Date 20 September 1934
Author Roy G. Blakey
Title Federal Income Tax
Description A report to the Secretary of the Treasury
Location Box 62; Tax Reform Programs and Studies; Records of the Office of Tax Analysis/Division of Tax Research; General Records of the Department of the Treasury, Record Group 56; National Archives, College Park, MD.

(Certain Phases)
Roy G. Blakey


This is chiefly a series of short memoranda relative to proposals for income tax revisions that will, or should, come up for consideration in the forthcoming session of Congress; it s not a systematic treatise of all major problems concerning the income tax. The future, as well as the present, has been kept in mind, however. Some of the proposals discussed are concerned primarily with the equity of the tax; others, with administration; and still others, with revenue. The attempt has been made to consider all problems against a background of fundamental principles and experience, though taxes have been sketched very briefly rather than treated in detail. In fact, the entire memorandum is of this nature rather than a thorough-going, finished product, owing largely to the conditions under which it has been prepared and also because of the expressed desire of the Secretary for concrete suggestions for action rather than an extended report. Perhaps the most original suggestion is in Section VII relative to joint VERSUS separate returns.

Other phases of the income tax are discussed by Messrs. Haig and Shoup in separate memoranda being submitted at about the same time as this, though Professor Haig's memoranda have not been seen by the present writer.

Confidential To Mr. Viner.

There are a few confidential estimates in this memorandum, furnished by the Treasury Section on Financial and Economic Research. These are in Tables 1 and 2, pages 42-45, which are marked "Confidential".

The colored graph on bond price trends, which should be used in connection with the discussion of interest rates and future debt service, is loaned by Mr. McLeod for use in the original copy, but he wishes it returned to him later. A photostat is included as a substitute though it cannot show so much as the colored chart. If you or the Secretary request it, he would, of course, have an extra copy made for you.

This memorandum is not a thorough-going or finished product, so I am not desirous of having it published, though I have written it so that it can be made public if the Secretary so desires. All page references in text and on graphs and tables will have to be carefully rechecked if this memorandum in mimeographed or printed or even if it is retyped.

I have taken reasonable care to present accurate data but cannot be more than reasonably certain of the accuracy of the statistical assistance which I have had because of my short experience with this particular group. I have not had time to make further thorough independent test checks of the various calculations and data. This should be done in case the Treasury publishes this memorandum, if it is to maintain the high standard of accuracy naturally expected of such a Department.


I. Development and Present Status
II. Future Role of Income Tax


III. Estimates
IV. Rate Revisions
V. Personal Exemptions
VI. Tax Exempt Securities
VII. Joint VERSUS Separate Returns
VIII. Various Matters (Short Memoranda)

     1. Consolidated Returns
     2. Carrying Forward Losses
     3. Capital Gains and Losses
     4. Depletion and Depreciation
     5. Improving Administration
     6. Tax Appeals
     7. Various Matters




I. Development and Present Status

   1. Background
      a. Four American Tax Periods

   2. Earlier Income Taxes
      a. Civil War Income Tax
      b. Act of 1894
      c. Corporation Excise Tax and Constitutional Amendment

   3. Income Taxes, 1913-1934
      a. Development and Present Status
      b. Brief Comparison with Taxes of Other Countries
      c. Yields

II. Future Role of Income Tax

    1. Some Fundamental Principles

    2. Temporary Expedient or Permanent Tax?
        a. Does Depression Record Condemn It?
        b. Is it in Harmony with Ideals of Administration?

III. Estimates

     1. Revenues, Expenditures, and Debts
        a. For 1934-36
        b. For Type Years, "Normal", "Prosperous", "Depression"

     2. Factor of Safety
        a. Interest Rates and Debt Service
        b. Effects of Rising Prices and Emergency Legislation

IV. Rate Revisions

    1. Possible Rate Increases and Estimates of Their Effects on
    2. Comparison of British and American Rates
    3. Normal Tax and Surtax Bases

V. Personal Exemptions

       Possible Revisions and Estimates of Their Effects on Revenue

VI. Tax Exempt Securities

    1. Constitutional Questions
    2. Fiscal and Social Questions
    3. Outline of Problems Involved
    4. Amounts of Securities Outstanding
    5. Revenue Losses
    6. Effects of Taxes on Interest Rates
    7. Further Investigation Needed
    8. Tentative Conclusions
    9. Discussion of Proposed Amendments

VII. Joint versus Separate Returns

     1. The Problem
        a. Constitutional Questions Most Important
        b. Treadway Bill
        c. Treasury Position and British Practice
        d. Opposing Point of View

