Under the manufacturers' excise taxes, sales for export are tax-free. /14/ The question arises with respect to the net value added tax whether the exemption of sales for export would not complicate unduly the administrative determination of the net value product in those cases involving common and joint costs. Unless it is feasible to write into the law a simple formula for distinguishing the net value added of exports from the net value added of domestically consumed articles, it would appear undesirable, from the administrative viewpoint, to exempt sales for export. However, a formula satisfactory to both taxpayers and the Treasury may be found such as apportioning the taxpayer's total net value added on the basis of the proportion that the value of sales for export bears to the value of total sales. Under this formula a taxpayer's total net value added could be reduced by an amount determined by his export-sales' percentage.
B. Articles Used by Governments and Their Agencies
Under the manufacturers' excises, no tax attaches to articles sold by the manufacturer direct to the United States, any State, Territory of the United States, or any political sub-division of the foregoing, or the District of Columbia, for its exclusive use, provided the exempt character of the sale is established as required by the regulations. /15/
If the net value added represented by articles sold to governments and their agencies are exempt, the administrative complications of determining the net value of such sales in cases involving common and joint costs would be similar to the administrative problems arising under tax-free exports. As in the case of exports, the desirability and administrative practicability of exempting the net value of articles sold to governments and their agencies would be very limited unless a satisfactory formula is written into the law.
C. Articles for Further Manufacture
Under the manufacturers' excise taxes, articles for further manufacture are tax-free in order to avoid multiple taxation. /16/ It would not be necessary specifically to exempt articles for further manufacture in order to avoid multiple taxation under the tax. /17/ That is, the deductions described above already provide a system which taxes only the value of the article originated by the taxpayer. Consequently, in the case of a finished article, the sum of the bases of the several taxpayers responsible for producing the article at different stages of production and distribution is not greater than the value of the finished article and, therefore, multiple taxation is avoided. /18/
D. Administrative Exemptions
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. Consequently, satisfactory analyses must await imposition of the tax and records of the administrative experience thereunder. The following discussion presents certain information which indicates the nature of the problems.
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. /19/ Complete exemption of farmers and professionals would reduce the total number by about 6,800,000 and possibly 700,000, /20/ respectively. There would still remain between 2,500,000 and 4,500,000 "producers." 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. Agriculture and professionals have been used as illustrations solely because of the large numbers of small "producers" engaged therein and the generally accepted opinion that persons in these industries keep inadequate books and records.
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. /21/ 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. If only the tax base standard of exemption is applied, some producers with gross income from sales of as much as $50,000 to $100,000 would be exempt. Such producers could be expected to have adequate books and records and they also might account for appreciable portions of an industry's net value product.
It may also be necessary 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. For example, if producers with tax bases of less than $10,000 and not more than $20,000 in gross income from sales are exempt, the available information indicates that in the manufacturing industry only about one percent of the value of products would have been exempt in 1937, even if all establishments that produced less than $20,000 of products also had less than $10,000 of tax base. However, about 30 percent of the manufacturing establishments would have been exempt. /22/ From these data it may be inferred that roughly about the same proportions of tax base and taxpayers would have been exempt. Thus, in the manufacturing industries, a $20,000 gross income exemption probably would not have decreased the tax base significantly in 1937, and the additional inference may also be made that the competitive structure probably would not have been affected appreciably.
The same exemption applied to independent retail stores, however, indicates that a large portion of the tax base might have been exempt and that the competitive structure might have been affected appreciably. That is, in 1935, about 82 percent of the independent retail stores reported sales of less than $20,000 and accounted for 29.0 percent of the total retail sales by independent merchants. /23/ Assuming that about the same proportion of tax base would have been exempt, the data indicate that not only would there have been exempt a significant part of the tax base for this group but competition in the retail field might have been seriously disturbed.
