( Originally Published Early 1900's )
General Considerations. It is essential to the existence of civilized society that a certain amount of the labor of the social organism shall be devoted to the performance of the functions of government. The persons who perform these functions are government officers or employees. They have to be paid for their services, and large sums have to be expended by the government in the purchase of commodities for the public uses. It follows that government must be in receipt of an income with which to pay these expenses. This income is called revenue. From the very nature of the case it cannot be to any great extent gained by production, as individuals gain their income. It must therefore be obtained by a levy upon the people governed. This levy is called taxation, and the money collected by it is called a tax. The object of the present chapter is to set forth the principal methods of taxation, and to trace their effects upon the interests of society.
In discussing this subject it is very common to consider only the effect of collecting a tax. But the effect does not terminate when the citizen has paid his money into the public treasury. All money paid in is to be paid out again by the government, and the disbursement is as important a factor in the result as the collection.
The reader who has mastered the preceding chapters will see that the inflow and outflow of the public revenues are so connected that one cannot be advantageously considered apart from the other. Hence when the economist is asked what will be the effect if government should levy a tax, and thus largely increase its revenue, he would have to reply : I cannot tell what the effect will be until I know how the increase of revenue is to be expended. It may be expended abroad or at home; in levying war or in constructing a canal; in paying off a national debt, or in subsidies to various forms of industry. The difference between the effects of these various modes of expenditure is much greater than the difference between one method and another of levying a tax.
We shall begin by establishing certain principles common to all methods of taxation. In doing this we suppose the reader to have clearly in mind the nature of the monetary and industrial circulations as developed in the preceding book. The first principle to be understood is this :
In whatever way a government may collect a tax, the act of collection diminishes the monetary flow from the taxpayers to their fellow-citizens by an amount equal to the tax. This result is so obvious as not to need extended discussion. Every person who pays money to a public collector has so much the less to pay to his fellow-men for their goods or services, and thus his monetary flow is diminished. If the taxpayer makes this up by charging a higher price for his goods, then the per-sons who buy his goods, having to pay more for them, will have less money to spend in other directions. Thus the whole amount of taxes collected comes out of the monetary flow of the community. The money demand for labor must therefore fall off by an equal amount (IV. 37) ; and if there were no compensation for this, labor to an amount equal to the tax would be thrown out of employment until prices fell so as to restore the compensation. This effect has been fully developed in Book IV., Chapter VII., and therefore need not be further considered. Our conclusion is that if a flow T is collected as a tax, a quantity of labor valued at T will be found waiting for the employment of which it has been deprived by its employers being taxed.
But the compensation, is effected when government expends its revenue. This act produces the same effect as individual expenditure. That is to say, all the money expended by the government goes directly or indirectly to those who render it services. Payments to its officers reach them directly ; payments for supplies furnished reach the producers of those sup-plies through the regular channels of trade. Thus, in the act of expenditure the monetary flow is restored and a demand for labor is set up equal to the demand lost by the levying of the tax.
But this labor may not be, and probably is not, of the same kind as that thrown out of employment by the levying of the tax, and there must be a change of employment. We therefore reach the conclusion : The operation of levying and expending a tax consists in diverting a certain amount. of industry from the ordinary channels of business into the channels required by the government.
But it must not be inferred that such a change of labor is continually brought about by taxation. When a government once begins raising and expending its regular annual revenue, the change of industry must be made once for all, and the industry will continue in its new course so long as the tax remains substantially the same. Now all governments from time immemorial have been obliged to levy taxes in some way, and thus society has grown up to the system of having a portion of its work devoted to the government service. A real change in the effect occurs only when government makes a change in the amount of its revenue. If the revenue is diminished, the industry in government channels must be diminished, and other industry increased. The ordinary operations of taxation and expenditure do not therefore involve any disturbance in the supply of and demand for labor.
In drawing the preceding conclusions we have spoken of the government revenue as raised by taxation. A government may also supply its wants by borrowing money to be repaid at a future time. But all that has been said applies equally to this case. So far as the immediate effects are concerned, they are the same whether government raises money by taxation or by loans. Every dollar borrowed cornes out of the monetary flow from the person making the loan as completely as if it were obtained by taxation. Every person who loans money to the government loans that which otherwise he would have had to expend in other directions. And when the government expends borrowed money, it creates a demand for labor exactly the same as when it expends a tax.
