|III. COLLECTION AT SOURCE OF PAST YEARS' NORMAL
Great Britain and Australia are examples of countries which collect out of current year's income the income tax liabilities of the prior year.
A. COLLECTION AT SOURCE IN GREAT BRITAIN
1. PRIOR TO 1940: Prior to the Finance (No. 2) Act of 1940, the income tax for individuals whose incomes were derived wholly or chiefly from employment was payable in two installments on January 1 and July 1. Since 1931, however, employees could request employers to withhold the tax from their salaries and wages so that employees could spread their tax evenly throughout the year. All salaries and wages out of public funds, including the fighting service, the civil service and railway officials had their tax collected at source on this voluntary basis. The scheme was not, however, extensively utilized.
2. UNDER CURRENT LAW: The Finance (No. 2) Act of 1940 made compulsory the deduction at source of the tax on wages and salaries. The work of determining the tax is done by the income tax authorities. Tax liability is established on the basis of prior year incomes. /39/ The tax authorities inform the employer of the amount of tax due for each employee and it is the employer's duty to deduct such amount in weekly installments and pay over the tax to the tax authorities once a month. Lists are set up by each local tax authority showing the place of employment of each salaried taxpayer in the district. The tax authorities keep records of the monthly amounts withheld on behalf of each taxpayer. If a person becomes unemployed and is reemployed, or changes employment, the tax authority informs the new employer of the amount of tax liability remaining. The new employer spreads the balance of the tax over the rest of the year and withholds accordingly. If a taxpayer moves from one local assessment area to another, his record of tax payments and liability is forwarded. Any adjustments in tax liability are settled between the employee and the tax authorities. The employer's responsibility is merely to withhold an amount of tax as requested by the taxing authority. In effect, the procedure makes compulsory the voluntary system which had been in operation since 1931.
3. Problems Involved in Instituting The British System Into The United States
The main problem involved in connection with the British system is that it requires the revelation to employers of the amount of income derived by employees. Workers in the United States would object to revealing to employers their tax liabilities, since it would be possible (or employees would think it possible) to estimate their earnings from such tax liabilities. A similar situation existed during the 1913-1916 experiment with collection at source in the United States where under certain conditions it was necessary for employees to reveal to their new employers amounts earned during the year in order to obtain exemption certificates. /40/
It should be noted that if there is a year's spread between the year of origin of the income and the year of liability, as there is under the British system, the above objection is likely to be less than if the year of origin of the income and liability are identical, as they are in the United States.
B. COLLECTION AT SOURCE IN AUSTRALIA
Collection of the income tax at source is in effect under the income tax laws of the National Government of Australia and four of the six Australian States.
1. South Australia
The first use of collection at source in Australia was under the South Australian income tax, where it has been used continually since 1930.
(a) BASIS OF WITHHOLDING: Under the South Australian income tax plan, employers are required to deduct from the cash payment to the employee one shilling per pound, or fraction of a pound, on the portion of wages paid, in excess of ten shillings and to issue to the employee tax stamps corresponding in value to the amount deducted. These tax stamps are held by the employee until he obtains stamps of sufficient value to meet his income tax assessment for the previous year. /41/ The assessment is made in the usual way after allowing exemptions, deductions, etc.
If the employee, through previous unemployment, or for other reasons, has not obtained enough stamps by the tax payment date (May 31) to meet his tax, he is required to pay the balance in cash within the next month, or interest is chargeable.
(b) EXEMPTION CERTIFICATES: Where the employee had no taxable income in the previous year, he may apply to the Taxation Department for a certificate of exemption which acts as an authority for the employer to pay the employee his salary in full. Such an exemption is not given if the taxpayer owes any tax for previous years. Further, if the taxpayer can at any time produce sufficient stamps to cover his assessment, he is given a certificate of exemption for the balance of the year. Persons deriving income from other sources than salaries and wages may make similar arrangements with the Department of Taxation.
(c) ADMINISTRATION: This method is characterized as an unqualified success, facilitating prompt payment of taxes, and makes the income tax less burdensome. Some extra cost of collection is involved but it is indicated that this extra cost is trivial compared with the increased promptness with which the tax is collected. /42/
2. COMMONWEALTH OF AUSTRALIA
The Income Tax Assessment Act (No. 2), 1940, imposed a system of collection at source by the Australian Commonwealth Government similar to that used in South Australia. A variation is, however, introduced in the Commonwealth Government system, through the recognition of differences due to marital status.
(a) BASIS OF WITHHOLDING: The deductions to be made began on January 1, 1941, and will be on account of tax payable in respect of assessments for the current financial year based on income derived during the year ended June 30, 1940. The deductions are fixed amounts based upon salaries or wages being received and marital and dependent status at the time the installments are deducted.
When the taxpayer receives his notice of assessment, he will forward the book of stamps representing tax withheld during the year and a notice of assessment to the Taxation Department, where the face value of the stamps will be applied in payment of his tax. If the value of the stamps is insufficient to pay the whole of the tax, any balance must be paid by the employee in cash, and where the value of the stamps exceeds the amount of the tax payable, the excess will be refunded in cash immediately to the employee.
