Date 29 April 1941
Author unknown
Title Federal Tax on Net Value Added
Description Staff memo, Division of Tax Research, Treasury Department
Location Box 5; Other Miscellaneous Excise Taxes -- Value-Added and Primary Profit Taxes; Records of the Office of Tax Analysis/Division of Tax Research; General Records of the Department of the Treasury, Record Group 56; National Archives, College Park, MD.
 

(Not for distribution)

FEDERAL TAX ON NET VALUE ADDED

A Memorandum Prepared In the
Treasury Department, Division of Tax Research
April 29, 1941

FEDERAL TAX ON NET VALUE ADDED

SUMMARY OF FINDINGS

A. Structure of the Tax

1. TAXPAYERS. As a business tax, the theory of the tax on "net value added" suggests that it should be levied on all producers of goods and services irrespective of the form of business organization.

2. TAX RATES. Available discussions pertaining to the tax indicate that it might be considered as a substitute for or as additional to the payroll taxes, the corporation income tax, the individual income tax, and as a desirable alternative tax to a Federal manufacturers' sales tax or a Federal turnover tax. Consequently, the problem of tax rates might be viewed in the light of what rates of tax would return revenues equivalent to those taxes for which the net value added tax is to substitute. The size of tax base comparisons between the net value added tax and manufacturers' and wholesalers' sales taxes (to be found below) are a partial answer to the tax rate issue.

3. TAX BASE. Generally speaking, the tax base may be described as the gross income from sales plus the gross income from rents and royalties, less the cost of raw materials, supplies and energy consumed, depletion charges and gross royalties paid, and the cost of capital equipment consumed including depreciation, obsolescence and gross rents paid. Thus the tax base of any producer generally would include the amounts of wages and salaries paid, together with other compensation paid to officers and employees, entrepreneurial withdrawals, interest paid, profits earned, and not rents and royalties received.

Such a tax base, encompassing an admixture of outright business payments and residuals of receipts and payments, no doubt would have to be determined for a time period of not less than a year to coincide with the accounting practices of the tax-payer. In addition, the tax base generally would be an admixture of cash and accrual items and, consequently, would require highly developed and relatively complex business records. For these

In the case of imports, it appears administratively impractical to consider the determination of the amount of tax on the basis of the net value product for the exporting foreign producers. The tax basis probably should be determined as the dutiable value.

5. EXEMPTIONS. It appears undesirable, from the administrative viewpoint, to exempt sales of articles for export and for use by governments and their agencies, unless it is feasible to write into the law a simple formula for distinguishing the net value added of such sales from the net value added of other taxable sales.

Under the manufacturers' excise taxes, articles for further manufacture are tax-free in order to avoid multiple taxation. It would not be necessary specifically to exempt articles for further manufacture in order to avoid multiple taxation under the net value added tax.

The question of determining desirable administrative exemptions likely to preclude certain difficulties associated with large numbers of taxpayers and inadequate books and records is not subject to adequate analysis because of limited quantitative information. The total number of possible taxpayers under the net value added tax, including such professionals as may be classified in business or as "entrepreneurs," might be as large as 10,000,000 to 12,000,000. The administrative exemption of "producers" must be considered in the light of such large numbers of possible taxpayers and the foreseeable problem of adequacy of books and records in the case of small producers.

Because of the probable great variations in tax base, as a percentage of gross income, among industries and producers within an industry, administrative exemptions based on size of tax base might take the form of a dual standard. For example, a "producer" would be exempt if his tax base were less than $5,000 or $10,000, provided that, in addition, his gross income from sales did not exceed $10,000 or $20,000. It may also be desirable to vary the size of the standard of exemption by type of industry in order not to exempt too large a portion of an industry's tax base. However, if independent standards of exemption are determined for different industries, the


           Tax bases and number of taxpayers under the net
             value added tax and the manufacturers' and
                   wholesalers' sales taxes, 1935

