Comments upon reaction to the undistributed profits tax observed in talks with business men

(Memo. from Mr. Upham to Mr. Magill, October 9, 1937)

October 9, 1937

MEMORANDUM FOR MR. MAGILL

I found the feeling among business men and bankers against the tax on undistributed earnings even more marked during my recent trip than it had been in May.

Nearly every banker I visit gives me numerous illustrations drawn from among the customers of his own institution of business concerns which have abandoned expansion plans because of the penalties and rigors, as they see it, of the UP tax. Moreover, in numerous instances I encounter the business men themselves.

Let me cite briefly four examples.

(1) In New Orleans is a banker who has $30,000 to set his two sons up in business. He is completely discouraged about starting them in business because if they lose money, they stand a loss of 100 per cent, and if they make money, they cannot build the business institution into a constantly increasing unit by adding to surplus without paying a penalty rate and they cannot distribute to themselves as stockholders and owners without paying a personal income tax so high that it is a discouragement to their business initiative and interest in operating a business at all.

(2) The president of a very substantial concern in Kansas City which branch plans in more than a dozen states has had in contemplation the establishment of a number of new branches -- which would mean the employment of construction labor and the permanent addition of employees to the payroll of his company. He has abandoned all of his plans for new branches due almost entirely he says, and I think honestly, to the UP tax.

This particular individual, who has many complaints about the Bureau of Internal Revenue and taxes generally, has one angle which I had not had elsewhere, which may be of interest to you.

He says that one reason he cannot adopt the suggestion made by the proponents of the UP tax to increase the capitalization of his company is that the many states in which he operates branches base their tax upon capitalization rather than upon actual value of the business.

(3) A newspaper publisher in Des Moines with a fairly modern plant, newly erected only ten or twelve years ago, needs a completely new and enlarged publishing plant and plans were all made for the erection of such a building, out of accumulated surplus, at the time the UP tax was passed. They have abandoned the plan because of the impossibility of great difficulty or penalty in building up a new surplus to replace that which would have been expended for expansion.

(4) A Federal Reserve Bank, in accordance with the policy of encouraging loans to industry where it was impossible to secure them from commercial banks, made a substantial industrial loan. Later the UP tax was enacted. That concern is now penalized if it pays off to the Reserve Bank the loan which was made to enable it not to make a great profit but to barely continue in existence.

Even if cushions were inserted in the act to take care of those concerns which are in debt (for instance, the new struggling small company which has lost money and gone in debt for five years and made money for one year), those which have statutory or contract obligations and those which for some other reason need special treatment, many of the business men would still oppose the tax. In short, there is not as much belief in the principle of the tax as there formerly has been. Accounting and banking and credit concepts give tremendous importance to the surplus as a part of an American business institution. It will take a generation to greatly minimize the importance that is given to that concept.

It is not that business men feel their total tax is too great. A straight percentage income tax which took as much actual cash out of the business would not be resented. By the feeling is widespread (and business men believe there is evidence of its deleterious effect upon business activity) that the combined penalty on surplus accumulation and high personal income tax will result in a lessened business activity and eventually, for that reason, in greatly reduced tax revenues.

                                             Upm