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February 27, 1996
The Birth Pangs Of The Modern Income Tax -- An Early Treasury Study (Part 2).
Carl Shoup and Roy Blough


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Reprinted is a key 1937 Treasury study that examines the standards for a sound federal tax system and analyzes various tax reform proposals, which are being examined again in the current debate on tax reform (Part 2).

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CHAPTER 4

The Taxation of Business

A. General Principles of Business Taxation

1. NATURE OF BUSINESS TAXATION

In the present chapter taxes levied on business entities are being viewed impersonally, that is without regard to the final distribution of the tax burden among persons. Taxes would be based on some attribute of the business entity but not on the personal situations of the owners. Although the owner of one business might be poor while the owner of another and identical business was wealthy, the business taxes on the two might be the same.

2. PLACE OF BUSINESS TAXES IN THE TAX SYSTEM

Whether or not impersonal taxes should be imposed on business is a controversial question. All business taxes must, in the last analysis, fall on natural persons. Only through personal taxation can the ability to pay standard of tax justice be reached. If this standard were the only one followed in designing a tax system, there would be no place in the system for business or other impersonal taxes.

However, other tax standards point to the desirability of including business taxes in the system. The first such principle is that of revenue. The amount of revenue that can be raised from any tax, however universal its coverage, is limited. When governmental expenditures are heavy the need for funds is so great that if the purely personal taxes, such as the income tax, were the only sources of revenue they would probably break down due to the inducement on persons to avoid or evade them and to administrative difficulties in stopping evasion. Furthermore since personal taxes are very sensitive to cyclical fluctuations of business, revenues from personal taxes only might not show sufficient stability. All tax systems contain impersonal taxes, to many kinds of which some business taxes are superior, thus justifying their imposition even in the absence of other reasons.

A second principle or standard is that persons should not be given bonuses or special gains by changes in the tax system. Business taxes -- mostly on corporations -- have been imposed for many years by both Federal and State governments. /1/ Their elimination at this time would give rewards to the persons who hold stocks in business corporations /2/ by allowing larger returns on their investment and as a result, higher prices for stocks. Owners of common stock would be particularly benefited since in most cases the whole reduction in corporation taxes (except such as are shifted to consumers) would accrue to the common stockholder.

A third standard is that taxes should be based in part on benefit, especially where the benefit is special in character. A substantial portion of the cost of government arises from servicing or protecting business. While the benefits from such services in final analysis reach consumers or stockholders through lower prices or larger returns on capital investment respectively, they would be impossible to trace to their final recipients. Such benefits can be reached easier by imposing a business tax as a sort of service charge on the business or organizations directly receiving the benefit.

However, the tracing and measurement of benefits conferred on specific business concerns often, perhaps usually, present an impossible problem. This fact does not mean that the idea of a business benefit tax must be given up altogether. The same principle can be applied as is used in the motor taxes. The gasoline tax, for example, does not measure accurately the cost caused by individual motorists to government for construction and repair of highways. Rather, motorists as a group receive the benefits and the financing of those benefits is allocated among the members of the group on as accurate a basis as seems feasible.

If the group benefit principle is followed in the case of business taxation the standard for distributing the tax among specific concerns should probably be to impose the tax in such a manner as not to cause more than a minimum shifting of capital and labor among different industries and not to encourage the use of particular methods of organizing and financing business. The total amount of such a tax on all business combined should not exceed the benefit to business reasonably attributable to Government on a cost- caused basis, /3/ although of course business taxes in excess of such benefits may be justified on other standards than that of benefit. Also, the benefit principle in itself does not require business taxation to prevent inequities, since the ultimate distribution of government benefits received by business is very widespread.

A fourth principle or standard having a bearing on business taxation is that when society has permitted an excessive return, whether or not that return was due to benefits from government, as much of the excess as practicable should be taken back for public use through taxation. The excessive return eventually accrues to individuals but may be reached more easily by taxing business than by tracing and taxing the return to its final recipients. In order to reach excessive returns the tax must be imposed on the particular business concern and not on business as a whole, because whether or not the average returns of all business are excessive, those of many business units certainly are not. /4/

From these principles, several conclusions may be drawn. (1) Taxes may properly be imposed on business as such. (2) If business is taxed, one tax or group of taxes may attempt to reach government benefits. Although the most desirable method of benefit taxation would be to tax each business concern for the benefit that it specifically received, a group benefit charge on business as a whole may properly be applied. (3) A second tax or group of taxes should be imposed on individual business concerns through which an undesirable excessive return is being secured.

3. THE SPECIAL TAXATION OF CORPORATIONS

Most of the preceding remarks apply to business regardless of whether it is organized as corporation, partnership, or proprietorship. However, Federal business taxes in general have been (and are today) imposed only on corporations. The reasons for this are probably (1) administrative, (2) political, and (3) equitable. The administrative reason is that the application of a general business tax to the multitude of minute unincorporated enterprises would be difficult and costly. The political reason is that a large part of the voting population would be subject to the tax, whereas consciousness of the corporation taxes probably exists only in the case of a relatively small fraction of the population. The equitable reason (which is not sufficient to justify complete exemption of unincorporated business but might justify higher rates on corporations) is that the privilege of incorporation is valuable to most corporations. This in itself would not require especially heavy taxation of corporations since the benefits of the privilege are passed on in large part to consumers. However, if the government chooses to reduce the value of the privilege by taxation there would seem to be little objection on grounds of equity -- although an anomaly exists since incorporation is an act of state governments while the tax is imposed by the Federal government.

The writers do not here propose to extend Federal business taxes to unincorporated business, although the inequities of failure to do so are recognized. Rather the analysis is devoted to a comparison of the various possible forms of taxation that might be applied to corporations.

4. LIST OF CHARACTERISTICS FOR JUDGING CORPORATION BUSINESS TAXES

The following characteristics appear to be the more important ones for evaluating corporation business taxes. They are, of course, general standards discussed in chapter 1, or elaborations of them.

a. JUSTICE CHARACTERISTICS

(1) To what extent does the tax measure the special benefits derived by the specific business from government?

(2) To what extent does the tax measure excessive earnings of business?

(3) Are competitors taxed equally?

(4) Are the taxes likely not to be shifted regressively to consumers?

(5) Would the imposition of this tax protect vested interests or avoid giving special bonuses?

(6) Does the tax avoid the tendency to cause migration of labor or capital between industries?

(7) Does the tax avoid the tendency to encourage the use of particular methods of corporate organization or financing?

(8) Does the tax avoid discouraging willingness to take risks?

b. ADMINISTRATION

(9) Does the tax avoid excessive difficulties in administration?

5. TAXES TO BE EXAMINED

Among the many possible types of corporation business tax that might be imposed, the following deserve examination with reference to the above mentioned characteristics:

a. A TAX OF THE PROPERTY TYPE imposed on the going concern value of the business. Such taxes are used in state taxation of railroads, corporate excess, and [sic] like. The value of the total operating property is deemed to be equal to the value of the business as a going concern measured by the total value of stocks and bonds outstanding or by capitalized operating net income. Leased as well as owned property is often included in determining the tax base. /5/

b. CAPITAL STOCK TAXES. Three kinds may be distinguished: (1) a capital stock tax based on market value of stock outstanding, which would be substantially the same as the tax on going concern value except that rented property and the par value of bonds outstanding would be deducted from the total going concern value; (2) a capital stock tax based on the book value of the stock, which insofar as possible would tax the true value of the stockholders' investment in the company, adjusted for reinvestments and withdrawals; and (3) the existing Federal capital stock tax in which the taxpayer declares the value of the stock, which is then to be adjusted from year to year for changes in book value. This tax should be considered in conjunction with the existing Federal excess profits tax in which the adjusted capital stock value is used as the basis for measuring excess profits.

c. GROSS RECEIPTS TAXES. Two kinds may be distinguished: (1) taxes on the total receipts of a concern with no deductions, such as are often imposed on railroads, public utilities, insurance companies, etc.; (2) taxes on gross receipts less deductions of materials purchased, so that the tax is in effect one on "value added" by the operations of the business.

d. A CORPORATION INCOME TAX of the present variety, applying to corporate net income after deducting interest paid.

e. A TAX (LATER REFERRED TO AS A CORPORATION PRIVILEGE TAX) BASED ON CORPORATION OPERATING BUSINESS NET INCOME. Two methods of computing net income for such a tax are compared. In one (referred to later as Type 1) interest paid is not allowed as a deduction while interest and dividends received are not taxed. In the other (referred to later as Type 2) neither interest nor rent paid is allowed as a deduction, while interest, dividends, and rent received are taxed. /6/

Manufacturers' sales taxes and true excess profits taxes are not included as they are treated elsewhere in this or other chapters.

6. ANALYSIS ON THE BASIS OF CHARACTERISTICS

a. JUSTICE CHARACTERISTICS.

(1) TO WHAT EXTENT DOES THE TAX MEASURE THE SPECIAL BENEFITS DERIVED BY THE SPECIFIED CONCERN FROM GOVERNMENT? None of the taxes listed measures the special benefits derived from government by the business concern. Somewhat better than the others in reflecting benefits are: (1) the going concern value tax, since it represents the total value of property receiving services; and (2) the tax on gross receipts less purchases, since it measures the volume of operations carried on by the business requiring government services. The tax on operating net income (less deductions for interest paid and less interest received) comes nearer to measuring benefit than does the normal income tax since more nearly all corporations are taxed and since the business as a whole is taxed rather than only a varying fraction.

(2) TO WHAT EXTENT DOES THE TAX MEASURE EXCESSIVE EARNINGS OF BUSINESS? The tax on going concern value reaches excess earnings on the same basis as other earnings since all earnings affect the value of the going concern. In some cases, the capital stock tax based on market value probably reaches excess business earning even more than other earnings, since the bonded debt may represent a large part of the investment and normal earnings while excess earnings usually affect the value of the capital stock only. The corporation operating business income taxes likewise tax excessive earnings but do not distinguish them from other earnings. The income tax on final corporate net (the existing tax) probably reaches excess business earnings more than normal earnings in the case of corporations with bonds outstanding. The existing excess profits tax is in name only a tax on excess earnings, since the amount of the tax depends on the skill with which the owner of the corporation anticipates his future earnings. Only unexpected excess would be taxed. The size of the coexistent capital stock tax would depend largely on anticipated earnings. The other taxes are not affected by earnings either excessive or normal.

(3) ARE COMPETITORS EQUALLY TAXED? Any taxes that are applied only to corporations do not tax competitors equally. Likewise taxes imposed on income omit taxing competitors who are losing money; the present income tax omits more corporations than do the taxes on operating net income. The capital stock taxes do not tax corporate competitors equally in that corporations with heavy bonded indebtedness are not taxed on the same basis as those with no debt although the operating business units may be identical. The same comment applies to the present corporation income tax. It also applies to the type of corporation operating net income tax (Type 2) in which interest, etc., paid are deducted but interest, etc., received are taxed, since a system of corporations with inter- corporate borrowings, leases, or stock ownership is taxed heavier than a competing system in which these did not exist.

Whether in computing operating net income (Type 1), greater tax equality results from making rents paid not deductible the same as interest paid presents a difficult problem because of the mixed nature of rent. In part the lessor of real or personal property makes a contribution of capital to the lessee corporation similar to that of the bondholder, who loans funds to the corporation with which it buys property; and rent like interest is the return for the use of the capital. In part, however, rent is compensation to the lessor for the depreciation or depletion of his property, and for taxes levied on it to the extent that they are shifted in higher rent, all of which (except certain taxes) are items that the corporation owning all the property that it used could deduct in arriving at taxable income.

The importance of depreciation, depletion, and shifted taxes as elements in rents varies greatly among different kinds of property. The rent of urban land, for example, includes no payment for depreciation or depletion and probably none for shiftable taxes; while royalties on mineral lands are paid not so much for the right to use as for the right to extract and thus are largely payments for depletion. It would not be administratively feasible to separate each rent payment into return of capital on the one hand and depreciation, depletion, and shifted taxes on the other.

The dilemma resulting from the mixed nature of rents is that if they are deductible in computing operating net income, tax equality is not secured since the corporation that owns the property it uses is allowed deductions for depreciation, depletion, and taxes, while the corporation that leases the property it uses is not; while if rents are not deductible, tax equality is not secured since leasing reduces taxes on the return of capital used in the business. On balance less injustice and less pressure to use particular forms of capital structure seem likely to result if rents paid are deductible to the lessee (using) corporation and if, likewise, rents received are taxable to the lessor (owning) corporation.

(4) ARE THE TAXES LIKELY NOT TO BE SHIFTED REGRESSIVELY TO CONSUMERS? Taxes that fall on marginal producers are likely to be shifted to consumers. The taxes most likely to be shifted to consumers are those on gross receipts. The property taxes and capital stock taxes are also likely to be shifted since they are imposed both on concerns making income and those suffering losses. The capital stock tax now in operation is not quite as likely to be shifted as a genuine capital stock tax, since the chronically low income or loss corporation is likely to place a low value on its capital stock. Marginal producers may thus pay little tax. The taxes on net income are probably shifted only slightly if at all because they fall less heavily (if at all) on the marginal producers, than on super-marginal producers. If the marginal producers are no-profit concerns they pay no income tax so that there is no tax to shift; if they are small- profit concerns, the ratio between the taxed income and the gross sales is small, so the amount of shifting is small. Whether the taxes on operating net income are more likely to be shifted than the taxes on final corporate net is open to question; but since marginal producers may be either concerns with a bonded debt outstanding or concerns with no debt, there is probably no difference in the degree to which they are shifted.

(5) WOULD THE IMPOSITION OF THIS TAX PROTECT VESTED INTERESTS AND AVOID GIVING SPECIAL BONUSES? Since the corporation net income tax is in operation and has been for years, its continuation would not affect vested interests. A reduction of the tax, however, would tend to give a bonus to the present owners of corporate stocks, especially common stockholders, since the increase in return resulting from tax reduction would be capitalized in higher stock prices.

Likewise the present capital stock and excess profits tax combination has probably been capitalized to a considerable extent and the repeal of these taxes would give some undeserved gains.

The imposition of any of the other types of tax would have the opposite effect of reducing the returns of certain corporations and thus of reducing their stock values. If some other form of tax was substituted for the present normal income, capital stock, and excess profits taxes, the net effect on vested interests would, of course, depend in the case of each corporation on the relative burden of the old and the new taxes.

The imposition of either type of corporation business operating net income tax would injure vested interests of debtor corporations while bonuses would be given to corporations with no debt. Type 1 (exempting interest received from other corporations) would give bonuses especially to creditor corporations. Type 2 (in which deductions for interest, etc., paid are not allowed and interest, etc., received are taxed) would avoid giving special bonuses to creditors but would injure the vested interests of holding corporations since the deductions now allowed for dividends received would be removed. It would also place integrated combinations of creditor corporations and debtor corporations at a disadvantage in comparison with competing operating corporations that were financed directly by stocks and did not borrow from other corporations.

b. ECONOMIC EFFECTS CHARACTERISTICS.

(6) DOES THE TAX AVOID THE TENDENCY TO CAUSE MIGRATION BETWEEN INDUSTRIES? The gross receipts taxes would have a tendency to cause migration from industries in which net income constituted a small fraction of gross receipts to industries in which it constituted a large fraction, because of the lower effective tax on net income of the latter. This would be especially true of the gross receipts tax which allowed no deduction for purchases. To the extent that taxes were shifted immediately upon passage, the amount of migration would depend on the elasticity of demand for the products of the industry. Industries with a small ratio of income to gross receipts and a relatively elastic demand would tend to lose the most capital and labor.

The other taxes would not tend to cause migration since they fall on capital (not simply tangible property) or income and thus burden all industries to a fairly uniform degree.

(7) DOES THE TAX AVOID THE TENDENCY TO ENCOURAGE THE USE OF PARTICULAR METHODS OF CORPORATE ORGANIZATION AND FINANCING? The going concern value taxes, gross receipts tax with deduction for purchases, and operating net income tax (Type 1) with no taxation of interest received, have no effect on methods of corporate organization or financing, /7/ as no saving can be effected by changing organization or financing methods. The gross receipts tax without deduction for purchases would tend to cause integration of industry in order to escape one or more of the stages in the tax. This might be discouraged by the application of the tax to stages of production instead of to companies, but this would be difficult to apply and to administer. The capital stock taxes encourage the use of bonded indebtedness and leasing as a means of corporate financing, since thereby the value of the capital stock can be lessened. The income tax on corporate net (for example, the present tax) also tends to encourage financing by bonds instead of preferred stocks since the income subject to tax is thereby diminished. The operating net income tax (Type 2) with no deduction for interest, etc., received strongly discourages the use of holding companies and also all creditor corporations.

(8) DOES THE TAX AVOID DISCOURAGING WILLINGNESS TO TAKE RISKS? If there is any difference in the effect of the different kinds of taxes on the willingness to take risks, the income taxes probably discourage risk-taking more than the other kinds, since the business man must share his takings with the government in proportion to his take, while not being able to share his losses also with the government. The going concern value taxes and the capital stock taxes based on market value act substantially like the income taxes. In the case of the other taxes, although the risk of the loser is greater since he must pay his taxes, whether or not he makes a gain, the person making large profits pays no more than if he makes small profits. Thus the taking of chances for large gain is not discouraged. Whether the effect of any of these taxes is sufficient to be significant, and whether it is undesirable are perhaps open to question in the present state of knowledge.

e. ADMINISTRATION CHARACTERISTICS.

(9) DOES THE TAX AVOID EXCESSIVE DIFFICULTIES IN ADMINISTRATION? None of the taxes would be excessively costly to administer except possibly the capital stock taxes based on investment in which the investment might be very hard to ascertain. The capital stock taxes based on market value would also likely be hard to administer since many stocks do not have an ascertainable market value. The going concern value and income taxes would be more difficult to administer than the gross receipt taxes.

B. Proposals for Changing
Federal Business Taxes

1. REPEAL OF CAPITAL STOCK AND EXCESS PROFITS TAXES

The capital stock now imposed by the Federal Government is not a true capital stock tax either on the book value basis or the market value basis. It is inseparable from the present excess profits tax since the rather obvious purpose of the latter is to keep the declarations of capital stock values at a high level. The two taxes constitute in a sense a tax on unfortunate speculators; the clever or lucky forecaster pays a minimum of tax, while one not so fortunate pays either more capital stock tax or more excess profits tax. Since the tax rates on excess profits are much higher than those on capital stock there is a tendency to value the stock at more than its actual value to make sure that no future excessive earnings will make necessary the payment of an excess profits tax. Holding companies, however, are encouraged to value their capital stock at very much less than its true value since their net income is only 15 percent of the dividends received from subsidiaries.

The substitution for the present tax of a real capital stock tax based on investment or market value is not recommended for two reasons: (1) When a tax of this kind /8/ was formerly imposed, its administration was found very difficult. The determination of either true investment or of true market value is very difficult for large numbers of corporations. (2) Even if the administrative difficulties were overcome, the fact that the capital stock value would represent only the stockholders' equity, and that it would probably be shifted to consumers would indicate that it should not be used. Better taxes on corporation business are available.

The point is sometimes made that because of the adjustment of the declared value from year to year by adding earnings and deducting distributions, the base for the present capital stock tax will eventually become the true investment value of the stock. However, this is incorrect since the adjustments do not correct the original error; the only improvement in accuracy is that as capital value increases the relative importance of the error becomes less.

Because of the speculative element in the present taxes and because better methods of taxing business are available, the writers recommend that the capital stock and excess profits taxes be repealed.

2. BUSINESS PRIVILEGE TAX

To replace the revenue lost by the repeal of the capital stock and excess profits taxes, and to replace part of the reduction in the corporation normal income tax recommended below (see next section), the writers recommend the imposition of a corporation business privilege tax measured by operating net income. The income base for this tax would be different from that of the existing corporation income tax in that no deduction would be allowed for payments of interest. Similarly, interest received on capital invested by this corporation in other corporations would not be subject to the tax. The intention is to tax the income of the business as a whole without regard to the capital structure and without regard to nonoperating income. /9/

The characteristics of this tax have been previously indicated (see previous section on characteristics of business taxes). It does not reach corporations with operating losses and accordingly does not impose equal taxes on all competitors. However, it avoids driving marginal concerns (where marginal concerns are receiving no earnings) out of business and thus avoids causing tax shifting to consumers. Such part of the tax as may be shifted is likely to be small. The tax does not tend to cause migration from any industry to others or the adoption of any particular plan of corporation financing. Except that businesses having an operating loss are not liable for tax, which some may regret, the tax fits the standards of taxation better than any other form of business tax that has come to the attention of the writers.

The only serious objection that they see to the tax is on the ground of vested interests. Both the capital stock tax and the normal income tax exempt those parts of the assets or income, respectively, of which the equity belongs to the bondholders. As pointed out above, this violates standards of equality. However, bonds have been issued and other commitments made with full consideration to the existing tax preference to corporations in debt. To make a sudden change and to raise all revenues now raised by the capital stock, excess profits, and corporation normal income taxes from a business privilege tax on the base proposed would mean a shifting of burden that would disturb vested interests considerably. Corporations with heavy bonded debts, for example, the railroads, would have their taxes very greatly increased. Corporations with no bonded debt would have their taxes decreased, while corporations receiving much of their income from interest would have their taxes greatly decreased.

Because of the serious resulting disturbance to vested interests that would follow an immediate complete shift to the business privilege tax on operating net income, the writers believe that it should be introduced gradually, to begin at a rate sufficient to yield as much as the capital stock and excess profits taxes have been yielding, and increasing gradually to perhaps 5 percent in the course of 8 or 10 years.

3. THE CORPORATION NORMAL INCOME TAX

With the repeal in 1936 of the exemption of dividends from personal normal tax, even partial elimination of double taxation of corporation and personal income taxes ceased. The corporation tax has become in effect an impersonal business tax. The writers dislike the corporation normal tax for two reasons, first that the tax base is inferior to that of operating net income for a corporation business tax, and second that the rates are too high for impersonal taxation. Accordingly, they recommend three changes: (1) that the total unintegrated tax on corporations be reduced much below the present level; (2) that the corporation business privilege tax based on operating net income be substituted for the present tax over a period of years, and (3) that only such amount of the corporation normal tax be retained permanently as it is desired to use as a personal tax collected at source with exemption of dividends from personal income tax -- although the writers see little need for this kind of a corporation tax with a well-developed personal income tax system reaching the lower brackets of income.

Although recommending reduction in corporation taxation because of its impersonal character, the writers prefer impersonal corporation taxes that are not likely to be shifted to consumers, namely the net income taxes, to commodity taxes such as the manufacturers' excise taxes and the tobacco taxes, since the persons on whom the corporation income tax burden falls are commonly in higher income groups than are those upon whom the bulk of the commodity taxes fall. Accordingly, the lowering in the total corporate burden should await the lowering or elimination of such taxes.

It should be noted that the type of corporation business privilege tax proposed here is different in a very important respect from that recommended by the Division of Research and Statistics. In that plan dividends, interest, and rent received would be taxable, while interest and rent (and of course dividends) paid would not be deducted. This is double taxation of the same income merely on account of the corporate structure and violates the principle of equal treatment of different corporate structures fully as much as does the present corporation normal income tax. Interest and rents received from individuals may be properly taxable to the corporation since all interest (and rents in case they are for business purposes) are deductible from individual income. The nondeductible corporation items, however, should not be taxed twice.

An objection may be raised to putting holding and creditor corporations in better position than they are now or freeing them from taxation altogether. The reason for treating them in this way is a logical one. Capital cannot be employed in more than one business at the same time and the earnings on the capital should be taxed to the business in which it is employed. The reduction of taxes on creditor corporations is, however, a reason for making the transition to the operating net income base a gradual one.

Of course, if there is a desire to penalize indiscriminately all holding and creditor corporations in order to discourage their use in the business structure, the failure to allow deduction of interest, etc., received is logical. However, general taxation of this kind is a very crude method because not all such companies are undesirable and the tax does not distinguish them. /10/ For this reason the writers do not in general consider the use of taxation for this purpose desirable, unless it is carefully adjusted to achieve its ends.

In harmony with the above proposals, consolidated returns should be allowed unless control purposes dictate other treatment of them.

C. TRUE EXCESS PROFITS TAX

The existing federal excess profits tax, as described in the preceding section, is merely an adjunct to the capital stock tax, designed to prevent the taxpayer from setting much too low a value on his capital stock. It does not form a satisfactory basis for a true excess profits tax.

A true excess profits tax should be built up gradually, and the present is as good a time as any to start. The chief reasons for having an excess profits tax in operation in times of peace are two: (1) in case of war, an excess profits tax will almost surely be levied, and if it is hastily thrown together it will be unfair, may be relatively unproductive, and will be in grave danger of stifling essential initiative and encouraging extravagance; and (2) a state of quasi-monopoly or imperfect competition is so widespread as to justify an attempt to expropriate the excessive (economically unnecessary) profits arising from it.

A plan of gradual introduction of such a tax, with a statement of the chief problems to be met, is given in Facing the Tax Problem, pages 273-290, 409-411, 433-434, and 491-494.

An analysis and evaluation of the tax is given on the accompanying characteristics chart [missing from original].

CHAPTER 5

MANUFACTURERS SALES TAX

There is no general manufacturers sales tax now in the Federal tax system, and there has been none since the Civil War. The tax warrants discussion here, however, because it was seriously considered by Congress shortly after the World War and again in 1932, and because as a major source of revenue it will probably be considered again if Congress needs to raise a large amount of new tax money. /1/

1. REVENUE ASPECTS

The 1934 Sales Tax Memorandum /2/ estimated that, for a year comparable in activity and price level to 1931, a 1 percent tax would yield from $240 million to $290 million (if food were exempt, from $190 million to $220 million). Time has not permitted a similar set of estimates on later data, but at least it can be said that the yield would be substantially larger now. Since administrative considerations would probably allow a rate as high as 3 or 4 percent -- and possibly more -- the tax is a potential source of nearly $1 billion a year.

The manufacturers sales tax would be more stable in revenue yield than the income tax, but much less so than the tobacco tax. From 1929 to 1933 the base for a manufacturers sales tax declined about 50 percent. /3/ During the same period, the base for the corporation income tax declined about 75 percent, and the base for the tobacco tax, only about 3 percent. /4/ In a period of rapidly rising prices, the manufacturers sales tax would keep the government's revenues fairly well up with its increase in costs, with perhaps something to spare; its chief effect in actually checking inflation would come from the fact that it could readily be collected as often as once a month. /5/

2. ECONOMIC ASPECTS

As a regulatory tax the manufacturers sales tax has little merit. It
is too broad and too incapable of refinement. A few remarks are
possible, however, concerning its effect on the more important
economic factors.

It tends to decrease the volume of savings less than most taxes,
since most of its revenue comes ultimately from the low-income
consumer who would probably spend, rather than save, that part of his
money that goes to cover the higher prices caused by the sales tax.
Conversely, relatively little of the revenue comes from the wealthy
who would be disposed to pay the hidden tax charge with money that
they would otherwise save.

Compared with most major taxes, it tends to maintain the existing
distribution of wealth and income or even to change it in favor of
the well-to-do. It takes from the low-income receiver a larger
percent of this income than it does from the high-income receiver,
since the former spends a greater percentage of his income on the
taxed commodities than the latter does. This is probably the result
even when food is exempted.

