As part of the minimum-tax approach, both the House and the Administration have recommended what is called an Allocation of Deductions provision. Individuals with substantial amounts of tax-free income would be required to allocate itemized personal deductions between tax-free income and taxable income. This is a desirable provision, but various phase-in periods and exceptions recommended by the House and the Administration would blunt its effectiveness. Moreover, neither the House nor the Administration would extend this provision to corporations. Under present law, those who receive tax-exempt income derive a double benefit. The income never appears on the tax return; hence no tax is paid. Secondly, personal or non-operating business deductions can be deducted in full from taxable income. The AFL-CIO recommends that before such deductions are permitted, since they are designed to define ability-to-pay, total income (taxable and exempt income) should be taken into account: Thus, individuals with excluded income, as defined below, in excess of $10,000, should be required to allocate certain personal deductions in line with the ratio their adjusted gross income bears to adjusted gross income plus exempt income. The deductions that should be allocated are: interest and tax payments, casualty losses, charitable contributions, medical expenses, and cooperative housing expenses. Allocation formula should be as follows: Deductions X Adjusted Gross Income Allowable Deductions Excluded income which would cause deduction to be allocated should include the following: 1. One-half of capital gains. 2. State and local bond interest. 3. Depletion taken after the cost of the property has been written off. 4. The difference between the cost and the market value of property donated to charity. 5. Depreciation on real estate taken in excess of straight-line, except for lowand moderate-housing. Corporations with excluded income, as defined above, in excess of $25,000 should be required to allocate non-operating expense deductions between net profit from operations and excluded income. The allocation formula should be as follows: Net Operating Profit, Non-operating X: Allowable Non-operating Deductions Net Operating Profit The AFL-CIO further recommends that deductions disallowed under the allocation formula should be taken into account under the AFL-CIO proposed minimum tax. The disallowed deductions should be added to the $10,000 ($25,000 for corporations) of exempt income that would not be affected by the minimum tax. 5. The Senate should strengthen and improve other measures contained in the House bill. For example: -Interest on state and local bonds should be taxed in full with the federal government guaranteeing the bonds and providing an interest subsidy to assure that the fiscal powers of the state and local governments are not damaged. -Instead of the Hobby Farm loophole-closing proposals suggested by the House and the Administration, the loss-limit approach contained in S. 500 should be adopted. This procedure was recommended by Senator Metcalf and endorsed by a bipartisan group of 26 Senators. This approach is specifically tailored to the tax-loss farmer and ensures that legitimate farm operators will not be penalized. -The income-averaging formula should not be liberalized to include capital gains unless the preferential treatment accorded such gains is eliminated. -Interest deductions on bonds used to finance corporate mergers and acquisitions should be completely disallowed. ---All rapid depreciation on real estate should be disallowed, except for lowand moderate-income housing. -Accelerated depreciation on regulated utilities should not be allowed unless the tax benefits flow through to the consumer. Of equal importance, the Senate should provide more substantive relief to those whose incomes are moderate and whose tax burdens are unnecessarily severe. Tax relief and tax justice do not necessarily go hand-in-hand. The equity in the tax structure can be as badly damaged by tax cuts as it can by tax increases or the addition of new loopholes and gimmicks. Under the House-passed bill this concept was partially recognized. Though all groups would receive some relief through the combination of changes in the lowincome allowance, the standard deduction and the rate reductions, a significant proportion of the relief recommended by the House would flow to low- and middleincome taxpayers. Under the changes proposed by the Administration, needed relief for those just above the government-defined poverty threshold and those in the middleincome brackets would be cut back; the state-gasoline-tax deduction would be disallowed, and a tax cut would be given to corporations. Under the House proposals, $4 billion in tax relief is provided through the low-income allowance and the standard-deduction increases. Another $4.5 billion is granted through rate cuts. The first two relief proposals-the low-income allowance and standard-deduction provisions-provide 90% of the tax relief or $3.6 billion to those with incomes of $15,000 or