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No exemptions for the excess profits tax are particularly specified, but the levy is made applicable only to those corporations that are liable for the capital stock tax.

/78/ Secs. 702(6), 56.

/79/ This is, incidentally, the reason for considering the present capital stock and excess profits taxes together.

/80/ The taxes in dollars can be stated in this fashion:

Capital Stock: 1 (capital)/1000

Excess Profits: 1/20 (earnings - capital/8)

Combined: 1/20 (e - c/8) + 1 (c)/1000 or 200e/4000 - 21c/4000

This formula is taken from some notations made by Mr. Carl Shoup.

/81/ Corporation officials have been given two years in which to get the problem thoroughly in mind. The Revenue Act of 1934 gives them a new jumping off point, since their declared capitalization in the letter law need not agree with their declaration under the NIRA.

/82/ It represents a major advance, at least on the point of administrative feasibility, over the war excess profits Act.

/83/ Three other method of beginning the tax might have been adopted:

(1) Appraisal of the current going value of each firm' assets.

(2) Determination of original investment.

(3) Use of the "war profits" principle, by which profits over a past series of years are taken as a standard, and excess in the future is calculated upon the basis of the standard as thereby defined and determine.

(1) The appraisal method is subject to the following difficulties.

(a) It would immediately force the Bureau of Internal Revenue to undertake millions of valuations as a precedent condition for levying the tax. Comment by a series of Bureau officials interviewed was brief, "Impossible." Their view of the administrative difficulty has tremendous force when the Government' experience in valuing the railroads is remembered, and also when the Bureau's own struggles to get through with the 1913 valuation as provided in the income tax are recalled.

(b) The gain of equity is not so clear as it should be. The author has himself seen many appraisals of tangible property by equally expert appraisers in which the higher appraisal was twice the lower. When intangible enter the situation, the accuracy of appraisals stands on extremely shaky ground. A Bureau official, in discussing this matter, said that where intangibles were involved and the Bureau put several valuation experts to establish independent estimates, it was a matter of congratulation all around if the highest figure was no more than 100 per cent above the lowest, and that differences of several thousand per cent were frequent.

(2) In regard to the determination of original investment:

(a) An extremely heavy administrative load would be involved.

(b) The accounting material for reconstructing the original investment would be nebulous: disappearance, loss, and concealment or record for apt years would be a very large factor indeed. The difficulty would become greater the farther back the attempts at determination were carried.

Practically, it would be necessary to set a limiting date, not many years in the past, and value assets then held "as of" that date. Practically, therefore, the original investment formula is both an invested capital scheme and an appraisal proposal: an appraisal suggestion, notice, which is on an even slippier footing, if possible, than current appraisals.

(c) From the standpoint of justice, both the actual and theoretical gain is dubious. Specific business assets, entire businesses, and their earning power. To begin taxing now on the basis of original investment, after a retroactive purview, would hardly seem fair, and a decided bias would be introduced in the case of companies for which purchase of intangibles, say, caused them to appear as capital investment as against companies whose intangible assets had been developed by their own managerial cleverness. And so on. To go at the excess profits tax retroactively, digging out original investments, has much the same kind of objection from the standpoint of ethics as a land tax that proposed deliberately to tax away already developed land values.

(3) In regard to the "war profits" principle:

(a) It is extraordinarily difficult to pick out a period that would be uniformly fair to all types of business as a basis for determining the standard profit for that business. All sorts of price and profits distortions from varying types of price level movements occur; and for a tax begun at this particular time, when there has ben a severe deflation, this aspect of the matter would necessarily be exceedingly troublesome. The equity of the results to be obtained on this basis would be open to serious doubt.

(b) After the initial determination of the standard profit for each type of enterprise, additions and subtractions of capital would immediately begin. If the same rate of exemption were to be applied to new capital as was implicitly applied to the old capital by the standard profits, it would be necessary to determine at once the capital on which the standard profit was a rate, and the administration would be promptly thrown back on appraisal procedure outlined under (1) above or the original investment procedure outlined under (2) above. If a statutory rate or exemption were to be used for anew capital, then the law would shortly become an utterly unwieldy combination of a standard profit basis and an invested-rate basis for additions to capital.

