada at present has grown from $300,000,000, when they entered the war, to two billion five or six hundred million. Mr. Robins, I think that is entirely correct. I will put those figures in the brief. Mr. Copley. That is not much out of proportion compared to ours right now. Mr. Ceisp. No ; I think our increase was really greater. Mr. Geeen. We will call the next witness, Mr. Kriegh. STATEMENT OF MB. McKINLEY W. KBIEGH, CHIEF TAX DIVISION, AMEBICAN MININa CONGRESS, WASHINGTON, D. C. Mr. Keiegh. Mr. Chairman and gentlemen of the coitmiittee, I am chief of the tax division of the American Mining Congress, the national chamber of the mining industry of this country. At the present time we are conducting a nation-wide investigation as to the effect of State taxation upon mines My statement will be very brief with reference to this matter I have fol- lowed closely the statements made by other speakers at the hearings and will attempt not to duplicate any of the evidence which has been submitted The growing volume of outstanding tax-exempt securities is seriously' affect- ing the mining industry, especially in some of the sparsely settled States of the West where the natural-resource industries are required to bear the major portion of the local tax burden. The unprecedented demand for such securi- ties has encouraged public indebtedness and has resulted in unparalleled extravagance in State and local expenditures. In general I think that is the point that has been brought out by practically all of the witnesses before this TAX-EXEMPT SEGUKITIES. , 95 committee. Vast sums of liquicl capital have been withdrawn from the Nation's investment pool and diverted from normal channels of industrial and business enterprise to nonproductive channels, which impose a constant drain upon the basic industries of the country in the form of increased taxes. The mining Industry has been deprived of capital necessary to replace that which has disappeared in operations, and not only has the volume of productive capital been reduced, but the productivity of labor has been enormously les- sened, the increasing unemployment resulting in industrial unrest and distress- ing conditions throughout the mining districts. Increased taxes follow increased public indebtedness, and in many instances where the local and State bond issues have enlarged the local and State revenue requirements, mines and min- ing properties have been selected as the taxable resources which must bear the added burden. As a result, in many of the mining States the burden upon the mining industry is wholly disproportionate to that imposed upon other taxable property and is being constantly increased without regard to the injurious ef- fects which might accrue both to the State and the Nation. Since 1913 the revenue requirements for State purposes alone of Arizona, Colorado, Connecticut, Delaware, Missouri, Montana, Nevada, Oklahoma, and South Dal5:ota have been practically doubled, while the needs of Arlinsas, Iowa, Kentucky, Massachusetts, Michigan, New Jersey, New Mexico, New York, North Dakota; Pennsylvania, South Carolina, Tennessee, Texas, Utah, West Virginia, and Wyoming have been Increased by more than 50 per cent — some as high as 90 per cent. The remaining States show increases ranging from 15 to 50 per cent, with the exception of I^ouisiana, which shows a slight decrease in revenues for State purposes. Mr. Fbeae. That Is the total revenues for the State? Mr. Kbibgh. Just for State purposes ; yes, sir. Mr. Fkeab. The total revenues? Mr. Keiegh. Yes sir. It should be noted that the States showing the heaviest increase in revenue requirements are mostly mining States, and I am here to- day to urge the enactment of this amendment or some other amendment which follows this in principle, because the mining industry is being called upon to pay these increases resulting largely from the growing indebtedness and con- sequent large revenue requirements of the mining States and their political subdivisions. The " wasting resources " of the country must be conserved and measures must be enacted which will adequately safeguard them. Under present condi- tions their speedy exhaustion is encouraged. High local taxation is compelling their dissipation by forcing their exploitation, and togetheir with the lack of capital is preventing the development of low-grade ores and the discovery of new deposits. The mining States instead of increasing their indebtedness and revenue requirements, should follow a policy of rigid economy which will con- serve their ore reserves from which future revenues may be derived. In the case of many mines, particularly metal mines, increased production costs, in- cluding taxes, force selective mining, which automatically reduces the volume of commercial tonnage and automatically reduces the tax base In the mining States. Mr. Feeae. What direct relation has that to the exemption of securities? Mr. Keiegh. Increased State indebtedness Increases taxes, and the high tax burden is pressing very heavily just now upon the mining industry. Mr. Chanuler. If they did not exempt from taxation the securities of the State, would it not increase the taxes on account of the increased interest they would have to pay on securities? Mr. Keiegh. They have to establish a sinking fund Mr. Chandlee (interposing). Instead of reducing your taxes, then, in the West, would it not increase them? Mr Keiegh. You mean the raising of money by the issuance of these bonds? Mr. Chanulee. By the Issuance of bonds for the needed improvements in the West which everybody knows are needed, and needed very badly, in prac- tically every State west of the Mississippi River— would not the issue of taxable securities Increase the rate of Interest on those taxable securities, and thereby increase the taxes of the people of the State? Mr Keiegh. Well, I am not prepared to discuss that feature ; I am simply bringing before tlie committee the facts concerning the manner in which the mining industry is affected at this time; the effect upon other classes of in- dustrial bonds and securities I am not prepared to discuss. 96 TAX-EXEMPT SECURITIES. Mr. Chandler. I am not tiilking about industrial bonds ; I am talking about State securities. Mr. Kbiegh. I meant other taxable securities. Mr. Ohandlek. Now, you take those nontaxable securities at the present time, by placing a tax upon them, would It not increase the rate of interest on those securities in order to sell them, and would that not Increase the taxes of the people? Mr. Keiegh. I do not think so ; no, sir. Mr. Chandmk. Everybody that has been before us has stated that it will undoubtedly increase the rate of interest at least 1 per cent. Mr. Green. Oh, no. Mr. Copley. I am going to interpose here and deny that. I have asked every single witness that question and everyone said that it would not; not that it would. Mr. Chandler. Every one of them, as I caught it, said that it would. Mr. Copley. Well, I will leave it to the rest of the committee. Mr. Chandler. I will take the record for it when it is printed. Mr. Green. Mr. Chandler, when you were out there was quite an elaborate discussion of that matter between Mr. Copley and one or two or three witnesses. Mr. Chandler. Possibly it might have been by the last two or three witnesses. Mr. Copley. And two this morning. Mr. Chandler. Well, there were two or three this morning that admitted it would raise it at least 1 per cent, and all of them Monday said it would raise it at least 1 per cent, and your figures there just a moment ago, on the Canadian proposition, showed that the difference was about 1 per cent. Mr. Copley. Oh, no ; that was in competition between the tax exempt and taxable, but the point is that there will be no such competition when there are no tax-exempt securities. Mr. Keiegh. The production of the low-grade mine products simultaneously with the rich ore automatically increases commercial tonnage and prolongs the life of the mine; the removal of this rich ore alone reduces the low-grade ore which is left to ordinary rock having no commercial value. Thus excessive taxes tend to destroy a continuing source of revenue to the States. Some action must be taken to abolish tax-free Incomes so that the basic in- dustries of the Nation, especially In times of depression', shall not be required to bear any additional burden which rightfully should be spread over wealth now invested in tax-exempt bonds and securities, in addition to the burden of taxation imposed for the purpose of paying Interest on such securities and of building up a reserve for their redemption. Now, I have a few figures here which will bear out my statements. I do not want to bore the committee with any long discussion, but I want to show how this thing is bearing upon the mining Industry. In one State in 1917 the average ton of ore contained 4.6 ounces of silver, 63.3 pounds of lead, 83 cents worth of gold ; In 1921, taking the same mines for comparison, the ore produced contained $2.24 worth of gold, 16.3 ounces of silver, and 119.4 ounces of lead. That shows that the ore which is being produced! now has to be of a richer quality than the ore which could be produced in 1917, and that demonstrates the fact that the tax base, so far as natural resources are concerned, is being reduced. Mr. Chandler. Doesn't the high cost of labor and the general depression in business and the low market enter into that? Mr. Kriegh. There may be other elements, such as railroad rates, that enter into it. Mr. Chandler. There isn't a mine in the West now that can be operated at present high labor costs and the low market conditions unless it has high-grade ore In it. I represent one of the greatest mining districts in the United States, and I know that nine-tenths of the mines are shut down because of the fact that they are producers of low-grade ore. Only those with high-grade ore can run and pay the high wages at the present time, especially in view of the market conditions. Mr. Kriegh. If you will pardon me, let me cite just a few instances of local levies for local indebtedness. This is In Minnesota. The average per capita levy for local and school purposes in 77 cities and villages in the State of Minnesota not located in mining districts amounted to $S1.S9 Ih 1920, while in 17 cities and villages located In the mining districts the average per capita levy for local and school purposes last year was $164.29. Mr. Green. $164 per capita? Mr. Kriegh. Yes, sir. TAX-EXEMPT SECURITIES. 97 Ml-. Green. Well, that seems a very surprising figure. I have no doubt, how- ever, you have quoted it correctly, and especially in view of the fact that Min- nesota has a very large school fund. Mr. Kkiegh. This is quoted from the chairman of the State tax commission of Minnesota. Mr. Copley. That is quite possible. He says those are figures for a mining district. Usually there would be a very small number of people there and a very large amount of wealth. Mr. ICeieqh. The proposition is that the mining indlistry does not control the taxing power and does not control the Issuance of these bonds. The levy in one village of about 2,000 inhabitants represented " a per capita tax of $557.28 for every man, woman, and child in the village. Another village levied $320.16, another one $263.15, and another $244.91. Mr. Chandlbb. May I ask you what were those levies for? Mr. Kkiegh. They were for local improvements. Mr. Chandmsj. For local improvements? Mr. Kkiegh. And were paid for by the mining industry. Mr. Chandlek. And they paid for the entire Improvement during one year? Mr. Kkiegh. Tes, sir. Mr. Chandlek. That is exactly the point. I know in the oil fields down in my country a number of times where they have levied enough to put up a $40,000 or $50,000 schoolhouse, and they made the entire levy in one year, but the next year the levy would probably be one-half of 1 per cent. Mr. Kkiegh. I misunderstood your question. This levy is continuing. The so-called " richest village in the world " has a per capita tax levey for local and school purposes, of $212.13 for each of its 15,500 inhabitants. There is just one other figure that I would like to leave with the committee, and that is that mining corporations in 1918 used, as a deduction for income fax: purposes for State and local taxation, $51,000,000 approximately, while in 1919 the same corporations took as a deduction for State and local taxes ap- proximately $70,000,000, or an Increase of approximately 40 per cent. This is largely caused because of the increased issue of tax-exempt securities. Mr. Copley. May I ask you this question : Frankly, I am in your corner gen- erally on this proposition, but I do not quite follow you all through and I would like to get some information. Do you think that making the securities tax exempt has increased the number of securities issued? Mr. Kkiegh. I haven't any doubt of it. Mr. Copley. Why? Mr. KsiEGH. Because there is a demand for those securities. Mr. Copley. Yes ; because there is a demand for them. Now, if I am not mistaken, most of the witnesses — most of the other witnesses have testified — in fact, every one since I have been here — has testified that they did not be- lieve that removing this exemption would increase the interest rate that they would have to pay, consequently there would be no more of a burden, or less of a burden, for them to be issued at one time over another, whether they are tax exempt or not, so far as the burden on the State is concerned, the amount of interest the State should pay is concerned, but you think that the outside influences seeking for investments have encouraged the State organizations and municipal organizations to issue a lot of these securities? Mr. Kkiegh. Personally from my study of the situation, my view is this: That prior to these high taxes the indebtedness for the bond issue of localities was taken up largely by people living in those localities who wanted to im- prove their towns or their counties or their State ; whereas at the present time these securities are being sought by capitalists In New York City and every- where else regardless of where the bond Issue is located. Mr. Copley. And you thing that the seeking of those investments from these outside investors has led to the various Western States and municipalities to issue a lot of securities that they otherwise would not have issued? Mr. Kkiegh. I think that a great many localities would not undertake these improvements unless they knew where they were going to be able to market their securities; they know. that they can market them, and therefore they go to the people with the proposition of Issuing bonds. Mr. Copley. I am very glad to bring out that point, because that is some- thing I had not thought of. Mr. Gkeen. It always seemed to me that there was somewhat of a p.sycho- logical effect in the idea that the community thought they were getting some- 93671—22 7 98 TAX-EXEMPT SECURITIES. thing for nothing ; that they were getting these bonds without any tax being placed upon them, and therefore the proposition sounded pretty good. I know that argument is almost always made wherever any small community at least proposes to put out bonds. Mr. Oldfield. They can not make that the second time ; the people will fln(J it out the first time. Mr. Gkeen. Oh, yes ; they can still make the argument that they can get a low rate on bonds because' they are exempt from taxation. Most of them' believe they can get this lower rate, whatever the facts may be, and they think they are getting kind of an advantage over communities that do not issue bonds by that process. Mr. Keiegh. The situation in the mining districts is largely this: That the property is owned by the mining corporations or by individuals who own the mines, and the population is largely a floating one. Mr. Green. They do not pay any taxes, anyhow. Mr. Keiegh, No; they do not pay any taxes, but they have a vote, and they are perfectly willing to vote for something that the mining properties are go- ing to have to pay for. Mr. Houghton. Why should they care, then, whether the rates are high or low? Mr. Keiegh. It would not make any difEerence to the people in the mining districts, but it does make a great difference to the people who ovm the mines. I do not think that the mining industry as a whole owns a great deal of these tax-exempt securities — I mean people engaged in mining. They are put- ting what capital they can secure into exploration work and development, and when they can not secure that capital the industry remains at a standstill, and that is one of the causes for the depression in the mining industry to-day. Mr. Geeen. Tour point, then, is largely, as I understand you, that these bonds would not be marketed so easily if they were not tax exempt, and that therefore there would not be such an amount issued? Mr. Keiegh. That is my point; yes, sir. Mr. Copley. Let me ask, do you think the removal of this exemption would require the States and municipal subdivisions to increase their interest rates in order to sell their securities? Mr. Keiegh. I have not thought so ; no, sir. It depends largely on whether they have already impaired their credit by previous issues. Mr. Copley. Yes ; but I am discussing the new issues. Mr. Keiegh. If they have already impaired their credit by a large issue, undoubtedly they would. Mr. Copley. That would not be because the tax exemption had been re- moved, but it would be because they were exceeding their credit? Mr, Keiegh. Yes, sir. Mr. TiLSON. Is it your idea that they are unduly induced to go into borrow- ing arrangements because they can sell their securities at such a low rate of interest, whereas private individuals who have to pay taxes on their property have to pay a much higher rate of interest? Is that the idea, that they are encouraged because of the low rate at which they can sell their bonds? Mr. Keiegh. Because of the ease with which they can dispose of them at that rate of interest. Mr. Houghton. Yet you think there would be no increase in interest? Mr. Keiegh. I think there would be less volume of bonds issued. I do not think they could increase the interest. Mr. Chandlee. If there would be no increase in the rate of interest, why the necessity of this kind of legislation? Mr. Keiegh. Simply because there is a great volume of wealth that is not being taxed, that is not bearing its share of the tax burden, and that difference is being imposed upon the basic industries of the country, among which are the mining industries. Mr. Gkeen. I think that is one very strong argument upon which there has not been so far very much stress laid, although Mr. Mills mentioned it. This burden is being distributed back on the basic industries of the country. Mr. Copley. Now, Mr. Witness, I want to ask you another question. If you are correct in your contention that it will not increase the rate of interest which the municipalities will have to pay, do you think it will decrease the rate of interest which other industrial organizations will have to pay for money they want to borrow. TAX-EXEMPT SECURITIES. 99 Mr. Kriegh. I (-.hink tliat it would have a tendency to bring the conditions to a normal status. Mr. Copley. That is, reduce the industrial rate of intere.st? Mr. Khiegh. Yes, sir. Mr. Copley. Now, if you believe that, may I ask you do you think that con- tinue these securities as tax exempts is going to continue to put an increased cost of living on the people of this country ? .Mr. Kkiegh. Undoubtedly. Mr. Geeen. Mr. Holcomb, I believe, has not been heard. Is he present? A Voice. Mr. Holcomb was obliged to return to New York. Mr. Gkeen. We will adjourn, then, until to-morrow morning at 10.30, and we will begin promptly at that hour ; and I will say that we will have a very im:portant witness here, Prof. Seligman, of New York; therefore I would be glad if all members would be present. Mr. TiMBERLAKE. What others, Mr. Chairman, are to be heard? Mr. Green. No other names have come in. There may be one or two people who have been in here tentatively. (Whereupon, at 4 o'clock p. m., the committee adjourned until 10.30 o'clock a. m. to-morrow, Thursday, January 19, 1922.) Committee on Ways and Means, House of Representatives, Tliursday, January 19, 1922. Tie committee this day met, Hon. William R. Green presiding. Mr. Green. The committee will come to order. We have with us this morning quite a distinguished gentleman as a witness. Dr. Seligman, who will please come forward. STATEMENT OF PROF. EDWIN B. A. SELIGMAN, NEW YORK CITY. Mr. Seligman. I appear in my individual capacity, sir, and as the representa- tive of a State committee. As an individual, I may say that I am pirofessor of political economy at Columbia University. I have been president of the National Tax Association and have been president of the American Economic Association. I am at present a member of the committee cooperating with the Federal Census, representing the American Economic and the American Statistical Associations. I am also the American correspondent of several foreign academies and learned societies. In my representative capacity I come at the institgation of the Joint Com- mittee on Taxation of the State of New York, of which Senator Davenport is chairman, and which has been engaged for several years in carrying through a comprehensive series of tax reforms. He was desirous that the committee should be represented as in favor of a bill providing for a constitutional amendment to remedy the tax-exempt evil. Now, Mr. Chairman, with your permission I will say a few words, first, about the general aspects of the problem of tax exemption, and then a little later come to discuss the facts of the practical situation. The first point I want to take up is the general ai'gument. Why have tax- exempt securities been issued ? The advantages of exempting Government bonds from taxation are obvious. Tax exemption enables the Government to sell the bonds at a higher price, or what amounts to the same thing, to market the bonds at a lower rate of interest. Either way the Government gains. If we look at the history of tax exemption we find that Governments until recently have utilized tax-exempt bonds primarily in emergencies when there was a danger of the credit of the country being impaired, as in time of war. Beginning as far back as the origin of public credit. Great Britain and France frequently made their bonds — their Government stock, as it used to be called in those days — tax exempt, because it helped to bolster up their fading credit. The custom, however, gradually spread to times of peace ; and especially in this country the States and local divisions began to issue, a few decades ago, tax- exempt bonds for ordinary productive purposes, for the simple reason they could market them at a little lower rate of interest. As over against the obvious advantages of the system there are also disad- vantages. The conclusion as to the policy or impolicy of tax exemption, of 100 TAX-EXEMPT SECURITIES. course, must depentl upon the balancing of Hie advantages with tlie disad- vantages. Tlie first disadvantage of the system of tax-exempt bonds is that the Gov- ernment receives no taxes. The bonds being tax exempt yield no revenue for the Treasury. This is a very decided disadvantage, especially when, as generally happens, the Government loses more in its tax revenue than it gains through the lower interest charge. That lias not always been so; but it frequently happens, and I think that at the pi-esent time, as we shall see later, it is the case. The second argument against tax-exempt securities ;s of more modern growth. It is a result of the growing democratization of taxation and of the attempt of most countrie.s, including our own, to create a system of taxation which win be equal and responsive to the canons of modern democratic taxation. In other words, if you have tax-exempt bonds you have an inequality of tax- ation, because while the rest of the commrunity are subject to taxation the holders of these bonds escape taxation. Here, however, we must put in a little caveat. There is a general misun- derstanding on this point. It is not quite true to say that persons who buy tax-exempt bonds entirely escape taxation. It is not true, because they have to pay more for the bonds. If a tax-exempt bond bears the same rate of interest as a taxable bond, the tax-exempt bond will sell at a higher rate than the other. The man who buys the tax-exempt bond, although he pays no taxes, enjoys a smaller net income than he would receive if he did not have to pay more for the tax-exempt bond. If his advantage in escaping taxation were exactly counterbalanced by the higher price he has to pay for the bond his tax exemption would be of no use. In otlier words, he would really not enjoy any tax exemption. If this process, which the scientists call capitalization or amortization, and which is familiar to every bond broker in Wall Street, were absolute and exact, why, then there would not be any Inequality between the owners of taxable and tax-exempt bonds. The inequality would be ironed out by the process of capitalization. The process of capitalization is simple. Suppose that the current rate of interest is 5 per cent, so that 5 per cent bonds sell at par. If now a special or exclusive tax is imposed upon any class of corporations, like railroads, a tax, say of 1 per cent on the par value of the bond ; then, of course, the man who buys railway securities instead of getting $5 as his net return on a $100 bond would get only $4, since $1 must be given up as the tax. If, however, the tax is an «jxclusive tax, levied only on railways, and not on other corporations, what will the prospective purchaser of railway bonds do? Manifestly, he will not pay $100. Why should he pay $100 and get only $4 return when he could go to the next broker and buy another security for $100 which nets him $5 return? What would happen, naturally, is that he Would pay only about $80 for that railway bond, because $4 on $80 is the same rate of return as $5 on $100. In other words, when you have a special or exclusive tax on securities or other durable commodities, your future tax is discounted or amortized or capitalized into a lower selling value of the bond. That is what is called the process of capitalization. Now, if this process of capitalization were absolutely exact, it is true that the inequality would be wiped' out and the man who buys a security subject to special taxation really would not pay the tax. Although he gives up something to the Government as an annual tax, he has capitalized all future taxes into a lower price that he pays for the bond, so that his net income, despite the tax, is as large as that of the owner of a nontaxable bond. Conversely, just as the purchaser of a taxable bond is no worse off than the owner of a nontaxable bond, so the purchaser of a tax-exempt bond is no better off than the owner of a taxed bond. If the law of capitalization were exact, al- though he buys tax-exempt securities he would really not be exempt from taxa- tion. He would Indeed pay no annual tax but he would get a .smaller net income, the same net Income as the man who pays an annual tax. As a matter of fact, however, it is true that the issue of tax-exempt bonds creates Inequalities. There are several reasons for the failure of the law ol capitalization to work out exactly. First, the capitalization or amortization, which tends to iron out Inequalities assumes that you can look forward to a permanent tax of the same kind from year to year. You discount the future. Unfortunately, government needs change from time to time and you can never tell what the future rate of taxation will be. Our income tax changes almost from year to year. The English income tax TAX-EXEMPT SECURITIES. 101 changes from year to year. Therefore, the amortization or capitalization is never complete. The uncertainty as to the future causes a discrepancy in the process of capitalization. In the next place, our State and local taxes vary from State to State. So far, therefore, as our local tax-exejnpt securities are concerned, there is no exact correlation at all betvifeen a particular tax and the change in capital values. The chief reason, however, why there is no exact correlation is because of the development in modern times of the principle of graduated or progressive taxa- tion. We, like most countries, have a normal rate of income tax, and then we have the surtaxes or supertaxes. Now, the theory of capitalization, of course, depends on the assumption of a definitely recurring tax from year to year on that particular security. To the extent of the noi'mal tax, whatever it is, you can indeed count upon it. But where the supertax runs up, as it does with us, to 65 per cent, making the total maximum rate 73 per cent, all that can be capitalized or amortized is the 8 per cent. For no one knows who is going to get hold of that bond. The bond may be sold by a State or a municipality or the Federal Govern- ment, and it may be bought by a small man who only pays 8 per cent ; it may be bought by a richer man who pays 50 per cent on his hicome ; or it may be bought by a millionaire who pays 73 per cent on his income. Owing to this uncertainty only the 8 per cent tax is susceptible of amortization, and even that only if the market believes that the 8 per cent normal rate will last as long as the life of the bond. But the difference between 8 per cent, running all the- way up to 73 per cent, is not capitalized, consequently it follows that there is a wide discrepancy between the increased value of the bond and the capital- ized amount of the entire tax. When a man, therefore, under actual conditions buys a tax-exempt boiid, the most that can be capitalized is the 8 per cent. The remainder, not being capitalized, represents his actual exemption from taxation. It therefore remains true that despite the proce,ss of partial capitalization, the issue of tax-exempt securities does create a class of nontaxable individuals. That constitutes the fundamental infraction of deriiocratic justice in taxation, because it brings us back to the medieval system of privileges and exemptions. In France under the ancient regime the clergy were not taxed, the nobility were not taxed, the lawyers were not taxed. It was this series of class exemp- tions and privileges which finally helped to bring about the French Kevolution. What we are doing at present is to create a class of privileged individuals, privileged not because of their theology or their escutcheons or their knowledge of law, but privileged because of the amount of money they possess. That is the worst kind of privilege in a democratic community. If what I have said is true, you will see how fallacious is the argument which we hear on all sides that the issue of tax-exempt securities is, after all, defensible because the benefit to the' lender is passed on to the borrower. It is often claimed that the real parties to benefit are the governments which issue the bonds at a higher price or at a lower rate of interest, and that the public finally secures the advantage. That might be true in case the theory of capitalization were mathematically exact; but under the conditions as I have outhned them you will see the fallacy of the argument that the advantages of the tax-free securities are passed to the government and to the people at large. As a matter of fact, the advantage of the tax inures to the man who owns the tax-exempt bonds, and is not passed on to the government. In our case, only 8 per cent, not the 73 per cent, can possibly be passed on. And even that is not passed on. It is the lender and not the borrower who secures the chief benefit from the tax exemp- tion. Reverting then, to the general question, Is it a wise thmg for a government to issue tax-exempt bonds? In seeking for the correct answer you have to compare the advantage of a lower rate of interest payable by the government with the disadvantage of the loss of revenue and of the creation of a privileged Now, I concede at once that there are cases when the disadvantages are out- weighed by advantages. In times of crisis, in time of war, when you do not know how you are going to meet your expenses, when the very existence of the State may be at stake, anything is legitimate. Under such conditions govern- ments are justified in issuing tax-exempt bonds, just as they would be justified in doing a great many other things. But when the existence of the govern- ment is not at stake the argument does not apply, I may say right here, gentle- 102 TAX-EXEMPT SECURITIES. men, tlint when we entered the recent war and Secretary McAdao was consider- ing the question as to whether to make the Liberty bonds tax exempt 1 pleaded with him at that time to make them taxable. I told him that instead ot issmng 3i per cent bonds tax exempt he could issue 4 or 4i taxables, and that they would go just as well. Many others agreed with me. But Mr. McAdoo was obsessed with the idea that in some way or other Wall Street might put it over" on him, or that the Government must save this difCerence in interest and pay only 3i per cent instead of 4 or 4i. He had a short-time view. Hft did not have a long-time view. He thought only of the immediate future. Now, had we been in a bad situation the plan would have been all right. As a matter of fact, however, our credit was excellent. There was not any question of our ability to borrow money. England was paying 5 per cent at that time, you will remember— 5 and 5i per cent — and here we were able to issue loans at 34 or 4 per cent. Mr. McAdoo, in my opinion, made a great mis- take and did something which will tarnish his reputation as a great financier. Mr. OoixiEK. Suppose the first issue of 3i per cent bonds, which were non- taxable, had been issued, as you suggested, at 4J or 4i, taxable? Ton will recall that subsequent issues of bonds had to bear a higher rate of interest on account of the fact that we were issuing so many of them and we did not know how many we would have to issue. Now, what rate of interest do you think the subsequent issues which we had to issue might have borne? Mr. Seligman. We probably should have gotten the money at a little lower rate than England was able to get it. Instead of our total debt bearing an average rate of interest, as it does now, of about 4i per cent interest, it prob- ably would have borne an average of 4|, or possibly even 5. I doubt, however, that we should have paid that much. I think that we should have gotten all of the money that we would have needed at less than 5 per cent. The patriot- ism was such that all the war loans were taken by the public at several points above their real market value During the Civil War we had to pay 6 per cent, 7 per cent, and even 7.3 per cent. Mr. Gabneb. I do not want to divert you from your statement, but you said you thought that it was a disadvantage to have these tax-exempt securities issued. Have you anything to say about the apparent right of the States? Mr. Seligman. I am coming to that later. That is one of the most important things that we have to consider, but I am coming to that later on, if you will permit me. Mr. Gaenee. And while I am interrupting you, let me call attention to your illustration as to the rate of interest. I do not want to be misled by your illus- tration. Your illustration was that if one bond drew 5 per cent and the other 4 per cent, one would sell at par and the other one would sell at 80. That would depend very much on the maturity of the bond, would it not? ' Mr. Seligman. Surely. I assumed, of course, that they were otherwise abso- lutely equal in all respects. Now, that is the first point, sir, as regards the general theory. I wish to say that, as a general theory, ^^'hile an occasion may arise when tax-exempt bonds are legitimate, it is not a wise thing to issue them in ordinary cases, and certainly not in cases such as existed with us during the war and exist now. Mr. Houghton (interposing). Do I understand. Doctor, that you take- the position the National Government should always retain the right, in cases of emergency, to issue tax-exempt securities, and that the Government has that right? Mr. Seligman. Certainly ; it should have that right to use in emergencies. It has that right now, and I do not think that any sovereign government should abandon such a right. Now, ■\\'e come to the second point, where the States are interested. Let me call your attention to the distinction between the policy of the Government exempting its own securities from taxation and the policy of the securities being issued by one government which are taxed by another form of govern- ment. The point I want to make is this : The Federal Government exempts its own Federal bonds from taxation ; and the State governments exempt their own State and municipal bonds from taxation. It is this policy which I have hitherto been considering. But it is a very different question from that as to whether the Federal bonds may be taxed by the States, or whether the State and local bonds may be taxed by the Federal Government. Now, taking up first the question of the Federal Government taxing its own bonds or the State government taxing its own State and municipal bonds : This, TAX-EXEMPT SECURITIES. 