If independent standards of exemption are determined for different industries, the administration of the tax may be unduly complicated. If a high single exemption standard is determined for all producers in the attempt to avoid administrative problems associated with large numbers of small producers and inadequate books and records, then the competitive structure in some industries may be disturbed appreciably. If a low single exemption standard is determined to avoid competitive disturbances, then the administration of the tax may be unusually difficult because of the large number of taxpayers.
E. Other Exemptions
1. Section 101
Under Section 101 of the Internal Revenue Code certain corporations not operating for profit are exempt from the corporation income tax. While these corporations are not organized and operated for profit, they nevertheless produce a net value product and could be made subject to the tax. That is, these organizations contribute to the total national income and part of their contribution to the national income may also be considered as due to direct and indirect benefits received by them from governments. Insofar as the net value added tax is supported by the benefit theory in taxation, these nonprofit organizations, or at least some of them, could be defined as "producers" and, therefore, taxpayers.
2. Exemption of Certain Supplies for Certain Vessels and Aircraft
Under the manufacturers' excise taxes certain supplies used by certain vessels are exempt from tax. /24/ In addition, articles sold for use on foreign aircraft, subject to certain limitations, are considered to be exported and therefore subject to the same exemption as though exported. /25/ The exemption of such supplies from the net value added tax appears to raise questions and qualifications similar to those raised above with respect to the exemption of articles exported and articles sold to governments and their agencies.
IV. DATA PERTAINING TO TAX BASES AND TAXPAYERS /26/
A. Tax Base
The best available data approximating the net value added tax base are the estimates of "national income," published by the Department of Commerce. On the basis of this information, two possible tax bases have been approximated pertaining to the calendar year 1939. /27/
One tax base ("no exemptions" /28/ ) approximates the largest likely base under the tax and amounted to about $59,000,000,000 in 1939. This estimate consists of the estimated total "national income" less "income produced" by government. No adjustments were made either for additions to "national income" on account of the net value of imports or deductions on account of the net value of tax-free exports and tax-free sales to governments and their agencies.
If the industries of agriculture, trade, and service are entirely exempt on the basis of administrative necessity due to the large number of small producers and the likelihood of inadequate books and records, the "no exemptions" base would have been reduced in 1939 from about $59,000,000,000 to about $36,000,000,000.
Pending further study respecting a special "value added" definition for the finance industry, an additional $6,000,000,000 of tax base is in doubt. Finally, there is a "miscellaneous" group of producers accounting for $3,300,000,000 of "national income" in 1939, which represents a heterogeneous group of residual items and about which little can be said respecting the amount that might remain in the tax base.
A second tax base estimate was computed on the basis of the suggested administrative exemption of units with gross incomes of less than $20,000. /29/ From the $59,000,000,000 tax base estimate there were deducted the industrial categories of "finance" and "miscellaneous" because of the impracticability of making the administrative exemption adjustment. This reduced the total value added to about $50,000,000,000. Adjustments were then made on the basis of the suggested administrative exemption for each industrial category. These administrative exemption adjustments reduced the tax base from about $50,000,000,000 to about $58,000,000,000. Since the available data on size-of-income distributions could be used for adjustment purposes only on the basis of numerous assumptions, the reasonableness of the latter estimate may be more apparent than real. In any case it is too low unless the whole of the "finance" and "miscellaneous" industries are exempted.
B. Number of Taxpayers
Two estimates were made with respect to the number of taxpayers; one set for each of the two tax bases.
Associated with the $59,000,000,000 tax base there may have been about 11,000,000 taxpayers, not including an unknown number of taxpayers in the "miscellaneous" category of industry. /30/
If the producers in the industries of agriculture, trade, and service are exempt, the indicated number of taxpayers would be reduced to about 860,000. The finance industry accounts for 150,000 of this number.