As to its effect on willingness to risk and willingness to work, little if anything can be said of the manufacturers sales tax beyond the tentative supposition that it has practically no direct effect on the willingness to put money into hazardous enterprises rather than safe ones.

3. DISTRIBUTION OF BURDEN

From the point of view of justice, the tax has both favorable and unfavorable aspects. On the one hand, it would have relatively little effect on innocent vested interests -- it would be at so low a rate and would apply to so many lines of business that no one producer would be likely to find his business dropping off as markedly as it would be if it were subject to a high-rate special excise. On the other hand, the manufacturers sales tax is not suitable for use as a benefit tax or a tax on unmerited gains, and it has almost no ability at all to take account of differences in the economic status of the ultimate burden bearers -- except, indeed, that it is regressive in its incidence and hence tends to increase, rather than decrease, the regressivity that now exists at income levels below $2,000. The tax has the added disadvantage of resting in part on the business man during a period of transition.

4. ADMINISTRATION

While the tax would not be extremely easy to administer -- it might not make a much better showing than the income tax -- there is no doubt that it could be administered within a reasonable cost, perhaps 3 percent of collections at a 1 percent tax rate. However, the manufacturers with gross annual sales of less than $5,000 are so numerous that it would probably be necessary to exempt them if either undue evasion or unduly high costs were to be avoided. Again, the degree of cost would depend on the extent to which the tax was refined to avoid double taxation. /6/ The cost of complying with the manufacturers sales tax would probably be appreciably lower than that of the income tax. However, all these remarks on administration must be qualified by the reminder that they are comparing one tax as a whole with another tax as a whole. If the alternatives are, not a sales tax and an income tax, but a sales tax and an increase in income tax rates, the sales tax will have the greater administrative disadvantage in most instances.

5. TAX CONSCIOUSNESS

A federal manufacturers sales tax could not promote tax consciousness among the public. To try to trace the amount of the tax on the article all the way through the retailer and have him state it to the consumer as a separate item would usually be impracticable, although it is done in some cases at present under the manufacturers excise tax -- viz., the tax on automobiles, by certain firms at certain places.

6. FEDERAL-STATE-LOCAL RELATIONS

The manufacturers sales tax, in contrast to the retail sales tax, can be levied only by the Federal government, in practice, because the states are afraid they will drive manufacturing concerns away if they tax them on their sales at any but nominal rates. Thus in a narrow sense there is not likely to be any conflict on this tax between the Federal and State governments. But in a broader sense, there would be a decided conflict between this tax and the retail sales tax levied by nearly half the states, in some cases at a rate as high as 3 percent. At least the existence of these taxes probably makes it more difficult, politically, to impose a Federal manufacturers sales tax. /7/

        ANALYSIS AND EVALUATION OF TAX CHARACTERISTICS No.___
            Tax Manufacturers sales tax at 1 percent rate
                          Change in Tax____
---------------------------------------------------------------------
Characteristic      Situation with    Is tax (or      Possible method
                    respect to        change)         of improvement
                    this tax (or      desirable
                    change in tax)    in this
                                      characteristic?
---------------------------------------------------------------------
1. REVENUE          No estimate,           --               --
                    but would be
a. Volume           major source
                    even at 1
                    percent
b. Would show       Probably,              Yes              --
   yield            within
   change           range
   proportionate    of 1 to 3
   to rate          percent
   change           rate
c. Has stable       Rather                 No               None
   yield            unstable -
   through          - but less
   business         so than
   cycle,           income tax
d. Responds         Probably               Fair             None
   more than        not -- but
   proportionately  also would
   to rapid         not lag
   price            much
   rise

2. ECONOMIC EFFECTS

a. Causes           Probably               Yes              --
migration           not to a
of capital          significant
or labor            extent
between
industries

b. Restricts        Probably            No Opinion          --
   the              less than
   factors of       most
   production       taxes

(1) Volume of saving

(2) Willingness to  Probably               Yes              --
    take risks      little or
                    no effect

(3) Willingness to  Probably               Yes              --
    work            no effect

c.  Restricts          Yes              No opinion          --
    consumers'
    spending
d.  Suitable           No               Indifferent         --
    for
    specific
    control
    purposes

3. JUSTICE

a. Recognizes       Cannot do              No               None
   personal         this
   differences
   (1)
   Differences
   in amount
   of income
   (progressive
   burden)
(2) Other           Cannot do              No               None
    differences:    this
    kind of
    income,
    etc.
b.  Taxes              No               Indifferent         --
    special
    benefits
c.  Taxes              No               Indifferent         --
    unmerited
    gains
d.  Taxes           Probably,              Yes              --
    competitors     in most
    equally         cases
e.  Avoids          The loss               Fair             --
    loss of         is spread
    consumers'      pretty
    utility         thin over
    through         a number
    increase        of things
    in price
f.  In case of      Only small             Yes              --
    change (1)      danger in
    Preserves       most
    vested          cases, if
    interests,      tax were
                    enacted
(2) Avoids          Only small             Yes              --
    giving          amount
    bonus
4.  ADMINISTRATION

a.  Causes          Perhaps                Fair             --
    only            about 2 to
    moderate        3 percent
    cost to         of
    government      receipts -
                    - very
                    uncertain,
                    however

b.  Causes          Perhaps,               Fair             --
    only            difficult
    moderate        to say
    cost of
    compliance

c.  Results in      Probably,              Fair             --
    slight          provided
    amount of       all small
    evasion         (below
                    $5,000)
                    manufacturers
                    were
                    exempt
5.  Promotes        No, except             No               None
    tax             among the
    consciousness   manufacturers

6.  Intergovern-    Directly,              No               None
    mental          yes, but
    fiscal          it really
    relations       conflicts
    a. Avoids       with
    conflicts       retail
    of              sales
    government      taxes
b.  Avoids          Yes;                   No               None
    repressing      states
    decentrali-     cannot use
    zation          it. However,
                    might deter
                    retail tax
                    from using.

7. Other characteristics

a.

b.
---------------------------------------------------------------------

GENERAL EVALUATION
In a system that already has very highly progressive income and
death taxes, the economic effects are probably better than more of
the effects of the other taxes, and administratively, the tax is
practicable. But it fails sadly in most of the tests of justice,
and does not help with tax-consciousness or intergovernmental
relations. Advisable to use it only when income and death tax
rates get too high.

CHAPTER 6

DEATH AND GIFT TAXES

1. THE DESIRABILITY OF DEATH TAXES

UNIVERSAL ACCEPTANCE: Taxation of the transfer of property at death has been one of the most universally used tax forms in history. The purposes have included both revenue and control. The institution of inheritance is recognized to be specially granted privilege allowed only because the results therefrom are believed to be socially desirable; principally perhaps because of the encouragement given to the production and accumulation of wealth. When the danger of the concentration of wealth in the hands of a few persons has been thought to outweigh the desirability of wealth accumulation, inheritance has been limited and modified, largely through taxation.

PAINLESSNESS: Death taxes constitute a relatively painless method of raising revenue. The descendent is dead so the tax cannot hurt him at the time it is imposed, although of course it may have caused sacrifices during his life that he would not otherwise have borne. Perhaps usually the legatee or beneficiary has not sacrificed to create the wealth so the tax causes him no real sacrifice, although of course a wife or son may have helped build up the estate. An inheritance is probably looked upon by most beneficiaries as an addition to capital rather than as expendable income, so that the tax has relatively little effect on the beneficiary's standard of living. The beneficiary usually has other financial sources than the inheritance although in the case of widows and minor children this statement would perhaps not be true. If the tax is anticipated, no expectations are frustrated. All taxes cause some sacrifice, but the inheritance tax causes less than others.

ECONOMIC EFFECTS: Since death is an uncertain future event and since it removes from the scene of action the person chiefly interested, death taxation probably has less effect on the individual's activities than do other more immediately pressing taxes. A strongly urged argument is that heavy death taxes discourage the decedent from working and accumulating and thus prevent the creation of economic wealth that would otherwise be created. Against this view it is urged that because the tax will take a large part of the estate, the individual is encouraged to work harder and save more than he otherwise would in order to leave a competence to his heirs. Probably the forces of the two motives differ among individuals. However, the motives that induce most work and accumulation are likely to be found in an individual's own life rather than in his interest in his heirs, especially when the fortune becomes more than adequate to support his near kin.

The effect of the inheritance tax on the inheritor of wealth is probably to encourage work and accumulation. Much of the best mental power of the nation is wasted because its possessors do not need to work. While heavy inheritance taxes might deny some capable persons of capital needed to exercise their talents (although most inheritances appear not to be received until middle age), on the whole heavy inheritance taxes by making work necessary would probably lead to greater production and accumulation by the beneficiary than if such taxes were not imposed.

Perhaps the most influential argument brought against death taxation is that it destroys accumulated social capital. The argument runs that in order to pay the tax the estate must be liquidated, wholly or partially.

This liquidation is accepted as a destruction of social capital. This, however, is a fallacious view. Social capital consists of tangible wealth, which cannot be destroyed by merely selling the estate. The estate is sold to someone who buys it out of his income or out of his liquid accumulated savings; the social capital continues to exist.

A more valid contention is that death taxation slows up the formation of social capital. The purchaser of the assets of an estate buys them as an investment. He does not distinguish between such an investment and an investment in the production of new capital. Accordingly less liquid funds are available for investment in new capital than would probably be the case if inheritance taxes were not imposed.

Effects on social capital are in no way peculiar to death taxes. Highly progressive income tax rates, which also reduce the volume of funds available for investment, have a similar result. Indeed, the effects of income taxes on enterprise and accumulation are probably greater than those of death taxes. Income taxes apply to the present, the estate taxes to an uncertain and often distant future. Income taxes affect directly the rewards for enterprise; those rewards may never, and most of them probably will never be, subject to the estate tax.

The seriousness of this discouraging effect on capital growth depends on the ease with which a society may accumulate capital. In the early days of the capitalistic system the great need of new capital and the difficulty of accumulating it may have made heavy death taxes undesirable. At the present time, however, the surplus of the productive power of the country over minimum necessary consumption is so great that needed new capital can be brought into existence with little sacrifice and almost at will through the use of bank credit. Accordingly the argument against death taxes on the grounds that social capital is thereby prevented from growing is probably not a particularly significant one today. More light on this point, however, is badly needed.

Death taxes so severe as to result in a very substantial redistribution of wealth might result in the gradual decrease in the volume of social capital. The demands of the lower income groups for immediate income would shift productive activities from the replacement of capital to the supply of consumption goods for immediate use. The capitalistic system seems to require a considerable degree of inequality in order that it may have the necessary capital to operate -- although the present degree of inequality is perhaps unnecessarily great. A system of death taxation that would lead to almost complete redistribution and equality of wealth would probably have a very repressive long-term effect on production.

OTHER STANDARDS: With regard to the other tax standards the death taxes do not appear to be sufficiently better or worse than other taxes to affect materially the relative merits of the tax.

CONCLUSION: The conclusion of the writers is that transfer of property at death is an especially good source of taxation, and that the desirable level of rates is limited largely by the effect on the accumulation of capital, about which little is known.

2. DEATH TAXES AS A SOURCE OF FEDERAL REVENUE

REASONS FOR CLAIMS OF STATES: States have contended for exclusive use of death taxes chiefly on two grounds, priority and state control of descent. Death taxes were introduced in a great many of the states before the federal government passed the estate tax in 1916. The control of descent is vested in the states, so that it is claimed that in effect the state is creating the tax base and should therefore tax it. The embarrassment of the federal administration in enforcing a tax resting on state laws of descent is also emphasized.

ACCIDENT OF SITUS: There are, however, strong reasons why the federal government should impose death taxes. Under Supreme Court decisions the situs of intangible property for death taxation is the residence of the descendent. A large part of most estates, especially the larger ones, is in the form of securities and other intangible property. Accordingly the situs for purposes of death taxation for a large part of the property transferred is determined by the residence of the decedent at the date of his death. This residence may have been purely accidental so far as the state is concerned. A person may have spent practically all his life in one state and earned his fortune there. Then for one of a variety of reasons he may have moved to another state, established his residence and died shortly thereafter, giving the state all of the death taxes. Luck and whim have more to do with the location of the taxable base than can be justified.

NATIONWIDE SOURCES OF GREAT FORTUNES: Furthermore most large fortunes have not been earned in any one state. Business crosses state boundaries and has become national and international in character. To locate in a specific state the power to tax a large volume of social wealth that has been created throughout the country seems difficult to defend. Taxation by the federal government whose jurisdiction covers all of the states is more logical.

STABILITY OF REVENUE: Revenue from death taxes are subject to substantial variations from year to year. This is particularly true in individual states because the number of very wealthy persons residing therein is ordinarily relatively small and accordingly the number dying from year to year is highly variable. The larger the jurisdiction is the more nearly stable the revenues are from death taxes.

FEDERAL PROTECTION OF STATE DEATH TAXES: Because of the ease of shifting the situs of intangible property for state death taxation, states formerly competed -- and still do to some extent -- for wealthy people by imposing low death taxes or none at all. The federal offset or credit of state death taxes against the federal estate tax was granted to protect states from the annihilation of state death taxes by competition.

CONCLUSION: The conclusions of the writers are that states have no valid claim to exclusive use of the death taxes, and that some use by the federal government is desirable.

3. THE RELATIVE MERITS OF ESTATE AND INHERITANCE
TAXES FOR FEDERAL USE

DIFFERENCES BETWEEN ESTATE AND INHERITANCE TAXES: Death taxes are of two types. The estate tax is imposed on the net value of the total estate regardless of how it is to be distributed among beneficiaries. The inheritance tax is imposed on the share going to each beneficiary with the rates usually graduated according to the relationship of the beneficiary to the decedent and to the amount inherited. Rates imposed on strangers to the blood and distant relatives are usually higher than these imposed on close relatives.

INCIDENCE OF THE TAXES: The incidence of the two taxes is different. The incidence of the estate tax ordinarily is on the residual claimant or remainderman. If the will of the decedent grants specific sums to various beneficiaries and leaves the remainder to one of the beneficiaries the whole tax is borne out of this remainder, since it reduces the amount of the estate available to the heirs. In the case of the inheritance tax, however, the tax is imposed on the share received by each beneficiary and reduces that share alone.

This difference in incidence can be largely nullified by action of the decedent. Careful drafting of the will with death taxes in mind can place the incidence of either the estate tax or the inheritance tax upon the heirs whom the decedent wishes to bear it. Ability to forecast the amount of the estate is necessary to do this with approximate accuracy.

Another difference between the inheritance and estate taxes is that with the inheritance tax a wider distribution of the estate among beneficiaries usually reduces the total tax, the exact effect depending on the graduation of rates. Use of the inheritance tax might thus be expected to encourage wider distribution of estates as a method of minimizing the tax.

RELATION OF TAX TO ABILITY TO PAY: Death taxes may be considered personal taxes on the beneficiaries. Personal taxes should relate as closely as possible to the total economic position or ability to pay of the individual. Neither estate nor inheritance taxes achieve this result since nothing but the transfer of the property in question is considered. However, the inheritance tax comes somewhat closer to the standards of personal taxation than does the estate tax since the personal situation resulting from the transfer is considered in the case of the inheritance tax. The ability of the decedent to determine the incidence of the tax may largely nullify the superiority of the inheritance tax in this respect.

ADMINISTRATION: The estate tax is much easier for the federal government to administer than an inheritance tax would be. Only the amount of the gross estate less deductions need be determined. The tax can be imposed and collected without regard to any quarrels over the distribution of the estate -- except as these may involve charitable bequests. The difficult problems of valuing life estates and the interests of the remaindermen are avoided. Furthermore, since the laws of descent are state laws and are administered by state officials the determination of a federal tax would be placed more completely in the hands of state officials than might prove desirable for the federal government.

CONCLUSION: The conclusion of the writers is that the administrative factor is the more weighty and that on balance the estate tax is better for the federal government than the inheritance tax although the latter comes somewhat closer to ideals of justice.

4. ESTATE TAX EXEMPTIONS

A. EXEMPTION AND TAX STANDARDS.

ADMINISTRATION: Tax exemptions are allowed ordinarily because they promote both the administrative ease and the justice of taxation. Administratively the revenue derived would not justify the application of the tax to every estate. The allowance of an exemption saves the cost of administering the tax on a large proportion of estates without seriously affecting the amount of tax revenue produced. For administrative purposes the exemption need not be of the usual type; it would suffice not to impose the tax on any estate below a certain size, while taxable estates were allowed no exemption. The result of this procedure would be to encourage those close to the taxable line to attempt evasion but otherwise the effects on administration would be negligible.

JUSTICE: Two slightly different equitable bases for exemption have been proposed. One is that taxable capacity does not begin with the first dollar of income received or property owned. A minimum for subsistence is deducted and taxable capacity considered to begin only with amounts remaining after deducting the minimum. Part of the income of the millionaire represents no taxable capacity just as does part of the income of the very poor individual.

A slightly different basis for tax exemption is merely that after payment of the tax a minimum of subsistence should be left to the taxpayer. In the case of the poor individual this minimum will correspond to the exemption of a subsistence minimum. In the case of a wealthy person, however, so long as the rates are low enough so that the amount left after the payment of the tax is more than the minimum of subsistence, no exemption is required in order to give justice. The significance of these two equitable bases for exemption will appear below in the discussion of the application of exemptions.

REVENUE: By diminishing the amount subject to tax, exemptions decrease the amount of revenue that any given set of rates will produce. Whether the exemption also decreases the stability of revenue depends on the manner in which the exemption is applied and also on the rate structure.

B. METHOD OF COMPUTING ESTATE EXEMPTIONS.

DETERMINING THE EXEMPTIONS BY THE BENEFICIARY: The application of theories of personal justice in determining exemptions for estate taxation is difficult because the size of the estate, as previously mentioned, may bear no relation to the personal situations of those to whom the estate is distributed. Estate tax exemptions ordinarily disregard the distribution of the estate. However, exemptions might be determined by the number and relationship of the dependents, an exemption determined by relationship being allowed for each beneficiary and these exemptions added to determine the total exemption allowed the estate. The taxes, however, would be computed on the estate as a unit and not on the shares of the beneficiary. Such an exemption, would protect minimum subsistence better than the flat exemption, although in the case of estate taxation the connection with a minimum of subsistence is not easy to make. Professor Walradt recommended this method of computing exemptions. /1/ He recommended an exemption of $15,000 for the widow, $7,500 for a widower, $2,500 to $3,500 for each minor child, dependent on age, $5,000 for a parent, and special allowances for disabled dependents, but no exemption for children over 21 or for other relatives. The inclusion or exclusion of different relatives was based on the legal and moral obligation of the decedent to support them. The amount allowed was calculated on the probable period of support and the minimum requirement for subsistence.

Although the computation of exemptions in this manner would improve the justice of the estate tax as a personal tax, it does not seem practicable. The difficulties of imposing a federal inheritance tax would arise in determining the exemption -- that is, knowledge of the distribution of the estate among the beneficiaries would be required. Distribution is determined by state authorities, is sometimes a matter of litigation, and is often long delayed. The increased justice that might be achieved by using this method of computation would hardly overcome the increased administrative difficulties.

However, the typical distributions of estates should have a bearing on the amount of exemption that should be allowed. The writers are of the opinion that the present exemption of $40,000 is too large in view of the typical distributions of estate. Wisconsin statistics of 192728 throw some light on this subject. With an exemption for wives of $15,000, for husbands of $2,000, and for children regardless of age of $2,000, and of smaller amounts for other heirs, the average exemption taken on estates of between $50,000 and $1 million -- large enough to insure that full exemptions would be taken -- was only $17,000. /2/

Estates of all sizes for which inheritance tax reports were filed numbered 3,315 and were distributed to 14,381 beneficiaries, or an average of 4.33 an estate. Of these 869 were wives, or 0.26 wives an estate, 405 were husbands or 0.12 an estate, 5736 were children or 1.72 an estate, 1,116 were grandchildren or 0.34 an estate, 123 were parents or 0.04 an estate, while there were 5618 other beneficiaries or 1.69 an estate. Assuming all children were minor and entitled to the $3,500 maximum, and that there were no disabled dependents, the application of Professor Walradt's figures would give the following average:

     0.26 widow at $15,000      $ 3,900

     0.12 widower at $7,500         900

     1.72 children at $3,500      6,020

     0.04 parents at $5,000         200
                                 ------
     Total average exemption    $10,200

The writer hastens to recognize the danger of absurdity in using such
average figures, since no actual estate could be so constituted.
However, the average picture does throw some light on the general
situation. It would seem that while some hardship might be caused in
the case of an otherwise penniless widow with several young children,
on the whole -- and an estate tax can do only rough justice -- an
exemption of $20,000 would be adequate.

METHOD OF APPLYING THE EXEMPTION: Some controversy has arisen over the method of applying estate tax exemptions. Three methods may be distinguished. That now in use by the federal government is to deduct the exemption from the amount of the net estate and compute the tax at graduated rates on the balance. The effect of this method is to reduce the amount of the estate taxed in the highest brackets. The exemption may be said to be taken "at the top." Its result is to give the larger estates more exemption in dollars of tax than the smaller estates. A second method in use in some states is to begin the rate schedule with the first dollar of net estate and to allow a deduction of exemption from the bottom brackets of the tax. The exemption may be said to be taken "at the bottom." Its result is that every taxable estate, large and small, receives the same exemption in terms of dollars of tax. A variation in the method is to calculate the exemption as a specified number of dollars of tax to be deducted from the tax computed on the whole estate. This plan is used in the income taxes of Wisconsin and several other states. The third method is to reduce the amount of exemption allowed as the size of the estate increases so that for the larger estates the exemption entirely disappears. This type is called the "vanishing exemption." The vanishing exemption may be taken "at the bottom" or "at the top."

Exemptions taken "at the top" have been criticized because the result is more exemption in dollars of tax to large estates than to small estates. Whether one considers it unjust is perhaps determined by his idea of the proper relation of exemptions to tax-paying ability. The two views of this relation have been previously described. The exemption "at the top" rests on the view of justice that a portion of any estate represents no taxpaying ability. This amount must be deducted from every estate, large or small, to derive the part of the estate capable of bearing taxes. The exemption "at the bottom" and the "vanishing exemption," however, rest on the view that so long as a minimum of subsistence remains to the taxpayer after the payment of taxes, the need for an exemption has been met.

With any given schedule of rates and exemptions, the vanishing exemption results in the largest amount of revenue, the yield of the exemption "at the bottom" is next in size, and that of the exemption "at the top" is the least. The higher revenues in the first two cases are equivalent to slightly higher effective rates.

While the method of taking the exemption influences the distribution of the tax burden, it does not determine it. The tax on any estate is a function of both the exemption and the rate schedule. The same burdens on any size of estate may be achieved with each exemption system by adjusting the schedule of rates to produce the desired result. /3/

In case the method of calculating the exemption were changed from the "top" to the "bottom," with no change in rates, the most obvious result is to increase the amounts of tax collected from the larger estates. The larger the estate, up to the top brackets, the greater the increase in the amount of tax resulting from the change. However, the percentage increase in the tax paid and the increase in the effective rate of tax on the estate are greater for the smaller estates than for the larger ones.

The table below illustrates the situation:

---------------------------------------------------------------------
                            Amount of Tax
---------------------------------------------------------------------

               Present  Present Ex-  Increase   Percent   Increase as
              Exemption   emption     in tax  increase in  Percent of
Net Estate    "at top"  "at bottom"   amount      tax        Estate
---------------------------------------------------------------------
   $40,000       $   0        $  0      $  0        0            0
    50,000         200       1,000       800      400.0          1.6
    70,000       1,200       3,400     2,200      183.3          3.1
   100,000       4,200       7,600     3,400       81.0          3.4
   200,000      19,800      24,600     4,800       24.2          2.4
   500,000      80,400      87,600     7,200        9.0          1.8
 1,000,000     211,000     220,600     9,600        4.6          1.0
10,000,000   4,936,600   4,960,600    24,000        0.5          0.2
50,000,000  32,335,000  32,360,600    25,600        0.1          0.05
---------------------------------------------------------------------

In the table it is seen that the change in exemptions from the "top" to the "bottom" increases the taxes of the $50 million estate by $25,600 as compared to $800 for the $50,000 estate. However, this increase is only 0.1 percent of the total tax of the $50 million estate while the increase in the tax on the $50,000 estate is 400.0 percent. Similarly, although the increase in the effective rate (that is, the percent of the total tax to the total net estate) is 1.6 percent of the $50,000 estate (and 3.4 percent of the $100,000 estate), it is only 0.05 percent of the $50 million estate.

The effect of changing from exemption at top brackets to exemption at bottom brackets is thus more than merely requiring larger estates to pay a higher total tax. The progressive rate scale is altered, with relatively greater increases taking place in the smaller estates. Effective tax rates are also increased more in the smaller estates.

The real significance of differences in exemption methods is perhaps political: by substituting vanishing exemptions or exemptions at the bottom for exemptions at the top a somewhat higher effective rate may be imposed without changing the nominal rate schedule. In case higher estate tax revenues are desired, a shift in exemptions may be politically easier to accomplish than a shift in rates.

EXEMPTION OF INSURANCE: The exemption of insurance up to $40,000 violates principles of tax justice by preferring one type of asset to another. The writers see no valid reason for continuing it and recommend its elimination.

5. RATE LEVELS AND RATE STRUCTURES

Four principles may appear to be influential in determining an estate tax rate structure. The first is that no real hardship should be caused those for whose support the decedent was legally and morally responsible. The second is that the rate structure should recognize the desirability of a middle class of fairly wealthy people as distinguished from a class of very wealthy people. /4/ A third is that the rates should be so designed as to place an upper limit to the size of fortune that can be passed on for several generations without being replenished from other sources such as personal earnings. The fourth is that rates of tax should not be so high that discouragement of saving offsets benefits of the tax. The first of the principles is related to justice among persons, while the other three are factors of social and economic control. Obviously these four principles are not necessarily in harmony with each other and are probably always somewhat conflicting. Furthermore, they do not furnish much assistance in constructing an actual schedule of rates.

The principle that no real hardship should be caused those for whose support the decedent was legally and morally responsible is met by allowing an exemption and by imposing relatively low effective rates on the smaller estates. The desire to preserve a middle class of fairly wealthy people is met by not jumping the rates immediately to the highest brackets but rather increasing them gradually. Placing a limit on the size of fortunes is achieved by setting the effective rates on large estates so high that the ordinary income of an estate during the average lifetime of its holder will not be sufficient to pay the tax at his death. It may also be achieved as will be explained below by making some distinctions between a first generation transfer and a second generation or later transfer.

The most difficult principle to apply is the one relating to tax on the growth of social capital. Clearly the high rates of estate tax diminish the rate at which social capital may increase. Even a small amount of this effect may be in itself socially undesirable, so that from this particular point of view even an increased degree of inequality in wealth might be viewed as desirable. However, in this connection should be noted the question raised by some whether an indefinitely large increase in the volume of social capital is possible, when due to monopoly, refusal to invest capital at low rates of return, or for some other reason saving does not result in investment in new social capital.