The basic deduction is that relating to a single person without dependents at an amount which will secure the payment of the tax in full at the end of forty weeks. In the case of a married man with a dependent wife and children, the basic rate is reduced by a specified amount for each dependent.
(b) EXEMPTION CERTIFICATES: To authorize the employer to make weekly deductions lower than the basic deductions prescribed for a single person without dependents, the employee will be required to furnish a declaration in duplicate to his employer setting out therein particulars regarding his dependents. On the information shown in this declaration, the employer will reduce the basic deduction according to the number of dependents. The employer will retain one copy of this declaration and forward the duplicate to the Taxation Department.
Taxpayers may at any time make application to the Taxation Department for a certificate exempting them from further installment deductions from their wages. These certificates will be issued in those cases where (a) the assessed tax has been fully paid, (b) where the taxpayer's annual return shows that the income received for the year is less than the minimum amount taxable.
(c) USE OF TAX STAMPS: Tax installment stamps may be purchased at all post offices and other approved places as may be found necessary. Employers are required to make the prescribed deductions from each payment of wages and to hand the employees concerned stamps equal in denomination to the deduction made. The employee is required to affix the stamp to a page in a stamp book and to cancel it by writing thereon his name or initials and the date. He is responsible for the safe condition of his stamps until such time as he presents them to the Taxation office in payment of his tax.
While the law provides for compulsory collection at source in the case of salaries and wages, provision is made for taxpayers other than employees to purchase tax installment stamps from the authorized source as a means of assisting these taxpayers who desire to set aside a certain amount of tax from time to time, in anticipation of the receipt of a notice of assessment; for such taxpayers, however, the use of stamps is wholly voluntary.
3. Problems Involved in Instituting The Australian Plan Into The United States
The main problem connected with the Commonwealth system involves exemptions. Under the South Australian plan, a uniform exemption without recognition of differences attributable to marital status is allowed. Under the Commonwealth system, allowance is made for differences in marital status and dependents. Both present problems.
(a) UNIFORM EXEMPTION UNDER THE SOUTH AUSTRALIAN PLAN: Under uniform exemptions without recognition of the differences attributable to marital status, a large number of refunds may be involved. For example, if a $16 per week exemption were allowed /43/, approximately 18 million persons who are married or who have dependents and receive between $750 and $5,000 during the year, would be nontaxable. /44/
In connection with this type of exemption, it might be possible to avoid many refunds by providing for exemption certificates, that is, as soon as the taxpayer submitted to the Collector of Internal Revenue evidence that the amount withheld during the year was sufficient to meet his prior year tax liability, an exemption certificate would be issued. This would be authority for the taxpayer's employer to refrain from withholding any more during the year. Persons who did not have any tax liability during the past year would be given exemption certificates at the outset of the year to prevent unnecessary withholding. /45/
The difficulties with the South Australian procedure are:
(1) Exemption certificates would need to be issued to all employable persons. In 1941, for example, about 7 million persons filed taxable returns. The entire working force numbered over 50 million persons. It would therefore be necessary to issue exemption certificates immediately to about 43 million persons so that no tax would be withheld on their behalf. Exemption certificates would have to be issued to those with tax liability as soon as such liability was met.
(2) The issuance of exemption certificates must be prompt, or refunds will be necessary. If all withholdings were evidenced by stamps, and any excess of stamps could be cashed promptly at post offices, no great difficulty would be involved other than (a) nuisance to the individual who had tax withheld unnecessarily and (b) some adjustments in Government accounts for stamps cashed.
(b) EXEMPTIONS VARIED WITH MARITAL STATUS UNDER THE COMMONWEALTH PLAN: Under exemptions varied with marital status, the necessity for refunds would be reduced, since differences in personal exemption would be taken into account for the withholding. The problem of exemption certificates would, however, become more important. Some of the difficulties involved in exemption certificates which allow for differences in marital status and dependents were outlined above in connection with the Hart plan, (pages 16-17).
IV. COLLECTION AT SOURCE AS AN INFLATION CONTROL MEASURE
The largest portion of consumer incomes is not reached by the income tax. Likewise, only a small proportion of the population of the United States is subject to income taxation.
(a) NUMBER OF RETURNS: The National Resources Committee estimated that there were 39.5 million spending units in the United States on January 1, 1936. /46/ In 1936, 5.4 million Federal individual income tax returns were filed. These represent approximately 14 percent of the number of spending units. /47/ Of the 5.4 million returns filed for 1936, only 52.9 percent were taxable. The taxable returns were only 7.3 percent of the estimated number of spending units.
The 5.4 million Federal individual income tax returns filed for 1936 represented, when the spouses and dependents are considered, 11.4 million persons, or 8.8 percent of the population; and the 2.9 million taxable returns represented 5.0 million persons, or 3.9 percent of the population.
