/1/ "Statement of the Acting Secretary of the Treasury regarding the preliminary report of a Subcommittee of the Committee on Ways and Means relative to methods of preventing the avoidance and evasion of the internal revenue laws together with suggestions for the simplification and improvement thereof" 1933, page 15.
/2/ Community Property Income, Hearings before a Subcommittee of the Committee on Ways and Means, 1934, page 6, statement by Mr. Treadway of Massachusetts, a member of the Committee on Ways and Means.
/3/ H.R. 8396, 73rd Congress, 2nd Session.
END OF FOOTNOTES
In connection with its change of position the Treasury said that the original proposal appeared upon further study to present "numerous complications which would involve a long and complicated provision in order to accomplish its object," and that transactions between husband and wife inimical to the Federal revenues, a principal trouble aimed at in the non-community property States, were being provided for in the pending revenue bill through disallowance of any loss resulting from the sale of property between husband and wife. The substitute proposal would be adequate to remedy the discriminations under existing law in favor of community property States, would avoid "very many administrative difficulties and numerous amendments which would have to be made to provisions appearing all through the revenue act," limited the question to one issue and was "as likely to receive Judicial sanction as any other proposal that has come to the attention of the Deportment." /1/ Bartholow, the Treasury representative, also expressed the opinion that the Treadway bill might involve fewer inequities than the original proposal, since "The income that one person has no share in, does not manage and control, and cannot use in any way should not be used to measure such person's income tax." /2/
In 1937, at Hearings before the Joint Committee on Tax Evasion and Avoidance, Under Secretary Magill expressed preference for a provision that would require compulsory Joint returns of husband and wife in all the States rather than a provision aimed only at residents of the community property States. /3/
/1/ Community Property Income, Hearings before a Subcommittee of the Committee on Ways and Means, 1934, pages 30-32.
/2/ Idem, page 39.
/3/ Hearings before the Joint Committee on Tax Evasion and Avoidance, 1937, pp. 309-312.
END OF FOOTNOTES
In 1941, as already noted, the Treasury withheld approval of the mandatory Joint returns provision reported out by the Ways and Means Committee, on the ground that it failed to accord substantial relief to earned incomes of husband and wife.
5. THE CASE FOR AND AGAINST MANDATORY JOINT RETURNS: Adoption of mandatory Joint returns, WITHOUT special relief for earned net income, would eliminate many of the problems arising under the existing system. From the standpoint of equity, the Federal tax upon incomes of the same size in different States, whether community property States or ether, would be equalized; the tax upon married couples with combined income of the same size would be equalized, instead of being higher in the case of families where only one spouse has income or where the income is very unequally divided; and except for differences due to personal exemptions and other credits, the tax upon single persons and married couples with the same amount of income would be equalized. From the revenue side, certain forms of tax avoidance transactions between husband and wife would be rendered ineffectual; and it would not be possible for wealthy taxpayers to avoid the upper surtax rates applicable to their aggregate income. A substantial increase in Federal revenue would result. /1/ Finally, the proposal has the basic merit of recognizing the family as a single unit in its financial affairs, consistently with its unity in other respects and with governmental policy in other fields.
/1/ In this connection it should be noted that although joint returns are presumably now used only when they produce the lesser tax or at least do not affect the tax, under a compulsory provision they would be used universally by husband and wife living together. The additional cases thus brought in would be those in which the joint return produces a greater tax than separate returns.
END OF FOOTNOTE
The Treasury proposal for relief to earned net income is obviously not consistent with the position that husband and wife should be treated as a single taxable unit, but instead reverts to the position that with respect to earned net income they are to be treated as separate taxpayers. It has the further weaknesses of failing to remove Federal tax inequalities between community property States and other States, and of extending no benefits to the smallest combined earned net incomes (those aggregating $3,500 or less), even though as at present drafted it would accord relief to earned net incomes of maximum size.
