FEDERAL INCOME TAX REFORM
Mortimer M. Caplin
Partner Caplin & Drysdale
April 26, 1976
[Introductory note: Mortimer M. Caplin, lawyer and
educator and former U.S. Commissioner of Internal Revenue, is a
partner in the law firm of Caplin & Drysdale of Washington,
D.C. He is a member of the Bars of the District of Columbia, New
York and Virginia.
Following graduation from the University of Virginia
Law School, Mr. Caplin served as law clerk to Judge Armistead M.
Dobie, U.S. Court of Appeals for the 4th Circuit. He first practiced
law in New York City from 1941 to 1950 -- with time out for military
service in the U.S. Navy. During the Normandy invasion, he served
as a Navy beachmaster.
In 1950, Mr. Caplin returned to the University
of Virginia to become a professor of law, specializing in tax and
corporate law. He also continued in practice as a member of a Virginia
In 1960, following the election of President John
F. Kennedy, Mr. Caplin served on the President's Task Force on Taxation.
In January 1961, President Kennedy appointed him U.S. Commissioner
of Internal Revenue. He served in that post until July 1964, when
he resigned to resume private law practice in Washington with his
On leaving government, Mr. Caplin received the
Alexander Hamilton Award, the highest award conferred by the Secretary
of the Treasury "for outstanding and unusual leadership during
service as U.S. Commissioner of Internal Revenue".
In his speech, "Federal Income Tax Reform
-- 1976 Style," Mr. Caplin will analyze new trends in Federal
income tax reform -- contrasting the "every-person-a--taxpayer"
approach of the last comprehensive tax statute (1969 Tax Reform
Act) with the "tax shelter" emphasis in pending legislation.
He will then discuss the potential of tax reform in 1976, including
the Treasury's "major simplification" proposal to permit
sizable rate reductions for all.]
About 200 years ago, Edmund Burke said: "To tax and to please,
no more than to love and be wise, is not given to men." In this
same spirit, some view a good tax as one paid by someone else, and
tax reform as the easing of their tax burden while adding to that
of others. I say this not to be cynical, but to emphasize the varying
attitudes among us on what is meant by "loophole closing"
and "tax reform."
Scope of Tax Reform Proposals
How would this audience vote if we took a poll on such items as:
(1) taxing capital gain as ordinary income; (2) taxing municipal bond
interest; (3) using the same graduated rate structure for married
and single individuals; (4) ending the $100 exclusion for dividends
received by individuals; (5) eliminating the sick-pay exclusion and
deductions for child care expenses; (6) ending medical and casualty
loss deductions; (7) disallowing current deductions for intangible
drilling costs and what remains of percentage depletion from small
oil operators; (8) repealing the special tax accounting rules for
farmers; (9) taxing as income any appreciation in the value of assets
at the time of gift or death; (10) taxing individuals on contributions
to qualified employee and self-employed pension plans and individual
retirement accounts; (11) denying charitable deductions entirely,
or limiting them to the cost rather than appreciated value of donated
assets; (12) disallowing accelerated depreciation deductions for real
estate investments and equipment lease arrangements; (13) limiting
business and investment deductions to amounts "at risk"
by disregarding non--recourse borrowings in computing cost; (14) denying
deductions for mortgage interest payments and for state and local
What if by doing these things the government would maintain total
income tax collections at present levels, but you would cut your tax
rates in half, eliminate most record keeping and file a tax return
of only two or three pages? What if, under such a comprehensive tax
program, your particular tax bill would be about the same? What if
it were increased slightly?
Not that I recommend that all these things take place at once, although
there are those that do. Rather, I point to them to illustrate the
scope and variety of current tax reform proposals, and to raise the
practical political implications of trying to get support for all
or even some. Whether we are for or against a given item depends so
much upon our own circumstances, economic and social -- whether we
have inherited wealth; whether we earn income as employees, executives
or professionals; whether our income comes from investments; whether
we own business and, if so, the kind; whether we are working mothers,
aged, sick, disabled, or the beneficiary of one of the many other
preferences provided for in the Internal Revenue Code. So much depends,
too, upon our philosophy of government, our view of the American free
enterprise system, and our overall value structure.
Definition of Tax Reform
To many, tax reform and loophole closing suggest correcting the Internal
Revenue Code so as to eliminate errors, ambiguities and omissions
which permit wealthy people to avoid paying taxes. Yet, while some
provisions of this type do exist, they are comparatively few in number
and short-lived. For whether it be by the courts through judicial
interpretations, or by the Congress through direct legislative action,
this handful of "unintended benefits" is normally corrected
over time. This is not the real stuff that tax reform is made of.
What concerns the tax reformer today is not the unintended, but the
intended preferential Code provisions -- the special tax rates,
credits, deductions, exemptions, exclusions from income, deferrals
of tax liability -- the special benefits or preferences which deviate
from the generally accepted norm for our income tax. Critics describe
them in a variety of ways: "benefits," "preferences,"
"subsidies," "tax expenditures," "back door
spending," or simply "loopholes." Their supporters,
however, justify them on much higher grounds: "incentive,"
"stimulant," "relief," "fairness" and
"equity." A popular slogan for tax reform today is "capital
In the legislative arena, Congress is first faced with deciphering
the rhetoric of the various competing viewpoints. It then must weigh
the testimony and data before it in light of studies and recommendations
of the Treasury Department and the incumbent administration. And,
inevitably, it makes a choice -- or, as more frequently happens, a
compromise -- in enacting specific tax legislation which it concludes
is best suited to the times.