The suggested administrative exemption which reduced the indicated tax base to $38,000,000,000 also might have reduced the number of producers or taxpayers to about 960,000. /31/
C. Comparison of Tax Bases and Number of Taxpayers Under the Net Value Added Tax with Those Under the Manufacturers' And Wholesalers' Sales Taxes, 1935
In another memorandum /32/ tax base estimates for the year 1935 were presented with respect to manufacturers' and wholesalers' general sales taxes. For purposes of comparing the scope of a net value added tax with that of the other two taxes, 1935 estimates of the net value added tax base and number of taxpayers also were prepared. /33/
At the outset it should be clear that comparison of the estimates relating to the different taxes is limited. Thus only two types of comparisons are presented: (1) The estimates involving no exemptions for the net value added tax are compared with those involving only tax-free sales for further manufacture under the manufacturers' sales tax and also tax-free sales of articles for resale (i. e., sales to persons other than final users or consumers) under the wholesalers' sales tax; and (2) the estimates allowing for the administrative exemption of business units with gross incomes or sales of less than $20,000. The latter estimates are not strictly comparable because the net value added base is too low insofar as the industries of "finance" and "miscellaneous" are not included. These two industries account for $5,131,000,000 and $2,695,000,000, respectively, of the total of $47,947,000,000 "no exemptions" base. /34/
Comparison of tax bases and number of taxpayers under the net value added tax with those under the manufacturers' and wholesalers' sales taxes, 1935 ----------------------------------------------------------------- Net value Wholesalers' Manufacturers' Description added tax sales tax sales tax ----------------------------------------------------------------- Tax bases (in millions of dollars) No exemptions $47,947 $38,194 $29,996 Administrative exemption of units with gross incomes of 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 $20,000 844 175 97 -----------------------------------------------------------------
Additional comparisons were not made because of the impracticability of making comparable adjustments for the effects of the exemption of certain articles. That is, the nature of the data respecting the net value added tax is such that if it is desired to remove certain articles for purposes of measuring the likely effects of exemptions on the tax base and number of taxpayers, it is necessary to adjust the data in the several industries accounting for the production and distribution of the exempt articles. For example, if the effects of exempting "foods" are to be measured, it is necessary to remove from the industries of agriculture, transportation, manufacturing, wholesale and retail trade, and service (restaurants, etc.), those portions of the respective net values added accounted for by "foods." This procedure was considered to be impractical. The only practical method of adjusting the base for the exemption of "foods" would have been to assume that the net value added by "agriculture" adequately represented the net value added by "foods." This was considered an unreasonable assumption and, consequently, no further comparisons were made.
V. EQUITY AMONG TAXPAYERS
A. Nominal Uniformity of Tax Base
With some exceptions /35/ 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.
The proponents of the tax have stated that the tax base would be equitable to producers in all industries excepting agriculture and possibly some of the service industries, especially professions. /36/ The proponents question the equitableness of the tax base in these cases, not with respect to the uniform application of the definition of the tax base but with respect to what appears to be variation in the amount of tax base as a percentage of gross income from sales or gross value of output. Generally speaking, however, the proponents appear to believe that variations in tax base between industries and among producers within an industry are to be viewed mainly as variations in ability to pay tax, on the supposition that the net value added is a good index of general social and governmental benefits received or as more or less free (in the business accounting sense) aids to production. /37/
B. Data Pertaining to Variations in Tax Base
Variations in tax base among taxpayers can be measured as differences in the percentage of tax base to gross income. It appears reasonable to believe that if there are significant variations in tax liability among producers in the same industry, when measured as a percentage of tax to gross income, that competitive disturbances could be expected as a result of the tax and such disturbances could be viewed as inequitable to some producers.
1. Significance of Variations in Tax Base Among Industries
The Commerce Department's estimates of "national income produced" by industrial groups is the best available source of total likely tax base by industries. When these estimated tax bases by industrial groups are presented as percentages of the estimated gross incomes of the respective industries, surprisingly large variations are shown. For example, in 1934, the tax base would have approximated about 62 percent of the gross income of the communications and agricultural industries, 27 percent of the gross income of the manufacturing industry, and only 10 percent of the gross income of trade. /38/ Thus a one percent tax rate applied to the net value added of all industries 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. These variations in tax payments have caused the proponents of the tax some concern in the case of agriculture, but not in the case of the communications industry.