Even though the promotion of saving may be desirable, the revenue and social control results, as well as the revenue derived from the estate taxes, tend to offset the harm done through discouragement of capital growth. At some point, however, the disadvantages of slowing up capital growth will become more important socially than the revenue or desirable controls of the tax. That point sets the upper level beyond which rates should not go. Determination of the actual point is perhaps impossible for several reasons. First, determination of the actual effect of the tax on saving and accumulation is not easy. Second, the relative weights given in the minds of the people to the social advantages of heavy estate taxation as compared to the increased productivity that might result if the tax were not used vary from person to person and are not ascertainable by scientific research processes. The problem is a political one to be determined by a well-informed public opinion. In the opinion of the writers the estate taxes are much too low in what may be called the lower and middle brackets. It is believed that a very substantial increase in rates can be made without serious effect on the development of social capital and without hardship to dependents of the decedent. It is the belief of the writers that the upper rates are quite high enough at the present time both from administrative and economic viewpoints and that no increases in these brackets should be made now. The maximum rates of taxes (including all taxes) at the present time are high enough to prevent in some cases an estate being passed on unchanged from generation to generation. /5/ Some study should be given to the size of the estate at which this is true and to the desirability of adjusting tax rates to lower the size.

It should not be gathered from the above remark that the use of the estate tax is primarily for the purpose of effecting social control although undoubtedly this purpose will loom large in any estate tax program. Another important point is that high estate tax rates may be made to yield a very substantial amount of revenue. It would perhaps surprise the average person to know that, despite all the publicity and all the arguments for and against the tax, the total of federal and state death taxes is less than the yield of the federal liquor taxes.

Politically, the present appears to be a very good time to seek higher estate tax rates. Even the more conservative groups in society have been the source of expressions of condemnation against the passing of huge estates from one generation to another. This is a relatively new attitude and it cannot be expected to continue permanently without some setback for at least a time.

The writers approve in the main the rates proposed in Tax Revision Studies, 1937, volume V, p. 23 ff. The proposed totality form of rates interrupts the smoothness of the progression but may be justified by the improved public consciousness of the true burden. However, any totality rate scale should be accompanied (although not in the statute) by a bracket schedule showing the equivalent changes made in bracket rates by the law.

6. THE RIGNANO PLAN

A plan that has been suggested to prevent the transfer of a large estate from generation to generation indefinitely and yet not to discourage accumulation is the Rignano plan. The basic idea of this plan is to distinguish two parts of every estate, one comprising the value received by previous inheritance, the other comprising additions to the estate made by the decedent. A very heavy tax would be imposed on the first part and a relatively light tax on the second part. Proponents contend that while a person may accumulate for his children, he will hardly be influenced by distant generations.

Little analysis has been made of this plan to determine the applicability to American conditions. It is so radical a departure from present practice that no recommendation concerning it is made. However, the plan appears to contain merit and should be examined in detail as a possibility for future estate tax reform.

7. THE DESIRABILITY OF GIFT TAXES

The present federal gift tax law in the United States is intended as a supplement to the estate tax rather than as a tax imposed for its own sake. As the estate tax is increased in rate, the inducement to dispose of property by gift likewise increases. The gift taxes were intended to diminish or eliminate this inducement to avoidance.

Gifts add to the ability to pay of their recipients and might justifiably be taxed as a part of income. However, since they are not payments made for services rendered, their taxation to the recipient would logically be accompanied by a deduction from the income of the donor. Such deduction by the donor in the income tax would probably mean a net reduction in the amount of income tax collected and would constitute an additional encouragement to make gifts. Gifts might be taxed to the recipient and not permitted as a deduction to the donor on the ground that although they are not net income they represent ability to pay. Since, however, from the viewpoint of public interest the only objection to gifts is the evasion of death taxes, the existing approach appears to be the logical one.

8. THE INTEGRATION OF GIFT AND ESTATE TAXES

The operation of the existing gift tax does not really eliminate or greatly diminish the inducement to avoid the estate tax by inter vivos gifts. In the present law the first $5,000 of gift in any one year to any one person is not counted as a gift for tax purposes. Amounts of gifts beyond this amount are cumulated from year to year. An exemption of $40,000 is granted as in the estate tax. The gift tax rates in any bracket are three-fourths the estate tax rates. The tax paid in each year is the excess of the tax computed on the total aggregated or cumulated sum of net gifts both for the present year and for past years over the tax paid in past years on gifts similarly computed. The effect of this procedure is to accumulate the gifts, taxing all gifts made after passage of the act as a lump sum at progressive rates. This prevents avoidance of the higher gift tax bracket rates by distribution of the gifts over a number of years.

If the whole estate were distributed in gifts before death, the total gift taxes collected would be approximately three-fourths of the estate tax that would be imposed if the estate were distributed at death. The imposition of lower rates on gifts than on estates has a logical basis since the interest on the gift tax over a period of years may amount to the difference between gift and estate taxes or even more. However, if the gifts are given shortly before death the interest on the tax is not sufficient to equalize the gift and estate tax rates.

The failure of the present gift tax to act as a real preventive of estate tax avoidance arises from the fact that both taxes start with low rates and increase progressively. The saving in estate taxes from making gifts is in the highest bracket applicable to the estate while the taxes paid on the gifts themselves are bracketed from zero upwards. Also, there are two sets of exemptions, one for gift taxes and one for estate taxes. Accordingly, if only part of the estate is given during life the amount saved in estate tax may greatly exceed the amount paid in gift taxes.

The only method that appears capable of achieving the desired result of substantially equalized taxes is to carry the accumulation of gifts one step beyond the present law and to add them to the amount of the estate actually left at death. The tax would then be computed on the total gifts at the top bracket. After deducting the gift taxes actually paid during the life of the decedent, the balance would be the gift tax due at death.

For purposes of discussion it is assumed that this method would be constitutional although doubt exists whether it would be. If it is unconstitutional, the writers recommend that the constitution be amended to make it constitutional.

Some contend that if gifts may be added to the estate in determining the rate of tax applied to the gifts, a better method would be not to tax them until the time of death and then levy the tax on the combined amount of estate and gifts at that time. However, this procedure is subject to the defect that in case nearly all of the estate was given away during life, no funds might be available after death to pay the tax. The accumulated gift tax plan previously described is not subject to this defect. The larger amount of the estate given away during life, the larger the amount of gift taxes collected. The tax at death will never be so large as to take the remainder of the estate. However, because of the additional taxes that may be imposed at death due to the adding of gifts to the estate the amount of tax collected at death may constitute an extremely large portion of the remaining estate. Under some circumstances this might result in hardship.

Another method would be to value the whole property of the giver at the time the gift was transferred and impose the gift tax at the top bracket instead of at the bottom bracket. The more that was given away, assuming no replacement of funds in the estate, the lower the tax rates applied to succeeding gifts. Each gift could stand separately from all other gifts and be taxed at rates determined by the value of the total property of the giver at the time of the gift. Aside from the constitutional question that might arise in basing gift tax rates on the amount of property owned, the procedure would have almost impossible administrative difficulties. An inventory would have to be made of the total property of every person making a gift large enough to be taxed. This would not only constitute an almost intolerable intrusion into private affairs but would be extremely difficult to do. It would have to be repeated every time a gift was given. For this reason the plan is not feasible.

9. FEDERAL-STATE RELATIONS REGARDING THE DEATH TAX

Four policies that might be followed in relating the federal estate tax to the state death taxes deserve discussion at this time. The first is to leave the 80 percent credit of state taxes against the federal tax as computed under the rates of 1926 without change. A second is to repeal the 80 percent credit provision. A third is to extend the 80 percent provision or some lower percentage to the whole federal tax. The fourth is to substitute or supplement the credit by sharing the federal revenue from the estate tax with the state.

The continuation of the 80 percent credit against the federal tax as computed under the rates of 1926 has two disadvantages from the viewpoint of federal-state relations. The first is that the 1932 and later rate increases on smaller estates have increased federal but not state revenue, so that the federal government now receives a larger proportion of the tax paid on small estates than of the tax paid on large ones. This is contrary to the idea that small estates are usually more localized than large ones and that accordingly state taxes are more suitable on small estates. The second disadvantage is that the increases in federal rates suggested in this memorandum will decrease the revenues collected by the states since the federal estate tax is deducted before computing state inheritance taxes.

The repeal of the 80 percent credit provision would strongly tend to make the federal tax the only death tax, since the same forces of state competition that gave rise to the 80 percent credit in 1926 would again be active. Federal revenue would be increased by at most the $100 million states now collect. /6/ In view of the fact that states can administer death taxes successfully, that they have the claim of prior use and that their revenue needs are acute, repeal would be unfortunate.

The extension of the 80 percent credit provision to the currently existing and recommended rates would probably lose the federal government more revenue than the recommended rate increase would gain. Furthermore, it would mean an increase in state taxes on estates of largely national character, which are more logically a source of federal revenue.

The proposal to grant a share of the federal revenue to states repealing their taxes is made presumably as a method of bringing uniformity among states and reducing administrative costs. However, it constitutes a radical change in federal-state relations. Some reason exists for believing that such a change should not be made except as part of a general reorganization of federal-state relations in all tax fields. If the concession of federal sharing of revenue is made, it may not be available as a bargaining point to secure concessions by the states at other points.

Perhaps a better approach would be to change the calculation of the federal credit so that it applied to the recommended rates instead of to the 1926 rates, allowing a larger credit in the case of the fairly small estates than in the case of the very large ones, the total fiscal result to be about the present division of revenue between state and federal governments.

One reason for making no change at all at the present time is to await a general study of intergovernmental fiscal relations. Change now would tend to reduce the probability of thoroughgoing results coming from such a study. The present writers are inclined to this view and do not recommend any changes in relations between the federal government and the states at this time in regard to death taxes.

CHAPTER 7

SOCIAL SECURITY PAYROLL TAXES /1/

A. Old Age Benefit Taxes

1. DESCRIPTION OF TAXES

Two taxes (with respect to employment) are imposed by Title 8 of the Social Security Act of 1935. One is an income tax on wages, the other an excise tax on employers. Both are measured by payrolls and are paid by the employer, who deducts the income tax from the worker's wages. The rates of both taxes are 1 percent for the years 1937 through 1939, 1 percent from 1940 through 1942, 2 percent from 1943 through 1945, 2 percent from 1946 through 1948, and 3 percent beginning January 1, 1949. These taxes do not apply to compensation of more than $3,000 a year for any individual with respect to his employment with any employer nor to remuneration of individuals of 65 years of age and over. Also exempt from the tax are agricultural labor; domestic service in a private home; casual labor; services performed for religious, charitable, scientific, literary and educational organizations; services performed for the United States, a state, or political subdivision thereof; and services performed by officers and crew of certain vessels. The law makes no provision for the use of these taxes, which are part of the general revenues of the United States Government. However, it is understood that part or all of the proceeds of the taxes are to be paid into the old-age reserve account. Congress is not required under the Social Security Act to set up a reserve for the payment of old-age benefits. The law does not provide a legal obligation (one Congress cannot bind a future Congress) or even a declaration of policy to maintain a reserve. It merely authorizes the appropriation of an amount equal to the reserve requirement. Congress has not appropriated such an amount and probably will not do so since the yield of the payroll taxes will not be sufficient until 1946 to pay an actuarially sound premium.

2. PURPOSES OF DISCUSSION

a. WHAT THE PURPOSE IS NOT.

The purpose of the present discussion is not to deal with the questions of the desirability either of old-age pensions in general, of the contributory system of financing them, of the desirability of the old-age reserve account, or of the probable effects on federal finance if this account is built up as expected. The problem of the reserve account is an important fiscal problem, but is deemed outside the scope of the present assignment.

b. PURPOSE.

Accepting the existing social security system, the purpose of this discussion is to analyze the desirability of the taxes on employment as a source of funds for financing general public expenditures, as a source of funds for repaying the outstanding federal debt, and as special benefit taxes for financing old-age pensions.

3. QUESTION OF PROBABLE INCIDENCE OF TAXES

Although one of the payroll taxes is on the workers and the other on the employers, it by no means follows that the final incidence of each tax will be on the original taxpayer. The most likely points of incidence are the worker, the employer, and the consumer. Assuming the fully competitive system with full employment of capital and labor, orthodox economic analysis might lead to the conclusion that the incidence of both taxes would be upon the workers. However, the exact incidence of the taxes cannot be determined by such reasoning because many of the assumptions are non- existent in the present economic order. It is more probable that the actual incidence of the tax will vary from industry to industry and from time to time, depending upon competitive conditions and other circumstances. The significance of the actual incidence in determining the desirability of the tax will be discussed later.

4. DESIRABILITY OF PAYROLL TAXES FOR FINANCING
GENERAL PUBLIC EXPENDITURES

During the early years, before the payment of pensions becomes heavy, the payroll taxes will undoubtedly be spent either to finance general governmental expenditures or to reduce the public debt. This section and the following one deal with the characteristics of the payroll taxes when used for those purposes respectively.

a. REVENUE.

The payroll taxes are expected to produce a large volume of revenue. The estimate in the budget for 1938 is $621,800,000. This revenue should prove more stable than the corporation income tax because it falls on an element of gross income rather than on a net income left after deduction of expenditures. However, it would be less stable than a gross sales tax on consumers' goods since wages fluctuate more in depression than do expenditures on consumption goods.

b. JUSTICE.

The payroll taxes are in general regressive. If the incidence of the tax is on the worker, they are slightly regressive below $3,000 and very regressive above that point. They are slightly regressive below $3,000 because wages constitute a larger share of the total income in the case of very small than in the case of larger incomes. They are very regressive above $3,000 because the tax does not apply to any wages above that point.

If the incidence of the taxes is on the consumer, they being shifted to him as a cost of doing business, the taxes are regressive in the same manner as are sales taxes and other general business taxes.

If the tax burden rests with the employer and is not shifted either to the worker or to the consumer (a possibility in monopolistic and perhaps other industries), the tax is a form of business tax. It is not a very just form of business tax because it is measured by a cost instead of income and by one particular kind of cost, i.e., wages. It is not suitable as a form of personal taxation withheld at source from stockholders, partners, or proprietors, because it bears no relation whatsoever to their personal situations.

As a general revenue, the tax violates the principles of justice standards by discriminating among workers according to age, between exempt and taxed employments, and between industries employing much labor and those employing little labor relative to gross or net income.

c. EFFECTS OF THE TAX.

Unless the incidence of the payroll taxes is on workers the effect of the taxes -- at least when they are used as general revenues -- is to make the cost of labor somewhat greater as compared to the cost of labor-saving machinery. A resulting tendency would be to substitute machinery for labor with resulting, but probably temporary, unemployment. If the incidence of the tax is on the worker, labor will be no more expensive after the imposition of the taxes than before and no tendency to use labor-saving devices will result.

d. ADMINISTRATION.

The payroll taxes present the serious difficulty of enforcement against a large number of small businesses, many of which probably do not file income tax returns.

5. DESIRABILITY FOR FINANCING RETIREMENT OF PUBLIC DEBT

In most respects the same comments also apply to payroll taxes devoted to the retirement of the public debt. One difference is that a result of paying the national debt is to increase the amount of uninvested savings. In effect, the payroll taxes constitute forced saving by payers of the tax, transferring these savings to bondholders. If the public debt has been held by the banks and financed out of bank credit, the result of debt repayment is to reduce outstanding credit and to increase bank reserves. Whether loans to private industry follow will depend on the circumstances. If such loans are not made, the effect of debt payment is deflationary for private business activities. If they are made, the result is an increase in social capital in the same manner that newly issued bank credit results in such increase.

Perhaps the principal significance of these results is that in order to maintain a desired relationship between consumer spending and saving in the nation, it may be necessary to shift the burden of other taxes somewhat from low to higher incomes to reduce the amount of funds likely to be saved.

6. DESIRABILITY AS A SPECIAL BENEFIT TAX

The standards of justice supporting the payroll taxes as special benefit taxes for old-age pensions vary according to the incidence of the taxes. If the incidence is on the worker, he is in effect building up assets for his old age. In the long run he is no worse off than before the imposition of the tax. Although the forced savings may increase total sacrifice to some persons, especially those who never reach old age, such compulsion may be defended on the ground that without it the individual would become a public charge in his old age.

If the incidence of the taxes is on the consumer, they become part of the costs of production entering into price. This is justified on the ground that the consumer is as properly chargeable for the depreciation of laborers as for the depreciation of capital. The support of a worker in his old age is a proper charge for the use of his productive services during his working life.

If the incidence of the tax is on the employer, the cost of production argument is applicable. Furthermore, the tax may perhaps be partially justified on the ground that employers have much to gain by a good system of old-age pensions. Not only is the employer more free to retire his workers when they become super-annuated, but their morale as workers should be superior to that of workers having less security.

However, objections are raised to the use of the payroll taxes for financing old-age benefits. If the incidence is upon the worker, the taxes will be opposed by some on the ground that the wage received by many workers does not allow for saving even though that saving be compelled, and on the further ground that if the public is so greatly interested in old-age pensions as to set up a compulsory system, general taxes on ability should be relied on to finance them. If the incidence of the tax is on the consumer, the objection may be raised that it is not fair to place the burden of supporting part of the population in old age on the general public while the remainder of the population receives no such benefit. Granted that the consumer should pay the cost of production of an industry, it is unjust that those costs should be paid for one industry and not for others.

A further objection is that when the payroll taxes are used in a contributory system of old-age pensions the coverage is limited since small business units, for example farmers and home owners, cannot be included under the terms of the system for administrative reasons. Self-employed persons in the trades or professions are also very difficult to tax.

The present system is in effect contributory, partially on an individual basis and partly on a group basis. In part, the individual is contributing for his own old-age pension. In part, the group of workers and employers as a whole are contributing for group pensions. All workers will receive more than they contribute directly in the payroll income tax, with interest. Payroll taxpayers as a group, with the assistance of interest on funds, will support old-age pensions for the aged as a group, but in few cases will the taxes (plus interest), with respect to the employment of any specific individual, exactly support his pension. Some receive more, some less as compared to taxes with respect to their employment.

7. CONCLUSIONS

In view of the apparent intent to make the payroll taxes benefit taxes to finance old-age benefits, and of the complicated nature of the problem of old-age pension financing, the writers do not care at this time to draw any conclusions as to the desirability of repealing or changing the taxes.

B. THE TAX ON EMPLOYERS OF EIGHT OR MORE

1. NATURE OF THE TAX

The Social Security Act of 1935 imposed on employers of eight or more workers an excise tax equal to 1 percent of total wages for the calendar year 1936, 2 percent for 1937, and 3 percent thereafter. Wages of agricultural workers, domestics, servants, employees of federal, state, and local governments, employees of religious, charitable, and similar organizations, and officers and crews of vessels are not included in the measure of the tax.

The taxpayer is allowed a credit against the tax equal to the amount paid by him into an approved unemployment fund under state law, such credit not to exceed 90 percent of the federal tax. It is clear from the wording of the act that the primary purpose of the tax is to encourage states to set up approved unemployment funds so that their employers may be able to secure the 90 percent credit against the federal tax.

In order that an unemployment fund may be approved, all taxes and other revenues collected for the fund shall immediately upon receipt be paid over to the Federal Secretary of the Treasury where the money is deposited to the credit of the state in the Unemployment Trust Fund. States are permitted to draw against their credit in the Unemployment Trust Fund in order to pay unemployment compensation. The money in the Fund may be invested in securities of the United States or guaranteed by the United States. Such securities may either be purchased on the open market or be special obligations issued by the Treasury to the Fund. It is not anticipated that the amount of the Fund will become very large, since after the preliminary period of two years, during which no compensation may be paid, withdrawals will in general probably equal accumulations. Total deposits in the Fund as of May 31, 1937, amounted to $270 million.

The Social Security Act provides that the federal government shall pay to the states such amount as the Social Security Board may determine necessary for the proper administration of the state unemployment compensation law. The maximum authorized to be appropriated for this purpose is $49 million. Treasury grants to states accumulated to May 31, 1937, totaled about $10 million. The appropriation for such aids for the fiscal year 1938 is $19 million.

2. TAX ON EMPLOYERS OF EIGHT OR MORE AS A
BENEFIT OR CONTRIBUTORY TAX FOR UNEMPLOYMENT
COMPENSATION

As a benefit tax or charge tax on employers of eight or more it is not very significant for the federal government, although the cost of administering the unemployment compensation systems may increase substantially in the future. However, to the extent of that cost the tax may be considered a benefit tax.

As a benefit or contributory tax, the tax on employers of eight or more corresponds to some standard of justice whether the incidence is on the worker, on the employer, or on the consumer. If the incidence is on the worker, the tax is in effect an insurance premium in which all workers are guaranteeing to a greater or lesser extent each other's employment. Some injustice may result from this in the case or workers in highly stable industries. Provisions for merit ratings or other distinctions between employers giving full employment and those with a poor employment record may to some extent reduce the injustice. However, regardless of merit rating the interest of employees even in highly stable industries in the general employment of all workers is perhaps sufficient that they may with justice be required to help finance a general system of unemployment compensation on grounds of benefits received.

If the tax acts as a cost of doing business and has its incidence on the employer or the consumer, the tax may be justified by the argument that the cost of a finished product should include all the labor and capital costs. The existence of a free labor market with a body of unemployed men on which to draw is of advantage to the employer and to the consumer. The cost to the worker and to society of maintaining a body of unemployed should be considered one of the costs of production to be charged for in price.

When the tax is used as a benefit charge it is less likely to promote mechanization of industry and shifting of capital between industries than when employed as a tax for general revenue. The desire of workers to be employed in covered establishments, the order and regulatory influence introduced into the labor market, and other benefits might be expected to offset harmful tendencies of the tax.

3. TAX ON EMPLOYERS OF EIGHT AS A TAX FOR GENERAL REVENUE.

To some extent the tax on employers of eight or more will serve as a source of the general federal revenue. The federal share of the tax is to be paid into the Treasury in the same manner as all other federal tax collections. While it may properly be assumed that the grants to states for unemployment compensation administration are paid from the collection of this tax, the amount of such grants at the present time is substantially less than tax collections during the fiscal year 1937. The yield of the tax to the federal government was $58 million. The estimate for the fiscal year 1938 is $153 million. This is of course a very substantial revenue in excess of the $19 million appropriation for aid for state unemployment compensation administration. The excess will not likely be as much in the future, since, on the one hand, the full 90 percent credit will be taken in practically all states, and on the other hand, the grants for administration will undoubtedly increase substantially when the payment of benefits begins. In any case, however, the net yield to the federal government should be considerable except possibly in years of extreme depression.

The federal revenue from this source will undoubtedly fluctuate considerably between prosperity and depression years due to fluctuation of payrolls. The tax will probably be more stable in yield than the corporation income tax but less stable than a general sales tax.

In considering the justice of the tax without reference to the benefits to be paid to workers from unemployment compensation funds, the incidence of the tax is quite significant. If the incidence is on the worker, the tax is a special proportional tax on the wage income of workers in the covered industries. Such a tax is regressive as to total income since, as the size of total income increases, wages constitute a decreasing percentage of total income. The tax violates the standard of justice that all persons in similar situations should be similarly taxed, since it exempts from taxation workers in a large number of establishments having less than eight employees as well as in several important industries.

If the incidence of the tax is on the employer, three types of discrimination are present: (1) between employers whose expenditures are largely for labor and employers whose expenditures are largely for other types of expenses, (2) between employers of eight or more and employers having less than eight employees, and (3) between exempted and taxed industries, -- although the industries exempted are not competitors of those taxed except in a very general way.

If the incidence of the tax is on the consumers, the tax constitutes a generally regressive tax. Since it is imposed at all stages in the productive process, there is a chance for pyramiding to result.

As a general revenue measure, the tendency of the tax is to encourage the substitution of capital for labor. There is likewise a tendency for employers on the taxable borderline to discharge one or more employees in order to get into the tax-exempt class; in terms of total number of employees, this effect is not likely to be serious. The shifting of the tax to consumers may of course reduce the consumption of goods in the same fashion that manufacturers' excises or sales taxes reduce it.

The tax will not likely produce many new difficulties of administration. It is collected at the source and there is some check against the payroll taxes and the corporation income taxes.

4. FEDERAL-STATE RELATIONS

So far as the federal government is concerned, the tax on employers of eight or more is significant primarily as a method of exercising federal control over the states. As such it has been upheld by the Supreme Court on the grounds that unemployment is a national problem and that the federal government may handle it either through national instrumentalities or by assistance to the states. In effect, however, the tax is a method of coercing the states. As such, it reduces somewhat the financial independence of state government. Inter-state uniformity and some integration of federal and state taxes result, although at the expense of local autonomy. The tax may be an important precedent for future attempts to exercise federal control over state government.

Since the tax is not a good one to furnish general revenue, the credit for employer contributions to state funds should leave only enough to finance the federal aid for unemployment compensation administration. However, no change in the credit should be made until the total amount of the aid when the states' systems are in full operation is known.

CHAPTER 8

CUSTOMS

This chapter is divided into three sections. The first analyzes the implications of the tax standards for a system of customs duties. The second describes the way in which the system imposed by the United States fails to reach to the standards -- this being easier than to describe the ways in which it approaches them. The third section indicates some changes in the system that would bring it closer to the standard. This treatment unfortunately involves considerable repetition of ideas.

1. IMPLICATIONS OF STANDARDS FOR A SYSTEM OF
CUSTOMS IMPOSED FOR REVENUE

A. VOLUME OF REVENUE.

To secure a large volume of revenue from customs duties, the duties should be imposed on commodities of general use, and their rates should not be higher than the point of maximum productivity. It is not necessary that the duties apply to a large number of commodities as the experience with customs systems has been that relatively few commodities produce the large majority of the revenue. Accordingly, when revenue tariffs are imposed on a long list of articles, little is gained to offset the resulting complexity.

B. STABILITY OF REVENUE.

To secure a revenue that will be free from wide variation due to changes in the physical volume of goods imported, articles of customary use should be chosen. If it is desired to have a revenue reflecting price changes, the tariffs should be imposed at ad valorem rates rather than as specific amounts on the physical volume of goods imported.

C. JUSTICE.

Customs duties are not in harmony with any of the usually accepted standards of justice. A really productive tariff system is almost inevitably regressive in incidence because substantial revenues can be obtained only on articles that are used by the mass of people. Actual hardship can be kept at a minimum, however, by choosing articles which, although they are widely and customarily used, are luxuries or comforts rather than necessities. Tariffs, being indirect taxes, do not take into account personal differences. They bear no relation to any special benefit received.

Specific duties are likely to be more regressive than ad valorem duties unless they are carefully classified. This is because specific duties constitute in effect a higher ad valorem rate on low quality goods, which ordinarily would be consumed by the low income groups in the community, than on higher quality goods.

The imposition of new duties and the raising of rates violate the standard that vested interests should not be distributed and that special bonuses or favors should not be given to particular groups. If the customs duties are sufficiently high to destroy indirectly any considerable part of the market for exported goods, the vested interests in industries producing those goods are harmed. If, when duties are placed on goods imported, no offsetting excise is placed on similar goods produced within the country, a bonus or special favor is given to domestic producers. To avoid injuring vested interests or giving bonuses, tariffs for revenue should not be imposed at rates so high as to greatly reduce importation, and they should be offset by equal internal excise taxes on the domestic production of the same goods. In case vested interests have been built up under long-established tariffs, the maintenance of the tariffs at existing rates is of course necessary to protect such vested interests. This last principle is in conflict with most of the others.