103 as I have sought to point out, is a matter of policy, resting on a weighing of comparative advantages. In my opinion, however, the Federal Government ought not to issue any more tax-exempt bonds. It ought not to have issued them during the war, and it ought not to issue any more now, chiefly for the reason that what is gained on the one hand is outweighed on the other in dollars and cents. But something else is lost which is of far more importance, namely, tlie awakening of suspicion and the growing feeling on the part of many in this •country that we are creating a conllict between social classes. And that is a tiling which a democratic government ought not to develop. If you will say : Well, but we have these billions of Federal bonds outstand- ing, all the Liberty bonds, and the Victory notes, and we can not do away with their tax exemption, I would answer yes, you can do away with it. You could not pass any retroactive law, of course. We do not want to impair the obligation of contracts. But as these bonds come due — and some of them are coming due in a very few years — and even before they come due you can refund them into bonds which no longer carry the tax-exempt feature. Of course, you will have to pay a little more ; but on the whole you will gain, because, although you are paying a little more in issuing higher-interest bonds, you are gaining in the way of greater returns from taxation, and you will gain above all in making this feeling of suspicion and doubt and uneasi- ness in the country disappear. , So I say that so far as the Federal Government is concerned, the sooner the Federal Government refunds the outstanding tax-exempt bonds into taxable bonds the better for everyone concerned. llr. Hawlet. If I may interrupt you, would we not need to obtain the consent of the holders of the bonds? Mr. Seligman. That is what I say. Through the refunding operation you would have to otter the holder a little inducement. There have often been such refunding operations in this country and in England and in France. It can be accomplished by giving the holders a little something. It lias been done and it can be done. It will cost something, but the cost will be comparatively slight. You could not compel the bondholders, of course, to accept taxable bonds, but you could induce them to do so. Mr. Gkeen. I take it. Doctor, that your point is that even if this feeling of suspicion and distrust of the wealthier classes is not entirely well founded, yet it exists to a large extent, and that is a matter that those sitting in our position ought to take into consideration. Mr. Seligman. Exactly. I think that you have put the point very accu- rately, sir. Now, we come to the States and local divisions. What is the attitude which our States take toward their own State or local bonds? As a matter of fact, most of the States of this country to-day tax the bonds of other States. Mr. Hawlbt. You mean that they tax the bonds or the income from the bonds? Mr. Seligman. It depends. Those States that have property taxes tax the bonds, and those States, like New York, that have income taxes tax the income received from the bonds. It depends upon the form of taxation that is in vogue in the State. I do not think that the States of this country are likely in the immediate future to abandon the tax-exempt feature of their own securities. But I think that they are wrong. In the course of time they will realize that they are wrong. That is due very largely to the change in the methods of taxation that is going on in this country to-day. In most of the States we still have the general property tax which was at one time universal. Under that general property tax, it is notorious, as you are aware, that per- sonal property and especially intangible personal property had slipped out of the assessment list. So that as a practicable proposition it does not matter much, from the point of view of revenue, whether the bonds are tax exempt or not. Nine times out of ten they are not reached by the assessor at all. When, however, you have an income tax, the situation is very different. We have State income taxes now, as you know, in New York, in Massachu- setts, in Wisconsin, in Delaware, and in some of the Southern States, and they are arguing it earnestly in California and other Western States. It will not be long before most of our developed industrial States have come over to the income tax, although the more purely agricultural States will probably stay for some time on the present basis. 104 TAX-EXEMPT SEG-UEITIES. When you have an income tax, the argument in favor of a State taxing its own securities is just about as strong as the argument in favor ot the i eaeral Government taxing its own securities. ,. 4. ■ j. The advantage that the State or municipality or the school district possesses in marketing its bonds at a little higher price is outweighed by the loss of revenue and also especially in the more developed States by the growth of this feeling that you are letting the richer people oft. That is the chief reason why the committee which I represent, -and marlc you, a joint legislative committee, not a private committee, but a committee of both houses of the legislature, is in favor of abolishing the exemption of its own securities, no matter what is done anywhere else. We come now to the question which is really before you. The question before you to-day is the much more difficult question as to how far the States should have the right to tax Federal securities and how far the Federal Government should have the right to tax State securities. Now, before we take up that question, it is just as well to know what wo are dealing with and how many securities there are. In the testimony that you have heard during the last two days, and which I have had the privilege 'of reading hurriedly this morning, some interesting figures have been presented to you, some of them accurate, but some, I imagine, not quite so' accurate. I have taken the trouble to endeavor to secure a little more accurate figures as to the amount of these tax-exempt securities. First, then, how about the municipalities and States? How many of those are outstanding? Unfortunately, we have no exact official statistics, but ws have the figures in the census of 1913. We know exactly how many bonds were outstanding in States and counties and in incorporated places of over 30,000 and in civil divisions of less than 30,000, including drainage and irrigation districts, school districts, and the like. Taking those figures, I may say that they amounted to almost !i;4,000,000,000 in 1Q13. The exact figures are appended herewith : States i .$364, 836, 427 Counties 333, 236, 161 Local : > Over 30,000 2, 489, 665, 185 3,000 to 30,000 316, 695, 105 2,500 to 3,000 232, 023, 319 Under 2,500 111, 516, 694 Other specified civil divisions 103,068,188 Total 1 3, 834, 807, 291 For 1919 we have two reports published by the Census, one affecting States and the other affecting incorporated places of over 30,000. We find that in 1919 the bonds or funded debt of the States had risen from $364,000,000 to $625,000,000, almost double. We find that in the cities of 30,000 or over the outstanding bonds bad risen from $2,489,00,000 to $3,904,000,000. Applying the same percentage of growth to the counties and the civil divisions under 30,000, for which we have no figures, it would bring the outstanding tax-exempt securities in 1919 to a little over six billions. The figures since then were presented to you accurately yesterday by one of the witnesses, and we know exactly how many have been issued in 1919, 1920, and 1921. Last year we know, for instance, that about $1,300,000,000 were issued. So, if we add the issues for 1919, 1920, and 1921 together, you will find that there must now be outstanding over nine billions, and in a few months will reach ten billions ; not, indeed, as> one of the witnesses said, tliir- teen billions, but considerably more than the figures which were reported by Mr. McFadden based on Mr. Kahn's estimates of seven billions. Between nine and ten billion is a pretty close estimate, I think, of the amount of State and municipal tax-exempt securities outstanding. Now, how about the Federal tax-exempt securities? Here, again the figures that have been given to you are inaccurate, especially those <^ven bv Mr McFadden, on the authority of Mr. Kahn. Mr. Kahn Includes in the tax-exempt securities of the United States only the Liberty 3i per cent and the Victory notes, which, as you know, are interchangeable, either Sj per cent or 4J per cent, according as they are taxable or nontaxable. Mr Kahn did this because TAX-EXEMPT SECURITIES. 105 of tiie fact that the tax exemption in the intervening Liberty loans is restricted. On some of them the tax exemption is restricted to a period of from two to five years after the declaration of peace, and in all of them the amount of tax- exempt securities that can be held by any one man is limited. The exact facts are set forth in the table herewith, which does not, however, include minor changes made by the new revenue law : Exemptions of United States war obligations from Federal income surtaxes. (All are exempt from " normal " Federal tax. Besides the tuUy exempt 3J per cent bonds and 35 per cent notes, a maximum amount of $160,000 may, If properly distributed among the various classes of obligations, be held free from surtaxes and profits taxes.) Class of obligation. Maximum amount of principal , interest on which Is exempt. Time limit on exemp- tion . Conditions. Bonds; First Unlimited Until maturity Second (1) 55,000 Joint exemption for second,. third, and fourth bonds, cer- tificates of indebtedness, and war savings certificates. May be applied to any one of these classes or may be divided among them. Joint exemption for second, third, and fourth bonds. May be applied to any of these classes or may be di- vided among them. Second (2) 830,000 Atter Jan. 1, 1919, un- fil 5 years after presi- pential proclama- tion of peace. 9 years after presi- dential proclama- tion of peace. After Jan . 1, 1919, for 3 or 4 years; that is, while Victory notes may be held. Second (3) $45,000. . Second (4) $20,000 of this exemption is $45,000, it may not exceed l-l times amount of fourth bonds sub- scribed for a7id still held at time of tax return. May be applied either to second or third bonds or may be di- vided between them. Third Identical with ex- emptions (1), (2), (4) of second bonds. do. of this exemption is S20^000, it may not exceed 3 times amount of Victory notes sub- scribed for and still held at time of tax return. May be applied either to second, « third, or fourth bonds or may oe divided among them. Fourth (1).. Fourth (2) S30,000 2 years after presiden- tial proclamation of peace. Identical with ex- emptions (1), (2), (4) of second bonds. S30,000 fourth 1 (1). First converted into 2 years after presiden- tial proclamation of peace. Do fourth 1 (2). Certificates of indebted- ness. War-savings certifica es. Identical with exemp- tion (1) of second 'bonds. do : 3^ per cent notes Unlimited .. Until maturity Do. 1 Converted bonds are included with the class of bonds Into which they have been converted, with the exception of first bonds converted into fourth bonds, which are separately listed because of special ex- emption. Inasmuch as it is possible, however, even under these laws, for any one man to hold as much as $160,000 worth of tax-exempt securities, it is possible, and I think very probable, that most of our Liberty bonds and Victory bonds are now held by people who do not pay taxes on them. Even the rich man — $160,000, you see, is a pretty good amount for a small man — even the rielimanmay buy State and municipal bonds, and after taking as much as he likes of the first Liberties and last Victories where the exemption is complete, will add the $160,000 of 106 TAX-EXEMPT SECUKITIES. these intervening Issues. It is possible that a few Individuals who subscribed more than $160,000 to the second, third, and fourth loans may still have them in his possession, but with prevailing prices it is not lilcely. And even if it were the case, it is quite certain that in a few years the excess of taxable bonds will have been converted into tax-exempt bonds of the other issues. Federal or State. So that it would not be correct to exclude any of the Liberty ■or Victory bonds from the category of tax-exempt bonds. From my point of view it is reasonable to include all of the outstanding Liberty and Victory bonds as securities, which when held by individuals pay virtually no income tax. Now, in the last public-debt statement, that of November 30, 1921, you will find in the report of the Secretary there were outstanding almost nineteen bil- lions. The exact flgiu-es are appended herewith : First Liberty $1, 952, 144, 300 Second Liberty 3, 313, 764, 750 'Third Liberty 3, 60S, 599, 800 Fourth Liberty ; 6, 350, 182, 300 Victory notes 3,608,809,300 Total 18, 832, 000, 450 Treasury notes 701, 897, 700 •Certificates of indebtedness 2,288,730,000 VVar-saving securities 657, 026^ 501 Grand total, war securities 22, 479, 654, 6.51 Now, you must add to that sum the farm loans of almost .$500,000,000. Moreover, we must not forget that our certificates of indebtedness. Treasury motes, and war-saving securities amount to another three and a half billions; and within a short time these will probably have to be funded. And unless our present practice is reversed, these will mean so many more tax-exempt Jbonds, bringing the total up to twenty-three billions. If, however, we con- servatively estimate the Feneral tax-exempt securities at twenty billions and if we add to that ten billions of the State and locals you have the figures which are pertinent to our investigation. In other words, we have about .$30,000,000,000 of tax-exempt securities. Now, the total wealth of this country, according to the latest report of the National Bureau of Economic Research, published a few weeks ago, is esti- mated at $286,000,000,000, making the tax-exempt securities aljout one-tenth of the whole. Mr. Oldfibld. I do ciot understand your last statement. It seems that you contend or figure that all of the Federal outstanding bonds are exempt from taxation ; therefore, the Government Is getting no taxes from any of the $20 - 000,000,000 bonds that have been issued. Is that corerct? Some of these bonds are taxable, are they not? Mr. Selisman. That is, indeed, true, sir. but practically it Is not true • that IS to say, by restricting your purchases in every issue you can buy only tax- ■exempt bonds. Mr. Oldfield. $160,000. You think, then, that the Government to-dav is getting no revenue from those bonds? Mr. Seligman. Not a penny. Take, for instance, the second Llbertv bonds There were $3,314,000,000 outstanding. Now, I maintain— of course I can not prove. It, but the statement can not be disproved— I maintain that those will naturally be held by people who own under $160,000 apiece of the three issues Why should not they be so held? It is to the interest of every man to put fS™*" ««oi2v?°'1™^^"*° tax-exempt securities. Why should he own more than $160,000 when he can vn-tually exchange them for first Liberties or Victories ? Mr. Oldfield There is no reason for taxing the Federal bonds at all as long as this $160,000 provision is in the law. Mr. Bacharach. You believe that the people who purchased the bonds origi- nally have disposed of those bonds? Mr. Seligman. I think that is a pretty fair assumption to make After the wave of patriotism which was engendered by the war passed by most prudent people tried to get the largest returns on their money possible Esoeclallv since the recent rise in the price of the Liberties it has become to their interest to dispose of any excess holdings over $160,000 and to convert them into first TAX-EXEMPT SECURITIES. 107 Liberties or Victories. Tliis is no longer any question of patriotism. It is a matter of pure business. I think, therefore, that that question can be an.swerecl in the arnrmative. Mr. Bachahach., I do not appear to be able to find anyone who has disposed of his bonds. I have made inquiries among the members of this committee iOT Instance. ' Mr. Seligmas. May I ask a question right there? Did any of those gentlemen that you have m mind take more than $160,000 worth of the second, third and fourth Issues? Mr. Bachaeach. I think that pretty nearly all of the members of this com- mittee .iust purchased a reasonable amount. Mr. Seligman. And all of those are exempt up to $160,000. Mr. Oldfield. That should be repealed. It should never have been placed on the books. Mr. Gabner. It can not be repealed. Mr. Oldfield. It should never have been placed there. I opposed that at the time. Mr. Gaener. There is one other thing that I would like to call to your atten- tion. You assume that it was a mistake on the part of Congress to exempt these securities from taxation. ThaJ; is your opinion about that. But because Congress makes a mistake and puts out $20,000,000,000 tax-exempt securities jour position is and you argue that for that reason the first bonds to be made taxable should be the State and municipal bonds. I want to call your attention to the fact that the eighteenth amendment took away the power of the States and adde'd power to the National Government, and the nineteenth amendment took away rights of the States in certain particulars. We now have before Congress, and it will probably pass at an early date, a bill taking away from the States jurisdiction in certain criminal matters. Now you propose, and those who agree with you, to take away from the States their credit. After all of these things are removed, just what functions are the States going to perform? Mr. Seligman. If you will permit me, sir, I am going to address myself par- ticularly to that subject later on. I consider it very important, but I am now trying only to give you the statistics. I will be glad to take up that question a little later. Mr. CoLLiEE. Doctor, I understood you to say that you could not prove it, but it was your opinion that the rich men of the country are not holding in ■excess of $160,000 of Liberty bonds? iMr. Seligman. No ; I did not say that. I said of the second, third, and fourth issues. The wealthy people will naturally buy the first issue, which have com- plete exemption, or the last issue of Victories of over $6,000,000,000, Both of these have complete exemption. Mr. Houghton. Doctor, is it your opinion that the rich do not hold over $160,000 of the second, third, and fourth Liberty bonds? Mr. Seligman. I think so. There is no reason why they should. Mr. Houghton. And it is your opinion that large corporations and banks, and persons who purchased great blocks, do not now have them ? Mr, Seligman. Not by any manner of means. I am going to take that up at once. I shall be glad to try to give statistics about that. Mr. Preae. You had reached the point where you said there is outstanding $30,000,000,000 and the total wealth of the country is $286,000,000,000. Mr. Seligman. The point I am trying to bring before you is what the Govern- ment loses through tax-exempt securities. Now, we come to the question as to the ownership of these tax-exempt securi- ties. In the first place the banks still own some of these securities. While we have fairly definite figures for 1918, we do not know exactly how much has been disposed of since then. My estimate would be that the banks still own from 7 to 10 per cent of the outstanding $30,000,000,000. Then come the corporations — the industrial corporations, the insurance companies, and the like. How much do they own? Here again exact figures are not available. My guess — and I want to be conservative — is, the corporations to-day own from 10 to 15 per cent of the outstanding tax-exempt securities. This would make a total in this group, of bonds held by banks, national. State and saving banks and other corporations, of from 17 to 25 per cent. Let us take the higher figures and say that 25 per cent of the bonds are now owned by corporations, by other than individuals, leaving only 75 per cent in the hands of individuals. I think that this is a fairly conservative estimate. What, now, does the Gov- 108 TAX-EXEMPT SEOUEITIES. ei-nment lose here? If the bonds were taxable the corporations would pay 10> per cent on them, or, under the new law, 121 per cent, upon the income from those bonds. For the income from the bonds would be included in the gross in- come and the net corporate income on which taxes are payable. So there the Government will be losing about 121 per cent on one-quarter of the outstanding tax-exempt bonds. The next question is how many of these bonds are owned by small people who do not pay income taxes, because they do not come within the limits, such as married men with less than $2,000 income. Well, we have not so far found any means of securing exact figures. But in view of the great amount of patriotism engendered in the war, in view of the fact that the bonds were pur- chased by the small farmers, servant girls, and workmen who had bank bal- ances, and who bought a bond or two, I should guess — although it would be a wild guess, I admit — that the amount held in the country would amount to one- quarter of the whole. I should guess that the tax-exempt bonds held by people- who have less than $2,000 income and who would not pay any tax anyway, even it the bonds were taxable, amounted to 2.5 per cent of the entire issue. I am endeavoring to make the situation just as favorable as I can for those who be- lieve in the tax-exempt securities. Well, then, that leaves only half of the entire amount outstanding in the hands of persons who would pay a tax in case the bonds were taxable. Now, how much tax would they pay? That is an interesting question. How much tax would they pay in case the bonds were taxable? Well, sir; I have here been able to utilize the returns presented by the Commissioner of Internal Revenue in his 1918 report on statistics of income, which is the latest we have. The figures show that the recipients of incomes above $25,000 are getting fewer in number every year, which shows, of course, that they are investing to a greater extent in these tax-exempt bonds. The other classes of taxpayers, with incomes from $2,500 to $5,000, from $5,000 to $10,000, and from $10,000 to- $15,000, are filing more returns. The total number of returns is growing, but the returns of $25,000 and up are diminishing. This is especially noteworthy in the higher classes. Returns from $500,000 to $1,000,000 and over $1,000,000- diminished 43 per cent and 52 per cent, respectively. Now, in 1918 out of $1,127,000,000, which was the personal income tax yield, the recipients of Incomes of from $25,000 to $50,000 paid in round figures 11 per cent of the total tax, their rate being 25 per cent. The recipients of incomes of from $50,000 to $100,000 paid 13 per cent of the entire tax and their rate was about 45 per cent. The recipients of incomes of from $100,000 to $150,000 paid 9 per cent of the- entire tax and their rate was 60 per cent. The recipients of incomes from $100,000 to $300,000 paid 11 per cent of the entire tax and their rate was 65 per cent. Mr. Feeae. What year was that? Mr. Seligman. That was for 1918, the last figure we have. The recipients of Incomes of over $300,000 paid about 23 per cent of the entire t.ax, almost a quarter of the entire tax, and they paid it at a rate of 70 per cent of their net income. Now, then, what are the conclusions from this? Inasmuch as most of the tax- exempt bonds are owned by these classes, since otherwise they would be in- creasing instead of diminishing in number, it would be a very conservative esti- mate to say that on the average they were subject to a 40 per cent tax It is- difficult to estimate, but I think that we could figure it at 40 per cent I think that it is really nearer 50 per cent, but I am willing to grant that th(?v pav 40- per cent. For, as we have seen, two-thirds of the taxpayers paid over 25" per cent income tax; and of this two-thirds about one-half paid over 65 per cent tax. Yet, in order to be very conservative, I estimate that the averao-e of these two-thirds paid only a 40 per cent tax. If there were no tax-exempt"securities, then, they would pay a rate of about 40 per cent Now, then what are the results? We have $30,000,000,000 of outstanding securities. State and local, bearing an average interest rate of about 4J ne? cent, roughly speaking. That means that the income from this ,$30 000 000 000- is about $1,300,000,000. That is the annual interest on tax-exennJ^^Sltiesin this country to-day. eAeiiipi secunties m Now as we have seen, the banks and corporations would, if there were no- exemption, pay 121 per cent on one-quarter of this. A quarter of -SI had not gotten there before the war the hope of ever getting there. You have taken away a very important stimulus to effort and you have created a sense of social wrong that is a very grave problem, because it is a social wrong to take a third of the income of a man who, with his brains, made $50,000 last year and had not a penny before, and to take nothing of the income of a man sitting at home or in his club and enjoying an income of $50,000 derived from tax-exempt bonds. Mr. Fbeae. That is what this amendment seeks to reach? Mr. Leffingwell. That is what this amendment seeks to reach. Now that is a social injustice of the greatest magnitude and its effect upon the people's feeling toward the State and toward each other in these days is, I think, a really serious thing. Mr. Oeisp. One of the resolutions before this committee provides that any State or municipal bonds that might be issued by the various States and munici- palities from the date that the constitutional amendment is submitted to the States for ratification, etc., to prevent any tax;-free securities thereafter being issued, from that date. I would like you to state your opinion as to whether or not it is advisable to put that In such a resolution and, if so, whether it would be constitutional. TAX-EXEMPT SEGUraTIES. 