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Fore:

The newAdministration and Congres sin 1969 will begin.a fresh examination ofthe Federal tax ' system and needs forrevising it. The present study deals withthe second most important part of th ertax system `(in -terms of revenue), th ecorporation income tax. The examinationof certain major ,aspects of the tax is de-signed to belp, not only in the discus-sions of revision in anyone year, but,als oover a much longer future ,

The study reviews thehistory of th e;corporation ;tax from its initial form asan "excise tax in `1909. The historicalsection covers various experiments' and

,proposals that have been made, as wel l;'as changes that bave,proved ;more,orIesspermanent. :

The central purpose has been to ana-lyze recent experience and, research inorder to suggest some'pnorities in taxrevision. The volume of research relat-ing directly and indirectly to the corpo-ration income tax is so large-that a reviewof results", `necessarily, selective, andtentative.

On the question of tax incidence, a',typothesis is suggested that the burdenis widely spread through changes in var -ioys ~orXn nf_incorne, notamerely.through

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:'.changes in dividends or in consumerprices. The most significant effect of thecorporation tax appears to be on the tota lvolume of business investment expendi-tures. A substantial reduction in the rateof the tax from its present all-time hig h(with the 1968, surcharge) would .'be ~~a "major 'revision . for the long-run .

The ' "Introduction, Summary, an dConclusions" condense the essentials o fthe study for those who may not have thetime to read the whole text, and providea guide for `those ',;who wish to : delvefurther.

George A. Bishop, Director, Federa lAffairs ' Research, was primarily respon-sible for 'the :'preparation of this."study .

The. Tax Foundation is a private, non-profit organization . founded in 1937, toengage in non-partisan research andpublic education, on the fiscal and man-

.Jagement aspects of government. Its pur-pose is to aid in the development of moreefficient and economical government. Itserves as a national information agency 'for individuals and organizations con-cerned with government fiscal problems ,

T aYovrroAnox, INN

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December.1966

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Table. of ContentsPAGE

~INTRODUCTION, SUMMARY, AND CONCLUSIONS

7Purpose and Nature of the Study . . . 7Summary 8

Incidence and Burden 8`Analysis of Economic Effects 1UNature and Structure of the Corporation Tax . .'', 12

Conclusions

: .

, , . : 16

I. ' .'HISTORICAL CHANGES IN THE ROLE OF TH E;CORPORATION INCOME TAX 1909.1968 19

The Initial Form of the Tax :119

Changes in the Nature of the Tax, Rates, and Collections `'19Depreciation Policy . .

. , . ,

28The Investment Tax Credit , : 29'Treatment of Dividends 30Tax Payment Speed-Ups 3 1Revenue and Expenditure Control Act of 1968

32Summary : . : '. : .. " 32

II. INCIDENCE AND BURDEN : . . . .

. ' . . . ,33Definitions of Incidence and Burden, : 34Significance of Imputed Income 36Empirical Analyses of Corporation Tax Incidence '38Conclusion , ; :

43

IIL .EFFECTS ON PROFITS, CORPORATE SAVINGS ,DIVIDENDS, AND INVESTMENT , 44

Determinants of Corporate Profits : . .

46Dividends 50Undistributed Corporate Profits :54

" .Business Investment, ; : . .

'54:

rends in Income Shares : ; 56Debt-Equity ;Ratios 62Conclusion . : 82.

IV. THE NATt1RE AND STRUCTURE OF TH ECORPORATION INCOME TAX 66

. .Alternative Forms of Taxation 86A Separate Profits Tax-A Value-Added Tax . . .

:68An "Integrated" Income Tax _ :69

Structural Changes in the Corporation Tax 71Tax Treatment of Foreign Income 72Depreciation Policy 73Use of Tax Credits 74The Multiple Surtax Exemption 74Tax Treatment of Corporate Reorganizations 75

Conclusion 75

List of Tables and. ChartsTABLE

PAGE

1 . ,'Federal *Tax Collections by Major Source, Percentage Distribution, Selecte dFiscal Years 1913-1968 20

2 Federal Tax Collections by Major Source, Selected Fiscal Years 1'913-1968 2 13' Federal Corporation Income Tax Fates and Credits, 1913-1968 22

"4 'Investment Tax Credit and Corporate Assets Affected, Income Years 1962-1966 .29

5 Income and Product Sides of the U.S. National Accounts, Calendar Year 1967 356 Estimated Corporation Income Tax Burden in Relation to Income on all Familie s

by Income Class, 1961 :39 ~7' Corporate "Cashfiow," Dividends, Payout Ratio, and Effective Tax Rate, . Cal-

endar Years 1947-1967 498 -Gross National Product by Type of Income, Calendar Years 1947-1967 58

9.. _ 'Sources of `Funds ' of Non-farm, Non-financial Corporations, Calendar Year s1947-1967 :63 .

