MEMORANDUM Q THE SALES TAX Carl Shoup MEMORANDUM Q THE SALES TAX
Estimated Variations in Tax Yield, Calendar years 1929, 1931 and 1933 For Several Major Taxes Including Variation in Hypothetical Sales Tax Yield Under Unchanging Rates and Unchanging Scope of Tax Law.
Value of Products, Census of Manufacturers, 1931, of Industries Whose Products Were Not Segregated as Being Wholly Taxable or Wholly Exempt.
Value of Products, Food Industries, Census of 1931
Value of Products, Clothing Industries, Census of 1931
Value of Products, Clothing Industries, 1931
TABLE OF CONTENTS Recommendation General Consideration Definition Historical Summary Future Developments Similarity of Sales Tax to Existing Excises Considerations to be Weighed in Judging the Sales Tax Estimates of Tax Base and Tax Yield Variability of Yield Questions Concerning Scope of Manufacturers' Sales Tax Definitions of "Manufacturing." Avoidance of "Double Taxation" or "Pyramiding." Sales to Non-Taxable Persons or Firms APPENDIX ONE Methods of Estimating Tax Base for Sales Tax Domestic Production Exemption of Foods Exemption of Food and Clothing Taxation of all Manufacturers' Sales General Sales Tax APPENDIX TWO Method Deriving Estimates of Variability in Yield of Several Important Taxes Corporation Income Tax Individual Income Tax Tobacco Tax
(a) A sales tax should not be used to replace any of the tax revenue now being received by the Federal Government.
(b) Even if revenue needs should force an increase in taxation, it would be preferable to rely first on increases in income and estate taxes, and possibly on some of the temporary excises, before levying a sales tax.
(c) if a sales tax is to be levied, it should be a manufacturers' sales tax, unless the rate required is 8 per cent or more when it might be better to impose a general sales tax at a lower rate.
(d) If a manufacturers' sales tax is to be levied and if revenue needs permit, the tax should be levied only on finished products not including any products the purchase of which, by a taxable manufacturer, represents a business expense deductible for income tax purposed. That is, exemption should be granted to sales to taxable manufactures, not only of materials, but also of equipment (e.g. machinery) and supplied (e.g. oil for machinery, fuel).
(e) Further, if possible from a revenue viewpoint, articles of food should be exempt and perhaps also certain articles of clothing.
DEFINITION. -- The term "sales tax" as used in this memorandum means a tax applicable at one or more stages in the commercial and industrial process (extracting, manufacturing, wholesaling, retailing) and levied and levied at a uniform rate /1/ on all sales of all tangible personal property except those specifically exempted. Thus it contrasts with the various manufactures' excises and the present processing taxes, which are levied at varying rates on a few specified commodities, and the "special taxes" on communications, issuance and transfer of securities, etc., which tax the rendering of services and the transfer of intangible usually not subject to a sales tax. Sales taxes in some countries apply to receipts from professional services (doctors, lawyers, etc.).
HISTORICAL SUMMARY. -- Although the sales tax was employed in ancient times and in the later middle ages, its introduction in modern times, aside from a few experiments in the nineteenth century, can be dated 1918, when the German Government adopted a low-rate general sales tax. France followed in 1920, and in a few years the tax had spread over four continents and had become an important element of national taxation in this continental European countries that had participated in the World War. During the last two years sales taxes have been enacted in many of the States of the United States and are
/1/ Rate discriminations may be made among various stages -- retail, wholesale, etc.
