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POTENTIAL SIMPUHCATION OF ”SHE
FEDERAL ENCOME TAX LAW BY
ELIMINATSNG SPECEAL TREATMENT
OF CAPETAL GAiNS AND LOSSES

Dissertation for the Degree of Ph. D.
MICHIGAN STATE UNWERSITY

JACK DENMS SCHROEDER

1 975

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LIB 53 A L Y L.
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Michigan State
University

  

This is to certify that the
thesis entitled
POTENTIAL SIMPLIFICATION OF THE FEDERAL
INCOME TAX LAW BY ELIMINATING
SPECIAL TREATMENT OF CAPITAL

GAINS AND LOSSES
presented by

Jack Dennis Schroeder

has been accepted towards fulfillment
of the requirements for

Ph.D degree inAccounting

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Date Nomber 11, 1975

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ABSTRACT

POTENTIAL SIMPLIFICATION OF THE FEDERAL INCOME TAX LAW BY ELIMINATING
SPECIAL TREATMENT OF CAPITAL GAINS AND LOSSES

By

Jack Dennis Schroeder

The federal income tax law is complicated and the cost of
compliance on the part of the taxpayer and administration on the part of
the federal government is great. Costs of compliance from a taxpayer
standpoint include recordkeeping, filing of returns, and dealing with tax
audits with their attendant controversy. Also included is the cost of
becoming acquainted with the law, hiring expert advisors, or in the absence
of these, the cost of inadvertently overpaying one's taxes. From the
standpoint of the federal government there are costs of researching,
drafting, enacting, administering, and adjudicating complex tax provisions.

It is the considered opinion of many writers in the field of
taxation that the federal income tax in general is too complicated, and the
subject responsible for the greatest amount of complexity is the capital
gain and loss provisions. Complexity is the antithesis of understanding,
and understanding is an important first step in orderly compliance in a
self assessment income tax system.

The sources of complexity are many and varied, some of which are
unavoidable. Much complexity is the result of a $1 trillion plus economy
with.its multitude of ways to frame business transactions and to earn

money. Some complexity is the result of the accounting conventions of

 

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Jack Dennis Schroeder
realization and the year as a time period for the purpose of income
measurement. Another source of complexity results from the Social and
political decision to utilize a progressive tax rate Structure in deters
mining tax liability. The point of common ground of each of these sources
of complexity is that distinctions must be made. In the case of realiza—
tion there is a difference in tax consequences if an appreciated asset is
held or sold. For a calendar year taxpayer there are different tax con-
sequences for receiving an item of income on December 31 or on January 1.
For taxpayers in general, there are different tax consequences between
receiving the first dollar of taxable income in a year and receiving the
one-millionth dollar of taxable income.

The absence of a normative concept-of income for tax purposes has
hindered progress in the development of a logically consistent tax statute.
In too many cases statutory law reflects the result of lobbying pressures
or of ad-hoc legislation designed to attain a particular objective with
no thought to the statute in its entirety. A useful normative concept of
income for tax purposes is the "accretion concept," long associated with
the names of Robert Haig and Henry Simone. The acceptance of a normative
concept of income would promote uniformity by minimizing distinctions bet-
ween types of income and deductions in addition to providing a directional
guide in tax policy questions. There should be no deviation from the norm
except for urgent administrative reasons, and then any deviation should be
recognized as such and not as an integral part of an income concept for
tax purposes.

If the accretion concept of income were adopted as a directional
guide, there would.be no special treatment of capital gains and losses;

realized capital gains and losses would be treated the same as ordinary

 

 

gains and
and losse
sources 0
(l) to ex
and judic
provision
taxpayer .
ber of ch.
simplicitj

I?
Internal F
Revenue Se
Court, Cou
Revenue Cc
on a 1002
Court of ;
Classifica
Revenue R1
SPGCial t1
tains tho:
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Jack Dennis Schroeder
gains and losses. If there were no special treatment of capital gains
and losses much of the complexity would be eliminated from the various
sources of federal income tax law. The objectives of this study are:
(l) to examine the basic sources of tax law (legislative, administrative,
and judicial) to determine the extent to which the capital gain and loss
provisions are complicating factors in governmental administration of and
taxpayer compliance with federal income tax law, and (2) to propose a num-
ber of changes in the law which will have the dual purpose of promoting
simplicity and improving equity.

The examination and analysis of tax law include a study of the
Internal Revenue Code, the published Revenue Rulings of the Internal
Revenue Service, and the decisions of the federal District Courts, Tax
Court, Court of Claims, Court of Appeals, and Supreme Court. The Internal
Revenue Code, Court of Claims cases, and Supreme Court cases are examined
on a 100% basis, while the decisions of the District Courts, Tax Court and
Court of Appeals are examined on a random sample basis. A three category
classification is used. The first category contains those Code sections,
Revenue Rulings, or court cases which would be eliminated were there no
special treatment of capital gains and losses. The second category con-
tains those sections, rulings, or cases which have capital gain and loss
implications although they could not be entirely eliminated if there were
no special treatment of capital gains and losses. The third category con-
tains those sections, rulings, and cases which would be unaffected if there
were no special treatment of capital gains and losses.

The research results show that in the first category, the 100%
capital gain and loss classification,.the judicial source of tax law con-

tained a greater proportion than either the legislative or administrative

Jack Dennis Schroeder
sources. The legislative source had the second greatest proportion, with
the administrative source a distant third. In the second category, the
capital gain and loss implication category, the legislative source had
the greatest proportion, followed by the judicial source, and the adminis-
trative source was again a distant third. Taken as a whole, however, it
would appear that the capital gain and loss distinction plays a signifi—
cant role in the overall complexity of the federal income tax.

Political considerations aside, it would appear that a great
amount of complexity can be eliminated if there were no special treatment
of capital gains and losses. Accompanying this change, there would have
to be a redefinition of realization to include the point of time of gift
and death and possibly more liberal averaging provisions. Redefining
realization is necessary to alleviate the "lock-in" effect, and more
liberal averaging provisions are necessary to avoid the inequity of taxing
the appreciation of an asset which has occurred over a number of years,
in the year of realization at progressive tax rates.

The advantages of eliminating special treatment of capital gains
and losses relate not only to the advantages of a less complex tax law,
but also to a more equitable tax law. The principles of horizontal and
vertical equity can be more closely adhered to, and this could be an

important first step in the direction of a comprehensive tax base.

POTENTIAL SIMPLIFICATION OF THE FEDERAL INCOME
TAX LAW BY ELIMINATING SPECIAL TREATMENT
OF CAPITAL GAINS AND LOSSES

By

Jack Dennis Schroeder

A DISSERTATION

Submitted to
Michigan State University
in partial fulfillment of the requirements
for the degree of

DOCTOR OF PHILOSOPHY

Department of Accounting and Financial Administration

1975

 

 

Li 1; N-“Cfl'l' W

1““— ‘

 

“V C°Pyri
JACK DJ
1975 I

 

 

 

© Copyright by
JACK DENNIS SCHROEDER
1975

ii

I visi
Gaa for his g:
to thank Profe
of the thesis

The fi
3? tenure at .“
gratitude is d
Accounting and
aany other for

Finall;

and encourage:

 

ACKNOWLEDGMENTS

I wish to express my sincere appreciation to Professor Charles J.
Gaa for his guidance and encouragement during this study. Also, I wish
to thank Professor Steven Dilley and Professor James Stapleton, members
of the thesis committee, for their helpful comments and interest.

The financial support provided by Michigan State University during
my tenure at Michigan State is gratefully acknowledged. A special debt of
gratitude is due Professor Gardner M. Jones, Chairman of the Department of
Accounting and Financial Administration, for his encouragement and for the
many other forms of assistance he provided.

Finally, I wish to thank my wife and family for their assistance

and encouragement.

Jack D. Schroeder

iii

LIST OF TABLE
LIST OF TIGER
(EPTER:

I. INTRO

Oh
Sc<
Met

Prc

Foc

IL

 

Ar;
an;

 

 

Ar:

a;

PO:

 

LIST OF

LIST OF

CHAPTER:

I.

II.

TABLE OF CONTENTS

TABLE S C O O O O C O O O O O

FIGURES . . . . . . . . . . .

INTRODUCTION . . . . . . . . .

Brief History of Capital Gains Taxation

United States . . . . . . .
Objectives of the Study . .
Scope of the Study . , . .
Methodology of the Study

Problem Areas . . . . . . .

Footnotes for Chapter I .

ATTRIBUTES OF A GOOD TAX SYSTEM

Equity . . . . . . . . . .

A Theoretical Concept of Income

Administrative Convenience
Definition of Realization .

Economic Effects . . . . .

Arguments For Special Treatment

and Losses . . . . . . . .

Arguments Against Special Treatment of Capital

Gains and Losses , . . . .

of Capital Gains

Footnotes for Chapter II . . . . .

iv

Tax Purposes

in the

Page
vii

ix

10

l3

14
14
17
20
28

32

36

42

46

CHAPTER :

PO:
Su;

The
Co:

Inc

Cos

For

N- THE E;
TAX L:

So:

So;

RES

Th.
Ca;

St,1

5a.~

 

Sa~|
R6,;
Trg

Rel

 

TABLE OF CONTENTS

(Continued)

CHAPTER:

III. COMPLEXITY IN THE FEDERAL INCOME TAX
Definition of Complexity . .
Sources of Complexity . . . . . .
Possibilities for Simplification
Suggestions for Simplification .

The Capital Gain Distinction as a
Complex1ty O O O O O O O O O I 0

Indications of Complexity . . . .
Costs of Complexity . . . . . . .
Summary . . . . . . . . . . . . .

Footnotes for Chapter III . . . .

Source of

IV. THE EXAMINATION OF SELECTED SOURCES OF

TAX LAW . . . . . . . . . . . . . .
Sources of Federal Tax Law . . .
Scope of the Study . . . . . . .
Research Methodology . . . . . .

The Relative Investment Advantage
Capital Gains . . . . . . . . . .

Statistical Measures . . . . . .
Sample Size . . . . . . . . . . .
Sample Results . . . . . . . . .
Research Results . . . . . . . .

Trends . . . . . . . . . . . . .

Relative Importance of the Categories .

Page

48
48
49
57

58

63
65
69
72

73

76
76
79

81

84
92
94
95
97
100

108

CHAPTER :

I:

V. RECO.‘

Su

Ad
P0:
Cor

Foc

menu;

A. COL'RT
\T) "In

ANALYS
SPECIA

FEDEEU.

 

 

TABLE OF CONTENTS
(Continued)

CHAPTER:
Interpretation of the Research Results . . . . . . .

Footnotes for Chapter IV . . . . . . . . . . . . . . .

V. RECOMMENDATIONS . . . . . . . . . . . . . . . . . . . . .
Summary . . . . . . . . . . . . . . . . . . . . . . .
Primary Recommendation . . . . . . . . . . . . . . . .
Additional Recommendations . . . . . . . . . . . . . .
Possibilities for Future Research . . . . . . . . . .
Conclusion . . . . . . . . . . . . . . . . . . . . . .

Footnotes for Chapter V . . . . . . . . . . . . .

APPENDIX:

A. COURT CASES AND REVENUE RULINGS SELECTED FOR EXAMINATION,
AND THE RESULTS OF THE EXAMINATION . . . . . . . . . . .

B. ANALYSIS OF INTERNAL REVENUE CODE SECTIONS AFFECTED BY
SPECIAL TREATMENT OF CAPITAL GAINS AND LOSSES . . . . . .

C. FEDERAL INCOME TAX EXPENDITURES CALENDAR YEAR 1972 . . .

BIBLIOGRAPHY . . . . . . . . . . . . . . . . . . . . . . . . . .

Page

111

115

116
116
122
124
126
126

128

129

149

153

155

TABLE

Iv
O

‘N
o

10.

11.

 

 

TABLE

10.

11.

LIST OF TABLES

Page

The Percentage of Capital Gains Excluded for the Period
1934-1937 0 O O O O O O O O O O O O O O O O O O O O O O O O O 6

The Accumulation of $1 of Investment at the End of N
Years at an Annual Rate of Appreciation of 10% and
Marginal Ordinary Income Tax Rates of 30, 50, and 70% . . . . 26

The Relative Investment Advantage of Holding an Appre-
ciated Asset as Opposed to Selling the Asset and
Reinvesting the Proceeds . . . . . . . . . . . . . . . . . . 27

The Number of Revenue Rulings and Court Cases Concerning
Internal Revenue Code Sections 1-1399, 1964—1973 . . . . . . 84

The Accumulation of $1 of Investment After Taxes at the
End of N Years at an Annual Rate of Appreciation of 10%
and Marginal Ordinary Income Tax Rates of 30, 50, and 70% . . 88

Investment Advantage Attributable to Capital Gains with
Marginal Tax Brackets of 30, 50, and 70% . . . . . . . . . . 90

Sample Results by Year for Revenue Rulings and Court Cases . 96

Estimates of the Proportions of Court Cases Which Were
100% Capital Gain and Loss, Had Capital Gain and Loss
Implications, or Both, for the Period 1964 Through 1973 . . 99

95% Confidence Intervals About the Estimated Proportions

of Court Cases Which Were 100% Capital Gain and Loss, Had
Capital Gain and Loss Implications, or Both, for the

Period 1964 Through 1973 . . . . . . . . . . . . . . . . . .100

Estimated Proportions of Revenue Rulings Which Were Either

100% Capital Gain and Loss, Had Capital Gain and Loss
Implications, or Both, for the Periods 1964 Through 1968

and 1969 Through 1973 . . . . . . . . . . . . . . . . . . . .103

Estimated Proportions of A11 Court Cases Combined Which

Were 100% Capital Gain and Loss Cases, Had Capital Gain

and Loss Implications, or Both, for the Periods 1964

Through 1968 and 1969 Through 1973 '. - - . - - . - - - . - .107

vii

TABLE

12.

13.

14.

Estirs
in thy
Gain a

Relati
and J;
100: C
Implic

PrOpor
Cases

 

TABLE

12.

13.

14.

LIST OF TABLES

Page

Estimated Proportions of Revenue Rulings and Court Cases
in the Categories 100% Capital Gain and Loss, and Capital
Gain and Loss Implications . . . . . . . . . . . . . . . . . 109

Relative Importance of the Legislative, Administrative,

and Judicial Sources of Tax Law, Within the Categories

100% Capital Gain and Loss, and Capital Gain and Loss
Implications . . . . . . . . . . . . . . . . . . . . . . . . 110

Proportion of Code Sections, Revenue Rulings, and Court
Cases in the Three Classification Categories . . . . . . . . 117

viii

 

 

 

LIST OF FIGURES
Page
FIGURE:
1. The Methods of Taxing Appreciation as Ordinary Income , , , 26

2. Methods of Taxing Appreciation . . . . . . . . . . . . . . 87
3. The Percent of Investment Advantage Attributable to

Capital Gains, With Marginal Tax Brackets of 30, 50,

and 700/0 0 O O I O O O O O O O I O O I O O O C O O O O O O O 92
4. Estimated Proportions of Revenue Rulings Which Were Either

100% Capital Gain and Loss or Had Capital Gain and Loss

Implications, for the Period 1964 Through 1973 , , , , , , 101

5. Estimated Proportions of Revenue Rulings Which Were 100%
Capital Gain and Loss Rulings Plus the Estimated Propor-
tions of Revenue Rulings Which Had Capital Gain and Loss
Implications, for the Period 1964 Through 1973 , , , , 102

6. Estimated Proportions of All Court Cases Which Were Either
100% Capital Gain and Loss Cases or Had Capital Gain and
Loss Implications for the Period 1964 Through 1973 , , , , 105

7. Estimated Proportions of Court Cases Which Were 100%
Capital Gain and Loss Cases Plus the Estimated Propor—
tions of Court Cases Which Had Capital Gain and Loss
Implications for the Period 1964 Through 1973 , . . . . . . 106

ix

 

The I
compliance or
the part of 1
Point of the
Preting the s

V0€fully 111-
lation. In a
and trained 1.:
requirements ,
to V°1Untar113
through instn
Prepared an d c
about which ta
merely reflect

:. u

 

do not end v

 

 

CHAPTER I

INTRODUCTION

The Federal income tax law is complicated, and the cost of
compliance on the part of the taxpayer and the cost of administration on
the part of the federal government are great. The costs from the stand-
point of the federal government include the administrative costs of inter-
preting the statutes enacted by a Congress which itself is far too often
woefully ill—informed as to the meaning and consequences of its own legis—
lation. -In addition, Internal Revenue Service personnel must be educated
and trained in this highly complex tax law, and the law with its filing
requirements must be communicated to millions of taxpayers who are expected
to voluntarily comply. Communication with most taxpayers takes place
through instructional booklets and through the large number of tax forms
prepared and distributed by the Internal Revenue Service. These tax forms,
about which taxpayers perennially complain because of their complexity,
merely reflect the complex statutes upon which they are based. A simpli—
fication of income tax forms cannot be obtained without a simplification
of the tax law itself. The problems associated with complicated returns
do not end with their filing, however, the returns must be audited.
Arithmetic must be checked, amounts must be verified, returns may have to
be selected for closer scrutiny, and interviews with taxpayers and their
representatives may take place. If controversy exists between the taxpayer
and government, a conference may result at the district or appelate levels
of the Internal Revenue Service. Finally, if agreement is not reached

1

 

 

 

through ad
which may '
monetary c:
mated budg.
billion.l
Frc
rent things.
elimination
return form
into old re
Vhich is us:
The
tinCtIOns B":
tion is made
expenditure,
question ari
expenditure
to the qUeSt
diStinctiOn-g
A180, the ta
a “annex. as

the Outer l

‘

 

noveVEr , a1,

cat 10,],

 

2

through administrative appeals, there is the process of judicial review
which may be carried through the Supreme Court. As an indication of the
monetary cost of administration of the internal revenue laws, the esti-
mated budget of the Internal Revenue Service for fiscal 1975 was $1.881
billion.1

From the standpoint of the taxpayer, simplification means diffe-
rent things, including a minimization of computational complexity, the
elimination or minimization of recordkeeping, and a reduced number of tax
return forms which can be filled in easily without having to dig deeply
into old records. Simplification also means a minimization of conflict,
which is usually costly or at the very least annoying to the taxpayer.

The complexity of the income tax law is the direct result of dis-
tinctions which are made in the substantive tax law. Any time a distinc-
tion is made between types of income, classes of taxpayers, or types of
expenditures, to name a few, there exists a more complex tax law. The
question arises as to whether a particular kind of income, taxpayer, or
expenditure falls within one classification or another. Since the answer
to the questions means dollars to the taxpayer and to the government,
distinctions must be drawn very carefully and delimited very sharply.
Also, the taxpayer has a right to arrange his financial affairs in such
a manner as to minimize his taxes. Thus, he will often attempt to seek
the outer limits of a distinction, barely remaining on the favorable side.
However, although proper form is necessary to obtain the desired classifi-
cation, it is not sufficient. The Supreme Court has ruled in an early
case that "substance" prevails over "form," and that to hold otherwise

. "2

"would be to exalt artifice over reality. . . Thus, a higher order

of complexity results, which calls for the determination of a taxpayer's

motives.

of the rev
This unavo
problems i:
of net inc:
convention
another so'.
ture is the
Vertical ec
there is a
where that
PaYer benef
10" bracket

Whi
VOidable’ t
of distincu:
tIOn of the
neutraliZQd
Some eXampl

r1on‘bllsines

 

cost, and s

    
 
 

Th e

breadth of

an

ween aSSEtg

motives.

Much complexity emanating from the income tax is a necessary part
of the revenue raising function of the tax, and therefore unavoidable.
This unavoidable complexity relates primarily to the many accounting
problems involved in income determination, such as, annual measurement
of net income, the definition of the taxable entity, and the realization
convention. In addition, the progressive tax rate structure provides
another source of unavoidable complexity. The progressive tax rate struc-
ture is the product of political and social decisions designed to achieve
vertical equity among taxpayers. It is a source of complexity in that
there is a different tax effect on a dollar of income, depending upon
where that dollar falls within the tax rate schedule. Therefore, a tax-
payer benefits from moving taxable dollars from high bracket entities to
low bracket entities or from high bracket years to low bracket years.

While there does exist a great deal of complexity which is una-
voidable, there also exists a great deal of complexity which is the result
of distinctions made which are not essential to the revenue raising func-
tion of the income tax. It is this type of distinction which could be
neutralized, and if neutralized much complexity would be eliminated.

Some examples of these avoidable distinctions are tax exempt interest,
non-business property tax deductions, depletion deductions in excess of
cost, and special treatment of capital gains and losses.

The capital gain distinction presents a particularly bountiful
source of complexity because of it's advantageous tax position and the
breadth of it's scope. Mr. Jerome Hellerstein in his book Taxes, Loopholes,

and Morals, in describing the difficulties involved in drawing a line bet-

 

ween assets that qualify for capital gains treatment and those that do not

said that
income ta
tually ev
payers, t
cited the
complexit)
Administra
gain is "t

in the Ame

Brief Histc
\

The

Ponds to th
0f the 16th
day Series .
OCtOber 3’ :
act, net in(

nition has I

That
hereina,
inClUde
or Comp,
whatEve:
trade, C
Cr Pets:
in real I
SEQUrit_
on for .

l

 

 

i
This

iHCome tax 6,

 

imposed on a

to the rate

 

4
said that "[i]t is one of the most vexatious and slippery problems in the
income tax field. While plausible explanations can be offered for vir-
tually every nice distinction drawn, as a matter of equality between tax-
payers, the whole complicated structure is indefensible."3 Another writer
cited the capital gains area as "the most significant single cause of tax
complexity."4 And Mr. Stanely S. Surrey, top tax advisor to the Kennedy
Administration and former Harvard law professor has stated that the capital
gain is ”the subject singly responsible for the largest amount of complexity

in the American tax laws."5

Brief History of Capital Gains Taxation in the United States

The history of capital gains taxation in the United States corres-
ponds to the history of the Revenue Acts enacted subsequent to ratification
of the 16th Amendment to the Constitution on February 25, 1913. The present
day series of income tax laws originated with the Revenue Act approved on
October 3, 1913 effective retroactively to March 1, 1913. In this first
act, net income was defined as in the following paragraph and this defi-
nition has been continued in substance in subsequent acts.

That, subject only to such exemptions and deductions as are
hereinafter allowed, the net income of a taxable person shall
include gains, profits, and income derived from salaries, wages
or compensation, or personal service of whatever kind and in
whatever form paid, or from professions, vocations, businesses,
trade, commerce, or sales, or dealings in property whether real
or personal, growing out of the ownership or use of or interest
in real or personal property, also from interest, rent, dividends,
securities, or the transactions of any lawful business carried
on for gain or profit, or gains or profits, and income derived
from any source whatever.

This first act included an income tax section assessing a basic
income tax at the rate of one percent, with an additional income tax
imposed on annual income in excess of $20,000 graduated from one percent

7

to the rate of six percent on annual income in excess of $500,000. This

section.
ginning «
This Code
every inc
economic

0
Act of 19
the legal
In the muc
expanded u
in earlier
Cepital, f‘
to include
assets. .
gain from a
engaged in

Cap

1913. Ray

has identif

 

tax trefltme
1913 to 192

gains and 1

 
 
  
 

1922 thrOUg
flat 12 1/2

Surtax rate

In

5

section originally less than fifteen pages in length, was the modest be—
ginning of a statute that has grown to become the Internal Revenue Code.
This Code is today lengthy, incredibly complex, and affects virtually
every individual, business, transaction, and because of its profound
economic impact, virtually every social and economic policy issue.

Once Congress had enacted the income tax section of the Tariff
Act of 1913, the stage was set for the court decisions which provided
the legal interpretation for the word "income" to include capital gains.

In the much quoted case of Eisner v. Macomber_the Supreme Court majority

 

expanded upon a judicial definition of income which had been formulated
in earlier cases: "'Income may be defined as the gain derived from
capital, from labor, or from both combined,' provided it be understood
to include profit gained through a sale or conversion of capital

.Il8

assets. . . The following year in the case of Merchants Loan Company

 

v. Smietanka the Supreme Court held that the word "income" included a

 

gain from a single isolated sale as well as profits from sales by one
engaged in buying and selling as a business.9

Capital gains and losses have been subject to varying rules since
1913. Ray Sommerfeld, Professor of Accounting at the University of Texas,
has identified six distinct historical periods in the development of the
tax treatment of capital gains and losses.10 During the first period,
1913 to 1922, capital gains and losses were taxed the same as any other
gains and losses, there was no special treatment. The second period,
1922 through 1933, saw capital gains subject to an alternate tax of a
flat 12 1/2% while all other taxable income was subject to the normal
surtax rates.

In the relatively short period 1934 through 1937 a proportion of

 

 

the capi
the leng
excludin
of the H
favors a
income.l
gains di‘
capital 1
gain. It
to be hel
18 months
term capi
gains Her;
two identj

the most i

Act of 196

 

6

the capital gain could be excluded from taxable income, depending upon
the length of time of the holding period (Table 1). This method of
excluding a portion of the gain resurfaced briefly when former Chairman
of the House ways and Means Committee Wilbur Mills suggested that he
favors a sliding scale for the exclusion of capital gains from taxable
income.11 The fourth distinct period, 1938 through 1949, saw capital
gains divided into three groups for tax purposes: the long—long—term
capital gain, the long-term capital gain, and the short—term capital
gain. To qualify for the long—long-term capital gain a capital asset had
to be held for 24 months. The long—term capital gain holding period was
18 months. Short term capital gains were 100% included in income, long-
term capital gains were 66 2/3% included, and long-long-term capital
gains were 50% included. Professor Sommerfeld implied that the final

two identifiable periods were actually the result of several minor changes,
the most important change occuring with the passage of the Tax Reform

Act of 1969.

TABLE 1

THE PERCENTAGE OF CAPITAL GAINS EXCLUDED FOR THE PERIOD 1934-1937

 

 

 

Holding Period Percentage Exclusion
One year or less 0
One to two years 20
Two to five years 40
Five to ten years 60
Over ten years , 80

 

Perhaps we are on the threshold of a new period in the history
of capital gains. With the economy at the bottom of a recession and the

stock market none too healthy, there are pressures being exerted to

liberal
been qu
to bols

stock m.

Revenue

tax law.
has said
may unde
who have
more libe
addition

change in

VF
n.‘

factors wh
trEatri'ient:

the 131?er
small tax c
maximum tax

“my 50:,

 
 
 
  
  

term CaPita
items is co
taxpayers t
capital gai

maintain If”.

7

liberalize the tax treatment of capital gains. Representative Mills has
been quoted as stating that he would "push for lower capital—gains taxes
to bolster the economy so that 'every American can get back into the
stock market.”12

On the other hand other tax experts including former Internal
Revenue Commissioner Sheldon S. Cohen have urged Congress to simplify the
tax law. Mr. Cohen in testimony before the House Ways and Means Committee
has said that those who write the law and the officials administering it
may understand what it means, "but God help millions of people out there

who have to live with it."13

With these countervailing pressures for
more liberal benefits for capital gains, for simpler tax laws, and in
addition for the closing of tax "loopholes," the direction of the next
change in the tax treatment of capital gains is far from certain.

While the direction of the next change is not certain, there are
factors which exist today which would make the elimination of special
treatment of capital gains appear to be more possible than any time since
the preference was first allowed. The basic factor is the relatively
small tax differential between the maximum tax on earned income and the
maximum tax on capital gains. The maximum tax on earned income is cur-
rently 50%, which is not a great deal higher than the maximum tax on long-
term capital gains which is 36.5%, if the minimum tax on tax preference
items is considered. The smaller the differential, the less pressure by
taxpayers to seek capital gains. Reduced pressure by taxpayers to seek

capital gains would, presumably, result in less political pressure to

maintain the preference.

objective
I

three pri
cial) to 1
sions are
and taxpa}
a mmber c
dual purpo
changes in
and losses.
at death ir
comrehensi
taxing a ga

brackets in

W

The
is cC’mPI‘ised
Spacificauy
Sections 111.
Of the admin:

Revenue RUI 1' r

 

arismg from
only the pub:
maimed, P;
the)’ are not

 

 

Objectives of the Stugy

The objectives of this study are twofold. First, to examine the
three prime sources of tax law (legislative, administrative, and judi-
cial) to determine the extent to which the capital gain and loss provi—
sions are complicating factors in the governmental administration of
and taxpayer compliance to federal income tax law. Second, to propose
a number of changes in the federal income tax law which will have the
dual purpose of promoting simplicity and improving equity. The proposed
changes include: (1) elimination of special treatment of capital gains
and losses, (2) presumed realization of gain or loss at time of gift or
at death in addition to realization upon sale or exchange, and (3) a
comprehensive program of income averaging to alleviate the problem of
taxing a gain which has accrued over a number of years at high marginal

brackets in the year of presumed or actual realization.