129 _ Mr LEFFiNGWELt. I do not know that I would like to give an offhand opin- ion about the latter question. I would say, offhand, that it was hagglina- with a great big problem to try to catch the fellow who might get in under the wire, and I should think probably the tendency of such a provision would be to make the constitutional amendment a little harder to pass. After all, we have been at this business of manufacturing tax-exempt securities for a good while and why raise a question as to the propriety of the constitutional amendment bein°- retroactive ? ° Mr. Ceisp. I knew you had given this matter a great deal of thought and I wanted your views. Mr. Copley. I do not think the intention was to make the amendment retro- active, but that such securities as shall be issued between the date of submitting this amendment to the various States and the final ratification by 36 States shall be taxable after the ratification. Mr. Leffingwell. Is not that retroactive? Mr. CoPMY. No ; I do not think that is making it retroactive. Mr. Leffingweli,. I think it is. Mr. Gakneb. It is Congress passing a constitutional amendment as of a cer- tain date before the States have ratified it. Mr. Copley. But the taxing shall not begin until after it is ratified. Mr. TiLSON. We certainly have the right to make that kind of a constitutional amendment and get it ratified If we can. Mr. Leffikgwell. I do not think it is certain you can properly make a con- stitutional amendment retroactive in its effect as regards securities issued before final ratification. Mr. Feeab. There would be a very small amount of those, any way, as compared to that large amount now in existence. Mr. Leffingwell. And unless you have that question very seriously to con- sider I would not jeopardize the amendment for the sake of catching a few more securities. Mr. Gaeneb. Let me see if I understood you a while ago. If I understood you correctly, it is your contention that the income of the citizens of the United States pay the tax? Mr. Leffingwell. Yes. Mr. Gaeneb. The income of the citizen, whether he is a laborer with an Income of $2 a day or whether he has an income of $20,000,000 a year, pays the tax during that fiscal year? Mr. Leffingwell. Yes. Mr. Gakneb. And, if I understood you, it was your theory that they should pay in proportion to their ability to pay, according to their income? Mr. Leffingwell. I think so. Mr. Gaeneb. And the only reason you opposed the surtaxes you spoke of, the higher surtaxes, was that you were not getting the tax according to the income of the individual that we sought to reach? Mr. Leffingwell. I would not say the only reason, but I think that is an important reason. . Mr. Gabnee. That is one of the principal reasons, and they ought to pay according to their ability to pay, according to their income? Mr. Leffingwell. Yes. And when I say in proportion to their ability to pay, measured by their income, I do not mean in direct proportion to their income, . because I believe that a certain moderate graduation of the income taxes is justified in economics ; but the immoderate graduation, which has become a feature of our surtaxes in this country, is not really justifiable. Mr. Copley. You think that is being passed on to the people of smaller Income? Mr. Leffingwell. Being passed on to the consumer? Mr. Copley. Yes. Mr. Leffingwell. Because of the withholding of capital from legitimate business enterprises or making it moi-e costly. I said in answer to Congress- man Garner, that I did not think that the constitutional amendment would prevent the States and municipalities from financing their legitimate require- ments, and I do not ; and I do not think it would cost them any more money to finance their legitimate requirements ; but I do think that the existing situ- ation artifically stimulates expenditures which I do not recognize as legiti- mate requirements of the States and municipalities and that because of the apparent but not real cheapness of the money which they are able to ob- tain, they are making wasteful or deferable expenditures when the capital 93871—22 9 130 TAX-EXEMPT SECUKITIES. Of (lie country could more usefully be divei'ted to tlie enteiT.rise of private business men, wbo are i^overned solely by the law of selt-interest ratliti tlian ideallsui or poi-k-barrelisui, which in some sort of combination so trequently aftect public expenditures. . , Mr, LoNcwoETH. Is not this also true, that under this present provision where these municii)al securities are tax exempt, that the municipahty does not get the full amount that that bond is worth to the very rich man? Mr. Lefftngwetx. No ; it certainly does not get it. , Mr. LoNowoKTi-i. What were the figures that you gave— I remember you had it graduated? Thev showed that the man with a million dollars of mcomt;, that the tax-free bond was worth to him in the neighborhood of lu to 16 per cent, wasn't it? Mr. Leffingwell. Oh, yes; easily. You get a very good measure of what the Government, on the other hand, gets for the exemption, a very practical measure of that, if you look at some of our own securities. For example, the market value of the difference between — the measure of the difference in value of a wholly exempt Government security and a snrtaxable Government security is to be found in a comparison of the first Liberty 34's and the first Liberty 4i's. You will find that nowadays they are running very close to- gether in the market, both of them around 97|, the market price, and the spread there is three-fourths of 1 per cent, the difference between 3i per cent on the fully exempt and 4i: per cent on tlie partly taxable. Sir. Copley. Mr. Leffingwell, what percentage do you imagine of that first 4-i issue are held by people who pay taxes? Mr. Leffingwell. Well, it is very hard to determine, and we have con- ceded at the outset that a very large percentage of tliose securities to-day are obtaining exemption because of the distribution among small holders. Mr. Copley. And also probably because they are owned by life insurance companies and savings institutions? Mr. Leffingwell. Yes, sir ; corporations that do not pay taxes on them. But making allowance for all those factors, it is safe to say that the difference in market value of tliree-fourths of 1 per cent is no measure at all of the value of tax exemption to the very wealthy individuals carried by 3i per cent Liberty bonds. Then take the history of the Victory notes. The number of tax exempt, fully exempt Victorys have been steadily diminishing. That shows that the spread of 1 per cent is not sufficient to make the 3i per cents, fully exempt, more attractive than the 4| per cents, and you are getting those notes out of the way. So I think the value to the borrower of exemption is very slight. Yet this Government has not been issuing any exempt securities — any fully exempt securities — for a long time, so that those issues have an actual scarcity value and, in view of the proposed constitutional amendment, a potential scarcity value very much greater. BIr. Oldfield. What proportion of our outstanding bond issues are exempt from all taxation, and those that are not exempt? Mr. Leffingwell. It is quite impossible to say what proportion of our out- standing bond issues are actually in the possession of persons who have to pay taxes on their income, because of the fact that the taxation depends upon the amount of the holdings of each individual owner. Mr, Oldfield. Prof, Seligman said this morning that it was his opinion that none of them are paying any tax, for the reason that under the $160,000 clause that they have in the law they will take those and then they will take the rest of them that are not taxable, and then the rest of those that are taxable are held by the little people who naturally do not have to pay any taxes, Mr, Geeen. And the insurance companies. Mr. Oldfield, And the insurance companies. He thinks that none of them are paying taxes now. Mr. Leffingwell. I imagine he exaggerated a little if he says none of them, but undoubtedly there are in existence to-day a very, very large number of exempt holders. Mr. Copley. Mr. Lefl^ngwell, this bill of course proposes to tax the incomes of private individuals. Now, take the private individuals of this country, what percentage of the investment bonds, in your .iudgment, of all characters— tax- able, partly taxable, and totally exempt— what percentage is held by men ' whose incomes are over $20,000 and men whose incomes are under $20 000 ' TAX-EXEMPT SECUPiITIES. 131 Mr. Leffinqwell. I could not give you im estimate. And I do not under- stand why you say only private individuals. Wliy does tliis not extend to in- comes from corporations? Mr. Copley. Tliis law does not propose to tax corporations — the income from corporations. Mr. Leffingwell. That distinction had not occurred to me. It says " have power to tiix Incomes derived from securities issued after the ratification of this article." Mr. Copley. I do not think the intention was that it should be an additional tax on business beyoyd the present tax on business under the present law. 1 think it has to do solely with the incomes enjoyed by private individuals. Mr. Leffingwell. This does not deal with any tax levy; this simply creates the power. Mr. Copley. I appreciate that. Mr. Leffingwell. I do not understand that if this amendment were adopted there would be anything to prevent taxing incomes derived from bonds held by corporations. Mr. Copley. I do not think any of the proposers of this resolution had in mind taxing anything but private incomes. What do you think, Mr. Chairman? Mr. Geeen. We have power to tax corporations now independent of the ordi- nary restrictions on taxations of private incomes. Mr. Leffingwell. You have not the power to tax the incomes derived front nontaxable securities as such. Mr. OLDFiKLn. This just has to do with nontaxable securities? Mr. Leffingwell. That is all. Mr. Copley. But ultimately the tax is going to be assessed against the indi- vidual enjoyer of an income. Mr. Oldfield. And a corporation or an individual either that has nontaxable securities can become taxable? Mr. Leffingwell. If the Congress taxes them. Mr. Oldfield. Yes. In other words, if a corporation owns a million dollars'' worth of these nontaxable securities and we pass this resolution Mr. Copley (Interposing). Congress already fixed that, for instance, in this present tax law ; and as it understands it, this is aimed at the private indi- vidual, although there is nothing to prevent carrying it as far as Congress sees fit. Mr. Leffingwell. This present tax law that you speak of only affected the taxation of incomes derived from Liberty bonds, which carried certain specific exemptions by the terms of the contract with those bondholders. Mr. Copley. The reason I am asking that question is, I think, that some of the bond companies have had estimates made as to the percentage of bonds bought by men enjoying various incomes — in fact, I am very sure of that, because I have had considerable experience with them myself, and I won- dered if you had at hand any one dividing point, or whether you loiew by memory the approximate amotlnt of bonds held by those with incomes above and those below $20,000? Mr. Leffingwell. No. It is a commonplace of the investment banking busi- ness that since the war and the high surtax rates the average purchasie of bonds has fallen to a very low figure, somewhere around two or three or five thousand dollars to a purchase, as against a purchase of $50,000 for an aver- age before. That is a very crude recollection of things I have heard. It is certainly the fact that there has been a very marked change in the problem of distribution, and that investment banking houses have been forced to get a much wider distribution. That in itself is not a bad thing. If you could add to your list of Investors people who buy approximately two or three or five thousand dollars and retain those that used to buy in blocks of $500,000, then the country would be getting the benefit of the stimulation of adequate capital. To-day we have got a very awkward situation and quite an unusual situation in the investment markets of America. AVe have the Government of the United States borrowing at 4i per cent to meet its current requirements, and we have call money down very cheap. You can get money at the banks for very little and vet when an industrial company wants capital for the expansion of Its plant or the resumption of its business or the enlargement of its inventory— and precious -few of them, unhappily, do, these days— it has to pay a very, very high rate I regard the spread between the rate for money as such, which is perhaps to be deterihined by the rate for United States Government Treasury certificates and bankers' acceptances, and is around 4 per cent to-day, 132 TAX-EXJiMPX SECUBITIES. and the rates which business companies in good credit have to pay for capital, which may be up around 8 per cent — tliat spread is so great as to be umhrajltfey. Mr. Gopi.EY. Six months ago many of them had to pay 9 and 10. Mr. Leffingwell. Yes. Mr. Copley. Companies with excellent credit. Mr. Leffingwell. And it is unhealthy because the history of every previous, period of business depression has been that the stimulation to business has fol- lowed the easing of investment capital. Under those circumstances the fore- sighted man has said, " Yes; I can borrow mpney very cheaply now, andl I will buy property. I will upbuild my plant ; I will get myself in position to do busi- ness at a great big protit, because I have made these extensions when things were down." And that has always been a great factor in accelerating the return to normal. Now we do not get that stimulant, in spite of having easy money am the street, and one reason, in my .judgment, why we do not is that our surtaxes are so liigli and we have this exemption from taxation, the rate for investnaeitt capital does not adjust itself as promptly as it used to do, to the rate for miojiiiey as such. Mr. Fkeak. Isn't it due largely, also, to the fact that there is a general de- pression in business at this time? In other words, if a man goes into the bank with good security and the certainty of the interest being paid, what would Be- the reason there would be a larger interest, as you say, between that secnnrity and the security offered by a school district out in Missouri or elsewhere? I cam not understand, if he has good security, and he is going to get his interest., and the business is in good condition, why there should be any distinction between the school district out there, because he will get the money anyhow,, and get Iiis. interest. Why should there be a large spread? Mr. Leffingwell. Well, to some extent in this problem we are discussing, high surtax and exemption from taxation. Mr. Fkeae. I can not understand why that should have any difference in effect upon a proposition of that kind. He is going to put this into a:Dy other invest- ment outside of the question of tax-exempt securities. For instance, he will buy a bond issued by the New York Telephone Co., where they Issued $50,000,000 in bonds that was oversubscribed nine times ; now, he is ready to do that ; that is a taxable security ; he did that without any question at 6 per cent ; now, why should he not be perfectly willing to invest in a private business if he can see his money is going to be well secured? Mr. Leffingwell. The telephone bond is an illustration of the fact that we are ad.1usting ourselves to this condition. I think the adjustment is retai-ded by the fact that people have to receive either the inducement of a very high degree of security, freedom from risk, or of a very high nominal income to counteract the heavy surtaxes which they have to pay on taxable securities. Mr. Copley. Y'es, Mr. Leffingwell ; it was not more than a year ago or a year and a half, as I recall, that the American Telephone & Telegraph bo. was paying 8 per cent for money, Mr. Leffingwell. That was at a time when we did not have cheap money rates. Mr. Copley. Certainly. Mr. Leffingwell. And, of course, you realize that that movement in money rates was explained by economic causes which are not present to-day. The transition from a period of inflation to a period of deflation is always" accom- plished only over a period of stress, and that was the period of stress between inflation and deflation. Mr. Copley. I was going to tell Mr. LetTuigweU that I think most of the members of this committee would be very much interested in having him tell ns how near he thinks this period of stre.ss is over. ^ Mr. Leffingwell, The period of stress is over ; the period of depression is on. To my mind, the United Stiites is ad.iusting itself to a period of depression Mr. Hawmy. Having successfully answered the first part of the question how long is the period of depression going to last? ' Mr. Leffinswell. The answer to that depends on how long it takes the world to ad.iust itself to tlie consequences of the World War and when I say " world " I do not mean America alone. Mr. Hawley. An X is an unqnown quantity? Mr. Leffingwell, No ; X is the disturbance of the world's international po- sition in consequence of the malad.iustment of the international financial situa- tion growing out of tlie war. We have lost our foreign market and we are wondering why we can't sell our goods. I do not see why we are wonderin"-- Jt seems to be perfectly apparent on the face of It. »' TAX-EXEMPT SECUEITTES. 133,- Mr. Hawley. Jlr. Lefflnswell, it has been advanced in support of the resolu- tion that to deprive the States of the right to issue tax-free l)onds would not talce away from them a right reserved to them by the Constitution, but rather putting them back into their original position and only affecting a courtesy or opportunity that has been granted to them by custom. What do you say of that as a legal proposition? jMr. Leffingwell. Why, as a lawyer, the Constitution is to me what the Supreme Court of the United States says it is. and the Supreme' Court of the United States a hundred years ago said that this right of exemption existed That is not a question of custom ; it is a matter of law. It is just as much in the Constitution as if you could see the words in the articles of the Con- stitution. Mr. Watson. It has been stated that if nontaxable securities are permitted to remain the investment A\-ould be so great that probably incomes would have to be taxed 40 per cent. Do you believe that the increase in nontaxable securi- ties would grow to such an extent after business has resumed its normal state? Mr., Leffingwell. It would be idle for me to attempt to make an exact calcu- lation as to how soon you will reach that point, but I think you are going that way. Mr. Watson. Going in that direction? Mr. Leffingwell. Yes. Theoretically a State ought to be able to impose taxes adequate to ipeet its necessities, no matter what happens. Practically it is not so ; practically you will find that indirect taxes are only effective up to a certain point and that if you inhibit yourself by the issue of these exempt securities from imposing taxes you will gradually work toward the point where it be- comes a matter of serious embarrassment to find revenue to meet the bills of the Nation. That is the situation in which a number of the countries on the continent of Europe find themselves. Nobody can say with respect to any coun- try beforehand just when the point will be reached, where the constant in- creases in indebtedness and the accompanying privilege of not paying taxes will bring the States' credit to the breaking point. Mr. Watson. When business becomes normal, do you not think money will be . withdrawn from nontaxable securities and seek industries? Mr. Leffingwell. I think that will depend upon the tax policy and the rates of interest and one thing and another. Mr. Watson. I mean in the natural course of events? Mr. Leffingwell. No ; I do not see any very great likelihood of that. It seems , to me that it could only happen if this country were to reduce its surtaxes to a reasonable point, and I have not seen any likelihood of that. Mr. Fkeak. Let us see whether you are right about that. What amount of money to-day is tied up by those surtaxes of which you are speaking? Mr. Leffingwell. What amount of money is tied up ? Mr. Fbeae. Yes ; wliat amount — what is the total amount of money ; that is, . money that is subject to investment — we have got $30,000,000,000 that has been suggested in tax-exempt securities ; now, what proportion of that $30,000,000,000 is held by these people in the high surtax class? You have spoken of it a num- ber of times. I wonder if you have figured it out? Mr. Leffingwell. No ; I have not any figures on that. Mr. Fbeae. Would it amount to a billion dollars? Mr. Leffingwell. I could not make an (yliinate. Mr. Feeae. Then, of course, the assertion that it is due to the surtaxes, that is not necessarily well considered unless you know what proportion of this thirty or fifty billion dollars that makes up the investment money was in the hands of those who would pay high surtaxes. Mr. Leffingwell. I would not be willing to agree with you about that. I think the thing stands on the face of the situation, and while statistics would be very interesting, you do not need statistics to prove that the business man on the whole does what it is profitable for him to do. Mr. Feeae. But here is a situation that we know that by reducing the surtaxes to 32 per cent from 65 per cent it made an estimated difference of $98,000,000 in the income to the Government. Now, you could estimate from that, roughly, the amount of money that was involved in the surtaxes over 32 per cent. That is not a suflicient amount ; it is not a drop in the bucket ; in other words, com- pared to the enormous amount of money which is used for carrying on of in- dustries and for the purchase of bonds. Mr. Leffingwell. -But you reduced your surtaxes only after the capitalists of this country had had four or five years to put their capital in exempt se- curities. 134 TAX-EXEMPT SECUEITIES. Mr. Freae. But those securities, if they were released to-morrow, are going to be bought by some one else. Now, you are speaking about the surtaxes and saying that that is the cause for the present disturbance; I am wondering if that is right. Mr. Lbffingwell. I think that is a factor, partly because the tendency is to throw the burden of taxation out of balance and to divert capital away from the industrial and business borrower into the wasteful or deferable enterprises of public authorities. Mr. Fbeae. Well, we were assured that the repeal of the excess-profits tax was going to start all the wheels of industry in operation, but, of course, that has not resulted and we knew it would not ; now, if we reduce the surtaxes to 20 per cent, would it start the wheels in operation, unless there was some industry that could furnish profitable investment? Mr. Leffingwell. It is a good deal like the one-horse shay ; you can not trust any man who tells you that here is the key to prosperity. Mr. Fkeae. That is true. Mr. Leffingwbll. You can say to the doctor, " What are the things that are at fault? " Now, some doctors are saying to you, " One of the things that is at fault is the exemption of securities, coupled with the high rates of surtax " ; other ■doctors are saying to you that " the situation in Europe is a prime factor," and you will go around the economic field and you will find every single one of those factors ought to have careful attention by such a committee as this. I am not proposing to you the theory that the amendment of the Constitution in the re- spect we are discussing it is a cure-all, but I say that it is, to my mind, the most important single domestic reform affecting the revenues which you could enact. Mr. Gkeen. Before we conclude, for the sake of enlightenment of persons who read these hearings, since you have made some very important statements I would like to have yoti state the extent of your experience in the Treasury De- partment and what positions you formerly occupied. Mr. Leffingwell. I came into the Treasury in May, 1917, about a month after the declaration of war, as a dollar a year man at the request of Secretary McAdoo, and spent about six months in an unofficial position in the Treasury working on the Liberty loans. About the beginning of October, 1917, the then fiscal assistant secretary of the Treasury, Mr. Crosby, was sent to Europe and I was appointed to his place and served as fiscal assistant secretary throughout the remainder of the war. and for about 18 months after armistice day — that is, until the 4th of July, 1920. Mr. Gkeen. Now, I understood your experience with the Liberty loans, with which you had so much to do, convinced you that if we had made all of the' issues entirely tax exempt there would not have been a great deal of difference in the rates. Am I correct about that? Mr. Leffingavell. I do not think you would have saved anything in the nomi- nal rates if all the issues had been tax exempt, because I think the sup- ply was so great that the exemption would have lost all scarcity value. What held up the Liberty Si's was the fact thot t)ie 'I'lv - i".>i.|- sideration by this committee of the proposals of Secretary McAdoo in con- nection with the second Liberty loan had definitely — and it was thought definitively — embarked upon the policy of issuing no more fully exempt bonds, so that at once the Liberty Si's acquired a scarcity value for those people who wanted the world's premier security, tax exempt. Mr. Houghton. And that means that if there had been no tax-exempt securities the rate would have been practically the same as it is to-day "> Mr. Leffingweix. Well, I could not go to that extreme. The surtax rates in war time were so high that I would guess that the limited exemptions which we gave in connection with the second and subsequent Liberty loans were a necessary evil. Two wrongs do not make a right, but sometimes they make a go of the bond issue. I am not inclined to think that you could have put out 4| per cent fully taxable Liberty bonds while surtax rates were running up to 70 per cent. I do not think so. Mr. Houghton. In other words, owing to the high surtaxes, it became neces- sary to put tax exemption into effect? Mr. Leffingweix. A sugar-coated medicine. There is a very interesting history of those exemptions. The Treasury was utterly opposed to any exemp- tions from surtaxes. Its original proposals contemplated none at all and Mr. Gannon introduced the amendment to the second Liberty bond bill givln? $.5,000 exemption—that is, exemption up to an amount of principal of $5 000 from surtaxes— and he made a wonderful little speech for it and carried 'the TAX-EXEMPT SECUKITIES. 135 House ; and tliat little coat of sugar was unquestionably an important factor in helping through the second Liberty loan ; and the Treasury put its principles in its pocket and came along and suggested from time to time further limited exemptions, but always, with the exception of the Cannon amendment, with a statute of limitations that was carried in the very amendment, so that the exemption from surtaxes automatically dies at a stated period after the termination of the war. Of course, it is fair to say that except for political affairs, with which the Treasury had nothing to do, the termination of the war would have been a fact a couple of years sooner than technically it became a fact, and these exemptions would have been out of the way by now, or nearly so. The accidental — from a financial point of view the accidental — deferment of the date of the termination of the war from some time in the summer of 1919, when tbe peace treaty was signed, till some time in the summer of 1921 when the President proclaimed peace, added two years to those exemptions. That is- nobody's fault, but it is just part of the rather interesting history of those events. Mr. Houghton. Blay I go back to one matter that has been bothering me somewhat? I can not help thinking that one reason why tax-exempt bonds played rather a small part in the floating of loans during the time of the war, when the Government practically wanted all the money, was the exceptional financial conditions of the Government and the people at that time. Suppose three years from now there should be a great flare-up in the world and that we had outstanding twenty or twenty-five billion dollars worth of bonds, and that then we had to offer bonds to raise money ; do you still think it would be well for us to pass an amendment, which ties our hands and deprives the Gov-* ernment of its right to issue a tax-free bond? Mr. Leffingweix. Tes, I do ; because wars and everything else ought to be financed out of the current taxes to the maximum of your power, and to my mind there is nothing Avhlch in an emergency should so earnestly be avoided as the creation of exemptions from taxation. Mr. Houghton. Tou have got to buy the money. Mr. Leffingwell. Yes ; but you can buy it cheaper if you will pay them a straight nominal interest rate than when you add little exemptions here and little exemptions there. Mr. Houghton. This morning we had a number of interesting figures from Dr. Seligman, and among others were the actual differences in cost, so far as it could be ascertained roughly, between what tax-exempt bonds were costing and what straight bonds would have cost, and he figured, as a minimum, about $150,000,000, as I remember the figures. It seems to me that sum is a maximum. In other words, the financial spread between the two methods is comparatively not very great. Emphasis therefore should be laid upon the social and political aspect of the matter. Mr. Leffingweli,. I go a step further than he did. While there is obviously going to be some nominal difference between the interest rates, I think the tendency is to exaggerate that nominal difference, and to my mind actual saving never exists at all, because the addition of the money withheld from the Public Treasury because of tax exemption to the money paid in interest will bring you a total cost greater in the ease of tax-exempt bonds than in the case of a taxable bond. Mr. Gkeen. Unless some member of the committee has some question that he considers of special importance, we have another witness to hear, Mr. Marsh, and I would like to permit Mr. Leffingweli to conclude. Mr. Leffingweli. May I add to my testimony, Mr. Chairman, a copy of an article that I wrote about a year ago on this subject, in which my views upon it are somewhat more consecutively stated? I think perhaps it will be of interest in connection with this general discussion. Mr. Green. We will be very glad to have you make it a part of your remarks. Mr. Hawlet. I suggest that it be printed in the ordinary type and not In that fine type that they generally use for such matters. Mr. Gkeen. I think that is a good suggestion. The reporter will make a note of that. Have you anything further, Mr. Leffingweli? Mr. Leffingwell. I have nothing further, Mr. Chairman. I appreciate very much your courtesy and attention. Mr. Geeen. The committee is very greatly indebted to you. Mr. Leffingwell. (Mr. Leffingwell submitted the following naner-i 136 TAX-EXEMPT SECURITIES. Federal Tax Revision. [By U. C. Lefflngwell, former Assistant Secretary of the Treasury.] There .seems to be pretty general agreement about the evil of the present excess profits tax and the higher rates of surtax. Probably the evil of the ex- css profits tax, bad as it is, has been exaggerated, and the evil of excessive sur- taxes has been underestimated. • Obviously, the first remedy is to cut down Government expenditure and sal- vage the Government's war stocliSi and investments, but though all agree upon this principle, there is, unhappily, no agreement upon its application. In the absence of a radical program of economy and salvage, relief from burdensome taxes on excess profits and incomes can only be had by substituting other sources of revenue. The substitutes proposed are far from commanding general approval. A sales tax can not fail to be a eonS'Umption tax in effect, and as such its tendency must be to throw an undue share of the burdens of government upon those least able to bear them. A tax on undistributed incomes of corporat'ons would be harmful in its secondary economic effect, because it would offer a strong in- centive to excessive distributions by way of dividend and dependence upon new borrowings for additions, betterments, and improvements. It would penalize conservatism and stimulate extravagance in corporate management. Discus- sion of tarift revision seems to be proceeding from the point of view of pre- venting or restricting imports, rather than from the point of view of adding revenues. As import duties can not be collected on goods which are not im- ported, it seems scarcely probable that tariff revision along the lines projected will result in any very important addition to the revenues of the Federal Gov- ern. A tariff on imports, too, is a consumption tax, and for this reason and also because it is so obviously injurious to the interests of a country which has become a creditor as well as an exporter on balance, I believe that even the traditional and hereditary friends of protection will heS'itate to go very far in upward tariff revision. The Federal Government is thus confronted by a real dilemma. The existing taxes are gravely burdensome, so burdensome as undoubtedly to retard recovery from the present business depression. Alternative taxes which have been pro- posed are far from meeting general acceptance and are all of them subject to objections quite as grave, or graver. The war increased the Federal Government's debt to $24,000,000,000. The States did not bear any of the burden of financing the war itself, but they are rapidly increasing their indebtedness in order to pay a bonus to the soldiers. Furthermore, semisocialistic conceptions of the function of the State have led the Federal Government and States and municipalities into new fields of activity involvin,g new expenditures. There has been a stupendous increase in the aggre- gate of indebtedness of the Federal, State, and municipal governments. Though the Federal Government did for some time make commendable proeress in reduc- ing the public debt, Federal debt reduction has, for the moment at least, come to an end, and State and municipal indebtedness has been increasing by leaps and bounds. The menace of this debt, great as it is, would be slight indeed because of the vastfless of our resources were it not for the fact that as our govern- mental authorities borrow money they grant to the lenders exemptions from taxation which gravely impair the revenues of the borrowers. A private company when it borrows new money has to show some reasonable ground for its belief that the investment of the proceeds of the loan will add to its revenue. Our governmental authorities, however, when they borrow money generally use the proceeds for no productive purpose and, what is far worse, grant exemptions from taxation which actually impair, and may ulti- mately destroy their ability to meet the interest and principal of our debt If it were not for the tragedy of it, one might find amusement from the mad scramble of our public authorities to borrow money on terms which pro<'res- sively impair their revenues. Before the war tax ex-emption was of trivial im- portance, because public debts in this country were relatively small and taxes For the year 1916 net income amounting to $992,972,985 was" included in the r''n";"'%"vot*o?o*'?ro''^.''^"^',^'^ "et income over $300,000 a year. This aggregate fell to $731372,153 for the year 1917 ahd to $392,247,329 for the year 1918. There is little reason to believe that the actual income of the richer taxpayers TAX-EXEMPT SECUPaTIES. 