10 Sources of Funds of Non-farm, No

"Corporations, Percentage Distri-. .bution, Calendar Years '1947-1967 . . ` 64

11' . Gross Corporate Product as a ;Percentage of GN,P, ,Calendar: Years,4947-19 7 . . , ;_67

„ :.CHART

1 Federal Corporation Income Tax Rates, 1913-1968 27 1

Gross National Product Related to Personal Income from Factor Services, Cal -endar Years . 1947-1967 37

3 ;GNP Components on the Income Side, Calendar Years 1947 . 1967 45

4, -'Percentage Changes in Corporate Profits Related to Percentage Changes in theIndex of Industrial Production, Quarterly 1948-1967 4i

5 Corporate Profits Related to Index of Industrial Production and Index of Labo r-Cost Per Unit of Output in Manufacturing Quarterly 1948-1967 4A

6 Corporate Cashfiow, Profits, Dividends, Undistributed Profits, Payout Ratio, an dIndex of Utilization in Manufacturing, Quarterly 1948-1967

T `” Dividends Related to Corporate -Cashflow and Index of Utilization in Manufac -turing, Quarterly 1(148-1967

8 Undistributed Profits Related to Corporate Cashfiow and Index of Labor Cos tper United of Output in Manufacturing, Quarterly 1948-1967

9 Corporate Profit Share of Gross Corporate Product under Alternative Deprecia-tion Methods, Selected Years 1929-1966

10 Structure of Long-Term Invested Capital, U,S, Manufacturing Corporations ,Selected Years 1955-1967 61

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Introduction, Summary, and ConclusionsPURPOSE AND NATURE OF THE STUD Y

The Revenue and Expenditure Con- extent of reliance on different types oftrol Act of 1968 marked the beginning taxes, their comparative burdens, an d

'

of a new consideration of Federal tax economic effects . This study examinesreform, it directed the Administration the role of the corporation income tax

:to submit proposals for tax revision by and selected changes, revisions, and al -the end of 1968 . While such proposals, ternatives that have been proposed . Theas it turned out, were not made public, : emphasis is on possible revisions relate d.the Treasury Department's studies and to the goals of greater equity in the ta xsuggestions were given to the new Ad- system and the maintenance ; of.a high.ministration and tax-writing comn .'.ttees rate of economic growth..of Congress . Many additional proposalswill undoubtedly be `made in the' new The study is primarily concerned with

session of Congress . ,Jong-range issues, and only incidentall ywith the role of the corporation tax in

Extensive tax revision takes a long ,stabilization" policy, that is, short-ru ntime to plan, analyze, and develop in ~"fiscal measures to stabilize economic.acceptable form, Detailed studies of the " activity and help maintain a high leve lFederal tax system in 1955 and 1959 by of employment. The study does not at -Congressional committees and by pri- ,tempt to cover the numerous issues in-vate groups contributed signifi cantly. . , to : volved in administrative quid compliancetax changes in the early 1960's . 1 problems.

The last substantial revisions of theFederal tax structure were in the Rev- -The corporation income tax is a main

-enue Acts of 1962, 1964, and 1965. The stay of Federal revenues, It now ac.

1962 act introduced an investment tax counts for about one-fifth of total Fe d

credit and made changes in the treat- eral budget receipts, as estimated ;for .

ment of foreign income and various busi- the fiscal year 1969 .

nesa expenses . The 1964 act reduced the Despite the large rise in social insur-individual income tax rates on the aver- lance taxes, the share of the corporationage by about 20 percent. It reduced the tax in Federal tax collections (excludin ggeneral corporation income tax rate by miscellaneous receipts) has remained a tabout 8 percent (from 52 percent to 48 roughly one-quarter of the total sincepercent) . The 1965 act repealed a large World War II, Excise taxes now accountnumber of miscellaneous excises, for only 9 percent of the total, employ-

A long-range view of Federal tax re- nient taxes for 18 percent, and the indi -vision must include consideration of the vidual income tax for 50 percent ,

1,

U.S . Congress, Joint Committee on the Economic Report

F'ede~ral Tax Policv for Economic Growth an dStability, papers submitted by panelists appearing be tore tE~e Subcommittee on Tax Policy, 84th Cong ., 1stseas, November 9, 1955 ; U,S, House of [tepresentatIves . Committee on Ways and Means, Tax RcvistOttCompendtunt, compendium o/ Papers on Broadening the Tax Base, submitted in connection with the pane ldiscussions on the same subject, November

195 9Bibliography No, 9, Federal Tax Revision, February,

(three volumes) . Sec also Tax Foundation Researc h1963,

7

The rate of the corporation tax is a tan all-time high, if we exclude the excessprofits taxes of wartime periods. The 10percent surcharge of 1068 raised th egeneral rate (normal tax plus surtax )from 48 percent to nearly 53 percent .If account is taken of the current speed-up in payment dates to make tax pay-ments concurrent with liabilities, th eeffective rate of the tax on a cash basi sis still higher .

A large unkn%,wn in dealing with the,corporation tax is its incidence, or im-pact, on individual taxpayers . In general,the effects of this tax are so difficult t oquantify that the tax rate and structurehave been mainly determined by imme-diate needs for revenue and politica lconsiderations relating to the taxation ofbusiness versus taxation of, individuals .

