====== SUMMARY ======
As background for later sections on tax reform in "Facing the Tax Problem," Book One explores the nature and history of the American tax system. Describing a wide variety of federal, state, and local taxes, the section also details the evolution of U.S. taxation from 1914 to 1937. The section outlines criteria for judging a tax system.
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On an average, every person in the United States pays $100 a year in taxes. Some of course pay much more and some much less. In one way or another, however, a yearly total of $12,500,000,000 is being collected by the federal, state, and local governments. This is the highest amount in the nation's entire history. An even greater amount is being spent, the excess being covered chiefly by borrowing. Another $15 to $20 a person would be needed if borrowing were to be ended and expenditures were to continue undiminished.
More than one-fifth of what the statisticians call national income is used to pay taxes -- and the tax money, when it is paid out in government expenditures, in turn accounts for more than one-fifth of the national income. The fraction would be close to one-fourth if borrowing were to be replaced by an increase in taxes.
Directly or indirectly, every person pays something. If he does not pay directly to the government, he at least helps others pay through increased rent and prices for food, clothing, and other necessities of life. Sometimes he is reminded of his indirect role by the tax stamps on the cigarette package or liquor bottle, or by the pennies and tokens of the sales tax. Taxes so high and so wide- spread are bound to awaken public interest.
In the United States, moreover, the unusually large degree of local self-government leads to conflict among the 175,000 taxing jurisdictions. The recent shift of powers from localities to states and from states to nation has
broken up traditional tax patterns and has stimulated the search for
federal, state, and local tax co-ordination.
Legislators, government administrators, specialists in taxation, and many kinds of taxpayers' organizations have been planning, promoting, and actually carrying into effect programs for tax reform. In some of the programs, taxation is simply a means of raising revenue; in others, it is a way of assuring government control over economic activities.
Thirty-six states have had their state and local tax systems thoroughly examined by special commissions and committees in the eight-year period 1929-36. /1/ The federal government has passed ten major revenue acts in the same period. /2/ Of the 932 opinions that the Supreme Court rendered from 1929 through 1935, approximately 250, or 27 per cent, concerned tax cases. /3/ Since 1929, six textbooks or compilations of readings on public finance have been published in the United States -- some of them in more than one edition. /4/ At the same time, a stream of comments on the tax system has flowed from the presses in newspapers, magazines, and pamphlets.
A CATALOGUE OF COMPLAINTS
Out of this intense activity, much of it critical, several major complaints about the tax system have emerged. They are listed below. Not everyone will agree that all of them are justified, or that they are the most important. They are not wholly consistent, partly because different complaints often come from different groups. Whatever their shortcomings, however, the criticisms
/1/ See Note 1, Special Comprehensive Reports on State and Local Taxation in the Period 1929-36, p 509.
/2/ See Note 2, Federal Revenue Acts in the Period 1929-36, p. 509.
/3/ See Note 3, Supreme Court Tax Cases in the Period 1929-35, p. 510.
/4/ See Note 4, Textbooks and Books of Readings in Public Finance in the Period 1929-36, P. 511.
are important in the degree of dissatisfaction that they indicate.
(1) The federal tax system is said to be dangerously unproductive in view of the enormous government expenditures. If expenditures are not sharply cut, it is claimed, the yield of the federal tax system must somehow be greatly increased in order to avoid disastrous inflation.
(2) The tax system is charged with being too sensitive to changes in business. According to this view, the highly sensitive taxes, such as those on incomes and estates, shrink alarmingly during a depression, when the burden on government grows and revenue is most needed. In prosperous periods, these taxes are said to encourage wasteful spending, owing to the large yields that such periods produce.
(3) On the other hand, the tax system is criticized for not being sensitive enough to changes in business. In depressions, according to this view, taxes ought to drop even more than they have done, in order to encourage governmental borrowing and creation of new purchasing power, which will tend to promote recovery. In prosperous periods, this doctrine demands heavy taxes in order to prevent excessive speculation.
(4) The tax burden is said to be so heavy that it is crushing the country by stifling business initiative and other aspects of private enterprise. The government is seen as a voracious silent partner whose exactions discourage business ventures, especially the risky ones.
(5) The tax burden is a crushing load, according to a variant of this complaint, which charges that it is eating into the capital of the country and is preventing the accumulation of new capital.
(6) The tax laws are said to distribute the burden of taxation unfairly. Real estate values (or cigarettes, or high incomes, or low incomes, etc., etc.), it is said, are
taxed too heavily compared with other property, or with persons.
Special provisions in many taxes -- for example, the treatment of
capital gains and losses in the income tax, and the exemptions given
to certain organizations under the property tax -- are branded as
(7) The tax laws are unfairly administered, according to another complaint. For example, property tax administration is said to be careless and even intentionally discriminatory. Some taxpayers find the federal income tax administrators irritating in their meticulousness. They are charged with being partial to the government at the expense of the taxpayer, and are said to employ subordinates who do not show even a minimum of courtesy to the taxpayer whose personal accounts they examine.
(8) Some critics say that the tax system is being diverted from what they believe to be its only proper function -- the raising of revenue. They declare that it is being transformed into an instrument for the control of business and for other non-fiscal purposes. For example, they believe that corporation finance policy is unduly influenced by the tax on undistributed profits, and that the federal taxing power is being used to coerce the states into levying death taxes and social security taxes.
(9) Again, the tax system is condemned as a chaos of conflicting taxes, which cause the government heavy expenses in administration and also cause the taxpayer who tries to comply with the law heavy expenses in time and money. For example, federal, state, and local governments all have their own administrative forces to collect their own gasoline taxes, on the same gallon of gasoline. Tax differentials may also cause changes in location or business practice. Taxpayers have to take state income tax laws into account in deciding whether to live in the state where they work, or commute from another state and so avoid part of a state tax. In order to avoid paying a sales tax, consumers seek refuge in cum-
bersome mail-order methods, where there is interstate delivery.
These complaints are serious. In so far as they are true and can be remedied, they call for action. Some doubt is proper, though, both of their truth and of the possibility of relief. Their truth may be questioned because no one ever likes to pay taxes, and consequently complaint is universal and perpetual. They cannot all be remedied because no tax system can accomplish all the ends that the complainants seek. Nevertheless, they must be considered with care and sympathy.
HOW THE VOLUME HAS BEEN PLANNED
This volume has been planned to give the general public a working knowledge of (1) what the present tax system is, (2) how the various forms of taxation fulfil the tests that can be applied to them, and (3) what should be done to improve the system and its various parts.
Book One gives a broad background in order to create a proper perspective. Besides this introduction a brief description is presented of the American tax system as of January 1, 1937. Another chapter sketches the changes of the past quarter century. A final chapter outlines the way in which the tax system will be analyzed and judged in the succeeding chapters.
Book Two is divided into two parts. The first part analyzes the tax system in the light of what are, in practice, its primary aims -- the collection of revenue and social control. The other part is devoted to secondary aims -- tax justice, ease of administration, and so on. These secondary aims are not reasons for levying taxation, but they guide the choice among taxes, once the primary aims have been clearly defined. /5/
/5/ See Note 5, Explanation of the Order of Presentation, p. 511.
Book Three contains the conclusions and specific recommendations of the directors of research.
Book Four is the report of the sponsoring committee which presents some detailed conclusions on the more pressing problems of taxation.
THE AMERICAN TAX SYSTEM: 1937
The $12,500,000,000 in tax revenue that is being raised in the United States comes from federal, state, and local systems. The largest share is federal revenue -- $5,500,000,000. The states are receiving about $2,500,000,000 and the localities about $4,500,000,000. /1/
The thousands of local systems and the state systems are all more or less independent of each other and of the federal system. The result is a much greater degree of tax decentralization than in any other major nation of the western world. Indeed, the decentralization is so marked that the entire body of taxes in the United States is rarely thought of as one system. The term "system" will, nevertheless, be used in the present survey to cover the aggregate of taxes levied by the federal government, the state governments, and the local units within the states. The term may be misleading in some ways, but at least it draws attention to the importance of considering all these taxes as a single group, not as isolated units.