Opponents to the general proposal for mandatory joint returns insist, however, that it is inequitable: (1) to impose on a married working couple a tax as high as that on a couple having an equal money income earned by the husband and enjoying in addition the benefit of the wife's work in the home; (2) to compel a joining of incomes for tax purposes in the case of those husbands and wives whose financial affairs are in fact not merged but as independent as those of two singles persons; and (3) to impose on a married person a higher tax than that imposed on a single person with the same income, simply because the former has a spouse with income. As affecting the revenue, they make the point that tax avoidance transactions between husband and wife will not be eliminated but will simply take the various forms already existent under joint returns. (See section IIIB.) It is also contended, without much substance, that mandatory joint returns would infringe upon women's rights and encourage divorce and immorality.
6. CONSTITUTIONALITY: The constitutionality of a requirement for mandatory joint returns is unsettled. In 1931 the Supreme Court /1/ held that a Wisconsin income tax statute authorizing an assessment against a husband of a tax computed on the combined total of his and his wife's incomes and augmented by surtaxes resulting from the combination, although under the laws of the State the husband had no interest in or control over the property or income of his wife, was violative of the due process and equal protection clauses of the Fourteenth Amendment. /2/ The Treasury has suggested that this decision is not conclusive for the two reasons that (1) the Wisconsin law was evidently interpreted by the court as requiring that the husband should pay the tax on his wife's income, whereas the present proposal would give the spouses the option of apportioning the tax between them on an equitable basis and (2) the Federal Government is not under the same constitutional restrictions as the States in this respect. /3/ The opposing point is made, however, that regardless of its apportionment, the tax upon each spouse will still be determined partly by reference to the income of the other spouse.
/1/ Holmes, Brandeis and Stone dissenting.
/2/ Hoeper v. Tax Commission of Wisconsin, 284 U.S. 206.
/3/ Statement of the Acting Secretary of the Treasury regarding the Preliminary Report of a Subcommittee of the Committee on Ways and Means, 1933. See also memorandum from Ray to Tarleau, "Federal Taxation of Community Property," November 24, 1941.
END OF FOOTNOTES
7. STATE PRACTICE WITH RESPECT TO COMPULSORY JOINT RETURNS: None of the 32 States that impose income taxes require compulsory Joint returns. Under the Wisconsin income tax statute which the Supreme Court invalidated in 1931, separate returns might be filed by married persons living together as husband and wife, although the tax was required to be computed on the combined taxable income.
B. THE TAXATION OF INCOME ACCORDING TO (1) PERSON EARNING AND (2) MANAGEMENT AND CONTROL
1. THE PROPOSAL: After the House had rejected the provision for mandatory joint returns in the revenue bill of 1941, the Finance Committee inserted in the Senate bill a provision requiring that for Federal income tax purposes:
"(a) Income earned by each spouse (whether or not treated as community property under the state law) shall be deemed the income of the earner thereof. "(b) Income derived from property of the marital community (except such property as constitutes either income derived from the separate property of either spouse or property acquired therewith) shall be considered as the income of the spouse who has the management and control thereof under the law of the jurisdiction in which the marital community exists."
This provision, which resembled previous proposals made in 1921, 1924, and 1934, was subsequently withdrawn by the Finance Committee on the floor of the Senate.
A provision of this sort would not eliminate separate returns but would eliminate community property returns by re-allocating community property income between husband and wife for purposes off the Federal income tax.
With respect to earned income, the allocation would be substantially like that in most non-community property States, so far as the Federal tax is concerned. In non-community property States generally earned income is taxed under existing law to the spouse earning it, because the income is viewed as first belonging to such spouse regardless of how it may be shared or assigned. In community property States, however, where only one-half the earnings are ever owned legally by the earning spouse. taxation to the person EARNING rather than to the person owning such income would reach the earnings as a unit in cases where they represented compensation solely to the husband (or wife), and at the same time would accord working wives the same privilege of a separate return with respect to earned income that is enjoyed by wives in other States.
Property income of the marital community would also be reached as a unit if taxed to the spouse having management and control, this spouse under community property laws being the husband. Income derived from separate property would continue taxable to the owning spouse. The parenthetical insert in paragraph (b) of the Senate provision (above) was intended to ensure this result even in the few community property States where income from separate property becomes community income.
