LEGISLATIVE HISTORY OF THE ALLOWANCE OF LIFO FOR TAX PURPOSES
Abstract: The legislative history of the allowance of LIFO for tax purposes is documented. The legislative process was structured around veto points of the law and yielded an examination of the political environment out of which the LIFO tax provisions emerged. LIFO provisions were analyzed relative to alternative tax options available to firms, administrative and judicial activities, overall tax legislation including tax rates, and general economic conditions. Production processes of firms lobbying for LIFO were examined and the views of academics and practitioners were incorporated. In addition to providing the basis for a regulatory event study by identifying the critical dates in the legsilative process, insight into the timing and choice of inventory accounting methods for financial reporting as well as for tax is gained.
LIFO, the last-in, first-out inventory accounting method, has been a topic of interest to accounting researchers in several areas, including capital market research, financial statement analysis, inventory policy, taxation, and history. In one way or another, most of these research efforts have attempted to provide evidence on the general issue of whether the use of alternative accounting policies matters. Assuming it does, the next question is whether to allow managers to choose accounting methods or to impose uniform methods.
What makes LIFO such an appealing method to study in this area of research is the direct link between book and tax reporting which results from the statutory conformity rule. That is, LIFO may be used for tax purposes only if it also is used for financial reporting purposes. LIFO produces lower accounting.
I gratefully acknowledge the helpful comments received at various stages of this research from Nick Dopuch, Silvia Madeo, Powell Niland, Grace Pownall, Gary Previts, Bob Virgil, Steve Zeff, participants at the Tax History Conference at the University of Mississippi, and two anonymous referees. I also wish to thank William Cooper, Gary Previts, and Alfred Roberts for providing me with unpublished materials.
income in periods of rising prices, but higher after-tax cash flows. There has been speculation that managers may forego higher after-tax cash flows in favor of higher reported earnings. This speculation motivated a number of researchers to assess the stock price behavior associated with firms’ LIFO adoptions [e.g., Sunder, 1973; Ricks, 1982; Biddle and Lindahl, 1982]. The two opposing hypothesis were (a) the market can “see through” accounting income and will reward adoptors; (b) the market will penalize such adoptors. Unfortunately, such studies suffer from two major problems: (1) when do market agents become aware of a firm’s decision to voluntarily switch to LIFO? and (2) how should the researcher control for confounding factors such as changes in earnings? While progress has been made in dealing with these problems [e.g., Stevenson, 1987; Biddle and Ricks, 1988], results presented in Dopuch and Pincus  suggest that the use of an event date near the end of the year in which firms first announce that they have adopted LIFO may miss a large part of the potential market response to the event.
Speculation that managers forego tax savings under LIFO for higher reported earnings (and assets) also motivated re-searchers to attempt to identify the determinants of accounting choice [e.g., Abdel-khalik, 1985; Hunt, 1985; Lee and Hsieh, 1985; also see Chasteen, 1971]. There is some evidence that debt constraints may explain inventory choices, but little if any support that management compensation plans do. Recently, Dopuch and Pincus  provided considerable evidence that inventory choice and tax savings are related. However, some nontax explanations also were supported, and data were not available to conduct tests to distinguish between the alternative explanations.
Somewhat concurrent with the development of these trends of research is the attempt to assess stock price effects of new laws and regulations impacting on firms’ operating, financing, and investment decisions [e.g., Schipper and Thompson, 1983; Binder, 1985a; Madeo and Pincus, 1985; Pownall, 1986]. Obvi-ously, a researcher interested in the impact of LIFO adoptions could conceivably assess stock price effects of legislative changes that led to the allowance of LIFO for tax purposes. For example, firms could be selected on the basis of such things as having previously adopted LIFO for book purposes, belonging to industries actively engaged in lobbying for LIFO, and/or having operating characteristics that suggest LIFO use would be beneficial for tax or other reasons. To the extent that such firms benefit more from LIFO relative to the market as a whole, stock prices at the time of key legislative events should reflect the capitalized value of the future tax benefits derived from using LIFO for tax purposes multiplied by the probability that a sample firm will in fact adopt LIFO.
There are, of course, problems in implementing such regu-latory event studies. One set of problems concerns statistical analysis. Changes in the regulatory regime impact all firms at the same points in time, and firms most affected typically are from related industries. Hence, the researcher is not able to randomize the sample selection over time or across firms. Progress, however, has been achieved by applying the econometric technique of generalized least squares and developing conservative statistical estimators [e.g., Schipper and Thompson, 1985; Binder, 1985b].
Another problem concerns the identification of the critical events in the legislative process. Prior research has used some-what ad hoc approaches with mixed success [e.g., Schipper and Thompson, 1983; Binder, 1985a]. Ideally, the choice of event dates should be based on theories that model the regulatory process and its inherent critical steps. Researchers could then rely on these theories to isolate those dates that are predicted to be significant information events. However, no such general theory currently exists, although recent research by political economists provides the outlines of a framework for improving the selection of event dates [e.g., Cox et al., 1987a and 1987b; Gilligan and Krehbiel, 1988; Weingast, 1988; also see Pownall and Pincus, 1988]. One approach, referred to as “gates and signals,” focuses on the veto points in the legislative process. “Gates” are hurdles that any proposed bill must clear prior to enactment; and “signals” are information disclosures about the likelihood of passage through a future gate. While dating the passage through a “gate” (e.g., a vote on the Senate floor) is usually not difficult, dating the occurrence of “signals” about the likelihood of passage can be problematical. It is here that a thorough examination of the historical record is required.
The purpose of this study is to document the legislative history of the allowance of LIFO for tax purposes in order to provide a reliable basis for identifying such critical events. This research thus supplements that of Davis  who provided a history of LIFO from the development of the base stock method through the allowance of dollar-value LIFO (and beyond). The legislative histories that are developed are structured around the veto points of the law. The focus of this investigation was on gathering information about LIFO-related statements and activities of interested parties at each stage of the legislative process, and on documenting the level of disclosure and understanding of the implications of proposed legislative remedies. In this way the political environment out of which LIFO legislation emerged was examined [see Merino et al., 1987]. Such a review of the LIFO legislative process will highlight the potential benefits and costs of performing such detailed studies of legislative changes.
The first LIFO provision was included in the Revenue Act of 1938, and then was replaced with a new provision in the 1939 Act. I begin, however, in 1936 since the issue of taxation of inventory profits was raised (again) during Congressional committee hearings, and as a result, industry lobbyists were referred to and had discussions with Treasury Department officials on the issue over the next two years. I end with the 1942 Revenue Act since the major legislative developments were completed by then.
Special consideration was given to the analysis of the substantive economic, accounting, and tax issues related to LIFO. Legislation was analyzed relative to the menu of related tax options available to firms, the significant LIFO-related administrative and judicial activities, the overall thrust of particular tax legislation including changes in tax rates, and the general economic conditions prevailing at the time. In addition, the production processes of industries lobbying for LIFO were examined, and the views of academics and practitioners were reviewed. Hence this research also provides insight into both tax legislative processes and the choice of accounting methods for book purposes. For example, the extent to which tax bill drafting was followed in the press, even though it was conducted behind closed doors, is documented, as is how close tax substitutes to LIFO arose or disappeared as part of legislative compromises. Also, the notion of the “best” accounting method for inventory is explored, and some additional evidence about time clustering regarding LIFO adoptions is presented. And, of course, the emergence of the conformity rule is traced.
I relied principally on transcripts of Congressional commit-tee hearings and floor debates. Various secondary sources, including books, articles, and tax services also were used. Particularly with regard to closed committee sessions, news reports in the financial press were the most timely and often the only source of information. Finally, memoirs and interviews with key participants also proved useful. Additional details about the approach are in the Appendix.
The remainder of the paper is organized around each of the four tax acts examined. A concluding section provides suggestions for future research.
REVENUE ACT OF 1936 AND BEFORE
The provision regarding inventory valuation entered the Internal Revenue Code in 1918 and read as follows:
Whenever in the opinion of the Commissioner [of the Internal Revenue Bureau] the use of inventories is necessary in order to determine the income of any taxpayer, inventories shall be taken by such taxpayer upon such basis as the Commissioner, with the ap-proval of the Secretary [of the Treasury], may pre-scribe as conforming as nearly as may be to the best accounting practice in the trade or business and as most clearly reflecting the income.
