So much for an indication of a general approach to one phase of the risk problem. To this line of attack an obvious rejoinder is available. It can be objected that it leaves wholly out of account the chief engine by which economic society progresses in a material sense: economic pioneering. That is to say, notice must be taken of (a) concerns that are affected by risk during a period when they are trying to find a place, even in an industry that in the main is not especially risky; (b) the establishment of new industries; and (c) the developmental aspects -- inventions, production and distribution techniques, explorations, and so forth -- in old industries.

Probably the averaging method is sufficient to care for the risks incident to firms endeavoring to secure a niche in a safe and going industry. Their initial losses, to repeat, can be offset against later gains; if they fail to win a position, the excess profits tax will probably not have touched them; and, if their position in the industry finally is attained, they will presumably participate in the safety of the industry as a whole. The other elements of economic pioneering, involving serious risks of course, cannot be spoken of with nearly so much assurance. It is possible, however, to make certain observations in regard to them.

There is, it is fair to say, a good deal of romanticism about economic pioneering these days. The picture is ordinarily one of the wildcatter or explorer, after a life of disappointment and expense and hardship, at last attaining deserved wealth. Take the possibility of large reward from these men, and their efforts, it is supposed, will cease. Against this it can only be urged that the days of individual mineral exploration on an economically significant scale appear to be about over in this country. The business of exploration and discovery is being more and more undertaken by organized companies already in the field, for whom the balancing of risks, one against another, in itself offsets the risk element in considerable measure. /53/

Much the same can be said of the individual inventor. He contributes a great deal to economic society and does so, according to theoretical presumption, because of the prospect of large rewards. In this case it may also be recalled, however, that a great deal of the scientific progress made today is the accomplishment of workers in university and government laboratories, in the research divisions of private industrial companies, and in the clinics of hospitals and foundations. /54/ For these people, neither the risk nor the reward factor is of much significance. They have salaries; and they receive little or nothing else except prestige from their success. /55/

If, after experience with an excess profits tax law, the problem of the individual inventor or explorer seemed sufficiently important, perhaps a special proviso could be drafted to take care of it. It might be provided, for instance, that the income from an invention or mineral discovery, or the proceeds from its sale, should be exempt from excess profits taxation so long as it remained in the hands of the original individual discoverer or was sold by him for cash or money's worth. For companies carrying on the same work, it might suffice to permit the capitalization, for excess profits tax purposes, of the expenses incident to the development of a patent or discovery and perhaps allowing the capital proceeds from the first sale of the patents or discoveries to be exempted. /56/ The writer does not, of course, foresee all of the permutations of law that might be necessary to prevent repression of pioneering in this sense, but the task does not seem insuperable. A good deal of experience with the manner in which an excess profits tax law actually works in practice will certainly be necessary before a definite solution can be suggested.

Aside from the inventor and discoverer, however, a real difficulty remains. It concerns the capital risks incident to the financing of new and dubious products: production and marketing efforts, in short, in which a considerable series of losses are likely to be incurred initially. Here the illustration used to be the motion picture industry, now it is radio, television, and air conditioning, among others. It is possible, naturally, to disparage the effect of an excess profits tax even for this class of undertaking. It can be suggested, for instance, that enterprise of this sort will not be discouraged materially by the tax, since the incentive will not depend so much upon the absolute rate of reward as upon the existence of a differential in the reward for economic pioneering as measured against the reward for capital investment in older, established, and safer lines. It can be pointed out that under the excess profits tax the economic pioneer will obtain his differential even though he is compelled to pay a portion into the public treasury. It can also be pointed out that, if the tax operated to discourage the venturing of capital in the more hazardous fields, it will be forced in the long run into safer endeavors. A force will thus be loosed to cause a decline of returns in the latter and an increase of returns in the former, re-establishing in part at least the previous differential. Yet, when all that is said, it does not appear that the excess profits tax can be clearly absolved from a possible repressive influence on the riskier types of new industrial undertakings.

6. The question of intangibles with reference to capitalization depends for its answer almost entirely on the composition of the intangible assets. Since, in the theory presented by this paper, the excess profits tax rests upon a ratio of earnings to proprietor's capital at stake, it appears that certain elements of intangible-type income should not fall within the scope of the tax.

