Address by Roy
Blough, Director of Tax Research, Treasury Department,
PROBLEMS IN THE APPLICATION OF THE ABILITY CONCEPT
It might go without saying that I am here purely in a personal capacity and that nothing I may say should be interpreted as indicating or reflecting the attitude of the Treasury Department.
When our Program Committee asked for a paper re-examining the tax canon of ability to pay, I was glad to accept the invitation because I had been interested in the subject for a number of years, and looked forward to the opportunity of studying the literature to an extent that I had not previously attempted. Very shortly thereafter, however, the prospect of a Revenue Act of 1940 came suddenly into view. That revenue act was hardly passed when work was begun on the second Revenue Act of 1940, involving the excess profits tax and this measure is even now before the Congress. In the process, the hope of giving intensive study to the subject of ability to pay had to be abandoned, or at any rate postponed.
In this circumstance, it may be of some interest to turn attention to a phase of the subject about which one may speak from observation and experience, without the necessity of studying the voluminous literature in the field. I refer to the practical aspects of applying the principle of ability to pay.
Let us suppose there is set up a small group of technically trained persons who have been assigned the task of designing a tax system for a country similar in general character to the United States. Let us assume further that every member of this group firmly and sincerely believes that taxes should be imposed according to the principle of ability to pay. Let us see the nature of the problem these people will face in designing a tax system in accordance with this principle, what obstacles they will encounter, what success they may reasonably expect to attain.
In stating that the committee is in agreement that taxes should be imposed according to the principle of ability to pay, it is assumed that the members of this committee all agree on what ability to pay is, and when a tax is in harmony with ability to pay. I am afraid that such agreement would be had to find.
Ability to pay seems to have meant different things to different people and to some people it seems to convey a very vague notion indeed -- a sort of general goodness. There can be observed in the term, as it is variously used, at least the following ideas: the maintenance of the same relation in the distribution of wealth and income between persons as existed prior to the imposition of the tax; the correction of the distribution of wealth and income by changing that distribution; and the existence of certain types of special ability attributed to business, to land, to investments of various kinds, and to persons and corporations with special privileges. A concept of ability to pay broad enough to include all these ideas is straining internal consistency to the utmost.
Furthermore, i,t must be assumed that ability to pay is sufficiently measurable for practical application. Critics have pointed out that it is largely immeasurable because of the subjective character of the concept. It seems probable that general acceptance by the public of certain beliefs regarding when a tax is in harmony with ability to pay makes the concept usable even though it is not strictly measurable. For this discussion let us give it the benefit of any doubt.
Our group of exports will be confronted first with the reality that there is a tax system already in existence in the century. This tax system, presumably, is not in harmony with the principle of ability to pay, or otherwise a new design would not have been requisitioned. It will have to be assumed that the body of experts has the power to change all existing tax institutions. That, in itself, will not be a simple matter, since the people and the tax administration have become accustomed to the existing system.
Paradoxically, the process of replacing existing levies by ability to pay taxes may in many cases result in violations of the ability to pay principle of not interfering more than necessary with income distribution. Vested interests will have boon created. Certain old taxes will have been capitalized. Much of the tax on land, for example, will have ceased to be a burden in the same sense as are most of the other taxes, since it will have been allowed for in the purchase price of land. An application of the principle of ability may thus result in subsidies to some groups in the community through reduction of capitalized taxes.
Again, certain of the consumption taxes like those en tobacco, liquor and gasoline are being passed on to consumers, at least in the, main. At the same time, they have adversely affected the profitability of the industry which has been reflected in the prices paid for stocks by their present owners. In some instances, the principle of ability to pay may require the repeal or reduction of some of these consumption taxes which, however, cannot be accomplished without conferring undeserved advantages on some members of the community.
Even though our little group is firmly convinced of the desirability of taxation according to ability to pay, it will hardly seek to apply that principle to every segment of the government's revenues. Some services rendered by government are so similar in character to the commodities bought and sold en the private markets, that the taxes are little mare than a purchase price for such services. Indeed, some of the services will be sold directly for a price to each consumer, based en his consumption; this would ordinarily be the case with water and electricity. Other services, such as reads, cannot be successfully financed in that way and may be paid for through taxes. These taxes will scarcely be imposed according to ability to pay, by even the most ardent sponsors of that principle.