Originally referred to as Section 22(c), this provision ap-pears in virtually identical form as Section 471 in the 1986 Code. Notice that specific inventory accounting methods were not listed; hence, a LIFO-like method was not explicitly prohibited. Nevertheless, this provision was interpreted by the Treasury Department as requiring inventories to be valued at cost or at the lower-of-cost-or-market (LCM), where cost was defined as first-in, first-out (FIFO) or in some cases as average cost [Harvey, 1937; Butters and Niland, 1949, p. 156]. In particular, the base stock method was prohibited by Treasury as early as 1919. Similar to LIFO, base (or normal) stock attempts to match current costs against current revenues.1 While an appeals court ruled in favor of a firm using base stock in 1925, a unanimous Supreme Court decision in 1930 disallowed normal stock methods [Davis, 1982, pp. 6-7]. The year-to-year inventorying of a fixed quantity of goods at a constant price, which meant that an inventory gain of one year was offset against an inventory loss of another, was not permitted for tax purposes under a system that taxed income on a yearly basis [Lucas vs. Kansas City Structural Steel Co., 281 U.S. 264].
The combination of several factors led some interested parties to lobby for a LIFO-like provision in connection with debates on the Revenue Act of 1936. First, wide fluctuations in certain commodity prices had occurred beginning in the late
1Hence it is consistent with the maintenance of physical operating capacity. See, e.g., Butters and Niland , chp. 11, and Davis  for comparisons of the base stock and LIFO methods.
1920′s and gave rise in some industries to significant holding-losses followed by holding-gains — referred to as inventory profits. For instance, the wholesale price index fell from 61.9 for 1929 to 42.1 for 1932, and then rose to 52.0 by 1935.2 Second, it was proposed in the 1936 revenue bill that the top marginal corporate tax rate would rise from 133/4 to 15%, and the existing tax on excess profits would rise from five to between six and 12% [CCH, 1935-1937]. Third, the proposed act included a provision to tax undistributed profits at rates as high as 27%. This would be done without distinguishing between inventory profits and operating profits — just like the income tax. Fourth, potentially close tax substitutes for LIFO — e.g., operating loss carryovers, income averaging, deductibility of inventory reserves, as well as the base stock method — were not available.
A representative of the Tanners’ Council of America submitted two briefs asking for tax relief for inventory profits before the House of Representatives Committee on Ways and Means (W&M) on April 2 in its hearings on the Revenue Act of 1936 [Hearings, 1936, pp. 379-83]. There was no discussion of the issues raised, and the House bill that emerged, H.R. 12395, made no changes to Section 22(c).
A Wall Street Journal (WSJ) article [Cotter, May 4, 1936] noted that the Revenue Bureau did not recognize normal stock or LIFO methods, and without them it was claimed that the proposed tax bill would be ruinous to many companies. Several witnesses appeared with regard to the taxation of inventory profits at hearings on H.R. 12395 held by the Senate Committee on Finance (hereinafter Finance). Included were representatives of the tanners industry and the American Mining Congress. Specific proposals were made to amend Section 22(c) to allow the “normal or necessary stock method in those industries in which the taxpayer consistently keeps his accounts in accordance with such methods” [Finance Hearings, 1936, pp. 627 and 718]. Witnesses were referred to Treasury Department experts to discuss further the acceptance of normal stock methods even though Treasury’s predisposition to insist upon the use of FIFO and judicial precedent against the use of normal stock were noted [Finance Hearings, 1936, pp. 716-9 and 1938, p. 147].
Not surprisingly the tax bill that ultimately became law in 1936 did not reflect any changes in Section 22(c) but did include the above noted increase in corporate tax rates and tax on
2Wholesale Price Index = 100 for 1947-49. Source: U.S. Department of Commerce, Business Statistics .
Pincus: Legislative History of the Allowance of LIFO for Tax Purposes 29
undistributed profits [U.S. Statutes, 1936, pp. 1648-756]. Rela-tive to other corporations, the 1936 Act was bad news for firms for which inventory profits were substantial. Such firms were at a relative disadvantage in paying cash dividends to avoid the undistributed profits tax or in paying the undistributed profits tax itself — as well as paying the regular income tax — because inventory profits do not generate cash. Interestingly, the word LIFO or phrase “last-in, first-out” were never mentioned in the Congressional hearings.4 Rather, the issue of taxing inventory profits was raised but only the normal (or base) stock method was specifically mentioned. A chronology of events in the legislative history of the 1936 Act appears in Table 1.
Table 1 Chronology of LIFO Events, Revenue Act of 1936
Thu., 4/2 Witness raises inventory profits issue before W&Ma (in WSJ).
Tue., 4/21 W&M report: no tax-relief for inventory profits (WSJ 4/22).
Wed., 4/29 H.R. 12395 passes House (WSJ).
Mon., 5/4 WSJ article: negative impact of proposed tax legislation in
absence of LIFO-like methods.
Thu., 5/7 Witnesses/Proposals presented before Finance re: inventory
profits (WSJ 5/8).
Mon., 6/1 Finance report: no change to Section 22(c) (WSJ 6/2).
Fri., 6/5 Amended H.R. 12395 passes Senate.
Fri., 6/19 Conference Committee Report approved by House: no change to
Sat., 6/20 H.R. 12395 approved by Senate.
Mon., 6/22 H.R. 12395 signed by President.
a W&M and Finance are abbreviations for the House of Representatives Committee on Ways and Means and the Senate Committee of Finance, respectively.
REVENUE ACT OF 1938
The second “recession” of the 1930s was gripping the nation by late 1937. The average annual post-depression (1934-1936) rate of growth in real GNP of 11% would be halved in 1937 and become a negative 4.6% in 1938.5 Business stimulation via tax revision was widely accepted as Congress met in a special
3See the WSJ [November 10, 1937, pp. 1, 8] for an example of the tradeoffs firms were making between the undistributed profits tax and cash dividends.
4The phrase “last-in, first-out” was used in the WSJ article of May 4, 1936. Also see Finance Hearings [1938, pp. 160-1, 165-6] and footnote 8.
5Real GNP in 1954 dollars. Source: U.S. Department of Commerce Business Statistics .
session.6 A special subcommittee on tax revision, chaired by Rep. Fred Vinson (Ky.), met in executive session beginning in November, but a report to the entire W&M Committee was not issued until early in the next session.
The subject of inventory profits was raised by a witness on the last day of hearings before W&M in January 1938 [Hearings, 1938, pp. 1181-4]. The witness was Maurice E. Peloubet, a CPA who represented the Copper and Brass Mills Products Association and who had appeared at Finance’s hearings in 1936 representing a mining association. He noted that the discussions he and others had had over the past two years with Treasury representatives yielded no tax relief for inventory profits for affected industries, such as brass, leather, petroleum and cordage, that carried substantial in-process inventories. Partial relief, however, had been given to the cotton textile and flour mill industries. They could apply the results of hedging transactions to their inventories. For instance, losses as well as gains from hedging were included to “eliminate risks due to fluctuations in the market price of cotton and thereby tend to assure ordinary operating profits” [G.C. Memo, 1936]. Gains and losses from such hedging could be treated as ordinary operating items rather than the result of speculative transactions subject to capital loss limitations. Effectively, the combination of FIFO and hedging resulted in inventory profits not being taxed.
Peloubet claimed that several other industries faced the same problem with inventory price fluctuations during production, but that no futures markets existed for them to hedge. LIFO, he argued, would yield the same result on taxable income and therefore for reasons of equity should be permitted. Moreover, the use of LIFO was claimed to be the best accounting method for a small set of industries having certain general characteristics. For example, in the copper and brass fabricating industry, raw material prices fluctuated frequently, prices of the finished product fluctuated in direct proportion to the raw material price changes, and there was an extended production process. Pricing reflected the returns for fabrication work — the operating profits — and the cost of the metal to be fabricated. Profits were not made on the raw material, copper. Rather, the metal typically was purchased at the same time the fabricator and its customer contracted for the production and future delivery of
6See WSJ [November 3, 1937], pp. 1, 4 and WSJ [November 15, 1937], pp. 1, 2. When the special session was formally called by the President in mid-October, neither the recession nor tax revision were mentioned as issues Congress was likely to focus on. See WSJ [October 14, 1937, p. 1 and p. 2],
the finished product (e.g., copper wire). LIFO, it was argued, should be permitted for tax purposes because by purging inventory profits from the calculation of income, it yielded the most accurate reflection of the way firms in the industry operated.
A LIFO provision was not included in the W&M bill that passed the House (H.R. 9682). During Finance’s hearings in March a number of witnesses, including Mr. Peloubet, appeared in support of LIFO [Hearings, 1938, pp. 143-67, 175-6, 429-30, 480, 484-7] .7 Of particular interest were the following items he brought to the Committee’s attention: the identification of 26 public corporations that had adopted LIFO or base stock for financial reporting purposes, including reporting to the Securities and Exchange Commission (SEC), with most having done so in the mid-1930′s; and letters from a number of CPA firms and excerpts from the monograph by Sanders et al. , A Statement of Accounting Principles,8 in support of LIFO.