A growing volume of research hasmade some progress in reducing theunknowns in the impact of the,tax and indelineating its effects . The present studyis, in part, an interim review of this re-.search and an evaluation of results fo r;purposes of Federal tax revision . How-ever, the very quantity of research workbeing done suggests that recent result swill 'be modified in the future .2

Chapter I sketches the history of theFederal corporation income tax from it sfirst adoption as an "excise" tax in 1909 .This history is marked by numerous ex-periments with changes in the form, andattempts at rationalization, of the tax,

Chapter II reexamines concepts of in-cidence as applied particularly to thecorporation income tax . It is suggested

=I

that new definitional approaches are nec-essary for a large revenue producing taxthat has important effects on the aggre-gates of the economy — employment,output, investment, and the genera lprice level .

Chapter III reviews recent researc hon the effects of the corporation tax o ninvestment, saving, and economi cgrowth. It also examines these effects inthe light of the most recent data throughthe end of calendar 1967. The events ofthe past three years, which include th etax reductions of 1964, add useful evi-dence that sometimes modifies resultsof research done with data going only tothe early 1960's .

Chapter IV examines certain alterna -`tive approaches to taxing corporations :the "integration" approach to incometaxation which would not recognize thecorporation as a separate entity for taxpurposes, and the value-added tax . Theintegration approach has been given anew emphasis because it has been rec-ommended by the Royal Commission onTaxation in Canada, The value-addedtax has attracted more attention recentlybecause of its adoption by the CommonMarket countries of Western Europe .This Chapter also reviews selected issuesin the structure of the corporation in -come tax. These are issues prominent indiscussions of current tax revision,

SUMMARY

Incidence and Burden

much economic analysis has used anaggregative approach to problems of na -

Questions of tax incidence have been ti.onal economic policy. Traditionally,given a new setting in recent years when the incidence of taxation was examine d

2. See Tax Foundation Research Bibliography No, 28, "The Effects of the Corporation Income Tax and It sRole in the Federal Tax system . "

8

in the context of the probable effects ofa tax on the cost position of a firm, or aparticular industry, given the demandfor its product, and the resulting chang ein the output and price of its products.

k,a This approach is justifiable in dealingwith a tax which is a small element inthe economy, or in examining the reac-tions of individual firms. Because of it ssize, however, the Federal corporatio nincome tax (which produces about $38billion a year) requires other kinds of

-'analysis . The large amount of revenueinvolved (and the associated govern-ment expenditures) must affect the leve l

`of business activity, the level of incom ein all segments of the economy, and th e'demand for corporate products .

Attempts have been made to take ac ---count of broader effects of the corpora-Lion income tax and to analyze its inci-dence in the framework ; of possiblechanges 'in all major segments of th eeconomy. However, both theoretical an d_statistical efforts meet with great diffi-culties in trying to define and measureeffects of changes in the corporationincome tax on the assumption that "otherthings remain the same." just how "otherthings" are to be held the same is a cen-tral problem. Statistical efforts to isolatethe effect of the corporation income ta x

. from other influences on corporate prof-its have yet to achieve definitive answers .

,%penditures are a large proportion oftheir incomes. Further, the tax fallsrather unevenly on different types ofproducts and services . The importanceof the corporate form of business in vari -ous industries differs, as does the degre eto which the tax is likely to be passed on .Public utilities, for example, can gener-ally pass the tax forward as a normal par tof costs because it is part of the rate -making process . Corporations in someindustries may be subject to such com-petitive pressures, e .g., from imports ,that little forward shifting is possible .

On the other hand, if the corporatio ntax falls largely on shareholders, theburden again bears little relation to thesize of the shareholders' income . Manypersons with low incomes, particularl yamong the retired population, are heav-ily dependent on dividends . Some share-holders with high incomes may be ableto avoid part of the tax burden by influ-encing corporate decisions in favor oforeater retained earnings . (The tax law,however, provides a penalty for undue "accumulation of corporate earnings . )

On either of these views about the in-cidence of the corporation income tax ,equity among individuals is not promoted by heavy reliance on this tax .

The present study suggests that par tof the difficulty of analyzing the burdenson individuals lies in the fact that ,

The problem of incidence has usually through this tax which is not levied di -been posed as the extent to which the rectly on individuals, the governmentcorporation tax is shifted forward into has diverted a portion of national outpu tproduct prices, or on the other hand, from private uses over a long period . -

-- -reduces profits after tax. (The tax may, Consequently, it is difficult to measur eunder some conditions, reduce returns the burden on individuals in relation t oto other factors of production.)

the incomes they might have receivedOn the view that the corporation tax is had this tax not been levied and ' iad gov -

largely reflected in product prices, . it is ernment expenditures been correspond -similar to a sales tax on corporate prod- ingly lower, or if the same level of ex-ucts, The impact on low income groups, penditures had been financed by a dif-then, is heavy because their consumption ferent kind of tax .

9

Individuals cannot be expected toassess what their incomes would be wer ethere a substantially lower level of taxe sand government expenditures. Individu-als usually make their decisions on con-sumption and saving in the light of theirincomes actually received, and with littl eregard for potential or accrued income ,e.g., in the form of undistributed corpo-rate profits . A certain degree of illusionconcerning the size of total real incom eis involved. The effects of taxes may bedifferent than if no illusion were in-volved and some taxes contribute more

. . . '. than others to this illusion .

