2. Closely connected with the whole accounting question is the proper treatment of appreciation, depreciation, depreciation reserves, surplus, stock dividends, obsolescence, and depletion.

a. Price level appreciation has been referred to. But beyond that, assets may appreciate in the market by virtue of an alteration in the competitive position of an establishment, as a general measure of its managerial efficiency, earning power, and for a multitude of reasons. The determination of such appreciation, if it is to be allowed, is certainly not easy, either in respect to justice between companies or from the point of administrative simplicity; and the other side of the shield, of course, is the question of depreciation, depreciation reserves, and obsolescence.

The proper depreciation allowance varies from company to company, from industry to industry, and according to the type of asset. The depreciation of intangibles is particularly nebulous. Obsolescence is ordinarily unpredictable as to the time of its occurrence, and the determination of its amount is extremely difficult when it has occurred. Contingent reserve funds set up to care for it may not be called upon for long periods, if ever, and can easily become, therefore, an unwarranted element of invested capital, so that the excess profits tax is escaped in whole or in part by the apparently lower rate of profits. On the contrary, problems of administrative adjustment arise whenever companies endeavor to conceal their true rate of earning by the opposite process, namely, by failing to take a sufficient reduction of capital investment through concealment of the real degree to which their plant, equipment, intangibles, inventories, and so forth, are either depreciated, depleted, or obsolete.

b. Depletion is another troublesome problem, whether for arriving at taxable income under an income tax or under an excess profits tax, and is notably important with respect to the latter whenever, as must customarily be true, the value of the depleting property is a part of invested capital. It is subject to much the same type of comment as has just been made in regard to depreciation and obsolescence. It possesses, moreover, interesting collateral difficulties. In many types of mineral lease, for instance, the costs of development and exploration are undertaken by the lessee and not the lessor. Thus the question of lessee depletion must be solved, together with the basis upon which depletion, usually incalculable in reality, is to be allowed for income and capital purposes: cash cost and development expense, or "discovery value".

c. Closely tied up with the preceding problems is the question of earned surplus. Plainly, the amount of the surplus will in part depend upon the deductions from gross income permitted for such factors as inventories, depreciation, depletion, and obsolescence. With companies differing widely in accounting practice and in the kind and character of assets, critics of excess profits taxation can express a reasonable doubt as to the Government's ability to adjust all of the various accounts with sufficient nicety to arrive at the true net income and, therefore, to arrive at real fairness between businesses; and while the same thing may be said against almost any type of business income levy, it becomes doubly significant when, as in an excess profits tax, undistributed earnings will reappear in the invested capital account. In that manner the errors of one year result in a distortion of the tax base, not merely for the year in which it is made, but for succeeding years as well -- a distortion, incidentally, that could easily become cumulative in effect unless the Government exercised exceeding care in discovering and correcting the cause.

Surplus accounts, moreover, are the source of troubles other than proper accounting technique and administrative determination; for, though they may be re-invested in the business that possesses them, they may also take the form of investment in the securities of Governments or of other businesses, or they may be held in cash. In either of the latter two events, they can be used to nullify the purpose of an excess profits tax. A company would only need, in order to escape the tax, to build up undistributed profits in conservative, low-yield investments to a point at which the average return on its capital would bring it below the exempted "normal" rate of earning permitted by law, and, the more excessive its profits, the greater the degree of defeat it could inflict upon an excess profits enactment. /33/ To be sure, the inclusion of investments in capital might be forbidden; but that step would then immediately involve a series of fine distinctions in order to take care of perfectly legitimate contingency reserves of one sort or another; a further series of administrative complexities would be established, and a further basis for litigation and conflict with the taxpayer.

d. An accounting problem occasionally stressed is the difficulty of determining profits from long-term contracts. It is frequently true that these do not belong appropriately in the year in which they are actually realized. Yet the assignment of these profits will materially affect the liability of a company under an excess profits tax, since, if such income is dispersed over a series of years, there may be no excess, while the opposite process of concentration might create the appearance of an excess and equally occasion a tax liability. Should the excess profits tax be graduated, this problem becomes more severe.

e. With a temporary excess profits tax, designed for use simply during the period of a war, avoidance is possible by capital investments that are authentic and justifiable but that will not yield a return in the form of realized profits for a considerable period in the future. By piling up capital while the profits tax is in force, a company reduces its apparent rate of earning. It avoids the levy for the time being in that manner and is not caught later on because, when its investment becomes productive, the temporary tax will have been repealed. Conversely, the amortization of facilities acquired to assist the Government in a war must be allowed as a deduction from income over and above the effect of the facilities in increasing capital investment. This adjustment presents many of the same difficulties as were mentioned in the discussion of obsolescence and depreciation. But, in addition, two valuations must be arrived at, that for war and that for peace; and, since war-time plant, equipment, and inventories will have a peace-time value ranging all the way from complete utilization down to zero or even lower in the case of materials so dangerous that expenditure must be made for their destruction. And, since the subjects dealt with will be unusual, more than the ordinary amount of guesswork and inaccuracy must necessarily be occasioned.