Basic Tax Tenets
Before examining current tax reform proposals I would like to list
certain principles that Congress is cautioned to keep in mind as it
drafts tax legislation. Some have been eroded by exceptions and refinements;
some at times conflict with others. Nevertheless, they are familiar
guideposts and do provide a good starting point for further discussion.
Revenue should be raised in such a fashion that the imposition of
the tax will not in itself cause the taxpayer to change his economic
behavior, that is, to invest in one type of business activity rather
than another or to conduct his affairs in a particular form solely
because of the tax.
Fairness and equity:
All taxpayers should pay their fair share of taxes. To this end all
forms of economic income should be treated alike, without favoring
one form of realization of income over another. Equal taxes should
be imposed on taxpayers at similar income levels (horizontal equity);
and reasonable rate differentials should be imposed on classes of
taxpayers at different income levels (vertical equity).
The principal goal of our tax laws should be raising revenue and,
in the process, promoting economic growth and stability. We should
be highly selective before using our tax system to regulate conduct
or to achieve specific social and economic objectives; excessive use
for non revenue ends has led to complexity, higher rates, and charges
of discrimination and unfairness.
Tax laws should be drafted so that, to the extent possible, they are
understandable to taxpayers and reasonably predictable in application.
They should be simple enough to permit both accurate compliance by
taxpayers and efficient and evenhanded administration by the Internal
Our "do-it-yourself" or self-assessment tax system is the
most efficient in the world, and Congress must make every effort to
strengthen taxpayer confidence in its operation. This system of "taxation
by confession"- which through compliance alone accounts for some
97 percent of our tax collections -- depends largely on the good will
and voluntary cooperation of tax- payers. Unfairness, discrimination
and abuse erode this confidence; and they must ever be rooted out
and eliminated as new tax legislation is considered.
Almost as an annual rite, at the commencement of each Congressional
tax reform hearing, invited tax experts testify on these tenets of
taxation. It is like the visiting dignitary's pitch of the first ball
on the opening day of the baseball season: after the ceremonies, the
players take their positions and the real game begins. There are the
usual betting odds on the probable outcome; but, under our democratic
political system, the results are far from predictable. They depend
in large part upon the efforts and influence of the various protagonists
and also upon the recorded reactions of hometown voters.
Tax Reform Act of 1969
Our last wave of tax reform actually dates back to 1968, when Congress
reluctantly enacted an extra 10 percent income tax surcharge on American
taxpayers and, in the same breath, directed President Johnson to present
a reform package by year end. While the Treasury Department embarked
on comprehensive studies, Lyndon Johnson was not persuaded that it
was proper for the Congress to direct the President to submit tax
legislation; consequently, no tax reform bill was sent to Congress.
Instead, by letter to the Speaker of the House of Representatives
dated December 31, 1968, the President formally advised the Congress
of the existence of the Treasury proposals but said that he would
make no recommendations as he was leaving office on January 20. In
other words, he had decided to give his successor a free hand on tax
Early in January 1969, however, outgoing Secretary of the Treasury
Joseph W. Barr roused public opinion by releasing some disturbing
statistics and predicting a "taxpayer revolt" unless tax
reform was soon forthcoming. He pointed to 155 individual tax returns
with adjusted gross incomes of over $200,000 a year and 21 returns
with adjusted gross incomes of over $1,000,000 on which not one cent
in federal income taxes was paid. Barr's statement seized the newspaper
headlines nationwide and Congress found itself besieged with demands
for corrective action.
With this public outcry echoing continuously throughout the Capitol,
a sweeping law was enacted on December 30, 1969. Affected was almost
every individual and industry in the country -- including private
foundations, cooperatives and financial institutions. The legislation
was unbelievably complex; some 27 groups of tax reform and a multitude
of policy decisions were reflected in 255 pages of new tax law and
thousands of pages of committee reports and hearings. Nevertheless,
two dominant goals are discernible in the legislation: (1) to make
sure that everyone pays "some" tax (in order to take care
of Barr's 155 high-income non-taxpaying individuals); and (2) to narrow
the gap between the tax on capital gains and the tax on ordinary income.
Congress sought to achieve these two goals in a variety of ways.
For one thing, it made a partial head-on attack on a number of the
highly-publicized tax shelters -- real estate depreciation, percentage
depletion, capital gain livestock, farming, citrus groves, unlimited
charitable deductions and private foundations. Not that the alleged
abuses were eliminated completely, but through a host of precise albeit
limited changes it made each a little less attractive, a little less
Beyond this, Congress took two additional steps:
First, it offered two carrots to discourage shelter- shopping:
one, more liberal rules for averaging income (including capital gains)
over a five-year period; the other, the imposition of a maximum tax
of 50 percent on earned income. It was thought that with only half
of the earned income going to the government and half retained by
the individual, taxpayers would regard this as a fair trade-off and
would find it less attractive to engage in tax avoidance and tax minimization
Second, it wielded two sticks -- to prevent total escape from
the other tax-catching sections and to penalize those who made excessive
use of the tax preference provisions: one, a 10 percent minimum tax
on tax preference items; the other, a limitation on the deductibility
of "excess investment interest."
