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MUNITIONS  INDUSTRY 


PBELIMINAEY  EEPOET  ON  WARTIME  TAXATION 
AND  PRICE  CONTROL 

BY  THE 

SPECIAL  COMMITTEE  ON 

INVESTIGATION  OF  THE  MUNITIONS  INDUSTEY 

UNITED  STATES  SENATE 

PURSUANT  TO 

S.  Res.  206  (73d  Congress) 

A  RESOLUTION  TO  MAKE  CERTAIN  INVESTIGATIONS 

CONCERNING  THE  MANUFACTURE  AND  SALE 

OF  ARMS  AND  OTHER  WAR  MUNITIONS 


July  29  (calendar  day,  August  20),  1935.— Ordered  to  be  printed 
with  illustrations 


UNITED  STATES 

GOVERNMENT  PRINTING  OFFICE 

WASHINGTON  :  1935 


„,       „  1  (Report 

,4th  Congress  SENATE  No.  944 

1st  i^icssion  Part  2 

Munitions  industry 


PEELIMINAEY  KEPOKT  ON  WARTIME  TAXATION 
AND  PEICE  CONTROL 

BY  THE 

SPECIAL  COMMITTEE  ON 

INVESTIGATION  OF  THE  MUNITIONS  INDUSTEY 

UNITED  STATES  SENATE 

PURSUANT  TO 

S.  Res.  206  (73d  Congress) 

A  RESOLUTION  TO  MAKE   CERTAIN  INVESTIGATIONS 

CONCERNING  THE  MANUFACTURE  AND  SALE 

OF  ARMS  AND  OTHER  WAR  MUNITIONS 


July  29  (calendar  day,  August  20),  1935. — Ordered  to  be  printed 

with  illustrations 


UNITED   STATES 

GOVERNMENT  PRINTING  OFFICE 

WASHINGTON  :  1935 


iURUU    FOR   _^*^,  H    \(i 
»IUHICIPAMS0VE8N^r 

1935 


Bfi§T0W  PUBLIC  im^0i 


THE  SPECIAL  COMMITTEE  ON  INVESTIGATION  OF  THE  MUNITIONS 

INDUSTRY 

GERALD   P.  NYE,  North  Dakota,  Chairman 
WALTER   F.  GEORGE,  Georgia  ARTHUR  H.  VANDENBERG,  Michigan 

BENNETT  CHAMP  CLARK,  Missouri  W.  WARREN   BARBOUR,  New  Jersey 

HOMER  T.  BONE,  Washington 
JAMES  P.  POPE,  Idaho 

Stephen  Raushenbdsh,  Secretary 

Alqer  E[iss,  Legal  Assistant 

L0T7IS  Shebman,  Special  Assistarit  in  the  Preparation  of  this  Report 


CONTENTS 


Page 

Introductory  statement 1 

Findings  and  recommendations 3 

Part  I.  War-Time  Taxation 

I.  Consideration  of  the  effects  of  severe  war-time  taxation 8 

1.  Tendency  to  pass  increased  taxes  on  by  increasing  prices 8 

2.  Effect  of  severe  taxation  on  productivity 10 

3.  Severity  of  taxation  during  World  War 12 

II.  Consideration  of  particular  types  of  taxes 16 

1.  Average  pre-war  income  as  a  tax  base 16 

2.  Invested  capital  as  a  tax  base 19 

III.  Difficulties  involved  in  determining  net  income 27 

1.  Depreciation 27 

2.  Depletion 28 

3.  Amortization 30 

4.  Time  of  accrual  of  income 34 

IV.  Degree  of  administrative  discretion  desirable  in  tax  statutes  in  view 

of  post-war  attitudes  and  back  taxes 37 

V.  Tax  evasion  and  avoidance 44 

1 .  Special  assessments 45 

2.  Deduction  of  capital  losses 47 

3.  Instances  of  readiness  of  taxpayers  to  rely  on  technicalities  to 

avoid  taxes 49 

4.  Obstructive  tactics 52 

5.  Tax-exempt  securities 52 

Part  II.  Price  Control 

I.  Price  control  as  a  means  of  eliminating  war  profits 56 

1.  Varying  costs  of  industry  and  the  profits  of  low-cost  producers.  56 

(a)   Ineffectiveness  of  excess-profits  taxes  to  equalize  profits  of 

low-cost  producers 63 

(6)   Impracticability  of  the  individual  prices  proposal 66 

(c)   Price  regulation  of  monopoly  business 68 

(1)  The  aluminum  industry 69 

(2)  The  nickel  industrv 70 

(3)  The  sulphur  industry . 72 

2.  Business  interests  of  the  price-fixing  administration 73 

3.  Difficulties  of  cost  determination 84 

(a)   The  necessity  for  estimating  future  costs 84 

(6)   Cost  padding 85 

(c)   The  ratio  method  of  price  determination '91 

4.  Nonenforceability  of  price  regulations 92 

5.  The  strike  of  capital 94 

(a)   The  copper  industry 95 

(6)   The  steel  industry 100 

(c)   The  building  and  operation  of  the  Old  Hickory  Powder 

Plant 107 

6.  Impotence  of  governmental  clubs 111 

(a)  The  power  to  requisition  and  commandeer 111 

(b)  The  priorities  system 115 

7.  Constitutional  difficulties  of  price  fixing 116 

in 


IV  CONTENTS 

Page 

II.  Price  control  as  a  means  of  preventing  inflation 117 

1.  Introduction  of  marginal  producers 117 

2.  Increasing  plant  facilities 118 

3.  Encouraging  farm  production 119 

4.  Inevitable  cost  increases 120 

(a)  Insurance  rates 120 

(b)  Labor  costs 121 

(c)  Transportation  costs 121 

5.  The  sellers' advantageous  position  in  war  markets 122 

6.  Abnormal  pre-war  price  levels 125 

III.  Price  control  as  an  aid  to  increased  war  production 127 

1.  Curtailment  of  civilian  consumption 127 

2.  Market  stabilization 128 

APPENDIX 

Exhibit  No.  1388:   Corporation  income  and  profits  tax  rates,  exemptions 

and  credits  under  the  Revenue  Act  of  1909-28,  inclusive 132 

Exhibit  No.  1756:  Income  and  excess-profits  tax  data  for  18  corporations- _  136 
Letter  from  Thomas  J.  Coolidge,  Acting  Secretary  of  Treasury,  to  Senator 

Gerald  P.  Nye,  on  valuation 139 

Excerpt  from  Exhibit  No.   1343:   Memorandum  on  valuation 147 

Exhibit   No.    1405:   Summary  of  amortization  allowances  of  $500,000  or 

over,  as  allowed  by  appraisal  section  up  to  April  30,  1925 159 

Exhibit  No.  1402:   Refunds,  credits,  and  abatements  exceeding  $250,000 

through  special  assessment  allowed  from  July  1,  1921,  to  April  30,  1925-.  164 


T4th  Congress   )  SENATE  (  Kept.  944 

1st  Semi  on        f  1      Part  2 


MUNITIONS  INDUSTRY 


July  29  (calendar  day,  August  20) ,  1935. — Ordered  to  be  printed  with  illustrations 


Mr.  Nye,  from  the  Special  Committee  on  Investigation  of  the  Muni- 
tions Industry,  submitted  the  following 

PARTIAL  PRELIMINARY  REPORT— WARTIME 
TAXATION  AND  PRICE  CONTROL 

[Pursuant  to  S.  Res.  206  and  244,  73d  Cong.;  S.  Res.  8,  74th  Cong.] 

The  Special  Committee  on  Investigation  of  the  Munitions  Industry, 
authorized  by  Senate  Resolution  206  '  of  the  Seventy-third  Congress 
to  investigate  the  munitions  industry,  to  review  the  findings  of  the 
War  Policies  Commission,  and  to  inquire  into  the  desirability  of  creat- 
ing a  Government  monopoly  in  respect  to  the  manufacture  of  muni- 
tions, submits  the  accompanying  introductory  statement  and  partial 
report: 

INTRODUCTORY  STATEMENT 

On  April  12,  1934,  the  Special  Committee  on  Investigation  of  the 
Munitions  Industry  was  authorized  and  directed  by  Senate  Resolu- 
tion No.  206  of  the  Seventy-third  Congress,  among  other  things,  to 
review  the  findings  of  the  War  Policies  Commission  and  to  recommend 
such  specific  legislation  as  may  be  deemed  desu-able  to  accomplish  the 
purposes  set  forth  in  such  findings  and  in  the  preamble  to  Senate 
Resolution  No.  206.  The  preamble  referred,  among  other  things,  to 
the  long  standing  demands  of  American  War  Veterans,  speaking 
through  the  American  Legion,  for  legislation  to  take  the  profits  out 
of  war. 

Pursuant  to  these  clauses  of  the  resolution  public  hearings  were 
held  in  September  and  December  of  1934  and  throughout  the  first  4 
months  of  1935.  Because  many  of  the  witnesses  and  the  companies 
whom  they  represented  were  required  to  be  examined  with  respect  to 
other  provisions  in  the  resolution  as  well  as  with  respect  to  those  direct- 
ing a  review  of  the  findings  of  the  War  Pohcies  Commission,  the  com- 
mittee's hearings  on  this  latter  topic  were  in  man}^  instances  not  held 
separately  from  its  hearings  relating  to  other  provisions  of  the  resolu- 
tion. 


1  By  S.  Res.  244  of  the  73d  Cong,  and  S.  Res.  8  and  129  of  the  74th  Cong,  the  amount  which  the  Com- 
mittee was  authorized  to  expend  was  increased. 

1 


Z  MUNITIONS    INDUSTRY 

This  report  is  designed  to  cover  in  a  preliminary  ^  way  the  results  of 
that  part  of  the  committee's  investigations  carried  on  in  connection 
with  its  review  of  the  findings  of  the  War  Policies  Commission.  The 
primary  obligation  imposed  upon  the  War  Policies  Commission  by 
Public  Resolution  No.  98  of  the  Seventy-first  Congress  was — 

to  study  and  consider  amending  the  Constitution  of  the  United  States  to  provide 
that  private  property  may  be  taken  by  Congress  for  public  use  during  war,  and 
methods  of  equalizing  the  burdens  and  removing  the  profits  of  war,  together  with 
a  study  of  policies  to  be  pursued  in  the  event  of  war. 

The  two  chief  means  of  equahzing  the  burdens  and  removing  the 
profits  of  war  wliich  have  been  employed  in  the  past  and  which  were 
considered  by  the  War  Policies  Commission  are  (1)  taxation,  and  (2) 
control  of  prices.  These  two  metliods  have  received  serious  considera- 
tion by  this  committee  which  has  heard  testimony  of  Government 
officials  and  of  private  citizens  familiar  \\dth  these  fields. 

In  the  case  of  all  witnesses  and  companies  investigated  by  the  com- 
mittee that  were  engaged  in  substantial  business  activities  during  the 
World  War  the  committee  has  endeavored  to  ascertain  the  facts 
relating  to  the  effect  on  the  war  profits  of  such  witnesses  and  companies 
of  taxation  and  price  control.  The  committee  has  also  examined  the 
official  records  of  the  Government  relating  to  the  use  of  these  two 
methods  during  the  World  War.  The  accompanying  preliminary 
report  sets  forth  the  results  of  the  committee's  investigations  as  to 
wartime  taxation  and  control  of  prices  as  a  means  of  removing  profits 
from  war  and  equalizing  the  burdens  of  war. 

2  Because  of  the  extent  of  testimony  taken  by  the  committee  in  the  course  of  its  investigations  the  com' 
plete  testimony  is  not  in  final  printed  form.  Consequently,  in  many  instances  the  citations  to  the  record 
contained  in  this  report  have  had  to  be  made  to  galley  proof  sheets  rather  than  to  the  final  pages  of  the  testi- 
mony. 


FINDINGS  AND  RECOMMENDATIONS 

The  committee  has  in  Senate  Report  No.  577  recommended  that 
H.  R.  5529  \vith  the  amendments  proposed  in  that  report  be  enacted 
into  law.  That  bill  is  designed  to  prevent,  so  far  as  legislation  can 
cope  with  such  forces,  the  distressing  inequalities,  the  shameless 
profiteering,  and  the  staggering  aftermath  of  the  last  war. 

The  committee  reaffirms  its  recommendation  that  H.  R.  5529  as 
amended  should  pass  and  is  firmly  of  the  opinion  that  the  bill  repre- 
sents a  long  advance  toward  its  purposes. 

The  committee  recognizes,  however,  the  importance  of  the  question 
of  whether  there  is  complete  assurance  that  the  Federal  Government 
has  all  the  necessary  powers  to  achieve  this  goal. 

This  question  has  been  raised  before  at  various  times.  It  was 
raised  during  the  war  by  industrial  groups,  in  an  endeavor  to  weaken 
any  attempt  by  the  Government  to  fix  low  prices.  It  was  raised 
again  in  the  creation  of  the  War  Policies  Commission  of  1930.  In 
fact,  one  of  the  chief  duties  laid  upon  that  Commission  was  to  con- 
sider the  necessity  of  amending  the  Constitution.  It  was  raised 
again  in  1934  when  this  committee  was  created  and  charged  with 
the  duty  of  reviewing  the  findings  of  the  War  Policies  Commission. 

The  committee  now  undertakes  to  discharge  this  duty.  On  the 
basis  of  a  careful  review  of  the  World  War  experience  with  price- 
fixing,  based  on  the  study  of  all  the  minutes  of  all  the  governmental 
bodies  involved  in  that  price-fixing,  together  with  studies  and  analyses 
of  large  groups  of  profit  figures  and  income  tax  returns,  the  committee 
finds  that  in  order  to  prevent  wide-spread  profiteering  in  a  national 
war  emergency  several  amendments  to  the  Constitution  will  probably 
be  necessary. 

The  committee  takes  into  consideration  the  serious  objections  to 
these  amendments.  It  realizes  the  possibility  that  the  adoption  of 
such  amendments  may  create  other  situations  far  worse  than  the 
situation  of  profiteering  in  a  national  emergency.  It  simply  states  its 
findings,  based  on  the  evidence  in  this  report  and  in  report  no.  577, 
that  if  the  sole  purpose  under  consideration  is  the  avoidance  of 
profiteering,  the  following  amendments  to  the  national  Constitution 
must  be  made: 

1 .  The  first  of  these  amendments  should  permit  the  comrnandeering 
of  plant,  goods,  and  industrial  equipment  for  public  use  in  time  of  war 
without  the  determination  of  ''fair  compensation"  in  the  present 
way  through  review  by  the  courts  which  results  in  payment  at  the 
highest  possible  price  levels.  This  is  not  an  amendment  to  abolish 
the  payment  of  fair  compensation,  but  to  allovr  for  the  determination 
of  fair  compensation  according  to  the  directions  of  Congress  rather 
than  of  the  courts.      (See  pp.  Ill  to  116.) 

2.  The  second  of  these  amendments  should  make  certain  the  power 
of  Congress  to  tax  for  war-profits  control  on  such  bases  of  investment 
or  fixed  capital  assets  as  it  finds  to  be  fair  and  just  regardless  of  the 

3 


4  MUNITIONS    INDUSTRY 

possible  inequality  among  taxpayers  of  such  bases  and  without  the 
elaborate  procedure  which  may  be  unavoidable  under  existing  law. 
Without  this  amendment  the  tax  bases  proposed  in  H.  R.  5529  may 
be  successfully  attacked  by  those  bent  upon  securing  larger  profits 
than  it  permits.  (See  p.  8,  note  3;  p.  26,  notes  70  and  72  and  see 
pp.  19-20.) 

3.  The  tliird  of  these  amendments  should  permit  Congress  to  tax 
the  interest  of  tax-exempt  securities  during  a  national  emergency, 
(See  p.  52.) 

These  three  amendments  would  give  to  the  Government  the  neces- 
sar}"  power  to  fix  prices  and  pay  the  costs  of  a  war  through  taxation. 
The  other  possible  effects  of  these  amendments  are  considered  later. 

While  the  Government  would,  with  the  passage  of  H.  R.  5529  and 
the  adoption  of  these  three  amendments,  have  full  and  adequate 
power  to  control  the  economic  forces  of  the  I^ation  in  the  carrying  on 
of  a  war,  it  is  still  open  to  question  whether  these  powers  would  be  so 
used  by  the  officials  of  the  Government  as  to  eliminate  all  profiteering. 
There  are  two  reasons  for  believing  that  these  powers  would  not  be  so 
used. 

1.  The  main  interest  during  wartime  of  all  concerned  with  the 
conduct  of  the  war  is  not  that  of  saving  money,  but  of  securing  pro- 
duction as  rapidly  and  as  fully  as  possible.  Lowered  prices,  higher 
taxes,  avoidance  of  inflation  are  all  secondary  interests.  As  Mr, 
Charles  Hayden  told  the  Price  Fixing  Committee  in  May  1918: 

Our  Allies  are  crying  for  copper;  representatives  of  foreign  governments  are 
telling  me  as  an  individual:  "What  do  we  care  about  a  cent  or  more  in  price? 
What  we  want  is  the  stuff." 

The  moment  an  industry  threatens  that  lowered  prices  will  slow  down 
its  production,  or  that  high  taxes  will  make  it  impossible  for  it  to 
secure  working  capital,  the  Government  will  yield  as  it  yielded  in  the 
last  W'ar.  In  January  1918  the  War  Industries  Board  approved  a 
large  contract  with  the  Hercules  Pow^der  Co.  at  a  price  which  it  thought 
too  high  for  the  reason  that  "it  was  either  necessar}^  to  pay  the  70 
cents  per  pound  or  go  without  the  powder." 

The  apparent  alternative  of  commandeering  industry  is  in  fact  not 
an  available  alternative.  If  the  owmers  of  industry  are  compensated 
to  their  owm  satisfaction  and  surrender  their  enterprises  and  the  bene- 
fits of  their  operating  experience  to  the  Government,  as  in  the  case 
of  the  railroads  during  the  World  War,  the  cost  is  as  great  as  the  cost 
of  meeting  industry's  demands  for  its  services.  On  the  other  hand, 
if  any  significant  part  of  industry  were  to  be  arbitrarily  confiscated 
against  the  wishes  of  the  majority  of  the  business  community,  the 
chaotic  condition  resulting  from  the  great  social  and  political  ani- 
mosity which  would  be  aroused  thereby  would  definitely  retard  the 
production  wiiich  is  of  paramount  necessity  for  the  prosecution  of  a 
modern  war. 

During  the  World  War  the  copper  industry  simply  refused  to  pro- 
duce at  even  the  liberal  prices  first  proposed  by  the  Government. 
(See  p.  95  et  seq.)  The  steel  industry  similarly  refused  to  fill  Govern- 
ment orders  until  prices  had  been  stabihzed  at  levels  satisfactory  to  the 
industry.  (See  p.  100  et  seq.)  Judge  Gary,  representing  the  steel 
industry,  told  the  Price  Fixing  Committee  that  "manufacturers  must 
have  reasonable  profits  in  order  to  do  their  duty."  The  du  Pont  Co. 
refused  to  build  a  great  powder  plant  wliich  it  alone  was  quahfied  to 


MUNITIONS   INDUSTRY  5 

build  until  it  was  assured  of  what  it  considered  sufficient  profits. 
(See  p.  107  et  seq.)  Mr.  Pierre  du  Pont  wrote  that  "we  cannot  assent 
to  allowing  our  own  patriotism  to  interfere  with  our  duties  as  trustees." 

The  Government  is  more  at  the  mercy  of  such  a  strike  by  capital  or 
management  than  at  the  mercy  of  a  strike  by  labor.  The  War  Depart- 
ment bills,  which  have  been  prepared  for  adoption  upon  the  outbreak 
of  a  war,  provide  in  effect  that  labor  can  be  drafted  and  that  men  must 
either  work  or  fight.  It  will  be  entirely  within  the  power  of  the  Govern- 
ment, under  these  bills,  to  require  men  to  work  where  they  are  told 
and  to  select  any  leaders  of  a  labor  strike  and  draft  them  into  the 
military  service  the  moment  any  strike  is  threatened.  With  these 
powers,  and  with  a  whole  labor  pool  to  draw  on  in  the  form  of  the  con- 
script army,  there  is  no  question  that  the  Army  can  break  any  labor 
strike.  As  pointed  out  above,  it  is  in  no  similar  situation  in  regard  to 
a  strike  by  capital  or  management. 

There  is  also  another  factor  which  makes  a  strike  by  capital  or 
management  harder  for  the  Government  to  handle  than  a  strike  by 
labor.  The  latter  is  open  and  advertised.  All  the  force  of  patriotic 
pubhc  opinion  can  be  brought  to  bear  to  stop  it.  The  former  is 
neither  open  nor  advertised.  It  was  not  until  the  hearings  of  this 
committee,  some  17  or  18  years  after  the  event,  that  the  strikes  of 
certain  of  our  industrial  companies  in  connection  with  war-time  price 
fixing  became  loiown. 

2.  Wliile  this  incapacity  of  the  Government  to  take  over  or  to  dis- 
pense 'wdth  the  function  of  any  industr}^  is  the  main  reason  for  the 
expectation  that  even  complete  theoretical  authority  and  power  mil 
never  be  invoked,  there  is  another  subsidiary  reason.  The  administra- 
tion of  prices  and  procurement  is  inevitably  put  into  the  hands  of 
people  who  have  been  industrially  trained  and  who  are  sympathetic 
to  private  industry's  demands. 

During  the  last  war  the  interests  of  the  administrative  officials  were 
definitely  close  to  the  interests  of  the  regulated  industries.  (See  pp. 
13  to  83.)  Mr.  Brookings  told  the  nickel  industry:  "We  are  not 
in  an  attitude  of  envying  you  your  profits ;  we  are  more  in  the  attitude 
of  justifying  them  if  we  can.  That  is  the  way  we  approach  these 
things."  The  experience  of  such  men  must  be  used  by  the  Govern- 
ment and  yet  their  attitude  toward  the  contentions  of  industry  is 
inevitably  favorable.  Such  men  will  not  use  theoretically  full  powers 
to  eliminate  profiteering  even  if  they  have  them. 

With  these  two  considerations  in  mind  the  committee  makes  the 
following  findings  with  respect  to  war-time  taxation  and  price  control 
as  means  of  equalizing  the  burdens  of  war  and  of  removing  the  profits 
from  war: 

1.  It  must  be  recognized  that  war  inevitably  involves  waste  and 
increased  living  costs.  The  increase  of  costs  due  to  the  shift  of  pro- 
duction from  peace-time  to  war  purposes,  to  the  use  of  untrained 
labor  to  replace  men  drafted  into  the  army,  to  the  high  risks  of  war- 
time production  in  many  industries,  and  to  the  necessity  for  rapid 
production  and  delivery,  requnes  an  increase  in  some  prices  in  war 
time  whatever  form  of  price  control  is  exercised.  The  interrelation 
of  our  industries  will  spread  the  effect  of  these  increases  throughout 
our  economy.  This  means  that  no  arbitrary  plan  of  keeping  all  prices 
at  a  given  level  is  practicable  and  individual  prices  must  be  fixed  by 
governmental  agencies.     (See  pp.  117  to  126.) 


6  MUNITIONS    INDUSTRY 

2.  The  necessity  that  the  governmental  price-control  agencies 
must  largely  rely  upon  industry  for  their  information  as  to  costs, 
capacity,  production  needs,  and  other  fundamental  information,  and 
the  fact  that  the  personnel  of  these  agencies  must  be  largely  made 
up  of  men  who  have  been  industrially  trained  and  who  are  sympa- 
thetic to  private  industry's  contentions,  when  added  to  the  critical 
importance  of  increasing  industrial  output  in  war  time,  prevent  the 
fLxing  of  prices  below  such  a  level  of  profitability  as  the  bulk  of  the 
producers  in  any  industry  agree  is  fair.  (See  pp.  73  to  83  and  pp. 
55;  and  62-63.) 

3.  The  fact  that  costs  are  in  the  last  analysis  matters  of  opinion 
and  are  not  susceptible  of  scientific  determination,  and  the  gigantic 
nature  of  the  administrative  task  involved  in  enforcing  any  price 
provisions  opposed  by  a  substantial  portion  of  industry  make  it  im- 
possible to  eliminate  war  profits  by  price  control  except  to  the  extent 
that  industry  agrees  to  accept  a  limitation  of  its  profit-making  po- 
tentialities.     (See  pp.  84  to  91  and  pp.  92  to  94.) 

4.  There  are  large  profits  and  there  is  inequality  in  peace  time. 
The  strain  and  stress  of  war  is  not  conducive  to  the  adoption  of  fun- 
damental reforms  wliich  cannot  secure  acceptance  even  in  time  of 
peace.  We  must  guard  against  a  blind  belief  that  all  profiteering 
can  be  ended  by  proposals  for  war-time  taxes  and  industrial  control. 

5.  wSevere  war-tmie  taxation  ensures  the  subjecting  of  the  admin- 
istrative officials  responsible  for  its  operation  to  heavy  direct  and 
indirect  pressure  for  the  alleviation  of  tax  burdens,  it  increases  resist- 
ance to  tax  collection,  and  if  it  reaches  a  level  which  the  majority  of 
business  men  feel  is  confiscatory,  will  discourage  or  prevent  the  volume 
of  production  so  essential  to  the  successful  prosecution  of  a  major 
war  and  thus  defeat  its  own  ends.     (See  pp.  37  to  43  and  pp.  10  to  12.) 

6.  Because  of  the  difficulties  of  determining  in  any  exact  manner  the 
costs  of  all  business  and  hence  the  profits  from  business  and  because 
of  the  impossibility  of  closing  all  loopholes  in  legislation  designed  to 
apply  uniformly  to  our  immense  and  complicated  business  and  indus- 
trial structure,  income  taxation  cannot  eliminate  all  war  profits. 
(See  pp.  27  to  34;  84  to  91;  44  to  52  and  25-26.) 

The  committee  recognizes  that  the  first  two  of  the  constitutional 
amendments  herein  described  as  necessary  to  any  effective  control  of 
profiteering  contain  dangers  that  may  be  far  worse  than  the  evil  of 
profiteering.  The  power  of  commandeering  and  the  power  of  taxing 
without  uniformity — both  without  our  customary  elaborate  court 
review — increase  enormously  the  power  of  the  Federal  Government. 
If  that  Government  should  in  the  next  war  be  run  in  the  interests  of 
any  industrial  group  or  class  its  power  to  destroy  the  competitors  of 
that  group  or  class  would  be  without  the  traditional  protections  so 
familiar  to  this  country.  The  opportunities  for  militaristic  control  in 
war-time  are  well  known;  the  relaxing  of  constitutional  restrictions 
will  increase  these  opportunities. 

Furthermore,  under  these  proposed  amendments,  in  the  event  that 
any  group  controlling  the  Treasury,  Army^avy,  or  the  future  equiv- 
alent of  the  War  Industries  Board,  wishes  to  punish  those  who  may 
have  opposed  the  war  before  its  declaration,  or  those  who  have  criti- 
cized the  allocation  of  war  orders,  or  wishes  to  eliminate  certain 
competitors,  that  group  can  utilize  its  power  to  do  so.  If  there  is, 
therefore,  the  least  danger  that  any  group  of  industrialists,  through  the 


MUNITIONS    INDUSTRY  7 

sheer  size  of  their  investment,  or  through  their  absokite  necessity 
for  war  purposes,  such  as,  for  example,  the  steel  and  chemical  in- 
dustries, should  be  in  a  position  of  power  in  a  war-time  administra- 
tion, the  first  two  amendments  would  be  dangerous  weapons  to  place 
in  their  hands.  Even  a  temporary  abuse  of  power  by  such  a  group 
might  result  in  the  destruction  of  the  financial  independence  of  another 
group. 

To  the  amendment  providing  for  the  war-time  taxation  of  interest 
on  tax-exempt  securities  there  can  be  no  similar  objections. 


PART  I.  WARTIME  TAXATION 

I.  Consideration  of  the  Effects  of  Severe  Wartime  Taxation 

The  purposes  of  wartime  taxation  as  viewed  by  this  committee  are 
twofold:  First,  the  normal  purpose  of  raising  revenue,  which  in  time 
of  war  is  increased  in  importance  because  of  the  heavy  demands  upon 
the  Treasury;  and,  second,  the  removal  of  profits  made  from  the  war.^ 
It  is  assumed  by  the  committee  that  the  combination  of  these  two 
purposes  will  result  in  much  more  severe  taxation  in  wartime  than  in 
peacetime.  Not  only  will  tne  amount  of  total  collections  be  increased, 
because  the  increase  in  industrial  activity  almost  certain  to  be  incident 
to  war  will  make  a  larger  amount  of  profits  available  for  taxation — 
but  the  rate  of  taxation  must  be  increased  sufficiently  to  take  more 
than  the  war  profits,  since  obviously  the  total  cost  of  a  war,  sub- 
stantially all  of  which  is  borne  by  the  Government,  must  be  greater 
than  the  element  of  profit  in  that  cost  and  it  is  clearly  desirable  for 
the  Government  to  pay  as  much  of  the  current  expenses  of  the  war 
out  of  current  revenue  as  is  possible. 

It  must  be  recognized  that  in  determining  the  degree  of  severity  of 
taxation  which  should  be  employed  in  war  time,  it  is  important  to 
study  the  effects  of  severe  wartime  taxation  upon  the  economic  con- 
dition of  the  country  generally,  and  in  particular  upon  its  ability  to 
produce  materials  essential  for  the  conduct  of  war. 

(i)  tendency  to  pass  increased  taxes  on  by  increasing  prices 

There  can  be  no  doubt  that  business  men  in  general  regard  taxes 
as  a  cost  of  doing  business  and  consequently  attempt  to  recoup 
taxes,  as  well  as  other  costs,  out  of  sales  prices.  This  means  that, 
ordinarily,  an  increase  in  the  severity  of  taxation  does  itself  tend  to 
raise  the  price  level,  and  to  the  extent  it  is  passed  on  does  not  result 
in  any  decrease  of  the  total  volume  of  profits.  The  statements  of 
two  men  familiar  with  the  taxes  in  effect  during  the  last  war  may  be 
quoted  on  this  subject.  Mr.  Baruch  in  testifying  before  the  War 
Policies  Commission  made  the  following  statement: 

Excess-profits  taxes — standing  alone — have  no  effect  whatever  to  check 
inflation.  Their  onlv  effect  is  to  increase  it.  Thus  20  percent  of  $500,000  profit 
is  $100,000  and  20  percent  of  $1,000,000  profit  is  $200,000.  One  way  to  increase 
$500,000  profit  to  $1,000,000  profit  without  increased  risk  or  effort  is  to  double 
price.  For  this  reason  there  is  more  incentive  to  increase  prices — and  therefore 
profits— under  an  SO-percent  excess-profits  tax  than  there  is  without  it.  Indeed, 
the  main  result  of  such  a  system  is  to  induce  rapid  price  increases  to  absorb  the 

3  It  is  recognized  that  the  use  of  the  taxincc  power  to  remove  profits  from  war-time  production  and  com- 
merce may  not  be  permissible  under  the  Federal  Constitution  without  amendment.  The  attempt  to  make 
all  profits  uniform,  at  the  same  time  that  the  Government  has  power  to  commandeer  products  or  plants  that 
are  not  freely  made  available  for  the  prosecution  of  the  -wht,  i?  more  nearly  analogous  to  the  governmental 
authority  exercised  in  the  field  of  public  utilities  than  to  the  power  to  raise  revenue.  The  use  of  any  of  the 
Federal  powers  mav  be  limited  to  the  effecting  of  its  direct  purposes.  Cf.  the  recent  United  States  Supreme 
Court  case,  Louisville  Jcint  Stock  Land  Bank  v.  Radford,  decided  May  27,  1935,  dealing  with  the  bankruptcy 
powers  of  the  Federal  Government,  and  see  Bailey  v.  Dreiel  Furniture  Co.  (259  U.  S.  20).  On  the  other 
hand  it  is,  of  course,  impossible  to  forecast  with  any  substantial  certainty  the  extent  to  which  the  war 
powers  of  the  Federal  Government  may  be  construed  to  permit  the  removal  of  war  profits.  Furthermore, 
it  is  well  settled  that  the  motives  which  prompt  Congress  to  pass  revenue  measures  will  not  be  reviewed 
by  the  courts  and  that  incidental  efl'ects  of  tax  statutes  will  not  invalidate  such  statutes.  (See  Bailey  v. 
Drexet,  supra,  at  pp.  38,  40,  41.) 

8 


MUNITIONS    INDUSTRY  9 

tax.  Precisely  because  it  accelerates  and  in  nowise  checks  inflation  the  excess- 
profits  tax — without  more — offers  no  cure  at  all  for  war  evils.  On  the  contrary, 
it  aggravates  them.* 

Mr.  Colver,  who  was  chairman  of  the  Federal  Trade  Conimission 
during  the  war,  made  the  following  statement: 

*  *  *  the  way  to  make  anything  expensive  is  to  tax  it;  and  if  you  levy  a  tax 
on  war,  you  make  war  cost  more  than  it  should.  A  study  of  the  actual  working 
out  of  our  excess  profits  tax  during  the  last  war  will  demonstrate  beyond  any 
possible  question  that  it  did  not  recover  the  excess  profits;  that  it  did  not  keep 
prices  down,  and  that  it  did  not  stimulate  production,  but  that  on  the  contrary, 
it  slowed  production  down,  it  stimulated  prices,  and  it  made  the  cost  of  the  war 
to  the  taxpayers,  I  should  say,  twice  what  it  should  have  been.  I  would  say  that 
for  every  dollar  collected  in  excess-profits  taxes  that  got  into  the  Treasury  it  cost 
the  people  of  the  United  States,  or  it  will  cost  them  $10  unnecessarilj'.s 

The  ineffectiveness  in  recapturing  profits  derived  from  the  Great 
War,  of  taxes  based  upon  a  percentage  of  profit  appears  from  the 
figures  discussed  at  pages  13-15  and  65-66. 

Another  statement  of  Mr,  Colver's  stresses  the  point  that  since 
the  Government  in  war  times  becomes  the  largest  consumer,  a  pass- 
ing on  of  taxes  in  the  form  of  higher  prices  paid  by  the  Government 
as  consumer  not  only  permits  war  profits  but,  by  decreasing  the  pur- 
chasing power  of  the  Government,  tends  to  defeat  the  primary  pur- 
pose of  war-time  taxation — the  raising  of  sufficient  revenue  to  finance 
the  war — and  so  to  make  governmental  borrowing  inevitable: 

I  dissent  wholly  and  entirely  from  the  theory  that  excess-profit  taxes  justify 
unreasonable  price  structures  and  purge  unreasonable  profits.  Not  a  penny  of 
excess-profit  tax  has  been  or  will  be  paid  to  the  Government  that  has  not  first 
been  collected  with  many  other  pennies  from  the  people  of  the  country,  either  as 
consumers  or  as  tax  payers.  Since  the  Government  itself  is  by  far  the  largest  of 
all  buyers  at  fixed  prices,  it  seems  to  be  absurd  to  take  an  excess  dollar  out  of  the 
Treasury  in  order  to  get  34  cents  of  it  back  in  by  way  of  excess-profit  taxes.  The 
net  result  of  such  a  transaction  is  merely  creating  the  necessity  of  raising  an 
otherwise  unnecessary  66  cents  by  some  other  means  of  taxation  or  by  bond  sale. 
In  the  main,  it  is  not  industry  which  ultimately  pays  excess-profit  taxes,  but  the 
consumer,  and  onlj^  a  small  part  of  the  excess  which  the  consumer  pays  reaches 
the  Treasury  in  the  form  of  taxes.  The  whole  excess-profit  tax  theory  is  an 
attempt  to  lift  oneself  b}^  his  boot  straps,  and  there  is  lost  from  20  to  80  percent  of 
the  energy  employed  in  the  process.^ 

The  difficulty  of  determining  with  any  substantial  degree  of  cer- 
tainty the  costs  of  business  operations  makes  the  fixing  of  prices  by 
governmental  agencies  an  unsatisfactory  means  of  eliminating  wide- 
spread tendencies  toward  price  increases.  (See  pt.  II  of  this  report). 
Since,  for  the  reasons  pointed  out  above,  a  tax  of  a  percentage  of 
profits  does  cause  a  wide-spread  tendency  to  inflate  prices,  it  is  felt 
that  the  evils  of  such  a  tax  are  inseparably  linked  to  it  and  that  the 
principle  of  taxing  a  percentage  of  profits  must  itself  be  avoided. 
Consequently,  tliis  committee  has  recommended  that  corporate 
income  be  completely  confiscated  beyond  an  exemption  which  is 
itself  not  based  upon  a  percentage  of  profit.     Such  a  tax  would  remove 

*  War  Policies  Commission,  H.  Doc.  No.  163,  72d  Cong.,  1st  sess.  (1931),  p.  798. 

'  Hearings  before  the  Committee  on  Military  Afiairs,  House  of  Representatives,  68th  Cong-  Ist  soss.. 
Mar.  11,  13,  and  20,  1924,  p.  237. 

•  Garrett,  Government  Control  over  Prices  (1920),  p.  391. 


10  MUNITIONS    INDUSTRY 

the  incentive  to  pass  on  its  burden  in  the  form  of  higher  prices  ^  since, 
regardless  of  the  vohime  of  business  or  the  total  income,  only  a 
definitely  limited  amount  of  profit — determined  without  regard  to 
the  amount  of  income  received — could  be  retained  by  the  taxpayer. 
It  must  be  noted,  however,  that  such  a  tax  raises  other  problems, 
the  chief  of  which  is  the  effect  upon  production  of  a  limitation  of 
profit  which  ensures  that  beyond  that  limitation  an  increase  of  in- 
dustrial activitv  will  brins;  no  return. 


(2)    EFFECT    OF    SEVERE    TAXATION    ON    PRODUCTIVITY 

The  profits  of  any  business  do  not  appear  entirely  as  cash  but  are 
also  in  large  part  in  the  form  of  such  assets  as  accounts  receivable  and 
inventories.  Consequently,  the  average  company  does  not  have 
sufficient  cash  available  to  pay  as  taxes  anything  like  the  entire  amount 
of  its  current  profits.  Furthermore,  cash  reserves  are  vital  to  most 
businesses  to  finance  current  operation  and  will  be  particularly  needed 
in  war  time  to  finance  the  conversion  from  peace  to  war  production. 
Therefore,  in  order  to  assure  productivity,  cash  reserves  should  not 
be  drained  by  taxation  even  in  the  cases  of  companies  having  sm'- 
pluses  sufficiently  large  to  pay  severe  taxes. 

In  addition,  in  the  case  of  a  severe  tax  any  mechanical  error  in  favor 
of  the  Government  in  the  computation  of  the  tax  (which  involves 
the  complications  inherent  in  the  accounts  of  modern  large-scale 
business  where  depreciation,  depletion,  and  many  other  items  are 
largely  matters  of  judgment)  may  mean  the  destruction  of  the  tax- 
payer's business.  It  was  for  this  last  reason  that  Mr.  Ballantine 
when  Assistant  Secretary  of  the  Treasury  testified  before  the  War 
Policies  Commission  that  at  the  outside  a  tax  of  90  percent  of  profit 
was  the  maximum  that  could  be  used  safely: 

In  the  case  of  any  business  which  is  at  all  complicated  the  determination  of 
the  profit  for  a  particular  year  can  rarely  be  exact  but  must  rest  in  part  upon 
assumptions  and  estimates.  Almost  never  does  the  entire  profit  take  the  form  of 
an  actual  excess  of  cash  or  securities  at  the  end  of  the  year.  Generally  speaking, 
part  of  the  profit  is  in  the  form  of  inventories  and  in  the  form  of  improvements  or 
additions  to  factories.  Where  the  rate  of  tax  is  moderate,  errors  in  determination 
do  not  have  vital  consequences  and  average  out  over  the  years.  If,  however,  the 
entire  profit  is  to  be  taken  out  of  the  business,  errors  in  computation  might  be 
disastrous.  Without  elaborating  on  this  difficulty,  it  may  be  stated  that  to  allow 
some  margin  for  error,  any  workable  tax  would  presumably  have  to  be  computed 
on  some  percentage  less  than  100  percent — saj^  80  percent  or,  perhaps,  at  the 
outside,  90  percent.  Eighty  percent  was  the  rate  urged  by  the  Treasury  and 
adopted  as  the  maximum  in  1918  and  was  the  rate  finally  used  in  the  British 
excess-profits  tax.     Leaving  some  relatively  small  margin  of  profit  also  serves  the 

'  It  would,  however,  have  an  inflationary  influence  in  that  it  would  encourage  (1)  the  treatment  of  doubt- 
ful items  as  cost  rather  than  as  income,  and  (2)  higher  costs  in  general  than  would  be  normal.  Increases  in 
cost,  of  course,  result  in  a  tendency  to  increase  prices.  For  example,  during  the  World  War  in  the  desire 
to  avoid  having  the  Government  get  the  lion's  share  of  the  profits,  salaries  of  executives  were  increased 
inordinately  and  bonuses  liberally  distributed.  Compare  the  report  on  the  American  Metal  Mining  Co. 
in  the  Federal  Trade  Commission  Report  re  "Profiteering"  (65th  Cong.,  2d  sess.,  Doc.  248  (191S),  pp. 
19-20).  The  expansion  of  advertising  to  a  volume  beyond  what  certain  authorities  have  argued  to  be 
socially  desirable  dates  from  the  war  period.  "Only  the  shortage  of  paper  limited  the  expenditm^e  for 
advertising  according  to  one  Treasury  official."  Haig,  Taxation  of  Excess  Profits  in  Great  Britain  (1920), 
p.  148-,  note  5. 

Furthermore,  expenditures  were  encouraged  which  were  neither  extravagant  nor  designed  to  be  evasive, 
but  were  of  the  type  aiming  at  future  speculative  profits,  such  as  "repairs  and  betterments  not  presently 
needed  or  made  with  an  eye  to  the  future  and  in  anticipation  of  a  return  to  peace-time  basis.  Further, 
expenditures  are  lavishly  made  by  big  concerns  out  of  rapidly  accumulating  surpluses  which  are  in  the 
nature  of  strategic  advances  upon  other  weaker  competitors  and  which,  upon  a  return  to  peace-time  basis, 
will  tend  to  result  in  a  permanent  elimination  of  weaker  competitors  and  the  rapid  extension  of  monopolistic 
conditions.  These  expenditures  are  made  on  the  theory  that  out  of  every  dollar  so  spent,  the  Government 
itself  contributes  anywhere  from  20  to  80  cents  of  the  cost."  (Garrett,  Government  Control  over  Prices 
(1920),  pp.  391-392.) 


MUNITIONS    INDUSTRY  11 

purpose  of  furnishing  a  guaranty  to  the  Government  that  the  taxpayer  will  see 
to  the  administration  of  the  business  with  efficiency  and  economy.^ 

These  considerations  were  restated  in  substantially  the  same  form 
by  the  Secretary  of  the  Treasury  in  responding  to  a  resolution  of  the 
Senate  for  recommendations  and  opinions  as  to  the  proposal,  result- 
ing from  the  War  Policies  Commission's  investigations,  that  war 
profits  over  and  above  the  pre-war  average  be  taxed  at  a  rate  of  95 
percent.'^ 

In  time  of  war  increased  production  in  many  lines  of  industry  and 
uninterrupted  output  in  most  fields  of  industry  are  essential  and  are 
far  more  miportant  than  elmiinating  profiteering  or  preventing  a 
heavy  debt  being  passed  on  to  post-war  administrations.  Conse- 
quently, if  the  absolute  rate  of  any  war-time  tax  is  so  severe  as  to 
discourage  investment  required  for  reconditioning  idle  plants,  con- 
verting plants  from  nonessential  to  essential  production,  building  new 
facilities,  financing  larger  purchases  of  raw  materials  and  increased 
pay  rolls — to  name  a  few  of  the  wartime  requirements  for  capital  in 
expanding  production  and  eliminating  any  consideration  of  the  effect 
of  such  a  tax  on  existing  production — it  cannot  be  permitted. 

The  operation  of  investment  in  our  economy  is  quite  distinct  from 
any  ciuestion  of  the  Avillingness  of  any  individual  to  forego  profits  for 
a  patriotic  reason.  The  scale  of  profit  is  the  routine  method  by 
which  industrial  activity  is  carried  out.  The  investor  is  guided  not 
by  general  questions  of  usefulness  or  national  need,  about  wliich  he 
is  in  most  cases  not  advised,  but  simply  by  the  prospect  of  profit 
held  out  to  him.^''  If  this  is  cut  off,  expansion  of  industrial  activity 
may  cease,  and  will  in  any  event  be  seriously  curtailed,  and  even  exist- 
ing production  will  be  reduced.  In  such  an  event  the  financing  of  a 
large  part  of  the  needed  expansion,  without  considering  existing  pro- 
duction, by  the  Government  might  well  mean  a  greater  financial 
burden  on  the  Government  than  would  be  the  case  under  a  more 
moderate  rate  of  tax.  GovernrnxCnt  expenditures  in  loans  would 
be  increased  wdthout  any  assurance  that  Government  expenditures 
for  supplies  would  be  correspondingly  decreased.  Government 
revenue  from  a  tax  at  a  lower  rate  applied  to  a  larger  volume  of 
privately  financed  business  might  actually  be  greater  than  the 
revenue  from  a  tax  fixed  at  a  rate  so  high  as  to  discourage  expansion 
of  private  business.  The  administrative  burdens  imposed  on  the 
Government  in  carrying  out  such  financing,  and  the  resultant  neces- 
sary supervision  of  operations,  would  in  addition  be  enormous  and 
would  be  imposed  at  the  very  time  when  administrative  capacity 
would  already  be  sorely  overburdened  by  other  war  duties. 

Once  the  country  has  been  launched  upon  a  major  war  any  serious 
threat  to  the  stability  of  production  would  be  disastrous  and  the  intro- 
duction of  the  Government  into  business  on  the  large  scale  that  might 
be  required  by  a  confiscatory  tax  rate  could  not  be  effected  without 
such  a  threat. 


8  War  Policies  Commission,  House  Document  No.  IfiS,  72d  Cong.,  1st  sess.  (1931),  pp.  691-2. 

5  "2(1  Cong.,  1st  sess.,  Senate  Doc.  105,  p.  3. 

'"  See  letter  of  B.  M.  Baruch  to  committee  dated  Apr.  12, 1935:  "Much  as  it  may  be  decried,  the  cold  fact 
remains  that  ours  is  an  economy  motivated  by  profits.  A  certain  return  on  money  is  necessary  to  make 
our  industrial  system  work  •  *  •  Much  was  said  at  the  liearin;;  about  this  being  a  new  war  psychology 
*  *  •  Our  whole  industrial  system  is  a  complex  massive  machine  built  and  geared  to  run  on  investment 
and  profit.  There  is  no  proof  that  it  will  run  on  psychology  and  there  is  much  that  it  will  not.  Certainly 
we  should  not  .select  an  hour  when  the  enemy  is  at  the  gates  to  find  out  whether  it  will  or  not  *  •  « 
Money  will  not  invest  and  run  the  extreme  risks  of  war  production  for  a  fraction  of  3  percent." 


12  MUNITIONS    INDUSTRY 

Furthermore,  if  a  wartime  tax  is  so  burdensome  as  to  be  considered 
unfair  by  the  pubhc  at  large,  the  resulting  increase  in  the  all  too 
normal  tendency  to  avoid  or  evade  taxation  "  may,  quite  apart  from 
its  economic  and  social  effects,  result  in  a  decrease  in  net  revenue  to 
the  Government. 

(3).    SEVERITY  OF  TAXATION  DURING  WORLD  WAR 

Patriotism  in  the  last  war  was  tested  in  a  situation  where  the  highest 
excess-profits  tax  rate  continued  in  existence  for  only  1  year,  was  80 
percent  of  profits  over  and  above  an  exemption  of  at  least  10  percent 
of  investment,  which  as  pointed  out  above  at  page  8,  is  not  a  check 
on  the  absolute  amount  of  profits.  Mr.  Haig,  in  speaking  of  the 
British  experience  on  the  subject,  indicated  that  abuses  would  develop 
even  with  a  rate  far  below  80  percent: 

Best  informed  British  opinion  places  the  maximum  share  which  can  be  safely 
taken  by  the  Government  at  about  50  percent.  If  the  Gov'ernment  takes  more 
than  the  half  of  the  pound  of  profit,  abuses,  it  is  believed,  are  certain  to  develop.'* 

The  1917  Revenue  Act  imposed  income  taxes  up  to  4  percent  on 
corporate  incomes  remaining  after  payment  of  excess-profits  taxes  and 
relied  primarily  on  the  excess-profits  taxes  for  revenue.  These  taxes 
were  based  upon  a  pre-war  earnings  standard  that  required  a  determi- 
nation of  invested  capital.  To  a  flat  exemption  of  $3,000  was  added 
an  exemption  computed  by  applying  to  the  invested  capital  em- 
ployed during  the  taxable  year  a  percentage  equal  to  the  percentage 
which  pre-war  income  (1911-13,  inclusive)  was  of  pre-war  invested 
capital.  (Sees.  203,  200).  This  involved  a  computation  of  invested 
capital  and  income  for  two  periods,  but  since  the  act  fixed  the  maxi- 
mum percentage  of  current  invested  capital  at  9  and  the  minimum  at 
7  the  importance  of  pre-war  invested  capital  and  income  was  lessened 
as  compared  with  the  significance  of  current  invested  capital,  to 
which  the  definitely  limited  percentage  was  to  be  apphed,  and  current 
net  income. 

Net  income  over  and  above  the  7  to  9  percent  of  invested  capital 
was  taxed  at  varying  percentages^ — income  equal  to  15  percent  of 
invested  capital  less  the  credit  was  taxed  at  20  percent,  income  equal 
to  an  amount  between  15  and  20  percent  of  invested  capital  was 
taxed  at  25  percent,  between  20  and  25  percent  of  invested  capital 
at  35  percent,  between  25  and  33  percent  of  invested  capital  at  45 
percent,  and  over  33  percent  of  invested  capital  at  60  percent.  (Sec. 
201). 

The  1917  act  also  imposed  an  excise  tax  of  10  percent  upon  the 
net  profits  of  munitions  manufacturers  derived  from  the  sale  of 
specified  articles.^'' 

The  excess  profits  provisions  described  above  were  also  applicable 
to  individuals  and  partnerships  engaged  in  trade  or  business  and 
having  an  invested  capital.^"  Individual  incomes  were  subjected 
to  surtaxes  ranging  from  1  percent  on  net  incomes  between  $5,000 
and  $7,500  to  50  percent  on  net  incomes  over  $1,000,000,  in  addition 

11  See  pp.  44  to  52  infra,  for  a  discussion  of  the  problems  raised  in  the  field  of  taxation  by  the  normal' 
tendency  to  avoid  paving  taxes. 

12  Haig,  Taxation  of  Excess  Profits  in  Great  Britain,  1920,  p.  149. 

13  Revenue  Act  of  1917,  sec.  214.    The  articles  are  listed  in  sec.  301  (1)  of  the  Revenue  Act  of  1916. 

n  Sec.  201.  If  the  trade  or  business  had  no  invested  capital,  or  had  only  a  nominal  capital,  a  flat  8  percent 
tax  again.st  income  above  an  exemption  of  SPj.OOO  was  applicable.     (Sec.  209). 


MUNITIONS   INDUSTRY  13 

to  the  surtaxes  already  in  effect  under  the  1916  act  on  income  brackets 
from  $20,000  up.^^  (Sec.  2.)  Individual  incomes  were  also  subject  to 
a  2  percent  tax  on  the  first  $2,000  of  income  above  the  ordinary 
personal  exemptions  and  a  4  percent  tax  on  the  balance. 

The  1918  rates  were  considerably  more  severe  and  resulted  in  much 
greater  revenues — $4,286,500,000  as  contrasted  with  $2,937,800,000 
reported  due  in  the  original  unaudited  returns. ^"^ 

The  corporate  taxes  ^^  again  combined  a  pre-war  income  standard 
with  an  invested  capital  standard  but  in  a  different  manner.  In 
addition  to  an  income  tax  of  12  percent  on  income  over  $2,000,  all 
corporations  were  subjected  to  an  excess  profits  tax  of  (1)  30  percent 
of  net  income  up  to  an  amount  equal  to  20  percent  of  invested  capital 
less  a  credit  (computed  by  adding  to  $3,000  an  amount  equal  to  8 
percent  of  invested  capital)  and  (2)  65  percent  of  all  income  over  20 
percent  of  invested  capital.  In  addition  all  corporations  were  sub- 
jected to  what  was  referred  to  as  "a  war  profits"  tax  at  a  rate  of  80 
percent.  This  appeared  as  a  third  bracket  of  the  excess  profits  tax 
and  was  commonly  called  the  80  percent  bracket.  This  tax  was  not, 
however,  based  upon  invested  capital.  It  was  levied  against  income 
in  excess  of  a  special  credit  which  was  computed  by  (1)  adding  to 
$3,000  the  average  pre-war  net  income,  adjusted  for  capital  changes 
by  adding  or  subtracting  10  percent  of  the  increase  or  decrease,  as  the 
case  might  be,  of  current  invested  capital  as  contrasted  with  pre-war 
capital  '^  or  (2)  taking  10  percent  of  invested  capital,  whichever  was 
greater. 

This  80  percent  tax  on  income  less  at  least  10  percent  of  invested 
capital  was  only  payable,  however,  to  the  extent  that  it  exceeded  the 
excess  profits  tax  set  forth  in  the  two  preceding  brackets.  In  other 
words  the  excess  profits  tax  of  30  percent,  or  of  a  combination  of  30 
percent  and  65  percent  (depending  on  the  income  bracket  of  the  tax- 
payer), of  income  in  excess  of  $3,000  plus  8  percent  of  invested  capital, 
and  the  war  profits  tax  of  80  percent  of  income  in  excess  of  at  least 
10  percent  of  invested  capital,  were  alternative  taxes,  the  higher  of 
which  was  applicable. 

In  1919  the  80  percent  tax  was  eliminated  and  the  rates  of  the  excess 
profits  tax  were  reduced  from  30  percent  and  65  percent  to  20  percent 
and  40  percent.  On  December  31,  1921,  these  reduced  taxes  dis- 
appeared. 

Exhibit  1388,  reprinted  in  the  appendix  at  page  132,  sets  forth  in 
tabular  form  the  corporation  income  and  profits  tax  rates  in  effect 
from  1909  to  1928,  inclusive. 

Except  in  individual  instances,  the  eft'ectiveness  of  the  wartime 
taxes  in  recapturing  profits  can  be  estimated  only  roughly.  Mr. 
Ballantine  testified  before  the  War  Policies  Commission  that  corpora- 
tions reported  average  annual  net  incomes,  after  deduction  of  their 
estimated  taxes,  of  $5,900,000,000  for  the  years  1914  to  1916,  inclusive, 

's  The  total  surtaxes  in  effect  are  ^iveii  in  a  table  at  pp.  7t)4-5  of  H.  Doc.  163,  72d  Cong.,  1st  sess.  (War 
Policies   Commission   Hearings.) 

'9  72d  Cong.,  1st  sess.,  H.  Doc.  No.  103  (War  Policies  Commission  Hearings),  p.  701,  table  no.  1. 

"  Individuals  and  partnerships  engaged  in  business  were  not  subject  to  the  1918  excess  profits  tax  or  war 
profits  tax.  (Sec.  301a.)  Individual  incomes  were  subject  to  surta.xes  of  increased  severity.  (See  pp. 
704-5,  H.  Doc.  163,  72d  Cong,,  Ist  sess.)  The  ordinary  income  tax  rates  were  increased  to  0  percent  on 
the  first  $4,000  above  the  ordinary  personal  exemptions  and  to  12  percent  on  the  balance. 

1'  If  the  corporation  was  not  in  existence  during  at  least  one  of  the  pre-war  years  (1911  to  1913,  inclusive), 
the  first  alternative  means  of  computation  was  the  use  of  the  same  percentage  of  invested  cai)ital  that  the 
averacre  pre-war  incoijie  of  representative  corporations  was  of  their  average  i)re-war  invested  capital. 

ll.")79 — 3.5 2 


14  MUNITIONS    INDUSTRY 

and  average  annual  net  incomes,  after  the  estimated  wartime  taxes, 
of  $7,000,000,000  for  1917  to  1919,  inclusive. '^  On  this  basis  the 
war — despite  the  wartime  taxes — added  $1,100,000,000  a  year  to  the 
final  tax-free  profits  of  corporations  which  had  already  profited  largely 
by  the  huge  sales  to  the  Allies  made  by  this  country  before  April  6, 
1917.  As  contrasted  with  the  years  1911  to  1913,  inclusive,  which 
the  wartime  tax  statutes  fixed  as  the  pre-war  years  for  measuring  war 
profits,  corporation  profits  after  taxes  increased  69  percent  during  the 
war,  or  from  an  average  of  approximately  $4,123,000,000  to  $7,000,- 
000,000,  and  only  44  percent  of  the  increase  in  annual  profit  from 
$4,123,000,000  to  $9,500,000,000  was  taken  in  income  and  excess- 
profits  taxes.^" 

Exhibit  1756,  which  is  reprinted  in  the  appendix  at  page  136,  shows 
that  a  group  of  the  largest  manufacturing  and  mining  companies  in 
the  country  paid  in  taxes  (including  both  the  normal  income  and  the 
excess  and  war-profits  taxes)  only  25  percent  of  their  net  taxable  in- 
come for  1917  and  only  34.9  percent  of  their  1918  income,  according 
to  the  fuial  figures  of  the  Bureau  of  Internal  Revenue.  If  the  revenue 
agents'  determinations  of  net  taxable  income  are  used  22.8  percent  of 
1917  income  was  paid  as  taxes  and  32.8  percent  of  1918  income.  It 
must  be  remembered  that  these  computations  do  not  include  income 
received  by  these  corporations,  but  excluded  from  taxable  income 
because  (1)  invested  in  tax-free  securities  (see  p.  52)  or  (2)  allowed  as 
deductions  for  amortization,  depreciation,  or  depletion,  i.  e.,  set  up  as 
reserves  against  ordinary  business  risks  (see  p.  27  et  seq.),  to  mention 
a  few  of  the  allowable  deductions  from  income.  The  1917  net  income 
of  these  companies  after  deducting  payment  of  their  final  tax  liability 
was  26  percent  of  their  invested  capital  and  their  1918  income  on  the 
same  basis  was  10.5  percent  of  capital,  the  Bureau  of  Internal  Reve- 
nue's final  figures  show.  Before  taxes,  the  1917  income  was  34.8 
percent,  and  the  1918  income  15.6  percent,  of  capital.  If  the  revenue 
agents'  determinations  are  used,  the  results  are  39  percent  profit  in 
1917  and  11.8  percent  in  1918  after  taxes  and  50.5  percent  in  1917 
and  17  percent  in  1918  before  taxes.  Obviously,  the  80-percent  tax 
was  not  a  tax  of  80  percent  of  all  profits. 

Individual  instances  further  illustrating  that  the  tax  rates  in  prac- 
tice were  not  of  the  severity  usually  ascribed  to  them  appear  at  page 
65-66  of  this  report. 

^jlt  should  be  further  remembered  that  estimates  of  taxes  as  con- 
trasted with  income,  or  of  income  as  contrasted  with  investment,  are 
based  upon  (1)  the  taxpayers'  own  estimates  of  those  two  highly 
variable  items,  income  and  investment,^^  or  (2)  estimates  which  the 
taxpayers  consented  to  or  which  withstood  the  rigors  of  legal  proof, 
or  (3)  estimates  by  Government  agents  whose  time  and  expense  ac- 
counts were  limited,  whose  estimates  were  primarily  based  upon  the 
taxpayers'  figures  and  whose  estimates  were  made  not  only  with  an 
eye  to  the  necessity  of  substantiation  under  vigorous  attack,  but  also 
within  the  limitations  of  technical  statutory  standards  which  per- 
mitted the  elimination  from  income  of  many  items  which  would  be 

■  i»  72d  Cong.,  1st  sess.,  H.  Doc.  163,  p.  690.  While  these  figures  are  the  taxpayers'  own  estimates  and  con- 
sequently may  be  underestimates,  the  ratio  between  the  two  sets  of  figures  should  reflect  with  substantial 
accuracy  the  ratio  between  the  actual  income  in  each  of  the  two  periods.  The  basic  figures  on  which  Mr. 
Ballantine  apparently  relied  appear  in  Statistics  of  Income  for  1925,  U.  S.  Treasury  Department,  pp.  22-23. 

20  Statistics  of  Income  for  1925,  U.  S.  Treas.  Dept.,  pp.  22-23. 

21  See  pp.  19  to  36  for  an  analysis  of  the  impossibility  of  arriving  at  exact  determinations  of  income  and 
investment. 


MUNITIONS    INDUSTRY  15 

considered  as  income  for  ordinary  purposes.  As  Senator  Vanden- 
berg  pointed  out  in  his  examination  of  Homer  L.  Ferguson,  president 
of  the  Newport  News  Shipbuilding  &  Dry  Dock  Co.,  the  taxes  paid 
were  less  severe  and  the  profits  retained  greater  than  such  figures  in- 
dicate by  (1)  the  amount  which  the  estimates  of  income  excluded  de- 
batable or  hidden  items  and  by  (2)  the  amount  by  which  the  estimates 
of  investment  included  debatable  or  fictitious  items: 

Senator  Vandenberg.  What  you  are  saying,  Mr.  Ferguson,  is  that  an  attempt 
to  tax  war  profits  becomes  more  or  less  of  a  mathematical  maze,  dependent  upon 
an  agreement  as  to  what  base  you  are  going  to  start  from? 

Mr.  Ferguson.  Our  war-profits  tax  got  up  to  a  point  of  about  86  percent,  I 
think,  on  this  invested  capital. 

Senator  Vandenberg.  But  whether  or  not  it  is  a  comprehensive  or  adequate 
tax  depends  primarily  upon  the  base  to  which  the  tax  is  going  to  be  applied? 

Mr.  Ferguson.  Absolutely.22 

S2  Feb.  12, 1936. 


II.  Consideration  of  Particular  Types  of  Taxes 

Because  of  the  complicated  and  infinitely  varied  structure  of  the- 
country's  economic  life,  achieving  a  taxation  scheme  which  will 
in  fact  leave  uniform  profits  to  all  concerns  is  enormously  more 
difficult  than  the  determination  of  what  is  a  socially  desirable  profit  for 
any  single  concern,  difficult  though  the  latter  determination. is  as  indi- 
cated by  the  foregoing  part  of  this  report.  By  and  large,  the  needs 
of  individuals  can  be  stated  in  absolute  amounts  of  dollars  and,  at  the 
cost  of  hardship  in  particular  cases,  an  arbitrary  uniform  exemption 
could  be  fixed  that  would  raise  with  substantial  clarity  the  issue  of  the 
extent  to  which  taxation  of  individuals  should  be  carried.  But  in 
the  case  of  commercial  and  industrial  enterprise  the  business  unit's 
claim  to  profits  cannot  be  so  uniformly  determined. 

Even  though  the  preponderant  public  opinion  should  come  to  be 
that  in  time  of  war  a  business  unit  should  receive  no  more  tax-free 
income  not  distributed  to  individuals  than  individuals  should  them- 
selves receive,  the  economic  effects  of  such  a  tax  would  probably  be 
so  adverse  as  to  make  it  undesirable.  If  all  business  units,  regardless 
of  size,  natural  location,  patent  position,  amount  of  investment,  de- 
gree of  risk,  and  the  many  other  causes  of  variances  in  profits,  were 
to  receive  only  the  same  ultimate  profit,  new  investment  would  be 
encouraged  to  go  into  small,  safe,  low-capitalized  fields.  Existing 
large  and  efficient  firms  would  be  encouraged  to  subdivide  without 
consideration  of  efficiency,  since  increased  costs  would  not  lower  the 
owners'  ultimate  profits  as  a  general  rule.  Although  much  of  this 
could  and  probably  would  be  accomplished  by  purely  formal  corporate 
reorganizations,  it  is  clear  that  confusion  and  a  consequent  general 
slowing  up  of  the  productive  and  expansive  processes  in  industry 
would  occur  at  the  very  time  that  no  interference  with  maximum 
productive  capacity  can  be  tolerated. 

At  all  events,  it  seems  likely  that  any  wartime  taxation  measure 
that  can  hope  to  receive  serious  consideration  must  choose  for  a  tax 
on  corporations — if  not  on  all  business  units  ^^ — a  basis  or  standard 
that  will  recognize  in  some  manner  general  differences  in  profit- 
ability of  business  enterprise.  The  two  bases  most  frequently  referred 
to  in  theoretical  discussion  are  (1)  average  peacetime  profits  and 
(2)  the  amount  of  investment.  These  two  bases  were  both  used  during 
the  World  War  in  this  country  and  in  Europe. 

(1)  average  pre-war  income  as  a  tax  base 

The  War  Policies  Commission  recommended  a  tax  of  95  percent 
on  all  earnings  above  the  average  income  during  the  3  years  imme- 

28  The  1917  Revenu?.  Act  based  the  cxsess-proflts  tax  on  noncorporate  business  conaerns  on  the  invested 
capital  of  those  cDnc5rns,jun  as  it  did  in  the  case  of  corporations.  (Ssos.  201,  203,  204,  207).  This  was  eliminated 
from  the  war  profits  and  excess-prjflts  tax  cont.iin'jd  in  the  1918  act,  in  part,  at  least,  because  of  the  infinite 
difficulties  of  admiaistration  as  contrasted  with  the  relatively  small  amount  of  revenue  involved.  (Sec.  301). 
Sea  rep  irt  of  the  Hous3  Committee  on  Ways  and  Means  on  the  revenue  bill  of  1918,  65th  Cong.,  2d  sess., 
H.  Kept.  767,  p.  16, 

16 


MUNITIONS   l.^n)US^IlY  17 

diately  preceding  the  next  war.^^  Air.  Baruch  in  a  statement  filed 
with  the  committee  repeated  this  recommendation  but  advocated 
increasing  the  tax  to  100  jjercent  of  the  excess.^^ 

This  base  has  been  urged  largely  because  of  the  fantastic  complica- 
tions of  the  invested  capital  approach.  The  invested  capital  base 
involves  not  only  much  physical  difficulty  and  consequent  delay  due 
to  the  size  and  complexity  of  modern  business  but  also  many  decisions 
in  the  realm  of  discretionary  judgment  where  no  ruling,  unless  dis- 
tinctly favorable  to  the  taxpayer  or  acquiesced  in  by  him,  can  be 
safely  regarded  as  final  without  prolonged  Htigation. 

T,  S.  Adams,  formerly  chau'man  of  the  Advisory  Tax  Board  of  the 
Bureau  of  Internal  Revenue,  stated  that: 

The  intricr'-y  of  the  exro^s-prof^ts  tax  is  such  that  it,  is  hardh^  ?.n  exaggeration 
to  say  that  it  takes  more  time  to  teach  an  accountant  to  master  its  mysteries 
than  the  average  accountant  can  be  retained  in  the  service  after  he  has  attained 
such  mastery.  *  *  *  t^qh  j-ears  would  be  a  radically  short  estimate  of  the 
time  required  in  which  to  bring  the  taxpayers  and  the  administrative  authorities 
of  the  country  to  a  point  where  the  excess-profits  tax  could  be  reasonaV:)ly  well 
enforced. 2" 

Professor  Seligman  said: 

What  constitutes  invested  capital,  however,  is  so  elusive  as  to  be  virtually 
impossible  of  computation." 

The  War  Policies  Commission  analysis  of  testimony,  prepared  by 
its  executive  secretary,  Mr.  Robert  H.  Montgomery,  a  recognized 
expert  on  taxation,  states  that: 

Some  of  the  provisions  of  the  laws  were  so  highly  complicated  that  they  could 
not  even  be  litigated  because  they  could  not  be  reduced  to  logical  argument  pro 
and  con.  The  determination  of  what  constituted  invested  capital  was  an  insoluble 
problem  during  the  continuance  of  the  tax,  and  is  still  unsolved.  Some  of  the 
fundamental  principles  of  invested  capital  are  now  in  the  courts  and  will  be  there 
for  years  to  come.^* 

However,  the  pre-war  earnings  standard  involves  so  many  necessary 
exceptions  that  in  practice  it  is  coupled  with  the  invested  capital  base 
to  such  an  extent  as  to  lose  its  separate  identity. 

24  No  final  report  was  ever  submitted  by  the  War  Policies  Commission  but  in  the  Analysis  of  Testimony 
prepared  by  the  Commission's  executive  secretary  and  transmitted  by  President  Hoover  to  Congress,  there 
appears  the  following: 

"Tax  on  income  is  the  simplest  method  of  applying  a  war  tax.  Most  people  are  afraid  to  falsify  their 
income-tax  returns.  The  Government  machinery  for  collection  of  such  taxes  already  exists.  Its  method 
of  operation  is  generally  understood.  From  every  standpoint,  excess  profits  should  be  devised  on  the 
basis  of  income,  and  not  on  the  basis  of  invested  capital. 

"Individual  and  corporation  Federal  income  taxes  in  force  when  war  is  declared  should  be  continued. 
These  may  be  increased  if  desired.  In  addition,  and  retroactive  to  a  period  which  will  embrace  any  in- 
flation or  profit  due  to  war  activities,  there  should  be  imposed  an  excess-income  tax  of  95  percent  applicable 
to  individuals  and  corporations  alike,  not  graduated  nor  affected  by  invested  capital,  but  it  should  be  a 
straight  income  tax,  computed  somewhat  as  follows: 

"From  net  income  as  now  computed  deduct: 

"1.  .Average  net  income  for  the  .3  years  next  preceding  the  war  period. 

"2.  The  cost  of  additional  capital  facilities  required  for  the  war  and  in  due  course  to  be  authorized  by  the 
proper  governmental  war  agency.  Tax  deficiencies  to  bear  interest  at  6-percent  per  annum  to  prevent  the 
taking  of  deductions  which  are  not  likely  to  be  approved.  At  the  end  of  the  war  the  residual  value  of  the 
additional  facilities  to  be  adjusted. 

"3.  Receipts  of  income  in  excess  of  a  reasonable  annual  accrual  thereof,  where  the  income  has  been  accru- 
ing over  a  period  of  years  and  contains  no  element  of  war  profits,  such  as  fees  and  commissions  of  executors 
and  trustees. 

"4.  After  deducting  1,  2,  and  3,  above,  impose  a  tax  of  95  percent  on  the  balance. 

"One  of  the  advantages  of  the  foregoing  is  that  it  should  tend  to  prevent  the  extravagances  which  a  tax 
on  the  excess  profits  of  corporations  is  supposed  to  encourage,  because  it  imposes  the  same  high  rate  on 
individuals."    (Documents  by  War  Policies  Commission,  72d  Cong.,  1st  sess.,  H.  Doc.  271,  pp.  22-3.) 

25  Letter  of  Apr.  12,  1935,  from  Bernard  M.  Baruch  to  the  committee: ' '*  *  *  I  propose  *  *  *  to 
take,  by  special  taxes,  100  percent  of  all  profits  and  income  in  war  above  the  average  of  the  i)receding  3 
years  of  peace  *  *  *  Taxes  on  new  enterprises  will  have  to  be  adjusted  and  worked  out  separately 
*  *  *  At  the  same  time,  to  increase  the  regular  individual  and  corporate  income  tax  to  the  absolute 
point  of  diminishing  returns  *  *  *  I  do  not  propose  to  make  *  *  •  asset  values  any  factor  in 
determining  the  tax,  or  to  repeat  the  partial  futility  of  the  World. War  excess  profits  tax    •    •    •" 

-'5  Thirty-five  Quarterly  Journal  of  Economics,  p.  372,  Should  the  Excess-Profits  Tax  be  Repealed? 
(1920-21). 
"  Essays  on  Taxation  (1925),  p.  704. 
3s  Documents  of  War  Policies  Commission,  R.  Doc.  No.  271,  72d  Cong.,  1st  sess.  (1932),  p.  21. 


18  MUNITIONS    INDUSTRY 

Although  the  size  of  a  company's  investment  is  not  the  sole  or  even 
chief  factor  in  its  profit-making  capacity  and  so  the  invested  capital 
base  fails  to  reflect  accurately  the  normal  gradations  of  profitability 
in  competitive  business,  still  the  base  of  earnings  for  any  arbitrary 
period  is  more  Procrustean.  All  investors  seek  a  return  on  their 
investment.  This  fundamental  fact  is  recognized  in  the  use  of  in- 
vested capital,  although  the  degree  of  risk,  especial  skill,  and  other 
important  factors  making  for  gradations  of  profitability  are  ignored. 
But  the  pre-war  earnings  base  overlooks  production  and  profit  cycles 
and  guarantees  rich  returns  to  the  fortunate  company  that  v/as  at  its 
peak  in  the  pre-war  period  and,  unless  an  exception  be  made,  con- 
demns to  bankruptcy  the  concern  that  pulled  through  a  pre-war 
slump  by  the  use  of  reserves.^^  Similar^,  new  companies  and  expan- 
sion by  existing  companies  would  be  absolutely  profitless,  unless 
exceptions  be  made  in  the  theory. 

Because  production  must  be  encouraged  and  not  discouraged  in 
war  time,  these  exceptions  are  vital  and  can  only  be  taken  care  of 
by  an  application  of  the  invested  capital  base  in  these  cases.  The 
addition  of  new  capital  to  existing  concerns  is  so  continuous  and  wide- 
spread ,^°  and  it  is  so  difficult  to  restrict  effectively  the  device  of  new 
incorporation  by  companies  desiring  to  place  their  full  capital  under 
the  exception  where  the  exception  for  additions  to  capital  does  not 
give  them  the  exemption  they  desire,  that  the  tendency  is  irresistible 
for  the  whole  scheme  to  become  merely  an  alternative  tax  base  to  be 
chosen  b}^  the  taxpayer  when  it  is  to  his  interest  to  do  so. 

Indeed  in  most  foreign  countries  that  used  the  device  it  was  specifi- 
cally made  optional  with  the  taxpayer.  See  Taxation  of  Incom.es, 
Excess  Profits,  and  Luxuries  in  Certain  Foreign  Countries,  Legisla- 
tive Reference  Division,  United  States  Library  of  Congress;  and 
Haig,  Taxation  of  Excess  Profits  in  Great  Britain,  1920,  page  174. 

Finally,  tliis  plan  is  open  to  the  fundamental  objection  that  it  is 
based  upon  the  theory  that  only  profits  allocable  exclusively  to  the 
increase  of  industrial  activity  due  to  war  should  be  taxed.  As  pointed 
out  above  at  page  8,  any  war-time  taxation  measure  must  increase 
the  absolute  severity  of  taxation  as  contrasted  with  peace-time  taxes. 
Ordinary  peace-time  earnings  cannot  be  left  untaxed  in  time  of  war, 
much  less  the  unduly  enhanced  earnings  that  may  occur  in  a  period 
immediately  preceding  a  war.^^  Consequently,  with  or  without  its 
necessar}^  exceptions  the  pre-war  earnings  standard  cannot  furnish  a 
complete  war  time  taxation  plan.  It  would  have  to  be  supplemented 
with  some  other  plan  to  raise  the  needed  additional  revenue.  The 
complexity  of  administration  wliicli  would  result  from  the  use  of  two 
conjunctive  taxes,  one  of  which  would  have  lost  most  of  its  purpose 

S9  "Abnormallj  high  profits  in  the  past  should  constitute  no  ground  for  immunity  from  a  future  tax  on 
supernormal  profits.  This  is  not  word  play;  it  is  a  mere  suggestion  of  the  truth  that  an  a'onormal  state  may 
continue  for  a  considerable  time  without  becoming  'normal.'  Consider  finally  the  concern  which  has  had 
abnormally  low  profits  in  the  past,"  Adams,  35  Quarterly  Journal  of  Economics  (1921),  pp.  388-9.  See 
also  the  statement  of  the  British  Chancellor  of  the  E.xchequer  in  1920:  "I  would  remind  the  committee 
that  under  the  provisions  of  the  excess  profits  duty  prosperous  concerns  with  a  large  pre-war  standard 
may  escape  liability  for  the  tax  because  their  present  profits,  though  high,  are  not  in  excess  of  their 
standard,  and  at  any  rate,  t^ey  pay  tax  on  what  all  of  us  thinl:  an  unduly  low  scale."    Ibid,  p.  389. 

30  The  net  worth  of  2C0  lending  .'.merican  corporations  increased  in  the  period  1916  to  1921  from  $G,291, 
000,000  to  $11,363,000,000.  House  Mihtary  Aflairs  Committee,  Hearings  on  Universal  MobiUzation  for 
War  Purposes,  68th  Cong.,  1st  sess.,  p.  178. 

Whenever  new  capital  is  added  and  earnings  allocable  to  it  are  to  be  excepted  from  the  pre-war  standard 
it  is  necessary  to  compute  the  entire  investment,  in  order  to  determine,  by  computing  the  proportion  be- 
tween the  new  and  the  total  investment,  that  proportion  of  the  total  income  allocable  to  the  new  capital. 
See  Haig,  Taxation  of  Excess  Profits  in  Great  Britain,  (1920),  p.  81. 


MUNITIONS    INDUSTRY  19 

through  exceptions,  makes  the  pre-war  income  standard  an  undesir- 
able base  for  war-time  taxation. 

(2)    INVESTED    CAPITAL    AS    A    TAX    BASE 

The  primary  theoretical  objection  to  invested  capital  as  a  basis 
for  computing  the  amount  of  income  which  is  to  be  tax  free  is  that 
the  amount  of  investment  is  not,  in  ordinary  commercial  and  indus- 
trial enterprises,  the  sole  yardstick  of  the  rate  of  profit. ^^  As  pointed 
out  above  at  p.  16,  the  degree  of  risk,  geographical  location,  business 
skill,  patent  rights,  and  any  number  of  other  factors  condition  profit- 
ability and  a  tax  which  exempts  income  up  to  the  same  percentage  of 
the  invested  capital  for  all  business  does  not  treat  all  business  ratably. 
However,  the  chief  objections  to  the  use  of  the  invested  capital  base 
in  the  event  of  another  war  are  to  its  administrative  difficulties.^^ 

The  basic  administrative  difficulty  encountered  in  applying  the 
invested  capital  standard  is  in  the  valuation  of  the  assets  constitut- 
ing the  investment. 

The  late  T.  S.  Adams  of  Yale  University,  an  adviser  to  the  Treasury 
Department  and  one  of  the  leading  tax  experts  in  this  country,  gave 
his  opinion  as  follows: 

I  think  that  no  one  thing  so  conduces  to  delay  and  complexities  of  the  tax  laws 
as  the  necessity  for  valuation. 

I  think  it  may  be  possible,  and  I  hope  that  the  Department,  some  representa- 
tives of  which  are  present,  will  bestir  themselves  to  make  suggestions  to  get  away 
from  *  *  *  problems  of  valuation,  the  solution  of  which  problems  means  the 
exercises  of  judgment  and  differences  of  opinion,  mistakes,  and  delay.  If  there  is 
any  human  way  of  getting  away  from  that,  the  Government  of  the  United  States 
ought  to  get  awaj'  from  it.^^ 

As  a  matter  of  definition,  the  higher  the  valuation  permitted  for 
invested  capital,  the  greater  the  exemption  allowed  the  taxpayer, 
since  the  whole  purpose  of  providing  for  the  determination  of  invested 
capital  is  to  fix  the  amount  of  tax  exemption.  In  1917,  the  East 
Butte  Copper  Mining  Co.  made  $1,268,788;  the  Government  col- 
lected taxes  of  only  $69,071.  The  ratio  of  net  income  to  invested 
capital  before  taxes  was  19.7  percent;  after  taxes  it  was  18.7  percent, 
a  collection  of  only  1  percent. ^^  Indeed,  a  sufficiently  high  estimate 
of  the  invested  capital  of  any  company  would  make  all  of  its  income 
tax  free.  Consequently  it  is  to  each  taxpayer's  interest  to  secure  as 
high  a  valuation  for  its  invested  capital  as  possible. 

Cash  can  be  valued  without  difficulty,  but  there  the  simplicity 
ceases.  The  values  of  all  other  things,  as  Professor  Adams  observed, 
are  matters  of  judgment.  The  process  is  described  by  the  Supreme 
Court  as  follows: 

The  ascertainment  of  value  is  not  controlled  by  artificial  rules.  It  is  not  a 
matter  of  formulas  but  there  must  be  a  reasonable  judgment  having  its  basis  in  a 
proper  consideration  of  all  relevant  facts. ^^ 

31  "  There  is  the  even  more  damning  criticism  that  •  *  *  in  actual  operation  the  standard  of  in- 
vested capital  does  not  perform  the  function  of  determining  the  richness  of  profits  even  reasonably  well; 
*  *  *  the  results  of  its  application  are  eccentric  and  unfair  *  *  *  *"  (K.  H.  Montgomery, 
Excess  Profits  Tax  Procedure  (1921),  p.  122). 

3>  See  the  statements  quoted  supra  at  p.  17.  Letter  of  B.  M.  Baruch  to  the  committee  dated  Apr.  12, 
1935:  "  *  •  *  it  has  been  proved  that  any  excess-profits  tax  based  on  asset  values  is  too  complex  for  war 
administration  *  *  *  for  this  reason,  millions  of  dollars  in  taxes  escaped  the  Government  in  the 
World  War     •     *     *." 

33  G9th  Cong.,  1st  sess.,  S.  Rpt.  27,  p.  116.     (Italics  added.) 

3<  Exhibit  No.  1722. 