The accounting maze in any variety of excess profits tax, based as it is on the necessity of treading gingerly between capital and income, ramifies infinitely and in a manner impossible to anticipate. The difficulty, however, is roughly outlined and sufficiently emphasized.

E. For those to whom a large and steady revenue is paramount, the circumstance that our former excess profits tax lost productivity rapidly after the war condemns it.

F. Further, it is pointed out -- perhaps this should have been first in the list -- that there is no really objective method of arriving at a percentage over which profits shall be considered excessive and under which they shall be considered legitimate.

G. Finally, the excess profits tax has been condemned on the ground that, whenever the rates become high enough to yield a large revenue, there is a real temptation to use funds wastefully in order to avoid the tax. The theory is that wages, salaries, advertising, and other expenses can be augmented "on the Government's money," as the saying used to be, since, if the expenditure were not incurred, a large part of it -- assuming progression to high brackets -- would be absorbed by the Government anyway.

IV. Recapitulation and Evaluation.

The listing of arguments favorable as against arguments unfavorable does not of itself evolve a conclusion as to the real merits or demerits of excess profits taxation. The points raised on either side are of varying degrees of effectiveness, some of them apparently surmountable, others seemingly fallacious, still others requiring serious consideration.

It can be observed, of course, that most of the literature on the excess profits tax is now more than ten years old and that practically all of the hostile criticisms were written when the annoyances of American war experience and the distress of the 1920 collapse were fresh in every mind. It can also be observed that the administration of the tax was undertaken in a period when haste, confusion, and lack of precedent seriously militated against success.

At the same time, it is equally in keeping to recall that the testimony on the basis of past familiarity is almost uniformly against the tax, and this fact is the more telling because many of the witnesses cannot be accused of self-interest, defeatism, or inexperience. A proponent of excess profits taxation, therefore, may justly be expected to show that it now has a reasonable chance of succeeding where it previously failed. It must be shown that its advantages are sufficient to warrant an experiment, and that the arguments against it as a fiscal measure are currently of no effect, were originally mistaken, or are to be balanced against even less desirable alternatives.

Unfortunately, many of the points in dispute do not lend themselves to objective determination. There seems, at best, to be a disconcerting range of questions that, for the time being at least, must rest on judgment and not on demonstration. Hence, it hardly needs saying that in the notes following the writer is simply outlining his best opinion, with no special claim to expertness, giving reasons when they seem necessary and are available -- inadequate reasons in many instances no doubt -- and occasionally perhaps -- he would say because of unavoidable necessity -- resting his beliefs more on revelation than on logic. In addition, by no means all of the phases even of the various questions raised have been discussed. Partly, it has not always seemed requisite. More often, it is because the writer simply does not know the answer.

First of all, then, it seems reasonable to suggest that excess profits taxation in general and the present enactment in particular must be regarded as experimental. The consideration against excess profits taxation are, by and large, unusually forceful. That reason alone makes a tentative and unassured attitude of mind toward it almost inescapable. It means, in the writer's judgment, that rates must be kept low for a number of years in order that damage from the admitted imperfections of the tax will be minimized during a period of experimentation. In the end, it may be hoped that the acute perception of problems in practice will lead either to re-examination and revision of the tax in a manner that will make it justifiable in principle and effective in administration, or, after a thorough trial, will make its defects so clear and unavoidable that its final abandonment can unregretfully be accomplished. The assumption in these statements is fairly obvious: the author feels that, while the objections to an excess profits tax are grave indeed, its merits are likewise of sufficient importance to warrant for a time an exploration of its possibilities. In brief, he would hesitate to advise the initiation of an experiment in excess profits taxation, but, since the United States, probably more by indirection and accident than otherwise, now has a sort of excess profits tax on its statute books, he would certainly hesitate to counsel its abandonment. It deserves thorough testing, in his opinion, because former experience and the emphasis of former arguments are not entirely conclusive as a guide to current action. There is at least a modicum for optimum concerning the Government's chances of succeeding on the points of its previous failure.