--------------------------------------------------------------
                                Net    Whole-   Manufacturers'
        Description            value   salers'                
                               added    sales       sales     
                                tax      tax         tax      

--------------------------------------------------------------
              Tax bases (in millions of dollars)              

No exemptions                 $47,947  $38,194         $29,996

Administrative exemption of                                   
 units with gross incomes or                                  
 sales of less than $20,000    30,106   37,172          29,696

              Number of taxpayers (in thousands)              

No exemptions                  10,852      258             139

Administrative exemption of                                   
 units with gross incomes or                                  
 sales of less than $20,000       844      173              97
--------------------------------------------------------------

D. Equity Among Taxpayers

1. NOMINAL UNIFORMITY OF TAX BASE. With some exceptions, notably the "finance" industry, the general conception of the tax base as comprising a residual of producer-payments for wages, salaries, interest, net rents and royalties received, and profits and entrepreneurial withdrawals, appears to be applicable uniformly to all persons and business firms performing productive functions, irrespective of the stage of production and kind of trade or business, including professions and self-employed individuals.

2. SIGNIFICANCE OF VARIATIONS IN TAX BASE. Generally speaking, the available discussions pertaining to the net value added tax appear to indicate that variations in tax base between industries and among producers within an industry are to be viewed mainly as variations in taxpaying ability, on the supposition that the net value added is a good index of general social and governmental benefits received. Thus, the theoretical justification for the tax is based on a variation of the benefit theory of taxation which does not justify great differences in tax payments. The available discussions indicate that government is in fact a partner of private business; that government renders to business valuable services; and that, as a factor of production, government is entitled to a share of the net product of industry just as labor, capital, and the entrepreneur are entitled to shares. While it may be agreed that government is a factor of production and entitled to a share of the net value added by industry and that, barring capital levies, taxes must be paid from the shares of the net value product distributed by industries, it cannot be agreed that variations in the net value added tax base are a proper measure of varying governmental benefits extended to the different industries or that they represent government's varying contribution as a factor of production in the different industries. Furthermore, it cannot be agreed that a uniform rate of tax applied to the varying tax bases is a proper method of determining government's contribution as a factor of production in the same sense that wage, interest and profit rates are just determinants of the respective factoral contributions. Thus, until a more equitable measure of government's contribution to the net value product of different industries is found, the net value added tax applied at a uniform rate must be viewed as an inequitable form of business taxation.

In practice, the distribution of the tax load also would be inequitable. For example, a one-percent tax rate applied to the net value added of all industries, when measured as a percentage of estimated gross income, would mean a tax payment for the agricultural and communications industries of more than twice as much as that of the manufacturing industry and six times greater than that of the trade industry. In the available discussions respecting the tax these variations in tax payments have been a cause for some concern in the case of agriculture but not in the case of the communications industry. Significant variations in tax base also exist among producers in different branches of the same industry and among competitors in the same branch of industry.

The available data indicate the probability of great variations in tax burden among manufacturers simply because the technical processes they use in manufacturing require more or less labor per unit of output. Thus, equality among taxpayers generally will tend to vary with the amount of labor used in the production process. In the case of competitors employing appreciably different amounts of labor per unit of output, i. e., capital-using versus labor-using methods of production, the competitors using a larger proportion of labor will tend to be placed at a competitive disadvantage by the tax. In this respect the net value added tax resembles the existing payroll taxes. Clearly, however, the payroll taxes could not be justified on the basis that industry receives governmental aids to production in direct proportion to its wage and salary payments.

The view has been expressed that "in the sphere of production for the market guided by the profit motive, equality may be adequately measured in terms of 'value added by manufacture,"' The data available show that a tax based on this concept of equality would introduce serious differences in tax burden among industries, among branches of an industry, and among competitors within an industry. The "government-is-a-factor-of-production" idea is good theory but it cannot justify such variations in tax burden as appear likely to exist in fact.