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now important sources of revenue in sixteen states. /1/ Abroad, Holland recently introduced a sales tax, and Austria, Belgium, Czechoslovakia, Germany, and Italy, among others, have in the past few years increased their sales tax rates. /2/ In general, then, the sales tax movement has been growing steadily since 1918 and has probably not yet reached its peak. Great Britain and the United States appear to be the only mayor national Governments not using a sales tax. /3/
The federal Government levied a manufacturers' sales tax during the Civil War, increasing the rate from 3 per cent to 6 per cent in the period 1862 to 1865. /4/ Agitation for a national sales tax developed shortly after the world War and again in 1932. H. R. 10236, reported from the Committee on Ways and Means on March 8, l932, contained in Title IV a manufacturers' excise tax at the rate of 2- 1/4 per cent. It was of the conventional type to be described below, in that it exempted articles for further manufacture (but not plant equipment, machinery, and tools) sold to a taxable manufactures, thus avoiding, to some extent, multiple taxation of any given finished product. Exemption was granted to domestically produced from or garden products,
/1/ Arizona, California, Illinois, Indiana, Iowa, Kentucky, Michigan, Mississippi, Missouri, New Mexico, North Carolina, Oklahoma, South Dakota, Utah, Washington, and West Virginia.
/2/ Bulletin de statistique et de Legislation Compare. 1930- 1933, passim.
/3/ The exact status of the Soviet Government and of Japan in this respect is not known to the writer.
/4/ Some commodities were taxed at specific rates. Frederic C. Howe, Taxation and Taxes in the United States under the internal Revenue system. 1791-1895, New York, 1896, pp. 166-90.
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certain articles that are commonly sold to farmers (fertilizer, seeds, animal feed), certain widely consumed foods, water not in closed containers, articles already subject to tax, newspapers and periodicals, articles for religious purposes, textbooks, and books for the blind. Manufacturers with annual sales of less than $20,000 were exempt. The tax was beaten on the floor of the House, a series of manufacturers' excises and special taxes being adopted instead. Another unsuccessful attempt to impose a sales tax was made when Senator Walsh, on June 6,1933, introduced an amendment to the National Industrial Recovery Act (H.R. 5755) that would have levied a tax of 1-1/2 per cent on sales of finished articles by manufacturers, exempting, among other things, food, clothing, and medicine.
FUTURE DEVELOPMENTS. -- There will be decided pressure for a manufacturers' sales tax at the coming session of Congress, particularly if further delay in business recovery holds down the yield of present taxes and at the same time continues the need for large relief payments and makes the threat of inflation more ominous. Further, in the States noted above where a sales tax is an important source of revenue, inability to tax interstate sales and certain other administrative difficulties are generating a fairly active movement for a Federal tax, part or all of the proceeds to be distributed to the States.
It is noteworthy that very little agitation has developed for a "general" sales tax -- i.e. one that strikes virtually all sales, whether by producer or trader. This is the more curious in that it is the type most generally adopted abroad. With certain partial exceptions (notably Austria, Czechoslovakia, and Jugoslavia). Canada, Holland and Australia are the only major countries restricting the sales tax to one stage (Canada and Holland, manufacturing; Australia: wholesaling). and the modern originators of the sales tax -- France and Germany -- still retain the over-all turnover taxes with which they started.
The preference for a one stage sales tax is probably justified if the country's revenue need do not demand a one-stage rate higher than, say 2 or 3 percent. Perhaps it is still justified even if a rate of 6 percent (which has been used in Canada) is needed. However, if the revenue needs are such that, as in France, a 2 percent over- all tax is levied, at a rate of between 8 and 10 percent (assuming three transfers from producer to consumer). /1/ With such a high rate there come difficulties that might best be avoided by a lower rate spread over more taxpayers, which in turn, however, leads to still other problems. /2/
Furthermore, anything other than a retail tax makes more difficult the substitution (with distribution of the proceeds) of a Federal tax, in place of existing State sales taxes, since most of the revenue of the State taxes comes from retail sales. Agitation for such a substitution has been growing. The writer agrees that, if a sales tax must be
/1/ Suppose the producer sells to the wholesaler for $100, the wholesaler to the retailer for $120, and the retailer to the consumer for $170: a 2 percent general tax would yield about $8.
/2/ The nature of these problems cannot be discussed within the limits of the present memorandum, but it may by noted that they involve such difficulties as collection of small amounts from large numbers of taxpayers, decided changes in channels of trade, and fostering of vertical integration.
