Other taxes of interest to banks are summarized in Section 10, and Section 11 describes in-lieu taxation and built-up rates. Some concluding remarks are offered in Section 12.

2. CORPORATION INCOME TAX

The state corporation income taxes analyzed here include of course both those corporation income taxes that are applied directly to bank income either through ordinary or built-up rates (a concept that is discussed briefly in Section 10 below) and corporation franchise or excise taxes "measured by" net income, which allow the states to include in the tax base interest on federal obligations.

(a) Industrial Neutrality

An increase in the rate of a state or local corporation income tax, or of a tax measured by corporate net income seems likely to affect banks somewhat less than industrial and mercantile corporations, but more than most other financial institutions. In this sense the corporation income tax is unneutral in favor of financial institutions, including banks, but unneutral against banks vis-a-vis other financial institutions."

7

This conclusion is based chiefly on the facts that (a) in most states banks commonly hold a considerable part of their assets in the form of securities that are exempt from the State tax, but (b) certain other financial institutions, notably insurance companies, often benefit from the difficulties of defining their net income (though, to be sure, insurance companies commonly pay a tax on their premiums). The tax-exempt securities are not likely to rise in price by enough fully to offset exemption from the tax, since the total volume of such securities is so large that part of it must be absorbed by holders who receive less benefit from the exemption than do the banks and hence require a higher interest yield than the banks might accept.

As of 1968, twenty-six states imposed an income tax on commercial banks. The rates ranged from 2 per cent in Nebraska to 13.64 per cent in Minnesota, but the true tax burden imposed by the state tax is much less than those statutory rates, and to a degree that differs among the several states. This is because the federal income tax allows deduction of the state tax in computing the base for the federal tax, and some of the state income tax laws similarly allow deduction for the federal income tax in computing the base for the state income tax. This latter group of states, where both deductions are allowed, is

The corporation income tax, viewed in isolation from the personal income tax, of course tends to drive capital and labor from fields in which incorporation is necessary (including commercial banks) into real estate activities, farming, services, some branches of trade, and other industries where partnerships and proprietorships flourish. But taxation to the proprietors of all the current profit of the enterprise may, for high-income entrepreneurs, be more burdensome than the corporate tax rate plus subsequent taxation of whatever part of the profits is distributed. In any event the corporation income tax cannot be appraised with respect to the economy as a whole without taking account of the manner in which the individual income tax applies.

Interrelationships of the two taxes may be further complicated to the extent that states follow the Internal Revenue Code, subchapter S, in permitting a limited class of corporations to elect to be treated as if they were partnerships, so that corporate income, whether distributed or not, is taxed as ordinary income to the shareholders in these companies.

7 See Table 2 below for data as of November 1, 1963. From various sources, including the Commerce Clearing House State Tax Guide (the single-volume summary service), it appears that the tax provisions as of 1970 differ from those in Table 2 in that there is now no exclusion of either federal, home-state, or other-state interest payments on securities with respect to taxes "measured by" bank income in Alaska, Hawaii, Kansas, Missouri, New Mexico, North Dakota, South Carolina, South Dakota, and Wisconsin. Also, income taxes on banks have been imposed since 1968 in Iowa, Montana (1971), New Mexico, and Tennessee and, for State banks only at present, in Illinois, Maine, and New Hampshire. [See also table 20A in app. 6 at pp. 336-38, above. - Ed.]

referred to hereafter as "double deduction states.” To be sure, the federal government also allows consumers to deduct the state and local sales taxes in computing their taxable income, and similarly for real estate taxes, but there is no double deduction feature, since the federal government does not impose such taxes. The information on double deductibility does not bear directly on the issue of unneutrality, since the double deductibility, where it exists at all, is not limited to banks; but this information is helpful to an understanding of the absolute amount of the cumulated burden.)

