STATEMENT OF THE NATIONAL COUNCIL OF SAVINGS INSTITUTIONS

SUMMARY

1. The National Council supports passage of H.R. 1343.

2. Under section 593, savings banks have historically been required to meet a 72% asset test level to qualify for the full percentage-of-income bad debt allowance.

3. Changes made in ERTA in 1981 to make clear that savings banks with stock form of organization qualify for 593 BDA treatment unfairly penalize stock savings banks by requiring them to meet an 82% asset test level.

4. There is no tax policy or organizational reason to treat savings banks which opt for stock form of organization differently for purposes of the BDA than when they were organized as a mutual. In fact, current tax policy runs counter to public policy expressed in the Garn-St Germain Act of 1982, which allowed stock form of ownership to enhance the capital base of savings institutions.

5. Section 594 of the Code, alternative tax for mutual savings banks conducting life insurance business, should be modified to assure parity for stock savings banks.

STATEMENT

Mr. Chairman and members of the Subcommittee, my name is William P. Morrissey, Executive Vice President for Corporation Affairs, The Boston Five Cents Savings Bank. I am here today to present the views of the National Council of Savings Institutions on H.R. 1343, introduced by Congressman Lowry of Washington.

The National Council represents approximately 600 savings institutions having $400 billion in assets. Our membership consists of state and federally chartered savings banks and savings and loan associations. Among these are both stock and mutual savings institutions. A relatively new organization, the Council was formed on November 1, 1983, through consolidation of the National Association of Mutual Savings Banks and the National Savings and Loan League.

The National Council strongly supports H.R. 1343. This legislation is absolutely necessary to achieve parity between mutual and stock savings banks for purposes of the bad debt allowance granted by section 593(b)(2) of the Internal Revenue Code. We would also recommend that the bill be expanded to include parity for stock and mutual savings banks under section 594 of the Code which relates to the tax treatment of income from life insurance activities of savings banks. We will expand on this matter later on in our testimony.

Section 593(b)(2)—Percentage of taxable income bad debt allowance

Savings institutions are allowed to deduct reserves against loan losses under a percentage of taxable income formula contained in section 593(b)(2) of the Internal Revenue Code. Savings banks and savings and loan associations receive the full bad debt deduction of 40 percent if they maintain a percentage of their assets in specified, housing related assets as described in section 7701(a)(19)(C). For savings banks, this investment percentage has historically been 72 percent. For savings and loans, it has been 82 percent.

Until 1981, the Internal Revenue Code contained references only to mutual savings banks in sections 591 and 593, although the statute covered both stock and mutual savings and loan associations. The lack of reference to stock savings banks was simply because there were, until 1980, no such entities. Savings banks were traditionally chartered by the individual states and were of mutual character. In 1980, the first state granted authority for stock savings banks. In 1978 federal charters for savings banks were authorized and federal stock charters were permitted in 1982. Since the Internal Revenue Code referred only to mutual savings banks in section 591, 593 and 594, an amendment to the Code was adopted during consideration of the 1981 Economic Recovery Tax Act (ERTA) which clarified that stock savings banks qualified for the Percentage of Income Bad Debt Deduction under section 593(b). Unfortunately, the assist test requirement was set at 82 percent-that required of savings and loans, rather than at the traditional 72 percent required of savings banks. It has been suggested to us that this was the "price" extracted by the Treasury Department for its support of extension of section 593 treatment to stock savings banks.

Thus, a mutual savings bank converting from mutual form of ownership to stock form of ownership immediately faces a mandate to increase its "qualified" assets from 72 percent to 82 percent in order to qualify for the full BDA. This effectively denies them the full use of the section 593(b) deduction because they cannot easily change their asset mix to meet a test 10 percentage points above the traditional standard of 72 percent.

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Not only does the asset test level as it currently applies to stock savings banks deprive them of use of the full bad debt allowance, it also serves as a penalty for and a discouragement to conversion to stock charter. This runs counter to public policy as expressed in the Garn-St Germain Act of 1982, which authorized stock charters. It is certainly not a desirable result at a time when these institutions are recovering from a devastating economic situation and facing uncertainty in the near future. These institutions need to have all available options to increase their capital base and strengthen their net worth. The rebuilding of capital is not just in the best interest of the savings banks involved. It is equally in the best interest of the FDIC, the Congress, and the public at large.

Finally, the current application of an 82 percent asset test to stock savings banks make no sense. Conversion to stock form does not produce changes in the characteristics and investment powers of a savings bank. It is simply a change in the form of ownership.

Section 594-Tax treatment of life insurance activities of savings banks

A second area where the tax code creates inequities between mutual savings banks and stock savings banks is section 594, which relates to the tax treatment of the life insurance business of savings banks. Currently, the law allows alternative tax treatment for only mutual savings banks conducting life insurance business. This is again a section of the Code that was not updated concurrently with the development of stock savings bank charters.