The 10 percent minimum tax was one of the most highly publicized
provisions of the 1969 Reform Act. Barr's 155 individuals would now
come a cropper. No longer would any American escape the IRS tax net.
But, alas, as later history and studies were to prove, it did not
Part of the problem was that Barr and the Treasury staff looked at
the wrong tax returns in making the analyses and judgments which led
to the 1969 reforms. They focused on individual returns with over
$100,000 of "adjusted gross income" -- despite the fact
that "adjusted gross income" is not an adequate starting
point for determining the relative importance of tax preferences.
This is so because substantial preference items may have already been
employed in the very computation of adjusted gross income; and it
is a truism that many taxpayers with extremely modest adjusted gross
income have economic income of highly significant amounts. (I had
the opportunity to elaborate on this in the Indiana Legal Forum,
To illustrate, the computation of adjusted gross income is made on
Form 1040 "above the line" by adding in, among other things,
the net income or loss from Schedules C, D, E and F: (1) profit or
loss from a trade or profession (Schedule C ); (2) gain or loss on
the sale or exchange of property (Schedule D); (3) profit or loss
from the rental of real or personal property, the leasing of mineral
property, and the operations of partnerships or Subchapter S corporations
(Schedule E); and (4) profit or loss from farming (Schedule F). Losses
which reduce adjusted gross income to little or nothing above the
line ran thus be produced by first netting out the tax preference
items on the various schedules. For example, deductions for percentage
depletion, intangible drilling costs and accelerated depreciation
on buildings will be done on Schedules C or E. Similarly, farm losses
will be deducted on Schedule F; and one half of long-term capital
gains will be deducted on Schedule D. Of course, tax-exempt interest
is not reported at all.
Beyond this initial error, only nine tax preference items were finally
identified. Brisk lobbying efforts resulted in the elimination of
four additional items that had been originally considered: (1) Tax-exempt
interest on state and local bonds; (2) Appreciated portion of property
contributed to charity; (3) Farm losses resulting from special accounting
methods; and (4) Intangible drilling and development costs.
Finally, further softening of the minimum tax impact resulted from
the adoption of three limiting factors: a flat 10 percent rate; a
$30,000 exemption; and a deduction for regular income taxes shown
on the face of tax returns, with a seven-year carryover for taxes
not used to shield tax preference income.
1973 Tax Reform Hearings
Certainly by 1973, it was widely recognized that the minimum tax
on tax preference items was not achieving its goal. Treasury Secretary
Shultz acknowledged in his testimony before the House Ways and Means
Committee on April 30, 1973, that "significant" numbers
of taxpayers with large incomes were paying little or no tax. Congressman
Reuss (Wisconsin) said it was "like a sieve" and only a
"love tap" tax. He further characterized it as "a small
admission fee" for using tax loopholes, and no more than a "cosmetic
solution" to fundamental tax inequity.
More recently, Congressman Vanik (Ohio) and the staff of the Joint
Committee on Internal Revenue Taxation published statistics illustrating
the ineffectiveness of the 1969 changes. Based on an analysis of 1973
federal income tax returns, the figures demonstrated the following
expansion of Barr's original examples of 155 non--taxpaying high-income
|Number of Individuals
||between $500,000-$l million
||over $1 million
||average $2.5 million
In releasing this information, Congressman Vanik stated: "This
is only the tip of the iceberg....The Congress must devise a more
equitable tax system to insure that all Americans bear some proper
support of their nation's activities." The heart of the problem,
according to Secretary Shultz in his 1973 testimony, was "tax
A common characteristic of a tax shelter investment is that it produces
deductions and exclusions -- particularly in the early years -- which
may be used against other income of the taxpayer. The result may be
an outright reduction in taxes, an indefinite deferral of tax, or
a conversion of ordinary income into capital gain.
While he recognized that the tax rules inherent in tax shelters were
intended as incentives, he noted that they were having "a dangerously
demoralizing effect on the operation of our revenue system."
This is so, he said, because "it appears to most taxpayers simply
to provide a means by which the wealthy avoid the payment of income
The Treasury's suggested cure was to (a) limit the items excluded
from income, (b) prevent distortions that result from the timing of
deductions, and (c) bar the sheltering of other income. To achieve
this, the following steps were recommended: (1) repeal the minimum
tax for individuals and Subchapter S corporations; and (2) substitute
two new provisions: (a) minimum taxable income (MTI): to deal
with those tax items that are outright exclusions from income and
(b) limitation on artificial accounting losses (LAL): to deal
with those tax rules that provide deferrals.
As these recommendations are the cornerstone of pending proposals
now before Congress, let us briefly examine these two new concepts
in the form they were recommended by the Treasury Department.
Minimum Taxable Income (MTI)
MTI is a true alternative tax, not a penalty or added tax; for the
taxpayer is called upon to pay the higher of two taxes, not both.
It will prevent the combination of exclusions and itemized deductions
from offsetting more than one-half of a taxpayer's real economic income.
In turn, every individual will be required to pay on at least the
This is accomplished in the following manners:
1. Four current income exclusions are added to "adjusted gross
income": (a) one-half of long-term capital gains; (b) bargain
element of qualified stock options at the time of exercise; (c) percentage
deletion in excess of adjusted basis; and (d) income earned abroad
which is now excluded under Code section 911. (Two obvious omissions
are tax exempt interest on state and local bonds and the appreciated
portion of property gifts to charities.)