less. The Administration would cut back on both of these forms of tax relief. But the House rate cuts which in the main benefit higher income groups would remain intact. Specifically, of the $4.5 billion relief recommended through rate cutting, over half flows to the 10% of taxpayers with incomes of $15,000 or over. On top of this the Administration would provide a $1.6 billion tax cut to corporations. In basic terms, the Administration agrees with the House when the House wishes to cut the taxes of the wealthy. But the Administration says the House goes too far when it suggests cutting taxes for those of low and modest incomes--instead, claims the Treasury, corporate taxes should be cut. We endorse the House proposals to increase the low-income allowance to a flat $1,100. In addition, we endorse the House proposals to increase the standard deduction to 15% and $2,000. We do not agree with the general rate reductions recommended by the House and the Administration; nor do we feel there is any justification for a reduction in corporate taxes. Instead of the general rate reductions proposed by the House and the $1.6 billion corporate rate cut, we recommend a reduction in the tax rates that apply to the first $8,000 of everyone's taxable income for married individuals and the first $4,000 for single individuals. The rate changes would be as follows: The 14% rate should be cut to 9%. All other rates would remain the same. Under this procedure, every taxpayer would receive a tax reduction. But, the individual with a taxable income of $100,000 would get the same tax break as the $8,000 man. Under the rate structure recommended by the House, a married individual whose taxable income is $100,000 would receive a $3,600 cut while the $8,000 married individual would have his taxes reduced by only $80. The AFL-CIO proposal would grant both a cut of $130 (see Table 2). Under the AFL-CIO proposals, the net revenue loss would be approximately the same as that proposed by the House. It would be roughly $600 million more than proposed by the Administration-an amount that could easily be made up, for example, by eliminating the maximum-tax provision, effectively closing the hobby-farm gimmick, and adopting a meaningful minimum tax. We want to reemphasize that the complete loophole-closing programs we have urged would leave many billions of dollars which could be used for funding the social and economic programs which the Congress has enacted in recent years. The objective of tax justice is an ambitious one. But it is long overdue and critically urgent. There is no longer time for pause, delay, gestures or tokens. 1 Only twice since its inception in 1913 has the federal tax structure been revised. And these two revisions-in 1939 and 1954-were, according to a former Commissioner of Internal Revenue, only "faceliftings." The tax system must now provide for the interests and needs of a nation of over 200 million people who are demanding more and better public facilities. Yet many of the flaws that have existed since the federal government first began To tax incomes still exist and many new ones have been added. The costs of government are not being shared fairly. An unwarranted limitation is placed on the effectiveness of tax policy in promoting broad goals of balanced economic growth and full employment and public confidence is decaying. When tax revenues are to be spent, the legislative and executive branches appropriately study and evaluate every outlay of public funds to assure that Lational interests will be forwarded and priorities balanced. Yet, on the revenueraising side, tax policy is all too frequently considered only in terms of need for more dollars or fewer dollars. The temporary surtax, adopted in 1968, is a prime example. A flat percentage tax on top of the existing tax is a fair way to divide the burden of an increase in taxes--but only if the original burden is fair. Since a tax on a tax cannot be collected if no taxes are paid, those who are rich enough to avoid their fair share of taxes through capital gains, depletion, accelerated depreciation, tax-exempt interest and other tax-escape routes, pay no surtax on such exempt income. Because of this, others pay more and the basic inequities are compounded. What is more, many of the inequities cause the taxation system to run in direct opposition to the objectives sought through public tax-spending programs. For example: While the nation is being burdened with inflationary pressures and high interest rates, the task of easing these burdens is made more difficult by the tax system. Privileges such as the 7% investment credit and accelerated depreciation on real estate fuel the fires of the only source of inflationary demand in the national economy-business investment in plants, machines and equipment. $935 million in federal funds are being spent on low- and moderate-income housing; yet $800 million worth of tax loopholes go to real-estate operators constructing motels, office buildings, plants and high-rise, high-rent apartment complexes. $4.5 billion is spent to "stabilize