To the Congress of the United States:
The tax policy of the United States Government is of major significance to the national welfare. Taxes are the means by which our people pay for the activities of the Government which are necessary to our survival and progress as a nation. Decisions about Federal tax policy should be made in full recognition of the economic and budgetary situation, and should contribute to our national objectives of economic growth and broader opportunity for all our citizens.
At the present time, I believe we should make some revisions in our tax laws to improve the fairness of the tax system, to bring in some additional revenue, and to strengthen our economy.
Our general objective should be a tax system which will yield sufficient revenue in times of high employment, production, and national income to meet the necessary expenditures of the Government and leave some surplus for debt reduction. In the Budget Message, I estimated that receipts in the fiscal year 1951 will fall short of meeting expenditures by 5.1 billion dollars. This deficit will be due largely to the shortsighted tax reduction enacted by the Eightieth Congress, and to the present necessity for large expenditures for national security and world peace. Moreover, owing to the time lag between corporation earnings and tax payments, the 1949 decline in corporation profits will be reflected in lower tax receipts in the fiscal year 1951.
The policies I am recommending to the Congress are designed to reduce the deficit and bring about a budgetary balance as rapidly as we can safely do so. These policies are threefold: first, to hold expenditures to the lowest level consistent with the national interest; second, to encourage and stimulate business expansion which will result in more revenue; and third, to make a number of changes in the tax laws which will bring in some net additional revenue and at the same time improve the equity of our tax system. First, as to Government expenditures.
I have recently transmitted to the Congress a budget containing recommendations for appropriations and estimates of expenditures for the fiscal year 1951. This budget was carefully prepared with a view toward holding expenditures to the lowest possible levels consistent with the requirements of national security, world peace, economic growth, and the well-being of our people.
The decisions of the Congress, as well as unpredictable changes in circumstances over the next eighteen months, may alter in many particulars the character and amount of the expenditures contemplated in this budget. Nevertheless, I believe the estimates contained in the budget represent the most realistic appraisal that it is possible to make at this time of the necessary expenditures in 1951. I believe the Congress will generally concur in this view after it has had an opportunity to consider these estimates carefully.
The expenditures estimated in the 1951 budget have been reduced by about 900 million dollars below the level estimated for the present fiscal year. The policies recommended in the budget will permit further reductions in subsequent years as the cost of some of the extraordinary postwar programs continue to decline.
To achieve these reductions we must continue to practice rigid economy. At the same time, it would be self-defeating to cripple activities which are essential to our national strength. It will require wisdom and courage to find and hold fast to the course of wise economy without straying into the field of foolish budget slashes.
Second, as to the strength and growth of our national economy.
We cannot achieve and maintain a balanced budget without a strong and prosperous economy. A recession in economic activity would call for increased Government expenditures at the same time that revenues were reduced, thus creating greater budget deficits.
At the present time, the economy of the United States is growing, and we have every reason to expect it to continue to expand if we follow the right policies. It is largely the task of private business to achieve this growth. The Government, however, can and should contribute to it. Through such cooperation, national employment and income will grow. This will result, in time, in increasing Government revenues.
Just as the condition of our national economy has an overriding effect upon our efforts to balance the budget, so do our policies for managing the Federal budget have a decisive effect upon the national economy. Drastic reductions in Federal expenditures in the wrong places and at the wrong time could have serious disruptive effects throughout our economy.
Government revenue policies are as important in our economy as Government expenditure policies. Events of the last few years have proved that our economy can grow and prosper, and that employment, production and incomes can increase, at the same time that individuals and businesses are paying taxes which are high by prewar standards. However, taxes can and do have an important effect upon business conditions and economic activity. It should be our constant objective to improve our tax system so that the required revenues can be obtained without impairing the private initiative and enterprise essential to continued economic growth.
We should always keep in mind that the maintenance of a sound fiscal position on the part of the Government is a long-range matter. Nothing could be more foolhardy than to attempt to bring about a balanced budget in 1951 by measures that would make it impossible to maintain a balanced budget in the following years.
Third, as to changes in the tax laws.