D. ECONOMIC EFFECTS.

Protective tariffs are levied for their economic effects. The standard for revenue tariffs, however, is to avoid economic effects and especially to avoid the diversion of labor and capital from more productive to less productive industries. To reach this standard, two principles should be observed. The first is to place the revenue tariff, insofar as possible, on products that are not produced within the country. The second is that in case the product subject to the duty is produced within the country, an offsetting excise tax on internal production should be imposed so that domestic producers will not be encouraged to produce more than they would without the tariff.

E. ADMINISTRATION.

The administration of customs duties is easier when rates are low since smuggling is not profitable. Imposition of duties on only a small number of commodities by reducing to a minimum the number of commodities on which careful watch must be kept holds down the cost of administration. Specific duties are more easily administered than are ad valorem duties since only the physical volume of the product being imported need be ascertained, while in the case of ad valorem duties it is necessary also to assess the value of the goods. Assessment is often very difficult whether a foreign or a domestic valuation is followed. Administrative considerations are thus in conflict with considerations of justice and of stability of revenue. Data on costs of administering existing tariffs show that the costs are relatively high when compared to other taxes. However, much of the cost is due to the protective character of the tariff. Large overhead costs are incurred in preventing goods from entering the country. Such goods produce no revenue. The costs are compared with the duties collected from the relatively small amount of goods that actually enter the country.

F. OTHER STANDARDS.

Customs duties do not cause any conflict between federal and state governments, since their imposition is limited to the federal government. They result in very little tax consciousness. No change in rates or methods of imposition appear likely to change this.

2. EXTENT TO WHICH AMERICANS CUSTOM SYSTEMS VIOLATE STANDARDS

a. VOLUME OF REVENUE.

The American system of tariff and customs duties is designed for protective purposes rather than for revenue. However, since the system does produce a substantial amount of revenue and might be made to produce a great deal more, an analysis of the ways in which it violates the standards set up above may be useful.

The revenues produced by customs duties are much less than they might be principally because the tariff rates are deliberately set far above the point of maximum productivity. It is only through such rates that a high degree of protection can be secured. Some protection would be given at the point of maximum productivity but it would be relatively small. The tariff rates apply to a great variety of articles, most of which yield very little revenue. Lack of revenue does not mean, of course, that no burden is placed by such tariffs on domestic consumers. The consumer pays in the form of higher domestic prices but the "revenue" goes to domestic producers of the protected commodity rather than to government.

b. STABILITY OF REVENUE.

Tariff revenues are subject to variations due to changes in the physical volume of international trade and in the price level. American tariff revenues fluctuate more widely than would be necessary. This may be attributed partially to the fact that as long as a tariff rate is not completely protective and lets in some goods, relatively small changes in costs or prices at home and abroad may result in very substantial changes in the volume of international trade and accordingly in the volume of revenue. Perhaps more important is the fact that our tariff rates have been subject to frequent changes for political reasons. For example, in 1930 a general tariff revision upward was made at a time when, due to the general decline of world trade, the volume of revenue could have been maintained only by downward revision.

c. JUSTICE.

The protective tariff system bears no relation to any standard of tax justice. To the extent that it is fully protective it lets in no goods and produces no revenue while at the same time regressive burdens are placed on domestic consumers. The use of the protective tariff results in a bonus to some groups at the expense of others. After a protective system has been in operation for some time, vested interests are created. The sudden abolition of the tariff would destroy the vested interests and thus result in injustice, to avoid which, changes in the tariff system should be made slowly. It will be observed that in our history there have been frequent tariff changes. Each of these disturbed vested interests. Changes downward disturb the vested interests of American producers of protected articles. Changes upward disturb the vested interests of American producers of exported articles.

d. ECONOMIC EFFECTS.

Far from being designed to avoid economic effects, the protective tariff system has as its specific purpose the creation of such effects. It seeks to promote certain local industries that are deemed specially worthy of promotion, usually because of their political power rather than because of their economic desirability.

"The protective tariff may seem to promote some industry without injury to any other domestic industry. This appearance is due to the mechanism of international trade which hides the effects of the tariff. /1/

"All sales to foreign countries must sooner or later result in an equal volume of purchases from foreign countries. Unless one seller is willing to give his goods away in exchange for promises that are never fulfilled there must be an exchange of goods and services, at the same time or later, direct or round about. The world's supply of gold is much too small to finance unbalanced trade for long. In the absence of tariffs there develop certain industries naturally favored by the kinds of resources, skills, etc., of the country, that sell their products abroad. An equal amount of low-cost products of other countries is imported in payment. When a protective tariff is introduced, imports decrease, and consequently the foreign countries must reduce by approximately the same amount their purchases from the exporting industries. Thus the restriction of imports diminishes or destroys the foreign market for certain domestic products. The domestic producer of the protected commodity is benefited both at the expense of the domestic consumer, to whom he can charge a higher price for his product, and at the expense of the domestic producer for the foreign market."

It may be thought that although tariffs injure some industries no net social injury results because they benefit other industries. This is not the case since the result of the tariff is to divert labor, capital, and enterprise from goods that can be produced relatively cheaply in this country to goods that can be produced only at relatively high cost. Obviously, for example, a shift of production in the United States from cotton to bananas would be a shift from a low-cost industry to a high-cost industry. A sufficiently high tariff on bananas might encourage such a shift on the part of some persons. The social harm would be much greater than the social benefit.

At a previous point, mention was made of the desirability of using offsetting excise taxes to equalize the taxation of goods produced within and without the country. An American practice is to accompany excise taxes imposed on domestically produced goods with offsetting excises imposed on imports. This is of course a desirable equalization of tax burdens. In addition, however, excise taxes on imports are occasionally levied instead of regular customs duties, for example, the processing tax on coconut oils, and the recently enacted sugar tax. Whatever the purpose of this practice, it has the result of spoiling tax classifications and of hiding the true rates and coverage of import duties.

e. ADMINISTRATION.

Although the American system of tariff administration is probably relatively efficient, the use of the protective tariff makes the ratio of administrative costs to revenue yield higher than necessary. The expense of keeping out goods and preventing smuggling increases with the rate of the tariff rather than with the revenue derived from the tariff. Protective tariffs require great care to make sure that goods are not smuggled in as the high rates make smuggling profitable. Also in the American tariff system, the idea of a large free list for goods produced within the country, and a relatively small number of dutiable articles not produced in the country, is completely reversed. Most kinds of goods produced within the country are probably subject in one way or another to duties if imported, while those goods that are produced outside the country, and that might be made the source of considerable revenue, are placed on the free list presumably in order to avoid the regressive effect of duties on such articles. Of course, tariffs on goods produced within the country also are regressive in their final incidence.

WAYS IN WHICH REVENUE FROM CUSTOMS DUTIES MIGHT BE INCREASED

a. REDUCTION OF PROTECTIVE RATES.

From the above discussion it is clear that one of the ways of increasing customs revenues is to reduce the rate of the protective tariff in order to encourage the importation of a larger volume of commodities. The desire for revenue comes in direct conflict with the desire for protection. While the writers do not favor in general the application of the protective tariff, they recognize that a regulatory policy is of more significance to the country than an increase in revenue from tariffs might be. Hence, they do not wish to imply that the protective system should be abolished merely in order to increase revenues. The reduction of the protective tariff would have this effect, but it is supported primarily on the ground that economic benefits would flow from the gradual abandonment of the protective system.

b. TAXATION OF ITEMS ON FREE LIST.

A second method by which the revenue from customs duties could be increased is to impose duties on certain items that are now on the free list. Examples of commodities that have been recommended for such duties are tea, coffee, and cocoa. Duties on these were proposed in 1933 as a part of one of three alternative programs for raising certain additional revenues. Rates considered at the time were specific and were for coffee, five cents per pound, tea, ten cents, and cocoa beans, three cents. It was estimated that total revenues from this source would have been approximately $95 million in 1933. /2/

Objections to proposals to place tea, coffee, and cocoa on the dutiable list grow largely from the fact that these products, although in a sense comforts or semi-luxuries rather than necessities, are so customarily a part of the diet of the great mass of American people that the incidence of the tax would be distinctly regressive in character. This aspect of tax justice, together with the probable political difficulties of passing such a tax, probably made it undesirable as a source of revenue except in times of emergency.

CHAPTER 9

LIQUOR TAXES

1. REVENUE ASPECTS

The Federal liquor taxes produced $505 million in 1936 and $594 million in 1937, and the budget of January 5, 1937, estimated the 1938 yield at $644 million. Roughly, almost half is produced by the gallonage tax on distilled spirits, and almost half by the gallonage tax on beer. The rest of the liquor taxes, including the tax on wines, produce, consequently, a very small part of the total. Although it would not be advisable from most points of view to get more revenue from the liquor taxes, they could in practice be called on in a time of fiscal emergency. The beer tax is equivalent to about 1 cents per eight-ounce glass (usually sold at 10 cents, for draft beer) /1/ and even though the demand is assumed to be fairly elastic, and state taxes are taken into account, it seems certain that a doubling, for instance, of the federal rate would result in an appreciable (though by no means a 100 percent) increase in the revenue. The spirits tax revenue would probably not increase greatly, if at all, with an increase in the rate, partly because of the danger from bootlegging.

Not much can be hazarded about the degree of cycle sensitivity of the liquor taxes. Appeal to pre-Prohibition days is dangerous, in view of the great social and economic changes since then. The revenues have increased rather rapidly with the business recovery of the past few years ($411 million in 1935 to an estimated $644 million in 1938), but an important part of this increase is probably due to improvement in administration. Likewise, the reaction of the tax to a period of rapidly rising prices can probably not be forecast with a useful degree of accuracy.

2. SOCIAL CONTROL

In the field of social control, the liquor taxes are significant only in connection with the objective of restricting the consumption of liquor, particularly (and perhaps only) spirits. Whether the present spirits tax rate of $2.00 per proof gallon /2/ is repressive enough depends chiefly on one's answer to two questions: (1) How high can the rate be put before the consumption of bootleg liquor increases too much, and (2) how close to this point is it desirable to drive the rate? The first question is an administrative one, discussed below. In 1934, Williamson recommended that the rate be reduced to $1.00 until bootlegging was gotten under control. /3/ To the second question, any objective answer seems impossible to find. Perhaps for the time being no answer need be sought, on the assumption that the great majority would favor more restriction than is achieved by the $2.00 rate (plus state rates that are usually between 50 cents and $1.00, in 1934, at least), /4/ but would agree that for the time being the menace of illicit liquor makes it inadvisable to go much beyond the $2.00 level.

The existing beer tax probably exerts relatively little repressive effect on consumption, and the same seems to be true of the wines tax. So far as the present writers are concerned, there is no reason why they should be raised to exert such a pressure.

3. DISTRIBUTION OF BURDEN

In the distribution of the burden according to tax justice, the liquor taxes make a decidedly poor showing. About all that can be said for them is that, as they stand at present, they have harmed no innocent vested interests, and they take some account -- but perhaps not good account -- of differences in personal status to the extent that they burden the person who has enough "easy" money to be able to buy liquor (this argument breaks down in the case of the addict who must have his liquor, so that a higher liquor tax simply means in practice less food and clothing for the wife and children). The liquor taxes are not useful as benefit taxes or for expropriation of unmerited gain. Perhaps the spirits tax is in fact distributed progressively according to income of most drinkers within the lower income ranges (though there must be many exceptions), but the beer and wine taxes might well prove to be regressive at all income levels if the data were available.

4. ADMINISTRATION

The spirits tax -- but not the beer tax or the wines tax -- makes even a worse showing under the standards of administration than under those of tax justice. The situation now may not be so serious as it was when Williamson wrote in 1934, /5/ but compared with any other major source of revenue in the United States the spirits tax probably makes a very poor showing even at the present time. The ease with which a distilling unit can be set up, and the profits to be gained, owing to the high rate of tax (and possibly also to quasi- monopolistic elements in the legal trade) are the chief reasons. It would be interesting to have the Treasury make even a rough cost- accounting in order to get an approximation of the costs of collecting the spirits tax.

5. TAX CONSCIOUSNESS

More of the liquor taxes seems suitable for developing tax consciousness in the public. To show the amount of the tax on the stamp that is affixed to a bottle of spirits may not be feasible (on this point the advice of liquor tax officials should be obtained), and even if it were, some qualification should be attached, such as, "This tax paid by manufacturer; the government assumes no responsibility for its being passed on or not being passed on by the manufacturer, in whole or in part, to ultimate consumers." /6/ A spurious tax consciousness, arising from a mistaken belief that a tax was shifted to the person in question, might be worse than no realization of the tax at all. It is to be assumed that practically all of the spirits tax is shifted, but the public might be put on notice that there could be no guarantee of this. Moreover, liquor sold at bars, etc., outside of closed containers, could not in any way carry the message of the tax to the drinker. As to the beer tax, the problem is also difficult, in part because of the large amount of draft beer sold. Wine consumption is so small that no chance at all exists here for widespread tax-consciousness.

6. FEDERAL-STATE-LOCAL TAX COORDINATION

The liquor taxes occupy a strategic position in the federal- state-local coordination problem, but it is difficult to see just what coordination movement can result without a general fiscal coordination. The failure to achieve liquor tax coordination under relatively favorable circumstances in 1934 is discouraging. It would help the campaign against the bootlegger if the federal government had exclusive control over the spirits tax for a while. On the other hand, the states can, apparently, administer gallonage taxes and operate retail monopolies with a fair degree of administrative success, and in this respect the liquor taxes are important in the chance they offer the states to retain their fiscal independence. Certainly it seems clear that the states are not going to give up their existing liquor taxes without a substantial regard of some kind or other from the federal government.

The spirits gallonage tax and the beer gallonage tax are analyzed and evaluated on the accompanying characteristics charts. The "possible methods of improvement" are inserted for informational purposes only and are not to be taken as definite recommendations.

        ANALYSIS AND EVALUATION OF TAX CHARACTERISTICS No. P-I
           Tax Spirits Gallonage Tax        Change in Tax____
---------------------------------------------------------------------
Characteristic      Situation with    Is tax (or      Possible method
                    respect to        change)         of improvement
                    this tax (or      desirable
                    change in tax)    in this
                                      characteristic?
---------------------------------------------------------------------
1. REVENUE           Major;                --               --
   a. Volume         estimated
                     $300,000,000
                     for 1939,
                     or 4
                     percent of
                     total 1939
                     tax
                     revenues
   b. Would show     Probably              No               Only by
      yield          not,                                   lowering
      change         either up                              rate
      proportionate  or down                                greatly
      to rate
      change
   c. Has stable     Perhaps               Fair         None possible
      yield          moderately
      through        so; not
      business       much known
      cycle          about it,
                     in view of
                     post-war
                     changes

   d. Responds        No --                No          Tax on
      more than       would lag,                       value
      proportionately since it                         basis --
      to rapid        is based                         even then,
      price rise      on                               might lag
                      quantity,
                      not value

2. ECONOMIC EFFECTS

   a. Causes         Yes --             Yes, in             --
      migration      tends to           this case
      of capital     check              (see 2-d
      or labor       investment         below).
      between        in spirits
      industries     business

   b. Restricts      Not known             --               --
      the
      factors of
      production
      (1) Volume
      of saving

      (2) Willingness  Probably not     No opinion          --
          to take
          risks

    (3) Willingness   Probably not         Yes              --
        to work

    c. Restricts      Not known            --               --
       consumers'
       spending

    d. Suitable       To                   Fair          Raise
       for            restrict                           rate, and
       specific       spirits                            tie it
       control        consumption;                       more
       purposes       but rate                           closely to
                      is low,                            alcoholic
                      and not                            content
                      coordinated
                      with
                      percentage
                      of alcohol
                      in spirits
                      ready for
                      consumption

3. JUSTICE

   a. Recognizes      May have             No            Taxing on
      personal        progressive                        value
      differences     effect                             basis
      (1) Differences   occasionally                     might help
          in amount     -- but                           a little
          of income     capriciously
          (progressive
          burden)
     (2) Other          Cannot do          Fair        None possible
         differences:   this,
         kind of        except
         income         that it
         etc.           may in
                        some cases
                        get at
                        "luxury"
                        income.
                        Often it
                        simply
                        results in
                        the
                        family's
                        buying
                        less
                        necessities.

   b. Taxes           No                Indifferent         --
      special
      benefits
   c. Taxes           No                Indifferent         --
      unmerited
      gains
   d. Taxes          Yes, on               Yes              --
      competitors    the whole
      equally
   e. Avoids          No; heavy            No             Only by
      loss of         loss of                             lowering
      consumers'      utility                             rate
      utility
      through
      increase
      in price
   f. In case of      Yes, in              Yes              --
      change          that

     (1) Preserves    spirits
         vested       producers
         interests    may be
                      considered
                      to be on
                      notice to
                      expect
                      anything
     (2) Avoids       Yes; the             Yes              --
         giving       "bonus"
         bonus        would be
                      compensation
                      for the
                      risk in
                      (1) above

4. ADMINISTRATION

   a. Causes          Cost not             No          Only by
      only            known, but                       lowering
      moderate        is                               the rate
      cost to         probably                         to
      government      very high                        insignificant
                      -- may be                        point
                      highest in
                      system

   b. Causes          Cost not             No          Only by
      only            known, but                       lowering
      moderate        is surely                        the rate
      cost of         very high                        to
      compliance                                       insignificant
                                                       point

   c. Results in      No;                  No          By
      slight          apparently                       spending
      amount of       more                             much more
      evasion         evasion                          money on
                      than under                       enforcement
                      any other                        or by
                      federal                          lowering
                      tax                              rate
5. PROMOTES TAX       No                   No          Could
   CONSCIOUSNESS                                       amount of
                                                       tax be
                                                       stated on
                                                       stamps?

6. INTERGOVERNMENTAL FISCAL RELATIONS

   a. Avoids          No; almost           No          None
      conflicts       all states                       possible,
      of              conflict,                        apparently,
      government                                       except in
                                                       general
                                                       federal-
                                                       state-
                                                       local
                                                       revision

   b. Avoids          No; state            No               Repeal
      repressing      use would
      decentrali-     be more
      zation          extensive
                      without
                      federal
                      use
7. OTHER CHARACTERISTICS

   a.

   b.
---------------------------------------------------------------------
GENERAL EVALUATION

     As a control measure the tax is probably indispensable, and the
     luxury idea probably commands enough public support to uphold
     the tax -- but on most other counts it is either an indifferent
     or a poor tax, aside from the volume of revenue.

       ANALYSIS AND EVALUATION OF TAX CHARACTERISTICS No. P-II
           Tax Beer Gallonage Tax        Change in Tax____
---------------------------------------------------------------------
Characteristic      Situation with    Is tax (or      Possible method
                    respect to        change)         of improvement
                    this tax (or      desirable
                    change in tax)    in this
                                      characteristic?
---------------------------------------------------------------------
1. REVENUE

   a. Volume          Major;               --               --
                      estimated
                      $300,000,000
                      for 1939,
                      or 4
                      percent of
                      total 1939
                      tax
                      revenue
   b. Would show      Yes --               Yes              --
      yield           within
      change          moderate
      proportionate   range,
      to rate         perhaps
      change
   c. Has stable      Perhaps              Fair        None possible
      yield           moderately
      through         so; not
      business        much known
      cycle           about it,
                      in view of
                      post-war
                      changes
   d. Responds        No --                No          Tax on
      more than       would lag,                       value
      proportionately since it                         basis --
      to rapid        is based                         even then,
      price rise      on                               might lag
                      quantity
                      not value

2. ECONOMIC EFFECTS

   a. Causes          Present              Yes              --
      migration       rate is
      of capital      scarcely
      or labor        high
      between         enough to
      industries      have much
                      effect
                      this way

   b. Restricts       Not known             --               --
      the
      factors of
      production
      (1) Volume
      of saving
      (2) Willingness   Probably not       No opinion       --
          to take
          risks
      (3) Willingness   Probably not       Yes              --
          to work

   c. Restricts       Not known             --               --
      consumers'
      spending

   d. Suitable        Not at               Yes --           --
      for             present              beer
      specific        rate. At             drinking
      control         higher               needs
      purposes        rate,                little
                      could                control
                      check beer
                      consumption

3. JUSTICE

   a. Recognizes        Probably           No          None possible
      personal          regressive,
      differences       although
                        light --
     (1) Differences    about 1
         in amount      cents per
         of income      10-cent
         (progressive   glass
         burden)
      (2) Other         Cannot do          Fair        None possible
          differences:  this,
          kind of       except it
          income        may be
          etc.          considered
                        as a
                        burden on
                        semi-
                        luxuries
                        expenditures
   b. Taxes             No              Indifferent         --
      special
      benefits

   c. Taxes           No                Indifferent         --
      unmerited
      gains

   d. Taxes           Yes, on              Yes              --
      competitors     the whole
      equally
   e. Avoids          Not much             Yes              --
      loss of         loss, if
      consumers'      any, at
      utility         present
      through         rate
      increase
      in price

   f. In case of      A sharp              Fair             --
      change          increase
                      might be
      (1) Preserves   considered
          vested      unfair to
          interests   brewers,
                      etc., but
                      may- be
                      they are
                      "on
                      notice,"
                      like
                      distillers
      (2) Avoids      Yes, not             Yes              --
          giving      much room
          bonus       for bonus

4. ADMINISTRATION

   a. Causes          Cost not             Fair        None
      only            known, but                       possible,
      moderate        it should                        consistent
      cost to         be rather                        with
      government      low, it                          reasonable
                      seems                            administration

   b. Causes          Cost not             No          None possible,
      only            known, but                       probably
      moderate        is
      cost of         probably
      compliance      pretty
                      high
   c. Results in      Not known            Yes              --
      slight          to writer,
      amount of       but there
      evasion         seems to
                      be no
                      reason to
                      expect
                      much
                      evasion

5.  PROMOTES TAX      No                   No          State tax
    CONSCIOUSNESS                                      on
                                                       bottles,
                                                       etc.? On
                                                       the whole,
                                                       it seems
                                                       little can
                                                       be done

6. INTERGOVERNMENTAL FISCAL RELATIONS

   a. Avoids          No -- most           No          None
      conflicts       states                           possible,
      of              levy the                         apparently,
      government      tax                              except in
                                                       general
                                                       federal-
                                                       state-
                                                       local
                                                       revision

   b. Avoids          No; state            No               Repeal
      repressing      use could
      decentrali-     be more
      zation          extensive
                      without
                      federal
                      use

7. OTHER CHARACTERISTICS

   a.

   b.

GENERAL EVALUATION

Partly because of the low rate, the beer tax has several
advantages lacking to the spirits tax -- but in turn lacks the
raison d'etre of control. Its chief support, then, must be as a
luxury tax or semi-luxury tax. It probably has stronger support
generally, with respect to this, than the present writer is
willing to give it.

CHAPTER 10

TOBACCO TAXES /1/

1. REVENUE ASPECTS

Altogether, the federal tobacco taxes are producing slightly more than half a billion dollars a year, and the yield has been growing by about $50 million a year (1936, $501 million: 1937, $552 million; 1938 (estimate in budget of January 5, 1937) $569 million (this figure will probably be surpassed). However, almost nine-tenths of the total comes from the tax on small (i.e., ordinary size) cigarettes. This results from the high tax rate on cigarettes, not from a preponderant use of cigarettes compared with other tobacco products. Indeed, in 1932 cigarettes accounted for only 43 percent of the leaf tobacco consumed. /2/

The cigarette tax is one of the most stable major revenue producers, as far as cyclical influences are concerned, in the federal system -- a virtue or a defect, depending upon one's point of view, but probably a virtue from the writers' point of view, considering how very fluctuating other parts of the system are. The other tobacco taxes seem to be similarly stable. /3/ Cox points out that from 1929 to 1932 the physical quantity of leaf tobacco consumed decreased 13.4 percent. /4/ Aside from cyclical influences, however, there is a certain lack of stability, in that the cigarettes industry has shown a strong long-term trend upward, and the cigar industry a strong long-term trend downward.

None of the tobacco taxes is likely to produce an unchanged or increased real purchasing power for the government in the event of a rapid general rise in prices. Even if cigarettes, snuff, and smoking and chewing tobacco increase in price as fast as the general level of prices increases -- and of this there can be substantial doubt -- the dollar volume of tax receipts will not rise, since the tax is based solely on physical quantity. The cigar tax, linked roughly to retail price, would make a little better showing, but again the price of cigars would probably lag.

The cigarette tax would not only bring in more real purchasing power in the event of the rapid rise in prices, but at the same time would be made less regressive in its incidence, if the tax rate were put on the same basis that the cigar rate now is -- that is, the amount of tax per package would increase as the retail price of the package increased. Thus the smoker of 10-cent cigarettes would pay less tax than the smoker of 13-cent cigarettes, and so on. This change would not affect any of the other standards above, except that, with respect to a business cycle, the revenue might become slightly less stable.

The rates could of course be set at a level to give approximately the same revenue as the present 6-cent rate. Thus, a tax could be imposed at the rate of 1 cents for each 2 cents (or portion thereof) of the retail value.

This change was recommended by Cox in 1934. /5/

2. SOCIAL CONTROL

The tobacco taxes serve no purpose of social control directly (it is assumed here that there is no reason for repressing the consumption of cigarettes), but the cigarette tax does seem to have an influence -- doubtless unintended -- on the size of business units. The tax is so large -- equivalent to 6 cents on a package of 20 cigarettes -- that the working capital required to enter the business on a substantial scale is large, and this in turn tends to protect the large companies from competition and allow them to grow larger. However, the hugeness of the cigarette producing companies is chiefly traceable to other causes. /6/ With respect to the volume of savings in the country, the tobacco taxes probably discourage saving relatively little.

3. DISTRIBUTION OF

The tobacco taxes make a poor showing with respect to tax justice. They are not benefit taxes or taxes on unmerited gain. They do not allow for differences in economic status other than differences in income, unless a man's expenditure for tobacco is somehow a special indication of his power and duty to support government. This seems unlikely. Given two men with equal income, identical family status, etc., is there any reason for relieving the non-smoker of a share of the burden of supporting government, and placing it on the smoker? This, in effect, is what the tobacco taxes do. Indeed, they do worse than this -- they say that the tobacco user who prefers cigars (or snuff or smoking or chewing tobacco) to cigarettes should be and is thus relieved of part of the cost of supporting government. The tobacco used in manufactured tobacco and snuff is, in effect, taxed at about 18 cents per pound; that used in large cigars, 8 cents to 54 cents a pound; that used in cigarettes, $1.07 a pound. /7/ The taxes also fail -- with the possible exception of the cigar tax -- to levy a burden that is progressive according to income. With respect to the small-cigarette tax, (1) the tax is 6 cents a package, regardless of the cost of the cigarette; (2) the smaller the income of a smoker, the greater is likely to be the percentage (but not, of course the absolute amount) of his income that he spends on smoking. Both these factors tend to make the incidence of the cigarette tax regressive. The same factors operate (at different tax rates) with the taxes on chewing and smoking tobacco and snuff. The cigar tax varies roughly according to the retail price charged, but the second factor alone still tends to make this tax at least slightly regressive.