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levied, the Federal Government is the agency to collect it. At the moment, however, the prospects of inducing all the State to surrender sales taxes is so remote that the problem does not seem worth discussing, at least as an isolated matter. California, for instance, is receiving about $50 million a year from a sales tax, Michigan about $38 million, /1/ and Illinois, about $35 million /2/ -- about $9, $8, and $5 per capita, respectively. If distribution were on a population basis, the Federal tax would have to yield $1.1 billion to compensate California, or $966 million to compensate Michigan, for giving up its sales tax -- leaving nothing for the Federal Government. /3/ This would require a rate of 4 percent or more for a manufacturers' sales tax with virtually no exemptions. In other words, certain States have already gone into the sales tax field at such high rates that the Federal Government would have to pay a high price to induce them to retrace their steps.
The Australian tax, collected from wholesalers instead of manufacturers, has been discussed little if at all in this country. The writer has studied the Australian law, but has no information of value on administrative experience under it. In view of the complexity that wholesale trade has assumed in this country in the past two decades. it would probably be wise to prefer a manufacturers' sales tax, at least until more information is received on the Australian experiment, which has been in operation only about three years.
/1/ Revenue received during the period July 1, 1933 to June 30,1934 was $34.87 million, representing eleven months' collections.
/2/ Data in this paragraph on yield obtained by correspondence with state officials.
/3/ Indiana's receipts from its gross income tax were, on business, etc., done during the twelve months July 1933 to June 1934, $11.64 million -- about $3-1/2 per capita.
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SIMILARITY OF SALES TAX TO EXISTING EXCISES. -- The problems posed by a manufacturers' sales tax may best be approached by recalling that such a tax is, after all, nothing more than a large number of individual excise taxes similar to those now resting on producers of lubricating oils, matches, gasoline, toilet articles, etc. As can be seen from a study of memorandum P, the ease of administration varies greatly among the several commodities; so, too, do the probable distribution of burden of the tax, the effect of the tax upon methods of doing business, and other factors in the problem.
A thorough study of the sales tax would, therefore, necessitate an inquiry, if only brief, into the probable effects on each industry involved, or at least each major industry. It has not been possible to do this in the present memorandum, but the reader is urged to bear this point in mind when studying the generalizations in the following pages.
Since many of the problems to arise under a manufacturers' sales tax have already been met under the present exercises, this memorandum will not touch upon those sales tax points that appear to be satisfactorily handled under present law (e.g. determination of taxable value in the absence of an "arm's length" wholesale sale). It is to be assumed if a sales tax is levied it will include those relevant provisions of the present excises that have proved satisfactory in practice.
Finally, the advantages and disadvantages of a manufacturers' sales tax, to be mentioned in the next subsection, will be treated briefly because the standards developed and the points made in the memorandum on excises are for the most part applicable to the sales tax.
CONSIDERATIONS TO BE WEIGHED IN JUDGING THE SALES TAX. -- Whereas the excise taxes now in force are in general restricted to articles of luxury, or at least of "non-necessity," a manufacturers' sales tax whit no exemptions would be preponderantly a tax on the necessities of life. As such it would, if shifted, take a larger percentage of the income of the destitute than of the poor, of the poor than of the wall-to-do, and of the well-to-do than of the wealthy. This is, the tax would be "regressive" rather than "proportional" or "progressive," on a net income basis. It would also rest somewhat more heavily upon the urban population than upon the rural population, insofar as the latter consume more of what they themselves produce than do the former.
The equity of the tax is a matter for Congress to determine in the light of the revenue system a whole. The writer's personal feeling on the matter, after a study of Mr. Shere's Memorandum R, is that a sales tax, even with food and clothing exempted, would make the Federal revenue system less equitable than would increases in the income or estate taxes.
These considerations aside, however, there are three points that greatly weaken any appeal the tax might otherwise have on the basis of burden distribution.
First, it is wasteful for the Government to hand out relief payments with one hand and with the other take back part of the money through a tax on necessities (this can be largely obviated by exempting foodstuffs and clothing, with a corresponding decrease in revenue and a somewhat increased administrative burden arising from the necessity of distinguishing between exempt and taxable goods).