Thus, we must somewhat limit the scope to which we are going to try to apply the principle of ability to pay. Within this area, our committee must find enough money to support the functions of government at a given level. It makes a difference whether it is a high or a low level. If the amount of revenues to be raised is relatively small, there is a wide selection of taxes from which the committee can choose those which it considers most in harmony with ability to pay. If, however, the revenues to be raised are large in quantity, it may not be possible, in the practical nature of things, to raise the required amount of revenue without resort to a very large number of taxes. There are limits beyond which no single tax can be pushed. Let us assume that, in the hypothetical country, which has commissioned these experts, the level of revenues to be raised is high.
The committee is then faced with a somewhat serious dilemma. The application of the ability to pay principle requires that the tax be capable of being related to the economic position of the taxpayer. His economic position will involve the amount of income he receives, the amount of wealth he owns, and the personal and family responsibilities he has.
Taxes which are capable of being adjusted to take into account differences in economic position, however, are relatively few in number. They are, generally speaking, personal direct taxes. The tax which can be related nest readily to economic position is the personal income tax. Other taxes which relate to some element of personal economic position are the payroll taxes, the inheritance and gift taxes, and, to a somewhat lessor degree, the property tax, and net income taxes on business. The gross income taxes on business, the consumption taxes, and, to a considerable degree, property taxes, are not capable of being related closely to a person's economic position. Thus, if it wishes to raise the requisite amount of revenue, our committee will find it necessary to impose heavy taxes on the sources which can be adjusted to a parson's economic position and at the same time make extensive use of other sources as well. Some of the taxes may have no particular virtue except that they bring in revenue. They may be necessary, nonetheless, simply because of the volume of revenue to be raised.
It may prove feasible to set up a tax system which on the whole corresponds approximately to ability to pay, although it includes a number of taxes which do not correspond to ability to pay, by using as a compensating element taxes which can be adjusted to personal economic differences. Something can certainly be done along this line. However, the permutations and combinations of the various taxes as they fall upon different persons in the community make it unlikely that any compensatory tax imposed according to a reasonable classification can achieve the desired result. The payroll taxes fall on one group, the property taxes on another, the cigarette tax on still another, but the groups overlap so that some persons pay a high total amount of taxes and others pay a low total when the incidence of these and other taxes have all been determined -- and this our committee must in all conscience do if it is to know whether taxes are imposed in accordance with ability, even though it has never been adequately done and would require more time and expense than one cares to contemplate -- our committee would find that there were variations in taxation not only with respect to the size of income, but also within different income groups, according to types of property held, kind of industry in which employed, personal habits and tastes, and numerous other factors.
Specifically, consider the problem of integrating the income taxes with the estate and gift taxes. The estate and gift taxes are assessed in part on the basis of the amount of property passing at death, or transferred by gift. Observe that it is not income which passes but accumulated property. In a proper integration of income with estate and gift taxes, the relative ability to pay represented by income and property mist be considered -- another difficult problem. The property passing at death or by gift may net go to people in proportion to the property or income they previously held. Supposing two individuals with widely varying amounts of income or property each receive bequests of identical amounts. Should the death taxes on their bequests be identical, and if not, how should they differ?
Or, consider the problem of coordinating taxes en business with taxes on persons into a pattern consistent with the principle of ability to pay. Our committee will probably find itself in some disagreement as to whether corporations have ability to pay distinguishable from the abilities of the various people with different interests in the corporation. Suppose they answer that question in the negative and proceed to impose business taxes in such a way that they will fall on individuals in accordance with their ability. This will prove to be an impossible task since stockholders with varying incomes hold stock in the same corporation. Our committee may wish to ascertain whether on balance individuals with large incomes held stock in large suppressions and individuals with small incomes hold stock in small corporations, in order to determine whether business taxes can be adjusted oven roughly to personal ability.