Finally, the heavy rate of the cigarette tax causes an invisible burden in the loss of satisfaction, especially to persons of small means, who are prevented by the tax from smoking (or smoking more) cigarettes. (See discussion in Chapter I).

There seems no justification other than a historical one for burdening cigarette smokers more than cigar or pipe smokers or users of snuff or chewing tobacco. Consequently, the rates should eventually be made uniform per unit of retail value or (the British plan) per unit of leaf tobacco used. To obtain the same revenue as at present, the rate on cigars, smoking and chewing tobacco and snuff would have to be much higher than at present, and this change should come about gradually enough to inflict little damage on the innocent vested interests of producers of those commodities. The most feasible way, probably, is to work toward equality whenever tax relief or new revenue suggests a change in the tobacco taxes. Thus, in the case of tax relief, only the cigarette rates would be lowered, and, in the case of new tax revenue, only the taxes on other tobacco products would be raised. /8/

4. ADMINISTRATION

In administration the tobacco taxes, particularly the cigarette tax, apparently make an excellent showing. /9/ The eight largest concerns in the cigarette industry in 1933 employed 99.4 percent of all the wage-earners in the industry. /10/ Under such concentration, with concentration also in the physical units of operation, administration is probably very economical. Moreover, the taxpaying personnel is stable, and the taxpayers in most cases confine themselves to the production of the taxed article, thus making rigid tax controls feasible. The taxed product is easily defined without excluding almost completely similar articles. /11/ These administrative advantages may not obtain equally in the other branches of the tobacco industry, but -- except possibly in some cases in cigars -- the cost of administration is probably not high. The cost of compliance is probably rather high, /12/ but -- again excepting possibly some cigar manufacturers -- the amount of evasion seems to be very small. However, there has apparently been some evasion in the leaf-growing areas, and avoidance with tax-free cigarette papers, and it would be wise to adopt the suggestions made by Cox in 1934 to meet these problems, if this has not already been done. /13/

5. TAX CONSCIOUSNESS

The tobacco taxes generally are not good instruments of tax- consciousness, but something might be done with the cigarette tax by printing the size of the tax on the tax stamp that is on each package (with some qualification, as suggested under the liquor tax above, concerning the possibility of non-shifting.) Cigars are sold so frequently in units smaller than the box, that nothing that could be placed on the stamp, which goes on the box, would help much. On the other hand, smoking and chewing tobacco and snuff offer much the same possibility as cigarettes.

6. FEDERAL-STATE-LOCAL TAX COORDINATION

The tobacco taxes are not very good taxes for state or local governments. The revenue must come chiefly from cigarettes, and cigarettes are readily sent by mail in tax-free interstate channels, and are also, in the ordinary course of business, sold at thousands of retail stores that are difficult to control. Although many states do have cigarette or tobacco taxes, they are getting less than $50,000,000 a year from them. /14/

The tobacco taxes are analyzed and evaluated on the accompanying characteristics charts. The "possible methods of improvement" are inserted for informational purposes only and are not to be taken as definite recommendations unless so specified in the text above.

       ANALYSIS AND EVALUATION OF TAX CHARACTERISTICS No. Q-I
           Tax Cigarettes             Change in Tax____
---------------------------------------------------------------------
Characteristic      Situation with    Is tax (or      Possible method
                    respect to        change)         of improvement
                    this tax (or      desirable
                    change in tax)    in this
                                      characteristic?
---------------------------------------------------------------------
1. REVENUE

   a. VOLUME          Major;                --               --
                      estimated
                      $400,000,000
                      for 1939,
                      or 5
                      percent of
                      total tax
                      revenues

   b. Would show      Yes --               Yes              --
      yield           within
      change          moderate
      proportionate   range,
      to rate         perhaps
      change
   c. Has stable      Yes --            Yes -- in           --
      yield                             view of
      through                           instability
      business                          elsewhere
      cycle

   d. Responds        No --                No          Overcome
      more than       would lag                        part of
      proportionately decidedly                        lag by
      to rapid                                         linking
      price rise                                       tax with
                                                       retail
                                                       price

2. ECONOMIC EFFECTS

   a. Causes          Yes --            No, unless     Lower tax
      migration       there is          for some       rate
      of capital      probably          reason
      or labor        less              cigarette
      between         capital           production
      industries      and labor         is deemed
                      in the            harmful
                      cigarette
                      industry
                      than if
                      there were
                      no tax
   b. Restricts       Probably          No opinion          --
      the             less than
      factors of      most
      production      taxes, but
      (1) Volume of   it may
          saving      have
                      appreciable
                      effect
      (2) Willingness  No                  Yes              --
          to take
          risks
      (3) Willingness  Perhaps             Yes              --
          to work      not

   c. Restricts       Yes, among        No opinion          --
      consumers'      low-income
      spending        smokers,
                      at least

   d. Suitable        Only to           Indifferent         --
      for             restrict
      specific        volume of
      control         cigarette
      purposes        smoking
3. JUSTICE

   a. Recognizes
      personal
      differences

      (1) Differences   No                 No               None
          in amount
          of income
          (progressive
          burden)
      (2) Other        No --               No               None
          differences: unless
          kind of      income
          income,      spent on
          etc.         cigarettes
                       be
                       considered
                       one kind
                       of luxury
                       or semi-
                       luxury
                       income

   b. Taxes           No                Indifferent         --
      special
      benefits
   c. Taxes           No                Indifferent         --
      unmerited
      gains
   d. Taxes           Not if               No          Lower tax rate
      competitors     cigar,
      equally         snuff,
                      etc.,
                      producers
                      are
                      regarded
                      as
                      competitors
   e. Avoids          No --                No          Lower tax rate
      loss of         probably
      consumers'      considerable
      utility         loss this
      through         way
      increase
      in price

   f. In case of      Probably             Yes              --
      change          no serious
                      damage
     (1) Preserves    within
         vested       moderate
         interests    range

      (2) Avoids      Probably             Yes              --
          giving      no great
          bonus       bonus
                      within
                      moderate
                      range

4. ADMINISTRATION

   a. Causes          Yes,                 Yes              --
      only            apparently,
      moderate        though no
      cost to         figures
      government      are
                      available

   b. Causes          Not known             --               --
      only
      moderate
      cost of
      compliance

   c. Results in      Probably             Yes              --
      slight
      amount of
      evasion
5. PROMOTES             No                 No          State
   TAX CONSCIOUSNESS                                   amount of
                                                       tax on
                                                       stamp

6. INTERGOVERNMENTAL
    FISCAL RELATIONS

   a. Avoids          No; some             No          Given
      conflicts       states                           federal
      of              have the                         government
      government      tax,                             exclusive
                      sometimes                        use
                      at 2 or 3
                      a package

   b. Avoids          No; states           No          Lower rate
      repressing      would                            or repeal
      decentrali-     probably                         federal
      zation          use it                           tax
                      more if
                      federal
                      tax was
                      lighter
7. OTHER CHARACTERISTICS

   a.

   b.

GENERAL EVALUATION

     This tax has been a fiscal success because of the upward long-
     term trend of cigarette consumption, the apparent inelasticity
     of demand (compared at least to most taxed articles), and
     relative ease of administration, but it is grossly unjust to
     cigarette smokers compared both with other smokers and with non-
     smokers.

       ANALYSIS AND EVALUATION OF TAX CHARACTERISTICS No. Q-II
           Tax Cigar                     Change in Tax____
---------------------------------------------------------------------
Characteristic      Situation with    Is tax (or      Possible method
                    respect to        change)         of improvement
                    this tax (or      desirable
                    change in tax)    in this
                                      characteristic?
---------------------------------------------------------------------
1. REVENUE

   a. Volume          Very                  --               --
                      minor;
                      estimated
                      only
                      $16,000,000
                      in 1939,
                      or 1/6 of 1
                      percent of
                      total tax
                      revenue
   b. Would show      Yes,                 Yes              --
      yield           within
      change          moderate
      proportionate   range,
      to rate         perhaps
      change
   c. Has stable      Yes                  Yes              --
      yield
      through
      business
      cycle
   d. Responds        No --                No               None
      more than       might not
      proportion-     even keep
      ately to        pace
      rapid
      price rise
2. ECONOMIC EFFECTS

   a. Causes          Not heavy            Fair             None
      migration       enough to
      of capital      have much
      or labor        effect
      between         this way,
      industries      probably

   b. Restricts       Probably          No opinion          --
      the             less than
      factors of      most taxes
      production

      (1) Volume of
          saving

      (2) Willingness No                   Yes              --
          to take
          risks
      (3) Willingness Probably             Yes              --
          to work     no effect

   c. Restricts       Somewhat,         No opinion          --
      consumers'      perhaps,
      spending        among low-
                      income
                      smokers

   d. Suitable        No --                No               None
      for             unless at
      specific        higher
      control         rate, to
      purposes        restrict
                      cigar
                      smoking

3. JUSTICE

   a. Recognizes      No                   No               None
      personal
      differences

      (1) Differences
          in amount
          of income
          (progressive
          burden)

      (2) Other        No --               No               None
          differences: unless
          kind of      income
          income,      spent on
          etc.         cigars be
                       considered
                       one kind
                       of luxury
                       or semi-
                       luxury

   b. Taxes           No                Indifferent         --
      special
      benefits
   c. Taxes           No                Indifferent         --
      unmerited
      gains
   d. Taxes           Not if               No         Higher tax rate
      competitors     cigarette
      equally         producers
                      are
                      regarded
                      as
                      competitors

   e. Avoids          No --but             Yes              None
      loss of         at
      consumers'      existing
      utility         rates,
      through         this loss
      increase        is
      in price        probably
                      slight

   f. In case of      Probably             Yes              --
      change          no serious
                      damage
      (1) Preserves   within
          vested      moderate
          interests   range
      (2) Avoids      Probably              --               --
          giving      no great
          bonus       bonus
                      within
                      moderate
                      range

4. ADMINISTRATION

   a. Causes          Perhaps,              --               --
      only            no data
      moderate        available
      cost to
      government

   b. Causes          Not known             --               --
      only
      moderate
      cost of
      compliance

   c. Results in      Not known             --               --
      slight
      amount of
      evasion

5. PROMOTES TAX       No                   No          None probably
   CONSCIOUSNESS

6. INTERGOVERNMENTAL FISCAL RELATIONS

   a. Avoids          In most              Yes         --
      conflicts       states,
      of              yes --
      government      cigars are
                      often
                      exempt
                      when
                      cigarettes
                      are taxed
   b. Avoids          Yes --               Yes              --
      repressing      states
      decentrali-     would not
      zation          use it
                      much in
                      any case

7. OTHER CHARACTERISTICS

   a.

   b.

     GENERAL EVALUATION

     The story of this tax is practically the opposite of the
     cigarette tax -- a declining industry, a light tax rate ( of 1
     cent on a 5-cent cigar) and probably more difficult
     administration have combined to put the tax in a position of
     decidedly minor importance.

      ANALYSIS AND EVALUATION OF TAX CHARACTERISTICS No. Q-III
        Tax Snuff; Manufactured Tobacco     Change in Tax____
---------------------------------------------------------------------
Characteristic      Situation with    Is tax (or      Possible method
                    respect to        change)         of improvement
                    this tax (or      desirable
                    change in tax)    in this
                                      characteristic?
---------------------------------------------------------------------
1. REVENUE

   a. Volume          Minor;                --               --
                      estimated
                      only
                      $60,000,000
                      in 1939,
                      or 4/6 of 1
                      percent of
                      total tax
                      revenue
   b. Would show      Yes,                 Yes              --
      yield           within
      change          moderate
      proportionate   range,
      to rate         perhaps
      change
   c. Has stable      Yes                  Yes              --
      yield
      through
      business
      cycle
   d. Responds        No --                No          Probably none
      more than       might not
      proportion-     even keep
      ately to        pace
      rapid price
      rise

2. ECONOMIC EFFECTS

   a. Causes          Not heavy            Fair             None
      migration       enough to
      of capital      have much
      or labor        effect
      between         this way,
      industries      probably

   b. Restricts
      the
      factors of
      production

      (1) Volume of   Probably          No opinion          --
          saving      less than
                      most taxes

      (2) Willingness   No                 Yes              --
          to take
          risks
      (3) Willingness   Probably           Yes              --
          to work       no effect

   c. Restricts       Somewhat;         No opinion          --
      consumers'      perhaps,
      spending        among low-
                      income
                      smokers

   d. Suitable        No --                No               None
      for             unless at
      specific        high rate,
      control         to
      purposes        restrict
                      use of
                      tobacco

3. JUSTICE

   a. Recognizes      No                   No               None
      personal
      differences

      (1) Differences
          in amount
          of income
          (progressive
          burden)
      (2) Other         No --              No               None
          differences:  unless
          kind of       income
          income        spent on
          etc.          tobacco of
                        this kind
                        be
                        considered
                        one kind
                        of luxury
                        or semi-
                        luxury
                        income
   b. Taxes           No                Indifferent         --
      special
      benefits
   c. Taxes           No                Indifferent         --
      unmerited
      gains
   d. Taxes           Not if               No         Higher tax rate
      competitors     cigarette
      equally         producers
                      are
                      regarded
                      as
                      competitors
   e. Avoids          No --but             No               None
      loss of         at
      consumers'      existing
      utility         rates,
      through         this loss
      increase        is
      in price        probably
                      slight
   f. In case of
      change

      (1) Preserves   Probably             Yes              --
          vested      no serious
          interests   damage
                      within
                      moderate
                      range

      (2) Avoids      Probably             Yes              --
          giving      no great
          bonus       bonus
                      within
                      moderate
                      range

4. ADMINISTRATION

   a. Causes          Perhaps;              --               --
      only            no data
      moderate        available
      cost to
      government

   b. Causes          Not known             --               --
      only
      moderate
      cost of
      compliance

   c. Results in      Not known             --               --
      slight
      amount of
      evasion
5. PROMOTES TAX       No                   No          State
   CONSCIOUSNESS                                       amount of
                                                       tax on
                                                       stamps

6. INTERGOVERNMENTAL FISCAL RELATIONS

   a. Avoids          In most              Yes              --
      conflicts       states,
      of              yes
      government
   b. Avoids          Yes --               Yes              --
      repressing      states
      decentrali-     would not
      zation          use it
                      much even
                      if federal
                      government
                      relinquished
                      it
7. OTHER CHARACTERISTICS

   a.

   b.

GENERAL EVALUATION

     At 18 cents a pound the tax is heavier than the cigar tax but
     lighter than the cigarette tax, as a percent of retail price.
     Otherwise, its virtues and defects resemble, in general, those
     of the cigarette tax, except there seems to be no such strong
     upward trend in consumption.

CHAPTER 11

AUTOMOTIVE EXCISES

A. The Gasoline Tax

1. TAX HISTORY

The federal one cent tax on gasoline was first imposed by the revenue act of 1932. The rate has been continuously one cent per gallon except during part of 1933 when it was one and one-half cents. The tax was not recommended by the Treasury Department at the time of its adoption and was not included in the House tax measure. The tax was introduced as a source of revenue in the emergency and was intended to be dropped as soon as the emergency was over. It has been bitterly attacked by state officials and oil companies.

2. REVENUE

The gasoline tax is yielding revenue at the rate of approximately $200 million a year, as shown in the following table:

---------------------------------------------------------------------
              Collections From Gasoline Tax, 1934-1937
---------------------------------------------------------------------
                 Fiscal Years             Collections
---------------------------------------------------------------------
                     1934                 $203,000,000

                    1935                  161,532,000

                     1936                  177,340,000

                     1937                  196,533,000

           Estimate, 1938                  204,000,000

Gasoline taxes have shown great stability of revenue between the years of prosperity and depression. In the study reported in Facing the Tax Problem, page 327, the gasoline taxes showed a smaller standard deviation from trend than did any of the other principal forms of tax.

3. JUSTICE

a. Justice as a general revenue tax.

Used purely as a tax for general revenue, the gasoline tax has some superiority over other excises. As gasoline is an almost universally used commodity the tax falls on a large part of the population. Unfortunately, the tax is at least in part regressive. That part of the tax which falls on business users of gasoline is a business cost affecting almost all kinds of commodities. As such it is probably shifted to consumers and shares the regressiveness of other sales taxes. That part of the gasoline tax which falls on personal users of motor vehicles is probably also regressive for all except the lowest income groups who do not own cars. Expenditure for gasoline probably constitutes a larger percentage of the incomes of car users with relatively small incomes than with relatively large incomes.

Although a relatively desirable form of excise tax for general revenue, the federal gasoline tax cannot be justified as such a tax under present conditions except on grounds of dire need. Federal excises should not be levied without consideration to the state taxation placed on the same sources. For more than a decade before the federal government imposed its tax, the states had levied very heavy gasoline taxes largely as a method of benefit taxation for financing highways. Consequently, a federal tax for general revenue results in the imposition on gasoline of taxation so high as to be justifiable only by considering the use of automobiles as a luxury. In the United States, the greater part of automobile use is probably not in the luxury class.

b. Justice of highway benefit taxation of gasoline.

The gasoline tax is excellently fitted to serve as a benefit tax for imposing on road users as a group a tax for financing highway construction and repair. It is not a perfect tax for this purpose, however, because road use and the damage to roads are not necessarily proportional to the gallonage of gasoline used. Old, inefficient cars driven by the poorest groups in the community may use the largest amount of gasoline per mile traveled while they may do the least damage to the road. On the other hand, trucks powered with diesel engines and paying no federal gasoline tax whatever may use the roads a great deal and may do the most damage to them.

The federal government has for a number of years been paying federal aid to the states for highway purposes and has been constructing highways on nationally owned land. Appropriations for the general works program on highways, including aids to states, amount to $180 million for the fiscal year 1938. This program could properly be financed by benefit taxation on motorists through the gasoline tax. Special recovery and relief expenditures on public highways also have been substantial, for example, $250 million in 1936. Probably these expenditures should not be considered part of a a highway program to be financed by a benefit tax since the real purpose of the program was presumably to confer benefits on other people than motorists.

If the gasoline tax is imposed as a special highway benefit tax, the benefit standard implies that exemptions should be allowed for gasoline not used on the public highways, and that other motor fuel used on highways should be taxed. Such adjustments to a benefits standard would introduce administrative difficulties.

4. FEDERAL-STATE RELATIONS

The federal gasoline tax tends to curtail the powers of the states. State governments have had difficulties in finding good revenue sources. They introduced the gasoline tax and have demonstrated its feasibility and productivity as a source of state revenue. Evasion exists, but the cost of enforcing the tax on perhaps 95 percent of the gasoline has been relatively low. State and local governments are the principal builders of highways, and have used the gasoline tax for this purpose. In many cases, they have pledged future gasoline tax revenues for servicing highway bonds. Although on the average the percentage of revenues thus pledged is small, it is quite large in some states. For these reasons it appears that in the interests of decentralization, the gasoline tax should be left to the states and localities.

However, one consideration of federal-state relations leads to a conflicting conclusion. The development of the nation's highway system should not require permanent federal aids. Some observers are of the opinion that the national system of highways is already substantially complete and that federal aid should cease. However, great pressure still exists for the continuance of the aids. To discourage this pressure, which is in the long run inimical to decentralized government, the federal gasoline tax might be closely tied up with grants-in-aid to the states. The understanding might be that the federal government will reduce its gasoline tax as rapidly as the grants-in-aid are reduced.

5. ECONOMIC EFFECTS OF THE GASOLINE TAX

The oil industry has complained bitterly about the heavy gasoline taxes. Although it has some cause for complaint when these taxes are diverted from highways to other uses in view of the weight of the resulting excise, the industry can hardly complain either of injustice or of harm from the tax when used to finance highway construction and repair. The sale of oil products has been immensely stimulated by the development of good roads. Of course, the oil industry would be in still better position if all roads and streets were financed out of general taxes, for then it would have all the benefits and none of the burdens. Since, however, the highway program would unquestionably have been much slower in development without the gasoline tax, the oil industry has on balance been aided by the combination of gasoline tax and highway program.

Benefits to the oil industry probably diminish as the roads of the country improve. Additional money spent will make roads more pleasant to travel on and oil will make the system more universal, but may not lead to any such great increase in travel as may be attributed to the earlier expenditures on highway construction.

The gasoline tax in connection with the highway construction program has probably benefited the user of gasoline on the highway. Not only has travel to all parts of the country become possible and convenient with modern paved roads, but also the cost of using an automobile on a paved road is substantially lower than on an unpaved road.

6. ADMINISTRATION

The gasoline tax is a very simple one for the federal government to administer because of the concentration of importing and refining. This ease of federal administration combined with evasion of the state taxes has resulted in some urging that the federal government should administer the gasoline tax and distribute a portion of it to state governments for their highway use. This would, however, be an important step in subjecting state finance to federal control.

B. Tax on Lubricating Oil

1. TAX HISTORY

The revenue act of 1932 imposed a tax of four cents a gallon on lubricating oil sold in the United States by the manufacturer or producer and similar tax on lubricating oil imported into the United States. The tax has continued unchanged.

2. REVENUE

The tax on lubricating oil produced $27,103,000 in the fiscal year 1936 and $31,463,000 in 1937. The revenue is probably somewhat less stable than that from the tax on gasoline because a large percentage of the oil is used in manufacturing and other industries where fluctuations are more severe than in the use of automobiles.

3. JUSTICE

a. Justice as a source of general revenue.

The tax on lubricating oil falls on the same economic groups as does the tax on gasoline sales. In addition, it falls on other large groups because of the widespread use of lubricating oil for other purposes than in travel on public roads. Much of the tax constitutes a business cost to mechanical industries and is shifted regressively to the consumer. Except for the large base of individuals reached by the tax, the tax on lubricating oil is probably inferior in justice to some of the other excises. It would seem to be definitely inferior to the gasoline sales tax.

b. Justice as a benefit tax.

The lubricating oil tax may be looked upon as a benefit tax on road users. As such, it is inferior to the gasoline tax because so many other users of lubricating oil are subject to it. Insofar as it does fall on road use, it affects the same industry and the same users as the gasoline tax. There is, accordingly, little justification for having both an oil tax and gasoline tax for benefit purposes.

4. ECONOMIC EFFECTS

So far as the economic effects of the tax as a benefit tax on road use are concerned, the same comments apply to the tax on lubricating oil as to the gasoline tax. Insofar as the tax falls on other than road users, the excise of four cents a gallon is a heavy one, but probably not heavy enough to cause any substantial reduction in use, since lubricating oil is an industrial necessity, and constitutes a minor cost of doing business.

5. ADMINISTRATION

No particular problems appear to exist in administering the lubricating oil tax, although in his report three years ago, Professor Bryan noted that some difficulty was being experienced with reprocessed oil (see his memorandum page 42). Although the change of the lubricating oil tax from a specific tax per gallon to an ad valorem tax would increase its justice since at the present time it falls most heavily on the poorest grades of oil, the administrative difficulty of this change would possibly be so great as to make it undesirable.

C. Tax on Automobiles, Trucks, Tires,
and Accessories

1. TAX HISTORY

The revenue act of 1932 placed a tax of 2 percent on the manufacturer's sales price of automobile truck chassis and bodies; a tax of 3 percent on other automobile chassis and bodies and motor cycles; a tax of 2 percent on parts and accessories; and a tax of 2 cents a pound and 4 cents a pound on tires and inner tubes, respectively. Tractors are exempt from the tax and it has not been applied to truck or passenger trailers.

2. REVENUE

In the fiscal year 1937 these automobile excise taxes yielded $125 million as shown in the following table.

---------------------------------------------------------------------
               Yield of Automobile Excise Taxes, 1937
---------------------------------------------------------------------
Automobiles trucks                                $  9,031,000

Other automobiles and motor cycles                   65,265,000

Parts or accessories                                 10,066,000

Tires and inner tubes                                40,819,000

                                                   $125,201,000
---------------------------------------------------------------------

The writers have made no analysis of the stability of revenue from these automotive excise taxes. It might be expected, however, that the tax on automobiles would be relatively unstable between periods of prosperity and depression. The tax on tires and inner tubes would likely be quite stable both because it is a specific rather than an ad valorem tax and because the use of tires is more constant than the purchase of new cars. It would probably not be as stable as the tax on gasoline.

3. JUSTICE

a. Justice as a general revenue tax.

The tax on automobile trucks, and parts of each of the other taxes are imposed on business. As such they constitute a cost of doing business and are probably shifted to consumers. The incidence of such taxes is regressive.

The balance of the automobile excise taxes falls on car owners who buy and use their automobile for personal or pleasure purposes. The group involved in the tax is a large one and does not include the poorest income groups in the community. These remarks apply especially to the tax on new pleasure automobiles. The tax on parts or accessories falls on the owners and operators of old cars who are likely to be in the lower income groups. The tax on tires and inner tubes is a tax on road use and as such resembles the gasoline tax. The chief difficulty with the tax on automobiles arises over the fact that the motorist is already heavily taxed through the gasoline tax. This argument loses some of its weight in the light of the facts that motorists are a very broad group in the community and that purchasers of new cars ordinarily have substantial tax paying ability.

b. Justice as a highway benefit tax.

Of this group of taxes those on tires and inner tubes most nearly measure road use. A tax levied on a new car has little relationship to the amount of road use that will be yielded by the car. The tax is somewhat similar to the motor vehicle license, but is is inferior to such license since it is not progressive -- however, many license taxes are regressive -- and bears no relation to the number of years the car is used. Probably only the tax on tires and inner tubes should be seriously considered as a highway benefit tax. None of the taxes are as good a measure of road use as is the gasoline tax since even tires and inner tubes depreciate without use.

4. ECONOMIC EFFECT

The effects of the tax on automobiles and other taxes in this group in discouraging the manufacture and sale of the product involved have not been ascertained. However, the large and growing production of automobiles is superficial evidence that the industry has not been seriously hampered by the tax. Insofar as the tax reduces the ability of automobile companies to earn a profit it has probably been capitalized in the market values of securities. Except for persons who still hold the stocks that they held when the tax was first imposed -- who may, however, be the major number of stockholders -- the injury to the investors has probably been suffered already through a lower price for securities sold and would not be undone by removing the tax, while a bonus would be given to the present holders of the securities.

5. SPECIAL PROBLEMS

One suggestion that has been made is that the tax on passenger automobiles be made progressive. This is based on the assumption that the value of the car purchased bears some direct relation to the income of the purchaser and that for this reason a progressive excise tax from automobiles would be a better personal tax than the flat rate tax. Perhaps the principal objection to this proposal is that some upsetting of the vested interest of different automobile manufacturers in relation to each other would result. However, if the tax is kept permanently in the tax system, some degree of progression is in harmony with the principle of progressive personal taxation. The yield of revenue would not be increased to any great extent by progression since the great majority of cars sold are in the lower price ranges.

The taxes on automobile trucks and on parts or accessories should probably be repealed. As previously mentioned, the tax on trucks is a cost of doing business and accordingly is shifted to consumers. This violates one of the principles of excise tax theory, namely, that insofar as possible the excise should be on an article sold to the consumer and not on one that again enters into the process of production. The tax on parts and accessories, because of its regressive character and because in a sense it duplicates the original tax, should also probably be repealed.

