1. THIS IS INDEFENSIBLE. EXCESS PROFITS TAXATION CAN BE JUSTIFIED ONLY IF SOME FAIRLY CLOSE APPROXIMATION OF THE TRUE RATE OF PROPRIETORS' RETURN CAN BE ASCERTAINED. Unjustly to penalize risky enterprises, out of some motive of revenue greediness, will simply evoke resistance and evasion and discredit the whole tax as a fiscal instrument.

VERY LIKELY IT WOULD HAVE BEEN MORE EQUITABLE, ALL THINGS CONSIDERED, TO HAVE ADOPTED A LOWER STATUTORY NORMAL EXEMPTION AND THEN TO HAVE PERMITTED THE AVERAGING OF PROFITS. THE WRITER HAS SUGGESTED A FOUR-YEAR AVERAGING PERIOD. HE BELIEVES THAT CERTAINLY NOT LESS THAN A THREE-YEAR PERIOD SHOULD BE USED. Because of the losses that are frequent in beginning new businesses and "unearned losses," which appear in the downswing of a business cycle, another device is worth considering. That is, where a company actually lost money, instead of falling simply below the statutory exemption, it would be possible to permit the forwarding of losses regardless of time duration -- or at least for a much longer duration than three or four years.

True, both the averaging of profits and the indefinite forwarding of losses just proposed would materially reduce the revenue to be gained from an excess profits tax, even from the present enactment as it gradually begins to function on the excess profits basis. But it must be kept pre-eminently in mind that the whole rationale of excess profits taxation on any basis whatever is sufficiently a matter of debate so that an experiment in its direction should not be endangered by a procedure that is manifestly unreasonable. SPECIAL TAXATION OF EXCESS PROFITS IS NOT IN ANY WAY TO BE JUSTIFIED UNLESS THE PROFITS ARE, IN FACT, EXCESSIVE OR SUPERNORMAL; AND A YEAR IS MUCH TOO SHORT A PERIOD FOR DETERMINING THE REALITY OF ANY PROFIT RATE.

F. The flat-rate feature of the existing tax is questionable.

1. If there is such a phenomenon as an "excess" profit measured by earning rate, it follows that there are also various degrees of "excessivity." To tell the business that makes an excess of 10 per cent that will be taxed at the same rate as its neighbor, whose excess of earning is, say, 35 per cent, seem hardly just.

G. The Act excludes FOR THE FUTURE the capitalization of accruing intangible values so long as they remain in the possession of the original owner. Once more, this is probably IN GENERAL as it should be; but by means of purchase, company A by company B, the door is opened wide for the capitalization of all of the intangible values previously excluded. On this score, again, the law as it stands is open to complete rout. The British principle was correct in its general provisions with regard to ship sales during the war. Speaking very broadly, the sale price was not allowed as capitalization much beyond the capitalization in the hands of the seller. This meant that the purchaser might buy at whatever price he pleased, but that he had to assume the excess profits liability of the original owner.

Of course, the capital value represented by profit for the sale of intangible assets by company A will be taxed. As noted above, however, the Government will by the process have exchanged a continuing revenue on the income of the assets in return for a once-for-all assessment of the capital value represented. If the capital increment is taxed simply at income rates, the Government stands a good chance to get the worst of the bargain.

1. There probably should exist, as indicated in the preceding text, some differentiation in the treatment of various types of intangibles.

But beyond the notations as to possible reasons for segregating patents and copyrights for special treatment under certain conditions and some comments on the fruits of mineral discoveries, the writer has not been able to explore the subject.

2. Where corporation B buys all of the assets of corporation A, the generally correct principle appears to be: the capitalization of the purchased concern goes to the purchaser -- no more, no less. As a result it is probable that the sales value of intangible capital assets of certain classes would be less than if their purchase price could be included as capital at the price paid.

a. If this principle were adopted a nice question would arise in the event corporation B purchases only a part of corporation A. What fraction of A's capitalization is acquired?

H. The capital stock tax and excess profits tax get themselves into a curious difficulty in regard to their assessment periods.