Scope of the Study

 

The examination and analysis of the legislative source of tax law
is comprised of the income tax provisions of the Internal Revenue Code.
Specifically, this entails an examination of Subtitle A, Chapter 1,
sections 1-1399 of the Internal Revenue Code of 1954. The examination
of the administrative source of tax law is confined to the published
Revenue Rulings of the Internal Revenue Service dealing with issues
arising from.Code sections 1—1399 and for the ten year period 1964—1973.
Only the published Revenue Rulings of the Internal Revenue Service are
examined. Private or "letter" rulings are not examined since in general
they are not available for public inspection. The Code of Federal Regu—

lations, which is a major administrative source of tax law, are not

examined
Revenue
closely
court ca
for the
memorand:
Court of

decisions

Se
determine:
eliminated
(2) the pr.
implicatim
comPietely
be UnaffeCt
An example 1
of depreciat

a gain. An

  
  
  

(D is the C

from Sectiof:

9

examined because the Regulations follow section by section the Internal
Revenue Code, and an analysis of the Regulations would correspond very
closely to an analysis of the Code. For the judicial source of tax law,
court cases dealing with issues arising under Code sections 1—1399 and
for the period 1964—1973 are examined. The court cases examined include
memorandum and regular Tax Court decisions, District Court decisions,
Court of Claims decisions, Court of Appeals decisions, and Supreme Court

decisions.

Methodology of the Study

 

Sections 1-1399 of the Internal Revenue Code are examined to
determine: (1) the proportion of Code sections which would be completely
eliminated if there were no special treatment of capital gains and losses,
(2) the proportion of Code sections which have capital gain and loss
implications, even though for other reasons they probably could not be
completely eliminated, and (3) the proportion of Code sections that would
be unaffected by a repeal of special treatment of capital gains and losses.
An example of category (1) is section 1245 which deals with the recapture
of depreciation as ordinary income upon the sale of personal property at
a gain. An example of category (2) is the Code sections dealing with the
penalty tax on an excess accumulation of earnings. An example of category
(3) is the Code section setting forth the tax rate schedules. The Internal
Revenue Code is examined on a 100% sample basis, that is, all sections
from section 1—1399 are examined.

The published Revenue Rulings of the Internal Revenue Service are
analyzed to determine the proportion falling into the above named cate-
gories. Because of the volume of Revenue Rulings for the period 1964—

1973, they are examined on a stratified random sample basis rather than on

a 100:

lyzed ;
categor
decisic
random
1964-19

a 1002 l

p
.r :
oblem

 

10
a 100% sample basis.

Court cases for.the various federal courts are examined and ana-
lyzed in order to determine the proportion falling into the above three
categories. Memorandum and regular Tax Court decisions, District Court
decisions, and Court of Appeals decisions are examined on a stratified
random sample basis because of the large number of cases for the period
1964-1973. Court of Claims and Supreme Court decisions are examined on

a 100% basis because of the relatively few cases involved.

Problem Areas

 

Taxpayers in general dislike paying taxes. Consequently, they
are always looking for methods of reducing their taxes. The higher the
tax bracket the stronger the motivation to utilize the available tax
savings methods. There are basically three ways to reduce a tax bill.
(I) Pay taxes later rather than sooner. The advantage here results from
the concept of the present value of money. The later a tax bill is paid
the smaller is the present value of the eventual tax payment. An examr
ple would be taking a deduction in the current year rather than waiting
till a later year, or deferring income to a later year rather than hav-
ing it taxed in the current year. (2) Have income taxed in a lower
bracket rather than a higher bracket. Since the federal income tax is
progressive, a person with a stable income stream will pay less tax than
a person with a widely fluctuating income stream, given the same total
income. This second method of reducing taxes results in such tax saving
devices as splitting income among family members through outright gifts
or gifts in trust or through family partnerships or through arranging to
have income taxed in a low bracket year as opposed to a high bracket year.

(3) Have income taxed at less than the full rates provided in the tax

rate
gains
probl

separ

perne.
0f Iht
Conse<
cular
DECESS
This 1
t0 acc
haVe C
able t
tapita
be red

redUCe

inCOme
tUo at
ComPle
one We
prOPOS;
Payers'
rential
horiZOt

Capital

11
rate schedules. Examples of this tax saving device would be the capital
gains tax, income averaging, and the maximum tax on earned income. A
problem arises in that these three tax saving methods are not always
separate and distinct but often interrelate with one another.

The capital gain and loss provisions of the Internal Revenue Code
permeate federal income tax law at every level. However, the influence
of these provisions is often very subtle and not always readily apparent.
Consequently, it may not be possible to say with certainty that a parti-
cular section of the Code with its attendant complications would be un-
necessary if there were no special treatment of capital gains and losses.
This is the primary reason that the second category is necessary. It is
to accomodate those Code sections, Revenue Rulings, and Court Cases that
have capital gain implications, though for other reasons would not be
able to be eliminated. However, if there were no special treatment of
capital gains and losses, the pressure to utilize these provisions would
be reduced, and the complexity of the tax law would be correspondingly
reduced.

Much has been written concerning the complexity of the federal
income tax and also its equity, or rather lack thereof. Oftentimes, the
two attributes are thought to be diametrically opposed, in that less
complexity implies less equity. This viewpoint would be reinforced if
one were to read the Congressional hearings reports concerning any tax
proposal which bestows tax benefits on a specially situated group of tax-
payers. However, whenever any group of taxpayers is taxed in a prefe-
rential manner when compared to all other taxpayers, the principle of
horizontal equity is being violated. In addition, in the case of the

capital gain and loss provisions, the cost in terms of increased comple-

12
xity is enormous. This study will provide a measure of the additional
complexity which results from bestowing special treatment on capital
gains and losses. Chapter II reviews the literature concerning the attri-
butes of a good tax system as well as the arguments for and against spe-
cial treatment of capital gains and losses. Chapter III analyzes the
definition of complexity and the sources of complexity in the tax law in
general, and cites some specific examples of complexity emanating from
the capital gain distinction. Chapter IV presents the research results.

Chapter V contains the summary, conclusions, and recommendations.

P—‘IO

37:]???

In:
197

FOOTNOTES CHAPTER I

1The Budget of the United States Government, Fiscal Year 1975,
U.S. Government Printing Office, p. 233.

 

2Gregory v. Helvering, 55 S. Ct. 226, 268 (1935).

 

3Jerome R. Hellerstein, Taxes, Loopholes, and Morals (New York:
McGraw—Hill Book Co., Inc., 1963), p. 42.

 

4Philip M. Stern, The Great Treasury Raid (New York: Random
House, Inc., 1964), p. 82.

 

5Stanley S. Surrey, Tax Revision Compendium of Papers on

Broadening the Tax Base, Vol. 2, p. 1203.

 

 

6Lawrence H. Seltzer, The Nature and Tax Treatment of Capital
Gains and Losses (New York: National Bureau of Economic Research, Inc.,
1951), pp. 35-360

 

 

7Willard H. Pedrick and Vance N. Kirby (coordinating editors),

The Study of Federal Tax Law (Chicago: Commerce Clearing House, Inc.,
1972), p. 18.

 

8Eisner v. Macomber, 40 S. Ct. 189, 193 (1920).

 

9Merchants' Loan and Trust Co. v. Smietanka, 41 S. Ct. 386

 

(1921).

10Ray Sommerfeld, Hershel M. Anderson, and Horace R. Brock,
Introduction to Taxation (New York: Harcourt-Brace-Jovanovich, Inc.,
1972), pp. 208-215.

 

11"Mills to Push for Capital-Gains Tax Cuts to Bolster Economy,
'Free Up' Securities," Wall Street Journal, 22 May 1974, p. 2.

 

12Ibid.

13"A Tax Law Easy to Understand is Urged by Experts," Detroit
News, 25 June 1975, sec. C, p. 4.

13

pe
in

In

Tepl

Creas

CHAPTER II

ATTRIBUTES OF A GOOD TAX SYSTEM
From the beginning of systematic economic thought, men have
sought to identify the attributes of a good tax system. Adam Smith,
himself a one-time tax collector, has stated four maxims applicable to
tax systems in general:

1. Taxes on individuals should be in proportion to their ability
to pay.

2. The tax each individual should pay should be certain, not
arbitrary.

3. Every tax should be levied at a time, or in the manner, in which
it is most likely to be convenient for the contributor to pay it.

4. Every tax should be so contrived as to both take out and keep
out of the pockets of the people as little as possible over and
above what it brings into the public treasury of the State.
This last principle Smith interpreted to mean that a tax should be ca-
pable of economic administration, should not obstruct the industry of the
people, should not offer undue opportunities for evasion, and should not

"unnecessary trouble, vexation, and oppression" on the public.

impose
In addition to Smith's criterion of equity, certainty, convenience, and
economy of administration, a tax system should also be simple and have a

minimum of negative economic effects.

Equity

The first principle, that taxes should be proportional, has been
replaced by the principle of progressive taxation whereby tax rates in-

crease as income increases. The principle of progressive taxation, in

14

m

as
th
to
fit
80f
dec
a P
amo]
the:
redi
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15

turn, is based on the concept of vertical equity. Stated in its simplest
form, vertical equity calls for different tax treatment for those tax—
payers in different economic circumstances, with those who have greater
income, paying an increasing proportion of that income as taxes. Since
individuals in a society receive all income generated by an economy and
ultimately bear all of the taxes, the distribution of the tax burden is
at the heart of the problem of vertical equity. Advocates of progressive
taxation make the implicit assumption that income is not equitably dis-
tributed, thus, income should be redistributed through the use of progres-
sive taxation. The question of the propriety or impropriety of the dis-
tribution of income is a political and social question which necessitates
subjective judgement and which is not amenable to objective analysis.

In general, the concept of vertical equity is couched in terms
of the phrase "ability to pay." Advocates of this concept believe that
as a person's income increases, his ability to pay taxes increases more
than proportionately. This belief is based on three propositions: (1)
to obtain equality in taxation it is necessary that all taxpayers sacri—
fice equally, (2) sacrifice in taxation is based upon satisfaction fore-
gone by the taxpayer, and (3) as income increases utility or satisfaction
decreases at the margin. Taken together, these three propositions imply
a progressive tax rate system which equalizes sacrifice at the margin
among taxpayers. Very few people, however, would carry this sacrifice
theory to its logical conclusion, that is, through the tax system a
redistribution of income would take place which would result in equal
incomes for all persons in an economy. Attempts to combine these propo-
sitions and others into a rigorous analysis have been unsuccessful,

primarily because of the difficulty in making interpersonal comparisons

of

pr:
of
cor

SCC

Sinc

in c
Sure
Stan
th081
purpg
tiCal
t10n
EValué
in the
additi

is that

16
of utility.2

In addition to the principle of vertical equity, there is the
principle of horizontal equity. This principle calls for the taxation
of those in similar economic circumstances similarly. Ironically, the
concept of horizontal equity has been used in attempts to broaden the
scope of capital gains treatment. Used in this context, taxpayers have
argued before Congress that their particular type of income is similar
to a type of income already being afforded the favorable capital gains
treatment. Therefore, in order to achieve the similar taxation of those
similarly situated, their income should also be taxed as capital gain.
This view of equity has been stated as being the "privilege of paying as
little as somebody else."3 What should be argued, of course, is that
since a dollar of capital gain is no different than a dollar of ordinary
income, special treatment of capital gains should be eliminated, not
expanded.

A point which the concepts of horizontal and vertical equity have
in common is the requirement that changes in economic position be mea-
sured. This is absolutely necessary if those in similar economic circumr
stances are to be taxed similarly for purposes of horizontal equity, and
those in different economic circumstances are to be taxed differently for
purposes of vertical equity. The inability to agree upon a sound theore-
tical method for measuring economic position and changes in economic posi-
tion has caused tax theory and practice to suffer. It is impossible to
evaluate a tax system in terms of either horizontal or vertical equity
in the absence of a normative concept of income for tax purposes. An

additional benefit that a sound theoretical income concept can provide

is that it can act as a touchstone for legislators when considering

1e

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th.

If".

su;
inc
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plu
of

neg
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VET:

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they
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than
rent]
bank

Tetir

17
legislation in the tax area. It would give legislators a guide when
considering tax legislation, and theOretical backing for refusing the
requests of special interest groups for preferential tax treatment, if

these requests conflict with the normative income concept.

A Theoretical Concept of Income for Tax Purposes

 

A theoretical income concept which has received much academic
support is the accretion concept of income. The accretion concept of
income, long associated with the names of Robert Murray Haig and Henry C.
Simons, may be defined as the algebraic sum of consumption expenditures
plus or minus the change in a person's net worth over a specified period
of time.4 Under the accretion concept, income can be either positive or
negative, and it would be recognized for tax purposes whether or not rea-
lized from an accounting standpoint. If the accretion concept of income
were accepted in it's purest form, the absence of a realization require-
ment would necessitate a periodic revaluation of assets and liabilities
in order to determine the change in a person's net worth.

The primary advantage of the accretion concept of income is that
it treats all dollars in the same manner in spite of the way in which
they were earned, saved, or spent on consumption. This consideration of
the dollar as a common denominator is in noticeable contrast to the man-
ner in which current income tax provisions treat the dollar. To illus-
trate, under current tax law a dollar of wages is treated differently
than a dollar of capital gain; a dollar spent on food is treated diffe-
rently than a dollar spent on medical services; and a dollar saved in a
bank has different tax consequences if it is a part of a self—employed
retirement plan as opposed to not being part of such a plan.

For the purpose of determining either horizontal or vertical

 

he
th

tr.

It;

Ufa

18
equity, the prime requisite is to be able to measure the relative econo—
mic position of different persons.' For this purpose a common denominator
is necessary. In it's purest form the accretion concept of income pro—
vides this common denominator by treating a person's income as the dollar
value of his consumption expenditures plus or minus the dollar value of
the change in his not worth between the beginning and the end of his
reporting period. From the standpoint of the accretion concept of income
it is vital to treat every dollar of economic enhancement the same as
every other dollar. If, as is the case with capital gains, this is not
so, the common denominator is destroyed and the principles of horizontal
and vertical equity are made meaningless. A dollar of capital gain com—
mands exactly the same amount of goods and services in the market place
as a dollar of ordinary income. Therefore, a dollar of capital gain has
an equal amount of taxpaying capacity as a dollar of ordinary income.

Two disadvantages of the accretion concept of income as a norma—
tive concept of income for tax purposes, are (1) it violates Adam Smith's
maxim of taxpayer convenience, and (2) it violates his maxim of economy
of administration. The taxpayer convenience maxim is violated by the
requirement that income be recognized annually, whether or not realiza-
tion takes place. In the absence of realization, the accretion concept
of income places a tax burden on the taxpayer at a time when he may not
have sufficient liquid assets to satisfy the tax assessment. In addition,
this same requirement violates Adam Smith's maxim of economy of adminis-
tration. By requiring recognition prior to realization, a tremendous
administrative burden is placed upon the government and the taxpayer.

It is very difficult to determine a taxpayer's liability in the absence

of an objective market transaction, and much controversy is bound to

m

10;
ta:
tic

cir

Cal

tFpe
intr
means
8519

r916m

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l9
arise. The solution to these two problems, of course, is to retain the
realization convention.. However, if the realization convention is re-
tained, it should be recognized as a departure from the theoretically
ideal concept of income, and not as a part of the income concept itself.
The administrative aspects of the realization convention are discussed
more fully below.

Tax literature abounds with statements that attempt to rationa-
lize the distinction between capital gains and ordinary income on grounds
of improved equity or more generally with statements to the effect that
equity requires that distinctions be made between sources of income, types
of deductions, categories of taxpayers, etc. This viewpoint, of course,
is redundant if each distinction drawn is assumed to be a refinement
made necessary because taxpayers are differently situated. Taken to its
logical conclusion, there would have to be a different tax law for every
taxpaying entity, because there are no two persons whose economic situa-
tions are identical. Therefore, in order to consider their different
circumstances, they would have to be taxed differently. This conclusion
results from the fact that a common denominator is not used to measure
economic circumstances for purposes of determining horizontal and verti-
cal equity.

While it is true that differentiating between sources of income,
types of deduction, or the personal situation of taxpayers creates a more
intricate measure of ability to pay and a more complex law, it is by no
means certain that this more intricate measure results in a more equit-
able law. In fact, by destroying the dollar as a common denominator, the
relative positions of taxpayers become uncertain and the concepts of

horizontal and vertical equity are rendered meaningless.

 

re
ti
ti
th
oc
ec:
the
tic

1e:

tax
rel;

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20

Administrative Convenience

 

The accretion concept of income as expressed above does not
represent a tax formula which can be precisely followed in all situa—
tions, but should be viewed as a theoretical ideal or guide with excep—
tions being made only for urgent administrative reasons. For example,
the accretion concept of income would tax the net rental value of owner
occupied homes. Because of difficulties in measurement, this type of
economic enhancement may be excluded even though it should be recognized
that the exclusion is a departure from the ideal. Another area, men-
tioned above, which may require a deviation from the ideal, is the prob-
lem of when to recognize income for tax purposes. The accretion concept
of income calls for a periodic revaluation of assets with an increase in
value included in income and a decrease in value deducted from income.

Two problems exist with respect to the recognition of income for
tax purposes before realization in the accounting sense. The first
relates to the difficulty of obtaining an asset valuation prior to the
point of a market transaction. This problem is particularly troublesome
in the case of assets which do not have a readily available market, such
as a stock investment in a closely held company as opposed to a stock
investment in a publicly traded corporation. Taxpayers, their advisors,
and the Internal Revenue Service are keenly aware of the problem of valu-
ing assets which have no immediate market because of the requirement that
assets be valued for estate and gift tax purposes in the absence of a
market transaction. A second problem, which from the standpoint of
the taxpayer is probably more important than the valuation issue, is the
question of how to pay the additional tax assessment attributable to

the appreciation in assets if the assets are not actually sold. This

 

 

pa

ti

21
difficulty relates to Adam Smith‘s third maxim applicable to tax systems
in general that "every tax should be levied at a time, or in a manner,
in which it is most likely to be convenient for the contributor to pay
it."5 In a number of instances, current tax law recognizes the diffi-
culty of paying a tax assessment when liquid assets may not be available.
For example, the estate tax may be spread out over a ten year period if
stock in a closely held corporation represents a significant portion of
the estate. In addition, tax free exchanges and the installment method
of reporting income are allowed under certain carefully defined circum—
stances. These special provisions are designed to enable the taxpayer
to satisfy his tax liability at a time when he is most likely to have the
necessary funds available. Again, however, these departures from the
ideal should not be viewed as an integral part of an income concept for
tax purposes, but as a divergence from the norm made necessary because
of administrative convenience.

If the accretion concept of income is accepted for income tax
purposes, but for administrative reasons the realization convention is
maintained, a serious tax loophole would exist which would be intensified
if a dollar of capital gain were taxed the same as a dollar of ordinary
income. To illustrate this problem, consider the taxpayer who is in a
marginal tax bracket of 70% and is holding two assets, one which has
appreciated $10,000 and the other which has depreciated $10,000. The
taxpayer can sell or hold either or both assets. If he sells the appre-
ciated asset his $10,000 gain will net him $3,000, the remainder going to
the government in settlement of his increased tax liability. If the tax-
payer sells the asset which has declined in value, he will offset a por-

tion of his other income resulting in a tax saving of $7,000. Given the

a ‘ '
"I I'll-k

 

br
5r

all

22
taxpayer's awareness of the present value of a dollar and other things
being equal, an obvious investment strategy in this case would be to
recognize all losses and to let gains accumulate. Current tax law at—
tempts to deal with this problem by limiting the deduction of capital
losses from ordinary income to $1,000 per year for individuals, and by
requiring that capital losses be deducted only from capital gains in the
case of corporations. However, let us assume for the moment that the
accretion concept of income is adopted for tax purposes, modified only
by the realization convention. If this situation were to exist, the
above investment strategy would be available to the taxpayer, and because
of the increased tax rates on capital gains, it would become more impor-
tant .

If this strategy is followed, the problem then faced by the tax-
payer is how to realize on his investment in the appreciated asset in a
manner which will minimize his taxes. Under current tax law a number of
options are available to him: (1) he can hold the asset until he is in
a lower marginal tax bracket at which time he can sell it and pay the
reduced income tax assessment, (2) he can give the asset away either di-
rectly or in trust, thus, avoiding the income tax himself, or (3) he can
hold the asset until he dies, with the asset passing to his beneficiaries
at its fair market value at the time of his death.

Under the first method of avoiding the 70% marginal tax bracket,
the taxpayer is ultimately taxed on the appreciation, even though through
judicious timing his tax payment is less because he is in a lower tax
bracket. If the taxpayer utilizes the second method of avoiding the 70%
bracket, that is, he gives the appreciated property away, he will avoid

all income taxes himself, though he may be subject to gift taxes. From

23
the standpoint of the income tax, the asset appreciation will be taxable
to the donee upon realization by the donee. Presumably though, the donee
will be in a lower tax bracket than the donor. The third method of a—
voiding the 70% tax bracket is the most appealing from a tax viewpoint.
Under this method, the asset appreciation is never subject to the income
tax, since the tax basis of the asset to the heirs is the fair market
value of the asset at the time of death. The fair market value of the
asset, however, does enter into the decedent's estate for purposes of
the estate tax.

This taxpayer's difficulty and the suggested solutions point up
a number of interesting problems. First is the so called lock-in effect.
The taxpayer faced with a potential 70% tax on the appreciation of the
asset is effectively locked into his investment. The potential $7,000
tax assessment is a transaction cost of switching investments. The lock—
in argument is used to defend preferential treatment of capital gains and
is stated thusly: a tax on capital gains interferes with an investor's
decision making process by adding a transaction cost to selling an exist-
ing investment without adding a comparable cost to holding that invest-
ment.‘ The preferential treatment of capital gains, it is argued, some-
what alleviates this problem, but given the current relatively high
ordinary income tax rates, if capital gains were taxed as ordinary income
the lockein effect would be intolerable.

The immediate cause of the lock—in effect is the tax differential
between holding an appreciated asset and selling that asset, with the
intensity of the lock—in varying in direct proportion to the size of the
differential. Since the cause of the lockrin effect is the tax diffe-

rential between holding and selling the asset, the lock-in effect would

24
evaporate if the differential would disappear. The lock-in effect,
therefore, is the consequence of not being able to tax asset appreciation
on an annual basis in the absence of realization. If it is believed
necessary, for urgent administrative reasons, to maintain the concept of
realization for tax purposes, the problem would appear to be insoluble.
However, even though the current tax differential is the immediate cause
of the lock-in effect, there are other determining factors which aggra-
vate the problem and which are perhaps even more important.

The first of these other determining factors is the progressive
tax rate structure. Not only is the current tax differential important,
but the possibility of a reduced tax differential in the future would
also tend to intensify the lock—in effect. This can be illustrated by
the first suggested solution to the taxpayer's problem: hold the asset
until the taxpayer is in a lower marginal tax bracket. If all income
were taxed at a flat rate, there would be no point in holding an asset
until a lower rate could be obtained, and thus, there would be a lessen-
ing of the lock-in effect.

Related to the first solution, that is, waiting for a future
lower rate, is the second suggested solution to the taxpayer's predica-
ment: give the asset away and avoid the income tax altogether. The
income tax cost to the donor is zero, but there is a potential gift tax
cost which must be considered. If, however, the donor and donee are
viewed as a unit, as is the usual case with gifts between relatives, the
dance must recognize the appreciation upon the sale or exchange of the
donated asset. The tax advantage, similar to the first suggested solu-
tion, lies in the fact that the donee is usually in a lower income tax

bracket than the donor. Again, this advantage would not exist if it

25
were not for the progressive tax rate structure.

Another determining factor intensifying the lock-in effect which
is also related to the problem of the tax differential is the fact that
an asset held until the death of the taxpayer takes as a basis for income
tax purposes it's fair market value at the date of death. This income
tax provision provides tremendous incentive to hold appreciated assets
as opposed to selling them, because the tax effect of holding an appre-
ciated asset is so much superior to the tax effect of selling. To illus-
trate the advantage of holding an appreciated asset until death as op-
posed to selling it, assume a taxpayer who is in a 70% income tax bracket
and a 70% estate tax bracket is holding an asset with a zero tax basis
which has a market value of $10,000. If he sells the asset before death,
income taxes of $7,000 will have to be paid leaving $3,000 which will be
added to the estate. After the estate tax is paid, $900 will be left
for the heirs. Alternatively, if the taxpayer holds the asset until
death, no income tax would be due, but an estate tax of $7,000 would have
to be paid. It is obvious that the step-up in tax basis at death is a
tremendous incentive to hold appreciated assets, and this has the effect
of intensifying the lock-in effect.

In addition to all of the above factors, there is an investment
advantage to holding an asset thus allowing it to appreciate tax free,
rather than realizing annual appreciation, paying the tax due, and then
reinvesting the proceeds net of tax. This investment advantage, of
course, is also the consequence of not being able to tax appreciation
annually because of the assumed realization requirement. The two methods
of taxing appreciation as ordinary income are illustrated in Figure 1.

Cell all is the ideal method of taxing appreciated assets according to

26
FIGURE 1

THE METHODS OF TAXING APPRECIATION AS ORDINARY INCOME

 

311

Ordinary Income
Taxed Annually

 

a21

Ordinary Income
Taxed Upon
Realization

 

 

 

the Haig-Simone accretion concept of income. It corresponds to the way

most income is taxed, such as wages, interest, dividends, rents, royal-
Cell a21

assets if there were no special treatment of capital gains and losses,

ties, profits, etc. represents the method of taxing appreciated
but because of administrative convenience the realization convention was
maintained.
TABLE 2
THE ACCUMULATION OF $1 OF INVESTMENT AT THE END OF N YEARS AT AN

ANNUAL RATE OF APPRECIATION OF 10% AND MARGINAL ORDINARY
INCOME TAX RATES OF 30, 50, AND 70%

 

 

 

 

 

Ordinary Income Ordinary Income
Taxed Annually Taxed Upon Realization
(all) (a21)
Tax 30% 50% 70% 30% 50% 70%
Years
1 1.0700 1.0500 1.0300 1.0700 1.0500 1.0300
5 1.4026 1.2763 1.1593 1.4274 1.3053 1.1832
10' 1.9672 1.6289 1.3439 2.1156 1.7969 1.4781
15 2.7590 2.0789 1.5580 3.2240 2.5886 1.9532
20 3.8697 2.6533 1.8061 5.0093 3.8638 2.7183
25 5.4274 3.3864 2.0938 7.8843 5.9174 3.9504
30 7.6123 4.3219 2.4273 12.5146 9.2247 5.9348
35 10.6766 5.5160 2.8139 19.9717 14.5512 9.1307
40 14.9745 7.0400 3.2620 31.9815 23.1297 14.2778

 

 

 

 

 

 

 

27

Table 2 represents the accumulation of an original investment of
$1 which is appreciating at an annual rate of 10%, and is taxed either
annually or upon realization at marginal ordinary income tax rates of
30, 50, and 70%. As indicated by Table 2, the investment advantage of
deferring the income tax becomes more important the longer the asset is
held. This is a consequence of the fact that the effective compounding
rate of the classification "ordinary income taxed upon realization" is
greater than the effective compounding rate of the classification "ordi—
nary income taxed annually." The relative investment advantage of hold-
ing an appreciated asset as opposed to selling the asset and reinvesting
the proceeds net of tax is shown in Table 3. As indicated by Table 3,
the relative investment advantage of deferring the income tax becomes
more important the longer an asset is held and the higher the marginal
tax bracket.

TABLE 3

THE RELATIVE INVESTMENT ADVANTAGE OF HOLDING AN APPRECIATED ASSET
AS OPPOSED TO SELLING THE ASSET AND REINVESTING THE PROCEEDS

 

 

 

 

 

 

(Ordinary Income Taxed Upon Realization -
Ordinary Income Taxed Annual1y)
Ordinary Income Taxed Annually
(321 " all/all)
Tax 30% 50% 70%
Years

1 0.0000 0.0000 0.0000
5 0.0177 0.0227 0.0206
10 0.0754 0.1031 0.0999
15 0.1685 0.2452 0.2537
20 0.2945 0.4562 0.5051
25 0.4527 0.7474 0.8867
30 0.6440 1.1344 1.4450
35 0.8706 1.6380 2.2449
40 1.1357 2.2855 3.3770

 

 

 

 

28
The investment advantage of holding v. selling an appreciated asset is
another factor which intensifies the lock—in effect, and as stated ear-
lier, the higher the tax bracket and the longer an investment is held

the more important is the deferral of tax advantage.