Perhaps the extreme case of intangible assets is that of personal service businesses. For administrative reasons and for an additional reason -- that there is not now any recognized methodology by which the capital value of personal ability can be calculated independently of its earnings, and then a tax applied to the ratio between earnings and capital --, it is probably necessary to exclude personal services businesses from an excess profits levy. This procedure at once gets rid of the most glaring example of non-capital earnings. /57/

On the other hand, as heretofore indicated, it would appear that provision should be made for including in capitalization the costs of such intangibles as patents and copyrights. These are frequently very costly, are a legitimate base for capital expansion, and their inclusion would appear to be in accord with sound social and economic policy.

As to other intangibles, it is found that they range all the way from the congenial personality of the small business proprietor to franchises and trademarks worth millions. The several types into which these intangible properties fall need far more examination than this paper has been able to give them. Broadly speaking, the writer feels that most intangibles should be excluded from capital, even though bought and even though the proceeds are taxed in the hands of the seller. Having in mind chiefly such things as good will, trademarks, advertising slogans, and assets of life character it seems reasonable to contend that: /58/

(a) They are mainly developed by advertising and other prestige devices. These are competitively useful, but far more questionable from the point of view of social utility. In any event, the current expenditures made to develop them can be deducted in the determination of net income as against gross, and they will, if wisely made, yield their return in the form of an increased rate of profit. /59/

(b) The most important point of reference for valuing intangible assets is their earning power. In many cases they have no real cost whatever.

(1) If earning power is used as a basis for capitalizing intangibles, however, there must usually be no excess profit in respect to them. /60/ The capitalization must move upward automatically as their capacity to yield an income increases.

(2) If a company has earnings in excess of a normal return on its apparent investment in capital assets, the excess must generally be ascribed to some type of intangible possession -- perhaps no more definite than "good will," good management, or a fortunate location -- and the capitalization of these items must cause the appearance of excess largely to vanish.

(3) If the purchase price of assets secured from company A by company B is allowed full recognition as a capital investment by company B, then earning power based on intangibles formerly owned by company A will be reflected in the purchase consideration, though they may have been excluded when in the ownership of A; intangibles will have been capitalized by the transaction, and profits that were in the excess bracket at one time will now no longer fall in that category. The Government, assuming it taxes the sale price as a capital gain, will have exchanged a once-for-all assessment on the earning power represented and will have sacrificed a continuing annual revenue. /61/ Whether or not this shift is advantageous to the Government will depend on the rates of tax involved and the time duration over which the capital could be expected to persist as an income producing factor.

7. As far as strictly accounting objections to excess profits taxation are concerned, this memorandum can make little comment. As matters of accounting technique they are sufficiently impressive to make an excess profits tax extremely questionable if it were to stand alone in the tax system as the only levy resting on a definition and determination of business income. With the Federal tax system as it is today, however, there is one pertinent consideration: an excess profits tax can define income in the same manner that it is defined for other business income tax purposes. If this procedure is followed -- as in the present enactment -- the problem of additional administrative load is materially reduced. It can be suggested, for instance, that the Bureau of Internal Revenue must already deal with such things as depreciation, depletion, obsolescence, surplus, etc., in arriving at taxable business income. It is not compelled, therefore, to undertake their solution afresh. The union of the profits and income taxes obviates most new struggles, provided the "net income" is the same in both. The items entering into capital adjustment are either already arrived at for income tax purposes, obtainable from the income tax returns or probably can be added to the returns without too much difficulty. This does not mean that all is clear sailing: income accounting is still not so neat as a logical purist might wish. A case in point is the allocation of return from long-run contracts, already suggested. It remains largely unsolved under the income tax. So, too, its solution will not immediately be accomplished under the excess profits tax. When it is resolved for one, the other will benefit from the victory; and if that never occurs, the point is worth repeating: the conundrum, in itself, has not been made more complex by the addition of a tax resting on income. /62/

Under the head of accounting was included the question of appreciation and depreciation allowances. In part these are matters purely of accounting technique; in a measure, they raise problems of principle. To the extent that the former is true, the preceding comment is pretty much applicable. To the extent that the latter is the case, examination of how they should be properly treated under the law is necessary.