1. The former is on a fiscal year basis, July through June, the latter on an income-tax taxable year basis.

July                 June
  Capital-stock tax year

                                   Income-tax taxable year May

Now, the excess profits for the income-tax taxable year are calculated on the capitalization of the capital-stock tax taxable year. But, since the earnings of the income-tax taxable year may be in considerable measure (as at A in the rather extreme illustration used) attributable to new capital acquired after the close of the capital-stock tax taxable year (upon which, remember, the rate of excess profit is calculated), injustices of a serious degree must occasionally result.

a. Correction of this can be accomplished by amendment to make the years co-incident and by making the capitalization, not the close of the capital stock year, but the average for the year: preferably, for the present at least, the income-tax taxable year.

I. There is no special assessment provision in the present Act.

1. It is impossible to foresee all of the cases in which an excess profits tax, because of some unusual state of affairs, may work a manifest injustice, occasionally in a fashion really confiscatory. /86/ At the same time it is nearly impossible to frame a special assessment provision that is not in itself productive of an infinite amount of trouble. The writer is not willing as yet to define his attitude in this connection, but he is inclined to think that thorough consideration should be given to the necessities and possibilities in this direction. The necessity of a special assessment provision in the present law, of course, is considerably lessened by the high normal rate of exemption, and the low, ungraduated rate after the exemption has been passed.

J. For foreign corporations, the capital stock tax is laid on capital "employed in the transaction of its business in the United States." Its income is determined from "sources within the United States." Beyond the fact that there is added by these stipulations another element of guessing that officers of foreign corporations must face -- namely, how much of the total capital shall be declared in the United States --, there is the possibility that the excess profits tax may not evolve altogether satisfactorily in the case of foreign businesses. It is conceivable that the income from sources within the United States might in reality be due to capital investments elsewhere, so that the ratio or earnings to capital could be inflated and the tax unduly severe. Whether or not this is at all serious is not apparent at the moment.

K. Provision (1) /87/ in the capital adjustment outline and provision (2) raise valuation problems, which are, however, unavoidable.

1. Probably some redrafting should be done to prevent the contribution of intangibles and their declaration at exorbitant values.

L. Provisions (4) and (5) /88/ are designed to bring income exempt under the income tax into capital for the excess profits tax: dividends, gifts, interest, and so on.

1. This deserves study with particular reference to a possible proper differentiation of treatment for certain of these items.

2. In general, as stated under D-2, it seems unwise to place dividends and interest either in the capitalization or income picture.

M. The inclusion of net losses as a deduction from capital is so noteworthy an improvement over the previous excess profits Act that it deserves specific commendation.


/1/ Georgia's excess profits tax has crept into very few printed references, though it is mentioned in the local newspapers of the period. In his article, "Should the Excess Profits Tax Be Repealed," QUARTERLY JOURNAL OF ECONOMICS, May, 1921, Professor Thomas S. Adams cites two notices and also suggests later precursors to the excess profits taxes of the Great War.

/2/ Entitled the Revenue Act of "1918."


/4/ "The distinction between a war-profits tax and the excess-profits tax is not a matter of form, but of substance. By a war-profits tax we mean a tax upon profits in excess of those realized before the war. By an excess-profits tax we mean a tax upon profits in excess of a given return upon capital. The theory of a war-profits tax is to tax profits due to the war. The theory of an excess-profits tax is to tax profits over and above a given return on capital. A war-profits tax finds its sanction in the conviction of all patriotic men, of whatever economic or political school, that no one should profit largely by the war. The excess-profits tax must rest upon the wholly indefensible notion that it is a function of taxation to bring all profits down to one level with relation to the amount of capital invested and to deprive industry, foresight, and sagacity of their fruits. The excess-profits tax exempts capital and burdens brains, ability, and energy." William G. McAdoo, Hearings before the Committee on Ways and Means, 1918, p. 15.

Actually, both "war-profits" and "excess profits" taxes are similar in intent. Their difference lies only in the method by which excessivity is to be measured.

/5/ For a detailed discussion of the provisions of the various Acts, see LEGAL PROBLEMS ARISING OUT OF WAR PROFITS AND EXCESS PROFITS TAXATION. P. J. Mitchell (?), Bureau of Internal Revenue: 1933 (?).

/6/ ANNUAL REPORT OF THE SECRETARY OF THE TREASURY, 1919, pp. 23, 24. Mr. Glass said of the tax, "It encourages wasteful expenditure, puts a premium on overcapitalization and a penalty on brains, energy and enterprise, discourages new ventures, and confirms old ventures in their monopolies. In many instances it acts as a consumption tax, is added to the cost of production upon which profits are figured in determined prices, and has been . . . a material factor in the increased cost of living."