1. For instance, administrative difficulties were heavily underscored both by explicit statement and by implication. It can be claimed, however, that the Bureau of Internal Revenue is now in a position quite unlike its situation in the period in which it undertook to effectuate the war profits and excess profits taxes. The Bureau had then just proceeded from a long history of customs and excise administration into the assessment of taxes in which accounting techniques were paramount. Its staff of valuation experts was inadequate, its accounting personnel still in the process of assimilating principles and procedures. The lack of knowledge of income tax accounting outside the Bureau materially increased the burden of its work and gave a large premium to its men who could be drawn into private professional practice. /34/ This phase of the matter ran up and down the ranks of Bureau administration from the top in Washington through the field offices, from legal counsel to clerks. The result was that a majority of the returns on the old excess profits tax were turned in to Washington wrongly filled out in the first place, and the work of a relatively unstable and inexperienced staff was multiplied enormously. /35/

While no administration is, of course, ever perfect, it is especially plain that the Internal Revenue has used the last fifteen years to very great advantage. It has gained experience, the principles on which it operates have become more defined, and knowledge of then has been widely diffused. Moreover, there has been built up both within the Bureau and among practicing accountants a familiarity with income tax accounting that was utterly unknown ten or fifteen years ago. So far as administrative competence is concerned, therefore, it is certainly warranted to say that the Bureau is in a substantially improved position, and that the administrative arguments that were once so compelling have now lost much of their force. /36/ Thus, while it is apparent that in many phases of excess profits taxation there must still occur a great deal of administrative trial and error evolution and, in some phases, complete precision of administration will probably never be possible, it seems tenable to conclude that the development since our former effort will now permit the administrative application of an excess profits tax with somewhat less irritation, more certainty, and more fairness to the taxpayer, and with more satisfaction to the Government. /37/

It is probably essentially accurate to say that the bulk of administrative tribulations attendant upon our former excess profits tax experience rested upon the fact that Congress, instead of recognizing, as is done in the present law, the current capitalization of earnings, felt that immediate revenue requirements necessitated going behind such values to determine original costs or valuations as of January 1, 1914. /38/ This at once imposed an administrative task of almost insuperable magnitude and a the same time started the tax off on a basis that was shot through and through with inequalities, dependent not merely on the time at which the particular concern was organized, but also upon the various accounting practices it had followed during the course of its preceding history. It ignored the fact that vast amounts of securities and other evidences of ownership had changed hands countless times on the basis, not of actually invested capital, but of past, present, and prospective earning power.

But there is no need to emphasize these circumstances. They erected a structure of administrative impracticalities, and these were further pyramided because the manifest inequities of the law caused strenuous resistance everywhere to develop, once the stimulus of patriotism and easy profits subsided a little. While it is possible, therefore, to say that the Government is now in a better administrative position than it was during the war and immediate post-war years, there is at least an inferential doubt cast on the wisdom of approaching excess profits taxation from the war-time angle. The Government could doubtless do better than it did. Still, a law similar in character to the previous excess profits law would promptly inundate the administrative machinery in a flood of valuation cases, litigation, and accounting determinations, for which records would be fragmentary in many instances and destroyed in others. It appears advisable, in consequence, to avoid such problems if possible. /39/

One consideration, to the author's mind, is extremely important. That is, if profits taxes on the excess profits principle are to be used in time of national emergency, it behooves us to have a background of pretty continuous administrative experience to go on. /40/ Except perhaps for the business of arbitrarily jarring large amounts of revenue out of taxpayers, an excess profits tax, hastily enacted in contemplation of war or after the actual beginning of conflict, cannot hope to avoid the stigmata of its haste. It will inevitably be productive of an almost infinite distress and administrative complexity resultant from its hurried adoption and the inexperience of enforcement officials. A genuine consideration, then, in favor of such a tax at the present time, lies not so much in the immediate amount of revenue that might be obtained, but, instead, in the contemplation of its effective use when necessity commands such legislation. Surely it may said, moreover, that a national emergency is by no means confined to war -- or depression --; for an inflating business boom may be equally a true emergency, even if not so generally recognized.