Coincidentally, comments by Professor William Paton on A Statement of Accounting Principles appeared in the March 1938 Journal of Accountancy. LIFO, he said, “represents nothing more nor less than a major device for equalizing earnings, to avoid showing in the periodic reports the severe fluctutations which are inherent in certain business fields. . . It may be that in some situations the year is too short a period through which to attempt to determine net income . . . , but if this is the case, the solution lies not in doctoring the annual report, but in lengthening the period. . . . [I]t is not good accounting to issue reports for a copper company, for example, which make it appear that the concern has the comparative stability of earning power of the American Telephone and Telegraph Co.” [pp. 199-200].
The bill reported by Finance did not include any changes in Section 22(c) [Report No. 1567, 1938]. However, the WSJ [April 7, 1938] reported that Finance had adopted six amendments to
7Peloubet’s testimony would later be included in Moonitz and Littleton , pp. 450-6. He was followed at Finance’s hearings by Victor Stemp, a CPA and chairman of the Committee on Federal Taxation of the American Institute of Accountants. While testifying on a number of aspects in the tax bill, the brief he filed endorsed “the ‘normal stock,’ and ‘last-in, first-out’ or replacement methods” [Finance Hearings, 1938, pp. 167, 175-6].
8Sanders, Hatfield and Moore [1938, pp. 15, 43, 73-4]. Moonitz [1953, p. 459] notes that Hatfield did not mention LIFO in his Accounting, published in 1927, nor did Finney include it in the 1934 edition of his Principles. Documents incorporating the phrase “last in, first out” and recommending its use were prepared by a committee of the American Petroleum Institute as early as 1934 [reprinted in Jannis et al., 1980, pp. 172-175].
its tax bill that would be offered for consideration on the Senate floor. One of these amendments permitted LIFO. Debate in the Senate occurred Wednesday, April 6, through early Saturday, April 9. In the afternoon of April 8 [CR 1938, pp. 5042-44], Sen. Augustine Lonergan (Conn.), a member of Finance, attempted to bring up the LIFO amendment. The President pro tempore responded: “The Chair was advised that all committee amendments had” already been dealt with [CR 1938, p. 5042]. Finance chairman Sen. Pat Harrison (Miss.) then got the floor and had the following amendment stated:
The cost of goods sold during any taxable year beginning after December 31, 1938, may be computed upon the last-in first-out basis if such basis conforms as nearly as may be to the best accounting practice in the trade or business and is regularly employed in keeping the books or records of the taxpayer; and the change to such basis shall be made for any year in accordance with such regulations as the Commissioner, with the approval of the Secretary, may prescribe as necessary to prevent the avoidance of tax. Any taxpayer who, for any taxable year, is permitted under the preceding sentence to change to such basis shall be considered to have made an irrevocable election with respect to such year and future taxable years and shall not be permitted to change from such basis in any subsequent taxable year.
Sen. Lonergan noted that the use of LIFO was limited “to those taxpayers who regularly keep their books or records in accor-dance therewith, and who are engaged in trades or businesses in which the method is recognized as conforming to the best accounting practice.” He specifically mentioned the nonferrous metal smelting and fabricating and hide and leather tanning industries. Sen. Lonergan had noted the existence of a large number of brass mills in his state during Finance’s hearings [1938, p. 484]. Sen. Edwin Johnson (Colo.) indicated that discussions with Treasury officials held in the previous few days had again made clear Treasury’s refusal to allow LIFO under Section 22(c) as written. He argued that the requirement in the amendment that book and tax accounting conform would limit the use of LIFO to only a few industries, and he used data from the copper and brass fabricating industry to counter what he claimed was Treasury’s latest argument that LIFO would result in a loss of revenue of hundreds of millions of dollars. I was not able to determine the origin of the language in the amendment, although the notion of tax/book conformity was included in amendments proposed to Finance by Peloubet and others [Hearings, 1938, p. 146 and 1936, p. 627].
Chairman Harrison stated that the amendment had been controversial when discussed in committee and that he did not support it. “[B]ut I am perfectly willing to let it [be included in the Senate bill] so that we may look into the subject further” in the House-Senate Conference Committee. The amendment was agreed to by the Senate. Sen. Harrison congratulated Sen. Lonergan (a fellow Democrat) “on his perseverance and ability to obtain consideration of the matter in a committee amendment” [CR, 1938, p. 5044].
An article detailing the LIFO provision appeared in the WSJ [April 12, 1938]. Relying on accountants said to be knowledge-able in the matter, several industries were specifically identified as ones able to use LIFO. These were smelters and refiners of nonferrous metals, tanners, copper and brass fabricators, cop-per wire manufacturers, the petroleum industry and paper, rope and cordage manufacturers. Few other industries were expected to benefit from LIFO since it was seen as applicable only to companies (i) with relatively large inventories, (ii) where the main component of cost was a (few) basic raw material(s), (iii) where the turnover was slow because of the length of processing, and (iv) where the spread between finished goods and raw materials prices was fairly constant. The article also noted Treasury’s opposition to LIFO because of a feared loss of revenue.
When the Senate passed its tax bill it knew it would go to a House-Senate Conference Committee. It was in fact far from certain that any tax bill would emerge from the Conference since the two chambers appeared deadlocked over several issues, the most important of which were the repeal of the tax on undistributed profits and the easing of capital gains provisions. LIFO, while only in the Senate’s bill, was not mentioned in the press as a possible stumbling block for agreement by the Conference.
Except for Pat Harrison, none of the Senators appointed as conferees had spoken in connection with the LIFO issue in the public hearings or on the Senate floor. Of the House conferees, only Rep. Fred Vinson had asked questions of a W&M witness regarding LIFO.9
As was normal, the Conference Committee met behind closed doors. A compromise finally was achieved. A LIFO provision was included but it was not the one passed by the Senate [Document No. 177, 1938]. Instead of amending Section 22(c), a new provision was added as Section 22(d). Several things about the provision were noteworthy. First, only industries specifically identified could use LIFO; to wit: producers and processors of certain nonferrous metals and tanners. Second, except for tanners, LIFO could be applied only to raw materials “not yet included in goods in process or finished goods.” Third, inventories were required to be “taken at cost.” This precluded the use of the LCM rule with LIFO, and implied that in the year of LIFO adoption beginning inventories had to be stated at cost. Increases from previous LCM writedowns would be additional taxable income for the year prior to the switch. Fourth, an election to adopt LIFO had to be filed with the Revenue Bureau, but this could be done as late as the time of filing of the tax return for the year of adoption. Fifth, a switch to LIFO was irrevocable unless the Commissioner approved. Not included was a LIFO tax/book conformity rule, although such conformity was clearly implied in the Senate’s debate and provision.
Immediately after the Conference Report was presented to the Senate, Pat Harrison provided an explanatory statement regarding LIFO [CR, 1938, p. 6440]. He noted that a study of the Senate provision had urged that LIFO be restricted to a few industries as a first trial.10 He also noted that the conferees had had considerable difficulty in working out the provision, and that the result was not entirely satisfactory and improvements hopefully would be made in the next session as a result of a study to be conducted by Treasury.
The Conference Report, which the Senate approved on May 9, was bad news for nonferrous metal firms. These firms were vulnerable to inventory profits because of their extended fabrication processes during which frequent price changes occurred. Yet the provision effectively precluded them from using LIFO for work-in-process or finished goods inventories.
On May 11 a concurrent resolution to H.R. 9682 was proposed and approved by the Senate. Claiming that the Conference had failed to correctly state the agreed-to LIFO amend-
10The June 1938 issue of the Journal of Accountancy claimed that Treasury Department representatives had objected that the wording in the Senate’s provision was too general, and hence neither the effect on tax revenue nor the number of taxpayers qualifying could be determined. See “Editorial: Inventories and Taxes” . Also see Alvord .
ment, the resolution called for wording changes such that the same rules would apply to both the tanners and the nonferrous metal groups. That is, LIFO could be applied to all stages of production. The Senate resolution was read to the House on May 11 immediately preceding the presentation of the Conference Report in that chamber. There was no discussion of the LIFO issue. The House approved the Conference Report, but the concurrent resolution was referred to W&M, thus tabling the “corrective” changes [CR, 1938, pp. 6681-99, 6950].
Several industries which had been mentioned in Finance’s hearings and again in the April 12 WSJ article as ones likely to benefit from the use of LIFO were not granted permission to adopt LIFO under Section 22(d). Of particular interest was the petroleum industry. It had been the first industry identified for which LIFO was seen as the best inventory method.
Finally, there was some uncertainty that President Roose-velt would approve H.R. 9682. In fact, it became law without his signature [U.S. Statutes, 1938, pp. 447-584]. This was characterized in the press as a face saving action. The bill all but repealed the tax on undistributed profits which had passed in 1936 at Roosevelt’s urging.12 While this was viewed as being unacceptable to the President, the belief that the tax bill would stimulate business, which was seen as a necessity in light of the continuing recession, apparently made a veto of the entire bill too costly politically.