Secondly, the tax paid by consumers is paid indirectly and is a hidden burden. From certain points of view tax-consciousness may be undesirable, but the writer believes that every reasonable attempt should be made to keep the public as conscious as possible of its tax burden.
Finally, as can be seen from the discussion of several of the taxes noted in Memorandum P, a considerable part of the manufacturers' sales tax may not be shifted to the consumer but may instead rest as a burden on the producer or merchant, especially for the first year or two of the life of the tax. The result will of course vary from industry to industry. The is obviously no justification for a no-shifted sales tax, if only because the burden would be heavy or light's as the ratio of profit to sales was small or large -- and this ratio usually depends on factors entirely beyond the business man's control, being naturally smaller in a relatively fast-turnover /1/ business such as shoe manufacturing than in a relatively slow turnover business such as steel making.
The other chief objection is more of an economic nature. The tax strikes, among others, those business men who have been operating at a loss and/or those whose working capital position is weak. Temporarily, the tax may check business recovery by putting out of business, or into the hands of new owners, firms of this type. Over the long run, the tax would probably not halt any recovery that might otherwise occur, but the period of readjustment might severe.
/1/ Turnover, that is, of total capital including fixed assets.
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The sales tax is practicable for use as an important source of revenue in the sense that in this country and at this time the tax could be collected without excessive administrative expense and without a large loss of revenue through evasion, provided manufacturers having annual sales of $5,000 or less were exempted.
It can be collected an a monthly basis reflecting the preceding month's economic activity and therefore would rise in yield as the price level rose. This consideration is of particular importance if a period of uncontrolled inflation threatens and if, for political reasons, the check cannot be exerted on the expenditures side. THE WRITER HAS HEART, INFORMALLY, OF PROPOSALS TO VEST THE EXECUTIVE WITH AUTHORITY TO LAY A SALES TAX AT ANY RATE AND AT ANY TIME THAT AN EMERGENCY MIGHT DICTATE. WHETHER SUCH A PROPOSAL SHOULD BE CONSIDERED POLITICALLY OR CONSTITUTIONALLY FEASIBLE IS A MATTER FOR FURTHER STUDY. BUT IT ILLUSTRATES THE IMPORTANCE THAT A SALES TAX WILL ASSUME IF INFLATION BECOMES DRASTIC. /1/
However, a word of warming should be injected here. The sales tax per se is no cure for inflation. Used in the manner suggested above, it is merely a palliative designed to prevent the excess of expenditures over revenues from increasing more rapidly than otherwise, merely because of the reflex action of the rising price level upon expenditures. The sales tax in France did not prevent inflation; and inflation was finally stopped by an increase in the rate, not only of the sales tax and several other indirect taxes, but also of the scheduler income taxes. /1/
/1/ UNDERLINED MATERIAL IS CONFIDENTIAL AND IS NOT TO BE PUBLISHED.
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The sales tax is sometimes supported on the grounds that its yield is relatively stable throughout the business cycle. This point is discussed in detail in a section below, where it is shown that the tax is much less stable than some of the special excises, but much more stable than the income taxes as they existed under the Revenue Act of 1928.
In summary, the sales tax stands in the writer's mind as a tool that may be called upon if others, which he considers more suitable, cannot be used for political reasons -- using "political" in its broadest connotation to indicate what the mass of the people will tolerate. It is a crude tool, however, which may fail in almost every respect with the important exception that it can be counted upon for a large and fairly predictable amount of revenue quickly available. Finally, attention should be forcefully directed to the fact (clearly indicated by recent history) that the sales tax, once levied, tends to remain, owing to inertia and to the lack of organization among its widely scattered and haphazardly placed victims. Aside from the purely revenue aspect, the sales tax is one of the poorest of "emergency" levies.
/1/ Robert Murray Haig, The Public Finances of Post-War France. New York, 1929, p. 164.
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