A tax system that is the same in all parts of the country cannot be expected under a decentralized government. The federal government's tax system, it is true, is required by the Constitution to be uniform in the geographical sense. For example, the federal government could not set the rate of its gasoline tax at 2 cents a gallon in one part of the country and at 3 cents a gallon in another. /2/ The state governments, however, divide the
/1/ For the sources of these and other statements of yield, see chap. 6, Note I, Federal Tax Collections, 1913-37, p. 514, and Note I, State Tax Revenues, 1936, p. 529.
/2/ See Note I, Uniformity Requirement for Federal Taxes, p. 512.
country into forty-eight different tax systems (forty-nine, if the
District of Columbia is included). Moreover, a state system is
sometimes not geographically uniform. In Arkansas, for example, the
rate of the gasoline tax at interstate bridges and in towns near the
border is the same as the rate in the adjoining state, regardless of
the rate levied in the rest of Arkansas. /3/
In addition, each of the 175,000-odd counties, cities, school districts, and other local units into which the states are subdivided has its own tax system, but only on sufferance of the state. /4/ The units sometimes overlap -- for instance, counties and school districts. Only rarely do any two local units have exactly the same tax structure, including the same rates, although all local units depend almost entirely on the property tax in some form.
As a result of this overlapping, the United States is split up into hundreds of thousands of areas differing each from all the others in the cumulative federal-state-local tax burden directly applicable to the property or persons within its borders. The "tax system" of the United States is multi-layered, dual-sovereign, and geographically heterogeneous. This complexity makes it especially difficult to view the system as a whole.
A first step in understanding the system is a description of the place occupied in it by each of the principal taxes as of January 1, 1937. Unless otherwise indicated, the data on yield are estimates for the twelve-month period ending June 30, 1937, and are evened off to the nearest hundred million dollars. They are shown in graphic form in Chart I.
The property tax is practically the sole taxing instrument of all the local units in every state. It provides
/3/ Raymond E. Manning, "State Tax Legislation, 1935," Proceedings of the . . . National Tax Association, 1935, p. 30.
/4/ See Note 2, Number of Local Units, p. 513.
SOURCES OF TAX REVENUE IN THE UNITED STATES, 1937
about one-third of the total tax revenue -- federal, state, and local
-- and is the most productive tax in the entire system.
In a sense, however, it cannot be considered one tax. The meaning of the word "property" differs for tax purposes among the states. In a few states it means practically nothing but real estate. In most states it also covers tangible personal property, such as the stock in trade of stores, farm implements, automobiles, clothing, jewelry, etc., as well as at least some of the so-called intangibles -- shares of stock, bonds, money, credits, etc. /5/
In contrast with most of the other taxes in the United States, the property tax is levied on the value of property as of a given date -- not on gross income, or net income, or amount produced, or other bases that require measurement of a certain flow of money or goods over a period of time. The tax is normally levied once a year. In some states the valuations are checked and revised only once every two or three years, or at even more infrequent intervals.
The rate, which usually varies from year to year, differs widely throughout the country. In those communities where property is greatly undervalued by the tax assessors, the rate is of course apt to be very high. Any general statement about the size of the existing rates is thus bound to be wrong. However, a hypothetical rate on actual values, as contrasted with assessed values, that would supply the present revenue would probably exceed 1-1/2 per cent in the majority of areas. The rate is always proportional, never progressive, in the sense that, for a given kind of property, a single taxing jurisdiction levies the same rate on all parcels, no matter who owns the property or how large it is.
Most of the state governments make some use of the property tax, but they get a much smaller proportion of
/5/ See Note 3, "Intangibles," p. 513.
their tax revenues from it than the local governments do. The
property tax is producing about $4,500,000,000 a year, or about two-
thirds of total state and local tax revenues. The states get between
5 per cent and 10 per cent of their revenue from this source, or
about $200,000,000. /6/
The federal government levies no property tax, for reasons explained elsewhere. /7/
Next in importance in total yield is the income tax on individuals and corporations. Its use by the three levels of government is precisely the reverse of that of the property tax. The federal government depends heavily on it. The yield for the fiscal year 1936 was $1,400,000,000, or about one-third of all federal tax revenue, and the estimate for 1937 is $2,300,000,000 -- about two- fifths. In more prosperous years the tax has supplied nearly two- thirds of federal revenue. In 1936 the yield was about evenly divided between the corporation income tax and the personal income tax.
The personal exemptions are high enough to exempt the majority of income receivers from the federal personal income tax. For the income year 1934, about 3,300,000 persons were directly represented by taxable returns under this tax, /8/ and preliminary data for 1935 incomes indicate an increase of 18 per cent, which would bring the total to 3,900,000.
The income tax, corporate and personal, is used by only about two-thirds of the state governments, ordinarily as a minor source of revenue. In 1936 the states received in all about $250,000,000 from personal and corporation income taxes -- $150,000,000 from the former
/6/ National Industrial Conference Board, Cost of Government series, especially Cost of Government, 1923-34 (1934), pp. 28-29, 31, and Cost of Government in the United States, 1933-1935 (1936), pp. 27, 45. For state property tax yield, see also Note 1, State Tax Revenue, 1936, p. 529.
/7/ See Note I, Uniformity Requirement for Federal Taxes, p. 512.
/8/ Including dependents. See p. 355.
and $100,000,000 from the latter. /9/ In 1937 the total may be as
high as $300,000,000. Thus the income tax supplies about one-fifth of
the nation's total tax revenue. The states that levy the tax are
shown in Chart 2.
The yearly income on which the tax is levied is defined in a highly technical manner. It differs in only a few important respects, however, from the income that an accounting firm would call net income for a business or that an individual would call his income when applying to a bank for a loan. No state law is exactly like any other, or the federal law, in defining taxable income. However, in general, considerable uniformity exists among the states, even on the treatment of capital gains, dividends, and the income of non- residents.
The federal income tax rate schedule for individuals is progressive. Starting at 4 per cent on the first $4,000 of the taxpayer's taxable net income, it reaches 79 per cent on that part of the income above $5,000,000. The state rates are usually heavier than the federal rates in the lower ranges of income and always very much lighter in the higher ranges. The federal normal rate on corporations is progressive only in the very low ranges of income, and averages slightly less than 15 per cent, to which may be added the tax on undistributed profits described below. The state corporation rates are all much lower than 15 per cent.
The most striking feature of corporation taxation is the annual tax on undistributed profits levied by the federal government in the Revenue Act of 1936. This tax is imposed on that part of the corporation's net income that is not paid out, in the year in which it is earned, in the kind of dividends that are immediately taxable in the hands of the stockholders. Thus, if a corporation earns $1,000,000 in a given year and distributes among
/9/ See Note 1, State Tax Revenues, 1936, p. 529.
STATES IMPOSING THE INCOME TAX, JANUARY 1, 1937
its common shareholders $1,000,000 in par value of its own common
stock as a stock dividend, it has not distributed any of its profits,
from the point of view of the undistributed profits tax, since such a
dividend is not at once taxable to the stockholders. In general,
dividends are immediately taxable to stockholders when the
corporation (1) pays the dividend in cash, or (2) pays to a preferred
stockholder a dividend in the company's own common stock, or (3) pays
to a common stockholder a dividend in the company's own preferred
stock, provided some preferred shares are already outstanding, or (4)
pays to any stockholder a dividend in its own obligations, securities
of other corporations, or other property.
The rate of the tax depends on the proportion of the net income (after deducting the regular corporation tax payable) that is undistributed. If the amount undistributed is not over 10 per cent of the net income, the rate is 7 per cent of the undistributed amount -- at the most, therefore, 7/10 of 1 per cent of the corporation's income. Higher rates apply to such parts of the undistributed amount as may be in excess of 10 per cent. The maximum rate is 27 per cent of that part of the undistributed net income in excess of 60 per cent of the entire net income.
The tax does not apply to banks and trust companies, insurance companies, corporations that are in bankruptcy or receivership or are insolvent, and certain minor groups of corporations that are not fully subject to the ordinary corporation tax. Relief provisions are granted for reserves that must in certain cases be built up under the Banking Act of 1933, under the National Housing Act, and under private contracts executed before May 1, 1936, in so far as they expressly prohibit the payment of dividends. /10/
/10/ See Note 4, Details of Undistributed Profits Tax, p. 513.
The federal payroll taxes levied as part of the old-age benefits and unemployment compensation program in the Social Security Act of 1935 do not yet produce much revenue. The federal budget estimates for 1937 place the yield at $300,000,000, or 6 per cent of federal tax revenue, most of it from the old-age benefit taxes. However, if the similar taxes that the states are encouraged to impose for unemployment compensation are included, the payroll taxes promise to equal, and perhaps exceed, the income tax after five or ten years.