/7/ Annual Report of the Secretary of the Treasury, 1920, p. 30.

/8/ Thomas S. Adams, "Should the Excess Profits Tax Be Repealed?," QUARTERLY JOURNAL OF ECONOMICS, May, 1921, p. 363.

/9/ Robert Murray Haig, "The Taxation of Excess Profits in Great Britain," AMERICAN ECONOMIC REVIEW, Supplement No. 4, December, 1920.

/10/ Carl C. Plehn, "War Profits and Excess Profits Taxes," AMERICAN ECONOMIC REVIEW, June, 1920, p. 283.

/11/ Fred Rogers Fairchild, "Suggestions for Revision of the Federal Taxation of Income and Profits," AMERICAN ECONOMIC REVIEW, December, 1920, p. 785.

/12/ AMERICAN ECONOMIC REVIEW, Supplement No. 2, March 1919, p. 15, "At a time when revenue was a paramount consideration, this result is greatly to the credit of the tax and, considered in a broad way, is ample justification of its enactment. When this is said, however, praise must end and criticism begin; for it appears certain that the success of the tax was due not so much to the manner in which the law was drawn, as to the skill and good judgment of the Internal Revenue Department in administering the act, and to the loyalty of the taxpayers in complying as best they could with the crude, obscure and, in many ways, harsh and unequal revenue measure."

/13/ Quoted from Editorial Research Reports, by Richard M. Boeckel, July 25, 1933, p. 71.


/15/ As it became clear that the excess profits tax would probably be ended, there were a few expressions of regret. Thus Mr. Otto Kahn, while voicing the general sentiment that the law should certainly be repealed, took occasion to add: "I am sorry . . . because in theory it is a wholly just tax. I wish someone would invent a way by which the excess profits tax, or something in the nature of an excess profits tax, could continue . . . ." Hearings before the Committee on Ways and Means, December 21, 1920, p. 163.

Twelve years later, Mr. Ogden Mills was to speak in much the same vein when he said: "The excess profits tax -- I defy anyone to think of a better tax in theory, or a more abominable one in practice." Hearings before the Committee on Ways and Means, January and February, 1932, p. 25.

/16/ MESSAGE OF THE PRESIDENT OF THE UNITED STATES, to Congress, December 3, 1924, p. 3.

/17/ William J. Shultz, AMERICAN PUBLIC FINANCE AND TAXATION, Prentice-Hall, New York, 1932, p. 519.

/18/ REVENUE ACT OF 1934, Title V, p. 99.

/19/ This preliminary statement has seemed necessary because the bulk of prevailing opinion is not merely skeptical of excess profits taxation but is inclined equally to doubt the importance of its serious exploration in period of peace.

Mr. L. M. Parker, Chief of Staff for the Joint Congressional Committee on Internal Revenue Taxation, in response to an inquiry regarding the possible permanence of the present tax, has stated to the author that, with the existing temper of the Ways and Means Committee and with the present sentiment of Congress in general, some form of excess profits taxation will in all likelihood remain on the statute books. Mr. Parker's opinion gains weight from the probable revenue necessities of the next several years.

/20/ It may be helpful to the reader to explain that in this and the succeeding section the writer is endeavoring to estate as effectively as he can the general arguments that have been made for and against excess profits taxation without thereby committing himself to the validity of any of them. A partial attempt at evaluation is made in section IV.

/21/ In this connection, see the REPORT of the War Policies Commission.

/22/ Purely by way of personal illustration, the writer calls attention to the case of cotton mill known to him in the South. It has been operating continuously and profitably during the entire depression. Within the code price structure, designed to assist marginal concerns, it has been able to secure in the past six months a greater net profit than was previously earned in any two years of the company's history -- and the company history goes back through the war period.

At least occasional phenomena of this kind must necessarily occur whenever the Government endeavors to stimulate industry by price means directly, as in the codes, or by price means indirectly, as in the tariff. Could a satisfactory excess profits tax be developed, it would presumably function as a sort of partial re-capture clause -- an analogy with the Esch-Cummins Act has been suggested -- by which the Government might retrieve the uncontemplated financial boons that its price efforts occasion for supra-marginal establishments. Under such a fiscal re-capture device, a portion of the sting would be removed from price fixing. At the same time, it would not be likely to impair the position or activities of the marginal businesses for which the assistance was arranged. Their profits would hardly fall in the "excess" category.