Definition of Realizatiop_

 

There are a number of possible methods of diminishing the inten-
sity of the lock—in effect, each of which strives toward lessening the
tax advantage of holding an appreciated asset as opposed to selling it.
The first of these methods would be to redefine realization. Under cur-
rent tax law realization takes place, in general, at the point of time of
sale or exchange. As noted above, two methods that an individual may
employ to avoid the tax on appreciated property are to avoid realization
by giving the property away, or to hold the property until death. The
latter method which a taxpayer may use to avoid the income tax is parti—
cularly important because a taxpayer's heirs receive property at a
stepped-up tax basis, which means that the income tax is avoided on all
appreciation prior to the death of the taxpayer. Investments in the
hands of the elderly taxpayer are particularly sensitive to the "lock-in"
effect, since the intensity of the lockrin varies directly with age. To
reduce the lock-in effect occasioned by a definition of realization which
excludes gifts or inheritances, realization could be redefined to include
realization at the time of gift or death. With this new definition of
realization, the appreciation of property would always be taxed to the
individual who held the property as it appreciated. The lock-in effect
would be greatly diminished if a taxpayer was certain that eventually all
appreciation would be charged to his account for the purpose of the income

tax. The only advantage to the taxpayer under these circumstances would

29
be the advantage of an "interest free" loan on the amount of the deferred
tax. The tax advantage of this interest free loan would vary directly
with the life expectancy of the taxpayer. Because at the latest the loan
would become due at the death of the taxpayer.

The primary reason for not taxing appreciation on an annual basis
is that the increased administrative and compliance burden would be the
antithesis of simplification and thus unacceptable. The additional ad-
ministrative and compliance burden resulting from a redefinition of rea-
lization to include gifts and inheritances, however, would be minimal
because asset valuations must currently be made for the purpose of gift
and estate taxation.

As mentioned above, the current tax differential is the immediate
cause of the lock-in effect. If there was constructive realization at
the time of gift or death, much of this lock—in pressure would be reduced.
However, there would still remain two factors which would contribute to
the lock-in effect. The first is the option that the taxpayer has to
time his asset sales to take advantage of possible future lower tax rates.
The root of this problem lies in the progressive tax rate structure of
the federal income tax, and the inability to tax appreciation on an annual
basis. If because of vertical equity, a progressive tax rate structure is
desirable, and if for administrative reasons the annual taxation of appre-
ciation is not possible, the problem would appear to be insoluble. How-
ever, the taxpayer with widely fluctuating tax rates is probably the
exception rather than the rule, particularly in light of the fairly libe-
ral income averaging provisions of the current law. Therefore, for the
vast majority of taxpayers there is not a great deal of advantage to

manipulating realization to take advantage of fluctuating tax rates.

30

A second factor which must be considered when appraising the
lock-in effect is the tax deferral advantage attributable to the inabi—
lity to tax asset appreciation as it occurs in the absence of realiza—
tion. As Table 3 indicates, this is a real tax advantage which increases
the longer an asset is held, and/or the higher is an individual's tax
bracket. This tax advantage could be neutralized if upon realization
the taxpayer was subject to an interest charge to compensate the govern-
ment for taxes which were deferred in the past. Correspondingly, if
consistency is to be maintained, the government should rebate to the
taxpayer interest on deferred losses which were not realized in the past.
This suggestion, of course, would add a certain amount of complexity to
the tax law, which may or may not be worth the trouble, depending upon
one's view of the importance of the contribution of the deferral advan—
tage to the lock—in problem. If it was decided that an interest charge
should be made, certain simplifying assumptions would be necessary in
order to implement the charge. A basic assumption which would probably
have to be made would be the manner in which appreciation took place
over time; a straight line assumption being the simplest.

If capital gains were taxed as ordinary income, the lock-in
effect would be intensified because of the increased current tax diffe-
rential between selling and holding an appreciated asset. The two propo-
sals suggested to alleviate this lock-in effect are: (l) redefine reali-
zation to include gift and death, and (2) charge taxpayers interest on
tax deferral. Of the two, the first is critical, particularly realization
at the time of death. In the opinion of the author, the second proposal
is much less important. The reason for this is that the older taxpayer

is more likely to hold appreciated assets, and as stated above, the

31
intensity of the lock—in effect attributable to the step—up in tax basis
at death varies directly with the age of the taxpayer, and the intensity
of the lock—in effect attributable to the deferral advantage Varies
inversely with age. However, if the lock-in effect is still considered
to be serious even with constructive realization at the time of gift or
death, the second proposal is available.

It is interesting to note that some writers in the field of pub-
lic finance believe that the strength of the lock-in effect is greatly
overemphasized.6 They base their argument on the fact that most invest-
ments can be used as collateral for the raising of capital and thus funds
are not locked into a particular investment. In addition, the purchase
of an outstanding security is not an investment from the social point of
view, it is merely a switching of investments by investors with total
investment remaining the same. A distinction must be made between the
purchase of a capital good which from a social viewpoint is true invest-
ment, and the purchase of an outstanding security which is merely a port-
folio change.

One difficulty which must be considered if capital gains were to
be taxed as ordinary income in conjunction with constructive realization
at death, is the potential liquidity problem of estates containing the
bulk of their assets in closely held corporations or other family type
businesses. Upon death, an income tax would accrue on the unrealized
appreciation of assets being held in addition to the estate tax which
would also be due. For closely held business organizations sufficient
cash may be unavailable to settle these liabilities, thus forcing a sale
of all or part of the business with the resultant loss of family control

of the business. Current estate tax law recognizes the liquidity

32

problems of certain estates by allowing these estates to pay the tax due
over an extended period of time. In addition, closely held corporations
can distribute cash without the distribution being considered essentially
equivalent to a dividend, if the cash is used for the purpose of paying
the estate tax. These provisions are intended to alleviate the liquidity
problem of certain estates and these types of relief provisions could be
extended if necessary to assure the availability of cash to settle income
and estate taxes. While it is probably true that the most important
economic consequence of taxing capital gains as ordinary income, coupled
with maintaining the realization convention for purposes of administra-
tive convenience, is the lock-in phenomenon, other economic effects must

also be considered.

Economic Effects

 

If there were no special treatment of capital gains and losses,
would there be adverse economic effects that would offset the improve-
ments in equity, certainty, and simplicity? This is the question that
must be considered. Some of the general economic considerations have
already been reviewed (the lock—in effect and the need for a clear and
comprehensive concept of income), and others will be examined in the
sections of this chapter concerning arguments for and against the full
taxation of capital gains. In addition to the lock—in effect, a second
major objection from an economic point of view against the full taxation
of capital gains is that it would reduce the amount of risk capital avail-
able. The effect on saving and investment of full taxation of capital
gains has two aspects, (1) the effect on the total amount of savings,
and (2) the effect on the allocation of funds.

Taxes which impinge heavily upon savings slow the rate at which

33
capital is accumulated. However, society's present stock of capital will
not be reduced or depleted unless savings are reduced to the point at
which in total they are not sufficient to replace the existing stock of
capital assets. There can be little doubt that the burden of a full
taxation of capital gains would fall partially upon savings. The same
is true, however, of the burden of the full taxation of wages, interest,
dividends and other forms of income. Assuming that the encouragement of
savings is an appropriate economic goal of government, whether the prefe-
rential taxation of capital gains is a desirable means of attaining that
goal is open to question. It should be pointed out, however, that this
incentive is not available to all taxpayers, nor is it even available to
the same extent to all taxpayers with the same economic income. It is
an inequitable incentive in that it is available only to a small propor-
tion of the population. It is unjust not to allow the incentive to in-
vest to the wage earner, the person with business income, or the profes-
sional person while the person with capital gains is allowed a generous
incentive. If an incentive to save is to exist, for equity reasons it
should be broadly based and available to as many persons as possible,
rather than the few.

The second aspect of the effect on savings and investment, con-
cerns the assertion that a full taxation of capital gains would diminish
the attractiveness of risky ventures by reducing the after tax return of
these investments. While this assertion is probably valid, the same
argument is probably true of a tax on any source of income. A particular
venture is always less attractive if a tax is imposed than it would be
if there were no tax imposed. However, there are a number of counter

balancing factors which must be considered. First is the effect of the

34

tax treatment of losses. If there were full deductibility of capital
losses, the potential net loss on a risky venture would be reduced.
While it is true that investors do not invest with the idea that losses
will be incurred, it is also true that the possibility of loss does exist,
particularly in the case of a risky investment. In addition to the full
deductibility of capital losses, taxpayers have control of the moment to
recognize gains and losses for tax purposes, and this itself is an in-
vestment advantage. If the accounting concept of realization is to be
maintained (see the earlier discussion of administrative convenience),
the investor can get a current tax deduction for realized losses, yet
defer gains indefinitely. Another factor to consider is that investors
contemplate what they consider to be a satisfactory after tax rate of
return. If the tax rate increases, the before tax rate of return would
have to increase in order to maintain a constant after tax rate of return.
Since this is true, it would indicate that the full taxation of capital
gains would result in a bias in favor of the riskier investment which
promises a greater return, as opposed to an investment bias against this
type of investment. As pointed out above, there are many tax factors to
consider which may have opposite effects on different investors in their
choice of investment alternatives. Thus, the whole question of the effect
of tax factors on investment decisions is open to dispute.

In addition to tax factors, there are non-tax factors which play
a major role in an individual's investment decisions. In a comprehensive
attempt to assess the importance of tax and non—tax factors on the invest-
ment decisions of investors, Butters, Thompson, and Bollinger (after
interviewing a carefully selected sample of over 700 investors) stated:

Income-minded and security-minded investors . . ., in deciding
on an investment policy, tend to balance the current income yield

35

of their investments against the risk of capital loss, and to give
very little weight in their investment decisions to the possibility
of capital gains usually present in investments whiCh also present
high risks of capital loss. The high rates of the individual
income tax exert by far the most important tax influence on the
investment decisions of these groups of individuals, and their
predominant effect is to drive these individuals into lower yield,
less risky investments than they would otherwise make.7

and that:
The tax effects on investors interested mainly in capital appre-
ciation are quite different from those just summarized for the
income minded and security minded investors. Our field surveys
point overwhelmingly to the conclusion that, for appreciation-
minded investors, the single most important feature of the tax
structure is the differentially low rate at which long-term
capital gains are taxed in comparison with the much higher rates
on ordinary income, especially for incomes in the upper income tax
brackets. This differential has stimulated inherently venturesome
individuals to seek out investments which offered prospects of
capital gains rather than the receipt of ordinary income. . . .
Similarly, the absolute level of the capital gains rate and the
length of the six—month holding period were cited as investment
deferrents only in a very small number of instances.8
Thus, income minded investors "give very little weight in their invest-
ment decisions to the possibility of capital gains" and for investors
interested mainly in capital appreciation, it was the existence of a
differential rate of tax and not the absolute level of the tax which was
the most important factor. Non-tax factors that affect an individual's
investment decisions which were emphasized by the authors include the
personal circumstances of the individual, and his expectations of infla-
tion, general business conditions, etc.

In addition to the economic issues regarding the lock-in effect
and the effect on saving and investment, arguments both pro and con
concerning the appropriate taxation of capital gains and losses abound.
walter J. Blum, Professor of Law at the University of Chicago, has listed

twenty-five arguments "for" and eight arguments "against" special treat—

ment of capital gains and losses.9 As Professor Blum has pointed out,

36
many of the arguments for special treatment of capital gains and losses
are either irrelevant or redundant. A few of these arguments, however,
form the cornerstone for the divergent positions and thus merit discus-

sion.

Arguments For Special Treatment of Capital Gains and Losses

 

At the crux of the controversy of whether or not to afford spe-
cial treatment to capital gains and losses lies the question of whether
capital gains are, or are not income. If capital gains are not income,
they should not come under the income tax provisions of the law. Con—
versely, if capital gains are income, they should be subject to the
federal income tax. Henry C. Wellich, Professor of Economics at Yale
University and Assistant Secretary of the Treasury, 1958-1959, contends
that capital gains are not income.10 He bases his conclusions on national
income accounting concepts whereby capital gains represent the capitali-
zation of improved growth prospects. He contends that if this future
capitalized income is recognized in the present and then a second time
when this income eventually materializes, it will appear in the national
income accounts twice, and would therefore be double counting.11 The
realization concept of accounting is a crucial part of this argument.

It is contended that unrealized gains are taxed first as increases in
capital, when in fact they represent an expected increase in future cash
flows, and since these future flows will be taxed at normal tax rates
upon realization, the result is double taxation. However, under the
proposed full taxation of capital gains, there would be no taxation of
unrealized appreciation. A capital gain would be taxed as an improvement
in the economic position of a taxpayer only upon realization, and the

increased flow would be taxed at a later time to a second taxpayer as the

37
flow is realized. Both the increased capital and the increased flow
represent economic enhancement and thus taxpaying capacity. If there
were appropriate provisions to allow for capital recovery, there would
be no double counting.

Another aspect of this argument against treating capital gains
as income, relates to trust and property law. The point is made that an
asset held in trust can be divided into corpus and income interests.
Generally, a capital gain inures to the benefit of the corpus interest
unless specifically indicated otherwise by the originator of the trust.
Thus in the typical case where property is divided into a life estate
and a remainder interest, unless otherwise specified by the originator,
appreciation will inure as accretion to the remainder interest, and not
be available to the income interest.12 This argument is developed quite
extensively by Seltzer who points out that this concept of income is
based primarily on the nature of an agricultural economy.13 It is a
carryover from that period in England where an asset was a physical thing,
such as a piece of land, and the land was kept in a particular family by
passing to succeeding generations only the income interest and not the
corpus interest. Today intangible forms of wealth predominate in our
society and the distinction between the asset and the income from the
asset has been blurred.

Both aspects of this argument merely cloud the issue of whether
or not capital gains and losses should be afforded special treatment.
The critical question is still whether or not for income tax purposes we
should provide special treatment for capital gains and losses. The fact
that economists do not consider capital gains to be income for purposes

of national income accounting or that they are not considered as income

38

for purposes of property law is irrelevant. As Seltzer has pointed out:
Although different concepts of income may well be Valid for other
purposes, the proper measure of income for tax purposes is to be
found in the actual ex post results of economic activity, not in
subjective expectations or presumptions. Taxable income, it is
urged, should measure the relative capacity of individuals to pay
taxes, as indicated by the net annual additions to their wealth
from economic activity plus their consumption. Capital gains
supply an individual with the same additions as any other kind of
personal income to his power to buy consumption goods or invest-
ments. . . .14

The existing controversy as to whether capital gains should be subject to

the income tax would be settled if the accretion concept of income was

accepted for tax purposes. Under this concept, no distinction is made

with regard to the source of economic enhancement, all accretions to

economic power being subject to the income tax.

A second argument against taxing capital gains in full is that
the revenues obtained would be less than the costs of administering the
tax.15 While no estimates of dollar costs of administration are available,
much of the cost of administration is undoubtedly due to the distinction
between capital gains and losses and ordinary gains and losses. The
present special treatment of capital gains and losses creates major
definitional problems which would not exist in the absence of the dis-
tinction between capital and ordinary gains and losses. The greater the
tax advantage of capital gain over ordinary income, the greater the pres-
sure by taxpayers and their advisors to utilize the capital gains provi-
sions. In fact, one of the purposes of the 50 percent maximum tax on
earned income was to induce taxpayers to concentrate more on earning
income and less on employing tax gimmicks to shelter income from high
marginal tax rates.16 As will be discussed in greater detail in

Chapter III, the root causes of complexity in the federal income tax law

are the distinctions which are drawn between taxpayers, sources of income,

39

taxable years, types of expenditures, etc. If there were no special
treatment of capital gains and losses, one major distinction would be
neutralized, with a resulting decrease in complexity. A less complex tax
law would certainly be no more costly to administer than a more complex
tax law.

A third argument against the full taxation of capital gains is
that they are fictitious in that they merely reflect inflated asset
prices.17 In an economy such as our own, with an obvious built in infla-
tionary bias, this argument would appear to have some merit. A decline
in the purchasing power of money will generally be accompanied by a rise
in asset values, since the supply of such assets remains constant, while
the supply of dollars is increasing.

Looking from the other side, however, not all capital gains are
the result of inflation. Some may reflect increased retained earnings,
while others may reflect an increased future stream of income or a change
in the capitalization rate of a given future income stream. There have
been many proposals made to counter the effects of inflation on taxation.
One of the more recent proposals considered by Congress was the Corman
Bill, which would have provided for monthly inflationary adjustments at
an annual rate of 4 percent.18 This bill would have benefited the holders
of capital assets, but it would have been discriminatory against dividends
and interest-bearing securities that did not enjoy the exemption. It is
a well known fact that most taxpayers are affected by inflation, from the
wage earner who finds himself in a higher tax bracket when his wages keep
pace with inflation but his real income before taxes remains constant, to
the investor in fixed income securities who obtains a higher before tax

yield to compensate for anticipated increases in the general price level.

40
To ignore these individuals who are affected by inflation, while provid-
ing relief to the capital asset holder would be unjust. However, to tax
everyone on a constant dollar basis would be difficult if not impossible.
Finally, the government needs a specified number of dollars to operate.
Given the budgetary position, either a deficit or surplus position, a
specified number of dollars must be raised through the income tax. If
the tax base is reduced in order to account for inflation, it is axiomatic
that the average tax rate would have to be increased to compensate for
the reduced tax rate. Thus, the net effect on all taxpayers taken toge-
ther will be zero. This is not to say that the tax burden of each indi-
vidual would be the same after allowing for inflation as before. However,
since most individuals are aware of the problem of inflation it is prob-
able that they implicitly adjust for it in making economic decisions.

A fourth argument against the full taxation of capital gains is
that it would be unfair to tax gains which have accrued over a number of
years in the year of realization at high progressive tax rates. The
"bunching" argument was probably the original rationalization for prefe-
rential treatment of capital gains. There are two aspects of this problem,
both relating to the issue of realization, which have opposite effects.
The first concerns the taxpayer who holds an appreciating asset for a
number of years while he is in a constant relatively low marginal tax
bracket. If he sells the asset, it is possible that he would be pushed
to a much higher tax bracket, thus paying more taxes than he would have
paid if he had been taxed annually on the appreciation. Current tax law
contains provisions for income averaging which allows the taxpayer to pay
tax at the rate of five times the marginal tax on one—fifth of the

"averageable income." Possibly a better method of income averaging was

41
suggested by Emory who said: "perhaps [the bunching problem can be] best
solved by an averaging approach allowing the taxpayer to average the gain

over the number of years the asset is held."19

The primary advantage of
this type of averaging system is that it would provide a greater benefit
to those taxpayers holding assets for relatively long periods of time,
and less benefit to taxpayers holding assets for lesser periods of time.
This method of averaging would automatically grant the greatest tax
benefit to the long-term investor, and the least tax benefit to the
short—term speculator, without having to delve into the motives of the
various taxpayers.

The second aspect of the bunching problem deals with what one
writer has referred to as the "overlooked preference."20 This overlooked
preference refers to the tax deferral benefit available to the taxpayer
who holds an appreciating asset for a number of years without realization.
Even if capital gain were taxed as ordinary income at progressive tax

rates the taxpayer has still enjoyed the tax deferral benefit available

to most types of income. In the Report of the Royal Commission on

 

Taxation, the point was made that in principle the Commission felt that
appreciation of assets should be brought into income annually.21 The
Commission backed off from this position for practical reasons, yet not
in principle. Tax liability deferral has two effects on the taxpayer,
(1) it results in a "bunching" problem in that appreciation which has
accrued over the holding period of the asset is taxed in the year of rea-
lization, and (2) by not being taxed annually on the appreciation, the
taxpayer obtains the advantage of an "interest free" loan on the deferred

tax. For the taxpayer, the first effect is undesirable and the second

effect is desirable. Whether or not the taxpayer is at an overall

42
advantage or disadvantage, depends upon his marginal tax bracket during
the holding period of the asset and the rate of appreciation of the
asset. Perhaps a rough justice would be served by not allowing taxpayers
to income average capital gains, in order to offset the investment advan—

tage gained through tax deferral.

 

Arguments Against Special Treatment of Capital Gains and Losses

Perhaps the decisive argument against special treatment of capi-
tal gains and losses rests with Professor Blum's comment that "a dollar
is a dollar."22 One dollar, irrespective the source, commands the same
amount of purchasing power in the market place or can be saved in the
same manner as any other dollar. To distinguish dollars on the basis of
source is to undermine the common unit of measure, and to make meaning-
less any comparisons of relative economic position. In order to deve10p
an equitable tax system, a common unit of measure is a necessity, and
the dollar should be that common denominator.

A second argument against special treatment of capital gains and
losses is that a full taxation of gains would provide much needed addi—
tional revenue, or alternatively allow tax rates to be reduced. Robert
Eisner, Professor of Economics at Northwestern University, has stated:
"[The] exclusion of half of "realized" capital gains from adjusted gross
income and exclusion of all of capital gains in estates or in gifts
amounts to some ten to twelve billion dollars per year in lost revenues
to the United States Treasury."23 This amount is equal to approximately
10% of the tax revenues from the individual income tax. If there were no
special treatment of capital gains and losses, a substantial reduction in
the ordinary income tax brackets could be effected with no loss of reve-

nue. This would have the effect of further softening the impact of a

43
taxation of capital gains.
A third argument against preferential treatment of capital gains
and losses is that the distinction is a major source of tax law comple—
xity. In fact some writers in the area of federal income taxation have
stated that the separation of ordinary income from capital gain for tax
purposes "adds more complexity to our tax laws than any other single
notion."24 And concerning the cost of compliance another writer has
stated:
The cost of compliance is significantly greater under the capital
gains tax system, since the taxpayer may buy additional after-tax
income by purchasing legal and accounting services in order to
minimize taxes. While the additional costs may not be large rela-
tive to the gross national product, they do represent the time and
effort of able managerial and professional talent that could other-
wise be used to enhance the productivity of the economy.

The questions that must be answered by the Internal Revenue Service and

taxpayer alike include:

a. What should be included in the class of eligible transactions?

b. What should be the holding period criteria?

c. How should the value of gains and losses be defined?

d. When should taxes be paid?

e. What rate should be paid on capital losses?

f. At what rate should capital losses benefit the taxpayer?
These and other questions must be answered by reference to the various
sources of tax law which include the Internal Revenue Code, the various
Congressional committee reports, the Code of Federal Regulations, the
published Revenue Rulings of the Internal Revenue Service, and the
results of court cases dealing with federal income tax matters.

The provisions in the Code specifically related to capital gains

and losses are contained in Subchapter P sections 1201-1253. In terms of

44

volume these sections represent a relatively minor part of the law con-
cerning the federal income tax which is contained in sections 1-1399 of
the Code. The specific capital gain and loss Code provisions, however,
only scratch the surface of their actual impact on the law. Much of the
law is concerned with closing "loopholes" created by capital gains and
losses, that is, restricting the benefits of capital gains or applying
the penalties of capital losses, or extending the benefits to another
class of property or type of transaction. Economist Carl Shoup has esti-
mated that over half the verbiage in the Internal Revenue Code relates
in one way or another to the special treatment of capital gains and
losses.26

The New York Bar Association's Committee on Tax policy issued a
report on complexity in the federal income tax law which contained a
strongly worded statement about one consequence of complicated tax laws.
The committee stated: "This committee is unanimously of the view that
the present course of development of the tax law, if not reversed may
well result in a breakdown of the self assessment system. Indeed some
members believe that the breakdown has to some extent already occurred."2'7
This consequence relates to the whole problem of taxpayer morale. The
Tax Reform Act of 1969 was in large part a result of published statistics
showing that a surprising number of taxpayers with large incomes paid
little or no tax. While the capital gains preference is not the only
reason for these statistics, it certainly plays a substantial part. As
implied earlier, taxpayer cooperation is at the heart of a tax system,
particularly a self assessment system. In turn taxpayer cooperation
depends upon his faith in the fairness of the system.

In summary, the preferential treatment of capital gains and losses

45
makes it impossible to determine the fairness of our tax system in terms
of either horizontal or vertical equity. Both of these concepts require
a measurement of economic position, which in turn necessitates the accep-
tance of a normative concept of income for tax purposes. The accretion
concept of income, which does not distinguish among sources of accretion
to economic power, provides a useful concept of income for tax purposes.
In it's purest form this concept of income requires a periodic valuation
of assets, which would probably not be feasible for administrative rea-
sons. In order to ease the burden of administration, the realization
convention would have to remain. However, if the realization convention
was maintained, there would be an intolerable lock—in effect. The inten-
sity of the lock-in effect would be substantially reduced if realization
was redefined to include the point of time of a gift or the death of the
taxpayer. Not only would there be an improvement in the equity of the
tax system, but there would also be a less complex tax system, because a
major distinction in the tax law would be neutralized. An analysis of
the causes of complexity in the tax law is undertaken in Chapter III,
and the effect of the capital gain and loss distinction on the scope and

complexity of the tax law is examined in Chapter IV.

FOOTNOTES CHAPTER II

1Adam Smith, The Wealth of Nations, ed., Edwin Cannon (New York:
The Modern Library), book V, chapter II, part II, pp. 777—778.

2For an analysis of sacrifice theories of taxation, see:
Richard A. Musgrave, The Theory of Public Finance (New York: McGraw-Hill
Book Company, Inc., 1959), chapter 5.

3Louis Eisenstein, The Ideologies of Taxation (New York:
The Ronald Press Company, 1961), p. 176.

 

"See: Robert Murray Haig, "The Concept of Income: Economic and
Legal Aspects," in The Federal Income Tax, ed. R. M. Haig (New York:
Columbia university Press, 1921), chap. 1. Also see: Henry Simons,
Personal IncOme Taxation (Chicago: The University of Chicago Press, 1938).

 

 

5Smith, The Wealth of Nations, book V, chapter II, part II,

 

p. 778.

6Raymond L. Richmond, "Reconsideration of the Capital Gains Tax—-
A Comment," National Tax Journal 14 (1961): 403.

 

7J. K. Butters, L. E. Thompson, and L. L. Bolinger, Effects of
Taxation on Investments by Individuals (Harvard University Press, 1955),
p. 36.

 

 

81bid., pp. 41-42.

9Walter J. Blum, "A Handy Summary of the Capital Gains Arguments,'
Taxes--The Tax Magazine 35 (1957) : 247-266.

 

10Henry C. Wallich, "Taxation of Capital Gains in the Light of
Recent Economic Developments," National Tax Journal 18 (1965): 139-140.

llIbid.

12Blum, "A Handy Summary of the Capital Gains Arguments," p. 248.

13Seltzer, The Nature and Taqureatment of Capital Gains and
Losses, p. 25.

1“:b1d., p. 285.

15Blum, "A Handy Summary of the Capital Gains Arguments," p. 252.

46

47

16Internal Revenue Code of 1954, sec. 1348.

 

17Blum, "A Handy Summary of the Capital Gains Arguments," p. 255.

1"Meade Emory, "The Corman-and MillseMansfield Bills: A Look at
Some Major Tax Reform Issues," Tax Law Review 29 (1973): 96.

 

19Ib1d., p. 95.

20Richard Armstrong, "The Right Kind of Tax Reform," Fortune,
December 1972, p. 180.

21Report of the Royal Commission on Taxation (Canada), in Readings
in Federal Taxation, eds. Frank E. A. Sander and David Westfall (Mineola,

 

New York: The Foundation Press, Inc., 1970), p. 89.

22Blum, "A Handy Summary of the Capital Gains Arguments," p. 265.

23Robert Eisner, "Tax Incentives for Investment," National Tax
Journal 26 (1973) : 397.

24
p. 180.

Sommerfeld, Anderson, and Brock, An Introduction to Taxation,

25Martin David, Alternative Approaches to Capital Gains Taxation
(Washington: Brookings Institution, 1968), p. 4.

26Armstrong, "The Right Kind of Tax Reform," p. 180.

27Martin D. Ginsburg, "Tax Simplification—~A Practitioner's View,"
National Tax Journal 26 (1973): 317.

CHAPTER III

COMPLEXITY IN THE FEDERAL INCOME TAX

Definition of Complexity

 

'The word complexity connotes a difficulty of understanding.
webster's Third New International Dictionary defines complexity as any-
thing which is "marked by an involvement of many parts, aspects, details,
notions, and necessitating earnest study and examination to understand
or cope with."1 Complexity within the context of the federal income tax
means different things to different people, but in general, it refers to
the complex technical structure of the federal income tax. This complex
technical structure in turn refers to the complex substantive tax rules
with their complex interrelationships all of which is stated in complex
statutory terminology.

The search for simplicity in the federal income tax is practi-
cally as old as the modern day income tax. In discussing the income tax
Act of 1913, Mr. Justice McKenna referred to the Act as one "which con-
cerns the activities of men and intended, it might be supposed, to be
without perplexities and readily solvable by the off-hand conceptions of
those to whom it was addressed."2 In referring to the 1918 Act, Treasury
expert Dr. T. S. Adams said:

There is an imperative need for immediate simplification in the
systems of internal revenue taxes. The unvarnished truth is

that the income and profits taxes are so heavy and so intricate
that a sufficient number of auditors and experts cannot be secured

by the government to audit assess, and settle old claims as fast
as new claims are created.§

48

49

This statement was made at a time when our revenue laws consisted of

106 pages. And as recently as June 24, 1975 in a panel discussion before
the House Ways and Means Committee, former Treasury official John S. Nolan
strongly recommended "simplification before misunderstandings caused by
complexity in the law causes the public to lose confidence in the excel-
lent tax system."4

To the taxpayer, complexity can mean a difficulty in determining
his tax liability because of an inability to understand the tax forms or
his obligations under our voluntary self—assessment tax system. In addi-
tion, it can mean the possibility of an undesirable tax consequence be-
cause of the structuring of a transaction in a particular manner instead
of in some other manner. This, of course, is the result of the complex
variation in tax treatment of transactions that are often not materially
different in form or substance. To other taxpayers, complexity can mere—
ly mean the existence of complex arithmetic computations or the volume of
record keeping which is required.