The depreciation or appreciation of capital assets, if attributable to price level deflation or expansion, presents a plausible claim for adjustment of capital values in accord with these fluctuations. Practically, however, there would be awkwardness in the procedure. The present inadequacy of our price level indices would be a first-rank handicap; and, while the writer would not too thoroughly disparage the idea of price level adjustments for capital assets, the whole notion can be argued against. /63/

From the fiscal point of view, one of the objectives of the tax is to gain a mounting revenue as rapidly as possible in periods of business boom. The allowance of capital appreciation because of price level rises, usually evident at such times, would lessen this advantage of the tax. From the point of view of equity, it may be claimed that boom profits, arising when the price level moves upward, were not contemplated when the investment was made, and are largely a fortuitous and unearned gain; and that therefore, if the tax falls somewhat heavily on those companies that were lucky enough to secure their assets at the bottom of a price level trough, there is a certain rough justice in the circumstance. Moreover, (when the capital stock tax is used in connection with the excess profits levy) the company that acquires assets at a low point will be compensated in some measurable degree at least for the higher levels of its profits assessment by the lower amount of its stock tax. At the same time, a company that enters business on a price level peak will in a subsequent decline be in a better position with respect to excess profits but disadvantageously situated with respect to the capital stock tax payments. Insofar as companies are continuous, suffer continuous appreciation and depreciation of assets, and acquire and sell assets through the course of succeeding years, the injustice between companies on this score will be largely ameliorated. Even regarding extreme cases, then, that of a company organized at the lowest point of price level depression and that of one organized at the highest point of price level inflation, the injustice is not nearly so great as it might at first appear, since the process of continuous capital adjustment just mentioned will ordinarily take place through the several stages of the business cycle, and their capital cost will be pulled toward the averages. Most companies, of course, will be organized at neither extreme but will be capitalized at some intermediate point of/the business cycle. In substantial measure, the fact is, the apparent differentiation of treatment comes out in the wash. Admittedly, however, there will be a noticeable disparity of treatment, without price level allowances, between those companies that make a once-for-all capital investment either in a price level trough or peak.

This leaves the problem of appreciating and depreciating assets due to changes in the earning position of a company. Not much, in the writer's judgment, need be said in this regard. The object of the excess profits tax enters the picture precisely at this point, for the chief idea behind the tax is to levy upon invested capital, not upon earning power capitalization. However, the depreciation of assets by wear and tear, by depletion, and by losses, is still another affair. This should be cared for; it is adjusted under the present income tax procedure and will likewise be handled under the excess profits tax, subject always of course, to improvement in methodology and formulae. Here a neat point must be noticed. The existence of the excess profits tax will implement the administration of depreciation under the income tax, since the taxpayer will be caught between two fires. For the one, he will desire, of course, to make his depreciation allowance as large as possible; for the other, any unjustified depreciation that he secures is likely, in the long run, to prove costly when subsequent excess tax payment dates roll around.

8. In determining a correct principle for the levy of an excess profits tax, reserves and surplus accounts present a problem, as has been hitherto indicated, whenever they take the form of cash balances or investments. If the idea of an excess profits tax is to assess the rate of earnings on "proprietor's capital at stake in the business," then the items allowable as capital, it is obvious, must be given careful scrutiny. The danger of evasion purely by means of excessive cash balances included in capital is presumably somewhat minimized by a natural disinclination to lose the income from funds which could be employed. Experience in this connection will reveal the facts. Evasion by the investment method is much more likely.

The investments of company A in securities of company B, say, or in assets not used by it in the conduct of its business affairs are not "at stake" in company A. /64/ They are ventured in company B, and if they are to appear as capital there is a good basis for the view that they should emerge as part of the capital of company B, rather than company A. Speaking generally, therefore, it would seem that investments should be excluded from capital and their income, to be consistent, excluded from taxable income. As a practical matter, moreover, the inclusion of investment in capital would be likely to destroy the revenue productivity of the tax.

It needs to be re-emphasized, however, that a good deal of attention to detail, to draftsmanship, and to administration will be required. Otherwise, the principle of excluding investments from capital could exert a decidedly uneconomic pressure on concerns affected. In order to get perfectly legitimate contingency and other reserves in capital, they might be induced to freeze them in inventories, plant, and equipment at times when sounder policy would indicate that such reserves should be carried in liquid form.

9. The opposite aspect of the surplus and invested reserve problem is borrowed capital, which, according to theory, will secure an interest return from the business. The profits from the use of the capital will go to the business owners, not to the lenders. For that reason, strict adherence to the idea that an excess profits tax is an assessment on the rate of earning of proprietorship capital would require that borrowed assets be excluded from the capital account.