The payroll taxes form a specialized and crude type of income tax since they are levied on one kind of income -- wages and salaries -- without any deductions. The duty of paying is in every instance placed upon the employer. The amount of tax will depend upon the wages and salaries that he pays. The plan is not to become effective in its entirety until 1949, when the two taxes will equal 9 per cent of payrolls.
One of the taxes is to create an old-age annuity fund. The tax rate is to rise every three years, until by 1949 it is 6 per cent. Half the tax is to be deducted by the employer from the employee's stated wages, and the other half is to be contributed by the employer. The rate starts at the 2 per cent level for 1937-39.
The unemployment compensation tax differs in some important respects from the old-age fund tax: The rate will not go higher than 3 per cent, but it reaches this level in 1938, starting at 1 per cent on 1936 wages. None of the tax is to be deducted from the employee's stated wage. The tax does not apply to firms with less than eight employees. It is based on total payroll, while the old-age fund tax is not assessed on that part of any compensation from any one employer to any one employee that is over $3,000 a year. Finally, and most important,
it is primarily not a federal revenue measure, but a device to induce
the states to levy unemployment compensation taxes. It allows the
employer to deduct from the federal tax otherwise due any
unemployment compensation tax paid to a state up to 90 per cent of
the federal tax. By February 5, 1937, thirty-five states and the
District of Columbia had passed unemployment compensation laws that
had been approved by the Social Security Board. All of them imposed a
payroll tax on employers, and ten of them imposed a payroll tax on
employees. /11/ No estimate is attempted here of the yield of these
state taxes for the year ending June 30, 1937. The revenue that the
federal government gets from the tax in so far as it results from
lack of state action is used, not for the unemployment compensation
program, but for general fund purposes.
Both the old-age fund tax and the unemployment compensation tax exempt certain broad classes -- notably agricultural labor, domestic service in a private home, and employees of non-profit institutions.
A similar special tax is imposed on railroads to provide employee retirement pensions, and will yield more than $100,000,000 in 1937. In turn the railroads and their employees are exempt from the old-age payroll tax of the Social Security Act.
The highway network of the United States, especially that part of it built in the past ten years, has been financed largely by state taxes on gasoline and on motor vehicles. Every state (and also an occasional local unit) now imposes a tax on gasoline. The rates differ widely, but they are always in terms of cents per gallon.
The state and local yield of $600,000,000, or possibly
/11/ Letter of February 8, 1937, Informational Service, Social Security Board, Washington, D.C.
$700,000,000, with the added $200,000,00 that the federal government
derives from its tax of 1 cent a gallon, makes the gasoline tax, in
point of revenue, the largest tax in the country levied on a single
article. It supplies 3 per cent of federal tax revenue, 9 per cent of
state and local revenue, and 7 per cent of total tax revenue. Almost
all the money is collected from refiners and wholesale distributors,
Every state collects an annual registration tax from owners of motor vehicles, but in some states the tax is as low as $3.00 or $5.00 a year. Part of the yield in certain states should be considered simply as a substitute for exemptions granted to motor vehicles under the personal property tax. Usually the tax is a certain number of cents per hundred pounds of weight of the vehicle, laden or unladen, or per horse-power. In contrast with the gasoline tax, however, the ways of measuring the tax base differ so widely from state to state that no general statement means much.
The motor vehicle tax reaches more people directly than any other one tax. Probably from 15,000,000 to 20,000,000 families out of the 30,000,000 families in the United States pay the tax. /12/
Some localities make use of the registration tax, but virtually all the $300,000,000 annual revenue represents state moneys. The tax supplies about 13 per cent of state taxes but only about 2 per cent of total federal, state, and local taxes. The federal government collects no similar annual registration tax but covers certain parts of the automotive field by its special manufacturers' taxes, to be described below. /13/
LIQUOR AND TOBACCO TAXES
The federal liquor tax alone is yielding about $600,000,000 a year, or 11 per cent of federal tax revenues.
/12/ See pp. 352-53.
/13/ See Note 4, Federal Automotive Excises as Distributors of Benefit Taxation on a Cost-Caused Basis, p. 554.
The states are getting another $200,000,000. /14/ The tobacco tax
revenue is $500,000,000 for the federal government, but only slightly
more than $50,000,000 for the states. /15/
The federal tobacco tax is built up of a number of rates on different tobacco products. Most of its revenue is produced by the cigarette tax of $3.00 a thousand cigarettes -- equivalent to a tax of 6 cents on a package of twenty. Similarly, the federal liquor tax is composed of several taxes, chiefly the tax on beer and the tax on distilled spirits (whiskey, etc.), which contribute approximately equal amounts. The federal government can and does confine itself for the most part to collecting the liquor and tobacco taxes from manufacturers. While the states, too, get something from the liquor manufacturers, they depend largely on taxes applied to the wholesale and retail trade or on state distributing monopolies.
In recent years nearly half the states have experimented with the sales tax, which is levied, at a more or less uniform rate, on sales of most articles and many services. Important exemptions -- for example, food -- are sometimes granted. Almost all the revenue comes from the taxation of retail sales rather than sales by manufacturers or wholesalers. New York City, with its 2 per cent retail sales tax, and New Orleans, with a newly introduced 2 per cent tax of somewhat less general scope, are the only important local units employing the tax. On January 1, 1937, it was in force in twenty-two states, as shown by Chart 3.
The federal government has no sales tax; but, if it did, the tax would probably be confined to sales by manufacturers or wholesalers, since collection would be easier
/14/ See Note 1, State Tax Revenues, 1936, p. 529.
STATES IMPOSING THE SALES TAX, JANUARY 1, 1937
and the federal government would not need to fear the emigration of
manufacturers, as the states do.
In a few states that use a rate of 2 per cent or 3 per cent the sales tax supplies more than one-third of the total revenues of the state government. All together, the state governments are obtaining slightly more than $350,000,000 from the sales tax, and New York City and New Orleans, about $50,000,000. Thus, the sales tax is supplying about $400,000,000 a year -- 6 per cent of total state and local tax revenues.
The tax is often stated to the ultimate consumer as a separate item in his bill. In this respect the sales tax and the gasoline tax, among the major taxes, stand alone. The retailer, or other business firm, is the one who pays the money to the government, though he may not be the one who bears the burden of the tax.
DEATH TAXES AND GIFT TAX
The transfer of property at death is governed by state laws, not federal laws. The states, however, make less use of taxes on transfers at death than the federal government, and the local units do not use them at all. The states are collecting only slightly more than $100,000,000 a year from this source, or about 4 per cent of state taxes and less than 2 per cent of state and local taxes combined. /16/ Nevada is the only state that does not impose a death tax.
The federal government has far higher rates. Its maximum is 70 per cent on that part of the estate above $50,000,000. However, the taxpayer is allowed to deduct from the federal tax otherwise due much of the tax that he pays to any state. The net return to the federal government is $300,000,000 a year -- 5 per cent of total federal taxes.
Like the property tax, the death tax is based on the
/16/ See Note 1, State Tax Revenues, 1936, p. 329.
capital value of property. Like the income tax, it is levied at rates
that increase as the side of the tax base increases. It also depends
on many technical definitions to determine the base.
Death taxes are of two kinds: the estate tax, levied on the value of the decedent's estate as a whole, and the inheritance tax, levied separately on the share received by each beneficiary. The federal tax is an estate tax, but no general statement can be made about the state taxes. Some states levy both forms.
The high federal rates create an obvious inducement to give property away before death. Some of the gifts can by certain technicalities be taxed under a death tax. The possibilities of avoidance have seemed great enough, however, to warrant a federal tax on gifts. Its yield, though small compared with that of the other chief federal taxes -- less than $200,000,000 in 1936, or 4 per cent of federal tax revenue --, has been larger than was expected. It is estimated to be $100,000,000 for 1937. Collected annually, it has the unique feature of rates that rise with the cumulated amount of gifts made throughout the years by any one donor. The rates are fixed at exactly three-quarters of the estate tax rates. Only three states impose gift taxes.