farm incomes"; yet wealthy nonfarmers are encouraged, through the tax system, to disrupt and distort the farm economy. The large and growing concentrations of wealth and economic power are a source of growing national concern; yet the income-tax system allows $15 billion in appreciated assets to accumulate and be transferred to heirs without ever entering the tax base. At the same time, tax-exempt status is given to certain types of family foundations set up for avoiding taxes and perpetuating control of family and industrial financial dynasties. Eight million dollars are spent enforcing antitrust laws; yet the tax system provides incentives for those who would merge and "conglomerate." Oil, gas and other depletion allowances are justified largely on the basis of encouraging development of domestic productive capacity; yet similar tax benefits flow to those bolstering the productive capability of foreign nations. Some $25 billion in federal categorical grant-in-aid funds will go to the states and localities in 1969; yet the amount of federal money available to hardpressed state and local governments is diluted by allowing interest on state and local bonds to go tax-free, since this exemption costs the Treasury more than the states and municipalities gain. The nation is committed to alleviating the plight of its 25 million poor; yet many of these families today pay federal income taxes while many of the wealthiest legally ignore the federal tax collector. Though the case for reform is compelling and perhaps conclusively demonstrated by these incongruities and paradoxes, there is another too frequently overlooked aspect. Federal income taxes are not the only taxes Americans must pay. In fact, though federal income-tax revenues have grown and still loom largest among the taxes paid by most individuals, state and local taxes have grown at a far faster pace. What's more, the increases in state and local taxes have in the main resulted from levies on property and sales to consumers which take their toll from those whose ability to pay taxes is the least. 33-865-69-pt. 4 The 1969 Economic Report of the President showed that the combined feder state and local tax systems converge in such a manner as to redistribute incor "away from the poor." At the same time, those of modest and middle incom are bearing a disproportionately high share of the tax burden while those wi wealth and ability-to-pay escape their fair share. Thoroughgoing federal income-tax loophole closing and reform would make substantial contribution toward compensating for the unfair manner in whi the burden of other taxes fall. Furthermore, it is the federal income-tax system that most states look upon the standard for a good and fair way to allocate the costs of public services. number of states that do use income taxes use the federal definitions and stan ards as models for their own systems, and three states now “piggyback” the taxes directly upon the federal taxes that their residents must pay. Yet, as the inequities in the federal system grow and become more and mot notorious, the basic principles of taxation based on income and ability-to-pa become suspect and fair-minded state and local legislators find it increasingl difficult to convince those they represent of the advantages of fair taxatio methods. Capital gains CLOSING THE LOOPHOLES The capital-gains route is, according to the Treasury, the most important fac tor in reducing the tax rates of those with high incomes. In examining the tax returns of all those with incomes of over $100,000, th Treasury shows that this group shelters $3.8 billion from the tax base through this loophole-nine times the amount this group shelters through tax-exemp interest, 36 times the amount this group shelters through the unlimited-charita ble-contribution loophole, 54 times the amount this group shelters through tax loss farming. Under present law, when certain so-called "capital" assets are sold, the profi is taxed at only one-half the rates that apply to ordinary income. And, the tax rate cannot exceed 25% regardless of the amount of the seller's total income Capital assets under the Internal Revenue Code consist of property such as corporate stocks, vacant land, and other assets not held for use in the taxpayer's trade or business. In addition, profits from the sale of many other assets-although not defined by the Code as capital assets--can also receive this same privileged preferential tax treatment. Profits from the sale of livestock used for draft, dairy or breed ing; real estate used in a trade or business; royalties from sales of timber, iron ore, and coal deposits can all qualify for the preferential treatment as capita. gains as can gains on sales of business machinery and equipment. What's more, the capital-gains-tax escape route combines neatly with many other avoidance schemes, stimulating their use and compounding the tax benefits Accelerated depreciation on real estate-a loophole which permits postponement of taxes and creates opportunities for tax-loss gimmickry-also paves the way for