     2. New Solution Suggested
        a. General Option to File Separate Returns
        b. Removal of Discriminations in Community-Property-States
           and also in Other States
        c. Effects on Taxpayers and Revenues
        d. Heads of Families and Single Persons
        e. Possible Adjustments
        f. Constitutional and Administrative Questions

     3. Another Proposal
     4. Comparison of Different Proposals
     5. A Common Misconception

VIII. Various Matters (Short Memoranda)

      1. Consolidated Returns
      2. Carrying Forward Losses
      3. Capital Gains and Losses
      4. Depletion and Depreciation
      5. Improving Administration
      6. Tax Appeals
      7. Various Matters


Improving Administration

I. Development and Present Status of Federal Income Tax

     1. Historical Charts, United States, Great Britain, Canada
     2. German Income Taxes
     3. Australian Income Taxes
     4. French Income Taxes
     5. Revenue from Income Taxes, Various Nations, Summary Table
     6. Civil War Income Tax, Rates and Exemptions
     7. Civil War Income Tax Collections
     8. Cost of Collecting Income Tax and other Internal Revenue,
        United States, 1910-1934

III. Estimates

     United States Government Bond Yields, 1918-1934

IV. Possible Rate Revisions

     1. Effect of Various Suggested Rate Changes Upon Tax Liability
        of Different Income Classes

          a. Married Persons
          b. Single Persons

     2. Comparison of Effective Rates, United States, Great Britain,
        and Canada

     3. Explanatory Note on Methods of Making Estimates

V. Personal Exemptions

     1. Effect of Possible Exemption Changes upon Tax Liability of
        Different Income Classes

          a. Married Persons
          b. Single Persons

     2. Combined Effect of Both Rate and Exemption

          a. Married Persons
          b. Single Persons

     3. Explanation of Method of Making Estimates of Effects of
        Exemption Changes, Income Tax Unit

VI. Tax Exempt Securities

     1. Government Bond Interest Yields of Tax Exempt and Taxable

     2. Treasury Section Estimates of Effects of Tax Exemption on

     3. Statement of Tax Exempt Problem, indicating Data yet to be

VII. Joint versus Separate Returns of Husband and Wife Table
      Showing Numbers of Returns According to Marital Status

VIII. Various Matters

     1. Consolidated Returns, Effect on Revenue of not permitting,
        under certain assumptions

          a. Consolidated returns for 1930
          b. Consolidated returns for 1933
          c. Summary Table for 1930
          d. Summary Table for 1933
          e. Specimen Work Sheets

     2. Depletion

          a. Defects in Provisions of Present Law

List of Charts
List of Graphs
List of Tables

(All Charts in Separate Folder)


     1. United States Income Tax Rates and Principal Exemptions,

     2. Income Tax Rates and Principal Allowances in Great Britain,

     3. Canadian Income Tax Rates and Principal Exemptions,

(All Large Graphs in Separate Folder)


     1. Trend of Federal Taxes, 1903, 1910-1934

     2. Monthly Averages of Daily Yields on United States Bonds

     3. Index of Yields on United States Bonds

     4. Index of Yields on United State Short Terms Issues

     5. Effective Rates of Income Taxation -- United States and
        United Kingdom

     6. Effective Rates of Income Taxation -- United States and
        United Kingdom

     7. 1926 Net Income by Classes Showing Allowable Deductions for
        Personal Exemptions, Dividends and Interest on Government
        Obligations, and Normal Tax Base

     8. 1932 Net Income by Classes Showing Allowable Deductions for
        Personal Exemptions, Dividends and Interest on Government
        Obligations, and Normal Tax Base

     9. 1926 Net Income by Classes, Showing Surtax Base

    10. 1932 Net Income by Classes, Showing Surtax Base

    11. Comparison of Yields of Tax-Exempt and Taxable Government
        Bonds (Yield to Maturity of Selected Government Bonds)



      1. Estimates of Federal Receipts and Expenditures, 1935-1938

      2. Tentative Revenue Estimates, Revenue Act of 1934

      3. Estimates of Probable Revenue from Income Tax under Act of
         1934, "Normal", "Prosperous", and "Depression" Years