E. Effect of Tax on Consumer Prices

1. INCIDENCE AND SHIFTING. Under the general economic conditions expected to prevail during the period of rearmament, that portion of the tax attributable to the distributive shares of interest payments on short-term debts, wages, and salaries will tend to be shifted forward. Thus, it can be said that roughly three-fifths to four-fifths of the tax generally would tend to be shifted forward as higher prices of finished goods and services. Insofar as the incidence of the tax is on consumers, the burden of the tax will be regressive and not according to the principle of ability-to-pay.

However, in any one industry marked by great differences in tax base among competitors due to great variations in the amount of labor cost per unit of output, it may be that labor-using producers will not be able to shift much of their tax forward. Thus, the labor-using producers will tend either to absorb a good deal of the tax or change to more capitalistic methods of production. However, either method of adjustment to the tax would tend to limit the level of total employment, at least in the short run. This tendency might become an important source of economic disturbance under economic conditions expected to follow the rearmament program.

2. MULTIPLE TAXATION. One advantage claimed for the net value added tax is the avoidance of multiple taxation such as occurs under a turnover tax and to a limited extent under either a manufacturers' or wholesalers' single-stage tax. The net value added tax avoids such multiple taxation almost completely by allowing as deductions from gross income of a taxpayer all purchases from another producer. However, in the case of forward shifting of tax by producers at stages of production and distribution preceding final sale for consumption, some accumulation of tax would occur, but it appears that any such accumulation would be unimportant.

3. PYRAMIDING. Another advantage claimed for the net value added tax as compared to sales taxes is the avoidance of pyramiding. Pyramiding may be said to occur when a tax, levied on articles at early stages of production and distribution, is shifted forward and producers at later stages of production and distribution mark up the tax-increased prices of articles purchased at their customary rates of gross margin. In this way the tax becomes the base for further price increases and final purchasers pay a price that is greater than can be justified by the amount of tax collected by government.

Pyramiding is to be differentiated from multiple taxation, for the latter is an accumulation of tax that government receives while the former is a tax-induced addition to a seller's spread or margin that is not received by government.

Under the net value added tax pyramiding is just as likely to occur as under a turnover tax and probably would be more significant than under either a manufacturers' or wholesalers' single-stage sales tax.

Under the net value added tax price increases can be expected to occur as a consequence of the forward shifting of roughly three-fifths or more of the tax and the pyramiding of the forwardly shifted tax. Little, if any, price increases can be expected as a consequence of multiple taxation. Finally, the distribution of the burden of the tax, insofar as it is shifted forward, is similar to the distribution of the burden under sales taxes and, consequently, is regressive.

F. Administrative Problems

All of the administrative problems that are likely to arise under as complicated a tax as the net value added tax cannot be foreseen. In general, the tax cannot be applied effectively to small business concerns whose accounting systems are not as adequate as those of corporations.

1. SIMILARITY TO CORPORATION NET INCOME TAX. The tax embraces many of the gross income and deductions items of the corporation net income tax and the computation of the net value added tax base is analogous to the computation of the corporation net income tax base. Consequently, the administrative problems likely to arise under the tax, in large part, would be similar to those under the corporation income tax. In addition, there is sufficient dissimilarity between the two taxes so that problems which have not arisen under the corporation income tax may arise under the net value added tax.

2. ADEQUACY OF BOOKS AND RECORDS. The fundamental requisite of adequate books and records raises a question about the administrative practicability of applying the tax to small "producers" such as are found in great numbers in agriculture and the trades and services.

3. PROBLEM OF LARGE NUMBERS OF TAXPAYERS. The large number of possible taxpayers, even under very liberal exemption provisions, indicates the size of the administrative program required to collect the net value added tax.

When the problems of adequacy of books and records and large numbers of taxpayers are considered, the practical scope of the tax may very well be limited to corporations only. Thus, although the tax may be recommended as a general business tax applicable to all forms of business organization in return for benefits received in common by all businesses from the maintenance of a favorable business framework and environment by government, practical considerations of effective administration may limit the tax to corporations. In addition, it appears that a special tax base designed specifically for financial corporations would be necessary if they are to be taxed on a uniform basis compared to other taxpayers.