If, over the next few years, we hold expenditures to the minimum necessary levels and at the same time follow policies which contribute to stable economic growth, we can look forward to steady progress toward a balanced budget. Nevertheless, we should not rely only upon budgetary economy and upon economic expansion to produce a balanced budget. We should accelerate the attainment of this objective by changes in the tax laws. Drastic increases in tax rates, just as in the case of drastic cuts in essential expenditures, might prove to be self-defeating. Our primary objective should be to improve and strengthen our revenue system for the long run.
Under these circumstances, I am now recommending a number of important revisions in our present tax system, to reduce present inequities, to stimulate business activity, and to yield about one billion dollars in net additional revenue.
In making changes in the tax laws, we should be sure they move toward, and not away from, the major principles of a good tax system. Our tax structure should recognize differences in ability to pay; it should provide incentives to new undertakings and the expansion of existing businesses; it should support the objective of increasing opportunities for all our citizens to obtain a better standard of living; and it should rigidly exclude unfairness or favoritism.
Over the years, we have made important progress in building a good tax system. However, much remains to be done. There is need further to improve the distribution of the tax load to make it conform better with tax paying ability. There is need to reduce taxes which burden consumption and handicap particular businesses. Moreover, we should eliminate tax loopholes which enable some few to escape their share of the cost of government at the expense of the rest of the American people.
Many of the important and desirable tax revisions which should be made must be postponed until the budget situation improves. Nevertheless, a number of those steps can and should be taken now.
First, I recommend that excise taxes be reduced to the extent, and only to the extent, that the resulting loss in revenue is replaced by revenue obtained from closing loopholes in the present tax laws.
The excise taxes are still at substantially their wartime levels. Some are depressing certain lines of business. Some burden consumption and fall with particular weight on low-income groups. Still others add to the cost of living by increasing business costs.
Since we are limited in the amount of reduction we can now afford, we should choose for reduction those taxes which have the most undesirable effects. I believe that reductions are most urgently needed in the excise taxes on transportation of property, transportation of persons, long-distance telephone and telegraph communications, and the entire group of retail excises, including such items as toilet preparations, luggage, and handbags.
If these revisions are made, we will have reduced the most serious inequities of our present excise taxes. We should go further just as quickly as budgetary conditions permit. At present, however, we should reduce excises only to the extent that the loss in revenue can be recouped by eliminating the tax loopholes which now permit some groups to escape their fair share of taxation.
The continued escape of privileged groups from taxation violates the fundamental democratic principle of fair treatment for all, and undermines public confidence in the tax system. While few of these loopholes by themselves involve major revenue losses, collectively they result in the loss of many hundreds of millions of dollars every year.
I wish to call the attention of the Congress to the more important of these loopholes. While some of them are of long standing, their injustice has been aggravated as the taxes assessed against the rest of the population have been increased. A tax concession to a favored few is always unfair, but it becomes a gross injustice against the rest of the population when tax rates are high. The case for the elimination of these inequities would be strong even if there were no need for replacement revenue. It is compelling when excise relief depends on it.
I know of no loophole in the tax laws so inequitable as the excessive depletion exemptions now enjoyed by oil and mining interests.
Under these exemptions, large percentages of the income from oil and mining properties escape taxation, year after year. Owners of mines and oil wells are permitted, after deducting all costs of doing business, to exclude from taxation on account of depletion as much as half of their net income. In the case of ordinary businesses, investment in physical assets is recovered tax-free through depreciation deductions. When the original investment has been recovered, a depreciation deduction is no longer allowed under the tax laws. In the case of oil and mining businesses, however, the depletion exemption goes on and on, year after year, even though the original investment in the property has already been recovered tax free, not once but many times over.
Originally introduced as a moderate measure to stimulate essential production in the first World War, this special treatment has been extended during later years. At the present time, these exemptions, together with another preferential provision which permits oil-well investment costs to be immediately deducted from income regardless of source, are allowing individuals to build up vast fortunes, with little more than token contributions to tax revenues.
For example, during the five years 1943 to 1947, during which it was necessary to collect an income tax from people earning less than $20 a week, one oil operator was able, because of these loopholes, to develop properties yielding nearly $5,000,000 in a single year without payment of any income tax. In addition to escaping the payment of tax on his large income from oil operations, he was also able through the use of his oil tax exemptions to escape payment of tax on most of his income from other sources. For the five years, his income taxes totaled less than $100,000, although his income from non-oil sources alone averaged almost $1,000,000 each year.