      4. Federal Debt Service, 1919-1930

      5. Annual Debt Service Required to Amortize Debt of $30

      6. Annual Debt Service Required to Amortize Debt of $40

      7. Estimates of Probable Increase in Revenue for Each
         One-Per-Cent Increase in Normal Tax

      8. Estimates of Probable Revenue from Income Tax if 1918 Rates
         Were Incorporated in 1934 Act

      9. Estimates of Revenue Using British Exemptions and Rates --
         Taxing Capital Net Gains

     10. Estimates of Revenue Using British Exemptions and Rates --
         Exempting Capital Net Gains

     11. Relative Proportions of Normal and Surtaxes in United
         States and Great Britain

     12. Estimated Additional Revenue if $2,500 Exemptions Were
         Reduced to $2,000

     13. Estimated Increase in Revenue if Exemptions Were Not
         Allowed for Surtax

     13a. Vanishing Exemptions

     14. Prices and Yields on Tax-Exempt First Liberty Loan 3 1/2's
         and Taxable First Liberty's Converted

     15. Tax Advantage in Community-Property States

     16. Illustrative Schedule of Rates, Exemptions, and Credits
         Under New Proposal

     17. Tax Liability by Income Classes under New Proposal, Using
         Illustrative Rates, Exemptions, Etc.

     18. Estimated Effect on Yields of Filing Joint versus Separate
         Returns, 1934 Rates

     19. Estimated Effect on Yields of Filing Joint versus Separate
         Returns, 1918 Rates

     20. Estimated Surtax Rate Scale Required to Maintain Yields
         under New Proposal

     21. Number of Returns Sent to Field and Number of Examinations

     21a. Federal Income Tax Yields, 1903, 1910-1934

     22. Revenue from Income Taxes in Various Nations

     23. Revenue During Civil War Years

     24. Collections of Internal Revenue and Cost of Collection

     25. Monthly Average of Daily Yields on Selected United States

     26. Index of Yields on United States Short Term Issues

     27. Income Tax Liability under the 1934 Act for Man and Wife --
         Assuming Various Rate Changes

     28. Income Tax Liability under the 1934 Act for Single Person
         -- Assuming Various Rate Changes

     28a. Amount and Effective Rate of Tax on Speciment Incomes --
          Investment Income

     28b. Amount and Effective Rate of Tax on Speciment Income --
          Earned Income

     29. Estimate of Probable Revenue from the Federal Personal
         Income Tax -- 1934 Rates

     30. Estimates If Exemptions Reduced to $800 and $1,600 --
         Revenue Act of 1934

     31. Estimates If Exemptions Reduced to $2,000 for Heads of
         Families, Act of 1934

     32. Estimates If Exemptions Reduced to $2,000 and No Personal
         Exemption Permitted for Surtax Purposes

     33. Estimates with Family Returns Combined or Separate -- 1934

     34. Estimates with Family Returns Combined or Separate -- 1918

     35. Estimates of Probable Revenue from Corporation Income Tax,
         "Normal", "Prosperous" and "Depression" Years

     36. Income Tax Liability under the 1934 Act -- Man and Wife --
         Assuming Various Exemption Changes

     37. Income Tax Liability under the 1934 Act -- Single Person --
         Assuming Various Exemption Changes

     38. Income Tax Liability under the 1934 Act -- Man and Wife --
         Assuming Various Combinations of Rate and Exemption Changes

     39. Income Tax Liability under the 1934 Act -- Single Person --
         Assuming Various Combinations of Rate and Exemption Changes