converting what would be ordinary rental income into capital gains. The deple tion allowances for mineral industries, in themselves an unconscionable gimmick for deducting nonexistent expenses, also serve as the vehicle whereby ordinary income is unjustifiably converted to capital gains. Another major leak in the tax system, according to the Treasury Department results from the fact that large amounts of capital gains "fall completely outside the income system," since capital gains on assets transferred at death or by charitable donation go tax-free. The Treasury estimates that $15 billion of capita gains in 1967 were not taxed at all, through this escape route. If an individua holds an appreciated asset till he dies, the appreciation is not subject to the income tax. If an individual or corporation donates appreciated property to a charitable organization, the appreciation is never taxed-and the full appreciated value can be deducted from other income. For example, if a taxpayer donates $1,000 work of stock which cost him $100 he pays no tax on the $900 of appreciated value and is permitted to deduct the full value ($1,000) from his income. If he were in the 50% bracket, this gift o an asset which cost him $100 would save him $500 in taxes. If he sold the assets included half the capital gain in his income, and then contributed the $1,000 in cash, his net tax saving would have been only $275. If the $900 appreciation wer taxed at ordinary rates rather than the 25% maximum capital-gains rate, the donation of this asset that cost $100 would have only yielded a net tax saving of $50. Moreover, under certain circumstances it is possible for an individual to actu- "The American public has every right to ask what positive justification exists The modest reforms recommended by the House are welcome. Extending the holding period to one year and eliminating the 25% maximum are steps toward justice. Nevertheless the preferential one-half tax would not be changed nor would gains passed on to heirs be subject to income tax. The Administration proposals, if adopted, would largely undo the positive action taken by the House. To close this loophole, the AFL-CIO urges adoption of the following proposals: 1. Elimination of preferential tax treatment of capital gains for both individuals and corporations. Such gains should be taxed at regular tax rates. At the same time, the present income-averaging provisions should be broadened to include capital gains. The approximate revenue gain from the AFL-CIO proposal would be $6-7 billion. The House bill would raise $810 million and the Administration, $600 million. 2. Capital gains on property transferred at death. All appreciation (difference between original cost and market value) should be taxed in full on transfer at death. The tax rate should apply to all appreciation occurring after date of enactment; one-half the tax rate should apply to all gains decarring between an appropriate date such as January 1, 1950, and the date of enactment. The tax should be allowed as a deduction for estate-tax purposes. It should not apply on transfers between the decedent and spouse nor to estates valued at less than $60,000. To prevent "forced" sales of assets, appropriate installment-payment procedures should be adopted. The approximate revenue gain under the AFL-CIO proposals would be $3-4 billion. Neither the House nor the Administration made proposals in this area. Depletion Oil, gas and other mineral-extraction industries are allowed to take deductions for depletion. In principle, depletion for extractive firms is akin to the depreciation allowance taken by other industries and is geared to permit the gradual write-off of capital cost over the life of the investment. However, the percentage-depletion deduction formula is based on income; it has no relationship to the amount of investment. Moreover, unlike depreciation the annual deduction from income never stops-it continues even after the cost of the investment has been fully written off. On top of this, certain exploration and development expenditures are immediately tax-deductible (for other industries such expenditures would have to be amortized over a period of years) which means a major part of the investment of many companies has already been written off-yet the depletion allowance is not changed. As a result, according to Treasury estimates, oil, gas and other depletion deductions average twelve times the deduction that would be allowed if the deductions were based on actual costs. In the petroleum industry, for example, 90% of the depletion deductions taken are "excessive." In other words, these firms are legally deducting nonexistent costs. The percentage-depletion formula allows mineral operators to deduct amounts ranging from 5% (gravel, sand and clay) up to 27.5% (in the case of oil) of the gross income from the property-regardless of the amount of investment. The amount that can be deducted is limited to 50% of net income which means, in many cases, that only half the net income generated from the property is subject to tax. |