Twenty years later Maurice Peloubet [1958, p. 663] stated that “[t]he 1938 LIFO legislation was a masterpiece of awkward and inept drafting. It was not at all what the proponents of the legislation, either in or out of Congress, intended or desired.” Nevertheless, LIFO was now in the tax law, and according to Carman G. Blough, the first SEC chief accountant, Peloubet deserves much of the credit. Blough, who opposed LIFO, claimed that it had been “headed for death until the Internal Revenue Service began to accept it. . . .”13 A listing of dates related to the 1938 Act appears in Table 2.
l2See, e.g., WSJ [May 19, 1938, p. 2, and May 28, 1938, pp. 1, 4]. The graduated undistributed profits surtax and the basic corporate tax rate of 15% from the 1936 Act were replaced with a 19% rate that could be reduced to 16/4% with a dividends paid credit.
13See Ward [1980, pp. 75-7]. Ward’s transcript of a taped interview with Blough refers to “Pulvey … a partner in the firm Paux and Purvey and Co. . .. ” [p. 76], and to “Maurice Pulvey” [p. 77]. Reference is also made to one of their clients, Anaconda Copper [p. 76]. Undoubtedly, the accounting firm is Pogson
Table 2 Chronology of LIFO Events, Revenue Act of 1938
Tue., 1/25 LIFO witness before W&M hearings.
Sat, 2/19 Several key provisions of W&M bill reported on: no mention of LIFO (WSJ).
Tue., 3/1 W&M approves recommended bill: no LIFO provision.
Wed., 3/2 W&M bill becomes publicly available (WSJ 3/3).
Fri., 3/11 H.R. 9682 passes House (WSJ 3/12).
Fri., 3/18 LIFO witnesses appear
Sat., 3/19 J before the Senate.
Mon., 3/21 Finance Committee Hearings.
Tue., 4/5 Finance reports bill: no LIFO provision (WSJ).
Wed., 4/6 WSJ (4/7) report that Finance adopts LIFO amendment.
Fri., 4/8 LIFO amendment introduced/Adopted by Senate.
Sat., 4/9 WSJ brief report on LIFO/Bill passes Senate.
Mon., 4/11 Likely conferees identified in WSJ.
Tue., 4/12 WSJ detailed article on LIFO.
Wed., 4/13 Actual conferees listed/Deadlocked Conference possible (WSJ).
Sat., 4/23 Conference compromise reported (WSJ).
Wed., 4/27 Conference completes work/Senate provisions for LIFO
reported to be adopted (WSJ).
Mon., 5/9 Conference Report published with revised LIFO wording/
Approved by Senate (WSJ 5/10).
Wed., 5/11 Senate passes concurrent resolution re: LIFO/Conference
Report approved by House (WSJ 5/12).
Mon., 5/16 Senate concurrent resolution assigned to W&M.
Wed., 5/18 Uncertainty about President signing bill (WSJ 5/19).
Wed., 5/25 Tax bill reportedly will be approved (WSJ).
Sat., 5/28 Became law without President’s signature (WSJ).
REVENUE ACT OF 1939
As Sen. Harrison had said would happen, a committee was created by Treasury and charged with considering the entire question of LIFO, including the need for new legislation. Its members were CPAs: Edward A. Kracke, a Haskins & Sells partner; Carman Blough, who became an Arthur Andersen partner on July 1, 1938; and Roy B. Kester, an accounting professor at the Columbia University School of Business. Blough’s recollection, forty years later [Ward, 1980; also see
and Peloubet & Co. and the individual is Maurice Peloubet. Anaconda Copper was listed as a client of Pogson and Peloubet & Co. from 1927 onward in Peloubet's testimony before Finance [see Finance Hearings, March 18, 1938, p. 164]. Also, in his memoirs, Peloubet notes the particular contributions of Arundel Cotter, a WSJ editor, and Ellsworth Alvord, an attorney for several nonferrous metal firms, in gaining the acceptance of LIFO [Peloubet, n.d., pp. 62, 66].
Cooper, 1982], was that the committee was organized by Thomas Tarleau (Treasury’s legislative counsel). Kracke was already on record in support of LIFO, having advocated its use for pipeline companies.14 Kester was said to be neutral while Blough opposed LIFO because it did not represent the movement of goods, only the movement of costs. Blough believed that “in most businesses you sold what was got first before you ever sold what just came in” [Ward, 1980, pp. 79-81]. His work at Arthur Andersen “was to … fix the accounting principles that were to be followed by the firm, try to hold uniformity within the firm. So [when] the San Francisco office, or the Boston office . . . had a particular problem they would clear it with me in Chicago.” Given his views on LIFO, he doubted that he could certify LIFO-based statements and believed public accounting firms generally would have great difficulty accepting LIFO “as a fair statement” of a firm’s income. (LIFO was not codified as a generally accepted method until the issuance of Accounting Research Bulletin No. 29, “Inventory Pricing,” in 1947).
Blough did not expect many firms to adopt LIFO. He recalled arguing in the committee that the level of profits reported by firms “to their stockholders represents their success and if they have to follow a method of accounting which shows their profits less than they would otherwise, … I don’t think they’d want to buy it.” According to Blough, Tarleau responded: “Well, why, then shouldn’t we write into the statute a provision that if the company uses the LIFO method . . . for all of its financial statements and does not use any other, they may use it for tax purposes.” Blough felt he was not in a good position to disagree, given what he had just argued, and claimed further that both Kester and Kracke agreed with Tarleau’s statement [Ward, 1980, pp. 79-80].15 Hence, a LIFO tax/book conformity rule was written into their suggested legislative draft. The committee apparently met during the Summer of 1938 [Peloubet, 1971, p. 60].
An American Institute of Accountants (AIA) tax committee report that included an analysis of the 1938 LIFO provision was
15According to a Journal of Accountancy editorial [December 1938, p. 353], the SEC and the Revenue Bureau were studying the reconciliation of differences in accounting between the two agencies. SEC chairman William O. Douglas was reported to have said: “We are seeking points where we can make uniform various accounting rulings.” By mid-1939 Blough was on record in support of this, even with regard to LIFO [see Blough, 1939, pp. 269-70].
presented to Treasury in September 1938. While recommending broader application, the report supported the idea of restricting the use of LIFO to a limited number of industries.16 However, a conformity requirement was not mentioned. At about the same time, Treasury issued the first regulations under Section 22(d) [T.D., 1938].
The transcript of W&M’s hearings on revenue revision in 1939 included a brief filed by a representative of the American Mining Congress. It claimed that Section 22(d) limited applica-tion of LIFO to the tanning industry, noted that Treasury had studied the subject in response to instructions from the 1938 House-Senate Conference with a view toward introducing cor-rective legislation, and favored the extension of LIFO to other industries [W&M Hearings, 1939, pp. 133, 139].
The report filed by W&M [Report No. 855, 1939] made no mention of a possible LIFO extension, nor were any changes to Sections 22(c) or (d) included in the House bill (H.R. 6851) that passed overwhelmingly on June 19, 1939.
Finance’s report on H.R. 6851 was filed June 21 [Report No. 644, 1939] and included as Section 219 an amendment17 to Section 22(d). Specifically, LIFO could be used for any and all inventories so long as it was used “… to ascertain income, profit, or loss, for credit purposes, or for the purposes of reports to shareholders, partners or other proprietors, or to beneficiaries. …” Hence, the LIFO conformity rule, which was undeniably the Senate’s intent in its 1938 amendment, became explicit. Further, LIFO was “extended to all taxpayers . . . regardless of the business in which the taxpayer is engaged” [Senate Report, 1939, p. 6]. Another change was that beginning inventory for the year of LIFO adoption was to be treated as if it had all been acquired at the same time prior to the switch and was to be valued at the average acquisition cost. Subsequent increases in inventories were to be priced separately for each year; i.e., there were to be LIFO layers. Also included was wording to the effect that LIFO could be used whether or not it had been prescribed under Section 22(c). The implication was
16Committee on Federal Taxation . The report included a description of operating characteristics for which LIFO was seen as being most applicable. Virtually the identical characteristics had been included in the WSJ article of April 12, 1938.
17In February 1939 Congress passed a codification of the tax law, referred to as the Internal Revenue Code of 1939. Subsequent revisions (until the recodifica-tion of 1954) were treated as amendments.
that LIFO had not been created but statute, but rather was a method that the Commissioner had had the authority to allow.
The inclusion of LIFO was headline news on page 1 of the WSJ on June 21.19 Reference was made to a statement by a Treasury official that the LIFO extension would not result in any revenue loss. The LIFO amendment was agreed to without discussion by the Senate shortly before it passed its entire tax bill.