If individuals take little or no accountof income not currently received, theeffect of the corporation tax will dependin part on how corporate decisions areaffected by the tax. Corporations typi-cally save a larger proportion of an yaddition to net income than do individ-uals. (Many also continue to pay divi-dends even when current "profits ar eabsent.) Moreover, there is a muchcloser tie between saving and real in -

' :vestment in the case of corporations tha n-' in the case of individuals . Thus, change s

in the corporation income tax are likel yto have a closer relation to the rate o f

,.real investment than are changes in the'individual income tax. Small corpora-tions particularly are likely to be sensi-tive to changes in internal sources offunds.

Changes in business capital outlay saffect all personal income, first through

- short-run effects on the level of tota lpayments for productive services, andsecond through effects on productivity_and the rate of economic growth. Forportions of national output that hav enever been distributed as income to in-dividuals, no standard is easily available ,in terms of total pre-tax income and it sdistribution, with which to compare

after-tax results . The burden of the cor-poration tax on different people may b enot only harder to identify but also mor ewidely spread than is commonly as-sumed.

Analysis of Economic Effects

In the past 20 years, the corporationtax has not changed nearly so drasticallyas 'in the preceding 20 years . Partly forthis reason, it is difficult to separate theeffects of the corporation tax from effects ,of other changes in the economy . Never-theless, the past two decades are morelikely than any previous period =to besimilar to future conditions .

A review of recent research on th eeffects of the corporation income tax an drelated research on the determinants o f-national output and its major compo-nents, suggest the following' tentativ econclusions based `on evidence of the;period 1948-1967 : (1) The level of cor-porate profits (before tax), particularl yin the short run, is determined to a largeextent by influences other than the cor-poration tax rate . (2) The level of divi-dends is usually determined by influ-ences other than the corporation tax.(3) The impact of the corporation ta xappears to be largely on corporate sav-ing (or undistributed profits), both inshort-run fluctuations and for the lon gterm. (4) The effects of the corporationtax in changing the allocation of re-sources in the private sector of the econ-omy (the "misallocation" of resources )may be less important than either theshort- or long-run effects on the rate ofinvestment .

Corporate profits before tax are themost volatile item among the majo rkinds of factor incomes from productiveservices. Dividends, however, have bee nrelatively stable in relation to nationa l

10

output. Over the years 1947 to 1967 ,dividends averaged 2.7 percent of GNP ,and apart from the Korean War period ,the range of variation was from 2 .5 to2.9 percent of GNP. Over the sameperiod, corporate profits before tax (in-cluding, inventory valuation adjustment )averaged 11.0 percent of GNP, and thispercentage ranged from a low of 9.2percent in 1958 to a high of 13.2 percentin 1950.

Because of the greater stability ofdividends, the corporation tax tends t oincrease the short-run fluctuation in un-distributed profits . When corporate prof-its before tax fall, undistributed profit sfall relatively much more ; when corpo-rate profits before tax rise, undistributedprofits rise relatively much more .

This effect on internal sources of cor -,porate funds tends to be a "destabiliz-ing" influence through the busines scycle. That is, in a recession, when busi -ness investment tends to fall, the sharpcurtailment in internal sources of fundstends to accentuate the fall in invest-ment. In a boom period, when invest-ment and profits are rising, the relative;growth of internal funds permits a large rrise in investment than might otherwis ehave occurred.

The high level of the corporation in-come tax since World War II also ap-pears to have held down, or checked, th elong-run growth of undistributed profitsmore than it affected dividends . For the:period 1947 to 1961, undistributed prof-its showed no upward trend even incurrent dollar terms . This result wasattributable in part to the rapid growthof capital consumption allowances fro mthe low level of the immediate post-World War II years . However, since un-distributed profits have been the secondlargest source of funds for business in -

vestment (after capital consumption al-lowances), the slow growth in thes efunds probably served to hold down therate of business investment in relation toGNP. Gross private domestic investmen taveraged just under 15 percent of GNPin the years 1960 to 1964, as comparedwith 18 percent in 1948, 17 percent in1955, and 16 percent in 1966 . Over thewhole period 1948 to 1967, undistributedprofits of nonfarm, nonfinancial corpora -tions have amounted to about 81 percentof such firms' purchases of physical as -sets less capital consumption allowances.

In addition to its effect on interna lsources of funds, a corporate tax in theneighborhood of 50 percent is a largefactor in business investment decisions .The rate of return after tax is the pri-mary concern of investors and corporatemanagement. A high tax rate tends t oeliminate investments with low prospec-tive returns . If we take "other things"as given for an individual firm, the rateof return before 'tax must be twice as.high with such a tax rate to justify agiven investment. Such a tax rate alsotends to shift the "mix" of factor servicestoward those subject to lower taxes . Ahigh corporation income tax reduces th esize of capital stock most appropriate a tany given level of output . Efforts toeconomize on capital may also serve t oslow the rate of technological advancebecause much of technological change i sembodied in new plant and equipment .