The theoretical justification for the tax is based on a variation of the benefit theory of taxation which does not justify the great differences in tax payments. It is argued 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. /39/ 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 proper measures 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 must be viewed as an inequitable form of business taxation.
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.
2. Significance of Variations in Tax Base Within an Industry
Wages and salaries are by far the most important single component item of the tax base. For example, in the manufacturing industry, the available data for 1934 indicate that the tax base would have approximated 27.3 percent of gross income. The tax base as a percentage of gross income was composed of wages, salaries, pensions, and compensation for injuries, 24.2 percent; entrepreneurial withdrawals, 0.5 percent; interest on long-term debt, 0.5 percent; and net dividends paid plus business savings, 2.1 percent. Thus, in 1934, a year of low average profits, compensation of employees comprised about 89 percent of the total tax base; in 1929, a year of higher average profits, compensation of employees comprised about 77 percent of the total tax base. /40/ While variations in annual profits tend to affect the percentage importance of compensation of employees as a tax base item, the importance of wages is always greater than the sum of all other tax base items. /41/
It may be reasoned, therefore, that if the available data on wages and salaries as a percentage of value of products show great variations among different branches of the manufacturing industry, there is a high probability that the total tax bases among the branches of industry also will show great variations, although there is a chance that the variations among total tax bases will be reduced somewhat by compensating variations in other tax base components such as profits.
The 1937 Census of Manufactures shows that for all industries wages and salaries averaged 21.1 percent of value of products. For 34 selected branches in the manufacturing industry, wages and salaries varied, as a percentage of value of products, from 2.9 percent in the case of the cigarette industry and 6.3 percent in the condensed and evaporated milk industry to 44.3 percent in the case of the knitted gloves and mittens industry and 47.3 percent in the pottery industry. /42/
These 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. In this respect the net value added tax resembles the existing payroll taxes. No one has argued seriously that the payroll taxes be justified on the basis that industry receives governmental aids to production in a just proportion to its wage and salary payments. These great variations in wage and salary payments as a percentage of value of products emphasize the inequality in the assumption that governmental benefits received by industry can be measured by the net value added tax.
3. Significance of Variations in Tax Base Among Producers in the Same Branch of Industry
The available data respecting individual producers in the same branch of industry are restricted to public utility companies and railroads. These data indicate that appreciable tax base differences per unit of gross income can be expected to arise among competitors under the net value added tax. /43/
As already indicated above, important variations in tax base among producers are likely to be a function primarily of variations in wages and salaries and profits per unit of gross income. That is, while variations in interest payments also occur, interest is not as important an item of tax base as are wages and salaries. Furthermore, variations in interest payments tend to be compensated to a greater extent by opposite variations in profits than are variations in wage and salary payments.
For example, in the case of 30 selected public utility companies /44/ showing variations in interest payments from one fourth of one percent to over 38 percent of total compiled receipts, and variations in net income from .01 of one percent to almost 35 percent of total compiled receipts, there is an inverse relationship between interest and net income. When interest is high, net income tends to be relatively low and, conversely, when interest is low, net income tends to be relatively high. For these same companies, the relationship between wages and salaries and net income as a percentage of total compiled receipts does not show a clearly defined tendency one way or the other. To the extent, therefore, that variations in interest payments tend to be offset by profits, significant variations in total tax base of competitors will be dependent primarily upon variations in wages and salaries paid per unit of sales or 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. That is, producers employing labor-using methods of production must shift a larger proportion of their tax if they are to maintain their relative profit position compared to their capital-using competitors. However, due to competition from capital-using competitors, the labor-using producers may have to change to a more capital-using method of production in order to regain and maintain their profits. If they do not change, their profits may be less by virtue of the competitive necessity to absorb a relatively larger proportion of tax than their competitors.
In conclusion, contrary to the belief 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,"' /45/ the available data 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 a good one in theory, but it cannot possibly justify such variations in tax burden as appear likely to exist in fact.