Postwar Taxation and Economic Progress

By Harold M. Groves | Go to book overview

VIII. PERSONAL INCOME TAX (Continued)

TAX-EXEMPT SECURITIES

CRITICS have often referred to tax exemption of interest on government bonds as the crowning arch in the perverseness of the federal tax system.1

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1

The historical background of the tax-exempt security problem may be summarized as follows:

The tax-exempt security issue is by no means a new element in American tax conflict. The attempt by the federal government to tax the interest on state and local bonds was one of the issues at stake in the Pollock decision, which overruled the early income-tax statute of 1894. Passage of the Sixteenth Amendment, authorizing the federal taxation of income without apportionment according to population, involved a discussion of the question, and some assurances from the proponents of the amendment that it did not contemplate federal power to tax the income from state and local securities. As the graduation of rates increased, the exemption feature drew more and more criticism. Presidents Harding, Coolidge, and Roosevelt, and all the Secretaries of Treasury since 1919, have opposed tax exemption and advocated its elimination at least as to future issues. The power of the federal government to tax its own securities is conceded, but, as a matter of policy, many fully or partly tax-exempt federal bonds have been issued, and the policy was not definitely discontinued as to new issues until 1941. In the case of outstanding federal issues, the government is bound by contract, and only by the gradual process of refunding and reissue can these obligations be made fully taxable. Fortunately, the volume of such fully tax-exempt securities is not very large. The immunity of state and local bonds from federal taxation is protected by a long line of legal precedent. Recently the legal doctrine protecting state and local instrumentalities was revised by the Supreme Court to permit the taxation of salaries of public officials. This raised the hope of proponents of exemption elimination that the effort to tax the interest on state and local bonds would also be sustained. The taxation by states of federal bonds (through state income taxes and intangible property taxes) is also at stake and would probably follow the same rule as that accepted for federal taxation. During the twenties and middle thirties, attempts were made to secure Congressional authorization of constitutional amendments to clear away legal impediments to the elimination of exemptions. These attempts were unsuccessful and recent interest has centered about efforts to get action by Congress that would present the issue squarely to the Supreme Court. Early proposals, covered future issues only, but in 1942 the Treasury advocated the taxation

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