The federal Constitution forbids any of the units of government to impose a tax on exports, and it grants to the federal government alone the right to levy taxes on imports. Some of the taxes that are imposed by the federal government under this authorization are designed to balance existing taxes on domestically produced articles. Part of the liquor tax collected at customs, for example, is of this sort. For the most part, however, the $400,000,000 a year collected on imports represents the "tariff" -- that is, a series of special taxes on imported
articles of certain kinds. This amount now represents only about 7
per cent of total federal tax revenues. Shortly before the war,
however, customs supplied nearly 50 per cent.
Some articles are purposely taxed at such a high rate that they are imported not at all or in much smaller amounts than they would be without the duty. Some are on the "free list" -- untaxed. Many are between these two extremes. The rate schedule is bewildering in its variety, since a special rate is assigned to each taxable group of commodities.
The total estimated yield of the taxes mentioned above, for the twelve months ending June 30, 1937, is $11,300,000,000, or 90 per cent of the estimated total of $12,500,000,000. The rest of the taxes -- federal, state, and local -- comprise a miscellany, of which no one item produces an important amount of revenue.
Chief among the miscellaneous federal taxes are those applying to goods and services that Congress has seemingly considered to be luxuries or semi-luxuries. Automobile bodies and chassis, lubricants, tires and tubes, automobile accessories, furs, toilet preparations, radio parts, phonograph records, mechanical refrigerators, sporting goods, cameras and lenses, chewing gum (but not candy or soft drinks), matches, playing cards, firearms and ammunition, electrical energy (for domestic and commercial, but not for industrial, consumption), and toll telephone calls, telegraph, cable, and radio messages are taxed upon sale by the producer or importer. Admissions priced at more than 40 cents, safe deposit rentals, club dues, issues and transfers of stocks and bonds, transfers of title deeds, sales for future delivery, and transportation of oil by pipe line are also taxed. In most cases the rates range between 2 per cent and
10 per cent. Some of the taxes provide for exceptions and other
qualifications not noted in this summary.
Corporations in general pay a federal capital stock tax that is linked with a so-called excess profits tax.
Miscellaneous federal taxes imposed for regulation rather than revenue include those on narcotics, adulterated butter, process or renovated butter, oleomargarine, filled cheese, mixed flour, and crude petroleum. The special tax on coconut and other processed oils -- essentially a protective tariff duty -- continues as a remnant of the agricultural adjustment tax program. All together, the miscellaneous federal taxes named above produce about $700,000,000 a year, or 13 per cent of federal tax revenue.
Some of the states levy "severance taxes" on natural resources, such as oil, gas, coal, and minerals, removed from the earth. In some states the property tax as applied to forests is modified to encourage forestry. Annual corporation taxes at light rates -- for example, $2.00 per $1,000 -- based on authorized or outstanding capital stock are found in most of the southern states and middle western states. A tax on insurance companies, levied at rates near 1 per cent or 2 per cent and based on premiums received, is common. Special taxes on chain stores are widespread. Many localities levy special assessments on real estate at irregular intervals. They are not taxes, strictly speaking, but payments for direct benefits to the property resulting from local improvements, such as sewers, sidewalks, and street lighting. /17/
FEDERAL-STATE-LOCAL TAX RELATIONS
The tax system in the United States is decentralized because governmental activities in general are decentral-
/17/ For detailed information on taxes in the United States, see Tax Research Foundation, Tax Systems of the World, (6th ed., Chicago), passim (hereafter cited as Tax Systems of the World), and "State Tax Calendar" in The Tax Magazine, the usual sources of statements in the present survey on the number of states levying a given tax, and the rates imposed.
ized. If a local school district is to be independent, it must have
some financial resources of its own. If its income is received
entirely from the state or federal government, it loses either its
independence or its sense of responsibility.
On the other hand, the greater the freedom of small units to levy their own taxes, the more disorganized the system is as a whole. Multiple taxation, accounting difficulties, and other problems, noted elsewhere, arise. /18/ Moreover, the local units face certain economic restrictions on their power to tax. They may find, for instance, that wealthy residents will move if certain taxes are placed at too high a level. As a result, the tax revenue that the local unit can get may not be enough to carry the function, such as education, that is assigned to the unit.
The present system in the United States meets these difficulties in a variety of ways.
The local units depend almost entirely upon the property tax for their own revenues. In many states they receive substantial sums in addition as shares in state-collected taxes, and as grants-in-aid from the states and the federal government. In 1935, 41 per cent of total local revenues (not including earnings, fees, etc.) came from federal and state aid and shared taxes. /19/
The state governments use about as wide a variety of tax sources as the federal government. They are prohibited by the Constitution from imposing a tax on imports. Otherwise one state or another makes use of every important tax employed by the federal government, and many state governments depend also on the property tax.
The only major provision that has been adopted to coordinate federal and state tax measures is the tax crediting device, used with the death taxes and with one of the payroll taxes. The federal government allows
/18/ See pp. 366-68.
/19/ See p. 379.
the taxpayer to deduct from his federal tax otherwise due the amount
of tax paid to the states, with certain limitations. In the death
tax, the deduction is limited to 80 per cent of that part of the
federal tax as computed under the provisions of the 1926 federal
estate tax law. This device, in effect, allows any state to levy a
death tax up to that level without imposing any added burden on the
taxpayer. The limit to the payroll tax credit is 90 per cent of the
The states do not receive any share of any particular federally collected tax, but federal grants for highways and, in recent years, for relief have been large.
Co-ordination of federal, state, and local tax systems is thus still in a rudimentary stage. The only exceptions are elaborate systems of grants to localities, chiefly for education, that exist in a few states.
CHANGES SINCE 1914
An understanding of the rapidity and diversity of the tax system's growth during the war and post-war periods is essential in order to form an intelligent judgment on the system in its present form. A brief review of these changes follows.
THE WAR DAYS
The first of the revenue acts that was influenced by the war was voted on October 22, 1914, and extended for a year on December 17, 1915. It provided for low-rate stamp taxes, an increase in the beer tax, and miscellaneous minor tax provisions. The next revenue act, much more important, was the Revenue Act of 1916, which imposed the first of a series of rate increases in the personal income tax, recently introduced by the act of October 3, 1913. The increase was small: on incomes up to $150,000 an added 1 per cent or 2 per cent tax. The maximum rate, however, was moved up to 15 per cent. It applied only to that part of the taxpayer's income above $2,000,000. The former maximum was 7 per cent on that part of the taxpayer's income above $500,000.
The other lasting provision of the 1916 act was the introduction of an estate tax. The highest rate of the new tax was only 10 per cent, applicable to that part of the net estate in excess of $5,000,000. This was a modest beginning compared with the maximum rate of 70 per
cent in 1936, applicable to that part of the net estate in excess of
For the rest, the 1916 act depended chiefly on the munitions manufacturers' tax, which was merged in 1917 in a general excess profits tax.
War Taxes on Incomes and Profits
The next two years brought a fundamental change in the federal revenue system. A belief in the superior "productivity" of the "indirect" or consumption taxes has always been widespread. Despite this belief, the United States was able to revise its tax system so that its participation in the war was almost entirely financed by taxes on net income and excess profits, so far as it was financed by taxes at all. To some extent this revision was forced by the loss of liquor revenues through prohibition. In the main, however, it reflected a conscious effort to push direct taxes far beyond their previous limits.
An act passed on March 3, 1917, levied an excess profits tax. The War Revenue Act of 1917, approved October 3, 1917, strengthened the excess profits tax and increased the income tax sharply. The size of the change in the income tax is indicated in Table 1.
The Revenue Act of 1918, delayed in its enactment until February 24, 1919, provided another sharp increase in income tax rates, which also is illustrated in Table 1. In addition, the top rate under the war profits section of the excess profits tax was 80 per cent.
The peak of federal tax collections was reached in the fiscal year ending June 30, 1920. Of the total $5,700,000,000 collected in that year, the customs duties supplied only $300,000,000. The income and excess profits taxes supplied 73 per cent of the remaining $5,400,000,000. /2/
/1/ See pp. 44, 87.
/2/ For sources of data on federal revenues, see Note 1, Federal Tax Collections, 1913-37, p. 314.