In speaking of a war profits standard for the levy of an excess profits tax, in contrast with rate on capital, Mr. Thomas S. Adams had this to say:

"As a matter of theory, and in the average of normal case, I believe that these two standards the income standard and the capital, are essentially similar. In the long run, the real invested capital depends upon normal earnings . . . . If corporation X had enjoyed profits of $200,000 a year as a regular and normal thing before the war, its true invested capital could not, except by accident, have remained at $1,000,000. It capital asset, tangible and intangible, would have come to be worth $3,000,000 or more; they could have been old for that amount; and individual investors would have bought stock on that basis. In the normal case, the income and capital standards are, when properly interpreted practically the same."

In regard to the original investment he added:

"But we must get away from the "original investment." Where mature and well-developed corporations are concerned that concept has little meaning. The original ivestment has no permanence. It changes inevitably. Durable assets, such as land and buildings, depreciate and appreciate; and these variations may at times be taken up on the book and they will certainly be taken into account in any case of sale or consolidation. Intangible assets are built up and in turn disappear. The true capital, the true investment, changes with the shifting level of income and with future prospects based upon such income. Of course, if we take only the income of two or three years before the war, there is no necessary correspondence between such income and the true capital of the business. But what chanced to happen in the three years which preceded the outbreak of the war is not and should not be controlling in this connection . . . ." ANNALS, January 1981, p. 152.

/84/ This line of argument was donated by two Bureau of Internal Revenue officers. One of them wrote the following advice, which relates to several points:

"Wind up with paragraph that the practical administrator prefers a BASE laid down by the taxpayer because of its value as a matter of evidence in litigation. This principle has a wide application for tax purposes in accounting methods and claims made under oath. Also, if two or more taxes can be geared so as to be mutually interdependent and mutually destructive of rash contentions, it is very helpful administratively. The capital stock tax and the profits tax on declared value offer an excellent field for this type of legislative drafting."

While the capital stock tax, excess profits tax, and corporation income tax can be tied together, as indicated at a few point in the text, and each be made more or less to assist in the enforcement of the other, careful attention to relative rates will be necessary in order to secure the maximum effect in this direction. The aspects of interdependent relations are extremely important but are matters that this memorandum has been compelled almost entirely to ignore.

That the implementation of one tax by another is more than a myth, however, is witnessed in this language:

"With the advent of the excess profits tax law initiated in October 1917 and continuing through 1921, it could again be said that the allowances deducted for depreciation were entirely reasonable and, therefore, relatively free of difficulties."

"This it is believed could be attributed to the fact that since the invested capital factor in a large degree determined the tax liability, taxpayers confined their deductions to the more nearly actually sustained depreciation, and perhaps in a number of cases it was less than the actual losses suffered from that cause." Taken form special report on "Depreciation and Obsolescence" by C. H. Furst and R. E. Vierling, MEMORANDUM ON ADMINISTRATIVE EXPERIENCE WITH WAR PROFITS TAXES, by Joseph Weare and collaborators, Bureau of Internal Revenue: 1933. Mr. Weare, in his covering summary to the separate sections contained in report mentioned, adds that after the repeal of the excess profits tax in 1921 the volume of depreciation claims at higher rates immediately rose.

/85/ Attention as previously been called to the fact that companies whose main business consists of making investments probably present a special case.