The writer inclines to that view. /65/ As a contrary consideration it is evident, as was noted elsewhere, that such a policy will necessitate some very nice legal and economic distinctions as to exactly what does and what does not constitute borrowed resources. /66/

The contention that borrowed capital exclusion will cause the tax to fall with unequal severity upon undertakings in which little ownership capital is ventured but large, exceptionally short-term, often informal borrowing of the personal-credit type is used, undoubtedly has a degree of merit. It is an aspect of the personal-ability, rapid-turnover influence on the rate of capital earnings, which has had precious comment; and it has validity as an objection to the tax in proportion to the importance attached to the fact that apparent capital earnings are not exclusively capital earnings. /67/ The mere circumstance that the borrowings are large in proportion to the proprietors' capital does not seem to make an additional point. Further, the fact that the credit is short-term, rapidly rotated, and informal in many instances does not seem to have any additional bearing, save for the administrative difficulty of tracing the true situation. A series of short-term loans used for financing can be interpreted satisfactorily in the light of an average constant volume of borrowing.

Under the heading "source of capital" was mentioned the problem of extravagant salaries and bonuses when ownership and management are closely identified. Trouble arose on this score in connection with previous excess profits taxes; it is likely to arise again whenever rates on the excess profits tax are sufficiently heavy to provide a real stimulus for evasion. The severity of the difficulty, of course, will be associated with relative tax payments required in any particular instance under the personal income tax in contrast with the excess profits levy.

A formula for the ready solution of the problem does not appear. Primarily, the solution seems to rest on careful administration, and, perhaps even more important, upon the attitude of the courts toward disallowances of exorbitant salary and bonuses claims by the Commissioner of Internal Revenue. Officials in the Bureau feels that enforcement now will be somewhat easier than formerly, and the evasion of he tax by such methods can, as one of them phrased it, be confined to "petty stealing rather than grand larceny." /68/ In addition, they feel that the courts have been helpful in this direction in recent years. The case of Botany Worsted Mills v. the United States is cited. /69/

10. The argument that an excess profits tax falls more heavily on smaller rather than larger concerns can only be settled by factual data. The Treasury felt that it had proof, here presented in Appendix I, of the organizational regressivity of the former excess profits tax. Additional material is recorded in Appendix II. It is to be noted that the evidence thus far is that the larger rates of return on capital do not seem to arise in connection with the greatest aggregations of capital. There is a fairly consistent tendency in the other direction. Unfortunately, further statistical investigation has been beyond the possibilities of this memorandum. Unfortunately, moreover, the operation of the present law will not provide satisfactory information for many years. The method of initiating the tax -- by free declarations of capital on the part of the taxpayer -- means that the capitalization for tax purposes will for a long time be substantially at variance with actual capital.

To the extent that an excess profits tax falls with disproportionate severity on small businesses, it could be replied that the rationale of the impost has no necessary logical relation to the size of the business: its object is to attach for Governmental purposes excessive RATES of return on capital, regardless of the size of the undertaking that secures the rate. Admittedly, however, the demonstration that smaller businesses generally possess the higher rates of return would serve to indicate inferentially that the personal-ability factor probably has greater effectiveness in the smaller types of enterprise, and that the tax, therefore, instead of assessing personal ability along with capital in a uniform fashion would, in fact, be weighted against the personal-ability element. Furthermore, it seems plausible to believe, in accordance with notations elsewhere made in this paper, that large enterprises that involve several separate phases of economic activity will possess an advantage in comparison with smaller unit businesses of which each is involved in one aspect of the larger concern's business and all in the aggregate do the same total with the same efficiency. That is to say, company X, which sells commodities A, B, C, and D, may make a profit on A and C, and lose on B, and D, and as a result pay no excess profits tax on the total. Of four individual companies, A1, B1, C1, and D1, the same situation could result in excess profits taxes for A1 and C1.