FEDERAL TAX ON NET VALUE ADDED

I. INTRODUCTION

The proposal to tax net value added is a relatively new one in the field of taxation. The concept of net value added derives from one of several economic concepts of national income. It may also be termed the national income derived from industry or the net value product of all industry during a given year. As a business tax, the tax on net value added should be levied on that part of the national income originating with the taxpayer. That is, the net value of the product derived by the taxpayer from his business transactions.

Although the proponents of the tax have presented general descriptions of the meaning of net value added, they have not developed detailed definitions of the tax base and taxpayer. /1/

The following discussion of the net value added tax presents detailed considerations of the tax and of the more important problems associated with it.

II. DESCRIPTION OF THE TAX

A. The Taxpayer

As a business tax, the theory of the tax on "net value added" suggests that it should be levied on all producers of goods and services irrespective of the form of business organization. Thus, the term "producers" ought to include trades, businesses, professions, and other economic enterprise as performed by corporations, partnerships, independent entrepreneurs, cooperatives, self-employed persons, and other producing units, unless otherwise exempt, excepting governments and their agencies. As defined in this memorandum, the term "producers" also includes persons receiving royalties and rents from whatever source derived. In some cases this means that the "net value added" tax is, in effect, an additional individual income tax on net income from rents and royalties.

B. The Tax

In this memorandum the tax is conceived as a percentage of the net value of goods and services sold during a producer's annual accounting period, plus net rents and royalties received.

The proponents of the tax have not indicated the specific rates that it might be desirable to impose. However, in discussing the tax, the proponents have indicated that it might be considered as a substitute for or additions to the payroll taxes, the corporation income tax, the individual income tax, and as a desirable alternative tax to a Federal manufacturers' sales tax or a Federal turnover tax. /2/ Consequently, the problem of tax rates might be viewed in the light of what rates of tax would return revenues equivalent to those taxes for which the net value added tax is to substitute.

C. The Tax Base /3/

1. General Description

Generally speaking, the tax base may be described as the gross income from sales plus the gross income from rents and royalties, less the cost of raw materials, supplies and energy consumed, including depletion charges and gross royalties paid, and the cost of capital equipment consumed, including depreciation, obsolescence and gross rents paid. Thus the tax base of any producer generally would include the amounts of wages and salaries paid, including other compensation paid to officers and employees, entrepreneurial withdrawals, interest paid, profits earned, and net rents and royalties received.

Such a tax base, encompassing an admixture of outright business payments and residuals of receipts and payments, no doubt would have to be determined for a time period of not less than a year in order that it may coincide with the accounting practices of the taxpayer. In addition, the tax base generally would be an admixture of cash and accrual items and, consequently, would require highly developed and relatively complex business records. For these reasons the tax base of any taxpayer would have to be determined on the basis of allowable deductions from a defined gross income somewhat like the corporation net income tax; firstly, in order that the base may be applied uniformly to all taxpayers and, secondly, in order that there may exist adequate records to protect the interests of the Government and the taxpayers under the tax.

2. Tax Base Computation

Exhibit 1 has been prepared to illustrate a reasonable method of computing the net value added tax base. There have also been prepared (1) Schedule A for the determination of cost of goods sold and (2) Schedule B for information respecting the detailed composition of the net value added tax base.

For purposes of the net value added tax, gross income would not include the items of net short-term capital gains, net long-term capital gains, net gain (or loss) from the sale or exchange of property other than capital assets, and dividends and interest received, all of which are now included as items of gross income under the corporate normal tax net income computation. The capital gains and loss items do not add to or deduct from the value added by producers during the accounting period and, therefore, properly are disregarded under the net value added tax. Interest and dividends received are excluded from gross income to avoid double taxation, for interest paid and profits are items included in the tax base.