/86/ Allowing for abnormal situations, Congress, in passing the Revenue Act of 1918, seems to have had in mind something like the following:

(1) Where a corporation is place in a position of substantial inequality because of the time or manner of organization; (2) where the capital employed, although a material income-producing factor, is very small or is in a large part borrowed; (3) where there are excluded from invested capital intangible assets, of recognized value and substantial in amount, built up or developed by the taxpayer; (4) where the net income for the year is abnormally high, due to the realization in one year of (a) income earned during a period of years, or (b) extraordinary profit derived form the sale of property the principal value of which has been demonstrated by prospecting or exploration and discovery work done by the taxpayer, or (c) gain derived in one year from the sale of property the increase in value of which had accrued over a period of years; and (5) where proper recognition or allowance can not be made for amortization, obsolescence, or exceptional depletion due to the world war. Of. LEGAL PROBLEMS ARISING OUT OF WAR PROFITS AND EXCESS PROFITS TAXATION, by P. J. Mitchell (?), Bureau or Internal Revenue, 1933 (?) p. 160.

Probably after extended experience with an excess profits tax it would be possible to cover many of the foregoing points by provisions in the law itself rather than by special assessments.

/87/ Additions of "(1) the cash and fair market value of property paid in for stock or shares, (2) paid in surplus and contributions to capital . . . ."

/88/ Additions of "(4) the excess of its income wholly exempt from the taxes imposed Title I over the amount disallowed as deduction by section 24(a) (5) of such title, and (5) the amount of the dividend deduction allowable for income tax purposes, and minus (A) the value of property distributed in liquidation to shareholders, (B) DISTRIBUTION OF EARNINGS OR PROFITS, and (c) the excess of the deductions allowable for income tax purposes over its gross income . . . ."

END OF FOOTNOTES

APPENDIX I

REVENUE ACT OF 1918.

Table showing 7,899 representative corporations classified according to amount of invested capital and ration of net income to invested capital during the taxable year 1917.


                             Proportion or percentage of net
                               income to invested capital

                           1                2                3

Corporations
having invested      Under 7.          7 to 9.99.       10 to 14.99.
capital of--

                           4                5                6

Corporations
having invested      15 to 19.99.     20 to 24.99.      25 to 29.99
capital of--

                           7                8                9

Corporations         30 to 39.99.     40 to 49.99       50 to 59.99
having invested
capital of--

                          10               11               12

Corporations         60 to 69.99.     70 to 79.99.      80 to 89.99.
having invested
capital of--

                          13               14               15

Corporations         90 to 99.99.    100 to 124.99.    125 and over
having invested
capital of--

                   Corresponding tax (percentage of net income).

                              No tax.        0 to 6.     2 to 10.6.

Under $10,000                    5              3               1
$10,000 to $20,000               5              2               4
$20,000 to $40,000               8             10             185
$40,000 to $60,000              30             93             195
$60,000 to $80,000              59             67             146
$80,000 to $100,000             43             58             114
$100,000 to $15,000            116             99             193
$150,000 to $200,000            78             57             114
$200,000 to $250,000            51             48              82
$250,000 to $300,000            48             27              65
$300,000 to $400,000            54             38              65
$400,000 to $500,000            35             20              39
$500,000 to $750,000            47             24              56
$750,000 to $1,000,000          32             14              34
$1,000,000 to $1,500,000        32             13              37
$1,500,000 to $2,000,000        22             10              14
$2,000,000 to $3,000,000        15              7              18
$3,000,000 to $4,000,000         7              7               6
$4,000,000 to $5,000,000         4              3               5
$5,000,000 to $7,500,000        10              3               6
$7,500,000 to $10,000,000        2             --               3
Over $10,000,000                 4              3               2

Total                          707            606           1,384

                              8 to          12.25 to       16.8 to
                             14.25.           18.4.         22.8.

Under $10,000                    5              2               5
$10,000 to $20,000              29             65             114
$20,000 to $40,000             249            271             204
$40,000 to $60,000             202            151             119
$60,000 to $80,000             124            105              66
$80,000 to $100,000             88             60              52
$100,000 to $15,000            128             96              64
$150,000 to $200,000            65             56              29
$200,000 to $250,000            57             38              22
$250,000 to $300,000            23             21              14
$300,000 to $400,000            46             26              20
$400,000 to $500,000            28             26              14
$500,000 to $750,000            40             26              21
$750,000 to $1,000,000          18             14              13
$1,000,000 to $1,500,000        20             11               8
$1,500,000 to $2,000,000        12              6              --
$2,000,000 to $3,000,000         9              5               3
$3,000,000 to $4,000,000         9              3               1
$4,000,000 to $5,000,000         3              1              --
$5,000,000 to $7,500,000         2              2              --
$7,500,000 to $10,000,000        1             --               1
Over $10,000,000                --             --              --