PERSONAL INCOME TAX RATES AT CERTAIN LEVELS /a/
(NORMAL TAX AND SURTAX COMBINED)
That Part of Taxpayer's
Income Falling within
(Block of Income) Rate
(In Dollars) (In Per Cent)
1916 Act 1917 Act 1918 Act
5,000-6,000 2 5 13
10,000-11,000 2 7 16
20,000-22,000 3 12 21
50,000-51,000 4 16 36
75,000-76,000 5 21 48
100,000-150,000 7 31 64
Over 2,000,000 15 67 77
/a/ The rates given are the aggregate of normal tax and surtax. Since the surtax rate was at this time based on net income, while the normal tax rate was based on net income less certain credits, it is slightly misleading to cite the two rates in combined or aggregate form, as has been done above. However, the error introduced in this simplification is not significant for present purposes.
Excise and Consumption Taxes
The relative size of the yield given by the taxes on incomes and excess profits is the more surprising in view of the long list of other sources that were tapped by the war revenue acts. Taxes were placed on payments for transportation and communication, on admissions and club dues, on bond and stock issue and transfer, on documents of various kinds, and on the production of various "luxuries," such as automobiles, soft drinks, chewing gum, sporting goods, and so forth.
This large and miscellaneous assortment of taxes gives an impression of vast revenue resources. Yet the admissions tax, for example, even in the fiscal year 1920 when its 10 per cent rate applied to virtually all admissions, produced but $77,000,000 -- slightly more than 1 per cent
of the total internal revenue for 1920. The tobacco tax remained the
chief consumption tax. The rate of the cigarette tax, the major
producer of the tobacco group, was twice as high under the 1918 act
as it had been under the 1914 and the 1916 acts. Of the other
miscellaneous revenue measures, one of the more important was the
increase in postal rates in the Revenue Act of 1917, which had the
effect of laying a special tax on the senders of first-class mail.
Unimportance of Estate Tax
The estate tax played an unimportant role in the federal government's war financing. In part this reflects the claim of the states to a vested right in death taxes. Forty-two states were levying them at low rates in 1916. (In contrast, only three or four states were making a serious attempt to collect an income tax.) /3/
The 1916 act set the rate at 1 per cent on that part of the net estate -- that is, the gross estate minus all deductions including the minimum exemption -- below $50,000. The first 1917 act increased it to 1-1/2 per cent, the second 1917 act increased it to 2 per cent, and the last World War revenue act lowered it to 1 per cent. Similarly, for that part of the net estate between $250,000 and $450,000, the rate went from 4 per cent to 6 per cent to 8 per cent and back to 4 per cent.
In the higher ranges, the rates were at least not decreased by the last war revenue act. For the $2,000,000-$3,000,000 bracket, the rates in the successive acts were respectively 7 per cent, 10-1/2 per cent, 14 per cent, and 14 per cent. The maximum percentages under the respective acts were 10, 15, 25, and 25. Rates such as these explain why the peak yield of the federal estate tax for
/3/ See Note 2, Sources for Recent History of State and Local Taxation in the United States, p. 519.
the war and immediate post-war period was only $154,000,000 (1921).
Unused War Revenue Sources
The extent to which the federal government relied on income taxes and excess profits taxes is further surprising in view of the opportunities for other taxes that were not levied at all.
A gasoline tax had passed the House in 1914, and President Wilson urged it on Congress in 1915. However, a federal gasoline tax was not enacted until the depression of the '30's. In 1917 the Senate Finance Committee suggested revenue duties on coffee, tea, and cocoa, to be collected, of course, upon importation, but these "breakfast table taxes" found no place in either the war or the depression financing of the federal government. /4/
Considerable agitation developed during the war and shortly afterward for a general manufacturers' sales tax, to be levied only once on each finished product. Finally, there was always the technical possibility -- even if it was a political impossibility -- of raising substantial sums of money through high-rate taxes on such necessities of life as salt and bread.
A capital levy would have required an amendment to the Constitution, since it would almost surely have been considered a direct tax, and, as such, would have fallen under the apportionment clause in the Constitution. As is explained elsewhere, /5/ this clause requires that any federal direct tax not specifically exempted from its provisions must be apportioned among the states on a population basis. Thus, in the absence of an amendment, the rate of a tax on capital would have to be high in poor states and low in rich states.
/4/ H. G. Hendricks, "Federal Income Tax Rates, 1913-1922," Bulletin of the National Tax Association, XVIII, Nos. 3, 4 (December 1932, and January 1933), 79, 80, 105.
/5/ See Note 1, Uniformity Requirement for Federal Taxes, p. 512.
State and Local Taxes /6/
Experimentation with Existing Taxes
For the states and the local units of government the period 1914-20 was primarily marked by a reform of existing taxes rather than the adoption of entirely new types of tax. The chief example of this tendency was the experimentation with new methods of reaching personal property, particularly intangibles.
One method involved classification, achieved in a number of ways. Several states adopted constitutional amendments granting to the legislatures a broad power to classify all property; other states restricted the legislatures' power to tax at low rates to certain specified types of property. Low-rate annual taxes, particularly on intangibles -- stocks, bonds, etc. --; were then enacted. Minnesota and one or two other states achieved classification by incorporating in their constitutions fractional valuations for different classes of property. Some states substituted for the general property tax on mortgages and other secured debt low-rate once-for-all taxes collected at registration. Special treatment was developed for shares of stock in national banks.
Another method involved a restricted use of income rather than capital value as a tax base. Thus, public service corporations were taxed on gross receipts, mines and forests on a yield basis, and special income tax laws were enacted to reach the income from intangibles that escaped the property tax. In some states the income tax, although general in scope, was used in part as a supplement to the property tax, since property tax receipts were accepted in payment of it.
A widespread movement to reform local assessments resulted in the consolidation of assessment districts, the
/6/ See Note 2, Sources for Recent History of State and Local Taxation in the United States, p. 519.
centralization of control over local assessors, and the creation of
better machinery for putting assessments in the various districts at
a uniform ratio of assessed to true value. A number of states
established permanent tax commissions with broad powers over the
administration of state and local property taxes. A few large cities
adopted definite formulae for assessing property, notably the unit-
foot rule for land and the cubic-foot rule for improvements.
Use of Taxes Other Than Property Tax
The increase in the use of general income taxation by the states during the years 1914-20 was not startling. The number of states imposing the personal income tax effectively grew from two in 1914 to eight or nine at the end of 1920.
Somewhat more than one-fourth of the states either adopted death taxes during this period for the first time or extended them to direct heirs, who had been exempt in contrast with collateral heirs. Modest rate increases in the death taxes were common. Death taxes and income taxes in the states were even less important in terms of total revenue than they are today.
The state and local liquor taxes were fairly important at the beginning of the period, but they disappeared when prohibition took effect.
Several states raised their motor vehicle license fees. In 1919 Oregon introduced the gasoline tax. It was joined in the same year by Colorado, New Mexico, and North Dakota, and by Kentucky in the year following.
Fairly extensive changes in the state taxing systems were achieved in Connecticut (1915), Virginia (1916), Maryland (1916), Kentucky (1917), Missouri (1917), New York (1917-19), Alabama (1919), New Mexico (1919), North Dakota (1919), and possibly in one or two
CHANGES SINCE 1914
more. However, even in these states the property tax remained of
overwhelming importance in local finance.
THE PERIOD OF PROSPERITY
Alone among the major combatants of the war, the United States furnished a laboratory test of how the structure of a powerful tax system may be altered when tax reduction in huge amounts is possible. The revenue acts of 1921, 1924, 1926, and 1928 sheared away large segments of the federal tax base and cut the tax rates deeply. The first major change was the abolition of the excess profits tax by the revenue act that was approved November 23, 1921. Surtax rates came down slightly. The 1921 act put the combined maximum surtax and normal rate at 58 per cent on that part of the income over $200,000. Throughout the scale the rates remained well above those of the Revenue Act of 1917 (in the higher ranges they were much closer to the rates of the 1918 act than to those of the 1917 act). The estate tax rates were left unchanged, while among the special taxes only those on transportation and a few minor excises were repealed.
To preserve a proper balance in viewing the changes made in the Revenue Act of 1921 and subsequent acts, certain quantitative relations may be emphasized.
Personal Income Tax and Corporate Income Tax
In the fiscal year 1920, when federal tax collections reached their peak, the personal and corporation income taxes and the excess profits tax produced 69 per cent of the total federal tax revenue. By the fiscal year 1931 the excess profits tax had been repealed, personal income tax rates had been slashed drastically, and the corporation tax rate had been raised only slightly --
yet the corresponding percentage for the fiscal year 1931 had dropped
only to 66. Never in any of the years 1918-31 inclusive did it go
below 53, the level reached in 1923.