11. The feeling that in normal times a tax on differential profits will not yield substantial revenue for the Treasury is probably true enough, provided a large view of the word "substantial" is taken. Mr. Thomas S. Adams, many times quoted in other connections, mentioned the revenue consideration as one of the reasons for abandonment of the former profits tax. /70/ On the other side, his own statement is also worth recording. He said:

"In normal years we cannot expect a tax upon supernormal profits to yield the enormous revenue which we expect to derive from this source during the war. And yet, it is probable that even in lean years the tax would supply a revenue altogether worth while. In our vast country it seldom or never happens that all sections and all industries move together. When there is drought or financial depression in one part of the country, other sections enjoy abundant crops and prosperous business conditions. Where an epidemic prevails the doctors, at least, do a thriving business. There will always be some excess profits to tax. /71/

In regard to the excess profits tax, moreover, it may be suggested, that immediate, perhaps even normal, revenue is not the chief argument. The real argument lies along lines before indicated: what may be expected of the tax in the long run and in times when a business upswing is producing large profits.

12. With regard to wasteful expenditures "on the Government's money" in order to defeat an excess profits tax, a distinction in cases must be made. If a tax is temporary, outlays for advertising campaigns, plant, equipment, and other assets, it must be acknowledged, could logically be made with the idea that returns would appear after the tax had lapsed. With a permanent tax, this avenue of evasion would be closed. A purely wasteful expenditure, then, might lessen the taxable net income, but it would also lessen the realized net income at the same time and would not ordinarily be undertaken. The real question at issue, therefore, is whether the tax makes expenditures profitable that would otherwise be unprofitable. For illustration, it has been claimed that the high rate of a progressive tax, say 60 per cent, would cause businesses to be willing to spend $1.00 -- for instance on an advertising campaign -- for what would, in fact, yield only $0.40. The point overlooked in this connection is that the $0.40 will itself appear as income and be subject to the tax. The "net after tax" as a result of the transaction would be less than if the operation had not been undertaken.

In summary, it is well to repeat something of the language used at the beginning of this section. Most of the problems posed by the excess profits tax cannot be definitively settled. Even as to principle it is not clear that the use of a tax based on a percentage of capital earnings is justified, and it is by no means clear that capital earnings, if the principle were conceded, could be differentiated from other elements of economic income, which should or should not be subjected to equivalent taxation as the case may be. There is undoubtedly in many instances a type of economic return in connection with capital and personal services, roughly similar to the "unearned increment" aspect of land values: a type of economic gain, that is, for which the receiver has not apparently returned to society a QUID PRO QUO. Whether or not an excess profits tax can now or ever be made an instrument for fairly recapturing such items of income and converting them to social use through the Government is far more questionable, and about the only assured position that can at present be taken is that the end in view seems sufficiently attractive to merit a modest experiment to that direction.

The writer would add that, as Government activity becomes a greater and greater proportion of the total economic activity of the country, the necessity of balancing the budget by cycles rather than from year to year becomes ever more urgent. Otherwise, the relatively light tax load on the upgrade of a business cycle contributes to the swing of the pendulum in that direction, and the necessity for relatively heavier taxes as the pendulum moves downward lends force to the fall. It becomes more urgent, that is, for the Government fiscal policy to move as a counter agent rather than coincidentally and concurrently with the fluctuations of private finance. The excess profits tax, in company with most types of income tax, seems fitted to accomplish this result in part. The excess profits tax has this feature of advantage, moreover, beyond the ordinary type of business income levy: it can be made progressive, so that, as booms move on to their climax, the occurrence of earnings in the higher rate brackets yields a more than proportionately augmented revenue.

A point worthy of repetition is this: If the tax is to be used, as everyone seems to agree, in times of National emergency, such as war, or in times of business prosperity, as appears also logical, it is pre-eminently necessary to gain a background of experience and cohesion in the administration of the tax before the emergency arises. /72/ It is probably fair to add: The passage of a thorough-going excess profits tax would become politically inexpedient as we move from the slough of despond into happier days. Then the ordinary budget would probably be balanced, and the task of reducing the public debt, so desperately needful of accomplishment, is likely of postponement and delay until the turn of the business cycle has again made it difficult or impossible. /73/

V. The Present Law.

A. Provisions:

1. The tax on capital stock: $1.00 for each $1,000, equal to a rate of 1/10 of 1 per cent; on excess profits: 5 per cent on earnings greater than 12 1/2 per cent. /74/

a. Capital declarations, first year: taxpayer's return acceptable without restrictions; years subsequent to the first: original capital declaration maintained, subject to "adjustment."