Total                        1,158            985             770

                              21.5 to        30 to            36 to
                                31.           36.8             40.6

Under $10,000                   19             40              40
$10,000 to $20,000             178            136              83
$20,000 to $40,000             264            118              53
$40,000 to $60,000             103             53              23
$60,000 to $80,000              65             36              10
$80,000 to $100,000             54             15             109
$100,000 to $15,000             83             39              21
$150,000 to $200,000            41             19               8
$200,000 to $250,000            23             11               9
$250,000 to $300,000            15             11              --
$300,000 to $400,000            30             10               5
$400,000 to $500,000            22              7               3
$500,000 to $750,000            23             15               9
$750,000 to $1,000,000          17              4               2
$1,000,000 to $1,500,000        10              5               2
$1,500,000 to $2,000,000         5             --              --
$2,000,000 to $3,000,000         2             --              --
$3,000,000 to $4,000,000        --             --               2
$4,000,000 to $5,000,000         2              1              --
$5,000,000 to $7,500,000         2             --              --
$7,500,000 to $10,000,000        1             --              --
Over $10,000,000                --             --              --

Total                          959            520             280

                               40 to        42.8 to           45 to
                               43.4          45.5             47.1

Under $10,000                   45             28              18
$10,000 to $20,000              60             21              20
$20,000 to $40,000              20              9              10
$40,000 to $60,000              17              6               3
$60,000 to $80,000               5              3               1
$80,000 to $100,000              9              1               1
$100,000 to $15,000              6              7               4
$150,000 to $200,000             2              2               3
$200,000 to $250,000             2             --               2
$250,000 to $300,000             2              3               2
$300,000 to $400,000            --              6               1
$400,000 to $500,000             2             --              --
$500,000 to $750,000             5              1              --
$750,000 to $1,000,000           1             --              --
$1,000,000 to $1,500,000         1             --              --
$1,500,000 to $2,000,000        --              2              --
$2,000,000 to $3,000,000        --             --              --
$3,000,000 to $4,000,000        --             --              --
$4,000,000 to $5,000,000        --             --              --
$5,000,000 to $7,500,000        --             --              --
$7,500,000 to $10,000,000       --             --              --
Over $10,000,000                --             --              --

Total                          177             89              65

                             46.6 to     48 to     50.4 to
                              48.4       50.7        60       Total

Under $10,000                   15         37         51        314
$10,000 to $20,000              11         14          9        751
$20,000 to $40,000               5          6          9      1,421
$40,000 to $60,000               1          4          1      1,001
$60,000 to $80,000               1          4          1        693
$80,000 to $100,000              3          4         --        512
$100,000 to $15,000              2          3          3        864
$150,000 to $200,000             1         --         --        477
$200,000 to $250,000             2          2         --        349
$250,000 to $300,000             2          2         --        235
$300,000 to $400,000            --          1          1        302
$400,000 to $500,000            --         --         --        197
$500,000 to $750,000            --          1         --        268
$750,000 to $1,000,000          --         --         --        149
$1,000,000 to $1,500,000         1         --         --        110
$1,500,000 to $2,000,000        --         --         --         71
$2,000,000 to $3,000,000        --         --         --         59
$3,000,000 to $4,000,000        --         --         --         35
$4,000,000 to $5,000,000        --         --         --         19
$5,000,000 to $7,500,000        --         --         --         25
$7,500,000 to $10,000,000       --         --         --          8
Over $10,000,000                --         --         --          9

Total                           44         78         77      7,899

Source: HEARINGS before the Committee on Ways and Means, 1918, p. 41
 
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