The steadiness of the percentage shows the extent to which the decrease in need for revenue allowed a repeal or lowering of many other taxes. It also indicates the great responsiveness of the income tax to a period of prosperity. The figures in Table 2, showing total normal tax and surtax rates applicable to certain blocks of personal income, indicate how drastic the cuts in rates were.
PERSONAL INCOME TAX RATES AT CERTAIN LEVELS /a/
(NORMAL TAX AND SURTAX COMBINED)
Block of Income Rate
(In Dollars) (In Per Cent)
1918 Act 1921 Act 1924 Act 1926 Act
5,000- 6,000 13 8 4 3
10,000- 12,000 16 10 7 6
20,000- 22,000 21 16 11 10
50,000- 52,000 36 31 24 18
75,000- 76,000 48 43 33 23
100,000-150,000 64 56 43 25
Over 2,000,000 77 58 46 25
/a/ See note a to Table 1.
A tax reduction of 1 per cent of the income subject to normal tax was granted on 1929 incomes. With this one exception, the 1926 rates remained unchanged until the Revenue Act of 1932.
For each of the fiscal years 1925-31 inclusive the corporation income tax produced over 50 per cent of the income tax revenue. Segregated data for earlier years in the period from 1918 to 1925 are not available on a fiscal year basis. The importance of the corporation
CHANGES SINCE 1914
income tax contrasts with the greater publicity usually given to the
personal income tax. The range of the yield during the seven years
was narrow -- from 52 per cent to 60 per cent. This is worth noting
since the corporation tax rate was changed but slightly during this
period while the personal rates were cut severely by the 1926 act.
Prosperity had a greater effect on the yield of the personal tax than on that of the corporation tax. The most abrupt change in the corporation rate was from 10 per cent, on 1921 income, to 12-1/2 per cent, on 1922 income. The cause of this increase in an era of tax reduction was the abolition of the excess profits tax, which, except for a brief period, had applied only to corporations.
Customs and Cigarette Tax Yields
The customs revenue was raised from its insignificance of 1918 by the two tariff acts of 1921. These removed some articles from the free list and increased the rates on others. The general improvement in international trade also increased customs receipts. In 1918 the duties produced only 5 per cent of total federal tax revenue. By 1923 the percentage had risen to 18. It stayed within the range 16-18 through the fiscal year 1930. In 1931 it receded slightly, to 13 per cent, as the trade-restricting tariff of 1930 took effect and the depression deepened. Even 18 per cent, however, is a weak showing compared with 1913, when customs duties supplied 48 per cent of federal tax revenue.
The spread of the cigarette habit increased the yield of the cigarette tax remarkably -- from $151,000,000 in 1920 to $359,000,000 in 1931. The rate Of $3.00 a thousand levied by the Revenue Act of 1918 was the only important excise rate that was not reduced after the war.
Continued Unimportance of Estate Tax
The estate tax remained an unimportant source of revenue to the federal government. During the period from 1916, when it was introduced, through the fiscal year 1931, it reached its highest proportionate yield in 1923 -- 4 per cent of the total federal tax revenue. In each year from 1922 through 1931 its absolute yield was much lower than that of the cigarette tax.
The moderate rates of the war years were not raised during the decade of post-war prosperity. An increase approved in the 1924 act was retroactively repealed by the 1926 act, which put the rates nearly back to the level of the early part Of 1917. The maximum under the 1926 act became 20 per cent on that part of the net estate exceeding $10,000,000. Moreover, the crediting device, which had been tentatively inaugurated at a lower rate two years earlier, gave the states the privilege of taking 80 per cent of the tax for themselves. In the fiscal year 1930, when collections were reflecting the high prices of 1928 and 1929, the tax produced but $65,000,000.
Repeal of Excise and Consumption Taxes
The miscellaneous assortment of war-time special taxes that had given variety, but not much else, to the tax system was soon discarded. To name only the more important: the 1921 act dropped the passenger, freight, and express taxes; the 1924 act dropped the telephone and telegraph taxes and the soft drink and candy taxes; the 1926 act dropped the capital stock tax, the documentary stamp taxes, the tires and tubes tax, and the automobile truck tax; the 1928 act dropped the passenger automobile tax. In addition, the admissions tax was whittled down by exemptions until it produced but $3,000,000 in 1931.
The only war-time tax of this kind that thrived in the post-war era was the stock transfer tax. It was well
suited to the peculiar character of this period of prosperity.
Without a change in the rate the yield rose from $8,000,000 in 1919
to $47,000,000 in 1930. It dropped to $26,000,000 in 1931.
Relative Importance of Each Tax
By 1930 the federal tax system was yielding $3,600,000,000 a year, compared with $5,700,000,000 in the peak year 1920. Of this total, the corporation income tax was producing 35 per cent, the personal income tax 32 per cent, the customs duties 16 per cent, and the tobacco taxes 12 per cent. In 1931 the absolute amount of revenue was sharply lower, but the percentages were about the same. Even in 1932 the only pronounced shift, relatively, was upward for the tobacco taxes and downward for the personal income taxes.
Throughout the boom period and nearly until the depths of the depression the various parts of the federal revenue system maintained remarkably constant relations. The extremes shown by each tax in the percentage that it produced of total federal tax revenue during the years 1925-32, inclusive, are shown in Table 3 (with 1916 percentages given as contrast).
RELATIVE IMPORTANCE OF CERTAIN FEDERAL TAXES
1925-32 AND 1916
Extreme Percentages Percentage of
of Total Federal Tax Total Federal Tax
Tax 1925-32 1916
Corporation income tax 29 /a/ - 38 /b/ 8
Personal income tax 23 /c/ - 32 /d/ 9
Customs duties 13 /e/ - 17 /f/ 29
Tobacco taxes 11 /g/ - 21 /c/ 12
Liquor taxes /h/ 34
/a/ In 1925.
/b/ In 1928.
/c/ In 1932.
/d/ In 1930.
/e/ In 1931.
/f/ In 1925, 1927, 1929, and 1932.
/g/ In 1925, 1926, and 1927.
/h/ No revenue because of prohibition.
State and Local Taxes /7/
The state and local tax systems, as a whole, expanded while the federal system was being trimmed to fit prosperity. Unfortunately for those who would like a compact and precise statement of what happened, many of the necessary facts have never been assembled.
Dependence on Property Tax
The chief source of revenue remained the property tax. In urban areas the real estate speculation of the '20's boosted assessed values and, with them, tax revenues. In rural areas, however, the long-continued post-war liquidation resulted in a far less cheering picture. Certain modifications in the property tax laws influenced revenue: for example, the gradual extension of low-rate taxation or complete exemption of bonds, stocks, etc., and exemptions for veterans.
Growth of Highway Taxes
The gasoline tax, first used in the United States in 1919, reached a total yield of about $400,000,000 by 1929 and $500,000,000 by 1931. With the aid of a few rate increases here and there, the total revenue from this source decreased very little in 1932 and 1933. /8/ By spreading through every state in the eleven-year period 1919-29 the gasoline tax made a record that is not likely to be approached for some time, save possibly by the payroll tax for unemployment insurance.
The motor vehicle license tax had been extensively used even before 1920. With increases in rates and in the number of registrations, its revenue grew in importance up to 1930. In some states the tax was supplemented by
/7/ See Note 2, Sources for Recent History of State and Local Taxation in the United States, p. 519.
/8/ Finla G. Crawford, The Gasoline Tax in the United States, 1934 (Chicago, 1935), p. 5.
special taxes on commercial vehicles for hire or common carriers.
Income and Other Taxes
The personal income tax spread slowly and was generally levied at low rates. At the end of 1920 it was in force in ten states including one or two that administered it with little effectiveness; at the end of 1925, in eleven; at the end of 1929, in fourteen. These figures do not include the New Hampshire and Tennessee taxes, restricted to income from certain securities, etc. The corporation income tax had much the same record.
A few of the oil, metal, and coal states passed severance taxes, in the form of a certain percentage of the value extracted or at certain rates by the ton or barrel, etc. Many states increased the rates of the death taxes in the first half of the decade, partly because of the federal government's action. Bank taxes (particularly when a Supreme Court decision in 1921 upset the existing system), insurance company taxes, and capital stock taxes attracted much attention but still produced relatively little revenue. The embryonic forms of a general sales tax appeared in West Virginia and Georgia, and a few states tried a tax on tobacco products (or merely on cigarettes) with indifferent success.