To the tax practitioner, complexity relates primarily to the
regulations, rulings, and to some extent the statute itself. Their judge-
ment of complexity relates to their difficulty in understanding the
regulations, rulings, and statutes, and in making the determinations
and computations required by them. Much the same standards for judging
complexity are used by those charged with the responsibility of adminis-

tering the tax law, the Internal Revenue Service.

Sources of Complexity

 

The sources of complexity in federal income tax law can be divided

into three categories: (1) complexity arising from a vast and intricate

50
economic system itself, (2) complexity arising from the revenue raising
function of any income tax, and (3) complexity arising outside of the
revenue raising function of an income tax. Of these three sources, there
is little hope for a lessening of complexity in the first two categories
without a radical change in the economic system, or a reduction in the
dependence on the income tax as the prime revenue source of the federal
government. The hope for a lessening of complexity, therefore, lies in
the third category.

With respect to the first category, the fact that the income tax
at the federal level carries such a tremendous burden is one basic reason
for its complexity. The income tax for the fiscal year 1974 accounted
for over 68% of all receipts at the federal level out of total receipts
of over $237 billion.5 In addition, the income tax is a mass tax--a
requirement of the tremendous load it must bear. With its relatively
low exemptions, the population coverage is great. The tax system of the
United States, with an economy generating an annual GNP close to $1.5
trillion, together with the many types of businesses and ways people have
of earning money and arranging their financial affairs is bound to create
much complexity merely from its scope alone. Thus, the scope of a tax
system which is required to measure net income annually for millions of
taxpaying entities, earning income in a multitude of different ways, is
bound to result in a tax system with a great deal of complexity.

Regarding the second category, there is a great deal of complexity
which is inherent in the revenue raising function of any income tax, and
thus, is unavoidable. For example, not only must net income be measured
for millions of taxpaying entities, but it must be measured annually.

This results in two problems. First, the year is not usually the ideal

51
time period for measuring income. Much complexity is the result of cut-
ting off the tax period at the end of a calendar or fiscal year. Basic
difficulties exist because of this artificial cutaoff, such as, the deter-
mination of the proper period in which to recognize an item of income or
deduction for tax purposes. This issue encompasses all of the difficult
problems the accountant faces in making the appropriate revenue and ex-
pense accruals, and in general, involves all of the problems of properly
matching expenses with revenues. Since the taxpayer and the government
are well aware of the present value of a tax dollar to be paid in the
future compared with the present value of a tax dollar to be paid cur-
rently, it is inevitable that the taxpayer and the government would have
many disagreements on audit regarding the timing of income and deductions.
A second problem resulting from the necessity for an annual measurement
of taxable income is the rather obvious fact that measurements must be
made repeatedly, once a year. If, for example, returns were required
every 10th year instead of on an annual basis, as a minimum, many of the
difficult decisions involved in income determination would have to be
made only one-tenth as often. In addition, other difficult determinations
would not have to be made at all. From the standpoint of the government,
fewer returns would permit a closer scrutiny with the concommitant bene-
fit of better enforcement. This, of course, is not to advocate that
returns be filed only once every 10 years. For many valid reasons the
annual filing of a return and settlement of the income tax assessment is
necessary. Also, the annual filing requirement promotes simplicity in
many ways, since it is much.easier to collect data necessary for the
preparation of the return if it is only one year old as opposed to 10

years old.

52

Another source of complexity inherent in the revenue raising
function of any income tax is that it is based on the net income of
particular taxpaying units which must be precisely defined. ‘With regard
to net income, it is necessary to determine not only how much is to be
taxed but to whom it is to be taxed. To illustrate, since corporations
are taxed differently than trusts, which are taxed differently than part-
nerships, which are taxed differently than individuals, a precise articu—
lation of the definition of each is necessary. Even within the definition
of a corporation, life insurance companies are taxed differently than
mutual funds, which are taxed differently than utilities, which are taxed
differently than the ordinary corporation. Individuals are also not taxed
alike. A husband and wife are treated as one taxpaying unit, but the
children of the family are not included in the taxpaying unit. In addi-
tion, there are several classes of "single" individuals——the single per—
son, the single person who is head of a household, the surviving spouse
who maintains a household, and others. This is not an exhaustive list
of taxpaying entities, but it does serve to point up the fact that if we
are going to tax different taxpaying units differently it is necessary to
precisely define these units and to determine the income to be allocated
to each if more than one has come into contact with the income.

Another important source of complexity results from the fact that
the income tax is applied at significantly progressive rates.6 The pro-
gressive attribute of the federal income tax is the root cause of the
complexity, mentioned above, resulting from the need to precisely define
each of a multitude of taxpaying entities. If income was taxed at a flat
rate, which was the same for all taxpaying entities, there would be no

need to distinguish between a married person and a single person, or

53
between a single person who is a "head of the household" and one who is
not, or between a single person who is a "surviving spouse" and a
married person who is an "abandoned spouse." In addition, problems
associated with the question of who earned the income would be solved.
For example, families would derive no tax benefit from shifting income
among themselves, thus attempts to assign income from one family member
who is in a relatively high bracket to another who is in a lower bracket
and the whole complex tax pattern of family trusts would be eliminated.

If income was taxed at a flat rate, complexities resulting from
attempts by taxpayers to shift income from high tax bracket years to low
tax bracket years would also be eliminated. A stable pattern of taxable
income would not be of critical importance, thus, a taxpayer would not
feel compelled to artificially create this pattern. In addition, the
income averaging provisions, which are designed to benefit those with
rapidly rising incomes, would be unnecessary. Therefore, without a
progressive income tax rate schedule, taxpayers would have no tax motive
for trying to shift income between taxpaying entities or for trying to
recognize income for tax purposes in a low bracket as opposed to a high
bracket year to avoid high tax rates.

Another problem resulting from the progressive income tax, aggra-
vated when rates are high, is the need to give hardship relief in special
cases.7 Once the political decision is made concerning which taxpayer or
group of taxpayers is to benefit from a particular relief provision, in
order to prevent undue tax avoidance, the statute must be precisely
drafted with a view toward benefiting those who are deemed deserving and
excluding those who are not so deemed. Since it is the nature of tax-

payers and their advisors to minimize their taxes, relief provisions

54

must be precise instruments which prevent avoidance but do not injure
innocent taxpayers. As Randolph Paul has said, "It is not enough to
attain a degree of precision which a person reading in good faith can
understand; it is necessary to attain a degree of precision which a per—
son reading in bad faith cannot misunderstand."8

An illustration of this source of complexity is the historical
development of section 341 of the Internal Revenue Code. This section of
the Code was originally designed to prevent the conversion by taxpayers
of what would be ordinary income into capital gain through the use of a
"collapsible corporation." As originally enacted in 1950 as section
117(m) of the Internal Revenue Code of 1939, a collapsible corporation
was defined as one which was "formed or availed of principally for the
manufacture, construction or production of property." When the 1954 Code
was enacted, it was decided that section 117(m) was not strong enough
so further restrictions were added to the collapsible corporation rules
to increase their effectiveness. Thus section 341 of the 1954 Code came
into existence. It was soon obvious that section 341 was too broad, so
to provide relief in certain circumstances, section 341(e) was added to
the 1954 Code. Section 341(e) provides numerous exceptions to the appli-
cation of section 341 if certain complex tests are met. It is approxi-
mately four and one half pages long containing one sentence which is
almost a page long. The entire subsection (e) is virtually unintelligible.
In 1964 more relief was provided through the enactment of section 341(f),
which further complicated section 341.

Another source of complexity related to the revenue raising

function of any income tax is the fact that the tax is a net income tax.

There are two basic elements in the measurement of net income, the first

55

being gross income and the secOnd being deductions. In the United States
the application of the first element is quite broad—-"a11 income from
whatever source derived."9 Thus, certain complexities result from the
determination of what to include in gross income. The second complicat-
ing element is the determination of what is to be allowed as a reduction
of gross income in determining net income. In the United States, for
individuals, the process is further complicated by the distinction bet-
ween deductions allowable from gross income, which are primarily of a
business nature, resulting in an intermediate computation of adjusted
gross income, and deductions allowable from adjusted gross income, which
are primarily of a non-business nature, to determine taxable income.
Much controversy between taxpayer and government results from questions
of whether or not an expenditure is deductible in determining taxable
income, and then if deductible, whether from gross income or adjusted
gross income. The problem is further aggravated when a taxpayer has
expenditures which are part business and part personal in nature. In
this situation, somewhat arbitrary allocations must often be made which
inevitably lead to conflict between the taxpayer and the tax collector.
This allocation problem is an unavoidable source of complexity.

Concerning the deductions allowable from gross income, only those
deductions which are of a business nature are a necessary element in the
concept of a net income tax. All of the deductions which are allowed,
but are not of a business nature, are sources of complexity not essential
to the revenue raising function of a net income tax. It is this area
that holds the greatest possibilities for simplification. Through tax
benefits in the form of special deductions, exclusions, deferrals, exemp-

tions, credits, and methods of computing the income tax, Congress

56
provides financial assistance to a variety of business and social acti-
vities. For the most part, these tax expenditures are designed to stimu-
late or assist action whiCh Congress deems appropriate. The Common
ground shared by all of these special deductions, etc., is that each is
not essential to the revenue raising function of the income tax, but is
designed to provide tax relief to certain groups of taxpayers. These
special tax provisions result in a superstructure which is added to the
basic structure of a net income tax. Professor Stanley S. Surrey has

"10 It is a

called these special provisions a "tax expenditure apparatus.
way to distribute dollars to taxpayers indirectly through the tax system,
instead of directly through the budgetary process.

The amount and variety of these tax expenditures is very large.
Recent estimates indicate that the overall magnitude is equal to about

one-fourth of the federal budget.11

In addition, the scope of these tax
expenditures includes almost every relevant budget classification
including: natural resources (percentage depletion, intangible drilling
expenses); construction (accelerated depreciation); housing (accelerated
depreciation, deduction for mortgage interest and real property taxes,
tax credit for new housing); farming (cash method of accounting, expensing
of capital expenditures, capital gain treatment for certain assets held
for sale); investment (dividend exclusion, capital gain); and so on. A
tax expenditure apparatus of this magnitude and scope is bound to be
complex because in each situation an exception is made to the general
rule. However, the potential for complexity does not stop with the
current set of tax expenditure items. Exceptions have a tendency to

breed exceptions, and these exceptions other exceptions which are of a

higher order of complexity. When preferential treatment is granted to

57
one group, it is not long before others can demonstrate that they are
equally deserving of special consideration. Each additional exception
is strongly defended by its supporters usually on the basis of improved

equity.12

Possibilities for Simplification

 

It is the view of some tax experts that nothing can be done about
the complexity of the income tax system, because a complex society with
a complex economic system cannot avoid a complex tax system.13 This
statement is partially true. However, much complexity in the tax law is
not the result of either a complex society or a complex economic system.
There is a great deal of complexity which is the result of distinctions
which are made among sources of income, types of deductions, types of
taxpaying entities, etc., which are not essential to the revenue raising
function of an income tax. The capital gains distinction is a prime
example of this type of unnecessary distinction which results in comple-
xity. In general, the greatest possibilities for a lessening of comple-
xity lie in neutralizing the distinctions created by the above mentioned
tax expenditure apparatus.

It has also been suggested that simplification cannot be obtained
without the sacrifice of equity.14 The argument is that complexity
results from an attempt by Congress to respond to the needs of taxpayers
who merit special treatment. Even conceding the equity argument, however,
the question must be asked, is the additional complexity worth it? As
Justice Jackson said in the Dobson case: "No other branch of the law
touches human activities at so many points. It can never be made simple,
but we can try to avoid making it needlessly complex."15 Also, as was

stated earlier, equity is dependent upon the ability to measure the

58
income of taxpayers. The effect of the tax expenditure apparatus is to
make meaningless any comparison of the taxable incomes of taxpayers.
Thus, the relative taxpaying capacity of individuals cannot be measured,

which destroys the concepts of both horizontal and vertical equity.

 

Suggestions for Simplification

One suggestion for simplification is that all sources of tax law
be located in a single place.16 This would involve the codification of
all substantive regulations of the Internal Revenue Service and also all
court decisions. While the existence of all tax law in a single place
may be of some help, especially if one must determine the relative weight
to be granted to a particular authority, it is doubtful that much less
complexity would be obtained. This is particularly so because a compre-
hensive code would itself be quite voluminous, and tax reporting services
are already quite effective in gathering together the various sources of
tax law. In addition, even if all tax laws were codified, it would still
be necessary to examine the legislative history of the comprehensive code.
In the case of judicially initiated code sections, this would require an
examination of the court cases which gave rise to a particular code
section, thus, partially defeating the purpose of a comprehensive code.

A second suggestion for simplification is the opposite of compre-
hensive codification; redraft the tax statutes in broad outline form.17
A common complaint concerning existing statutes is that too often they
attempt to deal with specific, relatively unimportant situations, thus,
resulting in a cluttering up of the statutes with a multitude of minor
exceptions. The ideal statute under this conception would be one which

states the rules of law in general terms with the Internal Revenue Service

or courts treating exceptions on a case by case basis. The argument is

59
further stated that if the law were drafted in broad outline form, tax
experts could more easily understand the basic structure of the statute,
and less controversy concerning the proper application of the rules to
specific circumstances would result. However, this probably represents
wishful thinking in that it is the nature of taxpayers and their advi—
sors to seek the limits of tax statutes. It is doubtful, to say the
least, whether the application of a general rule to a specific case will
result in less controversy than the application of a specific rule to a
specific case. The effect of the general rule would probably be to give
the taxpayer more room for maneuvering.

A third possibility for simplification lies in the draftsmanship
of the statute itself. As Louis Eisenstein has stated: "The statutes
are enveloped in a peculiar verbal fog of their own. The Internal Reve-
nue Code, indeed, is a remarkable essay in sustained obscurity. It has

"18 The

all the earmarks of a conspiracy in restraint of understanding.
means of simplification lie here not in the substance of the statute but
in the means of communicating that substance. It includes logical
arrangement of Code sections, appropriate typographical changes, such as
better use of bold face type to set out descriptive headings and sub-
headings, better cross-referencing, shorter sentences, and possibly less
legal terminology. The prospects for simplification in this area, how-
ever, are quite limited. First, it is too much to expect that a tax
statute which reflects exceedingly complex substantive provisions can be
simply stated in nonlegal terminology. Second, the change in language
to a simpler form without changing the substance of the statute is an

exceedingly delicate operation. The fact that a particular provision

was poorly worded may have resulted in litigation to clarify the poor

60
wording, and a change in the language to a simpler form could well result
in another round of litigation.'

Each of the first three possibilities for increased simplicity
have in common the fact that there is no change in the substance of the
statute, but merely a change in the method of presenting the tax law.
Real prospects for increased simplicity lie in substantive changes in
the income tax provisions themselves.

Since every rule in substantive tax law is an attempt to draw a
distinction, the volume of rules and decisions necessary to define the
limits of a distinction can be reduced only if the number of distinctions
attempted to be drawn are reduced. Much simplification could result
without radical change in the prevailing concept of taxable income. For
example, the elimination of the deduction for extraordinary medical
expenses or casualty losses in excess of $100 would remove small parts
of the tax law which have become increasingly complex. The same could
be said for the elimination of most itemized deductions and exemptions,
and their elimination would not affect the prevailing concept of net
income.

There is, however, a limit to the extent which the tax law can
be simplified by the above method unless there is a willingness to elimi-
nate certain basic distinctions which hold key positions in the structure
of the tax law. As Henry Simona has said in his pioneer work Federal

Tax Reform:

 

Simplicity in modern taxation is a problem of basic architectural
design. Present legislation is insufferably complicated and nearly
unintelligible. If it is not simplified, half of the population
may have to become tax lawyers and tax accountants. Present laws
are marvelously well built. But they are abominable structurally.
They lack structure or sound foundational plan. . . .

As regards personal income taxation, which mainly concerns us
here, it is easier to promise simplification than to deliver it.

61

It can, we believe, be delivered in large measure. . . .

Four general prescriptions may be offered in passing:

1. We should greatly reduce present emphasis on the year as
an accounting period. . . .

2. We should avoid arbitrary special treatment for any parti-
cular kind of income or deduction. There should be no special-
interest dispensations in the prescribed methods of income deter-
mination. . . .

3. We should stop tax avoidance by simple fundamental measures,
instead of constantly diverting the avoidance stream from particular
channels by legislative gadgets. . . .

4. We should not perpetuate or multiply temporal categories
in the law. . . 19

Thus, there should be an elimination of the tax difference between ordi-
nary income and capital gain and between tax exempt income and other
income. There should be no difference between realized and unrealized
gains. And there should be no difference in tax whether an item was
accounted for in one year or another. Neutralization of these basic
distinctions requires a definition of net income in terms of net change
in economic position over a relatively long period of time. In theory
all economic enhancement would be brought into the tax computation over
time; and if an appropriate averaging device were utilized, timing diffe-
rences could also be almost perfectly neutralized. This would result in
a tax statute which is the ultimate in simplicity from a structural
standpoint.

These changes, of course, would require radical changes in the
concept of net income. In addition, a de-emphasis of the year as an
accounting period and the elimination of the realization concept would
result in great administrative burdens, which are the antithesis of
simplification. However, the elimination of arbitrary special treatment
of particular kinds of income or deduction would neutralize some of the

distinctions which are the source of much complexity in our federal

income tax laws; and this could be accomplished without radical change

62

in the traditional concept of income.

Some tentative-conclusions can be drawn from this analysis of
simplification of federal income tax provisions. There Can be no great
reduction in the complexity of the law through formal changes in its
structure, while the substance of the law is left unchanged. The pros-
pects for simplicity are somewhat brighter, however, when certain distinc-
tions relating primarily to itemized deductions are blunted. The neutra—
lization of these distinctions, which would leave the substance of the
net income tax unchanged, provides important though only limited possi-
bilities for simplification. The real possibilities for simplification
lie in the elimination of the germinal distinctions which underlie the
substance of federal income tax law. However, if for administrative
reasons the year is maintained as the time period for tax measurement,
and the concepts of realization and a progressive income tax are also
maintained, real simplification would appear to lie in the area of neutra-
lizing distinctions between types of income and deductions.

This would imply the elimination of special treatment of capital
gains and losses, the elimination of any tax exempt income, such as,
interest on municipal bonds, and the elimination of types of deductions
which are treated differently from other types of deductions, such as,
percentage depletion. A list of tax provisions that could be eliminated
by neutralizing tax distinctions which are not essential to the concept
of an annual net income tax can be obtained from a listing of the tax
expenditures published by the House Ways and Means Committee in June 1973,
and prepared by the staffs of the Treasury Department and the Joint
Committee on Internal Revenue Taxation. This list, segregated by budget

function is reproduced as appendix C.

63

The Capital Gain Distinction as a Source of Complexity

 

The basic difficulty which arises when one tries to distinguish
between capital gain and ordinary income is that in terms of the common
denominator, dollars of taxpaying capacity, there is no difference. In
fact, it is this absence of distinction which causes a rather unusual
coalition of taxpayers to call for an elimination of special treatment
for capital gains and losses. On the one hand, there are individuals
with large incomes but little or no capital gains who would like to see
preferential treatment of capital gains eliminated, usually accompanied
by a lowering of the top tax brackets. They are primarily concerned
with horizontal equity. On the other hand, taxpayers in the lower tax
brackets want preferential treatment of capital gains to be eliminated
because it is a strongly regressive element in a nominally progressive
income tax. Their concern, of course, is with vertical equity. The
definitional problems resulting from the capital gains distinction have
been called insoluble by one writer who likened the capital gains prob-
lems to those which would exist if "for some reason or another, [it was
decided] to tax wages at half the rate of salaries."20

The term "capital gain" has been used for such a long time by so
many people, that it has become quite familiar to most individuals.

This familiarity oftentimes leads to the mistaken impression that a

capital gain can be readily distinguished from something called ordinary
income. Nothing could be further from the truth. The capital gain dis-
tinction is a creature of the law, and as such, depends upon legal defi—
nition and interpretation for it's existence. Furthermore, the legisla-

tive definition is confined to a few relatively short sections. It is

only when the definition must be interpreted and applied to a particular

64

fact situation that the enormity of the definitional problems begins to
surface. Since the legislative definition of capital gain is stated in
quite broad terms, the responsibility for delimiting the boundaries of
the definition has been left to the administrative and judicial branches
of government, primarily the courts. With the obviously beneficial tax
differential between capital gains and ordinary income, taxpayers have
sought to have as much income as possible taxed as capital gain, which
places tremendous pressure on a loosely drawn capital gains definition.
With the Treasury Department cast in the role of "protector of the

' controversy was, and is inevitable. The responsibility for

revenue,‘
arbitrating disputes between the taxpayer and government rests with the
judiciary. The judicial system responded to their responsibility by

issuing conflicting opinions regarding many fact situations which were
essentially identical. In other cases, the judiciary attempted to make

more specific the boundaries of the capital gain definition which was

loosely drawn by Congress.

The net result is that the difficulties resulting from the defi-
nitional approach to capital gains are quite formidable. Not only are
the difficulties formidable, but they are also insoluble as long as a
distinction remains between a dollar of income called capital gain, and
a dollar of income called ordinary income. The approach used in the past
to reduce the pressure exerted by taxpayers on the capital gain defini-
tion, has been to reduce the tax differential between capital gain and
ordinary income. By reducing the differential, the advantage is lessened.
It is presumed that since the tax advantage is smaller, the pressure to
utilize the capital gain advantage will be lessened. The current tax

differential for individuals between the maximum tax on capital gain and

65

and the maximum tax on earned income is 13.5% (50% — 36.5%). However,
the current tax differential between unearned income and capital gain is
33.5% (70% — 36.5%), which is not an insignificant amount. The only way
to entirely eliminate the pressure on the capital asset definition, along
with the resulting complexity, is to neutralize the distinction between
capital gain and ordinary income. Unless this is done, the capital gain
area will remain a jungle of complexity, through which the taxpayer, his

advisors, and the government will continue to wander.

 

Indications of Complexity

To most taxpayers, contact with federal income tax laws is limi-
ted to tax forms which must be completed annually. From the standpoint
of these taxpayers, simplicity probably means a number of things. The
minimization of arithmetic. The elimination or minimization of record-
keeping requirements. And the reduction of tax return forms to a few
which can be filled in rapidly without having to dig into old records.
The tax forms themselves which daily face taxpayers and their advisors,
however, are merely reflective of the underlying statutory provisions
which they attempt to administer. A complex statute can only result in
complex forms. These forms include forms for returns, elections, support-
ing statements, aids in computation, worksheets, applications for exemp-
tion, and many others. Just choosing the corrent form for a business
transaction can be a difficult problem. An enumeration of so called
"public use" forms or, to use the words of Internal Revenue Service
Publication 481 (Description of Principal Federal Tax Returns, Related
Forms and Publications), "those forms which the taxpayer may need to
originate action on a tax matter," results in a list of 344 separate

forms.21 The list would include everything from Form 1040A (Short Form,

66
U.S. Individual Income Tax Return) to Form 7018 (Employer‘s Order Blank
for Forms) which is used to order more forms.

Selecting the proper form, however, is only the beginning of the
taxpayer's difficulties; the forms must be completed and filed. Due to
the complexity of the income tax provisions, approximately one-half of
all taxpayers (over 35 million in 1973), sought paid advice in filing
their tax returns.22 This excludes those who sought the free advice and
assistance from the Internal Revenue Service. Even with this assistance,
the number of errors in returns is alarmingly high. Former acting
Commissioner of the Internal Revenue Service, Mr. Raymond F. Harless,
has stated in testimony before the House subcommittee of the committee
on government operations:

As of April 30, 1973, 4,977 tax returns were prepared by tax
practitioners "shopped" by IRS. Of the 4,977 returns obtained,
3,031 (61%) were correctly or substantially correctly prepared;
834 (17%) incorrectly prepared but non—fraudulent and 1,112 (22%)
were potentially fraudulent. In one checkup of IRS employees,

a sample of 603 returns were examined, of which 447 (74%) con-
tained some type of technical or mathematical error or omission23
(318 in favor of the taxpayer, 129 in favor of the government).

In order to reduce the number of errors the Internal Revenue Ser—
vice administers a comprehensive program of taxpayer assistance and edu-
cation. The Taxpayer Service Division of the Internal Revenue Service
responded to approximately 34.5 million taxpayer inquiries in 1974.24
In addition, mini-computers were used to automatically prepare individual
income tax returns on Form 1040A, and an Integrated Data Retrieval System
was installed in all 58 district offices and 169 other offices in the
United States and Puerto Rico.25 Also, the Internal Revenue Service
administers a Spanish~speaking taxpayer assistance program, and a volun—

teer income tax assistance program to assist Spanish-speaking taxpayers

and low—income people, retired persons, and others who cannot afford to

67
have their returns prepared by tax practitioners.26 The Internal Revenue
Service recognizes the complexity of the income tax laws and the diffi-
culty taxpayers have in complying with them, therefore, as much assis-
tance as possible is offered to taxpayers.

Another indication of complexity in the tax laws, is the number
of taxpayer and Revenue Agent requests for "technical advice" from the
Office of the Assistant Commissioner (Technical) in the National Office
concerning the proper application of the tax laws to a particular set
of facts. For the fiscal year ending June 30, 1974 there were 14,017
taxpayer requests and 1,602 revenue agent requests.27 In addition to
"technical advice" which is furnished in connection with the audit of a
taxpayer's return, the Internal Revenue Service published in the Internal

Revenue Bulletin for 1974, "636 Revenue Rulings, 44 Revenue Procedures,

 

13 Public Laws relating to Internal Revenue Matters, 5 Committee Reports,
7 Executive Orders, 37 Treasury Decisions containing new or amended
regulations, 10 Delegation Orders, 3 Treasury Department Orders, 5 Court
Decisions, 7 Notices of Suspension and Disbarment from Practice before
the Service, and 150 Announcements of general interest."28 All for the
guidance of taxpayers, tax practitioners, and Internal Revenue Service
personnel.

The problems with complicated returns do not end with their
filing; they must be audited. Arithmetic must be checked, amounts must
be verified, returns may have to be selected for closer scrutiny and
interviews with taxpayers and.their representatives may take place. For
the fiscal year ending June 30, 1974, a total of 121.6 million returns

29

of all kinds were filed. Of these, 95.0 million were income tax re—

. 30
turns and the remainder employment, estate, gift, or excise tax returns.

68
The arithmetic was checked on 84.5 million returns and found to be in
error on 5.1 million returns.‘31 Also, for the fiscal year ending
June 30, 1974, 2.2 million returns were selected for audit including
2.0 million income tax returns.32

After the returns have been audited, if controversy exists bet-
ween the taxpayer and government, a conference at the district or appe-
late levels of the Internal Revenue Service may result. For the fiscal
year 1974, the appeals function within the Internal Revenue Service
disposed of 47,602 cases by agreement which is about 97% of all disputed
cases.33 Of the 3% disputed cases not settled by the administrative
appeals system, the Tax Court tried 997 cases; and the United States
District Courts and Court of Claims tried 369 cases.34 Each of these
sources of tax information add complexity to the income tax law in that
taxpayers or their advisors must be aware of them in order to properly
determine their tax liability and/or to avoid undesirable tax conse-
quences when planning economic transactions.

Complexity, as it relates to federal income taxes, is not solely
the result of the number of different sources of tax law or the volume
of the provisions emanating from these sources. Complexity also results
from the interaction of various provisions which are joined to form
intricate patterns, difficult to understand. It is the intricate inter-
relationships of these provisions that provide much of the uncertainty
for taxpayers and their advisors when planning economic transactions.

By way of illustration, section 483 of the Code calls for the imputation
of interest on deferred payment contracts if the stated interest rate is

less than 4%. The sole purpose of this section is to deter taxpayers

who are selling assets which would result in a capital gain from

69

overstating the selling price in exchange for a lower interest rate.
From an economic standpoint, of course, interest is included through the
higher than market selling price. From a compliance and administrative
standpoint, preventing the conversion of ordinary income into capital
gain is not the only effect of section 483. As described in the 1974

Ernst and Ernst National Tax Training Program manual section 483 could

 

possible:
. . . create personal holding company problems; terminate a valid
election to be an electing Sub-chapter S corporation; create a
non-deductible loss under section 267; affect the qualification
of a stock option; disqualify installment reporting; and affect
the status of an otherwise tax free reorganization. 5
Consequently, the effort to restrict taxpayers' use of the capital gain
provisions resulted in ripple effects some of which were probably
undreamed of when the statute was drafted. In discussing the complexity
of tax laws and the ignorance of the Members of Congress who vote on

them, Representative Wright Patman stated, "the tax laws are passed

with the Members not knowing exactly what they mean."36

Costs of Complexity

 

The cost of administration and compliance is without a doubt
greatly increased because of complex income tax laws. These costs are
both monetary and non-monetary in nature. As an indication of the mone-
tary cost of administration of the internal revenue laws, the estimated
budget for the Internal Revenue Service for fiscal year 1975 is $1.881
billion.37 While no dollar estimate of compliance costs have been made,
it would seem reasonable to expect that annual compliance costs are at
least this great; especially considering the fact that there are an

estimated 250,000 attorneys, accountants, and trained commercial tax

return preparers, preparing more than 35 million tax returns.