/23/ T. S. Adams, "Principles of Excess Profits Taxation," THE ANNALS, January 1918, pp. 147-158 (especially p. 156).

/24/ An editorial in the NEW REPUBLIC of March 1, 1922 put the latter points strongly. "When prices are soaring, the business man, it is true, must place himself in the way of harvesting the profits afforded by the times. But it is the times, not the business man, which creates them. They are treasure trove, and as such owe a quite special obligation to the state. And if, at such a time, the effect of the tax is somewhat depressant, it is by no means certain that this is a disadvantage. For the excesses of the boom have much to do with the despairs of the depression that follows."

The thought that excess profits taxation might be used to a degree for the restraint of a business boom, or for the restriction of particular industries, obviously opens up an interesting approach to economic control by Government. The subject is too big for the present paper, and the writer mentions it merely as ground that should in the future be thoroughly explored. Certainly the present enactment is not to be taken seriously as a control device.

/25/ PUBLIC -- NO. 135, 73d Congress. No closely defined rule for determining the profit is established. Apparently the 10 per cent is to be allowed on the direct costs of performing each contract, plus "a reasonable proportion of the indirect costs." Cf. THE TAX MAGAZINE, June 1934, p. 318.

The author has seen blank mimeographed contract forms of the War Department in which the re-capture of excess profits was seemingly to be based on the "value of facilities" used in the performance of the contract. It was the complaint of the revenue officials who commented on this provision that an appraiser would take into account the earning power of "facilities" in arriving at an estimate of their value, and that the excess profit, therefore, would largely disappear through the capitalization process.

/26/ Raymond B. Fosdick and Albert L. Scott, TOWARD LIQUOR CONTROL, Harper & Brothers, New York, 1933, p. 124.

/27/ "Any graduated tax on corporations is indefensible in theory, for corporations are only aggregations of individuals, and by such a tax the numerous small stockholders of a great corporation may be taxed at a higher rate than the very wealthy large stockholders of a relatively smaller corporation. The object of a graduated tax should be to make taxes fall upon the rich, who are best able to pay them. The graduated excess profits tax disregards this and often produces the reverse result," William G. McAdoo, Hearings before the Committee on Ways and Means, 1918, p. 15. The essential point of Mr. McAdoo's argument -- which directs itself at the unfortunate distributional aspects of corporation income taxation -- would have been unaltered if he had omitted the word "graduated." It would also have remained unchanged if he had been speaking of a proportional corporation income tax instead of an excess profits tax.

/28/ As an example of the textual theme the case of certain types of intermediate handlers in the chain of distribution is often cited. Frequently they do a large volume of business with little owners' capital involved. They take advantage of a good reputation, rather, to secure large advances of commodities to which they take title and turn almost immediately. Their equity -- using the word in the sense of ownership interest -- is likely to be extremely "thin", when viewed in the light of total resources used, and, judged on the basis of capital, profits may appear excessive. On the contrary, according to the argument, the application of an excess profits tax to these apparently excessive earning is a levy upon a character and ability reward and not upon a true capital return.

/29/ It has been suggested that personal service businesses might be brought into the excess profits tax by a provision for an exemption above which earning would be taxed, or a capital equivalent for the usual cost of necessary training and education in each profession or personal service business, perhaps even with a schedule of adjustments, could be set up and the profits tax applied to the rate of earning on the capital thus imputed.

The writer has not explored the various ramifications of either of these ideas, but believes that the latter, at least, is a possibility. Because of the circumstances stated in the text, namely that personal ability has elements of differential and monopolistic earnings just as truly as capital, and because the owners of many personal service businesses -- accounting and law firms are often examples -- are taking a profit on their investment in employees rather than on their own services as such, he would prefer to bring businesses of such character within the scope of an excess profits tax, if this form of taxation is to be used by the Government and if a satisfactory formula can be discovered.

/30/ The author's conversations with Bureau of Internal Revenue officials has yielded one uniform impression, to wit, their dislike of special assessment responsibilities. They seem to feel that, generally, additions to administrative burden are out of all proportion to the additional justice secured, and that, unless the Bureau is to be accused of favoritism, it must administer its special assessments in accord with stipulated and known regulations, which, in most instances, might as well be incorporated in law.

/31/ Mr. McAdoo said in 1918: "The excess-profits tax falls less heavily on big business than on small business, because big business is generally overcapitalized and little business is often undercapitalized." Hearings before the Committee on Ways and Means, p. 15.