137 of the country had fallen in that Interval. It is the 'axable income which has been reduced, and almost certainly through investment by the richer taxpayers in tax-exempt properties." The constitutional exemption of State and municipal bonds from Federal taxa- tion and of Federal bonds from State and municipal taxation rests not upon any written provision of the Constitution of the United States, but upon early deei- sious of the Supreme Court. The sixteenth amendment to the Constitution pro- vides that Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the States. But opinions and decisions of the Supreme Court, culminating in Evans v. Gore (253 U. S., 245), have made it as clear as may be, without an actual attempt to tax such income, that the sixteenth amendment did not extend the taxing power to new or excepted subjects, but merely removed all occasion otherwise existing for appor- tionment among the States of taxes laid on income, whether derived from one source or another, and that, therefore, Congress can not tax the income from State and municipal bonds. Congressman McFadden, chairman of the House Committee on Banking and Currenc}', has introduced a joint resolution proposing an amendment to the Con- stitution intended to remove this constitutional obstacle to sound and equitable taxation. The proposed amendment is as follows : "The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, which shall include incomes derived from securities created by the States and their subsidiary governments issued after the ratifica- tion of this article and salaries of all public oflicials, Federal as well as State, elected or appointed to office after the ratification of this article, without appor- tionment among the States and without regard to any census or enumeration." If Mr. McFadden's resolution were modified so as to give it mutuality, de- priving future Federal bonds of exemption from taxes of States and municipali- ties which tax their own bonds and depriving future State and municipal bonds of exemption from Federal taxes, then it should not be difficult to obtain the ratification of the amendment. Already there are indications of readiness on the part of State authoritties to consider such a proposal favorably. The recent report of the special joint committee on taxation and retrenchment of the Legis- lature of the State of New York proposes (p. 39) " that steps should be taken as soon as is practicable to abolish all income-tax exemptions for future issues (of State and municipal securities) and to secure an agreement with the Fed- eral Government with regard to future Federal bonds." Secretary Houston, in his annual report for 1920, pages 18S and 189, outlined the arguments for the withdrawal of exemption from future issues of joint- stock land bank bonds. The Treasury is on record as favoring curtailing the exemption of farm loan bonds so as to coincide with that of surtaxable Libertys. Exemption should be withdrawn from, future issues of Federal farm loan bonds altogether, and the Federal land banks should be authorized to charge and pay the market rate for money. The Federal Government should not be more gen- erous to those who finance the farmer than to those who financed the war. It should not permit its own agencies to grind out annually tens of millions of securities carrying exemption from its own taxes. These benefit wealthy investors and injure the public far mor« than they benefit farmers. Tax exemption is a very grave peril, for it undermines the very basis of public revenue and it is a social evil of the first magnitude. It casts the greater part of the tax burden upon earned incomes and gives more or less Immunity to unearned incomes. It diverts capital from productive enterprises and housing into wasteful or deferable Government enterprises. The present is an emer- gency of the utmost importance, demanding imperatively a constitutional amend- ment of the character proposed and statutes prohibiting the issue of additional exempt securities by Federal agencies. These remedies will, however, be incomplete without a revision of the reve- nue law reducing excessive surtaxes. Capital is as essential as labor and man- agement to the business life of the country. It is more mobile than labor or management. It is as elusive as a will-o'-the-wisp. By imposing excessive sur- taxes and leaving the door open to thp unlimited issue of exemijt securities by States and municipalities and Federal agencies our Government has done what it could to aggravate the industrial depression which is upon us. It is not enough to close one or two doors of escape from taxation. Capital, always sensitive, must be lured back into new enterprises, foreign and domestic, and into old enterprises which, in the present disturbed condition of affairs, no 138 TAX-EXEMPT SECURITIES. longer offer an assured Investment. The only allurement possible is that of a considerable profit after the payment of taxes. When the Government attempts, as it did in the war revenue acts, to tura a tax bill into a measure of social reform (?) and by means of it to take the property of a few for the benefit of the many, it violates a fundamental eco- nomic law. The very rich, who are subject to the highest rates of surtax, pretty promptly find means to escape a great part of the burden. The blunder- ing effort to impose the burden on them exclusively, however, drives their capi- tal from where it is needed to where it is not needed, and thus the real burden is borne by the multitude, who are deprived of the employment and other bene- fits Avhich would accrue from the free flow of capital to the points where it is really needed. If, therefore, Congress wishes to do its utmost to restore the economic situation to normal it will not only put an end to the creation of exempt securities, which divert capital from productive into nonproductive or wasteful enterprises, but will also remodel tlie revenue laws in such a way as, without reduction in the aggregate revenue, will uialo that we are able to not only pay a fair salary to the county agent but to furnish him with an automobile and equip his office with mimeographs and typewriters and machinery and with stenographers and with other things necessary to run an efficient organization. Through that means we are able to get the vast field of information that has been collected by the Department of Agriculture and by the various State branches where it does actual good on the farm. The trouble heretofore has been that there never has been any eflicient method of applying this vast fund of valuable information right on the farm where it does good. Mr. Treadway. In other words, I take it that the organization that you represent — by the way, what is your official position? Mr. McKenzie. Well, I am here as tax representative this morning. Mr. Teeadway. The farmers' organization intends to bring about practical results to the farmers in the next station below what the Government is doing in the way of education and information? Mr. McKenzie. We are the instrument through which the Government is doing that. Mr. Teeadway. In carrying the idea to the farm? Mr. McKenzie. .Tust say that again. Mr. Teeadway, Well, you get the information which the Government is sup- posed to provide through the Agricultural Department back to the men on the farm ? Mr. McKenzie. Yes ; that is one purpose. Mr. Teeadway. You are the instrumentality through which that is done? Mr. McKenzie. That is the primary object. Mr. Hadley. Well, as I understand it, your organization is analgous to this: You have in the counties where the stations are the instrumentalities!, the principal schools of instruction, or instruction in practical methods of farm- ing in which the farmers are instructed. Of course, that does not benefit Mr. McKenzie (interposing). I can probably illustrate that point better by Just giving an illustration here to the committee. Mr. Hadley. Well, in addition to my question, it works out in the interest of the farmers for practical information. You do not go into the question. of pohtics and public policy, but deal with general questions of farming? Mr McKenzie. The county" organizations have nothing to do with those things, and any question of public policy is not raised by the county organiza- tions. 158 TAX-EXEMPT SECURITIES. Mr. Hadley. That is the way I understood it. I want it to be clear, if tliat is not correct. Mr. McKenzie. That is correct. Mr. Oldeiem. I would like to ask a question, if I may, Mr. Chairman. The Chaieman. Yes. Mr. Oldfield. What relation is there between your organization and the farmers' union ? Mr. McKenzie. None whatever, sir. We had a relation yesterday. If you were up Mr. Oldfield (interposing.). There seemed to be some friction between the two organizations? Blr. McKenzie. There was yesterday. Mr. Oldfield. Well, has there been right along? Mr. McKenzie. I am not from the Middle West, and do not, of course, know the conditions in that section. Mr. Oldfield. Well, have you got more members in your organization than the farmers' union has? Mr. McKenzie. Oh, my goodness, yes. Mr. Oldfield. A great deal more? Mr. McKenzie. Yes. Mr. Oldfield. Do you know how many members there in the farmers' union? Mr. McKenzie. No. Mr. Oldfield. Does your organization furnish information and .men to fur- nish the agricultural crop reports throughout the country? Mr. McKenzie. They did during the war. For instance, you know they made those reports during the war, and you will find that the department testified that they were the most efficient agency that existed that they had found for collecting statistical data as to the probable crops in the hands of the growers. The Department of Agriculture sent out a request all over the United States for information and got those statistics back into the department and had them all tabulated back at the central offices of the State ; in my State in 10 days. Mr. Oldfield. Do you use them now? Mr. McKenzie. They are not making any surveys of the crops of farmers. I do not know what they are doing in the West about that. Mr. Oldfield. That is what I mean. Do your men make the crop report as to the local crops? Mr. McKenzie. Do they continue? Mr. Oldfield. Do you do that in cooperation with the men appointed by the Agricultural Department? Mr. McKenzie. Our county agent does that; He is the man. Mr. Oldfield. Y'ou mean the agricultural county agent — the man appointed by ■ the Agricultural Department? Mr. McKenzie. Yes ; he is paid partly out of the funds of the Agricultural Department and partly by the State and partly by the counties and partly by the funds that we furnish to them. Mr. Oldfield. I do not know how you get their names. I can not get the names for my county, for example. Mr. McKenzie. You mean that you can not get them from the Federal FnruT Bureau? Mr, Oldfield. No ; I mean the Agricultural Department. Mr. Gheen. I do not want to interrupt you, but we have other witnesses who have come here to testify, and we will have difficulty in getting through to-day it we continue along this line. Of course it really does not have any bearing oil this subject. Ml-. Oldfield. I undej'stand. Mr. McKenzie. You see, these county agents are the men that do the work. Mr. Oldfield. The men in the county, the county agent ; but the Agricultural Department seems to have a good many men in each county who make reports on conditions of crops. What about the crop reports at this time? Mr. McKenzie. May I explain that? I will explain that in this way: They send us circulars, and every time they send those — they send me circulars— asldng me to report either with regard to jny own fari'n or the farms ot mv neighbors, and the estimate may be with regard to potatoes, hay, oats, etc., raised in that section ; and those are not sent to the county agents especially, but to the farmers whose names have been put on that list liy some means by which I can not tell you. Mr. Oldfield. But the bureau has a list, has it not? TAX-EXEMPT SECURITIES. 159 Mr. McKbnzie. I can not tell you just liow the Department of Agriculture has made up those lists. I have never investigated that. The Chaieiian. Now, my friend, we want you to tell us whether you are for or against this proposition with regard to exemption from taxation of interest paid on Government, State, or municipal honds. We have several otiier wit- nesses to be heard, and I will ask you to go along as fast as possible, if you please. Mr. McKenzie. Mr. Chairman, I am in favor of the general principle and opposed to the issuance of tax-free securities at all, not only on municipal and State bonds but on Federal bonds. I am opposed to the principle of tax-free securities, and there are good and sufficient reasons, I think, for my position. As you gentlemen probably know, there is in existence to-day at lease $16,000,000,000 — I should say seventeen billion— of tax-free securities in the United States. The Ghaikman. That is about double what some gentlemen think. Mr. McKenzie. Yes; and it is about half what some other gentlemen have estimated it. I have taken the figures of Dr. Adams, of the Treasury Department, who, I think, is probably in the best position of any man in America to know approxi- mately what that figure may be, and I think that the estimates which I have given are conservative. The Chaieman. The Secretary of the Treasury estimates it at $10,000,000,000 or less. Mr. McKenzie. Well, I was not familiar with that. Mr. Young. Would you leave out of your statement the Federal farm land bonds? Mr. McKenzie. If you will permit me, I will come to that later. I have a special paragraph and something that I want to say about that. These tax-free securities are being issued at the rate of about a billion dollars a year, and there are very many unfortunate aspects to that thing. In the first place, the Government is not saving any very considerable amount of money. You would naturally think you are, but you are not even on the ques- tion of interest. If you will compare the rate at which your tax-free securi- ties sell and the Government tax-free securities, with the rate the Canadian securities are selling that are taxable, you will find that the difference between the tax free and the Canadian taxables in the amount of spread between the taxable and tax-free securities is trifling. I was talking to a gentleman day before yesterday who was an investment banker and his firm is dealing very largely in Canadian securities, and he tells me their securities now have a preferential position on the market equiva- lent to one-half of 1 per cent. Now, if that is true, the point that I have to make is that if our Government securities which are tax free, if you take that away from them, that they will probably still sell very nearly as high as they do now. The Ghaikman. How can you say that they will sell for as much as those that gre tax free when to-day the tax-free bonds drawing a rate of interest of at least 1 per cent more than the taxable bonds are selling for the same price? What is the reason for that? Mr. McKenzie. The reason for that is this : If you will abolish the tax-free privilege, these gentlemen who are escaping taxation by buying these bonds will no longer escape, and they will no longer have a place where they can put their money by which they can avoid taxation. The Chaieman. Do you think that that would change the rate of interest to a certain extent? Mr. McKenzie. The Government bonds would still occupy a preferential position. The Chaieman. You have no further proof; just your opinion — is that it? Mr. McKenzie. I have further proof. The conditions are actually existing to-day in Canada. The Chaieman. Well, they never existed here, did they? Mr. McKenzie. Did not our Government securities here have a preferential position on the bond market when they were taxable? The Chaieman. We never had any Government bonds that were taxable before the war — this late war. Mr. McKenzie. Well, we have got some now. The Chaieman. And the taxable bonds have borne a rate of interest much higher than the tax-free bonds. Mr. McKenzie. That is true. 160 TAX-EXEMPT SECUEITIES, The Chaikman. And yet both bonds sell at about the same price? Mr. McKenzie. Yes ; that is true. The Chaieman. So, you have no evidence that the rate would not change. Mr. McKenzie. I think that the evidence is this. Tou do not say so. 1 think that if we would cease to furnish them a place where they can put theu' money which can not be taxed that will change that relation, and I base that on the charge I made, with regard to conditions in Canada, that now exist in Canada. „..,.,. The Chairman. Somebody will own the outstanding bonds of municipalities and States whether they are tax free or otherwise. Mr. McKenzie. Absolutely. The Chaieman. So it will not make any difference to day who owns those municipal 'and State bonds, whether they are tax free or not ; somebody'.s money will be in them. Mr. McKenzie. Yes ; absolutely. The Chaieman. You said that those men were escaping taxation, didn't you? Mr. McKenzie. Absolutely. • The Chaieman. I hardly think that is correct, that those men are escaping taxation. If they are men who have large incomes, of course, they will prob- ably purchase securities where they can get the largest amount of income from them. Mr. McKenzie. Yes, sir. Mr. Fkeae. In that connection, Mr. Bache has been before this committee and he said that he was investing his money in tax-free securities for the purpose of escaping taxation. That is in the record. Mr. McKenzie. And other men have said that they were getting their money as rapidly as possible into tax-free securities. Mr. Young. Is it not true that the trust companies are sending out circulars in which they are asking if their depositors are quite sure that they are in- vesting their money in such a way as will reap the greatest advantage under the income-tax law and " tipping off " fellows how they can put their money into tax-free securities? ^ Mr. Watson. How many farmers are there who pay Federal taxes in a direct way? Mr. McKenzie. How many? Mr. Watson. How many farmers who are members of your bureau are paying Federal taxes in a direct way? Mr. McKenzie. I do not know. Mr. Watson. Are there many? Mr. McKenzie. Oh, yes. Mr. Watson. There are very few, I believe. Mr. McKenzie. Many farmers have other businesses besides farming. Mr. Watson. I am alluding to men who are actually farmers, not those who are in the manufacturing business, but farming in the old-fashioned manner, farmers you represent. How many pay Federal taxes? Ml'. McKenzie. I have no figures. The only thing that I could say to you would be this, that in many sections of the country they have made very little money. They are not only not making any profits but they have been living for a year or two out of their principal. Therefore they pay no direct taxes to the Government. Now, there are some places where that is not the case. For instance, while I have no figures to verify this, I think that if you will go to the State of California, where there are large and very strong cooperative as.sociations, you will find that the farmers there are comparatively prosperous, in a compara- tively prosperous condition, for this reason : Statistics show that the farmers in California are getting 49 cents out of tlie consumers' dollar as against an average of 37 cents, as we get all over the United States, and the farmers in California are getting 49 cents out of the consumers' dollar. If we were getting that, all of the farmers in the country would be prosperous. Mr. Young. What did you say was tlie general average? Mr. McKenzie. Thirty-seven cents for all agriculture, according to Mr. Ander,son's commission. The Chaieman. What are the crops that you refer to? Mr. McKenzie. The raisin crop — the raisin growers. The Chairman. Those alone? Mr. McKenzie. I do not have the figures for the others. I have those figures. I think that the others are practically in the same position. TAX-EXEMPT SBCUEITIES. 161 ?T^® ii^ri™^^'^- '*^^^' *^^* '® t^<^ O'^ly state In the Union that raises raisins Mr. McKenzie. Yes; that is true. The Ohaibman. That does not illustrate it. Blr. McKenzie. The citrus-fruit growers are, and so are the prune growers and so are the peach men. They have representatives down here at this con- ference, and they will tell you the same thing. And that, in my judgment is the chief difference. They get about 49 cents out of the consumers' dollar as against an average of 37 cents, and they have solved the problem. They have not done that by raising the price to the consumer. They have done it by shortening the route between the producers and the consumers and taking out the waste in the space between. Mr. Gaknek. You would not favor giving Congress power to prohibit the issuance of State and county bonds, would you? Mr. McKenzie. Yes, sir; under the following facts: I think your saving is probably not more than $85,000,000 in your interest and that you are losing not less than $600,000,000 in taxes, besides the large amount that is lost by the various States having income taxes. Mr. Gaenek. Yes, .1 know; but your principle of government, then, is that you would rather trust Congress as to the wisdom of issuing bonds than to trust the States? Mr. McKenzie. My theory is this: That America, so far as I know, is the only country in the world that is wealthy enough to have tax-free securities. No other country can afford it. Mr. Garnee. But you do not answer my question. You prefer to trust the Federal Government rather than to trust the States as to the wisdom of issuing bonds by those States or counties? Mr. McKenzie. My judgment is formed, and that Is that issuing tax-free securities is a mistake, and that therefore Mr. Gabnee (interposing). I did not ask you that. Mr. McKenzie. You asked me if I would rather trust Congress or the States. Mr. Gaenee. You at least should be fair. You are appearing here as a wit- ness. And I try to be fair with you. I think that you should, in fairness to yourself, answer the question. Mr. McKenzie. Now, put it again. Mr. Gaenee. You say that you would rather trust Congress as to the wisdom of issuing bonds by States and counties than to trust the States and counties? Mr. Young. He may not get the question. Mr. Gaenee. That is a fair question. You would rather trust Congress than the States and municipalities as to the advisability of issuing bonds? Mr. McKenzie. Congress can not issue any county bonds. Mr. Gaenee. Well, you have not answered the question I asked you. Mr. Feeae. You may not get the point. Of course, the Government does not Issue county bonds. Mr. Garner means tax-exempt securities. The Chaieman. The gentleman has said that he would trust Congress first, and Mr. Garner is trying to get an answer to his question. Mr. Fbear. The gentleman has made a statement as that in his private opinion will help elimination, and your organization is in line with that, is it not? Mr. McKenzie. I have come here and expressed my opinion that Congress has no power to stop it. Mr. Feear. Precisely. Mr. Gaenek. You did make this statement, and I presume that you will repeat it in the face of the suggestion of Mr. Frear and others : That you would give the Congress power to tax State and municipal bonds to the extent that they could not issue them. Mr. McKenzie. Now, if you will turn to the record, I think you will find that you are mistaken. Mr. Gaenee. Well, you did say that just a while ago. Mr. McKenzie. If you will refer to the record Mr. Gaenee (interposing). You would recommend giving power to tax State and municipal bonds, would you? Mr. McKenzie. Well, we will prohibit the issuing of all tax-free securities and then when the Government levies an income tax it will levy it on the income from State and county and municipal and school districts and all other bonds. Mr. Gaenee. You can answer this question, I know, yes or no. ■ Mr. McKenzie. That answers it. 93671—22 11 162 TAX-EXEMPT SECUEITIES. Mr. Gabner, Whether you would give Congress power to tax State and municipal bonds? Mr. MoKenzie. Do you mean directly or indirectly, through an income tax? Mr. Gakneb. Both. Mr. MoKenzie. No ; I would not give any such power. Mr. Gaknek. Then, any constitutional amendment to give Congress power to tax these bonds you oppose? Mr. McKenzib. It does not give Congress power to tax the bonds. Mr. Garner. I am not concerned with what it would give. I am asking you whether you would oppose it? Mr. McKenzie. Tax income? Mr.. Gabnkr. I mean the constitutional amendment that would tax State and municipal bonds. Mr. McKenzie. I am opposed to a capital levy of any kind ; if that answers. Mr. Fbeab. That is not the question before us, and never has been. Mr. McKenzie. Well, I do not believe that the Government is in such a desperate condition that it needs to make a levy upon capital to produce revenue. Mr. Fbear. There is no such bill before Congress. Mr. BIcKenzie. No. Mr. Garner. But you would give Congress power to tax incomes from State and municipal bonds? Mr. McKenzie. Absolutely. Mr. Green. Let me explain the bill. We may examine the amendment. We are giving the most consideration to the amendment proposed by Mr. McFar- land, and also to the one I proposed, but the intent of both is to accomplish the same purpose. And Mr. McFarland's amendment in particular gives the States the same power to tax Government as they tax their own bonds, or, to put it in the language of the amendment, to the same extent that it taxes its own bonds. Mr. McKenzie. I perfectly agree with that. I think that it is utterly futile to submit to the States any proposition that does not give that reciprocal power because the State will not ratify it and put their own securities at a disad- vantage. Mr. Treadway. Along that very line, may I ask this question: What would be your judgment — of course, it is only a matter of opinion — as to the possi- bility of the States ratifying such an amendment as the one we are consider- ing known as the McFaiiand amendment? Mr. McKenzie. When I get down to the last paragraph I will deal with that. I think that that is a very good question to ask. The Chairman. We have a number of witnesses, and I will ask you to hurry along. Mr. Fkear. I suggest that three-fourths of Mr. McKenzle's time has been taken up with questions so far and he has not had an opportunity to make his statement. The Chairman. Yes ; it is true that we have asked the gentlemen questions, but we have other witnesses to hear. Mr. McKenzie. Personally, I do not care whether we go ahead and fight it out with questions, or go along. I am not particular. Now, I want to say a word as to the result of the issuance of tax-free securi- ties and land taxes. You gentlemen who live In the open country and have farms will be interested to know that the average return which Mr. Ander- son's commission shows on land is 3i per cent, and to know that the taxes on the farm lands and other realty is mounting year by year. Last year, in the year 1921, the Governor of New York made the statement in his first mes- sage to the legislature that SO per cent of the net income of realty was ab- sorbed in taxes. Dr. Eichard T. Ely, who has been attending this conference on agriculture and who is the best authority on land taxes in the world, I think presented a paper at a meeting of the National Tax Association at Bretton Svoods in which he stated that in so far as he had been able to ascertain in his State 37 per cent of the net income from farm land was absorbed in taxes Now, one thing that this enormous proportion of income from 'land absorbed in taxes, one reason why the ratio is so large is because we have established a great class of people that do not pay any taxes. Mr. Young. You mean the net income on land? Mr. McKenzie. Net income ; yes. sir TAX-EXEMPT SECURITIES. 163 The farmer's property lays out of doors where everybody can see it, and this other class of property does not. Now, eventually we are coining to the place where we can divide all property into two classes, taxable and tax free, and we will come to the time when the result will be that there is simply one class of property which will be carrying the double burden, and that is not according to our American ideas of justice and fairness in taxation. There is another aspect to this tax-free securities proposition when you get down to it, and that is in regard to the States, counties, municipalities, and towns. Last year our governor, through sitting on the lid, kept down or made a reduction in our State budget of about $12,000,000 and did a very fine piece of work. Did it do the citizens any good? No; it did not. The counties and towns spent it for roads and other things, and then not only the $12,000,000 that the governor had saved, but a lot more, so that our rate of taxes this year is higher than it was the year before. In my own district where I live my State and county taxes last year were 9.5 mills. This year they are 14.46. They have gone up 50 per cent, and that has all happened through the unwise expenditure of money which they can get through tax-free securities. Our village. In which I live, appropriated $100,000 to fix up the streets, and then the village has around it the town, or township as it is called, in many places, and they wanted money, and they came and asked for a referen- dum to give them $50,000. Ordinarily the village does not have to pay any part of the upkeep of the roads in towns, but when they put on a bond issue, then the town compelled them to help pay the bond issue ; that is, our village will have to pay the interest on the $100,000 and will have to help pay the interest on the Improvements for which the $50,000 was paid in the township. The Ohaibman. May I interrupt? When you say that you spent $12,000,000 building roads and otherwise, you have the roads for it? Mr. McKenzie. Yes ; we have the roads and the farmers have the bill, and the city people and everybody else. The Chairman. Well, are you not in favor of building the roads? Mr. McKenzie. I am in favor of good roads in the country. Now, when you get down to the present condition of the farmers, and their ability to pay taxes, you are going to find that the taxes are getting to be a mighty serious matter. I suppose that you gentlemen are familiar with the figures that are given out by the agricultural commission, which showed that the net actual labor income to the farmer last year was $465. Mr. Watson. He does not pay Federal taxes. Mr. Fkeae. What was the purchasing power? Mr. McKenzie. Two hundred and nineteen dollars on a prewar basis. Mr. Watson. So, thus he pays State and no Federal taxes? Mr. McKenzie. How is that? Mr. Watson. The farmer, then, does not pay Federal taxes? Mr. McKenzie. He is below the income-tax rate. Mr. Feeae. I would like to make a suggestion, drawn out by what the gen- tleman has said, which might also be of interest, and that is that we have no way of knowing what the average man pays in taxes due to this very fact which has been mentioned, because income-tax returns are held in secret. The House struck out the proposal to make those tax statements public. The Senate wanted to make those returns open, but the conferees struck it out of the revenue bill. „ „ „„„ „„„ Mr. Gabnee. I believe that you said that the governor had saved $12,000,000 in your State, and the counties and municipalities spent the $12,000,000 and a lot more for roads? Mr. McKenzie. Correct. Mr. Gabnee. For roads and improvements to streets which did not do any good? Mr. McKenzie. No ; you are mistaken about that. Mr. Gaenee. The stenographer's notes will show that you said that they did not do you any good. ^ .,, ^ Now, it appears from the argument, that next we will have gentlemen coming here saying that they have lived in a community and that community issued bonds for the improvement of roads and streets over his protest, not being able to control the electorate, and authorized the issuance of these bonds, and is coming to Congress saying, "I can not get any relief; the majority is against me. We are coming down to see if we can not get relief from the Issuance of these bonds In these communities for the purpose of building good roads." 164 TAX-EXEMPT SECURITIES. Mr. Geeen. Of course, the rest of us did not hear the witness say anything of the kind. Mr. Garner. The stenographer's notes will show that he said that they did not do them any good. Mr. Green. No. Mr. Garner. It does not make any difference. He did not think that these counties and municipalities should use this $12,000,000 that the governor saved. Mr. McKenzie. In many cases it was unwise expenditure. Mr. Garner. That is it exactly. Mr. McKenzie. Mr. Garner, I want to go on record that I did not say that the money spent for roads did not do any good. The Chairman. Now, you are going on record. The stenographer has got what you said. Mr. Hawlbt. You will be permitted, I presume, to revise your remarks. Mr. Garner. Of course he will be. But if it is in the record will you permit it to stay there? Mr. McKenzie. Yes ; I am a good sport on that, Mr. Garner. Mr. Watson. Which would you prefer — the good roads or the money back— your proportionate share paid for the roads? Mr. Frear. At $40,000 per mile or more charged for concrete roads through the country. Mr. Watson. You must travel over mud roads or pay the taxes? Mr. McKenzie. If I had my preference of going back to the old roads or raising the taxes of the district, I would rather have the money than the road built by the money. Mr. Watson. Your share? Mr. McKenzie. Yes, sir. Mr. Watson. And have the old mud roads? Mr. McKenzie. Yes; because this particular road is built from New York up through the Catskills and does the farmers but a mighty little good. Mr. Watson. What percentage of farmers travel the road? Mr. McKenzie. There are not a dozen on the road, and it cost $40,000 a milfe. Mr. Watson. What is the length of the road? Mr. McKenzie. About 9 miles, I guess. The Chairman. It is now half past 11, and you will have to conclude very shortly, as we have other witnesses. I am going to ask you to finish as soon as possible. Mr. McKenzie. The next question is whether the farm loan securities should be tax free or not. That, to my mind, is one of the most serious problems that we have. You gentlemen here who are farmers know of the desperate straits that many of our farmers are in, especially in the far West and in the Middle West. They are without funds. The cattle raisers and the sheep men and the sugar-beet people are already down and out. Their business has been unprofit- able for two years, and they have no liquid capital and have to borrow money. Where the money came from originally that was invested in farm mortgages was from the vast estates of investors, and now a great many of those large estates all over the country have in recent years been putting their money into these farm mortgages and furnishing a vast fund that the farmers could borrow; but what has happened? Take estates like the Marshall Field estate and others of that sort, having tremendous sums and paying taxes on farm mortgages, will they buy farm mortgages now? An investment banker told me that they could not touch them unless they could get 14 or 15 per cent for them, as it was better for them to go and put their money into tax-free securities at the rate of interest that is being paid now, and the result is that that fund from all of these great estates, instead of going into farm mortgages, has been going into tax-free securities, and the farmers have been left high and dry. This conference which adjourned here last night has tried through the War Finance Corporation and through the Federal farm loan banks to get them to supply the fund. The Chairman. But Marshall Field's taxes will not be high unless their profits are great. Mr. McKenzie. Now, where is the money coming from if it does not come from the estates I have Just given? The Chairman. From Marshall Field? Mr. McKenzie. No ; the money has been coming from the great estates with large incomes and tliey have been putting that money into mortgages That TAX-EXEMPT SECTJEITIES. 