33  Standard  Oil  Co.  of  New  Jersey  v.  Southern  Pacific  Co.,  et  al.,  268  U.  S.  146,  50  Sup.  Ct.  46i'). 


20  MUNITIONS   INDUSTEY 

The  difficulties  and  delays  involved  in  applying  such  a  general  rule 
to  intangible  items  like  goodwill  and  patents  ^^  and  to  the  capital 
assets  of  heavy  industry,  which  have  no  market  values  because  they 
are  not  the  subject  of  general  commerce,  is  obvious.  Most  corporate 
assets  are  acquired  not  for  cash,  which  would  afford  some  index  of 
value,  but  for  stock  the  value  of  which  depends  upon  the  value  of 
the  very  assets  whose  value  has  to  be  determined  by  the  Government. 
To  reach  valuations  which  will  withstand  the  scrutiny  of  courts  one 
of  whose  primary  functions  is  to  protect  the  rights  of  individuals  and 
before  whom  the  burden  of  proof  is  borne  by  the  Government,  is 
still  more  difficult.^^ 

The  legal  difficulties  are  described  as  follows  in  a  letter  of  January 
28,  1935,  from  the  Acting  Secretary  of  the  Treasury  to  the  chairman 
of  this  committee,  which  appears  in  the  appendix  to  this  report  at 
p.  1.39,  and  which  deals  at  length  with  the  difficulties  involved  in 
valuation: 

The  legal  difficulty  and  uncertainty  in  the  determination  of  value  of  property 
not  subject  to  frequent  sales,  and  as  to  which  market  quotations  are  not  pub- 
lished daily,  arises  because  it  is  so  largely  to  be  determined  from  factual  and 
opinion  evidence,  none  of  which  is  legally  conclusive.  Such  evidence  is  the  best 
available.  Upon  such  evidence  the  value  is  determined  by  a  judge  or  jury,  in 
certain  instances  inexperienced  in  valuation  procedure  and  with  inadequate 
knowledge  of  considerations  governing  market  value.  The  weight  to  be  given 
to  the  evidence  is  entirely  within  their  discretion  and  short  of  the  adoption  of  a 
fundamentally  unsound  principle  or  an  erroneous  theorv  by  the  court  in  its  instruc- 
tions, it  is  impossible  to  secure  a  reversal  of  their  finding  if  there  is  any  evidence 
in  support  thereof  in  the  record.  It  is  a  rare  case  where  some  evidence  is  not 
admitted  which  will  support  a  most  unsound  finding  of  value. 

Valuation  for  the  excess-profits  taxes  of  the  World  War  was  not 
current  valuation,  but  value  as  of  the  time  of  investment.  Retroac- 
tive valuations  are  of  course  difficult  because  records  are  not  preserved 
indefinitely  and  because,  in  any  event,  the  task  of  reconstructing  a 
whole  scale  of  industrial  values  to  contrast  with  the  existing  records 
of  the  value  of  the  items  concerned  adds  to  the  uncertainties  and  con- 
troversies. However,  most  companies  have  some  valuation  data  as 
of  the  date  of  acquisition  of  assets,  whereas  the  task  of  valuing  all 
of  American  industry  as  of  any  single  date  would  be  colossal  if  not 
impossible.  Opinion  and  judgment  would  in  those  cases  where  no 
market  was  available  as  a  check,  be  practically  imfettered  and  the 
impossibility  of  conclusive  legal  determination  would  force  the 
Government  to  compromise  again  and  again  and  would  prolong 
final  valuation  indefinitely. 

Each  computation  of  a  tax  on  the  basis  of  invested  capital  invoh^es 
the  determination  of  two  variables — the  income  to  be  subjected  to  the 
tax  and  the  investment  to  be  used  in  fixing  the  exemption.  This 
section  of  this  report  is  concerned  only  with  the  latter  problem  but  it 
should  be  noted  that  since  income  carried  over  into  the  capital  of  any 
concern  becomes  a  part  of  the  investment,  the  latter  item  cannot  in 
most  eases  be  determined  without  a  simultaneous  determination  of  the 
income  of  prior  years.     The  determination  of  income,  which  is  re- 

36  During  the  World  War  there  was  of  course  a  strong  tendency  to  write  up  the  values  of  such  items  in 
order  to  increase  the  base  on  which  the  exemption  was  computed.  69th  Cong.,  1st  sess.,  S.  Rpt.  27,  pp. 
207-212;  American  Economic  Review,  vol.  IX,  no.  1,  Supp.  no.  2,  pp.  20-22;  Report  of  Committee  on  War 
Finance  of  the  American  Economic  Association,  (1919). 

3'  A  striking  example  of  recent  Federal  difficulties  in  this  regard  is  the  experience  of  the  Interstate  Com- 
merce Commission  with  the  recapture  provisions  of  the  Transportation  Act  of  1920.  After  10  years'  work 
the  Commission  was  virtually  ordered  by  the  Supreme  Court  to  begin  all  over  again  because  of  failure  to 
give  proper  attention  to  the  factor  of  reproduction  cost  in  its  valuation.  St.  Louis,  etc.  v.  O' Fallon,  279 
U.  S.  461  (1929).    See  examples  in  table  appearing  in  appendix  at  p.  146. 


MUiSriTIONS    INDUSTRY  21 

f erred  to  at  page  27  et  seq.,  raises  questions  as  much  in  the  reahn  of 
judgment  as  are  those  here  referred  to.  Taxable  income,  roughly 
speaking,  is  the  difference  between  costs  and  total  revenue.  Costs 
include  the  valuation  of  many  articles  as  difficult  to  value  as  those 
referred  to  above. 

The  investment  of  a  corporation  was  determined  as  of  the  time  it 
was  formed.  Consequently  reorganization  of  a  corporation  just  be- 
fore or  during  the  war  resulted  in  an  increase  in  the  valuation  of  the 
assets  acquired  by  the  new  company  because  of  the  rising  price  level. ^^ 
Consequentlj''  avoidance  of  taxes  by  corporate  reorganizations  was 
common.  A  flagrant  example  of  this  is  to  be  found  in  the  1917  trans- 
actions of  the  Old  Dominion  companies.  The  revenue  agent's 
report  indicates  that  by  means  of  a  fictitious  transfer  the  invested 
capital  was  increased  $10,000,000  for  tax  purposes.  On  February  12, 
1917,  when  the  Old  Dominion  Co.  of  Maine  held  virtual  ownership 
of  the  Old  Dominion  Co.  of  New  Jersey  through  possession  of  96  per- 
cent of  its  stock,  a  sale  was  made  of  the  New  Jersey  Company  to  the 
Maine  corporation  for  the  sum  of  $10,000,000.  The  fact  that  neither 
company  had  cash  in  hand  anywhere  near  this  sum  was  not  an  obstacle. 
The  New  Jersey  Company,  which  had  a  bank  balance  of  $350,000,  paid 
a  dividend  of  $9,969,875  to  the  parent  corporation.  At  the  same  time 
the  parent  corporation  drew  a  check  for  $10,000,000  in  favor  of  the 
subsidiary  in  payment  for  the  property. 

It  was  admitted  by  Mr.  C.  H.  Altmiller,  treasurer  of  the  Old  Dominion  Co.,  that 
the  deposits  v\'ere  made  and  checks  drawn  simultaneously  and  that  the  transaction 
was  purely  a  bookkeeping  one.^^ 

The  judgment  of  the  revenue  agent  was  that — - 

this  transaction  had  the  appearance  of  a  transfer  of  assets  substantially  their  own 
property  and  for  the  purpose  of  increasing  their  invested  capital  for  excess-profits 
tax  results.^^ 

The  history  of  the  Newport  News  Shipbuilding  &  Dry  Dock  Co.'s 
controversies  with  the  Governm_ent  over  its  1917  taxes  illustrates  the 
difficulties  in  fixing  invested  capital.  It  took  until  1931 — or  14 
years — to  settle  these  taxes  because  of  the  difficulties  of  determining 
invested  capital  *^  and  then  the  settlement  was  only  made  by  the 
Bureau  of  Internal  Revenue  giving  up  the  task  and  deciding  that  it 
could  not  determine  the  invested  capital  of  the  company  but  must 
make  a  special  assessment."*^  Under  such  an  assessment,  the  exemp- 
tion was  the  same  percentage  of  the  company's  net  income  as  the 
average  exemption  of  representative  concerns  in  the  same  or  a  similar 
business,  was  of  the  average  net  income  of  such  concerns. 

The  revenue  agent's  report  fixed  the  company's  invested  capital  in 
1917  at  $3,826,316  and  its  income  for  that  5^ear  at  $3,467,605  or 
a  profit  of  90.6  percent. ^^  The  company's  1917  tax  return,  made 
under  oath,  listed  its  capital  at  $10,377,605  and  its  income  at  $3,- 
368,238  or  a  profit  of  32.4  percent. ^^  The  revenue  agent  refused  to 
allow  as  part  of  the  invested  capital  an  item  of  $2,198,965  which  was 

38  Testimonj'  of  Arthur  A.  Balleatine  before  War  Policies  Commission,  H.  Doc.  No.  163,  72d  Cong.f 
Istsess.  (1931j,p.  692. 

38  Exhibit  no.  1717. 

«  Homer  L.  Ferguson,  Feb.  12,  193.5,  70  ZO;  Walter  G.  Mitchell,  Feb.  12.  1935,  80  ZO. 

41  Homer  L.  Ferguson,  Feb.  12, 1935,  67  ZO.  The  special  assessment  provision,  which  appeared  as  sec.  210 
of  the  1917  Revenue  Act  and  as  sections  327  and  32S  of  the  1918  act,  is  discussed  in  more  detail  at  pp.  45-47. 
infra.  In  the  1917  Act  it  was  to  be  applicable  "if  the  Secretary  of  the  Treasury  is  unable  in  any  case  satis- 
factorily to  determine  the  invested  capital*  ♦  »  " 

<2  E.xhibit    1556. 

»  Ibid. 


22  MUNITIONS    INDUSTRY 

part  of  the  total  loss  in  14  years'  operations  and  which  the  company 
added  to  its  estimated  value  of  its  physical  assets  on  the  grounds  that  it 
should  be  regarded  as  part  of  the  cost  of  the  plant  and  that  the  plant 
was  worth  its  cost.  In  other  words,  the  company  felt  that  due  to 
unfortunate  business  conditions  which  caused  the  company  to  lose 
money,  its  real  estate  increased  $885,000  in  value,  its  dry  docks 
$813,965,  and  its  patterns  and  drawings  $500,000.** 

The  revenue  agent  further  disallowed  an  item  of  $2,167,233  which 
was  the  difference  between  stock  of  a  par  value  of  $8,000,000  and 
assets  received  in  exchange  of  a  value  of  only  $5,832,766.  This 
item  the  company  also  considered  an  original  cost,  because  the  stock 
was  issued  to  the  Huntington  family  and  Mr.  Huntington  had  lost 
more  than  $2,167,233  in  the  course  of  the  company's  business 
history.*-^ 

Another  sum  which  the  revenue  agent  decided  did  not  represent 
an  element  of  value  was  a  bond  discount  of  $1,000,000  involved  in 
the  issuance  in  1903  of  $5,000,000  in  bonds  for  $4,000,000  in  cash  and 
other  assets.*''  Further  discounts  on  stocks  and  bonds  of  $1,508,849 
were  similarly  disallowed  by  the  revenue  agent." 

The  Bureau  of  Internal  Revenue  on  reviewing  the  agent's  report 
determined  that  the  company's  invested  capital  was  $3,822,549  *^  and 
its  income  $3,298,601  *^  or  a  profit  of  86.3  percent  although,  as  stated 
above,  no  tax  w^as  assessed  on  this  basis  because  of  the  final  decision 
to  use  the  special  assessment  provisions.  This  valuation  figure  was 
strenuously  attacked  by  the  company's  president,  Mr.  Homer  L. 
Ferguson,  in  his  appearance  before  this  committee.  Mr.  Ferguson 
testified  that  the  company  in  1917  was  actually  carrying  the  plant  at 
about  $20,000,000  and  had  fixed  the  value  of  $10,377,605  in  its  return 
under  protest  and  only  because  of  regulations  of  the  Bureau  of  Internal 
Revenue.^"  On  a  $20,000,000  investment,  a  profit  of  only  16.4  percent 
was  made.  Mr.  Ferguson  also  introduced  into  the  record  what  he 
described  as  the  dollar  cost  of  the  plant  and  assets  used  in  the  business 
which  amounted  to  $14,500,000.^^  On  this  basis  a  return  of  22.7  per- 
cent was  made  by  the  company. 

Of  11  valuations  made  by  the  metal  valuation  section  of  the 
Bureau  of  Internal  Revenue  the  original  valuations  of  $37,517,093 
were  157.19  percent  of  the  revised  valuations  of  $23,867,624.^-  See 
also  the  examples  as  to  variations  in  mineral  valuations  collected 
under  the  section  on  Depletion  at  page  29. 

a  Walter  Q.  Mitchell  and  Homer  L.  Ferguson,  Feb.  12,  1935,  80  ZO. 

«  Ibid. 

«  Walter  G.  Mitchell,  Feb.  12,  1935,  81  ZO. 

<"  Ibid,  Mr.  Mitchell  testified  that  the  total  of  appreciation  and  discount  items  disallowed  by  the  revenue 
agent  was  $6,875,047  and  that  an  additional  $360,000  was  disallowed  because  it  had  been  allowed  as  depre- 
ciation and  deducted  from  income  in  the  company's  1916  return.  The  difference  between  these  figures 
and  the  net  disallowance  of  $6,551,289,  represented  by  the  revenue  agent's  estimate  of  .$3,826,316  and  the 
company's  return  of  $10,377,605,  is  due  to  net  additions  to  invested  capital  made  by  the  revenue  agent 
because  of  other  items  not  referred  to  in  the  testimony. 

«  Letter  from  Secretary  of  Treasury  to  committee,  May  3, 1935,  which  states  that  "  Prior  to  the  determina- 
tion by  the  Commissioner  of  Internal  Revenue  that  the  profits  taxes  for  the  ta.xable  years  1917  and  1918 
should"  be  computed  under  those  provisions  of  law,  i.  e.,  the  special  assessment  provisions,  computations 
had  been  made  in  the  Bureau  of  Internal  Revenue  which  disclosed  the  invested  capital  of  the  taxpayer 
corporation  as  $3,822,549.44  for  the  taxable  year  1917  and  $5,500,091.75  for  the  taxable  year  1918.  Such  com- 
putations may  be  termed  final  in  that  they  were  the  last  made  in  the  Bureau  of  Internal  Revenue  and, 
accordingly,  represent  the  Bureau's  final  determination  but  the  files  disclose  that  the  taxpayer  was  not 
in  agreement  with  the  Bureau's  determination.  Differences  in  opinion  with  respect  to  the  correct  com- 
putation of  statutory  invested  capital  for  such  years  became  immaterial,  however,  when  the  Commis- 
sioner of  Internal  ReVenue  granted  the  taxpayer's  contention  that  the  profits  tax  liability  should  be  com- 
puted under  the  relief  sections  of  the  law  and  not  on  the  basis  of  statutory  invested  capital  and  net 
income." 

"  Exhibit  No.  1556. 

«o  Homer  L.  Ferguson,  Feb.  12,  1935,  69  ZO. 

«i  Ibid,  67  ZO-68  ZO. 

«2  69th  Cong.,  1st  sess.,  S.  Rept.  27,  pp.  109-110. 


MUNITIONS    INDUSTRY  23 

A  group  of  47  copper  mining  companies  were  valued  by  the  Bureau 
as  of  March  1,  1913,  for  depletion  purposes  at  $1,750,024,787  on  the 
first  valuation  and  at  only  $530,217,893,  or  a  difference  of  $1,219,- 
806,894,  on  the  second  valuation. ^^  These  same  properties  were 
again  valued  as  of  January  1,  1919,  at  $1,456,327,002  on  the  first 
valuation  and  at  only  $323,707,404,  or  $1,132,619,598  less,  on  the 
second  valuation. ^^  The  first  valuations  as  of  January  1,  1919, 
average  449.9  percent  of  the  second  valuations. ^^ 

Mr.  Baruch,  who  since  before  the  World  War  has  owned  26  percent 
of  the  stoclv  of  one  of  the  largest  tungsten  mines  in  the  world,^^ 
testified  in  the  following  manner  as  to  valuation  of  mining  properties: 

Mr.  Hiss.  It  is  a  very  difficult  matter  from  time  to  time  to  estimate  the  value  of 
ore  still  in  the  <a:round,  is  it  not? 

Mr.  EARUCii.  It  is  almost  impossible.  Witii  a  tungsten  mine  it  is  absolutely 
impossible." 

The  Government's  experience  with  valuation  difficulties  is  not 
limited  to  taxation.  By  1926  the  Interstate  Commerce  Commission 
had  expended  $27,000,000  in  13  years'  efforts  devoted  to  valuing  the 
railroads  of  the  country  ^^  and  did  not  complete  its  primary  valua- 
tions until  6  years  later. ^^  For  examples  of  the  difficulties  of  valua- 
tion in  the  railroad  and  public-utility  as  well  as  taxation  fields,  see  the 
excerpts  from  Exhibit  No.  1343  and  the  letter,  referred  to  above,  of 
the  Acting  Secretary  of  the  Treasury  dated  January  28,  1935,  which 
appear  in  the  appendix  to  this  report  at  page  147  and  page  139,  respec- 
tively. 

The  uncertainties  in  the  field  of  valuing  capital  assets  are  forcibly 
illustrated  by  the  variances  between  the  estimates  of  invested  capital 
contained  in  the  tax  returns  filed  by  a  group  of  the  country 's  largest 
industrial  concerns,  as  contrasted  with  the  estimates  of  the  revenue 
agents'  reports  on  the  same  companies  and  with  the  final  determina- 
tions by  the  Bureau  of  Internal  Revenue. 

The  total  invested  capital  reported  for  1917  by  15  such  corporations 
was  $775,799,312.  The  revenue  agents'  reports  estimated  the  total 
investment  of  these  same  companies  at  only  $547,642,452 — a  difl'er- 
ence  of  $228,156,860.  The  final  determinations  by  the  Bureau  totaled 
$717,284,142.6'' 

For  1918  the  total  invested  capital  reported  by  substantially  the 
same  group  of  corporations  was  $878,920,120.  The  revenue  agents 
reported  a  total  capital  of  $746,789,162  and  the  total  of  the  amounts 
finally  determined  upon  by  the  Bureau  was  $770,212,390.^^ 

It  must  be  remembered  that  the  final  figures  are  those  which  are 
either  determined  after  litigation  or  are  accepted  by  the  taxpaj'ers. 
The  increase  between  the  reports  of  the  various  agents  and  the  final 
figures,  which  meant  an  increase  in  the  taxpayers'  exemptions  also,  is 
undoubtedly  in  large  part  due  to  the  impossibility  of  strict  legal  proof 
of  the  estimates  arrived  at  by  the  agents.  Other  factors  which  ])re- 
sumably  played  some  part  in  this  increase  are  referred  to  at  page  37 
et  seq.     Of  course,  no  official  figures  of  invested  capital  in  themselves 

53  Ibid. 
5<  Ibid. 
55  Ibid. 

5«  Testimony  of  Bernard  M.  Baruch,  Mar.  29,  1935. 
■'•  Ibid. 

59  Mr.  Ernst's  report,  Senate  Investigation  of  the  Bui-eau  of  Internal  Revenue  (1926),  report  no.  27,  pt.3, 
p.  4. 
5'  Forty-?Lxth  Annual  Report  of  the  Interstate  Commerce  Commission  C1932),  p.  86. 
«»  Exhibit  No.  17S6,  appendix  p.  136. 


24  MUNITIONS    INDUSTRY 

indicate  fully  the  difficulties  of  determining  invested  capital,  since 
in  many  cases  the  Bureau  of  Internal  Revenue  decided  that  it  could  not 
ascertain  invested  capital  and  made  use  of  the  exception  of  "special 
assessments"  described  at  page  45  et  seq.,  of  this  report.  In  other 
words,  for  the  most  difficult  cases  no  figures  are  available  to  illustrate 
the  difficulties  since  invested  capital  was  never  determined. 

As  indicated  by  the  foregoing,  the  impossibility  of  any  exact  and 
scientific  determination  of  value  makes  the  invested  capital  base  a 
slow  and  expensive  method  of  determining  tax  liability  as  well  as 
one  which  offers  undoubted  opportunities  for  tax  avoidance.  It  has 
accordingly  been  almost  universally  condemned. ^^ 

Mr.  Arthur  Ballantine,  whose  record  as  Solicitor  of  Internal  Revenue 
in  1918,  as  Assistant  Secretary  of  the  Treasury  from  1932  to  1933, 
and  as  a  leading  tax  lawyer,  makes  him  one  of  the  foremost  experts 
in  taxation,  testified  before  the  War  Policies  Commission: 

There  is  no  question  that  the  experience  of  the  Government  and  taxpayers 
with  the  determination  of  invested  capital  was  unsatisfactory  and  that  this  basis 
should  not  be  used  again  except  as  a  last  resort."- 

The  War  Policies  Commission's  Anah^sis  of  Testimony,  prepared 
by  its  executive  secretary,  Robert  H.  ]Montgomery,  who  is  an  author 
and  a  recognized  expert  in  the  field  of  taxation  and  a  member  of  the 
well-known  accounting  firm  of  Lybrand,  Ross  Bros.  &  ^lontgomery, 
states  as  apparently  based  upon  uncontradicted  evidence: 

Most  of  the  administrative  difficulties  arising  out  of  the  excess-profits  tax  laws 
were  due  to  the  necessity  of  ascertaining  invested  capital.  This  base  should  not 
be  used  in  another  war.^^ 

IMr.  Ogden  Mills,  when  Secretary  of  the  Treasury,  adopted  Mr. 
Ballantme's  exact  language,  quoted  above,  in  responding  to  a  resolu- 
tion of  the  Senate  requesting  recommendations  and  opinions  as  to  the 
recommendations  of  the  War  Policies  Commission  for  wartime  taxa- 
tion.^* Mr.  Mills'  letter  also  stated  that  "the  experience  of  the 
World  War  clearly  demonstrated  'the  invested  capital  basis'  to  be 
impracticable  for  general  application."  ^^ 

Nevertheless,  the  fashioning  of  an  excess-profits  tax  on  the  base  of 
investment  has  the  distinct  merit  not  only  of  historical  familiarity, 
but  also  of  furnishing  at  least  a  rough  approximation  of  (1)  popular 
notions  of  fair  return  and  (2)  of  business  realities.  It  seems  clear, 
however,  that  the  advantages  of  this  type  of  tax  can  be  retained  "\\ith- 
out  the  delays,  uncertainties,  and  loss  of  revenue  attendant  upon 
valuing  the  investment  only  by  adopting  as  a  base  some  more  or  less 
arbitrary  estimate  not  open  to  varying  judgments  and  opinions. 

The  Treasury  Department  has  pointed  out  that  practically  all  the 
physical  assets  of  business  property  have  been  valued  at  fair  market 
value  for  depreciation,  exhaustion,  or  depletion  allowances  under  the 
income-tax  laws.^''  However,  these  valuations  do  not  include  land  or 
mineral  deposits  discovered  since  March  1,  1913,  or  any  of  the 
intangible  assets,  such  as  patents  and  goodwill,  which  bulk  so  large  in 
the  actual  value  of  any  business  enterprise.  In  addition,  they  would 
not  cover  the  new  plants  wnich  v/ar  demands  will  require.  Con- 
sequently they  leave  a  wide  field  open  to  the  difficulties  enumerated.. 

61  For  comments  in  addition  to  those  quoted  in  the  text  on  this  page,  see  p.  16  and  p.  19,  supra. 

62  72d  Cong.,  1st  sess.,  House  Doc.  No.  163,  p.  692. 

63  Documents  of  the  War  Policies  Commission,  72d  Cong.  1st  sess.,  House  Doc.  No.  271,  p.  21. 

64  72d  Cong.,  1st  sess..  Senate  Doc.  No.  105,  p.  4. 
•5  Ibid.,  p.  5. 

66  Letter  of  Acting  Secretary  of  Treasury,  Jan.  28,  1935,  appendix,  p.  139. 


MUIS'ITIONS    INDUSTRY 


25 


This  committee  has  recommended  that  the  declared  capital  value 
provided  for  by  section  701  of  the  Revenue  Act  of  1934  should  be 
adopted."  This  section  imposed,  as  an  excise  tax  on  corporations,  a 
tax  of  $1  per  $1,000  of  the  value  of  capital  stock  "declared  by  the  cor- 
poration in  its  first  return."  Section  702  imposed  an  excess-profits 
tax  of  5  percent  on  net  income  in  excess  of  12}^  percent  of  this  declared 
value.  These  sections  replaced  the  similar  provisions  appUcable  to 
1933  appearing  in  sections  215  and  216  of  the  National  Industrial 
Recovery  Act. 

The  Treasury  Department  made  it  clear  that  the  declared  value 
was  to  be  exclusively  within  the  discretion  of  the  taxpayer  and  could 
not  be  challenged  by  the  Government.®* 

The  legislative  history  of  these  provisions  makes  it  plain  that  Con- 
gress regarded  only  the  capital-stock  provision  as  important  from  a 
revenue  point  of  view  and  accordingly  \\dshed  to  encourage  high 
valuations  ."^^  The  excess-profit  provision  was  included  in  order  to 
insure  high  valuations.™ 

Whatever  the  Congressional  intent,  it  would  appear  that  corpora- 
tions anticipating  large  earnings  in  1934  and  immediately  succeeding 
years,  would  find  it  to  their  advantage  to  insure  exemption  from 
the  5-percent  tax  on  net  income  at  the  expense  of  increasing  the 
relatively  less  severe  capital-stock  tax.^^  The  sharp  increase  in  profits 
actually  experienced  by  many  corporations  prior  to  May  10,  1934, 
the  date  of  the  Revenue  Act  of  1934,  and  the  widespread  hope  of 
a  substantial  re^-ival  of  business  conditions,  would  indicate  that  the 

97  74th  Con?.,  1st  sess.,  S.  Report  No.  577.  p.  4.  ,,,.,,....  •.  ,    ^    , 

68  "»  *  *  tho  corporation  should  then  determine  the  original  declared  value  for  its  entire  capital  stock 
according  to  its  best  judgment."  (Instructions  on  reverse  side  of  1933  Capital  Stock  Tax  Return,  forms 
707  and  708,  Trea.surv  Department,  Internal  Revenue  Service,  revised  June  1933.)  "*  *  *  a  corporation 
*  *  *  may  assign"  any  value  it  desires  to  its  capital  stock  *  *  *."  U.  S.  Treasury  Department, 
Bureauof  Internal  Revenue,  Regulations  64  (1934  edition),  p.  vii.  „    -^     . 

99  Report  of  the  Senate  Finance  Committee  on  the  Revenue  Bill  of  1934,  73rd  Cong.,  2d  sess.,  8.  Rept. 

No.  558,  p.  6.  .  J  ,.  ,  ^v,  ci    * 

'» Ibid  ,  pp.  6-7:  "  A  reasonable  original  declared  value  is  assured  by  means  of  the  excess-profits  tax, 
which  is  based  on  the  relation  of  the  net  income  of  the  corporation  to  such  declared  value"  (p.  6).    "The 
primary  purpose  of  this  [excess  profits]  tax  is  to  induce  corporations  automatically  to  declare  a  fair  value  for 
their  corporate  stock  under  sec.  701"  (p.  7). 
"  The  Prentice  Hall  Federal  Tax  Service,  par.  27,  101  states:  .    ,    ^     , 

"An  illustration  showing  the  importance  of  making  the  original  declared  value  m  the  1934  capital-stock 
tax  return  high  enough  to  take  care  of  future  contingencies  is  given  below.  The  example  shows  corportaions 
A  and  B  both  of  which  have  the  same  net  income  and  dividend  distributions  over  a  3-year  period.  A 
uses  a  declared  value  of  $1,000,000  in  its  1934  capital-stock  tax  return  and  B  uses  $1,500,000. 


Declared  value 

Net  in- 
come 

Divi- 
dends 
paid 

Capital-stock 
tax 

Excess-profits 
tax 

Total  tax 

A 

B 

A 

B 

A 

B 

A 

B 

1934 

$1,000,000 
1,050,000 
1, 100,  000 

$1,  500,  000 
1, 550,  000 
1,600,000 

$100,  000 
90,000 
200,000 

$50,  000 
40,  000 
180,000 

$1, 000 
1,050 
1,100 

$1,500 
1,550 
1,600 

None 
None 
$3, 125 

None 
None 
None 

$1,000 
1,050 
4,225 

$1,500 

1935 

1,550 

1936 

1,600 

Total  capital- 
stock    and 
excess-prof- 
its tax  for  3- 
year  period. 

6,275 

4. 650 

Compare  in  this  regard  R.  H.  Montgomery,  Federal  Tax  Handbook  1934-1935  p.  1007:  "The  rate  of 
excess-profits  tax  is  so  much  higher  than  the  corresponding  rate  of  capital-stock  tax  that  in  all  instances  of 
doubt  as  to  future  earnings  it  is  desirable  to  increase  the  declared  value  of  stock  as  an  offset  to  the  applica- 
tion of  the  excess-profits  tax.  It  will  be  seen  that  for  every  $10,000  undervaluation  of  the  capital  stock, 
while  $10  is  saved  on  the  capital  stock  tax,  the  excess  profits  tax  is  increased  by  $62.50." 


26  MUNITIONS    INDUSTRY 

values  declared  by  many  concerns  under  section  701  would  be  unduly 
highJ'  ^ 

To  the  extent  that  these  factors  have  made  the  declared  values  too 
high,  there  would  be  a  loss  of  revenue  because  the  exemption  based 
upon  value  would  be  correspondingly  too  high.'^  An  attempt  has 
been  made  to  permit  appraisals  in  cases  where  the  declared  value  is 
found  to  be  unduly  high.  However,  the  scope  of  the  items  to  be 
included  in  any  such  appraisal  means  that  the  most  difficult  type  of 
valuation — determination  of  current-market  value  or  going-concern 
value—will  have  to  be  undertaken.^*  The  uncertainties  of  such  a 
valuation  in  the  case  of  the  average  industrial  corporation  make  it 
likely  that  an  appraisal  would  be  practicable  only  in  the  most  flagrant 
cases  of  overvaluation.^^ 

As  to  conipanies  formed  in  wartime  and  as  to  all  wartime  addi- 
tions to  capital,  valuation  of  the  familiar  type  will  be  necessary.  It 
is  further  recognized  that  the  peacetime  adoption  of  the  declared 
value  base  for  w^artime  taxation  purposes  may  encourage  attempts 
to  secure  extravagant  valuations  of  current  additions  to  capital  in  an 
effort  to  increase  the  wartime  exemption. ^"^ 

"  The  Atolia  Mining  Co.,  with  an  original  investment  of  $03,000  and  a  deficit  of  $42,243  in  its  caoital  ac- 
count, declared  a  value  of  $1,500,000  in  its  1933  return.  The  Chase  Brass  &  Copper  Co  with  a  caoital 
deficit  on  its  books  of  $2,100,724,  fixed  a  value  of  $3,000,000  in  its  1933  return  The  Freeport  Sulphur  Co 
with  a  capital  of  $5,577,775  on  its  books,  set  its  value  for  1933  at  $16,950,000.  The  General  Electric  Co  and 
subsidiaries,  with  a  1933  hook  value  given  its  capital  of  $429,0H'<,S23,  declared  a  1933  value  of  $148  7''9  254  and 
a  1934  value  of  $583,911,000;  the  Aviation  Corporation  and  subsidiaries,  with  a  1933  book  value  -^ven  its 
capital  of  $1,844,525,  declared  a  1933  valuation  of  $12,019,000  and  a  1934  valuation  of  .$8  250  000  " 

"  On  the  other  hand,  a  company  which,  because  of  anticipated  low  earnings  for  the  immediate  future 
Dxed  an  abnormally  low  value  on  its  capital  stock  may  be  able  to  object  to  the  use  of  that  valup  for  a  war- 
time excess-iirofits  tax,  if  it  saved  its  rights.  The  Inspiration  Consolidated  Copper  Co.,  in  making  its  1933 
capital  stock  tax  return,  stated  that  its  declared  value  "did  not  represent  the  fair  market  value  nor  the  actual 
value  ♦  *  *  of  the  outstanding  capital  stock  nor  of  the  property  owned  *  *  ♦  and  the  said  original 
declared  value  shcvn  on  tne  annexed  return  may  not  be  takf  u  nor  used  for  any  other  purpose  nor  in  anv 
other  proceeding  whatsoever."  The  company  stated  in  its  return  that  its  balance  sheet  showed  a  capital 
account  of  $46,283,616,  but  it  declared  a  capital  stock  value  of  only  $2,807,172.  Whether  such  an  obviously 
arbitrary  valuation  figure  can  constitutionally  be  used  as  the  base  of  an  exce.ss-profits  tax  where  as  in  thi« 
case,  the  taxpayer  clearly  cannot  be  said  to  have  estopped  itself  to  deny  that  it  is  a  fair  valuation  'is  at  least 
open  to  question.  Ildner  v.  Donnan.  285  U.  S.  312,  325-326,  328-329,  332,  and  see  also  LaBelle  Iron  Works  v 
U.  s..  256  U.  b.  377,  in  which  the  court  denied  a  claim  of  lack  of  uniformity  in  the  application  of  the  invested 
capital  standards  of  the  World  War  taxes,  and  Cumberland  Coal  Co.  v.  Board  of  Revision  284  U  S  23 
28-29,  in  which  discriminatory  valuation  for  State  taxation  was  held  a  denial  of  due  process'-  the  extent  if 
any,  to  which  confiscation  may  be  recognized  as  a  defense  to  taxation  which  is  neither  arbitrary  nor  d'is- 
crimmatory  cannot  be  predicted  Cf.  Louisnille  Joint  Stock  Land  Bank  v.  Radford,  U  S  Sup  Ct  May  27 
1935,  No.  717.  Certainly  an  excess  profits  tax  that  took  more  than  income  would  not  be  authorized  by  the 
sixteenth  amendment.  Eisner  v.  Macomber,  252  U.S.  189.  Other  instances  of  an  apparently  low  valuation 
accompanied  by  a  limitation  of  its  use  to  taxes  covered  by  particular  returns  are:  Bethlehem  Steel  and  sub- 
sidiaries, book  value  in  1933  of  capital,  $609,476,208,  19.33  declared  value  $100,000,000,  1934  declared  value 
$150,066,000;  Anaconda  Copper  Co.  and  subsidiaries,  book  value  in  1933  of  capital,  .$897,602,469  1933  declared 
value  $72.1.56,625,  1934  declared  value  .$273,964,125.  If  the  taxpayers'  contantion  in  any  such  case  were 
sustained,  some  other  method  of  determining  invested  capital  would  be  required.  See  following  footnote' 
'<  The  Revenue  Act  of  1934  did  not  define  the  value  to  be  declared.  The  Treasury  Department  directed 
corporations  to  consider  "the  value  of  the  corporation's  business  and  property  as  an  entirety  and  as  a 
going  concern"  and  in  doing  so  to  look  not  only  to  surplus  and  undivided  profits— which  depend  upon  the 
valuation  accorded  to  plant  and  other  assets  usually  recognized  by  corporate  accounting  practices— but 
also  the  franchise,  goodwill,  outstanding  contracts,  the  earning  capacity  of  the  corporation,  and  the 
market  value  of  its  shares  of  stock."  (Instructions  on  reverse  side  of  1933  Capital  Stock  Tax  Return  forms 
<07  and  708,  Treasury  Department,  Internal  Revenue  Service,  revised  June  1933  ) 

_  "s  It  is  very  doubtful  whether  the  Constitution  would  permit  the  exclusion  of  judicial  review  of  admin- 
istrative determination  of  such  a  value.  See  Phillips  v.  Oommissioner,  283  U.  S.  589,  595-600  and  Hagar  v 
Reclamation  District,  lU  U.  S.  701.  Indeed  it  is  not  unlikely  that  the  clas.ses  of  cases  in  which  judicial  de- 
termination of  facts  IS  required  by  the  Constitution  (Ohio  Valley  Water  Co.  v.  Ben  Avon  253  U  S  287- 
Crojvell  V.  Bf.s.so7i,  285  U.  S,  22)  would,  in  case  of  a  severe  tax,  be  extended  to  cover  the  valuation  issues  raised 
in  determining  income.  In  any  event  court  reviev.-  of  questions  of  law  is  so  familiar  to  our  courts  that  any 
hut  the  clearest  language  will  be  construed  as  not  intended  to  cut  ofT  all  judicial  review.  U.  S  v  Jefferson 
Electric  Co.  291  U.  S.  386  397-400.  But  even  if  it  were  possible  to  avoid  judicial  review  the  uncertainties 
present,  and  consequent  delay,  m  the  administrative  determination  would  make  an  appraisal  impractical 
except  in  rare  cases.  See  that  portion  of  the  letter  of  Jan.  28,  1935,  of  the  Acting  Secfetary  of  the  Treasury 
(Appendix,  p.  139),  which  discusses  "analytic  appraisals." 

;6  Sec.  701  (f)  of  the  Revenue  Act  of  1934  provides  for  adjustments,  under  the  .supervision  of  the  Com- 
missioner of  Internal  Revenue,  of  the  original  declared  value  for  additions  to  or  withdrawals  from  capital 


III.  Difficulties  Involved  in  Determining  Net  Income 

The  base  is,  of  course,  important  in  an  excess-profits-tax  scheme 
only  as  a  yardstick  for  measuring  the  amount  of  income  which  is  to 
remain  exempt  from  taxation.  The  more  fundamental  problem  is 
the  determination  of  taxable  income  to  which  not  only  the  exemption 
computed  from  the  base,  but  also  the  tax  itself  is  applied.  Net 
income  or  profit  is  merely  a  bookkeeping  item  for  any  business  enter- 
prise. It  is  the  difference  between  the  total  amount  received,  or 
gross  income,  and  the  costs  of  operating  the  business.  For  ordinary 
purposes  each  individual  business  estimates  those  costs  to  suit  itself. 
For  tax  purposes,  however,  costs  assume  a  critical  iinportance.  If 
costs  plus  the  tax  exemption  equal  gross  income  there  is  nothing  left 
for  the  tax. 

(1)   depreciation 

Ordinary  business  costs  include  many  items  which  are  purely  mat- 
ters of  opinion,  largely  opinion  as  to  the  value  of  things  consumed  in 
whole  or  in  part  in  the  operation  of  the  business.'^  One  of  the  major 
cost  items  of  this  type  is  depreciation.  The  factory  building  and  its 
machines  are  used  up,  in  whole  or  in  part,  by  the  process  of  production. 
Their  cost  is  part  of  the  cost  of  production.  How  much  they  are  used 
up  in  each  profit-taking  period  by  various  operations  is  a  matter  of 
judgment.  As  most  businesses  are  run  on  a  going  basis,  the  cost  of  used 
facilities  is  not  a  matter  of  the  cash  laid  out  for  them,  but  an  estimate 
of  their  value  in  terms  of  repair  or  replacement.  Consequently,  the 
uncertainties  of  valuation  referred  to  at  pages  19  to  24  of  this  report 
are  an  inevitable  part  of  the  taxmg  process  even  though  they  are 
to  be  eliminated  from  the  establishment  of  the  base  for  exemption. 

An  example  of  the  opportunit}^  for  increasing  the  item  of  deprecia- 
tion, and  thus  decreasing  the  amount  of  income  subject  to  the  tax,  is 
furnished  by  the  sale  of  the  New  York  Shipbuilding  Co.  to  the  Ameri- 
can International  Corporation  in  1916  for  a  price  of  $2,929,573  above 
the  New  York  Shipbuilding  Co.'s  previous  estimate  of  the  value  of  its 
property.  The  American  International  Corporation  was  building 
ships  for  the  Navy  and  the  Emergency  Fleet  Corporation  under  cost 
plus  a  percentage  of  cost  contracts.  The  higher  the  costs  the  greater 
the  cost  payments  and  the  percentage  fee,  and  the  smaller  the  taxes  on 
the  total  amount  received. 

"'  It  is,  of  course,  impossible  to  catalog  all  the  ditllculties  involved  in  the  determination  of  costs.  This 
part  of  the  report  merely  discusses  certain  of  those  difficulties  most  frequently  encountered  in  the  field  of 
costs.  It  should  also  be  noted  that  the  mere  physical  task  of  examining  the  books  of  a  large  corporation  is 
staggering,  as  is  illustrated  by  the  following  excerpt  from  exhibit  1435,  a  Treasury  Department  memo- 
randum relating  to  the  taxes  of  the  >ie\v  York  Shipbuilding  Co.: 

"After  a  very  careful  study  of  conditions,  viz,  the  system  of  bookkeeping  and  record  keeping,  the  prac- 
tices of  the  corporation,  etc..  it  is  the  opinion  of  your  examiners  that  it  is  an  utterly  impossible  task  to 
attempt  to  determine  correct  costs  in  connection  with  each  contract.  It  is  our  unqualified  opinion  that 
even  a  large  corps  of  men  working  for  an  indefinite  time  could  not  even  approach  accuracy.  Thousands 
and  probably  hundreds  of  thousands  of  vouchers,  labor  tickets,  store  requisitions,  etc.,  would  have  to  be 
examined  and  reanalyzed,  and  the  books  all  recast.  During  the  war  emergency  the  plant  employed  in 
the  neighborhood  of  22,000  men." 

It  took,  approximately,  22  men  5  years  to  audit  the  1917  and  1918  returns  of  the  United  States  Steel  Cor- 
poration. Exhibit  1740.  Obviously,  the  Government  must  largely  accept  the  books  kept  by  the 
taxpayer,  which  means  that  on  many  doubtful  items  ol  cost  neither  the  taxpayer's  veracity  nor  its  judgment 
is  questioned. 

2.7 


28  MUNITIONS    INDUSTRY 

Mr.  Raushenbush.  This  profit  of  $2,929,000,  which  you  had  paid  in  excess  of 
the  value  of  the  plant,  the  purchasing  company  had  paid,  that  was  immediately 
written  onto  the  books,  was  it  not;  I  mean  distributed  among  the  property"? 
You  tried  to  allocate  that  to  ways  and  yards  and  the  like,  and  did  so  allocate  it 
almost  immediately. 

Mr.  Parker.  The  new  corporation  paid  a  certain  price  for  the  assets,  plant, 
land,  buildings,  and  all  the  price  they  paid  for  it  was  the  price  at  which  the  new 
corporation  set  it  up  on  its  books. 

Mr.  Raushenbush.  That  price  was  $2,929,573  above  the  old  price,  and  you 
then  distributed  it  among  various  assets,  assigned  so  much  to  this  and  so  much  to 
that,  did  you  not? 

Mr.  Parker.  The  corporation  set  it  up  on  its  books,  and  it  did  not  make  any 
difference  at  what  it  was  held  on  the  books  of  the  previous  company. 

Mr.  Raushenbush.  But  my  point  is,  it  did  not  set  it  up  as  goodwill? 

Mr.  Parker.  Not  at  all.  It  was  an  actual  purchase  of  tangible  property,  a 
tangible  asset. 

Senator  Clark.  Two  and  a  quarter  million  dollars  above  what  the  old  company 
carried  it  on  its  books? 

Mr.  Parker.  Exactlv,  sir. 

Mr.  Raushenbush.  Almost  $3,000,000,  Senator. 

All  through  the  following  years,  when  you  were  doing  work  for  the  Navy  and 
the  Emargency  Fleet  Corporation,  you  tried  to  depreciate  that  $2,929,000,  did 
you  not? 

Mr.  Parker.  I  believe  properly  so. 

Mr.  Raushenbush.  And  to  have  that  depreciated  against  the  naval  vessels  and 
the  Emergency  Fleet  Corporation  vessels.     You  believe  they  did  so? 

Mr.  Parker.  Yes,  sir. 

Mr.  Raushenbush.  And  you  remember  quite  accurately,  do  you  not,  that 
both  the  Navy  and  the  Emergency  Fleet  Corporation  constantly  insisted  that  was 
a  nondepreciable  item,  a  goodwill  item  that  you  had  paid  for? 

Mr.  Parker.  That  is  correct. 

Mr.  Raushenbush.  So  that  for  a  period  all  through  the  war  and  later  years, 
when  the  tax  matters  became  important,  there  was  a  constant  fight,  let  us  say, 
between  the  company  and  the  Navy  and  the  Emergency  Fleet  Corporation  and 
the  Internal  Revenue  Departm.ent,  on  the  question  of  whether  or  not  the  Govern- 
ment would  really  pay  for  that  depreciation  on  the  goodwill  you  had  paid  for? 

Mr.  Parker.   Not  quite  a  fight,  but,  say,  a  conference. 

Senator  Clark.  A  controversy,  was  it  not?  "* 

(2)    DEPLETION 

Mining  companies  include  as  a  cost  item  depletion  of  their  ores. 
That  is,  they  fix  a  value  for  their  ore  properties  in  the  ground  and 
as  each  unit  is  mined  and  sold  charge  a  proportionate  amount  of 
that  value  as  a  cost. 

Mr.  Baruch,  who  has  had  long  experience  with  mining  properties, 
testified  as  follows  as  to  the  difficulties  involved  in  valuing  sulphur 
mines: 

Mr.  Hiss.  This  indicates  again,  does  it  not,  Mr.  Baruch,  the  diflficulty  of 
fixing  a  value  on  any  mining  property? 

Mr.  Baruch.  And  especially  one  like  that.  You  cannot  see  anything.  You 
sink  way  down  into  the  bowels  of  the  earth  and  put  in  hot  water  and  the  sulphur 
comes  out.     I  do  not  see  how  you  can  determine  the  value  of  a  property  like  that.^^ 

The  Texas  Gulf  Sulphur  Co.,  of  wliich  Mr.  Baruch  is  a  dominant 
stockholder,  was  purchased  for  $250,000  but  was  allowed  a  value 
for  depletion  purposes  of  $38,920,000  by  the  Bureau  of  Internal 
Revenue.^*' 

Additional  examples  of  the  uncertainty  and  impossiblity  of  exact 
ascertainment  of  mineral  valuations  are  as  follows: 


"  Testimony  of  N.  R.  Parker,  Jan.  21,  1935. 

"  Testimony  of  Bernard  M.  Baruch,  Mar.  29,  1935. 

7"  69th  Cong.,  1st  sess.,  Sen.  Rep.  No.  27,  p.  &d. 


MUNITIONS    INDUSTRY  29 

HOUSTON    COAL    &    COKE    CO.. 

On  this  basis  the  lease  is  given  a  value  of  $918,884.60  and  the  depletion  unit 
is  given  21.3  cents.  As  a  royalty  of  10  cents  was  stipulated  in  the  lease,  the  coal 
in  the  ground  was  thus  valued  at  31.3  cents,  when  it  was  established,  undisputed 
fact,  agreed  to  between  the  Income  Tax  Unit  and  the  Pocahontas  operators, 
that  the  market  price  of  coal  in  the  ground  on  March  1,  1913,  was  17.9  cents. 
*     *     * 

In  this  case  nearly  $718,000  of  value,  due  entirely  to  good  will  and  selling 
ability,  is  attributed  to  coal  in  the  ground  and  returned  to  the  taxpayer  as  tax- 
free  depletion.*' 

UNION    SULPHUR    CO. 

In  1896  Herman  Frasch,  who  had  invented  and  patented  a  process  which  it 
was  believed  would  be  successful,  organized  the  Union  Sulphur  Co.  with  a  capital 
of  $200,000.  The  property  in  question  was  acquired,  subject  to  a  mortgage  of 
$165,000  in  exchange  for  $100,000  par  value  of  the  capital  stock  of  the  com- 
pany. The  remaining  $100,000  of  capital  stock  was  issued  to  Frasch  in  exchange 
for  his  patent. 

The  value  of  the  deposit,  as  of  date  of  acquisition,  allowed  by  the  Income  Tax 
Unit  for  invested  capital  purposes,  was  $3,000,000.^2 

UNITED    STATES    GRAPHITE    CO. 

This  property  was  acquired  in  1893  in  exchange  for  stock  of  the  taxpayer  of 
the  par  value  of  $35,000.  The  value  allowed  for  invested  capital  purposes  for 
1917  was  $335,000,  or  $300,000  in  excess  of  the  par  value  of  the  stock.     *     *     *  ss 

TEMPLE    COAL    CO. 

The  mining  property  of  this  company  was  acquired  on  June  24,  1914,  at  public 
auction,  by  the  promoter  of  the  company  for  $5,609,423.33  cash.  This  cash  bid 
was  based  upon  and  exactly  equaled  the  value  which  had  been  placed  upon  the 
property  by  an  engineer  employed  by  the  vendor. 

Oh  July  1,  1914,  7  days  after  its  purchase  for  cash,  this  property  was  turned 
over  to  the  taxpayer  in  exchange  for  capital  stock. 

The  value  allowed  upon  this  property,  for  invested  capital  purposes,  as  of  July 
1,  1914,  was  $10,443,678.29.8" 

BORDER    ISLAND    CO. 

The  valuation  of  $130,000,  as  of  June  15,  1923,  for  invested  capital  purposes 
was  accepted  by  the  taxpayer,  but  a  protest  was  filed  as  to  the  valuation  of 
$121,082.25,  as  of  March  1,  1913,  for  depletion  purposes,  and  the  case  was  re- 
viewed by  the  solicitor's  ofRce.  *  *  *  The  solicitor's  office  made  a  valua- 
tion, by  an  analytic  appraisal,  of  $196,159.99  as  of  March  1,  1913.     *     *     *  85 

UNITED    STATES    GRAPHITE    CO. 

The  taxpayer  claimed  a  March  1,  1913,  value  on  this  mine,  for  depletion  pur- 
poses of  $516,926.45.  Mr.  A.  R.  Shepherd,  a  special  conferee,  designated  by 
and  working  directly  under  Mr.  S.  M.  Greenidge,  head  of  the  engineering  divi- 
sion, was  permitted  to  overrule  the  nonmetals  section  and  allowed  a  March 
1,  1913,  value  of  $1,043,044.56.86 

NEW    JERSEY    CALCITE    CO. 

The  taxpayer  claimed  a  value  of  $130,000  on  these  leases  as  of  April  1916  to 
be  depleted  in  annual  installments  between  April  1916  and  the  expiration  of 
the  leases.  *  *  *  "phe  valuation  engineers  fixed  the  value  of  these  leases  at 
$8,9.50.93. 

The  taxpayer  appealed  from  this  determination  to  the  committee  on  appeals 
and  review,  which  allowed  a  value  of  $106,000  on  these  leases." 


"  69th  Cong., 

1st 

sess., 

,  S. 

Rept. 

27, 

p. 

52. 

82  Ibid. 

,  p. 

65. 

'3  Ibid, 

PP 

.  60-61. 

s*  Ibid. 

.  p. 

59. 

95  Ibid. 

.  p. 

61. 

88  Ibid. 

,  p. 

48. 

>^  Ibid. 

.  P- 

53. 

11579- 


30  MUNITIONS    INDUSTRY 

.       (3)    AMORTIZATION 

Another  important  item  that  appears  in  the  costs  of  many  indus- 
trial concerns  is  that  of  amortization.  Not  only  is  the  replacement 
and  repair  of  plant,  which  appears  as  depreciation,  a  cost  of  doing 
business;  in  addition  there  is  an  attempt  to  collect  the  total  original 
cost  of  plant  and  facilities.  This  is  comparable  to  the  depletion  of 
mineral  properties;  but  in  ordinary  peace  time,  business  enterprises 
have  distinguished  between  industries  like  mining,  whose  capital 
assets  are  by  their  very  nature  used  up  in  operation,  and  those  whose 
capital  assets  merely  require  repair  and  replacement  from  ordinary 
wear  and  tear.  However,  during  war  time,  when  the  erection  of  new 
plants  and  additions  to  plants  is  vitally  necessary  to  furnish  the 
needed  increased  production  called  for  by  wartime  demands,  amorti- 
zation takes  on  added  significance.  If  some  return  on  investment  is 
necessary  to  secure  expansion  of  industry,  it  is  clear  that  some  assur- 
ance that  the  investment  itself  will  not  be  lost  must  also  be  furnished. 
And  the  mere  fact  that  war  calls  for  new  facilities  indicates  that  with- 
out the  war  demand  those  facilities  may  be  useless.  The  prospect  of 
tax  avoidance  increases  industry's  natural  war-time  demand  for 
liberal  amortization  allowances  and  the  Government's  desire  to 
encourage  expanded  production  conflicts  with  its  need  of  revenue. 

Because  it  was  felt  that  equity  required  a  recognition  of  the  sub- 
stantial risk  that  wartime  construction  would  be  valueless  after  the 
war,  provision  was  made  in  the  1918  Revenue  Act  for  the  reduction 
of  net  taxable  income  by  the  amount  paid  out  for  the  creation  of 
facilities  constructed  or  acquired  on  or  after  April  6,  1917,  for  the 
production  of  articles  contributing  to  the  prosecution  of  the  war.** 

The  erection  of  large  capital  facilities  is  a  process  which  may  extend 
over  a  great  period  of  time,  and  may  be  subject  to  many  changes 
therein.  Specifications  for  construction  may  change.  By  mutual 
agreement  or  otherwise  what  may  have  been  contracted  for  originally 
may  be  different  from  what  is  erected  ultimately.  Furthermore,  it  is 
difficult,  as  a  matter  of  equity,  to  determine  wiiether  facilities  which 
have  been  contracted  for  before  the  war,  are  actually  required  for  a 
war,  as  distinguished  from  a  peace-time  use.  It  is  therefore  an  over- 
simplification to  speak  of  capital  expenditures  or  facilities  erected  or 
acquired  within  the  war  period: 

Practically  every  large  claim  for  amortization  includes  allowances  upon  facili- 
ties for  the  construction  or  acquisition  of  which  the  taxpayer  was  bound  by 
contract  prior  to  April  6,  1917,  but  which  were  not  fully  paid  for  on  that  date.^s 

Many  plants  were  not  completed  until  after  the  war  was  over. 
Although  the  original  incentive  for  commencing  construction  may 
have  been  a  war-time  demand,  it  cannot  be  said  that  the  continuance 
of  such  construction  represented  a  response  to  war-time  needs. 
Nevertheless,  it  would  be  ruinous  to  interrupt  building  operations 
once  they  have  proceeded  beyond  a  certain  stage,  and  a  failure  to 
recognize  this  would  add  to  the  difficulty  of  getting  large  scale  con- 
struction started  at  a  time  when  no  one  can  foresee  the  duration  of 
war  needs. ^° 


88  Revenue  Act  of  1918.  sees.  214  (a)  (9);  234  (a)  (8).  See  Report  of  the  House  Ways  and  Means  Com- 
mittee on  the  Revenue  Bill  of  1918,  65th  Cong.,  2d  sess.,  H.  Rep.  No.  767,  pp.  10,  13.  The  sections  cited 
also  permitted  amortization  for  the  construction  or  acquisition  of  vessels  on  or  after  Apr.  6,  1917,  for  the  ■ 
transportation  of  articles  or  men  contributing  to  the  prosecution  of  the  vi^ar. 

»9  eeth  Cong.,  1st  sess..  S.  Rept.  27,  p.  135. 

80  Ibid.,  pp.  136-137. 


MUNITIONS    INDUSTRY  31 

Industrial  development,  it  must  also  be  remembered,  possesses  a  con- 
tinuity of  its  own  apart  from  war  conditions.  It  is  accordingly  very 
difficult  to  separate  mushroom  war-time  growth  from  normal  indus- 
trial development. 

Considerable  difficulty  may  be  experienced  with  corporate  entities 
set  up  during  the  war  that  take  over  capital  plants  which  have  been 
erected  by  other  companies  prior  to  the  war.  In  fact  amortization 
was  frequently  allowed  in  this  situation: 

This  statute  has  been  construed  by  Income  Tax  Unit  to  allow  amortization 
upon  the  mere  legal  fiction  of  acquisition,  where  there  was  no  increase  in  pro- 
ductive capacity  for  war  purposes,  and  where  the  acquisition  and  subsequent 
discarding  of  plants  was  for  the  sole  purpose  of  consolidating  an  industry  and 
killing  competition.^' 

The  device  of  incorporation  was  subject  to  another  artifice  which 
clearly  illustrates  the  difficulty  of  defining  what  are  articles  con- 
tributed for  the  prosecution  of  the  war,  and  segregating  them  from 
articles  not  required  for  the  prosecution  of  the  war.  For  example, 
railroads  were  specifically  held  by  the  Bureau  of  Internal  Revenue 
and  by  the  courts  not  to  fall  under  the  scope  of  the  amortization  pro- 
visions, inasmuch  as  they  did  not  contribute  to  the  manufacture  of 
articles  required  for  the  war.  Nevertheless,  amortization  amounting 
to  $2,789,185.49  was  allowed  to  common-carrier  railroad  corporations 
whose  stock  was  owned  by  the  United  States  Steel  Corporation  and 
its  subsidiaries,  upon  facilities  owned  not  bj"  a  producer  of  articles 
but  by  a  railroad  corporation  possessing  only  the  attribute  of  having 
its  stock  owned  by  a  company  which  also  owned  stock  of  a  war-use 
producer: 

The  United  States  Steel  Corporation  produced  nothing,  but  it  is  the  owmer  of 
the  stock  of  other  corporations,  which  did  produce  articles  contributing  to  the 
prosecution  of  the  war.  Thus,  we  have  railroad  companies  allowed  amortiza- 
tion, because  their  stock  was  owned  by  a  corporation,  which  owns  the  stock  of 
another  corporation,  which  comes  within  the  class  entitled  to  amortization. '- 

Pipe  lines  were  also  allowed  amortization  on  the  ground  that  their 
stock  was  owTied  by  the  oil-producing  companies.  Among  the  oil 
companies  thus  benefited  was  the  Texas  Co.,  the  Sun  Oil  Co.,  and  the 
Sinclair  Oil  &  Refining  Co.  Although  the  practice  was  condemned 
by  the  Solicitor  of  the  Bureau  in  a  ruling,  allowances  were  made  to 
housing  corporations  which  were  subsidiaries  of  various  steel  corpora- 
tions, etc.,  on  the  ground  that  the  parent  company  was  entitled  to 
amortization,  although  a  corporation  organized  to  erect  houses  in  the 
first  place  would  not  be  entitled  to  amortization.  Similarly,  amortiza- 
tion was  allowed  on  tank  and  refrigerator  cars,  and  even  on  land,  to 
corporations  on  the  ground  that  they  were  otherwise  eligible  for 
amortization.^^ 

There  is  abundant  opportunity  for  discrimination,  and  for  adminis- 
trative confusion,  in  the  case  of  facilities  erected  during  the  war  for  a 
war  purpose,  but  as  replacements  for  facilities  winch  were  becoming 
obsolete  and  deteriorating  at  the  time  when  the  new  facilities  were 
being  erected.  The  problem  is  to  gage  adequately  the  extent  to 
which  a  facility  is  being  erected  because  of  a  wartime  demand,  as 
contrasted  with  being  installed  in  a  situation  where  natural  deprecia- 
tion factors  would  have  rendered  its  installation  essential  anyway, 

«i  Ibid.,  p.  137. 
"  Ibid.,  p.  142. 
M  Ibid.,  pp.  123-144. 


32  MUNITIONS    INDUSTRY 

Probably  because  of  the  complexity  of  the  engineering  problem,  old 
and  new  facilities  had,  when  comparative  capacity  in  the  production 
in  the  post-war  period  was  being  taken  into  consideration,  to  be 
grouped  together  in  determining  the  value  in  use  ^*  of  facilities  installed 
during  the  war: 

All  of  the  taxpayers  to  whom  the  larger  allowances  for  amortization  were  made 
were  going  concerns  before  the  war.  They  all  had  facilities  of  age  and  condition 
varying  from  practically  new  to  scrap.  There  was  no  attempt  made  in  any  of  the 
larger  cases  to  determine  the  actual  usefulness  or  comparative  remaining  useful 
life  of  the  facilities  amortized  for  loss  of  useful  value.'^ 

An  indication  of  the  advantageous  treatment  that  could  be  procured 
by  a  company  in  a  condition  to  consider  in  the  aggregate  its  anti- 
quated and  modern  plants,  is  supplied  by  the  following  illustration: 

Thus,  although  this  war  plant  was  the  only  plant  owned  by  the  taxpayer  which 
could  be  economically  operated,  and  was  in  full  use  to  95  percent  of  its  rated 
capacity,  and  although  its  full  rated  capacity  would  be  reached  in  1  year,  it 
was  considered  to  be  surplus  capacity  and  to  represent  a  loss  to  the  extent  of 
47.4  percent  of  its  cost,  because  the  company  had  on  the  scrap  pile,  charged  to 
scrap,  a  collection  of  antiquated  plants  which  could  not  be  economically  operated.'^ 

Indeed,  it  may  well  be  doubted  whether  in  practice  any  real  dis- 
tinction can  be  drawn  between  facilities  erected  for  wartime  use,  and 
those  erected  during  wartime  but  which  do  not  directly  produce 
articles  for  which  the  Government  has  a  need. 

The  fundamental  difficulty  with  amortization  provisions,  however, 
is  the  impossibility  of  valuing  the  loss  of  usefulness  in  a  plant  con- 
structed in  wartime  which  a  return  to  peace-time  conditions  will 
involve.^''  Not  only  are  the  familiar  difficulties  of  valuation  of  the 
plant  encountered;  in  addition,  a  forecast  must  be  made  of  future  use- 
fulness—at best  a  matter  of  opinion  based  on  many  guesses  even  for  a 
future  period  of  time  in  which  conditions  can  be  foretold.  But  post- 
war conditions  can  never  be  foretold  with  accuracy: 

The  deduction  is  largely  founded  upon  the  idea  of  normalcy.  It  presupposes 
a  return  to  stable-post-war  conditions  of  a  normal  character.  The  difficulty  is 
that  the  words  normal  and  abnormal,  stable  and  unstable,  ordinary  and  extraor- 
dinary, or  whatever  comparatives  are  used  are  relative  words.  Amortization  to 
this  extent  involves  a  theoretical  impossibility,  a  fixed  standard  of  normalcy  in 
connection  with  business  and  industrial  conditions.  The  difficulty  here  is  that 
every  large  war  is  followed  for  a  more  or  less  extended  period  by  chaotic  business 
and  industrial  conditions.  In  order  to  work  equitably  and  without  discrimina- 
tion the  provision  must  be  applied  with  a  degree  of  discretion  and  judgment 
probably  never  before  demanded  in  the  administration  of  our  income-tax  laws.^^ 

Furthermore,  one  frequent  result  of  war  is  an  increase  in  the  total 
peace-time  business  not  only  of  victor  nations  but  of  individual  cor- 
porations, as  is  indicated  by  the  history  of  the  Aluminum  Co.  of 
America,  referred  to  on  the  following  page. 

It  is  small  wonder  that  the  Bureau  of  Internal  Revenue  did  not 
find  it  easy  to  administer  the  amortization  provision  as  applied  to  a 
loss  of  value  in  use: 


w  See  footnote  94,  infra. 

95  Ibid.,  p.  153. 

96  Ibid.,  p.  154. 

97  There  were  three  situations  in  which  amortization  allowances  were  made  after  the  last  war;  (a)  where 
property  was  completely  discarded  or  sold;  (b)  where  there  was  involved  reduced  replacement  cost,  i.  e., 
war-lime  facilities  being  discarded  although  not  totally  useless  and  replaced  by  less  costly  equipment 
adequate  for  peace-time  demands;  (c)  where  "value  in  use"  had  been  reduced.  In  connection  with  the 
first  type  of  situation  there  is  always  present  the  possibility  of  collusive  sales  of  war-time  equipment  in  order 
to  write  off  amortization  allowances.  The  second  class  of  situations  involved  the  usual  difficulties  of  valua- 
tion. However,  most  criticism  has  been  concentrated  upon  amortization  allowances  based  upon  loss  of 
value  in  use. 

99  Holmes,  Federal  Taxes,  p.  853. 


MUNITIONS    INDUSTRY  33 

While  the  amortization  provision  was  first  inserted  in  the  1918  act,  it  was  not 
until  August  19,  1923,  that  the  first  ruling  by  anyone  in  authority  interpreting 
this  provision  [dealing  with  loss  of  value  in  use]  of  the  regulations  was  made. 
This  ruling  was  made  by  Solicitor  Hartson  in  the  /.  /.  Case  Threshing^  Machine 
Co.  case  and  condemned  the  basis  upon  which  every  large  amortization  allow- 
ance for  reduced  value  in  use  had  been  made.  This  ruling  was  not  published 
until  Noveinber  3,  1924,  8  months  after  the  expiration  of  the  period  within 
which  redetermination  of  amortization  allowances  could  be  made.  Although 
this  ruling  was  made  7  months  before  the  expiration  of  the  period  within 
which  redetermination  could  be  made,  there  was  not  only  no  attempt  to  rede- 
termine allowances  made  upon  the  condemned  basis,  but  this  ruling  has  not  been 
followed  in  a  single  case,  not  excepting  the  case  in  which  it  was  made.'^ 

The  reliability  of  any  valuation  of  post-war  usefulness  is  illustrated 
by  the  case  of  the  Aluminum  Co.  of  America.  The  tax  liability  of 
this  company  for  1917  was  $9,114,909;  in  1918  it  was  reduced  to 
$2,260,230.  The  chief  reason  for  the  decrease  was  the  change  down- 
ward that  had  been  effected  in  net  taxable  income,  which  appeared 
in  1917  as  $25,840,326  and  as  $10,417,814  in  1918.  The  major  part 
of  this  reduction  of  more  than  50  percent  in  taxable  income  was  not 
due  to  a  fall  in  business  but  to  the  fact  that  the  company  was  allowed 
an  amortization  deduction  of  $10,650,059,  distributed  as  follows:  ^ 

On  property  completed  in  time  for  war  production $2,  167,  565 

On  property  not  completed  in  time  for  war  production 8,  482,  494 

Total 10,650,059 

If  this  deduction  had  not  been  allowed,  the  net  taxable  income 
would  have  been  over  $21,000,000,  and  a  higher  tax  than  that  paid  for 
1917  might  well  have  resulted  because  of  the  higher  1918  rates, 

The  basis  for  the  amortization  allowance  was  the  assumption  that 
all  the  production  capacity  of  the  company  in  excess  of  82,000,000 
pounds  represented  a  loss.^  The  inaccuracy  of  this  estimate  of  value 
in  use  may  be  seen  from  the  fact  that  in  1919  the  Aluminum  Co.'s 
production  was  128,476,872  pounds,  in  1920  it  was  138,042,272  pounds 
and  from  1923  to  1931  it  varied  from  a  low  of  128,658,222  pounds  in 
1923  to  a  high  of  229,036,636  pounds  in  1930.^  Indeed,  although 
production  and  sales  have  both  fallen  oft'  since  the  beginning  of  the 
depression,  the  capacity  of  the  company  has  been  substantially 
increased  since  1929-30.*  And  yet  the  Aluminum  Co.  was  permitted 
to  deduct$10,000,000  fromincome  on  the  theory  that  the  plant  capacity 
of  a  less  productive  period,  which  had  cost  it  that  amount,  was 
not  usable  in  times  of  peace.  Furthermore,  ciuestionable  as  this 
decision  was  as  demonstrated  by  later  facts,  it  is  certain  that  as  to 
four-fifths  of  the  plant  capacity  acquired  by  the  $10,000,000  expendi- 
ture, the  Government  received  no  benefit,  since  that  part  of  the  plant 
which  was  represented  by  the  $8,000,000  amortization  allowance  was 
not  in  production  until  after  the  conclusion  of  the  war. 

The  importance  of  the  amortization  section  for  the  reduction  of 
taxes  may  be  seen  in  the  fact  that  in  168  cases  amortization  allowances 
up  to  April  30,  1925,  totaled  $425,921,945.^  Most  of  these  allowances 
were,  naturally,  to  companies  who  profited  most  heavily  by  the  war, 
i.  e.,  companies  manufacturing  primary  war  materials,  such  as  steel, 

«»  69th  Cong.,  1  St  sess.,  S.  Rept.  27,  p.  149. 

1  Exhibit  no.  1746. 

2  Exhibit  No.  1746-A. 

3  Letter  of  May  23, 1935  from  the  Aluminum  Co.  of  America,  appendix  to  that  part  of  hearings  containing 
"Exhibit  No.  1746-B."  The  company's  war-time  production  was:  1917,  129,860,592  pounds;  1918, 
124,724,924  pounds.    Ibid. 

Ubid. 

« Exhibit  1405,  reprinted  in  the  appendix  to  this  report  at  p.  159. 


34  MUNITIONS    INDUSTRY 

ships,  macliinery,  chemicals,  and  munitions,  because  their  expansion 
due  to  war  needs  was  largest.  More  than  $600,000,000  was  claimed 
by  these  companies,  who  each  got  an  allowance  of  at  least  $500,000. 
Some  of  the  larger  allowances,  in  addition  to  that  of  the  Aluminum 
Co.,  follow: 

United  States  Steel $55,  000,  000 

Bethlehem  Steel 22,  000,  000 

Du  Pont  de  Nemours 15,  000,  000 

The  impossibility  of  estimating  with  dispatch  and  with  finality  the 
items  of  depreciation,  depletion,  and  amortization  has  led  this  com- 
mittee to  recommend  that  (1)  an  arbitrary  maximum  of  2  percent  of 
gross  income,  or  of  an  adjusted  cost  of  the  property,  be  set  for  depre- 
ciation deductions,  (2)  an  arbitrary  percentage  of  gross  income  be 
used  to  fix  depletion  deductions  of  9  percent  in  the  case  of  gas  and 
oil  wells,  of  2%  percent  in  the  case  of  coal  mines,  of  5  percent  in  the 
case  of  metal  mines,  and  of  7/2  percent  in  the  case  of  sulphur  mines, 
with  an  overall  limitation  that  in  no  event  shall  the  amount  so  com- 
puted exceed  50  percent  of  net  income,  and  (3)  no  amortization  allow- 
ances be  permitted,  but  instead  governmental  loans  be  authorized 
for  such  construction  as  it  is  found  is  required  for  the  prosecution  of 
the  war  and  cannot  otherwise  be  financed.  It  is  recognized  that,  in 
the  case  of  depreciation,  the  maximum  percentage  allowance  is  likely 
to  become  the  fixed  allowance  and  that,  in  the  case  of  such  allowances 
as  well  as  of  the  fixed  depletion  allowances,  tax  avoidance  will  result 
to  the  extent  that  in  individual  cases  the  fixed  allowances  are  in  excess 
of  the  amounts  which  would  be  arrived  at  on  the  basis  of  a  reasonable 
valuation.  It  is  further  recognized  that  if  allowances  for  amortiza- 
tion are  eliminated  there  will  be  considerable  insistence  that  new 
construction  must  be  paid  for  by  outright  governmental  subsidy. 
Most  expansion  is  financed  by  borrowed  capital  and  the  mere  fact 
that  the  lender  is  the  United  States  will  not  remove  the  demand  for 
assurance  against  loss  of  the  amount  invested  in  assets  wliich  may 
prove  valueless  upon  the  conclusion  of  the  war.  Consequently,  it 
must  be  realized  that  the  reasons  causing  the  normal  demand  for 
alleviation  of  governmental  burdens  on  industry  upon  a  return  to 
peace  (see  p.  37  et  seq.,  infra,  in  relation  to  pressure  for  compromise 
or  reduction  of  back  taxes)  will  make  it  inevitable  that  strong  pressure 
will  be  exerted  for  the  reduction,  by  compromise  or  otherwise,  of  any 
Government  war-time  construction  loans  outstanding  when  the  war 
ends.  For  similar  reasons  it  is  likely  that  substantial  amounts  of 
any  such  loans  as  are  not  reduced  or  compromised  will  be  defaulted. 
Finally,  it  is  to  be  noted  that  under  either  a  subsidy  or  a  loan  plan 
the  Federal  Government  will,  following  the  termination  of  the  war, 
own  extensive  plants  and  equipment,  the  usefulness  and  value  of 
which  as  a  whole  will  be  conjectural.  To  the  extent  that  these  plants 
and  equipment  are  made  up  of  integral  parts  of  various  private  cor- 
porations, their  value  will  be  less  than  the  general  level  of  war-time 
construction.  As  to  the  plant  and  equipment  which  the  Government 
has  acquired,  the  choice  will  be  between  Government  operation  and 
sale  for  little,  if  any,  better  than  salvage  prices. 

(4)    TIME    OF    ACCRUAL    OF    INCOME 

Furthermore,  since  large-scale  modern  business  is  not  run  on  a 
cash-and-carry  basis,  the  time  wdien  income  is  earned  is  not  a  matter 


MUNITIONS    INDUSTRY  35 

of  black  and  white.  Taxes  are  collected  annually  but  profits  upon 
any  one  transaction  may  be  due  to  more  than  a  year  of  operation 
and  the  apportionment  to  the  periods  when  they  were  "earned"  is  in 
part  purely  a  matter  of  opinion.  The  fact  that  war-time  tax  rates 
are  higher  than  peace-time  rates  makes  the  determination  of  when 
profits  accrue  an  important  element  in  war-time  taxation. 

An  example  of  this  is  furnished  by  the  case  of  the  Newport  News 
Shipbuilding  &  Drydock  Co.,  which  naturally  wished  to  state  its 
profits  as  accruing  in  1922  rather  than  in  1921,  because  the  excess- 
profits  taxes  ended  on  December  31,  1921.  The  revenue  agent  in  a 
confidential  report  to  his  superior  stated  that: 

About  the  time  of  closing  the  books  each  year  many  memoranda  are  not 
actually  issued  until  January  of  the  following  year,  and  the  auditor  is  told  by 
Mr.  Ferguson  (dictated  often  by  Mr.  Gatewood)  how  to  close  certain  long-term 
contracts.  Particular  reference  is  made  to  memorandum  dated  Januar}'  11,  1922, 
pertaining  to  1921  closing,  regarding  contracts  for  hulls  261  and  262,  which  states 
"no  change  from  present  instructions."  This  memorandum  bears  initials  of 
Mr.  Gatewood.  These  are  the  contracts  where  $2,283,474.88  profits  were  not 
reported  until  1922,  although  contracts  were  fully  paid  and  work  had  ceased  for 
several  months  prior  in  1921.  Mr.  Gatewood  and  Mr.  Ferguson  should  each  be 
required  to  state  under  each  [oath(?)]  why  this  large  amount  of  income  was  not 
reported  in  1920  and  1921,  when  only  10  percent  of  expenses  was  taken  as  profits 
each  month  in  those  years.  Certainly  at  the  end  of  1920  they  knew  what  per- 
centage of  the  contract  was  completed  and  should  have  adjusted  the  profits  in 
1920  to  show  the  proper  income  for  1920  as  required  by  article  36  of  regulations 
62.  Again,  they  should  have  restated  their  profits  at  the  end  of  1921  when  the 
contract  was  actually  closed.  The  same  condition  appears  in  many  other 
contracts,  which  are  detailed  in  my  report  in  exhibit  H. 

I  do  not  wish  to  accuse  these  gentlemen  of  any  wrong  intent,  or  even  intimate 
such,  but  I  cannot  lielp  but  feel  that  such  action  was  intentional,  whatever  the 
motive.  But  I  have  refrained  from  making  any  suggestions  of  wrong-doing  in  my 
report,  but  I  hold  that  the  income  properly  belongs  in  1920  and  1921  and  a 
penalty  for  negligence  should  be  added  for  not  restating  same.* 

The  position  of  the  company  as  to  the  two  ships  mentioned  by  the 
agent  was  stated  by  the  company's  president  as  follows: 

Mr.  Ferguson.  May  I  state  in  connection  with  261  and  262,  which  were 
mentioned,  that  they  were  two  oil  ships,  the  largest  ever  built,  for  the  Standard 
Oil  Co.  of  New  Jersey.  These  vessels  were  of  new  design  and  were  miuch  larger 
than  any  ships  that  had  ever  been  built  up  to  that  time.  The  guaranty  on  those 
ships  ran  for  1  year  after  delivery. 

The  company  was  liable  for  the  ships  for  a  j-ear.  The  income-tax  people  said 
that  the  profit  should  be  taken  at  the  time  when  the  money  was  paid.  We  held 
that  on  accouiit  of  the  risk  involved  through  a  year's  guaranty  on  a  ship  of 
tremendous  size,  and  different  from  any  other  oil  ship,  that  we  or  anyone  else 
had  built  up  to  that  time,  that  we  should  be  protected  until  our  guaranty  period 
should  elapse.'' 

This  was  also  the  advice  given  by  the  company's  lawyers.^  The 
revenue  agent  felt  that  "where  both  parties  to  the  contract  are 
responsible,  as  in  the  case  of  contracts  for  hulls  261  and  262,  the 
contract  can  be  closed  and  adjustments  subsequently  made  for  any 
differences."  ^  This  view  was  reinforced  by  the  fact  that  actually 
"only  a  few  small  adjustments  for  material  were  made  in  1922."  ^° 
But  Mr.  Ferguson,  the  president,  was  anxious  to  be  able  to  report  to 
Mr.  Huntington,  the  substantial  owner  "  of  the  company: 

8  Exhibit  No.  1557. 

1  Feb.  12,  1935.  72  ZO 
*  E.\hibit  no.  1557 

9  Ibid. 

10  Ibid. 
"  Ibid. 


36  MUNITIONS    INDUSTRY 

In  going  over  our  tax  situation  in  detail,  we  find  that  our  taxes  for  last  year 
will  be  very  much  less  than  I  have  heretofore  indicated  to  you,  as  the  two  Standard 
Oil  ships  have  guaranties  which  do  not  expire  until  the  latter  part  of  this  year.  12 

As  Mr.  Ferguson  agreed  in  connection  with  a  similar  report  on  the 
situation,  he  was  simply  trying  to  put  profits,  earned  in  part  at  least 
in  high  tax  years,  into  the  lower  tax  years.^^  The  significance  of  his 
efforts  appears  from  the  figures  set  forth  in  Exhibit  No.  1615. 
The  Bureau  of  Internal  Revenue  transferred  to  the  years  1920-21 
profits  totaling  $3,149,189.73  which  the  company  had  reported  as 
earned  in  later  years.  Instead  of  a  tax  of  $393,648.72  on  these 
profits  this  would  call  for  a  tax  of  $1,448,627.27,  without  taking  into 
account  the  additional  tax  due  if  any  of  the  contracts  from  which 
the  $3,149,189.73  profits  were  derived  were  entered  into  during  the 
war.  The  profits  allocable  to  such  contracts  would  be  taxed  at  the 
war-time  rate  of  80  percent  (see  p.  50,  infra)  instead  of  at  the  normal 
1920-21  rate  of  40  percent  used  in  preparing  Exhibit  No.  1615. 

12  Letter  from  Mr.  Ferguson  to  Mr.  Huntington  of  Feb.  2,  1922,  read  into  the  record  on  Feb.  12,  1935, 
gaUey  73  ZO. 

13  Feb.  12,  1935,  73  ZO. 


IV.  Degree  of  Administrative  Discretion  Desirable  in  Tax 
Statutes  in  View  of  Post- War  Attitudes  as  to  Back  Taxes 

The  complexities  of  any  excess-profits  tax  naturally  suggest  the 
possibility  of  increasing  the  flexibility  of  the  administration  of  taxes 
to  avoid  delays  and  injustices  alike. 

The  Joint  Committee  on  Internal  Revenue  Taxation  reported  in 
1927  that— 

The  recommendation  that  tax  cases  should  be  settled  by  administrative  action, 
rather  than  through  litigation,  and  the  abandonment  of  the  policy  that  all  cases 
must  be  decided  upon  the  basis  of  absolute  accuracy,  have  been  discussed.  It  is 
believed  that  the  adoption  of  these  recommendations  is  vital." 

It  should,  however,  be  noted  that  the  liigh  tax  rates  of  wartime 
encourage  the  use  of  administrative  discretion  for  leniency  to  tax- 
payers. The  British  experience  in  this  connection  is  described  by 
Professor  Haig  as  follows: 

In  the  case  of  the  excess-profits  duty  particularly,  with  its  high  rates  and  its 
many  opportunities  for  disagreement,  it  has  been  considered  wise  to  conduct  the 
administration  along  broad  lines.  The  assessors  have  not  failed  to  utilize  their 
administrative  discretion.  As  one  of  them  remarked:  "We  wipe  off  £20,000  one 
way  or  another  as  though  it  were  a  halfpenny."  The  Board  of  Inland  Revenue 
has  specifically  said  to  the  local  surveyors  that  "owing  to  the  present  high  rates 
of  taxation"  they  desired  "that  in  doubtful  cases  the  allowances  granted  in 
calculating  excess-profits  duty  should  err  on  the  side  of  generosity  rather  than 
otherwise."  '^ 

The  results  of  the  wide  discretion  vested  in  the  administrative 
officials  by  the  special  assessment  provisions,  discussed  at  p.  45  et  seq. 
of  this  report,  resulted  in  considerable  loss  of  revenue  in  cases  that  do 
not  appear  particularly  deserving  of  leniency. 

There  is  the  further  consideration  that,  by  and  large,  controversy 
as  to  taxes  arises  in  post-war  years.  Even  though  it  be  assumed  that 
the  traditional  American  hostility  to  taxes  is  substantially  lessened 
during  wartime  for  patriotic  reasons,  this  can  affect  only  the  taxes 
paid  during  war  on  the  basis  of  the  taxpayer's  own  return.  He  does 
not  know  until  after  the  war,  in  many  cases,  that  the  Government 
believes  additional  taxes  are  due. 

Exhibit  1756,  appendix,  p.  136,  shows  that  17  of  the  largest  corpora- 
tions engaged  in  the  production  of  steel  and  aluminum  and  in  the 
mining  of  sulphur,  copper,  and  tungsten  ^^  reported  as  due  for  1917 
taxes  only  $49,927,931.  The  revenue  agents,  upon  investigation  and 
audit,  determined  that  almost  $40,000,000  more  should  have  been 
paid,  or  a  total  of  $89,882,631.  Substantially  this  same  group 
reported  taxes  of  $45,993,859  as  due  for  1918.  ^The  revenue  agents 
reported  that  the  total  should  have  been  $59,580,309. 

'^  Report  of  the  Joint  Committee  on  Internal  Revenue  Taxation  (1927),  vol.  Ill,  p.  45. 

'5  Haig,  Taxation  of  Excess  Profits  in  Great  Britain  (1920),  p.  97. 

>6  Bethlehem  Steel  Corporation,  Republic  Iron  &  Steel  Co.,  Crucible  Steel  Co.,  Lukens  Steel  Co.,  Alle- 
gheny Steel  Corporation,  Otis  Steel  Co.,  Calumet  &  Hecla  Co.,  Inspiration  Consolidated  Co.,  Kennecott 
Copper  Co.,  Phelps  Dodge  Corporation.  Ahmeek  Mining  Co.,  Union  Sulphur  Co.,  Freeport  Texas  Co., 
Atolia  Mining  Co.,  Wolf  Tongue  Mining  Co.,  Primos  Chemical  Co.,  and  Aluminum  Co.  of  America. 