This method of handling interest and dividends introduces the problem of applicability of the net value added tax base to financial institutions whose gross income is accounted for largely by interest on loans, notes, mortgages, bonds, bank deposits, etc., taxable and nontaxable interest from government obligations and dividends. If financial institutions are to be subject to the net value added tax, it appears that a special tax base will have to be developed for them.


[Part 1 of 2]

   Exhibit 1: Illustration of net value added tax base computation

-----------------------------------------------------------------
                       Gross income                              

 1.  Gross sales (where inventories are an income-               
      determining factor)                               $________
        Less: Returns and allowances                    ---------
        Cost of goods sold (From Schedule A)                     
         a.  Wages, salaries and interest                        
             allocated to cost of goods sold            ---------
         b.  Materials, supplies, insurance,                     
             utility services, depreciation and                  
             depletion allocated to goods sold          ---------
 2.  Gross receipts (where inventories are not an                
      income-determining factor)                                 
        Cost of operations                                       
         a.  Wages, salaries and interest allocated              
             to cost of operations                      ---------
         b.  Supplies, insurance, utility services,              
             and depreciation allocated to cost of               
             operations                                 ---------
 3.  Rents                                                       
 4.  Royalties                                                   
 5.  Other income: For example:                                  
         a.  Cash discounts from purchases and                   
             refunds received                           ---------
         b.  Profits from installment operations        ---------
 6.  Net value added gross income (sum of items 1 - 5)           

                        Deductions                               

 7.  Rents and royalties paid                                    
 8.  Repairs, excluding compensation paid to employees           
 9.  Depreciation not elsewhere specified                        
10.  Depletion not elsewhere specified                           
11.  Insurance not elsewhere specified                           
12.  Losses by fire, storm, shipwreck, etc.                      
13.  Taxes, not including employees' and employers'              
      contribution to social security taxes and                  
      corporation net income and excess profits                  
      taxes /1/                                                  
14.  Bad debts                                                   
15.  Other deductions: For example:                              
         a.  Advertising                                ---------
         b.  Lawsuit payments                           ---------
16.  Total deductions (sum of items 1(b), 2(b) and               
       7 to 15)                                                  
17.  Net value added (item 6 minus 16)                           
-----------------------------------------------------------------

[Part 2 of 2]

   Exhibit 1: Illustration of net value added tax base computation

----------------------------------------------------------------
                       Gross income                             

 1.  Gross sales (where inventories are an income-              
      determining factor)                                       
        Less: Returns and allowances                    $_______
        Cost of goods sold (From Schedule A)                    
         a.  Wages, salaries and interest                       
             allocated to cost of goods sold                    
         b.  Materials, supplies, insurance,                    
             utility services, depreciation and                 
             depletion allocated to goods sold                  
 2.  Gross receipts (where inventories are not an               
      income-determining factor)                                
        Cost of operations                              --------
         a.  Wages, salaries and interest allocated             
             to cost of operations                              
         b.  Supplies, insurance, utility services,             
             and depreciation allocated to cost of              
             operations                                         
 3.  Rents                                              --------
 4.  Royalties                                          --------
 5.  Other income: For example:                                 
         a.  Cash discounts from purchases and                  
             refunds received                                   
         b.  Profits from installment operations        --------
 6.  Net value added gross income (sum of items 1 - 5)  --------

                        Deductions                              

 7.  Rents and royalties paid                           --------
 8.  Repairs, excluding compensation paid to employees  --------
 9.  Depreciation not elsewhere specified               --------
10.  Depletion not elsewhere specified                  --------
11.  Insurance not elsewhere specified                  --------
12.  Losses by fire, storm, shipwreck, etc.             --------
13.  Taxes, not including employees' and employers'             
      contribution to social security taxes and                 
      corporation net income and excess profits                 
      taxes /1/                                         --------
14.  Bad debts                                          --------
15.  Other deductions: For example:                             
         a.  Advertising                                        
         b.  Lawsuit payments                           --------
16.  Total deductions (sum of items 1(b), 2(b) and              
       7 to 15)                                         --------
17.  Net value added (item 6 minus 16)                  --------
----------------------------------------------------------------
                         FOOTNOTES TO TABLE

     /1/ The Declared Value Excess Profits Tax is deductible.