165 is what I meant by that reference. I just used that as an Illustration to show what Is taking place. That is where the money was coming from for these mortgages, coming from people who had a large income. They are now taking their money and investing it in tax free securities, and the result is that the farmer does not have that reservoir to draw from, audi that is one of the most serious problems you can consider here, gentlemen. Mr. Feeab. Mr. McKenzle, your suggestion is that of your organization in this matter ? Mr. MoKenzib. Yes. Mr. Freak. And you believe that the result of the present system is that the money from large estates is passing from mortgages into tax-free securities? Mr. McKenzie. Yes, sir; and I know it. Mr. Young. About this matter, and your organizations, have not your organi- zations pretty generally considered this guestion and passed resolutions on it? Mr. MoKenzie. So far as I know, there is absolutely no difference in opinion between the great farm organizations of this country. If you will go back to the year 1921, you will find resolutions adopted by the Grange and the Farm Bureau almost word for word and identical. If you will note the resolution adopted in 1921 by the American Farm Bureau and the Grange, you will find that the object and the purpose is the same. The wording of the Grange resolutions is just turned backwards. They say that they are opposed to the repeal of the law making Federal bonds taxable. We say that we are opposed to the issuance of tax-free securities. But that means the same thing. There is absolutely no difference of opinion among farm organizations upon that question, so far as I know. The Chaieman. Oould you put the rest of your statement in the record? Mr. McKenzie. I have just two more matters. It will only take me a very few minutes. I want to call your attention to the action taken last night by the conference in regard to the tax-free principle on Federal farm loan bonds, liat conference went on record as being in favor of the abolition of all tax-free securities, except on Federal farm loan bonds, and the reason assigned for this phase is the thing to which I have called your attention, and the necessity for capital for these farmers. Then the withdrawing of the usual source of supply, and the third is the fact that both the land and mortgages that are based on that land are now being taxed, and the farmer is already paying more than his fair sliare of taxes, and that this would only be offset of a trifle. There are approximately $8,000,000,000 total of these farm mortgages in ex- istence, and only less than $500,000,000 Federal farm loan bonds/. Now, I think that that is about all I have to say, except Mr. IJAWLET (interposing). What do you suppose will be the 'altimate amount of these Federal farm, loan bonds that will be issued? Mr. McKenzie. Why, nobody has any information on that. Mr. HAWLEY. Of course, there are $500,000,000 now outstanding, and that is only a small proportion of the total that will in the course of (Ime be Issued? Mr. McKenzie. Yes. The only hazard I could make in regard to that would be that in the history of the country we had issued, as I said a moment ago, approximately $8,000,000,000 in farm mortgages. Possibly be half, and it may be less than that amount of those securities — underlying securities — might be available as a basis for the Federal farm loans, so that we might get up to $4,000,000,000, but that would be years and years before we could do it. Mr. Gkeen. Under the proposed amendment tlie Government could tax those bonds at any time that it saw fit? Mr. McKenzie. There is no question about that. Mr. Oldfield. I would like to ask one question, Mr. Chairman, if I may. Does your organization take in merchants and railroad employees? Mr. McKenzie. Take my situation in my county. I live in a little village of about. 3,500. Just take, as an illustration, our membership. We have just in- creased our membership this year, and we have the judge of the court; we have the entire board of the county supervisors ; we have, I guess, every prominent doctor ; we have every good merchant in my village ; we have all of the farmers we can get in that village, of which our town is the heart. ' We take up and consider different problems of interest ti the people on the farm. The cashier of one of our banks sat in one of our meetings, in which we were forming a cooperative association, and got up and said that he wanted to go on record as saying that his bank would help us all that it could. 166 TAX-EXEMPT SECtrKITIES. Mr. Oldfield. And, as a matter of fact, you have among your membership bankers, merchants, and railroad people? Mr. Mckenzie. The great bulk are farmers. Eighty per cent or more are farmers living on the land. Mr. Tkeadway. What is the name of your town? Mr, McKenzie. Walton. Mr. TBEADWAY. What county? Mr. McKenzie. Delaware. Mr. Teeadway. Mr. Chairman, I would like to ask the witness to kindly answer a question I asked him and to which he said he would refer in his last paragraph, and that is with reference to his opinion as to the possibility of the States adopting such an amendment as this. Mr. McKenzie. I beg your pardon, but that slipped my mind. All I want to say with reference to that is that the States will adopt it if you should put in such a proviso as Mr. Lever suggested yesterday at the conference — I have no doubt but that the States will adopt it in a very short time. Mr. Teeadway. A¥hat was his suggestion? Mr. McKenzie. The suggestion was that the Federal farm-loan bonds be ex- cepted from the general provision and be left nontaxable, and he says that he can go down in his State, South Carolina, and have it adopted any time; and we th'nk that you could do the same thing in the other agricultural States, and that that constitutional amendment would be passed in short order. Mr. Teeadway. That would be making it sort of divisional, would It not? Mr. McKenzie. Tes. Mr. Geeen. I do not think that any amendment with reference to farm-loan bonds should be considered. When those are issued, we can make them tax- able, now, if Congress sees fit, and we do not neei an amendment for that purpose. Mr. McKenzie. I understand that there are two bills here. I am not familiar with them. Mr. Teeadway. What would be your answer to my direct question as to the possibility of adoption by the States of the amendment, such as the one that Mr. McFadden proposes? Mr. McKenzie. That would tax State and municipal bonds without taxing the Federal issue. That is the way I understand it. It would not have a chance — it would not have a Chinaman's chance. Mr. Geeen. The amendment, in brief, is that the Federal Government shall have the right to tax the State securities to the same extent that they tax their own, and the States have a right to tax the Federal securities to the same extent. Mr. Teeadway. It is reciprocal. Mr. Gaenee. So if we did tax the State and municipal bonds we would nec- essarily have to tax the farm-loan bonds under this amendment. Mr. Geeen. Not necessarily. Mr. Gaenee. Tes. You can not say that you would put their securities^ those of the farm-loan bonds — on an excepted list and treat them different from any other Federal securities. Mr. Geeen. The farm-loan bonds are neither Federal nor State securities. Blr. Gaenee. So you would have to have the same rate applied to one as to the other. Now, 's it your position that you would have all the securities issued by the Federal Government, the States, the counties, and the municipalities, subject to taxation by the Federal Government, but you want to exempt the farm-loan bonds? Mr. McKenzie. For the reasons I have stated. Mr. Gaenee. And, of course, under this constitutional amendment those bonds would increase during the next 25 or 50 years and would probably run up to eight billion, or they might even reach the sum of ten billion, and you would have that enormous sum tax free. Mr. McKenzie. I think that there is not tlie remotest possibility that within the next 25 years the Federal farm loan bonds will ever reach any such sum. Mr. Gaenee. Well, as I understood you, you said that there were outstanding now $8,000,000,000 of farm mortgages? Mr. MoKenzeb. Yes ; that is, approximately. Mr. Gaener. And there is outstanding $500,000,000 of farm loan bonds. Would not the farm-loan mortgages take the place of these other mortgages very rapidly? TAX-EXEMPT SECURITIES. 167 Mr. McKenzie. No, sir. In the first place, many of tliose loans are on security that could not be accepted by the Federal farm-loan bank, and they never can get Federal farm loans, because the Federal farm-loan banks will not take them. Mr. Gaener. There is not sufficient security? Mr. McKenzie. There is not sufficient security, and they will not take them. In the Second place, unless they get a faster move on them than they have ever had before it will take a longer time than that. Mr. G-iENEE. But if you eliminate all other exempt securities as far as you coitld all farm mortgages from taxation, no doubt there would be more money going into these bonds in view of the fact that you propose to tax everybody else. Mr. McKenzie. I believe that It is unfair to tax both the land and the mort- gage. Mr. Gaenee. Well, that could be arranged throughout the States easy enough. Mr. McKenzie. It has not been, and we have a chance to do something now. Mr. Gaenee. I understand that it has not been, but I am just speaking about what could be done. Mr. Hawlet. Mr. McKenzie, would it be necessary for several States, in order to take advantage of the taxing of the issues of bonds, if the amendment should be adopted, to change their present form of taxation from a property tax to Include an income tax and probably a graduated income tax? Mr. McKenzie. Many now have. I think there are six or eight. Mr. Hawlet. I think there are five or six. Mr. McKenzie. I think there are six or eight. New York has an income tax. Mr. Hawlet. Would it be necessary in order that they might participate equally under the constitutional amendment to change their form of taxation to include income tax? Mr. McKenzie. T think so ; but I think the States are coming to that very rapidly now, for the reason, as I said, that they are already taxing land and real property out of all proportion. Mr. Geeen. So that there may not be any misunderstanding, I want to state again that there is no proposition before the committee to exempt farm loan bonds. They would be left just where they are now. Mr. McKenzie. Well, now, that, of course, is a matter for the Congress. My recommendation would be that you accept Mr. Lever's suggestion, which is a very wise one. You gentlemen are interested, and can ask him to come before you. He sat on the committee on which I sat, the finance committee, at the con- ference. He came before the finance committee and said that if he could not put that over, sell it to the conference, that he would eat his old hat. And I think that he would sell it to you gentlemen, if you would give an opportunity. Mr. Young. What consideration did you give to a resolution such as the one that is before this committee, such as .Judge Green interpreted this resolution to be? Mr. McKenzie. I did have one before this conference on the program to be established by the American Farm Bureau Federation. Mr. Young. Well, that resolution is plain, is it not, as Judge Green interpreted the resolution? Mr. McKenzie. Yes, sir. The Ghaieman. In other words, Mr. Lever says that if he can not convince us, he will eat his hat? Mr. McKenzie. No ; he did not say that with regard to you, Mr. Chairman. I said he said that with regard to the conference. The Chaikman. He said that to you? Mr. McKenzie. He said that if he could not sell it to the conference that he would eat his hat. He knows that you are a hard-boiled organization. The Chaikman. Well, you tell him when he comes up here to bring his hat along. Mr. Feeae. It would be just a question of indigestion with him. The Chaieman. Now, my friend, while you are speaking about taxing land mortgages, I want to say that there are many States in the Union, I believe, that do not do that very thing. Mr. McKenzie. Many of them do. The Chairman. Well, I do not know of many. There may be many of them. Mr. McKenzie. If you will notice the annual resolution passed by the Grange year after year and year after year, you will see that they are objecting to that thing. 168 TAX-EXEMPT SECUEITIES. The Chaikman. Now, if you have concluded, we will hear Mr. Allfree. STATEMENT OP MR. H. B. ALLFEEE, OE NEWTON, IOWA. The Chaikman. Mr. Allfree, please give your name and the business you rep- resent to the reporter. Mr. AiiFBEE. Mr. H., B. Allfree ;" my address Is Newton, Iowa ,and I am in the farm-loan banking business. Mr. Teeadway. You are appearing here individually and not as a representa- tive of any organization? Mr. Allfeee. No ; I am not representing any organization ; but what I want to bring to your attention is this matter of tax exemption. Mr. Geeen. Just a minute, Mr. Allfree. I might say that Mr. Allfree appears here at the request of Congressman Ramseyer, in whose district he resides. Mr. Allfeee. Upon this tax-exemption matter, whereby the diverting ol moneys from sources where they have been used in the past and are being used now tof tax-exempt securities, and out of this is working a hardship upon the people in my country in the Central West. For more than 25 years I have been actively engaged in the loaning of money to farmers and the selling of those securities. Mr. Watson. Is ydur bank a national bank or a trust company? ■ Mr. Alefeee. My business Is incorporated under the name of H. B. Allfree (Inc.). I am also vice president of the first national bank in my home town, though not actively. I have for more than 25 years been engaged in this occupation, and we have built up a clientele of private investors. Now, as you gentlemen no doubt know, it is no trouble to sell a farm loan made under proper restrictions and with proper values to the insurance com- panies, or to other trust companies or banks, but that does not really aid the young farmer or the man who wants to secure a farm of his own. The man who has 60 per cent of the value of his farm the Insurance companies or the joint-stock land banks or Federal land banks or any other private or- ganizations, of course, can aid him to get a farm, but for the man who only has a small amount of money, say a few thousand dollars and wants to become a landowner, they can not take "care of him, and he has been coming to use and we have been taking care of him. We have been able to interest capital, men who are acquainted with our territory, and who know the conditions to loan more than the insurance com- panies, more than the trust companies and other loan companies would loan. We have been able to find men who would loan as high as 75 to 80 per cent of the sale price of the land, and this has enabled us to furnish money so that the small men or the men with small capital could become landowners and farmers. And this has been very vital, gentlemen, because with the high values we have had on our high land it is almost impossible for a young man starting out to become a landowner, as .Judge Green, no doubt knows that. Those are the farmers that we have been trying to help, because we have enough tenant farmers in Iowa now, and the conditions have almost become such that a Inan when he gets his farm paid for is more or less on easy street and ready to retire. Mr. Watson. What percentage fail to obtain loans from the Federal farm- loan bank and afterwards apply to the loaning companies? Mr. Allfeee. Well, I would say, generally speaking, that one-third of the farm loans in Iowa are not acceptable to the insurance companies, one-third of the loans on Iowa lands. Now, we have been able to build up an outlet for these kinds of loans where people would come in, were ihvited to come in, to our territory and become interested in tJaese securities, and willing to take the risk and take the chances. Of course, you know that they got a little higher rate of interest than the other loans, and that had something to do with it and something to do with their purchasing those mortgages. The conditions have now changed, owing to the fact that the wealthy men who have had large sums there find that they can divert their money into securities where they are not taxed. Mr. Young. Those are the men to whom you have been selling your loans? Mr. Allfeee. Yes, sir. Mr. Watson. What rate of interest do the farmers pay you on those loans? TAX-EXEMPT SECUEITIES. 169 Mr. Allfeeb. Well, the rates generally run all of the way— we have had them in 1916 down where they would be 5, 5i, and 6 per cent. , Mr. Watson. What is the rate of interest? Mr. Allfeee. How is that? Mr. Watson. What is the legal rate of interest in your State? Mr. Allfeee. Well, of course, in Iowa we can charge as high as 8 per cent. That charge can be made, but very few farm loans are ever made at any such rate as that ; and these loans heretofore have been made at a very much lower rate than that. I have one man who has put over a million dollars in loans out through my office. I think he has nearly, or close to, $2,000,000. His rate has always been 6 per cent. When the rate was 5 per cent he charged 6, but he was- willing to loan, say, $150 per acre on land worth, say, $200 per acre, and he got out of those loans a little higher rate and was willing to take the risk. Now, that very individual has told me that it would be impossible for him to continue his money on farm mortgages when he could buy tax-exempt ae- cm'ities and be relieved of the high income tax he was paying. I think he figured with me that the rate he received from these loans was a trifle over 3 per cent, although he was receiving 6 per cent interest. Mr. Hadley. Is that the reason that you say one-third of the farm loans, speaking generally, would not be acceptable to the insurance companies, that men are in this situation, and that practically one-third of the farm loans in Iowa would not be made by the insurance companies? Mr. Allfkeb. Yes ; I would think that there would be more than one-third of the farm loans that would not be acceptable to the Federal land banks and to the insurance companies and the trust companies. Mr. Hadley. And that field is to be further restricted by reason of these tax securities? Mr. Allfeeb. Those people who have got loans coming due are not able to renew those loans, and it is impossible to secure loans from these large inves- tors; and the only place that they can secure loans is from the little parties, and the outlet, as you might say, has been, of course, under these conditions almost stopped for several montlis. Now, I know of four or five foreclosures in my territory which have been caused on account of the fact that the man who has made the loan now wants his money and the parties are unable to get it elsewhere. Now, the tax-exempt securities have been responsible for this situation, be- cause they have been taking the money that has really been of the greatest aid to us In Iowa. Now, I think that the insurance companies have 65 per cent of the mortgages, and I think that the Federal land banks have loaned $25,000,000 in Iowa, which is not a great deal, gentlemen, when there Is over $1,000,000,000 of farm mort- gages in Iowa. , , , • i But none of those banks and none of those companies has ever helped a single individual to acquire a farm. They have been of no particular benefit along that line. If a man has $20,000 worth of Government bonds and wants to bor- row $10,000 on them, he does not have to worry about it. He is under no obli- gation to the person who makes the loan, and there is no trouble m getting the money. The same thing is true with regard to farm mortgages. If a fellow owns'that farm he can mortgage it to tie .joint-stock land banks, or the BeUeral land banks, or the insurance companies; but K„„<.fn- t« Mr. Watson (interposing). Has the emergency tariff bill been of benefit to your State? Mr. Allfeee. How is that? ,, ^^ , „ ,, „ Mr Geeen. Mr. Watson, this has nothing to do with the matter before the committee, and we would like to hear these other witnesses Mr Watson. The witness claims the farmer can not get loans on farms on account of the conditions on the farm, I think that my question is gerpmne Mr. Allfeee. Well, I would be glad to answer you. I think that it has helped ^°Mr. Geeen. Of course, you realize that there will be no end to it if we go into that question. , ,.„„ Mr Watson. Well, I would like to know the answer to my question. _ Mr' Allfeee. Yes ; I think it has, although you know that Iowa is strictly a corn State. We do not raise much wheat In Iowa, but we do raise corn. Mr Hawley. And beef? Mr. Allfeee. And hogs and beef ; yes, sir. 4.t,„ 4.„„f 4->,nt This is the thing that I want to bring before this committee-the fact that . it will aid the man who needs the aid. The man who needs the aid is the man 170 TAX-EXEMPT SECURITIES. who is going to be hurt the worse by the continuance of the tax-free securities, because we hav6 to deiDend upon these people with large capital who want to invest in Iowa farm mortgages, and we have depended on those people ; and, as I say, I presume that one-third of our farm mortgages in Iowa are now owned by private individuals, and, of course, he, like all of the rest of us, when he finds that he can buy something else that will furnish him with as good a security as he has, and will pay him the same rate he is now getting, and, in addition, will relieve* him of all obligations to anybody, why, of course, he is going to buy that particular security. Mr. Hawley. Mr. AUfree, there was a book published recently by Bass & Moulton entitled "America and that Balance Sheet in Europe." They make a statement that I think will interest you. They state, under the law of 1918, that where the maximum paid by persons paying in the highest brackets, which was 73 per cent, that they would need to receive an income of 14.81 per cent on their investment to equal a 4 per cent investment in tax-free bonds. Mr. Allfeee. Yes, sir. Mr. Hawlet. And by comparing that with the present law of 1921, where the person in the higher brackets will have to pay 58 per cent, their money will have to earn 9-J per cent in order to equal 4 per cent in tax-free securities. Mr. Allfhee. This is a concrete case, gentlemen. One customer of mine who has loaned money in our territory and has never exacted a higher rate on his loan than 6 per cent, tells me — and he is not an immensely wealthy man — that his income is just a trifle over 3 per cent. Mr. Hawley. Well, it is from those people that you get this money? Mr. Allfeee. Yes, sir. Mr. Gbeen. We have had another witness who has stated what you are say- ing is frequently true. Mr. Allfkee. Yes, sir. The Chaieman. Mr. AUfree, if I am correct, there were 114 people in the United States who paid the maximum under the tax of 1919. Out of 107,000,000 there were 114 who had an income that brought them into the maximum brackets. Mr. Allfeee. Well, of course, is not this a fact, though, that the men who can afford to support their Government or country anyway are taking advantage of these things when their income reaches those large figures? The Chaieman. Yes ; if they can they do. Any man is going to take advantage of it if he can save his money. Mr. Hawley. Those in the lower brackets have to get a proportionately higher rate on their Income? Mr. Allfeee. Yes, sir. The Chairman. Mr. Lyons is here, and we will hear him for a few minutes. I will have to ask you to hurry along ; we can only give you about 5 minutes. STATEMENT OE MR. THOMAS E. LYONS, OF MADISON, "WIS. The Chaieman. Give your full name and the business you represent to the reporter. Mr. Lyons. Thomas E. Lyons, Madison, Wis. I will agree to take less than 5 minutes, if it may please your honor. Mr. Peeae. I will say, Mr. Chairman, that Mr. Lyons is chairman of the State tax commission of Wisconsin. Mr. Hawley. You are a State official, then ? Mr. Fbeae. He is here without any expectation of appearing before the com- mittee. Mr. Lyons. I came to Washington in connectoin with another matter and am merely appearing here at your request, and all I want to say is that I am a mem- ber of the State tax commission. AVe of Wisconsin have had an occasion, of course, from time to time to consider this question. I do no profess to have given it an exhaustive study. I do know somewhat the attitude of the publicists and the students of taxation and the writers on the subject, and also the attitude of the National Tax Association, and from our own experience and the information gleaned in this way, all members of the commission are in favor of the prin- ciple of prohibiting the issuance of tax-free securities. That is practically all that I desire to say. I just wished that to go into the record. Mr. Hadley. Do you know the attitude of the other State officials'' Mr. Lyons. Except that Mr. Lord is present, and he is chairman of the Na- tional Tax Association and can discuss that better than I can. TAX-EXEMPT SECURITIES. 171 Mr. Geebn. Mr. Lord is here, and when you conclude we can hear him. Mr. Hadley. I did not know that. Mr. Lyons. Mr. Lord is president of tlie National Tax Association, and that ■hody, as you know, has gone on record emphatically in favor of the prohibition of the issuance of tax-free securities. Mr. Gkeen. We can hear Mr. Lord. Mr. Feeae. Mr. Lyons, any statement that you wish to add to your remarks, I think that the chairman will permit added when you revise your remarks. Mr. Lyons. Yes ; I thank you. The Chaieman. Just put anything that you have in writing and give it to the clerk, and we will be glad to incorporate it in the record with your renuirlvs. We will hear Mr. Lord. STATEMENT OE MK. SAMUEL LORD, PBESIDENT OE THE NATIONAL TAX ASSOCIATION. . The Chaieman. Mr. Lord, will you state your full name and the interests you represent to the reporter? Mr. LoED. Samuel Lord. I represent no interest, unless it be the general in- terest of the people of my State and of the country generally. I am at the present time chairman of the tax commission of the State of Minnesota, and I also at the present time hold the position of president of the National Tax Association, a body whose purposes, I tliink, probably already have been ex- plained to this committee. Mr. Teeadwat. What does the membership consist of, Mr. Lord? Mr. LoED. The membership of the National Tax Association consists of the taxing officials throughout the United States and the Canadian Provinces ; the economists or teachers or professors in a large number of the colleges in the United States, especially of the departments of economics, and people generally who are interested in the subject of taxation. Anyone can be a member of the association who desires to become a member. Mr. Geeen. As I understand, it Includes State officers, then? Mr. LoED. It does, and county officers, if they desire to be members. Mr. Teeadway. Individually or representing States? Mr. LoED. The governors under the plan of organization of the association — the governors of the various States everywhere appoint delegaes to attend the conferences, and they are very largely attended. I think that at the conference held at Bretton Woods, N. H., there were some 300 or thereabouts in attendance from all parts of the United States. Mr. Timberlake. The question has arisen here as to the probability of the States ratifying this amendment should it pass. I would like to ask you if it is your opinion that your association would be the association to be appealed to by the State officials relative to the advisability of the ratification of the amendment ? Mr. Lord. Oh, I think to some extent that would be true, and I am very sure the various tax commissioners — and there are many of them in the United States— would appeal to us and give us their views upon the subject as men, perhaps, who have given some thought to questions of this kind. Mr. Hadley. Through your contact with State tax commissioners, do you know what the attitude of the State tax commissioners is on this general subject? „ -,^,.,-11 Mr. LoED. Very generally they are in favor of an amendment which will prohiijit the issuance of tax-free securities, Mr. Hadley. Mr Hadley Have you a tabulated statement showing that? Mr. LoED. No, I have not. I did not come here for the purpose of addressing or appearing before this committee. I happened to be in the city on other mat- ters and was asked to come up and maJte this statement. I am myself m favor of the principle involved in the bills before Congress, and I feel that there is a very general sentiment throughout the country m favor of this ^""mi^^Teeadway To what extent has your association studied this question? Mr. LoKD. Manv of them have gone much more deeply into it than I have. Mr. Teeadway.' Have you taken any official action? Mr. LoED. We have, and I think the resolutions of the National Tax Asso- ciation have been placed in the record as a part of the hearings. We intended that they should be, and I instructed that copies of the resolution be fur- nished. 172 TAX-EXEMPT SECURITIES. Mr. Fkear. What was the character of the resolutions on the subject, just generally? Mr. LoED. In a general way we are in favor of the prohibition of the issu- ance of tax-free certificates and we are in favor of the proposed amendments. Mr. Hawi.et. From the information you have and knowing that it vfill re- quire the formal action of three-fourths of the States to adopt the amend- ment, do you think that there is a large proportion of the States in favor of the amendment? Mr. LoBD. AVell, I can not speak for any section of the country except the Northwest. I think that in that part of the country there is a very general sentiment in favor of the principle involved. Mr. Watson. They would be in favor? Mr. LoED. I am inclined to think that they would. Mr. Freab. The President of the United States is in favor of it in his address. Mr. LoED. And I am in accord with the President's views on the subject. I do not think there is any more I care to say to the committee. The Chairman. Mr. McFadden, do you want to be heard for a few moments? Mr. McFadden. Yes, sir. STATEMENT OE HON. LOXIIS T. McPADDEN, A REPRESENTATIVE IN CONGRESS FROM THE STATE OP PENNSYLVANIA. Mr. McFadden. From the questions propounded here by the members of the committee, it would indicate that there Is a grave doubt which exists as to whether the States will ratify tliis amendment. I just wanted to give my own thoughts on that. I do not think that that is a matter that should concern Congress at all. I think that it is the duty of Congress to turn this matter over to the States and let them do with it what they want to. If they i)ermit this economic evil to continue it is their responsibiliy and no fault of Congress. It is a national measure and unless something is done it will be the most troublesome proposition before this country inside of 10 years, if not now. We will have to deal witli it some time. Why delay it. Therefore it seems to me that it is the duty of Congress to act on this matter now and put it up to the States and let them pass upon it as they see fit. Mr. Treadwat. I do not want you to misunderstand the inquiries that I was making this morning. I was looking for information from back in the country where they came from. Mr. McFadden. No; I do not. I have some letters that will interest the members of this committee, from some of the governors of the States on this matter. I am very glad that Mr. Lord, the president of the National Tax Association, is here to speak this morning on this subject. I might say to the committee that the secretary of the National Tax Association has addressed letters to all of the governors of the States, and the responses have come here, and I have some of them in my possession. As the replies have come in from the governors they have been sent to me. I will not bother to read them, but I will state that thev approve this propo- sition so far. Mr. Timberlake. From just what States have you received letters' Mr. McFadden. Here is a letter from Michigan. I might read that It is from the governor of the chairman's State and it might interest Mr. Fordney. The Chairman. I would be very glad to have vou j-ead it (Mr. McFadden read the following letter:) State Tax Commissioners and State Boakd of Asskssorr, Lansing, January 19, 1922. Dear Me. Holcomb : I was unable to get to the governor until Tuesday I then took up the matter with him with regard to the hearing before the Ways ■ and Means Conmiittee of the House of Representatives at Washington and as a result he sent the following telegram to Hon. J. W. Fordney chairman of the committee : ' " Tlie practice of exempting Government securities from taxation is a vicious one, and I urge the adoption of a resolution of Congress providing for a con- stitutional amendment prohibiting the further issuance of tax-exempt bonds " I trust this information will be pleasing to you. B. F. BuKTLEs.s, Secretarii, TAX-KXEMPT SECUEITIES. 