The structure of the federal tax system has been markedly changed through a series of revenue acts caused by the depression. The change has certain curious aspects. The income tax rates have been put back on the war-time level, and the estate tax rates have been raised higher than ever before; yet the percentage of total federal tax revenue coming from incomes, profits,
and estates has been very low. In each of the years 1933-36 it has
been lower than in any year since 1917.
The depression has of course reduced the productivity of high income tax rates, high estate tax rates, and the excess profits tax. Also the recovery and reform program his seemed to those in power to demand the use of other new revenue measures -- for example, the processing taxes that financed for a while the farm relief program. The repeal of prohibition made available a revenue source that no government, whatever its preference for income taxes, would dare neglect. These three factors alone go far toward explaining the high percentage of total revenue supplied by taxes other than those on income and estates.
The transformation of the federal tax system was largely completed during the calendar years 1932 and 1933.
The Revenue Act of 1932
The Revenue Act of 1932, passed before the elections of that year, included a large increase in income tax rates. The rate scale was copied from the 1921 act except that the progression (normal tax plus surtax) extended to 63 per cent on that part of the income above $1,000,000, instead of stopping at 58. The 1921 scale, it will be recalled, was on the average higher than that of the Revenue Act of 1917 and not far below the all-time peak reached by the schedule in the Revenue Act of 1918. Thus the 1932 act had the second highest rate schedule in United States history.
The other main achievements of the 1932 act were a doubling, roughly, of the estate tax rates, coupled with the imposition of a gift tax, and the introduction of a series of automotive taxes, chiefly a tax on gasoline -- the first the federal government had ever enacted. The first-class postage rate was also increased.
Changes in 1933-34
Beer and wine of not more than 3.2 per cent alcohol by weight were termed "non-intoxicating" by Congress early in the next year (March 22, 1933) and were subjected to certain taxes. The $5.00-a- barrel tax on beer has proved a surprisingly large source of revenue. The Liquor Taxing Act of 1934, approved January 11, took account of the repeal of the Eighteenth Amendment by imposing a tax of $2.00 a proof gallon on spirits.
Meanwhile, on May 12, 1933, the Agricultural Adjustment Act was adopted. Its processing taxes were destined to yield at the rate of $500,000,000 a year before they were invalidated by the Supreme Court early in 1936. Shortly after the agricultural legislation, came the National Industrial Recovery Act (June 16, 1933) with its capital stock tax and so-called excess profits tax.
Changes in 1934-36
Since the Liquor Taxing Act of January 1934 three important federal taxes have been the subject of legislation: the estate tax, the income tax, and the social security taxes.
The rates of the estate tax -- and, with them, those of the gift tax -- were materially increased by the Revenue Act of 1934 and again by the Revenue Act of 1935. Under the latter act they have reached a level almost twice as high as that of the 1932 act, and this was twice as high as the level that prevailed from 1926 to 1932. A comparison of the rate levels at selected points is given in Table 4.
The income tax was revised by the Revenue Act of 1935 to increase surtaxes on incomes above $50,000. The Revenue Act of 1936 makes dividends subject to the personal normal tax even though they come from corporations that have paid a corporation income tax. The
1936 act also imposes a special tax on the undistributed profits of
The Social Security Act, passed August 14, 1935, levies taxes that are planned to total 9 per cent of payrolls, as
ESTATE TAX RATES AT CERTAIN LEVELS
Block of Net Estate Rate
(In Dollars) (In Per Cent)
1926 Act 1932 Act 1934 Act 1935 Act
Under 50,000 1 1 - 5 1 - 5 2 - 10
200,000-400,000 4 11 16 20
2,000,000-2,500,000 10 25 34 38
Over 10,000,000 20 45 60 67 - 70
discussed elsewhere. /9/ The Carriers Taxing Act of August 29, 1935,
levies similar taxes to provide for railroad pensions. It replaces
in part the Railroad Retirement Act, held unconstitutional by the
Supreme Court on May 6, 1935.
Changes of Twenty-Five Years
The federal tax system is indeed harder to picture in brief and simple outline than it was when the depression struck or even during the war. However, the figures in Table 5 at least suggest the revolutionary changes of the past quarter-century. They represent the percentage of the total of federal tax revenue accounted for by each of the taxes noted, in the fiscal years 1913 and 1936.
State and Local Taxes
The minor shifts in 1920-29 had somewhat prepared the states for the time when they were to be called on to give aid to the local units. /10/ The property tax, more particularly the real estate tax, sank under the weight of the depression to an extent that seemed at first hardly
/9/ See pp. 263-65.
/10/ See Table Q, p. 577.
credible in view of its record for consistent yields through the
preceding decades. Counties, cities, towns, school districts, and
special districts curtailed their services
RELATIVE IMPORTANCE OF FEDERAL TAXES
Percentage of Total
Tax Federal Tax Revenue
Customs duties 48 10
Taxes on incomes and profits 5 36
Estate tax and gift tax -- 10
Automotive taxes -- 8
Tobacco taxes 12 13
Liquor taxes 35 13
Other taxes -- 10
sharply. In some states certain activities became a responsibility
of the state governments -- either directly, by state administration
of the activities, or indirectly, by state subsidies to the local
administrative units. The money was usually raised by borrowing or by
the use of new state taxes.
Rapid Spread of Income Taxes and Sales Taxes
The income tax spread rapidly among the states during the depression. At the end of 1929, only fourteen were imposing personal income taxes; on January 11, 1937, the number was twenty-nine. Neither figure includes the restricted income taxes of New Hampshire, Ohio, and Tennessee. Corporate income taxes were on the books of sixteen states in 1929 and thirty on January 1, 1937. At least seven of the states that had personal income taxes in force at the beginning of 1930 raised their rates during the next seven years.
The sales tax, usually in the form of a tax of 2 per cent
FACING THE TAX PROBLEM
or 3 per cent on all sales at retail, was in force in twenty-two
states and the cities of New York and New Orleans on January 1, 1937.
Gasoline tax rates were, on the whole, not greatly increased.
However, in 1934 about 18 per cent of the total state and local
revenue from the tax was not earmarked for the building or
maintenance of highways or the servicing of highway bonds. /11/ As a
result of the repeal of prohibition, most states imposed liquor
taxes, usually gallonage taxes similar to those of the federal
In 1935 and 1936 minor luxury taxes and selective sales taxes spread rapidly. Four states adopted a cigarette tax in 1935, and one in 1936, bringing the total number of cigarette-taxing states to twenty. The taxes are at fairly high rates, from 1 cent to 3 cents for a package of twenty cigarettes of the usual grade. Arizona in 1935 and Kentucky in 1936 imposed miscellaneous luxury taxes, some of which were repealed shortly. Kentucky, Maryland, and Pennsylvania enacted taxes on admissions.
In 1936 many states enacted payroll taxes in order to participate in the unemployment compensation plan.
Important Regional Differences
Important regional differences are apt to be overlooked in generalizing about a country of nearly 130,000,000 people. At one extreme is Nebraska, which has passed through the entire period 1925- 36 without adding a single new tax of importance to its state or local revenue system except a liquor tax. At the other extreme are Michigan, Ohio, West Virginia, and other states, where the property tax plays a much less important part than before the depression, having been replaced to a large extent by sales taxes and gross production taxes. /12/
/11/ See p. 258.
/12/ See Note 3, Notable Decreases in Property Tax Assessments or Collections, State and Local, p. 525.
CHANGES SINCE 1914
Nominal Stability of Some Property Taxes
Property tax rates in urban centers remained almost unchanged during the depression, judging by the average for cities of more than 30,000 population. This average is somewhat misleading since a study of each of the forty largest cities shows in many cases an appreciable fluctuation in tax rate from year to year. The relative stability in part reflects a stable tax base. Assessed valuations in cities, on the average, remained almost unchanged in 1931 but dropped approximately 4 per cent in 1932, 8 per cent in 1933, 6 per cent in 1934, and 2 per cent in 1935, and remained almost unchanged in 1936. The percentage drop is from year to year. /13/
In some farm areas assessed values were written down much more sharply than the average, and rates also decreased. In most localities, rural and urban, however, the assessors seem not to have lowered assessed values in proportion to the fall in market values.