A last observation is permissible. The administrative obstacles bound up in any tax cannot be judged absolutely. They must be given a relative evaluation: relative to the importance of the revenue obtainable, immediate or prospective; relative to social and fiscal policy; and relative to available alternatives. There is an agreed naivete in seizing hold of some apparently desirable tax program and urbanely ignoring the details of effecting it in practical routine; but there is an equal naivete, more commonly overlooked, in taking an affrighted view of the administrative mountain and backing away, all too forgetful of what may lie behind. It is open to affirmation that the business of pounding ahead at the successful administration of difficult taxes is in many cases more to be relished than the losses of their abandonment or the burden of administering their substitutes. Thus the administrative difficulties of the excess profits tax are admittedly large, but they must be examined in conjunction with the possibility of its equitable and practicable development into an important source of revenue, in conjunction with its more effective use in time of war when fiscal requirements and political expediency will doubtless compel its adoption, and in conjunction, finally, with present alternate sources of an equivalent revenue.

Obviously, the bases for judgment on some of these matters go far beyond any claim to expertness by an economist, as such. Regarding alternate sources for equivalent general-purpose revenues, the writer would rank the income tax and the estate tax as much more desirable than an excess profits tax, and sales taxes as generally less desirable. When a comparison must be made between excess profits taxation and straight business income taxes, the question is more debatable. Many of the administrative difficulties of an excess profits tax are equally evident in a tax of the nature of our present corporation income assessment, and the latter has little if any apparent superiority when a point by point comparison of equities is made. It falls on individuals in an uncertain and probably unsatisfactory manner; it is unfair in its incidence among organizational units; and, since it rests upon small rates of profit as well as large, it is more likely to levy upon "marginal" earnings than is an excess profits tax. It may, therefore, be more disturbing to the normal course of economic activity than a tax of the excess profits character, which exempts low rates of return. Consequently, the writer is inclined to place an excess profits tax a bit higher in esteem than general business income taxation at flat rates and no exemptions. Warning must be given, however, -- particularly because of the present basis for beginning the excess profits assessment -- /41/ that much will depend upon the AMOUNT of revenue that it is necessary to raise and the SPEED with which it is necessary to raise it. That is to say, a large, new revenue -- even though theoretically more desirable -- might create a greater disturbance than an equal addition to older taxes to which administrative officials were accustomed and the economic system adjusted. The writer has no way of knowing how to evaluate the latter factors.

2. The theoretic arguments against the tax seem to the writer, generally speaking, to merit careful reconsideration. The statement, for example, that the distributive aspects of the tax are unsatisfactory and that the expanded personal-income surtaxes take care of the situation, does not meet the point.

The personal income tax rests upon the notion that the possession of private income measures ability to pay taxes and that, broadly regarded, the larger the income the greater the ability: always remembering that a certain minimum income is shielded from such a levy. The excess profits tax, on the other hand, has nothing to do with individual distributive shares of income. It rests upon the assumption that a surplus return to capital also constitutes an ability to pay - shielding from assessment a stipulated normal earning. This has no reference -- and it is intended to have none -- to the question of whether the share that a particular owner gets from a business is large or small. It contends, in short, that the canon of ability must not be stated simply in terms of the total net acquisition of the individual, but must have a second point of reference in some fairly definite relation to the economic investment necessary to secure that return. This point of view has been supported quite vigorously by the late Mr. Thomas S. Adams, /42/ noted above as having been one of the most effective critics of the tax. It is in part the background of Mr. J. A. Hobson's thought on taxation: it is the idea of the differential surplus, whether of capital, or land, or personal productivity, as a yardstick of ability to support government.

Probably the argument for excess profits taxation from the standpoint of ability departs too widely from the conventional interpretation of that term. Probably its general acceptance, if it ever occurs, will need to wait upon the passage of sufficient time to allow this second point of view regarding ability to become itself conventionalized. Likewise an argument from the benefit canon, easily made, would surely be denounced as a perversion of a time-honored sanction of public finance. The writer is disinclined to insist that the excess profits tax should be squeezed into the existing molds of orthodox taxation dogma. It would be better so, for the tax would then have the prestige of traditional concepts and apparent conservatism, but, if attention were in such fashion to be diverted from the points really at issue and directed to a terminological dispute, the effort would certainly not be worth the cost.