House discussion of the amended Senate version of H.R. 6851 was brief. The Senate changes were viewed as minor and technical and were readily agreed to. The House debate, how-ever, did include discussion of the LIFO amendment [CR, 1939, p. 7802]. It was claimed to have been worked out by Treasury, but was not brought to the attention of the House during its initial debate of H.R. 6851 because final wording had not been completed at that time. The issue apparently was discussed in an executive session of the W&M subcommittee on Internal Revenue Taxation.
President Roosevelt signed the bill into law on June 29 [U.S. Statutes, 1939, pp. 862-85]. Of note is that net operating loss carryforwards, which were eliminated in 1933, were reinstated. Also, the top corporate rate was reduced from 19 to 18%. However, the new rate never took effect. It would be superseded by higher rates enacted in 1940.
The new LIFO provision was applicable for taxable years beginning after December 31, 1938. It is still in force in virtually identical form as Section 472 of the 1986 Code. LIFO-related events in the 1939 Act are detailed in Table 3.
Noting that the 1939 Act placed few restrictions on the use of LIFO beyond the conformity rule, Carman Blough offered the following comments: “… Congress and the Treasury . . . ap-parently believe that businessmen and their accounting advisors may be trusted not to adopt an unreasonable or inappropriate method of accounting for general corporate accounting purposes, even tough they might find some tax advantages in so doing” [quoted in Cooper, 1982, p. 128]. Blough believed that accounting principles should not be prostituted for the sake of tax savings, and he advocated criteria to limit the application of LIFO [Cooper, 1982, p. 129].
18See Alvord  who raised the possibility that this might lead to recognition of LIFO under Section 22(c) for taxable years prior to 1939, the first year the amendment took effect.
Table 3 Chronology of LIFO Events, Revenue Act of 1939
Summer 1938 Treasury organized committee to review LIFO issues meets/
LIFO Tax/Book Conformity Rule explicitly included in new
Thu., 9/1/38 American Institute of Accountants report to Treasury argues
for broader application of LIFO.
Thu., 5/25 W&M Chairman announces unexpected early start to
hearings on corporate tax revision (WSJ 5/26).
Fri., 6/2 Brief filed with W&M to extend LIFO.
Fri., 6/16 W&M Committee report filed: no LIFO changes (WSJ 6/17).
Mon., 6/19 H.R. 6851 passed House: no LIFO changes (WSJ 6/20).
Wed., 6/21 Finance report filed: LIFO extension included (WSJ).
Thu., 6/22 Senate passes H.R. 6851 (WSJ 6/23).
Fri., 6/23 House accepts Senate amendments.
Thu., 6/29 President signs bill (10 p.m.).
Mon., 7/3 WSJ article ambiguously notes LIFO effective date.
In a May 1940 article, William Paton reiterated and ex-panded on his opposition to LIFO [pp. 357-60]. He disputed the argument that unrealized profits are recognized under FIFO. While acknowledging that profits can be “tied up” in inventory when prices rise and thus not be available immediately for cash dividends, he said that the same was true of any absorption of profits in non-cash assets. “There is a no lack of realization. . . . The literal fact is that specific goods which cost” a certain amount were sold and goods costing a higher amount were purchased and made available for sale. He believed that LIFO “in the physical sense . . . would seldom if ever be desirable as a . . . policy, and seldom if ever in practice is such an order of use actually followed for any considerable period. . . . Here seems to be a serious objection to the general use of [LIFO] as an accounting procedure.” He rejected the view that LIFO was appropriate because “inventory is essentially a fixed asset, at least to the amount of a normal stock, and should be priced accordingly.” To Paton: “The requirement that the records shall show the cost of the existing layout of facilities, rather than the cost of an earlier generation of assets, is almost axiomatic.” And concerning income taxes he said: “… restricting reported profts in years of good business and advancing prices and improving the showing in years of shrinking volume and falling prices [by using LIFO] will not affect the total amount of tax substantially over a period of years where there are no net losses in particular periods. Moreover, to the extent that net losses may be forwarded and treated as allowable deductions in succeeding years, the importance of [LIFO] as a means of modifying tax liability is minimized.”
A response to Paton from Maurice Peloubet appeared the following month [1940, pp. 446-50]. He claimed that Paton had consistently assumed that the results of FIFO were “actual,” “true,” or “real,” while those of LIFO were “artificial” or “stabilized.” “In industries to which [LIFO] properly applies no better case can be made for assuming that [FIFO] reflects physical movement than that [LIFO] reflects such movement. In either case this is unimportant. What we are concerned with is a constantly and necessarily maintained investment in goods of an identical character. That would seem to be almost as ‘true’ or ‘actual’ as whether we happen to take a bar of metal from the top or bottom of a pile. …” And, “the inclusion of any inventory as a current asset which cannot be disposed of except on liquidation of the enterprise [no matter how its cost is computed,] must necessarily confuse the picture of the current asset position, as the other composites are based on the possibility of quick cash realization.” He said that Paton’s examples had made clear the limitations of LIFO by applying it to inappropriate situations. “The answer to all of Professor Paton’s examples is that where the method does not apply, it is inapplicable. …” The relatively limited application of LIFO, he said, had long been recognized, and he (again) identified characteristics of production processes and industries for which it was best suited. And he said: “In what might be called the dark days after the [Supreme Court decision outlawing base stock type methods,] when it seemed hopeless to expect any recognition of last-in, first-out related methods for tax purposes, businessmen and economists [advocating LIFO] did not change their views. . . . They felt it their duty to stockholders and the public to present their accounts on what they thought to be a proper basis.” Further, “[t]here is no adequate substitute … for a method embodying the principles of [LIFO] in determining taxable income. … A taxpayer could be quite effectively ruined by [a run of] three or four years of rising prices where tax was levied on profits based on an identical inventory carried at successively higher prices. . . . The fact that later on he would have losses to apply against profits that he might make still later on would probably be somewhat lightly regarded by the bank from whom he had to borrow to pay his taxes. …” (Recall that operating loss carrybacks were not then permitted).
As of late 1941 no section within the Internal Revenue Bureau had been set-up to study LIFO and give authoritative opinions in advance of firms’ applications to adopt LIFO [Barker, 1942]. Apparently, there had been few LIFO adopotions up to that point. Butters and Niland [1949, Tables 18 and 29] provide data on the year of LIFO adoption, for book purposes, for a sample of 176 manufacturing firms that switched by 1947. Only 18% switched by 1940, the majority doing so for 1939 or 1940. Of the earliest adopters, 53% were from the nonferrous metal or petroleum industries. Generally declining prices in the 1938-40 period provided little incentive for most firms to adopt LIFO.
A review of leading tax services prior to the Revenue Act of 1942 reveals that relatively few regulations were issued for Section 22(d) under the 1938 and 1939 Acts. LIFO was referred to in the regulations as the “elective” or “optional”method. One particular regulation, issued under the 1939 Act and referred to as the specific-goods concept, should be noted. In spite of the extension of LIFO to all taxpayers, it was Treasury’s interpretation that LIFO was applicable to a few basic commodities which could be easily measured in terms of physical units — for example, yards, pounds, and barrels [BNA, 1980, p. A-34]. This rule would prove to be a serious impediment to qualifying for LIFO for a number of firms, especially retailers.
REVENUE ACT OF 1942
This tax act, World War II’s first, proved to be the largest revision of the Code up to that time. Raising revenues for the war was its major thrust. Corporate tax rates (including a surtax) would more than double to 40% for 1942, relative to 1939, and the excess profits tax would jump to 90%. Two LIFO provisions were included: Section 118 regarding interim reporting; and Section 119 regarding involuntary inventory liquidations.
W&M Hearings ran from March 3 to April 17, 1942 and filled three volumes. The first witness was Treasury Secretary Henry Morgenthau who stated that the overall task was “to frame the new revenue act so … that it will facilitate the maximum production of war materials. . . ” Additionally, controlling inflation was to be critical. Morgenthau presented data
20The wholesale price index fell from 56.1 for 1938 to 50.1 for 1940. See also “Editorial: Inventories in a Declining Market”  and Barker .
21 Another regulation dealt with the conformity rule. See Commerce Clearing House [1938-1942], Prentice-Hall , and Treasury Decision 4959 [December 28, 1939].
showing a doubling of commodity prices during World War I and current data suggesting that a similar pattern of price increases had already emerged [Hearings, 1942, pp. 1,2, 11].
The next witness was Randolph Paul, the tax adviser to the Secretary. Paul provided details on some of the proposals Morgenthau had discussed, and presented additional proposals of a more technical nature — one of which concerned LIFO [Hearings, 1942, pp. 93-4]. Specifically, Treasury wanted Con-gress to relax the conformity rule to allow firms to switch to LIFO even if earlier in the year of switch they had issued FIFO-based interim financial reports to shareholders or others. Further, the rule relaxation was to be retroactive to 1941. Treasury believed the interim conformity rule served no useful purpose and unfairly discriminated against firms which followed the practice of publishing financial reports on an interim basis.