Certain states in the past have granted to savings banks the authority to operate a life insurance business. These states are Connecticut, Massachusetts and New York. Savings Bank Life Insurance (SBLI) has been offered in Massachusetts since 1908, in New York since 1939, and in Connecticut since 1941. The insurance is consistently rated at or near the top in terms of consumer value every independent study.

This is how Consumer Reports summed up this unique consumer service in a study published in February 1980:

"Special bargains are available to some buyers. Residents of Massachusetts, or people who work there, have an excellent buy available in the form of Savings Bank Life Insurance, sold by savings banks. Savings Banks in New York and Connecticut also offer low-priced life insurance."

We think stock savings banks in these states should be encouraged to continue offering this product.

The tax code, in section 594, provides a special rule for tax treatment of income from the life insurance business of savings banks. The provision allows such income to be taxed under the rules for life insurance companies, as if the life insurance business of the banks were operated as a separate company. Section 594 uses the term mutual savings bank because, as pointed out earlier, there were no stock savings banks until the early 1980's.

In 1981, when the amendment to ERTA relating to stock savings banks was adopted by the Senate, it provided the BDA for stock savings banks and included provisions which granted equal tax treatment for life insurance income of mutual and stock savings banks. It was also the understanding of parties involved that the provision was included in the Conference Agreement on ERTA. The Conference Report on the Economic Recovery Tax Act of 1981 states:

". . . the Senate amendment extends the special rule under which mutual savings banks can compute their tax on life insurance business as if it were a second corporation to stock associations which are regulated as mutual savings banks."

The Conference adopted the Senate amendment.

Unfortunately, questions have arisen about the section 594 application to stock savings banks because the final language failed to strike portions of the section which used the term mutual saving bank.

We, therefore, would ask that section 594 be amended to clearly allow equal tax treatment of life insuarnce income of mutual and stock saving banks.

CONCLUSION

In summary, we strongly urge adoption of the provisions contained in H.R. 1343 and would urge the inclusion of provisions amending Section 594 to assure parity for stock institutions in that area.

While the specific purpose of this hearing is of a narrower focus, I would like to take this opportunity to share with the Subcommittee the Council's recommendation that the asset test be reduced to 72 percent for savings and loan associations. Given the economic realities of today and the increasing similarities in powers of

savings banks and savings and loans, we believe such action is necessary and we urge the Subcommittee to give this action its full consideration.

This change would allow the savings and loan industry to modify its asset structure as authorized in the Garn-St Germain Act of 1982 in order to provide a cushion against future downturns in the mortgage market-thus resulting in a stronger industry. Even such limited restructuring of the asset base will take time. It is, therefore, important that the bad debt allowance be used in this transition to build a reserve base that will provide stability and strength for the industry and for the financial system as a whole.

I appreciate the opportunity to appear before you and present the views of the Council. I will be pleased to answer any questions the Subcommittee members may have.

Chairman STARK. Mr. Tuccillo, we just went through this in the life insurance industry. I have a hunch we will be looking at the taxation of banks. Senator Dole has a particularly warm spot over the way banks have been helpful in passing legislation to help us improve compliance. I think he wants to return the favor next year. There are some of us who would like to help him in that endeavor.

But, first of all, what about if we could calculate the economic income of banks, savings and loans, various lending institutions, and put some kind of a minimum tax-either make them all operate on historic loss, economically making more sense, and with a variety of carryback and carryforward provisions-wouldn't do away with this as larger banks, then these banks cross over into various lines of businesses-it seems to me somebody shouldn't save money just because they happen to sell insurance through a structure of a bank. Or should they be penalized because they happen to be an installment loan provider through the format of a finance company?

It seems to me those distances are bleeding away, and we could— we tried to do it in the insurance thing—if there is a need to adjust the net taxable income, we just adjust it and say, OK, as in the case of the insurance companies where you get to deduct 25 percent. We have to equalize the various financial institutions by doing it that way rather than filling the Code with a bunch of deductions which really no longer serve their purpose, unless there are a few savings banks left who just do mortgages and really nothing else.

Would that be acceptable to your association?

Mr. TUCCILLO. I think you raise a number of issues. Let me try and distinguish between short- and long-term issues.

In the short run essentially what we are asking for here is a restoration of equity between savings banks with two different types of charter. As long as the law reads as it is, we feel that all savings banks should be treated as

Chairman STARK. There is a reason for that, is there not? In the mutual bank, all of the reserves stay to protect the integrity of the assets which guarantee the depositors. In a stock company, they could indeed dividend out some of the money and, therefore, it doesn't have the same public interest as allowing large reserves that a mutual company would have.