Somewhat in repetition, then, let the matter be put this way: the excess profits tax focuses its attention on the rate of return to proprietor's capital rather than on individual income. It takes its start on the idea, similar to the exemptions in the individual income tax, that a certain "normal" rate of return should be shielded from tax and then demands from increments above normal a share of the differential earning, presumably converting back to society's use through Government activity a portion of the surplus return that certain types of capital have been able, for whatever reason, to command originally from society. The tax, in short, refers itself to the rate-of-return circumstances under which a given income from proprietor's capital is secured. Bluntly, it says that of two incomes of $10,000, for example, one of which represents, say, a return of 25 per cent on the capital risked and the other a return of 10 per cent, the former shall pay a heavier tax. Admittedly, this tax of itself could conceivably introduce a regressive element into the Federal revenue system. Thus, an individual income of $10,000, to use our previous figure, might pay under the excess profits tax a smaller rate than the individual income of $1,000. The result would depend on the composition of the two units of income with respect to the rate of return on capital involved; and it might very well be that the smaller capital would have secured a higher rate of earning than the larger. /43/ The defense of the tax in the face of this set of facts must rest upon the contention, as was indicated, that capital -- whether large or small, whether held by individuals whose total income is great or little -- shall not be permitted to secure from economic society a rate of reward higher than the statutory normal without paying a premium for the privilege.

It is plain that this introduces on a broader scale than heretofore a new basis for regular taxation, but one with which there is already familiarity in some detail. We have long known distinctions in income taxation with reference to how an income is secure: earned and unearned; we have long approved the program of differentiation in licenses, excises, and customs on the ground that one economic activity was more meritorious than another, or that the earning of income in one set of circumstances in one economic activity was more to be praised or condemned than in another, or that the use of funds in one way is more desirable than in another. We know distinction in inheritance taxation between direct and collateral heirs, presumably because of the degree of fortuity involved in the inheritance. We use estate taxes, admittedly unsatisfactory in their incidence on individual income recipients, on the grounds of administrative ease, but also for the reason, among others, that the size of the estate that the deceased has been able to establish is a measure in a fashion of the extent to which the benefits of government have applied to him.

The objection here, of course, is obvious. It will be said that the excess profits tax -- along with the others just mentioned -- injects an element of ethics, nebulous and elusive, into the economics of taxation, that a tax is being justified on a non-fiscal basis or used for a non-fiscal purpose. /44/ The reply to this, in the author's judgment, is conclusive. Every canon of taxation having to do with equity, and some of the others, are purely ethical concepts. Economists like to surround them with a good deal of reasoning supposedly of an economic character; but at the bottom, the writer's opinion is, they all go back to a pure and simple presumption of what is RIGHT as against what is WRONG, and the subsequent reasoning is scarcely more or less than rationalization. He would say, therefore, that the basis of defense of the excess profits tax, so far as equity is concerned, is fundamentally at one with the defense of other taxes; and add that rationalization, usually condemned out of hand and doubtless usually to be avoided, is by no means especially to be condemned in this instance. The real question comes down to this: is it fairer, on the whole, to limit the rate that proprietorship capital can have without paying a differential tax, or is it fairer to let it secure whatever it can? If the answer affirms the fairness of the tax, a reasonable case can be constructed by relating the tax to the ability of surpluses to stand special levies, by altering the theory of benefit to suit the case, and by suggesting that a differential tax of this sort does not fall on marginal profits and therefore does not disturb the economic structure. If the answer opposes the fairness of the tax, that too can be reasonably defended by denying the existence of ability apart from the individual, by claiming the benefits of government as absolutes not in any sense measurable by the rate that any particular capital may happen to obtain, and by asserting that the tax will, in fact, fall on the marginal profits of riskier enterprises.

The point is, there does not appear any way by which an economist (or anyone else, for that matter) can inductively list the points for and against the principle of excess profits taxes and then objectively and quantitatively adjudge the merits of the tax as against its demerits. The undersigned, for example, predisposed to favor the tax, believes it should at least be given a friendly trial. One of his colleagues in the Taxation Group expresses the sentiment of many others when, after surveying the same factors, he writes, "I feel it is fairer, and still more strongly that it is wiser. . . . " not to adopt the principle of excess profits taxation.