37 


38  MUNITIOiSrS    INDUSTRY 

The  delay  involved  in  auditing  returns  is,  of  course,  considerable, 
but  the  above  figures  show  its  necessity  if  revenue  is  to  be  secured.^'' 
The  audit  of  the  income,  excess-profits,  and  war-profits  tax  returns  of 
the  United  States  Steel  Corporation  and  its  subsidiaries  for  1917  and 
1918  required,  approximately,  the  services  of  22  men  for  a  period  of  5 
years. ^^ 

Obviously  the  physical  work  of  auditing  returns  is  not  of  itself  the 
major  cause  of  delay  in  completing  excess-profits  tax  collection.  The 
many  doubtful  items,  such  as  invested  capital,  depreciation,  deple- 
tion, amortization,  require  consultation  and  conference  that,  of  course, 
become  protracted.  The  1917  Colt's  Patent  Firearms  Co.  taxes 
were  not  settled  until  1926  or  later. '^  The  Newport  News  Shipbuild- 
ing and  Dry  dock  Co.'s  1917  taxes  were  not  settled  until  1931.^°  The 
Republic  Iron  and  Steel  Co.'s  1918  taxes  were  finally  settled  in  1932.^^ 
The  Phelps  Dodge  1917  and  1918  taxes  were  finally  determined  in 
1929."  The  1918  taxes  of  the  New  York  Shipbuilding  Co.  required 
10  years  for  settlement .^^  If  litigation  has  to  be  resorted  to,  the 
delay  is  increased.  The  Joint  Committee  on  Internal  Revenue 
Taxation  reported  that  as  late  as  1927 — 

The  controversies  under  the  excess-profits-tax  acts  impose  by  far  the  greater 
burden  upon  the  Board  of  Tax  Appeals.  For  example,  53  percent  of  the  tax  years 
involved  m  cases  before  the  Board  are  under  the  Revenue  Acts  of  1917  and  1918. 
Thirty-three  percent  are  under  the  Revenue  Act  of  1921.  That  is,  86  percent  are 
under  the  Revenue  Acts  of  1917,  1918,  and  1921.  The  provisions  of  the  Revenue 
Act  of  1918  appear  18,472  times,  and  the  provisions  of  the  Revenue  Act  of  1921 
appear  16,042  times  in  the  cases  pending  before  the  Board. -^ 

It  is  also  largely  after  the  war  that  the  taxpayer's  demands  for 
refunds  and  credits  are  acted  upon.  As  an  example  of  this,  it  may 
be  pointed  out  that  in  the  year  1930  the  Bureau  of  Internal  Revenue 
granted  $11,488,524  refunds  of  taxes,  by  admitting  overassessments  of 
that  amount,  for  amortization.  The  only  amortization  allowances 
which  have  been  permitted  by  the  internal  revenue  laws  have  been 
for  the  construction  or  acquisition  of  facilities  on  or  after  April  6, 
1917,  for  the  production  of  articles  contributing  to  the  prosecution 
of  the  war,  and  for  the  construction  or  acquisition  of  vessels  on  or 
after  AprU  6,  1917,  for  the  transportation  of  articles  or  men  con- 
tributing to  the  prosecution  of  the  war.  This  was  14.23  percent  of 
the  overassessments  determined  in  1930  for  all  taxes.  Similarlj^,  in 
that  year  overassessments  were  determined  of  $12,263,512  for  in- 
vested capital  and  $3,596,501.44  for  special  assessments.^^  These 
provisions  appeared  only  in  the  Revenue  Acts  for  the  years  1917  to 
1921.  On  December  5,  1932,  the  chief  of  the  staff  of  the  Joint  Com- 
mittee on  Internal  Revenue  Taxation  stated  that: 


"  The  New  York  Shipbuilding  Corporation's  taxes  for  the  years  1918  to  1921,  inclusive,  furnish  a  further 
striking  example.  The  company's  return  for  1918  reported  income  of  $1,595,042  and  taxes  due  of  $684,422. 
In  1926  examination  by  revenue  agents  resulted  in  a  determination  by  these  agents  that  income  had  been 
$4,563,844  and  taxes  should  have  been  $3,210,500.  For  1919,  1920,  and  1921  the  company's  returns  showed 
$1,674,386,  $3,370,170.  and  $2,295,417  as  income  and  $535,295,  $1,288,790,  and  $433,117  as  ta.xes.  The  revenue 
agents'  corresponding  figures  were  $6,495,913.  $8,708,894,  and  .$3,707,360  for  income  and  $4,419,109,  $5,361,611, 
and  $1,569,870  for  taxes.  For  the  4  years  the  company  reported  a  total  of  $2,941,627  due  in  taxes;  the  revenue 
agents  found  $14,561,091  due.    The  final  tax  settlement  in  1928  was  for  $5,705,308.    Exhibit  No.  1421. 

18  Letter  of  Apr.  4, 1935,  of  the  Acting  Secretary  of  the  Treasury,  exhibit  1740. 

"Testimony  of  H.  D.  Fairweather,  treasurer,  pt.  9,  p.  2105. 

20  Testimony  of  Homer  L.  Ferguson,  president  (70  ZO),  and  Walter  G.  Mitchell  (80  ZO),  Feb.  12, 1935. 

21  Exhibit  1740-D. 

22  Exhibit  1721. 

23  Testimony  of  Walter  G.  Mitchell,  Jan.  21, 1935. 

2'  Report  of  the  Joint  Committee  on  Internal  Revenue  Taxation  (1927),  vol.  Ill,  p.  41. 
s'  Report  of  Joint  Committee  on  Internal  Revenue  Taxation,  Mar.  3,  1931,  p.  19. 


MUNITIOXS    INDUSTRY 


39 


The  most  important  factor  in  connection  with  overassessments  are  the  old 
excess-profits-tax  cases.  When  these  cases  are  finally  settled,  overassessments 
should  be  substantially  less.  The  following  table  shows  to  what  large  extent  these 
excess-profits-tax  cases  have  affected  the  overassessment  total: 

Percent  of  total  overassessments  represented  by  overassess7nents  for  the  excess-profits 

tax  years 

"  Percent 

14  months'  period,  Feb.  28,  1927-Apr.  24,  1928 88 

7  months'  period,  May  29,  1928-Dec.  31,  1928 77 

12  months'  period,  Jan.  1,  1929-Dec.  31,  1929 71 

12  months'  period,  Jan.  1,  1930-Dec.  31,  1930 59 

12  months'  period.  Jan.  1,  1931-Dec.  31,  1931 53 

Over  one-half  of  the  total  overassessment  still  results  from  adjustments  for  the 
years  1917  to  1921,  inclusive.  These  tax  cases  are  over  12  years  old.  Moreover, 
the  interest  attributable  to  the  excess-profits  tax  years  represents  73  percent  of 
the  total  interest  paid  on  all  overassessments  reported  to  the  committee  during 
the  calendar  year  1931.  It  is  true  that  the  table  shows  considerable  progress  in 
settling  these  old  cases,  but  it  is  evident  that  the  work  is  far  from  concluded. ^^ 

In  the  12-month  period,  January  1  to  December  31,  1932,  the 
percent  of  total  overassessments  attributable  to  the  excess-profits 
tax  years  was  54  and  in  1933  it  was  51.^'' 

The  following  table  compiled  by  this  committee's  staff  from  official 
sources  and  hmited  to  refunds  for  invested  capital,  amortization,  and 
special  assessment,  gives  some  idea  of  the  amounts  involved  in  refunds 
of  excess-profits  taxes  after  the  war: 

Refunds,  credits,  and  abatements  of  internal-reveyiue  taxes  on  grounds  listed 


Invested  capital 

Amortization 

Special  assessments 

Amount 

Percent  of 
total  re- 
funds, etc. 
for  all 
causes 
and  for 
all  taxes 
during 
periods 
listed 

Amount 

Percent  of 
total  re- 
funds, etc. 
for  all 
causes 
and  for 
all  taxes 
during 
periods 
listed 

Amount 

Percent  of 
total  re- 
funds, etc. 
for  all 
cau.ses 
and  for 
all  taxes 
during 
periof  s 
listed 

Julyl,  1921,  to  Apr.  30, 
1925' 

Apr.  30, 1925,  to  Mar.  1, 
1927 

$34, 155,  015.  29 

32,  584,  357.  74 
2,  279, 938.  56 

12,  263,  512.  08 
2,  772,  406.  99 
1, 059,  610. 16 

19.91 

$11,457,030.06 

{') 

18, 196, 096. 81 

1,  502,  326.  29 
11,488,524.70 

1, 150,  337.  37 

2,  249,  743.  59 
631,521.38 

6.66 

$39,  686,  500. 00 

26, 008,  452.  53 

2,  617,  706. 97 

3,  596,  501.  44 
2,  825,  582. 80 

193, 800. 98 
90,  718. 07 

23.13 

Mar.  1,  1927,  to  Dec. 

31,  19283-,. 

17.93 
3.52 

15.19 
9.49 
3.88 

10.01 
2.32 

14.23 
3.96 
8.23 
4.38 

14.31 

Jan.  1,  1929,  to  Dee.  31, 
1929  < 

4.04 

Jan.  1,  1930,  to  Dee.  31, 
1930  5 

4.45 

Jan  1,  1931,  to  Dec.  31, 

1931  6 

Jan.  1,  1932,  to  Dee.  31, 

1932  7 

9.67 
.71 

Jan.  1,  1933,  to  Dec.  31, 
1933  8 

.63 

Total       

85,11.5,450.82 

46,  681,  580.  20 

75, 019,  262.  79 

'  Limited  to  refunds,  etc.,  of  $250,000  and  over.  Report  of  the  Select  Committee  on  Investigation  of  the 
Bureau  of  Interna!  Revenue,  69th  Cong.,  1st  sess.,  S.  Rept.  27,  p.  194.  Dates  for  this  period  have  been  sup- 
plied by  the  staf?  of  the  Joint  Com.mittee  on  Internal  Revenue  Taxation. 

2  No  figures  available. 

3  The  figures  for  these  and  the  succeeding  years  are  limited  to  refunds,  etc.,  of  $75,000  and  over.  No 
figures  available  for  the  period  of  Apr.  24,  1928,  to  June  1,  1928.    H.  Doc.  43,  71st  Cong.,  1st  sess.,  p.  25. 

^  H.  Doc.  478,  71st  Cong.,  2d  sess.,  p.  32. 

5  n.  Doc.  223,  72d  Cong.,  1st  sess.,  p.  19. 

6  H.  Doc.  535,  72d  Cong.,  2d  sess.,  p.  19. 

7  H.  Doc.  279,  73d  Cong.,  2d  sess.,  p.  20. 

8  H.  Doc.  145,  74th  Cong.,  1st  sess.,  p.  16. 

•"  Report  of  Joint  Committee  on  Internal  Revenue  Taxation,  Dec.  5,  1932,  p.  63. 
"  Report  of  Joint  Committee  on  Internal  Revenue  Taxation,  Jan.  1,  1935,  p.  46. 


40  MUNITIONS   INDUSTRY 

It  should  be  noted  that  for  the  years  prior  to  July  1,  1921,  and  for 
the  22-month  period  from  April  30,  1925,  to  March  1,  1927,'^  and  for  the 
month  of  May  1928,  no  figures  are  available.  From  July  1,  1921,  to 
December  31,  1933  (excluding  the  23-month  period  from  April  30, 
1925,  to  March  1,  1927,  and  from  April  24,  1928,  to  June  1,  1928, 
for  which  no  figures  are  available),  a  period  of  10  years  and  7  months, 
the  total  refunds,  credits,  and  abatements  for  the  three  listed  items 
amounted  to  $206,816,293.81.  As  pointed  out  in  the  notes  to  the 
above  table  no  refund,  credit,  or  abatement  of  less  than  $75,000  has 
been  included  in  these  figures  and  for  the  period  April  1,  1921,  to 
April  30,  1925,  only  refunds,  etc.,  of  $250,000  and  over  are  included. 

Vast  sums  of  money  were  involved  in  taxes  in  the  last  war  and  in 
the  next  there  is  every  reason  to  believe  that  with  a  higher  rate  of 
tax  even  larger  sums  will  be  involved.  Without  attempting  to  in- 
crease administrative  discretion,  decisions  either  way  can  be  rationally 
sustained  with  equal  validity — which  virtually  amounts  to  saying 
that  one  man's  judgment  is  as  good  as  another's: 

IX  is  a  common  thing  for  a  million  dollars  or  more  in  taxes  to  turn  on  some 
accident  of  organization,  or  some  fine-spun  distinction  about  which  nearly  as 
much  can  be  said  upon  one  side  as  upon  the  other.-' 

The  administrative  discretion  vested  in  the  Bureau  of  Internal 
Revenue  by  any  wartime  taxation  scheme  must  be  great  inasmuch  as 
so  many  of  the  items  to  be  determined  are  matters  of  judgment.^" 
Furthermore,  the  power  of  compromising  taxes  admittedly  due 
where  collection  of  the  full  amount  would  make  the  taxpayer  insol- 
vent,^"^ ol)viously  ofi"ers  large  room  for  the  exercise  of  discretion  in  the 
determination  of  how  much  a  corporation  can  pay  and  remain 
solvent.^^ 

The  inevitability  of  the  delay  in  the  collection  of  war  taxes  and  the 
amounts  involved  create  a  post-war  political  situation  in  the  tax 
field.  It  is  obvious,  as  Mr.  Baruch  stated  in  his  testimony,  that  a 
taxpayer  would  "rather  have  somebody  friendly  than  unfriendly" 
in  the  administrative  post.^^  Upon  a  return  to  peace-time  conditions 
there  is  inevitably  the  strongest  kind  of  demand  for  leniency  in  regard 
to  disputed  war  taxes.  Business  is  seriously  handicapped  by  the 
colossal  readjustments  required  by  the  transition  to  peace-time 
production.  Public  opinion  is  not  vitally  interested  in  the  technical 
questions  involved  in  tax  liability  to  pay  for  a  war  which  has  passed. 
Alleviation  of  the  tax  burden  can  become  an  important,  if  a  seldom 
expressed,  political  slogan.  Professor  Adams  has  described  the 
situation  as  follows: 


■i  Some  idea  of  the  refunds  that  must  have  been  made  during  this  22-month  period  for  the  listed  causes 
can  be  obtained  from  a  comparison  with  the  $76,000,000  refunded  during  the  following  22-month  period 
of  Mar.  1,  1927.  to  Dec.  31.  1928. 

28  Needed  Tax  Reform  in  the  United  States,  T.  S.  Adams,  2d  ed.  1920,  p.  9. 

3c  Furthermore,  an  effect  of  delay,  and  the  taxpayer  can  in  many  cases  bring  about  delay  regardless  of  the 
flexibility  of  administration  granted,  is  to  encourage  the  administrative  officials  to  close  cases  as  quickly  as 
possible,  with  at  times  a  minimum  of  care,  in  order  to  keep  up  with  current  work,  Although  it  took  10 
years  to  settle  the  1918  taxes  of  the  New  York  Shipbuilding  Co.  (testimony  of  Walter  G.  Mitchell,  Jan.  21, 
193.5) ,  the  only  audit  of  the  company's  gross  sales  of  $470,000,000  for  1922  to  1925  was  an  office  audit  requiring 
haltanhour.  Exhibit  no.  1425.  The  easiest  way  to  close  thecaseof  a  taxpayer  who  uses  dilatory  tactics  or 
who  closely  contests  each  point  is  to  agree  with  his  contentions.  There  is  an  undoubted  incentive  for  ad- 
ministrative discretion  to  be  used  in  such  a  wp.y  as  to  lighten  administrative  burdens,  i.  e.,  in  favor  of  the 
taxpayer. 

31  Rev.  Stat.  3229.  This  has  been  narrowly  construed  by  the  Attorney  General.  16  Opin.  Atty.  Gen. 
249.  The  Bureau  of  Internal  Revenue  has  in  practice  restricted  the  use  of  this  section  in  the  manner  stated 
in  the  text,  69th  Cong.,  1st  sess.,  S.  Rept.  27,  pp.  184-185. 

32  See  the  criticisms  of  various  compromises  by  the  Bureau  contained  in  69th  Cong.,  1st  sess.,  S.  Rept. 
27,  pp.  184-193.    See  also  p.  42  infra,  for  two  examples  of  compromise. 

33  Bernard  M.  Baruch,  Mar.  28,  1935. 


MUNITIONS    INDUSTRY  41 

The  real  evil  is  found  in  the  resulting  uncertainty,  the  accumulation  in  the 
Treasun-  of  claims  for  back  taxes  and  penalties  aggregating  billions  of  dollars, 
the  dread  with  which  these  claims  must  inspire  the  business  world,  the  invitation 
which  this  situation  offers  to  political  jobbery  and  the  wrongful  mixture  of  big 
business  in  tax  politics.^^ 

The  necessarily  mde  latitude  for  administrative  judgment  will  be 
subjected  to  the  most  compelling  of  influences.  A  striking  example  of 
this  can  be  found  in  the  experiences  of  the  period  following  the  last 
war.  On  December  16,  1922,  Mr.  Andrew  W.  Mellon,  then  Secre- 
tary of  the  Treasury,  wrote  to  C.  F.  Kelley,  president  of  the  Anaconda 
Copper  Mining  Co.,  about  a  proposed  revaluation  of  copper  mines  for 
taxation  purposes: 

After  full  consideration  of  this  question  I  am  convinced  that  the  values  here- 
tofore placed  upon  the  copper  mines  for  purposes  of  determining  invested  capital 
and  of  computing  the  deduction  for  depletion  are  excessive;  the  depletion  rate 
previously  allowed,  based  upon  these  values,  is  so  high  as  to  practically  wipe  out 
the  operating  income  of  many  of  the  copper  companies  in  ordinary  years.  The 
data  show  that  due  to  the  excessive  values  placed  upon  the  ore  bodies  of  the 
copper  companies  for  invested  capital  and  depletion  purposes,  the  copper  industry 
for  1917  and  subsequent  years  has  not  paid  a  fair  and  equitable  tax.  On  the 
other  hand,  however,  these  valuations  of  the  copper  mines  were  made  by  the 
Bureau  of  Internal  Revenue,  and  in  many  cases  the  copper  companies  contend 
that  they  were  given  to  understand  that  the  values  fixed  on  their  properties 
by  the  Bureau  were  final  values.  Consequently  the  operations  of  the  com- 
panies since  the  determination  of  these  values  by  the  Bureau  were  based  upon  the 
consideration  of  the  tax  liability  for  prior  years  have  [having?]  been  settled. 
Furthermore,  representations  have  been  made  that  a  readjustment  of  taxes  of  the 
copper  companies  for  prior  years  upon  the  basis  of  the  revaluation  now  recom- 
mended by  the  Income  Tax  Unit  would  impose  a  tremendous  hardship,  and,  in 
some  cases,  would  result  in  insolvency.  After  full  consideration  of  the  question  it 
is  believed  that  the  matter  should  be  settled  upon  a  compromise  basis.  In  accord- 
ance with  this  view  the  valuation  of  the  copper  mines  for  invested  capital  and 
depletion  purposes  for  the  j-ears  1917  and  1918  will  be  allowed  to  stand  upon  the 
basis  heretofore  fixed  by  the  Department,  but  for  1919  and  subsequent  3-ears  the 
valuation  will  be  corrected  to  conform  to  what  the  Department  regards  as  a  more 
proper  method  of  valuing  the  copper  mines. ^s 

As  was  too  frequently  the  case,  the  ''compromise"  meant  a  waiver 
by  the  Government  of  its  claim — in  this  instance  for  additional  taxes 
during  the  war  years.  The  only  quid  pro  quo  furnished  by  the  tax- 
payers that  could  have  been  received  by  the  Government  in  exchange, 
is  the  possibility — not  referred  to  by  Mr.  Mellon — of  an  agreement 
that  the  taxpayers  would  not  exercise  their  inalienable  right  to  delay 
settlement  as  to  subsequent  years  for  which  the  wartime  tax  rates 
had  been  lowered. 

Wartime  taxes  when  computed  in  peacetime  seem  unduly  high. 
This  also  helps  to  encourage  administrative  leniency.  Mr.  Parker, 
the  chief  engineer  for  the  Select  Committee  of  the  Senate  on  Investi- 
gation of  the  Bureau  of  Internal  Revenue,  who  later  became  the  chief 
of  staff  of  the  Joint  Committee  on  Internal  Revenue,  referred  to  this 
at  the  end  of  his  report  on  the  administration  of  the  special  assess- 
ment provisions: 

In  closing  our  report  on  this  subject,  we  wish  to  make  clear  that  the  time 
available  for  the  investigation  of  this  feature  of  the  revenue  act  was  not  sufficient 
for  as  thorough  and  complete  a  study  as  the  importance  of  the  subject  demands. 
We  hope  we  have  brought  out  that  the  special  assessment  section  of  the  bureau 
has  it  within  their  power  to  hantl  back  millions  in  taxes  bv  the  stroke  of  a  pen. 
If  a  company  makes  $38,000,000  and  has  to  pay  a  tax  of  $19,000,000,  the  tax 
looks  high  so  the  Bureau  finds  a  way  to  hand  the  ta.xpayer  back  $5,000,000.     It  is 

^  Adams,  Needed  Tax  Reform  in  the  United  States,  2d  ed.  (1920),  p.  9. 
^  Exhibit  no.  1713. 


42  MUNITIONS    INDUSTRY 

a  big  tax,  but  surely  Congress  would  not  have  set  up  an  80  percent  bracket  in  1918 
if  it  did  not  expect  anybody  to  be  taxed  at  this  rate. 

The  Bureau  appears  to  have  forgotten  that  there  was  a  World  War  in  1918; 
that  our  boys  were  giving  their  lives  for  their  country  in  foreign  lands;  and  that 
the  industries  of  the  country  were  also  supposed  to  do  their  part  by  contributing 
the  larger  portion  of  their  profits.  Surely,  lives  are  as  important  as  dollars,  and 
too  much  sympathy  should  not  be  given  to  large  companies  whose  very  profits 
depended  in  a  large  measure  to  [on?]  the  extraordinary  deinands  for  production  in 
nearly  all  lines.  The  Bureau  has  also  forgotten  that  inasmuch  as  taxes  are 
necessary  in  a  fixed  amount  to  meet  the  expenses  and  obligations  of  the  Govern- 
ment, then  every  dollar  improperly  refunded  to  a  taxpayer,  means  another  dollar 
taken  away  from  the  present  taxpaying  public.  The  allowances  under  the  excuse 
of  special  assessment  look  very  much  like  grand  larceny  from  our  present  day 
taxpayers. ^^ 

The  power  of  compromising  taxes,  referred  to  above  at  page  40, 
puts  a  great  burden  upon  the  administrative  officials.  No  adminis- 
trative official  likes  to  assume  the  responsibility  of  putting  a  company 
out  of  business.  The  sudden  change  in  industrial  conditions  due  to 
the  cessation  of  war  activities  meant  that  many  companies  that  had 
made  and  distributed  large  profits  during  the  war  contended  that 
they  could  not  pay  additional  taxes,  assessed  after  the  war  following 
audit  and  investigation,  upon  those  profits.  It  is  difficult  for  an  ad- 
ministrative official,  unfamiliar  with  the  details  of  a  given  business, 
to  pit  liis  judgment  against  the  judgment  of  those  in  charge  of  the 
business.  The  Atolia  Mining  Co.,  one  of  the  largest  producers  of 
tungsten  in  the  world,"  had  a  very  profitable  liistory  during  the  war 
because  of  the  great  need  for  tliis  alloy  in  the  manufactm'e  of  high- 
speed cutting  tools  used  in  the  manufacture  of  armaments.^*  Divi- 
dends of  $4,715,100  were  distributed  in  1916  to  1918,^^  inclusive,  to 
stockholders  whose  original  investment  was  only  $63,000.^°  At  the 
conclusion  of  the  war  the  demand  ceased  and  with  it  the  market  fell. 
Because  of  the  difficulty  in  valuing  the  properties  the  Government 
was  unable  to  complete  its  check  of  the  Atolia  tax  returns  until  after 
the  war,  when  an  additional  assessment  of  $345,000  was  made.*^ 
The  company,  in  which  Mr.  Bernard  M.  Baruch  held  a  26-percent 
interest,*^  alleged  inability  to  pay  more  than  $165,000  in  view  of  the 
adverse  business  conditions,  and  asserted  that  all  its  liquid  assets 
amounted  to  only  $100,000,'*^  although  in  its  sworn  income-tax  return 
for  that  same  vear  (1923)  the  company  valued  its  ores  alone  at 
$5,000,000.*'  A  compromise  settlement  of  $200,000 '^  was  finally 
effected,  a  loss  of  $145,000  to  the  Treasury,  or  more  than  one-third 
of  the  additional  assessment. 

The  1918  taxes  of  the  New  York  Shipbuilding  Co.  were  settled  in 
1928  by  a  compromise  based  upon  the  company's  contention  that 
it  would  be  forced  into  liquidation  if  a  full  tax  were  collected.*®     The 

36  69th  Cong.,  1st  sess.,  S.  Kept.  27,  pt.  2  ,p.  267. 

3'  Testimony  of  Bernard  M.  Baruch,  Mar.  29,  1935,  95  BBQ. 

3^  American  Industry  in  the  War,  report  of  the  War  Industries  Board,  by  Bernard  M.  Baruch,  chairman 
(1921),  p.  144. 

39  Exhibit  no.  1744  E. 

«  Exhibits  nos.  1741;  1748  A. 

"  This  amount  included  taxes  for  the  period  1906  to  1919,  but  substantially  all  of  it  was  for  the  war  years. 
Exhibit  1748.  Even  this  was  a  reduction  of  the  maximum  amount  of  tax  found  to  be  due.  Originally  the 
company  was  assessed  additional  taxes  of  .$600,000.  Exhibits  1744  and  1744  A.  Apparently  by  virtue  of 
the  special  assessment  provisions  of  the  wartime  tax  laws  (see  p.  —  of  this  report)  this  was  reduced  to 
$345,000.     Exhibits  1741,  1744  D,  1743. 

^-'  Testimony  of  Bernard  M.  Baruch,  Mar.  29,  1935,  95  BBQ. 

43  Exhibit  1743. 

«  Ext.i')!t  1748  B. 

«  Exhibit  1743  A. 

43  Exhibits  1420,  1421;  testimony  of  Walter  G.  Mitchell,  Jan.  21,  1935,  28GP. 


MUNITIONS    INDUSTRY  43 

company  estimated  it  had  a  liquidating  value  of  $3,000,000  and  an 
appraisal  value  of  $4,250,000/^  although  in  its  report  to  its  stock- 
holders it  stated  the  value  of  a  comparable  part  of  its  assets  as 
$11,000,000.^^  . 

Any  increase  in  discretionary  power  to  administrative  officials  niay 
mean  a  loss  in  revenue  greater  than  the  savings  in  administrative 
expense  resulting  from  the  administrative  flexibility. 

«  Exhibit  1430;  testimony  of  N.  R.  Parker,  Jan.  22,  1935,  43QP. 
«8  Testimony  of  N.  R.  Parker,  Jan.  22, 1935,  43QP. 


V.  Tax  Evasion  and  Avoidance 

Any  analysis  of  the  problems  involved  in  war-time  taxation  of  the 
kind  contemplated  by  this  report  must  take  accomit  of  the  question 
of  tax  avoidance*^  and  of  outright  evasion. 

It  will  be  remembered  that  the  Senate  Committee  on  Banking  and 
Currency  uncovered  the  fact  that  for  the  year  1930,  17  of  the  partners 
of  J.  P.  Morgan  &  Co.,  including  Mr.  J.  P.  Morgan,  paid  no  taxes, 
and  5  paid  taxes  aggregating  $56,000,  and  that  for  the  years  1931  and 
1932,  no  partner  paid  any  tax.^'' 

It  is  important  to  distinguish  tax  avoidance  from  tax  evasion  since 
the  two  are  frec^uently  confused  in  the  popular  mind.  One  reason 
for  this  confusion  is  the  substantial  similarity  of  the  motives  for  em- 
ploying the  devices.  Whether  the  action  is  legal  or  illegal,  the  pur- 
pose is  to  reduce  or  to  eliminate  the  amount  payable  as  a  tax.  Be- 
cause the  end  result  is  the  same,  there  is  a  popular  feeling  that  any 
action  intended  to  accomplish  tliis  must  of  necessity  be  illegal. 

This  confusion,  of  coui'se,  ignores  the  whole  Anglo-American  con- 
cept of  the  function  of  law  as  furnisliing  a  definite  and  predictable 
set  of  rules.     Mr.  Justice  Holmes  said: 

We  do  not  speak  of  evasion  because  when  the  law  draws  a  line,  a  case  is  on  one 
side  of  it  or  the  other,  and  if  on  the  safe  side  is  none  the  worse  legally  that  a  party  has 
availed  himself  to  the  full  of  ivhat  the  law  ipermiis.  When  an  act  is  condemned  as  an 
evasion,  what  is  meant  is  that  it  is  on  the  wrong  side  of  the  line  indicated  by  the 
policy  if  not  the  mere  letter  of  the  law.  ^^     (Italics  added.) 

By  definition  a  transaction  which  has  for  its  purpose  the  reduction 
of  taxes  is  not  illegal  if  the  means  employed  are  in  themselves  part  of 
the  applicable  rules.  (See  U.  S.  v.  Isham  (17  Wall.  476,  84  U.  S. 
496);  Weeks  v.  Libby  (269  Fed.  155);  Fidelity  Trust  Co.  v.  Lederer, 
(276  Fed.  51).) 

The  legal  concept  merely  reflects  the  general  attitude  that  taxes 
are  a  necessary  evil  to  be  minimized  as  far  as  possible: 

As  a  group,  men  are  patriotic;  as  individuals,  they  will  pay  as  small  a  tax  as  can 
be  calculated  and  will  secure  as  high  prices  and  extract  as  great  profits  as  can  be 
extracted.  *- 

The  methods  of  avoidance  depend  upon  the  rules  specified  by  the 
tax  statutes.  However,  it  should  be  noted  that  provisions  ostensibly 
intended  for  one  purpose  are  often  logically  apphcable  for  other 
purposes.  Provisions  apparently  designed  to  prevent  burdens 
generally  conceded  to  be  undue  as  applied  to  certain  taxpayers,  are 

*5  Tax  avoidance  is,  of  couise,  not  purely  a  -war-time  phencn  ecf  n.  It  is,  bcwever,  so  much  a  part  of  the 
traditional  American  altiti  de  uward  Governff  ent  that  it  is  to  be  dcubted  whether  settled  forms  of  avoid- 
ance thct  have  grown  up  in  tin,es  of  peace  will  disappef.r  under  the  stimulus  of  war-limjc  patriotism.  Ac- 
cordingly, in  the  examples  of  tax  avoidance  discussed  in  this  part  of  the  report,  hoth  war-time  and  peace- 
time illustrations  have  been  induced.  The  instances  of  avoicar.ce  ret  forth  in  this  report  are  meant  to  be 
illustrative  of  a  general  tendency  and  not  a  full  list  of  loopholes  w  hich  if  stopped  up  w  c  uld  eliminate  avoid- 
ance of  taxes.  As  indicated  in  the  text,  seme  avoidance  is  inevitable  because  of  the  con;bination  of  (I) 
avoiding  undue  hardship  on  certain  classes  of  taxpayers  and  (2)  uniformity  of  taxation,  as  goals  of  A  merican 
tax  measures.  Furthermore,  the  ingenuity  of  accountants  and  law  yers  tends  to  make  any  list  of  n  eans  of 
avoidance  incon.plete  nlmost  as  soon  as  it  is  drafted. 

5"  Report  on  Stock  Exchance  Practices,  V2d  Cong.,  2d  sess.,  S.  Eept.  14f  S,  p.  321. 

51  BnUen  v.  Wiscovsiii  (240  U.  S.  025.) 

"  Garrett,  Government  Control  Over  Prices  (1920)  p.  3S1. 

44 


MUNITIONS    INDUSTRY  45 

often  also  equally  available  for  the  avoidance  of  large  amounts  of  taxes 
the  burden  of  which  appears  less  obviously  unfair.  It  is  the  frequent 
use  of  such  provisions  for  the  avoidance  of  large  sums  of  apparently 
fair  taxes  which  is  probably  the  real  basis  for  the  popular  confusion  be- 
tween evasion  and  avoidance.  Although  the  legal  distinction  be- 
tween the  two  is  no  less  clear  whether  the  scope  of  the  exemption  is 
generally  approved  or  not,  the  social  distinction  between  evasion  and 
avoidance  is  in  many  cases  not  so  clear.  However  the  individual 
taxpayer  can  usually  formulate  a  justification  for  using  what  the  popu- 
lar mind  regards  as  "loopholes"  in  the  tax  laws: 

There  has  been  a  hue  and  cry  against  so-called  "tax  evaders."  Many  speeches 
were  made  in  the  last  Congress  which  should  be  characterized  as  dishonest,  but 
I  will  merelj'  call  them  the  "unintelligent  mutterings  of  the  ignorant  and  uni- 
formed." [sic]  Many  charges  were  made  that  certain  rich  men — names  of  10 
being  used — had  been  guilty  of  evading  income  taxes.  I  will  assume  that  most 
of  those  who  made  the  charges  are  too  ignorant  to  know  the  difference  between 
tax  avoidance — which  is  legal — and  tax  evasion,  which  is  illegal.     *     *     * 

Avoidance  does  not  even  involve  moral  turpitude.  When  tax  rates  are  oppres- 
sive and  unscientific,  the  instinct  of  self-preservation  asserts  itself  strongly.  When 
there  is  no  concealment  of  facts,  there  can  be  no  "willful"  evasion.  There  is  not 
even  negligence.  The  law  purports  to  define  in  meticulous  detail  what  sort  of 
transactions  are  taxable.  If  taxpayers  can  think  of  a  way  of  doing  something, 
which  way  is  not  forbidden  in  the  law,  there  is  no  fraud,  nor  attempted  evasion. 
The  courts  uniformh'  protect  taxpayers  who  merely  select  methods  of  transacting 
business  which  involve  the  least  or  no  liability  for  tax.  The  position  of  taxpayers 
under  a  highly  intricate  tax  law  is  not  that  of  an  independent,  impartial  judge 
trying  to  be  fair,  no  matter  who  is  hurt.  No  possible  criticism  can  l)e  directed 
at  taxpayers  who  follow  the  law  as  it  is,  rather  than  as  it  would  be,  if  Congress 
had  said  something  else.''^ 

The  literal  applicability  of  exemption  provisions  not  only  to  cases 
of  exceptional  hardship  but  to  cases  in  which  the  justness  of  the  tax 
is  practically  beyond  dispute,  makes  the  traditional  resistance  of  the 
taxpayer  to  the  tax  collector  present  a  dilemma  to  those  drafting  tax 
laws  designed  not  only  to  raise  revenue  but  to  equalize  the  burdens 
of  war.  On  the  one  hand  it  is  important  that  the  tax  statutes  be  not 
so  inflexible  or  so  harsh  as  to  penalize  particular  groups  in  a  way  that 
would  arouse  widespread  public  disapproval  of  the  entire  taxation 
scheme;  on  the  other  hand  e:  emptions  made  in  situations  universally 
admitted  to  justify  a  relaxation  of  the  severity  of  the  tax  are  certain  to 
be  "availed  *  *  *  to  the  full  of  what  the  law  permits "  by  those 
whose  claims  to  mitigation  of  tax  burdens  are  less  obviously  valid. 

(1)    SPECIAL    ASSESSMENTS 

A  signal  example  of  this  is  to  be  found  in  the  "special  assessments" 
of  excess-profits  taxes  during  the  World  War.  The  co.mplexity  of  the 
problem  encountered  in  deter.mining  invested  capital  was  recognized 
by  Congress  in  the  1917  Revenue  Act  as  likely  to  result  in  cases  in 
which  it  would  actually  be  impossible  to  carry  out  the  statutory 
mandate.^*  In  the  1918  act,  which  bore  greatly  increased  rates,  the 
exception  was  extended  also  to  cases  in  which  the  Commissioner  of 
Internal  Revenue  found  that- — 

53  Robert  A.  Montgomery,  Federal  Tax  Handbook  l'J.34-35,  p.  iv. 

54  Sec.  :;10,  Revenue  Act  of  1917.  Mr.  Montgon.ery  states  that,  despite  the  express  lin  itation  of  this 
provision  to  cases  where  the  Secretary  of  the  Treasury  was  "unable  *  *  *  satisfactorily  to  deterniice 
the  invested  capital,"  in  practice  "tl.ioLgh  the  exeicise  of  administrative  discretion  to  an  extent  which 
csn  be  justified  only  when  oce  ccnslocjs  the  seiioi  sness  of  the  issi  es  involved,  this  S€cti(  n  was  applied 
when  invested  capital,  even  though  dffnitely  kncwr,  was  'serious  y  disprororticnatt'  to  tie  taxable 
income."    Montgomery,  Excess  Profits  Tax  Procedure  1921,  p.  7. 

11579 — 35 4 


46  MUNITIONS    INDUSTRY 

the  tax  if  determined  without  benefit  of  this  section  would,  owing  to  abnormal 
conditions  affecting  the  capital  or  income  of  the  corporation,  work  upon  the  cor- 
poration an  exceptional  hardship  evidenced  by  gross  disproportion  between  the  tax 
computed  without  benefit  of  this  section  and  the  tax  computed  by  reference  to 
the  representative  corporations  specified  in  paragraph  328.'^ 

The  "special  assessment"  so  made  available  subjected  the  taxpayer 
to  a  tax  of  the  same  proportionate  size  as  the  average  tax  paid  by  a 
group  of  "representative  corporations  [partnerships  and  individuals] 
engaged  in  a  like  or  similar  trade  or  business."  ^^ 

The  1918  act  apparently  attempted  to  safeguard  this  provision 
against  use  as  a  means  of  easy  avoidance  of  taxes  by  specifying  that 
it  was  not  to  apply  to  cases  in  which  the  tax  computed  normally — 

is  high  merely  because  the  corporation  earned  within  the  taxable  year  a  high 
rate  of  profit  upon  a  normal  invested  capital. ^^ 

The  vagueness  of  such  a  standard  as  the  special-assessment  pro- 
visions and  the  consequent  opportunity  for  disagreement  and  delay 
are  apparent.  Mr.  Ballantine  testified  before  the  War  Policies  Com- 
mission that: 

This  special-assessment  provision,  while  perhaps  necessary,  was  found  to  be 
uncertain  and  vague  in  its  application  and  was  one  of  the  most  troublesome 
features  of  the  excess-profits  tax.^^ 

Instances  of  the  effects  of  this  provision  in  operation  show  that  the 
R.  J.  Reynolds  Tobacco  Co.,  which  was  in  the  highest  income  brackets, 
was — 

allowed  abatements  and  credits  amounting  to  $1,698,265  for  the  year  1918. 
Their  statutory  tax  would  have  amounted  to  $10,226,521;  this  has  been  reduced 
under  section  328  to  $8,528,266.  The  percentage  of  final  profits  tax  to  net- 
income  amounts  to  40  percent.^^ 

The  American  Car  &  Foundry  Co.  was — 

refunded  and  abated  under  section  328  of  the  act  of  1918  the  amount  of  $5,209,204 
on  account  of  its  1918  tax.  The  net  income  of  this  taxpaj^er  was  $37,443,246,  the 
final  profits  tax  under  special  assessment  was  $17,244,552,  the  final  percentage  of 
profits  tax  to  net  income  amount  to  46  percent. 

We  would  call  attention  to  the  fact  that  the  United  States  Steel  Corporation, 
an  allied  industry,  was  in  the  80  percent  bracket  in  1918  and  was  assessed  a  total 
tax  amounting  to  about  57  percent  of  their  net  income.^^ 

Similar  illustrations  concerning  the  Youngs  town  Sheet  &  Tube  Co., 
the  Northwest  Steel  Co.,  and  the  Pittsburgh  Steel  Products  Co.  indi- 
cate to  what  extent  some  of  the  big  corporations  took  advantage  of 

55  Sec.  327,  Revenue  Act  of  1918. 

5«  Revenue  Act  of  1917,  sec.  210;  Revenue  Act  of  1918,  sec.  328.  The  language  quoted  in  the  text  was 
identical  in  the  two  acts  except  that  only  tlie  1917  act  contained  the  reference  to  partnerships  and  indi- 
viduals, since  the  excess-profits  tax  of  the  1918  act  applied  only  to  corporations.  The  manner  of  determining 
the  special  assessment  was  slightly  different  in  the  two  acts:  In  the  1917  act  the  deduction  from  income  for 
which  invested  capital  was  supposed  normally  to  be  used,  was  determined  by  applying  to  the  taxpayer's 
income  a  percentage  equal  to  the  ratio  between  the  average  deduction  and  the  average  income  of  the  rep- 
resentative concerns.  In  the  1918  act  the  tax  itself  was  determined  by  applying  to  the  taxpayer's  income 
a  percentage  equal  to  the  ratio  between  the  average  tax  and  the  average  income  of  the  representative 
corporations. 

5'  Sec.  328,  Revenue  Act  of  1918.  Cf.  Mr.  Montgomery's  statement  in  footnote  51,  supra,  that  even  the 
1917  provision  was  used  where  invested  capital  was  seriously  disproportionate  to  taxable  income. 

5s  House  Document  163,  72d  Cong.,  1st  sess.,  p.  693. 

"  Senate  Report  27,  69th  Cong.,  1st  sess.,  p.  222. 


MUNITIONS    INDUSTRY 


47 


the  special-assessment  procedure  in  effect  to  reduce  the  excess-profits 
tax  rate  to  a  much  lower  one  than  that  the  statute  provided  for.^" 


Name 

Amount  of 
regular  tax 

Amount  of 
refund  due 
to  special 
assessment 

Youngstown  Sheet  &  Tube  Co.,  Youngstown,  Ohio           . 

.$19,  469,  794 
1,  380, 692 
4, 698, 161 

$3  482  610 

Northwest  Steel  Co.,  Portland,  Greg    .. - 

923, 236 

Pittsburgh  Steel  Products  Co.,  Pittsburgh,  Pa.. 

1,830,227 

A  list  of  refunds  in  excess  of  $250,000  allowed  from  July  1,  1921,  to 
December  31,  1925,  due  to  the  special  assessment  provisions,  is  re- 
printed at  page  164  of  the  appendix  to  this  report  and  total  refunds 
under  these  provisions  during  other  periods  of  time  appear  at  p.  39, 
supra.  The  amount  of  tax  which  was  never  assessed  because  of 
allowances  under  these  provisions  cannot  be  estimated  although  the 
committee's  record  contains  examples,  developed  in  the  course  of 
examining  the  tax  records  of  isolated  companies,  which  indicate  the 
extent  of  the  practice." 

(2)    DEDUCTION    OF    CAPITAL    LOSSES 

The  customary  provision  in  American  income-tax  statutes  per- 
mitting deduction  of  capital  losses  from  taxable  income  has  frequently 
been  used  to  avoid  taxes  which  the  generality  of  public  opinion  may 
well  believe  could  have  been  paid  without  undue  hardship. 

In  the  course  of  tliis  committee's  investigation,  it  has  been  found 
that  the  late  iUfred  I.  du  Pont  paid  no  income  tax  during  the  7  years 
1920  to  1926.  His  gross  income  in  that  period  was  over  $29,000,000. 
The  following  explanation  of  these  transactions,  showing  the  part 
which  deductions  of  capital  losses  played  in  reducing  Mr.  du  Font's 
tax  liability,  was  furnished  to  this  committee  by  the  Treasury 
Department: 


Taxable  years 

1 

Income  tax 
paid 

2 

Refunds 
allowed 

3 

Gross  in- 
come 

4 

Losses  on  security  trans- 
actions 

Nemours 
trading 

other 

1920  . 

None 

None 

None 

None 

None 

None 

None 

$7,  800.  76 

115,791.78 

108,  584. 16 

100, 134.  68 

None 
None 
None 
None 
None 
None 
None 
None 
None 
None 
None 

.$6, 199,  639. 98 
1,031,713.46 

5. 946,  324.  82 
5.  047,  012.  94 
1,  837,  886.  48 

3. 947,  641.  39 
5,  575,  954.  57 
1,  022, 990. 92 
1,  054, 482.  38 
1,  300, 423.  51 

713.814.55 

$2, 499, 900. 00 

1,  249,  875.  00 

1,  000,  599.  00 

999,  900.  00 

None 

None 

26,950.00 

None 

None 

None 

None 

$152,  823.  65 
31  703  74 

1921 

1922 

4,  918,  771  43 

1923 

1  777  681  50 

1924 

804  115  72 

1925 

828  l''!  75 

1926. 

335, 969. 32 
4  252  50 

1927 

1928 

'  59,  246. 90 
15  229  35 

1929 

1930 

11  364  ''8 

'  Indicates  profit  rather  than  loss. 


60  Ibid,  pp.  222-223. 

61  See  the  case  of  the  Newport  News  Shipbuilding  &  Drydock  Co.,  whose  1917  taxes  are  referred  to  at 
pp.  21-22;  the  Atolia  Mining  Co.,  whose  war-time  taxes  are  discussed  at  p.  42,  had  taxes  reduced  from  -$600,000 
to  .$.345,000,  apparently  primarily  through  this  provision;  the  United  Verde  Extension  Mining  Co.'s  taxes 
for  1917  were  estimated  at  $o,.548,823  by  the  revenue  agent  and  at  $5,739,100  by  the  engineers  of  the  Senate 
Committee  on  Investigation  of  iJureau  of  Internal  Revenue,  but  by  virtue  of  the  special  assessment  pro- 
vision only  $2,845,070  was  assessed  against  the  company.  Exhibit  1715  .\;  69th  Cong.,  1st  ses^s.,  S.  Rept. 
27,  fit.  2,  p.  258.  See  general  report  on  special  assessment  made  to  Senate  Committee  on  Investigation  of 
Bureau  of  Internal  Revenue,  69th  Cong.,  1st  sess.,  S.  Rept.  27,  pt.  2,  pp.  247-267,  the  conclusions  of  which 
are  quoted  at  pp.  41-12  of  this  report. 


48 


MUNITIONS    INDUSTRY 


The  amounts  shown  in  the  first  column  under  item  4,  "Nemours  Trading",  are 
losses  claimed  on  sale  or  other  disposition  of  stock  of  Nemours  Trading  Corpor- 
ation.^'^ In  addition  to  these  items,  the  taxpayer  claimed  deductions  for  worth- 
lessness  of  debts  due  from  Nemours  Trading  Corporation  in  the  sums  of  $499,- 
993.70  for  the  year  1924,  $809,704.95  for  the  vear  1925  and  $1,670,749.92  for  the 
year  1926. 

******* 

The  amounts  shown  in  the  second  column  under  item  4  above  as  losses  on 
"Other"  security  transactions  cover  all  losses  on  all  securities  such  as  stocks, 
bonds,  and  mortgages  except  the  losses  incurred  in  connection  with  Nemours 
Trading  Corporation.  Although  your  letter  refers  only  to  losses  on  stock  trans- 
actions, it  is  impossible  from  the  inforination  at  hand  to  distinguish  between  the 
losses  on  stock  transactions  and  losses  on  bond  transactions  for  all  years  and  for 
this  reason  the  amounts  stated  above  under  the  second  column  of  item  4  cover 
all  other  security  transactions  rather  than  all  other  stock  transactions. 

The  figures  stated  under  item  3,  "Gross  income",  above,  should  not  be  confused 
with  amounts  shown  in  individual  income-tax  returns  as  "Total  income",  as 
for  example,  the  amount  shown  on  line  12  of  form  1040,  individual  income-tax 
ret^urn  for  the  calendar  year  1930,  which  is,  in  effect,  net  income  with  the  exception 
of  deductions  to  be  taken  on  lines  13  to  18,  inclusive,  for  interest;  taxes;  losses 
byjf^re,  storm,  etc.;  bad  debts;  contributions  and  "Other  deductions  authorized 
by  law"  (and  not  claimed  elsewhere  in  the  return).  The  figures  stated  under 
the  gross  income  column  above  have  been  compiled  from  the  various  items  of 
gross  income  for  each  year  without  diminution  for  such  items  as  cost  of  securities 
sold,  depreciation  and  other  expenses  of  rented  properties  and  other  items  which 
are  applied  against  gross  income  items  in  the  income-tax  returns  in  computing 
the  "Total  income"  figure  as  contrasted  with  the  "Net  income"  figure.  This 
explanation  of  the  gross  income  figures  stated  above  is  given  somewhat  in  detail 
in  order  that  it  may  be  clearly  understood  that  cost  of  securities  sold  has  not  been 
deducted  in  computing  these  figures,  which  accounts  for  the  fact  that,  while 
large  gross  income  figures  are  reflected  for  several  years,  no  income  taxes  were 
assessed  or  paid  for  those  years  as  the  cost  of  securities  sold,  bad  debts,  and  other 
deductions  allowable  under  the  various  revenue  acts  exceeded  the  gross  income. 

It  is  shown  under  item  2,  above,  that  no  refunds  have  been  allowed.  It  is 
to  be  understood  that  this  refers  to  refund  of  taxes  paid  with  respect  to  the  taxable 
years  1920  to  1930,  both  inclusive,  and  that  it  has  no  reference  to  any  refunds 
which  might  have  been  made  during  any  of  those  years  of  income  taxes  paid  for 
any  taxable  year  outside  of  the  period  1920  to  1930,  both  inclusive. 

The  figures  shown  above  are  as  reflected  in  the  returns  as  originall}^  filed  by 
the  taxpayer  but  adjusted  to  show  any  corrections  made  thereto  by  the  Bureau 
of  Internal  Revenue  before  final  approval  of  the  returns. 

'The  returns  filed  for  the  years  1921  to  1926,  both  inclusive,  were  joint  returns- 
of  Albert  I.  du  Pont  and  his  wife  Jessie  Ball  du  Pont,  and  the  various  items 
gross  income  and  deductions  of  each  spouse  are  not  segregated  in  the  returns, 
therefore,  the  figures  stated  for  such  years  cover  the  income  and  deductions  of 
both  Mr.  and  Mrs.  du  Pont.^^ 

The  Senate  Committee  on  Banking  and  Currency  brought  out  the 
prevalence  of  the  avoidance  of  taxes  by  sales,  involving  capital  losses, 
to  relatives  of  the  taxpayer  who  obligingly  resold  back  to  the  taxpayer: 

This  device  was  exceedingly  favored  by  leaders  of  American  finance,  whose 
relatives  were  generally  possessed  of  considerable  wealth  in  their  own  right.. 

w  A  frequent  concomitant  of  the  use  of  the  provision  for  deduction  of  capital  losses  has  been  the  setting 
up  of  a  personal  holding  company.  This  device  was  described  as  follows  by  the  House  Ways  and  Means 
Committee  report  on  the  revenue  bill  of  1934: 

"Perhaps  the  most  prevalent  form  of  tax  avoidance  practiced  by  individuals  with  large  incomes  is  the 
scheme  of  the  'incorporated  pocketbook'.  That  is,  an  individual  forms  a  corporation  and  exchanges  for 
its  stock  his  personal  holdings  in  stocks,  bonds,  or  other  income-producing  property.  By  this  means  the 
income  from  the  property  pays  corporation  tax,  but  no  surtax  is  paid  by  the  individual  if  the  income  is 
not  distributed. 

"  For  instance,  suppose  a  man  has  $1,000,000  annual  income  from  taxable  bonds.  His  tax  under  existing 
law  will  be  $571,100.  However,  if  he  forms  a  holding  company  to  take  title  to  the  bonds  and  to  receive 
the  income  therefrom,  the  only  tax  paid  will  be  a  corporate  tax  of  $1.37,500  as  long  as  there  is  no  distribution 
of  dividends.  Thus  a  tax  saving  of  $433,600  has  been  eflected."  (73d  Cong.,  2d  sess.,  H.  Rept.  No.  704, 
p.  11.) 

This  permits  an  individual  taxpayer  to  realize  his  income  in  the  years  and  in  the  amounts  he  desires  and 
so  to  avoid  the  high  taxes  in  effect  in  war  years.  The  connection  between  this  device  and  the  provision 
for  deducting  capital  losses  is  apparent  when  it  is  recognized  that  the  shares  of  a  personal  holding  company 
are  not.  of  course,  registered  on  any  market.  As  a  result  of  this  absence  of  any  market  value,  the  oppor- 
tunity for  establishing  apparent  losses  by  the  sale  of  the  stock  of  such  a  company  is  considerable. 

63  Exhibit  no.  1398.    See  also  exhibits  nos.  1397  and  1397- A. 


MUNITIONS    INDUSTRY  49 

Thus,  Thomas  S.  Lamont,  a  partner  of  J.  P.  Morgan  &  Co.  established  losses 
amounting  to  $114,807.35  in  the  sale  of  securities  to  his  wife  on  December  31, 

1930.  The  tax  on  the  amount  of  loss  thus  established  would  have  been  $20,365. 
In  April  1931  he  repurchased  the  securities  from  his  wife.  Both  sides  of  the 
transaction  were  effected  without  the  intervention  of  any  intermediary.  The 
payments  were  evidenced  by  entries  on  the  books  of  J.  P.  Morgan  &  Co. 

Mr.  Pecora.  Now,  in  what  form  did  she  make  payment  to  you  for  these 
securities  on  December  31,  1930? 

Mr.  Lamont.  Her  account  in  the  office  of  J.  P.  Morgan  &  Co.  was  debited,  was 
charged  with  the  cost  of  these  securities,  and  my  account  was  credited. 

Mr.  Pecora.  *  *  *  How  was  that  sale  of  those  securities  by  your  wife  to 
you  effected  in  April  1931? 

Mr.  Lamont.  I  bought  it  back  direct  from  her.  Didn't  occur  to  me  to  do  it 
in  any  other  manner. 

Mr.  Pecora.  That  is,  there  was  no  broker? 

Mr.  Lamont.  There  was  no  broker. 

Mr.  Pecora.  Or  any  other  agent  or  intermediary  involved  in  the  purchase  of 
these  securities  by  you  from  your  wife? 

Mr.  Lamont.  That  is  right. 

Otto  H.  Kahn,  of  Kuhn,  Loeb  &  Co.,  testified  that  on  December  30,  1930,  he 
sold  five  blocks  of  securities  to  his  daughter,  Maude  E.  Marriot,  whicli  he  later 
■reacc}uired  by  assignnient  in  writing.  Although  the  assignment  was  dated 
December  31,  1930,  he  stated  that  the  document  was  actually  executed  in  March 

1931,  thereby  placing  the  retransfer  just  beyond  the  60-day  limitation  period. 
Through  this  method,  a  loss  of  $117,584  was  established  whereby  Kahn  was 
enabled  to  deduct  upward  of  $16,000  from  his  income  tax  for  1930. 

Charles  E.  Mitchell,  chairman  of  the  National  Citv  Bank,  sold  to  his  wife  in 
1929,  18,300  shares  of  National  City  Bank  stock  at  a  loss  of  $2,872,305.50. 
This  transaction,  Mr.  Mitchell  admitted,  was  entered  into  for  the  express  pur- 
pose of  establishing  the  loss  for  income-tax  purposes.  He  later  repurchased  the 
istock  from  his  wife. 

Senator  Brookhart.   What  price  did  you  pay  for  those  last  purchases? 

Mr.  Mitchell.  I  sold  this  stock,  frankly,  for  tax  purposes. 

Senator  Brookhart.  That  was  to  avoid  income  tax? 

Mr.  Mitchell.  Throwing  my  fortune  into  the  breach  as  I  did  for  the  benefit  of 
this  institution,  Senator  Brookhart,  in  1929,  I  had  a  definite  loss  in  that  stock 
which  I  was  forced  to  take. 

Senator  Brookhart.  In  other  words,  bj^  making  a  sale  of  it  that  showed  a  loss 
in  your  income? 

Mr.  Mitchell.  That  certainly  did. 

Senator  Brookhart.  And  then  you  bought  it  back  afterward? 

Mr.  Mitchell.  Yes,  sir. 

Senator  Brookhart.  That  sale  was  just  really  a  sale  of  convenience,  to  reduce 
your  income  tax? 

Mr.  Mitchell.  You  can  call  it  that  if  you  will. 

Senator  Brookhart.  Well,  is  that  right? 

Mr.  Mitchell.  Yes;   it  was  a  sale,  frankly,  for  that  purpose     *     *     *_ 

As  a  result  of  this  transaction,  Mitchell  paid  no  income  tax  in  1929.^'' 

<3)    INSTANCES   OF  READINESS   OF  TAXPAYERS  TO   RELY  ON    TECHNICAL- 
ITIES TO  AVOID  TAXES 

In  the  year  1916  when  the  du  Pont  Co.  was  makmg  large  profits 
from  the  sale  of  war  products  to  the  AlHes,  it  objected  to  the  impo- 
:sition  of  the  income  tax  on  that  part  of  its  income  derived  from 
exports,  on  the  ground  that  such  income  was  made  immune  from  tax- 
ation by  section  9,  article  I  of  the  Constitution,  wldch  provides  that 
"no  tax  or  duty  shall  be  laid  on  articles  exported  from  any  State."  ^^ 

M  Report  on  Stock  Exchange  Practices,  73d  Cong.,  2d  sess.,  Senate  Rept.  No.  1455,  p.  322  et  seq. 
■M  E-xhibit  No.  1403.     ' 


50  MUNITIONS    INDUSTRY 

The  Revenue  Act  of  1918  in  section  301  (c)  provided  that  the  high 
1918  tax  rates  should  be  applicable  to  that  part  of  the  income  derived 
in  1919  and  later  years  from  war-time  contracts  with  the  Government. 
The  Newport  News  Shipbuilding  &  Dry  dock  Co.,  which  had  made  a 
profit  of  32.4  percent  in  1917  on  its  investment  according  to  its  own 
return,*^*' 90.6  percent  according  to  the  revenue  agent's  report/^  and  86.3 
percent  according  to  the  invested  capital  as  determined  by  the  Bureau 
of  Internal  Revenue  in  revision  of  the  agent's  report/'^  protested 
against  imposition  of  the  tax  on  that  part  of  its  income  which  was 
derived  from  work  done  pursuant  to  the  mandatory  orders  of  the 
President.  The  theory  of  the  protest  was  that  these  were  "forced 
orders"  and  that  the  statute  when  it  was  phrased  to  read  "Govern- 
ment contracts"  did  not  envisage  such  orders. 

Compulsory  contracts  were  most  frequently  used  to  afford  protec- 
tion to  governmental  contractors  from  third  parties  whose  contractual 
rights  antedated  the  governmental  orders. "^^  The  concept  of  the 
sovereign's  commandeering  power  permitted  priority  to  be  given  to 
the  Government  without  the  contractor  incurring  liability  under  his 
precedent  private  obligations.^"  Certainly,  as  the  company's  record 
shows  "  and  as  the  fees  provided  in  the  contracts  indicate,  the  New- 
port News  Co.'s  "forced  orders"  were  profitable: 

Senator  Vandenberg.  Mr.  Ferguson,  when  we  are  discussing  this  so-called 
"force  contract",  are  we  discussing  the  cost-plus  10-percent  contracts? 

Mr.  Ferguson.  Some  of  them  were  cost  plus  10  percent.  They  were  all 
changed  to  cost  plus  a  fixed  fee.  Some  of  them  were  cost  plus  a  fixed  fee  in  the 
first  place.  The  only  cost-plus  10-percent  contracts  which  we  ever  completed 
was  the  first  of  a  group  of  destroyers^ — ■ — 

Senator  Clark.  Was  that  during  the  war,  Mr.  Ferguson? 

Mr.  Ferguson.  Yes.  The  battle  cruiser  contracts  were  signed  in  1916,  and 
they  were  cost  plus  10  percent,  but  later  on  changed  to  cost  plus  a  fixed  fee  of 
$2,000,000.  The  battleship  Iowa  was  cost  plus  a  fixed  fee  from  the  beginning. 
A  group  of  tankers  we  built  for  the  Navy  Department  were  cost  plus  a  fixed  fee, 
plus  one-half  of  the  savings  under  a  certain  price. 

Senator  Vandenberg.  This  is  after  the  war,  is  it  not? 

Mr.  Ferguson.  No;  this  was  during  the  war.  It  was  during  the  war  period. 
I  do  not  remember  just  when  the  battleship  Iowa  contract  was  settled. "^ 

Indeed,  since  the  1918  tax  rates  permitted  an  exemption  of  income 
up  to  an  amount  equal  to  at  least  8  percent  of  invested  capital  in  all 
cases,  the  issue  raised  by  the  Newport  News  Co.  could  not  have 
arisen  unless  the  contracts  yielded  substantial  profits. 

The  claim  of  the  company  was  stated  in  a  brief  prepared  by  Robert 
H.  Montgomery: 

It  was  clearly  not  the  intention  of  Congress  to  tax  at  what  are  realh^  penalty 
rates,  income  derived  from  the  execution  of  the  President's  orders. 

Section  301  (c)  of  the  Revenue  Act  of  1918  was  inserted  by  the  Conference 
Committee,  and  in  explaining  it  to  the  House,  the  Chairman  of  the  Ways  and 
Means  Committee  said: 

"  Though  the  80-percent  war  profits  tax  is  eliminated  for  the  next  fiscal  year — 
since  there  are  no  war  profits  for  1919-20 — the  conferees  put  in  a  provision  ex- 
tending the  80-percent  war  profits  tax  for  the  calendar  year  1919  to  catch  the 
profits  that  are  derived  in  1919  from  war  contracts  made  in  1918  and  1917,  so 
that  the  profiteers  will  not  get  off  with  80  percent  eliminated  after  Januarv  1, 
1919." 

******* 


6«  Exhibit  1556. 

e'Ibid. 

«8  Letter  from  Secretary  of  Treasury  to  committee,  May  3,  1935,  quoted  in  part  on  p.  22,  note  45. 

69  Testimony  of  Lt.  E.  M.  Brannon,  Dec.  21,  1934,  95-96  FM. 

"">  Ibid,  cf.  Exhibit  No.  1094  quoted  at  p.  96  and  of.  pp.  111-115. 

"  Exhibit  No.  1556. 

"  Feb.  12,  1935,  74Z0. 


MUNITIONS    INDUSTKY  51 

The  owners  of  shipyards  who  were  prevented  from  undertaking  hicrative 
commercial  work  and  were  commanded  to  devote  all  their  facilities  to  the  pro- 
duction of  vessels  for  the  Government  at  prices  stipulated  by  the  Government, 
can  hardly  be  considered  the  profiteers  the  conference  committee  intended  to 
reach. '2 

The  company  felt  no  hesitation  about  relying  upon  such  a  tech- 
nical means  of  avoiding  taxes;  as  a  matter  of  routine,  taxes  were  re- 
duced whenever,  and  as  far  as,  possible: 

Senator  Vandenberg.  What  was  there  about  a  cost-plus-10-percent  contract 
which  so  invaded  the  ordinary  contractual  prerogative  that  it  ought  not  to  be 
considered  in  ordinary  tax  practice? 

Mr.  Ferguson.  I  take  it — it  is  a  legal  question  with  which  I  am  not  ac- 
quainted— but  I  take  it  that  being  a  Presidential  order  contract— — - 

Senator  Vandenberg.  I  am  not  asking  about  the  legal  phase.  I  would  not 
undertake  to  enter  that  field,  either.  I  am  talking  about  the  practical  phase. 
Do  you  not  invite  the  inference  that  if  you  consider  a  cost-plus-10-percent  con- 
tract an  invasion  of  your  ordinary  contractual  privileges,  do  you  not  invite  the 
presumption  that  a  10-percent  profit  above  all  cost  items  is  a  great  hardship, 
and  a  great  invasion  of  vour  usual  opportunitv  of  doing  a  great  deal  better  than 
that? 

Mr.  Ferguson.  No. 

Senator  Vandenberg.  It  seems  to  me  that  you  do.  Go  ahead,  Mr.  Raushen- 
bush. 

Mr.  Raushenbush.  The  point  that  you  were  to  accomplish  by  these  protests 
which  were  laid  before  them  by  Mr.  Montgomery  and  your  learned  attorneys 
and  others,  was  simply  to  reduce  the  taxes  on  all  the  Government  work  during 
the  war,  on  the  ground  that  it  was  a  forced  contract?  That  is  not  to  say  that  10 
percent  was  too  much  or  too  little,  but  that  the  taxes  were  too  much.  Was  not 
that  the  point  of  it? 

Mr.  Ferguson.  I  presume  so.''* 

The  United  Verde  Extension  Mining  Co.  stated  on  March  30,  1918, 
when  it  filed  its  1917  tax  return,  that  it  could  not  determine  its  tax 
liability  because  it  could  not  determine  its  invested  capital.  The 
Bureau  of  Internal  Revenue  replied  on  June  10,  1918,  that — 

A  final  conclusion  has  not  been  reached  but  from  the  consideration  so  far  given, 
it  is  apparent  that  the  amount  of  taxes  owing  will  probably  not  be  less  than  that 
indicated  below  *  *  *  [$2,123,809.55]  *  *  *  Upon  final  audit  of  your 
returns  you  will  be  advised  of  the  conclusion  reached  and  if  the  amount  deter- 
mined to  be  due  is  in  excess  of  amount  above  stated,  a  further  assessment  will  be 
made;  if  less,  you  may  file  a  claim  for  refund  of  the  amount  overpaid. 

The  collector  at  Baltimore  assessed  the  same  amount  in  a  duplicate 
assessment  and  on  September  27,  1918,  notified  the  Bureau  that  an 
abatement  should  be  allowed  as  to  liis  assessment  because  the  amount 
assessed  had  already  been  paid.  On  February  19,  1919,  the  company 
was  notified: 

Your  claim  for  the  abatement  of  internal-revenue  tax  has  been  allowed  as  shown 
above.  No  further  demand  for  the  payment  of  the  amount  allowed  and  abated 
will  be  made  upon  you. 

Tliis  was  a  standard  paragraph  used  in  allowing  abatements  in'the 
case  of  duplicate  assessments.  On  January  24,  1923,  the  company 
was  notified  of  a  further  assessment  of  $721,260. 

The  company  resisted  this  additional  assessment  on  the  ground  that 
the  letter  of  February  19,  1919,  closed  the  case  and  that  under  section 
1313  of  the  Revenue  Act  of  1921,  wliich  made  decisions  of  the  Commis- 
sioner of  Internal  Revenue  free  from  review  by  any  other  adminis- 
trative official,  the  case  could  not  be  reopened. ^^ 

"  Exhibit  no.  1561. 
'<  Feb.  12,  1935,  74  Z  0. 

"  Exhibits  1715;  1715A.  For  examples  of  the  use  of  the  device  of  incorporation  to  avoid  taxes  see 
p.  21  and  p.  31,  supra. 


52  MUNITIONS    INDUSTRY 

(4)    OBSTRUCTIVE    TACTICS 

The  traditional  resistance  to  paying  taxes  at  times  assumes  forms 
which  justify— without  much  room  for  phiusible  arguments  of  the 
kind  quoted  above  at  page  45  the  popular  confusion  between  evasion 
and  avoidance.  All  profits  taxes  depend  finally  upjn  records  kept 
by  the  taxpayer  and  known  in  their  entirety  only  by  him. 

A  memorandum  of  revenue  agents  assigned  to  the  New  York  Ship- 
building Co.  tells  how  a  company  official  informed  them  every  day  for 
3  weeks  that  he  was  going  to  produce  certain  schedules  and  then 
finally  admitted  that  he  was  "stalling": 

To  verify  the  correctness  of  the  taxpayer's  returns,  or  books,  it  is  most  essen- 
tial to  procure  the  schedules  referred  to  and  to  examine  tlie  computations  of 
earned  profit  on  each  contract  that  was  made  by  the  taxpayer  and  appear  thereon. 
Such  schedules  have  been  requested  of  the  taxpayer,  first  over  3  weeks  ago,  and 
photostats  thereof  were  promised  by  Mr.  Norman  F.  Parker,  assistant  treasurer, 
almost  daily  after  the  first  request. 

Last  Saturday,  on  request  again  for  the  schedules,  Mr.  Parker  informed  us  that 
he  had  been  "stalling"  and  that  we  knew  it,  but  that  the  corporation's  counsel 
had  advised  him  to  delay  giving  the  schedules  to  us.  He  called  his  counsel  by 
telephone,  a  Mr.  Orr,  connected  with  White  &  Case,  attorneys,  while  we  were 
present,  and  explained  the  situation,  and  stated  to  Mr.  Orr  that  he  believed  we 
were  entitled  to  the  schedules  and  should  get  them.  Mr.  Orr's  advice,  we  were 
informed,  was  not  to  deliver  them. 

To  date,  the  situation  remains  the  same,  the  schedules  have  been  refused  on 
the  advice  of  counsel,  so  we  are  informed  by  Mr.  Parker  and  Mr.  J.  T.  Wicker- 
sham,  the  treasurer. 

The  points  raised  by  the  Solicitor  have  developed  other  points  that  make  it 
imperative,  in  the  opinion  of  your  examiners,  after  their  investigation  thus  far, 
that  a  reexamination  be  made  of  the  taxpayer's  books  for  the  period  extending 
from  1918  to  1921,  inclusive. 

Their  investigation  thus  far,  with  the  information  we  have  been  able  to  gather, 
results  in  an  increase  in  income  over  income  as  determined  by  the  revenue  agent 
from  Trenton,  who  made  the  last  examination  for  the  period  1918  to  1921,  in- 
clusive, of  approximately  $8,000,000. 

It  is  the  positive  opinion  of  your  examiners,  with  the  information  gained  thus 
far,  that  there  should  be  recommended  to  the  Commissioner  that  a  reexamina- 
tion be  made  of  all  of  the  taxpayer's  books  and  records  for  the  years  1918  to 
1921,  inclusive;  and  that  the  taxpayer  should  be  duly  notified  under  the  pro- 
visions of  section  1105  of  the  Revenue  Act  of  1926  that  such  investigation  has 
been  ordered.'" 

The  truth  of  this  charge  was  conceded  by  Mr.  Parker  in  his  testi- 
mony: 

Mr.  Raushenbush.  Do  you  have  any  comment  to  make  on  the  statement 
here  that  you  had  been  "stalling"  under  the  advice  of  your  attorneys? 
Mr.  Parker.   None,  except  that  that  was  true.^"" 

Such  subterfuges  as  this  last,  and  open  evasion,  cannot  be  prevented 
by  the  terms  of  any  tax  statute,  except  to  the  extent  that  penalties 
are  effective,  and  in  the  case  of  delays  and  generally  obstructive  tac- 
tics, as  contrasted  with  open  evasion,  there  is  usually  no  evidence 
sufficiently  conclusive  to  impose  penalties.  However,  the  effect  in 
loss  of  revenue,  or  in  serious  delay  in  the  receipt  of  revenue,  is  im- 
portant in  any  realistic  statement  of  the  problems  of  taxation. 

(5)    TAX-EXEMPT    SECURITIES 

An  additional  source  of  tax  avoidance  is  the  large  amount  of  tax- 
exempt  securities  available  for  investment  by  corporations  and 
individuals.     Because   of   the   doctrine   of   the   immunity   of   State 

'«  Exhibit  No.  1428. 

"  N.  F.  Parker,  Feb.  13,  1935. 


MUNITIONS    INDUSTRY  53 

instrumentalities  from  interference  by  the  Federal  Government, 
income  derived  from  the  securities  of  any  State  or  political  sub- 
division of  a  State  cannot  be  taxed  by  the  Federal  Government. ^^ 
Consequently,  in  the  absence  of  a  constitutional  amendment  any 
war-profits  tax  can  be  defeated  to  the  extent  of  the  interest  paid 
on  State,  county,  and  city  indebtedness.  This  has  been  estimated 
by  the  staff  of  the  Joint  Committee  on  Internal  Revenue  Taxation 
as  amounting  to  $980,000,000  per  year.^^  So  far  as  individuals  are 
concerned,  the  bulk  of  State  and  local  securities  is  held  by  persons 
in  the  high-income  brackets  and  the  amount  so  held  has  been  steadily 
increasing.  Of  all  tax-exempt  income  from  State  and  local  securities 
reported  by  individuals  in  1924,  persons  having  net  incomes  of  over 
$100,000  reported  58  percent;  in  1925  the  figure  was  64  percent;  in 
1929  it  was  70  percent;  and  in  1930,  the  latest  year  for  which  complete 
income-tax  statistics  were  available,  74  percent  of  the  income  from 
tax-exempt  State  and  local  securities  reported  in  individual  income 
tax  returns  was  reported  by  taxpayers  having  net  incomes  of  over 
$100,000.^'* 

Similarly  a  large  amount  of  Federal  securities  are  completely  tax 
exempt  from  Federal  taxation. 

On  August  31,  1933,  the  total  interest-bearing  debt  of  the  United  States,  out- 
standing, amounted  to  $22,722,597,530,  of  which  amount  $12,860,055,350  was 
subject  to  surtax,  and  $9,862,542,180  was  wholly  tax  exempt  as  to  both  income 
and  surtax.  It  appears  that  the  average  annual  interest  charge  on  this  Federal 
debt  will  be  approximately  $825,000,000,  indicating  an  average  interest  rate  of 
approximately  3%  percent. *' 

It  is  at  least  doubtful  whether  the  war  power  will  permit  the 
abrogation  of  the  right  to  receive  wholly  tax  free  the  interest  on  more 
than  40  percent  of  the  total  Federal  debt,  as  of  August  31,  1933, 
without  a  constitutional  amendment. ^^ 

"8  Pollock  V.  Farmers'  Loan  &  Trust  Co.  (157  U.  S.  429). 

"9  Prevention  of  Tax  Avoidance,  73ci  Cong.,  2d  sess.,  House  Committee  Print  (1933),  p.  25. 

80  Ibid.,  p.  26. 

81  Ibid. 

82  The  United  States  as  a  sovereign  may  remove  thie  remedies  necessary  for  the  enforcement  of  a  right 
against  it,  but  it  appears  that  it  may  not  abrogate  the  right  itself.  See  Lynch  v.  United  States,  292  U.  8.  671, 
Perry  v.  United  States  (U.  .S.  Sup.  Ct.,  Feb.  IS,  1935,  No.  532).  The  distinction  is  important  in  the  Federal 
taxation  of  Federal  bonds  containing  tax-free  covenants,  since  the  United  States  must  there  assert  a  positive 
right  to  tax  collection  which  is  met  by  the  countervailing  right  of  exemption.  Of.  Lynch  v.  United  States, 
supra.  The  Supreme  Court  has  recognized  that  the  fifth  amendment  limits  the  taxing  power  {Heiner  v. 
Donnan,  285  U.  S.  312,  326;  see  Louisville  Joint  Stock  Land  Bank  v.  Radford,  May  27,1935,  No.  717.)  If 
such  an  analysis  is  adopted  by  the  Supreme  Court  and  the  taxpayer's  right  is  also  held  to  be  immune  from 
the  war  power  (cf.  Ei  parte  Miltigan,  4  Wall.  2,  120-127),  it  seems  hardly  possible  that  Government  credit 
in  war  time  would  permit  the  drastic  alternative  of  threatening  removal  of  remedies  of  enforcement  of  the 
rights  to  interest  or  principal  unless  consent  were  given  to  taxation  of  interest. 


PART  II.     PRICE  CONTROL 

The  purposes  of  price  control,  whether  in  the  form  of  the  war-time 
practice  or  in  that  of  the  Baruch  price  ceiUng  proposal,  are  generally- 
viewed  as  putting  a  limit  to  war  profits  and  as  aiding  in  the  prevention 
of  inflation.  In  considering  the  methods  of  their  achievement  it  is 
necessary  to  take  into  account  the  existence  and  significance  of  other 
war-time  policies.  Primary  among  these  is  the  policy  of  stimulating 
the  production  of  goods  deemed  essential  for  the  successful  prosecu- 
tion of  the  war. 

The  general  bearing  of  this  factor  on  the  height  of  prices  may  be 
seen  from  the  statements  of  Govermnent  officials  who  were  actually 
engaged  in  the  work  of  fixing  prices  during  the  war.  Mr.  Brookings, 
who  was  chairman  of  the  Price  Fixing  Committee,  stated  to  the  repre- 
sentatives of  the  steel  industry  at  a  meeting  on  March  20,  1918: 

Take  the  cost  of  producing  ore,  assemble  it,  and  follow  it  around  through  the 
production  of  the  different  grades  of  steel.  I  find  it  difficult  to  justify  in  my 
mind  the  prices  that  exist  todaj-,  but  we  have  not  that  sort  of  a  problem.  We 
believe  it  necessary  to  stimulate  production.' 

The  dominant  policy  of  the  committee  was,  as  Lt.  Col.  Robert  H. 
Montgomery,  its  Army  member,  has  said,  "to  stimulate  production 
by  one  way  or  another."  -  Gen.  Palmer  E.  Pierce,  who  was  a  member 
of  the  War  Industries  Board,  which  controlled  prices  before  the  organi- 
zation of  the  Price  FLxing  Committee,  testified  as  follows  in  the  War 
Policies  Commission  hearings: 

Senator  Robixsox.  In  your  view,  I  assume  the  prime  necessity  is  adequate 
supply? 

General  Pierce.  Yes,  sir. 

Senator  Robixson.  And  prompt  supply? 

General  Pierce.  There  is  no  question  about  that. 

Senator  Robixsox.  Were  the  prices  you  fixed  made  with  regard  to  that  con- 
sideration? 

General  Pierce.  Yes,  sir;  and  the  protection  of  the  Government.^ 

When  Lieutenant  Colonel  Harris,  who  is  director  of  the  Planning 
branch  of  the  War  Department,  was  asked  in  his  appearance  before 
this  committee  what  policy  he  felt  would  be  pursued  in  the  event  of 
another  war,  he  testified: 

If  it  relates  to  materials  we  have  to  have,  and  cannot  get,  we  have  got  to  put 
the  prices  high  enough  to  draw  out  the  required  amount.* 

'  Minutes  of  the  Price  Fixing  Committee,  Mar  20,  1918. 

2  Garrett.  Government  Control  over  Prices,  War  Industries  Board  Price  Bulletin  No.  3,  p.  244. 

3  "2d  Cong.,  1st  sess.,  H.  Doc.  No.  1H3,  p.  148. 
*  Lieutenant  Colonel  Harris,  Dec.  20,  1934. 

55 


I.  Price   Control   as   a   Means   of  Eliminating   War   Profits 

(1)   VARYING   costs   OF   INDUSTRY   AND   THE   PROFITS   OF   LOW-COST   - 

PRODUCERS 

In  ordinary  times,  any  industry  in  which  one  company  does  not 
completely  monopolize  the  field,  as  in  aluminum  and  nickel,  con- 
tains producers  whose  costs  vary.  The  causes  of  this  variation  rest 
in  the  inevitable  differences  between  companies  in  degree  of  integra- 
tion, advantage  of  natural  resource,  skill  of  labor,  and  efficiency  of 
management.  An  even  greater  tendency  toward  cost  dispersion  arises 
from  war,  which  brings  in  numbers  of  new  producers  who  are  faced 
with  the  alternative  of  using  less  efficient  factors  of  production, 
constructing  new  facilities,  or  bidding  existing  facilities  away  from 
established  companies. 

Under  these  conditions  of  varying  costs  a  single  commodity  price, 
set  at  a  level  which  enables  high-cost  producers  to  exist,  naturally 
results  in  excessive  profits  for  low-cost  producers.  These  profits 
increase  as  the  war  need  for  production  becomes  more  pressing  and  a 
greater  tendency  expresses  itself  to  increase  the  number  of  producers. 

When  the  United  States  entered  the  World  War,  industry  already 
contained  many  high-cost  producers  who  had  been  encouraged  by 
the  inflated  price  level  brought  on  by  the  European  war  activities. 
The  price-control  bodies,  in  attempting  to  retain  their  production  and, 
if  possible,  add  to  it,  announced  a  rule  of  fLxing  prices  at  the  bulk 
line  of  cost  of  production.     From  its  definition — 

The  term  "bulk  line"  of  production,  as  it  came  into  use  during  the  war,  meant 
the  indispensable  amount  of  any  commodity  that  the  war  program  required 
should  be  produced,  and  the  "bulk  line"  of  cost  meant  the  unit  cost  to  produce 
the  last  unit  lot  of  that  requirement  by  the  marginal  producer. ^ 

it  is  apparent  that  the  rule  simply  meant  that  prices  would  be  fixed 
at  that  point  which  would  bring  in  what  was  deemed  to  be  all  the 
necessary  production. 

The  amount  of  profits  which  could  be  gained  in  any  industry  whose 
prices  were  set  by  such  a  standard  would,  of  course,  be  dependent 
upon  the  actual  cost  conditions  in  that  industry.  Particularly 
significant  would  be  the  extent  of  the  difference  in  costs  and  the  pro- 
portion of  the  industry  producing  at  a  low  cost.  In  the  following  table 
of  costs  and  production  percentages,  as  determined  by  the  Federal 
Trade  Commission,  it  is  possible  to  estimate  how  large  both  these: 
factors  were  in  the  iron  and  steel  industry: 

i  Garrett,  op.  cit.  p.  400. 
56 


MUNITIONS    INDUSTRY 


57 


Costs  found  by  the  Federal  Trade  Commission  for  September  191S  ^ 

BEEHIVE  COKE 

[Qovernment  price  $6  per  net  ton] 


Production  cost 
per  gross  ton 


■Companies  producing  up  to  60  percent  of  total 

Companies  producing  over — 

60  to  70  percent  of  total - 

70  to  80  percent  of  total.. 

80  to  90  percent  of  total.. — 

90  to  100  percent  of  total... 


$2. 93-  $4. 44 

4.44-  4.99 
4.99-  5.44 
5.44-  6.47 
6. 47-  11. 45 


PIG  IRON  (BASIC) 
[Qovernment  price  $32  per  ton] 


Companies  producing  up  to  60  percent  of  total 

Companies  producing  over—' 

60  to  70  percent  of  total 

70  to  80  percent  of  total 

80  to  90  percent  of  total... 

90  to  100  percent  of  total 


$18. 14-$22. 06 

22. 06-  24. 32 
24. 32-  25.  41 
25. 41-  27.  49 
27. 4&-  45. 72 


INGOTS  (OPEN  HEARTH) 
[Government  price  $73  per  ton] 


Companies  producing  up  to  60  percent  of  total 

Companies  producing  over— 

60  to  70percent  of  total-. 