Turning to the integration of income with consumption taxes, our committee will be confronted with a host of perplexities and conflicting views. It will find it necessary to agree on a pattern of consumption by income groups, and it will find it necessary to develop such patterns for all the goods or services subjected to consumption taxes. We can assume that it will reach an agreement on the variety of consumption patterns among the different commodities and services. When it comes to consider consumption taxes on such commodities as liquor and tobacco, it may find it difficult to confine itself to considerations of tax justice alone, to the exclusion of moral and other non-economic considerations.
Payroll taxes will present a different set of problems. For persons in covered and taxed employment, the relationship between payroll and individual income taxes, for instance, could conceivably be established. The rates of the income tax could be so adjusted as to take account of the taxation of wages and salaries at the source through payroll taxes. When, however, the committee comes to consider the fact that payrolls in some employments are not subject to payroll taxes and that in all employments only part of the payrolls are taxed (annual earnings in excess of $3,000, for instance, being exempt) agreement on a method of integration will be more difficult.
Were this committee sitting today, it would probably be considering the proper relationship of an excess profits tax to the individual income tax. In doing so it would cover some of the some ground traversed in its consideration of the business taxes. It would be particularly necessary to agree on such issues as, has a corporation ability to pay of its own or will its excess profits of necessity have to be related to the economic status of the corporation's stockholders?
These are all real problems, but let us assume that our committee has boon able to develop a method for integrating the several constituents of the tax structure into a system which in the aggregate distributed the tax load in conformity with ability to pay. Its task will not yet have boon completed.
Our system of government is conducted on two main levels -- Federal and State -- and on a variety of local levels. A tax system which might conform to the principle of ability to pay when employed by a country with a unitary form of government, may not be adaptable to meet the needs of a federated form government such as ours. The individual taxes employed would need to be adapted to the peculiar problems of the governmental level using them.
States, for example, have found it much more difficult than has the Federal Government to make large use of the personal income tax. In its application they have encountered some problems which do not confront the Federal Government, or confront it only to a considerably lesser degree. A State, for instance, in imposing an income tax, must recognize the fact that the Nation is an economic unit and that while persons have residences within States, they may receive incomes from diverse out-of-state sources. The Federal Government faces the same problem, since some individuals derive income from foreign sources, but it is relatively of much less importance.
The States have a related problem to which the central government is not exposed. Their boundaries are not trade barriers -- at least not admittedly so -- hence persons and businesses move with considerable freedom across State lines. A State which alone sets out to impose taxed according to the principle of ability to pay without reference to the tax policies of ether -- especially neighboring -- states, may be confronted with the emigration of the persons and businesses which have the greatest ability. Its taxes on those with especially large taxpaying abilities are likely to be higher than the taxes imposed by some other states. Our committee of exports could avoid this, if they were providing tax systems for all of the States at the same time. They may, on the other hand, consider it desirable to make some Federal provision for preventing inequalities on the burdens of the taxpayers of different states which would result in their movement out of the tax jurisdiction.
Unless our committee was prepared to make provision for largo distribution of funds from States to localities, and even from the Federal Government to the States, it could not expect to set up a system of taxation based exclusively on ability to pay. Problems of administration and the possibilities of migration limit local jurisdictions to the imposition of only a few types of taxes which are not ordinarily deemed to be in harmony with the ability to pay principle. Even States, as has been indicated, have difficulty in placing much reliance on ability to pay taxes.
Thus, our committee would find itself involved in the serious problem of attempting to correlate taxes at Federal, State and local levels on the basis of ability to pay, while at the same time bearing in mind other objectives of a federal plan of government -- objectives such as local self-government -- which would not necessarily harmonize with a tax system as thus set up.
As our committee proceeded with its work, assuming it to be a competent committee, it would undoubtedly become alarmed at the possible effects of its newly conceived tax system on the economic system of the country. Even if it disregarded the protective tariff as outside its jurisdiction, it would still have some very difficult choices to make. For instance, it might find that the taxes to be imposed according to ability to pay rested so heavily on certain portions of the taxpaying public that production and employment were unduly repressed. It might conclude that taxes imposed at certain other points would result in less economic repression. There is no particular reason for believing that the taxes imposed in harmony with ability to pay would also achieve a minimum of business repression.