Eleven of the states imposing a corporation income tax on banks in 1968 were double deduction states (in Wisconsin, however, deductibility is limited. Given a federal corporation income tax with a marginal rate of 45 per cent for large corporations, the double deduction feature reduces the burden of the state tax considerably from what the statutory rate indicates. Thus Alabama's 6 per cent tax adds to the bank's total federal and state tax bill an amount equal to only 1.7 per cent of income before federal or state tax (hereafter termed "pre-tax income). The Alabama tax is itself not really 6 per cent of the pre-total-tax profit, since it applies only to profit after federal tax, and, in addition, the federal tax is not really 48 per cent of pre-total-tax profit, since it applies only to profit after the Alabama tax. Arizona's 5 per cent tax is really but a tax of 1.4 percent on pretax income and so on. Table 1 shows the statutory rates in column (2), and the net additional burden imposed by the state tax, expressed as a percentage of pre-tax income, in column (3).8

TABLE 1.-NET ADDITIONAL BURDEN FROM STATE TAX ON NET INCOME OF COMMERCIAL BANKS

1 Significance of rate depends largely on treatment of government obligations; see table 2.

* Indicates a double-deduction State: see text.

316 percent of Federal tax plus license tax, 2 percent of net income.

4 Rate computed annually; in 1967, 9.5.

5 Maximum.

⚫ Deductibility of Federal taxes is limited to 10 percent of net income before Federal taxes.

7 Tax is 4 percent of gross earnings less earnings paid to depositors.

* If the tax base is assumed to equal net income.

Source: Federation of Tax Administrators, State Taxes on the Income, Dividends, and Shares of National Banks (RM-411 Nov. 1968), and supplementary note for sec. 2, below.

The formula for this net additional burden is, when the state does not allow deduction of the feder... s-fs, where s is the rate of the state tax and f is the rate of the federal tax. In the double deduct the net additional burden of the state tax is given by: (s-2fs+f-s), (1-fs). See Supplementary: section, below at pp. 366-67.

Some of these state rates are "built-up" rates, that is, they include additions to the general corporation income tax rate to allow for the fact that corporations in general, in the state in question, pay certain taxes that banks do not, primarily because of the inhibitions of Section 5219.

The true net burden of the state tax also depends on its treatmen of interest on government bonds (see Table 2 below), but there is no practicable way of allowing for this in Table 1.

Interest on state and local obligations is exempt under the federal income tax. Such interest is taxable in some states, exempt in others, or is exempt as to obligations of the domiciliary state or its subdivisions, but taxable as to obligations of other states or their subdivisions. Interest on federal obligations is taxable in some states, exempt in others. The state income tax laws on this point, for corporations in general, as of November 1, 1963, are given in columns 2, 3, and 4 of Table 2.

When a bank increases its holdings of state or municipal obligations that are taxable by the domiciliary state but not by the federal government, it does not increase its federal tax bill at all, and deductibility of the federal tax, in computing the base for the state tax, has no

TABLE 2.-INTEREST ON GOVERNMENT OBLIGATIONS AND INTERCORPORATE DIVIDENDSTREATMENT UNDER STATE CORPORATION INCOME TAXES AS OF NOV. 1, 1963 (WITHOUT SPECIAL REFERENCE

TABLE 2-INTEREST ON GOVERNMENT OBLIGATIONS AND INTERCORPORATE DIVIDENDSTREATMENT UNDER STATE CORPORATION INCOME TAXES AS OF NOV. 1, 1963 (WITHOUT SPECIAL REFERENCE TO BANKS-Continued

sff received from corporations taxed upon at least 50 percent of their income in Arizona for the year preceding payment. * Dividends from State banks BT Trust companies and national batikring associations are exellipt.

• Only to extent declared from income which has been taxes in Galliorme

not traded on an exchange er over the counter

mic Corporation's regular anu usual course of operations or obligations

Exempt oniv il corporate recipient is engaged in business in Georgia and subject to Georgia income tax. Dividends from Georgia and Federal banks and trust companies are exemp

I received from a Q) corporation subject to income tax of another State and of which 95 percent of stock is owned by corperations doing business in hawa (2) Dal er insurance company organized and doing business in hawaii; (3) corporation with at least 10 percen CT income ter taxable year preceding Gividens payment attributes to and taxable by Hawa Dividends from a national paneing association are completely exellip

*Except that interes ม certain bonds Ssue ນ foans municipaitues is exempt.

$ft received from corporation taxable by tuato un more than 50 percent of its taxable income for year preceding divident declaration. Otne.wise by taxable. That portion of dividen! is exempt paye' colpo alic

and trust companies are tolam

representing earnings of the payer corporation on which: Kansas income tax has been paid derives at least 10 percent of its nei mooie itum natisas sources. Dividends from bankS exemp

1: Dividends on stock c Kentucky banks and trus, compames are fully exemp".