70  to  80  percent  of  total 

80  to  90  percent  of  total 

90  to  100  percent  of  total 


$30. 60-$33. 42 

33.  42-  35. 16 
35. 16-  39. 77 
39.  77-  41. 86 
41.  86-  66. 34 


STRUCTURAL  SHAPES 
[Qovernment  price  $3  per  100  pounds;  $67.20  per  gross  ton] 


Companies  producing  up  to  60  percent  of  total 

Companies  producing  over— 

60  to  70  percent  of  total 

70  to  80  percent  of  total.. 

80  to  90  percent  of  total 

90  to  100  percent  of  total 


$45.  54-$ 

45.  54-  49.  37 
49.  37-  52. 07 
52. 07-  57.  69 
57. 69-  76.  79. 


PLATES-SHEARED 
[Qovernment  price  $3.25  per  100  pounds;  $72.80  per  gross  ton] 


Companies  producing  up  to  60  percent  of  total 
Companies  producing  over— 

60  to  70  percent  of  total 

70  to  80  percent  of  total _ . 

80  to  90  percent  of  total _. 

90  to  100  percent  of  total 


$46. 30-$56. 80 

56. 80-  59. 56 

59.  56 

59.  56-  66.  28 
66.  28-  82.  25 


MERCHANT  BAR 
[Government  price  $3.50  per  100  pounds;  $78.40  per  gross  ton] 


Companies  producing  up  to  60  percent  of  total 
Companies  producing  over— 

60  to  70  percent  of  total 

70  to  80  percent  of  total 

80  to  90  percent  of  total 

90  to  100  percent  of  total 


$44. 82-$48. 45 

48.  45-  48.  74 
48.  74-  53.  38 
53.  38-  68.  98 
68. 98-  87. 15 


'  Garrett,  op.  cit.,  p.  404. 


58  MUNITIONS    INDUSTRY 

The  figures  show  that  at  the  set  prices  the  lowest-cost  producers 
were  able  to  make  extremely  large  profits.  In  the  case  of  beehive 
coke,  for  instance,  the  $6  price  constituted  a  margin  of  $3.07  or 
104  percent  over  the  low  cost  of  $2.93.  Large  profit  percentages  are 
also  visible  for  the  lowest-cost  producers  of  the  other  commodities. 
The  margins  have  been  computed  to  be  as  follows:  76  percent  for 
basic  pig  iron;  139  percent  for  open-hearth  ingots;  48  percent  for 
structural  shapes;  57  percent  for  sheared  plates;  and  75  percent  for 
merchant  bar. 

Furthermore,  the  cost  conditions  of  the  majoritj'-  of  the  producers 
were  such  as  to  enable  even  the  average  producer  to  secure  large  profit 
margins  from  these  prices.  For  60  percent  of  the  companies  producing 
beehive  coke,  the  fixed  price  constituted  a  profit  margin  of  at  least  35 
percent.  Computed  percentages  for  the  same  proportion  of  the  other 
industries  follow:  Basic  pig  iron,  45  percent;  open-hearth  ingots,  118 
percent;  structural  shapes,  48  percent;  sheared  plates,  28  percent ,-^ 
and  merchant  bar,  62  percent. 

feimilaiiy  wide  profit  margins  for  large  proportions  of  the  bituminous 
coal  and  beet-sugar  industries  may  be  seen  in  the  charts  facing  page 
58  and  at  page  59. 

Just  as  the  necessity  for  maintaining  the  marginal  producer  was 
found  to  be  a  major  cause  of  high  profits  and  prices  during  the  World 
War,  it  will  be  found  to  have  a  good  deal  of  significance  for  any 
evaluation  of  the  effectiveness  of  the  price  ceiling  proposal. 

The  proposal,  as  outlined  by  Mr.  Baruch  to  this  committee,  would 
take  the  entire  price  structure  existing  on  a  pre-war  day  and  set  that 
up  as  a  ceiling  of  maximum  prices  for  the  duration  of  the  war.  Operat- 
ing in  conjunction  with  special  taxation  it  is  claimed  that  war  would 
thereby  be  prevented  from  being  a  profitable  industry  and  its  un- 
pleasant aftermaths  for  future  generations  would  also  be  forestalled: 

Briefly,  my  proposal  is  that  Congress,  after  it  declares  an  emergency  exists, 
shall  authorize  the  President  to  clamp  a  ceiling  down  over  the  whole  price  structure 
in  effect  on  or  about  the  date  of  declaration  of  war,  when  there  is  a  fair  relationship 
an^ong  human  activities  and  their  rewards,  and  make  it  unlawful  thereafter  to 
charge  a  higher  price  for  any  service  or  thing.  But,  coincident  with  that,  a  fair- 
price  commission  shall  be  set  up  to  make  adjustments  upward  or  downward  as 
necessity  may  recjuire.  Money,  like  other  things,  would  be  controlled  and 
directed,  and  told  for  what  purpose  it  could  be  used  and  the  charge  for  such  use. 

By  heavily  increasing  the  present  peace  taxes  and  placing  an  excess  war-profit 
tax  on  all  earnings  above  peace-time  earnings,  any  war  profits  which  might  strain 
through  the  price-stabilization  sieve  would  be  captured,  and  thus  war  would  be 
prevented  from  being  a  profitable  industry.  And,  finally,  the  plan  of  "paying  as 
you  fight"  would  save  generations  unborn,  as  well  as  ourselves,  untold  misery. '^ 

Provision  would  be  made,  however,  for  upward  and  downward  price 
changes.  Mr.  Baruch  made  this  very  clear  in  his  testimony  before 
the  War  Policies  Commission: 

Some  witnesses  seem  to  think  that,  once  this  existing  maximum  is  established 
there  are  to  be  no  changes.  I  tried  to  make  it  clear  that  there  is  at  once  to  be  set 
up  a  competent  tribunal  to  adjust  any  maximum  prices,  either  upward  or  down- 
ward, whether  to  cure  incidental  injustice  or  hardship  or  to  increase  production. 
That,  of  course,  will  inject  artificiality,  but  artificialitj-  will  be  the  exception  and 
not  the  rule  as  would  be  the  case  with  plans  which  propose  fixing  the  prices  of  base 
ccnimodities  separatelj'.  On  the  other  hand  some  witnesses  say  "He  proposes  to 
fr.?"ze  prices  and  then  immediately  to  unfreeze  them."  I  propose  to  unfreeze 
nothing.     I  propose  to  adjust  the  few  exceptions. ^ 

■  Bernard  M.  Baruch.  Mar.  27,  1935  (galley  49  BBQ). 
*  72d  Cong.,  Ist  sess.,  H.  Doc.  No.  163,  p.  796. 


coaxa  OF  beet  sugar,  season  of  isir-is 

ties  ID  tcnna  o(  torn 
a  New  York) 


fr'iinferi': 


■4bo  ^  '     ^  '^SOQ 

Quarterly  Journal  of  Economics  Vol.  33.  facing  p.  218.) 


11570—35.      (Face  p.  58.) 


MUNITIONS    INDUSTRY 

PRICE-FIXING 


59 


60  MUN^ITIOiSrS    INDUSTRY 

The  high  cost  producer  situation  would  furnish  an  important 
occasion  for  such  adjustment.  Mr.  Baruch  in  his  testimony  before 
this  committee  agreed  that  it  would  be  necessary  to  raise  prices  to 
bring  the  marginal  concerns  into  production.  He  stated  that  this 
was  the  method  used  in  the  last  war  and  that  he  knew  of  no  other 
way  to  meet  this  production  problem: 

Mr.  Hiss.  Mr.  Baruch,  there  are  a  few  questions  relating  to  the  price-ceiling 
plan  which  you  have  discussed  that  I  would  like  to  ask  you. 

In  time  of  war,  is  it  not  true,  taking  any  industry  in  which  there  are  marginal 
producers,  high-cost  producers,  at  that  time  not  in  production  but  whose  pro- 
duction is  needed,  is  it  not  true  that  the  only  way  to  bring  them  into  production  is 
by  increasing  the  price  of  their  product  above  the  prevailing  price? 

Mr.  Baruch.  There  might  be  other  devices,  but  that  is  the  one  into  which  we 
were  forced  during  the  war. 

Mr.  Hiss.  Directing  it  now  toward  a  future  time  of  war,  do  you  know  of  any 
other  way  to  bring  in  these  marginal  producers  who  at  that  time  are  not  in  pro- 
duction but  whose  production  is  needed? 

Mr.  Baruch.  No. 

Mr.  Hiss.  Then,  in  any  price-ceiling  scheme  there  will  have  to  be  exceptions 
over  the  prevailing  prices  for  such  industries? 

Mr.  Baruch.  There  might  be. 

Mr.  Hiss.  Is  it  not  true  that  the  reason  the  marginal  producers  are  not  in 
production  is  because  they  cannot  produce  profitably  at  the  prevailing  price 
level? 

Mr.  Babuch.  Yes,  sir.' 

Ascertaining  the  magnitude  of  this  factor  will  aid  in  determining 
to  what  extent  the  price  ceiling  will  vanish  with  the  creation  of  open- 
ings in  it  through  the  medium  of  so-called  exceptions. 

Its  fundamental  strength  is  in  the  fact  that  the  desire  to  prevent  a 
price  rise  may  be  largely  overshadowed  by  the  need  for  production  to 
which  it  is  tied  up.  In  explaining  the  importance  of  the  marginal 
producer  for  the  World  War  price  fixing,  Professor  Taussig,  who  was 
a  member  of  the  Price  Fixing  Committee,  has  said: 

The  guiding  factor  was  the  necessity  of  maintaining  output.  The  commodities 
dealt  with  were,  to  repeat,  such  as  were  wanted  in  great  quantity  by  the  Govern- 
ment. A  large  output  was  imperatively  needed,  or  at  least  was  supposed  by 
the  military  authorities  to  be  needed.  This  was  the  real  justification  for  bolster- 
ing up  the  marginal  concern  and  fixing  a  price  at  which  the  marginal  concern 
could  continue  in  business.  This  too  was  the  ground  for  excluding  from  con- 
sideration the  extraordinarily  high  costs  of  the  producers  at  the  extreme  right  of 
the  curve,  sporadic  contributors  who  probably  could  not  have  operated  with 
profit  under  any  price  conditions,  and  whose  output  would  be  no  more  and  no 
less  whether  prices  were  fixed  at  a  somewhat  higher  or  somewhat  lower  figure. 
But  the  bulk  line  producers  had  to  be  maintained.  Their  output  was  needed, 
and  the  only  way  to  secure  it  was  to  pay  them  a  price  which  would  induce  the 
continuance  of  operations.  It  was  this  situation  which  caused  the  marginal 
producers  to  occupy  such  a  dominant  place  in  the  price  fixing  operations.'" 

The  draft  report  assembled  by  General  Hugh  S.  Johnson  for  the 
chairman  of  the  War  Industries  Board,  now  pubhshed  as  Committee 
Print  No.  3,  makes  the  point  that  in  the  light  of  the  need  for  pro- 
duction prices  in  most  cases  would  not  be  lowered  if  any  part  of  the 
high  cost  output  would  thereby  be  lost: 

*  *  *  In  most  of  these  cases  the  need  for  increased  production  was  so 
great  that  wherever  increased  demand  had  inflated  a  price  the  Government 
could  not  afford  to  fix  a  price  so  low  as  to  cut  off  one  single  source  of  production. 
It  mattered  not,  therefore,  that  some  highly  organized  business  showed  a  cost  of 
production  low  beyond  all  proportion  to  some  small  and  independent  producer. 
The  needs  of  our  men  in  France  would  brook  no  price  that  would  decrease  the 

9  "-prnard  M.  Baruch,  Mar.  29,  1935  (galley  77  BBQ). 

I"  Price  Fixing  as  Seen  by  a  Price  Fixer,  Quarterly  Journal  of  Economics,  vol.  33,  p.  228. 


MUNITIONS   INDUSTRY  61 

output  of  even  the  high-cost  producer.     The  proposition  to  fix  a  price  on  cost 
plus  profit  was  explored  and  found  utterly  impracticable." 

The  number  of  commodities  affected  by  the  high-cost  producer 
exception  is  closely  correlated  with  the  number  of  commodities  whose 
production  it  would  be  deemed  necessary  to  stimulate  in  time  of  war 
and  it  is  necessary  to  recognize  that  the  demand  of  the  military  forces 
is  not  confined  to  the  direct  implements  of  war  such  as  ordnance, 
ships,  and  ammunition,  but  reaches  also  to  the  many  items  needed 
for  the  equipage  and  maintenance  of  the  military  forces.  In  each 
such  industry  an  eas}'  method  of  gaining  additional  production  will  be 
to  increase  prices  to  a  level  which  will  permit  the  existence  of  high  cost 
producers. 

Furthermore,  the  manufacturers  who  supply  the  military  demands 
in  the  first  instance  must  increase  their  purchases  of  raw  materials. 
Consequently  the  price  control  body  must  stimulate  the  production 
of  industries  which  are  seemingly  far  removed  from  the  theater  of 
war.  The  consequent  price  increases  of  basic  materials  set  up  de- 
mands for  price  increases  by  the  producers  of  nonwar  materials  who 
find  the  increases  in  the  prices  of  basic  materials  reflected  in  their  costs. 
Forces  are  thus  set  in  motion  throughout  the  entire  price  structure 
which  w^ill  contend  ^\dth  the  legislative  declaration  that  prices  shall 
not  rise. 

It  is  clear  that  the  need  for  increasing  the  production  of  any  com- 
modity is  not  a  matter  susceptible  of  exact  mathematical  calculation. 
The  military  need,  even  though  expressing  itself  as  a  more  or  less  uni- 
fied demand,  varies  from  month  to  month  according  to  the  fortunes 
of  war  and  the  reaction  of  the  authorities  to  them.  It  is  also  neces- 
sary to  estimate  the  civilian  demand,  which  is  largely  a  matter  of 
guesswork,  because  of  the  many  different  companies  involved. 
Finally,  account  must  be  taken  of  the  demand  set  up  for  raw  materials 
by  the  manufacturers  of  finished  products.  Throughout  the  process 
of  determination,  judgment  is  the  major  factor. 

This  consideration  was  stressed  by  the  War  Industries  Board  in  its 
reply  to  the  Department  of  Justice's  inquiry  regarding  the  fixing  of 
prices  for  cement.^-  The  statement  was  drafted  on  March  4,  1918, 
at  a  meeting  of  the  Board  attended  by  Mr.  Baruch,  Mr.  Brookings, 
Judge  Lovett,  Admiral  Fletcher,  and  Mr.  Ingels,  and  reads  as  follows: 

March  4,  1918. 
Hon.  G.  Carroll  Todd, 

Assistant  to  the  Attorney  General, 

Department  of  Justice,  Washington. 

Dear  Sir:  Mr.  Eugene  Mej'er,  Jr.,  has  referred  to  the  War  Industries  Board 
your  letter  of  the  13th  ultimo  addressed  to  him,  and  which  came  in  his  absence, 
about  the  cement  industry;  and  I  am  directed  by  the  Board  to  write  you  as  follows: 

The  only  documentary  evidence  upon  which  the  War  Industries  Board  acted  in 
determining  the  price  to  be  paid  by  the  Government  (not  by  the  public)  for  cement 
was  the  report  of  the  Federal  Trade  Commission,  the  report  of  Mr.  Humphrey, 
and  Mr.  Meyer's  recommendation,  copies  of  all  of  which  the  Board  understands 
are  not  [now?]  in  3'our  possession.  The  War  Industries  Board  in  dealing  with 
question[s?]  of  price  of  materials  required  by  the  Government  considers  a  great 
variety  of  circumstances — cost  data,  changing  eleraent[s?]  therein,  former  prices, 
especially  the  urgency  of  the  need  and  availability  of  the  needed  supply,  etc.; 
and  without  undertaking  to  weigh  evidence  as  in  judicial  proceedings,  the 
Board  applied  its  business  judgment  and  common  sence  in  the  light  of  all  the 

11  Committee  Print  No.  3,  p.  38. 
iJ  Exhibit  no.  1274. 

11579—35 5 


62 


MUNITIONS    INDUSTRY 


circumstances  to  the  particular  object  in  hand,  which  is  to  get  what  the  Govern- 
ment needs  when  it  is  needed  upon  the  fairest  terms  the  Board  is  able  to  arrive 
at,  and  the  time  allowed,  and  the  lights  before  it.  Thus  it  dealt  with  the  question 
of  cement  prices  which  it  fixed  for  the  first  four  months  in  1918,  and  the  Board  is 
not  disposed  to  reconsider  the  subject  during  that  period,  except  as  to  prices 
that  are  to  become  effective  thereafter. 

The  Board  does  not  consider  that  its  action  should  interfere  in  any  way  with 
any  measures  the  Department  of  Justice  may  contemplate  for  the  enforcement  of 
any  law  that  the  cement  producers  or  dealers  may  have  violated  at  any  time. 
The  Board  did  not  make  any  investigation  as  to  any  such  violations.  The  Fed- 
eral Trade  Commission  has  made  apparently  an  exhaustive  study  of  the  cement 
business.  The  War  Industries  Board  did  not  conceive  it  to  be  the  duty  of  the 
Board,  and  it  had  not  the  facilities  to  institute  investigations  to  ascertain  whether 
there  was  any  illegal  conspiracy  in  the  trade.  The  result  of  its  action  in  fixing 
prices  in  any  case  should  be  considered  in  the  light  of  the  circumstances  under 
which  and  the  purposes  for  which  it  acts — getting  within  the  time  required  an 
adequate  supply  of  war  materials  which  the  Government  needs,  and  the  price 
question  though,  always  important,  is  after  all  not  the  first  consideration,  and 
there  should  always  be  considered  the  fact,  as  illustrated  by  its  action  with  respect 
to  steel  prices,  that  it  uses  a  very  broad  business  judgment  in  a  great  emergency 
without  regard  to  strictly  Federal  Trade  Commission  reports  or  other  cost  data. 
Very  respectfully, 

(Signed)     H.  P.  Ingels, 

Acting  Secretary. 

Another  factor  conditioning  the  extent  of  rise  is  the  nature  of  the 
cost  information.  Although  figures  were  available  in  the  World  War 
it  was  found  that  for  a  variety  of  reasons,  which  are  treated  in  a  later 
section  of  tliis  report,  they  were  extremely  unreUable. 

Furthermore,  there  was  such  a  wide  variation  in  costs  that  the 
discretion  of  the  price-fixing  body  was  in  good  measure  unlimited  in 
its  choice  of  the  marginal  cost.  The  following  table  of  cost  variations 
in  the  iron  and  steel  industry  shows  how  wide  the  cost  range  was,  both 
in  absolute  dollar  amounts  and  in  percentages.  It  has  been  derived 
from  the  table  appearing  at  page  57  of  this  report. 

Range  of  costs  from  lowest-cost  to  highest-cost  producer 


Commodity 


Beehive  coke 

Pig  iron  (basic) 

Ingots  (open  hearth) 

Structural  shapes 

Plates  (sheared) 

Merchant  bar 


Lowest  cost 


$2.93 
18.14 
30.60 
45.54 
46.30 
44.82 


Highest  cost 


$11.45 
45.72 
66.34 
76.79 

82.25 
87.15 


Amount  of 
difference 


$8.52 
27.58 
35.74 
31.25 
35.95 
42.33 


Percent  range 
of  highest  cost , 
to  lowest  cost 


230 
152 
117 
69 

78 
94 


The  judgment  of  the  Price  Fixing  Committee  in  the  revision  of 
the  copper  price  in  the  World  War  apparently  was  exercised  largely 
in  favor  of  the  producers.  In  May  1918  the  copper  producers  de- 
manded an  increase  over  the  23 Jo-cent  price  fixed  on  September  21, 
1917.  The  minutes  of  June  27,  1918,  show  that  their  primary 
arguments  were  based  on  the  increase  in  freight  charges  which  were 
shown  in  the  testimony  before  this  committee  to  amount  to  only 
one-fifth  of  a  cent  per  pound  ^^  and  upon  a  wage  increase  which  had 
not  yet  been  granted.  The  revised  price  determined  July  2,  1918, 
was  set  at  26  cents,  an  advance  of  2^  cents  over  the  September 
1917  determination. 


13  Bernard  M.  Baruch,  Mar.  28,  1935  (galley  63BBQ). 


MUNITIONS    INDUSTET  63 

The  attitude  of  the  Price  Fixing  Committee  toward  the  industry 
was  ilhistrated  by  Mr.  Brooking's  statement  in  the  minutes  of  July 
2,  1918: 

Just  as  soon  as  this  information  commenced  to  come  in  on  increased  cost,  we 
did  trv  to  protect  the  producer  in  asking  the  Government  not  to  place  any  large 
orders  of  copper  with  the  producer,  because  we  would  be  responsible  for  that, 
and  having  it  in  mind,  we  feel  that  we  ought  to  at  least  spare  you  all  that." 

Envisaging  price  increase  the  Price  Fixing  Committee  discouraged 
governmental  purchases  at  the  prevailing  lower  prices.  Mr.  Baruch 
agreed 'in  his  testimony  that  tiiis  action  would  result  m  mcreased  cost 
to  the  Army  and  Navy: 

Senator  Clakk.  Would  you  assume  from  the  language  in  Mr.  Brookings'  state- 
ment that  that  was  the  pohcv  of  the  Price  Fixing  Committee,  sometinie  m  advance 
of  fixing  a  higher  price,  to  ask  the  Government  to  refrain  from  placing  orders  at 

Mr  Baruch!  If  thev  did,  it  was  a  silly  thing  to  do.  It  seems  so  stupid  that 
it  fs  hard  to  characterize  it  without  getting  hot  about  it. 

Senator  Cla.rk.  It  would  seem  to  me  that  if  that  was  the  pohcy,  it  would  have 
resulted  in  verv  great  cost  to  the  Government.  The  consumption  of  copper  by 
the  Government  at  that  time  was  very  large,  and  if  the  Government  knew  a 
month  before  that  the  price  was  going  to  be  used,  which  was  ultimately  reached, 
and  deliberatelv  refrained  from  placing  any  orders  at  the  lower  price,  it  would 
naturallv  result  in  a  greatly  increased  cost  to  the  Army  and  Navy,  would  it  not.' 

Mr.  Baruch.  Unquestionably.^^ 

The  need  for  encouragement  of  production  vras  another  matter 
stressed  by  the  copper  representatives  in  their  successful  negotiations 
for  a  higher  price.  Mr.  Cotton  made  the  foRowmg  statement  at  the 
May  22^  1918,  meeting  of  the  Price  FLxiDg  Conmiittee: 

Now  I  must  say  in  all  seriousness  that  we  yield  to  no  man  or  any  set  of  men 
in  our  patriotic  devotion  to  this  country  and  this  Nation  inthis  great  crisis.  1 
am  quite  willing  that  all  sorts  of  bouquets  be  thrown  to  various  enterprises,_but 
I  will  insist  that  the  smaller  copper  producers  in  this  country  are  jus^t  as  patriotic 
as  any  portion  of  the  industry  itself.  I  was  very  happy  to  hear  the  chairman 
of  this  committee  sav  this  morning  that  you  need  copper  and  you  need  produc- 
tion It  was  as  we  understood  it— you  have  about  a  month  s  supply  on  hand. 
You  have  sold  119,000  tons  for  July  delivery  ahead  of  your  production,  ihat 
is  perfectlv  evident.  So  it  stands  conceded  upon  the  face  of  the  record  here 
that  the  United  States  needs  to  encourage  the  production  of  copper  Ihat 
being  so,  it  seems  to  me  every  angle  of  this  question  should  be  carefully  con- 
sidered by  your  committee  in  undertaking  to  represent  a  fair  price  for  the  metal. i» 

'  \t  the  time  of  the  armistice,  however,  the  copper  producers  had  a 
surplus  stock  on  hand  of  750,000,000  pounds,  which  represented  4 
months'  production.^'  Furthermore,  on  June  20,  1918,  the  Federal 
Trade  Commission  reported  that  "In  addition  to  the  advantage  gained 
in  cost  by  many  companies,  attention  is  called  to  the  fact  that  the 
output  is  bemg  so  materially  increased  that  it  is  beheved  that  the 
additional  production  will  more  than  care  for  the  loss  of  the  produc- 
tion of  several  very  high-cost  producers  who  may  find  it  necessary  to 
close  down  durmg  1918  ".'^  Disregardmg  this  information,  presented 
by  a  Government  agency,  the  Price  Fixing  Committee  mcreased  the 
price  ostensibly  to  stimulate  production.  r       ,, 

(a)  Ineffectiveness  oj  excess-profits  tax£S  to  equalize  profits  oj  tow-cost 
producers.— In  the  World  War  it  was  impossible  to  overlook  the  fact 
that  a  policy  of  settmg  a  price  at  cost  of  production  plus  a  reasonable 

H  Exhibit  Xo.  1707.  „, 

15  Bernard  M.  Baruch,  Mar.  28,  1935  (galley  64BBQ). 
i«  Exhibit  No.  1711.  ,    „      „,„„„, 

!•  Bernard  M.  Baruch,  Mar.  28,  1935  (galley  64  BBQ). 
If  Exhibit  No.  1712. 


64  MUNITIONS   INDUSTRY 

profit  to  the  marginal  company  meant  the  acquisition  of  excessive 
profits  by  the  large  low-cost  companies.  In  suggesting  means  for 
handling  this  dilemma,  Judge  Gary,  of  the  United  States  Steel  Corpo- 
ration, counseled  utilization  of  the  excess-profits  tax,  but  only  in  order 
to  equalize  the  profits  of  the  low-cost  producer.  It  was  his  opinion 
that  reasonable  profits  had  to  be  assured  to  all  manufacturers  in  order 
that  they  might  "do  their  duty."  At  a  meeting  of  the  Price  Fixing 
Committee  with  the  steel  representatives,  held  March  20,  1918,  he 
stated: 

Now  you  wish  to  arrive  at  a  basis  which  will  not  permit  those  companies  best 
integrated  to  receive  any  more  than  a  reasonable  profit  and  yet  permit  the 
smaller,  less  integrated  plant,  with  high  costs,  to  receive  also  a  reasonable  profit. 
I  may  say  that  the  larger  concerns,  including  our  own,  are  willing  to  assist  a  few 
of  the  smaller  plants  if  a  practicable  basis  would  be  ascertained.  This  question  is 
being  studied.  I  don't  know  yet  how  it  can  be  done.  The  chairman  and  some 
of  his  associates  at  least,  are  familiar  with  the  views  of  our  general  committee  as 
to  what  ought  to  be  the  basis  of  settling  this  question,  and  I  must  say  I  have 
been  surprised  that  the  Government  representatives  generally  have  not  fuUy 
considered  and  adopted  this  basis.  That  is,  by  allowing  every  branch  of  industry 
to  realize  fair  and  liberal  profits  and  then  by  taxation,  in  our  case  the  excess- 
profits  tax,  leveling  these  profits.  It  seems  to  all  of  us  so  simple,  so  easy,  that 
the  Government  should  adopt  that  method.  Increasing  the  excess-profits  tax 
if  it  is  desired  so  as  to  compel  such  a  corporation  as  ours,  for  instance,  to  pay 
enough  taxes  to  bring  down  its  net  results  to  practically  the  basis  which  would 
be  fair  and  reasonable  to  the  smaller  manufacturers  and  at  the  same  time  allowing 
them  to  realize  a  good  profit,  fair  profit.  That  would  be  entirelj'  satisfactory  to 
all  of  us  and  certain!}-  ought  to  be  satisfactory  to  the  Government,  because  by 
adopting  that  you  are  maintaining  prosperity  to  the  company,  and  it  would 
enable  all  manufacturers  to  realize  reasonable  profits.  It  would  be  an  easy  as 
well  as  logical  method.  It  would  protect  all  concerned,  especially  the  Govern- 
ment. There  must  be  reasonable  profits  in  all  lines  of  business.  The  manu- 
facturers must  have  reasonable  profits  in  order  to  do  their  duty.i^ 

Mr.  Brookings,  of  the  Price-Fixing  Committee,  apparently  enter- 
tained the  same  view: 

At  an  executive  session  of  the  Price-Fixing  Committee,  held  July  8,  1918,  a 
discussion  took  place  to  determine  to  what  extent,  if  any,  the  excess-profits  tax 
should  be  considered  in  the  fixing  of  prices.  Mr.  IBrookings  submitted  a  memo- 
randum stating  that  the  Price-Fixing  Committee  was  created  to  stabilize  values 
and  prevent  extortionateh-  high  prices.  It  was  not  intended,  however,  unneces- 
sarily to  depress  values  to  a  point  where  there  would  be  little  or  no  excess-profits 
tax.  The  policy  of  the  committee  should  be,  he  believed,  so  to  shape  price  that 
the  less  efficient  or  small  producer  would  receive  a  fair  profit,  even  though  that 
gave  the  larger  and  more  efficient  producer  a  very  liberal  profit.  It  was  expected 
that  the  new  excess-profit  tax  would  equalize  this  discrepancy  by  taking  a  larger 
proportion  of  the  liberal  profits  earned.^" 

The  effect  of  such  views  was,  of  course,  to  shift  the  responsibility 
for  the  limitation  of  profits  to  a  different  administration — the  Treas- 
ury— and  to  postpone  the  determination  of  how  far  profits  should 
be  hmited.  A  corresponding  tendency  was  thus  set  up  for  the  Price- 
Fixing  Committee  not  to  be  concerned  overmuch  about  the  height  of 
prices  from  the  point  of  view  of  limitation  of  profit.  In  Garrett, 
Government  Control  Over  Prices,  it  is  stated  that — 

The  Price-Fixing  Committee  gave  frank  recognition  to  the  fact  that  a  deter- 
mination to  fix  prices  at  the  "bulk  line"  would  give  the  low-cost  producers 
enormously  large  profits.  They  relied,  however,  upon  the  Government  getting 
those  profits  through  the  operation  of  the  excess-profits  tax.  Chairman  Brook- 
ings gave  voice  to  the  sentiment  that  it  made  no  especial  difference  to  the 
Government  whether  those  profits  were  held  in  check  by  the  committee  or  taken 
by  tax. 21 

19  Minutes  of  the  Price- Fixing  Committee,  Mar.  20,  1918. 

20  Garrett,  op.  cit.,  p.  241. 

21  P.  409. 


MUNITIONS    INDUSTRY  65 

It  can  be  seen,  however,  that  the  World  War  tax  legislation  was  not 
designed  to  accomplish  even  the  restricted  purpose  of  profits  equaliza- 
tion. The  taxation  section  of  tliis  report  pointed  out  that  the  highest 
rate  levied  during  the  war  was  80  percent  of  net  income,  less  a  large 
exemption  equal  to  either  the  taxpayer's  pre-war  profits,  or  10  per- 
cent of  its  invested  capital,  whichever  amount  was  greater.  Leaving 
20  percent  of  the  profits  untaxed  meant  that  higher  prices  and  conse- 
quently higher  earnings  ensured  larger  absolute  amounts  of  profits 
after  tax  and  consequently  higher  ratios  of  earnings  to  capital.  For 
example,  at  a  price  which  enabled  a  company  to  earn  $1,000,000 
profit,  $200,000  plus  exemptions  would  be  immune  from  tax.  But  if 
the  price  were  raised  so  that  earnings  doubled  to  $2,000,000,  immune 
income  would  now  amount  to  $400,000 — twice  as  high  a  ratio  to 
capital.  It  would,  therefore,  make  a  good  deal  of  difference  to  the 
low-cost  producer  whether  his  profits  were  checked  by  price  control 
or  were  left  to  taxation. 

Even  more  important  than  this  consideration  was  the  fact  that  once 
a  low-cost  company  had  in  its  possession  the  excessive  profits  ren- 
dered possible  by  the  single  price  system,  all  the  devices  outlined  in 
the  taxation  section  of  this  report  were  available  to  retain  them  and 
to  avoid  payment  of  even  the  war-tax  rates.  The  committee's  study 
of  the  tax  returns  of  a  group  of  important  companies  ^^  shows  that 
according  to  the  final  determination  of  the  Bureau  of  Internal  Rev- 
enue, taxes  were  paid  of  only  25.1  percent  of  their  1917  net  taxable 
income  and  34.9  percent  of  their  1918  income.  Due  account  should 
be  taken  of  the  large  amount  of  profits  which  do  not  appear  as  net 
taxable  income  because  they  were  either  deemed  not  to  be  income  or 
not  taxable  by  one  device  or  another. ^^ 

The  committee's  staff  has  compiled  a  table  of  the  income  and  taxes 
of  major  steel  companies,  as  finally  determined  by  the  Bureau  of 
Internal  Revenue.  The  amounts  of  tax  collected  in  comparison  with 
the  net  taxable  income  earned  shows  why  steelmakers  such  as  Judge 
Gary  were  content  to  have  the  Government  rely  upon  taxation  to 
remove  excess  profits.  Bethlehem  Steel  Corporation,  for  instance, 
made  the  large  sum  of  over  $61,000,000  in  1918,  but  it  paid  a  tax  of 
about  $14,500,000.  In  1918,  when  80  percent  of  war  profits  was 
supposed  to  be  taken  away,  it  paid  taxes  of  only  $2,155,000  on  its 
income  of  over  $16,000,000.  It  is  indicative  of  the  understatement 
in  figures  of  net  income  before  taxes,  that  although  Bethlehem's  net 
taxable  income  was  decided  by  the  Bureau  of  Internal  Revenue  to 
have  decreased  from  1917  to  1918  when  higher  rates  went  into  effect, 
yet  the  companv  increased  its  dividend  pavments  from  $8,100,000  in 
1917  to  $9,300,000  in  1918,  and  the  RepubHc  Iron  &  Steel  Co.  paid 
the  same  dividends  in  1918  as  in  1917,  although  its  net  taxable 
income  had  decreased. 

^2  See  appendix,  p.  139. 

23  See  supra,  p.  27  et  seq.  for  an  analysis  of  the  problems  involved  in  computing  taxable  net  income 
and  see  p.  44  et  seq.,  for  an  analysis  of  some  of  the  devices  referred  to  in  the  text. 


66 


MUNTTIOlSrS    INDUSTRY 
Final  tax  settlements  of  steel  companies 


Company 


Year 


Net  in- 
come before 
taxes 


Taxes 


Net  in- 
come after 
taxes 


Divi- 
dends 


Bethlehem  Steel  Corporation  and  subsidiaries  ' 
Republic  Iron  &  Steel  Co.  and  subsidiaries  2.. 

Jones  &  Laughlin  Steel  Co.^ — -. 

Crucible  Steel  Co.  of  America  and  subsidiaries  ' 

Otis  Steel  Co.« - 

Allegheny  Steel  Co.  L.. 

Lukens  Steel  Co.  and  subsidiaries  - 


/1917 
11918 
/1917 
U918 
/1917 
11918 
fl917 
\1918 
/1917 
11918 
/1917 
11918 
/1917 
11918 


$61, 859,  308 
16,  645,  269 
26,  631,  989 
12,  201,  728 
51,  358,  012 
32,  767,  507 
30,  299,  964 
24,  573,  323 
9, 989,  355 
5, 820,  047 

7,  510, 947 
3,  430,  477 

8,  639,  477 
6,  181, 250 


$14,  417, 948 
2, 155,  777 
9,  904,  339 
5,  290,  685 
20,  081,  271 
17,  090,  598 
6, 853,  968 
14, 121,  973 
4,  654,  689 
3,  716,  275 
3, 168,  965 
1,  755,  314 
2, 839, 156 
1,  588,  422 


$47, 441, 359 
14, 489,  491 
16,  727,  650 
6,  911, 042 
31,  276.  741 
15,  676, 908 
23,  445,  995 
10, 451,  350 
5,  334,  666 
2, 103,  772 

4,  341, 981 
1,  675, 163 

5,  800,  320 
4,  592,  827 


$8, 177,  320 
9, 386, 160 
3,  381, 460 
3,  381, 460 

(.*) 

(*) 
7,  562,  500 
1, 750, 000 

(«) 

(*) 

i*) 

(*) 

(*) 
620, 000 


1  Exhibit  No.  1740-A. 

8  Exhibit  No.  1740-D. 

3  Exhibit  No.  1740-F. 

*  Dividend  figures  not  available. 

»  Exhibit  No.  1740-E— Tax  computations  for  fiscal  years  ending  Aug.  31,  1917,  and  Aug.  31,  1913. 

«  Exhibit  No.  1740-C. 

'  Exhibit  No.  1740-B. 

8  Exhibit  No.  1738— Tax  computations  for  fiscal  years  ending  Oct.  31,  1917,  and  Oct.  31,  1918. 

The  failure  of  taxes  to  remove  excessive  profits  is  equally  apparent  in 
the  copper  industry.  Kennecott  Copper  Corporation,  a  low-cost  pro- 
ducer, whose  1917  costs  were  8  cents  per  pound,  compared  with  the 
average  of  ISji  cents  per  pound,^*  made  more  than  $22,000,000  profit 
in  that  year,  of  which  the  Government  collected  back  only 
$2,036,000.^^  Likewise  the  Inspiration  Consolidated  Copper  Co., 
whose  1917  costs  were  ll'o  cents,^*^  made  over  $9,000,000,  of  which  it 
paid  back  to  the  Government  less  than  $1,000,000.^^ 


Final  tax  settlements  of  copper  companies 


Company 


Kennecott  Copper  Corporation  > 

Ahmeek  Mining  C0.2 

Inspiration  Consolidated  Copper  Co.^ 

Phelps  Dodge  Corporation  * 

East  Butte  Copper  Mining  Co.^ 

Calumet  and  Hecla  and  Torch  Lake  Canal 

Co.,  Consolidated. 6 
Miami  Copper  Co." 


Year 


f  1917 
I  1918 
f  1917 
I  1918 
;  1917 
I  1918 
f  1917 
\  1918 
/  1917 
\  1918 
/  1917 
\  1918 
/  1917 
1  1918 


Net  income 
before  taxes 


$22, 423, 325 

8, 090, 863 

2, 330,  699 

2,  618, 137 

9,  230,  254 

6, 331, 882 

23,  850, 821 

14, 323,  215 

1, 268, 788 

167, 170 

13, 293,  597 

4, 142, 465 

4,  837, 704 

5, 323, 975 


Taxes 


$2, 035, 797 

1, 053,  500 

928, 492 

1, 455, 168 

1, 071, 357 

761, 492 

3, 546,  667 

3, 496,  881 

69, 071 

19, 325 

2,  872,  773 

706, 167 

1,  083, 810 

3, 034, 690 


Net  income 
after  taxes 


$20, 387, 528 

7, 037, 363 

1, 402,  206 

1, 162, 968 

8, 158, 897 

5,  570, 390 

20, 304, 154 

10,  826, 334 

1, 199,  717 

147, 844 

10, 420, 824 

3, 436, 298 

3, 753, 893 

2, 289,  285 


Dividends 


$15, 885, 643 

11,359,636 

2,  800, 000 

1, 600, 000 

9, 451,  227 

9, 455, 736 

10, 800, 000 

10, 800, 000 

831, 731 

632, 774 

8,  500, 000 

5,  500, 000 

6,  537,  247 
3, 362, 013 


1  Exhibit  No.  1716. 

2  Exhibit  No.  1718. 

3  Exhibit  No.  1719. 
*  Exhibit  No.  1721. 


«  Exhibit  No.  1722. 
6  Exhibit  No.  1723. 
?  Exhibit  No.  1720. 


(b)  Impradicahility  oj  the  individual  prices  proposal. — Recognizing 
the  inefiicacy  of  the  tax  system,  Wilham  B.  Colver,  the  Federal  Trade 


2«  Exhibit  No.  1712. 

25  Exhibit  No.  1716 

26  Exhibit  No.  1712. 
2'  Exhibit  No.  1719. 


MUXITIOXS   INDUSTRY  67 

Commission  member  of  the  Price-Fixing  Committee,  suggested  adop- 
tion of  the  individual  prices  proposal.  Under  this  plan,  instead  of 
fixing  a  single  price  on  the  basis  of  the  marginal  cost  producer  for  the 
entire  industry,  separate  prices  would  be  set  for  each  producer  on  the 
basis  of  his  individual  costs.  Lower-cost  producers  would  therefore 
receive  lower  prices  and  there  would  be  less  profits  for  the  tax  system 
to  collect  back. 

Although  the  proposal  appeared  to  hold  low-cost  producers  to 
reasonable  profits,  the  almost  insuperable  difficulties  of  administra- 
tion prevailed  against  its  adoption.  Prunary  among  these  was  the 
necessity  for  checking  the  books  of  large  numbers  of  producers  in 
order  to  prevent  the  addition  to  profit  by  means  of  cost  padding. 
R.  H.  Montgomery,  also  a  member  of  the  Price-Fixing  Committee, 
believed  that  there  were  not  enough  accoimtants  \\'itliin  the  country 
to  undertake  this  task.  In  a  memorandum  to  the  committee,  he 
wrote: 

Cannot  be  effectively  administered,  because  it  is  expected  that  the  machinery 
of  control  will  include  a  system  of  reports  and  inspection  emanating  from  hundreds 
of  producers,  who  have  every  interest  to  overstate  their  costs.  The  available 
supply  of  skilled  accountants  in  this  country  is  exhausted.  The  present  demand 
from  legitimate  sources  greatly  exceeds  the  supply.  My  familiarity  with  this 
matter  leads  me  to  object  to  setting  up  a  S3-stem  of  control  which  is  not  operatively 
possible.  28 

At  pages  87-89  of  this  report  the  difficulties  of  auditing  costs  even 
where  slalled  men  are  available  are  noted. 

Under  tliis  proposal  there  would  also  have  been  raised  the  problem 
of  valuation  since  provision  was  made  for  taking  account  of  cost 
differences  which  were  due  to  the  size  of  the  investment.  In  his 
memorandum  to  the  Price-Fixing  Committee,  Mr.  Colver  wrote: 

Equity  as  between  producers  requires  consideration  of  the  amount  of  the  invest- 
ment and  its  character.  For  instance,  it  is  often  found  that  a  low-furnace  cost 
has  only  been  obtained  by  the  expense  of  a  high  investment  per  ton  of  output, 
while  frequenth-  a  high-furnace  cost  may  be  coupled  with  a  low  investment.  It 
is  obvious  that  the  application  of  a  uniform  unit  profit  without  reasonable  con- 
sideration and  scrutiny  of  investment  will  be  inequitable.  -^ 

The  inherent  complexities  of  valuation  which  have  been  noted  at 
pages  19-24  of  this  report  further  indicate  that  the  results  of  actual 
administration  of  the  proposal  would  probably  have  been  very 
different  from  the  description  of  its  theoretical  operation. 

The  provision  for  governmental  pooling  of  individual  production 
and  resale  under  uniform  prices  in  order  to  put  all  consumers  on  a 
uniform  basis  would  also  have  raised  difficult  administrative  problems. 
This  provision,  however,  is  essential  to  prevent  (1)  the  instability  of 
production  on  the  part  of  high-cost  producers  who  would  be  uncertain 
of  customers  at  their  higher- than-average  prices  and  (2)  the  colossal 
administrative  task  of  policing  the  requirement  that  low-cost  pro- 
ducers must  not  receive,  in  the  form  of  purchase  price  or  rebate,  the 
increased  price  which  many  buyers  would  be  willing  to  pay.  The 
plan  contemplated  the  conduct  of  business  on  the  usual  basis,  pro- 
ducers making  deliveries  directly  to  their  customers  but  receiving 
their  payment  from  the  pool  at  their  individual  prices,  while  con- 
sumers paid  the  composite  price  to  the  pool.  Where  the  product 
was  in  great  demand,  there  would  have  arisen  a  tremendous  task  of 


«3  Garrett,  op.  cit.,  p.  386. 
"  Ibid.,  p.  393. 


68  MUNITIONS   INDUSTEY 

policing  industry  to  prevent  direct  payments  to  sellers  at  other  than 
Government  prices,  and  even  where  bills  were  routed  through  the 
Government  pool  of  preventing  the  payment  of  rebates.  In  addition, 
it  would  have  been  necessary  to  create  a  central  bookkeeping  agency 
through  which  all  the  bills  of  transactions  between  individual  buyers 
and  sellers  would  pass.  Obviously,  if  such  a  plan  were  applied  to  any 
large  part  of  the  country's  industry,  the  central  recording  of  every 
purchase  and  sale  would  cause  in  itself  a  strong  tendency  toward 
delay  in  industrial  production. 

Furthermore,  theoretical  limitation  of  per  unit  profits  of  low-cost 
producers  by  means  of  the  lower  prices  supposedly  guaranteed  under 
this  plan  or  under  the  price-ceiling  scheme  overlooks  the  tremendous 
profits  which  are  gained  by  the  war-time  increase  in  the  volume  of 
business. 

An  increased  turnover  means  greater  profits  because  the  same  rate 
of  earnings  is  being  multiplied  by  the  extent  of  the  turn-over  increase. 
Many  of  the  most  profitable  peace-time  businesses  rely  upon  a  low 
price  with  a  small  per  unit  profit  because  of  the  quantity  sales  that 
are  thereby  insured.  To  this  increase  in  total  volume  of  profits  must 
be  added  the  increased  profit  due  to  increase  in  the  rate  of  profit 
which  comes  from  the  fact  that  increased  war  sales  are  procured  with 
relatively  little  increased  sales  cost  and  the  fact  that  where  there  has 
been  idle  capacity  there  is  also  relatively  little  increase  in  overhead 
costs. 

As  an  example  of  the  operation  of  these  factors  Mr.  Baruch  has 
cited  a  company  which,  if  it  increased  its  turn-over  four  times,  would 
be  able  to  increase  its  profits  830  percent  of  its  normal  profit  of  10 
percent  on  its  invested  capital;  and  even  after  paying  an  excess-profits 
tax  of  80  percent  would  still  retain  earnings  amounting  to  160  percent 
of  its  normal  profits: 

Consider,  for  example,  the  simple  case  of  a  company  capitalized  for  $1,000,000, 
selling  $1,000,000  worth  of  goods  annually,  making  20-percent  gross  profit,  or 
$200,000  on  its  turn-over,  and  having  $100,000  of  expenses  of  administration 
and  selling,  leaving  a  net  profit  of  $100,000,  or  10  percent,  on  both  its  normal 
turn-over  and  its  capital.  Suppose  also  that  10  percent  of  its  cost  of  manufac- 
ture, or  $80,000,  are  fixed  overhead  charges — depreciation,  maintenance,  super- 
vision, taxes,  etc.  Then  its  costs  for  material  and  direct  labor  are  $720,000  for 
every  million  dollars'  worth  of  goods  it  sells.  Now,  suppose  that  war  comes 
and  we  need  the  full  capacity  of  that  plant.  We  give  it  orders  for  $4,000,000 
worth  of  goods,  to  be  delivered  in  a  single  year.  It  has  no  increased  selling  and 
general  administrative  expense,  because  the  demand  is  so  great  that  no  such 
effort  is  required.  Neither  do  the  fixed  overhead  elements  of  its  manufacturing 
costs  increase  greatly — say,  only  to  $90,000.  What  happens  to  the  profits  of 
that  plant?  Its  material  and  direct  labor  costs  on  its  $4,000,000  sales  are  $2,880,- 
000.  To  this  it  must  add  $90,000  for  fixed  overhead  charges  in  its  factory  and 
$100,000  for  general  and  administrative  expense,  making  a  total  cost  for  goods 
sold  of  $3,070,000.  Its  net  profit  is,  therefore,  $930,000,  or  930  percent,so  of 
its  normal  profits  in  peace.  It  is  making  nearly  100  percent  on  its  investment, 
and  its  net  profit  on  turn-over  has  increased  from  10  to  23  percent.  Even  if  we 
assess  a  tax  of  80  percent  on  the  $830,000  of  excess  over  peace  profit,  that  plant 
will  still  be  making  $260,000,  or  260  percent  ^i  of  its  normal  profits. 

I  want  you  particularly  to  note  that  this  example  considers  no  increase  in 
price  whatever.32 

(c)  Price  regulation  of  monopoly  business. — Where  excessive  profits 
are  gained  by  well  integrated  low-cost  companies  in  nonmonopolistic 
fields  of  business  it  becomes  exceedingly  difficult  to  limit  the  profits 

3"  Corrected  to  830  percent. 
31  Corrected  to  160  percent. 
82  War  Policies  Commission  hearings,  op.  cit.,  p.  798. 


MUNITIONS    INDUSTRY  69 

of  monopolies  who  may  point  to  these  other  companies  as  the  basis 
for  a  plea  of  uniformity  of  treatment  and  who  may  even  invoke  the 
Constitution  on  the  ground  that  their  property  is  being  subjected  to 
confiscation.  Study  of  these  industries  in  the  last  war  shows  that 
even  with  the  reduced  difficulty  of  administration,  war  profits  were 
not  limited. 

(1)  The  aluminum  industry. — In  aluminum  price  fixing  the  compli- 
cating factor  of  high-cost  producers  was  absent  inasmuch  as  there  was 
only  one  important  operator,  i.  e.,  the  Aluminum  Co.  of  America. 
According  to  the  report  of  the  War  Industries  Board :^^ 

The  industry  in  the  United  States  is  in  the  hands  of  one  concern,  the  Aluminum 
Company  of  America,  which  owns  numerous  plants  in  the  United  States  and  one 
in  Quebec,  Canada.  It  is  the  sole  producer  of  virgin  metal,  and  it  controls  prop- 
erties covering  practically  every  step  and  process  in  the  industry  from  the  mining 
of  bauxite  ore  through  the  finished  castings  and  utensils. 

The  committee  has  found,  however,  that  the  single  producer  in 
this  field  had  a  consolidated  net  taxable  income  for  the  year  1917  of 
$25,840,326  which  was  40.8  percent  of  its  consolidated  invested 
capital.  Of  this  profit  a  tax  of  $9,114,909  was  collected.  Taxes  in 
the  year  1918  decreased  to  a  sum  of  $2,260,230.  Net  taxable  in- 
come decreased  to  $10,417,814  but  income  before  amortization  de- 
ductions was  $21,386,360,^*  and  the  production  of  aluminum  bv  the 
company  only  changed  from  129,860,592  pounds  in  1917  to  124,724,924 
in  1918.'' 

The  first  price  determination  in  the  aluminum  industry  was  in 
connection  with  the  preparedness  campaign.  In  April  1917,  an 
agreement  was  entered  into  with  the  Government  for  the  sale  of 
8,000,000  pounds  of  aluminum  ingots  at  27)2  cents  a  pound.'^  The 
price  was  apparently  fixed  on  the  same  basis  as  the  remainder  of  the 
preparedness  campaign,  i.  e.,  "to  sell  their  own  Government  its  war 
needs  at  pre-war  prices."  '^  It  should  be  noted,  however,  that  the 
10-year  average  of  prices  from  1907  to  1917  of  25.543  cents  was  in- 
creased to  27)2  cents  because  of  a  claimed  increase  in  the  cost  of  pro- 
duction '^  and  that  inclusion  of  the  inflated  values  of  the  war  years 
prior  to  our  entry  raised  the  price  7)2  cents  above  the  normal  level  of 
20  cents  prevailing  before  the  commencement  of  the  European  war.'^ 

Furthermore,  on  the  basis  of  the  Federal  Trade  Commission's 
report  that  the  cost  of  production  of  aluminum  ingots  was  15)^  cents 
in  1917,*''  a  per-unit  profit  margin  of  more  than  80  percent  was  obtain- 
able. It  must  also  be  realized  that  this  gift  price  applied  only  to  a 
small  percentage  of  the  total  primary  aluminum  production  of  the 
United  States,  which  in  1917,  was  approximately  143,300,000  pounds.*^ 

The  bulk  of  production  was  sold  at  much  higher  prices.  In  Sep- 
tember 1917  the  Aluminum  Co.  agreed  with  the  War  Industries  Board 
"to  accept  direct  and  indirect  orders  at  the  prevailing  contract  prices" 
which  were  38  cents,  provision  being  made,  however,  for  refund  by  the 
company  of  any  differences  between  this  and  the  future  fixed  price. *^ 

33  p.  148. 

3«  Exhibit  Xo.  1746. 

35  Aluminum  Co.  of  America  letter  to  the  committee  dated  May  23,  1935,  printed  in  appendix  to  that 
part  of  Hearinjis  in  which  Exhibit  No.  1746-B  appears. 

39  Report  of  the  War  Industries  Board,  p.  149. 

"Ibid.,  p.  131. 

"  Exhibit  no.  1747. 

39  In  August  1914  the  contract  price  of  9S-99  percent  aluminum  was  $0.19  per  pound  and  the  open-market 
price  was  .$0.1988  per  pound.    War  Industries  Board  Price  Bulletin  No.  34,  p.  84. 

<o  Exhibit  no.  1747. 

«  E.xhibit  no.  1746. 

«  Report  of  the  War  Industries  Board,  p.  149. 


70  MUNITIONS    INDUSTRY 

On  February  28,  1918,  the  price  of  ingots  was  fixed  at  32  cents  per 
pound,  which  represented  a  decrease  of  6  cents  from  the  prevailing 
contract  price.  The  usual  method  of  computing  the  price  reduc- 
tion from  the  spot  price  of  60  cents  per  pound  creates  an  erroneous 
impression  since  most  of  the  aluminum  production  was  sold  on  a 
contract  basis.  Mr.  Davis,  president  of  the  Aluminum  Co.,  testified 
before  the  House  Committee  on  Foreign  Affairs  on  June  6,  1917,  as 
follows: 

In  this  way  our  entire  product  has  been  shipped  and  delivered  to  the  United 
States  consumers  from  the  beginning  of  the  war  to  the  present  time  at  prices 
in  no  case  in  excess  of  37  cents  a  pound,  and  averaging,  perhaps,  about  32  cents 
a  pound.  The  average  price  that  we  received  for  all  of  our  products  during  the 
month  of  April  1917  just  passed  was  35  cents  per  pound. 

You  wiU  see,  therefore,  that  the  statement  or  impression  that  we  are  selling  our 
product  to  the  United  States  consumers  at  60  cents  a  pound  is  as  erroneous  as 
such  a  statement  could  possibly  be.^^ 

On  the  basis  of  the  IS^-cent  cost  estimate  of  the  Federal  Trad© 
Commission,  there  was  a  per-unit  profit  margin  of  more  than  100  per- 
cent. But  even  this  price  was  raised  to  33  cents  per  pound  on  May  9, 
1918. 

We  also  find  an  allegation  of  the  Government  that  the  Aluminum 
Co.  of  America  has  not  fulfilled  its  obligation  in  respect  to  refunding 
the  difference  between  the  contract  and  fixed  prices.  In  a  recent 
suit  by  the  Aluminum  Co.  of  America  against  the  United  States,  the 
Government's  counterclaim  states  that  although  a  joint  audit  has 
settled  that  $1,540,473  is  the  amount  to  be  refunded,  the  Aluminum 
Co.  has  repaid  $263  directly  and  a  similar  amount  indirectly.**  To 
the  extent  that  the  Aluminum  Co.  succeeds  in  this  course  of  action 
it  will  have  nullified  the  attempt  at  price  fixing. 

One  of  the  company's  defenses  to  the  counterclaim  attempts  to 
accomplish  the  same  end  by  way  of  a  constitutional  objection.  It 
contends  that: 

If  these  attempts  [the  price  announcements  of  Feb.  28,  1918,  and  May  9,  19181 
were  price-fixing  proclamations,  and  were  intended  to  apply  to  contracts  made 
prior  to  September  24,  1917,  they  would,  with  respect  to  such  contracts,  deprive 
the  plaintiff  of  its  property  without  due  process  of  law  and  take  the  said  property 
for  public  use  without  just  compensation  in  violation  of  the  fifth  amendment  to 
the  United  States.^ 

although  almost  all  the  1917  and  1918  deliveries  had  been  contracted 
for  prior  to  the  commencement  of  price  fixing.  Committee  Print 
No.  3  states: 

The  Aluminum  Co.  advanced  its  base  price  on  contracts  from  37  cents  to  38 
cents  in  March  1917,  and  it  is  stated  that  practically  all  of  the  metal  for  1917 
and  1918  deliveries  was  contracted  for  in  March  and  April  of  the  earlier  year.*^ 

(2)  The  nickel  industry. — The  nickel  industry  is  controlled  by  the 
International  Nickel  Co.,  according  to  the  report  of  the  War  Indus- 
tries Board — *^ 

The  war  required  directly  or  indirectly  nearly  90  percent  of  our  nickel  supply, 
but  the  problem  of  controlling  the  price  and  distribution  was  a  very  simple  one,. 

"  Exhibit  no.  1747. 
"  Exhibit  no.  1747. 
«  Exhibit  no.  1745. 
<'  P.  182. 
«P.  152. 


MUXITIOXS    IXDUSTRY 


71 


because  the  country's  production  is  practically  all  in  the  hands  of  one  company, 
the  International  Nickel  Co.  This  company  brings  the  raw  material,  in  the 
form  of  "matte"  and  ore,  from  the  Sudbury  deposits,  Ontario,  Canada,  and 
refines  them  at  Bayonne,  N.  J.  A  small  quantity  of  "matte"  comes  also  from 
New  Caledonia  and  from  Tasmania. 

Again  the  committee  finds  that  even  with  the  absence  of  a  number 
of  producers  operating  at  varj-ing  costs  and  the  consequent  necessity 
for  a  high  price  to  keep  high-cost  producers  in  operation,  that  the  com- 
pany having  the  monopoly  in  this  field  had  a  high  net  income,  namely, 
813,992,729  in  the  year  ended  March  31,  191S,  according  to  the  final 
determination  of  the  Bureau  of  Internal  Revenue.  Taxes  in  that 
period  were  $3,131,422.  The  amount  of  profit  taken  away  by 
taxation  is  represented  in  the  decrease  of  the  percentage  of  income 
to  invested  capital  from  23  percent  to  17.7  percent,  a  difference  of  5.3 
percent  of  invested  capital.  Dividends  paid  for  the  fiscal  vear  ending 
March  31,  1918,  were  $8,483,330.*^ 

The  first  price  was  agreed  upon  in  August  1917.  The  figure  of 
40  cents  per  pound  of  ingot  nickel  was  determined  by  reference  to 
the  price  International  Nickel  was  charging  the  Canadian  Govern- 
ment. Apparently  it  was  not  felt  that  the  United  States  should  get 
the  benefit  of  a  price  lower  than  the  charge  to  the  Allies.  The 
minutes  of  the  War  Industries  Board,  August  17,  1917,  reported: 

Mr.  Baruch  presented  a  communication  dated  August  15  from  the  Ordnance 
Department,  No.  G-4701  7/11  relative  to  an  arrangement  with  the  nickel  inter- 
ests for  supplying  nickel  to  the  Government  at  the  same  price  as  to  the  Canadian 
Government,  and  stated  that  the  price  of  40  cents  was  now  offered  by  the  Nickel 
interests. 

It  was  moved  and  carried  by  the  Board  that  this  price  should  be  considered 
satisfactory.^^ 

A  Federal  Trade  Commission  study  shows  that  it  cost  Inter- 
national Nickel  less  than  half  of  this  price  to  produce  ingot  nickel, 
the  exact  amount  being  $0.18786.^" 

On  January  8,  1918,  a  new  schedule  of  prices  was  agreed  upon. 
There  are  set  forth  the  prices  fixed  by  the  War  Industries  Board  and 
the  costs  of  the  International  Nickel  Co.  as  determined  by  the 
Federal  Trade  Commission:  ^^ 


Jan.  8, 191S 

(prices  per 

pound) 

July  1917 
(costs  per 
pound) 

February 
1918  (costs 
per  pound) 

Ingot  nickel  .- - 

$0.35 
.40 
.32 

$0. 18786 
. 23787 
.  17313 

$0. 2201 

Electrolytic  nickel- -  .  . 

.2972 

Monel  metal 

.2121 

These  prices  prevailed  for  the  remainder  of  the  continuance  of  the 
war.  Mr.  Pope  Yeatman,  chief  of  the  nonferrous  metals  section  of 
the  War  Industries  Board,  sent  a  memorandum  to  Mr.  Brookings, 
Chairman  of  the  Price  Fixing  Committee,  recommending  that  there 
be  no  downward  revision  in  prices.  He  felt  that  the  Federal  trade 
figures  of  26.58  cents  based  upon  $0.22  costs  plus  10  percent  allow- 

4s  Exhibit  No.  1750. 
4»  Exhibit  No.  1749. 
«« Ibid. 
"  Ibid. 


72  MUISriTIONS    INDUSTRY 

ance  on  the  investment  was  entirely  too  small.  The  major  factor 
in  his  argument  was  that,  before  the  war,  prices  of  35  cents  to  40 
cents  a  pound  were  quoted.  Even  though  these  prices  represented  a 
margin  of  more  than  100  percent  of  the  cost,  Mr.  Yeatman  thought 
that  "while  high  prices  have  been  received,  there  has  been  nothing 
savoring  of  profiteering,"  ^^ 

The  increased  profits  resulting  from  increased  production  were  not 
thought  by  the  Price  Fixing  Committee  to  be  a  factor  justifying  price 
decrease.  Its  attitude  is  represented  in  the  following  statement  made 
by  Mr.  Brookings  at  the  May  20,  1918,  meeting: 

Of  course  we  know  that  our  war  needs  have  enormously  increased  the  con- 
sumption of  nickel.  The  Navy  program  and  the  Army  program  have  required 
nickel  for  alloying  certain  steel  and  has  doubled  your  production  and  has,  of 
course,  enormously  increased  your  profits.  We  are  not  in  an  attitude  of  envying 
you  your  profits;  we  are  more  in  the  attitude  of  justifying  them  if  we  can.  That 
is  the  wa}-  we  approach  these  things.^* 

The  Canadian  source  of  nickel  represents  an  additional  difficulty 
involved  in  attempting  to  control  war  profits,  namely,  those  gained  on 
goods  produced  in  foreign  countries.  The  costs  of  an  American 
company  may  be  increased  by  the  simple  device  of  increasing  the 
price  of  the  raw  material  as  it  is  conveyed  to  it  by  the  foreign  branch. 
Determination  of  the  foreign  costs  will  in  general  depend  upon  the 
company's  un verifiable  statements. 

(3)  The  sulphur  industry. — During  the  war  period,  sulphur  was  sold 
to  the  Government  at  a  price  of  $22  per  long  ton,  which  was  the 
uniform  price  quoted  for  every  month  from  January  1913  to  March 
1916,  when  the  first  rise  was  registered.^*  The  field  was  in  the  hands 
of  only  two  companies,  the  Union  Sulphur  Co.  and  the  Freeport  Sul- 
phur Co. 

On  August  6,  1917,  a  letter  was  sent  to  Mr.  Henry  Whiton,  chair- 
man of  the  committee  on  sulphur,  at  the  direction  of  the  Paymaster 
General  of  the  Navy,  asking  for  an  opinion  as  to  what  constituted  a 
reasonable  price  based  upon  cost  of  production  rather  than  prevailing 
or  pre-war  market  price.     The  letter  reads  iu  part  as  follows: 

At  the  time  of  the  last  purchase  of  Navy  requirements,  the  Union  Sulphur  Co. 
offered  the  amount  required  at  a  price  of  $22.50  per  ton.  In  view  of  the  market 
prices  current  at  that  time  and  the  fact  that  the  offer  of  the  Union  Sulphur  Co. 
was  apparently  based  upon  pre-war  prices,  the  quotation  of  the  Union  Sulphur 
Co.  was  accepted  and  appreciated  by  the  Navy. 

Since  that  time,  the  Government's  price  policy  has  been  more  definitely 
established  and,  so  far  as  it  can  now  be  interpreted,  it  is  that  manufacturers 
should  supply  the  Government's  demands  at  fair  and  just  prices  and  in  fact, 
authority  has  been  granted  to  the  Government  to  place  orders  with  producers  on 
such  a  basis. 

The  difficulty  of  determining  what  constitutes  a  fair  and  just  price  is  obvious. 
However,  the  present  policy  is  to  base  this  price  upon  the  cost  of  production 
plus  a  reasonable  profit,  considering  industry  as  a  whole;  in  other  words,  to  judge 
of  the  reasonableness  of  prices  from  the  standpoint  of  the  cost  of  production 
rather  than  from  the  prevailing  or  previously  current  market  prices.  Under  this 
plan,  the  purpose  is  to  be  as  liberal  as  possible  allowing  manufacturers  the  benefit 
resulting  from  efficient  methods  of  production,  in  case  after  [other?]  domestic 
manufacturers  in  the  same  line  produce  at  higher  costs  and  provided  that  the 
products  of  these  other  manufacturers  are  required  to  meet  Government  needs.^^ 

62  Exhibit  Xo.  1749. 

63  Exhibit  No.  1747. 

6«  War  Industries  Board  Price  Bulletin  No.  45,  Prices  of  Mineral  Acids,  p.  16. 
65  Exhibit  No.  1751. 


MUNITIONS    INDUSTRY  73 

Union  Sulphur  Go's,  unit  costs  including  depletion  were  $6.82  per 
ton  in  1917  according  to  its  own  income  tax  returns/*^  Application 
of  the  cost  of  production  formula  to  this  industry  would  thus  have 
shown  that  at  the  Government  price  a  monopoh'  company  was  making 
a  per  unit  profit  of  more  than  200  percent. 

On  August  20,  1917,  the  Paymaster  General  reiterated  the  Navy's 
request  for  a  statement  of  the  basis  upon  which  it  was  decided  by  the 
committee  on  chemicals  that  $22  per  long  ton  was  a  reasonable  price. 
The  Paymaster  wrote: 

In  view  of  the  fact  that  the  committee  on  chemicals  has  thoroughly  canvassed 
the  situation  in  regard  to  sulphur  with  a  view  of  determining  upon  a  reasonable 
price  and  believes  that  $22  per  long  ton  at  the  mines  represents  such  a  price,  it  is 
suggested  that  the  committee  formulate  a  statement  of  the  basis  upon  which  this 
conclusion  was  reached  for  the  approval  of  the  War  Industries  Board  and  for 
submission  by  the  War  Industries  Board  to  the  various  departments  for  their 
formal  approval." 

In  response  to  this  request,  Mr.  Nichols,  chairman  of  the  committee 
on  chemicals,  explained: 

In  suggesting  to  the  Union  Sulphur  Co.  that  they  quote  the  Navy  S22  per  ton 
f .  0.  b.  mines,  it  was  with  the  idea  of  carrying  out  exactly  what  is  being  done  for 
everybody  else  except  that  no  ordinary  buyer  is  permitted  to  contract,  not  know- 
ing what  "the  Government  needs  will  be.  In  the  ease  of  the  Navy,  I  asked  the 
Union  Sulphur  Co.  to  arrange  in  case  a  lower  price  was  made  for  anyone  that  the 
Navy  should  have  the  benefit  of  it  on  the  undelivered  portions. ^s 

On  September  7,  1917  Mr.  Bingham,  secretary  of  the  War  Indus- 
tries Board,  stated  in  a  memorandum  to  Admiral  Fletcher  relating 
to  the  method  by  which  the  sulphur  price  was  determined: 

Second,  asking  how  recommendations  were  arrived  at,  it  was  the  opinion  of 
the  Board  that  it  was  unnecessary  and  impossible  for  the  Board  to  present  their 
reasons  for  decisions  when  making  recommendations.^^ 

Finally  on  September  12,  1917,  the  War  Industries  Board  wrote 
the  Paymaster  General  that  the  price  was  fair  but  gave  no  reason  for 
its  determination: 

This  matter  has  been  investigated  by  a  committee,  and  it  has  been  found  that 
considering  the  condition  of  the  market  and  other  circumstances,  that  a  price  of 
$22  per  ton  at  the  mine  is  as  fair  and  just  a  price  as  can  be  obtained  at  present.^" 

The  tax  statements  of  the  Union  Sulphur  Co.,  however,  show  that 
in  1917,  according  to  the  final  determination  of  the  Bureau  of  Internal 
Revenue,  its  net  taxable  income  was  $7,211,000,  representing  a  return 
of  49  percent  of  its  invested  capital  of  which  it  paid  $2,613,000  in 
taxes.  In  1918  its  net  taxable  income  according  to  its  own  report 
was  $10,568,000,  representing  a  return  of  58  percent  of  its  invested 
capital,  of  which  it  paid  taxes  of  $5,794,000.^^ 

(2)    BUSINESS    INTERESTS    OF    THE    PRICE-FIXING    ADMINISTRATION 

In  the  last  war  there  was  a  very  close  connection  between  business 
and  the  price-control  administration,  either  through  the  actual  pres- 
ence of  interested  parties  in  governmental  posts,  or  through  the  reh- 

«6  Bernard  M.  Baruch,  Mar.  29,  1935. 

t"  Exhibit  No.  1752. 

»  Exhibit  No.  1753. 

"  Exhibit  No.  1754. 

M  Exhibit  No.  1755. 

"  Exhibit  No.  17o5-A. 


74  MuisriTioisrs  industry 

ance  on  business  representatives  for  advice  and  information  con- 
cerning their  owai  industries.  This  condition,  wliich  must  prevail  if 
the  persons  who  are  in  direction  of  industry  in  peacetime  are  to  aid 
in  its  wartime  control,  results  in  the  creation  of  a  powerful  counter- 
poise in  the  shape  of  double  interest  to  the  elimination  of  war  profits. 
It  is  necessary  to  recognize  that  such  devices  as  the  formal  severance 
of  relationships  or  the  discontinuance  of  company  compensation  for 
the  duration  of  the  war  do  not  extinguish  the  real  interest  of  the 
official  in  his  company  since  in  most  cases  he  will  return  to  it  with 
the  coming  of  peace.  Furthermore,  there  will  always  be  a  strong 
tendency  not  to  antagonize  business  connections  wliich  may  have 
been  built  up  over  a  long  period  of  years  and  from  which  future 
benefit  can  be  expected.  Finally,  as  was  the  case  in  the  World 
War,  there  is  the  very  direct  interest  which  comes  from  stock  owner- 
sliip  in  companies  subject  to  regulation. 

These  definite  mterests,  combined  with  the  habits  of  thought  and 
the  personal  associations  of  men  who  have  spent  their  lives  in  private 
enterprise,  make  for  a  sympathetic  attitude  toward  the  complaints 
of  those  who  remain  in  charge  of  industrial  operations  and  a  willing- 
ness to  rely  upon  the  information  presented  by  industry. 

The  parent  body  of  the  many  administrative  agencies  set  up  to 
control  industry  during  the  war  was  the  Council  of  National  Defense. 
Its  creation  was  authorized  in  the  Army  Appropriation  Act  approved 
August  29,  1916,  and  its  formal  organization  occurred  on  October  11, 
1916.  There  were  two  bodies  in  the  Council,  one  composed  of  6 
Cabinet  Secretaries,  and  the  other  Ivnown  as  the  Advisory  Com- 
mission, composed  of  7  private  citizens.  These  latter  were  Bernard 
M.  Baruch,  Daniel  Willard,  Holhs  Godfrey,  Howard  E.  Coffin, 
Franklin  H.  Martin,  Samuel  Gompers,  and  Julius  Rosenwald. 

Divisions  and  committees  were  soon  added  to  the  Council.  On 
February  28,  1917,  a  body  known  as  the  Munitions  Standards 
Board  was  formed  and  a  month  later  the  General  Munitions  Board 
was  organized  with  Frank  A.  Scott  as  chairman.  According  to  the 
War  Industries  Board  report,^-  this  body  had  the  same  chairman  and 
included  the  same  ci\'ilian  personnel  as  the  Munitions  Standards 
Board. 

The  names  and  industrial  connections  of  the  members  of  this  Board 
were  read  by  Chairman  Willard  at  the  February  28,  1917,  meeting  of 
the  Council  of  National  Defense.     They  are  as  follows: 

W.  H.  Vandervoort,  Root  &  Vandervoort,  builders  of  special  machine  tools 
and  president  of  the  Moline  Automobile  Co. 

E.  A.  Deeds,  formerh'  general  manager  of  the  National  Cash  Register  Co., 
president  of  the  Dayton  Engineering  Laboratories  Co.,  and  interested  in  many 
industrial  activities. 

Frank  A.  Scott,  Warner  &  Swasey  Co.,  Cleveland,  manufacturers  of  automatic 
machinery  and  optical  instruments. 

Frank  Pratt,  General  Electric  Co.,  Schenectady. 

Samuel  Vauclain,  Baldwin  Locomotive  Works,  Remington,  and  Westinghouse 
Cos. 

John  E.  Otterson,  vice  president,  Winchester  Arms  Co.^^ 

62  P.  21. 

63  Exhibit  No.  1245. 


MUXITIOXS    IXDUSTRY  75 

With  the  commencement  of  the  speculative  price  rises  which  at- 
tended our  entrance  into  the  war,  the  Advisory  Commission  of  the 
Council  of  National  Defense  formed  a  number  of  committees  to  deal 
wdth  the  commodities  that  were  especially  subject  to  war  demand. 
The  report  of  the  War  Industries  Board  states  the  purpose  of  the 
organization  of  these  committees  to  have  been  the  provision  of  a 
source  of  information  for  the  Government  as  to  the  supply  capacities 
of  industry  and  a  similar  source  for  industry  as  to  the  needs  of  the 
Government.     Also: 

The  question  of  fair  prices  and  suitable  methods  for  making  equitable  distribu- 
tion of  Government  orders  could  be  discussed  by  the  Advisory  Commission  with 
these  committee  members,  who  were  for  the  most  part  the  most  influential  and 
best  informed  men  in  their  respective  lines  of  business.^* 

It  was  found  that  the  very  qualities  which  made  the  members  of  the 
committees  and  the  boards  useful  because  of  their  experience  also 
raised  the  question  of  double  interest.  For  instance,  at  the  June  5, 
1917,  meeting  of  the  General  jMunitions  Board  the  minutes  state  that 
Chairman  Frank  Scott  retired  when  consideration  was  made  of  a 
communication  from  the  Ordnance  Department  regarding  a  proposed 
arrangement  with  the  Warner  &  Swase}^  Co.  for  the  manufacture  of 
3,000  panoramic  sights  for  the  field  artillery.  The  Board,  proceeding 
on  its  deliberations  in  the  absence  of  Mr.  Scott,  found  the  price  to  be 
fair  and  just  and  recommended  that  the  orders  be  placed. ""^ 

In  the  minutes  of  July  13,  1917,  there  is  report  of  the  Board's 
acceptance  of  the  resignation  of  Mr.  Hanson  as  chairman  of  the 
machine-gun  committee.  He  tendered  his  resignation  "due  to  his 
having  accepted  a  position  ^vith  the  Colt's  Patent  Fire  Arms  Manu- 
facturing Co.,  who  were  to  receive  and  had  received  Government 
orders  for  machine  guns."  ^'^ 

A  memorandum  approved  by  the  Secretary  of  War  was  presented 
at  the  June  20,  1917,  meeting  asking  the  Board  to  reconsider  its 
recommendation  of  the  Thompson-Starrett  Co.  to  build  the  canton- 
ment at  Yaphank,  Long  Island,  because  of  the  interest  in  that  com- 
pany of  W.  A.  Starrett  who  was  Chairman  of  the  Committee  on 
Emergency  Construction.  The  Board  referred  the  matter  of  Mr. 
Starrett's  interest  in  the  Thompson-Starrett  Co.  and  the  George  A. 
Fuller  Co.  for  investigation.  On  the  next  day  it  was  reported  that 
his  interest  in  the  former  company  had  ceased  about  4  j^ears  ago  and 
that  his  brother  was  the  president  of  the  latter." 

The  report  of  the  War  Industries  Board  hints  at  the  difficulties 
which  arose  from  the  nature  of  the  personnel  of  the  committees  that 
were  aiding  in  the  procurement  work  of  the  Government.  It  states 
that — 

Dissatisfaction  began  to  come  to  light  on  the  part  of  firms  not  directly  repre- 
sented on  the  committees.  The  possible  misconception  of  the  position  of  tbe 
<?ommittees  in  appearing  to  represent,  even  in  a  vague  sense,  both  the  buying  and 
selling  interests,  was  very  soon  felt."^ 

The  Munitions  Board  itself  began  to  respond  to  the  criticism.  On 
June  19,  1917,  Major  Stimpson  was  requested  by  the  Board  to  investi- 

M  Report  of  the  War  Industries  Board,  p.  21. 
M  Exhibit  No.  1251. 

66  Ibid. 

67  Ibid. 

'^Report  of  War  Industries  Board,  p.  22. 


76  MUNITIONS    INDUSTRY 

gate  new  methods  of  organization  which  would  settle  the  problem 
of  double  interest.     It  was  said  at  the  meeting: 

This  is  particularly  necessary  in  relationship  to  the  membership  on  a  board 
or  subcommittee  of  a  man  who  is  actively  interested  in  a  concern  which  may 
benefit  bj'  the  awarding  of  a  contract  concerning  the  recommendation  of  which 
the  subcommittee  or  board  has  some  authority. s» 

However,  on  July  28,  1917,  the  minutes  of  the  executive  committee 
of  the  General  Munitions  Board  contain  a  copy  of  a  telegram  which 
was  sent  by  Mr.  Julius  Rosenwald,  a  member  of  the  Board,  to  Presi- 
dent Wilson.  This  registered  vigorous  protest  against  a  provision 
in  a  pending  bill  which  attempted  to  handle  the  problem  of  interest 
in  corporations  receiving  Government  orders  by  men  in  advisory 
capacity  to  the  Government.     The  telegram  follows: 

Dear  Mr.  President.  It  is  of  the  most  vital  importance  that  the  rider  in 
the  food  bill  referring  to  the  Advisory  Commission  and  its  method  of  securing 
supplies  be  stricken  out.  To  cast  suspicion  on  men  in  many  industries  who 
without  exception  have  been  eager  to  serve  the  Government  rather  than  them- 
selves will  destroy  a  spirit  which  should  be  encouraged.  The  committees  repre- 
senting these  industries  have  succeeded  in  instilling  and  securing  a  loj'alty  to 
the  Government  from  many  in  their  own  lines  that  could  never  have  been  pro- 
duced under  the  old  system.  Even  at  this  early  stage  of  the  war  the  savings 
to  the  Government  due  to  this  desire  to  serve,  runs  into  many  tens  of  millions 
of  dollars.  Having  been  entrusted  with  a  responsibilitj'  to  protect  and  serve 
their  Government  interests  a  patriotism  has  been  aroused  in  these  men  which  is 
absolutely  necessary  to  secure  rapid  production.  It  is  probably  impossible  to 
devise  any  plan  which  is  dishonesty  proof  but  any  man  of  standing  in  his  pro- 
fession or  industry  will  sacrifice  everything  rather  than  be  unfaithful  to  his  trust. 
At  any  rate,  such  has  been  my  experience  with  the  men  who  have  served  as 
advisers  to  the  Commission  which  I  have  had  the  honor  to  appoint.  The  present 
system  should  not  be  destroyed  until  a  better  one  is  found.  If  changes  in  method 
are  desirable  they  can  be  made  after  proper  in\estigation.  It  is  vital  that  the 
cooperation  which  has  already  been  established  should  be  maintained  and,  further- 
more, it  is  of  greatest  importance  that  confidence  exist  between  Government 
and  industrv  and  that  suspicion  which  has  existed  on  the  part  of  both  be  elimi- 
nated.™ 

On  July  28,  1917,  the  General  Munitions  Board  was  superseded  by 
the  War  Industries  Board.  This  action  was  taken  "with  the  approval 
of  the  President",  and  its  purpose  was  stated  in  the  minutes  of  the 
meeting  of  the  Council  of  National  Defense  as  follows: 

— to  expedite  the  work  of  the  Government,  to  furnish  needed  assistance  to  the 
departments  engaged  in  making  war  purchases,  to  devolve  clearly  and  definitely 
the  important  tasks  indicated  upon  direct  representatives  of  the  Government  not 
interested  in  commercial  and  industrial  activities  with  which  they  will  be  called 
upon  to  deal,  and  to  make  clear  that  there  is  total  disassociation  of  the  industrial 
committees  from  the  actual  arrangement  of  purchases  on  behalf  of  the  Govern- 
ment. It  will  lodge  responsibility  for  effective  action  as  definitely  as  is  possible 
under  existing  law.  It  does  not  minimize  or  dispense  with  the  splendid  service 
which  representatives  of  industry  and  labor  have  so  unselfishly  placed  at  the 
disposal  of  the  Government.^' 

Unlike  the  practice  in  the  change  of  the  Munitions  Standard  Board 
to  the  General  Munitions  Board,  some  change  was  made  in  the  per- 
sonnel of  the  War  Industries  Board.  Robert  S.  Brookings  was  named 
commissioner  of  finished  products;  Robert  S.  Lovett,  priorities  com- 
missioner; Hugh  A.  Frayne,  labor  commissioner;  Col.  Palmer  E. 
Pierce,   Army   representative;   Rear  Adm.    T.    F.    Fletcher,    Navy 

6»  Exhibit  No.  1251. 

7'  Ibid. 

'1  Exhibit  No.  1269. 


MUNITIOiSrS    IXDUSTEY  77 

representative;  Bernard  M.  Baruch,  commissioner  of  raw  materials; 
and  Frank  A.  Scott,  chairman  of  the  board. ^^ 

In  March  1918,  the  President  separated  the  War  Industries  Board 
from  the  Council  of  National  Defense  and  made  it  responsible  directly 
to  himself.  Later  in  that  same  month  the  Price  Fixing  Committee 
was  organized,  also  as  an  independent  body  reporting  directly  to  the 
President.  It  is  stated  in  the  report  of  the  War  Industries  Board  " 
that,  "It  was  the  purpose  of  the  President  in  choosing  the  committee 
to  name  on  it  no  one  having  a  personal  financial  interest  in  any  result 
of  the  committee's  recommendations." 

The  War  Industries  Board  itself  was  divided  into  57  commodity 
sections  which  were  relied  on  for  the  information  which  was  the  basis 
of  the  development  of  policy  and  its  administration  of  those  pohcies. 
There  were  also  created  war-service  committees  to  represent  the 
various  industries  whose  interests  were  involved  before  the  Wai 
Industries  Board.  According  to  the  report  of  the  War  Industries 
Board  ^*  "a  war  service  committee  spoke  and  acted  as  agent  and 
representative  of  an  industry  and  not  as  agent  of  the  Board." 