No logical basis appears for not taxing trucks and passenger trailers at the same rates as are trucks and passenger cars respectively.

D. Taxes on Crude Petroleum, Refined
Petroleum and Gasoline From Natural Gas

The taxes on crude petroleum, refined petroleum and gasoline from natural gas were introduced in connection with a system of regulating the petroleum industry by the federal government. That system has been declared unconstitutional. The facts that they yield little revenue (approximately $1 million), that they are on an already heavily taxed industry, and that the original purpose for their passage has been secured lead to the conclusion that they should be repealed.

E. Taxes on the Movement of Oil by Pipelines

Taxes were imposed on the transportation of crude petroleum by pipelines from 1917 through 1922. A new tax was imposed in 1932 at the rate of 4 percent on the charge for the transportation service. Since most crude oil is moved by pipelines, this is a general tax on the crude oil industry. However, it is not proportional either to the volume or the value of the crude oil since all crude oil is not transported the same distance. In a sense the tax is a rough burden on the production of oil. It has nothing particularly to recommend it as a general tax except its productivity. The yield of the tax amounted to $11,244,000 in 1937. In view of the other burdens on petroleum, it is perhaps unwise to impose this as a general tax. It is unsuitable for use as a highway benefit tax since the relationship of the tax to the final road-use of gasoline is very distant. Much of the crude oil eventually goes into fuel oil for burners, diesel oil, paraffin, and numerous other oil products. The tax should probably be repealed when revenue conditions make this feasible.

CHAPTER 12

MANUFACTURERS' EXCISE TAXES, OTHER THAN AUTOMOTIVE TAXES

The federal government imposes eleven manufacturers' excise taxes, not including in this count the six automotive excise taxes, /1/ which are discussed in a separate group in Chapter XI because of their possible connection with highway expenditures. In 1937 these eleven taxes produced slightly less than $100 million. Two of them -- the electrical energy tax and the toilet preparations taxes -- produced over half of that total ($54 million out of $95 million). At the other extreme, the chewing gum tax and the cameras and lenses tax each produced less than $1 million. /2/

In 1934 the present writer prepared a memorandum for the Treasury, "Manufacturers' Excises and Special Taxes -- Memorandum P" /3/ in which he described and expressed his opinion of each of these taxes. In the absence of further special study since then, his attitude toward these taxes remains unchanged. Practically none of these taxes has anything to recommend it except the modest revenue that it produces. If, however, some of them must be retained, the most promising are: (1) The tax on toilet preparations, provided dentifrices, mouth washes, and soaps are exempted (at present they are taxed, but at a low rate); (2) the tax on radios and phonographs (if they are somewhat revised, as suggested in the 1934 Excise Tax Memorandum or revised as suggested in Vol. VI of the 1937 Tax Revision Studies); and (3) the tax on electrical energy, if it has in general been made payable by the consumer, via the power companies, through rate adjustments. If the radio and phonograph rate were made 10 percent instead of the present very low rate of 5 percent, then these taxes might total about $50 million a year.

As to repeal, there would seem to be no pressing fiscal need for keeping the taxes on cameras and lenses; chewing gum; firearms, shells, and cartridges; sporting goods; articles made of fur; and matches. The total of these in 1937 was $25 million -- an amount that can easily be picked up by an almost imperceptible increase in income tax rates. Whether the tax on mechanical refrigerators should also be repealed at once is perhaps slightly more of a question. It produces $10 million a year.

In view of the minor importance of these taxes, an extended discussion of their characteristics does not seem warranted, and the reader is referred to the characteristics tables presented herewith for the two taxes that produce over half the revenue -- the taxes on electrical energy and toilet preparations. The "possible methods of improvement" are for information only, and do not represent positive recommendations unless noted in the text above.

       ANALYSIS AND EVALUATION OF TAX CHARACTERISTICS No. S-I
          Tax Electrical Energy         Change in Tax____
---------------------------------------------------------------------
Characteristic      Situation with    Is tax (or      Possible method
                    respect to        change)         of improvement
                    this tax (or      desirable
                    change in tax)    in this
                                      characteristic?
---------------------------------------------------------------------
1. REVENUE

   a. Volume          Minor;               --               --
                      estimated
                      $40,000,000
                      in 1939,
                      or 1/2 of 1
                      percent of
                      total tax
                      revenues
   b. Would show      Yes                  Yes              --
      yield
      change
      proportionate
      to rate
      change

   c. Has stable      Probably             Yes              --
      yield           fairly
      through         stable
      business
      cycle
   d. Responds        Would                No               None
      more than       probably
      proportion-     lag, since
      ately to        electricity
      rapid price     rates
      rise            would
                      probably
                      lag

2. ECONOMIC EFFECTS

    a. Causes         Has a                Fair             None
       migration      tendency
       of capital     to keep
       or labor       capital
       between        and labor
       industries     out of the
                      electricity
                      business;
                      rate not
                      heavy
                      enough to
                      have much
                      effect
   b. Restricts
      the
      factors of
      production

      (1) Volume of   Over the             No opinion       --
          saving      short
                      term, yes,
                      after
                      ultimate
                      shifting
                      of tax,
                      perhaps
                      not much
                      effect
      (2) Willingness   Probably           Yes              --
          to take       no great
          risks         effect
      (3) Willingness   Probably           Yes              --
          to work       no effect

   c. Restricts       Over the          No opinion          --
      consumers'      short
      spending        term, no;
                      after
                      ultimate
                      shifting
                      of tax,
                      perhaps
                      some
                      effect

   d. Suitable        No                   Indifferent      --
      for
      specific
      control
      purposes

3. JUSTICE

   a. Recognizes
      personal
      differences

      (1) Differences   No,             No, on the whole    None
          in amount     whether
          of income     shifted or
          (progressive  not --
          burden)       except
                        that the
                        very
                        poorest
                        classes
                        probably
                        feel no
                        burden
      (2) Other         No --              No               None
          differences:  whether
          kind of       shifted or
          income        not
          etc.

   b. Taxes           No                Indifferent         --
      special
      benefits
   c. Taxes           No                Indifferent         --
      unmerited
      gains
   d. Taxes           Not if               Fair             None
      competitors     coal, gas,
      equally         etc.
                      producers
                      are
                      competitors
   e. Avoids          Yes, until           Fair             None
      loss of         it is
      consumers'      shifted
      utility         ultimately
      through         -- then
      increase        perhaps
      in price        not
   f. In case of
      change

      (1) Preserves   If not               No          Provide
          vested      shifted,                         for
          interests   is very                          shifting
                      hard on                          to
                      stockholders                     consumer
                      in certain
                      companies
      (2) Avoids      Doubtful             ?                --
          giving
          bonus
4. ADMINISTRATION

   a. Causes          Probably;            Yes, probably    --
      only            no data
      moderate
      cost to
      government
   b. Causes          Not known            --               --
      only
      moderate
      cost of
      compliance

   c. Results in      Probably;            Yes, probably    --
      slight          no data
      amount of
      evasion
5. PROMOTES TAX       No                   No          Shift tax
   CONSCIOUSNESS                                       to
                                                       consumer
                                                       and charge
                                                       as separate
                                                       item

6. INTERGOVERNMENTAL FISCAL RELATIONS

   a. Avoids          Not                  Fair             --
      conflicts       entirely;
      of              doubtful
      government      how
                      serious it
                      is

   b. Avoids          Yes;                 Yes              --
      repressing      federal
      decentrali-     repeal
      zation          would
                      probably
                      not affect
                      state use

7. OTHER CHARACTERISTICS

   a.

   b.

GENERAL EVALUATION

     Because of the peculiar problem of shifting and incidence
     involved here, the tax is a special class. It is a very poor tax
     to take on and off frequently and suddenly, because adjustment
     to its burden must be so slow and difficult. In general, it
     cannot be rated high, but it is one of the better excises.

       ANALYSIS AND EVALUATION OF TAX CHARACTERISTICS No. S-II
          Tax Toilet Preparations        Change in Tax____
---------------------------------------------------------------------
Characteristic      Situation with    Is tax (or      Possible method
                    respect to        change)         of improvement
                    this tax (or      desirable
                    change in tax)    in this
                                      characteristic?
---------------------------------------------------------------------
1. REVENUE

   a. Volume          Minor;               --               --
                      estimated
                      only
                      $20,000,000
                      in 1939,
                      or 3/10 of 1
                      percent of
                      total tax
                      revenues
   b. Would show      Possibly,            Fair        Lower rate
      yield           within
      change          moderate
      proportion-     range
      ate to rate
      change

   c. Has stable      Probably             --               --
      yield           not; not
      through         enough
      business        experience
      cycle           yet to
                      know

   d. Responds        Probably not         No               None
      more than
      proportionately
      to rapid
      price rise
2. ECONOMIC EFFECTS

    a. Causes         Yes, but             Fair             None
       migration      at present
       of capital     rates, not
       or labor       much
       between        effect,
       industries     probably

   b. Restricts
      the
      factors of
      production
      (1) Volume of   Probably             No opinion       --
          saving      less than
                      most taxes
      (2) Willingness   No                 Yes              --
          to take
          risks
      (3) Willingness   Probably           Yes              --
          to work       no effect

   c. Restricts       Yes               No opinion          --
      consumers'
      spending
   d. Suitable        No                Indifferent         --
      for
      specific
      control
      purposes
3. JUSTICE

   a. Recognizes
      personal
      differences

      (1) Differences No                   No               None
          in amount
          of income
          (progressive
          burden)
      (2) Other         No --              No               None
          differences:  unless
          kind of       income
          income,       spent on
          etc.          those
                        articles
                        (cosmetics,
                        etc.)
                        subject to
                        the 10%
                        rate be
                        considered
                        one kind
                        of luxury
                        or semi-
                        luxury
                        income
   b. Taxes           No                Indifferent         --
      special
      benefits
   c. Taxes           No                Indifferent,        --
      unmerited
      gains
   d. Taxes           Probably             Yes              --
      competitors     yes, in
      equally         general
   e. Avoids          No -- but            No               None
      loss of         at
      consumers'      existing
      utility         rates,
      through         this loss
      increase        is
      in price        probably
                      slight

   f. In case of
      change

      (1) Preserves   Probably             Fair             --
          vested      no serious
          interests   damage
                      within
                      very
                      moderate
                      range
      (2) Avoids      Yes                  Yes              --
          giving
          bonus
4. ADMINISTRATION

   a. Causes          Probably             No            Not known
      only            tends to
      moderate        be costly
      cost to
      government
   b. Causes          Not known         Not known,       Not known
      only
      moderate
      cost of
      compliance
   c. Results in      Probably             Fair          Not known
      slight          is
      amount of       difficult
      evasion         to enforce
                      completely
5. PROMOTES TAX       No                   No               No
   CONSCIOUSNESS

6. INTERGOVERNMENTAL FISCAL RELATIONS

   a. Avoids          Yes, no              Yes              --
      conflicts       state is
      of              using it
      government
   b. Avoids          Yes --               Yes              --
      repressing      even
      decentrali-     without
      zation          federal
                      use,
                      doubtful
                      if states
                      would use
                      it
7. OTHER CHARACTERISTICS

   a.

   b.

GENERAL EVALUATION

     Except for the administrative problems which may be troublesome,
     this is one of the better excises, especially if dentifrices,
     soap, and mouth washes are excluded.

CHAPTER 13

DOCUMENTARY, ETC., STAMP TAXES

Under the heading "Documentary, etc., Stamp Taxes" come ten taxes, which produced $70 million in 1937. Nearly half ($31 million) came from the tax on stock transfers. Most of the rest came from six taxes whose proceeds are lumped in the collection figures, so it is not known how much each one yields. The six taxes are on:

Foreign insurance policies

Issuance of bonds

Issuance of stock

Passage tickets

Real estate transfer ("deeds of conveyance")

Transfer of bonds

The remainder is accounted for by the taxes on sales of produce for future delivery, playing cards, and silver bullion transfers.

As with the manufacturers' excise taxes, the present writer, in his 1934 memorandum to the Treasury ("Manufacturers' Excise and Special Taxes"), described each of these taxes and commented on them. None of them is an outstandingly good tax, but if fiscal considerations preclude repealing all of them, the stock transfer tax is the best one to retain. It has few positive disadvantages, and it would be helpful in yielding revenue in case of a sharp rise in the price level. About the same may be said for the tax on sales of produce (chiefly cotton and wheat) for future delivery. With such taxes, however, it would be wise to institute studies at once to try to discover the level at which the tax does or may interfere seriously with the floor traders. /1/ Also, it might be wise to tie the stock transfer tax closer to the market price of the stock. /2/

The bond transfer tax is as good as the stock transfer tax to retain except for the administrative problem, of which the present writer knows little, but which he assumes is serious in view of the ease with which bearer bonds are passed from hand to hand.

The rate on playing cards (10 cents a package) seems high -- too high for justice, but, it would seem, not high enough to check gambling appreciably. Indeed, the tax might well be dropped completely.

The real estate transfer tax should be retained, at least at a nominal rate, since the tax stamps aid state and local governments in setting values for assessment under the property tax.

If all the stamp taxes except the taxes on stock transfer, bond transfer, futures transactions, and real estate transfers were repealed, /3/ the annual revenue loss would be about $25 million (giving a conservative guess that the bond transfer tax produces $10 million). Specifically, this would mean the repeal of the taxes on foreign insurance policies, issuance of bonds, issuance of stock, passage tickets, and playing cards. However, there may be special questions connected with the foreign insurance policies and passage tickets.

The accompanying charts present the chief characteristics of the two taxes (aside from the deeds-of- conveyance tax) that are recommended for retention. The "possible methods of improvement" are for information only, and do not represent positive recommendations unless noted in the text above.

       ANALYSIS AND EVALUATION OF TAX CHARACTERISTICS No. T-I
          Tax Stock Transfer               Change in Tax____
---------------------------------------------------------------------
Characteristic      Situation with    Is tax (or      Possible method
                    respect to        change)         of improvement
                    this tax (or      desirable
                    change in tax)    in this
                                      characteristic?
---------------------------------------------------------------------
1. REVENUE

   a. Volume          Minor;               --               --
                      estimated
                      $30,000,000
                      in 1939,
                      or 2/5 of
                      1 percent
                      of total
                      tax
                      revenues
   b. Would show      Yes                  No               --
      yield
      change
      proportionate
      to rate
      change
   c. Has stable      No -- very           No               None
      yield           unstable
      through
      business
      cycle
   d. Responds        Not unless           Yes         Link tax
      more than       volume of                        closer to
      proportion-     trading                          price of
      ately to        increased                        share
      rapid price     sharply
      rise

2. ECONOMIC EFFECTS

   a. Causes          Apparently           Yes              --
      migration       not, at
      of capital      least at
      or labor        present
      between         rate
      industries
   b. Restricts
      the
      factors of
      production

      (1) Volume of   Probably          No opinion          --
          saving      more than
                      most taxes
      (2) Willingness   A slight           Fair             --
          to take       tendency -
          risks         - almost
                        negligible
                        at present
                        level

      (3) Willingness   Probably           Yes              --
          to work       no effect

   c. Restricts       Probably          No opinion,         --
      consumers'      not
      spending
   d. Suitable        Yes, in a            Fair        Perhaps none
      for             rough way,
      specific        to control
      control         volume of
      purposes        speculation
3. JUSTICE

   a. Recognizes
      personal
      differences

      (1) Differences   No                 No               None
          in amount
          of income
          (progressive
          burden)
      (2) Other       No                   No               None
          differences:
          kind of
          income,
          etc.
   b. Taxes           No                Indifferent         --
      special
      benefits

   c. Taxes           No, unless        Indifferent         --
      unmerited       accidently,
      gains           now and
                      then

   d. Taxes           Probably             Yes              --
      competitors
      equally
   e. Avoids          Yes, at               Yes             --
      loss of         least at
      consumers'      present
      utility         rates
      through
      increase
      in price

   f. In case of
      change

      (1) Preserves   Yes, if change       Yes              --
          vested      is moderate
          interests
      (2) Avoids      Yes                  Yes              --
          giving
          bonus
4. ADMINISTRATION

   a. Causes          Not known         Not known           Not known
      only
      moderate
      cost to
      government
   b. Causes          Not known         Not known      Not known
      only
      moderate
      cost of
      compliance
   c. Results in      Not known,        Probably yes        --
      slight          but should
      amount of       suppose
      evasion         little
                      evasion
5. PROMOTES TAX       Not among            Fair             None
   CONSCIOUSNESS      a very
                      large part
                      of the
                      populace
6. INTERGOVERNMENTAL FISCAL RELATIONS

   a. Avoids          No, at               Fair        Exclusive
      conflicts       least not                        federal use
      of              with New
      government      York State

   b. Avoids          Probably,            Fair        Abolition
      repressing      except in                        of federal
      decentrali-     New York                         tax
      zation          State,
                      which
                      might make
                      more use
                      of tax
                      otherwise

7. OTHER CHARACTERISTICS

   a.

   b.

GENERAL EVALUATION

     At a low rate this tax seems relatively harmless and burdenless,
     although it does not have many positive virtues, even from a
     fiscal point of view, owing to the uncertainty of its yield.

       ANALYSIS AND EVALUATION OF TAX CHARACTERISTICS No. T-II
          Tax Bond Transfer               Change in Tax____
---------------------------------------------------------------------
Characteristic      Situation with    Is tax (or      Possible method
                    respect to        change)         of improvement
                    this tax (or      desirable
                    change in tax)    in this
                                      characteristic?
---------------------------------------------------------------------
1. REVENUE

   a. Volume          Not known,           --               --
                      but in any
                      case not
                      more than
                      $20,000,000
                      or so
   b. Would show      Yes                  Yes              --
      yield
      change
      proportionate
      to rate
      change
   c. Has stable      Not known         Not known      Not known
      yield
      through
      business
      cycle
   d. Responds        No                   No               No
      more than
      proportionately
      to rapid
      price rise
2. ECONOMIC EFFECTS

   a. Causes          Apparently           Yes              --
      migration       not, at
      of capital      least at
      or labor        present
      between         rate
      industries

   b. Restricts       Probably          No opinion          --
      the             more than
      factors of      most taxes
      production

      (1) Volume of
          saving
      (2) Willingness   Probably           Yes              --
          to take       no effect
          risks
      (3) Willingness   Probably           Yes              --
          to work       no effect

   c. Restricts       Probably not      No opinion          --
      consumers'
      spending
   d. Suitable        No                Indifferent         --
      for
      specific
      control
      purposes
3. JUSTICE

   a. Recognizes      No                   No               None
      personal
      differences

      (1) Differences
          in amount
          of income
          (progressive
          burden)
      (2) Other       No                   No               None
          differences:
          kind of
          income
          etc.
   b. Taxes           No                Indifferent         --
      special
      benefits
   c. Taxes           No                Indifferent         --
      unmerited
      gains
   d. Taxes           Probably             Yes              --
      competitors
      equally
   e. Avoids          Yes, at least        Yes              --
      loss of         at present rates
      consumers'
      utility
      through
      increase
      in price
   f. In case of      Yes, if              Yes              --
      change          change is
                      moderate
      (1) Preserves
          vested
          interests
      (2) Avoids      Yes                  Yes              --
          giving
          bonus
4. ADMINISTRATION

   a. Causes          Not known         Not known      Not known
      only
      moderate
      cost to
      government
   b. Causes          Not known         Not known      Not known
      only
      moderate
      cost of
      compliance

   c. Results in      Not known,        Probably no    Abolish bearer
      slight          but should                       bonds
      amount of       suppose
      evasion         considerable
                      evasion,
                      owing to
                      bearer
                      bonds
5. PROMOTES TAX       Not among            Fair             None
   CONSCIOUSNESS      a very
                      large part
                      of the
                      populace
6. INTERGOVERNMENTAL FISCAL RELATIONS

   a. Avoids          So far,              Yes              --
      conflicts       yes
      of
      government
   b. Avoids          Yes --               Yes              --
      repressing      doubtful
      decentrali-     if states
      zation          would use
                      it in any
                      case

7. OTHER CHARACTERISTICS

   a.

   b.

GENERAL EVALUATION

     The remarks made about the stock transfer tax may be repeated
     here, with the additional comment that evasion of this tax is
     relatively easy.

CHAPTER 14

MISCELLANEOUS TAXES

Under the heading "Miscellaneous Taxes," the Internal Revenue groups the taxes on:

Telephone, telegraph, radio, and cable facilities, leased
wires, etc.

Admission to theatres, concerts, cabarets, etc.

Transportation of oil by pipe line

Club dues and initiation fees

Leases of safe-deposit boxes

Articles that are regulated or prohibited by special
taxes: adulterated and processed or renovated butter,
mixed flour, filled cheese, oleomargarine, narcotics,
crude petroleum processed, etc., articles under National
Firearms Act. There are a few other prohibitively-taxed
articles, not mentioned in this list.

A tax that is really the equivalent of a customs duty: The tax on coconut, etc., processed oils.

This memorandum will not cover the regulatory or prohibitive taxes, since analyses are conveniently available elsewhere, but it is worth repeating here that the tax burden on oleomargarine should be sharply reduced, leaving only a moderate tax for pure food regulation. /1/

Likewise, the coconut, etc., oils tax will not be discussed here, since it is in reality the equivalent of a customs duty.

As indicated in the 1934 Excise Tax Memorandum, the admissions tax is probably the best of the other five taxes. The taxes on club dues and safe-deposit boxes are not harmful, but yield extremely little revenue. None of these taxes ranks very high. All together the five taxes produced $64 million in 1937. If only the admissions tax were retained, the revenue loss would be $44 million. If the club dues and safe deposit taxes were also retained, the revenue loss would be $36 million.

The accompanying tables show the characteristics of the two largest revenue producers in this group -- the telephone, etc., taxes and the admissions taxes. The "possible methods of improvement" are for information only, and do not represent positive recommendations unless noted in the text above.

       ANALYSIS AND EVALUATION OF TAX CHARACTERISTICS No. U-I
        Tax Telephone, Telegraph, etc.     Change in Tax____
---------------------------------------------------------------------
Characteristic      Situation with    Is tax (or      Possible method
                    respect to        change)         of improvement
                    this tax (or      desirable
                    change in tax)    in this
                                      characteristic?
---------------------------------------------------------------------
1. REVENUE

   a. Volume          Minor;               --               --
                      estimated
                      $30,000,000
                      in 1939,
                      or 2/5 of
                      1 percent
                      of total
                      tax
                      revenues

   b. Would show      Probably             Fair        Lower rate
      yield           not quite;
      change          rates are
      proportion-     already
      ate to rate     fairly
      change          high

   c. Has stable      Not known         Not known      Not known
      yield
      through
      business
      cycle
   d. Responds        No                   No          Narrow the
      more than                                        rate
      proportion-                                      brackets,
      ately to                                         telephone;
      rapid                                            link radio
      price rise                                       and cable
                                                       taxes to
                                                       price

2.  ECONOMIC EFFECTS

   a. Causes          Has a                Fair             None
      migration       tendency
      of capital      this way;
      or labor        probably
      between         not very
      industries      effective
                      at present
                      levels

  b. Restricts
     the
     factors of
     production

      (1) Volume of   Probably          No opinion          --
          saving      about
                      average
                      for all
                      taxes

      (2) Willingness   Probably           Yes              --
          to take       little
          risks         effect
      (3) Willingness   Probably           Yes              --
          to work       no effect

   c. Restricts       Probably          No opinion          --
      consumers'      about
      spending        average
                      for all
                      taxes

   d. Suitable        No                Indifferent         --
      for
      specific
      control
      purposes

3. JUSTICE

   a. Recognizes
      personal
      differences

      (1) Differences   No --              No               --
          in amount     except
          of income     that the
          (progressive  part of
          burden)       the tax
                        that is on
                        personal
                        consumption
                        does not
                        reach very
                        poor
                        classes

      (2) Other        No                  No               None
          differences:
          kind of
          income
          etc.

   b. Taxes           No                Indifferent         --
      special
      benefits
   c. Taxes           No                Indifferent         --
      unmerited
      gains

   d. Taxes           No --                No          Put rates
      competitors     radio and                        on uniform
      equally         cable;                           ad valorem
                      telegraph;                       basis
                      and
                      telphone,
                      all taxed
                      at did
                      different
                      rate

   e. Avoids          No                   No          Lower rates
      loss of
      consumers'
      utility
      through
      increase
      in price
   f. In case of
      change

      (1) Preserves   Might                No               --
          vested      damage
          interests   interests
                      of
                      telephone,
                      etc.,
                      stockholders
                      somewhat
      (2) Avoids      Probably             Yes              --
          giving
          bonus
4. ADMINISTRATION

   a. Causes          Not known         Not known           --
      only
      moderate
      cost to
      government
   b. Causes          Not known         Not known      Not known
      only
      moderate
      cost of
      compliance
   c. Results in      Probably             Yes              --
      slight
      amount of
      evasion
5. PROMOTES TAX       Yes                  Yes              --
   CONSCIOUSNESS

6. INTERGOVERNMENTAL FISCAL RELATIONS

   a. Avoids         Probably,             Fair             --
      conflicts      although
      of             many
      government     states
                     have taxes
                     that might
                     be
                     compared
                     to these
   b. Avoids          Probably;         Yes                 --
      repressing      doubtful
      decentrali-     if states
      zation          would act
                      differently
                      if federal
                      government
                      abandoned
                      these
                      taxes
7. OTHER CHARACTERISTICS

    a.

    b.

     GENERAL EVALUATION

     Even among the excise, stamp, and miscellaneous taxes, these
     telephone, etc., taxes do not rank high except in ease of
     administration. They fall on transactions that are often of a
     business nature rather than a luxury nature.