70

In addition to the direct costs of administration and compliance,
there are many important indirect costs. Included among these indirect
costs are the costs of training and education. Most tax advisors have a
substantial investment in their knowledge and understanding of the tax
laws. This investment is both monetary and non-monetary; monetary from
the standpoint of an investment in formal educational programs and in
the tools of his trade necessary to remain abreast of the most recent
changes in the tax law, and non-monetary from the standpoint of the time
and effort necessary to master the tax law. It is interesting to note
that for the tax expert there are substantial real costs involved in any
significant changes in the tax law; whether these changes are designed
to simplify the law or whether they are made for other reasons. However,
one must take a long view when considering a move to an admittedly better
tax system and not be overly concerned with short term costs and incon-
venience. Without this long View, the status quo would always be main-
tained and change would never take place.

Additional monetary costs include the legislative costs of
researching, drafting, and enacting the statutes; and the judicial costs
of adjudicating controversy which results from complex provisions.
Finally, there is the inestimable cost to taxpayers who inadvertantly
overpay their taxes because of a lack of knowledge of the intricacy of
the tax laws and an inability to afford or obtain competent tax advice.

As important and substantial as the monetary costs of complexity
are, perhaps of even greater importance are the non—monetary costs of
complexity. The income tax system in the United States is based on the
principle of selfwasseSSment. In turn, this principle is based upon

taxpayer goodwill without which the system would cease to function.

71

Complicated tax provisions which the taxpayer cannot understand may
cause some taxpayers to becOme annoyed or even hostile—~a potentially
dangerous attitude in a system whiCh depends to a great extent on volun-
tary cooperation on the part of the public. This annoyance or hostility
may be evidenced in a number of ways. A taxpayer might react against
having to turn to a professional to prepare his return, or he might
object to find that he overpaid his taxes at some time in the past
because he did not understand the complexities of a particular tax pro-
vision, or he might rebel at finding that he just misses a preferential
provision even though his situation is seemingly identical to the pre-
ferred case. Given this annoyance, a taxpayer may convince himself that
he is justified in ignoring complex tax laws which are difficult to
understand and more importantly may be difficult for the government to
effectively police. As Randolph E. Paul has said, ". . . laws are made
for men. Men must live by them. They must understand them, for under-
standing is the first step in orderly compliance."39

Another important cost of complexity is the opportunity cost of
those involved in tax work. Tax work is essentially non—productive.
Much time and talent is devoted to tax planning designed to maximize tax
benefits and this effort produces nothing for society as a whole. As
one writer in the field of taxation has stated, ". . . the golden oppor-
tunity of this decade could be lost to us because our top talent was
consecrating itself to the invention of new and better capital gains."40
Complexity within the tax laws, therefore, is manifested in many diffe-
rent ways, some avoidable others unavoidable. The common denominator
among all manifestations of complexity is that they are all costly.

Complexity is costly in monetary terms, and perhaps even more importantly

when taxpayer morale is affected, in non—monetary terms.

72

Summary

The causes of complexity can be divided into three categories:
(1) complexity resulting from the scope of the economic system itself,
(2) complexity inherent to a net income tax, and (3) complexity result-
ing from provisions grafted onto the basic structure of the income tax
which bear no basic relation to that basic structure and which are not a
necessary part of its operation. 0f the three sources of complexity,
the first two offer no hope for simplification. Hope for simplification
lies in the third category. Within the third category, many knowledge-
able writers believe that the capital gain and loss provisions result in
a greater amount of complexity than any other single notion. The effect
of the capital gain and loss provisions on the scope and complexity of

the federal income tax law is examined in Chapter IV.

FOOTNOTES CHAPTER III

lWebSter's‘Third New International Dictionary of the Emglish
Langpgge, unabridged (Springfield, Mass.: G. and C. Merriam Company,

1961).

 

2Lynch v. Turrish, 247 U.S. 224 (1918).

3Dr. T. S. Adams, cited by Randolph E. Paul, Taxation for
Prosperity (New York: BobbséMerrill, Co., 1947), p. 28.

 

 

4Standard Federal Tax Reports~-Taxes on Parade (Chicago:
Commerce Clearing House, Inc., June 25, 1975), p. 2.

5Annual Report 1974 Commissioner of Internal Revenue (Washington,
D.C.: U.S. Government Printing Office), pp. 10—11.

6For a comprehensive theoretical discussion of progressive
taxation, see Harry Kalven and Walter J. Blum, The Uneasy Case for
Proggessive Taxation (Chicago: Phoenix Books, 1953).

 

7See Note, "Tax Equity and Ad Hoc Legislation," Harvard Law
Review 84 (1971): 640-663.

8Paul, Taxation for Prosperity, p. 707.

 

9Internal Revenue Code, sec. 61.

 

10Stanley S. Surrey, Pathways to Tax Reform (Cambridge: Harvard
University Press, 1973).

11Stanley S. Surrey, "Complexity and the Internal Revenue Code:
The Problem of the Management of Tax Detail," Law and Contemporary Problems
34 (1969): 684.

12For a discussion of equity as it applies to the taxing process,
see Louis Eisenstein, The Ideologies of Taxation (New York: The Ronald
Press Company, 1961), chapter 7 and Philip Stern, The Great Treasurpraid
(New York: Random House, Inc., 1964), chapter 15.

 

13See the remarks by Edwin S. Cohen before the American Bar
Association National Institute on Tax Reform, Tax Lawyer 23 (1970): 424.

 

14Paul, Taxation for Prosperity, p. 411.

73

74

15Dobson v. Commissioner, 64 S. Ct. 239, 243 (1943).

 

16Walter J. Blum, "Simplification of the Federal Income Tax Law,"
Tax Law Review 10 (1954).: 240.

 

17Ibid., pp. 241—242.

18Eisenstein, The Ideologies of Taxation, p. 215.

 

19Henry C. Simons, Federal Tax Reform (Chicago: The University of
Chicago Press, 1950), pp. 28—30.

 

20Carl S. Shoup, testimony before the Joint Committee on the

Economic Report on Federal Tax Policy for Economic Growth and Stability,
84th Cong., lst sess. (1955), p. 345.

 

 

21Federal Tax Forms (Chicago: Commerce Clearing House, 1975),
pp. 51-710

 

22Tax Return Preparation-—Internal Revenue Service and the

Commercial Return Preparer, Hearing Before a Subcommittee of the Committee
on Government Operations, House of Representatives, 93rd Cong., lst Sess.
(1973), p. 16.

 

 

23Ibid., p. 14.

24Annual Report 1974 Commissioner of Internal Revenue, p. 2.

 

25Ibid., p. 3.

26Ibid., p. 5.

27Ibid., p. 31.

281bid., p. 31.

29Ibid., p. 9.

BOIbid.

3llbid., p. 14.

321b1d., p. 19.

 

75

331bid., p. 23.

34Ibid.

35Ernst and Ernst, 1974 National Tax Training Program, level 1,
chapter 15, p. 10.

 

 

 

 

 

36103 Congressional Record 6356 (1957).
37The Budget of the United States Government, Fiscal Year 1975, r
p. 233. 2
38Tax Return Preparation-—Internal Revenue Service and the E
Commercial Return Preparer, p. 16. f
39 . .
Paul, Taxation for Prosperity, p. 409. I
40 '

Walter J. Blum, "How the Growth of Favored Tax Treatment Affects
Taxpayers and Practitioners, Journal of Taxation 4 (1956): 29.

CHAPTER IV

THE EXAMINATION OF SELECTED SOURCES

OF FEDERAL INCOME TAX LAW

Sources of Federal Tax Law

 

The sources of federal income tax law are many and varied. The

three primary sources, however, are: (l) legislative, (2) administrative,

 

and (3) judicial.

Within the legislative area we have the statute itself, which
currently is the Internal Revenue Code of 1954. The Internal Revenue
Code is incorporated into the United States Code as Title 26. It is
divided into Subtitles which are subdivided into Chapters, Subchapters,
Parts, Sections, Subsections, Paragraphs, and Subparagraphs. When speak-
ing of the legislative sources of tax law, it is not enough to consider
only the statute. In addition, the committee reports of the House Ways
and Means Committee, the Senate Finance Committee, and the Conference
Committee must be considered in order to determine the oftentimes elusive
"intent of Congress."

The administrative sources of federal tax law consist primarily
of regulations and rulings. In general, regulations have been classified
into two categorieSe-legislative and interpretive.1 Legislative regula-
tions result from the authority which Congress has delegated to the
Secretary of the Treasury to prescribe detailed rules for certain Code
sections. Interpretive regulations are designed to interpret the various
sections of the Code and to serve as a guide for the Internal Revenue

76

77

Service and the taxpaying public.2 The second major source of tax law
within the administrative ares results from the rulings program of the
Internal Revenue Service. The program consists of two types of rulings--
letter rulings and Revenue Rulings. As stated by Mr. Mitchell Rogovin,
former chief counsel of the Internal Revenue Service:

A letter "ruling" is a written statement issued to a taxpayer by

the Office of Assistant Commissioner (Technical) in the National

Office which interprets and applies the tax laws to a specific

set of facts. Rulings are issued only by the National Office

and are generally issued in respect to transactions that have

not been consummated. A "Revenue Ruling" is an interpretation

by the Service, issued only by the National Office and published

in the Internal Revenue Bulletin for the information and guidance

of taxpayers, Service personnel, and others concerned.
Letter rulings are designed to provide the taxpayer with certainty
regarding the tax consequences of a particular transaction. These letter
rulings may only be relied upon by the taxpayer to whom issued, and then
only if all the resulting facts of the transaction are as stated in the
initial request for ruling. Published Revenue Rulings, on the other
hand, are designed to promote uniformity of interpretation among the
public and among Internal Revenue Service personnel, and to inform all
interested parties as to the position of the Commissioner of the Internal
Revenue Service with respect to particular issues. In addition to regu-
lations and rulings, administrative sources of tax law include Revenue
Procedures, Technical Information Releases, Opinions of the Attorney
General, and many others. Published Revenue Procedures usually result
from internal management documents of the Internal Revenue Service.
Their function is to make public, procedural statements issued primarily
for internal use which affect the rights and duties of taxpayers. In

addition, Revenue Procedures are used to communicate to taxpayers instruc—

tions which are given to Internal Revenue Service personnel for the

78

purpose of simplifying audits. The Technical Information Release is
designed to communicate quickly with tax specialists and technical pub—
lications important technical developments which are not of interest to
the layman or the general news media. It would be used for example, to
inform tax technicians of a new election which has to be made within a
relatively short period of time. Of the administrative sources of tax
law, the Code of Federal Regulations is the most important, followed
closely by published Revenue Rulings. All other sources are of rela—
tively less importance.

The third basic source of tax law is the judiciary. Regardless

 

of how articulate a statute may be, and how detailed and clear the inter-
pretive regulations and the many informal administrative rulings may be,
there is usually room for interpretation and controversy. Taxpayers and
their advisors are always on the hunt, and rightly so, for methods of
minimizing their taxes. The Supreme Court has recognized the principle
that "when the law draws a line, a case is on one side of it or the
other," and if the case is on the safe side, it is "none the worse
legally that a party has availed himself to the full of what the law
permits."4

The federal judiciary consists of the Tax Court, District Courts,
Court of Claims, Court of Appeals, and the Supreme Court. The Tax Court
decisions, in turn, can be divided into "officially reported" decisions
and "memorandum" decisions. The officially reported or regular Tax Court
decisions are usually those decisions which involve an interpretation of
law. Memorandum decisions, on the other hand, generally require the

determination of a fact situation to be applied within previously settled

legal principles.

79
Scope of the Study_

The purpose of this study was to determine the effect of the
capital gain and loss provisions on the scope and complexity of the
sources of federal income tax law by examining elements from each of the
sources of tax law: legislative, administrative, and judicial. Only
the areas of federal tax law dealing with income tax provisions were
considered. This restriction had the effect of limiting the study within
the legislative area to those provisions arising under sections 1—1399 of
the Internal Revenue Code of 1954. Within the administrative and judicial
areas, the study was limited to administrative rulings and court deci-
sions resulting from problems and controversy created by the income tax
provisions (sections 1-1399) of the Internal Revenue Code. Specifically
excluded from examination were the statutory provisions dealing with the
federal gift tax, estate tax, excise taxes, and social security taxes,
as well as any administrative rulings or court decisions arising there-
under.

Within the legislative area, the research was limited to the
Internal Revenue Code of 1954. The legislative reports of the House ways
and Means, Senate Finance, and Conference Committees were not examined
since they are reflective of the content of the Code.

Within the administrative area, the research was limited to an
examination of the published Revenue Rulings of the Internal Revenue
Service. Private or "letter" rulings, technical advice memoranda, and
other such information are not currently available for public inspection.
The current position of the Internal Revenue Service is that this type
of information is exempt from the disclosure requirements of the Freedom

of Information Act.5 The availability of letter rulings, technical

80
advice memoranda, etc., is currently at issue in a suit pending before
the United States Court of Appeals for the Sixth Circuit in Fruehauf

Corp. v. Internal Revenue Service. The Revenue Rulings examined were

 

limited to the Rulings issued in the 10 year period 1964 through 1973.
The 10 year period 1964 through 1973 was selected because it was long
enough to provide a reasonable estimate of the characteristics being
examined, yet short enough to allow a relatively large sample to be
selected from each year in order to gain the desired precision.

Also excluded from examination was the Code of Federal Regula—

tions, which is the official interpretation of the Internal Revenue Code

 

by the Treasury Department. The Code of Federal Regulations was excluded
because the sections of the Regulations affected by special treatment of
capital gains and losses are the same sections of the Internal Revenue
Code which are affected by special treatment of capital gains and losses.
Consequently, the proportion of Regulations dealing with capital gains
and losses should be approximately the same as the proportion of Code
sections dealing with capital gains and losses.

Within the judicial area, cases arising in each jurisdiction of
the federal courts were examined with a view to determining the effect
that the capital gain and loss provisions have on the issues involved in
the cases studied. The cases examined included cases from the United
States Tax Court, both memorandum and regular decisions, the District
Courts, Court of Claims, Court of Appeals, and Supreme Court. Only cases
concerning issues arising from sections 1-1399 of the Internal Revenue

Code were examined, and these for the 10 year period 1964 through 1973.

81

Research Methodology

 

Sections 1a1399 of the Internal Revenue Code have been analyzed
in order to determine: (1) the proportion of Code sections whiCh would
be completely eliminated if there were no special treatment of capital
gains and losses, (2) the proportion of Code sections which have capital
gain and loss implications and would be affected by elimination of
special treatment of capital gains and losses, but for other reasons
could not be entirely eliminated, and (3) the proportion of Code sections
which would be unaffected by the absence of special treatment of capital

gains and losses.

 

FP-I

An example of the first classification is section 1245 which
calls for the recapture of depreciation as ordinary income upon the sale
of depreciable personal property at a gain. The purpose of this provi-
sion is to prevent a taxpayer from taking a depreciation deduction from
ordinary income, especially at an accelerated rate, and then selling the
asset for an amount in excess of its book value and recognizing capital
gain through the operation of section 1231, thus effectively turning
ordinary income into capital gain.

Examples of the second classification are Code sections 531
through 537 dealing with the penalty tax on an excess accumulation of
earnings. The purpose of these sections is to force corporations to pay
dividends currently rather than retaining earnings beyond the reasonable
needs of the business. Although these sections are related to capital
gains, they are not entirely capital gain sections. There are basically
three reasons that a taxpayer may not want his closely held corporation
to pay current dividends: (1) a deferral of a dividend results in a

deferral of the tax on that dividend, and other things being equal it is

82
always better to make a tax payment later rather than sooner, (2) the
taxpayer may want to shift income from a current high tax bracket year
to a future low bracket year with Obvious tax benefits, and (3) the tax-
payer may want his corporation to accumulate earnings with a view towards
selling his stock at the appreciated value and realizing capital gain
instead of ordinary dividend income. If special treatment of capital
gains and losses were eliminated, the third tax saving motivation would
be absent but the other two would remain. Consequently, sections 531
through 537 would have to remain because of the first two tax saving

motivations, the pressure to utilize a closely held corporation for

 

strictly tax saving reasons would be diminished, since the third tax
saving motivation would be absent. In addition, it is probable that if

a taxpayer expected to be taxed at ordinary income rates on the appre-
ciation of his stock in his closely held corporation, he would be more
inclined to pay current dividends rather than to accumulate liquid
assets. This is particularly true given a progressive tax rate struc-
ture whereby the recognition of ordinary income in the year of realiza—
tion may result in the taxpayer being in a much higher tax bracket than
he would have been in had he realized periodic dividends over a number of
years.

An example of the third classification is the definition of a
dependent. Even if there were no special treatment of capital gains and
losses, the complexity in the federal income tax law resulting from the
existence of a dependency exemption would still remain. This threefold
analysis of the Internal Revenue Code gives a quantitative indication of
the effect of the capital gain and loss provisions on the scope and com-

plexity of this source of federal income tax law.

83
The second major source of tax law originates in the administra-
tive area. The published Revenue Rulings of the Internal Revenue Service
were examined on a stratified random sample basis to determine: (1) the
proportion of Revenue Rulings which would have been completely eliminated
if there were no special treatment of capital gains and losses, (2) the

proportion of Revenue Rulings which, while not dealing strictly with

'7

capital gains and losses, have capital gain and loss implications, and
(3) the proportion of Revenue Rulings which have no capital gain and loss
implications. It was necessary to randomly sample the Revenue Rulings

rather than to analyze all of them because of the sheer volume issued a

 

during the 10 year period 1964 through 1973 (see table 4).

The third major source of tax law whiCh was examined was in the
judicial area and included memorandum Tax Court, regular Tax Court,
District Court, Court of Claims, Court of Appeals, and Supreme Court
decisions. Because of the large number of memorandum Tax Court, regular
Tax Court, District Court and Court of Appeals decisions for the period
1964 through 1973 (see table 4), they were examined on a stratified
random sample basis to determine the proportion of cases in each of the
three classifications. However, since the number of Court of Claims and
Supreme Court cases for the period 1964 through 1973 was relatively small
(see table 4), they were examined on a 100% basis to determine the pro-
portion of cases falling into the above listed categories.

The analysis of court decisions presented a special problem be—
cause of the possibility of multiple issues being involved in a single
court case. The second classification category was stated as containing
Code sections or Revenue Rulings which had capital gain and loss impli—

cations though not exclusively so, that is, there may be other reasons

84
TABLE 4

THE NUMBER OF REVENUE RULINGS AND COURT CASES CONCERNING INTERNAL
REVENUE CODE SECTIONS 1-1399, 1964 THROUGH 1973

 

 

1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 Total

 

Revenue Rulings 152 166 249 330 432 449 459 421 378 436 3,462
Memorandum Tax

Court 298 294 245 243 269 266 331 314 229 252 2,741
Regular Tax Court 143 126 125 125 168 172 192 171 147 146 1,515
District Court 187 172 186 200 154 182 150 169 144 136 1,680
Court of Claims 27 22 25 33 33 28 29 15 19 24 255
Court of Appeals 241 171 201 171 164 183 198 196 186 187 1,898
Supreme Court - 8 5 3 3 4 3 l 4 5 36

 

that would prevent a Code section or Revenue Ruling from being eliminated
even if there were no special treatment of capital gains and losses.

This also held true for court cases, but in addition, the second classi-
fication for court cases includes those cases in which there were

multiple issues one of which was wholly or partly a capital gain issue.
The multiple issue problem did not exist with respect to the analysis of
the Internal Revenue Code or the published Revenue Rulings of the Internal

Revenue Service.

The Relative Investment Advantage Attributable to Capital Gains

 

With few exceptions, there are only three methods that a taxpayer
may utilize to reduce his income tax assessment. First, a taxpayer may
utilize devices to defer the payment of taxes, assuming a constant margi-
nal tax bracket. The advantage in this method lies not in reducing the
total number of tax dollars paid, but in the timing of the tax payment.
Given the choice between the payment of a dollar of income tax today and
a dollar of income tax a year from today, the knowledgeable taxpayer will

choose the latter because the present value of the dollar to be paid in

85
the future is less than the present value of the dollar to be paid today.
The deferred tax is equivalent to an interest free loan from the govern—
ment to the taxpayer and over time can become quite valuable because of
the mechanics of compound interest. There are many provisions in the
Internal Revenue Code which benefit the taxpayer by allowing him to defer
the payment of income taxes beyond the time that an economic gain has
arisen. Examples include the installment method of reporting gain on
deferred payment sales, tax free exchanges, and tax free reorganizations.
However, in addition to these rather obvious methods of deferring the
payment of income taxes is the not so obvious method resulting from the
accounting convention of realization, whereby taxable income is not
recognized until a taxable sale or exchange occurs.

The second method a taxpayer may use to reduce his income tax
assessment is to have economic enhancement taxed at less than the full
statutory rates. Examples include preferential treatment of capital
gains, the maximum tax on earned income, tax exempt income, and income
averaging. Each of these methods have in common the fact that income is
removed from the progressive tax rate schedule and taxed in a preferen-
tial manner.

The third method to reduce income taxes is also aimed at escaping
from the full effect of the progressive income tax rate schedule.

Devices used by taxpayers to obtain this goal include shifting income
from high tax bracket to low tax bracket years by controlling realization,
or moving income from high tax bracket entities to low tax bracket enti-
ties through the use of family partnerships, gifts in trust, and closely
held corporations, among others.

A problem, mentioned earlier, existed in the classification of

86

Code sections, Revenue Rulings, and court cases, because it was not
always possible to state that a particular section or ruling or court
case would have been unnecesSary if there were no special treatment of
capital gains and losses. The possibility existed that a particular pro-
vision was necessary in order to curtail all three of the general methods
a taxpayer uses to reduce his income taxes. However, by eliminating spe-
cial treatment of capital gains and losses, the pressure to utilize a
particular tax saving device would be reduced but not eliminated. An
example of his mentioned earlier is the penalty tax on the excess accu—
mulation of earnings. From a conceptual standpoint, it would be ideal
to be able to quantify the reduced pressure to use a particular tax
saving device if there were no special treatment of capital gains and
losses. Since this is not possible, the second classification used in
this study, capital gain and loss implications, but not 100% capital
gain and loss, was necessary.

Even though it is not possible to quantify the reduced pressure
to utilize a particular tax savings device, it is possible to measure
the relative importance, from a dollar standpoint, of the capital gains
advantage as opposed to the tax deferral advantage, holding a taxpayer's
marginal tax bracket constant. If a taxpayer acquires an investment at
the beginning of year 1, the following matrix (figure 2) indicates the
possible methods of taxing the appreciation of that investment. Cell all
is the ideal method of taxing income according to the Haig—Simone defini-
tion of income, that is, appreciation would be taxed annually as ordinary
income. Cell a22 is the method currently being used to tax appreciation,
that is, it is taxed only upon realization in a taxable transaction as

capital gain. If there were no special treatment of capital gains and

87
FIGURE 2

METHODS OF TAXING APPRECIATION

 

 

 

 

 

a11 a12
Ordinary income Capital gain
taxed annually taxed annually
321 a22
Ordinary income Capital gain
taxed upon taxed upon
realization realization

 

losses, but the realization convention remained, appreciation would be
taxed upon realization in a taxable transaction as ordinary income,

cell a The accumulation of $1 of investment after taxes at an annual

21'
rate of appreciation of 10%, marginal ordinary income tax rates of 30,

50, and 70%, and tax methods as indicated in cells a 21, and 2 f

11’ a 22 °

figure 2, is shown in table 5.

For example, at a marginal ordinary income tax rate of 50%, the
original $1 investment would accumulate to $34.1945 after taxes if
realized at the end of 40 years and the appreciation was taxed as long
term capital gain. 1f the appreciation was taxed as ordinary income
when realized at the end of the 40th year, the original $1 investment
would accumulate to $23.1297. If the appreciation was taxed annually as
ordinary income at a marginal tax rate of 50%, and the net of tax proceeds
reinvested, the original $1 investment would accumulate to $7.0400 at
the end of 40 years.

Total investment advantage is defined as (a21 « all). Using the

88

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umnu uomm mnu uooamou sown? Nmm was .mN .mH mum Ammmv Haoo you sofiumxmu mo mommy o>Huoommo onaea

.Hooo. umoumoo Ou popesou muanoam Ha<a

 

 

 

 

 

 

 

 

 

 

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coao.wa wo~m.a~ o~mo.¢~ noma.m NHmm.¢H manm.ma mmaw.~ ooam.m meno.oa mm
Humo.HH Humm.ma cumm.¢H mamm.m m<-.m oqam.NH m-a.~ mHNm.q mNHo.n om
ommm.n oo~m.m mmmm.m aonm.m q~am.m mamw.n wmmo.~ wowm.m ¢n~¢.m mm
mmmn.q oam~.m cwom.m mman.~ mmcm.m mmoo.m Hcow.H mmmo.~ nmom.m om
Nmoo.m mwmm.m ooo~.m Nmmm.H owwm.~ o¢NN.m owmn.H ammo.u ommn.m ma
mmmo.~ mmma.~ oqmm.~ Hwnq.a mcmn.a omHH.N amqm.a mmmo.a whom.a oH
womm.a mnm¢.H mem.H NmmH.H mmom.H a-¢.a mmmH.H mom~.H omoq.a m
omoo.H omno.H ommo.H oomo.H oomo.H oo~o.a oomo.H oomo.H oono.H H
mums»
New Now Non No“ Mom non Non Non Nom xma
Amumv .Aamov AHHmV
aaooaumufiHmou does oofiumwfiamou com: haamsoam woxmu
vmxmu meow Hmuaoou cease maooow humofieuo oaooaw humofivuo

 

 

 

 

 

«NON Qz< .0m .9m mo mm9<m x<H mZOUzH MM<ZHQKO A<ZHUM<Z Qz< NOH ho ZOHH<HUmmmm<

mo MH<M A<Dzz< z< H< mmmmw 2 mo nzm mm? H< mmx<H Muhm< Hzmszm>ZH me am no ZOHH<ADZDUU< mmH

m mam<a

89

above figures, total investment advantage is (34.1945 - 7.0400). It is
the difference between the amount of dollars that would accumulate by
the end of the 40th year if the investment was realized at the end of
the 40th year and the appreciation was taxed as long term capital gain,
and the amount of dollars that would accumulate by the end of the 40th
year if the 10% annual appreciation was taxed annually as ordinary
income and the proceeds, net of tax, reinvested. The investment advan-
). Using

tage attributable to the capital gain element is (a a

22 ' 21
the above figures, the investment advantage attributable to the capital
gain element is (34.1945 - 23.1297). It is the difference between the
amount of dollars that would accumulate by the end of the 40th year if
the appreciation was taxed as capital gain and the amount of dollars
that would accumulate by the end of the 40th year if the appreciation
was taxed as ordinary income. The investment advantage attributable to

the deferral element is defined as (a Again, using the above

21 ' 311)'
figures, the investment advantage attributable to the deferral element
is (23.1297 - 7.0400). It is the difference between the amount of
dollars that would accumulate at the end of 40 years if the appreciation
was realized and taxed as ordinary income at the end of the 40th year,
and the accumulated dollars at the end of 40 years if the appreciation
was taxed annually as ordinary income and the proceeds, net of taxes,
reinvested.

The percentage of investment advantage attributable to capital
gains is (a22 — a21)/(a22 «-a11 , which is the investment advantage
attributable to capital gains divided by the total investment advantage
(see table 6). 'The percent of investment advantage attributable to

deferral is (a all)’ which is the investment advantage

21 ' a11”“22 '

90

H 7

 

 

 

 

 

 

 

 

 

 

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mo.oo mw.mq mq.om amw¢.¢ cmmn.n mmoo.a nmow.ma woaw.ma coom.ma mm
qa.~o No.mq wq.mm mnmn.n <~HH.¢ «50¢.N wee~.m NmHo.m n¢om.n om
om.¢c nm.m¢ mm.nm -¢¢.m owmc.u ummq.a wme.m omwm.¢ Ham¢.m mu
mn.wo mm.mm mm.~¢ oeoo.~ mmam.a Hmmw. woam.~ mooe.~ swam.a om
wn.mn Hm.oo No.0m ONHH.H mean. come. mmom.H oqom.H oaam. ma
Ho.ow cm.on mo.Hc mumm. «mam. ommu. ammo. «can. anwm. OH
qm.aw mo.aw we.mn omam. onH. name. mnmm. mama. moaa. m
oo.ooa oo.ooa oo.ooH ammo. ommo. omHo. ommo. ommo. onHo. H
mummy
NON Now Non Now New Now Now Now Non wow
AHHm I Nva\AHNo I «Nov AHNm 1 «Nov
mofimw Hmuwmmo ou monw Hmufimmo AHHm I Numv
oaamusnwuuum owmuom>vm ou manmusnfiuuuo ammuom>vo

unmaumm>cfi mo unmouom

 

ammuam>mm unmaumo>oH

 

unoaumo>ofi Hmuoa

 

 

 

N2 8.2 .8 .8 mo memeofim as... 44253

mHHS mzH<U A<HHm<o OH mAm<HDmHmHH< mo¢Hz<>Q< HZHZHmm>zH

o mqm<a

91
attributable to deferral divided by total investment advantage.