Furthermore, it might be the governmental policy of the country whose tax system our committee was reforming, to place restrictions on certain types of business activities, to encourage other types or to ameliorate the maldistribution of income and wealth. If so, our committee would be confronted with a choice between holding firmly to its concepts of tax justice regardless of public policy in other spheres and tempering tax justice in the interest of increased economic activity or other objectives of public policy. Conceivably, it could elect to hold the tax system aloof from these policies. Some would almost certainly elect to follow that course. On the other hand, the committee might conclude that the taxing power was so important a part of the total power of government that taxation must cooperate in the achievement of all important public aims. In that event, the committee might wish to consider the desirability of using taxes as a means of stimulating or retarding investment. In like manner, it might elect to employ taxation in redistributing wealth and income, in promoting or retarding rural interests in relation to urban interests, or in stimulating the flow of investments to certain geographical areas. Today, with national dauphins uppermost in our minds, it would quite likely find it necessary to keep in view the urgency of building armaments and accumulating large supplies of war essentials.
I think it very unlikely that in this day and age a tax system would receive the endorsement of a substantial number of people unless it did take into consideration these other public objectives, the achievement of which may be enhanced through taxation. This does not mean that the committee would find it desirable to increase the total volume of tax revenue solely for the purpose of achieving certain non-fiscal ends. It means rather that in meeting the revenue needs there would be large opportunities for choice among taxing provisions that would work in the direction of one aim or another.
Thus far these speculations have boon predicated on the assumption that our hypothetical committee worked in isolation, temporarily aloof from the public. If this were not the case, and if the committee employed the democratic processes of our legislative Committees, including public hearings, etc., it would find its task even more overwhelming. It would be deluged with proposals from persons in all walks of life and from all kinds of business organizations. Each of these would present seemingly convincing evidence supporting a particular case for special treatment, resulting in lower taxes. In all of these cases, the committee would be confronted with evidence that the special treatment urged was in harmony with the principle of ability to pay, and that it would promote the public interest and general prosperity. After hearing some hundreds of these cases, the committee would find it difficult to consider the general problem of taxation without regard to the way in which it was going to affect individuals and individual industries. In its considerations it would be obliged to take account of the way in which tax objectives affect the various groups, and it would be obliged also to arrive at some sort of decision regarding the merits of the different cases and the importance of each in achieving tax objectives.
If our committee of experts pursued some such course as the one I have so inadequately sketched, the results of its labors would not resemble very closely a tax system based purely on the principle of ability to pay. It would have taken into account administrative considerations, revenue requirements, competing tax jurisdictions, the convenience of the taxpayer, and the costs of tax compliance. It would probably also have taken into consideration the effects of the tax on production and employment and on the distribution of wealth and income. It would have had to integrate taxes which it did not particularly desire into a system which it found acceptable.
Does this mean than that ability to pay has nothing to contribute, no role to play? Have tax students boon wasting their time on an illusion? Has the popular movement in the United States during the pact half-century which has resulted in the introduction of the income tax and its development as an increasingly large source of revenue, been misdirected and futile? Certainly the answers must be in the negative, The ability to pay principle has boon an ideal of tax justice which has served as a directive toward which the people of the United States have been endeavoring to move as rapidly as possible. The existence of obstacles to the achievement of a purpose does not invalidate the purpose. The recognition of other objectives reduces the universality of any one objective, but in no sense eliminates it. Certainly tax justice will continue to be a fundamental purpose of taxation; and ability to pay or some similar maxim will continue to be the dominant principle in tax justice.
In summary, ability to pay is not the sole universal principle of tax distribution as some writers appear to have thought a generation or two ago. There is no one universal principle or canon of tax distribution. Tax principles must reflect the objectives which government seeks to achieve. These objectives extend beyond the narrow field of tax justice. They involve fundamental aspects of production and distribution in the economy. While ability to pay accordingly is not, and cannot be, the sole basis on which to construct a tax system, it is, as the leading criterion of tax justice, one of the important principles of a cod tax system and accords with the basic objectives of democratic government.