     40. Number of Joint Returns of Husbands and Wives -- If
         Exemptions Are Reduced

     41. Number of Returns of Single Men and Single Women, Not Heads
         of Families

     42. Number of Returns of Single Men and Single Women, Heads of

     43. Additional and Total Returns for 1934. If Personal
         Exemptions Lowered $500

     44. Joint Returns of Husbands and Wives by Income Classes

     45. Joint Returns of Husbands and Wives, Method of Estimating

     46. Estimated Additional Revenue for Each $100 Decrease in

     47. Estimated Additional Tax from Those with Net Income over

     48. Estimated Additional Tax from Those with Net Income under

     49. Estimated Additional Tax on Additional Joint Returns -- If
         Exemptions are Lowered

     50. Estimated Additional Tax on Additional Single Returns -- If
         Exemptions are Lowered

     51. Estimated Additional Revenue Based on Returns for 1926,
         1928, 1931, and 1932. If Exemptions Are lowered

     52. Comparison of Yields of Tax-Exempt and Taxable Government
         Bonds (Yield to Maturity)

     53. Rate of Tax Assuming Total Income Derived from Government

     54. Actual and Equivalent Taxable Yields of United States
         Government Obligations

     55. Actual and Equivalent Taxable Coupon Rates of United States
         Government Obligations

     56. Estimates of Tax-Exempt Securities Outstanding 1923, 1931,

     57. Tax-Exempt Obligations Reported in Individual Returns for

     58. Amount of Tax-Exempt Securities Held by Non-Taxable
         Corporations, 1931

     59. Amounts of Tax-Exempt Securities Held in Federal Trust and
         Investment Funds

     60. Summary of Estimated Ownership of Tax -- Exempt Securities
         by Income Groups

     61. Holdings of United States Government Securities by Banks
         and Insurance Companies

     62. Individual Returns -- According to Family Relationship By
         Income Classes

     63. Increase in Tax Liability for 1930 Had Member Corporations
         of affiliated Groups Been Taxed Separately

     64. Increase in Tax Liability for 1933 Had Member Corporations
         of Affiliated Groups Been Taxed Separately

     65. Consolidated Returns for 1930 by Number of Member

     66. Consolidated Returns for 1933 by Number of Number



This memorandum is concerned primarily with the Federal income tax, but this tax should be an articulated and integral part of a well-planned fiscal system. Therefore, the first recommendation is:

Formulate the main outlines or framework of a well-thought-out, comprehensive, elastic, forward-looking fiscal plan, setting it squarely and firmly on the foundation of the following basic recommendations:

1. Coordinate tax, expenditure, debt, and other parts of fiscal policy.

2. Support strong public credit policy with strong and courageous tax policy.

3. Coordinate fiscal policy with other Government policies.

4. Make tax policy contribute to economic prosperity. (Prosperous business, full employment, large national income, high standards of living, large tax base, adequate Government service and general welfare are all interdependent.)

5. Devise long time plan of debt management or/and build up reserves in fat years to cushion lean periods. (Requires coordination of tax, debt, and banking policies -- and more. Budget balancing should be cyclical rather than annual, but the almost universal temptation is to rely too much upon borrowing. This should be avoided by an enlightened tax policy, supported by courageous, shrewd, and tactful statesmanship.)

6. Begin seriously the coordination of Federal taxes with State and local taxes.

Income Tax


First, determine role which income and other taxes should play in the coordinated fiscal plan.

It is recommended that the income tax should be drafted to supply approximately one-half to three-fourths of Federal taxes in normal and prosperous years and from one-fourth to one-half in years of serious depression and the first half of recovery therefrom.

If the income tax is relied upon to the extent recommended, a larger proportion of the citizenry should share in its payment than at present, chiefly through lower exemptions and increases in normal rates, or as suggested in the next paragraph.

If income taxes are to yield adequate revenues for serious emergencies, especially if they are to obviate the tremendous pressure for less desirable taxes, such as those on general sales, not only should exemptions be lowered but also effective rates should be substantially increased on the lower and middle surtax brackets as well as upon the highest brackets.

Specific Measures

The following specific recommendations relative to the income tax refer chiefly to matters with which Congress is likely to be concerned, or which it should consider, at the next session. The time available has been insufficient to deal with many important matters; only a few of those mentioned have had intensive attention, and none really adequate study.

Rate -- Individuals

Additional revenues will be needed besides what moderate recovery will bring. The income tax share of these revenues that is not supplied by lowering exemptions may properly be secured by one, or a combination, of the following rate changes.

1. An increase of 10 per cent of taxes calculated under the provisions of the 1934 Act would, under present conditions, raise about $44,000,000 from individuals and about $42,000,000 more if applied to corporations also. Under "normal" conditions, represented by 1926 incomes, such a rate increase would yield about $180,000,000 from individuals and about $140,000,000 from corporations, or about $320,000,000 from both individuals and corporations. (These and following estimates are tentative.)

2. Each increase of 1 per cent in normal tax rates would raise about $50,000,000 under present conditions and about $100,000,000 in a "normal" year.

3. Rates of the war-time Act of 1918 substituted for those of the 1934 Act would not increase revenues greatly during depression but would yield about 10 per cent more in a "normal" year and 15 per cent more in a prosperous year (1928 base).

4. Effective rates might be increased by approximately one-fourth, one-half, or by some other fraction of the difference between United States and British schedules. It is estimated that, if FULL British rates were incorporated in the 1934 Act, other provisions remaining substantially unchanged, the yield would be $3,000,000,000 in a year like 1931, $5,000,000,000 in a normal year (1926 basis), and $6,500,000,000 in a year like 1928.

The present writer's preference among the different rate revision suggestions -- assuming lowered exemptions as recommended on page 12 below -- is for a moderate change or rates in the direction of (but not to the extent of) the British schedules, to the extent necessary to meet absolutely essential revenues. This revision should be within the bounds of political expediency, but there should be no shrinking from a courageous tax policy for the maintenance of STRONG public credit even in the face of contemporary unpopularity.