With many important exceptions, the localities, and to a much lesser extent the states, held the property tax nominally at or near prosperity levels. However, owing to substantial delinquency, they had to get along on much smaller collections. Even the nominal amount was sharply reduced in some instances, particularly in states like Michigan, Ohio, and West Virginia, where low, overall, property tax rate limits were voted into the constitutions under the stress of the emergency. /14/
/13/ See Note 4, Fluctuation in Urban Property Tax Rates and Assessed Valuations During the Depression, p. 525.
/14/ See Note 3, Notable Decreases in Property Tax Assessments or Collections, State and Local, p. 525.
TESTING THE TAX SYSTEM
THE PROCESS OF JUDGING A TAX SYSTEM
In Chapter 1 some common complaints about the tax system of the United States were listed. They indicate that the system is failing to achieve certain aims. It is, therefore, in order to ask what the aims of the tax system are, or can be.
In fact only by a clear definition of what is wanted of a tax system is it possible to judge it. Once the aims are clear, however, any tax can be judged by testing its performance against each one of them. Book Two is given over to these tasks. After the aims are defined, they are applied to the various taxes, one by one, and in the end certain conclusions are drawn.
Primary and Secondary Aims
The aims of taxation fall into two groups -- primary and secondary. The primary ones are so important that they may be called the main purposes of taxation. Under the existing economic system these are, broadly speaking, two: (1) to raise revenue, and (2) to control production, distribution, or consumption. Thus, a tax may be levied to supply money for expenditure on highways, education, etc., or it may be levied to restrict imports, decrease consumption of liquor, etc. Some taxes show a mixture of both of these primary aims.
Once the primary aim has been fixed in testing a tax, a number of secondary aims must be considered. For example, if the primary aim is to raise $1,000,000,000 in
tax revenue in a given year, it can be accomplished in a number of
ways. The choice must depend on what secondary aims are selected,
and how much weight is given to each one compared with others that
may be inconsistent with it.
Secondary aims cannot be considered the main purposes of taxation. Given an existing system, with no desire for added revenue or for a change in social control, no one would urge additional taxation simply in order to make the public more tax conscious. The secondary aims may be reasons for replacing existing taxes, as when an attempt is made to shape the relative burdens of taxpayers more closely to some pattern of tax justice. They cannot, however, be motivating forces behind taxation in general.
Relative Importance of Aims
Two secondary aims commonly held are (1) simplicity in administration and (2) a nice adjustment of the tax burden to each individual's ability to pay. Both of these aims cannot be reached within the same tax system. Some aims must therefore be sacrificed if others are to be realized. More precisely, a closer approach to one must be sacrificed so as to lessen the distance from another. This idea of how far a tax attains its aim involves measurement. Terms must be used that are comparative and, if possible, quantitative.
A quantitative statement of the administrative aim is sometimes vaguely made by appealing for a "low cost of tax administration." Ideally, the aim would be a cost of zero. In view of other aims, however, a cost as high as 2 per cent of the tax revenue may be rated as good. Some aims, particularly those concerned with justice, can never be stated in figures. Larger and smaller quantities can, however, almost always be distinguished and can
be expressed in comparative terms. The main difficulty at present is
apt to be not the rough sort of measuring that is necessary, but the
careful definition of the aim.
The same problem of measuring and assigning relative weights is found in the primary aims. In theory, the two aims of revenue and social control are opposed to one another. Almost no conflict can be found, however, in American practice. Aside from the customs duties, and possibly the tax on spirits, the taxes aimed at social control tap sources that apparently would never have been relied upon for large yields.
The process of testing a tax system is a purely technical one. It should be unbiased. It cannot be completely so, however, partly because the testing cannot be done without some choice of the aims to be studied, and this process of selection involves a certain amount of personal judgment.
TESTS TO BE MADE
The tests that have been selected for use in Chapters 5 to 24 are based on the two primary aims mentioned above and a number of widely recognized secondary aims. As far as possible, the tests have been devised to enable the reader to judge the present tax system on the basis of the aims that he himself favors. In this section of the book no judgments at all on policies are intended and no suggestions offered for action. These matters are reserved for Chapters 25 to 27 inclusive.
The tests are applied to the entire existing tax system of the United States -- federal, state, and local. In the process of testing the system, individual taxes are considered, one by one. Occasional summaries, however, are given where they are needed to present a balanced view of the system as a whole.
There follows a brief resume of the tests that are to be made.
The Two Primary Aims
In considering the aim of raising revenue, attention must first be given to the question of whether a nation has a definite "taxable capacity." /1/ This leads naturally to a study of the specific amounts of revenue that can be expected from specified changes in rates, tax base, etc. /2/ By comparing these figures with estimated expenditures, /3/ the problem of balancing the budget may be outlined. /4/
The other primary aim -- social control -- accounts for many features of the present tax system in the United States. /5/ Some persons, however, will not agree that this should be a primary aim. They claim that any effects that the tax system has on the consumption of certain products, such as liquor, or on the volume of certain kinds of production, such as domestic production sheltered by a tariff wall, should be purely incidental. In their view social control should, at the most, be a secondary aim.
Social control through taxation has had several objectives in the United States. Sometimes the objective has been to promote certain industries. /6/ Reform of business organization and practice has been another. /7/ A miscellaneous group of other industrial controls also deserves attention. /8/ The government has regulated through taxation certain types of consumption that may become socially dangerous -- for example, the consumption of liquor. /9/ Finally, the redistribution of wealth and income is a possible objective of importance. /10/
/1/ See chap. 5 (pp. 57-68).
/2/ See chap. 6 (pp. 69-93).
/3/ See chap. 7 (pp. 94-120).
/4/ See chap. 8 (pp. 121-28).
/5/ See chap. 9 (pp. 129-40).
/6/ See chap. 10 (pp. 141-52).
/7/ See chap. 11 (pp. 153-87).
/8/ See chap. 12 (pp. 188-94).
/9/ See chap. 13 (pp. 195-202).
/10/ See chap. 14 (pp. 203-14).
One of the most important of the secondary aims of a tax system is to distribute the burden among the persons in the community on a fair or just basis. /11/ The actual distribution of the burden of the whole system is very difficult to measure and describe, even in broad terms. /12/ The distribution of certain parts of it, however, is known. This knowledge, though fragmentary, has practical value. For example, it is evident that some widely discussed changes in the real estate tax would in effect amount to a random distribution of gifts by the government. /13/ Likewise, the existing system can be examined to find out the extent to which it distributes the burden on the basis of benefit /14/ and on the basis of the social undesirability of certain kinds of income. /15/ The adaptability of the system to the personal status of the taxpayer, chiefly in an effort to tax according to ability to pay, can be described. /16/
Relative stability of revenue is another important secondary aim. Two different tax systems may raise the same amount of revenue over a certain length of time, but the revenue may come in steadily under one system, and irregularly under the other. Thus one of the secondary aims for a tax system may be cyclical stability, or, on the contrary, cyclical instability. A closely related problem is the effect of an inflationary period of rapidly rising prices on the tax system. /17/
Another series of tests can be made to reveal the ease or difficulty with which the tax system is administered, and the extent to which taxes are evaded. Data can be obtained on the cost of administration and also on the cost of compliance. The latter topic includes the extent to which business firms are used as unofficial tax collectors. /18/
/11/ See chap. 15 (pp. 217-20).
/12/ See chap. 16 (pp. 221-37).
/13/ See chap. 17 (pp. 238-54).
/14/ See chap. 18 (pp. 255-70).
/15/ See chap. 19 (pp. 271-93).
/16/ See chap. 20 (pp. 294-21).
/17/ See chap. 21 (pp. 322-35).
/18/ See chap. 22 (pp. 336-51).
The tax system influences public attitude toward taxation by producing tax consciousness. This may be a mere feeling of irritation or a genuine interest in improving the system. If it is the latter, it becomes an important secondary aim that can be applied as a test. /19/
Finally, the tax system in the United States operates under a decentralized form of government. As a result, special devices have to be used in order to get a generally acceptable tax system without sacrificing state and local self-government. The degree to which any given tax is adaptable to these conditions is the last of the tests made in this book. /20/
/19/ See chap. 23 (pp. 352-64).
/20/ See chap. 24 (pp. 365-87).
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