3. Such comment to one side, these paragraphs probably disclose why the high surtax rates on individual incomes do not cover fully the case to be made for the excess profits tax. /45/ From the revenue point of view, it is conceivable that the latter could be productive in a period when the building up of corporate undivided profits was causing the former to fall considerably short of its maximum productivity. In any event, by introducing a new item in the tax base, if need be, a ,new element of progression in the tax system, the excess profits assessment places at the disposal of Government additional means of moving its revenues upward behind an economic boom, an additional means of retiring the public debt rapidly in times of prosperity: a means that, unless the rate of the tax were exceptionally heavy and the exempted rates of profit exceptionally low, would probably not fall on the profit margin in such a manner as of itself to affect adversely the volume of economic activity, that would not of itself raise existing prices or lower existing standards of living. /46/

Notice that this does not intend to indicate that an excess profits tax would keep revenues absolutely abreast of a boom. The lag between the date at which profits are earned and the tax is paid is to great. For the same reason, the tax would not be particularly useful as a control device in a period of rapidly inflating prices. But these facts do not entirely destroy the value of the tax along the lines suggested; for as the price level increased the yield of the tax would likewise increase, and, over the prosperous phase of the business cycle, the Government would automatically secure an expanded revenue without the necessity of specific new legislation. The lag of the tax on the up-side of the business cycle would be counterbalanced by a lag on the down-side. /47/

4. As for the argument that the excess profits tax is a tax on efficiency and not a tax levied for Government assistance or on monopoly, several rejoinders may be made. In fact, however, the criticism must in part stand as valid.

In the first place, efficiency is of itself a monopolistic element in economic society and the differential return which it enjoys constitutes in effect an ability to bear differential taxation. The personal income tax is itself in considerable measure a tax on personal ability. It is doubtful, in the next place, if large differential percentages of return on capital will exist over any considerable period of time in strictly competitive undertakings. Where important differential returns on capital are persistent, there is nearly certain to be some monopolistic or quasi-monopolistic element as a precedent condition. The normal forces of competition may be presumed gradually to whittle away, over a period, most of the larger percentage differentials; provided, always, there is genuine competition. In any event, it is probably reasonable to say that these various elements of monopoly are so manifold, take effect so pervasively through the entire range of managerial efficiency, location, patents, copyrights, credit facilities, transport costs, raw materials, resources, marketing facilities, and so on, as to be infinitely more general in determining the rate of capital return in particular establishments, industries, and branches of industry than is popularly supposed. The Government cannot, of course, make any uniform or universal attempt to control such differential factors, but it may claim a share of the advantages. Finally, if some fairly temporary circumstances, even in a normally competitive situation, should give differential advantages to a particular concern or a particular industry, the Government may claim a portion of these gains during their existence. /48/

So far, then as an excess profits tax catches the fruits of personal ability, a case can be made for it. It is not necessarily to be condemned on that account. Unfortunately, it reaches income from personal ability AND incomes from monopoly, Government assistance, fortuity, and so forth, at the same rate. Between two equal returns, the one accounted for by an exercise of personal ability and the other by monopoly, Government assistance, and so on, the excess profits tax fails to distinguish. It would only distinguish in the manner implied in the preceding paragraph, namely, in the degree to which personal ability profits generally fall below the exempted normal earning from which excessivity is measured, or in the lower brackets of a graduated tax, and monopoly profits generally go above the exempted level, or into the higher brackets. In the degree to which the foregoing was not the situation, the implication of critics would not be met. For they have presumably in mind the thought that personal ability, however unwittingly monopolistic itself, /49/ gives society a QUID PRO QUO, which most other types of monopoly or fortuitous gains do not. Therefore, if there is a reason to tax the surplus earnings of personal ability, there is reason to tax the various sorts of monopoly income still more heavily. In this objective, the excess profits tax only partially succeeds. It probably goes much further in the direction than any other general tax; its lack of perfection does not prove that it should not be used for what it can accomplish; but on the point here in question it lacks, even in theory, something of logical neatness.

5. The risk differences in various businesses is a major criticism of an excess profits tax. The problem is, how shall those enterprises in which the risk element is great and the rewards for success necessarily large, according to presumption, be granted such special treatment as will not make the tax repressive? Plainly, a normal rate of exempted earning might be unduly liberal for the safer lines of industry and at the same time insufficient for the riskier undertakings.

Three methods of attack on the problem present themselves:

(a) One is to establish a fairly high statutory normal, untaxed. Thus the exemption of 12 1/2 per cent in the existing law probably takes care, in itself, of a substantial amount of risk. From the risk point of view solely, however, a high normal exemption is open to the objection that it allows undeserved freedom from taxation for the non-risky businesses.

(b) A second method, more important, is to use the averaging device, by which the gains of one year can be offset against losses of preceding or succeeding years.