/32/ Cf. Appendix I.

/33/ In this connection, the following comment was made on the practice of certain companies that set about to escape the operation of previous excess profits legislation in the United States: "A larger invested capital was built up by reducing or entirely eliminating cash dividends. Instead, stock dividends were issued. In this way, the corporation retained the amount of the dividend as invested capital," Milton Rindler, "Let the Excess Profits Tax Sleep," THE ANNALIST, December 3, 1923.

/34/ A Bureau official, who was a member of its legal staff during the period of the war profits and excess profits taxes, inserted in the preliminary copy of this MS. the remark: "Lack of familiarity with income and accounting problems on the part of courts was an even more serious obstruction to good administration of an excess profits tax."

/35/ The following quotation is pertinent:

"Taxpayers had no experience with profits taxes of this kind, nor had the Bureau of Internal Revenue. The Bureau was compelled immediately to expand its organization and personnel enormously to enter the new and untried field of audit of this class of taxes in an attempt to solve issues therefore never encountered and for that very reason never solved. There was then no background, no procedure, no rulings on the multiplicity of factors entering into the proper computation of invested capital now based on fuller understanding by the Bureau and the taxpayer alike today." Joseph Weare, MEMORANDUM ON ADMINISTRATIVE EXPERIENCE WITH THE WAR PROFITS TAXES, types MS., Bureau of Internal Revenue, 1933, p. 3.

/36/ This statement results from conversations of the written with several Bureau of Internal Revenue officers who are familiar by first had contact with the Bureau's experience with the war-time excess profits tax. Their opinion is that the Bureau could now succeed tolerably well in administering most of the points that previously gave trouble. They are inclined to express themselves, however, as reluctant in regard to any type of excess profits tax that would require the Bureau to determined original investments or require in a short period the appraisal of assets for a large mass of taxpaying companies -- as a basis, say, for initiating the tax. Cf. p. 83, infra.

/37/ Quoting again from Mr. Weare:

"Procedure, law and interpretations have been developed so that certain principles would now be recognized without controversy, for which formerly there was no foundation, and support. The higher ground of greater understanding, clarification of issues and speed in settling contested points which still cause trouble, has been reached by almost constant research and conference over a period of fourteen years, during which both taxpayers and the Bureau have learned much that need not learned again." p. 3.

"Necessity for such long delays in the closing of cases and fixing of the final proper amount of tax, involving as it does the inconveniences and risks f change in the financial status of taxpayers and their ability to pay, should not again arise." p. 4.

/38/ It appears have been necessary in most instances, under the laws of October, 1917 and February, 1919, to discover not merely the current rate on invested capital but the rate on pre-war capital as well. Cf. P. J. Mitchell (?), LEGAL PROBLEMS ARISING OUT OF WAR PROFITS AND EXCESS PROFIT TAXATION, Bureau of Internal Revenue: 1933 (?), p. 12 et esq. (especially p. 18).

/39/ Cf. also, p. 83 -- footnote /83/.

/40/ Sir Josiah Stamp, who was intimately concerned with the British excess profits tax, implies the significance of this factor when he writes of the "immense importance" of an administration with "great tradition, resource, elasticity, and ability" operating an "established machine" in contrast with "new, ad hoc administration." TAXATION DURING THE WAR, Yale University Press, New Haven, 1932, p. 208.

/41/ discussed below, p. 81 -- B.

/42/ "It is a shallow and narrow interpretation of this principle that tests its very application by the effect of the tax upon the consumer; which surveys man, the taxpayer, only as one who clothes his back and feeds his body. There are many valid varieties of this great principle of taxation and among them are those which survey the taxpayer in his capacity of producer, which take the business man in his economic and political environment, which recognize the truth that the state and community stand as silent partners in every business enterprise, which make a permanent place in our revenue system for a tax designed to take for the community a fair portion of all profits in excess of the amount required a fair portion of all profits in excess of the amount required to elicit the requisite investment of capital. Such a tax would be in true conformity with the ability principle; it would spare the infant industry; it would spare all industries during periods of depressions; it would encourage industrial experimentation; and would lay the heaviest burden upon those who have been most fortunate. It solves, in a reasonably satisfactory way, their difficult question of finding a graduated or progressive tax for business enterprise. It may possibly supply, what is even more difficult to find, a practicable and equitable method of business taxation," "Excess Profits Taxation," The Annuals, January 1918, p. 153.