Judge  Gary,  of  the  United  States  Steel  Co.,  however,  did  not  think 
of  the  war  service  committee  as  representing  industry  alone.  At  the 
meeting  of  the  Price  Fixing  Committee  with  the  representatives  of  the 
iron  ore,  pig  iron,  and  steel  industries  held  June  21,  1918,  he  said; 

Our  committee  does  not  appear  here  as  an  advocate,  but  more  as  a  judge  or  as 
an  advisory  committee,  having  in  consideration  the  interests  of  the  Government 
and  the  interests  of  the  steel  producing  and  the  iron  producing  fraternity. "^ 

^ATien  this  statement  was  presented  to  Lieutenant  Colonel  Harris, 
Director  of  the  Planning  Branch  of  the  War  D  epartment,  he  testified: 

I  do  not  know  what  he  could  mean  by  that.  Certainly  the  detailed  negotiations 
of  that  particular  conference  would  show  that  Judge  Gary  was  not  a  judge  on  that 
occasion."^ 

In  the  minutes  of  the  Price  Fixing  Committee  March  20,  1918, 
Judge  Gary  stated  his  conception  of  the  relationship  between  the 
Government  and  the  manufacturers: 

We  are  anxious  to  get  at  facts  and  figures,  and  to  arrive  at  some  conclusion 
that  is  fair  and  reasonable  to  all  concerned.  If  it  was  a  question  of  bargain 
only,  then  the  manufacturers  would  be  trying  to  secure  as  much  as  possible  for 
their  product,  and  your  board  would  be  endeavoring  to  secure  as  low  prices  for  the 
Government,  its  Allies,  and  the  general  public  as  possible.  But  we  don't  feel  lilce 
approaching  the  subject  from  any  such  point,  and  I  am  sure  you  don't.  ^^ 

That  there  was  no  dealing  at  arm's  length  between  the  Government 
and  business  was  further  indicated  by  the  statements  of  Mr.  Brookings 
at  the  same  meeting  made  in  response  to  Judge  Gary's  remarks: 

We  appreciate  the  attitude  the  steel  people  have  always  shown.  We  are  in 
entire  sympathy  with  practically  all  of  the  things  you  have  stated.  None  of  us 
are  steel  people  and  therefore  we  have  been  perfectly  willing  to  be  more  or  less 
guided  by  you,  and  I  think  we  have  been  wiseh'  guided. ^^ 

'2  Report  of  the  War  Industries  Board,  p.  22. 

"  P.  78. 

■<  P.  103. 

«  Exhibit  No.  1273. 

'«  Lieut.  Col.  Harris,  Dec.  14,  1934. 

"  Exhibit  No.  1270. 

"  Ibid. 


11579 — 35- 


78  MUNITIONS    INDUSTRY 

In  fact  the  steel  industry  through  a  committee  of  the  American 
Iron  &  Steel  Institute  was  given  the  work  of  computing  the  price 
differentials  for  finished  steel  products.  The  Government  only  fixed 
the  raw  material  prices."^ 

An  indication  of  the  War  Industries  Board's  varied  work  with 
complex  problems,  which  offered  opportunities  for  industrial  mem- 
bers of  war  service  committees  to  give  advice  which  controlled 
decisions,  may  be  gathered  from  the  committee's  study  of  the  pro- 
ceedings of  the  Board  from  December  10,  1917,  to  January  10,  1918. 
This  covers  only  the  meetings  held  by  the  Board  and  does  not  include 
the  many  problems  that  were  presented  to  it  outside  of  meetings. 
The  following  tabulation  is  of  dates  of  meetings  and  of  the  subjects 
presented:  ^^ 

December  10,  1917.  Special  meeting  to  consider  steel  prices  with  representatives 

of  the  steel  industries. 
December  13,  1917.  (1)  Plan  from  war  minerals  committee  to  increase  supply  of 

pyrites;   (2)   arrangments  covering  royalties  for  Lewis  machine  gun  patents; 

(3)  compact  for  power  for  Muscle  Shoals  nitrate  plant. 
December  14,  1917.  Special  meeting  with  copper  industry  to  consider  conditions 

as  bearing  on  possible  revision  of  prices. 
December  20,  1917.  Royalty   agreement  with   Flurscheim   for   manufacture   of 

T.  N.  A. 
December  21,  1917.  Order  for  smokeless  powder  with  Aetna  Explosives  Co. 
December  22,  1917.  Price  fixing  of  steel. 
December  24,  1917.  Price  fixing  of  steel. 
December  28,  1917.  Price  fixing  of  steel. 
January  2,  1918.   (1)   Attitude  of  Swiss  manufacturers;   (2)  order  for  30,000,000 

pounds  of  smokeless  powder  from  the  Hercules  Powder  Co.;  (3)   action  to 

secure  necessary  raw  materials  for  explosive  program;   (4)  request  for  assistance 

in  securing  explosives  from  Ordnance  Department;   (5)  cooperation  of  Allies. 
January  4,  1918.   (1)   Crude  T.  N.  T.  explosives;   (2)  price  fixing  of  nickel. 
January  9,  1918.   (1)   Price  fixing  of  copper;   (2)  price  fixing  of  aluminum. 
January  10,  1918.  Price  fixing  of  aluminum. 

At  the  December  10,  1917,  meeting  to  consider  steel  prices  a  large 
number  of  businessmen  representing  the  steel  industry  were  present. 
A  list  of  the  men,  with  their  industrial  connections,  follows: 

Representing  the  steel  industry:  F.  N.  Beegle,  president,  Union  Drawn  Steel 
Co.,  Pittsburgh,  Pa.;  James  B.  Bonner,  representative,  American  Iron  and  Steel 
Institute,  Washington;  James  A.  Burdon,  president,  Burdon  Iron  Co.,  Troy, 
N.  Y.;  E.  A.  S.  Clarke,  president  Lackawanna  Steel  Co.,  New  York,  N.  Y.; 
A.  C.  Dinkey,  president,  Midvale  Steel  &  Ordnance  Corp.,  Philadelphia,  Pa.; 
James  A.  Farrell,  president  United  States  Steel  Corp.,  New  York,  N.  Y.;  W.  J. 
Filbert,  comptroller  United  States  Steel  Corp.,  New  York,  N.  Y.;  Judge  E.  H. 
Gary,  chairman  United  States  Steel  Corp.,  New  York,  N.  Y.;  F.  H.  Gordon, 
gen.  mgr.  of  sales,  Lukens  Steel  Co.,  Coatesville,  Pa.;  E.  G.  Grace,  president 
Betlilehem  Steel  Co.,  South  Bethlehem,  Pa.;  W.  S.  Horner,  president  Nat'l 
Ass'n  of  Sheet  &  T.  P.  Mfrs.,  Pittsburgh,  Pa.;  A.  F.  Huston,  president  Lukens 
Steel  Co.,  CoatesviUe,  Pa.;  Eli  Joseph,  member  of  firm,  Joseph,  Joseph  &  Bro., 
New  York,  N.  Y.;  Willis  L.  King,  vice  president  Jones  &  Lauglilin  Steel  Co., 
Pittsburgh,  Pa.;  W.  Vernon  Phillips,  president,  F.  R.  Phillips  &  Sons  Co.,  Phila- 
delphia, Pa.;  Karl  C.  Roebling,  gen.  mgr.  of  sales,  John  A.  Roebling's  Sons  Co., 
Trenton,  N.  J.;  Chas.  M.  Schwab,  chairman  Bethlehem  Steel  Co.,  South  Beth- 
lehem, Pa.;  John  A.  Topping,  president  Republic  Iron  &  Steel  Co.,  New  York, 
N.  Y.;  Roy  A.  Rainey,  Rainey  Coke  Co.,  New  York,  N.  Y.;  Scott  Stewart,  ass't 
to  Roy  A.  Rainey,  Rainey  Coke  Co.,  New  York,  N.  Y.^i 

The  chairman  of  the  Board  did  not  conceive  of  the  function  of 
these  men  as  simply  to  plead  the  cause  of  the  steel  industry.  He  ex- 
plained— 

79  See  infra,  pp.  104,  106. 

80  Exhibit  No.  1271. 

81  Ibid. 


MUXITIOXS    IXDUSTRY  79 

that  while  the  cost  data  in  course  of  preparation  by  the  Federal  Trade  Commis- 
sion was  not  yet  at  hand  it  had  been  felt  advisable  to  call  the  representatives  of 
the  steel  industry  to  Washington  to  discuss  the  general  situation  as  brought  about 
b}'^  the  prices  fixed  and  by  general  conditions  in  order  that  the  Board  could  ap- 
proach the  subject  more  intelligently  and  a  decision  be  arrived  at  more  expe- 
ditiously when  the  Federal  Trade  Commission  data  came  to  hand,  it  being  under- 
stood that  in  the  terms  of  the  previous  price  agreements  it  had  been  stipulated 
that  prices  would  be  reconsidered  prior  to  January  1st,  1918.^^ 

Even  when  the  cost  information  was  available,  the  lack  of  familiar- 
ity of  the  Government  officials  with  it  encouraged  reliance  upon  the 
interpretation  of  this  information  offered  by  industrj-.  In  Garrett, 
Government  Control  Over  Prices,  it  is  stated,  "Neither  the  price- 
fixing  committee  nor  the  Food  Administration  to  any  extent  availed 
themselves  of  a  detached  scientific  committee  whose  business  it  was 
to  analyze  for  them  and  interpret  cost  sheets  prepared  by  the  Federal 
Trade  Commission." ^^ 

In  fact,  there  were  occasions  when  the  cost  information  of  the 
industry  regulated  was  substituted  for  that  of  the  Federal  Trade 
Commission.  When  the  fixing  of  tanning  prices  was  considered,  the 
Federal  Trade  Commission's  figures  showed  an  average  cost  of  12 
cents.  Figures  were  presented  by  the  industry  showing  costs  of  13.5 
cents.     Prices  were  fixed  on  the  basis  suggested  by  the  tanners.^* 

The  following  table  which  has  been  prepared  by  this  committee's 
staff  indicates  some  of  the  industrial  connections  and  sources  of 
income  of  the  principal  officials  concerned  wdth  the  work  of  price 
fixing  and  the  general  control  of  industry  during  the  war: 

82  Exhibit  No.  1271. 

83  P.  179. 

8<  Ibid.,  p.  321. 


80 


MUNITIONS    INDUSTRY 


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84  MUNITIOlSrS   INDUSTRY 

(3)    DIFFICULTIES    OF    COST    DETERMINATIONS 

The  policy  of  setting  prices  at  cost  of  production  plus  a  reasonable 
profit  involves  the  necessity  of  procuring  accurate  cost  information. 
Profits  and  prices  increase  as  unjustifiable  additions  to  cost  are 
allowed  and  failure  to  note  decreases  in  cost  persists.  The  oppor- 
tunities for  such  errors  are  numerous. 

(a)  The  necessity  for  estimating  future  costs. — -Prices  must  bs  set  for 
a  substantial  period  of  time  in  the  future  since  it  is  obviously  im- 
possible from  the  standpoint  of  Government  and  business  alike  to 
have  continued  price  redeterminations.  It  is  therefore  necessary  for 
the  Government  body  to  take  account  of  probable  future  changes  in 
cost,  upon  which  the  price  is  supposedly  based.  In  doing  so,  it  should 
be  recognized  that  there  will  be  at  least  as  great  force  in  the  mainte- 
nance of  production  contention  as  in  the  motive  to  limit  profits  and 
inflation,  especially  since  producers  can  point  to  the  general  condition 
of  increasing  war-time  cost. 

Price  fixing  for  the  aluminum  industry  in  the  World  War  indicates 
the  tendency  of  price-control  bodies  to  err  on  the  side  of  generosity. 
At  a  meeting  of  the  Price  Fixing  Committee  held  May  9,  1918,  Mr. 
Brookings  said: 

We  felt  after  hearing  all  Mr.  Davis  [president  of  the  Aluminum  Co.  of 
America]  had  to  say  about  it,  and  taking  into  consideration  the  probable  increase 
as  raises  [sic]  were  going  up,  and  we  fixed  the  price  at  32  cents. ^^ 

Since  the  costs  of  the  Aluminum  Co.,  practically  the  only  producer, 
were  17^2  cents  a  pound  by  their  own  statement  ^^  and  15}^  cents 
according  to  the  Federal  Trade  Commission,*'^  this  price  of  32  cents 
a  pound  was  certainly  designed  to  cover  any  probable  increases  in  costs. 

With  this  consideration  in  mind,  it  becomes  very  important  that 
cost  figures  be  as  recent  as  possible.  Yet  we  find  that  in  the  World 
War,  acc-ording  to  the  chairman  of  the  Price  Fixing  Committee,  rehable 
figures  could  not  be  obtained  for  a  period  closer  than  2  months  prior 
to  the  Committee's  meeting.  Mr.  Brookings  said  at  a  meeting  with 
the  copper  representatives: 

We  have  gone  into  that  very  exhaustively  and  as  I  have  explained  to  you, 
we  have  had  the  cost  sheets  for  the  month  of  March;  that  is  the  latest  month 
we  could  get;  we  never  can  bring  figures  much  closer  than  60  days  to  a  meeting 
of  this  kind  if  we  get  reliable  figures. ^^ 

Where  a  single  price  is  to  be  determined,  it  is  necessary  to  obtain 
figures  of  the  proportion  of  the  output  coming  in  at  the  various  costs 
in  order  to  determine  the  point  of  marginal  production.  According 
to  the  report  of  the  War  Industries  Board,  the  time  required  for  the 
completion  of  such  studies  was  in  some  cases  more  than  3  months:  ^^ 

As  the  exigencies  of  the  day  pointed  to  industrj^  after  industry  as  necessary 
fields  for  the  exercise  of  price  control,  the  Federal  Trade  Commission  was  invited 
to  assign  to  each  a  corps  of  these  experts  to  investigate  and  report  on  the  costs  of 
production.  The  studies  usually  extended  to  all  producing  plants,  or  where  this 
was  impracticable,  to  a  large  number  of  typical  plants,  from  the  lowest  to  the 
highest  cost  producers,  and  their  prosecution  required  usualh'  from  1  to  3  or 
more  months. 

It  should  be  recognized  that  these  time  estimates  were  for  the  rela- 
tively limited  scope  of  price  fixing  in  the  World  War.     Retail  prices, 

«  Minutes  of  Price  Fixing  Committee,  May  9,  1918. 

98  Ibid.,  Jan.  9,  1918. 

8'  Ibid.,  May  9,  1918. 

89  Ibid.,  May  22,  1018. 

*»  Keport  of  War  Industries  Board,  p.  76. 


MUNITIONS    INDUSTRY  85 

with  the  exception  of  food  and  fuel,  were  generally  unregulated  ^°  and 
in  the  field  of  wholesale  prices  only  573  of  the  1,366  commodities  com- 
prising the  War  Industries  Board  Price  Index,  were  subject  to  control 
at  the  termination  of  the  war.^^  Furthermore,  in  the  case  of  iron  and 
steel,  the  Government  only  set  the  prices  of  the  basic  raw  materials. 
It  left  the  task  of  determining  thousands  of  price  differentials  for  the 
finished  products  to  the  American  Iron  and  Steel  Institute.^-  Ob- 
viously, if  a  scheme  such  as  the  suggested  price  ceiling  were  adopted, 
the  delay  would  be  multiplied  many  times  oyer. 

(b)  Cost  padding. — In  addition  to  bald  misstatements  of  amounts, 
it  is  possible  to  manipulate  accounts  so  that  what  normally  appears 
on  the  financial  sheet  as  profit  is  converted  into  cost.  Inventories 
may  be  over-valued  and  depreciation  reserves  increased  to  levels  which 
are  distinctly  not  usual. 

On  other  cost  items,  padding  enables  business  to  reap  a  double 
advantage  at  the  expense  of  the  Government.  Extravagant  increases 
in  salary  are  made  to  justify  price  advances,  at  the  same  time  that  the 
recipients  are  gaining  exceptional  benefits  therefrom;  similarly  new 
construction  of  capital  facilities  is  accounted  for  as  an  operating  cost 
of  making  repairs. 

The  incentive  to  engage  in  this  type  of  practice  is  especially  strong 
where  the  individual  price  system  is  used,  as  was  the  case  in  the 
World  War  Food  Administration,  because  of  the  direct  connection 
between  the  individual  producer's  price  and  cost.  This  increases 
with  impairment  of  the  possibility  of  effective  check-up,  and  where 
there  is  no  auditing  of  cost  records  whatever,  manufacturers  can,  of 
course,  use  these  devices  with  impunity.  Surprising  as  it  may  seem, 
the  Milling  Division  of  the  Food  Administration  at  one  time  refused 
to  avail  itself  of  the  independent  auditing  facilities  of  the  Federal 
Trade  Commission  because  it — 

took  the  view  that  it  was  not  its  business  to  police  the  industry  and  that  to  dis- 
cipline millers  or  to  attempt  anything  of  the  sort  would  perhaps  defeat  that 
spirit  of  voluntary  cooperation  which  it  was  anxious  to  develop. ^^ 

The  result  has  been  described  as  follows: 

Not  a  few  millers  took  advantage  of  the  situation  and  loaded  their  cost  reports 
with  improper  items.  Some  came  to  believe  that  they  would  never  be  investi- 
gated or  molested  if  they  should  pad  their  cost  reports.  Such  items  as  new  con- 
struction and  equipment,  largely  increased  salaries  to  officers  (in  some  cases  made 
retroactive  to  include  a  fiscal  period  closed  before  the  beginning  of  Food  Adminis- 
tration control),  bad  debts  of  ancient  standing,  excessive  depreciation  charges, 
losses  on  miscellaneous  outside  investments,  etc.,  were  added  to  current  costs  of 
production  and  so  charged  to  the  consuming  public.  Under  the  conditions  of 
demand  which  then  existed  prices  inflated  in  this  way  could  be  easily  obtained 
for  the  flour;  in  fact,  flour  could  be  sold  for  almost  any  price  limited  only  by  the 
flexibility  of  the  seller's  conscience. "■* 

In  the  case  of  the  steel  industry,  where  a  single  price  was  set,  the 
Federal  Trade  Commission  was  able  to  make  only  a  limited  cost 
study  directly  from  the  books  of  companies.  This  inquiry  was 
begun  in  June  1917  and  was  confined  to  the  c[uestion  of  the  costs  of 
plates  and  shapes.  It  was  also  limited  to  the  few  large  companies 
which  were  responsible  for  the  greater  part  of  the  country's  steel 

>"  Qarrett,  op.  cit.,  p.  550. 

«i  Ibid.,  p.  417. 

»a  Ibid.,  p.  267. 

03  Wilfred  Eldred,  Wheat  and  Flour  Trade,  1917-18,  Quarterly  Journal  of  Economics,  vol.  33,  p.  47. 

M  Ibid.,  p.  47. 


86  MUNITIONS    INDUSTRY 

capacity.  However,  it  was  not  until  September  8,  1917,  that  a 
brief  summary  report  was  made  to  the  President. ^^ 

Thereafter  the  Government  rehed  primarily  on  the  monthly  cost 
sheets  that  were  sent  in  by  the  companies.  The  plan  of  ascertaining 
costs  directly  from  the  books  was  ruled  out  by  the  practical  circum- 
stances of  the  war.  The  necessity  for  speed  in  handling  a  great 
volume  of  work — the  Commission  received  over  5,000  cost  sheets  per 
month — also  restricted  the  process  of  checking  up  on  the  accuracy  of 
the  cost  sheets.  It  was  only  in  the  cases  of  important  high-cost 
companies,  where  "the  figures  seemed  as  if  they  might  possibly  be 
inaccurate",  ^^  that  the  Commission  asked  explanation  or  correction 
by  correspondence.  Comparison  of  the  figures  on  the  sheets  with 
those  on  the  books  of  account  was  probably  confined  to  an  even  smaller 
number  of  cases. 

That  reliance  simply  on  the  uncorroborated  statement  of  the 
producers  would  result  in  a  general  tendency  to  overstatement  of  cost 
and  understatement  of  profit  may  be  seen  from  the  fact  that  companies 
urged  higher  prices  on  the  ground  of  inabihty  to  profit  from  the  low 
levels,  although  later  check-ups  showed  high  earnings.  The  Federal 
Trade  Commission  letter  of  June  1918  on  profiteering  stated: 

Recently,  mills  in  class  3  made  objection  that  the  Government  prices  were 
too  low  for  them.  A  special  examination  of  their  profits  by  the  Federal  Trade 
Commission  showed  that  in  almost  every  case  these  objecting  mills  were  enjoying 
unusual  returns.  The  following  table  of  percentage  of  return  on  investment  in 
10  mills  in  class  3  will  show  the  profits  in  1917:  ^^ 

Alan  Wood  Iron  &  Steel  Co 52.  63 

AUegheny  Steel  Co 78.  92 

American  Tube  &  Stamping  Co 40.  03 

Central  Iron  &  Steel  Co 71.  35 

Eastern  Steel  Co 30.  24 

Forged  Steel  Wheel  Co 105.  40 

FoUansbee  Bros.  Co 112.  48 

Nagle  Steel  Co 319.  67 

West  Penn  Steel  Co 159.  01 

West  Leechburg  Steel  Co 109.  05 

At  a  meeting  of  the  Price-Fixing  Committee  with  the  copper  pro- 
ducers, Mr.  Brookings  made  the  unquahfied  statement  that  his  figures 
were  absolutely  contrary  to  those  of  the  industry  every  time  the  latter 
were  presented: 

We  told  you  the  figures  were  so  conflicting  that  we  had  little  confidence  in 
them.  We  are  going  to  get  the  facts;  we  are  going  to  find  some  ways  and  means 
of  taking  care  of  the  small  producer.  We  want  information.  Every  time  you 
presented  anything,  I  presented  other  figures  that  were  absolutely  contrary, 
based  upon  such  information  as  we  had  on  some  of  these  low-cost  producers — 
based  upon  the  conditions  as  they  have  existed  for  years  as  well  as  they  exist 
today  .93 

The  tendency  to  shape  figures  with  an  eye  to  the  necessities  of 
Government  regulation  is  illustrated  by  the  following  letter  which 
passed  between  the  members  of  Swift  &  Co.:^^ 

Chicago,  November  26,  1917. 
Mr.  Edward  F.  Swift,  second  floor: 

We  have  had  a  virtual  statement  from  Mr.  Cotton  that  the  Government  ex- 
pects to  establish  profit  control  in  the  leather  industry.  With  this  notice,  I  think 
we  should  at  least  consider  the  advisability  of  reappraising  the  properties  of  the 

95  Federal  Trade  Commission  Report  on  War-Time  Profits  and  Costs  of  the  Steel  Industry,  p.  44. 

«» Ibid. 

«'  65th  Con?.,  2d  sess.,  S.  Doe.  No.  248,  p.  9. 

»9  Exhibit  No.  1711. 

«'  65th  Cong.,  2d  sess.,  S.  Doc.  No.  248,  pp.  16  and  17. 


MUXITIOXS    IXDUSTRY  87 

following  companies:  A.  C.  LawTence  Leather  Co.,  National  Calfskin  Co.,  Win- 
chester Tannery  Co.,  St.  Paul  Tannery  Co.,  Ashland  Leather  Co.,  St.  Joseph 
Tanning  Co.  (in  which  we  have  only  50  percent  ownership). 

If  it  is  agreeable  to  you,  will  arrange  with  Mr.  Moon  to  go  into  the  matter  and 
submit  figures.    Awaiting  your  reply, 

Louis  F.  Swift. 
I  approve  if  done  quietly  and  promptly. 

L.  F.  S.  (Sic) 

Even  where  the  Government  made  strenuous  attempts  to  audit  and 
check  the  costs  stated  by  business,  the  process  of  auditing  was  found 
to  be  difficult,  slow  and  expensive.  As  an  indication  of  this,  the  ex- 
perience in  checldng  the  Bethlehem  Shipbuilding  Company's  books  in 
regard  to  its  war-time  contracts  with  the  Emergency  Fleet  Corporation 
may  be  cited.  The  announced  policy  of  the  management  of  the 
parent  company,  the  Bethlehem  Steel  Corporation,  was  one  oi  coop- 
eration with  the  Government  auditors.  The  following  situation, 
however,  prevailed  at  the  shipbuilding  company's  Harlan  plant 
located  in  Wilmington,  Del.,  according  to  the  final  report  of  the 
Government  auditor:^ 

The  working  conditions  at  this  plant  were  very  unsatisfactory. 

The  works  accountant  was  far  from  even  being  agreeable  and  his  assistance 
during  the  whole  period  of  reaudit  was  practically  useless  and  of  no  value  _ what- 
ever. The  WTiter  cannot  recall  even  one  instance  where  anything  but  mislead- 
ing replies  were  given  to  questions  asked  pertaining  to  a  proper  solution  of  the 
various  questionable  conditions  that  were  brought  to  light  throughout  the  entire 
course  of  the  reaudit.     *     *     * 

Certain  valuable  cost  records  pertinent  to  our  needs  on  the  overhead  audit 
were  withheld,  some  were  never  handed  over,  and  others  given  after  we  were 
forced  to  build  up  the  costs  from  amounts  shown  on  controlling- journal  vouchers. 

Of  those  cost  records  which  we  were  unable  to  obtain,  the  entire  stores  requisi- 
tions for  the  years  1916  and  1917  and  a  part  of  1918,  1919,  and  1920,  totaling 
about  $30,000,  were  an  outstanding  feature. 

Of  those  records  which  the  contractor  withheld  until  we  had  completed  our 
build-up,  the  following  were  the  most  important: 

1.  Detail  cost  ledger  for  repair  and  renewal  orders. 

2.  Contractors'  detailed  statement  of  items  credited  cost  and  charged  dis- 
allowed cost. 

The  time  employed  to  work  up  these  two  features  practically  covered  a  period 
of  six  months  for  each  of  three  auditors.     This  is  a  conservative  estimate. 

Many  Journal  entries  were  made  without  any  explanatory  reference;  this 
feature  consumed  considerable  time  in  order  to  determine  the  true  nature  of  such 
entries;  working  papers  showing  detail  were  evidently  destroyed;  in  fact  Beth- 
lehem relied  on  memory  to  give  an  explanation  of  these  entries.  Other  entries 
purporting  a  description  were  entirely  misleading. 

Even  if  there  had  been  active  cooperation  on  the  part  of  all  the 
company  officials,  an  effective  audit  would  have  been  extremely 
difficult.  A  current  audit  was  carried  on  while  the  ships  were  being 
built  but,  according  to  a  report  by  the  construction  auditor  of  the 
Shipping  Board,  it  was  necessarily  a  superficial  job.^  In  the  first 
place,  the  Emergency  Fleet  Corporation  was  short-handed.  Whereas 
the  Navy  Department  had  about  70  auditors  at  Bethlehem's  Alameda 
plant  and  100  at  Fore  River,  it  had  only  seven  men  at  Alameda  and 
about  twelve  at  Fore  River.  From  seventy  to  a  hundred  men  are 
required  at  a  single  plant  of  one  company  for  a  thorough  current 
audit.  Furthermore,  the  different  Government  auditors  at  the  five 
plants  failed  to  agree  as  to  what  should  constitute  cost.^ 

1  Report  of  C.  C.  Colliflower,  traveling  auditor  of  U.  S.  Shipping  Board  Emergency  Fleet  Corpora- 
tion, on  Audit  of  Operating  Expenses  of  Harlan  Plant,  Beth.  Ship.  Corp.,  January  1916  to  December  1920, 
inclusive,  p.  1  S. 

-  Report  of  J.  A.  Hou-;ick,  General  Scope  of  the  Audit  of  Bethlehem  Shipbuilding  Corporation  Records 
U.  S.  S.  E.  E.  F.  C.    Nov.  2-1,  1934. 

3  Ibid. 


88  MUNITIONS    INDUSTRY 

Because  of  the  ineffective  character  of  the  current  audit,  it  was 
decided  in  the  early  part  of  1920  that  a  reaudit  was  necessary.  This 
work  was  first  entrusted  to  a  private  accounting  firm.  After  this 
firm  had  been  at  work  for  over  a  year  and  had  been  paid  about 
$600,000,  they  were  ordered  to  stop,  on  the  ground  that  the  results 
of  their  audit  were  of  no  use  to  the  Government.*  The  Emergency 
Fleet  Corporation  auditors  then  undertook  to  finish  the  job  and  did 
so  about  two  years  after  it  had  been  begun. 

The  Lukens  Steel  Co.  case  offers  another  instance  of  cost  padding 
by  means  of  which  it  was  possible  for  industry  to  maintain  high 
prices. 

Mr.  Baruch  testified  before  the  Graham  committee  that  as  to  the 
prices  of  plates:  "There  was  a  concern,  the  Lukens  Iron  &  Steel  Co., 
which  made  it  impossible  for  us  to  give  the  price  for  steel  plates 
lower  than  we  did."  °  According  to  his  testimony,  this  company  was 
a  high-cost  producer: 

The  Lukens  production  was  made  at  a  loss,  but  we  held  the  price  down  with 
the  understanding  that  they  would  get  pig  iron  at  a  price  that  would  enable 
them  to  get  out  with  a  profit.  Thej"  were  not  an  integrated  plant.  For  in- 
stance, Uke  the  steel  corporation  or  others,  they  had  no  blast  furnaces  and  no 
coal.« 

On  December  22,  1917,  at  a  meeting  of  the  War  Industries  Board, 
proposal  was  made  for  a  study  of  Lukens  and  other  high-cost  pro- 
ducers to  determine  whether  special  arrangements  should  be  made 
to  continue  them  in  operation  because  of  the  claim  that  they  could 
not  produce  at  a  profit  under  the  existing  level  of  prices : 

The  case  of  the  Lukens  Steel  Co.  was  discussed  and  the  point  brought  out 
that  in  accordance  with  data  submitted  that  company  could  not  produce  plates 
at  the  price  fixed  at  a  profit.  Accordingly  it  was  moved,  seconded,  and 
unanimously  carried  that  investigation  be  made  of  the  actual  price  the  Lukens 
Co.  and  other  companies  who  claim  that  they  are  unable  to  produce  at  a  profit 
at  the  prices  fixed  are  receiving  for  the  purpose  of  determining  from  actual 
prices  received  and  the  profits  so  disclosed  whether  these  companies  can  continue 
at  the  present  prices  or  whether  some  other  arrrangement  covering  their  specific 
cases  should  be  made.'' 

The  committee  has  found,  however,  that  in  the  same  year  the 
Lukens  Steel  Co.  made  a  profit  of  90  percent.  Its  net  taxable  income 
for  1917  was  finally  determined  by  the  Bureau  of  Internal  Revenue 
to  be  $8,639,477,  a  90.1  percentage  of  its  invested  capital  before  taxes. 
After  taxes  were  paid,  the  percentage  was  60.5.  In  1918  its  net  tax- 
able income  was  $6,181,250,  which  was  22.2  percent  of  its  invested 
capital.  The  effect  of  taxes  in  that  year  was  to  leave  a  net  income 
after  taxes  of  19.7  percent;  *  moreover,  in  1918  conditions  for  the 
Lukens  Co.  were  apparently  good  enough  to  warrant  the  retirement 
in  cash  of  more  than  $6,000,000  of  preferred  stock.^ 

The  devices  used  by  this  company  in  its  attempt  to  frustrate 
the  accurate  ascertainment  of  its  costs  has  been  described  in  a 
Federal  Trade  Commission  report,  which  is  reproduced  in  part: 

The  data  obtainc^l  by  ]*\Ir.  Kccver  at  his  f  rst  visit  showed  merely  the  com- 
bined cost  of  all  sheared  plate  mills  of  the  Lukens  Co.  and  subsequent  informa- 
tion obtained  from  the  company  has  also  shovrn  the  costs  in  the  same  waj'.     This 

*  Ibid. 

«  Bernard  M.  Baruch,  Mar.  29, 1935  (gaUey  91  BBQ). 

e Ibid. 

7  Bernard  M.  Baruch,  Mar.  29,  1935  (galley  91  BBQ). 

s  Exhibit  No.  1738. 

« Ibid. 


MUNITIONS    INDUSTRY  89 

has  a  misleading  effect,  as  the  total  cost  so  shown  is  compared,  when  under  con- 
sideration, with  the  selling  price  fixed  by  the  Government,  namely,  $3.25  per  100 
pounds  for  sheared  plate,  and  the  fact  that  extras  are  allowed  for  sizes,  gages, 
etc.  It,  therefore,  becomes  necessary-  to  find  the  cost  of  plates,  rolled  on  the 
different  mills,  so  that  a  fair  comparison  may  be  made  between  the  selling  price 
of  the  particular  products  and  the  cost  price,  the  selling  price,  of  course,  being 
$3.25,  plus  extras. 

Whilst  the  company  is,  of  course,  making  no  false  returns,  the  impression 
created  is  that  it  is  not  above  allowing  incorrect  conclusions  to  be  drawn  and  that 
it  would  not  object  to  assisting  to  the  formation  of  such  incorrect  conclusions, 
provided  they  were  in  its  favor.  As  supporting  this  idea,  whilst  Mr.  Hoover 
knew  of  the  existence  of  the  iron-ore  concern  and  also  of  the  blast  furnaces,  when 
we  sent  the  company  a  letter  on  November  20  telling  it  to  make  returns  of  all 
its  costs,  it  was  specifically  stated  that  if  any  subsidiary  companies  were  controlled, 
those  companies  were  also  to  make  their  returns.  We  had  no  returns  from  the 
subsidiary  companies  until  we  rediscovered  the  existence  of  them.  Furthermore, 
the  company's  action  in  compounding  the  costs  of  three  different-sized  mills 
appears  to  be  for  the  purpose  of  showing  a  high  cost;  and  when  its  representatives 
appeared  before  Commissioner  Davies  they  continued  to  claim  loudly  that  their 
cost  was  above  the  Government  price  of  S3. 25,  which,  whilst  being  perfectly 
true,  has  no  bearing  on  the  matter,  as  they  are  not  getting  $3.25,  but  $3.25,  plus 
extras.  They  have  also  said  nothing  about  the  profit  on  pig  iron  or  iron  ore  at 
the  Government  price,  rather  giving  the  impression  that  they  are  a  no.  3  classed 
company,  which  has  to  buy  its  pig  iron  in  the  open  market;  whereas,  in  point  of 
fact,  a  considerable  proportion  of  their  pig  iron  could,  no  doubt,  be  purchased  from 
their  subsidiary  company,  whether,  in  fact,  such  is  done  or  not. 

The  company  reorganized  about  October  1916  from  the  Lukens  Iron  &  Steel 
Co.  to  the  Lukens  Steel  Co.,  and  at  this  time  increased  its  capital  from  $500,000  to 
$22,500,000.  No  doubt,  in  the  past  its  operations  have  been  so  profitable  that 
this  was  merely  issuing  stock  for  surplus.  When  we  were  making  inquiry  to 
determine  the  costs  of  investment  in  various  iron  and  steel  operations,  we  sent  a 
request  to  the  Lukens  Co.  to  give  us  particulars  concerning  their  investment. 
The  information  which  they  supplied  was  of  the  most  meager  description,  con- 
sisting merely  of  two  figures:  Plant  and  property,  approximately  $9,000,000; 
and  working  funds,  $5,000,000.  If  Mr.  Basset  is  the  accountant  which  Mr. 
Hoover  believes  him  to  be,  it  seems  absurd  to  suppose  that  the  information 
which  we  requested  in  our  communication  could  not  have  been  furnished  in  detail. 

With  regard  to  the  profitableness  of  the  company's  operations,  it  is  worthy  of 
note  that  the  profits  reported  for  the  months  of  July,  August,  September,  and 
October,  before  providing  for  Federal  taxes  and  writing  off  $300,000  for  bad 
debts  in  October,  amounted  to  considerably  over  a  million  dollars  in  the  remaining 
months. 

In  response  to  the  Commission's  request  for  information  concerning  the  invest- 
ment particulars  and  profit  and  loss  figures,  the  Lukens  Co.  desired  to  know  the 
authority  under  which  the  Commission  was  acting. 

The  personal  attitude  of  Mr.  Gordon,  who  has  represented  this  company  in 
various  interviews,  is  that  of  a  very  injured  party,  and  it  may  be  that  this  is 
assumed  in  order  to  make  Mr.  Basset  justified  in  making  the  statements  which 
he  does  about  the  unprofitableness  of  the  company's  operations. 

The  company  has  definitely  refused  to  make  plates  for  the  Government  at 
$3.25.  The  Steel  Corporation  appears  to  be  able  to  make  plates  profitably  at 
this  price,  and  there  seems  to  be  no  reason  why  the  Lukens  Co.  should  not  do 
so,  when  they  have  very  large  equipment  both  in  open-hearth  capacity  and  plate- 
mill  capacity.  The  company  now  has  the  largest  plate  mill  in  the  world,  namely, 
204  inches,  and  as  they  have,  at  any  rate,  pig-iron  capacity  which,  even  if  not 
used  for  their  own  operations,  can  be  sold  at  a  profit,  so  that  the  effect  is  that  the 
company  for  part  of  its  requirements,  at  any  rate,  is  as  well  integrated,  with  the 
exception  of  coke,  as  some  of  the  bigger  steel  companies,  only  inefficient  opera- 
tions can  run  their  costs  up  to  the  point  where  their  operations  are  unprofitable-^" 

Other  supposedly  high-cost  steel  companies  made  excessive  profits 
at  the  same  time  that  their  cost  position  was  being  used  as  a  justifica- 
tion for  fixing  high  prices.  The  Otis  Steel  Co.,  which  is  cited  in  a 
Federal  Trade  Commission  Report  ^°  as  being  in  the  same  class  of 
integration  as  the  Lukens  Steel  Co.,  made  a  profit  of  139  percent  in 

»»  Exhibit  No.  1739. 


90  MUNITIONS   INDUSTRY 

1917,  according  to  the  final  determination  of  the  Bureau  of  Internal 
Revenue.^^  In  that  year,  on  an  invested  capital  of  $7,154,632,  this 
company  made  $9,989,355  before  taxes,  the  function  of  which  had  been 
described  by  Judge  Gary  as  equalizing  the  profits  of  the  low-cost 
companies  with  the  "reasonable  profit"  that  the  high-cost  company 
would  obtain  from  the  fixed  price.  Even  after  taxes  were  paid,  the 
income  of  the  Otis  Steel  Co.  amounted  to  74  percent  of  its  invested 

capital.  o.      1  /-I  J 

Another  company  m  this  cost  class,  the  Allegheny  bteei  Co.,  accord- 
ing to  its  own  tax  return,  made  $6,832,100  in  1917,  amounting  to  112 
percent  of  its  capital  of  $6,060,999.1'  After  taxes  were  paid,  its  net 
income  still  amounted  to  60  percent  of  its  capital. 

The  effectiveness  of  auditing  cost  records,  like  the  effectiveness  of 
the  Bureau  of  Internal  Revenue's  settlement  of  tax  returns,  is  limited 
by  the  judgment  nature  of  many  items  of  cost.  Especially  is  this 
true  of  depreciation  and  depletion  where  valuation,  with  all  its  attend- 
ant difficulties,  is  involved.  Here  also  we  find  that  it  was  a  matter 
for  agreement  and  adjustment  between  the  Government  and  the 
producer.  At  a  meeting  of  the  Price-Fixing  Committee,  Mr.  Brook- 
ings stated: 

We  have  here  before  us  the  production  of  all  these  properties.  To  show  you 
the  amount  of  detail  when  we  gather  eight  or  nine  hundred  producers  tlmt  are 
producing  fifty  million,  it  won't  look  as  queer.  We  have  found  dithculty 
in  some  of  these  costs.  We  have  had  cost  sheets  presented  to  us  of  twenty-three, 
twentv-four,  twentv-five,  or  twentv-six  cents,  whatever  the  case  may  be,  and 
when  we  have  analvzed  them,  we  have  reduced  them  to  nineteen  cents  or  some- 
thing like  that.  Tliey  have  put  in  other  things  that  are  their  views  as  to  depletion. 
Mv  own  experience  teaches  me  that  the  average  man  is  as  hones u  as  i  am;  i  try 
to  be  honest;  that  is  all  I  say.  There  are  different  methods  of  accounting,  different 
methods  of  arriving  at  these  things.  When  we  changea  cost,  we  generally  do  it 
with  the  consent  or  acknowledgment  of  the  party;  that  is  fair.^^ 

An  important  factor  decreasing  cost  that  was  not  taken  account 
of  was  the  intercompany  profits  of  well-integrated  companies  which 
appeared  on  the  books  as  costs. 

Usual  sources  of  such  profits  were  the  payments  to  subsidiary 
companies  of  regular  market  prices  by  the  parent  organizations  lor 
raw  materials  or  transportation.  Prices  fixed  on  this  basis  omitted 
to  account  for  the  profit  wliich  the  parent  company  was  gaining  by 
doing  business  with  itself.  This  also  meant  that  the  full  advantages 
of  in°tegration  were  not  being  passed  on  to  purchasers,  of  whom  the 
largest  was  the  Government. 

The  extent  of  the  disparity  between  actual  cost  to  the  subsidiary 
and  sale  price  to  the  parent  company  appears  in  the  following  dis- 
cussion in  the  Price  Fixing  Committee  regarding  the  provision  ot 
bauxite  for  the  Aluminum  Co.  of  America: 

Mr.  Taussig.  What  is  the  reportion  [proportion?]  of  your  consumption  of 
bauxite  as  compared  with  the  others?  „* +v^ 

Mr  Davis.  I  suppose  we  use  perhaps  66%%  of  the  total  consumption  of  the 
country;  we  produce  practically  all  there  is  produced  m  this  country. 

Mr  WoosTER.  You  fixed  the  price  on  it?  Do  you  say  it  is  selling  at  $10.00  a 
pound  [ton?]  that  is  your  price,  and  you  practically  make  the  price  on  bauxite 
throughout  the  United  States?  ,,      ^        ,  i     i  „„^ 

Mr  Davis.  That  never  has  been  the  case,  because  the  French  people  have 
always  fixed  the  price  on  bauxite. 

11  Exhibit  No.  1740-C.    The  succeeding  data  is  from  the  same  source. 

12  Exhibit  No.  1740-B. 

13  Exhibit  No.  1406. 


MUNITIONS    INDUSTRY  91 

Mr.  WoosTER.  What  is  the  duty? 

Mr.  Taussig.  It  is  free. 

Mr.  Brookings.  That  same  question  came  up  before  and  we  simplj'  side- 
tracked it  and  said,  we  are  treating  your  investment  and  capital  as  one,  and  j'our 
return  on  your  capital,  and  to  be  consistent,  inasmuch  as  you  had  fixed  the  price 
under  which  bauxite  is  sold,  we  must  take  the  cost  to  you,  and  the  cost  to  you  is 
what  we  have  given  you  credit  for. 

Mr.  Davis.  Our  contention  in  that  is  a  little  different,  I  think,  from  what  j'ou 
put  it.  As  a  matter  of  fact,  25  or  30  years  ago,  we  having  practically  invented  the 
use  of  bauxite  for  aluminum,  bauxite  was  nothing  but  dust  with  no  value,  but 
we  went  to  our  concern,  and  of  course  we  did  not  realize  how  large  this  industry 
was  going  to  grow  and  we  bought  for  two  or  three  hundred  thousand  dollars  some 
bauxite  land.  We  have  spent  nearly  $2,000,000  for  bauxite,  within  the  last  two 
years,  in  cash.  My  point,  is  Mr.  Brookings,  that  because  we  were  fortunate 
enough  to  buy  this  bauxite  30  years  ago  at  a  cheap  price  that  anybody  should 
say  tliat  aluminum  can  be  made  with  bauxite  at  25  cents  a  ton,  for  it  could  not, 
unless  somebody  should  take  our  place. 

Mr.  WoosTER.  The  fact  is  that  it  is  made  for  that.  It  costs  you  $0.50,  I 
think." 

It  was  not  until  less  than  a  month  prior  to  the  armistice,  that  the 
Chairman  of  the  Price  Fixing  Committee  stated  he  had  discovered 
the  United  States  Steel  Corporation  to  have  been  maldng  an  inter- 
company profit  on  the  cost  of  rails: 

The  chairman  announced  that  contrary  to  his  previous  understanding,  he  had 
discovered  that  the  United  States  Steel  Corporation's  cost  figures  on  rails  are  not 
strictly  integrated,  and  that  there  is  about  a  $5  per  ton  intercompany  profit,  a 
part  of  which  might  possibly  be  charged  to  transportation. i^ 

(c)  The  ratio  method  oj  price  determination. — It  has  been  suggested 
that  many  of  the  difficulties  of  the  cost  method  of  price  determination 
can  be  avoided  by  simply  revising  prices  according  to  a  ratio  method: 

The  beauty  of  the  price  ceiling  is  that  adjustment  upward  of  depressed  seg- 
ments where  increased  production  is  required  is  a  matter  of  calculating  ratios  and 
not  of  intricate  studies.  Also,  with  a  ceiling  put  over  even  a  dislocated  structure, 
segments  that  are  too  high  or  too  low  can  be  adjusted  downward  or  upward  in 
the  same  manner.  In  neither  case  is  there  necessarily  a  question  of  computing 
costs." 

There  are  limitations  on  the  use  of  tliis  device.  As  Mr.  Baruch 
has  stated  in  liis  testimony  before  the  War  Pohcies  Commission,  down- 
ward price  revision  requires  cost  studies: 

It  is  a  much  more  difficult  thing  to  revise  maximum  prices  downward  than  to 
revise  them  upward.  It  requires  exhaustive  cost  studies  and  long  and  difficult 
negotiations.!' 

It  can  readily  be  seen  that  in  time  of  war,  when  production  is  a  vital 
consideration,  no  action  mil  be  taken  to  lower  prices  until  it  is  defi- 
nitely ascertained  that  necessary  production  will  not  be  lost.  This 
requires  information  as  to  the  costs  at  which  the  various  proportions 
of  output  are  being  brought  in. 

The  World  War  experience  was  that  lack  of  cost  information  de- 
layed downward  price  revision. 

The  efforts  of  the  War  Industries  Board  to  fix  the  prices  of  cotton 
textiles  are  in  point.  The  Board  met  and  fixed  a  price  but,  "there 
was  a  decided  absence  of  cost  data.     Several  requests  had  been  made 

'<  Minutes  of  the  Price-Fixing  Committee,  May  9,  1918. 

:5  Ibid  Oct.  21,  1918. 

16  Supplementary  statement  of  Bernard  M.  Baruch,  Apr.  12,  1935. 

1"  War  Policies  Commission  Hearings,  op.  cit.,  p.  807. 


92  MUNITIONS    INDUSTRY 

for  such  data,  but  the  representatives  of  the  industry  claimed  that 
the  time  required  for  their  collection  and  compilation  would  be  too 
long  to  make  them  available  for  immediate  use."^*  When  price  re- 
vision was  considered,  "the  same  lack  of  cost  information  held  up 
negotiations.  Indeed,  'the  failure  of  a  large  number  of  cotton  mills 
to  submit  their  cost  sheets '  resulted  in  the  postponing  of  any  revision 
until  November  16."^^  When  cost  data  finally  were  obtained,  the 
Government  found  that  under  the  original  price  a  profit  considerably 
larger  than  25  percent  on  plant  investment  was  being  made.^'^ 

Again,  in  the  case  of  sole  and  belting  leather:  "It  was  not  until  the 
middle  of  July  1918  that  the  question  of  sole  leather  prices  was  taken 
into  consideration  by  the  Price-Fixing  Committee  and  even  then, 
because  of  lack  of  sufficient  cost  data,  no  definite  action  was  taken. "_^^ 

Upward  price  revision  requires  cost  information  if  any  attempt  is 
to  be  made  at  profits  hmitation.  Readjustment  upward  cannot  be 
confined  to  the  pre-war  price;  it  will,  in  the  usual  case,  be  set  above 
that  level.  The  very  fact  that  high-cost  producers  were  unable  to 
operate  at  normal  pre-war  prices  indicates  the  necessity  for  this. 
It  should  be  remembered  that  although  the  August  1914  price  for 
wheat  was  $1.07  a  bushel,  the  war-time  minimum  price  was  fixed  at 
$2.26  per  bushel  to  stimulate  production.  Cost  determinations,  no 
matter  how  difficult,  are  necessary  to  keep  some  check  on  the  impulse 
to  raise  prices. 

If  profits  are  to  be  limited,  costs  must  also  be  determined  in  situa- 
tions analagous  to  Mr.  Baruch's  illustration  of  the  cost  decrease  re- 
sulting from  increased  production  (supra,  p.  68).  He  has  stated  the 
process  as  follows: 

Mechanical  mass  production  brings  low  costs,  but  only  when  the  machines  are 
operating  close  to  capacity     *     *     *,  ,  •  u  c     j 

These  machines  represent  enormous  aggregations  of  capital,  on  which  fixed 
charges  are  very  great  *  *  *  when  they  are  speeded  the  results  in  reduced 
cost  per  unit  are  sometimes  almost  fabulous. 22 

Failure  to  take  this  into  account  means  that  "even  with  a  fixed 
price  structure  and  a  high  excess-profits  tax  there  will  be  huge 
profits."  '^ 

(4)    NONENFORCEABILITY    OF    PRICE    REGULATIONS 

In  addition,  there  are  the  profits  which  accrue  to  sellers,  who  by 
wholesale  nonobservance  can  easily  render  ineffective  price  schedules 
which  they  do  not  consider  satisfactory. 

In  the  field  of  price  enforcement,  as  in  that  of  taxation,  it  is  neces- 
sary to  distinguish  between  avoidance  and  evasion.  The  former 
method  of  defeating  governmental  rules  works  itself  out  legally  by 
following  the  rules  and  taking  advantage  of  the  loopholes  therein. 
For  example,  in  the  World  War,  millers  defeated  the  regulation  liniit- 
ing  them  to  a  profit  of  25  cents  per  barrel  of  flour  by  creating  jobbing 
departments  in  order  to  get  the  additional  jobbers  profit  of  50  to  75 
cents  a  barrel. 

18  Garrett,  op.  cit.,  p.  298. 

i»  Ibid,  p.  301. 

80  Ibid,  p.  302. 

>i  Ibid,  p.  322. 

23  War  Policies  Commission  hearings,  op.  cit.,  p.  799. 

M  Ibid. 


MUNITIONS    INDUSTRY  93 

According  to  Eldred,  Wheat  and  Flour  Trade:  1917-18  ^*— 
Out  of  some  1,500  mills  reporting  their  costs  to  the  Food  Administration  under 
the  voluntary  agreement  439  had  separate  jobbing  departments  on  June  18,  1918. 
In  many  cases  these  jobbing  departments  were  new  creations,  designed  to  cover 
up  profits  in  excess  of  the  allowable  maximum.  It  was  an  undoubted  weakness 
in  the  rules  which  permitted  and  perhaps  even  suggested  the  creation  of  these 
bogus  jobbing  departments. 

Recent  experience  with  the  N.  R.  A.'s  attempt  to  enforce  minimum 
prices  has  uncovered  the  many  possibilities  for  noncompliance  in  the 
complicated  field  of  price  regulation.  For  example,  Dr.  Corwin 
Edwards,  technical  director  of  staff  of  the  Consumer's  Advisory 
Board  of  the  N.  R.  A.,  stated  at  the  N.  R.  A.'s  hearings  on  price 
policy  that  producers  in  the  machined  waste  industry  took  advantage 
of  the  brand  method  of  filing  prices  by  simply  changing  the  name  of 
their  brand  if  they  wanted  to  change  their  price.^^ 

The  relations  between  buyer  and  seller  also  offered  devices  for 
avoidance.  Dr.  Edwards  stated  that  some  wholesalers  would  sell 
to  retailers  at  the  prescribed  price  but  would  also  give  them  adver- 
tising allowances  which  were  much  larger  than  those  offered  by  com- 
petitors.-^ In  the  event  of  war  where  the  purchaser  would  be  anxious 
to  make  concessions,  the  process  could  be  easily  reversed;  i.  e.,  he 
would  forego  the  usual  allowances  granted  by  the  seller. 

The  difficulties  of  preventing  outright  violation  or  "bootlegging" 
would  become  insuperable  if  prices  were  set  at  levels  which  business 
would  not  agree  to  in  the  first  instance.  In  the  World  War,  enforce- 
ment was  a  relatively  minor  problem  because  of  the  profitable  nature 
of  the  fixed  prices.  It  was  the  opinion  of  Commander  John  M. 
Hancock,  the  naval  representative  on  the  Price  Fixing  Committee, 
that  enforcement  of  the  price  freezing  plan,  whose  main  feature  has 
been  pointed  out  to  be  the  use  of  pre-war  prices,  would  require  ma- 
chinery which  would  not  work,  unless  this  proposal  was  merely  intended 
for  psychological  effect: 

The  only  fear  I  have  from  having  heard  the  discussion  this  morning  is  that  it 
involves  too  much  machinery,  unless  it  is  going  to  be  a  statute  passed  jirimarily 
for  the  effect  it  will  have  on  people's  minds.  But  if  you  are  going  to  try  to  en- 
force it  I  am  afraid  it  is  going  to  involve  too  much  machinery,  and  machinery 
that  won't  work.^' 

General  MacAethur,  chief  of  staff  of  the  United  States  Army, 
testified  before  the  War  Policies  Commission  that  attempting 
enforcement  of  the  price-freezing  plan  would  meet  with  antagonism 
and  that  in  final  result  it  would  be  largely  gesture: 

Freezing  of  prices  would  appear  to  be  a  doubtful  expedient  because  so  many 
factors  are  involved  that  injustice  must  follow.  Evasion  and  court  appeals  are 
inevitable.  In  the  end  the  Government's  efforts  would  probably  be  largely  ges- 
ture. Attempts  at  enforcement  would  likely  create  antagonism,  and  the  Gov- 
ernment would  lose  the  essential  elements  of  good  will.  Without  complete  and 
unstinting  popular  support  no  nation  can  hope  to  fight  to  victory. ^s 

2<  Quarterly  Journal  of  Economics,  vol.  33,  p.  48. 

2'  C.  D.  Edwards,  statement  at  N.  I.  R.  A.  price  hearing,  Jan.  9,  1935. 

28  Ibid. 

27  War  Policies  Commission  Hearings  op.  cit.  p.  155.  One  of  the  psychological  situations  which  price 
freezing  is  designed  to  prevent  has  been  described  by  Mr.  Baruch  as  follows:  "  Destruction  of  domestic 
morale  through  a  just  and  bitter  resentment  by  soldiers,  and  their  families  (and  indeed  by  all  persons  of 
fixed  income)  at  the  spectacle  of  grotescjuely  e.xaggerated  profits  and  income  to  those  engaged  in  trade  or  in 
services  for  sale  in  competitive  markets  and  the  constantly  increasing  burden  of  bare  existence  to  all  those 
who  are  not  so  engaged.  This  is  the  greatest  source  of  complaint  of  "unequal  burdens."  The  present 
demands  for  "etiualizing  burdens"  and  "taking  the  profits  out  of  war"  both  go  back  to  the  single  phenome- 
non of  war  inflation.  There  is  no  more  important  problem  to  solve — whether  we  consider  it  purely  as  a 
means  to  maintain  the  solidarity  and  morale  of  our  people,  or  as  the  basis  of  our  economic  strength  for  war 
purposes,  or  to  avoid  war's  aftermath  of  economic  prostration,  or  on  the  broader  grounds  of  humanity  and 
even-handed  justice."    (Ibid  p.  33.) 

2s  Ibid  p.  372. 

11579 — 35 T 


94  MUNITIONS    INDUSTRY 

These  difficulties  of  keeping  the  actual  level  of  prices  coterminous 
with  the  prices  announced  to  the  pubhc  will  be  increased  with  the 
increase  in  the  number  of  commodities  and  individuals  regulated. 
Wliere  all  prices  are  to  be  regulated,  as  under  the  price-ceiling  scheme, 
the  task  appears  to  be  an  administrative  impossibility.  Furthermore, 
it  is  necessary  to  remember  that  in  addition  to  policing  thousands  of 
commodity  prices  and  all  the  producers  and  seUers,  whether  wholesale 
or  retail,  in  tliis  country,  it  will  also  be  necessary  under  Mr.  Baruch's 
suggestion  of  a  penal  sanction  against  the  buyer  to  supervise  all 
buyers. 

(5)   THE  STRIKE  OF  CAPITAL 

The  folly  of  relying  upon  any  voluntary  limitation  of  profits  has 
been  well  demonstrated  by  the  experience  of  the  Government  in  the 
World  War.  This  committee's  investigation  has  developed  the  fact 
that  the  use  by  business  of  its  power  of  forcing  price  concessions  from 
the  Government  by  making  that  a  condition  of  continued  production, 
which  amounted  simply  to  a  "strike  of  capital"'^  was  not  uncommon 
and  was  not  confined  to  the  minority  of  industry. 

Mr.  Baruch  in  his  statement  to  the  War  Policies  Commission  has 
pointed  out  some  of  the  inadequacies  of  cooperation  in  the  prevention 
of  inflation: 

Yet  I  venture  to  think  that  there  is  not  one  of  those  industrial  leaders  who 
would  not  heartily  agree  with  me  in  saying,  first,  that  it  would  be  impossible 
to  prevent  general  inflation  by  any  Nation-wide  convention  as  to  price;  second, 
that  no  one,  no  matter  how  generous,  could  agree  to  restrict  his  own  price  unless 
all  other  prices  affecting  him  were  restricted  or  unless  his  price  were  already  so 
high  that  his  profits  were  exorbitant,  and,  finally,  that  substantial  price  reduc- 
tions by  agreement  (even  from  highly  profitable  peaks)  could  not  be  secured 
unless  those  willing  to  agree  through  high-mindedness  knew  that  the  Government 
body  with  which  they  were  dealing  had  some  sanctions— some  control  with 
actual  teeth  or  some  disciplinary  power  to  apply  to  recalcitrant  or  unwilling 
subscribers  in  the  event  of  default.^o 

He  has  also  indicated  the  lack  of  cooperation  in  the  last  war, 
especiafiy  in  the  important  iron  and  steel  industry: 

I  wish  the  record  and  my  memories  permitted  me  to  agree  with  the  picture 
presented  bv  these  witnesses  of  each  commodity  group  gathering  around  to  hear 
our  price  determinations  and  then  going  away  "enthusiastic  for  doing  it.  1 
wish  I  could  also  agree  that  after  a  meeting  of  steel  leaders  with  the  becretaries 
of  War  and  IS  aw  before  the  war  "the  effect  of  that  kind  of  price  control  through 
leadership  *  *  *  was  that  the  general  price  level  of  iron  and  steel  prices 
went  down  after  America  went  into  the  war."  My  recollection  is  of  a  long  and 
tedious  period  of  bickering  attended  at  first  by  such  public  statements  bythe 
President  as  "those  who  do  not  respond  in  the  spirit  of  those  who  have  given 
their  lives  for  us  on  bloody  fields  far  away  may  safely  be  left  to  be  dealt  with 
by  opinion  and  by  the  law,  for  the  law  must,  of  course,  command  these  things. 
I  recall  a  bitter  controversy  between  the  chairman  of  the  Shipping  Board  and 
the  industry  in  June  1917  leading  to  the  Pomerene  bill  which  proposed  to  authorize 
the  President  to  fix  iron  and  steel  prices  and  to  commandeer  the  plant  of  any 
producer  who  failed  to  comply.  I  remember  also  what  I  am  free  now  to  relate 
since  Judge  Garv  himself  has  said— in  efiect— that  he  kept  the  steel  industry 
from  being  nationalized.  He  was  quite  correct.  Due  to  the  inability  of  Govern- 
ment to  reach  agreement  with  the  steel  industry,  I  was  compelled  to— and  did— 
secure  authority  from  the  President  to  commandeer  certain  companies  in  that 

2»  Senator  Nye  said:  "CaUing  the  attitude  of  the  steel  industry  and  the  copper  industry  a  strike  I  would 
suggest  that  the  only  difference  between  their  strike  and  a  strike  oflabor  was  that  in  the  case  of  the  steel 
and  copper  people  their  strike  was  carried  on  behind  closed  doors.  They  won  their  stnke,  if  we  c^n  call  it 
that.  They  won  the  higher  price  they  were  seeking,  they  woii  higher  profits  as  a  result  of  their  delaY,  and 
the  Government  did  not  get  as  large  a  slice  of  the  profits  back  m  the  way  of  taxes  that  t  thought  it  was 
going  to  get  \gain  for  that  reason,  it  seems  to  me  that  we  need  the  stillest  kind  of  club  to  deal  witn  a 
situation  like  that  in  the  future".    (Mar.  29,  1935,  Galley  2  WC). 

3»  War  Policies  Commission  Hearings,  op.  cit.,  p.  815. 


MUNITIONS    INDUSTRY  95 

industry  if  it  should  become  necessary.  While  all  this  was  going  on,  the  index 
figures  of  the  United  States  Department  of  Labor  show  the  following  as  to  the 
prices  of  iron  and  steel: 


1917 — Continued. 

July 230.2 

August 227.  6 

September  (price  fixed) —  214.3 

November 143.  7 


1915 64.  7 

1917: 

April 170 

Mav 182.7 

June 204 

As  Commander  Hancock  expressed  it  in  his  testimony  (p.  154)  relating  to  price 
control  through  leadership  and  agreement: 

"*  *  *  the  President  said  to  Mr.  Brookings  (chairman  of  the  price-fixing 
commission),  'Let  the  manufacturer  see  the  club  behind  your  door.'  "  ^i 

Apparently,  patriotism  was  in  some  instances  confined  to  merely 
deploring  the  excessive  profits  that  were  being  gained.  Mr.  Baruch 
stated: 

I  recall  vividly  that  during  the  war,  even  after  we  had  by  price-fixing  compelled 
a  reduction  of  35  percent  from  the  peak  index  figure  of  iron  and  steel,  and  even 
after  the  80  percent  excess-profits  tax  was  in  effect,  some  high-minded  and  public- 
spirited  steel  men  came  to  me  expressing  apprehension  over  the  enormous  profits 
they  were  making  under  our  restrictive  system  operating  at  its  best.  The  reason 
they  were  making  such  profits  in  spite  of  all  we  could  do  is  made  clear  by  the 
example  I  have  given  you.  If  to  the  enormous  increase  in  profits  shown  by  that 
example  we  add  the  profits  due  to  a  runaway  market,  the  figures  of  profit  become 
even  more  astouishing.^- 

(«)  The  Copper  Industry. — Prior  to  the  entry  of  the  United  States 
into  the  World  War,  the  leading  copper  producers  of  the  country 
responded  to  the  appeal  of  the  preparedness  campaign  and  sold 
45,510,000  pounds  of  copper  to  the  Government  at  a  price  of  16.67 
cents  a  pound.  The  arrangement  was  proposed  by  Eugene  Meyer, 
Jr.,  according  to  the  Report  of  the  War  Industries  Board,'^  and  was 
finally  effected  by  Bernard  M.  Baruch. 

Mr.  Baruch  came  to  Washington  early  in  1917  to  take  charge  of  raw 
materials  as  a  member  of  the  Advisory  Commission  of  the  Council  of 
National  Defense.  He  commenced  negotiation  on  the  proposal  and 
on  March  13,  1917,  communicated  to  Secretary  of  War  Baker  that 
the  copper  producers  were  anxious  to  meet  the  Government  in  a  patrio- 
tic manner.  High  hopes  were  held  out  that  a  successful  negotiation 
would  serve  as  a  precedent  in  the  naming  of  prices  that  would  result  in 
large  savings  to  the  Government:^* 

Hon.  Newton  D.  Baker,  March  13,  1917. 

Secretary  of  TT'or,  Washington,  D.  C: 
Have  had  conference  with  leading  copper  producers,  who  are  anxious  and  desir- 
ous of  meeting  the  Government  in  a  patriotic  manner  to  give  them  whatever  copper 
the  Government  may  need  at  the  right  time  and  a  proper  and  fair  price.  This 
will  apply  not  alone  to  their  needs  in  a  crisis  but  also  the  needs  arising  from  the 
expenditures  in  their  present  preparedness  campaign.  They  desire  to  know  the 
approximate  amounts  needed  and  the  approximate  time  for  delivery.  I  wish  you 
would  take  this  matter  up  immediately,  as  I  believe  that  it  would  result  in  establish- 
ing a  precedent  in  the  naming  of  prices  for  all  raw  material  which  would  result  in  a 
large  savings  [sic]  to  the  Government  and  which  perhaps  might  affect  contracts 
already  given  out  and  which  might  be  most  potent  in  causing  coordination  be- 
tween business  and  Government,  which  I  understand  was  one  of  the  underlying 
reasons  for  the  President's  desire  in  forming  the  council  and  its  commission.  I  am 
sending  a  copy  of  this  telegram  to  the  Secretary  of  the  Navy,  as  I  deem  it  advis- 
able for  the  Army  and  Navy  to  act  jointly  in  this  matter. 

Bernard  M.  Baruch. 


31  72d  Cong.,  1st  sess.,  H.  Doc.  No.  163,  pp.  815  and  816. 

32  War  Policies  Commission  Hearings,  op.  cit.,  p.  799. 

33  p.  131. 

«  Exhibit  No.  1690. 


96  MUNITIONS    INDUSTRY 

The  Secretary  of  the  Navy  replied  to  Mr.  Baruch  on  March  14, 
1917,  that  a  very  large  reduction  in  price  could  be  effected  because 
the  average  cost  of  production  was  about  10  cents  per  pound.^^  At 
this  time  electrolytic  copper  was  selling  at  a  price  of  approximately 
36  cents  per  pound  to  large  buyers  ^^  which  represented  on  the  basis 
of  this  cost  estimate,  an  average  per  unit  profit  of  more  than  250  per- 
cent. 

The  16^^-cent  price  granted  to  the  Government  in  aid  of  its  war 
preparedness  campaign  was  based  upon  a  10-year  average  of  pre-war 
prices.  These  years  included  the  very  high  prices  in  the  3  years  pre- 
ceding our  entry  into  the  war  when  the  copper  industry  was  selling 
to  the  Allies  at  the  extremely  large  profits  which  have  already  been 
indicated.  On  the  basis  of  the  Secretary  of  the  Navy's  cost  estimate 
the  "gift"  price  to  the  Government  was  thus  productive  of  an  aver- 
age profit  of  66%  percent.  Furthermore  only  45,000,000  pounds  of 
production  were  affected,  20,000,000  going  to  the  Navy  and  25,000,- 
000  to  the  Army,  in  contrast  with  the  more  than  2,000,000,000 
pounds  of  electrolytic  copper  which  entered  trade  in  1917.^^ 

The  price  was  determined  March  20,  1917,  after  little  more  than  a 
week  of  conferences  by  Mr.  Baruch  with  the  copper  interests.  The 
action  of  the  industry  was  characterized  in  the  following  manner  by 
Mr.  Gifford  who  was  then  director  of  the  Council  of  National  Defense: 

This  willingness  to  furnish  the  copper  supply  needed  by  the  Government  at  the 
maximum  concession  in  price,  is  a  very  gratifying  evidence  of  the  recognition  of 
men  in  large  affairs  of  their  patriotic  obligation  and  both  War  and  Navy  Depart- 
ments appreciate  their  generous  and  public-spirited  attitude. '^ 

It  has  been  indicated  however  in  the  testimony  before  this  com- 
mittee that  at  about  this  time  a  great  deal  of  talk  was  going  on  con- 
cerning the  possibihty  of  commandeering.  Senator  La  Follette  and 
others  having  suggested  thedesirabihty  of  conscripting  industry  and 
wealth  as  well  as  man  power.  It  is  clear  that  the  action  of  the  copper 
producers  was  later  used  as  an  argument  against  commandeering.  In 
July  1917  when  the  Army's  representatives  told  Mr.  Baruch  that  they 
wished  to  commandeer  copper  from  one  company,  which  would  be  a 
convenience  to  the  Army,  he  w^rote  Secretary  of  War  Baker  suggesting 
that  the  copper  be  commandeered  from  all  producers  proportionately 
and  stressed  the  helpfulness  of  the  industry: 

Yesterdav  afternoon  Major  Brett  and  Lieutenant  WiUiams,  of  the  Ordnance 
Department,  called  at  my  office  and  stated  the  needs  of  the  Army  to  be 
5  000  000  pounds  of  copper,  of  which  500,000  pounds  was  for  immediate  delivery 
'  The  object  of  their  visit  was  to  discuss  the  commandeering  of  copper  and 
thev  desired  to  commandeer  from  one  company,  as  that  would  be  a  convenience 
to  them.  I  would  suggest  that  if  you  intend  to  commandeer  copper  or  anything 
else  that  you  commandeer  it  from  all  producers  proportionately.  , .     ,     , 

There  inay  be  some  misunderstanding  but  I  think  it  would  be  particularly 
unfortunate 'and  unfair  if  we  should  commandeer  any  article  without  aUowing 
the  producers  from  which  it  is  to  be  commandeered  an  opportunity  to  be  heard. 
Also  you  will  recall  that  the  copper  people  were  the  first  people  who  came  forward 
in  a  helpful  spirit  at  a  time  when  it  meant  much.^o 

The  price  was  apparently  a  very  reasonable  one  for  the  producers 
and  it  is  a  certainty  that  no  participant  in  this  "gift"  lost  any  money. 

35  Exhibit  No.  1691. 

'"  W^I'r^IndustriJs^  Board  Price  Bulletin  No.  34,  "  Prices  of  Ferroalloys,  Nonferrous  and 
Rare  Metals  ",  p.  23. 
3S  Exhibit  No.  1692. 
=»  Exhibit  No.  1694. 


MUNITIONS    INDUSTRY  97 

Senator  Clark.  Now,  Mr.  Baruch,  there  was  no  suggestion  at  that  time,  was 
there,  on  the  part  of  any  of  these  copper  producers  that  they  were  in  any  danger 
of  losing  money  at  a  price  of  167^  cents;  the  money  was  there? 

Mr.  Baruch.  They  could  not  make  it  to  me,  because  I  would  laugh  at  them.'*" 

The  movement  for  higher  prices  soon  began  with  the  direction  of 
attention  to  the  relationship  between  high  prices  and  the  maintenance 
of  production.  On  May  2,  1917,  Mr.  Eugene  Meyer  wrote  Mr. 
Baruch  the  following  letter: 

Since  our  talk  in  Washington  I  have  given  careful  study  to  the  copper  sta- 
tistics. The  refinery  production  in  the  United  States  in  1910  was  654,000  tons. 
It  showed  very  little  increase  for  several  j^ears.  It  slowly  increased  until  in 
1913  it  was  731,000  tons.  Even  in  1915  it  was  736,000  tons,  but  the  1916  figures 
jumped  to  1,040,000  tons.  This  enormous  increase  in  production  coincided  with 
the  big  rise  in  price,  and,  in  my  opinion,  was  unquestionably  due  to  the  rise  in 
price. 

To  keep  up  the  production  it  will  be  necessary  to  maintain  a  high  price.  There 
is  a  lot  of  this  copper  which  cost  very  much  above  the  prices  that  prevailed  under 
normal  conditions.  To  reduce  the  prices  radically  would,  in  my  opinion,  unques- 
tionably reduce  the  production." 

In  June  1917  the  military  need  for  copper  became  intense  but 
apparently  it  could  not  be  met  at  the  previous  price  to  the  Govern- 
ment of  16;^  cents.  A  25-cent  price  was  arranged  by  the  raw  ma- 
terials committee  headed  by  Mr.  Baruch  and  was  recommended  by 
the  Munitions  Board  for  acceptance.  This  price,  which  the  copper 
producers  held  out  for  at  a  later  time,  was  thought  to  be  too  high  by 
the  Secretary  of  War  and  on  July  6  there  was  a  communication  from 
the  Ordnance  Department  stating  that  he  disapproved  it.  The 
minutes  of  the  General  Munitions  Board  at  a  meeting  held  July  13, 
1917,  follow: 

Copper:  A  communication  froin  Mr.  Mej^er  dated  July  11,  attaching  copy  of 
communication  from  the  Ordnance  Department  (No.  770.15/124)  dated  June  25, 
accepting  the  price  of  25  cents  per  pound  for  60,000  pounds  of  copper  arranged 
for  by  the  raw  materials  committee  was  presented;  likewise  copy  of  communica- 
tion froin  the  Ordnance  Department  dated  July  6  (No.  G-470. 15/19)  stating  that 
the  Secretary  of  War  had  disapproved  of  the  arrangement  referred  to,  and  a 
communication  from  J.  D.  Ryan,  chairman  of  the  copper  committee,  dated  July 
10,  relative  thereto  was  presented  and  ordered  made  a  matter  of  record.'" 

In  July  1917,  as  can  be  seen  from  Mr.  Baruch's  letter  on  page  96, 
the  Army  was  apparently  intent  on  using  the  commandeering  power, 
and  on  August  7,  1917,  the  War  Industries  Board  decided  that  com- 
mandeering should  be  used  to  gain  the  necessary  supply  if  the  copper 
producers  would  refuse  to  accept  a  tentative  price  of  20  cents  per 
pound: 

Meeting  of  the  War  Industries  Board,  held  at  10  a.  m.,  Tuesday,  August  7, 
1917,  in  room  945,  Munsey  Building. 

Present:  Mr.  F.  A.  Scott,  chairman;  Mr.  Baruch;  Mr.  Brookings;  Admiral 
Fletcher;  Mr.  Frayne;  Judge  Lovett;  Colonel  Pierce;  Mr.  H.  P.  Bingham,  sec- 
retary. 

Copper  desired  by  British  and  French  Governments:  It  was  moved  and  carried 
that  in  connection  with  the  negotiations  which  Mr.  Baruch  is  to  carry  on  with 
the  copper  interests  relative  to  the  furnishing  to  the  British  and  French  Govern- 
ments of  approximately  60,000,000  pounds  desired  for  immediate  shipment,  that 
Mr.  Baruch  be  requested  by  the  War  Industries  Board  to  offer  the  copper  pro- 
ducers a  payment  on  account  of  20  cents  per  pound  for  this  amount  of  copper  with 
the  stipulation  that  such  payment  on  account  should  be  entirely  disregarded  in 
fixing  the  final  price  to  be  paid  for  this  copper,  which  final  price  might  be  above  or 
below  20  cents  per  pound,  and  further  that  if  the  copper  producers  refuse  to  enter 

«'  Bernard  M.  Baruch,  Mar.  27, 1935.    Galley  66  BBQ. 
"  Exhibit  No.  1693. 


98  MUNITIONS    INDUSTRY 

into  such  an  agreement,  that  then  the  Government  wiU  proceed  to  commandeer 
the  necessary  supply.'*'^ 

But  on  the  next  day,  according  to  the  minutes,  the  War  Industries 
Board  yielded  to  make  an  offer  of  a  tentative  price  of  22 K  cents: 

Copper-  Negotiations  with  copper  producers.  Mr.  Brookings  stated  that  Mr. 
Ryan  had  stated  to  him  that  when  the  needs  of  the  Allies  are  mcluded  m  the 
negotiations  for  supplying  of  copper  for  military  needs,  the  copper  mterests  are 
not  willing  to  accept  a  memorandum  price,  but  are  willing  to  give  the  necessary 
copper  at  a  firm  price  of  25  cents  per  pound,  whereupon  Mr.  Baruch  made  the 
following  motion:  . 

"Resolved,  That  as  the  copper  emergency  required  immediate  action  necessary 
to  secure  a  supply  for  our  Government  and  our  Allies,  that  the  Board  endeavor 
to  secure  from  the  copper  interests  the  needs  of  ourselves  and  our  Allies  at  a 
price  to  be  fixed  when  we  receive  the  report  of  the  Federal  Trade  Commission 
as  to  the  costs  and  for  purposes  of  payment  on  account  of  deliveries,  a  tentative 
price  of  22I2  cents  be  fixed  with  the  understanding  that  this  price_  shaU  in  no 
way  be  taken  into  consideration  when  the  final  price  is  to  be  determined. 

This  motion  being  duly  seconded  by  Judge  Lovett  was  unanimously  adopted." 

At  this  time  the  Secretary  of  War  was  also  beginning  to  make  con- 
cessions, the  War  Industries  Board  minutes  of  August  17  statmg  that 
he  suggested  arrangement  of  a  price  of  25  cents  a  pound  for  the  Allies. 
Even  this  high  price  would  have  to  be  brought  about  by  the  "mdivid- 
ual  friendly  act"  of  Mr.  Baruch: 

Present:  Mr.  Scott,  chairman,  Mr.  Baruch,  Admiral  Fletcher,  Mr.  Frayne, 
Judge  Lovett,  Colonel  Pierce,  Mr.  Bingham,  secretary. 

Copper — Allied  purchases:  Colonel  Pierce  stated  that  in  accordance  with  the 
instructions  of  the  Board  he  and  Mr.  Baruch  called  upon  the  Secretary  of  War 
relative  to  the  procurement  of  copper  for  certain  of  the  Allies,  with  particular 
reference  to  the  instructions  given  the  Board  by  the  Secretary  of  War  under 
date  of  August  14,  regarding  such  matters.  The  Secretary  of  War  referred  them 
to  the  Secretary  of  the  Treasury  who  was  carrying  on  negotiations  with  the 
Allies  covering  this  subject.  The  Secretary  of  the  Treasury  expressed  preference 
for  the  instructions  issued  by  the  Secretary  of  War  in  that  the  Board  at  present 
should  only  offer  the  Allies  its  friendly  services  until  its  present  negotiations  were 
completed!  Colonel  Pierce  then  stated  that  he  again  saw  the  Secretary  of  War 
who  suggested  that  taking  all  into  consideration  for  this  emergency,  it  might  be 
preferable  to  arrange  to  furnish  this  copper  at  a  price  of  25  cents,  if  such  an 
arrangement  could  be  possibly  brought  about  through  the  individual  friendly  act 
of  Mr.  Baruch." 

The  War  Industries  Board  was  convinced  in  September  1917  that 
22  cents  a  pound  would  be  a  reasonable  price.  This  conclusion  was 
more  than  justified  by  Federal  Trade  Commission  figures  which 
showed  that  97  percent  of  production  was  being  brought  in  at  a  cost 
of  less  than  20  cents  per  pound.  The  2-cent  differential  at  this  price 
would  have  given  the  high-cost  producers  of  this  group  a  profit  of 
10  percent  and  the  low-cost  producers  a  much  larger  margin.  Many 
of  the  latter  were  producing  at  costs  of  less  than  the  average  of  13.6 
cents  which  represented  a  profit  of  57  percent  for  the  average  producer. 
The  Federal  Trade  Commission  reported  United  Verde  Extension 
Mining  Co.'s  costs  to  be  7  cents;  Kennecott  Copper  Co.,  8  cents; 
and  Inspiration  Consolidated,  12  cents. *^ 

However,  Mr.  Ryan  told  the  War  Industries  Board  that  the  price 
of  voluntarv  cooperation  from  the  copper  industry  was  25  cents  per 
pound;  at  the  22-cent  price,  he  stated  that  it  would  be  impossible  to 


«  Exhibit  No.  1698. 
«  Exhibit  Xo.  1699. 
«  Exhibit  No.  1700. 
«  Exhibit  No.  1712. 


MUNITIONS    INDUSTRY  99 

obtain  the  cooperation  of  the  majority  of  mine  owners.  He  went 
further,  to  virtually  deliver  an  ultimatum  to  the  Government  that  if 
a  22-cent  price  were  fixed  it  would  be  necessary  for  the  Board  to 
appoint  other  producers  to  manage  the  distribution  of  copper: 

MEETING  OF  THE  WAR  INDUSTRIES  BOARD,  HELD    SEPTEMBER  10,  1917,  AT  12  A.  M.  IN 
ROOM    945,    MUNSEY    BUILDING 

Present:  Judge  Lovett,  acting  chairman,  Mr.  Baruch,  Mr.  Brookings,  Admiral 
Fletcher,  Mr.  Frayne,  Mr.  Bingham,  secretary,  and  representatives  of  copper 
interests:  Mr.  J.  D.  Ryan,  Mr.  Joseph  Clendenin,  Mr.  T,  Wolfson,  Mr.  R.  L. 
Agassiz. 

Copper  price-fixing. — Mr.  Ryan  stated  that  if  22  cents  per  pound  were  fixed 
as  a  price  for  copper  that  it  would  be  impossible  to  obtain  the  voluntary  cooper- 
ation of  the  majority  of  mine  owners.  If  25  cents  were  fixed  he  assured  the 
War  Industries  Board  that  he  and  the  other  copper  producers  present  would 
obtain  all  the  copper  of  the  country  voluntarily  from  all  producers,  and  that  he 
would  see  to  it  that  the  copper  was  properly  distributed  and  the  price  con- 
trolled. This  would  likewise  cover  the  300,000,000  pounds  produced  outside  of 
the  United  States.  Should  22  cents  be  fixed,  this  300,000,000  pounds  could  not 
he  controlled.  The  breaking  of  the  sliding  scale  of  wages  now  in  force  which 
the  War  Industries  Board  stated  they  would  insist  upon  when  fixing  a  22-cent 
price  would,  Mr.  Ryan  said,  be  disastrous  and  would  eventually  curtail  pro- 
duction of  copper.  He  said  that  the  copper  producers  present  would  do  all 
they  could  to  help  the  Government  no  matter  what  price  was  fixed,  but  that 
they  were  convinced  that  at  a  22-cent  price  they  could  not  control  the  entire 
copper  output,  and  that  being  convinced  of  this  fact  they  would  suggest  that 
other  copper  producers  be  appointed  to  manage  the  distribution  of  copper 
should  the  low  rate  be  fixed.  The  copper  producers  at  this  point  retired  from 
the  meeting. ^8 

On  September  21,  1917,  the  War  Industries  Board  yielded  from  its 
price  of  22  cents  which  had  been  a  concession  from  the  original  price  of 
20  cents  offered  on  August  6, 1917.*'  The  final  figure  was  23 K  cents, 
representing  a  splitting  of  the  difference  in  the  final  opposing  prices  of 
the  Government  and  the  copper  producers.  Even  at  this  price  with, 
its  consequent  opportunities  for  excessive  war  profits,  it  was  necessary 
for  Government  to  utter  a  threat  of  commandeering  in  contemplation 
of  noncooperation.  The  statement  of  the  Board  as  accepted  by  the 
President  stated  that — 

The  proper  departments  of  the  Government  will  be  asked  to  take  over  the  mines 
and  plants  of  any  producers  who  fail  to  conform  to  the  arrangement  and  price,  if 
any  there  should  be.^^ 

The  nature  of  the  control  over  distribution  which  the  copper 
producers  could  now  guarantee  was  indicated  in  the  final  statement 
prepared  by  the  War  Industries  Board  for  the  signature  of  the 
President.  One  of  the  considerations  imposed  by  the  Board  in  con- 
sideration of  the  granting  of  the  23}2-cent  price  was  that: 

the  operators  shall  sell  to  the  Allies  and  the  public,  copper  at  the  same  price  paid 
by  the  Government,  and  will  take  the  necessary  measures,  under  the  direction  of 
the  War  Industries  Board  for  the  distribution  of  the  copper  and  to  prevent  it 
from  falling  into  the  hands  of  speculators,  who  would  increase  the  price  to  the 
public. ^8  ^ 

In  liis  testimony  before  the  committee  Mr.  Baruch  said  "Do  not  for 
a  moment  let  me  be  put  in  the  position  of  defending  their  patriotism, 
and  all  that  kind  of  tiling,  because  I  realize  that  we  had  to  use  a  club."  *^ 

<8  Exhibit  no.  1702. 
<'  Exhibit  No.  1697. 
<8  E.xhibit  No.  1703. 
«  Bernard  M.  Baruch,  Mar.  28,  1935  (galley  59  BBQ). 