2. The resulting sum is called "expanded adjusted gross income"
3. To get the " MTI Base," deduct from EAGI the following:
(a) $10,000 floor; (b) personal exemptions; (c) casualty loss deductions
exceeding 10 percent of EAGI; and (e) investment interest and investment
expenses (deductible under Code section 212) to the extent of investment
4. Divide the MTI Base by two to get "minimum taxable income"
5. Apply the regular income tax rate structure against the greater
of (a) normal taxable income, computed as at present; or (b) MTI.
To repeat, the purpose of MTI is to tax at least 50 percent of an
individual's real economic income at regular income tax rates. And
to achieve this, only 50 percent of his real economic income may be
offset by exclusions and itemized deductions.
In the reform bill passed by the House in December, 1975 (H.R. 10612),
MTI was rejected; the 1,969 minimum tax was retained and the Treasury's
LAL proposal was adopted, both in strengthened form. Before the Senate
Finance Committee, however, Chairman Russell B. Long (Louisiana) indicated
strong support for the MTI approach, although it is doubtful that
it will survive the Senate's 1976 mark-up of the bill.
Limitation on Artificial Accounting Losses (LAL)
As noted above, the Treasury's LAL principle is contained in H. R.
10612, and is under consideration by the Senate Finance Committee.
Its aim is to require a matching of deductions with related income,
and thereby prevent the sheltering of other income through earlier
1. LAL achieves its goal by deferring any deduction which is "clearly
associated" with income to be received in future years. Among
the Treasury's examples of deferment are the following: (a) intangible
drilling and development costs for oil and gas wells; (b) prepaid
feed in cattle-feeding syndications; (c) Accelerated over straight-line
depreciation for buildings; (d) accelerated over straight-line depreciation
for personal property under net leases; and (e) pre-opening costs
during the construction of realty, including interest, taxes, fees
2. None of these LAL deductions will be allowed until the property
produces income. In other words, deductions are matched with the same
class of income to which they relate; and they are allowed as offsetting
deductions only when the income is earned.
3. No offset against other income-no sheltering-is permitted.
4. However, deferred LAL deductions are not abandoned. Rather, they
are placed in a "deferred loss account" and held in suspense
for use in succeeding taxable years.
5. They later become deductible against the first "net related
income" realized from the property; or on the sale or other disposition
of the property to which the deferred loss is attributable.
LAL is a complex accounting concept and there are many refinements
and details that need to be analyzed to fully understand its operations.
The House has elaborated on the concept significantly, and in many
instances has toughened its application. Needless to say, if LAL is
finally enacted, it will put an abrupt end to the practice of large
year-end write offs, currently enhanced by limited partnership syndications
and non-recourse leveraging arrangements.
The Tax Reform Act of 1975 (H.R. 10612)
After almost three years of deliberation and hearings, the House
on December 4, 1975 passed the Tax Reform Act of 1975 (H. R. 10612).
Some 700 pages in length, the legislation vies with the 1969 reform
act in its breadth and scope. To tax reformers, the bill's sharp attack
on tax shelters is its most important aspect.
The House approach is twofold: (a) to expand upon the Treasury's
LAL proposal and (b) to broaden the existing minimum tax.
LAL: In fine detail, the bill applies LAL to six types of
operations: (1) real estate; (2) farm operations (including breeding
and feeding of livestock); (3) natural resources (oil and gas); (4)
movie shelters (including film purchase and production company arrangement);
(5) equipment leasing; and (6) sports teams (players' contracts and
Beyond this, the bill places severe limitations on other types of
shelter techniques: deductibility of prepaid interest and nonbusiness
interest, nonrecourse financing, recapture rules, and use of syndicated
limited partnership arrangements.
As a whole, the LAL and related changes would seriously undermine
the attractiveness of most tax shelter investments.
Amendments to Minimum Tax: As a final touch, H.R. 10612 retains
the minimum tax on tax preference items but significantly strengthens
its impact. This is done by the following changes:
1. Rate: The penalty tax rate is increased to 14 percent (in lieu
of 10 percent).
2. Exemption: The exemption is reduced to $20,000 (in lieu of $30,000);
and, in addition, the exemption is phased out dollar-for-dollar as
the preference income exceeds $20,000 -- so that at $40,000 of tax
preference items there is no exemption.
3.Income Tax deduction: The bill eliminates the present deduction
for income taxes as well as the tax carryover provisions.
4. Tax preference items: New preference items are added -- (a) intangible
drilling costs for development wells; (b) itemized deductions in excess
of 70 percent of adjusted gross income; (c) accelerated over straight-line
depreciation/amortization on all leased equipment; (d) interest and
taxes during construction of realty; and (e) certain depreciation
on players' contracts.
These changes alone are estimated to raise additional revenue of
almost $1 billion a year. If adopted in conjunction with the LAL provisions,
the promises of the 1969 Revenue Act will more likely be fulfilled:
i.e., that every citizen with real economic income will pay income
taxes; and that the gap between the taxation of earned income and
capital gain will be sharply narrowed.