Despite the advantage given to deb tfinancing by the high corporation in-come tax, the last two decades haveshown little shift in corporate financia lstructures on the whole . The major shiftappears to have been from preferredstock to long-term debt. Common stockequity has approximately maintainedits share in the total financial structureof major industries and all manufactur -

11

The years 1966 and 1967, however, - virtue of the law? Should not all incom esaw a large upsurge in corporate debt . be allocated and taxed to individuals,

A recent estimate of the "efficiencyas has teen : suggested by the Royal

-Commission on Taxation in Canada ?

cost" of taxes on income from capital — Should not a more uniform tax on al lthat is the loss in real income or output as 'business whether incorporated or not,.a result of a shift in resources from heav_ .such as a value-added tax, be substi-ily taxed uses to others taxed only light- tuted for all or part of the corporationly or not at all —puts the amount be- tax? These questions have never re-

faween $1.5 `billion and $25 billion "per ceived very satisfactory answers, and i tyear. ;seems unlikely that really : :satisfactory

By way of comparison, the long-run answers can be found .`rate of growth in corporate product has ''been about 6 percent, and for corporate At the state government level, the

profits over the past two decades about corporation income tax has been justi-

;5 percent per year. At the 19681eve1 of fled in part as a kind of franchise tax

corporate profits, this annual grc .vth -a tax levied in exchange for the benefit s

would be about $4 1/z billion. A small : .:presumably conferred by the franchise

-

change in the rate , of growth, .. like eom- of; operatin,

gas a corporation .

pound interest, could result in a large It has also been argued that the gov -cumulative change in , the total over a ":ernment contributes in some way to allperiod of a decade or more . 'Similarly, a forms of production, and that this con -

change in the rate of business in- tribution provides a justification for a

-vestment in relation to total national tax' on business . 'The theory of govern-

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product could make a substantial differ- :ment as a "partner" in economic produc-

-once in the bong-range "rate ,of economic tion provides at best only limited sup-growth port for the corporation income tax, in

part because much economic activity is "Nature and Structure of the carried on outside the corporate form ,. ..Corporation /nconse Tax Nevertheless, the arguments are made

In general this study suggests that the :that incorporation provides substantia lbasic form of the tax, i.e ., as a separate 'benefits, as well as capabilities for mak -tax on the net income of corporations, ing and using profits without distribu -1as certain advantages over sweeping tion to individuals, -so that a separate tax

experiments in new forms of taxation . In is justified.large part, these advantages arise out of One role for the corporation income,our long experiencf; with this tax, rather tax is to provide a means of taxing in-from its basic characteristics. come that would not be received by in . -

Rationale of the Corporation Tax, A dividuals, even in the absence of theheavy tax on the net income of corpora- tax. As suggested by the debates of thelions, which we have arrived at largely 1936's over the undistributed profits tax,through the pressures of war and other some way is appropriate for taxing in -emergencies, raises fundamental ques- come not distributed to individuals ..tions

concerning its

rationale .

Why Without some form of tax on corpora -should such a tax be levied on the cor- tions, it is argued, stockholders wouldporation, a "person" which exists only by have an easy means of avoiding the in -

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the U.S, competitive position and theflow of investment abroad `is to reducethe corporation tax .ratc .

Another approach to the taxation o fcorporations, one which is aimed at amore uniform treatment of all forms ofincome, has had a long history in theUnited Kingdom. Until recently, thecorporation tax there was viewed pri-marily as a,means of collection of theindividual income tax at the source . In.965 the United "Kingdom abandone d

this view of the tax, and followed th eUnited States example by adopting aseparate tax on corporate profits . Yet atthe same time, the Royal Commissionon Taxation in Canada (also known asthe Carter Commission) advocated an"integrated income tax, designed as Via .comprehensive -tax on all 'inconle .

The Carter Commission argued tha tAhe corporation as such has no taxpay-ing capacity, and that the tax on the cor-poration necessarily falls on individuals .Partly for administrative reasons, th eCommission recommended the continu-ation of a tax on corporations at a flatrate of 50 percent. However, it also rec-ommended that the tax base of the resi-dent shareholder should include th e

,:corporation income paid or allocated t ohim, "grossed-up" for the corporation ta xon his dividends . In other words, theshareholder would be assumed to re-ceive a proportionate share of corporateprofits before tax, for the purpose of cal-culating his individual income tax lia-bility, The individual would then be al -lowed, as a credit against his individua lincome tax, the amount of the corpora-tion tax included in his taxable income .Realized capital gains would be taxed atordinary income tax rates .

taken in response to these development sin Europe. One possible way to influence

The integration recommendations o f

dividual income tax by accumulatin g'income through corporations . Such jus• •tifications, however, can hardly supporta corporation, tax rate . at the currentlevel ;

Considerable attention has been pai drecently to the alternative of a value -added tax, particularly because of itsactual and proposed adoption by th e;Common Market countries of Wester nEurope. Apart from the particular mer-its of the value-added tax, it would hav ethe advantage of being refundable o nexports, while the corporation tax is not .Moreover, the widespread adoption ofthis tax in Europe will subject U .S. ex-ports to larger "border taxes " represent-ing the equivalent of the value-adde dtax on production in those countries .