100  MUNITIONS    INDUSTRY 

In  response  to  Senator  Clark's  statement  that  "when  they  were- 
offered  by  the  Government  22  cents  a  pound,  it  seems  to  me  that  the 
demands  of  the  copper  producers  were,to  say  the  least,  exorbitant," *° 
Mr.  Baruch  said  "All  that  you  say  is  correct,  sir.  I  am  not  seeking 
to  defend  their  actions."  ^^ 

In  May  1918,  when  the  copper  producers  returned  to  demand  a  fur- 
ther price  increase  from  the  War  Industries  Board,  there  is  recorded  in 
the  minutes  of  the  Price  Fixing  Committee  the  refusal  of  the  Anaconda 
Copper  Co.  and  the  Calumet  &  Hecla  Co.  to  agree  to  furnish  copper 
at  23^2  cents  per  pound.  Mr.  Kelley,  of  the  Anaconda,  said  "We  have 
always  agreed  for  a  definite  time  to  furnish  copper  at  a  definite  price ; 
I  could  not  agree  to  furnish  copper  for  the  Anaconda  at  23)^  cents.^^ 
Mr.  Agassiz,  of  the  Calumet  &  Hecla,  then  said  "I  cannot  agree  for 
our  company."  ^^  There  should  be  set  against  this  last  statement  the 
fact  that  the  Calumet  &  Hecla  made  a  profit  of  34.9  percent  in  1917, 
according  to  the  final  determination  of  the  Bureau  of  Internal  Reve- 
nue.^* According  to  the  Federal  Trade  Commission's  study,  the 
Anaconda's  costs  amounted  to  $0.16546  a  pound  in  the  year  1917  and 
decreased  to  $0.16484  m  March  1918." 

Differences  between  companies  also  had  their  effect  in  adding  to 
the  pressure  on  the  Government  to  make  price  concessions.  In  the 
May  meeting  Mr.  Brookings  characterized  the  controversy  between 
the  American  Smelting  &  Refining  Co.  and  certain  low  cost  producers 
over  the  adjustment  of  long  term  contracts  entered  into  prior  to  the 
commencement  of  the  war  and  unfavorable  to  the  smelting  company, 
as  an  attempt  to  delay  adjustment  in  order  to  force  up  prices: 

Mr.  Brookings.  We  haven't  considered  your  question  at  all;  we  said  we 
wouldn't.  What  you  are  doing  is  to  try  to  put  over  the  settlement  of  your 
trouble  upon  the  Government.  The  Government  declines  to  do  it.  You  can 
shut  down  tomorrow,  that  is  your  business. 

Mr.  Brownell.  That  is  our  business? 

Mr.  Brookings.  We  don't  propose  you  shall  put  it  over  on  the  Government. 

Mr.  Brownell.  And  we  are  not  regarded  as  unpatriotic? 

Mr.  Brookings.  You  can  take  that  as  you  will. 

******* 

Mr.  Brookings.  We  point  to  the  evidence  now  that  we  made  our  case  abso- 
lutely. There  was  no  rebuttal  of  any  kind.  It  was  entirely  a  question  of  ad- 
vance in  the  cost  of  wages  and  the  advance  in  the  cost  of  material;  it  was  an 
advance  as  the  result  of  the  war  and  the  Government  wasn't  responsible  for  that. 
We  went  so  far  as  to  tell  you  to  present  your  bill  to  the  Kaiser  if  you  attempted 
to  locate  the  responsibility  on  anybody.  You  gentlemen  didn't  do  the  right 
thing.  We  said,  "Come  into  court  with  clean  hands  to  adjust  an  unfair  differ- 
ence." There  isn't  a  court  in  the  United  States  but  would  say,  "Gentlemen, 
you  have  no  standing  in  this  court  at  all." 

Mr.  Brownell.  I  think  you  are  charging  us  with  something  of  which  we  are 
not  guilty.     You  are  assuming  a  conspiracy — ■ — 

Mr.  Brookings.  Not  a  conspiracy  but  a  delaying  of  the  adjustment  between 
yourselves,  hoping  that  the  pressure  upon  the  Government  would  facilitate ^^ 

(6)  The  steel  industry. — Between  April  and  July  1917,  a  speculative 
increase  was  recorded  in  the  War  Industries  Board  iron  and  steel 
price  index  which  rose  almost  100  points  from  274  to  370.^^     As  a  re- 

«»Ibid.  (galley  60  BBQ). 
"  Ibid. 

"  Exhibit  no.  1711. 
M  Ibid. 

i<  Exhibit  no.  1705. 
55  Exhibit  no.  1712. 

"  Minutes  of  the  Price  Fixing  Committee,  May  22,  1918. 

"  War  Industries  Board  Price  Bulletin  No.  3,  Garrett,  Government  Control  over  Prices,  p.  246. 
See  also  the  price  index  charts  of  steel  plates  and  steel  sheets  facing  p.  128  and  of  the  metal  and  metal 
products  group  facing  p.  126. 


MUNITIONS    INDUSTKY  101 

suit,  the  different  branches  of  the  Government  began  to  make  vigorous 
protests.  On  July  12,  1917,  the  President  delivered  a  strong  warning 
with  special  reference  to  the  steel  industry  that  those  "who  do  not 
respond  in  the  spirit  of  those  who  have  gone  to  give  their  lives  for 
us  on  bloody  fields  far  away  may  safely  be  left  to  be  dealt  with  by 
opinion  and  the  law,  for  the  law  must,  of  course,  command  these 
things".^^     The  Secretary  of  the  Navy  said: 

There  is  no  justification  for  a  tremendous  increase  in  the  cost  of  basic  mate- 
rials. The  Almighty  put  these  things  in  the  ground  and  the  only  additional  cost 
over  normal  times  is  in  getting  them  out.  Under  the  law,  the  President  is 
authorized  to  fix  a  reasonable  price  for  what  is  needed  for  the  Navy.  There 
is  no  disposition  whatever  to  cause  any  hardship  to  the  producers.  We  are 
perfectly  willing  and  intend  to  pay  them  a  fair,  even  a  liberal,  profit,  but  we  will 
not  pay  exorbitant  prices,  such  as  are  being  quoted  in  some  instances.^^ 

The  Chairman  of  the  Shipping  Board  was  reported  as  favoring  the 
commandeering  of  all  steel  plants  in  the  event  of  their  refusal  to  accept 
the  prices  to  be  fixed  on  the  basis  of  the  cost  of  production  study  of  the 
Federal  Trade  Commission,  and  in  Congress  a  bill  was  debated  which 
provided  for  commandeering  any  producer  or  dealer  who  failed  to 
conform  with  its  requirements.^" 

Dissatisfaction  with  the  high  prices  of  steel  was  evident  even  before 
the  entry  of  the  United  States  into  the  war.  As  part  of  the  prepared- 
ness campaign,  Mr.  Baruch  approached  the  steel  interests  in  the 
matter  of  getting  lower  prices.^^  A  contemporary  memorandum  which 
is  committee  exhibit  no.  .1728  indicates  that  a  $2.90  price  for  steel 
plate  was  considered  to  be  the  very  most  that  should  be  asked  of  the 
Government : 

We  do  not  feel  that  an  analysis  of  the  situation  would  justify  a  price  greater 
than  $2.90. 

Judge  Gary,  however,  felt  that  the  steel  industry  could  not  deliver 
at  this  price.  In  another  war-time  memorandum  appears  the  follow- 
ing report: 

Conferred  with  Judge  Gary  at  his  house  at  9:15  in  the  morning,  at  which  time 
he  outlined  the  difficultv  of  arranging  a  fixed  price  for  plates  and  bars.  I  thought 
the  price  should  be  abo'ut  $2.90  for  plates  and  $2.50  for  bars,  but  he  stated  that 
the  many  independents  could  not  deliver  at  that  price  and  make  profit. 

I  communicated  from  his  house  with  Secretary  Daniels,  who  said  he  would  fix 
a  price  later.^^ 

In  a  letter  of  March  31,  1917,  Secretary  of  the  Navy  Daniels  wrote 
Judge  Gary  that  the  steel  industry's  price  of  $3.50  could  hardly  be 
considered  a  reduction  in  price  since  the  highest  price  hitherto  quoted 
was  $2.90.  However,  the  Secretary  was  "glad  to  note  that  the  spirit 
manifested  by  the  members  of  the  committee  was  loyal  and  hberal: " 

I  am  in  receipt  of  your  favor  of  the  30th,  enclosing  copy  of  the  letter  which 
you  have  sent  to  Mr.  Bernard  M.  Baruch,  chairman  of  the  raw  materials 
committee  of  the  Advisory  Commission  of  the  Council  of  National  Defense,  and 
also  a  letter  to  Mr.  Baruch  giving  the  names  of  the  committee  selected  by  you 
as  president  of  the  American  Iron  &  Steel  Institute,  on  steel  and  steel  products, 
I  am  very  glad  to  note  that  the  spirit  manifested  by  the  members  of  the  com- 
mittee was  loyal  and  liberal. 

"  Report  of  the  War  Industries  Board,  p.  115. 

M  War  Industries  Board  Price  Bulletin,  No.  33,  p.  20. 

«•  War  Industries  Board  Price  Bulletin  No.  3,  p.  249.  According  to  this  proposal,  price  fixing  and  control 
were  to  be  under  the  supervision  of  the  Federal  Trade  Commission  rather  than  the  Council  of  the  National 
Defense. 

81  Report  of  the  War  Industries  Board,  p.  111. 

«2  Exhibit  No.  1727. 


/ 


102  MUNITIONS    INDUSTEY 

The  prices  you  name,  f.  o.  b.  Pittsburgh,  are  in  excess  of  what  I  had  hoped  and 
expected  would  be  made.  While  I  appreciate  the  fact  that  everyone  wants  to  be 
helpful,  at  the  same  time  I  wish  to  draw  your  attention  to  the  fact  that  the 
highest  prices  which  the  United  States  Government  has  paid  have  been  on  the 
basis  of  $2.90  for  plates  and  that  was  the  price  named  by  the  Carnegie  Co.  to  the 
Government  and  which  has  not  been  raised. 

While  I  appreciate  the  increased  cost  of  production  and  that  the  market  at 
present  is  continuing  to  rise,  the  countrj*  would  not  feel  that  the  steel  manu- 
facturers had  made  a  reduction  in  their  price  when  the  Government  was  charged 
$3.50  as  against  the  last  price  of  $2.90.*53 

In  May  of  that  year  the  Secretary  of  the  Navy  turned  over  to  Mr. 
Baruch  a  letter  which  he  thought  pertinent  to  the  reduction  of  steel 
prices.  The  Secretary's  correspondent  referred  to  the  fact  that 
arguments  against  the  Government  price  were  being  sent  to  country 
newspapers  and  queried  the  justification  for  the  steel  industry's 
demand  when  the  cost  of  common  labor  had  risen  only  $1  a  day. 
The  costs  of  materials  which  were  controlled  by  the  large  steel  manu- 
facturers and  which  were  the  main  grounds  offered  for  a  higher  price 
however  had  gone  up  out  of  all  proportion  to  this  50-percent  labor 
increase.  Ferromanganese,  for  instance,  had  advanced  more  than 
1,000  percent: 

May  24,  1917. 
My  Dear  Mr.  Baruch: 

I  received  a  letter  today  from  a  gentleman  in  Illinois,  as  follows: 

Copies  of  the  Wall  Street  Journal  are  being  sent  out  to  country  papers 
complaining  about  the  price  the  Government  is  demanding  steel  for.  As  an 
excuse  they  quote  the  increased  price  of  the  products  as  follows:  Collinsville 
[Connelsville?]  coke,  in  1914,  $1.75,  now  $8;  Bessemer  iron,  $14.90,  now,  $44.95; 
basic  iron,  $13,  now  $42;  ferromanganese,  $37.70,  now  $425;  common  labor,  $2, 
now  $3. 

Now,  if  these  prices  are  correct,  why  the  great  raise?  Does  it  cost  much 
more  for  labor  to  produce  these  things,  except  labor  itself,  than  it  did  in  1914? 
To  an  outsider  it  looks  as  if  there  was  a  great  rake-off  on  the  products  above- 
quoted,  and  there  is  a  suspicion  that  the  steel  manufacturers  are  interested  in. 
the  other  products. 

I  thought  this  would  interest  you. 
Sincerely  yours, 

JosEPHUs  Daniels." 

While  price  negotiations  were  going  on,  the  Government  was  feeling 
the  pressure  of  the  armed  forces  for  production.  In  a  memorandum 
of  June  21,  1917,  a  conference  of  Army  and  Navy  officers  stressed 
the  necessity  of  gaining  maximum  steel  production  and  indicated 
their  willingness  for  the  adoption  of  prices  sufficiently  high  to  attain 
that  end.  Rehance  was  placed  on  the  excess  profits  tax  to  coUect 
back  exorbitant  profits : 

Memorandum  adopted  by  the  Joint  Conference  of  Army  and  Navy  Officers 
with  James  A.  Farrell,  representing  the  Iron  and  Steel  Institute,  June  21,  1917. 

It  is  absolutely  essential  to  fix  a  price  for  steel  which  will  meet  the  requirements 
of  the  three  great  agencies  of  the  Government  (War  Department,  Navy  Depart- 
ment, and  Shipping  Board)  that  are  to  use  the  product  and  which  will  also  meet 
the  requirements  of  the  manufacturing  interests  of  the  country  at  large,  *  *  * 
but,  above  all,  the  necessary  thing  is  to  fix  the  price  at  a  point  that  will  assure 
the  maximum  steel  production  throughout  the  country;  *  *  *  exorbitant 
profits  if  any,  to  be  taken  back  by  means  of  an  excess  profits  tax.^^ 

The  consequent  pressure  on  the  Government  for  a  final  decision 
appears  in  the  memorandum  of  General  Purchasing  Officer  R.  E.  Wood 

63  Exhibit  No.  1726. 

64  Exhibit  No.  1729. 
«  Exhibit  No.  1730. 


MUNITIONS   INDUSTKY  103 

to  General  Goethals  dated  June  28, 1917.  The  construction  of  wooden 
and  steel  ships  was  virtually  at  a  standstill  because  of  the  purchasing 
officer's  inability  to  settle  on  the  price  of  steel: 

The  situation  that  has  arisen  with  regard  to  the  price  of  steel  is  handicapping 
the  work  of  the  Purcliasing  Department  very  seriously. 

The  orders  for  the  Moore  and  Scott  ships  have  not  been  accepted  as  no  price 
is  stipulated,  and  the  steel  companies  will  not  accept  an  order  without  a  price. 
An  early  delivery  is  stipulated  on  these  Moore  and  Scott  shijas.  Their  orders 
for  steel  have  already  been  held  up  10  days  and  completion  of  the  ships  wiU 
be  delayed  accordingly,  besides  giving  rise  to  a  great  many  possible  claims. 

We  will  be  obliged  to  furnish  the  parties  who  make  our  boilers  with  steel. 
We  cannot  get  a  price  on  boiler  steel,  or  get  steel  to  our  boilermakers  until  the 
general  question  has  been  settled.     The  same  will  apply  to  marine  engines. 

It  is  possibly  not  realized  that  30  percent  of  the  material  that  goes  into  a 
wooden  hull,  and  over  50  percent  of  the  material,  including  propelling  ma- 
chinery, that  goes  into  a  wooden  ship,  is  steel  or  steel  products,  and  that  the 
woodeii  ships,  as  well  as  the  steel  ships,  will  be  held  up  seriously  unless  this 
matter  is  decided  in  the  very  near  future.  Until  it  is  decided,  our  work  will  be 
practically  at  a  standstill,  for  I  cannot  close  any  contracts  on  propelling  ma- 
chinery or  on  fastenings,  forgings,  shafting,  etc.,  until  this  matter  is  decided.'''' 

Other  departments  of  the  Government  were  also  finding  that  war 
preparations  were  being  seriously  hampered  by  the  delay  in  fixing 
prices  for  the  steel  industry.  The  Navy  Department,  Shipping  Board, 
Ordnance  Department,  and  the  Panama  Canal  Commission  reported 
that  the  unsettled  condition  was  holding  up  almost  all  their  activities. 
The  Munitions  Board  decided  on  July  24,  1917,  that  the  necessity  for 
prompt  action  in  fixing  some  price  should  be  communicated  to  the 
Secretary  of  War: 

Steel — Necessity  Jor  fixing  some  price. — Mr.  Howe  brought  up  the  question  of 
the  present  steel  situation  as  to  the  holding  up  of  necessary  orders  due  to  the 
lack  of  a  price.  It  was  reported  by  the  various  representatives  that  practically 
everything  is  held  up  because  of  the  unsettled  condition.  The  Departments 
reporting  are  the  Navy,  Shipping  Board,  Ordnance  Department  (ammunition 
steel  and  rifle-barrel  steel),  and  the  Panama  Canal  Commission. 

After  considerable  argument,  Mr.  Scott  and  Mr.  Rosenwald  were  asked  to 
interview  the  Secretary  of  War  and  lay  the  facts  before  him,  registering  with 
the  Secretary  the  opinion  of  the  Board  that  something  must  be  done  promptly 
as  the  delay  was  seriously  hampering  the  preparations  for  war.^^ 

Four  months  after  the  entrance  of  the  United  States  into  the  war 
the  Bureau  of  Supplies  and  Accounts  in  the  Navy  Department  sub- 
mitted a  memorandum  to  the  Secretary  of  the  Navy  stating  that  almost 
no  steel  sheets  had  been  ordered  since  the  declaration  of  war.  Also 
that  it  was  only  at  this  late  date,  August  6,  1917,  that  the  last  of 
the  stock  plate  and  shape  order  was  being  allotted.  This  was  due  to 
the  unintegrated  finished  steel  producer's  inability  to  operate  on  the 
basis  of  the  inflated  raw  material  prices: 

The  last  of  the  stock  plate  and  shape  order  (agreement  between  the  Steel  Cor- 
poration and  the  Navy  dated  April  20)  is  only  now  being  allotted,  although  a 
large  portion  was  ready  for  allotment  in  May.  One  cause  of  the  delay  arises 
from  the  fact  that  the  small  mills  cannot  produce  plates  and  shapes  at  $2.90  and 
$2.50,  respectively,  until  the  Government  controls  the  essential  raw  materials. 

Practically  no  steel  sheets  have  been  ordered  since  the  entrance  of  the  United 
States  into  the  war.'^'' 

On  the  same  day  the  minutes  of  the  General  Munitions  Board  con- 
tain other  instances  of  the  strong  bargaining  position  of  the  steel 
industry.     When  attention  was  called  to  a  plan  of  having  the  Midvale 

6«  Exhibit  No.  1732. 

«7  Bernard  M.  Baruch.  Mar.  29,  1935  (gaUey  89  BBQ). 

«8  Exhibit  No.  1734. 


104 


MUNITIONS    INDUSTRY 


Steel  Co.  furnish  the  Navy  forgings  and  Bethlehem  the  Army  forgings, 
Mr.  Scott,  chairman  of  the  Board,  referred  to  an  understanding  with 
the  companies  that  the  condition  of  the  determination  of  a  fixed  price 
was  the  equal  division  of  the  Navy  forgings  business  between  them. 
He  stated  that  he  ''did  not  believe  Bethlehem  would  agree  to  accept 
only  Army  forgings  at  the  prices  agreed  upon."  ^^  Another  instance 
is  to  be  found  in  Colonel  Blunt's  remark  that  the  United  Engineering 
&  Foundry  Co.  refused  to  bid  on  artillery  forgings  and  that  they 
gave  as  an  excuse  the  existence  of  the  Government's  8-hour  law.^'' 

According  to  a  letter  read  into  the  record  by  Mr.  Baruch,  the  indus- 
try was  holding  out  for  prices  which  he  thought  to  be  "high  and  unfair." 
The  possibility  of  noncooperation  by  the  steel  industry  moved  the  War 
Industries  Board  to  invoke  the  threat  of  commandeering.  Mr. 
Baruch's  letter  in  part  states  as  follows: 

Almost  immediately  after  the  declaration  of  war,  at  the  request  of  the  President, 
I  met  representatives  of  the  steel  companies  in  the  office  of  Elbert  H.  Gary,  71 
Broadway,  New  York  City,  more  particularly  in  reference  to  the  price  of  ship 
plates  which  they  fixed  at  Ayi  cents  a  pound,  assuring  me  they  knew  that  would  be 
satisfactory  to  the  Government.  I  urged  them  not  to  insist  upon  that  price 
because  it  was  too  high  and  imfair  in  the  circumstances.  They  could  not  see 
my  point,  although  later  in  the  evening  I  again  met  Judge  Gary  and  made  the 
same  request,  to  which  I  got  the  same  reply.  I  laid  this  information  before  the 
President  and  Mr.  Denman,  then  Chairman  of  the  Shipping  Board.  At  this 
period  I  was  chairman  of  the  raw  materials  section  of  the  Council  of  National 
Defense,  and  was  acting  in  that  capacity. 

Following  a  conference  at  Washington  in  July,  which  both  Judge  Gary  and 
I  attended,  it  was  decided  to  await  the  conclusion  of  an  inquiry  into  prices  of 
steel  which  the  Federal  Trade  Commission  was  making.  This  brought  about 
a  meeting  on  September  21  on  the  subject.  Previously  the  War  Industries 
Board  had  passed  a  resolution  declaring  that  "if  the  steel  interests  should  not 
be  willing  to  give  their  full  cooperation  because  of  the  prices  fixed,  the  War 
Industries  Board  would  take  the  necessary  steps  to  take  over  the  steel  plants."  " 

The  prices  that  were  finally  fixed  on  September  24,  1917,  follow, 
together  wdth  the  August  1914  prices: 


Commodity 

Basis 

Fixed  price  ' 

August 
1914  price- 

Lower  lake  ports 

$5.05  per  gross  ton.-  

$2.85 

Coke 

Connellsville 

$6  per  net  ton _  _ 

1.80 

$33  per  gross  ton 

$2.90  per  100  pounds 

13.00 

Steel  bars 

Pittsburgh-Chicago 

1.18 

do  -. 

$3  per  100  pounds 

1.37 

Plates 

do 

$3.25  per  100  pounds. 

1.18 

1  Garrett  op.  cit.,  p.  261. 

2  War  Industries  Board,  Price  Bulletin  No.  33,  Prices  of  Iron.  Steel,  and  Their  Products. 

The  success  of  the  steelmakers'  tactics  of  delay  and  noncooperation 
may  be  seen  in  the  vast  profits  obtainable  from  these  prices  at  the 
existing  costs  of  the  majority  of  the  producers  in  the  steel  industry 
which  have  already  been  alluded  to  on  page  58  of  this  report.  In 
viewing  these  prices  from  the  angle  of  reduction  of  inflation  it  is 
apparent  that  regardless  of  the  extent  of  the  decrease  from  transitory 
speculative  prices  prevailing  immediately  before  price  stabilization, 
the  basic  price  structure  of  the  steel  industry  still  remained  at  fabu- 
lously high  levels  over  pre-war  prices.     War  Industries  Board  Price 

69  Exhibit  No.  1733. 

70  Ibid. 

"  Bernard  M.  Baruch,  Mar.  29,  1935  (galley  81  BBQ). 


MUNITIONS    INDUSTRY  105 

Bulletin  No.  3  has  stated  that  "the  prices  fixed  by  the  War  Industries 
Board  did  not  represent  reductions  as  enormous  as  many  people 
believed  the  elaborate  Federal  Trade  Commission  inquiries  into  costs 
justified."  "  The  price  index  charts  facing  p.  128  show  that  the 
prices  of  steel  sheets  and  steel  plates  were  fixed  at  levels  above  the 
highly  inflated  all  commodities  index  and  that  it  was  not  until  after  the 
coming  of  peace  and  the  discontinuance  of  price  control  that  these 
prices  fell  through  the  all  commodities  level. 

It  has  also  been  pointed  out  that  the  price  reductions  were  in  fact 
not  as  much  as  they  appeared  to  be  since  the  exorbitant  market 
prices  of  July  represented  only  a  small  volume  of  sales : 

It  should,  of  course,  be  remembered  that  the  ver\^  high  quotations  of  July 
1917  were  never  realized  in  the  majoiity  of  contract  placements.  They  repre- 
sented simply  the  exorbitant  prices  which  certain  sales  could  command  because 
the  bulk  of  steel  was  booked  up  under  contract.  The  real  scaling  down  of  pi'ices 
from  the  high  point  of  July  1917,  therefore,  was  actually  much  less  than  one  might 
suppose  on  examining  the  above  figures." 

Furthermore,  it  should  be  recognized  that  since  it  had  been  decided 
not  to  apply  the  fixed  princes  to  past  contracts  a  large  number  of 
steel  transactions  were  removed  from  any  regulation."* 

The  steel  industry's  journal  stated  that  the  fixed  prices  were  really 
not  far  from  the  contract  prices  which  had  been  prevailing  for  the 
past  six  months  and  at  which  levels  profits  were  "quite  satisfactory:  " 

While  the  new  prices  on  plates,  shapes,  and  bars  are  lower  than  some  of  the  steel 
conferees  were  prepared  to  accept,  particularly  in  view  of  the  Steel  Corporation's 
last  advance  of  10  percent  in  wages,  which  other  producers  have  followed  without 
question,  it  is  to  be  considered  that  they  are  not  far  from  the  average  prices  on 
contract  shipments  in  the  past  six  months,  on  which  the  profits  of  integrated  com- 
panies as  well  as  of  some  that  are  but  partly  integrated  have  been  quite  satis- 
factory. With  the  readjustments  on  coke  and  pig  iron,  some  companies  of  the 
latter  class  will  do  fairly  well.  There  will  be  certain  hardships  to  a  number  of 
plants  that  must  buy  pig  iron,  even  at  the  new  S33  price.''* 

In  addition  to  the  unreliability  of  using  spot  prices  as  a  basis  of 
computing  the  size  of  the  reduction,  it  should  be  noted  that  the  con- 
servative Iron  Age  magazine  had  to  correct  the  War  Industries 
Board's  statement  of  the  market  prices  which  had  prevailed  prior 
to  stabihzation : 

The  extent  of  the  reductions  from  existing  market  prices  was  exaggerated  in 
the  official  statement  given  out  at  Washington.  Spot  coke  was  $12.50  last  week, 
rather  than  $16,  and  in  putting  pig  iron  at  $58  the  statement  went  to  an  extreme, 
since  $50  or  less  has  been  the  recent  level.^^ 

The  method  of  quoting  prices  also  had  the  effect  of  exaggerating 
the  extent  of  the  price  reduction.  The  Federal  Trade  Commission 
has  stated: 

In  order  however  to  prevent  possible  misunderstanding,  attention  should  be 
called  to  the  fact  that  the  prices  fixed  for  steel  products  were  generally  what  are 
known  as  base  prices;  that  is,  generally,  a  price  per  ton,  or  per  hundredweight, 
for  a  certain  standard  grade  and  "base"  size.  For  special  quahty  as  well  as  for 
the  numerous  sizes  other  than  the  "base"  size,  the  trade  custom  had  estabhshed 
"extras"  or  additions  to  the  base  prices,  and  these  customary  extras  were  con- 
tinued apparently  on  approximately  the  same  scale,  in  most  cases,  according  to  the 
recommendations  made  to  the  price-fixing  committee  by  its  own  advisers. 

"  Page  261. 

"  W.  I.  B.  Price  Bulletin  No.  X  P-  2G1.  See  Committee  Print  No.  3,  p.  129:  "An  adequate  analvsis  of 
cost,  however,  can  be  made  only  by  the  use  of  contract  prices,  for  it  is  probable  that  only  small  quanti- 
ties of  coke  were  purchased  at  the  hiph  market  prices." 

"<  Report  of  the  War  Industries  Board,  p.  117. 

«  The  Iron  Age,  Sept.  27,  1917. 

"  Ibid. 


106  MUNITIONS    INDUSTRY 

It  is  important  to  understand  this  situation,  because  the  average  costs  of  some 
companies  might  be  above  the  base  price  and  yet  the  products  could  be  sold  at 
profitable  prices  due  to  the  fact  that  most  of  the  tonnage  carried  large  "extras." 
The  use  of  "basing  points"  in  quoting  prices  was  also  allowed,  and  this  practice 
materially  affected  the  prices  received  by  many  of  the  companies.  At  first  both 
Chicago  and  Pittsburgh  were  allowed  as  price  basing  points  for  certain  steel 
products  but  later  Pittsburgh  only." 

The  differentials  for  the  various  types  of  products  were  determined 
by  a  committee  of  the  American  Iron  and  Steel  Institute  which  rep- 
resented the  steel  industry.  In  the  Report  of  the  War  Industries 
Board  "^  it  is  said  that — 

In  order  to  control  fully  the  prices  in  this  industry,  a  very  large  schedule  of 
differentials,  or  prices  for  products  which  vary  from  the  basic  types  had  to  be 
worked  out.  The  problem  of  calculating  this  was  assigned  to  the  industry  itself, 
and  the  work  was  accomplished  by  a  committee  of  the  American  Iron  and  Steel 
Institute.  These  differentials  were  promulgated  by  the  committee  directly  to 
the  industry,  but  when  once  announced  they  were  given  the  same  application  in 
all  policies' as  those  prices  fixed  specifically  by  the  President  through  the  War 
Industries  Board  or  later  through  the  price-fixing  committee. 

Even  Judge  Gary  agreed  that  in  some  cases  the  prices  fixed  by  the 
industry  itself  for  finished  products  were  too  high.^^ 

The  efl'eet  of  the  prices  set  was  to  strengthen  steel  stocks,  an 
important  factor  in  the  upward  movement  being  the  expectation  of 
a  revival  of  new  business  resulting  from  stabihzation  of  the  market.*" 
The  New  York  Times  of  September  25,  1917,  the  day  after  the  prices 
were  fixed,  reported: 

Steel  common  gained  2  points;  Lackawanna,  2%;  Repubhc  Iron  &  Steel,  2^8; 
Crucible,  1;  Bethlehem  Steel,  class  B,  2%;  Great  Northern  Ore,  2%;  Midvale 
Steel  and  Superior  Steel,  2  points.  New  York  Central  rose  l}i;  Union  Pacific, 
1%;  and  Baldwin  Locomotive,  4:%;  with  many  other  issues  rising  from  1  to 
nearly  3  points.  An  improvement  of  sentiment  toward  securities  was  generally 
evident  in  the  Street,  which  supplemented  the  increase  of  optimism  that  followed 
the  fixing  of  the  price  for  copper  last  week.     *     *     * 

The  lower  prices  will  have  one  effect,  it  was  said,  that  will  be  an  aid  to  the 
industrv.  This  will  be  the  new  business  that  will  result.  Since  the  beginning  of 
the  European  war,  building  operations  have  been  almost  at  a  standstill,  and  now 
the  lower  steel  prices  have  been  fixed,  the  builders  will  get  busy  and  the  country 
can  expect  to  experience  a  boom  in  the  building  business,  provided  the  steel  mills 
can  take  care  of  the  new  orders  thus  drawn  out.     *     *     * 

So  satisfactory  are  the  prices  fixed  for  iron  and  steel  products  that  western 
steel  makers  are  convinced  the  announcement  will  be  follov/ed  almost  imme- 
diatelv  bv  a  marked  revival  in  business,  writes  the  financial  editor  of  the  Chicago 
Herald.   '*     *     * 

L.  E.  Block,  vice  president  of  the  Inland  Steel  Co.,  said: 

"The  steel  and  iron  prices  fixed  by  the  Government  are  considerably  below 
those  prevailing,  but  I  imagine  that  under  all  the  circumstances  the  steel  manu- 
facturers will  be  fairly  well  satisfied  with  them.  All  steel  manufacturers  have 
on  their  books  a  very  large  number  of  unfilled  orders  taken  at  the  higher  prices. 
These  contracts  will  stand. 

"Buvers  who  have  contracted  for  iron  or  steel  at  the  higher  prices  must  accept 
delivery  at  those  prices,  but  I  do  not  believe  this  will  be  productive  of  any 
serious  inconvenience." 

In  speaking  of  the  price  fixmg,  however,  a  report  of  the  War 
Industries  Board  thought  that  the  steel  interests  were  to  be 
commended : 

*  *  *  in  view  of  the  fact  that  there  was  no  legal  authority  for  enforcing 
these  requirements,  we  considered  it  a  great  achievement  and  a  wonderful 
monument  to  the  patriotism  of  the  steel  manufacturers  in  the  country.^i 

"  Federal  Trade  Commission  Report  on  War  Time  Profits  and  Costs  of  Steel  Industry,  p.  20. 

'8  Pacre  121. 

•9  Minutes  of  the  Price  Fixing  Committee,  Mar.  20,  1918.  ,  .    ,,.      .    ,  •   ^     ^ 

80  See  discussion,  infra,  pp.  128-130,  regarding  the  stabilizing  effects  of  price  control  in  the  steel  industry. 

81  Committee  Print  No.  3,  p.  130. 


MUNITIOXS   TXDUSTEY  107 

At  a  later  point  there  appears  the  following  statement: 

The  Division  wishes  to  make  an  opportunity  of  recording  the  great  assistance 
rendered  by  the  American  Iron  and  Steel  Institute.  Hon.  E.  H.  Gary,  as  chair- 
man, appointed  a  committee  on  steel  distribution,  through  whom  the  Director 
of  Steel  Supply  distributed  to  the  various  mills  in  the  country  the  orders  for  war 
materials  received  from  the  various  departments  of  our  own  Government  and 
from  the  Allies.  Commercialism  was  entirely  dropped  from  their  calculation, 
and  they  entered  patriotically  into  their  work  with  no  thought  of  personal  gain, 
but  entirely  for  the  interest  of  our  common  cause.^^ 

(c)  The  building  and  operation  of  the  Old  Hickory  Powder  Plant. — 
With  the  foresight  bred  from  over  a  century's  experience  as  the 
Nation's  chief  source  of  military  powder,^^  the  du  Pont  Co.  directed 
its  engineers  to  seek  a  suitable  location  for  the  construction  of  a 
new  powder  plant  as  soon  as  diplomatic  relations  were  severed  with 
Germany — 2  months  before  we  declared  war.**  From  the  outbreak 
of  the  war  this  company,  which  one  of  its  officials  characterized 
as  "almost  a  subdivision"  of  the  Ordnance  Department,*^  strove  to 
convince  the  military  authorities  of  the  need  for  increased  powder 
capacity.**^     Not  until  October  1917  was  the  Government  convinced.*^ 

Fou/  days  after  the  War  Department  had  agreed  to  the  urgent 
necessity  of  additional  manufacturing  capacity  of  approximately 
1,000,000  pounds  of  powder  a  day**  the  du  Pont  Co.  submitted  a 
draft  contract  to  build  and  operate  plants  of  that  capacity.*^  This 
contract  estimated  the  total  cost  of  construction  at  $90,000,000  in- 
cluding a  fee  to  the  du  Pont  Co.  of  15  percent  of  cost.  The  company 
was  to  receive  in  addition  an  operating  fee  of  5  cents  a  pound  for 
each  pound  of  powder  produced,  plus  one-half  of  any  reduction  in  cost 
below  a  fixed  amount  per  pound,  the  Government  to  pay  all  costs 
of  operation. 

Substantially  this  agreement  was  signed  by  General  Crozier,  Chief 
of  Ordnance,  on  October  25,  1917.^°  On  November  7,  Robert  S. 
Brooldngs,  then  chairman  of  the  War  Industries  Board,  estimated 
that  in  addition  to  $13,500,000  to  be  received  as  compensation  for 
the  construction  of  the  plant,  it  was  quite  probable  that  under  this 
contract  the  du  Pont  Co.  would  receive  approximately  $30,000,000 
in  profits  for  operating  the  plant  the  first  year.  This  Mr.  Brookings 
felt  was  "utterly  out  of  ^calefor  any  possible  service  they  can  render. "^^ 

On  October  31,  Secretary  of  War  Baker  had  wired  the  du  Pont  Co. 
to  do  nothing  about  the  contract  until  they  heard  further  from  him.^^ 

On  November  14,  Air.  Brookings  reported  to  the  Secretary  of  War 
that  the  War  Industries  Board  had  had  a  long  conference  with  officials 
of  the  Ordnance  Department  and  with  representatives  of  the  du  Pont 
Co.,  but  that  in  spite  of  certain  changes  agreed  to  by  the  du  Pont  Co. 
he.  Judge  Lovett,  and  Mr.  Baruch  still  declined  to  approve  it.^^ 

82  Committee  Print  Ko.  3,  p.  135. 

83  "  Since  1805  the  du  Pont  Co.  has  provided  the  United  States  with  most  of  the  explosives  that  the  coun- 
try's fighting  forces  used  in  our  wars."  A  History  of  the  du  Pont  Co.'s  Relations  with  the  United  States 
Government,  Smokeless  Powder  Dept.,  E.  I.  du  Pont  de  Nemours  &  Co.,  Inc.,  p.  10. 

84  Exhibit  no.  1117. 

85  Part  15,  p.  3696. 

8«  Exhibits  nos.  1117,  1123,  1124. 
8'  Exhibits  nos.  1117,  1125. 

88  Exhibit  no.  1125,  dated  Oct.  4,  1917. 

89  Exhibit  no.  1126,  dated  Oct.  8,  1917. 
so  Exhibit  no.  1130;  See  Exhibit  1129. 
«i  Exhibit  no.  1139. 

92  Part  13,  p.  2959. 
»3  Exhibit  no.  1142. 


108  MUNITIONS    INDUSTRY 

But  although  the  Government  officials  thought  that  the  du  Pont 
demand  for  profits  was  exorbitant,  it  appeared  that  only  the  du  Pont 
Co.  could  supply  the  services  needed. 

The  company,  by  its  own  admission,  controlled  "about  90  percent 
of  the  smokeless  powder  producing  capacity  of  the  United  States"^* 
and  so  had  a  practical  monopoly  on  operating  experience.  The 
company  had  been  producing  1,300,000  pounds  of  military  powder 
a  day  since  1914  for  a  total  of  nearly  750,000,000  pounds,  and  believed 
their  capacity  equaled  that  of  Great  Britain  and  France  combined. ^^ 
The  du  Pont  Co.  also  had  in  effect  a  monopoly  as  to  experience  in 
the  construction  of  powder  factories.  Within  3  years  they  had  built 
factories  of  capacity  equal  to  the  contemplated  plant  and  so  were 
indeed,  as  they  said,  "m  possession  of  all  information  necessary  for 
the  carrying  out  of  this  project. "^^  The  blueprints  used  for  their 
factories  would  cover  some  60  acres  of  ground.^"  A  great  many  of 
these  drawings  were  standard,^*  and  so  did  not  need  to  be  duplicated. 

Daniel  Willard,  as  chau-man  of  the  War  Industries  Board,  told  the 
Secretary  of  War  on  November  26,  1917,  that  upon  the  evidence  of 
"demonstration"  it  was  the  opinion  of  the  Board  "that  the  du  Pont 
people  are  in  every  way  the  best  fitted"  for  constructing  the  plant 
in  the  least  possible  time  and  operating  it  with  the  greatest  efficiency. ^^ 
Pierre  S.  du  Pont  on  December  10,  1917,  wrote  that: 

General  Crozier  has  assured  us  that  he  beKeves  it  necessary  to  call  upon  us 
for  assistance  and  that  there  is  no  doubt  in  any  mind  that  our  company  should 
undertake  the  work  if  proper  compensation  can  be  determined.' 

The  du  Pont  Co.  recognized  the  strength  of  its  own  bargaining 
position: 

*  *  *  our  willingness  to  negotiate  has  been  based  entirely  upon  the  necessities 
of  the  Government  and  the  belief  that  our  company  is  not  only  the  best  equipped 
for  executing  the  work  prompth',  but  practically  the  only  organization  capable 
of  so  doing.2 

Mr,  Pierre  du  Pont  wrote  to  Mr.  E.  G.  Buckner,  a  vice  president: 

Our  commanding  position  in  the  explosive  industry  has  been  won  only  by  in- 
cessant work  and  expenditures  of  money  by  the  company.  The  situation  is  an 
asset  of  the  stockholders  which  cannot  be  dissipated  lightly. ^ 

It  must  be  remembered  that  these  negotiations  occurred  in  the 
midst  of  war.  The  mifitary  forces  urged  speed  at  all  costs.  Mr. 
Brookings  wrote  to  the  Secretary  of  War  after  the  November  14,  1917, 
conference: 

On  leaving  the  conference,  General  Crozier  announced  that  he  felt  that, 
regardless  of  price  the  Government  must  have  immediate  action  on  this,  and 
immediate  action  could  only  be  had  through  the  du  Fonts,  and  therefore  he  would 
urge  upon  you  the  emergency  necessity  which,  in  his  judgment,  overshadowed  all 
question  of  cost.* 

Lieutenant  Colonel  Harris,  v\hen  asked  by  the  chairman  whether 
there  was  a  more  critical  time  during  the  war  than  the  period  of  these 
negotiations,  testified: 

«<  Exhibit  no.  llnl,  at  p.  3277. 

»5  Ibid. 

86  Exhibit  no.  1U"\  at  p.  3272. 

S7  Exhibit  m.  1132.  at  p.  3145. 

"s  Testimony  of  Irenee  du  Pont,  p.  3170. 

"  Exhibit  no.  1148. 

1  Exhibit  no.  1154. 

a  Exhibit  no.  1151,  at  p.  3279. 

»  E.xhibit  no.  1132. 

*  Exhibit  no.  1142. 


MUNITIONS    INDUSTKY  109 

It  is  hard  to  say  which  was  the  most  critical  time  of  the  War,  but  that  was  a 
very  critical  time.^ 

For  3  months  the  building  of  the  Old  Hickory  powder  factory  was 
delayed  because  of  the  refusal  of  the  du  Pont  Co.  to  accept  the  liberal 
terms  offered  to  them. 

At  the  November  14  conference  the  War  Industries  Board — 

suggested  to  the  du  Fonts  that  they  go  ahead  and  construct  this  plant  and 
operate  it  after  construction,  charging  all  cost  of  every  kind  and  character  to  the 
Government,  and,  after  they  had  demonstrated  the  great  service  rendered  the 
Government,  to  leave  to  the  Secretary  of  War  the  question  of  their  compensation, 
assuring  them  that  the  Secretary  of  War  could  not  do  other  than  treat  them 
fairly — in  fact  liberally — if  he  assumed  the  responsibility  of  paying  them  a  fair 
price  for  their  service.^ 

On  November  26  the  War  Industries  Board  recommended  a  more 
liberal  offer,  having  ''so  far  been  unable  to  agree  with  the  du  Fonts 
as  to  what  would  be  fair  compensation  for  the  erection  and  operation 
of  the  plant."  ^  This  offer  provided  that  the  Government  would 
pay  "every  dollar  of  expense",  would  advance  $1,000,000  on  account 
of  profit  and  that  pending  the  completion  of  the  contract — 

the  Government,  through  the  Secretary  of  War,  will  endeavor  to  negotiate  with 
them  from  time  to  time  as  to  what,  if  any,  additional  compensation  they  should 
fairly  receive  for  their  services,  and  on  the  completion  of  the  contract  if  the 
du  Pont  Company  and  the  Secretary  of  War  have  not  been  able  to  agree  upon 
such  sum,  then  the  matter  shall  be  left  to  the  usual  form  of  arbitration- — that  is 
each  party  to  select  one  arbitrator,  and  the  two  so  selected  to  agree  upon  a  third, 
the  findings  of  the  two  of  these  three  to  be  binding  upon  both  interested  parties.* 

This  recommendation  was  adopted  by  the  Secretary  of  War  the 
following  day.^  On  the  recommendation  of  Fierre  S.  du  Font,^°  the 
president  of  the  company,  it  w^as  rejected  by  the  company's  board  of 
directors  on  November  28.^' 

On  December  12  the  Secretary  of  War  notified  the  company  that 
the  War  Department  had  "proceeded  to  work  out  a  plan  for  the  direct 
creation  of  this  capacity  by  the  Government  itself."  ^'  Mr.  Fierre 
du  Font  testified  that  the  Secretary  of  War  said  to  him  in  substance : 
' '  I  think  it  is  time  for  the  American  people  to  show  they  can  do  things 
for  themselves."  ^^ 

But  the  Government  had  no  real  alternative  to  accepting  the  terms 
of  the  du  Fonts. 

On  December  15,  1918,  D.  C.  Jackling  was  appointed  by  the  Sec- 
retary of  War  "to  build  and  operate  the  proposed  new  Government 
powder  plant."  "  Just  2  days  later  Mr.  Jackling,  who  apparently 
had  had  no  prior  experience  in  the  manufacture  of  powder  or  ex- 
plosives, ^^  suggested  to  Mr.  Fierre  du  Font  that  the  building  and 
operation  of  part  of  the  projected  factory  be  undertaken  by  the 
du  Font  Co.,  but  Mr.  Jackling's  terms  w^ere  refused. ^"^ 

5  Part  14,  p.  3193. 

6  Exhibit  no.  1142,  at  p.  3270. 
'  E.xhibit  no.  1148. 

8  Ibid. 

'E.xhibit  no.  1149. 
10  Ibid. 
n  Exhibit  no.  1150. 

12  Exhibit  no.  1157. 

13  Part  14,  p.  3188. 

14  Exhibit  no.  115S,  p.  3211. 

15  Testimony  of  P.  S.  du  Pont,  pt.  14,  p.  3211.    Testimony  of  Irfinfe  du  Pont,  part  XVII,  p.  4200. 

16  Exhibit  No.  1224  at  p.  3788  and  at  p.  3789,  letter  of  Jan.  9,  1918. 

11579—35 8 


110  MUNITIONS    INDUSTRY 

Under  the  decision  of  the  War  Department  that  the  "direct  crea- 
tion" of  the  plant  should  be  done  by  the  Government  itself,  Mr. 
du  Pont  felt  that: 

Our  company  believes  it  unnecessary  to  reveal  our  practices  with  respect  to 
such  lines  of  manufacture  that  are  now  commercially  developed  in  the  United 
States,  such  as  those  of  sulphuric  acid,  nitric  acid,  cotton  purification,  diphenyl- 
amine  and  ether,  as  sufficient  information  is  obtainable  elsewhere.  *  *  *  i^ 
general,  this  company  will  not  attempt  to  criticize  or  approve  the  plans  of  the 
War  Department  as  the  close  interrelation  of  the  parts  of  the  proposed  factories 
makes  piecemeal  criticism  useless  and  our  services  as  directors  of  the  whole 
project  are  deemed  by  the  Government  as  unnecessary. 

We  pointed  out  to  Mr.  Jackling  that  the  proposed  work  involved  no  problems 
that  cannot  be  solved  by  capable  engineers  of  industrial  training  but  that  econ- 
omy and  speed  of  reaching  maximum  output  with  a  properly  balanced  plant  are 
out  of  the  question  unless  the  work  is  in  charge  of  an  organization  of  experience. 
On  that  account  we  will  not  delegate  any  of  our  men  as  suitable  to  assist  the  War 
Department  in  its  work,  knowing  full  well  that  the  withdrawal  of  even  large 
numbers  of  them  cannot  win  satisfactory  results  for  the  Government  without  the 
backing  of  our  entire  organization.  Since  suspension  of  General  Crozier's  order 
we  have  taken  on  important  work  for  the  Government  which,  together  with  that 
heretofore  on  hand,  will  call  for  the  use  of  all  our  forces.  On  this  account  we 
should  not  be  called  upon  for  men.  If  the  War  Department  decides  to  set  aside 
this  recommendation,  we  request  that  negotiations  be  made  with  our  men  direct, 
though  we  would  appreciate  the  courtesy  of  being  informed  as  to  what  is  in- 
tended in  this  respect.'" 

Mr.  Irenee  du  Pont  testified  that: 

When  Mr.  Jackling  came,  he  tried  to  take  our  chief  engineer  away  from  the 
du  Pont  Co.,  upsetting  their  work,  and  the  chief  engineer  said,  "I  cannot  do  any- 
thing. I  cannot  help  you.  This  is  the  organization  that  does  the  thing.  You 
will  have  to  take  the  organization." '^ 

On  January  29,  1918,  Mr.  Jackhng  signed  a  contract  wdth  the 
du  Pont  Engineering  Co.,  a  wholly  owned  subsidiary  of  the  du  Pont 
Co.  ha\dng  an  invested  capital  of  only  $5,000,^^  for  the  construction 
of  a  plant  \\dth  a  capacity  of  500,000  pounds  of  powder  a  day.^° 
The  contract  provided  for  construction  fees  of  $500,000  plus  3  per- 
cent of  cost,  the  total  not  to  exceed  $2,000,000  ^^  and  for  operation 
fees  of  3}^  cents  per  pound  of  powder  deUvered,  plus  half  of  all  reduc- 
tions in  cost  below  base  costs. ^^ 

On  March  23,  1918,  a  substituted  contract  was  executed  under 
which  the  du  Pont  Co.  was  relieved  of  any  financial  strain  inasmuch 
as  the  Government  was  to  advance  $18,750,000  for  construction  and 
reimburse  this  fund  for  current  outlays  until  75  percent  of  the  total 
estimated  cost,  over  and  above  the  $18,750,000,  had  been  paid.^^ 
No  fee  was  to  be  charged  for  construction  but  the  Sji  cents  per  pound 
operating  fee  plus  one-half  of  any  savings  below  base  costs  remained,^"* 
and  the  capacity  on  which  this  fee  was  to  be  paid  was  increased  from 
500,000  to  900,000  pounds  a  day."  Furthermore  the  du  Pont  Co. 
could  sublet  any  part  of  the  construction  work  and  charge  fees  paid  in 
connection  therewith  to  costs. ^^ 


17  naid,  at  pp.  3788-89. 

18  Pt.  14,  p.  3178. 

19  Pt.  13,  p.  2948;  testimony  of  P.  S.  Du  Pont,  pt.  14,  p.  3218. 

20  Exhibit  no.  1165,  see  art.  II,  p.  3290. 

21  Ibid,  art.  VI. 

22  Ibid,  art.  X. 

23  E.xhibit  no.  1168,  art.  II,  p.  3299. 
2»  Ibid,  art.  IV,  par.  (c),  p.  3300. 

25  Ibid,  art.  I,  p.  3298. 

28  Ibid,  art.  II,  p.  3298  (italics  added).  "Whenever  it  is  inexpedient  for  any  portion  of  the  construction  work 
to  be  performed  by  the  contractor,  it  may  in  its  discretion,  sublet  such  portion  of  the  work,  upon  the  most 
advantageous  terms  obtainable  consistent  with  the  best  interests  of  the  United  States. 


MUNITIONS    INDUSTRY  111 

In  fact,  a  fee  of  $1,078,000  was  paid  to  the  Mason  &  Hangar  Co. 
for  construction  work  costing  $21,511,000.-^ 

In  addition  a  further  advance  of  $18,954,000  was  to  be  made  in 
three  equal  installments  to  finance  production  costs.-* 

The  January  29,  1918,  contract  authorized  Mr.  Jackling  to  order 
changes  in  specifications  and  otherwise  to  direct  the  work  and  required 
this  approval  for  purchases  and  the  like.-^  The  primary  reason  for  the 
March  23  contract  was  the  du  Pont  Engineering  Co.'s  desire  to  be 
free  "to  proceed  in  its  own  way  in  the  construction  of  the  plant,  with- 
out all  these  delays  in  getting  approval  of  plans  and  specifications."  ^° 

Under  this  final  draft  of  the  contract  the  company  received  a  net 
profit  of  $1,961,560  for  the  operation  of  the  plant  ^^  which  never  reached 
full  capacity  because  of  the  termination  of  the  war.^-  The  $1,961,560 
profit  represents  over  5  cents  a  pound  on  the  35,538,345  pounds  ^^ 
produced.  Had  the  war  continued  the  Old  Hickory  contract  would, 
at  that  rate  of  profit,  have  yielded  a  return  of  $15,000,000  a  year 
(assuming  a  production  of  300,000,000  pounds  a  year),  on  the  $5,000 
capital  invested  in  the  Engineering  Co. 

For  3  months  during  the  World  War  the  du  Pont  Co.  refused  to  use 
its  knowledge  to  make  powder  for  the  Government  at  the  Govern- 
ment's cost  plus  the  liberal  reward  offered.    It  demanded  its  own  terms. 

Mr.  Pierre  du  Pont  called  his  company's  position  a  refusal  "to 
work  without  proper  compensation"  and  felt  it  "necessary  because 
the  directors  of  our  company,  acting  for  our  stockholders,  have  no 
authority  to  do  otherwise."^*  He  referred  to  the  "duties  of  our  oflacers 
and  directors  to  endeavor  to  win  reasonable  profits  for  the  stockholders. 
That  is  not  only  part  of  our  duty,  but  we  cannot  assent  to  allo\ving 
our  own  patriotism  to  interfere  with  our  duties  as  trustees."  ^^  It  is 
significant  that  Mr.  Pierre  du  Pont  vv'as  one  of  the  10  largest  holders 
of  the  common  stock  of  the  du  Pont  Co.  at  the  time  he  felt  that  his 
patriotism  must  not  interfere  with  his  duties  as  a  trustee  for  the 
du  Pont  stockholders.^^ 

(6)  IMPOTENCE  OF  GOVERNMENTAL  CLUBS 

(a)  The  power  to  requisition  and  commandeer. — It  has  been  claimed 
that  during  the  World  War  an  effective  club  existed  in  the  form  of 
the  Government's  power  to  requisition  and  commandeer  goods  and 
plants.  Both  these  powers  involve  the  actual  physical  seizure  of 
property  without  going  through  any  bargaining  process  such  as 
-accompanies  its  usual  acquisition  by  payment  of  a  contract  price. 

It  is  necessary  to  recognize,  however,  that  the  matter  did  not  end 
with  the  physical  taking  of  the  property.  The  statutes  under  which 
this  power  was  exercised  provided  for  the  payment  of  just  conipensa- 
tion."    If  they  had  not  done  so,  they  would  have  been  invalid  under 

"  Ft.  14.  p.  3226. 

24  Exhibit  no.  Ufi8.  art.  V,  par.  (a),  p.  3301. 

29  Exhibit  no.  llf.5,  arts.  II,  III,  and  V,  pp.  3290-91. 

31)  Testimony  of  W.  S.  Greg-?,  pt.  14,  pp.  3220-21. 

31  Exhibit  no.  1170. 

32  Testimony  of  W.  S.  Gregg  and  W.  B.  Banker,  pt.  15,  pp.  3599-3600:  ex.  1224,  p.  3784. 

33  Testimony  of  W.  S.  Gregg,  pt.  14,  p.  3181. 
31  Exhibit  1146,  p.  3273. 

3s  E.xhibit  1132,  p.  3145. 

38  Pt.  14,  p.  3164.    See  also  testimony  of  Ir§nee  du  Pont,  p.  2963. 

3'  A  typical  provision  of  the  war-time  legislation  appears  in  sec.  10  of  the  Food  and  Fuel  Control  Act; 
"•  *  *  the  President  is  authorized  from  time  to  time,  to  requisition  foods,  feeds,  fuel  and  other  supplies 
necessary  to  the  support  of  tlie  Army  or  the  maintenance  of  the  Xavy,  or  any  other  public  use  connected 
with  the  common  defense,  and  to  requisition,  or  otherwise  provide,  storage  facilities  for  such  supplies,  and 
he  shall  ascertain  and  pay  a  just  compensation  therefor." 


112  MUNITIONS    INDUSTKY 

the  Fifth  Amendment  to  the  Constitution.^^  It  has  been  well  settled 
doctrine  since  the  case  of  Ex  parte  Milligan  that  the  emergency  of 
war  does  not  create  new  powers;  the  actions  of  the  Government  are 
still  subject  to  the  limitations  imposed  by  the  Constitution.^^ 

Obviously  the  effectiveness  of  this  device  in  compelling  cooperation 
is  dependent  in  large  measure  upon  the  fear  which  it  inspires  of  detri- 
mental consequences  of  its  invocation.  The  executive  authority, 
however,  does  not  have  sole  power  to  determine  what  is  the  proper 
measure  of  compensation.  After  its  determination  has  been  made, 
the  company  whose  property  has  been  commandeered  may  appeal  to 
the  courts,  inasmuch  as  it  has  been  decided  that  under  the  Constitu- 
tion the  determination  of  just  compensation  is  a  question  reviewable 
by  the  judiciary.^" 

The  measure  of  compensation  to  be  used  where  property  has  been 
requisitioned  has  been  stated  by  the  Supreme  Court  in  the  case  of 
Phelps  y.  U.S.:'' 

The  Government's  obligation  is  to  put  the  owners  in  as  good  position  pecuni- 
arily as  if  the  use  of  their  property  had  not  been  taken. 

This  rule  obviously  leaves  very  little  of  a  coercive  nature  to  the 
commandeering  power  and  judicial  appHcation  of  the  rule  has  been 
sufficiently  Uteral  to  ease  whatever  harshness  and  arbitrariness  there 
may  be  in  commandeering. 

It  has  been  held  that  where  a  stable  market  price  exists,  determi- 
nation of  compensation  on  the  basis  of  cost  of  production  plus  a 
reasonable  profit  is  not  the  proper  method  of  restoring  the  producer 
to  a  position  similar  to  that  he  would  have  been  in  had  his  property 
not  been  commandeered.  In  U.  S.  v.  New  River  Collieries,''^  the 
Supreme  Court  appUed  the  rule  to  give  a  company  the  highest  pre- 
vailing market  price  as  compensation  for  coal  which  had  been  req- 
uisitioned by  the  Government.  It  permitted  the  use  of  export 
prices  rather  than  domestic  contract  prices  because  the  former  were 
higher. 

The  court,  in  L.  Vogelstein  v.  U.  S.,'^  decided  that  the  company's 
copper  stock  could  be  requisitioned  at  the  hberal  copper  price  fixed 
by  the  War  Industries  Board.  By  refusing  to  come  along,  the  com- 
pany in  this  case  was  in  no  worse  position  than  if  it  had  been  coopera- 
tive and,  in  addition,  had  the  possibility  of  gaining  a  larger  amount 
from  the  court. 

As  a  matter  of  fact  the  War  Industries  Board  entertained  a  good 
deal  of  concern  about  keeping  the  commandeering  price  at  the  same 
level  as  the  fixed  price.  The  following  excerpt  from  its  minutes  of 
May  28,  1918,^*  contains  the  discussion  on  that  point: 

Present:  Mr.  B.  M.  Baruch,  chairman;  Mr.  R.  S.  Brookings,  Brig.  Gen.  Hugh 
S.  Johnson,  Mr.  Hugh  Frayne,  Mr.  Alex  Legge,  Judge  E.  B.  Parker,  Mr.  G.  N. 
Peek,  Mr.  J.  L.  Replogle,  Mr.  L.  L.  Summers,  Mr.  H.  P.  Ingels,  secretary. 

Price  fixing. — Attention  of  the  board  was  called  to  the  probable  difference  in 
rulings  of  the  price-fixing  committee  and  the  board  of  appraisers  of  the  War 
Department  now  operating  under  the  direction  of  the  surveyor  general  of  pur- 
s' U.  S.  V.  L.  Cohen  Grocery  Co.,  255  U.  S.  81.     U.  S.  v.  New  River  Collieries,  262  U.  S.  34. 

39  4  Wall  2.    But  see  the  Selective  Service  cases,  245  U.  S.  366. 

"  U.  S.  V.  New  River  Collieries,  262  U.  S.  341. 

<i  274  U.  S.  340. 

«  262  U.  S.  341. 

«  262  U.  S.  337. 

"  Exhibit  No.  1249. 


MUNITIONS   INDUSTRY  113 

chases.  If  a  manufacturer  or  producer  refuses  to  deliver  his  product  to  the 
Government  at  prices  fixed  by  the  price-fixing  committee  and  the  product  is 
commandeered,  under  the  present  arrangements,  it  is  the  function  of  the  board 
of  appraisers  to  determine  a  fair  and  just  compensation.  Considering  the  de- 
moralizing effect  that  would  result  from  having  the  board  of  appraisers  fix  prices 
different  from  those  fixed  by  the  price-fixing  committee,  Mr.  Brookings  was 
requested  to  discuss  with  General  Johnson  the  advisability  of 

1.  Having  the  board  of  appraisers  work  with  the  price-fixing  committee,  or 

2.  To  have  the  price-fixing  committee  take  over  the  work  now  being  done  by 
^he  board  of  appraisers. 

Meeting  adjourned  at  12:55  p.  m. 

(Signed)     H.  P.  Ingels,  Secretary. 

One  of  the  functions  of  the  Price-Fixing  Committee  was  declared  to 
be  "when  materials  are  commandeered  prices  of  the  same  will  be 
fixed  by  this  committee."  *^  It  is  clear  that  however  ineffective  a 
threat  to  commandeer  at  the  same  level  as  the  fixed  price  with  reser- 
vation of  right  to  appeal  to  the  courts,  there  would  be  further  impair- 
ment of  its  function  in  the  possibility  that  the  administrative  deter- 
mination of  compensation  might  itself  result  in  the  award  of  a  larger 
sum  than  the  price  fixed. 

Another  defect  in  the  commandeering  power  was  its  limited  cover- 
age. Goods  could  be  commandeered  only  for  the  Army  and  Navy. 
Mr.  Baruch  testified  that  it  was  felt  that: 

There  was  nothing  in  the  commandeering  situation  that  we  could  use  to  com- 
mandeer from  one  civilian  producer  so  that  another  civilian  consumer  or  producer 
could  get  this  man's  products.''^ 

The  consequence  of  tliis  weakness  of  power  on  the  height  of  prices 
has  been  stated  by  him  as  follows: 

And  that  is  one  of  the  very  reasons  that  these  prices  were  not  fixed  quicker 
and  why  we  did  not  hammer  harder  than  we  did,  and  why  we  had  to  pay  more 
ihan  justified  for  the  Army  and  Navy."*^ 

The  efficacy  of  the  commandeering  power  to  induce  cooperation  was 
further  reduced  by  the  belief  of  the  responsible  governmental  authori- 
ties that  there  were  insurmountable  practical  obstacles  to  its  actual 
exercise.  These  were  apparently  of  sufficient  strength  to  dissuade  the 
Government  from  its  application,  even  where  there  was  an  admitted 
need  for  it. 

As  we  have  seen,  the  steel  industry  was  extremely  noncooperative  in 
the  price  negotiations  which  were  undertaken  to  lower  the  speculative 
high  prices  that  prevailed  even  after  the  United  States  entered  the 
war.  It  will  be  remembered  that  the  War  Industries  Board  had 
passed  a  resolution  declaring  that  "if  the  steel  interests  should  not  be 
willing  to  give  their  full  cooperation  because  of  the  prices  fixed,  the 
War  Industries  Board  would  take  the  necessary  steps  to  take  over  the 
steel  plants."*^  Yet  this  threat  was  not  backed  up  by  any  definite 
plan  for  concrete  action.  Mr.  Baruch  has  testified  before  this  com- 
mittee that  in  the  case  of  the  steel  industry  threat  he  did  not  know 
how  the  commandeering  power  would  have  been  put  into  execution: 

Mr.  Hiss.  Let  us  talk  about  the  United  States  Steel  Corporation. 

Mr.  Baruch.  Yes,  sir. 

Mr.  Hiss.  If  your  bluff  had  been  called,  what  would  you  have  been  able  to  do? 

Mr.  Baruch.  I  would  have  been  in  a  devil  of  a  fix. 

Mr.  Hiss.  Would  not  production  have  fallen  off? 

<5  Exhibit  No.  1274. 

<«  Bernard  M.  Baruch,  Mar.  29.  1935. 

«  Bernard  M.  Baruch,  Mar.  29,  1935  (galley  81  BBQ). 


114  MUNITIONS    INDUSTRY 

Mr.  Baruch.  If  I  could  not  have  gotten  Judge  Gary,  I  would  have  gotten  some 
other  fellow  down  the  line. 

Mr.  Hiss.  But  that  would  not  have  been  operation  by  a  Federal  bureau, 
would  it? 

Mr.  Baruch.  No,  sir.  We  might  have  had  to  put  it  in  charge  of  some  officer. 
I  do  not  know  how  we  would  have  worked  it.  It  was  not  very  clear  in  my  own 
mind.^^ 

Mr.  Baruch  lias  also  testified  before  the  War  Policies  Commission 
that  he  could  not  recall  a  single  instance  of  an  important  industrial 
enterprise  being  commandeered  during  the  entire  course  of  the 
World  War: 

*  *  *  During  the  World  War,  Government  had  power  to  commandeer 
factories  and  to  operate  them  under  bureaucratic  direction.  I  do  not  recall  a 
single  important  industrial  enterprise  that  was  thus  taken  over.  This  does  not 
mean  that  the  use  of  the  power  was  never  advocated.  On  the  contrary,  it  was 
seriously  urged  in  respect  of  a  great  industrial  plant  which  was  thought  by  some 
not  to  be  giving  full  cooperation  to  its  Government.  The  proposal  split  on  the 
rock  of  this  argument: 

Who  will  run  it?  Do  j^ou  know  another  manufacturer  fit  to  take  over  its 
administration?  Would  you  replace  a  proved  expert  manager  by  a  prob- 
lematical mediocrity?  After  you  had  taken  it  over  and  installed  your  Govern- 
ment employee  as  manager,  what  greater  control  would  you  have  then  than 
now?  Now,  you  can  choke  it  to  death,  deprive  it  of  transportation,  fuel, 
and  power,  divert  its  business,  strengthen  its  rivals.  Could  any  disciplinary 
means  be  more  effective?  If  j'ou  take  it  over,  you  can  only  give  orders  to 
an  employee  backed  by  threat  of  dismissal,  and  with  far  less  effect  than  j-ou 
can  give  them  now.  Let  the  management  run  the  plant  and  you  run  the 
management. 

Nobody  with  any  familiarity  with  industry  could  seriously  urge  a  wholesale 
assumption  by  any  Federal  bureau  of  the  responsibility  for  management  of  any 
or  all  of  the  vast  congeries  of  manufacturing  establishments  upon  which  we  must 
rely  for  extraordinary  effort  in  event  of  war.  Even  if  such  bureau  management 
could  prove  adequate  to  the  task  (which  it  could  never  do)  the  mere  process  of 
change  would  destroy  efficiency  at  the  outset.*^ 

The  practical  difficulties  were  made  especially  obvious  in  the  case 
of  industries  composed  of  large  numbers  of  producers.  Business 
men  who  were  cognizant  of  the  actual  working  of  industry  could 
readil}^  realize  how  improbable  it  was  that  the  \\  ar  Industries  Board 
would  attempt  to  displace  existing  management  which  knew  how 
to  run  its  business  and  place  new  men  in  many  different  plants  spread 
over  large  areas  and  set  up  a  vast  central  supervising  agency — all  at 
short  notice  and  at  a  time  when  the  demand  was  for  greatly  increased 
production.  In  fact  when  the  War  Industries  Board  was  talldng  of 
commandeering  the  copper  industry  they  were  bluntly  told  by  its 
representative,  Mr.  Ryan,  that  "it  would  be  impossible  to  com- 
mandeer all  of  the  small  high  cost  mines  as  there  are  such  a  great 
number."^" 

The  compulsory  orders  issued  by  the  Army  and  Navy  could  have 
been  of  no  greater  effect  than  the  commandeering  power.  They  did 
not  impose  a  penal  sanction  on  the  manufacturer  who  refused  to 
produce  the  required  commodities.  In  the  event  of  such  refusal,  the 
National  Defense  Act  simply  rendered  him  subject  to  the  commandeer- 
ing power.  Requiring  the  manufacturer  to  produce  goods  for  the 
Government  under  penalty  of  going  to  jail  would  undoubtedly  have 
raised  the  constitutional  question  of  involuntary  servitude. 

«  Ibid,  (galley  82  BBQ) 

"  72d  Cong.,  1st  sess.,  H.  Doc.  No.  163,  p.  53. 

40  Exhibit  No.  1701. 


MUNITIONS    INDUSTRY  115 

Actually,  it  has  been  found  that  the  compulsory  orders  issued  by 
the  Army  and  Navy  had  uses  which  were  quite  different  from  the 
functions  of  cutting  short  negotiations  and  inducing  cooperation  to 
get  production  at  lower  prices. 

For  example,  the  Judge  Advocate  General's  Office  ruled  that  a 
compulsory  order  could  be  used  to  place  orders  without  competition: 

Under  this  section  the  mere  placing  of  an  order  for  the  supplies  and  materials 
required  is  sufficient  without  the  execution  of  a  formal  contract.  Therefore  no- 
advertising  for  bids  in  any  form  whatever  or  filing  of  bids  is  necessary. ^i 

Furthermore  they  could  be  used  by  the  Government  to  gain  priority. 
Section  120  of  the  National  Defense  Act  provided  in  part  that: 

Compliance  with  all  such  orders  for  products  or  material  *  *  *  shall  take 
precedence  over  all  other  orders  and  contracts  theretofore  placed  with  such 
individual    *    *    *    corporation  or  organized  manufacturing  industry    *    *    * 

One  of  the  consequences  of  the  receipt  of  such  an  order  would  be, 
of  course,  to  relieve  the  producer  of  civil  liability  to  his  private  cus- 
tomers because  of  any  impairment  of  performance  due  to  the  Govern- 
ment work.  Lieutenant  Colonel  Harris,  stated  in  his  testimony 
before  this  committee,  that  in  his  opinion  priority  was  the  principal 
reason  for  the  use  of  compulsory  orders  by  the  Navy.^^  Lieutenant 
Brannon  of  the  Judge  Advocate  General's  Office  was  of  the  same 
opinion  as  to  the  purpose  of  issuance  of  the  War  Department  orders.^^ 

(6)  The  priorities  system. — In  addition  to  the  commandeering  power, 
it  has  been  said  that  the  Government  was  able  to  exert  coercion  by 
means  of  its  control  of  priorities.^* 

But  it  must  be  recognized  that  the  paramount  purpose  of  the 
priority  system  was  to  deal  with  the  problem  of  shortages.  By 
granting  certificates  of  preference,  essential  war  industries  could  be 
better  assured  of  gaining  the  raw  materials  necessary  for  production 
of  the  goods  required  by  the  military  forces  of  the  Nation.  An  effect 
of  their  denial  to  an  industry  or  plant  was  the  retardation  of  the 
flow  of  raw  materials  and  the  consequent  curtailment  of  its  output. 

In  the  case  of  iron  and  steel  it  is  necessary  to  recognize  that  the 
consequence  of  cutting  off  the  industry's  supply  of  fuel  would  have 
meant  a  diminution  in  the  flow  of  shells,  tanks,  and  other  iniplements 
of  war  to  the  Army  and  Navy.  Even  the  less  essential  industries, 
such  as  automobiles,  were  concerned  about  increasing  the  supply  of 
this  commodity.  At  a  meeting  of  the  War  Industries  Board  with 
the  representatives  of  the  automobile  industry,  the  following  discus- 
sion ensued: 

Mr.  DuRANT.  Can  we  increase  the  supply  of  pig  iron  and  what  would  it  be 
necessarv  for  us  to  do  to  obtain  the  increase? 

Mr.  Baruch.  Those  suggestions  are  referred  to  us  daily;  we  have  made  every 
move  possible  to  increase  pig-iron  capacity.  It  has  been  a  matter  of  fuel  and 
transportation. 55 

"  Vol.  1  of  Opinions  of  the  Judge  Advocate  General,  p.  141  (1917). 

«2  Lieutenant  Colonel  Harris,  Dec.  20,  1934. 

»  Lieutenant  Brannon,  Dec.  20,  1934.  ,  ^..       ..      ^ 

"  Mt.  Baruch,  in  his  supplementary  statement  to  the  committee  dated  Apr.  12,  1935,  gave  his  estimate 
of  the  priority  system: 

"May  I  add  that  commandeerin?  was  by  no  means  our  only  weapon.  Public  opinion  was  our  real 
weapon.  If  you  haven't  got  it,  a  deiiocracy  can't  fight  a  war.  If  you  have  got  it  you  need  little  else.  But 
we  did  have  much  more  than  that.  We  had  the  allocation  of  priority  based  upon  transportation  control 
authorized  by  statute.  That  alone  was  enough.  That  could  have  choked  to  death  and  ruined  any  cor- 
poration, and,  except  for  fines,  that  is  the  only  effective  penal  sentence  you  can  apply  to  an  artificial  person. 

«  Exhibit  No.  1274. 


116  MUNITIONS    INDUSTRY 

Invocation  of  the  priority  power  against  a  particular  plant  in  an 
essential  industry  would  be  limited  by  the  extent  of  the  unused  ca- 
pacity in  other  similar  plants.  Where  the  company  itself  furnished  a 
great  proportion  of  the  capacity,  as  is  the  case  in  the  steel  industry 
with  such  companies  as  United  States  Steel  and  Bethlehem,  there 
would  be  relatively  little  opportunity  for  the  diversion  of  business  to 
other  companies.  The  use  of  priorities  as  penalties  to  enforce  gov- 
ernmental orders  would  thus  work  against  the  primary  need  of  war- 
time, increased  production. 

(7)    CONSTITUTIONAL   DIFFICULTIES   OF   PRICE    FIXING 

Any  price-fmng  statute  attempting  to  severely  limit  profits  would 
raise  constitutional  problems.  The  price-ceiling  scheme  which 
attempts  to  fix  all  prices  throughout  the  entire  economic  structure 
would  be  questionable  on  that  very  ground.  It  was  the  opinion  of  the 
legal  section  of  the  War  Policies  Commission  that  to  uphold  such  a 
position  might  involve  an  innovation  by  the  courts  in  the  existing  law: 

The  question  arises  whether  or  not  to  uphold  universal  price  fixing  in  wartime 
it  will  be  necessary  for  the  courts  to  go  one  step  further  than  they  have  so  far 
gone,  namely,  to  hold  that  because  the  modern  methods  of  warfare,  which 
involve  the  Nation  as  a  whole  rather  than  merely  its  armed  forces,  the  emergency 
is  so  wide-spread  and  the  regulative  force  of  competition  so  universally  restricted 
as  to  cloth  with  public  interest  all  dealings  in  commodities  and  services,  whether 
for  public  or  piivate  consumption,  whether  at  wholesale  or  retail.  Whether  or 
not  that  proposition  can  be  sustained,  is,  in  its  ultimate  analysis,  the  question 
to  be  answered. 5^ 

The  case  of  Nebbia  v.  N'ew  York  ^^  although  liberalizing  the  public- 
interest  doctrine  leaves  open  the  question  of  whether  universal  price 
regulation  would  be  considered  to  be  a  reasonable  exercise  of  the  war 
power. 

And  regardless  of  the  decision  as  to  what  types  of  prices  may  be 
regulated,  the  problem  of  the  necessity  for  a  fair  price  will  remain. 
If  the  cases  on  commandeering,  such  as  U.  S.  v.  New  River  Collieries, 
are  followed,  it  would  seem  that  there  would  be  a  substantial  legal 
obstacle  to  the  prevention  of  profiteering  and  inflation  in  time  of 
war.  It  will  be  remembered  that  there  the  court  decided  that  pay- 
ment of  a  price  which  merely  represented  cost  of  production  plus  a 
reasonable  profit  was  not  sufficient  and  that  the  high  market  price 
for  exports  was  the  proper  test. 

"  War  Policies  Commission  Hearings,  op.  cit.,  p.  841. 
"  291  U.  S.  502 


II.  Price  Control  as  a  Means  of  Preventing  Inflation 

It  is  clear  that  the  probability  of  price  decline  is  remote  in  time  of 
war. 

The  published  practice  of  the  price-fixing  agencies  in  the  World 
War  was  to  set  maximum  prices  instead  of  prices  which  did  not  admit 
of  any  fluctuation.  iMr.  Baruch,  in  his  supplementary  statement  to 
this  committee,  has  stated  that  the  price-ceiling  proposal  also  con- 
templates this  type  of  price  regulation: 

*     *     *     In  simplest  terms,  I  propose — 

To  make  it  unlawful  to  raise  prices  in  any  war  from  the  day  of  declaration 
(or  thereabouts)  except  as  may  be  permitted  by  the  President  and  to  penalize 
both  seller  and  buyer  for  infractions.  Individual  prices  or  whole  groups  of  prices 
may  be  adjusted  up  or  down  by  a  price-adjusting  committee  as  occasion  requires. 
This  puts  a  ceiling  over  the  price  structure  but  permits  fluctuations  downward 
as  freely  as  before.  It  also  offers  sufficient  flexibility  to  meet  all  exigencies.  No 
price  is  fixed.     Nothing  is  frozen.^* 

However,  it  has  been  authoritatively  stated  in  a  War  Industries 
Board  pubHcation  that  the  distinction  between  maximum  and  mini- 
mum prices  was  really  a  theoretical  one  and  that  it  was  only  in  a 
very  few  cases  that  prices  sank  of  their  own  accord: 

It  was  characteristic  of  the  prices  fixed  by  the  Price-Fixing  Committee,  if, 
indeed,  not  of  all  prices  fixed  in  this  country  during  the  war,  save  those  for  wheat, 
pork,  and  hemp,  that  no  more  rigid  control  was  attempted  than  the  fixing  of  a 
maximum  price.  The  committee  really  set  limits  above  which  the  so-called  "fixed 
prices"  might  not  rise,  but  left  them  to  play  freely  below  those  points.  This  distinc- 
tion, though  precisely  accurate,  is  of  more  importance  in  theory  than  in  practice, 
because  usually  the  maxiynum  prices  became  the  actual  prices  and  operated,  m  the 
main,  as  fixed  prices.  The  various  Government  departments  (the  Department  of 
War,  the  Department  of  Navy,  the  United  States  Shipping  Board  Emergency 
Fleet  Corporation,  and  the  Railroad  Administration)  were  usually  guided  in  their 
purchases  by  the  fixed  maximum  prices  and  paid  them  without  more  ado. 

The  instances  in  which  the  market  sank  below  the  fixed  prices,  as  it  did  with 
zinc  and  lumber,  are  relatively  few.  The  committee,  when  such  a  circumstance 
occurred,  simply  reduced  the  fixed  maximum  price  to  a  lower  level.  =* 

When  it  became  known  to  the  Price  Fixing  Committee  that  there 
would  be  an  increase  in  the  copper  price  it  asked  the  Government  to 
refrain  from  placing  orders  until  the  higher  maximum  price  was  in 
effect.^o 

Numerous  economic  forces  existed  to  insure  the  continuation  of  the 
inflationarj^  price  levels  which  prevailed  prior  to  the  entry  of  the 
United  States  into  the  war.  These  arose  from  the  state  of  war  itself 
and  will  accompany  any  future  conflict,  regardless  of  the  type  of 
price  control  adopted. 

(1)  introduction  of  marginal  producers 

The  examination  of  Mr.  Baruch  by  this  committee  developed  the 
fact  that  the  necessity  for  increased  war  production  requires  that 
marginal  producers  be  brought  into  operation  who  could  not  have 

"  Supplementary  statement  of  Bernard  M.  Baruch,  Apr.  12,  1935. 
«»  Garrett,  op.  cit.,  p.  240.    (Italics  added.) 
«« Supra,  p.  63. 

117 


118  MUNITIONS    INDUSTRY 

existed  at  pre-war  price  levels  because  of  their  high  costs.  Because 
of  the  impracticability  of  the  individual  price  proposal,  prices  for  entire 
industries  must  be  raised  to  guarantee  this  marginal  production. 
As  we  have  seen,  this  inflationary  influence  on  prices  in  the  World 
War  operated  on  the  many  industries  whose  production  had  to  be 
stimulated  for  war  purposes,  and  the  price  rise  for  any  particular  com- 
modity was  as  high  as  war  fears  could  make  it.  These  considerations 
will  be  operative  to  carve  a  deep  and  wide  exception  to  the  price- 
eeiUng  plan.  ^^ 

(2)    INCREASING    PLANT    FACILITIES 

When  war  comes,  the  economic  structure  must  be  readjusted  to 
meet  the  changed  character  of  demand.  Guns,  ammunition,  sub- 
marines, and  other  implements  of  war  are  the  commodities  upon 
which  production  forces  must  be  concentrated.  A  similar  necessity 
exists  for  more  of  the  usual  peace-time  commodities,  such  as  clothing, 
shoes,  and  food.  By  means  of  the  interrelationship  of  commodities, 
this  shift  in  demand  communicates  itself  throughout  the  countrjT-'s 
price  structure. 

At  man}^  points  where  the  novel  demand  asserts  itself,  it  becomes 
necessary  to  either  provide  new  plant  facilities  or  to  convert  the  exist- 
ing plant  to  the  new  purposes.  To  accomplish  either  of  these  ends, 
large  sums  of  money  are  required.  War  industries,  it  should  be  noted, 
are  usually  heavy  industries,  where  investment  must  be  extensive. 

If  private  industry  is  to  be  induced  to  expend  its  money  for  new 
construction  or  for  conversion  of  existing  plants,  it  wUl  be  necessary 
to  make  attractive  the  transfer  of  capital,  especially  where  it  is  al- 
ready being  profitably  employed.  The  alternative  is  reliance  upon  a 
voluntar}'  spirit  of  cooperation  to  drop  profitable  investment  or,  in 
the  case  of  idle  capital,  to  enter  an  uncertain  and  different  field  of 
business.  With  the  coming  of  peace  and  the  termination  of  extraor- 
dinary war  demand,  many  facilities  built  for  the  purpose  of  the 
war  suffer  a  loss  in  value  from  the  curtailment  of  their  profitable  use. 
To  insure  investment,  business  requires  that  it  be  guaranteed  against 
this  future  loss  as  well  as  assured  of  a  return  on  the  investment. 

