Lawrence Howard Seltzer

English

Research Papers in Economics

This PDF is a selection from an out-of-print volume from the National
Bureau of Economic Research
Volume Title: Interest as a Source of Personal Income and Tax Revenue
Volume Author/Editor: Seltzer, Lawrence Howard
Volume Publisher: UMI
Volume ISBN: 0-87014-365-4
Volume URL: http://www.nber.org/books/selt55-1
Publication Date: 1955
Chapter Title: TAX REVENUES FROM INTEREST
Chapter Author: Lawrence Howard Seltzer
Chapter URL: http://www.nber.org/chapters/c2876
Chapter pages in book: (p. 42 - 46)INTEREST AS INCOME AND TAX REVENUE 1289
When the Treasury Department in September 1952 proposed to re-
quire banks to ifie information returns with respect to all payments of
interest amounting to $100 or more in one year, instead of requiring
such returns only with respect to interest payments of $600 or more,
the Wall Street Journal (Feb. 18, 1953) reported that some holders of
savings accounts were dividing up their accounts among a number of
banks in order that their interest receipts from any one bank would
fall short of $100 a year. In December 1952 the Treasury withdrew the
proposed change in its regulations because of protests from bankers
that the change would greatly increase their paper work.
HI. TAX REVENUES FROM INTEREST
1. Tax revenues from interest income in the 1940's far exceeded those of
previous decades, with a growing proportion from the lower taxable
incomes
Since the personal income tax is levied at the same rates on the total
from all sources (except for tax-exempt interest and long-term capital
gains) of an individual's taxable income, less his personal exemptions
and allowable deductions, his tax liability is not strictly made up of
separate amounts attributable to each of the various components of
his income, such as salaries, dividends, rents, etc.2° Nevertheless it is
useful for some purposes to act as if this were the situation. In practice
the additional tax that would be payable on an additional increment of
income is often taken into account by investors in choosing the char-
acter and form of new investments—as between bonds and common
stocks and as between tax-exempt and taxable bonds, for example.
This aspect receives attention in the next section of this paper. Because
the composition of taxable incomes of the different income groups and
the structure of tax rates have varied significantly over a period of
years, it is also interesting to measure the varying average impact of the
income tax upon the different components of personal incomes. The
average effective tax rate for each income group can be calculated by
dividing its total tax liabifity by its total adjusted gross income. By
20Theeffective tax rates OR Borne kinds of income have differed from the formal rates in varying
degree from time to time because of exemptions or credits applicable to particular kinds of income. A
zero rate, in effect, has been applied without interruption to interest from state and local government
obligations and from some obligations of the federal government and it8 instrumentalities. Interest from
large amounts of securities issued by the federal government and its agencies prior to 1941. was exempt
from normal tax, although not from surtax. An earned income credit, varying in different years between
1924 and 1943 (not allowable in 1932 and 1933), reduced the effective tax rates on incomes received as
compensation for personal service8 and with different limits, on property income also. Prior to 1936,
dividend income was exempt from normal tax. Under the Revenue Act of 1954, the first $50 of dividend
income received by any taxpayer was made wholly exempt from income tax, and a tax credit of 4 per
cent of the remainder of his dividend income was made applicable against his total tax liability.1290 AMERICAN STATISTICAL ASSOCIATION JOURNAL, DECEMBER 1955
applying the average effective tax rate so obtained to the amount of
interest income reported by each income group, a measure of the tax
liability that can be attributed to the interest component of taxable in-
comes may be obtained.2' In this way interest is not treated as the
marginal component of income, subject to the highest applicable brack-
et rates, but treated as if it were distributed among the various
brackets in the same proportions as all other components of income and
subject only to the average effective tax rate paid by each person or
income group on his or its adjusted gross income as a whole.
Measured in this way, the amount of tax revenue supplied by the