                          END OF FOOTNOTES

As conceived in this report, gross income would include (1) income from net sales, less the cost of materials and supplies or cost of goods sold after excluding wages, salaries and interest paid; or (2) gross receipts, where inventories are not an income-determining factor, less cost of operations after excluding wages, salaries and interest paid; (3) rents and (4) royalties received; and (5) other income, such as cash discounts from purchases.

Rents and royalties received by producers have been included as items of gross income as a practical alternative to placing the tax on NET rents and royalties paid by producers. That is, net rents and royalties paid are components of the national income which, from the point of logic, originate with the producer paying the rents and royalties and should be part of his "net value added." From the administrative standpoint, however, it appears necessary to allow producers to deduct gross rent and royalty payments from gross income because of the impracticability of requiring such producers to determine the net rents and royalties and to swear to the accuracy of the determination. Under the net value added concept, there properly may be deducted from gross rents and royalties such charges as depreciation and depletion. These deductions are within the province of the payee and not the payor. As an alternative, income from gross rents and royalties is included in the gross income of producers, and recipients of rents and royalties are defined to be producers. In this way it appears administratively practicable to include in the net value added tax base that part of the national income which is accounted for by net rents and royalties. However, this method of approaching the problem necessarily will include some individual recipients of rents and royalties as producers.

Wages, salaries and interest paid during the accounting period are component items of the net value added by producers. Consequently, such items chargeable to the cost of goods sold and cost of operations are not deductible from gross income from sales as they are under the income tax. Therefore, under the net value added tax, the cost of goods sold or cost of operations would have to be reported separately as taxable and nontaxable costs (items 1(a) and (b), and 2(a) and (b) of Exhibit 1).

In addition, a special Schedule (Schedule A) of cost of goods sold would be required for the proper administration of the tax. For example, during one year a producer may be increasing his inventories of finished goods and goods in process of production. During such a period his wage payments are greater than those chargeable to cost of goods sold. However, the wages paid to increase physical inventories would not be in the tax base. In a subsequent year, when the producer sold the goods from inventory, the wages previously paid for inventory increases now would enter the tax base. Since a considerable time period may elapse between the increase in inventories and sales from them, a record of accruing tax base items at book cost is necessary. Schedule A would provide such a record, although its usefulness as an administrative control would be limited by the diversity of products produced by a taxpayer. Since the most important taxpayers probably would be producers of diversified products, each product being built to or sold from inventories at different rates, it would be extremely difficult to check administratively the accuracy of accrual tax base items of cost of goods sold. The procedure outlined does have the advantage of keeping accounting for tax purposes in line with business accounting concepts.


             Exhibit 1: Schedule A - Cost of goods sold

---------------------------------------------------------------
1.  Inventory at beginning of year (at cost)                   
        a. Wages, salaries and interest              $_________
        b. Materials, supplies, insurance, utility             
           services, depreciation and depletion      ----------

2.  Materials or merchandise bought for manufacture            
     or sale                                         ----------
3.  Other costs incurred during the year                       
        a. Wages, salaries and interest              ----------
        b. Supplies, insurance, utility services,              
           depreciation and depletion                ----------
4.  Inventory at end of year (at cost)                         
        a. Wages, salaries and interest              ----------
        b. Materials, supplies, insurance, utility             
           services, depreciation and depletion      ----------
5.  Cost of goods sold                                         
        a. Wages, salaries and interest                        
             (items 1(a) + 3(a) - 4(a))              ----------
        b. Materials, supplies, insurance, utility             
           services, depreciation and depletion                
             (items 1(b) + 2 + 3(b) - 4(b)           ----------
---------------------------------------------------------------