(1) Capital adjustments mandatory: plus ". . . (1) the cash and fair market value of property paid in for stocks or shares, (2) paid in surplus and contributions to capital, (3) its net income, (4) the excess of its income wholly exempt from the taxes imposed by Title I over the amount disallowed as a deduction by section 24(a) 5 of such title, and (5) the amount of the dividend deduction allowable for income tax purposes, and minus (A) the value of property distributed in liquidation to shareholders, (B) distributions of earnings or profits, and (C) the excess of the deduction allowable for income tax purposes over its gross income." /75/

b. Basis of capital adjustments: "according to income tax law" applicable for each year; net income, the same as for income tax purposes. /76/

2. Application: to corporations, domestic and foreign. /77/

a. Foreign corporations, on the basis of capital employed in the United States.

3. Returns and payment: capital stock, annually, within one month after June 30th of each year; excess profits, same period for returns, but either annual or quarterly payments. /78/

B. General Aspects:

1. FOR THE FIRST YEAR, obviously, the set-up of rates -- 1/10 of 1 per cent on capital stock and 5 per cent on excess profits -- would provide a force to cause excess profits, on the one hand, to be concealed by enlarging the capital returned. /79/ On the other hand, the presence of the capital stock tax would act as a restraint on the return of capital on which earnings are less than 12 1/2 per cent; the point at which the excess profits levy begins. It follows that, regardless of ACTUAL capital investment, whether greater or smaller than the DECLARED CAPITALIZATION -- which was initially within the discretion of the taxpayer -- the least tax payment of these two taxes, taken in combination, could be attained by capitalizing net earnings on a 12 1/2 per cent basis -- that is, multiplying the earnings by eight. In this fashion the taxpayer would arrive at the minimum capitalization that permitted him to escape altogether from the excess profits levy. A minimum tax payment results, since, when earnings are capitalized, they are taxed 8/10 of 1 per cent, whereas, if not capitalized, they are caught under the 5 per cent rate. Thus, for the first year at least, the taxpayer's greatest advantage lies in absorbing excess profits in an expansion of his capital declaration; or, in case earnings did not equal 12 1/2 per cent on actual capital, in reducing declared capitalization to a 12 1/2 per cent basis. Stated another way: for every dollar that the taxpayer removed from a capital stock statement of eight times earnings, he saved 100/1000 of a cent, and lost 625/1000 of a cent (5 per cent on $1.00 divided by 8). /80/

It needs to be emphasized that the foregoing formulas apply only to the first year, since declared capital cannot thereafter be altered at will, but can only be adjusted in accordance with the law's stipulation. Contemplating a period of years, then, the optimum capitalization for the taxpayer might vary from the foregoing statement in accordance with the following factors:

a. The degree to which the business is likely to expand or contract.

b. The degree to which earnings increase or decrease without capital adjustment.

c. The time duration in which the two foregoing circumstances are likely to operate.

VI. General Comment on the Present Law.

A. The fact that the present enactment is confined to corporations is probably not justifiable so far as the excess profits feature is concerned -- certainly not if the theoretic arguments for excess profits taxation here advanced should finally be accepted by the Treasury.

1. The limitation is defensible, on the other hand, with regard to the capital stock tax. The customary idea here is that government conveys to corporations certain special privileges, which make special tax levies equitably permissible.

a. Note, however, that the argument frequently advanced, i.e. the defense of a flat-rate, inflexible capital stock tax on the ground that business receives the general benefits of government, regardless of whether or not it makes a net income, is only partially applicable. These benefits accrue to corporations and proprietorships alike. Further, if the excess profits tax is extended beyond corporations, as it seems it should be, the capital stock tax must likewise be extended, if the contemplated "balancing" effect of the two is not to be sacrificed in the case of proprietorships.

2. As a practical matter, most business is conducted under the corporate form, and there is administratively some excuse for confining the excess profits tax to the corporate sector of business. There are notable exceptions to this generality, nonetheless, and the problem should have thoroughgoing examination. There are many large individual proprietorships and partnerships competing with smaller corporations.

B. The tax starts off on the basis of guesswork. Each set of corporation officers is commanded to capitalize present earnings, and to estimate future earnings as best they may.