The value-added tax has been exam-ined by various groups and individua l:experts . The present study does not un-dertake a detailed examination of thecase for such a tax: On one point, how-ever, the study suggests that the value -added tax and the corporation tax aresimilar. The hypothesis put forwardearlier concerning the incidence of thecorporation income tax implies that thecorporation income tax can logically b eclassified as an "indirect':' tax. The GATT4,( General Agreement on Tariffs andTrade) rules, which permit exemptionof exports from indirect taxes only (onthe traditional assumption that profit staxes differ substantially in their priceeffects from a sales tax) can hardly b ejustified in the case "of 'taxes 1hat arelevied nation-wide .

As a recent Tax Foundation publica-tion pointed out, 3 there is a variety ofpossible U.S . policy steps that might b e

3 . Tax Harmonization in Europe and VA, Business (New York ; 1960,

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the Carter Commission have by nomeans been generally accepted in Can-ada. In the debates and studies of thepast two decades, the idea of an inte-grated income tax for the United State shas been repeatedly examined, in par tas a means of achieving a more equita-ble treatment of dividends. However, it, ,has yet to receive much support .

The possible effects of such integra-tion would be as difficult to trace as th e

-traditional questions of incidence of thecorporation income tax . The assumption.behind the integration approach is tha tahe corporation tax falls largely, if no tentirely, on the shareholder . The discus-Sion of incidence above suggests tha tthe burden of the corporation tax isprobably widely spread. On this view,the tax in part represents a portion o fnational output that cannot be easilyattributed, or imputed, 'to ;particulargroups of individuals .

Structure of the Corporation Tax . TheFederal corporation tax has seen man y<changes and experiments with its for mand structure. The general structure 'ofthe tax today is a relatively simple one :the current statutory rates (exclusive of

.,the 10 percent surcharge of 1968) con-sist of a 22 percent "normal" tax on allnet income, plus a "surtax" of 26 percenton net income in excess of $25,000 . Thistwo-step structure is a result of a lon gevolution over the last 60 years .

The corporation tax, however, in-volves many complications in determin-ing "net income," particularly in thevarious deductions allowed in arrivin gat net income. Among the difficult area sare the allowances for depreciation anddepletion, capital gains and losses, sur-tax exemptions and consolidated returns ,the special treatment of different kind sof corporations, and the treatment of

income earned in other countries. Thisstudy is not intended to deal in detai lwith structural problems . Nevertheless ,many changes have occurred in such taxprovisions, some of which raise important policy problems .

The Internal Revenue Code of 1954

"provided alternative methods of depre -,ciation, which substantially liberalized'these allowances, permitting faster write -offs in the early years of the life ofdepreciable assets . In 1962, by adminis-trative regulation, a set of guidelines wa sadopted for determining "useful lives "of depreciable assets. These guidelinespermitted write-offs in periods 30 to 40

percent shorter than those which ha dpreviously been in effect . The new pro-cedures also contained a "reserve rati otest" designed to provide "an objectivebasis for appraising the correctness o fthe useful lives claimed for tax pur-poses ." The reserve ratio test has been asubject of much controversy and its ap-plication has been largely postponed bythe Treasury .

These changes have muted the length ycontroversies over tax depreciation pot-icy that marked the previous decade .

In 1962 another important change wa smade in the introduction of the invest-ment tax credit. This is a credit againsttax liability amounting to seven percentof "qualified" investment in machiner yand equipment (3 percent in the case ofpublic utilities) . The investment creditserves to offset, at least in part, the ad -verse effects of the corporation tax-o ninvestment .

As a result of the inflationary pres-sures in 1966, the Administration pro-posed, and Congress enacted, a suspen-sion of the tax credit for the periodbeginning October 1, 1966 and endingJanuary 1, 1968, The "Restoration Act "

14

of 1967 restored the credit as of March 9 ,1967—as a result of an actual and pros -

:pective decline in business investment .Suspension of the credit in 1966 wa sstrongly criticized by many who argue dthat the credit was intended to be per-manent and not to be used as an instru-ment for short-run :effects on, businessactivity .

Despite the renewal of inflationarypressures in late 1967, no suggestion hasbeen made for another suspension of thetax credit . After the lengthy debate o f1967, the permanent character of th e

`investment credit appears to be gener-''ally accepted, and further use of change sin the credit for purposes of„economic .

"

stabilization seems unlikely.

-

The recent wave of mergers has raise danew problems of multiple surtax exemp-tions, 'intercorporate dividends, carry -over of losses, and tax-free exchanges ofstock. Existing provisions of the law o nthese points have been modified signifi -cantly in the past decade. Studies ofrecent economic developments may sug-gest that further revision is necessary . .