       ANALYSIS AND EVALUATION OF TAX CHARACTERISTICS No. U-II
          Tax Admissions                  Change in Tax____
---------------------------------------------------------------------
Characteristic      Situation with    Is tax (or      Possible method
                    respect to        change)         of improvement
                    this tax (or      desirable
                    change in tax)    in this
                                      characteristic?
---------------------------------------------------------------------
1. REVENUE

   a. Volume          Minor;               --               --
                      estimated
                      $20,000,000
                      in 1939,
                      or 3/10 of
                      1 percent
                      of total
                      tax
                      revenues

   b. Would show      No, not quite        Fair        Lower rate
      yield
      change
      proportionate
      to rate
      change
   c. Has stable      Not known         Not known      Not known
      yield
      through
      business
      cycle
   d. Responds        Yes, owing           Yes              --
      more than       to flat
      proportion-     exemption
      ately to
      rapid price
      rise

2. ECONOMIC EFFECTS

   a. Causes          Yes, to              Fair        Lower rate
      migration       some
      of capital      extent
      or labor
      between
      industries
   b. Restricts
      the factors
      of production

      (1) Volume of   Perhaps           No opinion          --
          saving      slightly
                      more than
                      most taxes

      (2) Willingness  Probably            Yes              --
          to take      no effect
          risks
      (3) Willingness  Probably            Yes              --
          to work      no effect

   c. Restricts       Probably             No opinion       --
      consumers'      almost as
      spending        much as
                      most of
                      the excise

   d. Suitable        No                Indifferent         --
      for
      specific
      control
      purposes
3. JUSTICE

   a. Recognizes        No --              No               None
      personal          except
      differences       that 40-
                        cent
      (1) Differences   exemption
          in amount     avoids
          of income     taxing the
          (progressive  very low
          burden)       income
                        groups
      (2) Other         Yes, to            Fair             None
          differences:  the extent
          kind of       that
          income,       income
          etc.          spent on
                        admissions
                        over 40
                        cents is
                        luxury
   b. Taxes           No                Indifferent         --
      special
      benefits
   c. Taxes           No                Indifferent         --
      unmerited
      gains
   d. Taxes           No,                  No               --
      competitors     because of
      equally         40-cent
                      admission
   e. Avoids          No, not              No          Lower rate
      loss of         entirely,
      consumers'      at present
      utility         rates
      through
      increase
      in price
   f. In case of      No; would            No               --
      change          probably
                      injure
      (1) Preserves   motion
          vested      picture
          interests   interests
      (2) Avoids      Would give           Fair             --
          giving      only
          bonus       slight
                      bonus, if
                      any

4. ADMINISTRATION

   a. Causes          Not known            Fair             --
      only            exactly,
      moderate        but
      cost to         appears to
      government      be
                      moderate

   b. Causes          Not known         Not known      Not known
      only
      moderate
      cost of
      compliance
   c. Results in      Apparently        Probably yes        --
      slight          not much
      amount of       evasion
      evasion
5. PROMOTES TAX       Yes                  Yes              --
   CONSCIOUSNESS

6. INTERGOVERNMENTAL FISCAL RELATIONS

   a. Avoids          Not                  Fair             --
      conflicts       entirely,
      of              but in
      government      most
                      states
                      there is
                      no
                      conflict
   b. Avoids          No;                  No               --
      repressing      probably
      decentrali-     state use
      zation          would be
                      much
                      wider,
                      without
                      federal
                      tax
7. OTHER CHARACTERISTICS

   a.

   b.

GENERAL EVALUATION

     The admissions tax is one of the best of the excise, stamp, and
     miscellaneous group, in its combination of reasonable
     administration and comparative freedom from the more serious
     faults in distribution of the burden.

CHAPTER 15

RECAPITULATION OF
RECOMMENDATIONS FOR CHANGE

This chapter presents, in summary form, the recommendations of the writers for changes in the present federal tax system. Numbers in parentheses refer to pages in preceding chapters. Reference to "Studies" is to the Tax Revision Studies, 1937, recently completed by the Division of Research and Statistics of the Treasury; reference is made only when the present writers agree with the Studies' recommendations.

The recommendations are of course to be taken as a unit; any substantial departure from any one of them would likely require a modification in one or more of the others.

Income Tax

1. Reduce personal exemptions and credit for dependents to $1,500, $800, and $300 or even $1,000, $500, and $200 if administrative conditions permit. Studies, Vol. 11, p. 2 (except they put married exemptions at $2,000).

2. Lower maximum surtax rates so that combined normal and surtax rates do not exceed 67 percent.

3. Lower corporation normal tax to about 7 percent or 8 percent at once; more slowly, if revenue requirements dictate (J-4). Studies, Vol. II, p. 2 (but they favor outright repeal).

4. Insofar as existing corporation normal tax is retained, exempt dividends in hands of stockholders from individual normal tax (if corporation normal tax is less than 4 percent, reduce exemption proportionately).

5. Adopt the general type of surtax schedule recommended in the Studies, Vol. II, p. 1, but probably on a somewhat higher level throughout (but for top rates, see above).

6. Allow a carryover of loss, business or otherwise, for as many years as administratively feasible -- probably five years at least. Studies, Vol. II, p. 3 (but they limit carryover to two years).

7. Enact an averaging system, probably of the continuous-balance type or at least of the shortened-balance type; maybe go so far as to use the Vickrey plan, -- in any case, however, no decision to be taken until the Division of Research and Statistics has studied the matter intensively.

8. (a) Amend the constitution to allow taxation of accrued gains and deduction of accrued losses at death or at time of gift, and enact legislation to include such gains or losses in the income of the last return of the individual (in case of death) or in the return in the year of gift (to avoid discrimination owing to the time within the year at which death occurs, the last return, in case of death, will have to be translated to an annual basis, or the gain or loss will have to be considered part of the last full year's return.

(b) Liberalize the deductions for loss either by (1) allowing capital losses to be offset against other income, with a carryforward of net loss, or (2) allowing an indefinite carryforward of capital net losses to be subtracted from capital net gains of future years (perhaps a limit such as a six- or seven-year limit -- but no shorter -- might be imposed if revenue considerations were impelling, but the important general principle is that, if everyone is certain to be taxed on his gains (above the exemption levels), everyone should be guaranteed an opportunity to utilize his losses.)

(c) As a first choice, amend the constitution to permit the taxation of accrued gains and the deduction of accrued losses and enact Plan A (note that this is bound up with the adoption of an averaging device).

(d) As to second, etc., choices, see the special section of recommendations below, immediately after the section on undistributed profits, covering both the undistributed profits tax and capital gains.

9., 10. Disallow discovery and percentage depletion and repeal section 105 (limiting tax on sale of oil or gas properties). Studies, Vol. II, p. 3.

11. Improve administration, particularly to obtain cooperation of taxpayers.

12. Limit deductions to charities by estates and trusts in the manner suggested in Studies, Vol. II, p. 4, but perhaps make the restrictions applicable only to estates and trusts formed after the passage of the law.

13. Revise the 15 percent charitable deduction as concerns partners in the manner suggested in Studies, Vol. II, p. 4.

14. Repeal the complete deduction allowed by the 90 percent clause (charitable contributions), as suggested in Studies, Vol. II, p. 5.

15. Probably revise the pension trust provisions, as suggested in Studies, Vol. II, p. 5.

16. Treat worthless stock like capital loss, as suggested in Studies, Vol. II, p. 5.

17. Revise treatment of building and loan societies, as suggested in Studies, Vol. II, p. 6.

Undistributed Profits Tax

1. Amend constitution and (depending on information gathered in the next year on the undistributed profits tax and the decision reached on capital gains taxation) the law to tax listed securities on annual inventory value, provided an averaging plan is also adopted, and to tax other security holders on distributive shares; than repeal undistributed profits tax.

2. Allow capital losses to be deducted against other income. Studies, Vol. IV, p. 46.

3. Allow losses to be carried forward for several years -- say five years. Studies, Vol. IV, p. 46 (but they limit it to two years).

4. Adopt suggestion in Studies (Vol. IV, p.47) to tax deficiency assessments of income at 5 percent and allow option of paying out such income or including it in current year's accounts.

5. Allow excess dividends to be carried forward much longer than at present -- say at least five years.

6. Probably revise liquidated-subsidiary provisions as suggested in Studies, Vol. II, p. 6.

7. Impose special 10 percent tax on credits allowed to corporations prohibited from paying dividends. Studies, Vol. IV, p. 48.

Alternatives in Taxation of Undistributed Profits and Capital Gains

Because of the importance of those two problems, this special section of recommendations is inserted to present first, second, third, etc., choices. Also, this section serves to show how closely the two problems are linked -- how any major change in the treatment of one is almost sure to affect the treatment of the other.

The alternatives can best be shown in chart form. All plans above the double line probably require an amendment to the Constitution; those below do not.

Corporation Privilege Tax

1. Impose a corporation privilege tax on same base as at present except that interest not to be allowed as deduction, and interest and dividends from other taxable corporations not to be included at all in gross income -- rate to be 1 or 2 percent to start with, and gradually increase over the years to a maximum of 5 percent -- or lower, if fiscally possible. Studies, Vol. II, p. 3 (but they favor different base and rate).

Capital Stock Tax

1. Repeal this tax. Studies, Vol. II, p. 2.

Excess Profits Tax

1. Repeal existing excess profits tax. Studies, Vol. II, p. 2.

2. Impose a true excess profits tax, but at nominal rates and merely for record-gathering purposes for several years.

Death and Gift Taxes

1. Reduce exemption from $40,000 to $20,000. Studies, Vol. V, p. 1.

                            FIRST CHOICE
         COVERS BOTH CAPITAL GAINS AND UNDISTRIBUTED PROFITS
---------------------------------------------------------------------
Averaging system for all income

Annual inventory of listed securities /a/

Distributive-share tax for unlisted equities /a/

Tax on realization for all assets (adjust basis for above)

Realization upon death or gift

Repeal sections 102 and 351, and probably most of sections 112 and
113, and the undistributed profits tax
---------------------------------------------------------------------
                            CAPITAL GAINS      UNDISTRIBUTED PROFITS
---------------------------------------------------------------------
If inventory method      Averaging system        Distributive-share
is not permitted,        for all income          tax, all equities
SECOND CHOICE:
                         Distributive-share      Repeal sections
                         tax, all equities       102 and 351

                         Tax on
                         realization, all
                         assets (adjust
                         basis)

                         Realization upon
                         death or gift
---------------------------------------------------------------------
If, further,             Averaging system        Distributive-share
distributive- share      for all income          tax for "unlisted"
tax on listed                                    equities /a/
securities is not        Distributive-share
permitted, THIRD         tax for "unlisted"      Heavy
CHOICE:                  equities                undistributed
                                                 profits tax on
                         Tax on                  "listed"
                         realization, all        equities /a/
                         assets (adjust
                         basis)                  Repeal sections
                                                 102 and 351
                         Realization upon
                         death or gift
---------------------------------------------------------------------
If, further,             Averaging system        Moderate /c/
distributive-share       for all income          undistributed
taxation on any                                  profits tax,
securities is not        Tax on                  pending further
permitted, FOURTH        realization, all        information
CHOICE:                  assets
                                                 Realization at
                         Realization at          death or at gift
                         death or at gift
                                                 Possibly, optional
                                                 distributive-share
                                                 tax
---------------------------------------------------------------------
If, further, no          Averaging system
constitutional           for all income
amendment is
possible, FIFTH          Tax on
CHOICE:                  realization, all
                         assets

                         (Almost surely no
                         tax at death or
                         gift, on gains)
---------------------------------------------------------------------
If, further, no          Averaging system        Moderate /c/
averaging system for     for gains and           undistributed
income as a whole is     losses alone (not       profits tax,
permitted, SIXTH         yet explored)           pending further
CHOICE:                                          information.
                         OR --Increase           Possibly, optional
                         sharply the             distributive share
                         percentages --          tax.
                         especially for
                         more than 5 years
                         -- in step scale
                         plan. /b/

                         OR -- One-table or
                         two-table
                         plans. /b/

                         OR -- Division
                         plan of Sept.
                         1937. /b/

                         OR -- Haig plan of
                         Sept. 1937. /b/
---------------------------------------------------------------------
     /a/ Actually, it may be possible and desirable to use some test
other than listing. Even if it is not, the recommendations stand.

     /b/ It is extremely difficult to choose among these plans, but
the reformed step scale is probably the best, all things considered
(the Division plan seems to have too much complexity for the taxpayer
for the advantages it brings, and the Haig plan seems to offer too
great an inducement to shift losses). The one-table and two-table
plans are really better except for the "jumps" in tax, and if those
jumps are not deemed too great, or can be reduced by some simple
device, the one-table plan in No. 7 would probably be the choice.

     /c/ That is, existing rates unchanged.

2. Increase rates as recommended in the Studies. (Vol. V. p. 4), and use totality rates as Studies suggest, but inform taxpayer also of equivalent bracket rates.

3. Coordinate gift tax with death tax by adding gifts to estate to compute estate tax and crediting gift taxes already paid. Studies, (Vol. V, p. 6). Amend Constitution if necessary to do this.

4. Repeal the $40,000 insurance exemption. Studies, (Vol. V, p. 2).

5. Use graduate scale suggested in Studies, (Vol. V, p. 3), for property previously taxed.

6. Restrict exemption to charitable bequests, as suggested in Studies, (Vol. V, p. 3).

7. Eliminate, as suggested in Studies, (Vol. V, p. 4), the option to value property at death or one year later.

8. Restrict $5,000 annual exemption in gift tax to all gifts together in the year, as suggested in Studies, (Vol. V, p. 7).

Unemployment Compensation Tax

1. Increase the credit, if later information shows this is necessary in order to reduce federal revenue to an amount equal to federal expenditures on administration of unemployment compensation system.

Customs Duties

Reduce the customs duties gradually, but thoroughly, to the point dictated by revenue or national defense considerations.

Tobacco Taxes

1. Adjust, as soon as feasible, the rates on the various tobacco products, to obtain much more equality than now exists -- and initiate this program by lowering the small cigarette tax rate to $1.50 a thousand (3 cents a package of 20), within two or three years if only $7.5 billion is needed in total tax revenue and if business conditions are as estimated for 1939 in the 1937 Tax Revision Studies.

2. Make the cigarette tax vary with the intended retail price.

3. State, on stamps, amount of small cigarette, snuff, and smoking and chewing tobacco taxes.

4. Check evasion in leaf-growing areas and through the use of tax-free cigarette papers, as suggested by Cox in 1934, unless tobacco tax administrators believe these problems no longer exist.

Automotive Excises

1. Repeal the taxes on lubricating oils, on accessories, and on trucks, unless revenue needs total $8 billion (see Chapter II). Repeal the taxes on passenger automobiles and motorcycles and tires and tubes if revenue needs drop below $7.5 billion (see Chapter II).

2. Repeal tax on movement to oil by pipeline.

Manufacturers Excise Taxes, Except Automotive Taxes

Stamp Taxes

Sundry Taxes

1. In these three groups, only the taxes on stock transfers, bond transfers, real estate transfers, and futures sales on commodity exchanges deserve a permanent place in the tax system. /1/ The others should be repealed /2/ -- practically all of them at once, and the remaining ones (taxes on toilet preparations, admissions, and possibly radios and phonographs) within two or three years, when the recommended income tax and estate tax changes will have had time to become fully effective. These remarks assume a total tax requirement of $7.5 billion. If the amount is much greater, all of these taxes will probably have to be retained, though of course one like the chewing gum tax, yielding only $1 million could easily be dispensed with.

2. If the toilet preparations tax is kept for any length of time the 5 percent tax on soap, toothpaste, and mouthwashes should probably be discontinued.

3. Revise the radio and phonograph tax as suggested in Vol. VI of the 1937 Tax Revision Studies, p. iv.

4. If the electrical energy tax is retained, it should be changed to a tax on consumers only if it appears that the power companies have not yet been able to get rate adjustments reflecting the tax.

5. Either change the stock transfer tax to a uniform percentage tax or levy specific rates in fairly narrow brackets, to impose on the average a burden about the same as at present. Studies, Vol. VI, Summary, p. iv (except as to level of rate).

6. Revise the toilet preparations tax, if it is retained, to include those who prepare or package toilet preparations in the form in which sold to consumers, as suggested in Studies, Vol. VI, Summary, p. iv.

7. Revise the tax on ticket brokers, if it is retained, to limit the 10 percent rate to excess charges not over 75 cents and to increase the rate to 25 percent on excess charges over 75 cents, as suggested in Studies, Vol. VI, Summary, p. iv.

8. Extend liability on admissions tax, if it is retained, to those responsible for collection who fail, wilfully or otherwise, to do so, as suggested in Studies, Vol. VI, Summary, p. iv.

9. Make the night clubs tax, if it is retained, a flat charge of 2 percent on total admission charges, as suggested in Studies, Vol. VI, Summary, p. iv.

10. Define sporting goods, if the tax on them is retained, more clearly, as suggested in Studies, Vol. VI, Summary, p. iv.

(The present writers have made no study of points 5 to 10 above, but wish to record their favorable reaction toward the Studies' proposal and reasons therefor).

Research

We recommend that research be initiated at once with respect to the following subjects (the topics are listed approximately in order of their importance; and Nos. 1, 2, and 3 are very urgent):

1. Feasibility of using an averaging system.

2. Rate needed to collect given sums from corporation privilege taxes both on very broad base recommended in Studies and on narrower base recommended in present report.

3. Specific questions concerning the undistributed profits tax.

4. Feasibility of splitting income of families or increasing spread between married and single exemptions.

5. Effect of taxes on stock, bond, and commodity transfers with respect to volume and kinds of trading.

6. Applying an earned income percentage, not to net income, but to net income less personal exemption and credit for dependents and (maybe) credit for exempt bond interest.

7. Methods of correcting injustices in graduated taxes that occur when prices rise rapidly.

8. Feasibility of Rignano plan.

9. Feasibility of stating tax on liquor tax stamps.

10. Feasibility of taxing imputed income.

11. Feasibility of restricting deductions for interest and bad debts on personal returns.

12. Cost of collecting each (major) internal revenue tax.

Miscellaneous Matters:

1. Appoint a commission of the kind referred to in Facing The Tax Problem, p. 436, 450, to plan federal-state-local fiscal coordination (Preface III).

2. Reduce three-cent letter charge to two cents and make up the difference by increasing charges on other mail and perhaps imposing charges where there now are none.

3. Repeal the recently enacted sugar tax (Act of Sept. 1, 1937).

FOOTNOTE TO PREFACE

/*/"Facing the Tax Problem is available from the various Tax Analysts' databases as Doc 96-4769 (309 pages).

FOOTNOTES TO CHAPTER 1

/1/ Note that the averaging device proposed in Chapter III is not of this kind.

/2/ See Facing the Tax Problem, pp. 332335, and Chapter III below.

/3/ For a brief statement of the argument on both sides of this question, see Facing the Tax Problem, pp. 16869 and 46872.

/4/ Facing the Tax Problem, Table 26.

/5/ More details, in the form of percentages for federal taxes alone, will be available in the forthcoming volume, Studies in Current Tax Problems.

/6/ Facing the Tax Problem, p. 255.

/7/ Facing the Tax Problem, p. 271.

/8/ See Facing the Tax Problem, p. 251.

/9/ See paragraph 82 on p. 421 of Facing the Tax Problem.

/10/ Facing the Tax Problem, p. 357.

/11/ Facing the Tax Problem, pp. 42527, 45051.

FOOTNOTES TO CHAPTER 2

/1/ By the Division of Research and Statistics, as reflected in the data in Tax Revision Studies, Vol. I.

/2/ In the same way that that term is used in Tax Revision Studies, 1937, Vol. I, in headings of tables on pp. 16 and 17.

/3/ State and local taxes are about $7 billion for 1937 (Facing the Tax Problem, p. 9) and will probably be at least $8 billion by 1939. The states will probably not be raising more than $0.3 billion or $0.4 billion from personal income taxes.

/4/ Note that as prepared in Chapter III the averaging device is open to this objection practically not at all.

FOOTNOTES TO CHAPTER 3, SECTION A

/1/ For further suggestions, see the third section of this chapter, dealing with problems common to the personal income tax and the corporation income tax.

/2/ As to preferred stock, see Section D of this chapter, on integration.

/3/ See Section D of this chapter.

/4/ Sec. 25(a)(1) and (2), Revenue Act of 1936.

/5/ See the discussion below, in this section.

/6/ These figures are taken from Facing the Tax Problem, pages 451454.

/7/ Assuming all income is earned.

/8/ For a few figures on combined federal and state income tax rates, see Facing the Tax Problem, pages 452454, and for details in eleven selected states, see the memorandum in the forthcoming Studies in Current Tax Problems (Twentieth Century Fund) -- "A Comparison of Aggregate Burden of Federal Income Tax and State Income Tax in Eleven Selected States," by Shoup, Shimberg, and Vickrey. For figures showing average rate of federal surtax only, on a few of the higher income levels, see the fourth column from the right in Table 6, page 73, Facing the Tax Problem. More details will be available in the memorandum by Burr and Vickrey, "Estimating Income and Estate Tax Yields," in the forthcoming volume, Studies in Current Tax Problems (Twentieth Century Fund).

/9/ As used in this section, this phrase also covers the credit for dependents.

/10/ Except as to the earned income credit. This could be adjusted, however.

/11/ For a brief analysis of this problem, see Facing the Tax Problem, pages 329335.

/12/ Note that this is somewhat of a change from the attitude of the present writer as expressed in his Memorandum G (pages 4142) to the Treasury Department in 1934.

FOOTNOTES TO CHAPTER 3, SECTION B

/1/ How Should Business Be Taxed. Tax Policy League, New York, 1937, pp.7485.

/2/ Op. cit., p. 75.

/3/ For the problem of the preferred stockholder, see Section D.

FOOTNOTES TO CHAPTER 3, SECTION C

/1/ The two averaging plans described herein embody some of the methods devised by Mr. Atlas of the Division of Research and Statistics.

/2/ This section of this chapter replaces the memorandum of August 4, 1937, to Mr. Magill.

/3/ For further details, see the section on capital gains later in this chapter.

/4/ An alternative would be simply to lump all such adjustments in reported income into the current year's income, regardless of what year they applied to.

FOOTNOTES TO CHAPTER 3,
AVERAGING OF INCOME FOR INCOME TAX PURPOSES

/1/ Under the rates in effect in 1937, A's total surtax and normal tax would be alternately $3,070 and $20,520 (making no allowance for exemptions and credits), an average of $11,795, while B's tax would amount to only $9,700 annually.

/2/ But if, for lack of foresight, spendthrift propensities, or other reasons, A does not even out his expenditure, but spends at a rate corresponding to his current income, it may well be argued that an approach to the principle of minimum sacrifice would involve taxing A more than B, since the chief burden of the tax would be upon A's expenditure at a time when the marginal utility of money would be low. But people do in fact average out their expenditures to a considerable extent, so that while this argument would be in full force if the tax were on the expenditure base advocated by Irving Fisher, with savings exempt (Irving Fisher: "Income in theory and income taxation in practice." Econometrica, Vol. 5, No. 1, January, 1937, and "A practical schedule for an income tax," The Tax Magazine, July, 1937), it can hardly apply to an income tax on income as normally defined for this purpose. Moreover, the tax on the high expenditure may and usually would be payable in the following year and thus would act to reduce expenditure in the year of low expenditure to a considerable extent.

/3/ The theory of this averaging device was apparently quite other than that of equalizing taxation; in fact, it was introduced at a time when graduation was almost nonexistent, consisting solely of an abatement at the lower end of the income scale. While there is no explicit statement in the acts to this effect, nor apparently do those who have to deal with the law so regard them, the peculiar provisions connected with the average basis of assessment may perhaps most easily be explained on the hypothesis that in theory the English income tax taxed the income of the year in which the tax was paid, and that since in cases where the income was of such a nature as to make it difficult either to collect the income at source as it is paid or to determine the income before the end of the year, an average of the income from that source for previous years was used as a method of estimating the income from that source for the current year. In line with this view are the facts that no assessment was made in a year in which there was no income from a given source, although there might have been substantial average income in previous years, while in the first year of income from a given source a provisional assessment was made regardless of the fact that an average of three previous years would result in a zero income from that source. Three-, five-, and seven-year averages were variously used with respect to different types of income. The average was purely with respect to a single source of income, and had no reference to the total income of the individual. It was only if the taxpayer was the sole and direct owner of the business or property producing the income that the use of the average had any substantial influence towards evening out his income; if he was a partner or stockholder, the income taxed was the amount distributed, independently of any average. The income tax paid by a company on its averaged income frequently did not correspond to the tax that it was required to withhold at the source from its disbursements to its shareholders, and where the standard rate of tax was changed from year to year the discrepancies frequently tended to cumulate. The net effect of the averaging method in reducing the fluctuations of the incomes subject to supertax at graduated rates and so equalizing the tax burden was probably very slight, nor did the witnesses who appeared before the Colwyn Commission in support of the averaging device make any great point of any such effect, if indeed they considered the matter at all.

/4/ For a summary of the history of the averaging provisions, see Great Britain: Royal Commission on the Income Tax (The "Colwyn Commission"): Report -- (London, 1920) Appendix 7(m). Testimony on the averaging provisions is indexed under "Assessment, average basis of." See also H.B. Spaulding "Income tax in Great Britain and the United States." (London, 1927) pp. 211-228.

/5/ The previous law had provided that the tax be assessed in the year following the income year, and paid one year later, that is, two years after the income year. This was particularly fortunate for as the tax paid in 1927 had been based on the income of the year 1925, the tax paid in 1928 could be based on the 1926 income and on the 1927 income; together with the tax on these incomes in later years, these incomes were in a sense taxed just once fully. Had there been no such previous lag in the collections, the state would either have had to suffer a postponement of revenues, or the income of one or more of the transition years would have had to bear tax the equivalent of more than once. This would not have been an insuperable obstacle, but certainly would have been a point capable of being much belabored in the hands of the opposition to an averaging device, as well as a source of considerable tax avoidance by taxpayers shifting as much of their income as possible out of the years that are taxed more than once. When the averaging device was abandoned in 1931, payment was not restored to the old basis, but the tax was required to be paid in the year following the income year, with the result that in order to avoid requiring two tax payments in one year, either the income for the year 1932, or of the income for 1931 and of the income for 1930 escaped tax altogether, tax being assessed on whichever of the two incomes was larger. This worked no substantial injustice on the average, but did result in a hardship to those taxpayers where great disparity existed between the income of 1932 and the average income for 193031.

/6/ A similar difficulty would have been experienced, it must be pointed out, had the provisions of the old law still been in effect, under which payment was made two years after the income was received. The average period of delay would have been the same in either case.

/7/ See Wisconsin Tax Commission -- Rules and Regulations of the Wisconsin Tax Commission under the Income Tax Act of 1931, pp. 215- 219.

/8/ While it is difficult to be certain that all cases have been covered, a cursory survey of available literature failed to reveal any instances of the actual use of averages for the computation of income taxes other than the four here cited.

/9/ New South Wales enacted in 1912 an averaging provision that applied only to income from farming, dairying, and pastoral pursuits which was very similar to, and in fact probably furnished the model for, the Commonwealth Act. The Commonwealth Act at first related similarly only to income from "primary production," but was amended to include all income before it took effect. In the 1936 revision of the Commonwealth Act, however, the averaging provision was again restricted to income from agriculture, effective with incomes for the year ending June 30, 1938. The writer has at present no information concerning the reasons for this step, although one reason may have been the desire for uniformity among the laws of the Commonwealth and the several states: the same revision of the act made provision for a considerable degree of integration of the administration of the commonwealth, state, and potentially at least, local income taxes.

See Rydge, Norman Bede, and Collier, J. B., Commonwealth Income Tax Acts, 19221929 (Sydney, 1929), pp. 82113, also Collier, J. B. and Rydge, Norman Bede, New South Wales Income Tax Acts (Sydney, 1930), pp. 3035.