A practical difficulty in application of the Senate provision is that it is not clear Just what income is to be considered under paragraph (b) property income. For example, are business and partnership profits to be considered earned income or property income or both or neither? Similarly, is income from fiduciaries to be considered property income? Or does the provision visualize three classes of COMMUNITY income, a) earned income, b) property income, and c) income that is neither earned income nor property income of which the first two would be taxed to one spouse while the third would continue to be divided on the community basis? It has been suggested that this ambiguity be met by recognizing "other income of the marital community" as a third category, which should be taxed to the spouse Having management and control.
2. ARGUMENTS PRO AND CON: The primary argument advanced in favor of this proposal is that it would circumvent the community property division of income between husband and wife, and thus eliminate an outstanding inequity in the Federal income tax. The proposal would not, however, solve inequities ascribable to separate returns in general.
Community property States "have put forward numerous arguments against the taxation of community income, in addition to some of those advanced against mandatory joint returns and those relating to the constitutionality of taxing a husband and wife as a unit. These arguments, stated briefly, are as follows: (1) That community property marital partnership should not be taxed as an entity when other partnerships are not so taxed; (2) That the spouse having management and control of community income is merely an agent or trustee; (3) That spouses in non-community property States can achieve division of income by making gifts to each other; (4) That spouses in non-community property States can split their income by setting up Joint tenancies, tenancies in common, and tenancies by the entirety; (5) . . .; (6) That the provision would cause an exodus from the community property States; and (7) That the community property States might avoid the provision by dividing management and control between the spouses." /1/
3. TREASURY POSITION: The Treasury has taken no public position with respect to the special provision for taxation of community income inserted in the revenue bill of 1941 by the Senate Finance Committee. It has generally indicated approval of similar prior proposals.
In 1921, the revenue bill as passed by the House required that community income be included in the gross income of the spouse having the management and control of the community property. What evidence is available indicates that this provision may have been sponsored by the Treasury Department. The Senate eliminated this provision and in conference the House conferees yielded in favor of the Senate action.
In 1924, Secretary of the Treasury Mellon recommended that a provision be enacted in the Revenue Act of 1924 requiring that the income received by an marital community be included in the gross income of the spouse having the management and control of the community property. Such a provision was reported favorably to the House, but was eliminated on the floor of the House by action of the Committee.
Mr. Prettyman, General Counsel of the Bureau of Internal Revenue, in a letter dated December 15, 1933, written to L. H. Parker, Chief of Staff of the Joint Committee on Internal Revenue Taxation, approved a proposal to tax the income received by a marital community to the spouse having management and control of the community property. /2/
/1/ See the extensive memorandum from Mr. Ray to Mr. Tarleau, "Federal Taxation of Community Property" November 24, 1941.
/2/ This letter appears in the Hearings on H.R. 8396, conducted by the Subcommittee of the Ways and Means Committee, 1934, at pp. 22-25.
END OF FOOTNOTES
In 1934, Hearings were held before a Subcommittee of the Ways and Means Committee on H.R. 8396, a bill sponsored by Representative Treadway. This bill proposed that the income of a marital community be taxed to the spouse having management and control. Mr. Bartholow, a Special Assistant to the Secretary of the Treasury, appeared as a witness in favor of the bill. (See Section IV A4 above)
C. UNIVERSALIZING COMMUNITY PROPERTY
1. THE PROPOSAL: Universalizing community property does not mean merely extending to non-community States the system now existing in community property States, but means rather extending to all income, including the income that is viewed in community property States as separate income of the husband and the wife, the equal division characteristic of community property income. It is a system under which the entire income of the husband and wife, whether received by one spouse or both, would be divided by two, each spouse computing a tax on his one-half share. No income tax jurisdiction at present uses this method. /1/
/1/ Carl Shoup, "Married Couples Compared with Single Persons under the Income Tax," Bulletin of the National Tax Association, February 1940, pages 131, 134 (i.a.) See also Blakey, "The Federal Income Tax" (a confidential study prepared in the Treasury in 1934), Section VII, in particular pp. E-109 ff.; and Viner, Supplementary Memorandum to the Secretary "Detailed Comments on Randolph Paul's Recommendations for Income Tax Increases". Dec. 14, 1939, p. 4. Estimates universalizing, community property or else dividing income 50-50 are: Hans to Magill 10/27/37 and Hans to Blough 8/7/41.