Exemptions -- Individuals

1. Reduce exemption of husband and wife and of head of family from $2,500 to $2,000.

2. If politically feasible, or if much more revenue is needed, reduce exemption of single person to $800 and that of husband and wife to $1,600.

3. Permit no personal exemptions for surtax purposes; allow such exemptions for normal tax only.

4. If the recommendation in paragraph 3 above is not adopted, then deduct the entire personal exemption from the first surtax bracket (or first and second brackets, if the first is not large enough to absorb the entire exemption) and thus prevent the personal exemptions from pushing up the other brackets to which higher surtax rates apply. Much the same thing might be accomplished by applying the Wisconsin plan to the Federal surtax, that is, by making the surtax exemption a flat number of dollars of tax to be deducted from the tax as first calculated without benefit of personal exemption. (See page 76)

Taxing Government Securities

1. Submit the constitutional amendment (Oliver plan) permitting the Federal Government to levy non-discriminatory income taxes upon FUTURE issues of securities authorized by the States, with provision for returning proceeds ratably to the States. Or,

2. Submit a constitutional amendment permitting Federal and State Governments to levy non-discriminatory income taxes upon each other's future issues of securities. (Government compensation might be included.) (Very doubtful whether three-fourths of States would ratify this.) (This recommendation is not urged very strongly.)

3. If neither of the above is politically feasible, enact a statute permitting non-discriminatory Federal and State levies of general excise taxes, measured by income, including income from tax-exempt Federal and State authorized Government securities, upon FUTURE issues of such securities. (Not urged strongly.)

(To attempt such an excise upon existing issues as some now propose, would be a breach of faith.)

Joint versus Separate Returns of Husband and Wife

(Proposals to eliminate discriminations now existing in community property and other States.)

1. Give husband and wife (and head of family) the option of being taxed on the basis of two separate returns (or for other division of total if they prefer), each for half of total family income, making rate and other adjustments so as to remove discriminations and decrease, increase, or maintain total revenues as desired. (Plan cannot be made clear in a sentence. See P.99)

2. If the above plan is not followed, it would be better to try the Treadway plan than none at all, though its constitutionality is in doubt and it would not eliminate so many existing discriminations as plan 1.

3. Taxing each spouse on income from his or her property plus one-half of income earned by both, with certain optional features, would be better than the Treadway plan in some respects, and its constitutionality may be less doubtful, though this plan removes fewer discriminations than plan 1.

Various Matters

Consolidated Returns. -- Elimination of consolidated returns (except for railroads) in the 1934 Act was probably a mistake but, now that the new provision is in effect, give it a reasonable trial before changing.

Carrying Forward Losses. -- Provide for the carrying forward of losses for two years, not only so-called business losses but capital and other losses in cases where gains would have been taxable.

Or apply some averaging system to eliminate the inequities of arbitrary measurement of income.

Capital Gains And Losses. -- Consider distributing gains and losses equally over years of accrual, not to exceed five years, and taxing the several fractions as if revenue agents had discovered deficiencies for years of accrual (without penalties, of course). The Wood plan, (Senate Finance Committee Hearings, 1934, p. 184) provides for taxing all fractions at rates applicable in year of "realization", and this would be slightly easier to administer though not so equitable. (Other features of the Wood plan are inequitable; some make it ineffective.)

(Professor Haig is to submit a memorandum on Capital Gains, contents not yet known to present writer who makes the above suggestion incidentally.)

Non-Income-Related Deductions. -- Discontinue the permission to deduct taxes, mortgage interest, and other expenses on owner-occupied homes, and expenses incidental to securing or enjoying other tax-exempt income of substantial monetary value, whether such income is received in the form of money or otherwise. (But see Act of 1934, Sec. 24 (a)(5).)

Depletion And Depreciation. -- Consider seriously the reduction of excessive depletion allowances, making thorough study, not only of depletion, but also of depreciation.

Retroactive Provisions. -- Discontinue making tax provisions retroactive, especially where such retroactivity imposes undue hardships upon taxpayers.

Simplification. -- Simplify and clarify the language in the statute and regulations, and also in the forms for reporting income. Avoid necessity of reference to too many other laws to ascertain meaning of one in question. On the other hand, do not be over-specific, especially to the extent of preventing proper administrative discretion from securing better results.

Improved Administration. -- Consider improving the quality of the staff in the Income Tax Unit and in the Field. Consider especially improving the quality and number of revenue agents.

Court Of Tax Appeals. -- Consider establishing a Court of Tax Appeals above the Board of Tax Appeals.

Various Matters. -- See pages 141-148 for several recommendations which are discussed very briefly.