173 Mr. McFadden. Here is another from the governor of the State of New Hampshire : Executive Chambee, Manchester, N. li., January 19, 1922. THy Deah Mr. Hoi.comb: Your letter of the 11th instant to Mr. Hale was placed among other papers upon my desk at Ooncord and failed to come to my attention until yesterday. In reply, I have to say that I have not time to formulate my views upon the matter of tax-exempt securities, giving reasons therefor, nor do I understand that is what you desire. It is easy for me to say, and with emphasis, that I am very strongly in favor of some amendment to the Federal Constitution looking toward the pro- hibition of the exemption from taxation of Government bonds, whether issued by the United States, the States, or the nmnicipalities. The only practicable way to accomplish that result is, of course, through the Government, and so far as I am informed this is impossible without some constitutional change. Albekt 0. Brown. Mr. McFadden., I also have a letter from the State tax commission of the State of Georgia : State Tax Commission, Atlanta, Ga., January 17, 1922. Dear Sib : I received your communication witli reference to the proposed amendment to the Federal Constitution, with regard to tax-free securities, some days ago. Owing to the fact that the governor has been out of the city for several days I did not, have opportunity to talk to him until to-day. He favors the general idea of the amendment, and I understand will give out an interview to the press to that effect. He thinks probably this is better than a direct suggestion from him to our Representatives in Congress. H. .T. FULLBRIGI-IT, State Tax Gom.missioner. Mr. McFadden. I also want to put in here two or three resolutions that have been forwarded to me, one from the Indiana Real Estate Association, and an- ' other from the Ohio State Tax Commission. I want to put those resolutions in, if I may, because they illustrate their views. (The resolutions referred to are printed in the record in full, as follows :) Indiana Real Estate Association, Indianapolis, Incl., January 2li, 1922. Dear Sir: A great many people, and most certainly the realtors of Indiana, are interested in the resolution you recently introduced to propose constitu- tional amendment prohibiting the future issuance of tax-exempt securities b.v States and municipalities. At the western district convention of this association held at Crawfordsville, Ind., on January 17, which was attended by representatives from the principal cities of Indiana, a resolution was passed favoring this amendment and the curtailment of future issues of these securities. An address made upon this subject by one of our membership was particu- larly well received, and as it will be printed for distribution, a copy will be sent to your office. Veknon C. Hastings, Pi~€si(lent. Paul O. Meredith, Executive Secretary. "Resolved, that this association favors the passage of the following joint resolution pending in the Federal Congress : [H. J. Hes. 102, Sixty-seventh Congress, first session.] " The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, which shall include incomes derived from securities created by the States and their subsidiary governments issued after the ratifi- cation of this article, and salaries of all public officials, Federal as well as State, elected or appointed to office after the ratification of this article, without apportionment among the States and without regard to any census or enumera- tion: Provided, That any State having in force a general income tax under which the income derived from securities created by it or its subsidiary govern-, ments and from salaries of public officials thereof are taxable and are actually taxed, shall, after the ratification of this rticle, have the power to lay and 174 TAX-EXEMPT SECURITIES. collect thereunder taxes on income derived from securities created by the United States and its possessions and Territories and on salaries of all public officials of the United States and of such possession and Territories." Columbus, Ohio, .January 20, 1922. I hereby certify that the above is a full and correct copy of a resolution passed at a meeting of the Ohio Tax Association the 20th day of January, 1922. R. Gkaves, Assistant Secretary. Mr. McFadden. And I want particularly to call your attention to a lettei^ which I received from Frank A. Cutting, of Boston, with which he incloses a clipping taken from one of the financial journals to the effect that: " New York American (financial section) says Rockefeller Foundation took $200,000,000 of New York City bonds recently sold to Morgan syndicate." (The letter referred to is printed In the record in full, as follows:) Boston, Mass., January 21 My Deae Repeesentative : I saw an article from Washington on December 7 where you demanded of Chairman Fordney, of the Ways and Bleans Com- mittee, an early hearing on your bill. For a good many years I have been a believer of everyone paying taxes. There should be no tax-exempt bonds issued of any kind by the Government, State, city, or town. Everyone should be forced to pay taxes. As it is now, the rich and those who know how are escaping taxation which is to be made up by others. The Government bonds which are now out should be refunded with bonds that are subject to taxation. Under such a method the Govern- ment, would, of course, borrow cheaper than anyone else. It has been esti- mated that if there were no tax exempts the Government would receive $300,000,000 per year more in taxes. I inclose you a clipping taken from the Boston News Bureau. All of the big institutions purchase tax exempts. Hoping for the success of your bill, I remain, Frank A. Cutting. Mr. McFadden. Thsse are clear-cut illustrations of what happens when those big investors have money to invest. They are not investing it in real estate mortgages or farm loans, and it is affecting mortgages on city real estate as well, and in that way interferes with building homes. I also have a statement and resolutions from the National Association of Real Estate Boards. (The document referred to is printed in the record in full, as follows:) " Prior to enactment of Federal income tax legislation the National Associa- tion of Real Estate Boards believe exemption of public bond interest from taxa- tion was just and the proper exercise of sovereignty. It is now convinced that the income-tax law radically changed the conditions pertaining prior to 1913. " Doubtless there were few who projected their thought far enough to see the tremendous line-up of sentiment against the opportunity afforded persons of large means by continuing of exempt features of public bonds when the Fed- eral income-tax law went Into effect. " In our opinion there is being erected, to the detriment of the public gen- erally, and particularly In the matter of home owning and solving the housing problem, a legalized class of nontaxpayers at the very period when the Gov- ernment needs its highest revenue. This situation burdens moderately well- off taxpayers in another direction ; as public bonds are a favored investment of those of large means, it tends to induce the Government units to borrow and spend money extravagantly. " The comfortably fixed taxpayer therefore catches it from both the Federal and local standpoints, and those of large means, who are usually the buyers of municipal and other like bonds, pay no taxes. Because of the high rates of interest being paid on local public bonds, and because of the high cost of im- proving, the officials get but a fraction of the normal value of the money spent ; all of which injures the ordinary taxpayer. This condition was probably not considered by those who drafted the income-tax law. " Our association believes in taking away from those of large means the inducements which are afforded by tax exempt securities, so as to let the money flow into the ordinary business channels, including mortgages, the mak- TAX-EXEMPT SECUEITIES. 175 ing of which is necessary to promote building and home owning. As long as those of large means can obtain a fuller net return by investing in tax free securities, they will not invest in other securities, including mortgages (the income of which is not exempt from taxation) bearing the ordinary lawful rate of interest, which is generally' 6 per cent. " Being a primary source of internal revenue, the tax on income should be equalized, and at reasonably low rates, and to do so it is necessary to make the returns on public bonds subject to tax, the same as other securities. " In our opinion the Government should rely upon its own credit upon the patriotism and desire of the citizens to aid It to get its requirements normal and exceptional. I should not give further special concession or inducements by way of tax exemptions. We believe the day has gone by when it is neces- sary or desirable for the Government to continue ofCering tax exempt premiums on public loans, while it retains the income tax. "At the annual convention of our Association held last July at Chicago, 111., among other things it was " Resolved,, That it is the sense of this association that we advocate the adoption of an amendment to the Constitution of the United States, empower- ing on the one hand the Federal taxation of the income from future obli- gations of the States and their political subdivisions, and on the other hand the taxation of future obligations of the United States and their political sub- divisions, in both cases with proper safeguards limiting such taxation. " A. J. Kelly, Jr., Chairman." Mr. McFadden. I also have a copy of a statement of the secretary of the National Tax Association under date of January 19, 1922. (The document referred to is printed in the record in full as follows:) [House joint resolutions 102, 211, 232.] The Ways and Means Committee gave a hearing yesterday on the bills to amend the Constitution to permit the inclusion of income from State and local securities in the Federal income tax. Hon. Ogden L. Mills, Representative from the State of New York presented the resolutions adopted by this association at Salt Lake City and Bretton Woods made a very able statement to the committee on the subject. The Indications were that a considerable majority of the members of the com- mittee is decidedly favorable and it now remains to follow up the matter by individual effort. It would be distinctly advantageous for members occupying official positions in the States to write the committee, expressing approval of the general principle involved. A suggestion of a point of view is that the proposed amendment is not in reality anything more than an extension of the sixteenth amendment, to make that amendment accomplish what was intended, i. e., make it possible to have a fair, equal, and just Federal income tax. The reciprocal feature which would permit the States to tax Federal securities, by income taxes, is not in reality to be considered as an essential quid pro quo. It is a wholly different proposi- tion, but one which it would seem perfectly proper to consider at the same time. The States should be enabled to secure effective and just State income taxes if they desire them and they should not be confronted with the difficulty of exempt securities. ' , . ^ ^ ,, The Ways and Means Committee and Congress ought not to hesitate to allow the States to exercise their choice in enacting this legislation. Their position ought certainly to be favorable to giving the States the chance to vote on the matter. Some of the committee seem inclined to think that in some way they are imposing this thing on the States. This is not so ; they are merely lettmg the States say whether they favor the proposition. Januaey 19, 1922. House op Repeesentatives, Washington, February 13, 1922. Dbae Me. Foednet : Supplementing my statement before your committee in connection with the consideration which you are giving to the subject of the ' repeal of future tax-exemption rights, and following out the suggestion of one 176 TAX-EXEMPT SEOUBITIBS. of tlie members of your committee, I beg to hand you herewith copies of replies from 27 governors, to whom I sent the following telegram : "An Immediate expression by wire is desired of your approval or views of' resolution now being considered by Congress to amend Constitution to prohibit the economic evil of further issuance of tax-exempt securities by the United States, States, and municipalities, in conformity with President Harding's last message to Congress. Your expression will be received as indicative of possible favorable action by your State in ratification of this amendment when passed by Congress." The governors from 15 States have either replied direct or through their instructions that they are favorable to a constitutional amendment repealing tins right. These States are as follows : Idaho, New Mexico, Arizona, Colorado, Kansas, Michigan, Montana, Nebraska, New Hampshire, Arkansas. Indiana, Alabama, Delaware; Utah, and Georgia. Seven replies are noncommittal and are from the governors of the following States : Mississippi, Louisiana, Oregon, Vermont, West Virginia, Wisconsin, and Missouri. Six replies are against the proposal and are from the governors of Maine, Kentucky, Oklahoma, Rhode Island, Maryland, and Massachusetts. In addition to the above two governors are reported to be away, and no atti- tude is expressed. I am also inclosing herewith copy of resolution favoring the enacting of a con- stitutional amendment providing for taxation of future issues of national. State, and municipal securities by the House and Senate of the State of Ne- braska. AVhen further replies are received from the governors of the remaining States I shall be pleased to forward you copies of their expressions. I shall be pleased, Inasmuch as this information was asked for by your com- mittee, to have this letter and the copies of the inclosed telegrams and resolu- tion placed in the record of the liearings on this subject. At this time I also want to call your attention to a decision handed down by the United States Supreme Court on January 30, 1922, in the case of Gillespie V. State of Oklahoma, which has a direct bearing on this subject. This decision settles definitely that a constitutional amendment is absolutely necessary in order to include income from public securities in Federal and State income taxes, and answers finally the question raised by many learned lawyers as to whether or not prior to this decision a constitutional amendment was necessary. L. T. McFadden. (The documents referred to are printed in full, as follows:) " [Telegrams.] Boise, Idaho, January 31, 1922. Am favorable to resolution amending Constitution prohibiting issuance of tax-exempt securities. Believe the great majority of Idahoans of this opinion. D. W. Davis, Govei-nor. Santa Fe, N. Mex., January 31, 1922. Sentiment here very generally approves resolution to amend Constitution to prohibit issuance of tax-exempt securities. I suggest a proviso that taxation of such securities, as between those of the United States and States and munici- palities, be required to be uniform, so that those of the States and municipalities can not be discriminated against by Congress, Meeuitt C, Mechem, Governor. Phoenix, Akiz., February 1, 1922. Personally I approve discontinuing issuance of additional tax-exempt se- curities, recognizing great necessity for such procedure. Until this is done the money which should be going into industry is diverted to nonproductive channels. However, I can not presume to speak for the State of Arizona, or the communities which go to make it up, on this important question. In my opinion it will require much more of an educational nature before this State and its various communities will be willing to forego enjoyment of this privilege. Thomas E. Campbell, Governor. TAX-EXEMPT SECITEITIES. 177 Denver, Oolo., January SI, 1022. In regard to Constitution of United States being amended so as to provide for the taxation of State and municipal tax-exempt securities, I most earnestly favor such amendment. These securities, next to bonds of our National Gov- ernment, are the very best in existence. For tlie Constitution of our Nation or States to be so framed that the best wealth in existence is exempted from taxation appears to me to be the height of Inequality and injustice. I most heartily concur in the recommendation of President Harding that this gross inequality should be speedily corrected. Any improvement in our tax system which tends to justice and equality will assist all lines of commercial business. O. H. Shoup, Oovernor. ToPEKA, Kans., January 31, 1922. I favor most emphatically the recommendation of President Harding in his message of December 6, and hope the Congress will submit a proposal looking to the amendment of the Constitution so as to enable us to prohibit whenever desirable an issue of tax-exemept securities. Henky J. Allen, Governor. Lansing, Mich., January 31, 1922. January 17 I wired Congressman Fordney : " The practice of exempting Gov- ernment securities from taxation is a vicious one, and I urge tlie adoption of a resolution of Congress providing for a constitutional amendment pro- hibiting the further Issuance of tax-exempt bonds." This expresses my views. Alex. J. Geoesbeck, Oovernor. Helena, Mont., February 1, 1922. I believe overwhelming sentiment of this State is favorable to prohibition of further Issuance of tax-exempt securities. The great danger attendant upon creation and holding of many billions of dollars of wealth that can not be taxed and in this way escape bearing its proportionate burden of government has alarmed most thinking men and women. Jos. M. DixoN, Oovernor. Lincoln, Nebk., February 1, 1922. Both houses of State legislature in special session assembled have just adopted unanimously a resolution opposing the further issuance of tax-free securities. This meets with my hearty approval, and I believe is in perfect accord with the sentiment of a very large majority of the people of this State. Samuel R. MoKelvie, Oovernor. CoNCOED, N. H., February 2, 1922. Ten years' service as chairman of the New Hampshire Tax Commission has convinced me that the further issuance of tax-free national, State, and municipal securities is extremely unwise ; therefore I favor some constitutional amendment for prohibition thereof, and believe this to be the sentiment of my State. Albeet O. Beown, Oovernor. Little Rock, Aek., February 1, 1922. Answering your telegram, I think Arkansas would ratify proposed amend- ment to the Constitution to prevent further issue of tax-exempt securities. Thomas C. McRae, Oovernor. Indianapolis, Ind., February 1, 1922. I am in favor of a tax measure prohibiting issuance of tax-exempt securities in ex^esl of a rate of 4 per cent. I am also opposed to securities of any kind exempt from Income tax. I approve of resolutions 211 and 10-. Wakren T, McCeat, Oovernor. 93671—22 12 178 TAX-EXEMPT SECURITIES. MoNTGOMEBY, Ala., Fedruafy 2, 1922. Message just reached me. I heartily indorse movement to amend Constitu- tion to prohibit furtlier issuance of tax-exempt securities by the United States, States, and municipalities. When National, State, and city Governments were weak the policy of exempting their securities was probably wise, as affordmg encouragement to investors. That reason no longer exists, and therefore spe-, cial favors to investors in Government securities should be withdrawn and large holders of wealth should be compelled to bear their just share of cost of govern- ments whose benefits and protection they enjoy. Thomas B. Kilby, Governor. DovEK, Del., February :., .. I heartily approve the President's policy with reference to tax-exempt securities. A. R. Benson, Secretary of State. Salt Lake City, Utah, February 1, 1922. Sending comprehensive statement my views of issuance of tax-exempt security by special delivery. Chakles R. Mabey, Governor. Salt Lake City, February 1, 1922. Deae Mk. McFadden : In response to your telegram of January 31, I have wired you as follows : " Sending comprehensive statement my views on issuance of tax-exempt securities by special delivery." Supplementing the above I am pleased to submit the following statement: Fundamentally, I am opposed to the principle of tax-exempt securities, but, of course, conditions, particularly local conditions, may alter cases. The elimination of the exemption feature would necessitate higher interest rates on mortgages as well as State and municipal securities, although I believe generally mortga.ges are carrying about as high a rate as the law will permit. In the absence of higher interest rates, taking into consideration the strength of the debtor, or, in other words, his assets and ability to pay, there undoubt- edly would be some difiiculty in marketing the securities. Necessarily, this advance in interest charges would be reflected to the taxpayer through tlie levies. Our situation in Utah may be a little peculiar, to the extent that the elimi- nation of the exemption feature may be subject to debate. The situation is this : We are not heavy investors in securities of any kind — we depend upon the eastern money markets largely to supply us with funds for public improve- ments as well as capital with which to develop our resources. Were our people heavy holders of securities, of course, the increase in our valuation would permit lower levies and probably the additional funds required to meet ad- vanced interest charges would not be felt by individual taxpayers in general. But under existing conditions New York and other outside States would collect the tax on our securities and our taxpayers would have to supplv the where- with to meet the advanced interest rates. But on the whole I am not certain but that this condition would be offset. If securities were not tax exempt then more money certainly would be available for industrial development and certainly the rates would not be higher. What we need in this State most of all is more money with which to develop our natural resources. If this money could be made available through the elimi- nation of tax-exempt securities then we would get more physical property on the tax rolls, more people to support the Government, and generally a wider distribution of the burden. Of course such exempt securities as already are issued would remain tax exempt, but new issues must meet the new situation. I am inclined to the opinion that the new money released for development and the work which I believe would be undertaken would more that offset any handicap we might experience as a result of advanced interest charges within the course of a few years. Charles R. Mabey, Governor. '' TAX-EXEMPT SECUBITIES. 179 Jackson, Miss., Januarp SI, 1922. Am not In position to venture an opinion as to what our people tliink of the tax exemption of securities. Lee M. Russell, Oovemor, Baton Rouge, La., January 31, 1922. Your telegram received. On request of Chairman Fordney, House Ways and Means Committee, Louisiana banliihg interests have appointed representatives to appear before that body when called upon to present views on movement to remove tax exemption in all future issues of public securities. I think it best to leave those representatives free to present views of Louisiana financial inter- ests without suggestions from' me. Thanks for your message. John M. Parker, Governor. Salem, Oeeg., January 31, 1922. Any opinion I might express as to tax-exempt securities would be purely personal, as ratification of such amendment solely legislative function. For every reason you offer that statement by me might be construed as indicative of legislative sentiment, must decline to ofl:er views. Ben. W. Olcott, Governor. MoNTPELiEE, Vt., February 1, 1922. Gov. Hartness does not care to express his view of resolution until he has given the matter further consideration. Henry B. Shaw, Secretary. Charleston, W. Va., February 3, 1922. Have publicly requested interested parties to advise your committee of ex- isting sentiment on proposed amendment to prohibit tax-free securities. Find opinion divided on subject. Some believe proposed legislation would require States to increase rate of interest on bond issues amounting to indirect taxation on property in States for support of Federal Government. Others believe it would eliminate advantage State now possesses over Individuals and thus foster private enterprise and industry. B. F. Morgan," Governor. Madison, AVis., January 30, 1922. . Wisconsin Senators and Representatives will be held responsible on their attitude regarding taxation of State and municipal securities. John J. Blaine, Governor. Jefferson City, Mo., January 31, 1922. Last advice from Governor Hyde he was at Washington Hotel, Washington, D. C. Hiram Lloyd, Acting Governor. Augusta, Mb., January 31, 1922. The Federal Government is gradually encroaching upon the • sovereign rights of the several States, and I have grave doubts as to the wisdom of further con- stitutional amendments that will take away from the States the control of their own affairs. Percival p. Baxter, Governor. Frankfort, Ky., February 1, Am opposed to any change in the law which will permit Federal Government to tax securities issued by the State or any municipalities thereof. Feel that such an act would be an invasion of taxing territory not authorized by good policy. Edwin P. Morrow, Governor. 180 TAX-EXEMPT SECUBITIES. Oklahoma City, Okla., February 1, 1922. • I doubt the wisdom of the proposed amendment to the Constitution exempt:_ ing from taxation securities of the United States and municipalities, as rec-" ommended in President's message to Congress. To me the problem is as broad as it is long and what we would gain in one direction we would lose in an- other. However, I have not had time to give the matter very careful considera- tion and my judgment may be of little value by reason thereof. J. B. A. Robertson, Governor. Peovidence, R. I., February 3, 1922. Referring to your telegram of January 31 regarding constitutional amend- ment to prohibit further issuance of tax-exempt securities, wish to advise that I am personally opposed to the proposed amendment, as I believe it would work a revolution in our form of government, would be a highly undesirable extension of the power of the Federal Government, and would destroy the fundamental plan on which our Government is founded. It would sweep aside the barriers laid down by John Marshall a hundred years ago, and would be a long step toward a centralized government. I hope the amendment will not be adopted. Emery J. San Sotjci, Governor. Boston, Mass., February 7, Massachusetts opposes permitting United States to tax State and municipal securities. Channing H. Cox, Governor. .Annapolis, Md., February 4, 1922. Dear Mr. McFadden : I received your telegram of January 31, and sickness prevented my answering it promptly. I am afraid I can not send you my approval of the proposition to tax future issues of State and city securities, be- cause I am not inclined to favor it. Albert C. Ritchie, Governor. Whereas Joseph W. Fordney, chairman of the Comm'.ttee on Ways and Means in the National Congress, has wired Gov. McKelvie as follows : " Does your State desire to send representatives to present its views at hearing now being held by Committee on Ways and Means on proposed constitutional amend- ment providing for taxation of future issues of national. State, and municipal securities? " and Whereas it is generally recognized that the exemption of billions of dollars of securities from taxation has provided an avenue of escape from taxation to those who desire to invest in such securities ; and Whereas if this plan of exemption from taxation is to be continued, the result will be that the burdens of taxation will fall most heavily upon productive capital and relieve nonproductive capital from its fair share of taxation : Be it therefore Resolved, That it is the sense of the Senate of the State of Nebraska that provision should be made against a further continuation of this form of tax exemptions, and that, if necessary so to do, an amendment should be made to the National Constitution so providing. Mr. Watson. May I a.sk a question? Mr. MoFadden. Yes, sir. Mr. Watson. It has been stated the farmers are opposed to tax-exempt securi- ties. Are bankers also? Mr. McFadden. Tliey are. You will find in the hearings a statement from the Investment Bankers A.ssociation of the United States in favor of the constitu- tional amendment. The bankers generally throughout the country with whom I have been in touch are heartily in favor of it. Mr. Hadley. You mean all bankers other than investment bankers ' Mr. McFadden. All bankers. Mr. Frear. I would suggest here that you attempt to secure these letters from the governors as soon as possible, and that you telegraph them immediately so as to have them incorporated with your remarks, such reports as you get from TAX-EXEMPT SECUEITIES. 181 various sections tlu-oiigliout tlie country. Tliat would give a general under- standing as to .how they feel on the matter. Mr. McFadden. Thank you for the suggestion. I will be very glad to do that :ust as soon as I leave the committee this morning. Now, with regard to the effect of exempting from taxation, Government bonds will be the highest-grade securities in the market and next will be the farm loan and high-grade municipal bonds and then the usual established order of high-grade securities will follow. I believe that particular advantage will accrue to the farmers in the sale of farm-loan bonds by the removal of this tax exemption. It will permit those securities to really become established as next to Government securities in a higher average, and I believe that they will receive a benefit by the removal of this tax exemption which will more than compensate for anticipated losses. Mr. TiMBBEEAKB. You heard the statement made by Mr. McKenzie, as to the statement at the conference made by Mr. Lever, that he would recommend the exemption of the farm-loan bonds? Mr. McFaddbn. Yes, sir. Mr. TiMBEELAKB. What is your opinion? Mr. McFadden. My own opinion would be that it would be an unfortunate thing to do. I think that the tax-exempt feature ought to be entirely removed. I believe that the sale of farm-loan bonds would not be interfered with. They would be placed next to Government securities. I do not think that they should be placed in the market above that of Government securities, but they will rank next to them in spite of anything, and as the money market gets back to normal they will be correspondingly benefited and will be sold on a much more favorable basis. Mr. Hadley. Your Idea is that it is a power that should be reciprocal, both Federal and State? Mr. McFadden. In order to get a ratification I think that is necessary. Personally, I would not do it unless it were necessary. Mr. Hadlet. I wanted to get your opinion on that. (Whereupon the committee adjourned.) Committee on Ways and Means, House or Kepeesbntatives, Tuesday, March 7, 19BS. The committee met at 2.30 o'clock p. m., Hon. William K. Green presiding. Mr. Geeen. The purpose of the meeting to-day is to hear the representatives of the States on the subject of the proposals before the committee relative to tax-exempt securities. Are there any State representatives present? [After a pause.] Mr. McFadden, of Pennsylvania, has something to say, and the com- mittee will be glad to hear him. 