The change in the interim conformity rule certainly was welcome news for firms that would have liked to adopt LIFO for fiscal 1941 because of price increases but had earlier in 1941 issued interim reports. The number of such firms may well have been large. Ex post, Butters and Niland [1949, Table 18] shows that 35% of their sample of firms which adopted LIFO by 1947 did so for 1941. Ex ante, wholesale prices had risen 11.2% in 1941 and were expected to continue to rise because of WWII. The tax benefits from using LIFO in such an environment were well understood [e.g., Kracke, 1939; Barker, 1942]. It seems highly likely, therefore, that the clustering of LIFO adoptions for 1941 was due to the surge in realized and expected prices in the presence of the highest corporate tax rate (31%) faced to that point. And the retroactive elimination of the interim conformity rule clearly facilitated such switches for the subset of firms which reported on an interim basis.
Several lobbyists appeared before W&M over the next few weeks in support of Treasury’s LIFO proposal, and W&M’s bill included a provision that was actually less restrictive. Not only would there be no interim conformity rule in the year of switch to LIFO, but in all subsequent years as well. “The bill permits the last-in first-out method to be used so long as all annual reports to shareholders, partners, or other proprietors, or for credit purposes are made on that basis” [Report, 1942 No. 2333, pp. 45-6, 71]. The bill that passed the House (H.R. 7378 on July 20) included the W&M recommended interim report relaxation as Section 116.
The interim conformity rule was not discussed during
Finance’s hearings on H.R. 7378. When Finance issued its report the interim rule elimination was labeled Section 118 [Senate Report, 1942, pp. 81-2]. The only change from the House bill was that the provision was retroactive to taxable years beginning after December 31, 1938, the effective date for the initial allowance of LIFO. This change was agreed to by the House conferees and was the provision in the final statute.
Several June 1942 WSJ articles about the course of W&M’s closed door deliberations reported that a provision establishing inventory reserves had received considerable support.22 To pre-vent the taxing of inventory profits, Treasury proposed that firms not using LIFO could deduct increases in inventory caused by price increases and set-up a reserve account to accumulate such deductions. In years when prices fell, which were expected to occur after WWII ended, the reserve would be reduced and taxable income correspondingly increased. Further, price indices could be used to determine the maximum amount of a reserve increase rather than requiring the specific identification of the price changes of individual inventory items.
Pressure to expedite the tax bill after more than four months of hearings and difficulty in drafting the inventory reserve provision resulted in its omission from W&M’s bill. A summary of the bill, prepared by Treasury, indicated that W&M had accepted in principle the inventory reserve provision [WSJ, July 13, 1942].
A witness appeared at Finance’s hearings to lobby on behalf of retailers for the inventory reserve plan [Hearings, 1942, pp. 1089-94].23 Some retail firms had adopted LIFO for book purposes as early as 1941, spurred at least in part by the development of dollar-value LIFO and its adaptation to the retail inventory method [BNA, 1980, A-35; Butters and Niland, 1949, pp. 298-9]. However, retailers had been unsuccessful in obtaining approval to allow use of price indices with LIFO because of Treasury’s insistence of the specific-goods concept — retailers’ inventories consisted of a large number of different products, rather than a few homogenous items. While preferring a relaxation of the LIFO regulations, which retailers argued was only fair since the 1939 Act had made LIFO available to all taxpayers, they hoped at least that Treasury’s inventory reserve proposal would be accepted.
Note that inventory reserves were a way to provide non-LIFO users relief from the taxation of inventory profits which were caused by the sharp price increases that accompanied WWII. Use of inventory reserves would expire after the war, once the economy — and prices — returned to a peacetime norm. Treasury’s support of inventory reserves, therefore, may have been a way for it to grant some short-term tax relief while retaining the specific-goods concept, which effectively limited the use of LIFO, for the future.
Other witnesses appeared before Finance to seek relief for involuntary liquidations of LIFO inventories [Hearings, 1942, pp. 2108-11]. Wartime restrictions and shortages had made it impossible for many firms to maintain base stock inventory quantities. For a firm using LIFO, depletion of low cost layers meant increases in taxable income.
In spite of the support for deductible inventory reserves, they did not become part of Finance’s bill. A fear that setting-up an inventory reserve would inevitably lead to demands for other kinds of deductible reserves apparently was a concern [McNair and Hersum, 1952, p. 184; WSJ, August 26, 1942]. An entirely new approach emerged as part of a compromise. A proposed increase in the excess profits tax rate to 90% was to be “cushioned” by several items. One cushion was a provision for a two-year carryback of net operating losses — both for the regular tax and for the excess profits tax [Senate Report, 1942, pp. 51-2, 122-4, 180-4].24 This provision was to help corporations that faced “periods of declining profits, especially at the close of a war economy in which their deductible expenses have been held down to a bare minimum by priorities, rationing, labor shortages, and other factors. …” The full Senate approved the carryback provision and it was subsequently agreed to by the House.
Another cushion included in the legislative compromise was the granting of relief for involuntary LIFO liquidations [Senate Report, 1942, pp. 43-44, 82-3]. Firms could replace wartime-induced liquidated LIFO inventories for up to three years after the end of WWII. Taxable income for the year of liquidation would be adjusted for the difference between the cost of the replacement inventory and the cost of the liquidated inventory.
Firms would file an amended return when the inventory was replaced to claim a refund. The burden of establishing the involuntary nature of the LIFO liquidation fell to the taxpayer, who was also required to elect this provision when the tax return for the year of liquidation was filed. Taxable years beginning after December 31, 1941 were covered. This provision, titled “Last-In, First-Out Inventory,” became Section 119 in the Senate bill that passed on October 10 and was accepted by the House [U.S. Statutes, 1942, pp. 798-985]. Key dates for the 1942 Act appear in Table 4.
Table 4 Chronology of LIFO Events, Revenue Act of 1942
Mon., 3/9 ” Thu., 3/12 Thu., 3/19 Mon., 4/13 Tue., 4/14 Thu., 4/16 ,
Mon., 6/15 Wed., 6/17 Mon., 7/13
Mon., 7/20 Thu., 8/6
Mon., 8/10 Thu., 8/13
Thu., 8/27 Fri., 8/28
Sat., 10/10 Mon., 10/19
Tue., 10/20 Thu., 10/29
Treasury tax advisor recommends conformity rule relaxation in year of change to LIFO before W&M (WSJ 3/5).
Witnesses in support of Treasury’s LIFO recommendation appear before W&M.
WSJ article: interim rule to be eliminated/Inventory reserves
recommended by Treasury (also WSJ 6/16).
WSJ: inventory reserves may be omitted in order to expedite
W&M report (also WSJ 7/8).
Tax bill summary in WSJ: interim LIFO rule elimination
included/Inventory reserves accepted in principle but not
drafted in time.
W&M Committee report filed: included more liberalized
interim reporting relaxation.
H.R. 7378 passes House (WSJ 7/21).
Witness for retailers urges adoption of inventory reserve plan
WSJ: inventory reserve almost foregone conclusion.
Witnesses before Finance seek inventory reserves
(WSJ 8/14)/Others seek relief for involuntary LIFO
Two-year carryback proposed (WSJ 8/28).
Treasury supports carryback/Also relief for LIFO
liquidations (WSJ 8/29).
Senate Finance Committee files report: same LIFO interim
rule as House except earlier effective date (WSJ 10/3)/
Inventory LIFO liquidation provision included.
H.R. 7378 as amended unanimously passes Senate
Conference report filed late in day: Senate’s LIFO rules
House and Senate agree to Conference report.
President signs bill.
The liquidation provision (which subsequently would be extended and then reinstituted for the Korean War) provided an additional incentive to adopt LIFO. Further, the failure to allow for deductible inventory reserves meant that non-LIFO firms facing wartime-inflation-induced inventory profits had few tax options available beyond LIFO.25 While operating losses could now be carried back for two years, for 1942, the first year covered by the Act, they could be carried back only one year. Further, most firms were not expected to generate operating losses until after the war. Finally, tax rates were higher in 1942 than in 1941 (31 versus 40% plus a higher excess profits tax rate), and inflation was up to 13%. It is not surprising, therefore, that second to 1941, the year with the largest number of manufacturing firms adopting LIFO in the Butters and Niland [1949, Table 18] sample was 1942 (22%).
With regard to Treasury’s insistence on the identification of the cost of specific products under LIFO, rather than allowing the use of price indices for groups of products, it would take court action to gring about a change [e.g., McNair and Hersum, 1952, pp. 187-96]. The most important case was Hutzler Brothers Co. [8 T.C. 14, 1947]. The Tax Court ruled that Hutzler, a department store, could use LIFO and could approximate the increase or decrease in inventory of an entire department through the use of a suitable price index. Treasury acquiesced in the Hutzler case in March of 1948.
