s millions of Americans have heard, taxes may be cut in 1963. As few realize,
this does not mean a bonanza. A big chunk of the relief will come in lowered
corporation taxes and will not be felt directly by the taxpayer. Even the
fairly sizable drop the Administration is projecting--perhaps $6 or $7
billion--will give the average taxpayer only $65 more spending money, and
unless Congress does something about the withholding rates, this may mean
simply a refund the next year or a series of hardly noticed reductions in the
quarterly payments of estimated tax.
This is not because the government is fainthearted. The overall cut is not
designed as succor for the oppressed but as a stimulus to business, a
recognized Keynesian move to pump a strong dose of consumer demand into a
vacillating economy. Each taxpayer may never feel the money come and go, since
Administration studies indicate that 94 cents of every dollar cut will be spent
instead of saved, adding a near-term demand factor of over $6 billion.
There are many economists, some of them as close to the White House as John
Kenneth Galbraith, who feel that this tack is wrong. The economically orthodox
(and they include a surprising number of congressmen) object to the very severe
budget deficit which the resulting drop in revenue will inevitably produce. The
Galbraithian school would tolerate the deficit all right, but would simply
create it in the other direction, by increasing government spending rather than
The White House is not necessarily for a smaller government-spending role, but
the President's Council of Economic Advisers has persuaded him that the present
tax rates are stultifying the economy, especially by tending to pinch off
post-recession upsurges before they have ripened into genuine recoveries. The
Administration's almost legendary concern with "getting the country moving" has
overcome any lingering doctrinaire hesitation.
Rate slashing is, however, only half of the tax program which President Kennedy
will send to the Congress this January. The second part is tax reform. Many
political commentators have already dismissed the chances for reform, on the
grounds that Congress will accept none. But there can be no question that the
Administration attaches the greatest importance to it. The President's decision
against cutting taxes in 1962 was clearly predicated not only on Congress'
coolness to an immediate cut but also on Secretary Dillon's view that the
President should not fritter away a year ahead of time the only conceivable
quid pro quo for congressional approval of his distasteful reform ideas.
It has been a persistent policy of this Administration that the existing tax
structure is in need of major overhaul and that this overhaul must take into
account not only some traditional ideas of tax fairness but some harsh new
facts of economic life which the changing world has thrust upon us. The Revenue
Act of 1962, though cut down from what the President requested, was a solid
first step. And if Mr. Kennedy can get Congress to take successive steps in
1963, or over a period of years, the result could be some dramatic changes in
the relative size of certain individuals' tax bills and an equally dramatic
change in the orientation of the tax law toward business.
From the Internal Revenue Code's tables of tax rates, one detects a reasonably
clear and consistent pattern based on two simple principles: first, the rule of
tax equality, or tax neutrality--that every taxpayer experiencing the same
increase in wealth should bear the same tax; second, the rule of
progressivity--that as a taxpayer's income goes up, the percentage of that
income taken in tax also goes up, to an almost confiscatory maximum of 91
The first rule, a basic concept of equality before the law, applies to taxes
paid both by individuals and by corporations; but the second affects only the
individual's tax. That is what is known popularly as "soaking the rich." But
its purpose is not to raise a wad of revenue from the upper tax brackets. Only
a tiny fraction of the government's revenue could under any circumstances come
from the wealthy--there are simply too few of them. It is the expression of a
social policy which seeks to fertilize democracy by redistributing the wealth
and narrowing the economic gap between the richest and poorest members of
society. While differences of opinion exist on just how steeply the progressive
rates should rise and how high they should ultimately climb, these general
rules seem widely accepted. What, then, is all the fuss about?
The trouble is that practice falls a sad distance short of theory. For example,
the rate tables indicate that a married man with an income of $1 million should
pay a tax of $859,000, or almost 86 percent, but he doesn't. Statistics for the
latest available year, 1960, reveal that taxpayers in the $1 million-and-over
class paid only some 45 percent of the amount they reported as taxable income.
Previous studies show that if receipts not technically required to be included
in taxable income were taken into account, the effective rate would be only
about 35 percent. Similar differentials could be established for various
categories of taxpayers in lower brackets.
This anomaly arises from what tax specialists call "erosion of the tax base." A
wilderness of special provisions written into the Internal Revenue Code
insulate particular kinds of income from the regular rates of tax, either by
carving them out of the category of ordinary income or by allowing offsetting
deductions or credits. To take a famous example, a person who owns an oil well
is permitted to deduct a so-called "percentage depletion allowance," which
frequently ensures that he will pay little income tax on his profits from
selling the oil. An advertising salesman may find that most of the pleasures in
his life--the shows and expensive meals, his clubs, yachts, and vacation
resort--come to him tax-free, courtesy of his expense account. The list could
drone on through the dozens of cases in which special exceptions are made.