'STATEMENT OF HON. LOUIS T. McEADDEN, A REPKESENTATIVE IN CONGRESS FROM THE STATE OF PENNSYLVANIA. Mr. McFadden. I just wanted to make one further statement to sum up. At the meeting when I was last before the committee the suggestion was made by some member of the committee that I communicate with the governors of the States in regard to this matter. I did communicate with them and I have, from time to time, sent this information to the chairman of the committee. I sent communications to 48 governors, and I have heard from 30 of them. Sixteen of the governors are favorable, 7 have reported against, and of the 30 replies which I have received 7 were noncommittal. Mr. Gaeneb. Did you send them a copy of the proposed amendment? Mr. McFadden. No ; I wired them the substance of it. I have already put in the record a copy of the telegram which I sent. I asked them to express them- selves. Of course, I realize, as you members do, that answers are simply the expression of one man in each of the States. Mr. Hawley. Did the governors indicate, when they wrote you,, that they expressed their personal opinions, or did they say they thought it was the general opinion in the States they represented? Mr. McFadden. Most of them simply expressed their own opinion. In some Instances— I have filed this information with the committee— the State legisla- ture, both the house and the senate, have gone on record in favor of it. I am 182 TAX-EXEMPT SECURITIES. in receipt of some telegrams to-day. Here is one from tlie Brookings Bank df Soutii Dakota. It says : " Bankers, business men, and farmers in favor of legislation toward discon- tinuance of continuous offerings tax-exempt securities and urge legislation along this line as proposed by farm-mortgage bankers' associations and others. G. J. Flittie, cashier." Here is another one, from New Orleans, from the chairman of the committee of the Louisiana Farm Mortgage Bankers' Association of America : " The people of Louisiana are, in my opinion, overwhelmingly opposed to tax- exempt securities and favor your bill (McFadden bill) for a constitutional amendment stopping their future issue. If I can be of any service, command me." Here is another one from Topeka, Kans., from the Kansas Bankers' Asso- ciation : " A year ago seven groups out of eight of Kansas bankers' associations passed resolutions favoring repeal of all tax-exempt securities, believing it to be the most unjust law on statutes, permitting wealthy to evade their .iust proportion of taxes and placing burden upon those least able to bear it." Mr. Hadley. Have you a memorandum of those, so that you could just state it at this time? Mr. McFadden. Of the States that are in favor? Mr. Hadley. Yes. Mr. McFadden. I have that right here. The States that have expressed them- selves in favor of an amendment are Idaho, New Mexico, Arizona, Colorado, Kansas, Michigan, Montana, Nebraska, New Hampshire, Arkansas, Indiana, Alabama, Delaware, Utah, Georgia, and Minnesota. Those against are Maine, Kentucky, Oklahoma, Rhode Island, Maryland, Massachusetts, and Connecti- cut. The balance of the States have not expressed themselves. Mr. Hawley. Read those that are noncommittal. Mr. McFadden. Mississippi, Louisiana, Oregon, Vermont, West Virginia, Wisconsin, and Missouri. Now, Mr. A. E. Holcomb, secretary of the National Tax Association, has been giving a good deal of thought to this matter. I do not know but what he may have sent to this committee a suggestion for an amendment. I realize, as you men do, the difficulty to get a proper wording to express just exactly what we are after and, with the view that this may be helpful, I am going to submit the language of his amendment to you now : " The United States and the several States, respectively, shall each have power to tax Incomes derived from securities issued, after the ratification of this article, by or under authority of the other : Provided, That no discrimina- tion is shown in such taxation." Now, there could also be added to that — but I think, perhaps, it could well stop right there — the following words, " in favor of the securities of the one and against those of the other." I just offer it as a suggestion when it comes to drafting the bill. It is the, subject-matter we are trying to cover, and I offer that as a helpful suggestion to you. Mr. Gaknee. That still leaves the Federal Government the power of levying a tax upon the incomes of State and municipal securities, including its power to prohibit their issue. Now, if you would include in that amendment Mr. Gkeen. Why do you say it gives the power to prohibit? Mr. Gaknee. Because it does. If Congress should determine this year, for in- stance, that the Federal Government would probably not issue any securities for the next five years and should levy a tax on the income from State, municipal, and Federal securities, of 50 per cent, we will say, that would virtually stop the issuance of all securities during that time, until that law was repealed. Now, if your amendment said that Congress could not levy a hiaher rate upon' the in- come from State and municipal securities than it 'did upon other propertv, I think you would protect the States a good deal ; but you do not do that. Every one of these amendments refers only to the income from State, municipal, and national securities. Certainly Congress should not have the power to levy a higher rate of tax upon the income from national, State, and municipal securi- ties than it does upon other property. Mr. McFadden. In this amendment I have suggested here, it reads- "Pro- vided, That no discrimination is shown in such taxation." Mr. Garner. That Is between the two securities; that is the national and State securities. TAX-EXEMPT SECUBITIES. 183 Mr. McFadden. I realize that. I can not imagine, in the wildest moment, that the United States would levy a tax of 50 per cent. Mr. Gabnee. a great many people who adopted the original Constitution did think so. Mr. Gbeen. I would not have thought it was within the purview of the wildest imagmation that that could be permitted under that amendment. No amend- ment that has ever been proposed would permit that unless a similar tax was levied on the securities of the Government. Mr. GAiiNEE. If it is- not within the purview of the wildest imagination, why not put it in the amendment to the Constitution ? Mr. Gbeen. You could not put it in that form. For example, we do not tax Income from corporation property the same as we do other income. Nor can we put in an amendment everything that somebody can imagine. It would take volumes for a single amendment. Mr. Gabnee. Well, you could limit it to income from any other securities. Mr. McFadden. Why do you not put a limitation upon all taxable sources? I just have this additional to say: These hearings have been pretty ex- terisively advertised to people all over the country ; there has been a very wide publicity given to these hearings and there has been general notice given to the people throughout the country that the Ways and Means Committee was considering this matter. The President has indorsed this proposition; three Secretaries of the Treasury have indorsed it ; the bankers, investment bankers, farm-mortgage bankers, public utility interests, American and investment and mortgage bankers, boards of trade, chambers of commerce, and farmers' organizations pretty generally — although there is some slight amendment which the farmers' organizations want to make, exempting farm-loan bonds — have indorsed it, and practically all of our economists, I think without exception, are in favor of a constitutional amendment to remedy this situation. And it seems to me, inasmuch as the committee has sent out word to the governors of the States, and they have not put in an appearance here to-day, it shows they are in favor of action by the Ways and Means Committee, or else are not very much interested in opposition, and I believe it is a responsibility the Ways and Means Committee has to now put this up to the States. That is the way you will get a real expression from the State as to whether they want this, or not. It seems to me, also, we should not continue to permit the States to defeat the purpose of national-revenue legislation. I mean by that, that the needs of the Government are such that they levy taxes upon those people who are the best able to pay and, at the same time, we are permitting the States to furnish an avenue of retreat for those people who should be paying taxes, to escape by putting their money in tax exempts. Now, I think this is a critical thing that ought to be considered, whether or not we are going to continue to permit the States to enact legislation to create vehicles for people that the United States wants to tax to escape taxation. That is exactly the predica- ment in which we are, and I hope the committee wiH consider this matter promptly and give the States an opportunity to vote. I believe the States and the people of the country want action and the chance to vote on this amendment to the Constitution. Mr. Fbeae. What information do you get, Mr. McFadden, from the States regarding the sentiment on this bill? Mr. McFadden. There are three or four ideas before you. I do not want to dictate or to attempt to dictate the form of the bill ; I want to be helpful to the committee. Mr. Fbeae. What information have you received? Mr. McFadden. I have made several suggestions here, and there are other suggestions here as to the form of the bill. I would say 98 per cent of the people from whom I have heard and 98 per cent of the comments that have been made in the press, which I have noticed, are in favor of action by this committee to submit this amendment to the States. The comment is practically all in favor of Mr. Fbeae. Substantially along the lines of your resolution? Mr. McFadden. Yes. Mr. Feeae. Those governors against, that you have mentioned ; have you placed in the record where those governors are from? Mr. McFadden. Yes. That has already been sent to the chairman of the ■committee, and he informed me their telegrams and statements would be placed in the record. 184 . TAX-EXEMPT SECURITIBS. This further thought occurs to me. I just had a letter this morning from Dr. 0. J. Bullock, of Harvard University— I guess he has been here Deiore your committee— one of our leading economists, and he wanted to comedown to this hearing. He expressed a very great interest in it and feels it is one of the important things that should be considered favorably. He is decidedly in favor of it and asked me to express that view to the committee. Mr. Fbeae. Have you any suggestion to offer to the committee as to what shall be done in the interim, before such an amendment could be adopted by the States, to meet the situation? Is there anything that can be done? Mr. McFadden. I do not see how it can be reached in any manner whatso- ever except by a constitutional amendment. I think the recent decision in the case of Oklahoma v. Gillespie has a bearing on it, and I think that is al- ready in your minutes and it would be well worth while to look into this de- cision. Mr. Feeab. There has been a suggestion urged very vehemently upon the committee that we adopt a strong inheritance tax, together with a gift tax, as the best alternative at present to reach the situation. Mr. McFadden. I will say to the gentleman I have not gone into the matter at all, and would not want to express myself on that. Mr. Hawley. The clerk has a brief here from Messrs. William W. Beet and J. Bnos Eay, members of the Maryland State Tax Commission. I suggest that it be printed in the hearings. Mr. Geeen. Without objection, that will be done. (The matter referred to is as follows :) Statement by William W. Beck and J. Enos Ray, Membeks of the State Tax Commission of Maryland. The State Tax Commission of Maryland, the highest taxing body in the State, lodges an objection to the proposed Federal amendment whereby the income from future issues of national, State, and municipal securities shall be tax- able. Naturally, our statement is for the benefit of the several States and the securities issued by them, without reference to what the Federal Government may choose to do with its own securities. The former is a matter for the States to present arguments, while the latter is a matter for the Federal Congress. We have only to go back a little way to remember that the first income tax law enacted by the Congress was pronounced unconstitutional; and, if we recall correctly, the ground of its unconstitutionality was that it levied a tax in violation of the Constitution, which provided that " direct taxes shall be apportioned among the several States which may be included within the Union according to their respective numbers * * *." Finally, the amend- ment to the Constitution authorizing the taxation of incomes was adopted by the required number of States. With that amendment, however, as a part of the law of the land, we are also correct in recalling that the Supreme Court has announced the salutary rule that with the adoption of the amendment the Gov- ernment gained no power to subject to a tax that property which it did not already have the right to tax, and that the main feature of the amendment was to avoid the " apportionment " provision of the Federal Constitution. Cer- tainly that must be true, otherwise it would not now even be suggested that it, would require a constitutional amendment to subject to taxation the income from State securities. Considered and construed in the light of whether the tax is to be imposed by the General Government or by the several States, the fact remains that the power to impose the tax is limited by the fact that the States and the Union are inseparable. Fundamentally it was contemplated that the maintenance perpetually of both the Federal Government and the several States depended upon the actions of each being unembarrassed and unimpaired in the right of taxation by any action of either. One of the essential functions of the States is to borrow money upon the faith and credit of the particular State and the taxation of such securities if admitted, even for so slight an amount, can be carried to the extent that the functions of the State in this regard might altogether be embarrassed and paralyzed. It has been suggested that the exemption of State securities from taxation puts commercial capital of private enterprises at a disadvantage. If this is true now, and we may accept it as true for purposes of the argument, it was true in t^e beginning when private capital was first employed, and the only difference is In one of degree ; that is to say, that the increase of population TAX-EXEMPT SECURITIES. 185 and that the Increase of the wealth of the people of the Government, when private enterprises demanded and employed more capital to conduct their enter- prises. That is as much true of private enterprises as it is of the States. With the increase in population and the progress of humanity, the States are obliged to make internal improvements, and these internal improvements are for the benefit of all, and by virtue of that fact alone, the State should be permitted to issue its bonds and to borrow money upon the faith thereof and to leave that power untrammeled and unembarrassed by any taxation and by virtue of the employment and use of public funds for public purposes they should have an advantage over private capital. Much more could be said both fundamentally and in favor of public capital as against private capital, but at least the foregoing represents a general view and a general objection to the proposition now advanced. What has been the policy of the Federal Government and the States since the adoption of the Constitution should be the continued policy of the Federal Government and the several States. By arguing for a continuation of that which happens to be a fundamental principle in the establishment of all government, we also argue for the maintenance of what might be termed a last vestige of State rights. We do not have to necessarily attribute to the founders of the Government, in the words of Thomas Jefferson, " a wisdom more than human and suppose what they did to be beyond amendment," for the maintenance of the general scheme in the matter under discussion. Certainly it is true, however, that to those who ■ worked out the general principles of our Government must be attributed great wisdom ; and the principles, if true at the time of the adoption of the Constitu- tion in this particular regard, are true to-day, even though wealtli has increased far greater than what the founders might even have conservatively predicted. Mr. Gabnee. Mr. Chairman, I desire to submit for the record a letter from Hon. Hubert F. Fisher, inclosing a letter and an argument by Mr. C. C. Pashby, president of the National Association of Comptrollers and Accounting Officers. (The matter referred to is as follows:) HorrsE or Repbeskntatives, Washington, February 10, 1922. Mt Dear Mr. Garner : I am inclosing herewith letter and statement from Mr. C. C. Pashby, president National Association of Comptrollers and Account- ing Officers, Memphis, Tenn. Mr. Pashby is very much interested in the defeat of the McFadden bill, and I would appreciate it if you would have the inclosure incorporated in the hearings before the Committee on Ways and Means. Cordially, yours, Hubert F. Fisher. National Association of Compteoliebs and Accounting Oej-ioers, Memphis, Tenn, January 30, 1922. Dear Mr. Fisheb: I beg to acknowledge receipt of the clipping which you sent me this morning, and inclose some comments on this subject of taxation of incomes from municipal bonds. I would thank you to get one copy into the hands of the Committee on Ways and Means and use the other in such way as you deem best. Tours, very truly, C. C. Pashby, President. To the Ways and Means Committee. Gentlemen: The National Association of Comptrollers and Accounting Officers is representative of those officers in a class of government, that, prior to the breaking out of the World War, had to do with the expenditures of amounts of money yearly that equaled the corresponding annual expenditures of the United States Government. That is to say, during the seven years prior to our entrance into the war, 1910 to 1916, the revenues of the general Govern- ment were (expressed to the nearest million in dollars) 617, 629, 627, 658, 668, 617, and 711, respectively ; and during the same time the receipts of cities of over 30,000 inhabitants were (expressed in the same manner) 760, 806, 849, 866, 1914 missing, 940, and 995 for 1916. These facts are quoted from the Annuals of the American Academy of Political, and Social Science, May, 1921, number. Now, except for the heavy war debt contracted, there is no conceivable reason why the per capita cost of the General Government should be any heavier 186 TAX-EXEMPT SEGUKITIBS. at this time than it was prior to the war. In fact if the reductions of Am^^^ ment Conference produce hoped-for results the cost of the national defense should be very materially reduced. I refer to the real ^f t f Me the clian^s in the currency should leave the tax collector and the taxpayer m tHe same relative position. , ^ „ „ „„„„i/iQr,<- nf My credentials are the fact that I am serving a second term as president ot the above-named comptrollers' association. I desire to register a;^ protest on behalf of the cities and all other subdivisions of the State against the adoption of a resolution by the Congress proposing any amendment to the Unitea btates Constitution looking to the laying of a tax on incomes derived from investment in notes, bonds, or other forms of indebtedness Issued by the btates ana tne subdivisions thereof. t. ^ 4. ■ In approaching the consideration of this question, the most salient tact is the alignment of forces having an interest in this proposed amendment. The undisputed fact In the discussion is the passing on to the city treasury of this income tax by the purchasers of the obligations of the cities. The im- mediate result will be to raise the rates of interest paid by cities and other subdivisions to the level of rates paid by private individuals and by firms and corporations. Some bankers say that whatever difference, if any, existed would be against the cities. If this proposition goes through we shall have to write our budgets so as to show, first, the amount of interest on bonded debt, and, second, the tax levy to cover the city's creditors' income tax on that Interest. To carry this plan to the logical result, let the cities and the States entirely relieve the General Government from contact with the taxpayer by adopting an amendment author- izing Congress to levy on all the minor governments an impost of from $1 to |3 for the Federal Government for every dollar collected for local use. This arrangement would, at least, be free from camouflage and would give the indi- vidual taxpayer a better conception of how the arrangement works. It should be borne in mind that cities and other minor divisions of the gen- eral scheme of government in this county are not organized for profit. They collect no revenues for purposes other than their day-to-day requirements and the repayment of borrowings for permanent betterments. As intimated above, this proposition gets its chief support from some highly theoretical writers on taxation and from the classes of borrowers who desire to obtain the money of other people at the lowest possible rates for use in their ventures for personal or corporation gain. Thus the man who borrows to erect a dwelling or a factory, buy a farm or construct a railroad will weigh the relative advantages, making his contribution to the Federal Government through one of these lenders or a part of it through those who lend moneys to his city. ' Much has been said since the income tax attained present proportions about , investors being driven out of the field of business ventures and into the whole- sale purchase of tax-exempt investments. This , claim is without foundation. In the first place, there is no agreement among those making this claim as to the whole amount of these tax-free investments extant. They are variously estimated at from ten to thirty billiort. The. annual production of wealth has been estimated in congressional de- bates at about fifty billion and Literary Digest published an estimate of up- ward of seventy billion. Edward Atkinson, writing years ago, estimates a yearly wealth production of $200 per capita. His dollar was worth more than our dollar and our facilities for creating wealth are better than those of the eighties. So the present estimate in debate is probably nearly correct. Ten per cent is often taken as the proportion of new wealth available for investment, and it is a very significant fact that out of this five billion minimum ■of new wealth available for new ventures the cities of the country, together with the States, Territories, and similar possessions, have, according to the Bond Buyer, absorbed on an average for the six years 1916 to 1921 six hundred and seventy-six million only per year. Approximately two hundred and sixty- three million were issued in 1918, and approximately one billion three hun- fired and four million were issued in 1921. When it is realized that a large proportion of State and municipal bor- rowings are merely refunding operations it is plain that there has been no serious interference with borrowing for private and corporate purposes. More- over, the rates which city and State Governments have had to pay during the past two years do not indicate any mad scramble for their paper.' TAX-EXEMPT SECUEITIBS. 187 Contrasted with this showing for State and municipal Issues is the report of corporation financing during 1920 and 1921. The Wall Street Journal shows $3,324,922,000 of new issues for 1920 and $2,780,874,000 of new issues for 1921. These are not tax exempt, while the smaller issues of States and cities are tax exempt. Starting at the conference called by the National Department of Labor at the White House March 3, 4, and 5, 1919, every possible pressure and Inducement has been brought to bear on cities to issue bonds and do work of every kind from eleemosynary motives. By speeches, resolutions, and to some extent by advertising communities have been urged to borrow and build. Build to furnish work and to create a market for material. Build streets, bridges, sewers, conduits, drains, schoolhouses, water supplies, town halls, hospitals, etc., even beyond immediate needs. And now the backwash has set in in the demand that there be an income tax on future issues of such bonds. If I may be permitted to submit a constructive criticism I would, except for the debt service and the present diminished purchasing power of the dollar, see our National Budget reduced to the per capita average of, say, 1914 to 1916. So far as the debt service is concerned I believe that the Federal farm-loan plan offers the best solution. AU issues should, as rapidly as they mature, be refunded into obligations which, shall be amortized in, say, 50 years. Such a program as this would remove some of the present pressure and help a return of normalcy. A word about the so-called " contributions " from the Federal Treasury to localities. The time was when they were regarded as a kind of largess, like money from home, but this dreamy stage has gone by and States and localities have come to realize that they are me^ly having their taxes levied and collected by way of Washington. If a State of wide expense shares in a Federal-road program In proportion to its vast area it also shares in propor- tion to its sparse populations and also in proportion to the mileage of post roads. Most localities have the enterprise and ambition to plan more under- takings than they are willing to pay for without any fillip from the Federal Government. Gov. Sproul, of Pennsylvania, addressing the Labor Department conference, developed the fact that the State revenues were equal to the interest at Liberty bond rates on a sum equal to the Federal taxes paid by the Inhabitants of Pennsylvania. The State revenues were forty to forty-five million and the tax one billion, and it is probable that the same proportion obtained throughout the Nation. The governor further mentioned inspections by three separate departments of the Federal Government at one plant and all this overlapping service in addition to that furnished by the State and the city. Ex-Scretary Houston, writing in a late number of the World's Wrok, has shown how insidious are the demands upon the Federal Treasury, but if your com-- mittee will beat its way back, except for obligations arising from the war, to approximately the times from 1910 to 1915, there will be no need for additional sources of Federal revenues. C. C. Pashbt, President. Mr. Geeen. As there seems to be no further witness appearing at this time, and as the committee desires to give full opportunity, unless there is some objec- tion, I would suggest that we adjourn until 10.30 o'clock to-morrow morning. (The committee adjourned to Wednesday, March 8, 1922, at 10.30 o'clock a. m.) ADDENDA. Memorandum on Behalf of the Investment Bankers' Association of Amekica Relative to Tax-Exempt Securities. The Investment Bankers' Association of America submits this memorandum relative to House joint resolution 211, introduced by Mr. McFadden ; House joint resolution 231, introduced by Mr. Foster ; and House joint resolution 232, introduced by Mr. Green, all of vs'hich propose to amend the Constitution in such a way as to remove the tax-exempt feature on all future issues of State and municipal securities. The Investment Bankers' Association of America advocates the adoption of an amendment to the Constitution of the United States empowering, on the one hand, the Federal taxation of the income from future obligations of the States and their political subdivisions, and, on the other hand, the taxation of future obligations of the United States by the States and their political subdivisions, in both cases wth proper safeguards limiting such taxation. This position was adopted by the association in May, 1920, at which time the board of governors adopted the following resolution : " Whereas the necessities of war financing and the consequent high taxation have caused to be questioned the policy of exempting from Federal taxa- tion income derived from obligations of the States and their political sub- divisions and have caused some advocacy of Federal legislation to tax the income from such obligations ; and " Whereas in the opinion of the board of governors of the Investment Bankers' Association of America, which is supported by the opinion of eminent counsel, the Federal Government has no power under the United States Constitution to impose a tax on such obligations or the income derived therefrom without a further constitutional amendment; and " Whereas, even if it should be decided by the United States Supreme Court that the power to tax such obligations is vest-ed in Congress under the Con- stitution as now framed, the imposition of a tax on the income from such obligations now outstanding would be considered a breach of faith by the investing public who in reliance upon the existing exemption from such taxation have paid for such exemption in the purchase price of such obliga- tions; and " Whereas, in the opinion of the board, tax. exemptions lead toward unsound public policy and the exemption from taxation by the United States of future obligations of States and their political subdivision should be abolished and the exemption from taxation by the States of future obliga- tions of the United States should likewise be abolished ; and " AVhereas, in the opinion of the board, it would be dangerous to both the Fed- eral and State Governments to empower either to tax the obligations of the other without limiting such power by proper safeguards : " Resolved, It is the sense of this board that the Investment Bankers' Asso- ciation of America advocate the adoption of an amendment to the Constitution of the United States empowering, on the one hand, the Federal taxation of the income from future obligations of the States and their political subdivisions, and on the other hand, the taxation of future obligations of the United States by the States and their political subdivisions, in both cases with proper safe- guards limiting such taxation." The recent decision of the Supreme Court of the United States in the case of Evans v. Gore (253 U. S., 245) would seem to definitely decide that Congress has no constitutional power to tax the income from obligations of the States and their political subdivisions, and that the sixteenth amendment to the Con- stitution did not serve to enlarge the power of Congress in this respect either as to existing or future issues of such obligations. This being true it follows that no such tax may be imposed without a further constitutional amendment authorizing it. Such an amendment would undoubtedly have to give the State governments the right to tax the income from United States Government bonds The sugges- tion of such an amendment brings to mind the essent'al difliculties of the prob- 188 TAX-EXEMPT SECURITIES. 189 ]em. If the Federal Government were given unlimited authority to tax the obli- gations of the States or their political subdivisions, it would be an exceedingly dangerous power to be granted under our form of government. It would be equally dangerous if the States were given unlimited power to tax the in- strumentalities of the Federal Government. The whole matter is very much broader than any mere question of taxation for raising revenue and goes to the very fundamentals of our government system. It has been wisely said that the power to tax is the power to destroy. In granting the power to the Federal Government to tax the income of State issues and also in granting to the States the reciprocal right to tax Federal obligations the grant of power in each instance should be confined to obliga- tions issued after the ratification of the amendment. This Is undoubtedly true as a matter of fairness and justice to the holders of outstanding bonds which have been bought and paid for on the basis of their present tax status. Down to the present time only a relatively few States have seen fit to adopt an income tax as part of their taxation policy. This being true, the reciprocal power of taxation to be given to the States ought not to be limited to the channels of income taxation, and the benefits of such reciprocal power ought to be open to all States, under such proper safeguards and limitations as will adequately protect against discriminatory and unjust levies, whether imposed by way of an income tax or by way of a property tax. It is, however, appreciated that the consideration of what these limitations should be presents qluestions of the greatest difficulty. We have no suggestion to offer as to the formula which will express the necessary limitations and safeguards. H. J. Res. 211, Introduced by Mr. McFadden, recognizes the principle ad- vocated by this association, and provides for certain reciprocal rights to the States in respect of Federal issues. Neither the joint resolution offered by Mr. Green nor that introduced by Mr. Foster contains this feature. For that reason the Investment Bankers' Association of America desires to express its opposition to both of the latter proposals and at the same time to express its approval of the principles embodied in the resolution proposed by Mr. McFadden, although believing that the resolution in its present form will have great difficulty in receiving the ratification of the necessary number of the States to make it an amendment. HowAED F. Bbebe, PresuJent. Paiji, V. Kbtseb, Counsel. Resolution of Civic Federation or Chicago. Whereas the present exemptions from income taxation of interest derived from obligations of local. State, and Federal Governments establishes a preferred class of investments which detracts investing capital from needed fields of home building, industry, and agriculture, and by creating an artificial demand for public securities tends to stimulate an unnecessary amount of borrowing on the part of State and local governments, with consequent Increases in State and local tax burdens ; and Whereas the exemptions of the income from these securities benefits chiefly the wealthier class of investors, enabling them to avoid in a legitimate way the higher graduations of the Federal income tax designed as a revenue- producing measure to reach the higher incomes, and thereby to the same extent increasing the burden of the revenues to be raised by taxation of the smaller and nonexempt incomes ; and Whereas the exemptions from income taxation of income from any source creates, in the language of Mr. Justice Holmes, of the United States Supreme Court (Evans v. Gore, .June, 1920), "a privileged class, free from bearing their share of the cost of the institutions upon which their well-being, if not their life, depends," a condition in conflict with the established ideals and, traditions of the American people : ISTow, therefore, be it Resolved bij the executive committee and advisory board of the Civic Federa- tion of Chicago, That we favor the submission by the Sixty-seventh Congress and the ratification by the several States of an amendment to the Constitution of the United States, but not retroactive in is. character, which will permit the taxation in the future of income from future issues of all public securi- ties and from all other sources, either by the United States Government or by the government of any State which may see fit to adopt an income tax as a part of its fiscal system. Adopted January 18, 1922. 