     The following subjects relating to income taxes are to be
covered by separate memoranda to be submitted by others:

Federal and State Tax Relations                     Mr. Haig

Capital Gains and Losses                            "   "

Individual Proprietorship, Partnership and
  Corporation: Differential Treatment under
  the Income Tax Law                                Mr. Shoup

Imputed Income and the Present Income Tax Law       "   "

Miscellaneous Income Tax Matters                    "   "

Memoranda are being submitted by others, as indicated, on the following taxes, which are in a sense special kinds of income taxes, or closely related thereto:

Excess-Profits Taxes                               Mr. Bryan
Estate, Inheritance, and Gift Taxes                Mr. Walradt

Section I Development And Present Status Of The Income Tax

The federal income tax may be seen in truer perspective, and hence its present status and future role may be better understood, if we recall first the main outline of the developments in Federal finance in the past.

Four American Tax Periods

Our National tax history is divided into four periods by our three great wars. Each of these wars called for emergency taxes; each left a huge debt and a permanently higher level of expenditures to finance. Though most emergency taxes were repealed after the wars, nevertheless, in every case the new needs caused the adding of an important new that became a permanent part of the National tax system.

Requisition And Customs Duties. -- Under the Articles of Confederation, the National Government had no independent source of revenue but made requisitions upon the several States. It is notorious that these requisitions were an extremely undependable source of National finance. The new Constitution gave the Federal Government the exclusive right to levy duties upon imports. Until the Civil War these duties were almost the sole important source of revenue, though receipts from public lands were of some significance, especially in the land speculation period preceding the panic of 1837.

Exercise Added. -- To finance the Civil War heavy excises and other internal taxes were levied. Tariff schedules were raised to unprecedented heights but were not very productive and main reliance was placed upon the internal taxes. /1/ After the war practically all important internal taxes were removed, except those on liquor and tobacco. This removal rendered highly protective the tariff rates, which previously had been mostly compensatory. These rates were maintained permanently at substantially war-time heights, but they were not so prohibitory that they stopped all importations. In fact in the period from the Civil War to the World War import duties usually yielded from about three-fifths to two-thirds of the Federal revenue. Most of the remainder was furnished by the excises on liquor and tobacco. Thus we see that in this period of 50 years these two excises shared substantially in the Federal tax burden that had been almost solely by customs duties in the preceding 70-year period.

Income Tax Added. -- The World brought on a revolution in Federal taxation. The income tax, made possible by a constitutional amendment approved in 1913, was put into operation in 1914. Under the pressure of war necessities, this new and previously insignificant source of revenue was expanded until it, combined with its variations of war and excess profits taxes, yielded from four to six times as much as the total of all taxes in pre-war years and much more than all other taxes combined during and following the war. For the war period the income tax was supplemented by numerous heavy excise and other internal taxes. Customs duties played a comparatively minor role. Following the war, practically all of the new and emergency taxes were abolished or reduced sharply and, of course, receipts declined. Tariff rates, however, were increased for protective purposes, and they yielded incidental but increasing revenues with rising prosperity. But in the post-war period, as well as in the war period, the income tax has played the major role in Federal finances.

Thus we see that the Revolution and the new Constitution gave the National Government import duties, the Civil War made excise taxes a major source of revenue, and the World War placed the income tax in the dominant role. These tax changes and additions were due, not only to the increased expenditures caused by the wars, but also to fundamental economic and political changes, which effected the nature of the tax base and the attitudes of the people toward Government functions and Government support.

Early Income Taxes

We shall next glance at some of the important features of our income taxes and of their evolution up to the present time. For the moment we shall consider chiefly the developments in connection with tax rates, personal exemptions, "earned" income credits, and a few other matters.

Civil War Tax. -- Our first national income tax law, passed in the first year of the Civil War (1861), authorized & rate of 3 per cent on the excess of all incomes above $ 800. Before it was put into effect, however, it was superseded by the law of 1862 and still later by the law of 1865, until incomes between $ 600 and $ 5,000 were taxed at 5 per cent, and above $ 5,000 at 10 per cent. After the war, when revenue needs became less pressing, there was a prolonged and bitter contest to abolish the tax. In 1867 the exemption was raised to $ 1,000 and the rate reduced to 5 per cent flat; in 1870 the exemption was raised to $ 2,000, and the rate reduced to 2 1/2 per cent. In 1872 the tax was abolished.