1 Louisiana exempts interes un certam opigations of Louisiana and its subdivisions issued under statules specifically exempting the interes er the of galu

To the exten: earned in Louisiana and to the extent that the income from which they are paro has been taxed under Louisiana lav.

1 Exempt as “investment income

I' Taxable under the upfect picome tax D dic exien permities by federal law.

16 in propertion to income assignes 10 Minnesota i recipien owns at least 85 percent of voting stock. Fully taxable if stock to being nero at revents

↑ Exempt diviuent have already borne a Mississippi taxa: Gividens income; this rejel provision is ter stockholders of noting companies Dvidenc

I receive Tom: a corp lācc

indicates. perhaps, exemp

1 On 50 percen

2 To extent D De ve det

2 To extent C percentage ?

receive func

peration

precetim

tual part el income subject to Missouri lax. Case law from leigh comporation deriving no income from Missou

Tele ve

Granvia un 5 persent or more of its entire gross income for im

DO receive by Colpoland in a molding compali,, állú tanpayer holds 50 percent or more of issuing cor-
STOCK

2 Complete v exempt" receiver from Datin corporation lai

subject to the knoge

siano ban tax, corporations able to the business - Only I receive: HOT with y owes subsidiary corporations the pay an income tax to Tennessee, otherwise, funy taxabis

unú v Jenius par from eathing, prior to Jan. 1, Les die Hot Aed on dividends (pait"; from earnings prior to Jan. 4,

Fru 200 Taulí latú on over 5. poisen of is told met mncome by Wisconsin in year preceding payment.

significance with respect to that increment of investment by the bank. In this case, then, double deductibility is no different from deductibility for the federal tax alone, and the net additional burden caused by the state tax on this increment of investment income is understated in Table 1, column 3, for the double deductibility states. Again, double deductibility is not limited to the banking industry.

Certain other increments of income to a bank may incur a federal tax, if not of zero as in the case above, at least of less than 48 per cent. Certain types of capital gain and loss give rise to this phenomenon, and by and large such gains and losses have probably been of more consequence for banks than for other industries, at least nonfinancial industries. This lower effective federal tax rate causes the figure in column 3 of Table 1 to be an understatement for the doubledeductibility states.

If a bank incurs a certain incremental expense, rather than experiencing an incremental gain as in the examples above, the reasoning above applies in reverse. The net cost, after all income taxes, is greater in the double deductibility states than in the others.

(b) Geographical Neutrality

Under the restraints of Section 5219, income taxation of national banks has been geographically neutral in one respect, namely, in the sense that no double taxation of income and no zero taxation of income could occur through differences in states' formulas for allocating a portion of a bank's income to the taxing state, or through differences in states' laws regarding deductibility of outlays or other differences in definition of taxable net income. The income, wherever earned, could be taxed by, and only by, the bank's home state.

With recent growth of banks' interstate activities the potentiality for impairing that aspect of geographical neutrality has increased, and if no restrictions are placed on the states, i.e., the post-1971 provisions of Section 5219 are retained, we may expect them to differ among themselves in formulas for geographical allocation and in definitions of net income for banks, just as they have done, and continue to do, with respect to non-bank firms. If the permanent part of the new bank tax legislation stands as passed in 1969, a certain amount of duplicate taxation of bank income among the states will doubtless develop. No doubt, also, some gaps will open up where a part of a bank's income escapes state tax entirely or is given, inadvertently, preferential treatment.

Activities for which allocation-of-income problems probably will arise are numerous, but the following are illustrative: loans by a bank in State A to a borrower in State B, where the closing takes place in State C, the funds to be spent in State D; purchase of consumer merchandise in A by a resident of B through use of a credit card issued by a bank in C; a working capital loan by a bank in A to a corporation in B, the funds to be spent by the corporation in C, D

; participation and overline loans in which a bank in A acts as the lead bank for, or cedes portions of loans to, banks in B, C, reserve loans by a money-market bank to a correspondent bank to satisfy state reserve requirements for the latter bank; leasing of