190 TAX-EXEMPT SECUEITTES. TAX Exemption of Secueities— Stomaby of Abguments— Tax Exemption Proves Disastkous to Sound Public Finance, Industrial Growth, and National Thrift. [By Melvin A. Traylor, president First Tmsl and Savings Bank,, Chicago.] In the days before the large expenditures of governmental political divisions for public and quasi public improvement, before the vast governmental loans occasioned by the late war, and particularly before the passage of our present progressive income tax, the question of tax exemption of securities was not such an Important one; but these conditions, together with the recent efforts (some successful and others, happily, unsuccessful) to extend the exemption feature, have made It to-day a very pressing one — a question not only determinative of our future taxation policy but vital to our entire economic structure. SECURITIES WHOLLY OR PARTIALLY EXEMPT. Government, Territorial, and insular bonds issued prior to April 24, 1917, the first Liberty bonds, the 3f Victory notes. Federal farm-loan bonds, and all municipals are totally exempt from the Federal income tax. Second, third, and fourth Liberty bonds, and the 4f Victory notes are exempt from the normal Federal Income tax, with additional exemption from surtaxes up to certain amounts. And, with the exception of municipals, they are exempt from State and local taxes, except inheritance taxes. The enormity of the problem can be seen when we realize that there are now outstanding some 18,000,000,000 Liberties and Victories alone. Fortunately most of these will eventually be retired. But there are, on a conservative estimate, $4,000,000,000 outstanding munici- pals (on June 30, 1913, there were $4,193,609,436), and the number is being constantly augmented, as shown by the following table of flotations (Bond Buyer, Aug. 21, 1920) : 1910 $324, 360, 955 1911 452, 113, 721 1912 399, 046, 083 1913 1 408, 477, 702 1914 445, 905, 510 1915 $492, 590, 441 1916 — 497, 403, 751 1917 444, 932, 848 1918 262, 818, 844 1919 770, 195, 248 The low figure for 1918 is largely due to the restrictions of the capital issues committee. During this period the number of annual fiotations increased from 4,163 In 1910 to 6,084 in 1919. And with this should be considered the approximately $4,000,000,000 of farm- mortgage Indebtedness potentially susceptible of ultimately being made tax exempt by being transferred into Federal farm-loan bonds. ARGUMENTS. We condemn, for reasons to be stated in more detail below, a policy of Fed- eral tax exemption of securities, because it — I. Nullifies the Federal income tax by (1) loss of revenue; (2) escape of taxa- tion by great portion of property; (3) destroying the progressive nature of the tax; (4) violating the ability principle of taxation; (5) discrimination between classes — in favor of the rich; (6) discrimination against both earned incomes and real estate investments. II. Impedes private financing. III. Discourages investment in new enterprises. IV. Encourages extravagance of governmental agencies. V. Increases public ownership. VI. Grants private subsidy — extension of the principle. VII. Unfair competition, tending to Government monopoly. VIII. Discourages thrift. IX. Causes inflation. X. Increases the cost of living. XI. Supports high income-tax rates. XII. And Is not sustained by practice abroad. TAX-EXEMPT SECURITIES. 191 I. NTJLiriES THE INCOME TAX. The first and greatest objection to the tax exemption of securities is that it tends to nullify the Federal income tax. The history of taxation in this country has not been a bright one, but after years of experimenting we have come to the income tax as the most desirable. It has been adopted by the Federal Government and by 10 or more States. If the efficacy of the Federal act is to be destroyed and the extension of this form •of taxation to other States is to be seriously impeded by the tax exemption of certain securities, it is time the difficulty was fully understood and overcome. The primary function of a tax is to (1) furnish the necessary money for the ■instrumentality which levies it. Beyond that (2) it should be simple of col- lection, (3) should not discriminate between classes of persons or property, and (4) should fall on every individual in accordance with his or her ability to pay. We shall see that the exemption of securities causes the Federal Income tax to fail in most of these important respects. First, the effect of the exemption on the net yield of a municipal bond yield- ing 34, 4, 4J, and 5 per cent is equivalent to a taxable bond yielding — Wlien tlie owner's net income is- 3Jper cent. 4 per cent. 4iper cent. 5 per cent. $10,000.. $20,000. I3U000.. $60,000. . $100,000. $200,000. $500,000-. Per cent. 3.93 4.17 4.43 5.07 7.95 9.72 12.07 Per cent, 4.49 4.76 5.06 6.80 9.09 11,11 13.79 Per cent. 5.06 5.86 5.70 6.62 10.23 12.50 16.62 Per cent. 5.62 5.95 6.33 7.25 11.36 13.89 17.24 Compare the effect of the municipal exemption with the actual yield of tax- able bonds held by an individual under the same tax rates. This is indicated by the following table : ■i Net income yield. Bate of income on investment. Taxable income — 4 per cent. 4-i per cent. 5 per cent. 5iper cent. 6 per cent. $5,000.. Per cent. 3.904 3.764 3.602 3.265 2.752 Per cent. 4.392 4.235 4.062 3.673 3.097 Per cent. 4.880 4.705 4.503 4.081 3.441 Per cent. 5,368 5.176 4.953 4.489 3.785 Per cent. 5.856 $10,000 5.646 $20,000 5.403 860,000.. 4.897 $100,000 4.129 We will now take up the objections in detail : 1. Loss of revenue. — It is impossible to calculate this loss exactly, because of the absence of data showing the distribution of tax-exempt securities ; but it is very great and must become greater as time goes on, as such securities tend to concentrate 'more and more in the hands of wealthy investors. Putnam estimates that on the basis of $4,000,000,000 outstanding municipals the annual loss to the Federal Government, if they were held by Individuals with an annual income of $50,000 would be $35,280,000, or a capitalized loss on a 20-year basis of $479,455,200; and on the assumption that they are held by individuals with an Income of $1,000,000, that the annual loss would be $112,- 480,000 and a capitalized loss of $1,528,603,200. I find no estimate of the loss on tax-exempt Federal bonds, but it must be vastly in excess of the slightly increased cost of issuing nonexempt securities in their place. The great loss on the Liberties and Victories will not, of course, be permanent, because they will eventually be retired. 192 TAX-EXEMPT SECURITIES. Putnam calls attention to the fact that if the $4,000,000,000 of outstanding farm-mortgage indebtedness ultimately goes into Federal farm-loan bonds, there will be an additional loss equivalent to that now sustained on municipals. 2. Great portion of property escapes taxation. — The second great principle of taxation is that all property shall bear its portion of the tax burden. As a matter of fact, the enormous surtaxes on large incomes drive their recipients into tax-exempt securities, with the result that an enormous amount of property- escapes taxation altogether. Mr. Robins has estimated that nearly $30,000,000,000 of property invested in ■ such securities partially or entirely escapes taxation. This figure was 40 per cent of the total wealth of the country in 1912, exclusive of real estate. Osgood illustrates this tendency of investment by comparing the income figures of 1917 with those of 1916, as reported by the United States Commis- sioner of Internal Revenue : " In 1916 the total personal income reported for tax was $8,349,901,983, and in 1917 it was $12,077,009,284. Of these totals, the amount of income from property, as distinguished from wages, business profits, and the lilJe, was $3,861,150,687 in 1916 and $4,469,901,354 in 1917. The income comprising interest from bonds, notes, and the like was $1,080,879,405 in 1916 and $936,715,456 in 1917. This shows a decrease in the income from this class of investments amounting to $144,163,949, in the face of a net increase in income from property amounting to $608,750,667." What amount of the diversion went into municipal bonds of course does not appear, but it is safe to assume that the difference in the figures is chiefiy due to change into that type of securities. 3. Destroys the progressive feature of the tax. — The theory of tlie progressive income tax is that the larger the income, the larger percentage of tax it shall pay. In practice, the exemption feature enables persons with large incomes to escape taxation entirely, and the full burden falls on persons who have the smaller incomes. 4. Violates the ability principle of taxation. — Upon this principle the income tax is based. By violating the principle, the tax must fail. By the operation of the exemption of securities the wealthy class — upon which ' the great burden of taxation should fall — is enabled by purchase of these securi- ties not only to escape a payment which is in actual accordance with their ability, but to escape payment altogether. 5. Discriminates hetween classes in favor of the rich. — If the issuance of tax- exempt securities and the opportunity of their purchase alTorded equal exemp- tion from taxation for all classes, it would be one thing — but such is not the case. In practice, while anyone may buy tax-exempt bonds and secure income-tax exemption thereon, on account of the graduated features of the tax the benefits derived therefrom do not accrue equally to all classes, but are least for those of moderate income and greatest for those of large income ; that is to say, there is no corresponding benefit between the purchase of a tax-exempt bond by a person with a $3,000 income and a person with a $30,000 income. Net income of married person without aepend- ent children. Total tax. Tax rate on whole income. Net yield or nontaxable 5 per cent bonds. Net yield of taxable 5 per cent bonds. Rate of interest required on taxable securities to yield 5 per cent. Annual value of tax exemption on $1,000 5 per cent bond (annual loss to Fpderal Govern- ment), Present value of tax exemption on $1,000 6 per cent "bond maturing in 20 years (present value of total loss to Federal G overn- raent). $3,000 ,$60 830 2,030 11,0.30 35, 030 101,030 323, 030 703,030 Per cent. 2.00 8.30 13.60 22,06 35. 03 50. ,50 84.60 70.30 Per cent. 6 6 6 5 6 6 5 6 Per cent. 4. 90 4.58 4.32 3.90 3.26 2.47 1.77 1.48 Per cent. 5.10 5.45 5.78 6.41 7.69 10.10 14.12 16.83 SI. 00 4.16 6.57 11.30 17.61 25.25 32.30 35.15 $12. 46 51.72 81.87 140. 82 218. 21 314.66 402.62 438.03 S10,000 $20,000 .. $60,000 $100,000 $200,000 $500,000 $1,000,000 TAX-EXEMPT SECURITIES. ] 93 Putnam gives an example, as follows (under tlie old rates) ■ A married ?*''il°nVn'"l°y!o dependent children is subject to a tax of 2 per cent if his inc.ime IS $3,000, of 22.06 per cent if his income is $50,000, and of 70.30 per cent if his income is $1,000,000. The yearly saving which each could make through the purchase of a 5 per cent tax-exempt bond would be $1, $11.30, and $35 15 respec- tively. If the same bond were subject to taxation, the net yield after paving income taxes ^vould be 4,90 per cent, 3.90 p'er cent, and 1.48 per cent respec- tively. 1 . J He gives the foregoing table. There is another aspect of this, which it worth noting besides the purely financial— and that is the social. It is discr;miiiatory legislation which must in itself be bad — it creates distinctions— it draws comparisons — it separates the rich from the not so fortunate— and in these days of unrest it tends to foster discontent. 6. Discrimination against earned incomes and real property. — To the extent that capital is attracted into tax-exempt securities just so far does the burden of taxation have to be borne by capital active in business, by professional in- come, and by real estate. Thus is " earned " income discriminated against in favor of " unearned." Thus is professional income discriminated against in favor of income from property. Active capital is induced to retire from busness and income from real estate bears more than its share. Note th:s : It is apparent everywhere that much capital is being withdrawn from business because it does not get sufhcient net return to justifytlie business risk. This is undoubtedly due primarily to the excessive surtaxes and the ex- cess-profits tax but is also influenced by the fact that tax-exempt secur;ties offer a safe and attractive resting place for the money. It is argued that security exemption is a step toward a " single tax " on real estate — a result we are all anxious to avoid ! II. IMPEDES PKIVATE FINANCING. Perhaps the next greatest objection to the tax exemption of securities is the difficulty which it has put in the path of private financing as distinguished from financing of any governmental agency. We have seen what a large return must come from a nonexempt security to compete with a tax-exempt one in the eyes of the large investor and his con- sequent avoidance of the former. As a result when a private firm or corpora- tion, a railway or a public utility conies into the market for capital it not only finds a diminished available supialy, but is. met with demands for an interest rate often all out of proportion to its ability to pay. Thus is private enter- prise and initiative hampered and retarded. We have seen only too mucli of this in recent years, and while not all of the difficulty can be laid to tax-exempt securities, they must shoulder a sub- stantial portion of the blame. III. DISCOURAGES INVESTMENT IN STEW ENTEEPEISES. If this is true of established business, how much more must it prevail to discourage new enterprises? And perhaps this is more serious than the other. The economic success of America in the past has largely depended on our initiative, our business fearlessness, and our power of invention and adoption. Whatever hampers invention discourages initiative and puts obstacles in the way of trying out new things — lays a heavy hand on American business. IV. ENCOIIEAGES EXTEAVAGANCE OF GOVERNMENTAL AGENCIES.- It can not be open to doubt that the fact that a governmental agency (Fed- eral, State, or local) is enabled, by the tax-exempt feature of its bonds, to secure money at below the going rate tends to lead it into extravagant and unnecessary expenditures. Public officials are only human beings after all. The continuance of the high income tax rate combined mth tax exemption will probably tend to still further increase the price and decrease the yield which municipalities will have to pay — thus making the danger more acute. 93671—22 13 194 TAX-EXEMPT SECURITIES. V. INCEEASES I'UBLIO OWiSTEESHIP. To the extent that private enterprise is hampered in obtaining necessary capital by the competition of tax-exempt securities, to the same extent is there a tendency for more and more enterprises to be driven into public ownership in order to obtain a similar advantage. To the extent that municipalities may obtain money at preferential rates are they going to be stimulated to embark in new and novel undertakings, many of which can not escape disaster. It is too much to believe that this tendency will not be fostered by the keen demand for such securities by investors. ~ Robins makes the argument that the public are deceived as to the real credit of tax-exempt borrowers— that from the fact that they pay 2 per cent to 3 per cent less interest the conclus'on is reached that the agency having this privilege is better managed and in better credit standing; that inasmuch as only the obligations of governmental instrumentalities can receive this privi- lege the result is to strengthen the demand for public ownership and public aid with disastrous results to private enterprise. This, he says, is a most effec- tive encouragement of state socialism. VI. DANGEE IN PEIVATE SUBSIDY. As long as the exemption feature was limited to obligations strictly govern- mental (i. e.. Government, State, and municipal bonds and notes) there were sufficient ob.iections to it to condemn it, but the extension of the principle to business and functions which are in their essence only partly or quasi govern- mental raises a new and additional series of objections even more vital than the former. The initial step in this direction was the tax exemption of the Federal farm loan bonds, the constitutionality of which is now before the United States Supreme Court. This has been followed by numerous attempts to give to other enterprises, some quasi governmental and some almost purely private, the benefit of this exemption. Witness the efforts to extend it to the obligation of export busi- ness, mercantile marine, building loans, etc. It is in this application of the principle and the possible extension, thereof that the great danger lies. There will always be, from time to time, certain interests which, for a particular reason and under particular circumstances, are deemed to require for purely practical reasons certain Federal assistance. This is inevitable — but is it not much better to meet this situation, to provide this subsidy in some direct manner, rather than by the creation of tax-exempt securifes, which undermine the theory of our entire taxation structure and create far-reaching dangers to our business and economic life? The danger of the tax exemption of the farm-loan bonds lies not so much in the actual application of this principle to the particular situation, but in the dangerous precedent thereby established. VII. UNEAIE COMPETITION — GOVERNMENT MONOPOLT. It is obvious that no private enterprise without this subsidy can meet the unfair competition of an enterprise in the same line of business which receives the benelit of this exemption. It is inevitable, therefore, that each line of en- deavor in which this exemption is granted shall ultimately become a govern- mental monopoly. VIII. DISCOUKAGES THRIFT IN PERSONS OE SMALL MEANS. To-day the gambling spirit is rife and promoters find quick purchasers of highly speculative securities among persons of small means. Whatever facilitates specuhitiou is bad. Whatever encourages sound invest- ment is good. The demand for tax-exempt securities from wealthy investors has so in- creased their price as to put this great mass of investments — the safest in the market — out of the reach of the small investor. TAX-EXEMPT SECUPaTIES. 195 IX. INFLATION. It must be true that this higher rate which private capital has had to pay has had a marl^ed influence in the period of inflation through which we have been passing. X. INCEEASES COST OF LIVING. The withdrawal of large investment funds from private enterprise to tax- exempt securities and the consequent difficulty of private enterprise to obtain capital with attendant high interest rates increases the cost of manufacture and the resulting price of the finished article. XI. SUPPORTS HIGH INCOME-TAX EATES. If the tax exemptions were abolished so that large incomes bore their just share of the tax burden, the entire scale of rates could be reduced, ^ XII. NOT PEACTICED ABKOAD. In England the income from Government securities issued before and during the war is taxable except to nonresidents. In Canada the policy of exemption has been abolished and the recent issue without exemption was oversubscribed. SUMMARY. Mr. Kingman Kott Eobins, of Rochester, summarized his argument as follows : " 1. Tax exemption of public securities is inexpedient, in that the loss in taxes is greater than the advantage in borrowing rate ; and, furthermore, that tax exemption of quasi public or Government sponsored issues is in effect a subsidy to a special class in the community, and a subsidy which costs the Gov- ernment much more in loss of taxes than the amount of saving in interest to the beneficiaries of the Government. " In other words, tax exemption is inexpedient in Government issues, and a costly form of subsidy to quasi Government issues. " 2. Tax exemption, by transferring the tax burden from the holders of tax- exempt securities to others in the community, violates the principle of taxing in accordance with ' ability to pay.' Tax exemption, therefore, is not only inexpedient — it is also unjust and uneconomic. " 3. Tax exemption, by rendering immune from taxation those who would otherwise have to pay the heaviest taxes under a graduated income tax, nulli- fies the working of the income tax. Exemption from taxation of the borrow- ings of one class in the community inevitably leads to exemption for others, and thus the whole foundation of the taxing system is progressively under- mined. "4. The subsidy of tax exemption of Government and quasi Government enterprises puts private enterprise at a disadvantage in competition, and tends to destroy Individual initiative, forces reliance on Government aid and leads inevitably to a degree of state socialism and bureaucratic dominance which must react harmfully on the country. " 5. The fact that a 5 per cent tax-exempt Security will yield as much net return to a wealthy capitalist as a business enterprise paying 12 per cent to 17 per cent discourages the investment of. capital in new enterprise." Action at Annual Confekences of the Xational Tax Association on Tax Exemptions. Thirteenth conference, Salt Lake City, Utah, 1920, 41 States being repre- sented : " Resolved, That this conference is of the opinion that exemptions of private property or income from taxation should be confined within the narrowest possible limits. "Resolved further, That this conference is unalterably opposed to the exemp- tion of interest from mortgages from income taxation, under either Federal or State laws, and that this conference is of the opinion that salaries of all public 196 TAX-EXKMPT SECUEITIES. officials and tl:e interest on future issiics r,f Federal, Slate, or municipal obliga- tions should be siiliject to income taxation." Fonrteentli conference, Bretton Woods, X. H., 1921, 3S States being repre- sented : " Resolved, That tliis conference reafiirms the position taken by the thirteenth annual conference on taxation held in Salt Lake City, Utah, on September 10, 1920, with reference to opposing the exemption from income taxation of the salaries of all public officials and of the interest on future issues of Federal, State, or municipal obligations, and hereby recommends the submission l3y the Sixty-seventh Congress and the ratificatioa) by the States of an amendment to the Consf.tntion of the United States \vhich will permit the principle thus stated to he embodied in our national income tax law." Certified from the record. Ar.FEEi) E. HoT.coMB, Secretari/. J.\NUARy 14, 1922. Chamber of Commerce or the United States of America, IVasliin'jton. D. (,'., January 1.'/, 1022. Hon. W. R. Green, House of Representatives. JilY Deae Congressman : The question of a constitutional amendment with respect to Federal taxation of income from municipal and State securities, to which you refer in your letter of January 11, has been considered by several of our committees. Our committee on financing war. back in 1917, announced that it would present a special report on the sub,1ect. Other matters intervened to absorb the committee's attention, however. Our committee on taxation which submitted a report about a year ago like- wise Avent over the subject. The conclusion of the conmiittee was that it should direct its recommendations to the policy which should be immediately followed in' Federal taxation. Consequently, it recommended that there should be no exemption of any' future issues of securities the income from which may law- fully be made sul3ject to Federal taxation. Necessarily, this referred to applica- bility of the Federal tax to income from securities issued from a Federal source. The committee's recommendation was .supported by the organizations in our membership and has now become one of the principles which we advocate with respect to taxation. TTie votes cast by our organization members were 1,386 in favor of the committee's recommendation and 275 in opposition. The com- mittee's discussion of the subject was as follows : " The committee has noticed the situation which arises by reason of the ex- istence of large amounts of securities the interest on which is now free from Federal income taxes. Such securities as are ailready outstanding have certain equities attaching to them, and respecting the exemption of their interest there should accordingly be no change in the law. Moreover, as the Supreme Court decided in .June that the sixteenth amendment to the Constitution does not extend the Federal taxing power to any subject earlier excepted, it would seem that future issues of bonds by States and their subdivisions can not be made subject to Federal income taxes so long as the Constitution remains in its present form. That this .should be the situation with respect to future issues causes us re.gret, as the existence of an increasing body of securities the interest on which is free from Federal tax will afford means for having income free from Federal tax. As to other future issues, the committee wi-shes to record its strong conviction, and recommends that there should be no exemption of any future issues the income from which may lawfully lie made subject to tax. This recommendation is made irrespective of the source of the issue, i. e., whether the source is the Federal Government or some agency such as a Federal farm loan bank." As the committee thought it more important to make a recommendation re- garding a policy which could be inaugurijted immediately, it confined its refer- ence about the constitutional situation to an expression of regret. This would seem to indicate the committee's point of view, but at the same time it afforded no opportunity for a vote among our members upon the subject of a constitu- tional amendment. In other words, we have hod no formal vote on the precise •subject abut which you inquire in your letter. D. A. Skinner, Secretary. INDEX. Page jXddenda Igg Allen, Henry J. , governor of Kansas, telegram 177 Allfree, H. B., Newton, Iowa, statement 168 Amendment to the Constitution, resolutions proposing 3 26 Draft of, suggested by Secretary of the Treasury 26 Analysis of personal income, etc., of families in United States 52 Baxter, Percival P. , governor of Maine, telegram 179 Beck, William W., member Maryland State Tax Commission, statement 183 Beebe, Howard F., president Investment Bankers' Association, memorandum. . 188 Benson, A. E,., secretary of state of Delaware, telegram 178 Blaine, John J. , governor of Wisconsin, telegram 179 Bonds, average yield on public-utility and municipal, 1910-1914 43 Brown, Albert O., governor of New Hampshire: Letter 173 Telegram 177 Burtless, B. F., secretary Michigan Board of Tax Commissioners, letter 172 Campbell, Thomas E. , governor of Arizona, telegram 176 Capital requirements of public utilities 52 Chamber of Commerce of the United States of America, letter of secretary 196 Chassell, Edward D. , secretary Farm Mortgage Bankers' Association of America, statement 56 Civic Federation of Chicago, resolution 189 Constitutional amendment, resolutions proposing 3, 26 Cox, Channing H., governor of Massachusetts, telegram 180 Cutting, Frank A., Boston, Mass., letter 174 Davis, D. W., governor of Idaho, telegram 176 Decline of taxable incomes over |300,000, table showing 19 Dixon, Joseph M., governor of Montana, telegram 177 Exemptions of war obligations from Federal income surtaxes 105 "Federal tax revision," by B. C. LefBngwell 136 Ferguson, William A., Baltimore, Md., representing National Association of Real Estate Boards, statement 75 FuUbright, H. J., State tax commissioner of Georgia, letter 173 Gadsden, Philip H. , vice presiden t United Gas Improvement Co . , Philadelphia, Pa.: Statement '■ ■ - 36 Taxation and public utilities 42 Gilbert, S. P., jr., Undersecretary of the Treasury: Letter to Hon. Louis T. McFadden 27 Statement 30 Governors of States, telegrams from 176 Groesbeck, Alex. J., governor of Michigan, telegram 177 Harriman, Edward A., Washington, D. C, statement 90 Hastings, Vernon C, president Indiana B,eal Estate Association, letter 173 Holcomb, Alfred E., secretary National Tax Association, letter 116 I II INDEX. Page. Incomes of $60,000 to $300,000 and over, 1916-1919 19 Incomes over $300,000. decline of taxable 1" Investment Bankers' Association of America, memorandum - - 188 Investments of $1,000,000 in tax-exempt securities and in common stocks compared • 23 Kilby, Thomas E., governor of Alabama, telegram 178 Kloss, D. S., representing Pennsylvania State Chamber of Commerce, state- ment 55 Kriegh, McKinley W., Washington, D. C, chief of tax division, American Mining Congress, statement 94 Leffingwell, R. C, ex-Assistant Secretary of the Treasury: "Federal tax revision" 136 Statement 118 Lord, Samuel, president National Tax Association, statement 171 Lyons, Thomas E., Madison, Wis., statement - 170 Lyons, W. E., Kansas City, Mo., letter 12 Mabey, Charles R., governor of Utah, telegram and letter 178 McCoy, Joseph S.. Government actuary: Advantages of investing in tax-free and taxable securities compared . . 22 Investments of $1,000,000 in tax-exempt securities and in commercial stocks compared 23 Loss through tax-free securities 21 McCray, Warren T,, governor of Indiana, telegram 177 McFadden, Hon. Louis T. (Pennsylvania): Letter to Hon. Joseph W. Fordney 34, 175 Letter to S. P. Gilbert " 34 Statement 4. 172, 181 McKelvie, Samuel R., governor of Nebraska, telegram 177 McKenzie, H. C, Walton, N. Y., representing the American Farm Bureau Federation, statement 155 McRae, Thomas C. , governor of Arkansas, telegram 177 Mansfield, Y. C, Spokane, Wash., letter 142 Marsh, Benjamin C, representing the People's Reconstruction League, state- ment 138 Maryland State Tax Commission, statement of members of 1S3 Mellon, Hon. A. W., Secretary of the Treasury: Draft of suggested amemdment to the Constitution 26 Extract from letter to chairman of the Committee on Ways and ileans 23 Letter to Hon. Joseph W. Fordney ." 18, 32 Letter to Hon. Louis T. McFadden 11, 25 Statement 13 Mechem, Merritt C, governor of New Mexico, telegram 176 Mills, Hon, Ogden L. (New York), statement 71 Morgan, E. F., governor of West Virginia, telegram 179 Morrow, Edwin P., governor of Kentucky, telegram 179 National Association of Comptrollers and Accounting Oflicers, statement of president 184 National Association of Rea,l Estate Boards; Resolution 76 Statement and resolutions 174 National Tax Association: Letter of Secretary Alfred E. Holcomb 116 Resolutions 71 195 Statement of President Samuel Lord ' 171 Statement of secretary I75 Nebraska State Senate, resolution ISO New capital required annually by public utilities 48 Ohio Tax Association, resolution I73 Olcott, Ben. W., governor of Oregon, telegram 179 Organizations opposing issuance of tax-exempt securities 88 INDEX. Ill Page. Parker, John M., governor of Louisiana, telegram 179 Pashby, C. C, president National Association of Comptrollers and Accounting 'Officers, statement 184 Pennsylvania State Chamber of Commerce, resolution 55 Peoples Reconstruction League, program of 139 Public utilities: Annual capital requirements 53 Annual capital requirements of steam railroads 54 Annual new capital requirements 48 Average yield on public-utility and inunicipal bonds, 1910-1914 43 ' Further issue of tax-exempt securities should not be permitted 50 New capital requirements of telephone and telegraph companies 53 Rates necessary to attract investment of new capital 52 Service will grow worse until relieved from income tax 49 Ray, J. Enos, member of Maryland State Tax Commission, statement 183 Resolutions proposing amendment to Constitution 3, 26 Ritchie, Albert C . , governor of Maryland, letter 180 Robertson, J. B. A., governor of Oklahoma, telegram 180 Robins, Kingman N., .Rochester, N. Y., president Farm- Mortgage Bankers' Association of America ; Organizations opposing issuance of tax-exempt securities 88 Statement 82 Russell, Lee M., governor of Mississippi, telegram 179 San Souci, Emery J., governor of Rhode Island, telegram 180 Seligman, Prof, Edwin B. A., New York City: Exemptions of war obligations from Federal income surtaxes 105 Letter 116 Statement 99 Shaw, Henry B., secretary to Gov. Hartness, of Vermont, telegram 179 Shoup, 0. H. , governor of Colorado, telegram 177 Skinner, D. A,, secretary Chamber of Commerce of the United States of America, letter 196 Statement by — AUfree, H. B., Newton, Iowa 168 Chassell, Edward D., secretary Farm Mortgage Bankers' Association of America 56 Ferguson, William A,, representing National Association of Real Estate boards 75 Gadsden, Philip H., Philadelphia, Pa 36 Gilbert, S. P., jr.. Undersecretary of the Treasury 30 Kloss, D. S., Pennsylvania State Chamber of Commerce 55 Kriegh, McKinley W., Washington, D. C, chief of tax division, American Mining Congress 94 Leffingwell, R. C, ex-Assistant Secretary of the Treasury 118 "Federal tax re^'ision" ^. 136 Lord, Samuel, president National Tax Association 171 Lyons, Thomas E., Madison, Wis 170 McFadden, Hon. Louis T. (Pennsylvania) 4, 172, 181 McKenzie, H. C, Walton, N. Y., representing the American Farm Bureau Federation 155 Marsh, Benjamin C, of the People's Reconstruction League 138 Mellon, Hon. A. W., Secretary of the Treasury 13 Members of Maryland State Tax Commission 183 Mills, Hon. Ogden L. (New York) 71 Robins, Kingman N., vice president Rochester (N. Y.), Chamber of Commerce -.-.- ^^ Organizations opposing issuance of tax-exempt securities ' 88 Seligman, Prof. B. A., New York City 99 Williams, John G. , president Philadelphia Real Estate Board 77 Steam railroads, annual capital requirements of 54 Stuart, Edward, director disaster relief service of American Red Cross, letter. . 148 IV JNDEX. Page. Taxation and public utilities 42 Tax-exempt securities: Disastrous to sound public finance, industrial growth, and national thrift.. 190- Memorandum of Investment Bankers' Association of America 188 Organizations opposing issuance of 88 Resolution of Civic Federation of Chicago '. 189 Total outstanding January 1, 1922 21 Tax-free securities, loss to Government through 21 Telephone and telegraph companies, new capital requirements of 53. War obligations, exemptions of,c rom Federal income surtaxes 105 Williams, ,Tohu G., president Philadelphia Real Estate Board, statement 77