As table 6 indicates, the relative investment advantage attri—
butable to capital gains increases as an individual's marginal tax
bracket increases. Consequently, it is the higher bracket taxpayer who
exerts the greatest amount of pressure on those provisions of the tax
law which allow him to realize capital gain instead of ordinary income.
As table 6 also indicates, the relative investment advantage attributable
to capital gains decreases the longer the asset is held, because the
longer it is held the more important the deferral advantage becomes. If
there were no special treatment of capital gains, the pressure by the
high bracket, short term investor to utilize those provisions which allow
him to recognize capital gains instead of ordinary income would disappear
completely. However, since the deferral advantage still remains, those
provisions in the tax law which have multiple objectives, such as the
penalty tax on an excess accumulation of earnings would have to remain.
However, since the capital gain advantage would no longer exist, tax-
payer pressure to utilize these provisions as a means of reducing their
income taxes would be diminished, and there would be less controversy
with resulting litigation and thus in one sense less complexity.

The percent of investment advantage attributable to capital
gains is illustrated in figure 3. The assumptions of figure 3 are iden—
tical to those in table 6. Curve A represents a marginal ordinary income
tax bracket of 70%, curve B a marginal ordinary income tax bracket of
50%, and curve C a marginal ordinary income tax bracket of 30%. It is
important to notice that although all three curves start out with an
investment advantage attributable to capital gains of 100%, at the end

of the first year, curve A whiCh represents a marginal ordinary income

92
FIGURE 3

THE PERCENT OF INVESTMENT ADVANTAGE ATTRIBUTABLE TO CAPITAL GAINS,
WITH MARGINAL TAX BRACKETS OF 30, 50, AND 70%

Percent

100 r

90 h

80 b

70 '

6O '

50 b

40 P B

30 '

20 '

10 -

 

1 1 1 A . 1 l in, Years

7

1 5 10 15 20 25 30 35 40
tax bracket of 70%, maintains a much higher proportion of investment
advantage attributable to capital gains by the end of the 40th year.
This indicates that there would be exerted much more pressure by those
in relatively high tax brackets to utilize those provisions which permit

the recognition of capital gains.

Statistical‘Measures

 

Since statistical sampling techniques were employed in this
study, it was first necessary to make certain decisions with respect to

sample precision and the desired level of confidence. These decisions

93
were particularly important because the size of the sample is directly
dependent on them; the narrower the required precision and the higher
the level of confidence, the larger must be the sample size. For exam—
ple, it would be meaningless to speak of an error range of sample results
which is as wide as i 30% or a confidence level of 80%. On the other
hand, in order to obtain a sample precision as narrow as i .5% and a
confidence level of 99%, the size of the necessary sample would be pro-
hibitive. With these constraints in mind a sample precision of i 5% and
a confidence level of 95% were chosen.

In addition to the required precision and confidence level, in
order to determine the necessary sample size, it was necessary to know
the population size and to estimate the maximum rate of occurence of the
characteristic of the population being measured. With regard to the
latter, the use of an estimated rate of occurence of 50% would be the
most conservative estimate possible, which would result in choosing the
largest sample necessary to obtain the desired precision at the required
confidence level. If the estimated rate of occurence is less than 50%,
the necessary sample size to obtain the desired precision and confidence
level would likewise be smaller.

Within the legislative area, the income tax provisions of the
Internal Revenue Code sections 1—1399, were surveyed on a 100% basis.
Within the administrative area, the published Revenue Rulings of the
Internal Revenue Service covering sections 1a1399 of the Internal Revenue
Code were examined on a random sample basis for the years 1964 through
1973.‘ Within the judicial area, court cases involving issues arising
under Code sections 1~l399 were examined for the period 1964 through 1973.

MemOrandum Tax Court, regular Tax Court, District Court, and Court of

94
Appeals decisions were examined on a random sample basis. Court of
Claims and Supreme Court deciSions were surveyed on a 100% basis.
Table 4 contains the population size, by years, of the administrative
and judicial sources of tax law. Table 4 contains only those Revenue
Rulings and court decisions which deal with problems arising from Code

sections 1—1399.

Sample Size

 

Using the statistical formulas (1) E = zafi and

 

(2) Bfi = Bji—P) 3:: the sample size was determined. The factor
N-

K:% is called the finite correction factor, needed for the case that
sampling is without replacement.

E = the maximum allowable error or the difference between the population
proportion and the sample proportion; i .05.

z = the normal deviate for a 95% confidence level; 1.96.

the estimated standard error of a proportion.

Q)
'0)
II

the sample proportion.

'6)
II

N = the population size.
n = the sample size.

As stated above, the sample size is dependent upon the estimated
population proportion of the characteristic being examined, with the
most conservative estimate being .5 which would result in the largest
sample. Since there was no prior information available as to the esti—
mated proportion of the characteristics of the population being examined,
a pilot study was made to determine this proportion. For the pilot study,
twenty Revenue Rulings and twenty court cases from each court category
were Selected on a random sample basis for each year 1964 through 1973.

The rulings and cases were analyzed to determine the proportion in each

95
of the three classification categories. With the information obtained
from the pilot study, it was determined that the maximum estimated pro—
portion of the characteristics being examined for purposes of determin-
ing the ultimate sample size was .30 for Revenue Rulings and memorandum
Tax Court decisions, and .40 for regular Tax Court, District Court, and
Court of Appeals decisions. Using .30 and .40 respectively, an ultimate
sample size of thirty per year or three-hundred was determined for
Revenue Rulings, memorandum Tax Court decisions, and regular Tax Court
decisions, and an ultimate sample size of thirty—one per year or three-
hundred ten was determined for District Court and Court of Appeals

decisions.

Sample Results

The three categories used to classify the Code sections, Revenue
Rulings, and court cases were: (1) 100% capital gain and loss, (2) capi-
tal gain and loss implications but not entirely capital gain and loss,
and (3) no capital gain and loss implications. As stated earlier, the
first category contains those sections, rulings, and cases that would
not exist were there no special treatment of capital gains and losses.
The second category contains those sections, rulings, and cases that
have capital gain and loss implications but may not be entirely elimi—
nated because of noncapital gain and loss considerations. In addition,
for court cases, the second classification contains those cases in which
there exist multiple issues, one or more of which.are wholly or partially
capital gain and loss issues, and one or more of the others, which are
not capital gain and loss issues. The third category contains those
sections, rulings, or cases that would have been unaffected were there

no special treatment of capital gains and losses.

96
The sample results for Revenue Rulings and court cases are
presented in Table 7, and for convenience, the first category is desig—
nated "all", the second categOry "some", and the third category "none".
The sample results for Court of Claims and Supreme Court decisions are
based on a 100% sample, that is, all cases were examined. The cases
and rulings selected for examination and the results of the analysis are

contained in appendix A.

TABLE 7

SAMPLE RESULTS BY YEAR FOR REVENUE RULINGS AND COURT CASES

 

 

Revenue Rulings:

 

1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 Total

 

All 0 0 1 l 2 2 2 0 3 3 14
Some 1 5 l 3 3 2 0 3 l l 20
None 29 25 28 26 25 26 28 27 26 26 266

 

Memorandum Tax Court:

 

1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 Total

 

All 1 3 2 l 3 l 1 2 0 3 17
Some 7 3 6 7 6 2 4 1 6 8 50
None 22 24 22 22 21 27 25 27 24 19 233

 

Regular Tax Court:

 

1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 Total

 

All 3 7 5 2 2 5 3 0 5 4 36
Some 5 3 6 4 8 7 2 5 8 4 52
None 22 20 19 24 20 18 25 25 17 22 212

 

District Court:

 

1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 Total

 

All 5 4 6 7 6 l 3 3 4 3 42
Some 3 8 5 5 4 7 7 6 7 6 58
None 23 19 20 19 21 23 21 22 20 22 210

 

97

TABLE 7 (Continued)

 

 

Court of Claims:

 

1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 Total

 

All 5 2 6 5 6 3 5 2 1 3 38
Some 1 2 1 ll 7 6 4 2 3 3 40
None 21 18 l8 17 20 19 20 11 15 18 177

 

Court of Appeals:

 

1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 Total

 

All 6 4 7 6 2 4 6 3 5 3 46
Some 5 3 6 5 6 7 3 2 5 4 46
None 20 24 18 20 23 20 22 26 21 24 218

 

Supreme Court:

 

1964 1965 1966 1967 1968 1969 1970 1971 .1972 1973 Total

 

All 0 3 3 0 l 0 1 O 0 0 8
Some 0 0 0 1 1 2 0 0 2 0 6
None 0 5 2 2 l 2 2 l 2 5 22

 

Research Results

 

The analysis of Code sections 1—1399 resulted in the examination
of 537 sections. Of these 537 sections, 44 or 8.19% would be completely
eliminated if there were no special treatment of capital gains and
losses, 174 or 32.59% have capital gain or loss implications although
they could not be completely eliminated, and 218 or 59.22% would be
unaffected by the elimination of special treatment of capital gains and
losses. The Code sections examined and the results of the examination
are listed in appendix B.

Within the administrative area of the tax law, Revenue Rulings
were examined on a stratified random sample basis. Therefore, it was
necessary to combine the sample results to obtain an unbiased estimate

of the population proportion. To accomplish this, the statistical

98

10 10
z p N / z N
h=l h h h=l h was used.

p = an unbiased estimate of the population proportion.

formula (3) p =

ph = the sample proportion of the characteristic being examined for the
hth strata, h being from one to ten years.

Nh

The unbiased estimate of the proportion of Revenue Rulings which would

the population size for the hth strata.

have been unnecessary if there were no special treatment of capital gains
and losses was .0546 or 5.46%. The unbiased estimate of the proportion
of Revenue Rulings which had capital gain and loss implications was .0624
or 6.24%.

Since a confidence level of 95% was specified, it was possible
to determine the estimated proportion of the characteristic being exa-
mined, and the 95% confidence interval. To accomplish this it was neces—
sary to compute an estimate of the standard error of a sample proportion

using the statistical formula:

A -A - 2
1 %0 ph(1 ph) "h “h Nh

h=1 “h Nh'l

 

 

(4) 8

fi = 10
Z N

h=1h

Where Gfi is an estimate of the standard error of a sample proportion,
and all other terms are as defined earlier.

The 95% confidence interval computed for the first category,
which contained those Revenue Rulings which would have been unnecessary
were there no special treatment of capital gains and losses, was .0546 i
.0267. Thus the precision actually obtained was much greater (the error
is smaller) than the originally required i .05. The 95% confidence inter-
val computed for the second category, which contained those Revenue

Rulings having capital gain and loss implications, was .0624 i .0267. If

99
the two categories were combined, that is, the combined category con-
sisted of Revenue Rulings that.were either 100% capital gain and loss,
or had capital gain and 1083 implications, the 95% confidence interval
for this new category would be .1170 i .0368.

Within the judicial area of the tax law, court cases were also
examined on a stratified random sample basis, so it was necessary to use
formula (3) in order to combine the sample results to obtain an unbiased
estimate of the population proportion. The results of these estimates
are presented in Table 8. As in the case Of Revenue Rulings, the 95%

confidence interval was computed for the court cases using formula (4).

TABLE 8

ESTIMATES OF THE PROPORTIONS OF COURT CASES WHICH WERE 100% CAPITAL
GAIN AND LOSS, HAD CAPITAL GAIN AND LOSS IMPLICATIONS,
OR BOTH, FOR THE PERIOD 1964 THROUGH 1973

 

 

 

All Some All + Some
Memorandum Tax Court .0572 .1619 .2191
Regular Tax Court .1161 .1736 .2897
District Court .1380 .1852 .3232
Court of Claims .1490 .1569 .3059
Court of Appeals .1511 .1480 .2991
Supreme Court .2222 .1667 .3889
All Court Cases Combined .1104 .1655 .2759

 

The results of this computation are shown in Table 9. It should be
noticed that in Table 9, there is no confidence interval around the
proportion for Court of Claims cases or Supreme Court cases. The reason
for this is that these proportions are the result of a 100% sample, there—

fore, there will be no sampling error.

100

TABLE 9

95% CONFIDENCE INTERVALS ABOUT THE ESTIMATED PROPORTIONS OF COURT
CASES WHICH WERE 100% CAPITAL GAIN AND LOSS, HAD CAPITAL GAIN AND
LOSS IMPLICATIONS, OR BOTH FOR THE PERIOD 1964 THROUGH 1973

 

 

 

_A11._ ' Some 1 x. All + Some
Memorandum.Tax Court .0572 i .0251 .1619 i .0384 .2191 i .0435
Regular Tax Court .1161 i .1318 .1736 i .0382 .2897 i .0455
District Court .1380 i .0349 .1852 i .0390 .3232 i .0472
Court of Claims .1490 i .0000 .1569 i .0000 .3059 i .0000
Court of Appeals .1511 i .0368 (.1480 i .0361 .2991 i .0466
Supreme Court .2222 i .0000. .1667 i .0000 .3889 i .0000
All Court Cases Combined .1104.i .0153 1.1655 i .0188 ..2759 i .0223

 

v V Viv.

Trends

In examining the various proportions resulting from the research,
the question naturally arises as to whether or not there was a discern—
able trend over the ten year period for Revenue Rulings and court cases.
In the case of Revenue Rulings, the following graph (figure 4) shows the
proportion of Revenue Rulings for each year which either would have been
unnecessary were there no special treatment of capital gains and losses,
or though necessary for other reasons, did have capital gain and loss

implications.

101

FIGURE 4

ESTIMATED PROPORTIONS OF REVENUE RULINGS WHICH WERE EITHER 100%
CAPITAL GAIN AND LOSS OR HAD CAPITAL GAIN AND LOSS
IMPLICATIONS, FOR THE PERIOD 1964 THROUGH 1973

Proportion

.12 ”

 

 

 

 

.10

.08

.06

.04

.02

Year
64 65 66 67 68 69 7o 71'72 73 '
100% capital gain and loss.
..... ._. capital gain and loss implications.

Figure 5 represents the two categories in figure 4 combined, that is, it
shows the estimated proportions of Revenue Rulings which.were 100% capi-
tal gain and loss plus the estimated proportions of cases which had capi-
tal gain and loss implications, even though for other reasons they would

not have been eliminated.

102
FIGURE 5
ESTIMATED PROPORTIONS OF REVENUE RULINGS WHICH WERE 100% CAPITAL GAIN
AND LOSS RULINGS PLUS THE ESTIMATED PROPORTIONS OF REVENUE RULINGS

WHICH HAD CAPITAL GAIN AND LOSS IMPLICATIONS, FOR THE PERIOD
1964 THROUGH 1973

Proportion

.16 P

.14 t

.12 P

.08 P

 

L n n. 1 1 1 1 1 1 41 Year
64 65 66 67 68 69 7O 71 72 73

In order to determine if there was a trend involved for the three cate—
gories, the proportions were combined into two periods, 1964 through 1968
and 1969 through 1973. The estimated proportions of cases in the three
categories, that is, the 100% capital gain and loss category, the capital
gain and loss implications category, and the combination of 100% capital
gain and loss and capital gain and loss implications category, are pre-

sented in Table 10.

103
TABLE 10
ESTIMATED PROPORTIONS OF REVENUE RULINGS WHICH WERE EITHER 100% CAPITAL

GAIN AND LOSS, HAD CAPITAL GAIN AND LOSS IMPLICATIONS, OR BOTH,
FOR THE PERIODS 1964 THROUGH 1968 AND 1969 THROUGH 1973

 

 

 

1964—1968 _ 1969-1973
100% Capital Gain and Loss .0362 .0661
Capital Gain and Loss Implications .0881 .0463
100% Capital Gain and Loss Plus
Capital Gain and Loss Implications .1243 . a .1124

 

v f

From Table 10 it appears that the trend for Revenue Rulings that
were 100% gain or loss was upwards; the proportion for the second five
year period being almost double that of the proportion for the first five
year period. The trend for the proportion of Revenue Rulings with capi-
tal gain and loss implications, however, was just the opposite; the
proportion for the first five year period being almost double that of the
proportion for the second five year period. For the two categories com-
bined, only a slight downward trend existed, reflecting the opposite
trends of the components of the third category.

In order to statistically test the existence of a trend, the
following three sets of hypotheses for the three categories of Revenue
Rulings are proposed:

(a) Ho: The proportion of Revenue Rulings for the period 1964 through
1968 which.were 100% capital gain and loss was the same as
the proportion of Revenue Rulings for the period 1969 through
1973 which were 100% capital gain and loss. p1 = p2.

H1: The proportion of Revenue Rulings for the period 1964 through
1968 which were 100% capital gain and loss was less than the
proportion of Revenue Rulings for the period 1969 through
1973 which.Were 100% capital gain and loss; there was an
upward trend. p1 < p2.

At the 5% level of significance, the decision criteria are: reject Ho

if z < -l.64; accept Ho if z 2 -1.64 where

104

p = the estimated proportion of Revenue Rulings for the period 1964
through 1968.

p = the estimated proportion of Revenue Rulings for the period 1969
through 1973.

= the estimated standard error of the difference of sample

8. .
p1—p2 proportions.

Since p = .0362, p = .0661, and 8. A = .0260, then 2 = —l.15. Since
1 2 pl—p2
z (-1.15) is not less than Za (-l.64), accept Ho. The test does not show

that the proportion of Revenue Rulings which were 100% capital gain and
loss rulings for the period 1964 through 1968 was significantly less
than the proportion of Revenue Rulings which were 100% capital gain and
loss rulings for the period 1969 through 1973.

(b) H0: p1 = p2 for Revenue Rulings which had capital gain and loss
implications, but were not 100% capital gain and loss
rulings.

P1 > P2-

At the 5% level of significance, the decision criteria are: reject H0
if z > 1.64; accept Ho if z 5 1.64. Since p1 = .0881, p2 = .0463, and

A

ofi1_fi2 = .0288, then 2 = 1.45. Since 2 (1.45) is not greater than
za (1.64), accept Ho. The test does not show that the proportion of
Revenue Rulings which had capital gain and loss implications for the
period 1964 through 1968 was significantly greater than the proportion

of Revenue Rulings for the period 1969 through 1973.

(c) Ho: p1 = p2 for Revenue Rulings which were 100% capital gain and loss

rulings, plus those which had capital gain and loss
implications.

At the 5% level of significance, the decision criteria are: reject H0 if

z > 1.64; accept Ho if 2 S 1.64. Since p1 = .1243, p2 = .1124, and

105

A

081452 = .0377, then 2 = .3156. Since 2 (.3156) is not greater than
2a (1.64), accept HQ.- The test does not show that the two proportions
were significantly different. In the three categories, therefore, there
was no statistically significant trend either upward or downward at the
5% level of significance.

For all court cases combined, diagrams similar to figures 4 and
5 show the proportion of court cases in the three categories for the ten
year period examined.

FIGURE 6

ESTIMATED PROPORTIONS OF ALL COURT CASES WHICH WERE EITHER 100% CAPITAL

GAIN AND LOSS CASES OR HAD CAPITAL GAIN AND LOSS IMPLICATIONS
FOR THE PERIOD 1964-1973

Proportion
.20 ’
.18 ’

.16 5

.14 "

.12 '

.10 '

 

 

l l L l _._.. 1 l l L l

2i:5 Year

64 65 66- 67 68 69 70 71 72 73

_ 100% capital gain and loss
_ ....... Capital gain and loss implications

106
FIGURE 7

ESTIMATED PROPORTIONS OF COURT CASES WHICH WERE 100% CAPITAL GAIN AND
LOSS CASES PLUS THE ESTIMATED PROPORTIONS OF COURT CASES WHICH HAD
CAPITAL GAIN AND LOSS IMPLICATIONS, FOR THE PERIOD 1964-1973

Proportion

.35-

.33 w

031'.

.29 P

.27 B

.25 -

.23 r

.21 -

.19 r

.17 -

 

I J 1 L 1 1 1 1 1 1 Year
64 65 66 67 68 69 70 71 72 73

As with Revenue Rulings, in order to determine if there were any
trends involved, the proportion of cases in the three categories were
combined into two time periods, 1964 through 1968 and 1969 through 1973.
The results of this consolidation are shown in table 11.

As indicated by table 11, the proportion of court cases for the

107

TABLE 11

ESTIMATED PROPORTIONS OF ALL COURT CASES COMBINED WHICH WERE 100% CAPITAL
GAIN AND LOSS CASES, HAD CAPITAL GAIN AND LOSS IMPLICATIONS, OR
BOTH, FOR THE PERIODS 1964 THROUGH 1968 AND 1969 THROUGH 1973

w ‘7‘ f

 

Vii ‘—

 

1964u1968 1969-1973
100% Capital Gain and Loss .1304 .0909
Capital Gain and Loss Implications .1742 .1567
100% Capital Gain and Loss plus
Capital Gain and Loss Implications .3046 , .2476

second five year period was less than the proportion of cases for the

first five year period in all three classification categories. As with

Revenue Rulings, it is possible to statistically test whether or not the

trend is significant. The following three sets of hypotheses are proposed:

(a) Ho: The proportion of court cases for the period 1964 through 1968
which were 100% capital gain and loss was the same as the pro-
portion of court cases for the period 1969 through 1973 which
were 100% capital gain and loss. p1 = p2.

H1: The proportion of court cases for the period 1964 through 1968
which were 100% capital gain and loss was greater than the pro-
portion of court cases for the period 1969 through 1973 which
were 100% capital gain and loss. p1 > p2.

At the 5% level of significance, the decision criteria are: reject Ho
if z > 1.64; accept Ho if 2 S 1.64. Since p1 = .1304, 62 = .0909, and
dfi -fi = .0155, then 2 = 2.5484. Since 2 (2.5484) is greater than

1 2
za (1.64), H0 is rejected. The test shows that the proportion of court
cases for the period 1964 through 1968 which were 100% capital gain and
loss cases was significantly greater than the proportion of court cases

for the period 1969 through 1973 which were 100% capital gain and loss

cases, thus, there was a statistically significant downward trend.

(b) H0:* p1 = p2 for court cases which had capital gain and loss impli-
cations but were not 100% capital gain and loss cases.

H1: p1 > p20

108
At the 5% level of significance, the decision criteria are: reject Ho
if z > 1.64; accept HQ if z 3 1.64.. Since p1 = .1724, p2 = .1567, and
661-62 = .0193, then 2 = .9067. Since 2 (.9067) is not greater than
za (1.64), H0 is accepted. There is no significant difference between
the proportion of cases with capital gains implications for the periods
1964 through 1968 and 1969 through 1973, thus, there was not a statisti—
cally significant downward trend.
(c) Ho: p1 = p2 for court cases which were 100% capital gain and loss

plus court cases which had capital gain and loss
implications.

H1: p1 > p2.
Since 6 = .3046, p = .2476, and 6. a = .0229, then 2 = 2.4891. Since
1 2 pI—p2
2.4891 is greater than 1.64, H0 is rejected. The downward trend, between
the two periods 1964 through 1968 and 1969 through 1973 for the combi-
nation of 100% capital gain and loss cases and capital gain and loss

implication cases, was statistically significant at the 5% level of

significance.

Relative Importance of the Categories

 

If the two categories, 100% capital gain and loss and capital
gain and loss implications, are compared, it can be seen that the esti-
mated proportion in the first category is smaller than the estimated
proportion in the second category for both Revenue Rulings and all court
cases combined (see table 12). It is possible to test whether or not
the difference in the estimated proportion is statistically significant,
that is, whether or not the capital gain and loss implication category
contained a greater proportion of Revenue Rulings or court cases than

the 100% capital gain and loss category.

109
TABLE'12
ESTIMATED PROPORTIONS OF REVENUE RULINGS AND COURT CASES IN THE

CATEGORIES 100% CAPITAL GAIN AND LOSS, AND CAPITAL GAIN
AND LOSS IMPLICATIONS -

 

 

. Revenue Rulings _ Court Cases
100% Capital Gain and Loss .0546 .1104

Capital Gain and Loss Implications .0624 .1655

 

For Revenue Rulings:

Ho: P1 = p2

where p1 = the proportion of Revenue Rulings in the capital gain and
loss implication category and p2 = the proportion of Revenue Rulings in
the 100% capital gain and loss category. At the 5% level of signifi-
cance, the decision criteria are: reject Ho if z > 1.64; accept Ho if
z s 1.64. Since p1 - .0624, p2 = .0546, and 6fi1_fi2 . .0192, then 2 =
.4623. Since 2 (.4623) is not greater than za (1.64), H0 is accepted.
The proportions of Revenue Rulings in the two categories were not signi-
ficantly different.

For court cases:
Ho: P1 = p,
H1: p1 > p2
where p1 = the proportion of court cases in the capital gain and loss
implication category, and p2 = the proportion of court cases in the 100%

capital gain and loss category. Since pl = .1665, 82 = .1104, and

831_§2 = .0124, then 2 = 4.44.. Since 2 (4.44) is greater than za (1.64),

H0 is rejected. At the 5% level of significance, there was a significantly

larger proportion of court cases with capital gain and loss implications

110
than court cases which were 100% capital gain and loss.

Not only can the relative importance of the two categories be
measured for each of the Sources of tax law, but also the relative
importance of each source of tax law within each category can be
measured. From Table 13 it can be seen that within the category 100%
capital gain and loss, the judicial source of tax law was the most impor—
tant in terms of the proportion, and the administrative source the least
important. In the category capital gain and loss implications, the
legislative source of tax law predominated in terms of the proportion

while the administrative source was the least important.

TABLE 13

RELATIVE IMPORTANCE OF THE LEGISLATIVE, ADMINISTRATIVE, AND JUDICIAL
SOURCES OF TAX LAW WITHIN THE CATEGORIES 100% CAPITAL GAIN AND
LOSS, AND CAPITAL GAIN AND LOSS IMPLICATIONS

 

 

 

100% Capital Gain and Loss Capital Gain and Loss Implications
Judicial .1104 Legislative .3259
Legislative .0819 Judicial .1655
Administrative .0546 Administrative .0624

 

The question arises as to whether or not these differences were statis-
tically significant within the two categories. Using the test for the
difference in sample proportions, each difference was statistically sig-
nificant at the 5% level of significance for both categories. In the
category 100% capital gain and loss, from the standpoint of the propor-
tion of court cases, Code sections, and Revenue Rulings, the judicial
source of tax law was the most important, and the administrative source
the least important. In the category capital gain and loss implications,
the legislative source of tax law was the most important and the adminis-

trative source again the least important.

111

Interpretation of the Researeh Results

 

The interpretation of the results of the research for the legis-
1ative sources of tax law (Internal Revenue Code) is relatively straight—
forward. If there were no special treatment of capital gains and losses,
44 Code sections or 8.19% of all Code sections dealing with the federal
income tax could be excised from the tax law. In addition, there are
175 sections or 32.59% of all Code sections dealing with the federal
income tax which have capital gain and loss implications even though
they could not be completely eliminated because of other considerations.
If the two categories are combined, a total of 219 sections or 40.78%
of all Code sections dealing with the federal income tax are affected
in some way by the concept of capital gain and loss. This is a quanti-
tative measurement of the importance of capital gain and loss provisions,
nothing has been said about the qualitative characteristics of these
capital gain and loss provisions. From a qualitative standpoint, these
capital gain and loss sections represent some of the most difficult to
apply provisions in the Code-~ranging from the complex computational
difficulties associated with the alternative tax on long-term capital
gains to the intricate rules associated with sales of property to deter-
mine whether or not the property was held "primarily for sale to cus-
tomers in the ordinary course of business." Thus, not only are the
capital gain and loss provisions important from a quantitative stand—
point, they are also important qualitatively.

The interpretation of the research results for the administrative
area is somewhat less straightforward than for the legislative area
because the technique of stratified random sampling was used as opposed

to an examination of the entire population. The effect of using a

112

sampling technique as opposed to a 100% examination is that the results
are stated in terms of an unbiased estimate of the population proportion
around which a confidence interval is constructed. For Revenue Rulings
sampled, the estimated population proportion of Revenue Rulings that
were 100% capital gain and IOSS'WaS 5.46% with a 95% confidence interval
of .0279-.0813. For Revenue Rulings that had capital gain and loss
implications but could not be completely eliminated if there were no
special treatment of capital gains and losses, the estimated population
proportion was 6.24% and the 95% confidence interval was .0357-.0891.
For the two categories combined, the estimated population proportion was
11.70% and the 95% confidence interval was .0802-.1538.