The reason for these myriad exemptions is easily identified. Whatever our
feelings about taxes in general, each of us knows that his own are too high.
Given time, each could construct a (to him) perfectly reasonable argument why,
in his own case, the tax should be lower. It is just this special-case thinking
which has made the Internal Revenue Code the patchwork of preferential
provisions which it is today. When some group, generally expressing itself
through a forceful professional lobby, pushes for a special tax break, there is
no public-interest lobby pushing the other way. Even though the necessary
effect of reducing one group's taxes is to thrust that much more of the burden
of government on all the other taxpayers, the millions who foot the bill seldom
notice, or even know about, the change. There is remarkably little political
hay in holding out against a tax cut, even a preferential one; and quite
understandably, few congressmen have enough concern for abstract tax justice to
take the political risks involved in offending the farmers, the steel industry,
the old folks, the labor unions, or whoever happens to be knocking on the
But there is more to this than sheer political cowardice. Tax men, including
the dean of American tax thinkers, the late Randolph Paul, have long maintained
that Congress simply does not believe in the high rates which the tax tables
set forth. Congress, they contend, would do away with them if it were not an
embarrassing move to explain to low-income constituents. So they simply vote
the special concessions as a kind of political end run.
Some years ago, H. L. Seltzer put forward a more imaginative theory. He saw in
the tax laws the expression of America's love for a good game. In his view,
Congress never wanted to make the Internal Revenue Code a clear and simple
dispenser of equity; it was willing to create a kind of fiscal maze through
which an astute taxpayer could straight-arm his way for a touchdown, a feat
which presumably brought him honor as well as wealth. This may be closer to the
psychological truth than we should like to admit. The trouble is that the game
has got out of hand. In an interview with Cameron Hawley, one company executive
reluctantly admitted that almost every action taken by the directors of his
company over a period of several years had been largely motivated by tax
considerations, adding: "It's frightening."
No one concession in the tax law is earth-shaking, and each may seem to follow
from the one before. The process is as gradual and relentless as erosion. But
the cumulative effect of all these tax deals is tremendous. Where the weary
taxpayer antes up some 21 percent of the gross national product in federal
taxes (over 26 percent counting state and local taxes), inequities in the
distribution of the load raise pressing questions of economic justice which a
democracy ignores at its peril.
Furthermore, there is a major political and economic issue hidden under the
tax-preference system. In general, the special tax provisions are made for men
of property, or at least men of business. As a result, the people bearing the
highest relative tax loads are those who live by their wits--teachers,
engineers, government administrators, social workers, writers, architects,
accountants, and others. These intellectual producers have one thing in common:
most of them live entirely on straight salaries, with no fringes, no capital
gains, no depletion, no exemption--that is, no tax gimmicks This hard fact has
drawn more and more able and educated people out of the government, the schools
and colleges, and even the garrets, into the ad agencies and the business
world, where tax advantages are available. An issue which we have never faced
squarely is whether we need incentives for business growth more than we need
tax incentives to produce excellence in other activities necessary to a healthy
To all of these problems of tax erosion or preference, the classic solution is
simple and Spartan: simply remove all preferences and impose the progressive
rates stated in the Internal Revenue Code to all kinds of income without
distinction. The trouble with this, as with so much of classical theory, is
that it does not really work out in practice. It is easy to say that high
progressivity must be imposed, but there is also good reason to believe that
the confiscatory rates we now have really do stifle work incentives. It is also
easy to say that all taxpayers should bear the same tax load, but do we really
mean that when we compare a vital young workingman with a retired person trying
to eke out a pension shrunken by decades of slow inflation?
If categorical solutions are impossible, one can still point to several areas
where the tax reformers by and large feel that changes ought to come. Today,
unlike ten years ago, there is a fairly broad consensus that the top rates
should fall substantially. Rumor has the top rate scaling down from 91 percent
to 65 percent, undoubtedly with some softening on down the line. This will
probably be achieved in the process of allocating the tax cuts scheduled for
1963. There is a strong feeling in some circles that at the same time certain
preferential provisions should be killed.
One subject of scrutiny is the businessman's fringe benefits. The 1962 revision
has already taken a swing at expense accounts. Up for further consideration
will be stock options, lump-sum pension payouts, and a host of problems which
arise in closely held corporations, where the plans stated to be for the
benefit of all employees sometimes turn out to be primarily for the benefit of
The second area will be the special tax preferences given to individual
investors. Although it is really an enforcement problem, the Administration's
request last year for withholding on dividend and interest payments reflects
the fact that large numbers of investors are simply not reporting these items
as income--costing the government some $600 million every year in lost revenue.