Both  these  purposes  were  effected  under  the  high  price  structure 
existing  prior  to  the  entry  of  the  United  States  into  the  war.  Many 
of  the  price  advances  have  been  explained  solely  on  this  ground.  ^'^ 

The  institution  of  price  control  did  not  eliminate  the  upward 
influence  of  amortization  on  prices.  It  was  now  urged  by  producers 
as  an  element  of  cost  justifying  price  increase.  When  the  question 
of  continuing  the  aluminum  prices  was  before  the  Price  Fixing  Com- 
mittee, the  producers  contended  for  an  increase  because  they  had 
enlarged  their  plants.  This  consideration  was  apparently  strong 
enough  to  warrant  an  advance  of  1  cent  over  the  existing  high  price 
of  32  cents  a  pound.  ^^ 

To  the  extent  that  price  increases  are  used  to  induce  this  new 
construction,  there  v/iU  be  another  gap  in  the  price  ceiling  which  will 
impair  the  effectiveness  of  that  proposal. 

The  use  of  Government  financing  has  its  limitations.  Unless  the 
Government  is  to  make  a  gift  of  the  new  plant  to  the  manufacturer, 

6'  See  supra,  p.  56-62. 

62  See  War  Induslries  Board  Price  Bulletin  No.  56,  Prices  of  Explosives,  for  a  statement  of  the  importance 
of  this  factor  in  the  prices  paid  by  the  Allies  for  military  explosives. 

63  Garrett,  op.  cit.,  p.  286. 


MUNITIONS    INDUSTRY  119 

it  must  be  repaid.  The  manufacturer  will  therefore  have  to  earn 
during  the  war  sufficient  to  recompense  for  the  future  loss  in  value, 
and  that  can  only  be  accomplished  by  a  price  set  at  a  level  which  is 
high  enough  to  take  this  into  account. 

Where  reliance  is  placed  on  a  tax  provision  for  amortization  as  a 
deduction  from  gross  income,  it  should  be  recognized  that  the  manu- 
facturer utilizing  it  is  enabled  to  gain  profits  from  a  facility  the 
expense  of  which  constitutes  a  subtraction  from  the  Government's 
revenue.  To  the  extent  that  this  has  to  be  made  up  by  borrowing 
there  is  a  tendency  toward  inflation.  Moreover,  there  are  many 
possibilities  for  profit  in  manipulation  of  the  inexact  determination 
of  loss  in  value.  ^^ 

The  allowance  of  amortization  as  an  element  of  cost  in  the  last  war 
permitted  gains  that  were  not  readily  visible.  For  example,  on  May 
9,  1918,  the  Price  Fixing  Committee  allowed  an  increase  in  the  price 
of  aluminum  from  32  to  33  cents  a  pound  because  of  the  manufacturer's 
plea  that  plants  were  enlarged  to  meet  war  production  needs. *^^  The 
Aluminum  Co.  of  America  subsequentlj^  gained  amortization  in  the 
amount  of  $10,650,059  under  section  234  (8)  of  the  Revenue  Act  of 
1918,  as  a  deduction  from  its  gross  taxable  income  on  the  theory  that 
much  of  the  war  construction  represented  excess  capacit}^  in  time  of 
peace. ^^  However,  this  company's  production  increased  after  the 
termination  of  the  war.  As  has  been  noted  in  the  taxation  section 
of  this  report,  production  was  124,724,924  pounds  in  1918;  128,- 
476,872  pounds  in  1919;  138,042,272  pounds  in  1920,  and  from  1923 
to  1931  it  varied  from  a  low  of  128,658,222  pounds  in  1923  to  a  high 
of  229,036,636  pounds  in  1930."  In  a  word,  this  company  was  able 
to  gain  two  amortization  allowances,  one  in  the  form  of  additional 
price  and  another  in  decreased  tax,  for  a  loss  in  value  of  capital 
facilities  which  never  materialized.  The  Government  suffered  doubly, 
both  in  its  loss  of  revenue  and  in  the  increased  cost  of  its  purchases. 

(3)    ENCOURAGING    FARM    PRODUCTION 

Another  situation  in  which  prices  will  be  adjusted  above  the  ceiling 
of  the  pre-war  price  norm  is  that  of  farm  products.  It  was  the  ex- 
perience of  the  World  War  that  not  even  existing  high  market  prices 
could  induce  a  sufficiently  increased  production  of  wheat.  The  possi- 
bility of  a  future  decline  when  the  crop  would  be  ready  for  market  made 
necessary  the  guarantee  of  a  minimum  fixed  price  which  would  be 
paid  at  that  time.  The  Lever  Act,  approved  in  August  1917,  set  a 
statutory  minimum  price  of  $2  per  bushel  of  wheat,  which  was 
increased  at  later  times  until  it  reached  the  figure  of  $2.26: 

The  scarcity  of  available  wheat  had  precipitated  a  panic.  While  fear  was  an 
element  in  the  situation,  the  problem  of  scant  supply  was  real.  Increased  world 
production  was  the  effective  remedy,  and  under  existing  conditions  America  was 
the  country  which  must  do  most  in  increasing  the  world  supply.  Wildly  fluc- 
tuating prices  are  not  attractive  to  the  American  farmer,  however,  especially  if 
the\'  reach  unusual  heights  at  a  season  of  the  year  when  liis  crop  is  not  ready 
for  the  market.  A  high  price  in  May  does  not  insure  a  high  price  at  harvest  time, 
later  on.  Moreover,  the  problem  of  world  supply  of  wheat,  which  became  acute 
in  the  spring  and  summer  of  1917,  could  not  be  alleviated  except  by  sowing  more 

6J  See  supra,  p.  32-34. 
«  Garrett,  op.  cit.,  p.  286. 
«9  Supra,  p.  33. 
6"  Ibid. 


120  MUNITIONS    INDUSTRY 

wheat  to  be  harvested  1  j^ear  later,  or  in  the  summer  of  1918.  Making  wheat 
culture  attractive  to  the  farmer,  therefore,  became  the  task  of  the  Government 
officials. 

Congress  completed  the  Food  Control  Act  (Lever  Act)  4  months  after  the 
United  States  had  declared  war  against  Germany,  and  it  was  approved  by  the 
President  on  August  10,  1917.  This  law  not  only  made  possible  the  organization 
and  program  of  the  Food  Administration,  but  section  14  named  a  minimum  price 
of  $2  per  bushel  for  the  1918  wheat  harvest  under  the  act.  Differentials  were  to 
be  set  up  for  the  several  standard  grades  of  wheat,  based  upon  No.  1  Northern 
spring  wheat  at  Chicago,  or  its  equivalent  at  the  principal  interior  primarj'^ 
markets.  The  President  was  authorized,  whenever  he  should  find  an  emergency 
to  exist  requiring  stimulation  of  production  of  wheat,  and  whenever  it  seemed' 
essential  that  the  producers  should  have  the  benefit  of  the  guaranty,  to  determine 
and  fix  what,  under  specified  conditions,  he  considered  a  reasonable  guaranteed 
price  for  wheat,  in  order  to  assure  producers  a  reasonable  profit. 

It  is  quite  evident  that  the  authors  of  section  14  were  concerned  entirelj^  with 
the  producer.  Production  of  wheat  was  the  world's  prime  need  and  the  purpose 
of  this  guaranty  was  to  serve  notice  upon  the  farmer  one  year  in  advance  of  his 
harvest  that  he  might  expect  at  least  $2  a  bushel  for  his  wheat  crop,  and  as  much 
more  as  the  market  should  justifj'  and  the  President  provide. ^^ 

It  has  been  claimed  that  the  effect  of  the  price  may  be  seen  in  the 
figures  of  crop  acreage  sowti.  According  to  the  Bureau  of  Crop  Esti- 
mates, Department  of  Agriculture,  the  acreage  sown  in  the  fall  of 
1916  was  40,534,000;  in  1917  it  was  42,301,000;  and  the  preliminary 
estimate  for  1918  w^as  49,261,000.'^^  The  importance  of  this  particular 
farm  product  exception  is  indicated  by  the  figures  of  production. 
In  1916,  636,318,000  bushels;  in  1917,  636,655,000;  and  in  1918,. 
921,438,000.^" 

A  somewhat  similar  treatment  was  accorded  the  problem  of  pork 
scarcity.  For  the  purpose  of  stimulating  production  in  1918,  the  head 
of  the  Food  Administration's  Meat  Division,  declared  in  October  1917 
that  the  price  for  hogs  would  not  "go  below  $15.50  per  hundred- 
weight for  the  average  of  the  pack's  droves  on  the  Chicago  market. "^^ 
He  further  stated  that  the  Food  Administration  would  attempt  to 
stabilize  the  price  so  that  the  farmer  would  be  assured  of  getting  13 
times  the  average  cost  per  bushel  of  the  corn  fed  into  the  hogs.  In 
this  case  there  was  no  statutory  enactment  but  the  Government  used- 
its  control  over  the  buying  of  the  Allies,  the  Army  and  Navy,  the 
Red  Cross,  the  Belgian  relief  and  the  neutrals,  all  of  which  had  been 
centralized  in  its  hands  to  keep  prices  at  the  stated  price  level. 

Mr.  Baruch  testified  before  the  committee  that  prices  of  some  farm- 
products  would  certainly  have  to  be  increased  in  war  time: 

Mr.  Hiss.  Mr.  Baruch,  it  is  true,  is  it  not,  that  we  will  be  forced,  in  any  future 
war,  to  increase  the  prices  of  some  farm  products,  as  the  most  effective  way  of 
getting  immediate  and  sudden  increase  of  production? 

Mr.  Baruch.   Yes,  sir. 

Mr.  Hiss.  And  that  will  affect  the  price  schedules? 

Mr.  Baruch.  I  also  think  you  have  got  to  do  it  in  peace  times,  but  in  war  times 
certainly." 

(4)    INEVITABLE    COST    INCREASES 

(a)  Insurance  rates. — Among  the  costs  which  cannot  be  held  down 
to  peace-time  levels  are  ship  and  freight  insurance  rates.  With  the 
natural  increase  in  risk  of  international  shipping,  insurance  com- 
panies must  provide  larger  reserves  to  meet  the  increased  burden.- 

68  Garrett,  op.  cit.,  p.  60. 

69  Ibid,  p.  68. 

"0  Statistical  Abstract  of  the  U.  S.,  1934,  p.  599. 

"  Garrett,  op.  cit.,  p.  89. 

"2  Bernard  M.  Baruch,  Mar.  29,  1935  (galley  78  BBQ). 


MUNITIONS    INDUSTRY  121 

The  only  way  of  accomplishing  this  end  is  by  raising  the  premiums 
paid  by  the  insurers.  How  large  a  risk  existed  in  the  last  war  may  be 
reahzed  from  the  fact  that  between  August  1,  1914,  and  November 
11,  1918,  a  period  of  a  little  more  than  4  years,  the  United  States  lost 
587  seagoing  documented  vessels,  exclusive  of  seized  enemy  and 
requisitioned  Dutch  ships.  The  total  tonnage  involved  was  1,146,236.^^ 
Domestic  rates  must  also  be  increased  to  take  care  of  the  added  strain 
that  is  put  on  the  internal  system  of  communication. 

This  item  appears  in  the  price  of  many  commodities  as  a  cost  in- 
crease which  warrants  further  advances  in  price.  Moreover,  prices 
must  increase  even  where  the  manufacturer  cannot  get  insurance. 
In  such  cases,  to  continue  in  existence,  he  must  act  as  his  own  insurer 
by  advancing  the  price  sufficiently  to  cover  the  increased  probability 
of  loss. 

(6)  Labor  costs. — It  should  be  noted  that  labor  costs  will  increase 
in  time  of  war  even  though  the  rates  of  wage  remain  stationary. 
Less  skilled  labor  must  be  used  in  the  many  industries  which  lose 
their  trained  men  who  are  replaced  by  persons  who  because  of  their 
lack  of  skill  will  produce  less  both  in  quantity  and  quality  of  goods. 
There  will  therefore  be  an  increased  cost  per  unit  of  the  commodity 
produced  which  must  be  allowed  for  in  the  final  price  set. 

(c)  Transportation  costs. — The  necessity  for  moving  large  quantities 
of  goods  and  men  means  that  there  is  imposed  upon  the  railroads  of 
the  country  a  great  physical  burden  of  work.  Older  equipment  is 
used,  more  repairs  are  needed  for  track  maintenance,  and  in  general 
it  costs  more  to  move  the  same  per  unit  amount  of  traffic.  This 
results  in  a  tendency  toward  the  imposition  of  higher  rates  if  there  is 
any  attempt  to  avoid  incurring  large  deficits. 

In  the  World  War  the  Government  raised  railroad  freight  rates  25 
percent,  effective  June  25,  1918,  in  order  to  gain  sufficient  revenue  to 
offset  the  threatening  deficit.  Even  with  this  large  advance,  the  net 
railroad  revenue  did  not  increase  according  to  expectations,  and  it  is 
reported  that  the  Director  General  of  the  Kailroads  stated  as  reasons: 

— the  necessity  of  moving  war  freight  expeditiously  regardless  of  expense,  the  loss 
of  men  to  the  draft  and  to  railroad  service  abroad,  and  the  substitution  of  inex- 
perienced labor  and  the  rapid  increase  in  cost  of  labor  and  materials.  Moreover, 
while  wage  increases  were  largely  effective  from  January  1,  the  railroads  received 
the  benefit  of  rate  increases  for  only  the  last  6  months  of  the  war."^ 

Furthermore,  it  was  pointed  out  by  Mr.  Baruch  in  his  appearance 
before  this  committee,  that  there  was  in  the  World  War  a  tendency 
toward  decentralization  of  plants.  The  net  effect  of  spreading  indus- 
tries like  munitions  over  the  country  is,  of  course,  to  increase  the  cost 
and  consequently  the  price  of  the  article  which  is  being  shipped  for 
longer  distances: 

Air.  Hiss.  Is  it  not  also  true  that  in  the  history  of  production  in  war,  that  in 
the  tie-up  of  transportation  which  inevitably  results  from  new  demands  on  trans- 
portation, goods  are  accumulated  at  unusual  places,  and  so  forth,  and  the  costs 
actually  go  up? 

Mr.  Baruch.  Yes,  sir;  unquestionably. 

Mr.  Hiss.  Is  it  not  true  that  many  manufacturers  have  to  enter  a  line  of 
production  with  which  they  are  not  familiar,  in  unfamiliar  lines,  and  consequently, 
because  of  unfamiliarity,  their  costs  increase? 

73  Garrett  op.  cit.,  p.  34. 

'<  Dixon,  Federal  Operation  of  the  Railroads  During  tiie  War,  Quarterly  Journal  of  Economics,  vol. 
-  33,  p.  608. 


122  MUNITIONS    INDUSTRY 

Mr.  Baruch.  Yes;  and  another  matter,  if  you  will  permit  me  to  interject  here^ 
is  that  because  of  transportation  difficulties  and  because  of  the  fact  that  many 
parts  of  our  country  have  no  business  at  all,  and  for  the  fact  that  we  must  scatter 
our  munitions  manufacturing  so  as  not  to  have  a  blow-up  or  a  falling  down  in 
some  place,  we  were  at  the  end  of  the  war  placing  orders,  as  I  said,  in  Denver,  and 
in  far  away  places,  without  reference  entirely  to  the  question  of  price.  So  that 
that  is  an  important  factor. 

Mr.  Hiss.  And  all  that  means  increased  cost  in  war  times  over  peace  timesf 

Mr.  Baruch.  Yes,  sir. 

Mr.  Hiss.  And  that  is  one  of  the  causes  of  increased  prices  usually  in  war  time, 
is  it  not? 

Mr.  Baruch.  Yes,  sir. 

Mr.  Hiss.  And  that  tendency  would  be  present  in  any  war? 

Mr.  Baruch.  Yes,  sir. 

Mr.  Hiss.  And  would  furnish  various  lines  of  industry  with  plausible,  reason- 
able arguments  as  to  why  their  particular  prices  should  be  increased? 

Mr.  Baruch.  They  will  find  more  than  you  and  I  can  figure  on  now.''^ 

(5)    THE  sellers'  ADVANTAGEOUS  POSITION  IN  WAR  MARKETS 

The  likelihood  of  a  continual  rise  in  the  price  ceiling  is  readily 
apparent  when  it  is  noted  that  war  markets  are  sellers'  markets. 
Buyers  must  procure  their  supply  without  regard  to  the  height  of 
prices.     In  the  final  report  of  the  War  Industries  Board  ^^  it  is  said: 

A  war  demand  differs  in  its  essential  nature  from  the  normal  demands  of 
peace.  In  ordinary  times  a  rising  price  carries  with  it  its  own  defeat.  Pur- 
chasers will  buy  so  long  as  they  can  make  a  profit  or  reap  a  satisfaction  by  doing 
so.  This  at  least  is  true  of  everything  except  the  most  extraordinary  luxuries. 
They  will  stop  buying  when  the  price  reaches  a  point  outside  the  range  where  the 
commodity  can  be  turned  over  at  a  profit.  The  inflated  price  drops  as  a  result. 
But  war  is  economically  the  greatest  and  most  scandalous  of  spendthrifts.  No 
economic  profit  comes  from  the  expenditure  of  an  instrument  of  war  and  no 
economic  profit  is  considered  in  connection  with  its  purchase.  The  demand  is 
absolute;  the  price  is  no  deterrent." 

In  the  last  war  this  consideration  not  only  cut  off  the  probability  of 
downward  fluctuation  but  furnished  a  major  force  for  the  advance  of 
prices  which  the  creation  of  the  price-fixing  body  did  not  terminate. 

For  instance,  on  January  2,  1918,  the  War  Industries  Board  ap- 
proved a  contract  with  the  Hercules  Powder  Co.  for  30,000,000  pounds 
of  smokeless  powder  although  they  were  of  the  opinion  that  the  70- 
cent  price  was  too  liigh.  A  reason  stated  in  justification  was  the  fact 
that  it  was  either  a  matter  of  paying  the  high  price  or  doing  without 
the  powder.     The  minutes  read: 

Under  the  advice  of  Mr.  Brookings  the  Board  approved  of  the  amended  con- 
tract with  the  opinion  that  while  the  Board  considers  70  cents  a  high  price  and 
that  as  7  cents  per  pound  charged  was  for  amortization  of  a  new  plant,  that  this 
should  have  been  so  shaped  that  this  plant  paid  for  by  the  Government  in  price 
should  have  been  the  property  of  the  Government  but  that  however  as  Captain 
Peters  reports  it  was  impossible  to  secure  this  and  that  it  was  either  necessary  to 
pay  the  70  cents  per  pound  or  go  without  this  powder  and  that  having  had  nothing 
to  do  with  the  negotiations  and  acting  only  as  Captain  Peters'  statement  of  the 

"  Bernard  M.  Baruch,  Mar.  29, 1935  (galley  78  BBQ). 

"  P.  7C. 

"  Compare  the  statement  made  at  p.  114  of  the  War  Industries  Board  Report  regarding  the  reasons  for 
the  excessive  rise  of  iron  and  steel  prices  prior  to  the  inception  of  control. 

•'  *  *  *  the  demand  was  absolute;  there  was  no  postponing  of  it.  Buyers  of  steel  in  times  of  peace 
expect  to  realize  a  profit  on  their  investment.  Steel  that  goes  into  buildings  and  bridges  must  be  bought 
at  prices  which  will  make  possible  satisfactory  returns.  Whenever  these  buyers  believe  prices  are  likely 
to  decline  in  the  near  future,  they  will  withdraw  from  its  market.  Their  attitude  serves  as  an  effective 
check  on  buying  when  prices  have  reached  what  is  considered  an  abnormal  level. 

"  The  attitude  of  the  Government  toward  its  war-time  purchases,  however,  differed  fundamentally  from 
this.  It  bought  with  no  expectation  of  earning  a  profit.  The  possibility  of  lower  prices  in  the  future  dii 
not  check  its  buying." 


MUNITIONS    INDUSTRY  123 

case  and  considering  its  emergency  nature,  the  Board  can  see  no  reason  why  the 
contract  should  not  be  made.'* 

Similar  considerations  appear  in  the  course  of  negotiations  with  the 
copper  interests.  In  the  September  11,  1917,  meeting  of  the  War 
Industries  Board,  Mr.  John  D.  Ryan,  President  of  tlie  Anaconda 
Copper  Co.,  and  spokesman  for  the  copper  industry,  said: 

*  *  *  if  22  cents  per  pound  was  fixed  as  a  price  for  copper  that  it  would 
be  impossible  to  obtain  the  voluntary  cooperation  of  the  majority  of  mine  owners. 
If  25  cents  were  fixed  he  assured  the  War  Industries  Board  that  he  and  the  other 
copper  producers  present  would  obtain  all  of  the  copper  voluntarily  from  aU 
producers,  and  that  he  would  see  to  it  that  the  copper  was  properly  distributed 
and  the  prices  controlled.'^ 

The  result  of  the  negotiations  was  that  the  Government  yielded  to 
allow  a  price  of  23.5  cents. 

In  the  February'-  7,  1918,  minutes  of  the  War  Industries  Board,  there 
is  recorded  the  offer  of  the  Anaconda  Copper  Co.  to  build  a  new 
manganese  plant  on  condition  that  there  would  be  no  price  regulation: 

The  Board  was  advised  that  the  Anaconda  Copper  interests  were  willing  to 
expend  approximately  a  million  and  a  half  dollars  toward  developing  manganese 
property  near  Butte,  providing  that  they  would  receive  a  guaranty  that  the 
Government  would  not  regulate  the  price.  Mr.  Baruch  was  requested  to  ask 
Mr.  Ryan  to  submit  a  definite  proposition  in  writing.™ 

Furthermore,  there  was  the  very  real  pressure  of  the  military  forces 
for  the  procurement  of  goods  regardless  of  price.  How  that  operated 
in  the  determinations  of  the  governmental  price-fixing  agency  may  be 
seen  from  Mr.  Baruch's  testimony  that,  "every  time  anything  hap- 
pened they  said, '  We  are  going  to  lose  the  war '  and  I  was  on  the  spot."  ^^ 

On  May  22,  1918,  Mr.  Charles  Hayden,  representing  the  Utah 
Copper  Co.,  justified  a  plant  cost  increase  of  more  than  100  percent 
over  normal  pre-war  costs  by  the  fact  that  this  might  speed  up  pro- 
duction and  aid  in  bringing  the  war  to  a  speedier  termination.  He 
stated  that  the  Allied  Governments  were  demanding  more  goods 
rather  than  lower  prices: 

We  have  seen  a  plant  being  built  at  Hog  Island  at  an  estimated  cost  of 
$42,000,000,  against  a  normal  pre-war  cost  of  $21,000,000.  At  first  blush  this 
seems  extravagant,  but  a  careful  analysis  shows  that  this  excess  cost  of  this  yard, 
if  it  enables  our  country  to  get  ships  6  months  earlier,  will,  by  that  very  fact,  if 
it  only  shortens  the  war  one-half  of  those  6  months  or  one-quarter  of  those  6 
months,  save  many,  many  times  its  cost,  as  the  daily  expenses  of  the  war  are  in 
excess  of  all  the  overcost  of  1  yard.  The  same  applied  to  the  situation  in  aircraft 
production.    And  now  what  are  we  confronted  with  in  the  copper  industry? 

Our  allies  are  crying  for  copper;  representatives  of  foreign  governments  are 
telling  me  as  an  individual:  "What  do  we  care  about  a  cent  or  more  in  price? 
What  we  want  is  the  stuff."  And  here  we  are  sitting  and  theorizing  as  to  whether 
or  not  the  Federal  trade  examination  of  costs,  or  a  theoretical  discussion  of 
margins  of  profits,  is  meaning  an  undue  profit  to  the  copper  industry,  when  there 
is  already  a  shoriage  of  over  100,000  tons  of  copper  at  the  present  time  and  when, 
in  the  interests  of  safety,  there  should  be  a  surplus  of  at  least  that  amount. ^^ 

This  consideration  is  significant  for  the  practice  in  future  wars  and 
especially  for  the  determination  of  the  extent  of  adjustment  that  will 
be  required  for  the  price-ceiling  plan.  Lieutenant  Colonel  Harris, 
Director  of  the  Planning  Branch  of  the  War  Department,  expressed 
doubt  as  to  the  possibility  of  continuing  the  Government  contract 

'8  Exhibit  No.  1271. 

'»  Exhibit  No.  1270. 

80  Exhibit  No.  1274. 

SI  Bernard  M.  Baruch  Mar.  27,  1935  (galley  50  BBQ). 

«J  Minutes  of  the  Price  Fixing  Committee,  May  22,  1918. 


124  MUNITIONS    INDUSTRY 

provision  which  allows  a  return  of  6  percent  of  the  estimated  plant 
value — an  admittedly  high  figure:*^ 

Mr.  HiS3.  Colonel  Harris,  W3  cannot  be  sure  at  the  present  time  that  the 
present  6  percent  provision  in  the  adjusted  compensation  contract  can,  as  a 
matter  of  practical  necessity,  be  retained  in  the  event  of  war? 

Lieutenant  Colonel  Harris.   To  be  perfectly  frank,  I  am  very  doubtful.^* 

An  increase  in  the  percentage  is  apparently  contemplated  at  the 
present  time  but  it  is  thought  advisable  to  defer  its  exact  determina- 
tion to  the  time  when  war  is  imminent.  The  following  excerpt 
is  from  a  War  Department  memorandum  of  February  20,  1934, 
headed,  "War-Time  Contracts  Forms  and  Emergency  Codes": 

The  question  of  the  amount  of  profit  to  be  allowed  the  contractor  is  one  of 
the  most  critical  in  any  form  of  cost-plus  contract.  The  fee  adopted  should 
be  fair  alike  to  the  producers  and  the  Government.  In  the  adjusted  compen- 
sation contract  the  fee  is  based  primarily  upon  the  rental  value  of  the  facility. 
It  is  true  that  the  contractor  assumes  few  of  the  risks  of  an  entrepreneur  for 
which  profit  is  paid.  He  does,  however,  have  certain  risks  of  management 
and  certain  expenses  for  which  no  compensation  is  made.  The  committee 
beUeves  that  some  increase  in  the  present  figure  might  well  be  made,  but 
doubts  the  advisability  of  attempting  to  determine  the  exact  amount  until  war 
is  imminent.     It  can  then  be  decided  on  the  basis  of  then-existing  conditions.^* 

The  committee  has  found  that  a  number  of  the  owners  and  execu- 
tives in  the  various  ordnance  districts  think  that  the  present  pro- 
visions are  not  sufficiently  liberal. 

The  following  excerpt  from  a  War  Department  memorandum 
dated  February  6,  1934,  and  headed  "Comments,  Criticisms,  and 
Proposals  on  the  Adjusted  Compensation  Contract  Form"  is  a 
comment  from  the  St.  Louis  ordnance  district  on  the  present  6-per- 
cent rate:  ^^ 

It  is  the  general  concensus  of  opinion  among  owners  and  executives  of  in- 
dustrial plants  in  this  vicinity  that  the  adjusted-compensation  contract,  while 
getting  away  apparently  from  the  cost-plus  contract,  still  retains  some  features 
highly  objectionable  and  subject  to  prolonged  argument.  Some  of  the  firms  are 
frank  to  state  it  would  be  extremely  difficult  for  them  to  voluntarily  enter  into 
such  a  contract  in  either  peace  or  war  time.     *     *     * 

There  is  no  question  but  that  the  proposed  contractors  in  this  vicinity  think 
the  reward  inadequate  and  unjust.  This  is  particularly  true  of  companies  hav- 
ing a  large  bond  issue  and  an  issue  of  preference-accumulative  stock  whereby 
the  fee  and  the  uncertain  bonus  would  not  be  sufficient  to  protect  the  company 
and  the  investors  of  the  preference  stock. 

******* 

It  is  the  opinion  of  this  office,  based  on  the  dicussions  at  the  various  con- 
ferences held  on  this  subject,  that  the  present  form  of  adjusted-compensation 
contract  includes  a  number  of  fundamentally  objectionable  features  and  is  not 
satisfactory  to  the  contractors  in  general.*^ 

The  San  Francisco  ordnance  district  entered  an  alternative  sug- 
gestion: 

After  careful  perusal  of  the  Bridgeport  district  report  on  the  adjusted-compen- 
sation contract,  it  is  believed  that  the  contract  is  impracticable,  and  that  its  use 
would  involve  intolerable  delay  in  the  initiation  of  procurement. 


83  Profits  of  much  more  than  6  percent  can  be  gained  under  these  contracts  by  coming  under  the  bonus 
provisions.  Valuation  difficulties  are  also  pertinent.  Mr.  Baruch  testified  on  Mar.  29,  1935  (galley 
99  BBQ).    "These  figures  are  all  too  high  there.    They  are  absurd." 

s»  Lieutenant  Colonel  Harris,  Dec.  14,  1934  (galley  15  FM). 

85  Exhibit  No.  1225. 

86  Exhibit  No.  1227,  Hearings,  p.  3823,  Lt.  Col.  Harris  described  the  ordnance  districts  as  skeleton  organ- 
izations engaged  in  the  field  development  of  industrial  planning.  There  are  14  such  districts  in  the  United 
States  set  up  on  a  geographical  basis  for  decentralized  procurement  in  war. 

8'  Lieutenant  Colonel  Harris,  Dec.  14.  1934  (galley  14  FM). 


MUNITIONS    INDUSTRY  125 

It  should  be  expected  that  the  set  price  will  permit  of  a  profit  of  at  least  10 
percent  on  the  gross  price  to  the  average  bidders.^* 

It  was  the  opinion  of  the  writer  of  the  Boston  district  comment  that 
the  Government  would  not  have  gotten  the  same  degree  of  coopera- 
tion from  manufacturers  during  the  World  War  if  there  had  been  no 
opportunity  for  profiteering: 

The  cost-plus  contract  offers  the  ideal  conditions  for  profiteering.  It  seems 
to  the  writer  questionable  whether  the  Government  would  have  received  such 
whole-hearted  cooperation  from  manufacturers  during  the  World  War  had 
all  opportunity  for  profiteering  been  eliminated.  In  other  words,  it  seems 
that  there  are  incentives  to  the  best  efforts  of  the  manufacturers  in  both  the 
fixed-price  and  the  cost-plus  contracts  which  are  absent  from  the  adjusted- 
compensation  contract.*^ 

(6)    ABNORMAL    PRE-WAR    PRICE    LEVELS 

A  major  reason  for  the  proposal  of  a  price  ceiling  based  upon  the 
schedule  of  prices  existing  at  a  pre-war  date  has  been  the  impression 
that  in  this  manner  a  normal  standard  for  control  would  be  created. 
Mr,  Baruch  has  stated  before  the  War  Policies  Commission: 

To  measure  inflation  of  price  and  profit  we  must  have  some  norm.  The 
obvious  norm  is  the  whole  price  structure  as  it  existed  on  some  antecedent  date 
near  to  the  declaration  of  war  on  which  the  normal  operation  of  the  natural  law 
of  supply  and  demand  can  be  said  to  have  controlled  prices.  That  determined, 
we  need  a  method  of  freezing  the  whole  price  structure  at  that  level.  The  obvious 
waj^  to  do  this  is  simple,  by  proclamation  to  decree  that  every  price  in  the  whole 
national  pattern  as  of  that  determined  date  shall  be  the  maximum  that  may 
thenceforth  be  charged  for  anything — rents,  wages,  interest  rates,  commissions, 
fees — in  short,  the  price  for  every  item  and  service  in  commerce.^" 

The  studies  of  this  committee  have  led  to  the  conclusion  that  there 
is  no  guaranty  of  normahty  in  a  pre-war  price  level.  Our  experience 
in  the  World  War  is  significant  in  this  connection.  Prices  prior  to 
our  entry  were  at  an  inflated  level,  the  Bureau  of  Labor  Statistics 
index  for  all  commodities  having  risen  62  percent  above  the  1913 
level  by  March  1917.  In  fact,  during  the  period  of  our  participation, 
there  was  an  additional  rise  of  only  40  points.  Furthermore,  there 
was  a  great  variation  in  the  rates  of  increase  of  the  various  groups  of 
commodities.  Metals  and  metal  products,  for  instance,  had  risen 
118  percent  by  March  1917,  while  foodstuffs  had  gone  up  48  percent 
and  farm  products  66  percent.  Difference  and  change,  rather  than 
uniformity  and  stability,  were  the  rule.^^ 

Mr.  Hurley,  who  was  at  one  time  Secretary  of  War  and  Chairman 
of  the  War  Policies  Comxinission,  agreed  that  to  have  put  the  price- 
freezing  provisions  of  the  McSwain  bill  into  effect  on  a  date  prior  to 
the  United  States  declaration  of  war  in  1917  would  have  resulted  in 
an  artificially  high  level  of  prices: 

Senator  Clark.  Mr.  Secretary,  I  understood  you  to  say  a  moment  ago  that 
you  had  not  read  the  McSwain  biU.  I  will  just  read  the  first  paragraph  of  it 
[reading]: 

"That  whenever  Congress  shaU  declare  war  or  the  existence  of  an  emergency 
due  to  the  imminence  of  war,  then,  from  and  after  a  date  prior  to  such  dec- 
laration which  date  the  President  is  hereby  authorized  and  directed  to  deter- 
mine and  publicly  proclaim,  it  shall  be  unlawful  for  any  pei'son  to  buy,  sell, 

8«  Ibid.    (Italics  added.) 

89  Ibid.,  p.  382:j. 

w  72d  Cong.,  1st  sess.,  H.  Doc.  No.  163,  p.  34. 

«i  See  Exhibit  No.  1689. 

11579 — 35 9 


126  MUNITIONS   INDUSTRY 

or  otherwise  contract  for  any  article  or  thing  at  a  higher  rate,  rent,  price,  com- 
mission, compensation,  or  reward  than  was  in  effect  at  the  date  so  determined." 

Now,  taking  the  declaration  of  war  in  1917,  or  immediately  prior  thereto,  the 
effect  of  such  a  provision  as  that  would  be  to  freeze  prices  at  an  artificially  high 
level,  would  it  not? 

Mr.  Hurley.  Yes,  sir.^^ 

When  the  chairman  asked  Mr.  Hurley, 

Could  American  industry  have  wanted  for  anything  finer  than  a  program 
which,  upon  our  entry  into  the  World  War,  would  have  found  prices  frozen  at  the 
point  that  prevailed  when  we  entered  the  war?  ^^ 

he  testified, 

My  own  opinion  is  that  we  already  had  price  inflation  due  to  the  war  before 
the  United  States  declared  war.  Consequently  it  would  have  been  unjust,  unfair, 
inequitable  to  have  frozen  prices  at  the  figures  that  they  were  on  our  advent  into 
the  war.9* 

(A  chart  of  index  numbers  of  wholesale  prices  illustrating  the  height 
to  which  prices  had  risen  in  April  1917  is  shown  facing  p.  126.) 

»>  Patrick  J.  Hurley,  Mar.  13,  1935. 
»3  Ibid. 
"  njid. 


WHOLESALE  PRICES 

1913-  19Z1 
[Index  numbers,   1913  =  100] 


II.jT;)— 35.      (Face  p.  126.) 


III.  Price  Control  as  an  Aid  to  Increased  War  Production 
(1)  curtailment  of  civilian  consumption 

Because  of  the  war  demand  for  increased  supply  and  the  time  new 
plant  construction  requires  it  becomes  necessary  to  divert  existing 
materials  from  their  usual  channels  of  distribution  for  the  duration 
of  the  war.  The  Government,  to  produce  goods  for  itself  and  to 
guarantee  that  war  industries  shall  have  an  uninterrupted  supply  of 
materials,  must,  as  a  consequence,  curtail  direct  and  indirect  civilian 
consumption.  By  outbidding  that  part  of  the  civilian  population 
which  cannot  meet  increased  prices,  Government  has  an  effective 
device  for  increasing  its  supply: 

Mr.  Hiss.  It  does  mean,  does  it  not,  that  in  time  of  war  the  civilian  needs 
cannot  be  filled  as  fully  as  in  times  of  peace? 

Mr.  Baruch.  Yes,  sir;  they  have  to  subordinate  themselves  to  the  war. 

Mr.  Hiss.  Does  that  not  mean,  then,  that  one  of  the  Government's  problems 
is  competition  in  the  acquisition  of  necessary  materials  with  the  civilian  popula- 
tion? 

Mr.  Baruch.  Yes,  sir. 

Mr.  Hiss.  In  all  past  wars  has  that  not  been  met  by  the  Government  outbidding 
the  civilian  population? 

Mr.  Baruch.  It  was,  except  with  us  in  the  last  war. 

Mr.  Hiss.  Was  it  not  one  of  the  reasons  why  prices  went  up  during  the  last 
war,  because  the  Government  had  to  pay? 

Mr.  Baruch.  With  which  we  tried  to  cope.     You  are  quite  right. 

Mr.  Hiss.  And  the  Government  had  to  secure  its  supplies,  regardless  of  cost, 
in  many  instances? 

Mr.  Baruch.  Yes.«5 

Civilian  consumption  is  automatically  curtailed  by  the  high  prices 
set  for  the  purpose  of  stimulating  the  production  of  war  industries. 
The  price-fixing  practice  in  the  World  War  has  been  described  as 
follows: 

It  was  the  policy  of  the  Government  for  the  sake  of  maximum  production,  to 
permit  the  automatic  raising  of  prices  by  the  law  of  supply  and  demand  to  the 
point  where  the  comfort  of  the  civil  population  was  endangered  and  then,  on  a 
scientific  determination  of  costs,  to  fix  a  price  high  enough  to  encourage  the  pro- 
ductive contribution  of  even  the  high-cost  producer,  to  the  maximum  consistent 
with  the  common  good,  even  at  the  risk  of  undue  profits  to  low-cost  producers, 
relying  on  excess-profit  taxation  to  equalize  gain  to  a  common  level.  By  this 
expedient  every  possible  field  of  production  was  encouraged,  the  danger  of  a  run- 
away or  speculative  market  was  avoided,  and  profits  were  standardized.^^ 

The  priority  system  was  also  designed  to  increase  production.  It 
gave  the  war  industries  a  direct  preference  in  the  procurement  of  the 
limited  supply  of  the  factors  of  production  and  thus  enabled  them  to 
meet  one  of  the  most  important  limitations  on  the  volume  of  produc- 
tion. Indirectly,  by  curtailing  production  for  civilian  purposes,  it 
released  labor,  supplies,  and  capital  for  use  in  the  war  industries. 
To  avoid  a  vast  problem  of  enforcement,  this  system,  of  course,  had 

««  Bernard  M.  Baruch,  Mar.  29,  1935  (galley  83  BBQ). 
«6  Committee  Print  No.  3,  op.  cit.,  p.  23. 

127 


128  MUNITIONS    INDUSTRY 

to   operate   in   conjunction   with   the   high   fixed   prices   which   had 
automatically  cut  off  a  large  part  of  the  force  of  civilian  demand. 

(2)    MARKET    STABILIZATION 

Price  control  is  useful  in  the  stabilization  of  markets. ^^  Where  prices 
fluctuate  at  high  levels,  purchasers  tend  to  curtail  consumption 
because  of  the  uncertainty  of  future  price  movements.  The  conse- 
quent irregularity  of  demand,  together  with  the  uncertainty  of  cost 
conditions,  causes  restriction  of  production.  Price  regulation  elim- 
mates  this  condition  by  fixing  a  price  which,  although  at  a  high  level, 
will  continue  without  fluctuation  for  a  period  of  time  and  upon  which 
business  men  can  make  more  accurate  calculations  of  future  costs 
and  sales.  The  preference  of  business  for  stable  markets  has  been 
described  by  Mr.  Baruch: 

As  to  the  morale  of  industry  at  large  in  the  World  War,  the  uncertainty  of 
the  daily  fluctuation  of  price  and  the  inevitable  rising  trend  on  all  sides  was  a 
matter  for  common  commiseration.  I  am  aware  of  no  able  and  experienced 
business  administrator  who  does  not  prefer  operation  under  stable  conditions 
to  operation  under  price  schedules  in  an  unforeseeable  state  of  flux.^'' 

Mr.  Yeatman  stated  in  a  memorandum  to  the  Price  Fixing  Com- 
mittee that  the  absence  of  a  speculative  rise  in  the  price  of  nickel  was 
due  not  only  to  patriotic  feeling  but  also  "to  the  belief  that  if  prices 
advanced  too  much  the  demand  for  the  product  would  lessen."^ 

These  factors  were  major  considerations  for  both  Government  and 
business  in  the  adoption  of  price  control  for  the  steel  industiy. 

The  report  of  the  War  Industries  Board  states  that  in  the  summer 
of  1917  "the  instability  of  prices  was  in  itself  hampering  production 
and  driving  business  into  confusion."  ^  The  index  of  iron  and  steel 
prices  fell  24  points  between  July  and  August  1917.^  An  additional 
36  point  decrease  was  registered  in  the  month  of  September.^  Bes- 
semer pig  iron,  Pittsburgh,  declined  from  a  high  of  $57.95  in  July 
to  $50.95  on  September  19.  Basic  pig  iron,  valley  furnace  reached 
its  high  of  $5-3  on  Julv  18  and  declined  steadilv  to  $42  on  September 
19.^ 

Business  was  reluctant  to  buy  in  this  condition  of  the  market. 
A  letter  from  Mr.  Crosby,  a  Buffalo  manufacturer  written  on  July  13, 
1917,  when  prices  were  at  a  speculative  peak,  stated  that  the  expected 
decline  in  prices  would  injure  business  because  taxes  would  be  assessed 
on  profits  computed  on  the  basis  of  high  value  inventories: 

The  situation,  in  my  judgment,  is  becoming  extremely  dangerous  for  the  ordi- 
nary manufacturer  and  the  ordinary  merchant.  A  very  large  part  of  his  profit 
is  in  his  inventory.  The  Government  is  going  to  ask  us  to  pay  taxes,  and  very 
heavy  taxes,  on  this  profit.  Even  if  the  Government  takes  no  action,  prices  will 
drop  suddenly  and  the  high  figures  of  the  inventories  will  melt  away  in  a  night.^ 

Expectation  of  future  shrinkage  of  value  also  curtailed  the  consump- 
tion of  steel  for  building  purposes.  This  factor  appeared  in  Samuel 
Vauclain's  letter  to  F.  A.  Scott,  then  Chairman  of  the  War  Industries 
Board: 


«8  Garrett  states  that  at  a  meeting  of  the  Price  Fixing  Committee  on  July  8,  1918,  Mr.  Brookings,  the 
Committee's  chairman,  "submitted  a  memorandum  stating  that :  the  Price  Fixing  Committee  was  created 
to  stabilize  values  and  prevent  extortionately  high  prices."    See  p.  64  supra. 

"  War  Policies  Commission  hearings,  op.  cit.,  p.  813. 

1  Exhibit  No.  1749. 

2  Page  72. 

3  W.  I.  B.  Price  Bulletin,  No.  3,  p.  246. 

4  Ibid. 

«  Bernard  M.  Baruch,  Mar.  29,  1935. 
8  Exhibit  No.  1735. 


Price  per  pound  of  steel  sheets  at  Pittsburgh  district  mills 
and  prices  of  all  commodities 


INDEX  NUMBERS   (  1913  =  100  ) 


PERCENT 

:'": 

350 

STEEL  SHEE 

ZS."  No  27  boil 

US  standard 

C/i  or  more 

^    \ 

300 



250 

- 

I 

—': • 

'\  .A^ 

200 

• 

* 

^^^^^ 

^  ji^"'" 

ALL    COMt. 

a 
10DITIES    — f. 

^y^^^^y^ 

\»>^ 

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t 

j^ 

r-r 

'^J*"*" 

100  - 

• 

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# 

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, , 1,  .1,  ii , , 

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,,l,,l,,l,, 

,,,.,I,,,,, 

,,i,,i i,,i 

:,ImI„I,, 

1913  191^ 

I  S   OCPARTMErJT  OF  AGPICULTURC 


1916 


1917 


1916 


1919 


H579 — 35.      (Face.  p.  128.)      No.  1 


600 


550 


500 


'tSO 


WO 


350 


250 


200 


PRICE  PER  POUND  OF  STEEL  PLATES  AT  PITTSBURGH 

AND  PRICES  OF  All  Commodities 


INDEX  NUMBERS   (  1913  =  100  ) 


1913  \9]k 

OS  DCPABTMENT  OF  AGRICULTURE 


1915 


1916 


1917 


1918 


1919 


NEG  BUREAU  OF  AORtCULTUflAL  ECONOMICS 

DATA  FUKKISMCD  BY  BUREAU  Or  LABOR  STATISTICS 


1157!) — :jr..      (Face  p.  128.)      No.? 


MUNITIONS   INDUSTRY  129 

September  1,  1917. 

Can  you  give  me  any  idea  how  soon  your  Board  will  undertake  to  determine 
a  schedule  of  prices  for  steel  products? 

The  reason  I  ask  is  that  large  steel  companies  in  which  I  am  interested  should 
now,  without  delay,  place  contracts  for  coke  and  other  materials  entering  into 
the  manufacture  of  open-hearth  steel.  The  lowest  price  for  coke  today  is  $11 
per  ton.  It  would  be  possible  to  pay  $6  per  ton  and  exist,  but  a  more  reasonable 
price  for  this  product  would  be  $5  per  ton. 

At  one  of  the  plants  in  which  I  am  interested  intend  to  put  in  a  byproduct 
coke  plant  of  sufficient  capacity  to  take  care  of  their  needs,  and  such  a  plant 
would  cost  $3,750,000  which  by  shrinkage  in  values  that  are  to  be  expected  in 
the  next  2  or  3  years  this  plant  could  not  be  valued  at  more  than  $2,250,000,  or 
in  other  words  a  shrinkage  of  $1,500,000  in  the  value  of  this  plant  is  liable  to 
take  place  in  the  very  near  future  if  contracts  are  taken  at  present  prices.^ 

Another  indication  of  consumer's  resistance  is  to  be  found  in  the 
downward  movement  of  unfilled  orders  of  the  United  States  Steel  Co. 
The  following  figures  are  reported  in  the  Iron  Age:  * 

1917:  Tons 

April     12,  183,000 

May      --       11,887,000 

June 11,  383,000 

July-       -          10,844,000 

August 10,407,000 

September 9,833,000 

October 9,  010,  000 

Concurrent  with  the  decline  in  steel  prices,  the  Iron  Age  which  had 
previously  been  opposed  to  control  began  to  change  its  opinion  on  the 
value  of  price  regulation.  In  late  July  it  reported  that  the  steel 
industry  was  beginning  to  fear  the  effects  of  an  unregulated  market: 

*  *  *  the  Government  is  not  alone  in  wanting  regulation  of  steel  prices. 
Many  producers  and  buyers  of  steel  have  feared  the  consequence  of  the  ungov- 
erned  upward  movement  of  the  past  6  months.^ 

And  in  the  issue  of  August  30,  1917,  a  few  weeks  before  prices  were 
fixed,  the  magazine  frankly  advocated  price  stabilization. ^° 

The  relationship  between  price  decline  and  advocacy  of  price  fixing 
by  the  steel  industry  is  reported  as  follows  by  the  War  Industries 
Board: 

By  the  end  of  July  prices  began  to  show  a  sharp  drop,  and  the  more  conservative 
factions  of  the  steel  industry  saw  only  peril  ahead  unless  the  Governmentbrought 
stabilization  to  the  market.  By  late  September  virtually  the  whole  industry 
was  disposed  to  recommend  that  formal  regulation  begin. ^^ 

The  stabilizing  effects  of  control  on  the  price  movements  of  steel 
plates  and  steel  sheets  are  apparent  in  the  charts  of  their  index 
numbers  facing  page  128. 

Apparently,  the  governmental  authorities  were  as  concerned  with 
the  welfare  of  the  steel  industry  as  they  were  with  the  high  prices  that 
were  adversely  affecting  domestic  consumers  and  the  Allies.  The 
Federal  Trade  Commission  report  on  war-time  profits  and  costs  of 
the  steel  industry  states: 

Furthermore,  the  Government  realized  that  it  would  probably  be  necessary  to 
go  even  further  and  to  regulate  prices  for  the  industry  generally,  not  only  in  the 
interests  of  associated  belligerent  j^owers  and  don.estic  consumers  but  also  in  the 
interests  of  the  industry  itself.  It  was  evident  that  the  extravagant  prices  all 
ready  prevailing  would  go  much  higher;  hence,  to  prevent  chaotic  conditions  and 

'  Exhibit  No.  1737. 

8  Bernard  M.  Baruch,  Mar.  29,  1935  fga'ley  90  BBQ),  Iron  Age,  December  1917. 

»  W.  I.  B.  Price  Bulletin  No.  3,  p.  250. 

10  Ibid. 

11  Report  of  the  War  Industries  Board,  p.  115. 


130  MUNITIONS    INDUSTRY 

attendant  disturbances  in  the  industry,  it  appeared  necessary  to  stabilize  prices 
and  to  allocate  the  supply  equitably  between  the  Government  and  other  con- 
6umers.'2 

In  the  report  of  the  War  Industries  Board  it  is  stated  of  the  initiation 
of  steel  control  that: 

It  was  quite  as  much  the  object  of  the  Government  to  stabilize  the  market  at  a 
point  which  would  effect  a  maximum  of  production  as  to  scale  prices  down  from 
higher  levels. '^ 

Adoption  of  price  control  for  the  copper  industry  was  also  due  in 
large  measure  to  the  need  for  stabilization. 

The  New  York  Times  of  January  6,  1918,  wrote  in  its  review  of  the 
effects  of  the  Government  policy  upon  business  for  the  year  1917: 

The  past  year  was  prosperous  for  the  copper  miners  [producers].  They  kept 
their  mines  operating  to  capacity  and  enjoyed  the  highest  prices  for  the  metal 
which  have  ruled  for  50  years.  *  *  *  The  United  States  and  Great  Britain 
fixed  the  price  of  copper  at  2334  cents  a  pound  in  order  to  prevent  a  runaway 
market  This  measure  has  greatly  benefited  copper  miners.  Had  the  price  not 
been  fixed,  there  would  have  been  price  fluctuations,  which  would  have  led  to  irreg- 
ular demands  for  the  metal.  The  average  production  cost  before  the  war  was 
around  8  cents  a  pound.  Some  mines  produced  at  around  5}^  cents.  The  cost 
is  now  about  10  cents,  with  many  of  the  larger  mines  producing  at  7}2  cents. 

The  chart  of  electrolytic  copper  prices  facing  page  130  indicates 
both  the  extent  of  fluctuation  at  the  time  of  the  United  States  entry 
into  the  war  and  the  smooth  flow  of  prices  after  the  inception  of 
price  control. 

12  Ibid.  p.  18. 
u  Ibid.,  p.  120. 


CENT*_ 


3S 


70 


|0 


ELECTROLYTIC  COPPER  PRICES 
January  1813  to  December  1918 


TFt^A/VTmofiD 


Tft\Anff>\io>ih 


V 


ffnPini^/sio>Jl 


^T^MTT^oTi^^r^^r^rc^^^r^mr^son 


IS 


30 


1315  15  If  1915  1316  1317  1918 

^UI{C£-  QHRRVn  of-  Cif.  /..  Zli  } 
11579 — 35.      (Face  p.  130.) 


APPENDIX 


131 


132 


MUNITIONS    INDUSTRY 


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MUNITIONS   INDUSTRY 


133 


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134 


MUNITIONS   INDUSTRY 


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MUNITIONS    INDUSTRY  135 


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136 


munitions  industpa' 
Exhibit  No.  1756 


INCOME  AND  EXCESS-PROFITS  TAX  DATA  FOR  13  CORPORATIONS 

Aluminum  Co.  of  America,  "Exhibit  No.  1746." 

Bethlehem  Steel  Corporation  and  subsidiaries,  "Exhibit  No.  1740 A." 

Republic  Iron  &  Steel  Co.  and  subsidiaries,  "Exhibit  No.  1740D." 

Crucible  Steel  Co.  of  America  and  subsidiaries,  "Exhibit  No.  1740E." 

Lukens  Steel  Co.  and  subsidiaries,  "Exhibit  No.  1738." 

AUeghanv  Steel  Co.,  "Exhibit  No.  1740B." 

Otis  Steel  Co.,  "Exhibit  No.  174t)C." 

Calumet  &  Hecla  Co.  and  subsidiary,  "Exhibit  No.  1723." 

Inspiration  ConsoUdated  Copper  Co.,  "Exhibit  No.  1719." 

Kennecott  Copper  Corporation,  "Exhibit  No.  1716." 

Phelps  Dodge  Corporation  and  subsidiaries,  "Exhibit  No.  1721." 

Miami  Copper  Co.,  "Exhibit  No.  1720." 

Ahmeek  Mining  Co.,  "Exhibit  No.  1718." 

Union  Sulphur  Co.  and  subsidiary,  "Exhibit  No.  1755A." 

Freeport  Texas  Co.  and  subsidiaries,  "Exhibit  No.  1755B." 

Atolia  Mining  Co.,  "Exhibit  No.  1748." 

Wolf  Tongue  Mining  Co..  "Exhibit  No.  1748D." 

Primos  Chemical  Co.  and  subsidiaries,  "Exhibit  No.  1740E." 

Source:   Files  of  the  Bureau  of  Internal  Revenue. 

Note. — Tax  liability  includes  both  income  and  excess-profits  taxes.     Figures 
for  individual  companies  appear  in  exhibits  indicated. 

Net  taxable  income  as  per  corporations'  returns  and  as  determined  by  revenue  agents 


Year 


1917,  18  companies- 
1918, 17  companies ' 


Net  taxable  in- 
come as  per 
corporations' 
returns 


$229, 189, 613.  58 
136, 937, 770.  39 


Net  taxable  in- 
come as  deter- 
mined by  revenue 
agents 


$290, 212, 129. 81 
142, 908, 612.  64 


Percent  of 
increase 


24.5 
4.2 


>  Companies  listed  except  Miami  Copper  Co. 
Net  taxable  income  as  determined  by  revenue  agents  and  as  finally  determined 


Year 


1917,  18  companies. 

1918.  17  companies  > 


Ket  taxable  in- 
come as  deter- 
mined by  revenue 

aeents 


$290,  212, 129. 81 
142, 90S,  612. 64 


Net  taxable  in- 
come finally  de- 
termined by 
Bureau 


$263, 339,  558. 67 
134, 151, 948.  53 


Percent  of 
decrease 


9.2 
6.1 


1  Companies  listed  except  Miami  Copper  Co. 

Net  taxable  income  as  per  corporations'  returns  and  as  finally  determined 


Year 


Net  taxable  in- 
come as  per 
corporations' 
returns 


1917,  18  companies. 

1918,  17  companies  ■ 


$229, 189,  613.  58 
136, 937.  770.  39 


Net  taxable  in- 
come as  finally 
determined  by 
Bureau 


$263,  339,  588.  67 
134, 151, 948.  53 


Percent 
of  in- 
crease 
(+)or 

decrea.se 
(-) 


-+-14. 9 
-2.0 


1  Companies  listed  except  Miami  Copper  Co. 


MUNITIONS    INDUSTKY 


137 


Invested  capital  as  per  corporations'  returns  and  as  determined  by  revenue  agents 


Year 

Invested  capital 
as  per  corpora- 
tions' returns 

Invested  capital 

as  determined  by 

revenue  agents 

Percent 
of  de- 
crease 

$775,  799,  312.  08 
878,  920, 120.  03 

$547,  642,  452.  81 
746,  789, 162.  34 

29.4 

1918,  14  companies  2     .           .     . 

15.0 

1  Companies  listed  except  Allegheny  Steel  Co.,  Atolia  Mining  Co.,  and  Freeport  Texas  Co. 

2  Companies  listed  except  Allegheny  Steel  Co.,  Miami  Copper  Co.,  Union  Sulphur  Co.,  and  Atolia 
Mining  Co. 

Invested  capital  as  finally  determined  and  as  determined  by  revenue  agents 


Year 


1917,  15  companies  '. 

1918,  14  companies  2. 


Invested  capital 

as  determined  by 

revenue  agents 


$547,  642, 452.  81 
746,  789, 162.  34 


Invested  capital 
as  finally  deter- 
mined by  Bureau 


$717,  284,  142.  24 
770,  212,  390.  36 


Percent 
of  in- 
crease 


30.8 
3.1 


'  All  companies  listed  except  Allegheny  Steel  Co.,  Freeport  Texas  Co.,  and  Atolia  Mining  Co. 
2  All  companies  listed  except  Allegheny  Steel  Co.,  Miami  Copper  Co.,  Union  Sulphur  oC,  and  Atolia 
Mining  Co. 

Invested  capital  as  per  corporations'  returns  and  as  finally  determined 


Year 


Invested  capital 
as  per  corpora- 
tions' returns 


Invested  capital 

as  finally 

determined  by 

Bureau 


Percent 

of 
decrease 


1917,  15  companies  i. 

1918,  14  companies  2. 


$/75,  799,  312.  08 
878,  920, 120.  03 


$717,  284, 142.  24 
770,  212,  390.  36 


7.5 
12.4 


•  Companies  listed  except  Allegheny  Steel  Co.,  Atolia  Mining  Co.,  and  Freeport  Texas  Co. 
'  Companies  listed  except  Allegheny  Steel  Co.,  Miami  Copper  Co.,  Union  Sulphur  Co.,  and  Atolia 
Mining  Co. 

Tax  liability  as  per  corporations'  returns  and  as  determined  by  revenue  agents 


Year 


Tax  liability  as 

per  corporations' 

returns 


Tax  liability  as 
determined  by 
revenue  agents 


Percent 

of 
increase 


1917,  17  companies '. 

1918,  17  companies  '. 


$49,  927, 931. 15 
45,  993, 839.  67 


$89, 882, 631.  86 
59, 580, 309.  46 


79.9 
29.5 


Companies  listed  except  Miami  Copper  Co. 

Tax  liability  as  determined  by  revenue  agents  and  as  finally  determined 


Year 


Tax  liability  as 
determined  by 
revenue  agents 


Tax  liability  as 
finally  deter- 
mined by  Bureau 


Percenter 
decrease 


1917,  17  companies  L 

1918,  17  companies  '. 


$89,882,631.86 
59, 580,  309. 46 


$66, 028, 958.  07 
46,841,914.37 


26.5 
21.2 


'  AU  companies  listed  except  Miami  Copper  Co. 


138  MUNITIONS    INDUSTRY 

Tax  liability  as  per  corporations'  returns  and  as  finally  determined 


Year 


Tax  liability  as 

per  corporations' 

returns 


Tax  liability  as 
finally  deter- 
mined by  Bureau 


Percent  of 
increase 


1917, 17  companies  ' . 
1918, 17  companies  ' . 


$49, 927, 931. 15 
45, 993, 839.  67 


$66, 028, 958. 07 
46,841,914.37 


32.2 
1.8 


1  Companies  listed  except  Miami  Copper  Co. 

Proportion  of  net  taxable  income  to  invested  capital,  both  as  determined  by  revenue 

agents 


Year 


Invested  capital 

as  determined  by 

revenue  agents 


Net  taxable  in- 
come as  deter- 
mined by  reve- 
nue agents 


Percent 


1917, 15  companies  1 $547,642,452.81 

1918,  14  companies  2 - 746,789,162.34 


$276, 560, 317. 07 
126, 923, 550.  55 


50.5 
17.1 


1  Companies  listed  except  Allegheny  Steel  Co.,  Atolia  Mining  Co.,  and  Freeport  Texas  Co. 

2  Companies  listed  except  Allegheny  Steel  Co.,  Miami  Copper  Co.,  Union  Sulphur  Co.,  and  Atolia 
Mining  Co. 

Proportion  of  net  taxable  income  as  determined  by  revenue  agents  to  invested  capital  as 

finally  determined 


Year 


Invested  capital 
as  finally  deter- 
mined by  Bureau 


Net  taxable  in- 
come as  deter- 
mined by  reve- 
nue agents 


Percent 


1917, 15  companies  '- 
1918,  14  companies '. 


$717, 284, 142. 24 
770, 212, 390. 36 


$276, 560, 317. 07 
126, 923,  550.  55 


38.4 
16.5 


1  Companies  listed  except  Allegheny  Steel  Co.,  Atolia  Mining  Co.,  and  Freeport  Texas  Co. 

2  Companies  listed  except  Allegheny  Steel  Co.,  Miami  Copper  Co.,  Union  Sulphur  Co.,  and  Atolia 
Mining  Co. 

Proportion  of  net  taxable  income  to  invested  capital,  both  as  finally  determined 


Year 


Invested  capital 
as  finally  de- 
termined by 
Bureau 


Net  taxable  in- 
come as  finally 
determined  by 
Bureau 


Percent 


1917,  15  companies  '_ 

1918,  14  companies  '. 


$717, 284, 142.  24 
770,  212,  390.  36 


$250, 048, 916.  08 
119,844,375.76 


34.8 
15.6 


1  Companies  listed  except  Allegheny  Steel  Co.,  Atolia  Mining  Co.,  and  Freeport  Texas  Co. 

2  Companies  listed  except  Allegheny  Steel  Co.,  Miami  Copper  Co.,  Union  Sulphur  Co.,  and  Atolia 
Mining  Co. 

Proportion  of  net  income  after  taxes  ^  to  invested  capital,  with  both  income  and  capital 
as  determined  by  revenue  agents 


Invested  capital 

as  determined 

by  revenue 

agents 


Net  taxable  in- 
come as  deter- 
mined by  reve- 
nue aeents,  less 
taxes 


Percent 


1917,  15  companies  ' 

1918,  14  companies  • 


$547,  642, 452. 81 
746,  789, 162. 34 


$215, 467, 139.  61 
88, 136,  275.  47 


39.3 

11.8 


1  The  final  determination  by  the  Bureau  of  tax  liability  has  been  used  as  representing  the  taxes  paid. 

2  Companies  listed  except  Allegheny  Steel  Co.,  Atolia  Mining  Co.,  and  Freeport  Texas  Co. 

3  Companies  listed  except  Allegheny  Steel  Co.,  Miami  Copper  Co.,  Union  Sulphur  Co.,   and  Atolia 
Mining  Co. 


MUNITIONS    INDUSTRY 


139 


Proportion  of  net  income  after  taxes^  to  invested  capital  with   both   income  and 
capital  as  finally  determined 


Year 


Invested  capital 
as  finally  deter- 
mined by  Bureau 


Net  income  after 

taxes  as  finally 

determined  by 

Bureau 


Percent 


1917, 15  companies ». 
1918, 14  companies  s. 


$717, 284, 142. 24 
770, 212, 390. 36 


$188, 955, 738. 62 
81, 057, 100. 68 


26.3 
10.5 


'  The  final  determination  by  the  Bureau  of  tax  liability  has  been  used  as  representing  the  taxes  paid. 
>  Companies  listed  except  Allegheny  Steel  Co.,  Atolia  Mining  Co.,  and  Freeport  Texas  Co. 
»  Companies  listed  except  Allegheny  Steel  Co.,  Miami  Copper  Co.,  Union  Sulphur  Co.,  and  Atolia 
Mining  Co. 

Proportion  of  tax  liability  as  finally  determined  to  net  taxable,  income  as  determined 

by  revenue  agents 


Year 


1917, 17  companies '. 
1918, 17  companies '. 


Net  taxable  In- 
come as  deter- 
mined by  revenue 
agents 


$290, 212, 129. 81 
142, 908, 612. 64 


Tax  liability  as 
finally  deter- 
mined by  Bureau 


$66, 028, 958. 07 
46, 841, 914. 37 


Percent 


22.8 
32.8 


J  All  companies  listed  except  Miami  Copper  Co. 

Proportion  of  tax  liability  to  net  taxable  income,  both  as  finally  determined 


Year 


Net  taxable  in- 
come as  finally 
determined  by 
Bureau 


Tax  liability  as 
finally  deter- 
mined by 
Bureau 


Percent 


1917, 18  companies.. 
1918, 17  companies  i. 


$263, 339, 588. 67 
134, 151, 948. 53 


$66, 028, 958. 07 
46, 841, 914. 37 


25.1 
34.9 


1  All  companies  listed  except  Miami  Copper  Co. 


Treasury  Department, 

Washington,  January  28,  1935. 
Hon.  Gerald  P.  Nye, 

Chairman  Special  Committee  Investigating  the  Munitions  Industry, 
United  States  Senate. 

My  Dear  Mr.  Chairman:  Reference  is  made  to  the  letter  of  the  Special 
Committee  of  the  United  States  Senate  Investigating  the  Munitions  Industry 
dated  December  12,  1934,  requesting  information  as  to  (1)  the  complexity  from 
an  engineering  and  legal  standpoint  of  the  matters  involved  in  the  determination 
of  value;  (2)  the  amount  of  time  it  would  take  to  make  an  adequate  investigation 
of  an  average-sized  industrial  plant;  and  (3)  specific  examples  of  different  valu- 
ations placed  on  property  by  experts  appearing  for  the  Government,  experts 
appearing  for  the  taxpayer  and  the  court,  and  inquiring  whether  your  committee 
could  be  supplied  with  information  as  to  the  personnel  which  would  be  required 
to  conduct  an  adequate  investigation  into  the  problem  of  valuation. 

The  legal  difficulty  and  uncertainty  in  the  determination  of  value  of  property 
not  subject  to  frequent  sales,  and  as  to  which  market  quotations  are  not  pub- 
lished daily,  arises  because  it  is  so  largely  to  be  determined  from  factual  and  opin- 
ion evidence,  none  of  which  is  legally  conclusive.  Such  evidence  is  the  best 
available.  Upon  such  evidence  the  value  is  determined  by  a  judge  or  jury,  in 
certain  instances  inexperienced  in  valuation  procedure  and  with  inadequate 
knowledge  of  considerations  governing  market  value.  The  weight  to  be  given 
to  the  evidence  is  entirely  within  their  discretion,  and  short  of  the  adoption  of  a 
fundamentally  unsound  principle  or  an  erroneous  theory  by  the  court  in  its 
instructions,  it  is  impossible  to  secure  a  reversal  of  their  finding  if  there  is  any 


140  MUNITIONS    INDUSTRY 

evidence  in  support  thereof  in  the  record.     It  is  a  rare  case  where  some  evidence 
is  not  admitted  which  will  support  a  most  unsound  finding  of  value. 

Market  value  has  been  defined  as  the  sum  that  in  all  probability  will  result 
from  fair  negotiations  of  an  owner  willing  to  sell  and  a  purchaser  willing  to  buy. 
Brooks-ScarUon  Corporation  v.  United  States  (265  U.  S.,  106  to  123;  44  Sup.  Ct. 
471).  The  fundamental  difficulty  in  establishing  the  market  value  of  industrial 
plants  arises  because  as  a  general  rule  no  two  of  such  plants  are  alike,  and  a  sale 
of  the  property  in  question  rarely  occurs  at  or  about  the  date  for  which  the 
market  value  is  to  be  determined.  Even  in  the  rare  cases  where  a  sale  of  the 
property  has  occurred  that  is  practically  contemporaneous  with  the  date  for 
which  the  value  is  to  be  determined,  the  conclusiveness  of  such  evidence  is  fre- 
quently impaired  by  the  introduction  of  evidence  attacking  the  fairness  of  the 
sale,  alleging  misrepresentation  of  fact,  duress,  or  force,  as  factors  in  the  trans- 
action. As  a  result,  in  the  case  of  the  valuation  of  the  great  majority  of  indus- 
trial plants,  evidence  of  value,  other  than  sales  of  the  property  itself,  must  be 
resorted  to. 

"This  value  of  propertj^  results  from  the  use  to  which  it  is  put  and  varies  with 
the  profitableness  of  that  use,  present  and  prospective,  actual  and  anticipated. 
There  is  no  pecuniary  value  outside  of  that  which  results  from  such  use.  The 
amount  and  profitable  character  of  such  use  determine  the  value."  Cleveland, 
Cincinnati,  Chicago  &  St.  Louis  Railway  Co.,  v.  Backus  (154  U.  S.,  439,  447). 

A  determination  of  value  based  on  estimates  of  present  and  future  profits  and 
an  appraisal  of  the  value  of  such  profits,  usually  designated  as  an  analytical 
appraisal,  while  theoi-etically  sound  and  in  many  cases  the  only  available  method, 
opens  a  wide  field  for  differences  of  opinion.  These  differences  arise  as  to  inter- 
pretation of  facts  existing  at  the  date  of  valuation,  as  to  what  reasonable  prog- 
nostications as  to  the  future  should  be  based  on  the  existing  facts,  and  finally  as 
to  what  the  market  reasonably  indicates  as  the  proper  factor  to  be  applied  to 
the  prospective  earnings  to  arrive  at  value,  that  is,  the  rate  of  capitalization  at 
which  the  earnings  are  to  be  valued. 

The  elements  essential  to  an  analytical  appraisal  of  market  value  are  primarily 
estimates  in  the  light  of  facts  known  at  the  date  of  valuation.  Estimates  must 
be  made  of  future  earnings,  of  the  time  when  such  earnings  may  be  realized,  and 
of  the  risk  involved  in  the  purchase  of  the  property.  When  these  elements  have 
been  determined,  tlie  conclusion  as  to  value  is  arrived  at  b}'  the  application  of  a 
sound  judgment  based  on  knowledge  of  market  transactions  in  measurably  com- 
parable property  at  the  nearest  available  time  to  the  date  of  valuation.  The 
value  sought  is  the  price  which  general  buyers  and  sellers  should  reasonably  agree 
upon. 

As  applied  to  the  appraisal  of  the  going-concern  value  of  an  industrial  plant, 
the  first  investigation  ordinarily  would  be  an  audit  of  the  books  of  the  operating 
company  to  ascertain  the  operating  costs,  selling  price  of  the  product,  operating 
profit,  overhead,  general  expenses,  and  depreciation,  and  an  analysis  of  the  capital 
accounts  and  a  descriptive  analysis  of  the  asset  and  liability  accounts. 

There  is  considerable  room  for  differences  of  opinion  as  to  what  should  be  in- 
cluded in  operating  costs  and  in  capital  account,  and  as  t  j  whether  or  not  the  past 
operating  costs  are  not  unduly  high  or  low  on  account  of  extraordinary  circum- 
stances; i.  e.,  frequently  claims  are  made  that  the  plant  was  in  the  development 
stage  or  that  repairs  and  replacements,  although  correctly  charged  will  not  be 
representative  in  determining  future  costs,  or  that  labor  was  untrained  or  ineffi- 
cient, or  that  exorbitant  or  inadequate  salaries  were  charged  by  interested  stock- 
holders or  owners.  What  adjustments  should  be  made  under  the  circumstances 
are  entirely  matters  of  opinion.  Similar  questior.s  may  arise  as  to  many  "non- 
recurrent" expense  items. 

Again,  questions  arise  as  to  whether  or  not  the  plant  was  running  at  a  represen- 
tative or  normal  capacity  during  the  period  prior  to  the  valuation  date,  consider- 
ing a  reasonable  expectancy  of  future  use  at  the  date  of  valuation,  and  as  to  the 
effect  on  costs  of  use  of  the  plant  at  "normal"  capacitj'.  Also,  where  the  results 
of  operation  are  erratic,  differences  of  opinion  arise  as  to  what  operating  period 
should  be  taken  as  representative.  The  foregoing  may  be  taken  as  illustrative, 
but  not  a  complete  list,  of  questions  in  which  differences  of  opinion  may  arise  in 
regard  to  operating  costs. 

As  to  the  future  selling  price  of  the  product,  admittedly  to  be  determined  in 
the  light  of  existing  conditions,  wide  differences  of  opinion  frequently  arise. 
Where  there  is  no  established  price  for  the  product  at  the  date  of  valuation,  i.  e., 
the  product  may  be  disposed  of  through  long-term  contracts  or  on  a  cost  or  cost- 
plus  basis,  the  difficulty  and  consequently  the  differences  of  opinion  in  the  esti- 
mate of  present  and  prospective  market  price  maj-  be  greatlj'  increased. 


MUNITIONS   INDUSTEY  141 

Having  proceeded  to  the  point  where  the  costs  of  production  and  marliet  prices 
are  determined,  the  operating  profit  is  a  matter  of  subtraction.  Ordinarily,  the 
percentage  of  the  seUing  price — that  is,  operating  profit  under  fluctuating  costs  and 
selling  prices — is  much  closer  to  a  constant  than  the  spread  between  cost  and  selling 
price,  and  a  recognition  of  this  fact  permits  the  fixing  of  the  margin  of  profit 
within  reasonable  limits.  The  application  of  this  method  of  determining  the 
margin  of  operating  profit  will  generally  be  resisted  by  proponents  of  a  high  value, 
when,  by  the  taking  of  costs  in  years  of  low  prices  against  a  higher  expected  future 
price,  the  estimated  margin  of  operating  profit  is  greater.  Consequentl}^  detailed 
analyses  of  such  figures  are  necessary  to  demonstrate  that  in  the  particular  case 
under  consideration  costs  bear  a  necessary  relation  to  selling  price,  that  is,  that 
an  increased  selling  price  is  accompanied  by  increased  costs  and  a  decreased  price 
is  accompanied  by  decreased  costs.  On  the  questions  of  overhead  and  general 
expenses  and  depreciation,  the  same  difi"erences  of  opinion  as  in  the  case  of  the 
direct  costs  frequently  arise,  that  is,  as  to  whether  or  not  extraordinary  circum- 
stances of  a  nonrecurrent  nature  have  unduly  affected  such  costs  during  the  period 
preceding  the  date  of  valuation.  In  addition,  if  the  value  of  one  plant  among 
several  or  of  a  part  of  plant  is  in  question,  the  proper  method  of  allocating  all 
indirect  costs  further  complicates  the  determination  of  value.  The  difficulty  of 
determining  depreciation  and  obsolescence,  and  the  allocation  of  such  charges, 
give  rise  to  the  same  differences  of  opinion  already  mentioned  with  respect  to 
direct  and  indirect  costs  of  production. 

The  audit  and  descriptive  analysis  of  the  asset  and  liability  accounts  are 
essential  in  an  analytical  appraisal  for  the  purposes  of  checking  depreciation  and 
plant  accounts  and  of  determining  the  capital,  other  than  plant  investment, 
necessary  to  the  conduct  of  the  business.  When  this  factor  is  determined,  a 
portion  of  the  profits  is  allocated  to  such  capital. 

The  determination  of  each  of  the  foregoing  factors  gives  rise  to  differences  of 
opinion.  The  amount  of  capital  actually  emploj'ed  in  the  case  of  a  single  plant 
varies  considerably  from  time  to  time,  and  the  amount  that  should  normally  be 
employed  is  essentially  a  naatter  of  opinion.  The  question  of  the  market  rate 
of  return  on  the  capital,  other  than  plant,  is  again  a  matter  of  opinion.  There 
remains  after  the  disposal  of  the  foregoing  determinations  the  ultimate  question 
as  to  the  rate  at  wliich  earnings  attributable  to  the  plant  should  be  capitalized, 
another  matter  of  opinion  based  on  the  judgment  of  experts. 

Estimates  of  expected  profits  are  not  infrequently  complicated  by  the  following 
circumstances:  The  product  manufactured  or  the  machines  used  in  the  manu- 
facturing of  the  product  are  covered  by  patents;  the  plant  operates  under  patent 
licenses;  the  product  is  manufactured  or  disposed  of  under  terminable  life  con- 
tracts; the  manufacturing  is  carried  on  in  leased  premises  at  rentals  other  than 
the  present  or  prospective  fair  rental  value;  the  plant  is  operating  for  others  under 
contract  with  results  which  are  more  favorable  or  less  favorable  than  might  be 
obtained  under  terms  of  a  contract  which  might  be  negotiated  under  present  or 
prospective  conditions.  These  factors  enhance  or  depress  present  earnings,  and 
future  earnings  must  be  adjusted  to  allow  for  the  discontinuance  of  the  effect  of 
such  factors.  The  amount  of  such  adjustments  is  at  best  a  matter  of  judgment 
and  opinion,  and  on  account  of  the  highly  technical  nature  of  the  subject  matter, 
particularly  in  circumstances  involving  the  use  of  patents,  is  inherently  difficult 
from  the  standpoint  of  administrative  and  judicial  determination. 

The  question  of  what  portion  of  the  earnings  are  attributable  to  patent  pro- 
tection and  what  portion  to  the  business  of  manufacturing  may  be  cited  as  one 
example  of  these  difficulties. 

In  the  case  of  the  valuation  of  one  plant  among  several  operated  bj-  a  business 
concern,  the  number  of  determinations  mentioned  above  are  multiplied  due  to 
the  necessity  of  allocation. 

By  numerous  decisions  of  the  Supreme  Court  of  the  United  States  it  is  firmly 
established  that  the  cost  of  reproduction  new  less  depreciation  constitutes  evi- 
dence properly  to  be  considered  in  the  ascertainment  of  value.  Standard  Oil  Co. 
of  New  Jersey  v.  Southern  Pacific  Co.  et  al.  (268  U.  S.  146,  45  Sup.  Ct.  465). 

In  the  same  case  the  court  points  out,  however,  that  such  evidence  is  not  the 
measure  or  sole  guide,  and  states: 

"The  ascertainment  of  value  is  not  controlled  by  artificial  rules.  It  is  not  a 
matter  of  formulas,  but  there  must  be  a  reasonable  judgment  having  its  basis  in 
a  proper  consideration  of  all  relevant  facts." 

The  estimation  of  cost  of  reproduction  new  requires  a  very  detailed  and  ex- 
pensive inventory  of  each  and  every  item  comprising  the  plant.     The  current 

11579—35 10 


142  MUNITIONS    INDUSTRY 

costs  of  all  of  these  items  must  then  be  estimated.  Such  estimates  include  pres- 
ent costs  of  the  land  occupied  by  the  plant,  grading,  excavation,  foundations, 
building  materials  of  every  description,  including  freight,  labor  and  superintend- 
ence during  construction,  cost  of  machinery  including  freight  and  installation, 
office  and  general  overhead  expense  during  the  construction  period,  engineering 
and  architectural  fees,  interest  on  capital  during  the  period  required  for  plant 
erection,  and  frequently  such  things  as  contractors'  profits,  overhead  and  gen- 
eral expenses,  and/or  cost  of  specialized  technical  supervision.  With  such  listing 
of  items  and  with  such  estimates  of  current  costs  and  prices,  the  cost  of  repro- 
duction new  is  computed.  The  depreciation  to  be  deducted  must  then  be  esti- 
mated. 

This  type  of  appraisals  are  usually  made  by  long  established  engineering  firms 
who  have  maintained  files  containing  price  lists  and  descriptive  matter  from  all 
available  manufacturers  of  items  making  up  the  plant  and  equipment  for  all 
types  of  industrial  concerns.  Such  estimates  of  depreciation  are  usually  the  per- 
sonal opinions  of  the  men  taking  the  detailed  inventory,  usually  the  minor 
employees  of  the  appraiser.  Such  a  man  looks  at  a  structure  or  a  machine,  or  at 
its  important  parts,  and  says  that  is  a  certain  percentage  of  as  good  as  new  insofar 
as  wear  and  tear  and  physical  decay  are  concerned.  The  estimation  of  obsoles- 
cence is  almost  never  attempted.  The  result  frequently  is  that  the  appraisal 
includes  estimated  costs  to  reproduce  such  things  as  masonry  buildings  which  are 
obsolete  and  would  be  more  expensive  to  reproduce  than  would  a  strictly  modern 
substitute  structure.  The  appraisal  may  include  machines  which  are  entirely 
obsolete  because  of  costs  of  operation  greatly  in  excess  of  those  of  modern 
machines,  yet  such  machines  may  exhibit  little  or  no  physical  deterioration  and  be 
included  at  practically  100  percent  of  cost  of  reproduction  new.  The  cost  of 
reproduction  new,  less  depreciation  representing  only  physical  deterioration,  is 
the  so-called  "sound  value"  of  this  type  of  appraisal.  Such  appraisals,  especially 
if  made  at  about  the  time  of  valuation,  are  extremely  difficult  to  meet  or  check 
retrospectively  unless  by  means  of  their  own  inherent  weakness  or  through  other 
evidence  of  value.  G.  C.  Thompson  Pottery  Company  v.  Routzahn  (25  F.  (2d) 
897).  On  account  of  their  lack  of  conclusiveness,  the  amount  of  detailed  work 
required,  the  remoteness  of  the  date  of  valuation,  and  the  intervening  changes 
in  plants  involved,  it  has  been  found  impractical  in  verifying  such  appraisals  in 
the  Bureau  of  Internal  Revenue,  to  do  more  than  require  that  such  appraisal 
show  the  date  of  acquisition  and  original  cost,  check  reproduction  costs  with  the 
best  index  factors  obtainable  to  determine  the  difference  between  original  cost  and 
reproduction  cost  new,  and  make  such  allowance  for  depreciation  and  obsolescence 
as  appears  to  be  justified  by  the  circumstances  of  the  particular  case. 

In  the  trial  of  valuation  questions  the  doUar  and  cents  figure  shown  as  reproduc- 
tion cost  new,  less  depreciation  and  obsolescence,  even  under  proper  instructions 
because  of  its  simplicity,  may  be  given  undue  weight  as  evidence  of  market  value 
rather  than  proper  consideration  with  the  other  evidence  in  the  case. 

In  the  case  of  plants  under  corporate  ownership,  the  sale  price  of  shares  of 
stock  in  the  market  may  be  admissible  as  evidence  of  the  value  of  the  assets. 
However,  the  shares  of  stock  and  the  net  assets  of  a  corporation  are  entirely 
different  things,  and  the  value  of  one  bears  no  fixed  nor  necessary  relation  to  the 
value  of  the  other.  Ray  Consolidated  Copper  Co.  v.  United  States  (268  U.  S.  373) . 
This  type  of  evidence  is  therefore  never  conclusive.  Unless  the  value  in  issue  is 
the  entire  going-concern  value  of  the  corporation,  such  evidence  is  not  a  measure 
of  the  value  of  the  property  {Pullman  Palace  Car  Co.  v.  Central  Transportation  Co. 
(171  U.  S.  138)),  although  it  may  be  a  part  of  the  foundation  for  expert  opinion 
on  value  and  a  fact  to  be  considered  by  the  judge  or  jury  with  other  evidence  in 
reaching  their  finding  of  value. 

Value  in  the  case  of  industrial  plants  generally  must  be  a  conclusion  based  on 
facts  and  the  expert  opinions  contributed  from  four  distinct  technical  fields,  that 
is,  accounting,  engineering  (construction  and  operating),  legal,  and  financial.  The 
conclusion  requires  a  correlation  of  these  contributions  since  the  factors  con- 
tributed from  each  source  are  interdependent  and  modify  the  effects  of  contribu- 
tions from  the  others. 