This is a shocking example of how present tax loopholes permit a few to gain enormous wealth without paying their fair share of taxes.
I am well aware that these tax privileges are sometimes defended on the grounds that they encourage the production of strategic minerals. It is true that we wish to encourage such production. But the tax bounties distributed under present law bear only a haphazard relationship to our real need for proper incentives to encourage the exploration, development and conservation of our mineral resources. A forward-looking resources program does not require that we give hundreds of millions of dollars annually in tax exemptions to a favored few at the expense of the many.
Some tax loopholes have also been developed through the abuse of the tax exemption accorded educational and charitable organizations. It has properly been the policy of the Federal Government since the beginning of the income tax to encourage the development of these organizations. That policy should not be changed. But the few glaring abuses of the tax exemption privilege should be stopped.
Responsible educational leaders share in the concern about the fact that an exemption intended to protect educational activities has been misused in a few instances to gain competitive advantage over private enterprise through the conduct of business and industrial operations entirely unrelated to educational activities.
There are also instances where the exemption accorded charitable trust funds has been used as a cloak for speculative business ventures, and the funds intended for charitable purposes, buttressed by tax exemption, have been used to acquire or retain control over a wide variety of industrial enterprises.
These and other unintended advantages can and should be removed without jeopardizing the basic purposes of those organizations which should rightly be aided by tax exemption.
A problem exists also with respect to life insurance companies. The tax laws have always accorded favorable treatment to the income received by individuals from life insurance policies and have made special provision for the taxation of life insurance companies. As a result of a quirk in the present law, however, life insurance companies have unintentionally been relieved of income taxes since 1946. This anomalous situation has meant that neither the companies nor their policyholders have paid taxes on more than 1.5 billion dollars of investment income per year, derived from productive assets worth about 60 billion dollars.
I understand that the Committee on Ways and Means of the House of Representatives has already undertaken to correct this situation for the past years. I urge that steps also be taken to develop a permanent system for the taxation of life insurance companies which will remove the inequities of undertaxation in this field without impairing the ability of individuals to acquire life insurance protection.
In addition to the tax loopholes I have described, there are a number of others which also represent inequities, and should be closed. Most of these permit individuals, by one device or another, to take unfair advantage of the difference between the tax rates on ordinary income and the lower tax rates on capital gains. As one example, under present law producers of motion pictures, and their star players, have attempted to avoid taxes by creating temporary corporations which are dissolved after making one film. By this device, their income from making the film, which ought to be taxed at the individual income tax rates, would be taxed only at the capital gains rate. Thus, they might escape as much as two-thirds of the tax they should pay.
All these loopholes have been under joint study by the Treasury Department and the staff of the Congressional Joint Committee on Internal Revenue Taxation. A practical program which would go far toward closing these loopholes can be enacted during the present session of the Congress. This would be a substantial step toward increasing the fairness of our tax system, and should add several hundred million dollars to its yield-sufficient revenue to permit substantial excise tax reduction where it is most urgently needed.
I wish to make it very clear that I could not approve excise tax reductions unless they were accompanied by provision for replacement of the revenue lost, because I am convinced that sound fiscal policy will not permit a weakening of our tax system at this time. Under present conditions, we cannot afford to reduce excise taxes first, in the hope that action will be taken later to make up for the loss in revenue.
Second, I recommend that the Congress enact legislation to provide one billion dollars in additional revenue, by revising and improving the estate and gift tax and the corporation tax laws. I believe that, under present economic conditions, this amount of additional revenue represents a proper balance between the objective of balancing the budget as soon as possible and the objective of coordinating tax adjustments with the requirements of continued prosperity.
A substantial part of the additional revenue should be obtained from revision of the estate and gift tax laws.
The Revenue Act of 1948 reduced the yield of the estate and gift taxes by one-third, or nearly 300 million dollars. Even before that Act, estate and gift tax yields were out of line with other revenues, and that Act made the situation worse.
In originally enacting the estate tax in 1916, the Congress pointed out that "our revenue system should be more evenly and equitably balanced" and that a "larger portion of our necessary revenues" should be collected from the "inheritances of those deriving most protection from the Government." Our estate and gift tax laws at present fall far short of this objective. They now produce less than 2 per cent of internal revenues, compared with 7 per cent ten years ago. To the extent that these taxes remain too low, the remainder of our tax structure must bear a disproportionate load.