1. This procedure is not possessed of so much logic as could be desired.

a. It allows the capitalization of present elements of monopoly, intangible earning bases of all sorts, past and existing frauds, and so forth.

b. The corporation officers who make mistakes will, later on, be charged with incompetence by their boards of directors if a succeeding wave of prosperity runs their company into the "excess" level, and the officers and boards, in their turn, will in the future pray to Congress for relief. Some injustice is likely to result from the decisions of ill-advised officers who, in this period of economic pressure, view the stock tax too fearfully, and are forgetful of the excess profits to come.

2. Purely from the point of view of administration, however, the use of this principle for beginning the tax must be overwhelmingly commended. To do otherwise would involve an immediate administrative load sufficient to dampen the enthusiasm of the most ardent friend of the tax.

3. There is a question whether or not the elements of justice do not outweigh the injustices resulting from errors of judgment. /81/

The author's opinion is, the adoption of the current evaluation principle, by means of capital declarations, as a basis for beginning the tax can, as a practical measure, only be commended. /82/ Obviously, it means that for the first year the tax is scarcely more than an addition to the rate on corporation incomes, afterward, it becomes in varying degrees for various corporations a capital stock tax, an income tax, and a true excess profits tax. As the years move on, with declared capital receding into the background, and adjusted capital assuming greater and greater significance, it assumes more and more the appearance of a true capital stock and true excess profits tax. In the interim, the mixture is weird but not disastrous. /83/

C. The law determines income on an income-tax basis. This identifies the administration of the two taxes, and means, as previously suggested, that ADDITIONAL administrative troubles resultant from the excess profits tax are at a minimum.

1. Moreover, to a degree at least, the one tax can assist the enforcement of the other. An instance was noticed in the case of depreciation, in which a temporary avoidance of the excess profits tax payment might be realized, but only at the cost of building up a concealed capital, which would thereafter be actually present as an earning asset, but which could not be claimed or allowed as capital, upon which no future depreciation could be taken, and which would inflate the excess profits taxes exactly as long as it lasted as an earning capital. /84/

2. The tie-up has one disadvantage in that income under the income tax is frequently litigation. Where such delay occurs the excess profits tax collection is likewise postponed.

a. The two taxes might, however, be disentangled at the collection point. That is, the income as originally listed in the return might be accepted, provisionally at least, for the excess profits tax, and the collection made, subject to further assessment in case the Bureau were sustained in raising the income statement. The statute of limitations would need to be so adjusted as to permit the procedure. Serious loss should not result.

D. Close examination of the capital adjustments shows that cash, investments, and, in general, any earnings to which the corporation as an organization retains title are allowable.

1. So far as funds actually re-invested in the business are concerned, this is as should be. The addition of cash to capital is not likely to be seriously unsatisfactory except in a few instances, and these probably could be covered by general provision giving the Bureau discretionary powers in cases which the cash allowance was apparently being used to avoid the tax. But even without such precaution this problem is not likely to prove especially irritating. Most businesses will find that the sacrifice of earnings by holding assets in cash, simply to evade the tax payment, will be too expensive.

2. Permission to include investments, perhaps other than invested depreciation and certain contingency reserves, as a part of capital, however, is questionable. /85/ Preceding discussion has indicated that the excess profit tax can hardly be defended unless it is a tax on the rate or earnings on PROPRIETOR'S CAPITAL AT STAKE IN THE BUSINESS. Investments are at stake in other businesses, and it seems difficult to believe that they can be appropriately allowed as a part of capital for the investing organization, any more than they could be properly permitted for corporation A, if corporation A, for instance, had distributed its earnings to stockholders and the stockholders had themselves invested the capital in corporations B, C, D, and so on. The present scheme apparently allows something akin to double counting of capital; for the capital of corporation A may re-appear as the capital of corporations B, C, D. Corporations B, C, and D will claim the statutory exemption on the investment at stake in their enterprise, but corporation A will also claim the statutory exemption on the identical capital. The total earnings of A, B, C, and D, assuming mutual interlocking investments all around, will get the advantage of two exemptions.

a. Further, from the revenue standpoint, this feature will go a long way toward defeating the tax. It will be open to any business to build up undistributed profits, invest them -- in "tax exempts," perhaps, -- and thus pull down the apparent average return on its capital until there is no visible excess. The greater a company's rate of earning, indeed, the more quickly could it get itself out from under this revenue device. The fact is, the issue of securities could be used to build up excessive capital in order to avoid excessive profits.

E. Aside from a fairly high statutory normal rate, the present law does not possess any means for meeting the needs of business in which the risk element is large.