In all categories, there were statistically significantly less
Revenue Rulings dealing either directly or indirectly with capital gain
and loss provisions than is the case with either Code sections or court
cases. This can probably be accounted for by the fact that Revenue
Rulings are only one source, and not even the most important source, of
tax law within the administrative area. The primary source for guidance
as to the position of the Treasury Department in the interpretation of
the Internal Revenue Code lies in their Regulations program. Since the
Regulations are correlated with the Code, the results of the examination
of the Code could also serve as an approximation of the proportion of
Regulations affected by capital gain and loss issues. If the position
of the Treasury relative to capital gain and loss issues is thoroughly
presented in the Regulations, there would be no reason to reiterate that
position by way of Revenue Rulings. Therefore, there would be a rela—
tively small proportion of Revenue Rulings dealing with capital gain and

loss issues.

113

For the judicial source of tax law, the interpretation of results
is similar to that of the Revenue Rulings—~there was an estimate of the
population proportion around which a confidence interval could be con-
structed. .The estimated population proportion and the 95% confidence
level for each type of case was presented in Table 9. For the category
100% capital gain and loss cases, the estimated population proportions
ranged from a low of 5.72% for memorandum Tax Court cases to a high of
22.22% for Supreme Court cases. For the category capital gain implica-
tion cases, the estimated population proportions ranged from a low of
14.80% for Court of Appeals cases to a high of 18.52% for District Court
cases. For the two categories combined, the estimated population propor-
tions ranged from a low of 21.91% for memorandum Tax Court cases to a
high of 38.89% of Supreme Court cases.

If all court cases are combined, the estimated population propor-
tion for 100% capital gain and loss cases was 11.04%, the estimated
population proportion for capital gain and loss implication cases was
16.55%, and for the two categories combined, the estimated population
proportion was 27.59%. The proportion of court cases which were 100%
capital gain and loss was significantly larger at the 5% level of signi-
ficance than either Code sections or Revenue Rulings in that category.
The prOportion of court cases that have capital gain and loss implica-
tions was significantly larger at the 5% level of significance, but
significantly smaller than Code sections in that category. Thus from a
relative standpoint, court cases had the greatest impact in the 100%
gain and loss category, but were second in importance to Code sections
in the Capital gain and loss implication category (see table 11).

A final word of caution in interpreting the research results

114
should be mentioned. For Revenue Rulings and court cases, historical
data provided the raw material for the research. This hiStorical data
cannot necessarily be relied upon as a prediction of the future. To
illustrate, when Supreme Court cases were examined and analyzed, it was
determined that 22.22% of the cases were 100% capital gain and loss cases.
This does not mean that in the future 22.22% of all Supreme Court cases
will be 100% capital gain and loss cases. This is particularly true for
Supreme Court cases, since once an issue is settled by the Supreme Court,
it becomes the law of the land and must be followed by everyone. That
particular issue will not come before the Supreme Court again. Even with
this caveat in mind, it can be seen that capital gain and loss provi-
sions do have a significant impact upon our tax laws from a quantitative

standpoint certainly, and probably also from a qualitative standpoint.

FOOTNOTES CHAPTER IV

lMitchell Rogovin, "The Four R's: Regulations, Rulings,
Reliance, and Retroactivity-—A View from Within," Standard Federal Tax
Reporter, Vol. 6 (1973) : 67,035.

2Ibid.

3Ibid., p. 67,040.

4Bullen v. State of Wisconsin, 240 U.S. 625, 630—31 (1916).

 

5Specifically, it is the position of the Internal Revenue Service
that these sources of information are exempt from the disclosure require-
ments of the Freedom of Information Act, 5 U.S.C. 552, in accordance with
subsections (b)(3) as specifically exempted from disclosure by statute,
including 26 U.S.C. 6103 and 7213 and 18 U.S.C. 1905, (b)(4) as trade
secrets and commercial or financial information obtained from a person
and privileged or confidential, (b)(5) as inter-agency or intra-agency
memoranda or letters which would not be available by law to a party other
than an agency in litigation with the agency and (b)(7) as investigatory
records compiled for law enforcement purposes.

115

CHAPTER V

RECOMMENDATIONS

Summagy

The purpose of this study was to examine the various sources of
tax law with a view towards determining the effect that the capital gain
and loss provisions have on the scope and complexity of the federal
income tax law. The Internal Revenue Code, published Revenue Rulings of
the Internal Revenue Service, and federal court cases were selected for
examination from the legislative, administrative, and judicial branches
of government respectively. The Code sections examined were limited to
those dealing with the federal income tax, sections 1-1399. The Revenue
Rulings and court cases examined were limited to those dealing with prob-
lems arising under Code sections 1—1399. In addition, the Revenue Rulings
and court cases examined were limited to the ten year period 1964 through
1973. The Code sections examined were classified into three categories,
(1) those Code sections which would be completely eliminated if there
were no special treatment of capital gains and losses, (2) those Code
sections which have capital gain and loss implications, but for other
reasons could not be completely eliminated if there were no special treat-
ment of capital gains and losses, and (3) those Code sections which are
not affected by special treatment of capital gains and losses. Similarly,
Revenue Rulings and court cases were examined and classified into three
categories, (1) those Rulings or cases which Would have been unnecessary
were there no special treatment of capital gains and losses, (2) those

116

117
Rulings or cases which have capital gain and loss implications, but for
other reasons would still have been necessary even if there were no
special treatment of capital gains and losses, and (3) those Rulings or
cases which would have been unaffected by elimination of special treat—
ment of capital gains and losses. The results of the examination are
presented in table 14 and for convenience, category (1) is labeled "all,"

1

category (2) "some,' and category (3) "none."

TABLE 14

PERCENTAGE OF CODE SECTIONS, REVENUE RULINGS, AND COURT CASES
IN THE THREE CLASSIFICATION CATEGORIES

 

 

 

A11 Some None
Code Sections 8.19 32.59 59.22
Revenue Rulings 5.46 6.24 88.30
Court Cases 11.04 16.55 72.41

 

The research results for Code sections are the consequence of a
100% sample of all Code sections dealing with the federal income tax,
sections 1-1399. The research results for Revenue Rulings are the conse-
quence of a stratified random sample of Revenue Rulings for the time
period 1964—1973, with each year representing a different strata. For
court cases, the research results are the consequence of combining the
research results for the various types of court decisions, memorandum
Tax Court, regular Tax Court, District Court, Court of Claims, Court of
Appeals, and Supreme Court, for the time period 1964-1973. The Court of
Claims and Supreme Court decisions were examined on a 100% sample basis.
The other court decisions were examined on a stratified random sample
basis, with each year representing a different strata.

Since Revenue Rulings and court cases were examined for the 10

118
year period 1964-1973, it was possible to divide both of them into two
five year periods, 1964vl968 and 1969—1973, in order to determine if
there were any statistically significant trends. For Revenue Rulings,
there were no statistically significant trends for the categories all,
some, and the category all plus some combined, at the 5% level of signi—
ficance. For all court cases combined, there was a statistically signi-
ficant downward trend for the categories all and all plus some, at the
5% level of significance. For the category some, taken by itself, there
was no statistically significant trend at the 5% level of significance.
The partial downward trend for all court cases combined can perhaps be
explained by the fact that the longer a tax provision remains a part of
the tax law, the more settled the legal principles become, resulting in
a reduced likelihood of controversy.

The question of whether or not there would be a significant
reduction in the complexity of the federal income tax law if there were
no special treatment of capital gains and losses naturally arises. In
examining table 14, the proportions in the category all, containing those
Code sections, Revenue Rulings, and court cases which would be unnecessary
if there were no special treatment of capital gains and losses, range
from a low of .0546 for Revenue Rulings to a high of .1104 for court
cases. In addition, for the category "some" the proportions range from
a low of .0624 for Revenue Rulings to a high of .3259 for Code sections.

In interpreting the significance of these proportions, it would
be a mistake to underestimate their addition to the complexity of the
tax law. The proportions obtained are a relatively crude measure of the
complexity added to the federal income tax law by the Capital gain and

loss provisions. As stated in chapter III, there is much complexity

119

which is strictly the result of the revenue raising function of the
federal income tax, and thus can not be eliminated. Examples include
the requirement that returns be filed annually, the requirement that
different entities be taxed differently, the political necessity for a
progressive tax rate structure, etc. In addition to complexity which is
unavoidable, there exists avoidable complexity evidenced by what has
been called the "tax expenditure apparatus." It is this avoidable com-
plexity, of which the capital gain and loss provisions are a part, which
offers the greatest hope for simplification. Although the proportions in
table 14 may appear relatively small when based upon the total amount of
complexity in the tax law, it may be that when taken as a proportion of
avoidable complexity, rather than total complexity, the capital gain and
loss provisions make up a significant proportion of this avoidable com-
plexity. And it is this avoidable complexity which makes the tax law
needlessly complex.

The cost of complex tax laws is unmeasurable in terms of dollars.
However, it is undoubtedly very large. There are the substantial admi-
nistrative costs of communicating the tax laws, collecting the tax,
auditing the returns, and investigating and prosecuting tax evaders. In
addition, on the part of the taxpayer, there are equally substantial
costs of complying with income tax laws. These costs include record—
keeping, filing of returns, and dealing with tax audits with their atten-
dant controversy. For the taxpayer, there are also costs which must be
periodically incurred to become acquainted with ever changing statutory
provisions, to hire expert advisors, or in the absence of these, the cost
of inadvertantly overpaying one‘s taxes. A non—monetary cost associated

with complex tax laws is the effect on taxpayer morale. This cost is

120

potentially the most important, particularly in view of the fact that our
tax system is based upon selfvassessment by the taxpayer and thus is
heavily dependent upon taxpayer goodwill for its efficient operation.
It is difficult to judge the fairness of complex tax provisions because
of the inability to accurately determine the relative tax burdens of
taxpayers. And if a taxpayer believes, either rightly or wrongly, that
the tax system is not fair, he may feel justified in being less than
honest in computing his tax liability. If this attitude became wide-
spread, it would result in the demise of our federal income tax system
as it exists today.

What is the cause of complexity in our federal income tax system?
The answer to this question in a word is distinctions. Whenever a dis—
tinction is made in tax law, it is equivalent to drawing a line, and once
this line is drawn it must be decided upon which side of the line a tax-
payer or a transaction falls. This decision, in turn, may have signifi—
cant economic consequences for a taxpayer. One example of a distinction
which adds complexity to the tax law is the additional $750 exemption for
blind taxpayers. Superficially this distinction would not appear to add
a great deal of complexity to the tax law. However, it is not absolutely
necessary to be sightless in order to obtain the benefit of the additional
blindness exemption. The statute provides that a taxpayer whose vision
in the better eye is no better than 20/200 with corrective lenses or whose
vision subtends an angle no greater than 20° shall be considered to be
blind for purposes of the blindness exemption:1 Even these very objective
tests were not enough to prevent controversy between the taxpayer and the
government. A taxpayer was held by the Tax Court to be entitled to the

blindness exemption even though his vision was better than 20/200 with

121
corrective lenses.2 The taxpayer‘s argument, with which the court agreed,
was that there was actual physical discomfort in the form of headaches
from.wearing corrective lenses which were extremely heavy and cumbersome.
Thus, the Tax Court introduced the subjectivity of physical discomfort
into what started out as a very objective condition, blindness. There-
fore, the effect of the blindness exemption is to add complexity to an
already complex tax law.

The original rationale for granting this additional exemption was
to partially compensate blind taxpayers for increased living costs occa—
sioned by their blindness. It is usually argued in general that this
type of provision accounts for the different circumstances of taxpayers,
and is thus more fair than a tax system which does not account for such
differences. However, this rationale ignores two important points.
First, the taxpayer who is in the greatest need of economic assistance
receives the least assistance, that is, the monetary benefit of the
additional blindness exemption varies directly with the marginal tax
bracket of the taxpayer. This, of course, is the consequence of our
progressive tax structure. For the blind taxpayer in the 70% tax bracket,
which for a married individual filing a joint return starts at taxable
income in excess of $200,000, the additional $750 exemption means a tax
savings of $525. For the blind taxpayer in the zero percent tax bracket
the additional $750 exemption results in a tax saving of zero. Thus, a
tax provision designed to assist the blind has the effect of granting the
greatest assistance to the wealthiest taxpayer, and the least assistance
to those in greatest need. The second point to consider when judging
the fairness of this particular provision is its selectivity. If a blind

person deserves an additional exemption, is not a deaf person or a person

122
with some other mental or physical handicap equally deserving? On the one
hand, it would be difficult to answer this question negatively, but on the
other hand, it would be an impossible task to design a tax system.which
accounts for the many different circumstances of the taxpaying public.
In addition, each time the tax base is eroded through special exemptions,
deductions, exclusions, credits, etc., the lost revenues must be made up
from some other source. The tax burden is merely shifted to another
group of taxpayers not eligible for special treatment. Given the
differing tax impact on taxpayers which is a consequence of our progres-
sive tax rate structure, and the selectivity of special tax provisions,
it is highly doubtful that these types of provisions improve the fairness
of our income tax system.

Another difficulty involved is that in order to account for the
differing circumstances of taxpayers, it is necessary to define what is
meant by circumstances. A common denominator is needed in order to
properly measure the economic circumstances of a diverse taxpaying popu—
lation. The common denominator used should be the dollar, and the concept
of income used to measure taxpaying capacity should be the accretion con—
cept of income. Under the accretion concept of income, taxpaying capacity
is measured by a taxpayer's consumption for a period of time plus or
minus his change in net worth for that period. This concept of income
treats all income in an identical fashion without regard to source of
income. In addition, no deductions for expenditures are allowed which

are not incurred in the earning of income.

Primarngecommendation

 

The primary recommendation is that special treatment for capital

gains and losses be eliminated. The reasons for this recommendation are

123

twofold. First, the complexity of the federal income tax is greatly
intensified by the existence of these special provisions.‘ This fact is
evidenced by the results of this research. For the Internal Revenue
Code, over 40% of the income tax sections are directly or indirectly
affected by the capital gain and loss provisions. In addition, for

court cases, it was estimated that almost 30% of the cases dealing with
the federal income tax for the period 1964 through 1973 dealt directly

or indirectly with capital gains and losses. These are significant
proportions particularly in light of the fact that a great deal of Code
sections and court cases are concerned with what was called the revenue
raising function of the income tax, and thus are an unavoidable source of
complexity. Unavoidable complexity is contrasted with complexity
resulting from special exemptions, deductions, exclusions, credits, etc.,
which are unrelated to the revenue raising function of the income tax.

If capital gain and loss sections, cases, or rulings, were measured as a
proportion of avoidable complexity, the resulting proportions would
certainly be a great deal larger.

The second reason for recommending the elimination of special
treatment of capital gains and losses is that these provisions result in
a most unfair tax law. The two concepts of equity which apply to income
taxation are the concepts of horizontal and vertical equity. Horizontal
equity implies the similar taxation of those in similar economic circum—
stances, and vertical equity implies different taxation for those in
different economic circumstances. The capital gain and loss provisions
violate both of these concepts of equity. By taxing capital gains and
losses in such a radically different manner than ordinary gains and

losses, thoSe in similar economic circumstances are not taxed similarly

124
and those in different economic circumstances are not taxed differently.
This is a consequence of violating the dollar as the common unit of
measure by treating a dollar of capital gain or loss differently than a
dollar of ordinary gain or loss. By way of contrast, the accretion con-

cept of income treats all accretions to economic power in the same manner.

Additional Recommendations

 

A major requirement of the accretion concept of income is that
assets and liabilities be valued at periodic intervals in order to deter—
mine the change in net worth for the period. Since a periodic revalua-
tion would result in tremendous administrative and compliance difficulties,
it is proposed that the accounting convention of realization be maintained
for tax purposes. Thus, gain or loss would be deferred until the point
of time or realization. This proposal should be recognized as a depar-
ture from the accretion concept of income made necessary for purposes
of administrative convenience and not as a part of the income concept
itself.

If the realization convention is maintained for tax purposes in
combination with full taxation of capital gains and losses, the lock-in
effect would become intolerable. As discussed in chapter 11, the lock-in
effect is the tendency for investors to avoid recognition of gains on
appreciated assets by not realizing those gains. The lock-in effect is
the consequence of the tax differential between selling an appreciated
asset and holding that asset.4 The effect is further aggravated by the
federal income tax provisions allowing appreciated property to pass to
beneficiaries of a taxpayer at a "steppedeup" basis, thus avoiding
permanently any income taxes on the appreciation of property prior to the

date of a taxpayer's death.‘ In order to reduce the strength of the

125

lock-in effect, it is necessary to reduce the tax differential between
holding and selling an asset. ‘This can be accomplished by requiring all
appreciation of an asset to be taxed to the holder of the asset. In
order to accomplish this, two changes in the tax law are proposed,

(1) tax all unrealized appreciation to the owner of an asset at the date
of death of the taxpayer, and (2) tax all unrealized appreciation to the
donor of an asset at the date of gift. These proposals would alleviate
the lock-in problem because a taxpayer would be certain that all appre—
ciation would eventuallbee taxed to him. The first proposal would be
particularly effective in unlocking the portfolio of the elderly taxpayer
since the strength of the lock—in effect varies directly with the age of
the taxpayer. The only advantage remaining to the taxpayer, if these
proposals were adopted, would be the advantage of tax deferral, which
could be eliminated by charging interest on unrealized appreciation at
the time of realization.

Another major argument against taxing capital gain in full is
that it would be unfair to tax the appreciation of an asset in the year
of realization at progressive income tax rates, when the rise in asset
value has taken place over a number of years. While there is merit in
this argument, there are income averaging provisions available to tax-
payers in the current tax law to alleviate this difficulty. If it was
felt necessary to grant further relief, income averaging provisions could
be liberalized to permit the spreading of a gain over the number of years
an asset was held. This latter proposal has the additional benefit of
, granting the greatest amount of relief to the taxpayer who has held an

asset for the greatest amount of time.

126

Possibilitiesfifor Future Research

 

The results of this research suggest two possibilities for future
research. First, if there were no special treatment of capital gains
and losses, it would be possible to eliminate the corporate income tax,
except perhaps as a withholding device. This possibility exists because
the income of a corporation would be taxed either as ordinary income
when a dividend is paid, or as ordinary income when corporate securities
were sold. Thus, the income of a corporation would always be taxed to
the owners of the stock of the corporation, either as a dividend, or as
the gain from the sale of stock in the corporation which has chosen to
retain its income, as opposed to paying a current dividend. The possi-
bility for future research in this instance lies in examining the extent
to which the sources of tax law would be simplified if the corporate
income tax were eliminated. The second possibility for future research
results from the fact that a major first step towards a comprehensive
income tax base would be taken if special treatment of capital gains and
losses were eliminated. A possibility for future research is the exami-
nation of the sources of federal income tax law to determine the amount
of complexity which is the result of using the federal income tax for pur-
poses other than revenue raising. In effect, the goal of such a study
would be to classify the sources of complexity in the tax law into avoid-
able and unavoidable complexity. The results of such research would pro—
vide a rough approximation of the price we are paying for allowing our

income tax system to be used for other than revenue raising functions.

Conclusion

VWV

 

It is the contention of many knowledgeable tax experts that our

federal income tax laws are in general too complicated, and the capital

127

gains area in particular is especially complex. This study has provided
a measure of the complexityresulting from special treatment of capital
gains and losses. However, increased complexity is not the only result
of the capital gain and loss provisions. In addition, there is the
effect of such provisions on the equity of the tax system. The capital
gain and loss provisions do damage to the principles of both horizontal
and vertical equity. Thus, not only are these provisions a complicating

factor in our tax law, but they also result in a less equitable tax law.

FOOTNOTES CHAPTER V

1Internal Revenue Code, Sec. 15l(d)(3).

 

2E. Hollman v. Commissioner, 38 T.C. 251.

 

128

APPENDICES

APPENDIX A

APPENDIX A

COURT CASES AND REVENUE RULINGS SELECTED FOR EXAMINATION
AND THE RESULTS OF THE EXAMINATION

The Revenue Rulings selected for examination were taken from the

Internal Revenue Cumulative Bulletin for the years 1964-1973. A sample

 

of thirty was selected for each year and classified according to whether
they would be unnecessary were there no special treatment of capital gains
and losses (All), whether they have capital gain and loss implications
though they would not be able to be eliminated (Some), or whether they
have no capital gain or loss implications (None). Memorandum Tax Court
decisions are from Commerce Clearing House' Tax Court Memorandum Decisions,
Regular Tax Court decisions are from the United States Tax Court Reports
published by the U. S. Government Printing Office, and all other court

cases are from Commerce Clearing House' United States Tax Cases.

129

Revenue Rulings

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenue Revenue Revenue
Ruling All Some None Ruling All Some None Ruling, All Some None
1964-31 egg, 1965- 5 ,__ x 1966-28 x
47 - 3g 10 x 34 x
54 x 20 x 45 x
55 x 21 x 51 x
63 x 58 x 70 x
70 x 80 x 101 x
71 x 81 x 106 x
89 x 83 x 138 x
90 x 105 x 143 x
108 x 107 x 145 x
127 x 109 x 156 x
174 x 117 x 207 x
193 x 143 x 209 x
198 x 162 x 220 x
212 x 201 x 224 x
218 x 228 x 251 x
221 x 235 x 263 x
222 x 241 x 266 x
224 x 259 x 282 x
225 x 270 x 314 x
236 x 286 x 320 x
246 x 289 x 321 x
273 x 294 x 324 x
277 x 298 x 339 x
282 x 299 x 346 x
284 x 307 x 358 x
313 x 308 x 360 x
314 x 310 x 363 x
328 x 314 x 364 x
330 x 315 x 366 x

 

 

 

130

Revenue Rulings

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenue Revenue Revenue
Ruling, All Some None, Ruling, All Some None Ruling All Some None
1967- 4 x 1968-32 x 1969- 3 x
14 x 55 x 13 x
15 x 59 x 35 x
16 x 68 x 36 x
31 x 77 x 87 x
33 x 122 x 171 x
35 x 131 x 175 x
51 x 153 x 177 x
63 x 167 x 191 x
67 x 183 _7 x 216 x
69 x 184 x 230 x
80 x 215 x 233 x
107 x 227 x 242 x
149 x 232 x 250 x
166 x 233 x 255 x
180 x 242 x 261 x
182 x 264 x 265 x
215 x 289 x 296 x
220 x 294 x 297 x
227 x 407 x 385 x
254 x 415 x 407 x
303 x 423 x 423 x
346 x 436 x 428 x
349 x 450 x 434 x
376 x 472 x 458 x
379 x 496 x 473 x
391 x 565 x 494 x
425 x 607 x 602 x
437 x 609 x 627 x
443 x 657 x 631 x

 

 

 

131

Revenue Rulings

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenue Revenue Revenue
Ruling, All Some None Ruling, All Some None Ruling, All Some None
1970- 1 x 1971—28 x 1972—52 x
16 x 32 x 78 x
26 x 43 x 83 x.
31 x 71 x 98 x
38 x 98 x 139 x
80 x 121 x 165 x
83 x 151 x 172 x
94 x 156 ,g, x 200 x
L 126 x 167 x 206 x
161 x 196 x 226 x
180 x 233 x 227 x
228 x 234 x 251 x
229 x 251 252 x
236 x 282 x 257 x
240 x 283 x 273 x
243 x 302 x 304 x
249 x 335 x 341 x
279 x 372 357 x
316 x 383 383 x
425 x 393 x 399 x
426 x 402 x 403 x
490 x 404 x 411 x
506 x 421 x 419 x
509 x 449 x 438 x
519 x 469 x 450 x
552 x 476 x 456 x
636 x 479 x 495 x
644 x 503 x 544 x
651 _”, x 505 x 562 x
655 x 577 x 580 x
Revenue Revenue
Ruling All Some None Ruling A11 Some None
1973-13 x 1973-228 x
32 x 242, x
42 x 277
43 x 300 x
46 x 360 x
59 x 386 x
69 x 391 x
80 x 411 x
94 x 448 x
103 x 505 x
114 x 520 x
138 x 536 x
155 x 578 x
176 x 583 x
227 x 605 x

 

 

132

Memorandum Tax Court Decisions

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Case Case Case
Number All Some None Number All Some None Number All Some None
1964-24 x 1965-41 x 1966- 1 x
32 x 55 x 3 x
38 x 66 x 10 x
45 x 98 x 18 x
53 x 110 x 23 x
54 x 118 x 24 x
56 x 123 x 26 x
63 x 132 30 x
73 x 135 x 62 x
79 x 141 x 70 x
85 x 142 x 73 x
105 x 149 x 84 x
116 x 152 x 85 x
125 x 161 x 107 x
148 x 167 x 109 x
178 x 168 x 130 x
179 x 174 x 140 x
184 x 187 x 143 x
190 x 197 x 159 x
191 x 218 x 167 x
209 x 224 x 197 x
' 213 x 250 x 202 x
223 x 265 x 206 x
236 x 268 x 207 x
264 x 273 210 x
294 x 279 x 216 x
297 x 294 x 224 x
w307 x 296 x 239 x
310 x 305 243 x
338 x 322 x 7' 266 x

 

 

 

133

Memorandum Tax Court Decisions

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Case Case Case
Number All Some None Number All Some None Number All Some None
1967- 9 _fi_ x , 1968-17 x 1969- 4 x
27 x 18 x 16 x
28 19 x 24 x
33 x 27 x 27 x
50 x 29 x 32 x
51 31 x 46 x
55 x 34 x 56 x
61 x 45 x 79 x
70 x 50 x 85 x
99 x 56 x 96 x
106 59 x 100 x
122 72 x 102 x
126 __, x 82 x 149 x
132 x 90 x 151 x
142 x 119 x 162 x
145 x 132 x 166 x
146 x 144 x 170 x
162 146 x 179 ’x
165 x 166 x 193 x
173 171 x 227 x
174 x 177 x 230 x
177 x 179 x 234 x
178 x 196 x 247 x
182 x 227 x 249 x
186 x 237 x 259 x
188 246 x 262 x
191 x 272 x 263 x
206 x 275 x 265 x
212 x 288 x 277 x
222 x 295 x 283 x

 

 

 

134

Memorandum Tax Court Decisions

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Case Case Case
Number All Some None Number All Some None Number All Some None
1970- 8 7 x ,,l97l- 4 x 1972- 9 x
15 x , 57 ,, x 13 x
20 x 64 x 18 x
31 x 77 x 24 x
34 x 107 x 26 x
45 x 114 x 42 x
47 x 124 x 46 x
63 x 149 x 58 x
86 x 160 x 66 x
107 x 164 x 82 x
128 x 175 x 93 x
131 x 177 x 97 x
142 x 179 x 104 x
148 x 186 x 106 x
158 x 187 x 109 x
173 x 190 x 110 x
174 x 198 x 120 x
175 x 209 x 140 x
191 x 212 x 146 x
204 x 219 x 148 x
214 x 237 x 160 x.
226. x 250 x 161 x
242 x 267 x 165 x
252 x 274 x 168 x
254 x 276 x 173 x
256 x 290 x 195 x
302 x 291 x 203 x
318 x 292 x 216 x
322 x 297 x 220 x
332 x 325 x 230 x
Case Case
Number All Some None Number All Some None
1973- 9 x 1973-132 x
27 x 159 x
30 x 169 x
31 x 173 x
34 x 183 x
36 x 191 x
37 x 220 x
38 x 229 x
43 x 230 x
56 x 233 x
82 x 234 x
88 x 242 x
98 x 251 x
105 x 263 x
122 x 283 x

 

 

135

Regular Tax Court Decisions

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Page Page Page
Number All Some None Number All Some None Number All Some None
1964-468' x 1965-448 ,, x 1966-397 x
582 x 487 x 439 x
605 x 500 x 501 x
608 ‘ x 572 x 615 x
685 x 663 x 1 x
840 x 667 x 25 x
9 x 723 x 41 x
13 x 733 x 47 x
72 x 743 x 219 x
211 x 824 x 272 x
273 x 836 x 295 x
283 x 900 x 302 x
419 ff x 20 x 375 x
441 x 39 x 382 x
482 x 137 x 492 x
732 x 159 x 502 x
769 x 178 x 1. 505 x
793 x 193 x 572 x
894 x 411 x 597 x
953 x 485 x 641 x
1067 x 632 x 706 x
1 x 647 x 796 x
8 x 718 x 842 x
105 ‘v'x 731 x 848 x
127 x 787 x l x
168 x l x 75 x
182 x 54 x 207 x
270 x 137 x 258 x
322 x 217 x 326 x
358 x 277 x 335 x

 

 

 

136

Regular Tax Court Decisions

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Page Page Page
Number All Some None Number All Some None Number All Some None
1967-391 x 1968—377 x 1969-543 x
399 x 430 x 611 x
415 x 461 x 651 x
428 x 541 x 805 x
467 x 570 x 841 x
471 x 575 x 915 x
483 x 599 x 927 x
537 x 670 x 987 x
560 x 52 x , 76 x
613 x 409 x 130 x
630 x 536 x 135 x
42 x 650 x 155 x
86 x 688 x 210 x
118 '- x 710 x 281 x
156 x 723 x 315 x
190 x 740 x 346 x
218 x 823 x 394 x
245 x 982 x 484 x
318 x l x 572 x
330 x 49 x 907 x
411 x 121 x 911 x
439 x 195 x 929 x
515 x 203 x 946 x
586 x 213 x 986 x
636 x 235 x 1006 x
640 x 337 x 1038 x
872 x 410 x 37 x
1 x 467 x 394 x
32 x 475 x 459 x
230 x 482 x 477 x