(b) AMOUNT OF INCOME: The amount of income reported for income tax purposes is a relatively small proportion of the total income received by individuals in the United States. The National Resources Committee has estimated for the year ended June 30, 1936, single individuals and families of two or more received an aggregate income of $59.3 billion. /46/ The Department of Commerce has estimated that for the calendar year 1936, income payments to individuals amounted to $62.4 billion. For individual income tax purposes, however, only $21.9 billion of total income before statutory deductions was reported for the taxable year 1936. Similarly, for 1937, the Department of Commerce estimated that payments to individuals amounted to $70.7 billion. The total income in 1937 before statutory deductions reported for income tax purposes was only $24.5 billion. The definitions of income used by the National Resources Committee and the Department of Commerce are substantially different from one another and from the concept of income under the Federal tax law. /48/ Comparisons based upon this data are therefore only rough approximations. It would appear, however, that only about 35 percent of the total flow of income to individuals is reached by the income tax.
Of the $24.5 billion total income reported on tax returns for 1937, $17.8 billion, or 72.4 percent, was reported on taxable returns, and $6.7 billion, or 27.6 percent, was reported on returns with no tax liability. Similarly, of the $21.2 billion net income, $15.2 billion, or 71.9 percent, was reported on taxable returns and $6.0 billion, or 28.1 percent, was reported on nontaxable returns.
The coverage of the income tax is narrowest in the low brackets where the greatest amount of income is concentrated. The National Resources Committee estimated that individuals with consumer incomes of less than $5,000 accounted for $47.6 billion of the aggregate $59.3 billion. While the data of the National Resources Committee and Statistics of Income as noted above are not strictly comparable, it appears that the total income before statutory deductions reported for income tax purposes covered less than 30 percent of the $47.6 billion in the low income classes but almost 90 percent of the higher incomes.
(c) EXPLANATION OF THE NARROW INCOME TAX BASE: The chief factors responsible for the relatively narrow income tax base are: (1) the size of the personal exemptions, (2) credit for dependents, and (3) earned income credit. The extent to which these allowances reduced the net income base reported for income tax purposes is shown in Table 19 for the years 1934-1939.
These credits are relatively more important in the low than in the high income classes. In 1939, for example, the personal exemptions, credits for dependents and earned income credit amounted to 59.0, 6.9 and 7.4 percent of net income. For the income classes under $5,000, these percentages were substantially higher, amounting to 31.0, 8.6 and 7.9 percent, respectively.
An additional factor affecting the narrow income tax base is the exclusion of certain income items from the statutory income concept. Among these items are interest from most governmental securities and income imputed to the ownership of a dwelling.
In view of the foregoing indication of the relatively small proportion of the total income reached by the income tax, it is evident that any payment system based upon the present levels of exemptions and credits would be inadequate as a means of price control.
A tax at source on behalf of current year liability while subject to the above shortcomings would have an appreciable effect as an inflation control measure through withdrawing compulsorily from current income the tax at regular intervals. A tax at source on behalf of past years' liabilities is in reality merely a method of facilitating payment. Its control effect is nullified by virtue of the time lag between the derivation of the taxable income and the payment of tax thereon. As a method of merely facilitating payment, collection at source would seem to be inferior to a voluntary stamp plan of the type described in our memorandum entitled "Some plans for easing the payment of the income tax" because of the administrative problems involved.
V. SUGGESTED TAX AT SOURCE
The price situation may develop in a way which would require tax measures designed to facilitate the control of inflation. In such circumstances, a special income tax collected at source may be desirable despite the various administrative problems discussed above in connection with the several types of plans which have been analyzed. /49/
A practicable plan which would adhere to the net income basis of taxation follows:
1. The special tax would be separate from the regular income tax and in the interests of equity would be imposed on all sources of income at graduated rates. The withholding of tax at source, would, however, apply only with respect to salaries, wages and commissions. A flat rate of tax would be imposed for withholding purposes and this would be credited against the total tax liability determined on the basis of an annual return reporting all sources of income.
2. For the purpose of determining total tax liability, the gross income, deductions, credits and exemptions would be the same as for the regular income tax. For the withholding tax, only personal exemptions, credit for dependents and a tentative deduction allowance of 10% of the amount of personal exemptions and credits would be recognized. /50/ Employers would accept the statement of employees as to marital and dependent status. /51/
3. The tax would be withheld at source on a weekly basis. The allowance for personal exemptions, credit for dependents and allowable deductions would be on the basis of a 50 week year. /52/ The amounts of weekly allowances for persons with different marital status and dependents are shown in Table 20.
4. Each week or wage payment period the employer would purchase tax stamps and turn over to the employee stamps equivalent to the amount withheld at source. The stamps would be obtainable at local post offices or from the Collectors of Internal Revenue. Employees would be required to countersign the stamps in order to discourage thefts.
5. Employees would accumulate stamps received as evidence of tax payment until the end of the year. At the close of each year employees would report their income from all sources if such income exceeded the annual personal exemption or, irrespective of the amount of income, if any tax had been withheld during the year. /53/ Total liability would be determined on the basis of the graduated rates imposed for the special tax. The tax at source would be credited against the total tax and all stamps submitted with the return in support of the credit claimed. Any tax liability in excess of the credit would be payable in cash. Any stamps accumulated by employees in excess of total tax liability would be cashed by the Bureau of Internal Revenue and paid over to the taxpayer.
This plan could be instituted promptly, and without the need for any elaborate administrative machinery.