interest component of taxable individual incomes in 1918—1950 ranged
from a low of $35 million in 1931 to a high of $288 million in 1950
(Table 18). In 1918—1920 low personal exemptions, high tax rates, and
exceptionally high interest rates (the average yield of Moody's Aaa
bonds was 5.49 per cent in 1919 and 6.12 per cent in 1920) contributed
to the relatively large revenues from interest in 1918—1920 ($147,
$135, $104 million). During 1921-1929 the net effect of more liberal
personal exemptions, falling tax rates, and sustained or rising interest
income and total income was to produce a fairly stable plateau of in-
come tax revenue from interest, averaging $79 million annually. The
influence of liberalized personal exemptions in 1921 and 1925 is clearly
reflected in the declines of those years.
During the 1930's, largely because of the depressed levels of total
personal incomes, tax revenues from interest averaged about 36 per
cent lower than during the twenties, despite the reduction in personal
exemptions and increased in tax rates that began in 1932. A sharp in-
crease in income tax revenues from interest took place during the 1940's
with the steep reductions in personal exemptions, increases in tax
rates, and growth in the public debt that acccompanied the rearma-
ment program and World War II. In 1950 the $288 million of income
tax liability for interest receipts reported on taxable individual returns
was more than six times that of 1938 and greater than that of any pre-
vious year.
Reflecting the progressive structure of effective income tax rates,
inclusive of the personal exemption provisions, the great bulk of the
income taxes attributable to interest receipts in all years between 1918
and 1940 was levied on the upper income groups (Table 19). Tax-
payers with incomes of $10,000 or more in this period, though receiving
about 46 per cent on the average of the annual amounts of interest
Forsome purposes the marginal or highest applicable bracket rate is more significant than the
average effective tax rate, as is illustrated presently.INTEREST AS INCOME AND TAX REVENUE 1291
TABLE18
INTEREST TAX LIABILITY, BY INCOME GROUPS, 1918-1950
(Thousands of Dollars)
Net income classesa
Less
than 2
2—3 3—5 5—10 10—2525—5050—100
100—
500
500
and Total
over
1018 1,706 2,2615,6759,29517,50017,32220,36745,64927,647147,242
1019 1,125 1,1683,9907,10416,62617,41020,74545,84921,290135,307
1920 1,309 1,995 4,4757,70717,03116,68218,28126,09010,788104,452
1921 1,313 1,532 3,1686,53614,93414,04413,62016,5954,878 76,618
1922 1,204 1,559 3,3737,13215,69716,47318,10824,3758,33906,258
1923 1,434 1,631 4,2215,56212,54812,76112,68818,372 5,61472,831
1924 8071,0092,6482,5959,38213,14915,38121,9087,77874,655
1925 134 365 8041,705 8,38812,98414,06617,422 6,88602,755
1926 135 417 7561,9619,18213,66615,02919,546 7,60068,294
1927 80 376 6622,1909,89714,90016,74522,890 8.98876,737
1928 141 490 801 2,31310,40215,92219,07028,71516,38394,242
1929 44 148 254 9707,86914,36417,13127,34118,124 86,245
1930 104 415 5052,1488,95112,59813,08516,2677,14761,310
1931 75 299 412 1,6156,4567,5427,7127,6353,32935,074
1932 9921,057 1,8374,82110,18811,4699,7890,5772,33652,080
1933 909 8741,5574,0598,4859,2718,2049,1752,58245,118
1934 534 694 1,2274,37610,88910,4298,4017,9942,72547,268
1935 497 659 1,1654,16411,19111,1879,8429,6032,44850,736
1936 796 991 1,6674,11010,89812,03112,73015,9136,42165,556
1937 774 9001,6454,13110,75911,04211,21414,6576,49861,620
1938 987 943 1,6474,0609,6078,6827,1109,1234,447 46,606
1939 1,017 1,039 1,7764,11510,0939,9668,51611,7586,040 54,320
1940 1,823 1,294 2,3665,02213,66115,29112,26113,5636,065 71,345
1941 5,871 5,1859,95913,95428,02823,42416,94117,4625,386126,211
1942 16,01111,60717,93724,48342,90933,92223,29621,4004,544198,109
1943 16,10112,54920,01431,74651,05039,91529,12926,8355,317232,657
194411,42211,46220,67833,55355,34442,58833,04229,23210,168247,489
1945 10,01311,21818,48834,28558,69147,04233,85528,5509,694251,837
1946 9,44210,25017,74832,41461,08149,86238,28434,90911,297285,288
1947 9,91811,23818,10233,54160,32249,17036,60335,80211,167265,867
1948 4,1876,62514,97028,10645,61240,51934,84738,73911,827225,432
1949 5,8848,39218,89133,61849,05041,74734,92136,09911,519240,122
1950 5,4457,82818,52036,81958,21054,27144,35147,08315,528288,054
In 1944 changedto Adjusted GrOSS Income Classes.
Source: StatisticsofIncome. Totheestimated tax liability arrived at as describedin the text,
weadded the tax liability attributable to the interest component of income from fiduciaries received
