Knowledge that Transforms

I APPRECIATE the opportunity of replying to Professor Guthmann's gracious note. In the hope that some sources of confusion in my paper may thus be eliminated, I shall consider what I believe to be his principal contentions: (1) That my chart' shows the dividend-earnings ratios for 1936 and 1937 significantly below normal; that this implies the undistributed profits tax had the effect of causing retention of earnings; and that this extraordinary result casts doubt on the validity of the analysis. (2) That a better understanding of the effects of the tax is to be obtained from his time series chart of the Cowles Commission indexes of dividends and earnings; and that this chart shows the proportion of earnings distributed in 1936 and 1937 to have been exceptionally high. (3) That from the point of view of individual business men the effect of the tax upon aggregate earnings distribution isimmaterial; and that the law as drafted was inequitable, in that it placed the greatest burdens on small corporations without access to the capital market, and on corporations with large debts or deficits. First, the chart referred to (p. 344) was presented as a simple scatter diagram and not as a regression analysis precisely because I was unwilling to assign a normal percentage of earnings to be distributed at each level of business activity. While a general negative relationship between the dividend-earnings ratio and activity is familiar to all students of this problem, and is borne out by the scatter diagram, the myriad factors other than business activity which must influence corporate distribution decisions would make dependence on a mathematical equation relating these two factors alone foolhardy in the extreme. While I believe industrial activity to be the most important single variable influencing the dividend-earnings ratio, I recognize that only a third (31 per cent actually) of the variability in the latter may be accounted for by the former. If the years in which dividends exceeded earnings be omitted (a procedure Professor Guthmann advocates elsewhere in his note, but with which I cannot agree-cf. pp. 343, 345), the points for 1936 and 1937 lie even closer to the regression line; they are certainly neither significantly above nor below it.

ON READING Mr. McIntyre's article' on the undistributed profits tax one is chiefly impressed not that he reaches the conclusion that the tax has no appreciable effect on dividend distributions but that his chart apparently indicates that the tax actually had the effect of causing a distribution that was very much below normal. His scatter-chart showing the ratio of dividends to earnings on the vertical scale and the per cent of industrial activity to on the horizontal scale shows a negative relationship as would be expected. But the two data for 1936 and 1937, the two years during which the tax was in effect, while showing a relatively high distribution compared with the mass of data, are considerably below and to the left of this main island of cases. The impression conveyed to the reader is that the dividend distributions of 1936 and 1937 were really quite low when read in the light of industrial activity. Thus it appears that the undistributed profits tax has the effect of causing retention rather than distribution of earnings. A possible explanation of this extraordinary result would lie in the definition of normal industrial activity for the years 1936 and 1937. As in most indexes of normality weighted heavily with the tendencies established in the 1920's there may well be a considerable overstatement of the normal trend line. The data which will establish current normality lie in the future and so are indeterminate. The final data for any trend or normal series are the most uncertain and the whole significance of the chart used in this article depends upon the accuracy of this normal for the last two years, 1936 and 1937. If a lower normal for industrial activity were established, the present position of the dividends-to-earnings ratios would move to the right and so alter the picture at its crucial point. A simpler and clearer picture is obtained by merely charting the Cowles indexes of earnings and dividends. Reference to the accompanying chart, Figure 1, showing these figures, leads one to the conclusion that the proportions of earnings distributed in 1936 and 1937 were comparatively high. Of the years in which dividends were less than earnings (and so bore a substantial relation to that year's earnings) only eight years showed a higher per cent than 1936 and 1937, three were within the range of the 1936 and 1937 data (74.4 per cent and 78.7 per cent), and forty-seven were lower.