Senate Finance Committee Hearing
The Senate Finance Committee is nearing the end of its hearings on
H. R. 10612. The bill's final form is difficult to predict, particularly
because of Chairman Long's strong opposition to LAL and expressed
interest in MTI. Further complications arise because this is a Presidential
election year and because, by June 30, 1976, Congress must act if
it is to extend the 1975 tax reduction provisions that expire on that
Senator Long was believed to be committed to drafting tax reform
legislation by June 30,1976. Recently he stated that this is not now
possible; and he added: "I am committed to passing a tax overhaul
bill by the end of this Congress . . . I am not wedding myself to
a specific date." Before the Senate Budget Committee, he also
expressed doubt that the goal of $2 billion from tax reform legislation
Almost every affected industry has testified before the Senate Finance
Committee on the dire economic consequences that would follow enactment
of LAL and the amended minimum tax -- as contained in H.R. 10612.
Senator Long has expressed his sympathy for the industry arguments
and, in fact, has urged them to mobilize their lobbying efforts in
the Senate. As he put it: "When the fur starts flying on the
Senate floor, some of your members had better come back to town and
talk to some people."
In contrast, Senator Edward M. Kennedy (Massachusetts) takes a much
more aggressive view on tax reform: he fully supports LAL and has
an overall program which he estimates will raise $7 billion a year.
Backed by at least 18 fellow Senators, he promises to make an aggressive
fight when H. R. 10612 is discussed in the Senate. As Senators Long
and Kennedy each said to the other in a recent interchange: "See
you on the floor, Senator."
As the Senate Finance Committee enters its final legislative mark-up
period, some outline of the Senate 1976 tax reform legislation is
beginning to suggest itself:
1. It is too late for tax reform legislation to be adopted by June
30, 1976; hence, it will be necessary to extend the cutoff date of
the 1975 tax reduction provisions so as to leave time for final enactment
of the reform bill.
2. Although MTI and LAL have a neat logic to them -- treating
exclusions from income separately under MTI, and timing of
"artificial" deductions separately under LAL -- they
are unduly complex as a package and raise serious business questions
during a particularly uncertain stage in our economy.
3. A revised version of the 1969 minimum tax, blending portions of
both MT1 and LAL, seems to be a more acceptable solution. A penalty
tax rate of 15 percent and a lower exemption have been suggested.
Also, it is probable that more items will be added to the tax preference
list, including some that were originally classified under LAL.
4. To cover the more egregious cases of leveraging through nonrecourse
financing -- widely publicized in tax shelter literature -- a new
"at risk" principle may be adopted. In brief, a taxpayer's
deductions and losses from a venture may be limited to the amount
of his actual investment that is "at risk" -- including
recourse loans and other adequate security. As nonrecourse loans would
not be taken into account for these purposes, loud outcries may be
anticipated from the investment community, particularly from real
We now await final word from the Senate and ultimately from the Conference
Committee and the House. But whatever the choice in 1976, it must
be recognized that it will be only a compromise solution to a tax
reform problem that has long troubled Congress.
STILL ANOTHER ALTERNATIVE
For some years, Congress has been concerned over taxpayers with high
economic income who pay federal income taxes at effective rates far
below those indicated by the statute -- often lower than the effective
rates of others having substantially less income. The Joint Committee
Staff reported in 1969 that increasingly "taxpayers with substantial
incomes have found ways of gaining tax advantages from the provisions
that were placed in the Code primarily to aid limited segments of
the economy." In many cases, they have found ways to "pile
one advantage on top of another" and, as both the House and Senate
agree, this is an "intolerable situation." Secretary Shultz,
you will recall, said that it "has a dangerously demoralizing
effect on the operation of our revenue system."
One obvious way of correcting this is to repeal all these special
provisions and, in their place, to adopt a broadly based income tax
with a lower rate structure than at present, coupling it with a liberal
averaging rule -- to take account of peaks and valleys of income and
losses over a period of years and the bunching of capital gains and
other forms of income. This approach has long been championed by many
tax reformers. Yet, because of apparent overwhelming political obstacles
facing such a proposal, Congress has not given it serious consideration.
Recently, however, Treasury Secretary Simon brought the plan back
to life when he proposed a broad based income tax that would permit
rates of 10-12 percent at the low end and 35-40 percent at the top.
To achieve this, he would "wipe the slate clean of personal tax
preferences, special deductions and credits, exclusions from income,
and the like, imposing instead a single, progressive tax on all individuals."
Simon has been led in this direction because of the increasing complexity
in the law, widespread feeling that the system favors the rich, and
a drop in the rate of taxpayers compliance. Repeating the warnings
of former Treasury Secretary Barr, he again cautions: "We are
faced . . . with an incipient taxpayer revolt." "What has
caused more bewilderment and distrust among taxpayers," he says,
"than the myriad of so-called loopholes which now litter our
tax code?" This would be corrected, he believes, by the new plan's
"simple elegance and its basic equity toward all tax-payers."
It would give us "a tax system that rests upon the twin pillars
of fairness and simplicity."
In 1963 and 1964, Senator Russell Long offered a comparable proposal
of an optional simplified income tax system -- permitting taxpayers
to elect to pay a lower tax rate upon agreeing to forego the benefit
of many of the special exclusions, benefits and deductions of the
present law. In a Reader's Digest article in 1969, I supported
a Simon-type plan, not on an optional basis, but as a fixed requirement
for all taxpayers. Liberal averaging rules and a lower rate structure
would have to be essential parts of such a comprehensive tax base
But is the Simon-type reform politically feasible at this stage
of our national development? Consider all the hard choices that we
would have to make -- in removing tax incentives which individuals,
business, charities, and state and local governments have relied upon
for decades. Consider the investments already made and the enterprises
already begun on the basis of existing tax assumptions. Consider the
line-drawing that would have to be made between business deductions
-- between deductions from gross receipts and gross income and deductions
from adjusted gross income. Consider the need for liberal transitional
rules over a period of years to provide fairness and equity and to
relieve hardship cases. Could all of these considerations be provided
for in a single tax reform bill? Or would the goal be more attainable
in a series of bills, adopted over a given period of time, following
a comprehensive study by a prestigious commission?