The low yield from the estate and gift taxes is due to serious weaknesses in the present law.
These weaknesses include excessive exemptions, unduly low effective rates on most estates, and the fact that the law as written favors large estates over smaller ones, and leaves substantial amounts of wealth completely beyond the reach of the tax laws. Large fortunes may be transmitted from one generation to another free of estate or gift tax through the use of life estates. By this means, vast accumulations of wealth may completely escape tax over several generations.
Furthermore, the present law affords excessive opportunities for tax reduction by splitting between the gift and estate taxes the total amount of wealth transferred by an individual. This makes the tax liability depend, not upon the amount of wealth which an individual leaves to his family, but upon the manner in which he arranges the disposition of his wealth. If a man leaves his estate of $300,000 at death, one-half to his wife and one-half to his three children, an estate tax of $17,500 must be paid. If his equally well-to-do neighbor gives away $180,000 to his wife and three children over a 5-year period and leaves them the other $120,000 at death, no estate or gift tax whatever is paid. This difference in tax, whether it depends upon fortuitous circumstances or the caliber of legal counsel, is obviously unwarranted.
To strengthen the estate and gift tax laws, several steps are necessary. The laws concerning the taxation of transfers by gift and by bequest, by outright disposition and through life estates, need to be coordinated to provide uniform treatment and a base for more effective taxation. In addition, the present exemptions should be reduced and the rates should be revised. These changes will not only bring in more revenue, but they will also improve the fairness of the estate and gift tax laws and bring these taxes nearer to their proper long-term place in our tax system.
The rest of the additional revenue should be obtained from adjustments in the corporation income tax. At the same time, certain improvements should be made in this tax.
I recommend a moderate increase in the tax rate applicable to that part of a corporation's income which is in excess of $50,000. At the same time, I recommend that the tax rate on corporate income between $25,000 and $50,000, which is now taxed at the excessively high "notch" rate of 53 per cent, be reduced to the same rate that applies above $50,000.
These changes in the tax rate structure would go far toward removing the handicaps which the present law places upon the expansion of small corporations. The removal of the excessive "notch" rate would reduce the taxes paid by medium-sized corporations whose continued growth is so essential to the dynamic expansion of our economy. The existing favorable tax rates for small corporations with incomes below $25,000 would be retained. The tax increase would be confined to less than one-tenth of all corporations.
Furthermore, I recommend that the loss carry-forward provision be extended from two to five years to provide more scope for offsetting losses of bad years against profits of subsequent years. This extension will give increased incentive to business investment affected by uncertain profit expectations. It will be particularly helpful to new businesses which, under the present provision permitting losses to be carried forward only two years, may be required to pay taxes over a period of several years during which they actually suffer a net loss.
At the same time that we make these changes in the tax laws to stimulate investment at home, we should make certain changes in the tax laws concerning income derived from foreign investments and personal services abroad. This would provide significant support to our efforts to extend financial and technical assistance to underdeveloped regions of the world.
Among the steps which should be taken at this time are to postpone the tax on corporate income earned abroad until it is brought home, to extend and generalize the present credit for taxes paid abroad, and to liberalize the foreign residence requirement for exemption of income earned abroad. These changes, together with the safeguards for our investors which we are in the process of negotiating with foreign governments, will provide real stimulation for the expansion of United States investment abroad.
The tax program I am recommending is designed to strengthen our tax system so that it will yield revenues sufficient to balance expenditures as they are further reduced over the next several years, and to provide some surplus for debt reduction. Because of the time lag in collecting taxes after their enactment, these recommendations will not result in any substantial increase in receipts in the fiscal year 1951, but they will result in larger revenues in subsequent years and, at the same time, substantially improve the structure of our tax system for the long run.
A sharp increase in taxes under present economic conditions would be unwise. However, in line with the policy of gearing changes in revenue laws to the needs of our economy, I would not hesitate, if strong inflationary or deflationary forces should appear, to support the use of all measures necessary to meet the situation, including more pronounced adjustment of tax rates upward or downward, as the case might be.
We have come through the war and a difficult transition period with the financial strength of our Government maintained and an economy producing far above prewar levels. We should continuously seek to sustain and improve these indispensable foundations for progress. The tax program I am recommending is an important and necessary means to that end.
HARRY S. TRUMAN