Current proposals for revisions in th ecorporation tax relate largely to admin-istrative difficulties and various contro-versial provisions in the law . The in-crease in the use of industrial revenu e

- :bonds (tax-exempt bonds issued by lo -cal governments, but used indirectly tofinance portions of certain commercia ldevelopments--a device to attract indus-try) led to the restriction of this exemp-tion in the Revenue and Expenditur eControl Act of 1968 . The rapid growt hof state and local bonds outstanding ha sled to new proposals for the tax treat-ment of interest on these securities ,or for alternative forms of state-loca lfinancitlg .

Other problem areas include the sta-

tus of various tax-exempt organization sand their commercial-type operations ,the treatment of financial institutions,the option of small corporations to b etaxed as partnerships, and the future ofthe "reserve-ratio test. for depreciableassets .

One area of growing significance i sthe tax treatment of foreign income . Inthe early post-World War II years, thetrend of U.S . tax policy was to favor for-eign investment—partly as a way of aid-ing recovery in war-torn countries andpromoting economic growth elsewhere ,:In accordance with a long-standing prin -ciple, income earned in other countrie s~by subsidiaries of U.S. companies wassubjected to U .S . income tax only whe n"repatriated," and the company wa s

,, (and is) allowed ,a credit against U .S.tax for taxes paid to other governmentson such income. Income of foreignbranches of U .S. companies, however,

, was currently taxable to the parent co mpony with credit for foreign taxes .

Partly as a result of U.S. balance ofpayments difficulties in the early 1960's ,the direction of tax policy relating toforeign income began to change, I n1961 the President recommended th eremoval of deferred tax treatment ofearnings of U,S. subsidiaries . The Rev-enue Act of 1962 did not fully incorpo-rate Administration proposals, but it didlimit tax deferrals to certain categoriesof income, and added provisions t ocheck the use of "`tax havens" . for ,for-eign operations ,

With continued difficulties in the bal-ance of payments, it is possible that fur-ther modifications of tax treatment o fforeign income will be added to the nu-merous controls that have been used tocheck the outflow of both long an dshort-term capital funds . The extensive

15

regulations imposed on foreign direct of business largely owned or controlledinvestment have been a serious admin- by foreigners, The objective of simplicity

-, ` istrative and compliance burden, and is not usually compatible either with th ealso have led to modifications of rules . .'goal of neutrality or with other polic ygoverning repatriation of income for objectives, particularly the maintenanc etax purposes . of a stable, or "equilibrium ;"- position in .

Regardless of the course of the bal-the balance of payments, 4

ante of payments problem, it is difficult In summary, no clear-cut alternative sto find agreement on basic prinelples 'or structural, changes in the corporatio nof taxation of foreign income . It is not income tax stand out as preferable to ieasy to pursue the objective of equal 'tlle existing form of this tax. Alterna-

"` treatment of foreign and domestic busi- tively, a reduction in the rate of this taxness and at the same time take account would appear to be a more practicalof measures most countries have adopted and significant revision than sweepin gDither to promote or to the ck the, growth changes In :the form of the .,tax ,

.CONCLUSION S

The conclusions of the study fall into ~of individuals bear the full burden . Athree categories, The first relates to thehypothesis is put forward that the cor -

- incidence and burden of the tax . The poration tax may be viewed in part as asecond concerns the chief economic ef- imeans by which output is diverted, to

;fects of, the tax. The third concerns the overnment, without the burden bein gessential rationale of the tax and possi- fully reflected in changes in real o rble structural changes, . While the con- ~ money' incomes as seen or measured byelusions are tentative and partly in the individuals . It is `suggested further thatform of alternative hypotheses,

. they " :' `the procedures generally used in as-

'may be, summed up -as follows ; : ; . signing or allocating pre-tax income to

-individuals could not be made precise

(_1) Incidence and Burden even with much. more ,adequate tatis- j

The usual approaches to the inci-dence of the corporation tax concentrate The diversion of resources from pri -,on the extent to which the tax is shifted vote uses occurs 111 such a way that the.forward into the prices of final products, burden is not readily apparent to indi -or falls on returns to capital or other Viduals'. In attempting to reconstruc tfactors of production . Neither of the ex- the way in which income would other -trenle positioIls, either that the tax is wise have been received by individuals ,fully shifted forward, or that it falls ex- too many alternatives are

possible t o' ;C'luSi1'aly on returns to equity capital, provide all easy answer to the question

- : :is

strongly

supported

by

statistical of "whose real iIlcome has been reduce devidence, by this tax,»

It is suggested here that the problem On this view,

questions of equityof incidence cannot be formulated most among individuals are lass importantappropriately in terms of what groups dean the affects of the corporation tax i n

4, 'A

more

delalled

discussion

of

these

Issues

cur tNational Tax Conference, "Tux Policies and the Balanc e

he

found

In

Proevedin►,m

of

the

2001

Tax

Foundatio nof Payments Problem," December 1968,

1 6

on the whole in corporate financial struc -tures. Nevertheless, the tax advantagesof debt financing do put pressure on cor -porations to increase debt-equity ratios ,and debt-equity ratios have risen no-ticeably in the last few years . Somemeasure to reduce the differential taxresults of debt versus equity financin gmay be desirable .

Quantitatively, the differential effect sof the corporation tax as among differentsectors of the economy would appear t obe less important than the effect of th etax on the~lotaI rate of business invest-ment.