/43/ The seriousness of this regressivity feature is much ameliorated by the fact that Americans of the smallest means are not customarily receiver of dividends.

/44/ The usual statement in public finance is that taxation should not be used for non-fiscal purposes. Possibly it would be sounder to say that taxation should be used for any desirable end for which it is an effective means. Probably the burden of proof, however, justly rest in each specific case upon those who advocate non-fiscal use.

/45/ It would be possible to construct a personal income tax that would take care of the phenomena that the excess profits tax gets at. The only necessity would be the introduction of a series of differentiations in the tax rate in accordance with the composition of the income. The procedure would be awkward, however, and unjustifiable when the excess profits tax can arrive at approximately the same result, and much easier, by collection at source.

/46/ While the excess profits tax has been accused business men of increasing prices and the cost of living, the assumption more attractive to economist is the tax remains largely where placed. Concerns on the competitive margin between bankruptcy and success will not be forced out of production by the tax because they will have no excess returns. In competitive industries, therefore, the supply of goods offered on the market will not be diminished by the tax, and producers who are caught by it will not be able to shift it in higher prices, and yet they will not themselves be driven from business because the tax is non-profits. For the monopolist, on the other hand, the calculation as to the relation of volume to price that will yield the greatest net return will not be disturbed by the presence of the tax. His greatest net profit, minus the tax. To assume that he will raise prices because of the tax, then is to assume that he will raise prices because of the tax, then, is to assume that he was, before the tax, fixing his price at a figure that yielded him less than could have been secured.

In speaking of cases in which the procedure has the power to determine his price, Robert M. Haig, op. cit., p. 157, has remarked:

"Such tender-hearted tyros at profiteering who depend on the tax to give them moral courage to charge what they can get for their goods in the market are probably rare economic phenomenon, and moreover, unless they happen to be selling directly to the consumer, anything they refrain from adding to their price is probably added to it by the next man in the marketing chain, so that the ultimate retail price is no lower."

He further said:

"It is not to understand how a tax which is imposed only after moderate profits have been accumulated can operate in an important and direct fashion as a cause of high price, if the market is freely competitive. Even in a seller's market. . . . , the power to charge a high price is not dependent upon the existence of such a tax."

In the long run, a profits tax may serve to diminish somewhat the volume of undistributed earnings that would otherwise be plowed back into business. Hence, indirectly, it might serve over a period to decrease the amount of capital equipment of the country and to cause a relative price rise in that fashion; and, directly, if it actually functioned to repress any type of enterprise, or caused laxity of management or wasteful expenditure, it would have a price repercussion.

/47/ The down-side lag, indeed, has been urged as an objection to the tax, Cf. speech by J. P. Adams in the Proceedings of the National Industrial Tax Conference, Chicago, 1920. The idea of the objection is that in a sharp recession of business concerns are embarrassed because large tax liabilities pile up in a good year and must be met in a succeeding poor year. Then funds are frequently insufficient because frozen in inventories, equipment, and plants. Then, unless credit can be obtained, the business must curtail its current expenditures or force its products on the market at sacrifice prices in order to secure cash for past tax assessments.

This phenomenon is doubtless occasionally serious for firms that do not follow the policy of accumulating sufficient tax reserves in liquid form. It does not appear, however, as a special objection to the excess profits tax. It would operate against most types of levy on business earnings in which, for administrative or other reasons, there is a considerable lapse of time between the earned date of income and the payable date of the tax. A point worth investigation, but not examined in this paper, is the possibility of shortening the time interval between earnings and tax collections, perhaps by quarterly assessments and payments.

/48/ Note, however, the following paragraph on risk.

/49/ The assumption is that personal ability is used for social rather than anti-social purposes.

/50/ Its possibilities, however, deserve more careful investigation then the writer has had time to make. The idea of putting in the stature a minimum additional allowances to the minimum, would be attractive in the event satisfactory objective methods for determining the additions could be evolved.

/51/ Writing in connection with our own previous excess profits tax, Mr. Thomas S. Adams said: "Proposals to vary the percentage for different types of business enterprise -- or to permit administrative authorities to adjust the percentages -- have on several occasions met with the approval of the Committee on Ways and Means, but upon a full canvass of the difficulties they have always been abandoned." He then went on to comment on the general idea as follows: "I do not believe it is possible to solve this problem by grant of administrative discretion, altho the British practice of increasing the statutory percentage offers an apparent improvement on the rigidity of the American law. But elasticity as between or among classes does not go to the root of the difficulty. We need elasticity within each class." "Should The Excess Profits Tax Be Repealed?" QUARTERLY JOURNAL OF ECONOMICS, May 1921, pp. 381, 382.