(c) A third method is to allow additions to the normal exemption after quasi-judicial determination of the particular situations of particular industries.

Both of these latter are time-honored British techniques: the last, to be sure, being apparently somewhat clumsy and uncertain, resting necessarily on a measure of guesswork, requiring fairly frequent revision, and probably not so closely in line with the American yearning for administrative precision as it should be. /50/ The administrative factor would doubtless preclude the grant of additional allowances to individual businesses, but would necessitate general grants to whole industries or, perhaps, branches of an industry. Yet such a procedure would not cover the risk factor with entire satisfaction; for risk is by no means associated exclusively with an entire industry or with an entire branch of industry and, in addition, it is not the same for all time periods. That is to say, the circumstances surrounding particular concerns in an industry -- for instance, their location in one section of the country as against another -- may make their special risk more or less than the risk of the industry taken as a whole. Moreover, industries may be exceptionally risky at one time -- as in their developmental stages -- and relatively quite safe at other times. The real adaptability of the additional allowance method to take care of risk, therefore, is open to serious question. /51/

The averaging of losses against gains is considerably more promising. /52/ If a four-year average were used, plus a 12 1/2 per cent normal earning allowance, a concern which made nothing for two years could earn 24 per cent for two years without subjecting itself to excess profits taxation; or it could earn 48 per cent in one year if it earned nothing for three years. These figures are illustrative -- there would be an almost infinite number of possible permutations --, and they demonstrate how a great amount of risk fluctuation could be cared for without serious repercussion.

The real service of the averaging method of handling variations in risk is not evident without some analysis of the risk factor. Regarding established industries, risk will apparently take effect on business chiefly in two ways: (a) fluctuations in the rate of profits from year to year, and (b) a rapid turnover among the firms engaged in a risky business. As an example, the earnings of the clothing industry will be materially affected by seasonal influences in one year as compared to another. The restaurant business is one in which there is a rapid change of establishments and proprietors. Doubtless many types of undertaking suffer from both kinds of risk.

Now it would appear that fluctuations of profit, under (a) above, would be satisfactorily solved by permitting the averaging of losses against gains; provided, of course, that the averaging period were long enough to arrive at a true rate of return. The rapid turnover of firms in a given business, under (b) above, requires further examination. Theoretically, it is conceivable that the life span of ALL the concerns might be short, that all of them begin and fail rather promptly. If that were true, it would probably also be true (in an industry which was itself permanent) that none of the firms would make sufficient profit to carry them into the excess profits category. What is more likely, is that some of the firms will be relatively permanent, reaping the cream of the profits, while others will discover the perils greater than their capacities and will fail after varying intervals, only to be replaced by still others that will meet the same experience.

Obviously, most of the undertakings that do not succeed will likewise not be touched by an excess profits tax. For them, there will be a REALIZED risk. For those that accomplish success EITHER PERMANENTLY OR FOR LONG PERIODS, it can be pointed out that the risk is UNREALIZED. Some item of personal ability, some special relation of the factors of production, or some other element has made risk non-operative as a realized deduction from income. There seems no reason for business in this class not to be subject to an excess profits assessment.

The problem is thus confined -- the discussion is still being directed to established but risky industries -- within narrower limits. There remain:

(a) Ventures that are temporarily successful, though they shortly collapse.

(b) Cases in which a business safe at one time becomes risky because of a change in its economic environment: an alteration of demand, a distortion of the relation of its price to other prices because of a price level contraction, and so on through numerous influences that might cause risk to develop where it had not previously been apparent.

As for the first of these, it can be said that the averaging of losses against gains will be extremely helpful. The excess profits tax will apply, that is, only during the period when there is demonstrable success. At the same time, it must be admitted that the tax may take for the Government funds that might otherwise build up reserves for meeting the incidence of risk when it became operative. As for risks that develop with a change of the times, the averaging device will again be most helpful, and, to make this point effective against the excess profits tax particularly, it would be necessary to show that a change of economic conditions would usually affect adversely those businesses that had previously been caught under the excess profits tax. But assuming, as was done under this heading, that safe industries are made unsafe by economic changes, there is no reason for also assuming that the excess profits tax will have ESPECIALLY operated theretofore to reduce the resources with which the particular business affected can meet the contingency. The tax will have fallen only on the more prosperous, and to that extent, indeed, would be more satisfactory than the same amount of revenue collected, say, on a straight business income basis.