Several avenues for future research are suggested in this section. First, the legislative histories documented in this paper provide the basis to identify the dates on which critical legisla-tive activities occurred regarding the allowance of LIFO and a set of firms likely to have been most affected. A colleague and I currently have a project underway in which we use the legislative histories to conduct an event study to assess the impact of the LIFO legislative provisions on the stock prices of a sample of affected firms.
A second research project might explore the timing of LIFO adoptions. The historical record strongly suggests the impor-
25Of course LIFO was effectively not a tax option for some firms, including retailers, because of the specific-goods concept.
26The third largest number of LIFO adoptions (12%) in the Butters and Niland [1949, Table 18] sample occurred in 1947. Wholesale prices rose 14.6% and 22.5%, respectively, in 1946 and 1947. The corporate tax rate was 38%.
tance of taxes in the choice of LIFO for book purposes — and in the timing of its adoption. In particular, it is unlikely that the clustering of LIFO book adoptions in 1941, 1942, and 1947 [Butters and Niland, 1949] is unrelated to the presence in those years of high (increasing) rates of inflation and corporate taxes. A similar scenario occurred in 1974 [Ricks, 1982; Biddle and Lindahl, 1982]. It would be interesting to more fully document the association between the timing of LIFO adoptions — for book and tax — and the rates of inflation and corporate taxes. A final suggestion for future research concerns petroleum companies. The Committee on Uniform Methods of Oil Accounting of the American Petroleum Institute (API) was on record as early as 1934 recommending the use of LIFO by petroleum firms. Yet not a single representative of any petroleum firm or industry association appeared as a witness before the Congressional committees in support of LIFO, and LIFO use was not extended to petroleum firms in the 1938 Act. Why did petroleum firms, individually or as a group, choose not to lobby in 1936, 1938, and 1939? An examination of the minutes and other documents of the Uniform Methods Committee of the API would seem to be a fruitful way to begin to address this question. Another possibility would be to examine correspondence (and other memoranda) between oil firms and their auditors. Letters from CPAs in support of LIFO, which were solicited by Peloubet and included in his submission to the Finance Committee hearings in 1938 on behalf of a copper and brass mills association, also made reference to petroleum firms. In any event, a careful study of the lobbying behavior of the petroleum industry with respect to LIFO has the potential to be an instructive example of a point made by Amershi et al.  that in a multiperiod game, it can be optimal for an agent not to lobby (vote) in support of a particular regulatory action even when its passage would be beneficial to the agent.
These suggestions for future research illustrate the impor-tance of historical studies in a variety of research areas. Further investigations are necessary to explore the interrelationships between tax and development of financial accounting practices.
1. Government Documents
Committee on Ways and Means, House of Representatives. “Hearings, Revenue Act, 1936.” (March 30, 31, and April 1, 2, 3, 4, 6, 7, 1936). 890 pgs.
Committee on Finance, United States Senate. “Hearings on H.R. 12395.” (April 30 to May 12, 1936). 973 pgs.
Congressional Record, v. 80 (January 3 to June 20, 1936). See Part 11 for H.R.
12395 (p. 554). United States Statutes at Large, v. 49, pt. 1, chp. 690. “Public Law No. 740:
Revenue Act of 1936.” (June 22, 1936), pp. 1648-1756. General Counsel Memorandum No. 17322. “Revenue Act of 1934,” by H.
Oliphant. Internal Revenue Cumulative Bulletin XV-2 (July-December 1936),
pp. 151-155. Committee on Ways and Means, House of Representatives. “Hearings, Revision
of Revenue Laws 1938.” (January 14, 15, 17, 18, 19, 20, 21, 22, 24, and 25,
1938). 1217 pgs. Committee on Finance, United States Senate. “Hearings on H.R. 9682.” (March
17, 18, 19, 21, and 22, 1938). 747 pgs. Senate Report No. 1567. “Revenue Bill of 1938: Report.” (January 5 (Calendar
day, April 5), 1938), 52 pgs. In Senate Reports: Public, v. 1; 10229. Senate Document No. 177. “Revenue Bill of 1938: Conference Report.” (April 20
(Calendar day, May 9), 1938). 31 pgs. In Senate Documents: Miscellaneous,
v. 2; 10248. Congressional Record, v. 83. (January 3 to June 16, 1938). See Part 12 for H.R.
9682 (p. 491). United States Statutes at Large, v. 52, chp. 289. “Public Law No. 554: Revenue Act
of 1938.” (May 28, 1938), pp. 447-584.
Treasury Decision 4865. Articles 22(d)-l to 22(d)-4. (September 29, 1938). Committee on Ways and Means, House of Representatives. “Hearings, Revenue
Revision — 1939.” (May 27, 29, June 2, 3, and 5, 1939). 284 pgs. House Report No. 855. “The Revenue Bill of 1939: Report.” (June 16, 1939). 56
pgs. In House Reports: Miscellaneous, v. 4; 10299. Senate Report No. 644. “Revenue Act of 1939: Report.” (June 21 (legislative day,
June 15), 1939). 11 pgs. In Senate Reports: Miscellaneous, v. 3; 10294. Congressional Record, v. 84 (January 3 to August 5, 1939). See Part 15 for H.R.
6851 (p. 855). United States Statutes at Large, v. 53, part 2, chp. 247. “Public Law No. 155:
Revenue Act of 1939.” (June 29, 1939), pp. 862-885. Treasury Decision 4959. Regulations Section 19.22(d)-l to 19.22(d)-6. (December
28, 1939). Committee on Ways and Means, House of Representatives. “Hearings, Revenue
Revision of 1942.” v. 1 (March3,5,9, 10, 11, 12, 13, 16, 17, 18, 19,20,23,and
24, 1942); v. 2 (March 25, 26, 27, 30, 31, April 1, 2, 3, 7, 8, and 9, 1942); v. 3
(April 10, 13, 14, 15, 16, and 17, 1942). 3,640 pgs. House Report No. 2333. “The Revenue Bill of 1942: Report.” (July 14, 1942). 187
pgs. In House Reports: Miscellaneous, v. 4; 10664. Committee on Finance, United States Senate. “Hearings on H.R. 7378.” v. 1
(July 23, 24, 27, 28, 29, 30, 31, August 2, 3, 4, 5, 6, and 7, 1942); v. 2 (August
10, 11, 12, 13, and 14, 1942). 2,376 pgs. Senate Report No. 1631. “The Revenue Bill of 1942: Report.” (October 2, 1942).
part 1 (275 pgs.); part 2 (14 pgs.) In Senate Reports: Miscellaneous, v. 4;
10658. Congressional Record, v. 88 (January 5 to December 16, 1942). See Part 11 for
H.R. 7378 (p. 633). United States Statutes at Large, v. 56, part 1, chp. 619. “Public Law No. 753:
Revenue Act of 1942.” (October 21, 1942), pp. 798-985.
2. Wall Street Journal Articles
“Taxing Fictitious Profits.” (April 2, 1936), p. 2.
“House Committee’s Tax Bill Changes in Summary Form.” (April 22, 1936), pp. 1, 2.
“What’s News.” (April 29, 1936), p. 1. Cotter, A. “Revenue Bureau Does Not Recognize Two Accounting Methods of
Easing Earnings Swings.” (May 4, 1936), p. 2. “White House Lash Necessary to Stop Tax Bill Revisions.” (May 8, 1936), pp.
1-2. “Tax Bill Reported; Tightens Provision to Force Dividends.” (June 2, 1936), pp. 1, 2.
“What’s News.” (October 14, 1937), p. 1. “Special Session Task Begins Where Previous Legislation Left Off.” (October 14,
1937), p. 2. “Glass Urges Federal Tax Law Changes to Aid Business.” (November 3, 1937),
PP. 1,4. “Many Companies Will Pay Surtax to Conserve Cash.” (November 10, 1937), pp.
1, 8. “Taxation Becomes Outstanding Issue as Congress Meets.” (November 15, 1937), pp. 1,2.
“Profits Tax No Burden, Says Vinson in Debate.” (January 31, 1938), p. 1. “Substitute for Surtax, Capital Gains Revision Approved by Committee.”
(February 19, 1938), pp. 1, 4. “What’s News.” (March 3, 1938), p. 1. “Summary of Changes in Corporate Sections of Revenue Laws by Proposed Tax
Revision Discloses Many Shifts Vital to Business.” (March 3, 1938), p. 3. “What’s News.” (March 12, 1938), p. 1. “What’s News.” (April 7, 1938), p. 1. “Senate Group Adopts Several Amendments to Tax Revision Bill,” (April 7,
1938), p. 4.