The Civil War income taxes differed in many respects from our present day taxes. For example, various important kinds of income did not come under the income tax proper but under special gross income and other tax provisions. This is merely one of many differences. On the other hand, we find that Civil War legislators and administrators struggled with many of the same problems which perplex their successors of today. Their problems about the definition of income, including questions concerning capital gains and losses, non-monetary income, publicity of returns, complexities of administration, and a host of other difficulties, all have a familiar ring today. Because of the war needs, or the psychology which accompanies such an emergency, or for some other, undetermined reason, the Civil War income tax did not meet the fate which the 1894 Act suffered at the hands of the Supreme Court. /2/

Act Of 1894. -- The income tax law of 1894 "was copied, with a few important exceptions, almost word for word from the old legislation of the Civil War period." It provided for a flat rate of 2 per cent on income in excess of $ 4,000. It included a tax on corporations and provided for information at the source and the withholding of taxes from salaries. It did not expressly exclude from taxable income the rental value of owner occupied residences -- as did some Civil War acts -- but did not include profits from sales of real estate held less than two years. It included also property acquired by gift or inheritance. This tax was initiated in part to make up for revenues expected to be lost through tariff reduction but chiefly as a result of the agrarian equalitarian or democratic reform movement of the latter part of the 19th Century (referred to below, Chapter II, page 36.)

The Supreme Court decision in the case of Pollock v. Farmers Loan and Trust Company (157 U.S. 429, 1895), which held this law unconstitutional, practically reversed Springer v. United States (102 U.S. 586, 1880), which sustained the Civil War tax.

Corporation Excise Tax And Constitutional Amendment. -- There were several attempts to circumvent the Court's decision and to accomplish by indirection what had failed through direct means. During the Spanish-American War it was proposed to tax the gross earnings of corporations, but, when the bill "emerged from committee, it provided for a special excise tax on the gross receipts of companies refining petroleum and sugar." Obviously, it was meant to appear as a tax upon two of the most unpopular trusts. This bill became law ant the Supreme Court held it to be no in conflict with the income tax decision. A federal inheritance tax of the same period was upheld also as not being a direct tax within the meaning of the Constitution.

Various political leaders, including President Roosevelt, expressed not only the desirability of a Federal income tax, but also the belief that one could be framed in such a way as to be upheld by the Court. After the Democratic Party had put in its platform of 1908 a demand for a constitutional amendment, Mr. Taft, as the candidate of the Republican Party, expressed the opinion that no constitutional amendment was needed, and that, if the protective system should fail to furnish enough revenue, an income tax that would be upheld could be devised. But in his inaugural address he said nothing about an income tax; instead, he suggested an inheritance tax if customs revenues should prove inadequate. A provision for such a tax was introduced into the new tariff bill of 1909, but the opposition by the States to a Federal tax on inheritances and the Western demand for an income tax were so great that the inheritance tax provision was dropped.

But in order to head off the movement for a general income tax, Congressional leaders were forced to favor a low excise tax upon corporations and to provide for the submission of a constitutional amendment, perhaps in the belief and hope that it would never receive the requisite approval of three-fourths of the States. The fate of the amendment was doubtful for some time, particularly after its rejection by New York, Massachusetts, and other influential States. In fact, it did not become law until 1913, that is, not until after the leaders of the new Democratic administration had decided to enact an income tax under the guise of an excise tax if the amendment failed or if its adoption was delayed longer. But its final ratification just at the new administration came in opened the way for a direct income tax, and the new law is the result. /3/

Recent Income Taxes

Taxes Of 1913-1934. -- The law of 1913 was copied largely from the 1894 and Civil War Acts, though numerous changes were introduced. The influence of earlier British experience also is apparent. Moreover, British war experience was very influential in our later war-time policy of raising great amounts of tax revenues instead of depending to a greater extent upon loans and inflation. This influence was particularly noteworthy in our munition manufacturers', war profits, and excess profits taxes, all variations of the income tax. But both before and since the war Great Britain has gone much further than the United States in raising revenues from income taxes on modest and medium-sized incomes. Her normal tax rates particularly have been much higher than ours. These are the rates that can be made fiscally most important because they apply to a much larger tax base than do surtaxes, especially those on the higher brackets.

Chart 1 (appendix to this chapter, page 157) gives an outline of the development of important features of our Federal income tax from its rebirth in 1913 to the present time. This outline covers important changes in rates, exemptions, and credits, affecting individuals and corporations. Accompanying charts and outlines (Charts 2 and 3 and outlines on pages 159-175, appendix to this chapter) give some comparable data for income taxes of other representative nations.