At a rate in the 'neighborhood of 50,percent, this tax is a large factor in long-term business investment decisions Th erate of return after tax is the primaryconcern of investors and corporate man -agement .

(3) The Structure of the Tux

If corporations are to continue ' to bean important source of tax revenue, th egeneral form of the present tax, i .e ., asa separate tax on the net income of cor-porations, has some advantages overalternatives that have been proposed ,

Adjustments have been made to thelong existence of this tax, and two dec-ades of tax revision have mitigated orremoved many objectionable features .

diverting resources in a different way'than would occur under other taxes, or

j if the corporation tax were lower an dgovernment expenditures were eorre-spondingly lower.

The evidence on the effects of the cor -poration tax suggests that a major alter -native private use of resources is busi -. ness investment. Changes in business in -;vestment affect , not only dividend in -come but all personal incomes, firs tthrough short-run effects on the level of,total personal income, and secon d;through effects on productivity and therate of economic growth. The burdenof the corporation tax may thus be mor ewidely spread than ., is commonlyassumed.

(2) Economic E§ects

The corporation income tax in the,,past two decades appears to have af-fected mainly the aggregate size of busi -;ness saving and investment . The effecton the national rate of investment maybe more significant than the "efficienc yeffects," Le., the relative shifting of re-'sources toward uses not heavily depend-ent on equity capital in the corporate:form, or in distorting effects on corpo-rate financial structures ,

The evidence suggests that short-termchanges in profits before tax and divi-dends have been governed largely b yforces other than the corporation incom etax. On the other hand, undistribute dcorporate profits appear to have beensubstantially affected by this tax, both inshort-run fluctuations and in the tren dover the last two decades . Undistributedprofits are the major source of funds fornet business investment .

Despite the advantage given to deb tfinancing by the corporation tax, th elast two decades have shown little shift

While problems remain with the cor-poration income tax, a new form of ta xat the Federal level, such as the value-addcd tax, would have to go through a"shakedown" period, even though it mayhave theoretical advantages ever thepresent corporation tax .

A different approach to the taxation o fcorporations is to try to "integrate" thecorporation and individual income taxe sso that income not paid out liy corpora -

17

18

IHistorical Changesin the Role of theCorporation~Jncome Taxi 1909 .1968

Ater its first enactment as an "excise" constitutional, Although there were nu-tax in 1909, the corporation income tax merous cases involving the excise tax o fduring World War I became a significant 1909, the Supreme . Court upheld ,` its

, .revenue producer—more important than constitutionality .3the individual income tax (Table 1) . 1

' After the 16th Amendment, the first'"Currently, its revenue importance is be-ingchallenged by social insurance taxes, income tax act in 1913 was applied to

Numerous changes have been made— :both corporations and individuals . How-

,-

often to be abandoned later —in th- ever, the corporation tax was viewed

structure of the corporation tax . These largely as a means of collection of th e

past experiments show many deadends tax at the source —dividends were

-in attempts at corporate tax revision, ;exempt from the

normal

tax applied .to

indivi duals . The

normal

tax ofand yet much that can be regarded a sprogress, one percent applied to all taxable in -_ . ..

} r come, corporate and individual ; the sur-tax levied on "upper bracket" individual s

TheInitial Form of the Tax began with a taxable income of $20,000and the rate reached a maximum of 6

The "excise" tax of 1909 was intro- percent on taxable income in excess, ofduced almost as an afterthought, late in $500,000,the congressional session, as a means o fmeeting a deficit. The tax was not pro- Changes in the Nature of the Tax,'Posed by the Administration orb

theY

Y Rates, and Collectionsa. . .House Committee on Ways and Means ,but introduced on the floor of the House The corporation tax rate was raise d

by Representative Cordell Hull and to 2 percent in 1916, 6 percent in 1917,

others, With relatively little debate, the and reached a peak, excluding excess-

tax, a one percent rate on net income, profits tax, of 12 percent in 1918 (Table,

was adopted as a source of additional 3 )

revenue. It was called an "excise" tax A special tax on munitions manufac --because of

the

constitutional

limits- turers was levied in 1916, at a rate oftions on income taxation . An income tax 121/2 percent on net profits, followingenacted in 1895 had been declared un- the example of the leadinvy hellivyPrPnt

1 . The civil war income tax did not apply to corporations as such, although assorted other taxes were a plie dto various types of business, (Paul Studenski and Herman F, Krooss, Financial History a/ the UnitedStates, New York; McGraw-Hill, 1952, pp, 141 .151) ,

2, Roy G, and Gladys C . Blakey, Tito Federal Income Tax (New York ; Longmans, Green and Co,, 1940) ,P. 26 ,3, Sidney Ratner, American Taxation (New York ; W, W. Norton and Co,, 1942), p, 29 ,4, A detailed history of changes In tax rates and major provisions of the law can be found in M, A, Chirel-

stein and others, Taxation in the United States, World Tax Series, Harvard Law School Internationa lProgram in Taxation (Chicago 1963), pp, 108 .120,11 .

19