/52/ "A large part of the function or service which the percentage deduction is designed to perform should be performed by another device that of smoothing or averaging profits from year to year. . . . A thoro-going acknowledgment of the fact that the annual accounting period is too short a time in which to strike a true balance of gain and loss, is a condition precedent to the fair and successful application either of an income or an excess profits tax." Ibid., pp. 382, 383.

/53/ "Prospecting for oil is a hazardous business, but if conducted on a scale large enough and in conjunction with other branches of the allayed industry. the risk and hazard are probably not so great as those involved in operating a hotel or conducting a corner grocery. There are a few mines which can be financed on a lower basis than many banks." Adams, "Should the Excess Profits Tax Be Repealed?" QUARTERLY JOURNAL OF ECONOMICS, p. 381.

/54/ A study of the source of current new discoveries would be interesting. If such an examination has already been made, it has not come to the writer's attention.

/55/ A point commonly overlooked is that for a considerable class of people, explorers, inventors, and enterprises, risk is its own reward. Thus the prospectors, inventors, and speculators that the author has known, as well as the economic pioneers in a business sense, have been most often possessed of some deep-seated psychological twist that would have forced them to do what they do very largely regardless of economic incentive. There is a sort of professional instinct, if it may be so-called, a thrill from success, which for most of these men outweighs, whether they realize it or not, all other considerations. They are explorers, inventors, and pioneers pretty largely because they cannot help themselves. When they make a strike that yields a fortune, they frequently expend it again in searching through other hills and dales, in tinkering with still further schemes for the revolution of technical processes, in advancing the cause of still newer produce. Just how far the economic incentive is necessary is by no means always clear. There are to be sure, non-pecuniary risks which are not discussed in this paper. The writer assumes them to be of such nature that they cannot be allowed for in a tax systems, or else that they manifest themselves in one or more of the pecuniary considerations outlined.

/56/ Considerable skill of draftsmanship and administration would be necessary to prevent PRO FORMA sales if this distinction were adopted. There is here the implication that the capitalization of the income from particular classes of intangibles -- patents and copyrights are most clearly in mind, though perhaps some others are also eligible -- should be permitted when they are sold for cash or money's worth, but that the capitalization of various other types of intangibles should be excluded from capital account even when purchased in bona fide transactions. See below, p. 90.

/57/ It does not, however, leave the tax theoretically in so nice a position as could be wished. See above, p. 20.

/58/ The earning capacity of publicly-granted franchises should certainly be excluded from capitalization.

/59/ The reader should be explicitly warned that there would be among economists the very sharpest divergence of opinion on the point of view involved in this paragraph. The author, moreover, wishes to repeat his textual notation that a very thorough investigation of the several classes of intangibles needs to be made before a definite attitude could be adopted toward any one of them.

/60/ Will depend in part, of course, upon the relaxation of the rate of return permitted in the excess profits tax law to the interest rate used in calculating the capital value of a given income.

/61/ CF. discussion of present law p.90. The policy of not allowing certain intangibles as capital, even if purchased, would tend to depress their sale value. The extent of the depressive influence would be determined among other factors, by the rate of statutory normal exemption permitted, and, in any particular transaction, on the pre-existing ration of the purchaser's earnings to his capital.

/62/ From the point of view of the tax paying business, as contrasted with administration, the addition of another injustice that already exist in the determination of taxed income.

It is to be noted that accounting difficulties have a real bearing on the type of excess profits tax that it is wise to attempt. A tax, that is, that attempted to reconstruct capital on a historical cost basis would apparently involve many accounting imponderables and in addition would involved an administrative load of a far greater order of magnitude than the existing statute, which accepts the current capital declarations of businesses.

/63/ Inequities caused by price level alterations are not confined to an excess profits tax. They are pervasive. They ramify in several directions with specific taxes, not merely because of differences in percentage burden caused by the price level change, but because the demand for various products is materially affected by the distortion of price relations as a result of price level movements; and in the case of ad valorem taxes, which do not rapidly adjust to the price level, the injustice is also apparent. Under an income tax, a taxpayer may find himself in a higher bracket, with no real increase of purchasing power but the with an increased tax, or he may find himself in the same bracket, with a lowered real purchasing power but the same tax. In either case an upward swing of the price level will have caused him to pay -- the tax rate structure being assumed constant -- a greater percentage of his real income in taxes. A argument against the excess profits tax on price level grounds, then is equally effective against many other taxes.