“Harrison Hopes New Tax Bill Will Be Passed Today.” (April 9, 1938), p. 3. “Roosevelt May Ask Retention of Surtax in Revenue Measure.” (April 11, 1938),
PP. 1-2. ” ‘Last-in-First-Out’ Inventory Valuation Would Aid Few Lines.” (April 12, 1938), p. 2.
“Roosevelt Faces New Congress Test Over Profits Tax.”’(April 13, 1938), pp. 1,3. “Business Tax Aids Retained in New Compromise Bill.” (April 23, 1938), pp. 1, 6. “Tax Revision Bill Conferees Finish Work on Measure.” (April 27, 1938), p. 1. “What’s News.” (May 10, 1938), p. 1. “What’s News.” (May 12, 1938), p. 1.
“Official Reticent on Outlook for Tax Bill Signing.” (May 19, 1938), p. 2. “Roosevelt Will Sign Tax Bill, Maybe Today; Expected To Criticize It.” (May 25,
1938), p. 1.
“Roosevelt Plans to Revive Tax Reforms in 1939.” (May 28, 1938), pp. 1, 4. “Two Main Features of Revenue Act of 1938 Concern Corporation Income
Taxation and Levy on Capital Gains Changed by Congress.” (May 28, 1938),
p. 4. “House Group to Hear Treasury Tax Revision Proposals Tomorrow.” (May 26,
1939), pp. 1,2. “Two New Concessions to Business Included in House Tax Bill.” (June 17, 1939), pp. 1,3. “What’s News.” (June 20, 1939), p. 1.
” ‘Last In – First Out’ Computing Theory Added to Tax Bill.” (June 21, 1939), pp. 1-2.
“Tax Bill Approved by Senate; House to Expedite Passage.” (June 23, 1939), p. 2. “Many Sections of New Tax Law Apply to ’39 Corporate Income.” (July 3, 1939),
P.6. “Text of Randolph Paul’s Statement to Ways and Means Committee.” (March 5,
1942), pp. 6, 16. “Independent Experts Urge Further Administrative Revisions in Tax Laws to
Equalize Operation.” (June 15, 1942), p. 3. “Treasury, Tax Experts Ask Reserve Fund As Protection Against Inventory
Losses.” (June 16, 1942), p. 2. “Tax Report.” (June 17, 1942), p. 1. “Tax Report.” (July 8, 1942), p. 1. “Summary of Tax Bill Prepared for House Ways and Means Group.” (July 13, 1942), pp. 5, 12.
“What’s News.” (July 21, 1942), p. 1. “Hearings on Tax Bill May End Thursday; Changes Indicate Easier Burden on
Firms.” (August 10, 1942), p. 3. ” ‘Shock-Absorbers’ May be Put in Tax Bill To Ease Excess Profits Levy on
Corporations.” (August 14, 1942), p. 3. “Corporation Tax Compromise Is Discussed; Liberal Treatment for Railroads
Approved.” (August 28, 1942), p. 3. “Senate Group Approves Provisions Easing Excess Profits Tax Impact on
Corporations.” (August 29, 1942), p. 3. “What’s News.” (October 3, 1942), p. 1. “What’s News.” (October 12, 1942), p. 1.
3. Secondary Sources and Rulings
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1940), pp. 432-443. Barker, R. “Last-in, First-out Method of Inventory Accounting.” Taxes: The Tax
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(October 1942), pp. 384-403. “Editorial: Inventories in a Declining Market.” Journal of Accountancy (January 1938), pp. 3-5.
“Editorial: Inventories and Taxes.” Journal of Accountancy (June 1938), pp.
457-460. “Editorial: Tax Accounting and Business Accounting.” Journal of Accountancy
(December 1938), p. 353. Kracke, E. “Inventories and Taxes.” Journa l of Accountancy (December 1939),
pp. 369-376. Harvey, J. “Some Observations on Accounting Practice With Special References
to Inventory Valuation.” Journal of Accountancy (December 1937), pp.
440-451. Hutzler Brothers Company v. Commissioner of Internal Revenue, 8 Tax Court 14
(January 1947). Jannis, C.P., C. Poedtke, Jr. and D. Ziegler. Managing and Accounting for
Inventories, NY: Ronald Press (1980).
Lucas v. Kansas City Structural Steel Co., 281 U.S. 264 (April 1930). McNair, M. and A. Hersum. The Retail Inventory Method and LIFO. NY:
McGraw-Hill (1952). Moonitz, M. “The Case Against LIFO as an Inventory -Pricing Formula.” Journal
of Accountancy (June 1953). Reprinted in Moonitz and Littleton (1965), pp.
457-469. Moonitz, M. and A.C. Littleton, editors. Significant Accounting Essays.
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Raised by Professor Paton.” Journal of Accountancy (June 1940), pp. 446-
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663-666. Peloubet, M. “The Memoirs of Maurice E. Peloubet.” Unpublished Manuscript
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title: The Story of a Fortunate Man: The Memoirs of Maurice E. Peloubet. Peloubet, M. “The Struggle for LIFO.” Price Waterhouse Review (Spring 1971),
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4. Other References
Abdel-khalik, R. “The Effect of LIFO-Switching and Firm Ownership on Execu-tives’ Pay.” Journal of Accounting Research (Autumn 1985), pp. 427-447.
Amershi, A., J. Demski and M. Wolfson. “Strategic Behavior and Regulation Research in Accounting.” Journal of Accounting and Public Policy (Fall 1982), pp. 19-52.
Pincus: Legislative History of the Allowance of LIFO for Tax Purposes 53
Biddle, G. and F. Lindahl. “Stock Prices Reactions to LIFO Adoptions: The
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Near the Earnings Announcement Dates of LIFO Adopters.” Journal of
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APPENDIX Approach to Examining the Historical Record
The general framework of analysis was structured around veto points in the legislative process. In the House of Representatives (i) the Committee on Ways and Means had jurisdiction over tax bills and held public hearings which were published, (ii) met in private to draft a bill, and (iii) brought the bill to the House as part of a published House Report. On the House floor, (iv) debate ensued under the rule that no amendments were permitted,27 and (v) the final bill was voted on and approved. In the Senate, the House bill was (vi) assigned to the Committee on Finance which typically held public hearings, (vii) met in executive session to write its bill, and (viii) issued a Senate Report containing the bill’s provisions. The bill (ix) was debated and could be amended on the Senate floor, (x) and when approved was sent back to the House. Typically, (xi) the House did not agree to the Senate’s bill and a Conference Committee was formed. (xii) Meetings of the Conference Committee were held as executive sessions. (xiii) Once agreement was achieved, Conference Reports were filed by the House and Senate conferees with their respective chamber. (xiv) The recommended bill was briefly debated and approved by each house, and (xv) the measure was sent to the President for his action.
Since I was interested primarily in the documents and articles that dealt with LIFO or related issues, I initially familiarized myself with the major LIFO legislative and administrative outcomes (i.e., key provisions and regulatory rules) as well as with the substantive inventory and tax issues and the industries most likely affected. The main source for this was Butters and Niland . I also used Jannis et al. . A careful reading of the Statutes was conducted next, followed by an overview of the legislative history of the Statutes presented in the Index to the applicable volumes of the Congressional Record (CR).
Transcripts of all debates on the floor of each house were in the CR. The published committee hearings were voluminous, running well over 10,000 pages for the four acts. Sometimes a topical index was included, but usually only a list of individuals who were witnesses and/or who filed briefs was presented along with their affiliations. Sometimes there was a notation as to the main issue they were addressing. The prior identification of issues and interested industry groups meant that affiliations could be used to identify individuals who potentially might be addressing LIFO or related issues. Once an individual appearing in connection with LIFO was identified, his name was searched for in other hearings. It is possible that I missed some witnesses by not having read the transcripts of all of the hearings on all parts of the tax bills. I believe, however, that no LIFO-related witnesses were missed. In no case did I find a reference to a witness in other testimony, in discussions or debates, or in any news or magazine articles that I had not already discovered.
As far as W&M, Finance and Conference Committee Reports were concerned, I read all LIFO proposals and associated commentaries as well as many other parts. As regards floor debates reported in the CR, I read a good deal of these and skimmed the parts obviously dealing with the non-LIFO aspects of the bills.
I read every article that I could identify as being tax-related that appeared in the Wall Street Journal over a period that began well before W&M Hearings commenced and ended after the Presidential action had been taken on the final bill. This was done for all the tax bills. I also examined the several indices in Taxes: The Tax Magazine and read all articles and rulings in any way related to LIFO. LIFO-related articles in the Journal of Accountancy and The Accounting Review also were reviewed as were numerous years of the CCH tax service.
Finally, I attempted to independently verify all of the claims made in the memoirs and oral histories available to me.