/10/ In general, the rearrangement of the taxpayer's income stream may reduce his total tax liability in one of the following ways:

a. By shifting income to years where the taxpayer's income is lower and the applicable rates are therefore also lower (This is essentially what an averaging scheme does for all taxpayers, and it is hard to see why this should be particularly reprehensible. But not all taxpayers are able to do this to the same extent under the present law.)

b. By shifting income to years when the entire schedule of rates is lower by reason of legislative action. It is not always easy to foretell, however, when the rates are going to be lower or higher. (To prevent this kind of shifting may be one of the more or less unconscious motives for enacting income tax legislation retroactively. If such action were futile, fewer retroactive laws might be one result.)

c. By putting income in the form of capital gains that are not realized until after the death of the taxpayer or until after the property has been disposed of by gift. This is the only form of evasion of changing the shape of the income stream that apparently cannot be checked merely by an averaging device. It is not so much a shifting of income from one year to another as putting it in a form in which it escapes taxation altogether.

d. By shifting income to future years in general. By doing this, the taxpayer gains an amount equal to the interest on the tax which he postpones, less the tax on this amount. Where the postponement is for a long period and the tax rates are high this may be a very substantial saving. For example, suppose that a taxpayer whose income is $175,000, and who is therefore subject to surtax at 60 percent and normal tax at 4 percent under the present rates, has the option of realizing income of $10,000 immediately, or of postponing realization for a period of 10 years. If he realizes now, he pays immediately an income tax on this income of $6,400, and may invest the remaining $3,600 at say 3 percent for 10 years, compounding the interest without realizing, and so obtain in the tenth year the sum of $4,838.10. Of this $1,238.10 is interest and therefore new income upon which, assuming that the rates remain unchanged, he must pay a tax of $792.38, leaving $4,045.72 as the net proceeds. If he does not realize immediately, the amount may be allowed to accumulate untaxed, and in 10 years at 3 percent will grow to $13,439.16, upon the realization of which a tax of $8,601.06 will be due, leaving a net proceed to the taxpayer of $4,838.10 or $792.38 more than by the other method. This net difference is the residue after paying tax, 36 percent (100 percent 64 percent) of $2,201.05, which is in turn the amount which $6,400, the amount of tax postponed, would earn at 3 percent compound interest in 10 years. More extreme examples occur with higher tax rates and longer periods.

/11/Under a strict accrual method of accounting and assessing income tax it might theoretically be extremely difficult or impossible for an individual to shift income from one year to another. In practice it is extremely difficult to prevent this. Some of the methods available under the present federal law are:

a. To sell or not to sell assets upon which gains or losses have accrued.

b. To have surplus retained in corporations rather than distributed as dividends (made expensive under the existing law by the undistributed profits tax, but never sufficiently so to make this unprofitable in all cases. Revisions in the law are apparently going to make the expense of this method of shifting income even smaller.).

c. To arrange to have fees, commissions, etc., delivered before or after the end of the year.

d. To under- or overvalue inventory.

e. To make larger or smaller allowances for depreciation, depletion, obsolescence, etc. Although in theory this method may be contrary to law, it is administratively exceedingly hard to check. Arbitrary allowances for depreciation, etc., made from administrative necessity, are frequently wide of the mark, and usually must be somewhat lenient to the taxpayer, on the average, if they are not to be harsh in individual cases.

/12/ This invariance may be shown as follows: (for simplicity it will be assumed in the mathematical analysis that income accrues continuously, tax is paid continuously, and that interest is compounded instantaneously at a rate i):

Let an individual have, for each interval of time dt in the
period of time from t=0 to t=b an accrued income a(t)dt, a
realized income r(t)dt, an income tax s(t)dt, based upon r, and
an expenditure x(t)dt; let his capital at time t be A(t), then
his interest income will be iA(t)dt. His other income (from
earnings, windfalls, etc.) will be designated w(t)dt = a(t)dt
iA(t)dt. For present purposes we consider w(t) and x(t) fixed,
r(t) variable at the will of the taxpayer, subject to the
condition that the taxpayer cannot shift income entirely out of
the period under consideration; more precisely, that the amount
of accrued capital gains at the beginning and end of the period
0 to b are fixed. Let G(t) be the amount of unrealized capital
gains at a given time, that is, the excess of the capital A over
its "basis" for tax purposes.

Then

[equation omitted]

where y stands for a variable time between 0 and t. If G(b) and
G(0) are held fixed, then

[equation omitted] (1)

Now the rate of saving is

[equation omitted] (2)

Substituting for a(t),

[equation omitted] (3)

Multiplying by e-it

[equation omitted]

Integrating,

[equation omitted]

Solving for A(t),

[equation omitted] (4)

Now the quantity which is to be proven invariant is

[equation omitted]

Substituting for r(t)dt with equation (1)

[equation omitted]

Substituting for a(t) from (3)

[equation omitted]

Substituting for A(b) from (4)

[equation omitted]

Now one of the quantities on the right-hand side of the equation may
be altered by merely shifting the realization of income about between
the limits 0 and b. The first term represents compound interest on
the original capital, the next two represent the realization of
previously accrued capital gains, the fourth represents the savings
of the period with compound interest, and the fifth the expenditure
for the period. I may be varied by changing the expenditure pattern
and saving either more or less, but this is not considered pertinent
for present purposes. The simplest method of preventing the taxpayer
from operating on the value of G(b) is to have an inventory at the
end of the period and bring all gains into account. This is
equivalent to setting G(b) = 0.

/13/ The required computations might be set out as follows on the income tax return:

1. Net income this year (after exemptions) $18,500

2. Adjusted total income as of previous year 9,200
(Copied from item 5 of previous year's return)

3. Total value of income taxes paid as of prev. year 252
(Copied from item 6 of previous year's return)

4. Interest for current year on taxes paid (5% of item 3) 12.60
(The rate of interest may be varied from year to year by
the treasury in accordance with current economic
conditions. The rate of interest must of course be the
same as that used in the computation of the
surtax tables)

5. Adjusted total income (sum of item 1, 2, & 4) 27,712.60

6. Present value of tax on item 5 1,204.02
(Computed from surtax table)

7. Present value of past income taxes paid 264.60
(Sum of items 3 and 4)

8. Tax due (Item 6 minus item 7) 939.44

Item 6 is computed from the following table:

SURTAX TABLE

For computation of total present value of surtax due on total adjusted incomes for the years 193738. For use only by taxpayers averaging their income for the years 1937 to 1938 inclusive.

Adjusted                    Total              Rate of tax on
total                   present value        excess within next
income                     of tax                 bracket

      $0                      $ 0                    0.0000%
   8,000                        0                    4.0959%
  12,004                      164                    5.1186%
  16,009                      369                    6.1408%
  20,015                      615                    7.1625%
  24,032                      902                    8.1836%
  28,030                    1,230                    9.2043%
  32,039                    1,599                   11.2441%
  36,050                    2,050                   13.2818%
  40,053                    2,583                   15.3176%

and so on. The chief difference between this and present surtax
tables is the fact that the figures are not rounded and the amounts
in the first two columns are a little over twice as large as the
corresponding amounts in present tables (the table is for taxpayers
averaging over two years at the surtax rates in the present law with
interest at 5 percent). The amounts in the first two columns would be
a little more than three times as large for a three-year period and
so on. The tax in line 6 is the sum of the tax on $24,022, or $902,
and the tax on the excess, $3,690.60, at 8.1836 percent, or $302.02 a
total of $1,204.02.

The table is computed as follows: A taxpayer with a steady annual income of $12,000 pays a tax each year of $440. Interest on the first year's tax at 5 percent is $22. This $22, added to that total income for the two-year period of $24,000 gives an adjusted total income of $24,022. The total present value of tax is $440 + $440 + $22 = $902. The next higher level given is an adjusted total income of $28,030, with a total present value of tax of $1230; thus the size of the total adjusted income bracket is $4,002, and the tax on this bracket is $1230 $902, or $328. The rate of tax on this bracket is therefore 328 divided by $4,002, or 8.1836 percent.

/14/ These limits may be obtained and demonstrated as follows: Let z(r,y) be the tax payable under a straight annual assessment upon a realized income r according to the basic schedule in effect at the time y. The total value of the tax paid up to time t, as of time t, will be equal, under the method of assessment described above in the text, to the total value of the tax paid over the same period by a hypothetical taxpayer with a steady income "r" (r may be termed the "average income" of the original taxpayer) of such a magnitude that the adjusted total income of the hypothetical taxpayer is equal to the adjusted total income of the original taxpayer. Thus we have:

[equations omitted]

/15/ Under a constant set of rates there will be a tendency for revenue to fall off gradually during the first few years of the application of such an averaging plan. This is caused by the elimination of the additional revenue which results from fluctuations in incomes of individuals as the mean length of individual averaging periods grow longer and more and more of these fluctuations are averaged out. For this reason, a further gradual decrease in the income levels at which given rates of tax become effective may be considered desirable in addition to the decrease of fifty percent suggested above; the necessity for this procedure will of course depend to a considerable extent on fiscal policy.

/16/ Many of the complicated, controversial, and often arbitrary regulations for determining when gains are realized may be discarded, or, if this is not done, at least there will no longer be any incentive for contention on either side. The only necessary requirement is that any amounts received from property be either reported as income or applied to reduce the basis of the property. Similarly with depreciation and depletion. The only limitation required is that whatever depreciation is deducted as an expense be applied against the basis. The problem becomes chiefly one of avoiding double counting and seeing to it that taxpayers do not postpone realization of income to the point where there is danger of loss of tax through insolvency. (This latter danger already is taken care of through the provisions in existing law for jeopardy assessment). It may be desirable to provide a slight incentive to taxpayers to report income and pay taxes as early as possible by setting the interest rate used in the computation of the tax slightly above the market rate.

FOOTNOTES TO CHAPTER 3, PROBLEMS COMMON TO THE
PERSONAL INCOME TAX AND THE CORPORATION INCOME TAX

/1/ Kanton Basel-Stadt. The writer's source for this information is a letter of July 28, 1937, from Professor Gerhard Colm to Professor Robert M. Haig.

/2/ This matter is explained in detail on p. 5 of the "Comments on Tax Revision Studies, 1937 -- Vol. III -- Capital Gains Tax," by Carl Shoup, Sept. 8, 1937.

/3/ Note that this is not a matter of high tax rates or low tax rates, but rate of progression -- and this rate of progression may be steep at very low tax-rate levels. It is certainly very gradual at the highest tax-rate levels.

/4/ The Division calls its plan an "accrual" plan, but this term is apt to mislead, in the present analysis, at least. The writer conceives of an accrual plan as being one that taxes gains and losses as they actually accrue. The Division's plan apportions gains and losses over several years.

/5/ The following examples of the operation of the Division's apportionment plan -- and to some extent of any plan that makes the tax rate applicable to the capital gains of several years depend on the income of any one year, such as the simplification of the Division's plan suggested by Dr. Haig -- show to what extent anomalous situations prevail.

Example 1. Given a taxpayer with $200,000 of gains accrued over a five-year period (or any combination being treated as such on the average), the tax and net income after taxes with varying amounts of other income are as follows (for simplicity in calculation, the normal 4 percent rate and personal exemptions are ignored, but the omissions do not significantly affect the results:

Ordinary income           Total surtax,        Net income
after personal            assuming gains       after surtax
exemptions                as noted above

[illegible]

Thus, a man must get somewhat more than $150,000 in other ordinary income before it will pay him to have any ordinary income at all, and, as shown by a computation not reproduced here, at all levels below $[illegible], the more he can reduce his other income, the better off he will be.

For a $[illegible] gain accrued over a 10-year period, the results can be illustrated as follows:

[Illegible table]

Here, an income of $[illegible] is the minimum break-even point. In 19[illegible], capital gains on assets held more than two years amounted to from 20 percent to 50 percent of all income in brackets above [illegible], and situations similar to the [illegible] were not uncommon.

Example 2. Consider a taxpayer with $50,000 ordinary income; a loss of $100,000 accrued during the last two years (or any set of losses giving a similar average under the division's apportionment plan) and a gain of [illegible] accrued over 10 years. His net income, and presumably his ability to pay, is likely to be no greater than than of a person having just the $50,000 ordinary income. Yet the former will have to pay, under the Division plan, $[illegible] as against $7,700 for the taxpayer with no gains or losses. It seems hard to justify such a difference on any grounds of ability to pay, and such treatment is likely to draw adverse comment from taxpayers with capital gains and their professional advocates. A more extreme example in which the tax was greater than the net income of the taxpayer occurs if a taxpayer with a $30,000 ordinary income realizes a gain of $200,000 over a two-year period and a loss of [illegible] over a 10-year period, the tax then being [illegible] under the Division plan.

/6/ The point here is this: Assume that A buys on Jan. 1, 1938 and sells on Dec. 31, 1940, gain $10,000, and engages in no capital- asset transactions in 1941; that B buys on Jan. 1, 1938, and sells on Dec. 31, 1940, gain $10,000; and buys on Jan. 1, 1939, and sells on Dec. 31, 1941, gain $10,000. B has twice as much gain ($20,000) as A ($10,000), but pays only twice as much tax, under the apportionment plan. Assuming that A and B have the same constant other income, 1938 to 1941 inclusive, which is the assumption the apportionment plan makes, the philosophy of the progressive rate scale calls for more than twice as much tax. If B's $20,000 gain does not consist of overlapping gains -- if it is $10,000 accrued and realized in 1938 and $10,000 accrued and realized in 1940, for instance -- he does pay more than twice as much tax as A, under the apportionment plan.

/7/ The tables in this section, and much of the analysis, are the work of William Vickrey.

/8/ The other variables -- size of other income, and size of capital gain -- are instrumental in determining, finally, the tax due, but they are not linked with the time variable.

/9/ If the answer were given in these terms, it would be in the same general class as, but much better than, the proposals to tax gains at some single arbitrary fraction of the top rate applicable to other income. Under No. 6 above, also, the answers could be in terms of tax rate rather than percentage taken into account.

/10/ However, the averaging plan formulated by Mr. Vickrey -- the cumulative averaging plan -- would apparently be neutral.

/11/ The trusts problem has not been examined in this memorandum, owing to lack of time, and also because it has been analyzed extensively in the course of the recent study on tax evasion and avoidance, but it may be said here that if a constitutional amendment is to be passed, it might be well to make it broad enough to enable Congress to deal with the problem of trusts.

/12/ But see the special section on capital gains and undistributed profits in Ch. XV.

/13/ See, for instance, the recently issued "Roseberry Report on Potential Tax Savings in Gifts, Trusts, and Bequests," Stanford Associates Bulletin No. 6, Stanford University, Calif.

/14/ In the words of the Federal Revenue Act of 1936, dealings in (1) "property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year" ("stock in trade" is mentioned as an example) and (2) "property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business." (section 117 (b)).

/15/ Another classification, cutting across the classification given here, divides gains and losses into those resulting from (2) transactions entered into with expectation of profit or alternatively in the ordinary course of business and (b) all other transactions. This classification, besides simplifying the problem too much for purposes of the present analysis, seems not to take into account adequately personal differences in ability or duty to support government.

/16/ Taxpayers not on a calendar-year basis would have to discover the prices for themselves -- or the Treasury might publish quarterly lists of prices.

/17/ However, the present section was written before the cumulative averaging device was developed (by Mr. Vickrey). This device accomplishes more than the other averaging devices. Thus the judgments passed in this chapter's tables are somewhat less favorable, in some respects at least, to Plans A and B than they would be if a cumulative averaging device were adopted. Indeed, such a device might make most of the other provisions of Plan A unnecessary.

/18/ Termed "Accrual" Plan by Division of Research and Statistics.

/19/ Example: Gain, $100. Tax, if asset is sold now, $30; net gain, $70. If gain declines to $87.50 in three years, and asset is then sold, tax is $17.50, and net gain is $70. Note that the tax is reduced both by the decline in the effective tax rate and the decline in the tax base.

/20/ In the first case he pays $5,000 tax because of the gain, and gains $1,000 in tax because of the loss -- a net tax increment of $4,000. The net gain before tax is $10,000 minus $5,000, or $5,000, and the net gain after tax, $5,000 minus $4,000, or $1,000. In the second case the net gain before tax is $2,000, the tax $1,000, and the net gain after tax, $1,000.

/21/ In the first case the loss reduces his tax by $300 (50 percent of 60 percent of $1,000), so the net loss after tax saving is $700. In the second case the loss reduces his tax by only $175 (50 percent of 40 percent of $875), so the net loss after tax saving is $700.

/22/ In this case the taxpayer should, logically, sell short.

/23/ In this case the taxpayer should, logically, sell short.

/24/ In this case the taxpayer should, logically, sell short.

/25/ To summarize the four possible cases:

Tax pressure:                   Method of maintaining
                                position that taxpayer would
                                maintain in absense of tax pressure

Delay in realizing gain         Short Sale

Hastening in realizing gain     Repurchase

Delay in realizing loss         Short Sale

Hastening in realizing loss     Repurchase

/26/ "The Distinction Between "Net" and "Gross" in Income Taxation," by Carl Shoup. See pages 10-12 and 25-35. National Bureau of Economic Research, New York City. (Part VI of forthcoming volume on Income).

FOOTNOTES TO CHAPTER 3, SECTION D

/1/Questions involved in integrating corporation and personal income taxes can be answered with somewhat greater certainty when only common stock is outstanding than when there is also preferred. When only common stock is outstanding, the whole corporate income goes to the common stockholder and the whole income tax burden falls on him -- assuming that it is not shifted to consumers. When, however, the corporation has both preferred and common stock outstanding, the preferred holder has a prior claim to earnings free of corporation income tax, which earnings, however, are part of the corporation income subject to tax. The common stockholder is thus burdened not only by the tax on the income that will be paid to him but also by the tax on the income paid to the preferred stockholder. In the absence of any tax shifting or capitalization, equality of taxation between preferred and common stockholders cannot be fully achieved. The inequality might be lessened by denying to the preferred stockholder the right to exemption from normal tax on his dividends while allowing such exemption to the common stockholder.

If, however, the distribution of the tax burden has been fully anticipated and discounted in determining the rate of dividend on the preferred shares, the effect is to tax the preferred and common stockholders alike. Integration problems are not increased by preferred stock in this situation. Preferred and common stockholders should be treated alike in dividend exemption.

In general, the location of the tax burden is probably taken into account by investors and accordingly affects the rate of preferred dividend allowed. However, such anticipation cannot always be accurate since unexpected changes in taxation or corporate earnings may occur after the stock has been issued. Whether or not part of the corporation income tax is borne by preferred stockholders, the removal of obvious inequalities between the burdens of the common stockholder and of investors in unincorporated business is well worth attempting.

For the sake of simplicity in discussion, it is assumed (except in minor cases where other assumptions are necessary) that only common stock is outstanding, or that if preferred stock is outstanding, the tax burden has been fully discounted in determining the rate of preferred dividend.

/2/ Suggested by Harley Lutz.

/3/ Notably Irving Fisher.

/4/ Some may consider that the receipt of taxable stock dividends constitutes realization. In an economic sense (as distinguished from the legal), realization has occurred only to the extent that the total market value of securities held has increased (some people will deny that there is any realization until sale).

/5/ A characteristic urged by some writers concerns the effect of integration methods in dampening the swings of the business cycle. It is omitted here because, due to the state of uncertainty existing in business cycle theory, the writers are not prepared to say even tentatively what the results of integration methods would be. Conflicting points of view are included in the sections "influence on payment of dividends," and "effect on corporation capital."

/6/ In the discussion, the writers sometimes present conflicting points of view without stating a conclusion, for the reason that they have not reached one. The complexity of the issues involved and the need for further study should be stressed.

/7/ Facing the Tax Problem, p. 162.

/8/ Assuming that the avoidance has not been eliminated by methods previously discussed. Even so, the saving is not net, however, since the capital gain increases the size of the estate subject to death taxes.

/9/ Payment in notes or other taxable obligations resembles forced borrowing; it gives an obligation to repay which at maturity will be realized in cash.

/10/ By economic power is meant the ability of a person to command goods and services, that is, exchange value. Corporate earnings may increase a stockholder's economic power in one or more of three ways. (1) They may be paid to him as a cash dividend. (2) If the dividend is not paid he may be in position to force its payment when he wishes; this is an increase in economic power equivalent to the dividend. (3) Whether or not he is in position to force the payment of the dividend, his stock may have increased in value on account of the corporate earnings; this increase in value is an increase in economic power. Of course, the second and third kinds of increase in economic power cannot be added; the larger of the two represents the increase to be counted. Thus, if corporate earnings with respect to a share of stock are $10, if the stockholder has the power to force their payment as dividends, and if the market value of the stock has increased $7 on account of the earnings, his economic power has increased $10.

/11/ See the section on legal characteristics.

/12/ See L. H. Parker, "Investigation of Possible Revisions of the Surtax on Undistributed Profits," pp. 87-95.

/13/ An additional point may be noted. If persons in control of the corporation came to the conclusion that dividend policies had a measurable effect on the price of stocks, they might decide on that dividend policy which increased the price the least and thus kept taxes (temporarily at least) at a minimum.

/14/ See discussion ealier for effects on security markets of the inventory method.

/15/ As the terms are used here individualism means control of the individual over his activities, while collectivism means the control of a group over the activities of the individual.

FOOTNOTES TO CHAPTER 4

/1/ Not only the capital stock and excess profits taxes but also the corporation normal income tax must be considered business taxes in this connection, since the latter has in recent years been only slightly integrated with the personal income tax and at present is not integrated at all.

/2/ Since in general business taxes have been imposed only on corporations the same comments would not apply to investments in partnerships and proprietorships.

/3/ Fallacies such as the one that since businesses could not get along without government therefore all business income is the measure of benefits from government should be avoided. Many factors are necessary to the creation of business income and government is no more responsible than other limiting factors.

/4/ The true excess profits tax is discussed in a later section.

/5/ Deductions of various kinds, for example, assessed value of tangible property, are often allowed in taxes of this general type.

/6/ The latter is the type recommended by the Division of Research and Statistics in Investigations of Tax Policy.

/7/ Except with respect to rent, previously discussed.

/8/ Apparently imposed on book value with some modifications.

/9/ For the problem of rent, see discussion in previous section.

/10/ For a discussion of this point with respect to holding companies, see Facing the Tax Problem, pp. 181-182.

FOOTNOTES TO CHAPTER 5

/1/ For a brief summary of the history of the Sales Tax see "Memorandum -- The Sales Tax," submitted to the Federal Treasury in 1934 by Carl Shoup (hereinafter referred to as "1934 Sales Tax Memorandum").

/2/ Details are given in Appendix One.

/3/ 1934 Sales Tax Memorandum.

/4/ For further data on cyclical variability of various taxes, see 1934 Sales Tax Memorandum, Appendix Two, and Facing the Tax Problem, pages 322-329.

/5/ For further comments on this point, see 1934 Sales Tax Memorandum.

/6/ For a discussion of double taxation under the manufacturers sales tax, see 1934 Sales Tax Memorandum.

/7/ For some data on the size of the inducement that might be needed to get states to give up their sales tax, see 1934 Sales Tax Memorandum.

FOOTNOTES TO CHAPTER 6

/1/ See his 1934 report on Federal Estate and Gift Taxes. p. 78 ff.

/2/ See Wisconsin Tax Commission, Report, 1928, p. 196.

/3/ Since there is no one correct rate scale, the difference in views of exemptions is largely metaphysical in the case of the estate tax. In the case of the income tax or of any progressive tax with exemptions varying according to personal status, a real difference in effects exists.

/4/ This preference for fairly wealthy as against very wealthy people rests on two assumptions: (1) that some inequality in wealth is necessary to secure adequate savings, and (2) that the extreme economic power and preferred position of a few (there can never be more than a few) very wealthy persons are undesirable.

/5/ See Facing the Tax Problem, p. 231.

/6/ Facing the Tax Problem, p. 22, 533.

FOOTNOTES TO CHAPTER 7

/1/ The Railroad Employment Compensation taxes are omitted from consideration as a special and minor problem.

FOOTNOTES TO CHAPTER 8

/1/ Facing the Tax Problem, p. 142.

/2/ See 1934 Treasury memorandum by K.M. Williamson.

FOOTNOTES TO CHAPTER 9

/1/ See Memorandum L, Liquor Taxes, submitted to the Treasury in 1934 by K.M. Williamson. This memorandum, which is drawn on heavily by the present writer, is probably the best concise, yet comprehensive, study of the liquor tax problem in the United States in recent years. It is hereafter referred to as "1934 Liquor Tax Memorandum."

/2/ A "proof gallon" is a gallon of distilled spirits containing one-half of alcohol by volume. If the gallon were 75 percent alcohol, it would be "150 proof" and would be taxed $2 plus $1, or $3. If it were 100 percent alcohol, it would be "200 proof," taxable at $4. But if the gallon is under "proof," the tax remains at $2 -- e.g., if the gallon contains only 40 percent alcohol. Naturally, therefore, practically no spirits are distilled at less than 100 proof, though they are blended and reduced in strength after the gallonage tax has been paid.

Special note for Mr. Magill:

With respect to [footnote 2], I intended to get the alcohol tax authorities to check on the accuracy of my statement concerning proof gallons, but did not get around to it. It might be advisable to show it to them soon to see if it needs any change -- though I am fairly sure that it is all right. C.S.

/3/ 1934 Liquor Tax Memorandum.

/4/ 1934 Liquor Tax Memorandum.

/5/ See Facing the Tax Problem, p. 566.

/6/ Facing the Tax Problem, p. 434.

FOOTNOTES TO CHAPTER 10

/1/ The most thorough treatment of the federal tobacco taxes of which the writer is aware is the 198-page typewritten report submitted to the Treasury by Reavis Cox in 1934. This is hereafter referred to as "1934 Tobacco Tax Memorandum."

/2/ 1934 Tobacco Tax Memorandum.

/3/ For comparative indices of stability, see Facing the Tax Problem, pages 326-327.

/4/ 1934 Tobacco Tax Memorandum.

/5/ For his reasons, see 1934 Tobacco Tax Memorandum.

/6/ See 1934 Tobacco Tax Memorandum.

/7/ See 1934 Tobacco Tax Memorandum.

/8/ See 1934 Tobacco Tax Memorandum.

/9/ 1934 Tobacco Tax Memorandum.

/10/ Twentieth Century Fund, Big Business -- Its Growth and Place, p. 42.

/11/ 1934 Tobacco Tax Memorandum.

/12/ 1934 Tobacco Tax Memorandum.

/13/ 1934 Tobacco Tax Memorandum.

/14/ Facing the Tax Problem, pp. 530-31.

FOOTNOTES TO CHAPTER 12

/1/ Also not including the minor tax on brewers' wort and malt (yield in 1937, only $822,000), which is connected with the liquor problem.

/2/ The pistols and revolvers tax produced only $100,000, but it should probably be considered in connection with the tax on firearms, shells, and cartridges.

/3/ Hereafter referred to as "1934 Excise Tax Memorandum."

FOOTNOTES TO CHAPTER 13

/1/ See 1934 Excise Tax Memo. As to the regulatory aspect of taxes on commodity exchanges, see Appendix 2 to that memorandum.

/2/ 1934 Excise Tax Memo.

/3/ The tax on transfers of silver bullion, however, presents a special problem.

FOOTNOTES TO CHAPTER 14

/1/ See Appendix 1 by Reavis Cox to Memorandum P submitted to the Treasury in 1934 by Carl Shoup, "Manufacturers' Excise and Special Taxes," and the analysis by Roy Blough in Facing The Tax Problem, pages 144-146, 192-193, and 196-197.

FOOTNOTES TO CHAPTER 15

/1/ However, there may be special cases for the taxes on foreign insurance policies and passage tickets, and there is of course for the silver bullion transfer tax.

/2/ Judgment is not passed here, however, on the minor regulatory taxes except to urge that the oleomargarine tax on yellow oleomargarine be sharply reduced and that the taxes on crude petroleum, refined petroleum, and gasoline from natural gas be repealed.

END OF FOOTNOTES