The doubters among us have noted: "Our taxes reflect a continuing
struggle among contending interests for the privilege of paying the
least." True though that may be, it is essential to the welfare
of this nation that we continue our quest -- with the backing of political
leaders, scholars, tax experts, and the public at large -- for a sound
and strengthened tax system. For, as President Kennedy noted in his
first tax message to Congress, such a system is necessary if we are
to maintain our national defense and "render the public services
for enriching the lives of our people and furthering the growth of
(1) Caplin, "Minimum
Tax for Tax Preferences and Related Reforms Affecting High Income
Individuals", 4 Indiana Legal Forum 71 (1970).
SELECTED QUESTIONS AND ANSWERS
As a former Revenue Agent, I can attest to the fact that there was
a lot of confusion and loss of morale in the service when T. Coleman
Andrews, after his resignation, announced his recommendation that
we eliminate the graduated income tax. How can you explain a former
Commissioner taking such a position, and what is your reaction, as
a former Commissioner, to the income tax?
I know Mr. Andrews. He is a very interesting man. He came out for
elimination of the income tax after he left the government. He ran
for President of the United States and its always popular to say "let's
eliminate the income tax" if one is running as a candidate for
At the same time he never proposed a substitute, and I don't know
how you can run a government without adequate financing. How do you
pay for the army and navy? How do you pay for a police force? How
do you pay for social services? You can point to other ways to raise
revenue but in the final analysis you must deal with a tax.
Now you have a sales tax, a manufacturers tax, a turnover tax but
such taxes are opposed to the basic philosophy of this country that
a tax should be imposed on the basis of the ability to pay. In terms
of what type of tax we should have, it may be that we are going to
need something other than an income tax as a supplement. Despite all
the pock marks, in our income tax laws, I come up personally with
the feeling that we should have a tax based on income. I would emphasize
economic income. Thus I tend to favor a much broader based tax than
we have today. I think that if we eliminated the bulk of the preferences,
exclusions, and special rates, that the tax form would become much
simpler. I think it would eliminate a lot of the mystery, and it would
eliminate a good part of the fear of not having complied.
When we get to the administration of the law, well that is another
problem. I do think we're involved in a very sad chapter today. I
don't know how you feel about the Internal Revenue Service, but from
my own experience, although in effect I'm doing combat every day representing
taxpayers now, I have a great respect for that organization. There
are some very fine people trying to do a tough job. But I do think
that a number of unfortunate things have happened. I think there has
been an attempt to tamper with the Service, and we saw that during
this recent Watergate experience. A couple of Commissioners left because
they didn't want the pressure. I think it affected morale within the
A new commissioner came in, Mr. Alexander, and he abruptly tried
to change rules; perhaps too abruptly. He called off investigations
that were going on for years, like Operation Haven down in the Bahamas,
and he sort of interfered with procedures that the intelligence division
engaged in, and he tried to make changes over night. I think a lot
of the things he did were in the right direction but I think it was
the manner he was moving that hurt.
I think it is terribly important that there be a kind of revival
of faith in the Internal Revenue Service, since the service affects
every individual in this country. There is a major job to be done
in restoring taxpayer confidence, and in trying to emphasize to people
that tax audits are not intended to put people in jail. Many of them
are routine. I'd say the bulk of them are routine. Today they are
using the computer more and more to identify returns by looking for
idiosyncrasies. This is a major subject. Essentially I come up with
the fact that I'm not prepared to scrap the income tax today.
There has been some criticism that our estate tax is catastrophic.
President Ford has indicated that there should be a change in that
area. There has also been some thought in combining the estate gift
and income taxes. I would like to know what your feelings are on this.
Well you know that for a great number of years, going back to 1968
there have been a number of major proposals revising the estate and
gift tax. I think Pro. Surrey, who is assistant secretary, came out
with one report, and then the American Law Institute, a body of lawyers
who have been studying this, come up with a similar basic program.
It isn't really a program to integrate all three taxes, but only the
estate and gift taxes.
The only place you might talk about any sort of integration so far
as the income tax is concerned is the taxation of appreciated property
at death or by gift. You might view that as really part of the estate
taxes, if you imposed a tax at death on the difference between the
original cost and the fair market value at death but that really isn't
viewed as a estate tax provision. What the proposals recommend is
having a "transfer" tax, making no distinction between a
gift and estate tax by having one set of graduated taxes. Every transfer
you make goes up into another bracket, whether it is in life time
or by death. This would eliminate a lot of the life-time estate planning
that we hear of. The proposals also aim to avoid generation skipping
i.e. To have a tax at each generation instead of permitting setting
up a long term trust, an intervivos or testamentary trust, where the
tax will be paid one time, and then maybe within the rule against
perpetuities it goes on for many generations, and no further estate
or gift tax is paid. Another proposal is to enlarge the marital deduction;
in affect a 100 percent marital deduction to permit you to have inter-spousal
transfers free of tax, with the idea that on the death of that generation,
the death of the surviving spouse, you will then impose that one tax.