Mr. TUCCILLO. The difference in practice is probably not as great as it sounds in theory, because the stock association is subject to the dictates of the market and has to hold a sufficient amount of

capital and surplus to convince potential buyers the stock is worthwhile.

To get to your second point, the longer run concerns that you expressed a moment ago, the council doesn't object to that kind of thorough review. About 10 years ago I was coauthor of what at the time was probably the foremost study of taxation of thrift institutions.

One of the problems we encountered in doing this study was the definition of economic income for any kind of financial institution. That is a fairly major problem. You can pick out an aspect of the Tax Code here for savings banks, an aspect there for savings and loans, an aspect there for commercial banks.

But the point is that the taxation of financial institutions has become such a complex weave that to say you can define economic income in this way for these institutions becomes a very complex problem.

The council is not opposed to a comprehensive review. I believe the Treasury representative this morning suggested that the Treasury is in favor of that, as well. We think in the longer run that may serve the interests of all financial institutions as well as public policy purposes.

But we see that as a very much a long run and very much a difficult concern.

Chairman STARK. Can you think of any reason why any growing bank or savings and loan, or savings banks, that is growing, and relatively not overcapitalized should pay any Federal income tax? With all the options and strategies available, it is pretty hard to conceive of any of them paying any anyway.

Mr. TUCCILLO. It is certainly the case with banks, commercial banks. Again, going back to my earlier studies, we are looking at commercial banks-we were fairly surprised at the degree to which banks can avoid taxes—in the subsequent 10 years the stories have become much more public.

With savings institutions, however, it is a slightly different point of view. The regulatory system is such that with the savings institutions if you are not explicitly allowed a certain power, then it is forbidden to you.

With banks it works the opposite. If you are not specifically forbidden to do something, you are allowed to. So the amount of leeway which savings institutions have is less.

For the most part, savings institutions which are growing and well capitalized have more options to minimize their tax burden than do other types of savings institutions but far less than do commercial banks in a similar or even a worse situation.

Under those circumstances, I think it is pretty hard to avoid paying some taxes for a growing institution. For the majority of the industry, however, which is not growing, it is awfully difficult to do those kinds of maneuvers.

In effect, a lot of the industry doesn't pay taxes simply because we don't have any income. It is a situation which we would certainly like to see remedied much more than the Congress, I am sure. For those with positive income, those savings institutions who are in a normal slow growth situation, it is very hard not to pay taxes. Chairman STARK. Thank you very much.

Mr. TUCCILLO. Thank you.

Chairman STARK. I am pleased to call the next panel. Mr. John Heilman, and Donald Alexander, counsel, for the Disabled American Veterans: Ellen Kay Hatch, national executive director of the American Kidney Fund, and William Lehrfeld, counsel.

They are here to testify on H.R. 1773, a piece of legislation introduced by the distinguished gentleman from Tennessee and the ranking member of our subcommittee, Mr. Duncan.

We have the prepared statements of all of the witnesses. If you would like to proceed to summarize them or expand on them in the order in which your names were called-it would be Mr. Alexander, Mr. Heilman, Ms. Hatch, and Mr. Lehrfeld-proceed.

STATEMENT OF DONALD C. ALEXANDER, COUNSEL, DISABLED AMERICAN VETERANS

Mr. ALEXANDER. Mr. Chairman, I don't propose to read my prepared statement. I do want to comment on what the Treasury had to say. The Treasury takes the position that an exchange of a limited right in a membership list is somehow a commercial activity that has to be taxed-whether the exchange is with another charity that is trying to build up its list of contributors, or with anyone else.

Now, a charity, unless it is a private foundation, has to get money from the public in order to carry on its charitable work. Perhaps the best way for a charity to solicit is through the mails.

Perhaps that is the most effective way, the least intrusive way, and the way that is least competitive with others. And a charitable list, the DAV's list, is not the same as the Tiffany list, Horchow's list, or the list of people trying to sell jojoba beans, for instance. Now, we find in the Internal Revenue Code that if a charity engages in a trade show, a bingo game, or rents telephone polls, that is not considered to be competitive and not subject to tax. But we do find kind of a strange court case that holds that rentals of mailing lists, followed up by exchanges of mailing lists—you don't give up the entire list-somehow is unrelated business income.

A charity has to maintain its mailing list in order to keep up its charitable activities. There is attrition every year.

You lose people, people move, people die, people lose interest in the charity. The only way to maintain your list is to mail to more people.

And the only sensible way to mail to more people is to mail in a way that is best designed to produce a return to the charity because those people are going to be interested in supporting that charity.

Where do you get the names? You get the names through exchanges of limited mailing rights with other charities. That is the best way to get it-if your list is not much larger than someone else's.

If your list is larger, you can maintain your list by giving limited rights to others, renting names to others, and then plowing that money back, and more back, into obtaining additional names.

That is what we are talking about. There is nothing commercial about it.