 

 

 

137

Regular Tax Court Decisions

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Page Page Page
Number All Some None Number All Some None Number All Some None
1970-170 x 1971-620 x 1972-539 x
221 x 720 x 587 x
327 x 761 x 633 x
355 x 796 x 666 x
408 x 1020 _, x 872 x
653 x 1046 x 884 x
663 x 248 x 94 x
702 x 263 x 174 x
705 x 434 x 207 x
722 x 453 x 219 x
734 x 548 x 241 x
905 x 556 x 381 x
1614 x 569 x 417 x
1675 x 710 ‘ x 526 x
1691 x 770 x 659 x
1707 x 828 x 679 x
1716 x 910 x 736 x
1 x 961 x 757 x
6 x 1142 x 825 x
94 x 1216 x 900 x
115 x 1242 x 940 x
156 1261 x 949 x
271 x 12 x 146 x
275 x 174 x 207 x
320 x 205 x ‘7» 220 x
335 x 249 x 248 x
429 x 265 x 272 x
434 x 302 x 302 x
441 315 x 461 x
538 x 349 x 516 x
Page Page
Number All Some None Number All Some None
1973-531 x 1973-647 x
681 x 663 x
783 x 807 x
791 x 957 x
857 x 988 x
13 x 1004 x
91 x 68 x
114 x 78 77’ x
125 x 140 x
141 x 155 x
158 x 189 x
199 x 249 x
227 x 268 x
480 298 x
549 x 398 x

 

 

138

District Court Decisions

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Paragraph Paragraph Paragraph
Number All Some None Number All Some None Number All Some None
1964-9144 ,, x 1965-9111 x 1966-9114 x
9145 x 9146 x 9141 x
9163 x 9176 x 9158 x
9174 x 9182 x 9181
9210 x 9186 x 9183 x
9211 x 9224 x 9208 x
9275 x 9241 x 9248
9301 x 9242 x 9275 x
9303 x 9263 x 9382
9360 x 9281 x 9429 x
9368 x 9302 x 9524 x
9418 x 9366 x 9533 x
9519 x 9385 x 9564 x
9530 x 9455 x 9575 x
9628 x 9485 x 9590
9651 x 9488 x 9608 x
9653 x 9494 x 9622 x
9672 x 9500 x 9638 x
9681 x 9528 x 9654 x
9695 x 9556 x 9662
9710 x 9599 x 9665 x
9716 x 9608 x 9679 x
9738 x 9609 x 9683 x
9773 x 9636 x 9690 x
9774 x 9674 x 9702 x
9784 x 9695 x 9705 x
9798 x 9700 x 9725 x
9799 x 9713 x 9728 x
9808 x 9717 x 9734
9812 x 9759 x 9766 x
9819 x 9765 x 9768 x

 

139

District Court Decisions

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Paragraph Paragraph Paragraph

Number All Some None Number All Some None Number All Some None

1967-9156 x 1968-9130 x 1969-9121 x
9162 x 9151 x 9122 x
9210 x 9152 x 9141 x
9226 x 9153 x 9147 x
9230 x 9188 9185 x
9232 x 9190 x 9189 x
9245 x 9212 x 9194 x
9247 x 9215 x 9220 x
9251 x 9228 x 9228 x
9255 x 9229 9237 x
9277 x 9230 9243 x
9299 x 9233 x 9256 x
9313 x 9252 x 9271 x
9316 x 9287 x 9284 x
9366 x 9307 x 9297 x
9386 x 9348 x 9308 x
9401 x 9374 x 9324 x
9431 x 9396 9346 x
9454 x 9405 x 9356 x
9482 x 9411 x 9359 x
9506 x 9483 x 9454 x
9531 x 9510 x 9543 x
9532 x 9538 x 9546 x
9554 x 9581 x 9563 x
9576 x 9588 x 9583 x
9601 x 9590 x 9602 x
9615 x 9595 x 9618 x
9628 x 9602 x 9659 x
9639 x 9649 x 9722 x
9642 x 9652 x 9725 x
9705 x 9657 x 9740 x

 

140

District Court Decisions

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

141

Paragraph Paragraph Paragraph
Number All Some None Number All Some None Number All Some None
1970-9113 x 1971-9128 x 1972-9109 x
9114 x 9138 x 9123 x
9131 x 9145 x 9165 x
9151 x 9159 x 9170 x
9163 x 9179 9175 x
9169 x 9200 x 9197 x
9188 x 9201 9202
9192 x 9211 x 9216 x
9239 x 9215 x 9316 x
9267 x 9216 x 9320
9292 x 9231 x 9324
9303 x 9266 x 9330 x
9392 x 9290 x 9364 x
9450 x 9291 x 9382 x
9459 x 9300 x 9430 x
9501 x 9308 x 9446 x
9526 x 9330 x 9493 x
9527 x 9332 x 9500 x
9528 x 9354 x 9511
9530 x 9508 9581 x
9549 x 9548 9585
9618 x 9563 x 9670 x
9621 x 9580 9675 x
9641 x 9582 x 9677 x
9664 x 9619 x 9683
9676 x 9691 x 9698 x
9699 x 9709 9707 x
9709 x 9715 x 9713 x
9710 x 9741 x 9731 x
9712 x 9752 x 9732
9720 x 9759 x 9762 x
Paragraph Paragraph
Number All Some None Number All Some None
1973-9111 x 1973-9575 x
9140 x 9631 x
9157 x 9639 x
9178 x 9644 x
9217 x 9671 x
9219 x 9677 x
9272 x 9681 x
9297 x 9705 x
9314 x 9723 x
9416 x 9726 x
9425 x 9735
9458 x 9744 x
9495 , x 9770 x
9512 x 9774 x
9553 x 9791
9555 x

Court of Claims Decisions

  

 
  

 
   

Paragraph
Number All Some None
12
9122 x
9213
9214
9215
9249
9250
9309
9310
9311
9412
9494
9495
9496
9546
9547 x
637
9638
9639
725
97 1
9792
9793

Paragraph
Number

Paragraph
Number

  
   

          
     
  
  
  

   

All Some None All Some None

        
 
   

1

  
 
 
 
   

117

  
   

9249
8

  

 
     
    

xxxxxxxxxx

 
 
  

N

 
   
  

    

N

  

   
  
  
   
    

  
    
     
     

NNNNMXN

 

9841
9842 x
9848 ~

  

142

Court of Claims Decisions

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

143

Paragraph Paragraph Paragraph
Number All Some None Number All Some None Number All Some None
1967-9123 x 1968-9122 x 1969-9124 x
9124 x 9123 x 9125 x
9186 x 9124 x 9126
9188 x 9171 x 9127 x
9189 x 9172 x 9190 x
9248 x 9220 x 9192 x
9249 x 9221 x 9193
9302 x 9223 x 9223 x
9304 x 9224 x 9224 x
9305 x 9237 x 9230 x
9371 x 9266 x 9275 x
9372 x 9267 x 9276 x
9373 x 9268 x 9325
9374 x 9273 x 9402 x
9375 x 9274 x 9403 x
9376 x 9330 x 9404 x
9377 x 9366 x 9473 x
9378 x 9367 x 9474 x
9439 x 9368 x 9475
9440 x 9373 x 9476 x
9499 x 9427 x 9477 x
9500 x 9428 x 9501 x
9501 x 9429 x 9537
9569 x 9472 x 9538 x
9570 x 9473 x 9539 x
9571 x 9474 x 9718 x
9572 x 9476 x 9719 x
9573 x 9621 x 9720
9574 x 9622 x
9685 x 9623 x
9722 x 9624 x
9723 x 9626 x
9724 x 9650 x

Court of Claims Decisions

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Paragraph Paragraph Paragraph

Number All Some None Number All Some None A Number All Some None

1970-9125 x 1971-9108 x 1972-9113 x
9126 x 9110 x 9114 x
9190 x 9170 x 9115 x
9191 x 9285 x 9253 x
9242 x 9337 x 9254 x
9243 x 9416 x 9255 x
9244 x 9478 x 9256 x
9245 x 9479 x 9355 x
9284 x 9482 x 9418 x
9285 x 9483 x 9419 x
9286 x 9542 x 9420 x
9287 x 9543 x 9421 x
9341 x 9544 x 9491 x
9344 x 9682 x 9554 x
9345 x 9683 x 9555 x
9346 x 9557 x,
9406 x 9560 x
9407 x 9561 x
9408 x 9740 x
9455 x
9456 x
9457 x
9458 x
9517 x
9518 x
9519 x
9651 x
9652 x
9698 x

Paragraph Paragraph

Number All Some None Number All Some None

1973—9114 x 1973-9351 x
9115 x 9353 x
9116 x 9433 x
9183 x 9434 x
9184 x 9507 .1 x
9234 x 9508 x
9235 x 9549 x
9292 x 9564 x
9293 x 9720 x
9347 x 9785 x
9348 x 9786 x
9350 x 9788 x

 

 

144

Court of Appeals Decisions

Paragraph Paragraph Paragraph
Number All Some None Number All Some None Number Al Some None
1964-9173 x 1965-9106 x 1966-9104 x
1 x 9126 9133 x

185 9147 9157

9 21 x 9179 91 8

x 91 195

919 92

NNNNMNXN
MNNNNN

N74

 

X
X
X
X
X

NNMMNNMNKN

 

145

Court of Appeals Decisions

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Paragraph Paragraph Paragraph
Number All Some None Number All Some None Number All Some None
1967-9141 x 1968-9118 x 1969-9119 x
9145 x 9120 x 9120 x
9178 x 9142 x 9129 x
9179 x 9143 x 9207 x
9180 x 9194 x 9208 x
9184 x 9200 x 9211 x
9191 x 9241 x 9222 x
9218 x 9245 x 9241 x
9219 x 9255 x 9267 x
9238 x 9256 x 9302 x
9286 x 9257 x 9350 x
9306 x 9262 x 9370 x
9307 x 9270 x 9375 x
9322 x 9279 x 9389 x
9339 x ,_g9322 x 9442 x
9369 x 9355 x 9448 x
9370 x 9363 x 9455 x
9385 x 9392 x 9456 x
9461 x 9402 x 9483 x
9488 x 9406 x 9521 x
9502 x 9434 x 9523 x
9529 x 9445 x 9566 x
9548 x 9460 x ‘ 9575 x
9555 x 9539 x 9579 x
9560 x 9540 x 9589 x
9626 x 9551 x_ 9632 x
9632 x 9592 x 9634 x
9659 x 9601 x 9678 x
9675 x 9634 x 9698 x
9700 x 9637 x 9737 x
9709 x 9638 x 9739 x

 

146

Court of Appeals Decisions

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

147

Paragraph Paragraph Paragraph
Number All Some None Number All Some None Number All Some None
1970-9101 5, 1971-9131 x 1972-9104 x
9110 x 9141 x 9154 x
9152 x 9155 x 9157 x
9223 x 9161 x 9183 x
9236 x 9164 x 9242 x
9271 x 9178 x 9250 x
9276 x 9187 x 9261 x
9279 x 9258 x 9273 x
9297 x 9259 9277 x
9301 x 9268 x 9280 x
9309 x 9272 x fig, 9317 x
9327 x 9312 x 9353 x
9330 x 9339 x 9366 x
9347 x 9374 x 9375 x
9378 x __9540 x 9400 x
9411 x 9558 x 9402 x
9435 x 9574 x 9450 x
9484 x 9588 x 9472 x
9486 x 9622 x 9485 x
9503 x 9634 x 9548 x
9539 x 9647 x 9594 x
9543 x 9659 x 9610 x
9552 x 9671 x 9612 x
9568 x 9675 x 9628 x
9589 x 9680 x 9660 x
9627 x 9689 x 9679 x
9642 x 9699 x 9688 x
9643 x 9706 x 9694 x
9650 x 9712 x 9729 x
9674 x 9713 9733 x
9678 x 9764 x 9741 x
Paragraph Paragraph
Number All Some None Number All Some None
1973-9133 x 1973-9541 x
9139 x 9543 x
9145 x 9545 x
9180 x 9577 x
9196 x 9595 x
9214 x 9596 x
9298 x 9608 x
9365 x 9614 x
9398 x 9620 x
9403 x 9630 x
9405 x 9650 x
9422 x 9659 x
9443 x 9664 x
9455 x 9773 x
9484 x 9778 x
9538 x

Supreme Court Decisions

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Paragraph Paragraph Paragraph
Number All Some None Number All Some None Number All Some None
1964 1965-9375 x 1966-9280 x
9379 x 9317 x
9381 x 9318 x
9382 x 9319 x
9387 x 9376 x
9406 x
9407 x
9409 x
Paragraph Paragraph Paragraph
Number All Some None Number All Some None Number All Some None
1967-9115 x 1968-9101 x 1969-9167 x
9117 x 9258 x 9198 x
9309 x 9383 x 9343 x
9348 x
Paragraph Paragraph Paragraph
Number All Some None ,Number All Some None Number All Some None
1970-9289 x 1971-9476 x 1972-9123A x
9405 x 9259 x
9653 x 9276 x
9292A x
Paragraph
Number All Some None
1973-9250 x
9412 x
9478 x
9515 x
9780 x

 

 

148

APPENDIX B

ANALYSIS OF INTERNAL REVENUE CODE SECTIONS AFFECTED BY

APPENDIX B

SPECIAL TREATMENT OF CAPITAL GAINS AND LOSSES

 

w w- V a

V V fi‘fi V

 

w— Vi v

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Section Section Section
Number All‘ Some None Number All‘ Some None ’Number All Some None
1 71x 7779 ‘77 7 x 166 x
2 x 80 I? x 1677 x
3 77‘ x 81 7 x 169 x
4 7 x 82 7 x 170 x
5 x 1017' x 171 x
11 7 x 102 77 7‘ x 172 x
12 x47 710347 x 173 x
_721 ‘77x 7104 x 174 x
31 x 105 x 175 x
32 x 106 7‘ x 77176 x
33 x 107 x 177 x
35 x 108 x 178 x
36 x 109 x 179 x
37 ‘ ‘ x 110 x 180 x
38 x 111 x 181 x
39 x 112 x 182 x
40 x 113 x 183 x
41 x 114 x 184 x
42 x 115 x 185 x
46 x 116 x 186 x
47 x 117 x 187 x
48 x 118 x 188 x
49 77' x 119 x 211 x
50 x 121 x 212 x
50A x 122 x 213 x
503" I ‘ if ‘ 123 x 214 x
51 x 124 x 215 x
56 x 77141 V x 216 x
57 x '7'142‘ V x 217 x
58 x 143 xw 7' 218 x
61 x ,_* 144 x' 219 x
62 x 145 x V 241 x
V 63 x 151 - ,x: 242, x
__ 71H x 152 g x 243 x
72» ,_ x 153 x 244 x
73 , “x‘ 154 1 “x _2_4_5_ x
74 x 16I,__ x 246 x
75w x v 162 x 247 x
76 __ x 163 x 248 x
77 x 164 x 249 x
78 x 165 x 250 x

 

149

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Section Section Section

Number All Some None Number All Some None Number All Some None
261 x 371 x 515 x
262 x 372 x 521 x
263 x 373 x 526 x
264 x 374 x 531 x
265 x 381 x 532 x
266 x 382 x 533 x
267 x 383 x 534 x
268 x 385 x 535 x
269 x 391 x 536 x
271 x 392 x 537 x
272 x 393 x 541 x
273 x 394 x 542 x
275 x 395 x 543 x
276 x 401 x 544 x
277 x 402 x 545 x
278 x 403 x 546 x
279 x 404 x 547 x
281 x 405 x 551 x
301 x 406 x 552 x
302 x 407 x 553 x
303 x 421 x 554 x
304 x 422 x 555 x
305 x 423 x 556 x
306 x 424 x 557 x
307 x 425 x 558 x
311 x 441 x 561 x
312 x 442 x 562 x
316 x 443 x 563 x
317 x 446 x 564 x
318 x 451 x 565 x
331 x 453 x 581 x
332 x 454 x 582 x
333 x 455 x 583 x
334 x 456 x 584 x
336 > x 461 x 585 x
337 x 471 x 586 x
338 x 472 x 591 x
341 x 481 x 592 x
342 x 482 x 593 x
346 x 483 x 594 x
351 x 501 x 595 x
354 x 502 x 596 x
355 x 503 x 601 x
356 x 504 x 611 x
357 x 507 x 612 x
358 x 508 x 613 x
361 x 509 x 614 x
362 x 511 x 615 x
363 x 512 x 616 x
367 x 513 x 617 x
368 x 514 x 621 x

 

 

 

150

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Section Section Section

Number All Some None Number All Some None Number All Some None
631 x 752 x 878 x
632 x 753 x 881 x
636 x 754 x 882 x
638 x 755 x 883 x
641 x 761 x 884 x
642 x 771 x 891 x
643 x 801 x 892 x
651 x 802 x 893 x
652 x 804 x 894 x
661 x 805 x 895 x
662 x 806 x 896 x
663 x 809 x 901 x
664 x 810 x 902 x
665 x 811 x 903 x
666 x 812 x 904 x
667 x 815 x 905 x
668 x 817 x 906 x
669 x 818 x 911 x
671 x 819 x 912 x
672 x 820 x 921 x
673 x 821 x 922 x
674 x 822 x 931 x
675 x 823 x 932 x
676 x 824 x 933 x
677 x 825 x 934 x
678 x 826 x 935 x
681 x 831 x 941 x
682 x 832 x 942 x
683 x 841 x 943 x
691 x 842 x 951 ' x
692 x 843 x 952 x
701 x 844 x 953 x
702 x 851 x 954 x
703 x 852 x 955 x
704 x 853 x 956 x
705 x 854 x 957 x
706 x 855 x 958 x
707 x 856 x 959 x
721 x 857 x 960 x
722 x 858 x 961 x
723 x 861 x 962 x
731 x 862 x 963 x
732 x 863 x 964 x
733 x 864 x 970 x
734 x 871 x 971 x
735 x 872 x 972 x
736 x 873 x 981 x
741 x 874 x 991 x
742 x 875 x 992 x
743 x 876 x 993 x
751 x 877 x 994 x

 

 

 

151

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

152

Section Section Section
Number All Some None Number All Some None Number All Some None
995 x 1234 x 1379 x
996 x 1235 x 1381 x
997 x 1236 x 1382 x
1001 x 1237 x 1383 x
1002 x 1238 x 1385 x
1011 x 1239 x 1388 x
1012 x 1240 x
1013 x 1241 x
1014 x 1242 x
1015 x 1243 x
1016 x 1244 x
1017 x 1245 x
1018 x 1246 x
1019 x 1247 x
1020 x 1248 x
1021 x 1249 x
1022 x 1250 x
1031 x 1251 x
1032 x 1252 x
1033 x 1253 x
1034 x 1301 x
1035 x 1302 x
1036 x 1303 x
1037 x 1304 x
1038 x 1305 x
1039 x 1311 x
1051 x 1312 x
1052 x 1313 x
1053 x 1314 x
1054 x 1321 x
1055 x 1331 x
1056 x 1332 x
1071 x 1333 x
1081 x 1334 x
1082 x 1335 x
1083 x 1336 x
1091 x 1337 x
1101 x 1341 x
1102 x 1342 x
1103 x 1346 x
1111 x 1347 x
1201 x 1348 x
1202 x 1351 x
1211 x 1371 x
1212 x 1372 x
1221 x 1373 x
1222 x 1374 x
1223 x 1375 x
1231 x 1376 x
1232 x 1377 x
1233 x 1378 x

 

APPENDIX C

APPENDIX C*+

FEDERAL INCOME TAX EXPENDITURES CALENDAR YEAR 1972
(By Budget Function)

National Defense
Exclusion of benefits and allowances to Armed Forces personnel

 

International Affairs and Finance
Exemption for certain income earned abroad by United States citizens
Western Hemisphere Trade Corporations
Exclusion of gross-up on dividends of less-developed country corpora-
tions
Deferral of income of controlled foreign corporations
Exclusion of income earned in United States possessions
Deferral of export income (DISC)

 

Agriculture
Farming: expensing and capital gain treatment
Timber: capital gain treatment for certain income

 

Natural Resources
Expensing of exploration and development costs
Excess of percentage over cost depletion
Capital gain treatment of royalties on coal and iron ore

 

Commerce and Transportation
Investment credit
Depreciation on buildings (other than rental housing) in excess of
straight-line depreciation
Asset depreciation range system for depreciation
Dividend exclusion
Capital gains: corporation (other than farming and timber)
Capital gains: individuals (other than farming and timber)
Bad debt reserves of financial institutions in excess of actual
Exemption of credit unions
Deductibility of interest on consumer credit
Expensing of research and development expenditures
$25,000 corporate surtax exemption
Deferral of tax on shipping companies
Five-year amortization of railroad rolling stock

Housing and Community Development
Deductibility of interest on mortgages on owner-occupied homes
Deductibility of property taxes on owner—occupied homes
Depreciation on rental housing in excess of straight-line depreciation
Five-year amortization of housing rehabilitation expenditures
Deferral of capital gain on sale to occupants of certain low-income
housing

 

153

 

154

Health, Labor and Welfare
Exclusion of employer-provided disability insurance benefits
Provisions relating to aged: combined cost for additional exemptions,
retirement income credit, and exclusion of social security payments
Additional exemption for blind
Exclusion of unemployment insurance benefits
Sick pay exclusion
Exclusion of workmen's compensation benefits
Exclusion of public assistance benefits .
Net exclusion of pension contributions and earnings:
Plans for employees
Plans for self-employed persons
Exclusion of other employee benefits:
Premiums on group term life insurance
Accident and accidental death premiums
Medical insurance premiums and medical care
Privately financed supplementary unemployment benefits
Meals and lodging
Exclusion of interest on life insurance savings
Deductibility of charitable contributions (other than education)
Deductibility of medical expenses
Deductibility of child and dependent care and household expenses
Deductibility of casualty losses
Standard deduction in excess of minimum.standard deduction
Five-year amortization of pollution control facilities (pre-1969 plants)
Credit for employment of public assistance recipients under WIN program
Five-year amortization of employer child care and on-the-job training
facilities

 

Education
Additional parental personal exemption for students
Deductibility of contributions to educational institutions
Exclusion of scholarships and fellowships

Veterans Benefits and Services
Exclusion of certain veterans benefits

 

General Government
Credit and deduction for political contributions

 

Aid to State and Local Financing
Exemption of interest on state and local debt
Deductibility of nonbusiness state and local taxes (other than on
owner—occupied homes)

*Source: Estimates of Federal Tax Expenditures, House Committee on Ways
and Means, June 1, 1973.
+The tax expenditure apparatus as a source of complexity is discussed in
chapter III.

BIBLIOGRAPHY

 

BIBLIOGRAPHY

Books

Butters, J. K., Thompson, L. E., and Bolinger, L. L. Effects of Taxation
on Investments bylndividuals. Boston: Harvard University Press,
1955.

 

 

Eisenstein, Louis. The Ideologies of Taxation. New York: The Ronald
Press Company, 1961.

 

Haig, Robert Murray, ed. The Federal Income Tax. New York: Columbia
University Press, 1921.

 

Hellerstein, Jerome R. Taxes, Loopholes, and Morals. New York: Random
House, Inc., 1963.

 

Kalven, Harry, and Blum, Walter J. The Uneasy Case for Progressive
Taxation. Chicago: Phoenix Books, 1953.

David, Martin. Alternative Approaches to Capital Gains Taxation.
Washington, D. C.: Brookings Institution, 1968.

Musgrave, Richard. The Theory of Public Finance. New York: McGraw-Hill
Book Company, Inc., 1959.

 

Paul, Randolph E. Taxation for Prosperity. Indianapolis: Bobbs-Merrill,
Co., 1947.

 

Pedrick, Willard H., and Kirby, Vance N., eds. The Study of Federal Tax
Law. Chicago: Commerce Clearing House, Inc., 1972.

Sander, Frank E. A., and Westfall, David, eds. Readings in Federal
Taxation. Mineola, New York: The Foundation Press, Inc., 1970.

 

Seltzer, Lawrence H. The Nature and Tax Treatment of Capital Gains and
Losses. New York: National Bureau of Economic Research, Inc., 1951.

 

Simons, Henry C. Federal Tax Reform. Chicago: University of Chicago
Press, 1950.

 

Simons, Henry C. Personal Income Taxation. Chicago: The University of
Chicago Press, 1938. ‘

 

Sommerfeld, Ray, Anderson, Hershel M., and Brock, Horace R.’ Introduction
to Taxation. New York: Harcourt—BracewJovanovich, Inc., 1972.

 

 

155

 

156

Smith, Adam. The Wealth of Nations, Edwin Cannan, ed. New York: The
Modern Library.

 

Stern, Philip M. The Great Treasury Raid. New York: Random House, Inc.,
1964. ‘1

 

Surrey, Stanley S. Pathways to Tavaeform. Cambridge: Harvard
University Press, 1973.

 

Articles

Armstrong, Richard. "The Right Kind of Tax Reform." Fortune,
(December 1972), 180.

Blum, Walter J. "A Handy Summary of the Capital Gains Arguments."
Taxes——The Tax Magazine, XXXV (1957), 247-266.

 

Blum, Walter J. "How the Growth of Favored Tax Treatment Affects Tax-
payers and Practitioners." Journal of Taxation, IV (1956), 28-31.

 

Blum, Walter J. "Simplification of the Federal Income Tax Law." Tax Law
Review, X (1954), 239-253.

Eisner, Robert. "Tax Incentives for Investment." National Tax Journal,
XXVI (1973), 397-401.

 

Emory, Meade. "The Corman and Mills-Mansfield Bills: A Look at Some
Major Tax Reform Issues." Tax Law Review, XXIX (1973), 96-99.

 

Ginsburg, Martin D. "Tax Simplification--A Practitioner's View."
National Tax Journal, XXVI (1973), 317—330.

 

Note. "Tax Equity and Ad Hoc Legislation." Harvard Law Review, LXXXIV
(1971), 640—663.

Richmond, Raymond L. "Reconsideration of the Capital Gains Tax--A
Comment." National Tax Journal, XIV (1961), 402-404.

 

Rogovin, Mitchell. "The Four R's: Regulations, Rulings, Reliance and
Retroactivity—-A View from.Within," Standard Federal Tax Reporter,
1973, 67,033—67,050.

Surrey, Stanley 8. "Complexity and the Internal Revenue Code: The Problem
of Management of Tax Detail." Law and Contemporary Problems,
XXXIV (1969), 673a710.

Wallich, Henry C. "Taxation of Capital Gains in the Light of Recent
Economic Developments." National Tax Journal, XVIII (1965),
1339150. » ‘7‘ 7 ‘7 fjtwjifi III

 

157

Public Documents

 

Annual Report 1974 Commissioner of Internal Revenue. Washington, D. C.:
Government Printing Office.

Budget of the United_States Government, FiscalfiYear 1975. Washington,
D. C.: Government Printing Office, 1974.

Code of Federal Regulations, Title 26.

 

Internal Revenue Code of 1939.
Internal Revenue Code of 1954.
U. 8. Congress. House. Committee on Ways and Means. Tax Revision

Compendium. Papers Submitted to the Committee on Ways and Means.
Vol. II. Washington, D. C.: Government Printing Office, 1959.

 

U. S. Congress. House. Hearing Before a Subcommittee of the Committee
on Government Operations. 93rd Cong., lst Sess., 1973.

 

U. S. Congress. Joint Committee on the Economic Report on Federal Tax
Policy for Economic Growth and Stability. 84th Cong., lst Sess.,
1955.

 

Court Cases

Bullen v. State of Wisconsin, 240 U. S. 625.

 

Dobson v. Commissioner, 64 S. Ct. 239.

 

Eisner v. Macomber, 40 S. Ct. 189 (1920).

 

Gregory v. Helvering, 55 S. Ct. 266 (1935).

 

Hollman v. Commissioner, 38 T. C. 251 (1962)

Lynch v. Turrish, 247 U. S. 224 (1918).

 

Merchants' Loan and Trust Co. v. Smietanka, 41 S. Ct. 386 (1921).

Other Sources
Detroit News. 25 June 1975.
Ernst and Ernst. 1974 National TaxfiTraiping Program.

Federal Tax Forms. Chicago: Commerce Clearing House, 1975.

 

158

Standard Federal Tax Reports—~Taxes on Parade. Chicago: Commerce
Clearing House, Inc., June 25, 1975.

 

Wall Street Journal: 22 May 1974.

 

Webster‘s ThirdfiNew International Dictionary of the English Language,
Unabridged. Springfield, Massachusetts, 1961.

 

 

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1 LI I) ‘_ r .1
hNHII (5! till '

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l/ L. _,. 111:1?