There has been talk for some time of ending the tax exemption on interest
received by investors from municipal and state bonds. The Administration has
already requested the end of the dividends-received credit, a device which
reduces taxes in proportion to the amount of dividend income, thus granting the
greatest benefit to the wealthiest investor.
Somewhat similar issues are raised by the deduction allowed for charitable
contributions of wealthy donors. A man in a 91 percent tax bracket can actually
make money by giving to his favorite charity--often one which he
controls--securities which have appreciated in value. If he sold the
securities, he would pay a capital-gains tax of 25 percent and have 75 percent
left. If he gives them to charity, he pays no capital-gains tax, but is allowed
to deduct 100 percent of this value, thus saving 91 percent on the deduction
from his income. Undoubtedly we need to redefine the limits of charity.
A healthy look will also be given to the tax treatment of oldsters. There are
several provisions now in the law (exemption of social security benefits and
the retirement-income credit, for example) which are supposed to alleviate the
hardships of old age but which in fact benefit the very wealthy as well as the
poor. Many tax students would scrap all of these, substituting some form of
special exemption or expressly stated preferential rate limited to those in the
lowest income group, who probably suffer the most from living on pensions or
fixed incomes in an era of inflation.
Just as the list of preferences could continue almost forever, so could the
list of proposals for doing away with them. If erosion of the tax base has been
a gradual process, so the task of rebuilding the lost base must also take time.
Many changes will simply never see the light of day, although this depends in
large measure on the extent to which the voting public can be made to see its
own interest in tax reform.
For many people the only proper function of the tax law is to raise revenue
impartially from those who can best afford it; they are not concerned with the
impact of the law on economic activity. But the taxing power is one of the
government's most potent tools for guiding the economy. This is the
carrot-and-stick theory, by which the government is enjoined to give tax
incentives to desired activities and to set up barriers against others.
Historically, this interventionist philosophy has been the property of
conservative spokesmen identified with business interests. Their plea, notably
limited to the carrot side of the theorem, is that government should give tax
incentives to the entrepreneur, making exceptions to the rules of tax
neutrality and progressivity to stimulate savings and investment. Conversely,
the liberal philosophy has generally favored tax neutrality. To the extent that
liberals have deigned to answer the interventionists on economic grounds, their
parry has simply been that we are doing all right under a regime of heavy
business taxation. Alvin Hansen observed in the 1950s that we live in an Alice
in Wonderland economy; the more we tax and spend for defense, the more
prosperous business grows.
The Kennedy Administration, interventionist by instinct, has abandoned classic
dogma to take up the carrot and the stick. The rapid changes which it discerns
in the American world economic position have persuaded it that the liberal
orthodoxy is too pat, and this in turn has produced a new look in the taxation
of business which may spell far-reaching consequences for the economy as a
The motive behind this shift is a deep-felt concern over the deteriorating
economic position of the nation. Internally, the economy has slouched back into
its fourth successive recession; unemployment hangs at peak levels, unused
industrial capacity has built up, and the rate of national growth is one of the
lowest in the industrial world. At the same time, U.S. companies have been
flocking in droves to invest in booming Europe, lured not only. by the
fastest-growing market in the world, but also by impressive differentials in
wage scale. The President has been faced with the frustrating spectacle of U.S.
capital departing a faltering domestic economy to make a major contribution to
the economic strength of Europe, and this at the very moment Mr. Kennedy must
attempt to negotiate with the European nations the all-necessary free-trade
deal, whose terms will depend critically on the relative economic strength of
the two continents.
One solution is to apply the stick of greater tax burdens to companies
investing overseas, in Europe particularly, while holding out the carrot of tax
benefits to those investing at home. But for the domestic investor the carrot
is hardly big enough; the overseas investor has a long lead in tax avoidance.
As long as we have had taxed income, U.S. businesses have been able to avoid
tax on their foreign operations simply by incorporating a subsidiary company in
another country. With some naivete, our statute has always defined the
subsidiary as something separate from its parent; since it is a foreigner and
does no business here, no tax is due, at least until the profits are paid over
into the parent company's bank account. And if the profits are accumulated
until the foreign company is liquidated or sold, only the low capital-gains tax
This freedom from U.S. tax has proved quite tempting. In some of the balmier
climates the local tax burden is very low. In Bermuda and Nassau there is no
income tax at all. Carrying this to the extreme, some companies and investors
have been led into the so-called tax-haven operation. In this case, a U.S.
company can shovel manipulatable income, such as insurance premiums, patent
royalties, or profits on export sales, into companies in Panama, Switzerland,
or other low-tax countries. For instance, a sale of American-made goods to a
German buyer can escape a large measure of tax by passing in legal concept
through a Panamanian corporation, even though the goods were shipped direct and
the only thing which happened in Panama was the filing of one bill of lading
and the issuance of another while the shipment was still at sea.