The back-door corporation "excise" (income) tax of 1909 was at the rate of 1 per cent upon corporate net incomes in excess of $5,000. This tax was merged with the income tax of 1913. Chart 1 shows that in the early years the income tax rates were very low, the personal exemptions for both normal and surtaxes were very high, and no differentiation was made for "earned" income. For several years the corporation rate was the same as the normal tax of corporate dividends received by individuals placed income from corporations, income form partnerships and income from individual firms all on a surtax parity, provided corporations distributed all of their net income annually as earned.

Corporate and individual normal and surtax rates were doubled in 1916 because of the European war. After we plunged into the conflict in 1917, all of the rates were increased tremendously, and personal exemptions were greatly reduced, by the Acts of 1917 and 1918. In addition, the war and excess profits taxes made heavy levies upon business profits, particularly upon corporation profits after 1917. The reverse process took place following the war. The excess profits tax was repealed in 1921, and exemptions for individual incomes were increased and rates were reduced every few years until 1932. Differentiation in favor of earned incomes was initiated in 1924, repealed in 1932, and revived in a different form in 1934. The income tax rate applicable to corporations was increased from 10 per cent to 12 1/2 per cent when the excess profits tax was repealed, but while this rate has been changed frequently since that time it was not increased very much until 1932, when it was raised to 13 3/4 per cent.

The ill-fated reductions in 1929 not only lessened revenues but had no apparent effect in stemming the depression. The Act of 1932, supplemented by the NIRA of 1933 and the leak-plugging act of 1934, raised rates very much and decreased exemptions somewhat.

The war revenue acts left some disparities between the income tax rates on corporations and the normal rate on individuals, but large disparities appeared only with the post-war reduction of the individual rates, on the one hand, and, on the other, the maintenance of corporation rates at, or their increase above, war-time levels.

Foreign Taxes, Noteworthy Features. -- Although this survey must be very brief, a few facts with reference to the income taxes of other countries may be pointed out. Personal exemptions in Great Britain and in most countries are much lower than in the United States. This difference is not so marked in Canada. Surtax ("super tax") rates in Great Britain are not so high as here, but normal tax rates are, and long have been, several times as high. The net earnings of companies are taxed at the normal rates. The usual inclusion of capital gains in taxable income, a different treatment of depreciation, the existence of state income taxes in the United States, and numerous other instances in which the American levy differs from the Britain make the British income tax appear relatively higher than it is, but, after making proper allowances, it is still substantially heavier upon modest and middle-bracket incomes than is the United States income tax. It is in these brackets that the bulk of a nation's taxable income lies.

The French income tax system prior to 1934 involved classification of incomes according to seven different schedules. However, the French schedule system varied from the British in that a different rate applied to nearly every schedule. The lowest rate was 10 per cent on wages and salaries and the highest a rate of 16 per cent on certain unearned income categories, such as incomes from buildings, land, and securities.

The European income tax systems have please increasing levies on single persons and childless couples. The French augment the general income tax (surtax) 40 per cent for single persons over 30 years old. Those over 30 years of age and childless after two years of marriage have their general income tax augmented by 20 per cent. The Italians place a special flat tax on single persons, which varies somewhat according to the taxpayer's age. In addition, a variable rate of tax is placed on single persons which is equal to 50 per cent of their complementary tax (surtax). In Germany the family man is favored by an increasing exemption for each additional child.

The income tax systems of Europe are also differentiated from the American in that many of them place a larger direct income tax upon corporate earnings. In Great Britain the net earnings of corporations are subject to the regular normal rate, or 22 1/2 per cent. In France an income tax rate of 15 per cent is applied on industrial and commercial profits, this is in addition to turnover taxes and sundry special stamp, registration, and transfer levies. A basic rate of 20 per cent of the net proceeds of corporations is levied by the German National Government. The Danish income tax rate on companies ranges from 6 per cent to 20 per cent.

Other features of certain foreign income taxes are given in Charts 2 and 3 and also in outlines in the appendix.

Yields. -- An examination of yields indicates that they responded to the various changes in rates much as might be expected (See Table 21a, page 162, and Graph 1). The high rates, low exemptions, and large profits of the late war and early post-war periods brought in unprecedentedly large revenues. Subsequent rate reductions were followed by lower yields, but increasing business profits in the late '20's brought increasing revenues even with lowered rates until after the crash of 1929. With the deepening of the depression returns fell away rapidly and continuously until the fiscal year 1933-34 showed evidence of an upturn. But neither the rates and personal exemptions alone nor the amount of business profits per se were responsible for all of the important fluctuations in yields. Provisions for treating capital gains, carrying forward losses, handling other deductions, etc. were other important factors. Some of these seriously exaggerated the rise in taxable income in prosperous years and its fall in years of depression.