Essentially what they are talking about is a modification of the exemptions
and a modification of the rate structure. There are hearings going
on now in the House Ways and Means committee on these provisions.
I think Congress will try to come out with some new law this year.
I doubt if they are going to have an estate and gift tax reform bill
this year, and I also think it is very shaky whether you will have
an income tax reform bill of any meaning this year but probably one
rather than the other. Now what do I think of it? Well essentially
I think those proposals are essentially sound. Where I have my only
difficulty is on the rate structure. How high will it be? Today the
estate tax goes as high as 77 percent, and I have some concern about
that. There are those who would say "well, let's encourage lifetime
accumulation, consumption, earning; let's cut back on the income tax
but with a death, let them have it." In other words you shouldn't
be able to pass on anything to the next generation. In effect, let
each person start more or less from scratch with some minimal base.
I just can't quite buy that. I think that we have to have some incentives;
it sort is part of the whole democratic process of ours and our enterprise
system. I think we ought to have a significant program of aiding people
who are in need, of making sure that we have full employment in this
country, and of giving everybody an opportunity for a job on a unbiased
basis, and to do all we can to push people along and give them an
education. But I am not in favor of confiscation of property at death.
I can buy a 50 percent rate; somehow that hits me as a good level.
As the earnings go up due to inflation the tax bite gets harder and
bigger. Is there any tax reform that would make the bite more equitable?
Well this is very disturbing factor. A lot of people say that if you
buy property at 100, and you sell it at 300 you ought to pay a tax
on that capital gain, the 200 points. And indeed maybe you ought to
be taxed as ordinary income. Some people on the other side of the
fence would say when you bought that property at 100, that was a particular
level of earning capacity or purchasing power. Now that we have had
inflation, that 300 doesn't buy anymore than the 100 bought. There
really hasn't been a true accretion of wealth or income. This is a
concern of Congress. There are some who want to have a price level
adjustment in your basis so that if you paid 100 you can adjust that
100 to take into account inflation. Another plan which has been seriously
considered is to permit instead of only a 50 percent exclusion of
long term capital gain (and the present bill requires a holding period
of one year for a long term capital gain rather than six months),
an additional exclusion for every five years. That, if you held the
property over 5 years, another 1 percent exclusion per year with a
maximum exclusion of a total of 70 percent. Thus you might pay a tax
of only 30 percent rather than 50 percent to take into account the
factor of inflation. Some of the opponents of this theory say that
if you do it to property, why don't you do it to earnings. The person
who is making 300 a week today, can't buy more than the person who
made 100 years ago, and you ought to have a compensating factor for
the inflation rate there too. It's hard to turn your back on that
argument. It seems to me we may have to face broadening the bands
of the bracket. Many people are pushed up into a higher tax bracket
by an increase in salary which is intended to put them on the same
level of purchasing power they had a year or two ago. They are paying
higher taxes today at higher rates, because they are pushed into a
higher graduated bracket. None of these issues are easy, but I do
think that this problem should be taken into account.
I gather from what you said that you are opposed to the gross receipts
tax, in lieu of an income tax. This is a thought that Milton Friedman
expressed for many years -- the use of a Gross Receipts tax. I was
wondering what specific objections you have for this tax.
Well let me just say this first, I think Milton Friedman restated
his plan the other day in Newsweek. Friedman, as I remember, says
there is very little revenue to be gained over 25 percent, and he
therefore proposed putting a ceiling of 25 percent. I mean the last
time in Newsweek he probably said that. People he alleged thus won't
go into tax shelters, I don't know if I can buy that. The trouble
with a gross receipts tax is the inequities. What if you got a little
business man who has inventory, are you going to tax him literally
on gross receipts? He may have net profit or he may have a net loss,
I have a lot of problems with gross receipts as a base. If you start
talking about a gross income tax or an adjusted gross income tax,
or one like the expanded adjusted gross tax, I could start buying
that. I think, based upon talking to a lot of taxpayers around the
country, and traveling to different parts of the country and having
the opportunity to meet with a lot of taxpayer groups, that there
are an awful lot of people who would even be willing to pay a little
more, (not a heck of a lot) if they could have the tax based on a
simplified adjusted gross income. This would eliminate the deductions
and the tax would assume a broadened base to eliminate some of the
shelter provisions as well, because everybody would be on a parity.
I think there is a lot to be said for that. I think as a matter of
fact secretary Bill Simon's idea, if he really means it, has an awful
lot of merit to it. The question is what are you going to do about
the fellow who is in real estate and tells you "I will not invest
in this deal unless I get so much depreciation, otherwise it doesn't
make any sense." Why should he take the risk? And what if the
real estate developers took the position unless we get this outside
capital we are not going to build the needed buildings. I don't know
maybe we should let the law of economics reach it's own level; and
give them this stimulus. Many people suggest we should. Give them
a direct subsidy instead of a tax deduction. That's a good theory
to give a direct subsidy, but we must also talk about balanced budgets.
Everyone wants to achieve a balanced budget by 1980, the balanced
budget year -- this is the language of both party platform. I will
say it will be very difficult to get direct subsidies enacted. You
will have to stand on a long line for that.