The  professions  or  avocations  from  which  the  contributions  are  made  are 
technical  and  have  developed  experience,  language,  and  methods  of  procedure 
peculiar  to  themselves.  As  a  result,  the  presentation  of  evidence  in  valuation 
cases,  in  such  a  manner  that  technical  complexities  are  minimized  and  the  tech- 
nical conclusions  appeal  to  the  common  sense  of  parties  having  to  deal  with  the 
determination  of  value,  is  a  difficult  matter  and  requires  intensive  preparation. 
Technicians  are  generally  prideful  or  unconscious  of  the  technical  manner  in 


MUNITIONS    INDUSTRY  143 

which  their  contributions  are  made,  and  reluctant  or  unable  to  reduce  their 
contributions  of  fact  or  reason  to  simple  fundamentals,  intelligible  to  technicians 
in  other  fields  and  to  the  nontechnical  man. 

A  further  difficulty  in  the  administration  and  judicial  determination  of  market 
value  is  due  to  a  loose  popular  conception  or  definition  of  value.  This  difficulty 
attends  the  whole  process  of  determining  value.  It  particularly  affects  expert 
opinion.  Some  fallacy,  or  a  combination  of  fallacies,  may  be  interwoven  in  or 
form  the  basis  of  the  opinion.  In  many  cases  the  incompetency  of  such  opinion 
is  not  or  cannot  be  shown  on  direct  or  cross  examination  with  the  result  that  such 
opinions  may  support  a  most  unsound  finding  of  value. 

A  few  examples  of  persistent  fallacies  of  this  nature  which  have  arisen  in  such  a 
manner  as  to  permit  their  rejection  by  the  courts  are: 

(1)  The  theory  that  more  or  less  uncertain  estimates  involved  in  the  determina- 
tion of  value  at  the  date  of  valuation  may  be  corrected  by  the  later  ascertained 
facts.     Ithaca  Trust  Co.  v.  United  States  (279  U.  S.  151). 

(2)  That  the  value  of  property  is  measured  by  the  subsequently  ascertained 
ultimate  return  therefrom,  or  that  latent  occult  intrinsic  value  controls  rather 
than  the  considerations  that  affect  market  value  and  have  their  influence  upon 
men  of  affairs.  Stratton's  Independence,  Limited,  v.  F.  W.  Howbert,  Collector 
(231  U.  S.  399).     Reinecke  v.  Spalding  (280  U.  S.  227). 

(3)  That  value  is  to  be  determined  under  an  assuinption  of  nonexistent  con- 
ditions, or  on  some  speculative  assumption  as  to  what  the  value  would  have  been 
if  something  which  did  not  occur  had  occurred.     National  Bank  of  Commerce  v. 

■City  of  New  Bedford  (29  N.  E.  532).  Bingham's  Administrator  et  al.  v.  Common- 
wealth (244  S.  W.  781).     Rice  v.  Eisner  (C.  C.  A.  2,  16  F.  (2d)  358). 

(4)  That  value  is  to  be  determined  by  some  morally  just  or  normal  standard 
divorced  from  the  conditions  existing  at  the  date  of  valuation  and  the  standard 
established  by  the  market  which  is  the  gage  of  the  considerations  which  influence 
general  buvers  or  sellers,  and  of  the  intensitv  of  the  social  desire  for  the  property 
at  the  time.  Ithaca  Trust  Co.  v.  United  States  (279  U.  S.  151).  Boyd  v.  Wiley 
(124  U.  S.  105).  United  States  v.  New  River  Collieries  Co.  (262  U.  S.  341-345). 
719  Fifth  Avenue  v.  United  States  (5  F.  Supp.  909).  United  States  v.  Cole  et  al. 
(T.  D.  4165,  C.  B.  VII-1268,  C.  C.  H.  1927,  p.  7720). 

(5)  Misconceptions  of  the  nature  and  character  of  the  property  to  be  valued. 
Reinecke  v.  Spalding  (280  U.  S.  227).  Kaufmann  &  Bauer  Co.  v.  Heiner  (34  F. 
(2d)  698). 

(6)  A  failure  to  properly  weigh  the  reasonably  assured  and  the  remote  or  more 
or  less  speculative  elements  which  contribute  to  value.  Johnson  v.  United  States 
(44  F.  (2d)  244,  70  Ct.  CI.  534).  719  Fifth  Avenue  v.  United  States  (5  F.  Supp. 
909).  Driscoll  et  al.  v.  Inhabitants  of  Northbridge  (210  Mass.  151,  96  N.  E.  59). 
United  States  v.  Cole  et  al.  (T.  D.  4165,  C.  B.  VII-1268,  C.  C.  H.  1927,  p.  7720). 
Commissioner  v.  Swenson  (C.  C.  A.  5,  45  F.  (2d)  61). 

(7)  Attributing  value  to  a  particular  property  based  on  earnings  derived  in 
great  part  from  many  other  elements  or  properties  contributing  to  the  produc- 
tion of  such  earnings.  Perfect  Window  Regulator  Co.  v.  United  States  (66  Ct.  CI. 
.147).     Keystone  Wood  Products  Co.  v.  Commissioner  (19  B.  T._  A.  1116). 

Another  further  weakness  from  a  governmental  standpoint  in  establishing 
market  value  is  due  not  infrequently  to  the  unwillingness  of  experts  in  specialized 
lines  to  accept  employment  as  opinion  witnesses  for  the  Government.  This  is 
largely  due  to  the  fact  that  in  many  cases  there  is  a  common  interest  extending 
throughout  all  industries  under  a  given  set  of  circumstances  to  secure  the  advan- 
tage of  nigh  or  low  values.  Competent  witnesses  are  either  directly  connected 
with  or  dependent  on  the  industry  for  their  regular  income.  Witnesses  of  the 
highest  qualifications  are,  therefore,  frequently  unable  or  unwilling  to  accept 
governmental  employment. 

The  Bureau  of  Internal  Revenue  has  had  to  determine  the  value  of  physical 
plants  as  distinguished  from  going-concern  value  at  March  1,  1913,  in  the  cases 
of  taxpayers  owning  plants  on,  and  operating  them  after,  that  date.  Such  de- 
terminations were  made  for  the  purpose  of  establisning  a  base  for  depreciation 
allowances.  In  the  great  majority  of  such  cases  the  taxpayers  and  the  Bureau 
have  been  able  to  agree  upon  a  value  equal  to  cost  less  sustained  depreciation. 
DiflBculty  in  these  cases  was  confined  generally  to  questions  of  correct  accounting. 
The  stable  nature  of  such  property  and  the  relatively  stable  price  level  for  a 
considerable  period  prior  to  and  at  March  1,  1913,  eliminated,  to  a  large  extent, 
questions  of  appreciation  in  value  and  were  in  a  large  measure  responsible  for  the 
.  comparative  ease  with  which  such  questions  were  settled. 


144  MUNITIONS    INDUSTRY 

On  account  of  the  instability  of  the  market  standards,  valuation  of  physical 
property  in  periods  of  dspresiion  or  unusual  prosperity  furnishes  the  opportunity 
to  present  opinion  evidence  out  of  line  with  the  general  market  conditions  existing 
at  the  time,  and  in  line  with  the  exigencies  of  the  case  and  the  idiosyncracies  of  the 
witnesses.  The  uncertaint}'  of  litigation  involving  value  questions  to  be  deter- 
mined in  such  periods  is  thereby  increased. 

On  account  of  their  peculiar  and  individual  characteristics  in  every  case  and 
the  confusion  of  their  qualitative  characteristics  as  distinguished  from  their 
quantitative  contribution  to  value,  intangible  elements  which  may  contribute  to 
the  value  of  industrial  property  generally,  such  as  goodwill,  trade  marks,  trade 
brands,  etc.,  are  the  frequent  sources  of  irreconcilable  differences  of  opinion  and 
litigation.  However,  in  determining  going-concern  value  as  a  whole,  available 
market  records  of  prices  of  securities  of  comparable  corporations  furnish  a  yard- 
stick or  market  standard  which  permits,  but  does  not  insure,  some  check  on  the 
reasonableness  of  opinions  as  to  value. 

When  patents  are  to  be  valued  separate  and  apart  from  goodwill,  trade  marks, 
trade  brands,  or  other  intangible  elements  contributing  to  the  value  of  property- 
operated  or  to  be  operated  as  a  whole,  the  values  of  each  are  inherently  matters  of 
opinions.  The  motive  of  interest  results  in  the  production  of  unreasonable 
opinions  in  such  cases.  Opinions  of  this  nature  are  of  frequent  occurrence  in 
which  earnings  in  excess  of  a  fair  return  of  the  tangible  property  are  attributed 
almost  entirely  to  patents,  although  it  is  patent  that  extensive  advertising  and 
good  management  have  built  up  a  large  element  of  goodwill.  Such  opinions  are 
the  source  of  increased  uncertainty  as  to  outcome  in  litigated  cases  of  this  nature. 

The  foregoing  recital  of  the  complexities  and  uncertainties  in  the  determination 
of  fair  market  value  from  commercial  and  legal  standpoints,  since  it  attempts  to 
cover  the  entire  field  in  a  general  way,  probably  overemphasizes  the  difficulties 
that  may  be  encountered  in  the  great  majority  of  cases.  If  the  foundational  facts 
are  fully  developed,  the  field  for  reasonable  differences  of  opinion  is  greatly 
narrowed.  Given  competent  representation  on  both  sides,  assurance  that  the 
valuation  will  be  competently  litigated  if  necessary  and  applying  the  standard 
of  a  common-sense  reaction  by  a  court  or  jury  to  the  evidence  which  may  be 
adduced  by  both  sides  rather  than  the  standard  of  decisions  in  exceptional  and 
extreme  cases,  the  great  bulk  of  valuation  issues  should  be  satisfactorily  disposed 
of  administratively. 

Your  question  as  to  the  amount  of  time  it  would  take  to  make  an  adequate 
investigation  of  an  average  sized  industrial  plant  is  difficult  to  answer  on  account 
of  the  varying  circumstances  under  which  such  an  investigation  may  have  to  be 
conducted.  A  few  of  the  circumstances  which  may  greatly  vary  the  time  re- 
quired in  such  an  investigation  are:  The  elapsed  time  between  the  date  of  the 
investigation  and  the  date  of  valuation;  the  condition  of  the  books  of  account, 
plant  records,  and  operating  records  of  the  plant  under  investigation,  and  the 
question  as  to  what  portion  of  the  work  of  the  investigation  may  be  thrown 
upon  the  owners  of  plants. 

The  answer  to  your  question  which  follows  is  not  based  on  the_  statistical 
analysis  and  should  be  taken  as  oubject  to  wide  variation  in  individual  cases 
even  under  the  assumed  conditions  which  are  suggested.  The  assumptions  made 
are  as  follows:  (1)  That  the  original  records,  minute  books,  stock  registers,  stock 
transfer  books,  books  of  account,  operating  records  and  plant  accounts  are  well 
kept  and  available;  (2)  that  the  burden  of  appraising  the  plant  to  be  valued  is 
placed  upon  the  owner  of  the  plant,  the  appraisal  to  show  as  to  each  item  making 
up  the  inventory  of  plant,  the  date  of  purchase,  the  cost,  the  facts  relied  on  to 
support  present  reconstruction  cost  equal  to  cost  or  departures  from  cost  either 
up  or  down,  and  the  facts  relied  upon  to  demonstrate  the  amount  of  depreciation 
and  obsolescence  accrued;  (3)  that  all  evidence  of  value  either  supporting  a  high 
or  a  low  value  within  the  knowledge  of  the  owner  of  the  plant  is  submitted  by 
the  owner  of  the  property;  (4)  that  the  owner  of  the  plant  is  restricted  on  any 
appeal  from  the  original  determination  of  value  to  the  foundational  facts,  as 
distinguished  from  conclusions  or  opinions,  submitted  before  the  original  de- 
termination of  value,  and  (5)  that  an  average  sized  industrial  plant  is  one  having 
a  value  of  about  $3,000,000. 

Under  the  conditioiis  assumed,  it  is  estimated  that  a  competent  auditor,  with 
1  assistant,  and  a  competent  engineer,  with  1  assistant,  would  require  about 
3  months  to  check  the  history  of  the  plant,  factual  evidence  as  to  transactions  in 
interests  in  the  plant  or  in  the  securities  of  corporate  owners,  operating  records, 
capital  accounts,  and  assemble  the  foundational  facts  upon  which  an  analytical 
appraisal  valuation  must  be  based,  including  reasonable  conclusions  as  to  recon- 


MUNITIONS    INDUSTBY  145 

struction  costs  new  less  depreciation  and  obsolescence,  and  as  to  the  earnings 
and  capital  accounts.  A  competent  valuation  expert  either  having  commercial 
experience  or  a  knowledge  of  commercial  transactions  and  of  market  conditions, 
and  with  some  legal  advice,  should  be  able  to  arrive  at  a  defensible  value  based 
on  the  standard  of  the  market  within  1  month.  In  cases  which  are  litigated 
there  should  be  added  to  the  above  time  to  prepare  for  trial  the  time  of  1  lawyer 
for  a  30-day  period,  1  auditor  for  an  additional  30  days,  1  engineer  and  1  valua- 
tion export  for  at  least  the  same  period  and  probably  10  days  for  3  expert  wit- 
nesses. If  the  principal  foundational  facts  are  stipulated  the  trial  time  may  be 
a  week  or  less.  If  agreement  on  the  foundational  facts  cannot  be  reached,  the 
trial  time  is  impossible  to  estimate  as  is  demonstrated  b}'  the  widely  varying 
length  of  the  proceedings  in  hearings  of  public-utility  commissions  with  which 
you  are  no  doubt  familiar. 

Your  additional  inquiry  as  to  whether  information  could  be  furnished  as  t  o 
the  personnel  which  would  be  required  to  conduct  an  adequate  investigation  of 
the  problems  of  valuation  must  be  answered  in  the  negative  on  account  of 
inadequacy  of  the  information  as  to  the  scope  of  the  inquiry  contemplated. 

The  table  attached  hereto*  shows  specific  examples  of  different  valuations 
placed  on  property  by  experts  appearing  for  the  Government,  by  experts  appear- 
ing for  the  taxpayer  and  the  courts,  as  well  as  a  few  cases  in  which  the  Govern- 
ment relied  on  sales  of  the  propertj'  in  question  and/or  the  sale  price  of  the 
owner  corporation's  securities. 

The  Bureau  of  Internal  Revenue  has  settled  administratively,  or  through  liti- 
gation, the  cost  or  fair-market  value  as  of  Tvlarch  1,  1913,  whichever  is  greater, 
of  practically  all  property  operated  in  the  United  States  which  is  subject  to 
depreciation,  exhaustioa,  or  depletion  allowances  under  the  income  tax  statutes. 

The  remaining  costs  (of  Mar.  1,  1913)  are  kept  up  to  date  in  connection  with 
the  preparation  and  audit  of  each  year's  income-tax  returns.  It  therefore  suggests 
itself,  that  adopting  the  value  remaining  after  deducting  allowances  recognized 
as  sustained  under  the  income  tax  statutes  as  a  basis  for  contractual  compensa- 
tion for  the  use  of  such  property,  may  be  worthy  of  your  consideration.  Such 
a  basis  has  the  merit  of  avoiding  the  burden  of  a  large  volume  of  revaluations.  It 
has  the  further  merit  that  a  large  percentage  of  the  original  value  determined  on 
other  than  a  cash-cost  basis  has  been  eliminated  through  the  allowances  for  ex- 
haustion, depletion,  and  depreciation.  The  necessity  for  valuing  land  and  possi- 
bly other  nonwasting  assets,  as  well  as  natural  resource  deposits  discovered  and 
patent  developed  after  March  1,  1913,  if  such  a  basis  were  adopted  v.'ould  still 
remain. 

Very  truly  yours, 

,  Acting  Secretary. 


*  See  p.  146  for  table  attached  to  above  letter. 


146 


MUNITIONS    INDUSTRY 


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MUNITIONS    INDUSTRY  147 

excekpts  from  exhibit  no.  1343 

memorandum  be  valuation 

1.  Valuation  Work  of  the  Interstate   Commerce  Commission 

The  difficulties  attendant  upon  valuation  are  perhaps  illustrated  most  graph- 
ically by  the  work  of  the  Interstate  Commerce  Commission  in  connection  with 
its  valuation  of  the  railroads  of  the  country  up  to  1926. 

*  *  *  the  Interstate  Commerce  Commission  in  valuing  only  the  prop- 
erties of  the  railroads  of  the  country  has  spent  more  than  13  years  on 
the  task  and  more  than  $27,000,000,  and  the  carriers  themselves  in  working 
on  these  same  valuations  have  spent  the  same  period  of  time  and  more 
than  $85,000,000.  (Mr.  Ernst's  Report,  69th  Cong.,  1st  sess.,  S.  Rept.  27, 
pt.  3,  p.  4.) 

This  statement  is  all  the  more  significant  in  view  of  the  fact  that  railroads 
have  for  a  long  time  had  their  rate  of  profit  regulated  in  the  public  interest 
by  both  State  and  Federal  Governments. 

For  years  past  railroads,  pipe  lines,  and  express  companies  have  been 
obliged  to  keep  their  books  in  accordance  with  accounting  methods  pre- 
scribed by  the  Interstate  Commerce  Commission.  *  *  *  There  are 
also  State  and  municipal  regulations  prescribing  the  form  of  accounting 
to  be  followed  by  various  public  utilities,  banks,  insurance  companies,  and 
other  forms  of  business  closely  connected  with  the  public  interest.  (691;h 
Cong.,  1st  sess.,  S.  Rept.  27,  pt.  2,  pp.  130-131.) 

Since  the  rate  of  profit  which  has  been  allowed  public  utilities  has  chai'ac- 
teristically  been  based  on  a  fixed  return  on  "  value ",  it  is  apparent  that  a 
considerable  store  of  information  must  have  been  present  on  the  subject  of 
valuation  and  on  the  techniques  of  attacking  the  problem.  Such  are  the  dif- 
ficulties that  have  been  encountered  in  connection  with  a  business  which  was 
the  first  to  be  subject  to  supervision  in  the  public  interest ;  it  is  impossible  to 
set  forth  the  extent  of  the  difficulties  which  will  be  encountered  in  connection 
with  the  valuation  of  industries  not  subject  to  similar  prior  scrutiny. 

Expenditures  in  connection  with  valuation  work  of  the  Interetate  Commerce 
Commission  have  continued  to  be  on  a  large  scale  since  the  time  of  the  Couzens' 
Report.  In  the  account  of  the  appropriation  and  expenditures  of  the  Interstate 
Commerce  Commission  for  each  fiscal  year  there  appears  an  item : 

Valuation  of  property  of  carriers :  To  enable  the  Interstate  Commerce 
Commission  to  carry  out  the  objects  of  the  act  entitled  "An  act  to  amend 
an  act  entitled  'An  act  to  regulate  commerce  ',  approved  Feb.  4,  1887,  and 
all  acts  amendatory  thereof  ",  by  providing  for  a  valuation  of  the  several 
classes  of  property  of  carriers  subject  thereto  and  securing  information 
concerning  their  stock,  bonds,  and  other  securities,  approved  Mar.  1,  1913. 

For  the  respective  years  1926-29,  the  amounts  listed  under  this  item  were  as 

follows : 

Year :  Amoant 

1926 $1,  883,  232.  97 

1927 1,  715, 140.  97 

1928 2,  563,  214.  00 

1929 2,  336,  670.  00 

(See  40th-43rd  Annual  Report,  Interstate  Commerce  Comm.,  1926-29.) 
The  size  of  the  appropriation  in  these  years  is  all  the  more  significant  in  view 
of  the  note  of  optimism  present  in  the  1922  report  of  the  Interstate  Commerce 
Commission  to  the  effect  that  the  valuation  job  had  been  practically  completed : 

"We  have  readied  the  state  in  valuation  of  the  steam  railroads  of  the 
country  where,  except  for  rechecking,  the  inventorying  of  roads  recently 
constructed,  and  a  few  minor  details,  the  original  field  work  has  been  com- 
pleted. Underlying  reports  are  being  issued  in  large  numbers,  and  hearings 
and  final  arguments  on  protested  tentative  valuations  are  in  progress.  Of 
287  tentative  valuations  served,  101  have  become  final  through  absence  of 
protest,  which  under  the  act  any  interested  party  may  file  within  30  days 
after  service  of  tlie  tentative  valuation.  Full  hearings  upon  protests  have 
been  had  in  39  cases.     Six  cases  have  been  partly  heard  and  3S  cases  are 


148  MUNITIONS    INDUSTRY 

assigned  for  hearing  before  December  31,  1922.    Final  arguments  have  been 
had  in  three  cases  and  12  were  set  for  argument  in  November.    Issues  raised 
by  protestants  in  19  cases  have  been  submitted  without  argument. 
******* 

We  have  completed  the  transfer  of  all  forces  and  records  of  the  Bureau 
to  the  central  office  in  Washington,  and  have  closed  the  San  Francisco, 
Kansas  City,  Chicago,  Chattanooga,  and  Washington  district  offices.  This 
has  been  accompanied  by  reorganization  and  closer  coordination.  The 
number  of  employees  has  been  reduced  to  approximately  .550,  or  about  one- 
third  of  the  maximum  reached  in  1918.  Expenditures  have  been  reduced 
from  approximately  $3,000,000  per  annum  during  the  first  few  years, 
$2,735,911  for  the  fiscal  year  1920-21,  and  $1,597,572  for  the  fiscal  year 
1921-22,  to  approximately  $1,300,000.  This  reduction  has,  in  large  part, 
been  made  possible  by  the  termination  of  original  field  work  (36th 
Annual  Report  of  Interstate  Commerce  Commission,  1922,  p.  70). 

The  report  of  the  Commission  two  years  later  is  much  less  hopeful  in  outlook. 

Based  on  our  experience  thus  far,  we  estimate  that  the  hearings  to  be 
held  on  protests  to  tentative  valuations  will  exceed  500  in  number.  We 
cannot  estimate  their  length.  It  is  apparent  that  satisfactory  completion 
of  the  work,  already  over  10  years  in  progress,  is  seriously  menaced  by 
delay  in  completing  these  primary  valuations.  Most  of  them  are  already 
from  6  to  10  years  old.  In  administering  the  act  present-day  valuations 
are  needed,  but  before  they  can  be  had  primai'y  valuations  must  have  been 
completed  to  serve  as  bases  for  carrying  the  valuations  forward.  There 
is  serious  disadvantage  in  the  lapse  of  so  many  years  between  the  pri- 
mary and  the  present-day  valuations.  With  the  passage  of  time  come 
cumulative  changes  in  the  property  by  reason  of  additions,  betterments,  and 
retirements,  thus  rendering  the  original  inventories  increasingly  unrepre- 
sentative of  present  conditions  (38th  Annual  Report  of  Interstate  Com- 
merce Commission,  1924,  p.  14). 

The  above-cited  passage  supplies  clear  indication  that  it  is  much  more  than  a 
mere  routine  matter  to  keep  a  valuation,  once  arrived  at,  up-to-date.  To  the 
same  effect,  see  the  39th  Annual  Report  of  the  Interstate  Commerce  Commission 
(1925)  : 

*  *  *  Qui-  valuation  order  no.  3  requires  carriers  to  keep  a  record  of 
additions,  betterments,  and  retirements  made  subsequent  to  date  of  the 
primary  valuation ;  to  render  annual  reports  to  us  showing,  by  primary 
accounts,  the  cost  of  such  property ;  and  to  report  the  units  of  property 
installed  and  retired  at  such  times  and  for  such  periods  as  we  may 
request. 

During  the  year  the  force  assigned  to  the  administration  of  this  order 
averaged  54  persons.  Of  this  number  an  average  of  29  were  assigned  to 
policing  and  checking  the  carriers'  records  in  the  field.  *  *  *  (39th 
Annual  Report  of  the  Interstate  Commerce  Commission,  1925,  p.  16.) 

The  same  report  also  contains  a  significant  statement  as  to  the  difficulties  of 
securing  sufficient  competent  personnel  at  salaries  that  the  Government  can 
afford  to  pay. 

Explanation  of  the  difficulty  of  keeping  a  valuation  current  may  also  be 
found  in  the  1930  report  of  the  Commission,  which  describes  the  extent  to 
which  property  values  in  the  railroad  industry  fluctuate  in  the  course  of  a 
year: 

Changes  in  the  property  of  the  carriers,  consisting  of  additions,  better- 
ments, and  retirements,  varying  in  amounts  from  more  than  one-quarter 
billion  to  more  than  one  billion  dollars,  occur  annually.  Price  levels,  like- 
wise, fluctuate  continually.  Therefore,  unless,  as  provided  by  paragraph 
Fifth  (f)  of  section  19a,  we  keep  inforined  of  such  changes,  both  in  the 
property  and  its  value,  the  valuations  quickly  become  obsolete.  The 
United  States  Supreme  Court  has  held  that  substantia]  fluctuations  in 
price  levels  affect  values,  and  it  is  the  settled  rule  of  that  Court  that  the 
lawful  rate  base  is  present  value.  It  follows,  therefore,  that  if  valua- 
tions are  to  be  of  practical  use  they  must  not  become  obsolete  (46th 
Annual  Report  of  the  Interstate  Commerce  Commission,  1932,  p.  89). 


MUNITIONS   INDUSTRY  149 

It  was  not  until  1932  that  the  Interstate  Commerce  Commission  completed  the 
valuation  process  which  it  had  so  hopefully  described  in  1922  as  practically 
complete  as  far  as  field  work  was  concerned,  and  which  had  been  entrusted  to 
it  by  Congress  in  1913. 

During  the  year  we  have  completed  the  last  of  the  primary  valuations 
of  the  1,685  steam  railroads  listed  for  valuation  as  existing  on  March  1, 
1913,  the  date  of  the  enactment  of  the  valuation  act.     These  valuations 
are  incorporated  in  1,035  final  valuation  reports,  although  a  few  have  not 
yet   been   published    (46th   Annual   Report    of   the   Interstate    Commerce 
Commission,  1932,  p.  86). 
The  recapture  provision  of  the  Transportation  Act  of  1920  added  very  meas- 
urably to  the  work  of  the  Bureau  of  Valuation  of  the  Interstate  Commerce  Com- 
mission : 

EEOAPTURE  VALUATIONS 

*  *  *  By  increased  appropriation  we  have  been  enabled  to  assign  a 
somewhat  increased  force  to  the  administration  of  this  order.  This  has 
averaged  64  employees,  40  of  whom  have  been  engaged  in  the  field  work  of 
policing  and  checking  the  carriers'  records.  Up  to  the  present  time  pre- 
liminary examinations  have  been  made  in  the  oflices  of  460  carriers.  Com- 
plete field  examinations,  covering  an  average  perioil  of  seven  years  subse- 
quent to  the  various  dates  of  valuation,  have  been  made  of  the  records  of 
205  carriers,  aggregate  mileage  68,000.  Field  examinations  covering  an 
average  period  of  eight  years  are  now  in  progress  on  30  carriers,  aggregate 
mileage  48,000.  The  present  force  available  for  this  work  still  falls  short 
of  the  requisite  number.  (40th  Annual  Report  of  Interstate  Commerce 
Commission,  1926,  p.  15.) 

In  fact,  in  one  year,  1930,  the  Interstate  Commerce  Commission  reported  that  its 
Valuation  Bureau  was  compelled  to  restrict  itself  in  large  measure  to  recapture 
cases : 

The  activities  of  the  Bureau  of  Valuation  have  in  a  large  measure  been 
restricted  during  the  year  for  which  this  rei>ort  is  made  to  valuation  work 
in  recapture  cases.  This  is  in  conformity  with  instructions  is.sued  .July  18, 
1929,  that  the  "  Bureau  give  precedence  in  its  valuation  work  to  recapture 
cases."  (44th  Annual  Report  of  Interstate  Commerce  Commission,  1930, 
p.  59.) 

It  should  be  noted  that  the  general  valuation  work  commenced  in  1913  was, 
in  comparison  with  the  recapture  valuations,  a  more  or  less  disinterested 
scientific  inquiry.  Valuation  in  connection  with  recapture  was  specifically 
linked  up  with  the  enforcement  of  a  policy  designed  to  limit  the  profits  of  the 
more  favorably  situated  carriers.  Anticipation  of  the  resultant  legal  difficulty 
in  the  courts  which  it  w^as  fearetl  the  recapture  provision  would  run  into 
necessitated  an  even  more  elaborate  personnel  and  much  fuller  investigation 
than  valuation  carried  on  from  a  purely  scientific  basis : 

*  *  *  It  soon  became  manifest  that  the  protests  were  to  test  with 
meticulous  detail  the  inventories,  prices,  methods,  theories,  and  conclu- 
sions, and  even  administrative  procedure,  and  that  as  to  any  and  all  of 
these  there  would  probably  be  appeal  to  the  courts.  Consequently  the. 
work  had  to  be  done  with  the  greatest  care,  not  only  for  the  sake  of  the 
undertaking  itself  but  also  to  withstand  attack  in  the  courts.  This  in 
turn  required  an  army  of  experts  consisting  of  engineers,  laud  appraisers, 
auditors,  accountants,  and  attorneys.  Protests  were  tiled  in  748  cases  and 
hearings  held  in  .503  cases.  Under  the  broad  latitude  afforded  by  the  law, 
which  gave  to  every  protestant  his  right  fully  to  be  heard,  hearings  on 
individual  properties  ran  many  months.  In  addition  there  have  been 
suits  attacking  our  decisions.  To  these  long-drawn-out  proceedings  during 
the  later  years  is  attributable  much  of  the  delay  in  the  completion  of  the 
primary  valuations. 

It  is  obvious  that  this  act  requires  the  most  extensive,  detailed,  and 
exhaustive  investigation,  culminating  in  a  valuation  of  the  complex  prop- 
erty of  the  railroads  extending  over  250,000  miles  of  main  track  and 
400,000  miles  of  all  tracks,  together  with  equipment,  terminals,  and  all 
other  holdings.     The  result  was  a  much  greater  undertaking  than  those 


150 


MUNITIONS    INDUSTRY 


who  wrote  the  many  detailed  requirements  into  the  law  could  realize  at 
the  time  of  its  enactment  (46th  Annual  Report  of  the  Interstate  Com- 
merce Commission,  1932,  p.  88). 

That  a  provision  such  as  the  recapture  provision  demands  heavy  policing 
is  apparent  when  the  amount  of  excess  income  which  the  carriers  reported  is 
-compared  with  the  Interstate  Commerce  Commission's  estimate  of  the  recap- 
turable  excess  which  they  had  actually  earned : 

Recovery  of  excess  net  railtcay  operating  income,  general  railroad  conti-ngent 

fund 


Period 

Number  cf 
reports 

Number  of 
reports  in 

whicii  excess 
income  is 
reported 

Total 

amount  of 

excess  income 

reported 

Applicable  period,  1920       

993 

975 
931 
902 
902 
897 
882 
870 
851 
843 
810 
753 

34 

27 
50 
53 
23 
32 
24 
10 
19 
27 
9 
2 

$2,  505, 006.  03 

■Calendar  year; 

1921 

458,  535.  72 

1922 

1, 867,  239.  33 

1923 

6, 909,  296.  66 

1924 -. 

1,196,261.90 

1925  .  .                                              

2,  402, 198. 71 

1926 

1,090,490.78 

1927                                                                                  

177, 566. 32 

1928.. 

1.115.087.16 

1929 

5,  378, 101. 20 

1930  ...              .                                   

381,  266.  47 

1931 -. 

07,821.48 

Total  excess 

23,548,871.76 

1 

While  the  carriers  reported  a  total  excess  income  of  only  $23,548,871.76,  one- 
half  of  which  is  subject  to  recapture,  for  the  period  1920  to  1931,  inclusive,  our 
estimates  of  recapturable  excess  income  for  the  period  1920  to  1930,  inclusive, 
amount  to  considerably  over  $300,000,000.  *  *  *  (46th  Annual  Report  of 
Interstate  Commerce  Commission,  1932,  p.  93.) 

And,  finally,  despite  all  of  the  Commission's  wrestling  with  the  problem  of 
valuation  for  recapture  purposes,  the  Supreme  Court,  in  the  O'Fallon  case,  279 
U.  S.  461  (1929),  by  insisting  that  the  Commission  had  not  paid  sufficient  atten- 
tion to  tlie  factor  of  reproduction  cost  in  its  valuation,  necessitated  a  wholesale 
revision  of  the  Commission's  work : 

The  amount  due  from  the  carriers,  according  to  preliminary  computations 
made  in  the  manner  outlined  above,  is  approximately  $300,000,000  for  the 
years  1920-28.     As  a  result  of  the  Supreme  Court's  decision  in  the  St.  Louis 
&  O'Fallon  case,  this  estimate  must  be  changed.     It  is  estimated  that  under 
the  present  system  of  quasi-judicial  hearing  procedure  a  minimum  of  six 
years  would  be  required  to  dispose  of  the  present  arrearage,  and  even  at  the 
end  of  that  period  the  work  would  hardly  be  current,  owing  to  accumula- 
tions during  the  interval    (43rd  Annual  Report  of  Interstate  Commerce 
Commission,  1929,  p.  87). 
Even  with  the  recapture  provision  repealed,  the  appropriation  for  valuation 
available  to  the  Interstate  Commerce  Commission  was  $1,000,000  for  the  year 
1933-34,  and  its  active  personnel  included  381  employees: 

The  amendment  above  referred  to,  together  with  repeal  of  provisions  of 
section  15a  relating  to  excess  net  railway  operating  income,  greatly  simplify 
the  valuation  work.  Together  with  the  completion  of  the  primary  valua- 
tions it  has  enabled  us  to  reduce  materially  the  personnel  and  expenditures 
in  the  Bureau.  The  reduction  was  possible,  also,  because  of  the  progress 
made  in  correcting  and  revising  the  original  inventories  and  underlying 
records  and  data.  For  the  last  fiscal  year  (1932-33)  the  appropriation  for 
the  Bureau  was  $2,750,000.  Its  personnel  on  June  1,  1933,  consisted  of  910 
employees.  The  appropriation  for  the  current  fiscal  year  (1933-34)  is 
$1,000',000,  and  its  active  personnel  on  July  1,  1933,  consisted  of  381  em- 
ployees (47th  Annual  Report  of  the  Interstate  Commerce  Commission,  1933, 
p.  74). 


MUNITIONS    INDUSTRY  151 

This  appropriation  is  insuflScient  to  allow  the  Commission  to  make  any  con- 
siderable progress  in  connection  with  the  valuations  of  carriers  other  than 
railroads : 

Section  19a  is  applicable  to  all  carriers  subject  to  the  provisions  of  the 
act.  InsuflBcient  appropriations  have  prevented  us  from  proceeding  with 
the  valuations  of  carriers  other  than  railroads  with  the  exception  of  the 
Pullman  and  telegraph  companies.  The  valuation  of  these  latter  companies 
is  being  prosecuted  as  far  as  appropriations  permit.  Requests  for  addi- 
tional appropriations  to  value  other  carriers  such  as  pipe-line  and  tele- 
phone companies  have  been  made  from  time  to  time  (47th  Annual  Report 
of  the  Interstate  Commerce  Commission,  1933,  p.  76). 

This  situation  exists  in  an  industry  with  a  well-established  tradition  of  regu- 
lation in  the  public  interest,  and  an  industry  whose  books  and  records  were  con- 
sequently in  much  better  shape  than  the  mass  of  American  industry.  Further- 
more, the  statute  (37  Stat.  701 ;  48  Stat.  221)  was  liberal  in  its  provisions  in  aid 
of  investigation ;  and  to  a  certain  extent,  comparative  checks  could  be  made 
with  data  which  had  been  acquired  by  the  State  public  utility  commissions 
which  had  preceded  the  Interstate  Commerce  Commission  in  the  field. 

2.  Genebal  Difficulties  of  Public  Utility  Valuation 

The  difficulties  which  have  only  sketchingly  been  brought  out  in  connection 
with  the  valuation  of  interstate  carriers  are  paralleled  throughout  the  public 
utility  field.  Frequently,  of  course,  the  issues  which  are  raised  in  specific  con- 
troversies do  not  directly  concern  themselves  with  the  problems  of  valuation. 
If  there  be  an  incentive  on  the  part  of  the  utility  to  provoke  delay,  obstacles  or 
confusion,  resort  is  often  had  to  legal  technicalities  and  to  statutory  issues. 
The  real  motive  underlying  the  attempt  to  thus  confuse  and  becloud  the  issue 
Avill,  in  the  usual  instance,  be  the  utility's  contention  that  it  is  being  imconstitu- 
tionally  deprived  of  a  fair  return  on  its  investment.  The  two  major  considera- 
tions which  are  germane  to  such  a  contention  are  the  value  of  the  utility's 
investment,  and  the  rate  of  return  on  its  investment  to  be  accorded  the  utility. 
The  complexity,  volume,  delay,  and  the  other  features  which  characterize  rate 
regulation  can  in  the  usual  instance  be  referred  to  the  problem  of  valuation. 

Voluminous  records  are  the  rule  in  public-utility  rate  controversies.     Thus : 

An  illustration  of  the  experience  of  the  commissioner  is  found  in   the 
case  of  The  Pacific  Northn-est  Public  Service  Compani/  v.  Oregon  Public 
Utilities  Comnvissioner  in  the  district  Federal  court  at  Portland,  Oreg. 
******* 

The  commissioner's  hearing  developed  a  transcript  record  of  .500  pages 
and  43  exhibits.  Among  these  exhibits  was  a  voluminous  study  and 
analysis  prepared  by  the  engineers  of  the  commission.  (Hearings  before 
the  Committee  on  the  .Judiciary,  House  of  Rep.,  73d  Cong.,  2d  session, 
S.  752,  serial  4,  p.  18.) 

Mr.  Minton,  of  the  Public  Utilities  Commission  of  Indiana,  testified  liefore 
the  House  Committee  on  the  Judiciary  as  to  one  case  involving  his  commission : 

Mr.  Minton  (Public  Utilities  Commission  of  Indiana).  If  we  are  taken 
into  the  Federal  court,  as  we  are  threatened  with  in  the  Electric  case,  as 
we  have  just  heard,  we  will  be  confronted,  of  course,  with  the  great  array 
of  volumes  of  exhibits  as  to  the  inventory  and  appraisal  of  that  property, 
some  sixty-odd  volumes  of  it,  and  perhaps  another  array  of  engineers. 
(Hearings  before  the  Committee  on  the  Judiciai-y,  House  of  Rep.,  73d 
Cong.,  2d  session,  S.  752,  serial  4,  p.  49.) 

He  had  an  even  better  illustration  in  his  testimony,  that  of  the  Indianaprjlis 
Water  case  which  reopened  a  controversial  situation  which  the  Supreme  Court 
had  at  one  time  passed  on : 

The  Indianapolis  Water  case  was  before  the  Supreme  Court  of  the  United 
States  in  192G;  its  title  was  McArdle  v.  Indianapolis  Water  company.  The 
higher  rates  were  sustained  by  the  Supreme  Court  of  tlie  United  States. 
During  the  time  of  the  depression  out  there,  they  instituted  a  proceeding 
against  this  water  company  to  reduce  their  rates  again.  And  the  case  was 
again  taken  into  the  Federal  court. 

Now,  that  the  case  started  early  in  the  fall  of  1931.  The  commission 
wrote  its  order  in  April  1932.    They  were  promptly  enjoined  in  the  Federal 


152  MUNITIONS    INDUSTRY 

court,  and  in  May  193S,  we  appeared  before  the  special  master  in  the  Federal 
court  to  start  to  take  testimony  in  that  case.  The  special  master  in  tliat 
case  is  a  distinguished  ex-judge  in  our  State,  a  former  United  States 
attorney,  and  he  was  master  in  chancery,  who  has  heard  a  number  of  utility 
cases  before.  We  started  on  the  1st  of  May  to  take  testimony,  took  the 
testimony  all  summer  long,  and  finished  about  the  middle  of  August ;  and 
we  had  compiled  the  largest  record  of  testimony  that  had  ever  been  taken 
in  the  Federal  court  in  Indianapolis,  according  to  the  statement  of  the 
reporter  who  reports  in  that  court,  and  has  been  reporting  there  for  30 
years;  a  record  of  15,000  typewritten  pages,  with  hundreds  of  pounds  of 
exhibits — books  of  exhibits,  running  from  200  to  400  pages  each. 

Now,  that  utility  had  been  before  the  commission,  with  its  engineers  aud- 
its experts,  and  had  gone  into  this  thing  ratlier  thoroughly  before  the  Com- 
mission. They  brought  this  firm  of  engineers  from  New  York,  a  dis- 
tinguished firm ;  and  when  they  came  into  the  Federal  court,  the  record 
whicli  was  made  before  the  Commission  was  utterly  ignored,  and  there  was 
no  attention  paid  to  it  at  all.  They  started  de  novo.  And  they  used  not  only 
the  engineers  used  before  the  Commission,  but  they  employed  in  the  mean- 
time an  additional  firm  of  engineers  in  the  city  of  New  York,  a  very  dis- 
tinguished firm,  I  understand  the  outstanding  firm  in  New  York — and  they 
brought  both  firms  out  there. 

And  so  we  had  two  great  firms  of  engineers  out  there  in  that  water  case. 
And  in  addition  to  that  they  brought  a  very  noted  utility  expert  from  New 
York  to  testify  about  the  rate  of  return.  They  brought  New  York  counsel 
out  there. 

So  we  spent  the  whole  summer  there  taking  the  testimony  in  that  case. 
The  briefs  have  just  been  filed  on  behalf  of  the  attorney  general,  who  repre- 
sents the  commission  in  that  matter  and  he  just  last  week  filed  his  brief 
before  the  master.  The  brief  is  a  document  of  some  200  or  300  pages,  and 
the  brief  filed  by  the  utility  is  some  300  pages,  I  suppose.  (Hearings 
before  the  Committee  on  the  Judiciary,  House  of  Rep.  73d.  Cong.,  2nd  ses- 
sion on  S.  752,  Serial  4,  pp.  48-49,  February  27,  1934.) 

The  expenses  entailed  by  such  a  procedure  are  considerable. 

in  the  Indianapolis  Water  Co.  case,  they  were  still  amortizing  the  expenses 
of  the  1926  rate  case  at  the  time  we  heard  the  last  case  out  thei'e  in  the 
Federal  court;  and  they  were  still  amortizing  in  Indianapolis,  to  the  tune  of 
$30,000  per  annum  in  expenses  of  that  case. 

The  Chairman.  What  were  the  expenses  in  the  case? 

Mr.  MiNTON.  Some  $200,000.  I  do  not  recall  the  exact  figure.  In  pre- 
paring this  case  to  present  to  the  master  last  summer,  the  Public  Service 
Commission,  through  its  attorney  general  and  legal  representative,  employed 
additional  engineering  help,  when  we  were  confronted  with  their  engineers 
on  behalf  of  the  utilities ;  and  we  spent  $25,000  of  the  people's  money 
trying  to  prepare  that  case  to  present  it  again  in  the  Federal  court.  And 
so  we  are  spending  thousands  and  thousands  of  dollars  in  that  one  case. 
(Hearings  before  the  Committee  on  the  Judiciary,  House  of  Rep.,  73d 
Cong.,  2nd  session,  on  S.  752,  serial  4,  Feb.  27,  1934,  p.  49.) 

Other  illustrations  may  be  adduced  of  investigations  which  not  only  cost  the 
State  considerable  money,  but  also  involved  delays  in  effective  administrative 
action  as  a  result  of  court  litigation.  Thus,  the  State  of  Kansas  spent  almost 
$100,000  upon  an  investigation  of  gas  rates  charged  by  a  company  serving  a 
hundred  or  more  towns.  Yet,  by  virtue  of  an  injunction  in  the  Federal  district 
court,  this  case  was  delayed  one  year.  (Hearings  before  the  Committee  on  the 
Judiciary,  House  of  Representatives,  73rd  Congress,  2nd  session,  S.  752.  serial 
4,  Feb.  27,  28,  March  1,  1934,  p.  258.)  In  New  Jersey  a  valuation  of  public 
utility  property  took  two  years  and  cost  more  than  $100,000.  (Hearings  before 
the  Committee  on  the  Judiciary.  House  of  Representatives,  73rd  Congress,  2nd 
session  S.  7.';2,  serial  4.  Feb.  27.  28.  :\Iarch  1.  1!«4.  p.  214.)  In  the  Pacific 
Telephone  and  Telegraph  Company  and  Home  Telephone  Company  cases,  after 
three  years  of  proceedings  within  the  State,  new  evidence  was  taken  before  a 
special  master  in  Federal  court ;  the  State  of  Washington  and  its  municipalities 
were  subjected  to  more  than  $100,000  in  the  way  of  expenditures.  (Hearings 
before  the  Committee  on  the  Judiciary,  House  of  Representatives,  73rd  Con- 
gress, second  session  on  S.  752,  serial  4,  Feb.  27,  28,  March  1,  1934,  p.  262.) 


MUNITIONS    INDUSTEY  153 

A  classic  instance  of  delay  caused  by  litigation  is  supplied  by  the  Chicago 
Telephone  case,  referred  to  four  times  in  the  hearings  before  the  House  Judiciary 
Committee  on  the  Johnson  bill.  (Hearings  before  the  Committee  on  the  Judici- 
ary, House  of  Rep.,  73rd  Cong.,  2d  session  on  S.  752,  serial  4,  pp.  23,  70-71,  138, 
224,  Feb.  27-Mar.  1,  1934.)  The  mere  printing  of  the  recoi-d  in  this  case  for  the 
United  States  Supreme  Court  cost  $25,000: 

What  the  10  years  of  litigation  has  cost  we  can  only  guess ;  but  we  linow 
from  the  opinion  of  the  United  States  district  court  that  the  city  of  Chi- 
cago was  obliged  to  seek  delays  because  it  lacked  funds  to  meet  the  costs 
which  fell  upon  it,  all  of  which  migtit  have  been  avoided  had  the  company 
been  willing  to  accept  the  method  of  review  provided  by  Illinois  law,  under 
which  the  record  before  the  Commission  would  have  been  transferred  to 
the  Court,  without  the  calling  of  additional  witnesses,  and  upon  which  an 
expeditious  decision  might  have  been  had.  (Hearings  before  the  Com- 
mittee on  the  Judiciary,  House  of  Representatives,  73d  Congress,  2d  sess., 
on  S.  752,  serial  4,  March  1,  1934,  p.  224. ) 

The  history  of  this  case  illustrates  the  potentialities  for  delay  present  in  our 
commission-court  system  of  rate  regulation: 

Mr.  Benton  (continuing).  Some  reference  has  been  made  here  to  the 
Illinois  Bell  Telephone  case.  I  will  be  glad  to  spend  a  little  time  pointing 
out  what  occurred  with  respect  to  that  case. 

On  August  16,  1923,  the  Illinois  commission,  after  investigation  and 
hearing,  made  an  order  reducing  the  charges  for  certain  classes  of  coin- 
box telephone  sei'vice  of  the  Illinois  Bell  Telephone  Co.  in  the  city  of  Chi- 
cago. The  company  applied  to  the  United  States  district  court  for  an 
injunction  on  the  ground  of  alleged  confiscation. 

On  December  21,  1923,  upon  a  showing  by  affidavits,  the  district  court 
granted  an  interlocutory  injunction. 

October  19,  1925,  the  United  States  Supreme  Court  affirmed  the  interlocu- 
tory injunction  in  a  per  curiam  opinion.  Smith  v.  Illinois  Bell  Telephone 
Company   (269  U.  S.  531). 

January  30,  1930,  after  a  hearing  in  which  3,000  pages  of  evidence  was 
taken  and  281  exhibits  were  introduced,  the  court  granted  a  permanent 
injunction.     Bell  Telephone  Company  v.  Moijnihan  (38  F.   (2d)  77). 

On  December  1,  1930,  the  United  States  Supreme  Court  reversed  the 
lower  court,  and  sent  the  case  back  for  further  finding  of  facts,  the  injunc- 
tion continuing  in  force  in  the  meantime.  Smith  v.  Illinois  Bell  Telephone 
Company  (262  U.  S.  133). 

On  April  29,  1933,  upon  consideration  of  evidence  taken  in  a  hearing  which 
extended  over  5  months,  the  district  court  handed  down  another  opinion  again 
finding  the  rates  confiscatory,  and  ordering  the  same  permanently  enjoined. 
Illinois  Bell  Telephone  Company  v.  Gilhert  (3  F.  Supp.  595).  From  this  de- 
cision the  Commission  prosecuted  an  appeal,  which  is  now  pending  before  the 
United   States   Supreme  Court. 

This  case  has  been  in  the  Federal  court  for  more  than  10  years.  It  has  been 
before  the  United  States  Supreme  Court  four  times  during  that  time  and  is 
now  there  the  fifth  time.  Whether  this  is  the  end  nobody  knows.  (Hearings 
before  the  Committee  on  the  Judiciary,  House  of  Representatives,  73d  Cong., 
2d  sess.,  on  S.  752,  serial  4,  Feb.  27,  28,  Mar.  1,  1934,  pp.  70-71.) 

Another  illustration  of  the  opportunities  for  delay  which  litigation  affords, 
cne  which  can  only  be  adequately  gauged  by  a  lawyer,  is  presented  by  the  fol- 
lowing summary  of  proceedings  in  the  case  of  Gi-eat  Northern  Utilities  Co.  v. 
Public  Service  Commission  of  Montana  (88  Mont.  180,  293  Pac.  2M;  52  F.  (2d) 
S02 ;  1  F.  Supp.  328,  289  U.  S.  130)  : 

September  21,  1927:  Commission,  on  its  own  motion,  instituted  inquiry 
into  reasonableness  of  rates  charged  by  Great  Northern  Utilities  Co.  for 
natural  gas  at  Shelby,  Mont. 

November  29,  1927 :  Public  hearing  at  Shelby,  Mont.,  on  issues  involved. 

October  1,  1928 :  Further  public  hearing  at  Shelby,  Mont.,  on  issues 
involved. 

December  20,  1928 :  Public  hearing  upon  reasonableness  of  new  schedule 
of  rates  proposed  by  Great  Northern  Utilities  Co.  for  competitive  purposes. 

January  22,  1929:  Order  of  commission  rejecting  proposed  schedule  of 
utility  and  requiring  utility  to  establish  a  specific  schedule  of  rates  effec- 
tive February  1,  1929  (P.  U.  R.  1929--B,  176). 


154  MUNITIONS    INDUSTRY 

February  8,  1929:  Action  instituted  by  utility  in  State  court  to  have 
order  declared  null  and  void  and  enforcement  thereof  enjoined. 

November  15,  1929 :  Second  amended  complaint  of  utility  filed. 

November  22,  1929:  Answer  of  commission  filed. 

November  30,  1929:  Motion  for  judgment  on  pleadings  filed  by  utility. 

February  4,  1930 :  Motion  for  judgment  on  pleadings  granted. 

February  4,  1930  :  Judgment  rendered  against  commission  declaring  order 
null  and  void  and  permanently  enjoining  its  enforcement. 

February  8,  1930 :  Commission  files  appeal  to  Supreme  Court  of  Montana. 

April  3,  1930:  Commission  files  motion  to  advance  appeal  on  docket. 
Granted.    Argument  on  appeal  set  for  June  9,  1930. 

June  9,  1930 :  Appeal  argued  and  submitted. 

July  29,  1930:  Supreme  Court  reverses  lower  court  and  remands  cause 
for  proceedings  not  inconsistent  with  views  expressed  (88  Mont.  180; 
293  Pac.  294). 

September  2,  1930 :  Utility  petitions  for  rehearing. 

September  9,  1930 :  Commission  files  objections  to  petitioon  for  rehearing. 

November  25,  1930:  Petition  for  rehearing  denied  (88  Mont.  232). 

December  22,  1930:  Utility  files  action  in  Federal  court  (U.  S.  Dist.  for 
Montana)  alleging  same  identical  facts  as  in  State  case  and  requests  in- 
junctive relief  on  theory  order  violates  fourteenth  amendment  to  Constitu- 
tion of  the  United  States.  (Same  grounds  urged,  inter  alia,  in  State 
courts.) 

December  22,  1930 :  Utility  moves  for  injunction  pendente  lite. 

January  2,  1931 :  Commission  moves  State  court  for  setting  of  State 
case  for  trial.    Granted  and  case  set  for  trial  for  January  23,  1931. 

January  15,  1931 :  Commission  files  motion  to  dismiss  in  Federal  court 
case. 

January  21,  1931 :  Utility  files  praecipe  for  dismissal  of  case  in  State 
court. 

June  29,  1931 :  Application  of  utility  for  interlocutory  injunction  comes 
on  for  hearing  before  Sawtelle,  circuit  judge,  and  Bourquin  and  Pray, 
district  judges,  at  Helena,  Mont. 

June  29,  1931 :  At  suggestion  of  court  cause  is  submitted  on  final  hearing 
with  the  right  of  Commission  to  file  its  answer  to  bill  of  complaint  on 
same  date. 

June  29,  1931 :  Answer  of  Commission  filed  raising  the  same  identical 
issues  of  fact  as  were  raised  in  the  State  case. 

July  22,  1931:  Stipulation  between  parties  agreeing  that  the  case  is 
submitted  on  application  for  interlocutory  injunction  only  and  not  on 
final  hearing. 

August  18,  1931:  Decision  of  three-judge  court  filed  (Bourquin  and  Pray 
award  interlocutory  injunction  to  plaintiff — Sawtelle  dissents)  (52  F.  (2d) 
802). 

August  19,  1931 :  Interlocutory  injunction  issued  against  Commission. 

September  15,  1931 :  Petition  for  appeal  filed  and  order  of  allowance 
made. 

September  28,  1931:  Sawtelle,  C.  J.,  files  special  concurring  opinion  (52 
F.    (2d)   805). 

February  24,  1932:  Appeal  argued  in  Supreme  Court  of  United  States. 

February  29,  1932:  Per  curiam  order  afllrming  action  of  special  court 
issuing  interlocutory  injunction  "  without  prejudice  to  the  consideration 
and  determination  at  final  hearing  of  all  questions  of  law  and  fact 
*     *     *  "  (United  States  Daily,  issue  of  Mar.  1,  1932,  p.  5,  col.  1). 

September  19,  1932:  Final  hearing  before  a  three-judge  Federal  Court. 

October  5,  1932 :  Three-judge  Federal  court  issued  permanent  injunction 
against  the  Commission's  order  (1  F.  Supp.  328). 

November  26,  1932:  Commission  filed  appeal  to  the  Supreme  Court. 

March  23  and  24,  1933:  Argument  on  appeal  before  United  States 
Supreme  Court. 

April  10,  1933:  Decision  of  United  States  Supreme  Court  upholding 
Commission's  order  (289  U.  S.  130;  77  L.  Ed.  1080). 

May  15,  1933 :  Mandate  from  the  United  States  Supreme  Court  was  filed 
with  the  clerk  of  thie  lower  court. 

June  7,  1933:  The  Commission  moved  for  a  decree  in  accordance  with 
the  mandate.  The  utility  countered  with  a  motion  to  file  a  supplemental 
bill  on  the  ground  of  changed  conditions.  Before  decision  thereon  the 
utility  submitted  a  new  tariff  to  the  Commission  and  upon  receiving  the 


MUNITIONS    INDUSTRY  155 

approval  of  a  majority  of  the  members  of  the  Commission  it  secured  an 
order  of  dismissal  of  its  action  iu  the  Federal  court. 

June  26,  1933:  Order  of  dismissal  entered.  (Hearings  before  the  Com- 
mittee on  the  Judiciary,  House  of  Representatives,  73d  Congress,  second  ses- 
sion on  S.  752,  serial  4,  Feb.  27,  28,  March  1,  1934,  p.  267.) 
Further  examples  of  procrastination  are  furnished  by  Smith  v.  Illinois  Bell 
Teleijhone  Company  (hearings  before  the  Committee  on  the  Judiciary,  House  of 
Representatives,  73d  Congress,  2d  session,  S.  752,  serial  4,  Feb.  27,  28,  March  1, 
1934,  p.  308)  ;  the  Worcester  Light  Rate  case  (hearings  before  the  Committee 
on  the  Judiciary,  House  of  Representatives,  73d  Congress,  2d  session,  S.  752, 
serial  4,  Feb.  27,  28,  March  1,  1934,  p.  225)  ;  the  Los  Angeles  Gas  case  and  the 
Pacific  Gas  and  Electric  case  (hearings  before  the  Committee  on  the  Judiciary, 
House  of  Representatives,  73d  Congress,  2d  session,  S.  752,  serial  4,  p.  215,  March 
1,  1934)  ;  the  Central  Kentucky  Gas  Company  v.  Kentucky  Railroad  Commission 
(hearings  before  the  Committee  on  the  Judiciary,  House  of  Representatives, 
73d  Congress,  2d  session,  S.  752,  serial  4,  Feb.  27,  28,  March  1,  1934,  p.  69)  ; 
and  the  case  of  The  St.  Louis  and  O'Fallan  Railway  Company  and  Manu- 
facturers' Railioay  Company  v.  United  States  of  America  and  Interstate  Com- 
merce Commission,  279  U.  S.  461,  which  finally  upset,  iu  the  year  1927,  the 
valuation,  for  recapture  purposes  for  the  recapture  periods  of  the  years  1920 
1921,  1922,  and  1923,  respectively. 

An  estimate  of  average  delay  was  supplied  by  the  Alabama  Public  Service 
Commission,  with  respect  to  injunction  suits  generally,  in  the  following : 

(1)  Such  an  injunction  suit  is  attended  with  great  delay.  After  the  suit 
is  filed  and  the  preliminary  orders  of  the  court  are  made,  under  the  rules 
of  the  Federal  courts,  a  master  is  appointed  to  take  testimonv.  The  taking 
of  testimony  is  rarely  completed  in  less  than  a  year,  and  iia  our  opinion, 
the  average  time  so  employed  will  be  found  to  exceed  12  months.  Upon 
the  conclusion  of  the  taking  of  testimony,  there  is  then  a  submission  before 
the  master.  Upon  this  submission,  the  master  usually  takes  several  months 
m  considering  the  testimony  and  in  preparing  and  writing  his  report.  The 
case  then  goes  to  the  trial  court.  It  requires,  as  a  rule,  several  months  to 
get  the  case  submitted  to  the  trial  court  and  after  the  submission,  as  a  rule, 
several  other  months  before  there  is  a  decision  by  the  trial  court.  In  this 
way  it  requires,  ordinarily,  2  years  to  get  the  case  to  a  decision  by  the  trial 
court.  It  will  require  in  most  cases  most  of  another  year  to  get  the  cause 
submitted,  heard,  and  determined  by  the  Supreme  Court  of  the  United 
States. 

Certainly,  it  is  safe  to  say  that  it  is  rare  if  any  such  injunction  pro- 
ceeding can  be  heard  and  determined  both  by  trial  court  and  the  Supreme 
Court  of  the  United  States  within  less  than  2  years.  The  records  will  show 
that  many  of  such  cases  have  consumed  from  3  to  5  years  in  the  final 
determination  thereof.  (Hearings  before  the  Committee  on  the  Judiciary 
House  of  Representatives,  73d  Congress,  2nd  session,  S.  752,  serial  4  Feb' 
27,  28,  March  1,  1934,  p.  262.) 

Compare  also  the  Consolidated  Gas  case.  (Hearings  before  the  Committee  on 
the  Judiciary,  House  of  Representatives,  73d  Cong.,  2nd  session,  on  S.  752,  serial 
4,  pp.  14-15,  February  27,  1934.) 

In  addition  to  the  customary  cost  and  volume  indicia  of  the  difficulty  of  utility 
inquiries,  Mr.  Reis,  general  counsel  of  the  Wisconsin  Public  Service  Commission 
supplies  useful  data  in  connection  with  the  problem,  often  overlooked,  of  the 
stafe  required  to  administer  a  utility  investigation: 

Mr.  Reis  (general  counsel.  Wis.  Public  Service  Comm.). 

We  cited  you  in  our  memorandum  to  the  Wisconsin  Telephone  case 
which  IS  the  most  stupendous  utility  inquiry  ever  undertaken  in  Wisconsin' 
Over  2()  accountants,  45  engineers,  rate  specialists,  and  others  of  the  com- 
mission s  staff  will  have  worked  for  almost  3  years  on  this  investigation, 
compiling  a  record  to  date  of  7,500  pages  of  testimony  and  361  exhibits 
at  a  total  cost,  before  it  is  all  over,  of  roughly  a  quarter  of  a  million 
dollars. 

Parenthetically,  I  may  say  that  a  substantial  portion  of  this  quarter  of 
a  million  is  charged  back  to  the  utility  (and  doubtless  ultimately  as  an 
operating  expense  to  the  ratepayer).  This  charge  is  made  under  a  law  of 
Wisconsin,  which  allows  the  commission  to  assess  against  the  utility  for 
regulation,  up  to  four-fifths  of  1  percent  of  the  gross  annual  revenue  to- 
gether with    a    remainder   assessment  of  one-fifth  of  1   percent  of  gross 


156  MUNITIONS    INDUSTRY 

against  all  utilities.  This  gives  us  a  budget  of  approximately  $1,000,000, 
one  of  the  largest  in  the  country  (Hearings  before  the  Committee  on  the 
Judiciary,  House  of  Representatives,  73d  Cong.,  2d  session,  S.  752,  serial  4, 
Feb.  27,  1934,  pp.  22-23.) 

The  Neiv  York  Telephone  case  is  almost  staggering  in  the  voluminousness  of 
its  records  and  the  number  of  stages  at  which  comprehensive  preparation  and 
revision  was  required,  plus  the  delay  consequent  upon  the  taking  of  the  various 
possible  steps  in  commission-court  procedure: 

Reference  has  been  made  by  Senator  Johnson  and  by  the  President  of  the 
United  States  to  the  Neio  York  Telephone  case.  I  just  want  to  give  you 
a  lew  of  the  dates  regarding  that  case — just  a  few  of  them.  The  Presi- 
dent said  that  it  had  taken  7  years.  Well,  that  was  true  at  the  time 
when  he  had  last  heard  of  it,  at  a  certain  stage  that  they  had  reached. 
But  it  has  taken  nearly  10  years  to  get  it  through,  from  the  time  the  case 
was  started  until  the  last  decision  in  the  United  States  Supreme  Court. 

Now,  what  happened?  Going  back  to  1923,  before  the  Public  Service 
Commission  of  the  State  of  New  York,  there  were  proceedings ;  over  18,000 
pages  of  testimony  were  taken  in  those  proceedings.  There  were  728  ex- 
hibits and  129  hearings  had  been  held. 

Then  some  time  later,  in  1924,  there  were  further  proceedings,  nearly 
8,000  pages  of  testimony  were  taken,  and  307  exhibits  were  received. 

But  on  January  23,  1924,  when  the  company  applied  to  the  Commission 
for  increases  in  rates,  which  were  not  promptly  granted,  they  proceeded 
very  shortly  thereafter,  on  April  26,  1924,  to  seek  to  obtain  an  order  from 
the  Federal  court  restraining  the  enforcement  of  rates  by  the  Commission. 
On  May  1  they  received  an  order  for  the  enforcement  of  rates,  allowing 
a  surcharge  of  10  percent,  that  is,  allow  those  rates,  plus  10  percent,  in 
the  city  of  New  York,  but  no  increase  outside  of  New  York.  A  master  was 
appointed,  and  710  hearings  were  held  in  that  case,  after  all  of  the  hear- 
ings that  had  been  held  before  the  Commission ;  710  hearings  were  held 
before  the  master.  That  is,  they  started  de  novo.  They  did  not  take  any 
of  the  record  made  before  the  Commission.  They  started  to  make  a  new 
record  entirely.  Over  36,000  pages  of  testimony  were  taken  before  the 
master  in  that  case  and  3,800  exhibits  were  received. 

Mr.  Olfver.  And  most  of  those  were  duplicates,  were  they  not,  of  those 
that  had  been  received  in  the  State  court? 

Mr.  Maltbie.  I  would  say  so,  or  substantially  so.  You  see,  this  was 
started  in  1924,  and  they  did  not  finish  the  taking  of  testimony  until  1928. 
So  they  were  4  years  in  there,  after  starting  in  1924 ;  and  you  have  always 
to  take  additional  testimony  for  additional  years ;  and  proceedings  lasted 
4  years  before  the  master. 

Mr.  Maltbie  speaking,  Mr.  Condon   (Rep.)  : 

The  taking  of  testimony  was  finished  on  September  10,  1928.  That  was 
over  4  years  later  than  his  appointment.  Briefs  were  submitted  and  on 
March  11,  1929,  the  master  made  his  report  to  the  court.  Then  there  was 
oral  argument,  and  the  statutory  court  made  its  decision  November  7, 
1929,  about  6  months  later.  Of  course,  it  was  a  very  elaborate  record 
and  the  findings  were  elaborate,  and  about  6  months  were  taken.  (Hear- 
ings before  the  Committe  on  the  Judiciary,  House  of  Representatives,  73rd 
Congress,  Second  Session,  S.  752.  serial  4,  Feb.  27,  28,  March  1,  1934,  pp. 
10-11). 

Despite  his  extensive  investigation,  the  court  found  the  master's  valuation 
erroneous : 

The  statutory  court  refused  the  master's  valuation  over  $120,0(X),000,  but 
found  that  the  rates  did  not  allow  a  fair  return  and,  consequently,  that 
the  order  of  the  Commission  was  confiscatory. 

Now,  that  was  in  the  fall  of  1929.  Then,  of  course,  the  Commission  had 
to  take  testimony  to  fix  rates  in  accordance  with  that  order,  and  the  Com- 
mission proceeded  to  do  so.  But  the  company  was  not  satisfied  with  the 
decision,  and  filed  an  appeal  to  the  United  States  Supreme  Court.  That 
was  done  in  the  early  part  of  1930;  and  here  we  are  in  the  early  part  of 
1934,  and  there  has  just  been  a  decision  made  dismissing  the  appeal. 
(Hearings  before  the  Committee  on  the  Judiciary,  House  of  Representa- 
tives. 73rd  Congress.  Second  Session,  on  S.  752,  serial  4,  Feb.  27,  28,  March 
1,  1934,  p.  11.) 


MUNITIONS    INDUSTRY  157 

Compare  also  the  'New  York  Telephone  case,  Hearings  before  the  Committee 
on  the  Judiciary,  House  of  Representatives,  73d  Congress,  Second  Session,  on 
S.  752,  serial  4.  Feb.  27,  28,  March  1,  1934,  pp.  12,  13,  14,  23-24,  138,  141.  The 
complexity  of  this  particular  valuation  proceeding  is  all  the  more  significant 
when  taken  in  conjunction  with  the  frequency  with  which  the  New  York  Tele- 
phone Company  has  been  involved  in  litigation : 

there  have  been  cases  affecting  the  New  York  Telephone  Co.  beginning 
a  long  time  ago — well,  I  will  not  go  back  before  the  war ;  but  there  was 
one  in  1915,  and  there  were  some  before  that.  But  there  were  other  cases 
affecting  the  New  York  Telephone  Co.,  beginning  in  1919  and  1920,  and 
they  had  been  befoi'e  the  Commission  constantly  from  1919  and  1920  until 
1930,  and  we  have  had  two  or  three  since.  He  may  be  entirely  right.  I 
am  not  positive.  (Hearings  before  the  Committee  on  the  Judiciary,  House 
of  Representatives,  73rd  Congress,  Second  Session,  S.  752,  serial  4,  Feb.  27, 
28,  March  1,  1934,  p.  16.) 

3.  Valuation  DiFFBaiENCES  in  Connection  with  Taxation 

The  practical  administrative  difficulties  which  valuation  for  rate-fixing  pur- 
poses has  encountered  is  well  matched  in  valuation  procedure  as  related  to 
taxation.  The  number  of  taxpayers  with  valuation  difficulties  is  much  larger 
than  that  of  the  public  utilities,  and  the  pressure  caused  by  mere  numbers  has 
produced  a  tendency  to  settle  most  of  these  controversies  outside  of  the  courts. 
For  that  reason,  instances  of  delay  in  connection  with  taxation  valuations  are 
characteristically  found  to  be  cases  of  administrative  delay.  Some  indication 
of  the  complex  and  involved  procedure  that  may  be  undergone  in  connection 
with  valuation  for  tax  purposes,  and  the  amount  of  time  that  this  consumes, 
is  given  by  the  following  summary  of  proceedings  in  the  case  of  the  Union 
Natural  Gas  Co.,  of  Pittsburgh,  Pa. : 

A  review  of  the  files  of  this  case  shows  that  there  is  still  pending  an 
additional  tax  of  approximately  $200,000  for  the  year  1917.  There  have 
been  apparent  delays  on  the  part  of  the  taxpayer  and  the  Department  has 
not  been  able  to  close  this  case  for  any  year. 

The  following  chronology  best  illustrates  the  conditions  prevailing  in 
this  case : 

May  29,  1918 :  Schedules  filed  answering  questions  in  the  1917  tax 
returns. 

March  19,  1919:  Taxpayer  requested  to  file  valuation  data. 

April  3,  1919 :  Second  request  asking  for  valuation  data. 

April  4,  1919:  Taxpayer  desires  to  comply  with  request  for  valuation 
data  and  asks  extension  of  time  and  conference. 

April  8.  1919 :  Conference  granted  for  April  16. 

April  16,  1919 :  No  conference  memorandum. 

January  26,  1920 :  Taxpayer  asks  for  ruling  regarding  drilling  expenses. 

April  19,  1920:  Taxpayer  asked  to  file  affiliated  questionnaire. 

May  26,  1920 :  Second  request  for  affiliated  corporation  questionnaire. 

July  21,  1920 :  Third  request  for  affiliated  corporation  questionnaire ; 
given  to  August  16  to  reply. 

December  4,  1920 :  Taxpayer  refers  to  letter  of  January  26,  1920,  asking 
for  ruling  on  method  of  handling  labor  and  drilling  costs  for  gas  wells. 

January  4,  1921  :  Taxpayer  reminds  Department  in  answer  received  iu 
reply  to  letters  of  January  26,  1920,  and  December  4,  1920. 

December  9,  1920 :  Affiliated  corporation  questionnaire  received  by  De- 
partment. 

January  13,  1921 :  Coal-valuation  section  asks  for  data  to  substantiate 
coal-land  values. 

January  22.  1921 :  Taxpayer  asked  to  file  consolidated  income-  and 
profits-tax  return  for  1919. 

February  4,  1921 :  Coal-valuation  reports  mailed  by  taxpayer. 

February  12,  1921 :  Taxpayer  advised  regarding  drilling  costs  per  request 
of  December  4,  1920. 

August  1921:  Form  O,  oil  and  gas  valuation  data  for  1917,  1918,  and 
1919  received. 

October  10,  1921 :  Taxpayer  asks  for  conference.  Conference  arranged 
for  October  18. 

11579—35 11 


158  MUNITIONS    INDUSTRY 

December  13,  1921:  Taxpayer  preparing  amended  returns  for  1917  to 
3:  20,  asks  status  of  case. 

December  27,  1921:  Valuation  oil  and  gas  properties  in  progress  by  oil 
and  gas  section. 

January  3,  1922 :  Taxpayer  asks  for  extension  of  time  for  filing  amended 
returns. 

January  10,  1922:  Extension  granted  to  February  15,  1922. 

February  18,  1922 :  Taxpayer  asks  for  90  days'  extension  to  file  amended 
returns. 

February  28,  1922 :  No  extension  granted. 

March  1,  1922:  Taxpayer  asks  further  extension. 

March  18,  1922:  No  extension  granted. 

November  7,  1922 :  Letter  to  taxpayer  explaining  valuation  methods. 

January  29,  1923 :  Revenue  agent's  report  filed  showing  additional  tax 
for  1917,  $232,440.70. 

February  1,  1923 :  Conference,  oil  and  gas  section. 

April  30,  1923 :  Taxpayer  asks  for  conference. 

May  2,  1923 :  Conference  granted  May  10. 

May  11,  1923 :  Conference,  oil  and  gas  section,  discoveries  disallowed. 

January  10,  1924:  Assessment  letter  showing  additional  tax  for  1917, 
$198,190.75 ;  for  1918,  $2,719.30.  This  letter  shows  that  taxpayer  paid  for 
1917,  $446,676.13,  and  for  1918,  $289,400.58.  The  consolidated  net  income 
for  1917  was  $3,330,798.48,  while  the  aggregate  net  income  for  1917  was 
$4,-553,827.21.    The  consolidated  invested  capital  for  1917  was  $13,448,957.62. 

February  8,  1924 :  Protest  filed  regarding  A-2  letter  January  10,  1924. 

May  2.  1924 :  Taxpayer  asks  for  conference  May  13,  1924. 

Z>lay  13,  1924 :  No  conference  memorandum. 

July  22,  1924 :  Conference  held  in  oil  and  gas  section. 

August  21,  1924 :  Conference  held  in  consolidated  audit  section  with  re- 
quest that  another  conference  be  held  September  12. 

September  12,  1924 :  Conference,  consolidated  audit  section ;  certain 
balance  sheets  requested. 

September  23.  1924:  Balance  sheets  received  by  Department. 

October  21,   1924 :  Conference,  consolidated  audit   section. 

December  1,  1924:  A  300-page  revenue  agent's  report  received  covering 
the  years  1918  to  1921,  inclusive,  showing  additional  tax  due  of  $29,865.01. 

March  14,  1925:  Department  refers  to  taxpayer's  appeal  and  asks  for 
additional  information. 

April  2,  1925 :  Taxpayer  granted  extension  to  April  24,  1925,  to  file  addi- 
tional information.  (Senate  Report  No.  27,  69th  Cong.,  1st  sess.,  January 
7,  1926,  pp.  9&-97.) 

This  might  be  compared  with  the  long  and  involved  court  procedure  in  the 
Great  Northern  Utilities  Co.  case  described  on  pp.  — . 

The  delay  involved  in  this  connection  has  important  consequences,  inasmuch 
as  frequently  the  statute  of  limitations  bars  assessments  and  controversial 
issues  cannot  be  raised  because  the  statute  has  run.    For  example : 

In  the  Kennedy  and  Springer  case  (2981),  the  Government  lost  a  tax  of 
about  $200,000.  on  $2,903,353  of  profits  from  the  sale  on  an  oil  lease, 
because  of  delay  until  the  statute  of  limitations  barred  an  assessment. 
Senate  Report  No.  27,  69th  Cong.  1st  sess.,  January  7,  1926,  p.  97.) 

The  valuation  section  of  the  Bureau  of  Internal  Revenue  are  even  more  hope- 
lessly unable  to  keep  up  with  their  work  than  the  similar  units  in  the  Interstate 
Commerce  Commission,  see  pp.  6,  10.  Thus,  in  connection  with  the  work  in  the 
oil  and  gas  valuation  section : 

The  work  of  this  section  is  so  far  behind  that  up  to  March  1,  1925,  prac- 
tically all  effort  was  concentrated  on  valuations  for  1919  and  preceding 
years. 

In  March  1925,  the  engineering  division  had  1,318  more  5-year-old  cases 
undisposed  of  than  in  March  1923,  a  loss  of  progress  of  207  percent  in  two 
years.    i(e9th  Cong.,  1st  sess..  Senate  Report  No.  27,  January  7,  1926,  p,  96.) 


MUNITIONS   INDUSTKY 


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MUNITIONS    INDUSTRY 


163 


164 


MUNITIONS    INDUSTRY 


Exhibit  1402 

Refunds,   credits,   and  abatements  exceeding  $250,000  through  special  assessment 
allowed  from  July  1,  1921,  to  Apr.  SO,  1925 

[Sec.  210  of  1917  act;  sec.  328  of  1918  act] 

tFrom  S.  Kept.  27,  69th  Cong.,  1st  sess.,  p.  221  (1926)] 


Name  and  address  of  taxpayer 


Section 


Total  refunds, 
credits,  and 
abatements 


W.  Beckers  Analine  &  Chemical  Works  (Inc.),  New  York,  N.  Y.. 

Shoellkopf  Analine  &  Chemical  Works  (Inc.),  Buffalo,  N.  Y 

Jos.  Joseph  &  Bros.,  Cincinnati,  Ohio 

T.  A.  Gillespie  Co.,  7  Dey  Street,  New  York,  N.  Y.-. , 

Runyon  Corporation,  7  Dey  Street,  New  York,  N.  Y 

International  Shell  &  Ordnance  Co.,  New  York,  N.  Y... 

International  Loading  Co.,  7  Dey  Street,  New  York,  N.  Y 

American  Shell  Co.,  7  Dey  Street,  New  York,  N.  Y 

Pickands  Brown  &  Co.,  Chicago,  111 

Coca  Cola  Co.,  Plum  Street  and  North  Avenue,  Atlanta,  Ga 

Eockford  Mitten  &  Hoisery  Co.,  Rockford,  111 - 

Mass  &  Waldstein  Co.,  92  William  Street,  New  York,  N.  Y 

J.  F.  Duthie  &  Co.,  Seattle,  Wash. , 

Atlas  Crucible  Steel  Co.,  Dunkirk,  N.  Y 

R.  J.  Reynolds  Tobacco  Co.,  Winston-Salem,  N.  C. 

Four  Wheel  Drive  Auto  Co.,  CHntonville,  Wis 

Theta  Oil  Co.,  76  West  Monroe  Street,  Chicago,  111 

Hecla  Mining  Co.,  Wallace,  Idaho... 

Allegheny  Steel  Co.,  Pittsburgh,  Pa.. 

United  States  Branch  of  Employers'  LiabOity  Assurance  Corporation,  Boston, 
Mass. 


H.  W.  Johns-Manville  Co.,  Madison  Avenue  and  Forty-first  Street, New  York. 

Neuss  Hesslein  &  Co.,  New  York,  N.  Y 

Fulton  Bag  &  Cotton  Mills,  Atlanta,  Ga 

Fellows  Medical  Manufacturing  Co.,  New  York,  N.  Y 

Bessemer  Coal  &  Coke  Co.,  Pittsburgh,  Pa 

The  Centaur  Co.,  250  Broadway,  New  York,  N.  Y 

Whitaker-Glessner  Co.,  Wheeling,  W.  Va 

Four  Wheel  Drive  Auto  Co.,  CHntonville,  Wis - 

Globe  &  Rutgers  Fire  Insurance  Co.,  New  York,  N.  Y 

Atolia  Mining  Co.,  San  Francisco,  Calif 

Latrobe  Electric  Steel  Co.,  Latrobe,  Pa 

Curtis  &  Co.,  Manufacturing  Co.,  St.  Louis,  Mo - 

E.  J.  Lavine  &  Co.,  Philadelphia,  Pa 

American  Car  &  Foundry  Co.,  165  Broadway,  New  York,  N.  Y.. 

Cleveland  &  Western  Coal  Co.,  Cleveland,  Ohio 

Lindsay  Light  Co.,  116  East  Grand  Avenue,  Chicago,  HI.  (fiscal  year) 

Youngstown  Sheet  &  Tube  Co.,  Youngstown,  Ohio 

Northwest  Steel  Co.,  Portland,  Oreg 

Select  Pictures  Corporation,  New  York,  N.  Y 

Carbon  Steel  Co.,  foot  Thirty-second  Street,  Pittsburgh,  Pa 

New  Jersey  Worsted  Spinning  Co.,  Garfield,  N.  J.  (fiscal  year).. 

The  Otis  Steel  Co.,  1140  Leader  News  Building,  Cleveland,  Ohio... 

Jobbers  Overall  Co.,  Lynchburg,  Va - 

J.  B.  Inderrieden  Co.,  332  River  Street,  Chicago,  111. 

Bartlett-Hayward  Corporation,  Baltimore,  Md 

Gans  Steamship  Lines,  12  Broadway,  New  York,  N.  Y.. 

West  Virginia  Coal  Co.  of  Missouri,  St.  Louis,  Mo - 

Whitney  Blake  Co.,  New  Haven,  Conn 

Electric  Storage  Battery  Co.,  care  of  J.  M.  Haynes,  attorney,  Investment  Build- 
ing, Washington,  D.  C 

Kokomo  Steel  &  Wire  Co.,  Kokomo,  Ind 

W.  and  A.  Fletcher  Co.,  Hoboken,  N.  J 

J.  C.  Penney  Co.,  354  Fourth  Avenue,  New  York,  N.  Y. 

Pittsburgh  Steel  Products  Co.,  Pittsburgh,  Pa — 

Hartford  Machine  Screw  Co.,  Hartford,  Conn... 


210 
210 
210 
328 
328 
328 
328 
328 
328 
210 
328 
210 
328 
328 
328 
210 
328 
210 
328 

328 
328 
210 
210 
210 
210 
328 
210 
328 
210 
210 
328 
328 
210 
328 
210 
328 
210 
210 
210 
328 
328 
328 
210 
210 
328 
328 
328 
328 
328 
328 

328 
210 
328 
210 
328 
210 


1, 829, 

348, 

600, 

526, 

1,819, 

1,010, 

1, 943, 

456, 

316, 

279, 

462, 

330, 

788, 

1, 698, 

348, 

427, 

492, 

556, 


625. 19. 
141. 16 
757. 02 
629.  74 
091. 69 
009.  54 
919.  33 
170.  25 
256.  39 
453. 36 
713.97 
038.  34 
385. 15 
334. 88 
265.  47 
931.  60 
615.  57 
915.  80 
553.  59 


325, 270. 72 
519, 000. 87 

421. 378. 13 
352,  506. 86 
280,446.88 
261, 153.  57 
368, 063.  26 
353, 033. 07 
241, 334.  31 
450,011.32 
256, 018. 46 
426, 047.  32 
278, 336.  38 
521, 825. 00 

5, 209, 204.  74 
457, 324. 44 

316, 890.  33 

3, 482, 610.  51 
923, 235. 81 
384, 475. 17 

559. 039. 14 

401,  577. 98 

398, 629. 35 
331, 981.  62. 

265. 373. 04 
1, 443, 735.  21 

508,285.10 
402, 458. 00 
337, 332. 02 

640, 188. 12 

282. 426. 05 
388, 526. 84 
469,246.88 

1, 830, 227.  55 
914,497.97 


Total- 


39, 686,  500. 00* 


o 


BOSTON  PUBLIC  LIBRARY 


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