The recently enacted Revenue Act of 1962 has already struck at these tax havens
by subjecting much of their income to an immediate U.S. tax, a move predicated
on the idea that one American should not get rich free of tax while another
pays the bills.
The Treasury's original program, however, went much further, seeking to impose
the immediate tax on all foreign subsidiary operations, no matter how
legitimate or far-reaching. Treasury officials deny that this was designed to
penalize overseas investment; it was merely the logical application of the
tax-neutrality rule in the international field. International businesses have
tried hard to disprove this notion by claiming that paying U.S. taxes on their
overseas operations will put them at a disadvantage compared with their foreign
competitors. In many cases, this may be correct. But domestic products also
compete with foreign goods, both at home and in the export trade, and taxes
hurt as much in Indiana as in Singapore.
If the Treasury is interested in fairness, the Administration is even more
concerned with the need to keep native industry competitive in a cutthroat
economic world. Therefore, 1962 also produced a proposal surprisingly
unorthodox in America--a relaxation of depreciation rules, which will permit
many businesses to write off equipment costs against their taxes more quickly,
and the legislation of a new device, the investment credit, which would permit
a business to recover a portion of the cost of capital equipment when it is
purchased without waiting for it to depreciate at all. In both cases, the
objective was to make it more profitable for a businessman to invest in better
equipment, thus making the American plant more efficient and better able to
compete in the world economy. This two-stage program would boost productivity
at the same time that the tax cut increases demand.
Walter Heller, the President's chief economic adviser, has said that this was
simply a decision to make investment in capital assets more profitable; it was
the most practical way to reach a result that he feels is essential.
Nevertheless, the investment-credit idea has changed the impact of the
investment stimulus. The orthodox conservative theory, as frequently voiced by
Keith Funston of the New York Stock Exchange, is to give the incentive to the
individual investor through freedom from capital-gains taxation and the removal
of the double tax on corporate dividends. His recommendation would be to
increase the available amount of investable funds in the hands of the public,
trusting that this in turn would cause greater capital investment.
The Administration's theory is markedly different. The investment incentive is
given not to the individual investor in a business but to the business itself.
Heller shrugs this off as a matter of practicality. The business executive is
the decision maker, he argues, and it does no good to make new funds available
to him if he does not consider it profitable to invest in new equipment. He
might merely put his increases in savings into a spiraling real-estate market
or overseas investments.
As a result of these seemingly pragmatic decisions, we are witnessing a strange
economic phenomenon. The Kennedy tax reforms, if Congress will see them
through, will undoubtedly increase the tax cost of getting corporate profits
into individual hands. At the same time, the tax law is giving the corporation
an incentive to reinvest earnings in assets of its own. It seems inevitable
that this will bind into corporate solution a great mass of paper wealth which
the individual stockholder will never get his hands on, thus stimulating the
already established trend toward greater corporate self-financing, autonomy of
management, and independence of the capital marketplace.
This may have been inevitable in any event. Certainly the tax program could not
create such an important change if there were not other strong stimuli.
However, clearly we have come to the point of final decision among three very
basic goals of taxing policy: the redistribution of wealth through progressive
tax rates; the fostering of economic growth; and the preservation of a
competitive marketplace of capital as the ultimate check on management
authority. The Administration's program seeks the first two goals at the
partial sacrifice of the third. The Funston theory would keep the second and
third at cost of the first. The orthodox liberal would choose the
redistribution of wealth and a free marketplace and ignore economic growth,
which could be left to more direct forms of government intervention. This is
the choice that lies ahead.
The most searching question about tax reform at the moment is not any specific
philosophy or proposal but the critical issue of whether the Congress can be
made to stand freer than it has in the past of the pressures put upon it for
special tax deals. It is idle to argue the abstracts of philosophy until
hard-pressed legislators are given an opportunity to decide tax issues
rationally on the basis of a comprehensive scheme. In 1955 Professor Cary
predicted that taxation by lobbyist would eventually break down the entire
self-assessing tax system. Today that prophecy is all too near fulfillment.
Copyright © 1974 by John Doe. All rights reserved.