by individuals and beneficiaries. This added tax liability was estimated by the same procedures as those
described in the notes to Table 4. However, a slight overestimate of tax liability attributable to interest,
of the order of 1 per cent, results from the small duplication in the figures.1292 AMERICANSTATISTICAL ASSOCIATION JOURNAL, DECEMBER 1955
TABLE 19
SHARESOF INCOME GROUPS IN TOTAL
ATTRIBUTABLE TO INTEREST,
TAX LIABILITY
1918—1950
1918
1919
1920
1921
1922
1923
1924
1925
1926
1927
1928
1929
1930
1931
1932
1933
1934
1935
1936
1937
1.2
0.8
1.3
1.7
1.3
2.0
Li
0.2
0.2
0.1
0.1
0.1
0.2
0.2
1.9
2.0
1.1
1.0
1.2
1.3
(Percentages)
11.813.8
12.915.3
16.017.5
18.317.8
17.118.8
17.517.4
17.620.6
20.722.4
20.022.0
19.421.8
16.920.2
16.719.9
20.521.3
21.522.0
22.018.8
20.518.2
22.117.8
22.019.4
18.419.4
17.918.2
In 1944 changed to Adjusted Gross Income Classes.
Note: The figures do not necessarily add to 100peroent due to
Netincomeclassesa(thousands ofdollars)
Less
than
2
2—3 3—5 5—1010—25 25—50
50—
100
100—
500
500
and
Over
1.53.96.311.9
0.92.95.312.3
1.94.37.416.3
2.04.18.519.5
1.63.57.416.3
2.25.87.617.2
1.43.53.512.6
0.6 1.32.713.4
0.6 1.12.913.4
0.50.92.912.9
0.50.82.511.0
0.20.31.19.1
0.71.03.514.6
0.91.24.618.4
2.03.59.319.6
1.93.59.018.8
1.52.69.323.0
1.32.38.222.1
1.52.56.316.6
1.52.76.717.5
31.018.7
33.915.7
25.010.3
21.76.4
25.38.7
22.57.7
29.3 10.4
27.811.0
28.611.1
29.8 11.7
30.517.4
31.721.0
26.5 11.7
21.89.5
18.4 4.5
20.35.7
16.9 5.8
18.9 4.8
24.39.8
23.810.5
19.6 9.5
21.611.1
19.08.5
13.84.3
10.9 2.3
11.52.3
11.84.1
11.33.8
13.2 4.3
13.54.2
17.25.2
15.04.8
16.3 5.4
1938
1939
1940
1941
1942
1943
1944
1945
1946
1947
1948
1949
1950
2.12.0
1.91.9
2.61.8
4.74.1
8.25.9
6.95.4
4.64.6
4.04.5
3.63.9
3.74.2
1.92.9
2.53.5
1.92.7
3.5
3.3
3.3
7.9
9.1
8.6
8.4
7.3
6.7
6.8
6.6
7.9
6.4
8.7
7.6
7.0
11.1
12.5
13.6
13.6
13.6
12.2
12.6
12.5
14.0
12.8
20.618.6
18.618.3
19.121.4
22.218.6
21.917.3
21.917.2
22.417.2
23.318.7
23.018.8
22.718.5
20.218.0
20.417.4
20.218.8
15.3
15.7
17.2
13.4
11.9
12.5
13.4
13.4
14.4
13.8
15.5
14.5
15.4INTEREST AS INCOME AND TAX REVENUE 1293
reported on taxable returns, paid on the average 89 per cent of the
annual amounts of income taxes attributable to interest. This extreme
relationship was moderated after 1940, partly because of a change in
the distribution of reported interest income in favor of the lower income
groups and partly because of the relatively greater increases of effective
tax rates on smaller than larger incomes. Between 1941 and 1949 in-
clusive, taxpayers with incomes of $10,000ormore reported an annual
average of 41 per cent of all the interest on taxable returns and paid
an annual average of 71 per cent of the income taxes attributable to
interest.
2. Taxes on interest income declined radically as a share of total income
taxes, but absorbed one-sixth or more of all interest reported on taxable
returns in most years since 1942.
As a proportion of total personal income tax liability, the amount
contributed by interest income ranged during the twenties from 11.2
to 8.1 per cent (Table 20). The proportion rose to 15.8 per cent between
1929 and 1932, when other components of income shrank more dras.-
tically during the economic collapse of that period. Thereafter a sharp
fall took place that continued with unimportant interruptions for the
next twelve years. In 1950, income tax liability attributable to interest
accounted for only 1.6 per cent of total personal income tax liability.
Income taxes absorbed a relatively small proportion of total interest
income reported on taxable returns during the two decades 1921—1940,
the proportion varying between 3.1 and 7.3 per cent (Table 21). It
rose sharply in the years following 1940, climbing to 11.0 per cent in
1941, 17.2 in 1942, 21.2 in 1943, 22.9 in 1944, and 23.6 in 1945, after
which it gradually declined to 15.9 per cent in 1949 and then rose to
17.8 per cent in 1950.
IV. INTEREST INCOME AND INTEREST RAPES AFTER TAXES
For the upper income groups, of course, the proportion of interest
income absorbed by income taxes rose to much higher levels during the
1940's, and the marginal rates rose higher still. The effective federal
tax rates on the first dollar of additional interest or other ordinary in-
come for a married man with two dependent children and the cited
amounts of statutory net income from other sources for the years
1940—1954 are shown in Table 22. To these, in states imposing their
own income taxes, should be added the marginal tax rates under the
state laws.

Interest as a Source of Personal Income and Tax Revenue

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