END OF FOOTNOTE
2. MERITS AND DEFECTS: A system of this sort would equalize the Federal income tax on married couples living in different States, and among married couples in the same State having the same money income, regardless of whether such income originated with one spouse or with both and regardless of its actual division between husband and wife.
It disregards, however, increased economic capacity due to the combination of the incomes of husband and wife; entails (unless accompanied by a substantial increase in tax rates) a serious loss of revenue, and is discriminatory toward single individuals, since they would pay a considerably higher tax, if in surtax brackets, than that imposed upon a married individual or a married couple with income of corresponding size.
D. VARIATIONS IN RATE STRUCTURE
1. THE WOOD PLAN: As an alternative to the Treasury proposal for compulsory joint returns, a plan was advanced in 1937 by Mr. Herbert S. Wood of the Treasury Department for adjusting the application of the income tax rates in such a manner that married couples would receive no advantage from filing separate returns and that the combined taxes on two unmarried persons or two married persons filing separate returns would be substantially the same as the tax or married couple with an equal total income. /1/ The method proposed for accomplishing this result was to adopt for "unmarried individuals a tax schedule which would retain the present rates but would apply them to brackets one-half the size of the present brackets." The rates and brackets applying to married couples who filed joint returns would be the same as at present.
/1/ Fuller discussion of the Weed plan is contained in the memorandum from which the above excerpts come, Blough to Megill, September 27, 1938, "Comment on Mr. Wood's 'Alternative Plan for Eliminating Inequalities in Income tax on Married Couples' (Memorandum from Mr. Wood to Mr. Megill July 26, 1937)."
END OF FOOTNOTE
2. EFFECTS: The result of the operation of this plan would be to increase the taxes paid by unmarried persons and married persons filing separate returns, in many cases very substantially. The tax imposed on a married couple filing a Joint return would be less than if separate returns wore filed except when the incomes of husband and wife were equal. In the latter case the taxes would be substantially the same, any variations being due to the treatment of personal and earned income credits.
The ratio of taxes on single persons to taxes on married couples filing Joint returns would be substantially the same as exists under the present law between taxes on single persons and on married couples in the States having community property provisions.
The Wood plan would increase the volume of revenue by increasing the taxes collected from unmarried persons and from married persons who chose to file separate returns.
3. EQUITY: From the viewpoint of equity the Wood proposal appears to rest on the proposition that the economic power of either husband or wife is in no case greater than one-half of the total economic power of both. Thus it would apply to all incomes the same principle that is applied at present in the community property States. The proposition would appear to be defective in that the economic power would not in practice be divided but in many cases would be combined in the hands of either husband or wife. The difficulty lies in the complexity of the marital relationship. It would appear, however, that for the larger incomes the existing law comes nearer to representing the financial relationship of marriage than would either the proposal for mandatory Joint returns or the Wood plan.
4. OTHER CONSIDERATIONS: The principal difficulty of the present law lies in its administration. Since the marital relationship is a very private one, tax administrators find great difficulty in learning the actual truth of the financial relationships between husbands and wives. Avoidance and evasion are thus difficult to prevent or detect. The Wood plan would eliminate the necessity of going behind the family unit to determine the financial relations of its members. It would add somewhat to administrative problems by providing two sets of rate brackets, although this may not be a significant addition to the existing complications.
Since the additional tax on bachelors under the Wood plan is substantial, the plan would tend to encourage marriage. It may be doubted, however, whether the number of cases in which the effects of income taxation would be decisive in promoting or retarding marriage are sufficient to be of much social significance.
Cases 1-4 Combined earned income credit under separate returns larger than the earned income credit under a joint return. (1941 Act)
CASE 1. One spouse subject to the minimum credit of $300 applicable to net incomes in excess of $3,000.
Combined Aggregate amount amount Items Husband Wife under under a separate joint returns return _______________________________________________________________ Earned net income 7,000 3,000 /1/ 10,000 7,000 Net income 10,000 5,000 15,000 15,000 Earned income credit 700 300 1,000 700