The alternative to permitting the accrual of tax base items at cost is to require all payments made with respect to tax base items during the year to be included in the tax base in the year paid. At first glance, this looks like an acceptable alternative, easy to administer. Closer observation leads to the conclusion that the administrative problem is not reduced. What is changed is the accounting procedure and not the complexity of the administrative problem. In the first place, only such tax base items as wage and salary payments could be handled in this fashion. The item of profits is still a residual determined on the basis of accrued receipts and expenses or costs. Secondly, sales from inventory would require a system of tax credits against tax payments made at the time of inventory increases. In short, the tax base accrual problem would become a tax credit accrual problem and the same accuracy of facts would be necessary under either method in order to achieve the same results. There appears to be little to choose between these two methods of handling physical inventory changes or among other methods that may be devised. /4/ Since the tax base accrual method is more in line with generally accepted business accounting, it appears to be preferable.

Repairs, excluding compensation paid to employees, depreciation, depletion and insurance not elsewhere specified, and other expenses, such as advertising, are non-controversial deductions. These are all payments for goods and services produced by producers other than the taxpayer in question, and the net value added with respect to such goods and services properly are taxable to the other producers. /5/

"Losses by fire, storm, shipwreck, etc.," are losses above insurance indemnity and are allowed on the same basis as depreciation.

Bad debt charges are allowed as an adjustment account for overstatements of net value added derived from business transactions. That is, while a taxpayer may have produced goods of value, he will not have realized or derived a net value added unless paid for such production.

All taxes, excepting employees' and employers' social security taxes, corporation net income and excess profits taxes, /6/ are allowed as deductions. The employees' social security tax payments are viewed as collections at source by the producer and, consequently, do not reduce the net value added derived by the taxpayer. Since pension payments by employers are not allowed as deductions but are viewed as accrued compensation of employees, employers' contributions to social security are not allowed on the same theory. That is, employees' and employers' social security tax payments are viewed as transfer items taxable at the time of transfer under the net value added tax, since unemployment compensation and old-age pension payments by government will not be taxed.

Taxes, such as licenses, fees, special assessments, sales taxes, customs, excises, and taxes on real property may be viewed as a special case of purchase of materials, supplies and services. So viewed, these taxes become cost items representing net value added by government and not properly taxable to the producer.

The amount of net value added derived from business transactions properly is determined before income and excess profits taxes. Consequently, corporation net income and excess profits taxes (excluding the Declared Value Excess Profits Tax) are not allowed as deductions against the net value added tax base. The net value added tax, however, is allowed as a deduction against corporation net income and excess profits taxes. If the net value added tax is imposed on sole proprietorships and partnerships, it also would be allowed as a deduction against sole proprietors' individual income tax liability, and in the case of partnerships it would be allowed as a deduction from the partnership net earnings available for distribution but not allowed as a deduction against the individual income tax liability of partners. This is the procedure followed with respect to employers' social security taxes, sales taxes, etc., under the corporation net income and excess profits taxes.

In summary, under the illustrated computation, the net value added tax base would be composed of (see Schedule B) (1) wages, salaries and interest allocated to cost of goods sold or (2) allocated to operations, (3) other compensation of employees not allocated to (1) and (2), (4) employers' contributions to social security taxes, (5) compensation for injuries to employees, (6) pensions, (7) interest paid and not allocated to (1) and (2), and net income from operations before payment of corporation net income and excess profits taxes. Thus, it can be concluded that the net value added tax would resemble closely an additional payroll tax and a net income tax without an interest-paid allowance.