/64/ Note that probably another view is proper when a company is conducting an INVESTMENT BUSINESS.

/65/ Borrowed capital was excluded under both the British and the American excess profits taxes. It has been said of the British, however , that they became ". . .inclined to believe that a more equitable tax would result if borrowed money were included in invested capital and interest on such sums deducted from taxable profits." Haig, THE TAXATION OF EXCESS PROFITS IN GREAT BRITAIN, p. 83.

A provision of this character apparently would be intended to have a double-barreled effect. On the one side the apparent rate of earnings and consequently the tax would be reduced by the expansion of capital to the extent of the borrowing, and on the other side the earnings would also be reduced by the deduction of interest. A nice problem arises when a company has assets inadmissible as capital and has at the same time made use of borrowed funds. For instance, if it has securities that are not admitted as capital and an equal amount of borrowing, shall the borrowing be held to have applied to the purchased of the securities, or shall it be considered as applying PRO RATA to the securities and to the admissible capital assets? The rule adopted will make a substantial difference in the calculation of invested capital, IBID., p. 87.

/66/ If the tax exerted a pressure for the clarification of the precise nature of certain types of securities, the influence might be all to the good.

/67/ See the discussion of personal ability, above.

/68/ The provision in the Revenue Act of 1934, Sec. 146 (d), a report to Congress of all salaries of corporation officers in excess of $15,000 will presumably build up a body of public information on customary payments for various classes of service. the Bureau, of course, should be possessed of a much greater fund of acts with which to combat unreasonable contentions than when it was administering the war excess profits acts.

/69/ Mr. JustiCe Sanford delivered the opinion of the Court. His language in part was: " . . .it is clear that extraordinary, unusual and extravagant amounts paid by a corporation to its officers in the guise and form of compensation for their services, but having no substantial relation to the measure of their services and being utterly disproportioned to their value, are not in reality payment for services, and cannot be regarded as 'ordinary and necessary expense' within the meaning of the section; and that such amounts do not become part of the 'ordinary and necessary expense' merely because the payments are made in accordance with an agreement between the corporation and its officers. Even if binding upon the parties, such an agreement does not change the character of the purported compensation or constitute it, as against the Government, an ordinary and necessary expense. . ." SUPREME COURT REPORTER, Vol. 49, 1928, p. 133.

The Court also held that in a suit for a refund the burden was on the taxpayer to show that the deduction claimed was ordinary and necessary expense.

/70/ "Should the Excess Profits Tax Be Repealed?" QUARTERLY JOURNAL OF ECONOMICS, May 1921, p. 369.

/71/ ANNALS, January 1918, p. 156.

/72/ A Bureau of Internal Revenue officer wrote this comment: "Let us have a moderate excess profits tax so that we can get some litigation as the years go by and get principles established and recognized."

/73/ The excess profits tax might be made more palatable to the business community if its proceeds were devoted to debt retirement.

/74/ REVENUE ACT OF 1934, Secs. 701 (a), 702 (a). These taxes were originally levied under the National Industrial Recovery Act: the capital stock tax "For each year ending June 30 . . ." and the excess profits tax ". . . for each income-tax taxable year ending after the close of the first year in respect to which . . ." the corporation was taxable under the capital stock tax (that is, after June 30, 1933. Both taxes were to become automatically of no effect after the fiscal year in which receipts (1) ". . . of the United States (excluding public-debt receipts) exceed its total expenditures (excluding public-debt expenditures other than those chargeable against such receipts), or (2) the repeal of the eighteenth amendment to the Constitution, whichever is the earlier. With minor changes they are now continued in the Revenue Act of 1934 and are, therefore, of force until specifically repealed by Congress.

/75/ Sec. 701 (f). Provision (C) means "net losses."

/76/ Secs. 701 (g), 702 (a).

/77/ Exemptions, capital stock tax: corporations not doing business in the tax year, and, in general, non-profit organizations of the mutual, fraternal, educational and benevolent variety (see Secs. 701(c), 101) mutual insurance companies, and life insurance companies in which policy reserves constitute at least 50 per cent of total reserves (see Secs. 201, 204, 207).