If you adopt a simplified tax structure, as you seem to suggest, wouldn't
the charities suffer thereby, and wouldn't they certainly oppose such
a move on humanitarian grounds.
Well this is the big argument that is being made. It so happens we
represent the Council on Foundations and I assure you the charities
have been up there on Capital Hill. At one time they were going to
treat as a tax preference the appreciated portion of property given
to charity. If you paid $100 for property and donated the property
to a charity when it was worth $300, you got a 300 dollar deduction.
The $200 spread was proposed as a tax preference. It was eliminated
by Congress because the charities were heard; they represent a very
large constituency. There are churches, there are schools, there are
colleges, there are all different types of foundations and they all
get up there and make themselves heard. The foundations of course
were injured tremendously in 1969 when the whole tax reform provisions
went in favor of private foundations. You must ask yourself whether
you are willing to pay the price for reform. Are you going to make
an exception for the charities? The treasury had some simplification
provisions which they proposed in 1973 which would sort of eliminate
a lot of the deductions but even then they carved out the charities
as a special group. You have a pretty strong constituency in the charities,
but in the main you're going to have to be awfully effective in bucking
them if Secretary Simon's proposal is to go through. Maybe he is going
to back off in his proposal and say you got the churches, synagogues,
the schools and we can't fight all of them. And this legislature may
have to carve that out as one exception, but this is the dilemma that
a legislator must face.
I can see your attack against the deductions or shelters to arrive
at Adjusted Gross Income, and you seem to favor the non-elimination
of the contributions deduction. But how about the other itemized deductions
for instance interest and taxes. Many people in the middle class category
have gone out and purchased homes knowing the additional amount that
they are paying and counting on those deductions, particularly since
the standard deduction has been increased to or take care of the apartment
dweller. At this point there seems to be an attack (I don't know how
successful it would be if it went politically) against those who own
a home and have to incur interest and real estate taxes. The elimination
of these deductions now to that homeowner after he bought the home
relying on the tax savings, could be devastating. And what are your
thoughts on allowing a credit against the tax for local taxes if a
deduction is denied?
You get into a question of transition rules, whether or not you ought
to allow people who own their houses at present to continue to take
the interest and tax deduction. Otherwise you are adversely affecting
the marketability of their home. Now another guy comes along and says
this homeowner is getting all of these deductions -- "I want
him to discount that house by 331/3 percent to take into account those
various rights." Again this is what has been the road block.
Gov. Carter got himself into difficulty a few weeks ago when he answered
a question about mortgage interest as being allowed as a tax deduction.
He seemed to have some difficulty on that and never finished his statement.
I don't want to knock him because he is a good man, but he was talking
about this so called comprehensive tax base with a limitations on
deductions as a trade off for lower rates. The most feasible time
for putting this type of scheme or plan into operation, is when you
propose a tax cut. If Congress can lower the rates it can state: "We
are going to take away all these itemized deductions and we will lower
your rates, and you are going to get a little reduction overall in
your tax but you're not going to get a deduction for your taxes and
interest." You might go along with that, because your overall
taxes are let us say, $5000. You are going to pay only $4500 under
the new plan, so you saved $500. They take away your interest and
taxes and they take away a few other deductions, like union dues and
things like that, but you are going to pay $500 less, so you go along
-- maybe. But the next year they raise taxes, and that's what everybody
is worried about if we agree to a comprehensive tax base. They may
just turn around and raise the rate once its adopted. As a matter
of fact there are those who have proposed a constitutional amendment;
that if you go into a comprehensive tax base you may never, without
a constitutional amendment, increase taxes over 25 percent. We are
back to Milton Friedman's plan. As to your question as to allowing
local taxes as a credit, I might say that I do have a thought that
I have espoused and written on. I'm against Federal-State tax sharing
the way it is. I'm in favor of a tax credit system whereby on your
Federal return you take a tax credit, for maybe not 100 percent but
for 50 percent of all the taxes you pay, and are given the option
of taking a deduction or credit, whichever is better. I think that
taxpayers in states and localities imposing these taxes ought to be
given a credit. The money shouldn't be poured back into a community
as general revenue sharing, where there was no responsibility in that
community for the raising of the taxes. Many communities have cut
back on their taxes and just take the general revenue share. I think
that a high tax state or high tax city ought to get consideration
so far as the citizens are concerned for that pattern. So I would
meet you half way on that, maybe, not all the way.
In the last year or so, there have been considerable talks about revising
the taxation of multi-national corporations particularly their foreign
subsidiaries. I wonder if you would comment as to your views on that.
We have a lot of fun talking about what happened in 1961 and 1962,
when one of the most dramatic things was the tax bill we then espoused.
It had two very significant provisions. One dealt with something called
T & E (travel and entertainment expenses) and that probably was
as revolutionary as anything else. I still don't know how that was
ever enacted, but that was one big area. The other major provision
was in the foreign field, The program we recommended at hat time was
to continue the foreign tax credit but to eliminate the deferral of
income. In effect we wanted current taxation of income earned by let's
say a 100 percent subsidiary abroad. We settled for a compromise something
called "Subpart F" which is probably the hugest monstrosity
in the Code. We did provide for a current tax to a U.S. company of
the earnings of a tax haven corporation. In trying to define a tax
haven corporation we really had a time of it. I again lead towards
current taxation of foreign earnings but also to continue the foreign
tax credit. Thus I sort of start off where I began some fourteen or
fifteen years ago.