            Exhibit 1: Schedule B - Information return on
               composition of net value added tax base

--------------------------------------------------------------
1.  Cost of goods sold (from face of return)                  
      a. Wages, salaries and interest                 $_______

2.  Gross receipts from operations (from face                 
    of return)                                                
      a. Wages, salaries and interest                 --------

3.  Wages, salaries, and other compensation of                
    officers and employees not included in                    
    (1) and (2)                                       --------

4.  Employers' contributions to social security               
    taxes                                                     
          a. Unemployment compensation      $_______          
          b. Old-age insurance              --------  --------

5.  Compensation for injuries to employees            --------

6.  Pensions                                          --------

7.  Interest not included in (1) and (2)              --------

8.  Net income (item 6 of Exhibit 1 minus                     
    items 1(a) and (b), 2(a) and (b), 7 to                    
    15 of Exhibit 1, and items 3 to 7 of                      
    Schedule B)                                       --------

9.  Net value added (sum of items 1 to 8)             --------
--------------------------------------------------------------

D. Other Problems Relating to Tax Base

1. Installment and Conditional Sales, Leases, Etc.

Under the manufacturers' excises, special provision is made in the law for computing taxes due in the case of leases of articles and installment and conditional sales. /7/ In these cases the regulations provide that a proportional part of the total tax shall be paid upon each payment with respect to the article. /8/ This procedure also could be followed in the case of such sales under the net value added tax.

2. Contract Manufacturers and Holding Company Arrangements

Contract manufacturers and the split-up of business firms into separate legal entities such as manufacturers, packagers, and selling agencies generally would not present an administrative problem under the net value added tax. That is, any attempt by producers to lower the tax base by the aforementioned legalistic methods would merely shift the size of the tax base from one taxable "producer" to another taxable "producer." This observation would not be true where a taxpayer would reduce his base by shifting a portion of it to the account of a nontaxable or exempt producer. Thus, the definition of taxable producer would need to be considered in the light of tax-exempt producers, insofar as the latter might provide a means of tax avoidance for taxable producers. /9/

3. Net Value Produced and Consumed by the Producer

Under the manufacturers' excises, /10/ if a person manufactures or imports an article subject to the excises and uses it, he is liable for tax with respect to the use of such article in the same manner as if it were sold to him and the tax (if based on the price for which the article is sold) is computed on the price at which such or similar articles are sold in the ordinary course of trade by manufacturers. /11/

Under the net value added tax, it does not appear desirable to establish, as under the manufacturers' excises, the fair price of articles produced and consumed by the producer. If the law and regulations required that such articles be entered as gross income at a fair price as determined in accordance with prices in the ordinary course of trade, the taxpayer would be charging himself a profit which would have the effect of fictitiously increasing his book profits. However, taxpayers could be required to include the cost of producing the articles consumed as part of gross income. This procedure appears to be necessary with respect to durable goods produced and consumed over more than one accounting period, but not with respect to goods produced and consumed in the same accounting period.

With respect to articles produced and consumed by the producer in the same accounting period, the tax base is a residual after certain deductions have been made from gross income and, from the taxpayer's standpoint, if the cost of such articles is added to gross income, it also must enter his books as an expense and thereby cancel out. Thus, in the case of articles produced and consumed in the same accounting period, it does not appear to be necessary to require taxpayers to establish the cost price of such articles and to enter such cost as gross income, since the books and records of the taxpayer would show certain cost allocation such as wages and salaries and interest paid, which, as residuals, automatically would enter into the tax base.

However, a special procedure would be required under the net value added tax in the case of articles produced and consumed by the producer over more than one accounting period, as would occur in cases of capitalized improvements. For such articles, the administrative procedure might require producers to include the cost of producing the articles consumed as part of gross income. From this kind of gross income there would be allowed as deductions all costs and expenses other than wages and salaries paid and interest paid in connection with the production of such articles. In this way the net value added by such articles would be shown in the tax base of the producers. In addition, the producer would be permitted to capitalize the total cost of the improvements in respect to which depreciation charges would be allowed.

4. Imports

In the case of imports, it appears administratively impractical to consider the determination of the amount of tax on the basis of the net value product for the exporting foreign producers. The tax on imports could be levied, assessed, collected, and paid in the same manner as the duties imposed by the Tariff Act of 1930. /12/ The tax base for imports could be the sum of the dutiable value (under Section 503 of such Act) of the article plus the custom duties, if any, imposed thereon under the law. /13/

 
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