In all this we refer only to the immediate economic effect. The ultimate effects are of course different, owing to the re-payment of the loan. When a tax is paid, the transaction between the payer and the government is completed. But when government raises money by a loan, the payer becomes the creditor of the government and thus a national debt is created. The result is that the government must pay the creditor an annual stipend during a period of time which may be stated or may remain undefined. This stipend is to be raised by taxation, which would not have been necessary but for the loan. Thus the ultimate result of borrowing instead of levying is that an increased revenue is to be raised in the future.
The effects of the various modes of government expenditure are determined in the same way as the effects of individual expenditure. This may be illustrated by considering the principal objects for which government needs a revenue.
I. That portion of the revenue which government pays to its officers and employés for their services returns immediately to the circulation, so as to form a part of the individual income of those persons.
II. That portion which is expended in the purchase of sup-plies is divided amongst the producers of the supplies as income, in the way already pointed out (IV. 30) If all the producers are citizens of the government, the money is immediately restored to the circulation from which it was withdrawn, as in the first case.
III. If the money is employed in paying off a debt held by its own citizens, it will soon reach the same general circulation. Each creditor will then be in possession of a sum of money which he otherwise would not have had. As a general rule he will expend the money in increasing his capital, because he has been considering the government bonds which he holds as a part of his capital. But, however he expends it, it must speedily enter into the general circulation, and be expended in the employment of labor.
IV. If the money is expended in public improvements intended to yield a profit, in canals or railways for example, the immediate effect of the expenditure is still the same. But the profit to be ultimately derived, from the improvement will be a source of gain which would not have been enjoyed had the expenditure been made for other purposes.
VI. If the money is spent abroad instead of at home, then it is of necessity withdrawn from the home circulation, and added to the circulation of the country to which it goes. The result will be a tendency to a fall of prices in the one country and a rise in the other. This will ultimately bring the money back again, and thus in the long-run the balance will be restored. Indeed, it is highly probable that the payment will have been made in the first place by exporting goods and not by exporting the money. That is to say, when the government has to make the payment abroad, it might purchase foreign exchange from its bankers. The home merchants, finding foreign exchange scarce in consequence, will be stimulated to export goods in order to keep up the balance.
It follows from all this that the really important question growing out of taxation is, not how the tax is to be levied, but how it is to be expended. In whatever way it is Ievied, it will have corné out of the pockets of the community, and different classes will probably have to pay nearly the same in any ease. But when the tax is expended, the government becomes the sole director of the labor which it employs by the expenditure. Indeed, what is really expended by the country is, not the money paid as tax, but the labor employed with it by the government. The money remains, but the labor is used up in the performance of some public work. Whether it is expended for the public good or not depends entirely on the object to which it is applied. If expended in war, then the labor of large bodies of men is turned into the channels of destruction instead of those of production, and the result is a loss to humanity of the whole labor thus directed. If directed to the current administration of justice, an advantage is gained; but the advantage terminates with itself. If devoted to public works which really prove profitable, it is expended with a future profit ; if to unprofitable works, it is wasted. If devoted to the payment of a debt, then on the whole the tendency will be to increase the capital of the country, because the bond-holders who receive the money will in most cases employ it in increasing their capital.
Different Kinds of Taxes. Taxes are ordinarily divided into direct and indirect.
A direct tax is one which it is supposed that the payer cannot collect again from the rest of the community by charging a higher price for his services.
Indirect taxes are those levied in such a way that the person who pays them can get his money back again by charging the rest of the community a higher price for goods ou which the taxes are levied.
Examples of direct taxes are those on income. An income-tax consists of a certain percentage of the total net income of the person on whom it is levied. Since the payment of such a tax does not increase his power of rendering service to the community, he can charge the latter no more after paying the tax than he could before. Taxes on the sum total of a man's wealth, and upon his houses and lands, are commonly supposed to fall into the same category.
Examples of indirect taxes are those levied upon the manufacture of commodities. In such cases it is supposed that the manufacturer can get his tax back again by charging a higher price for his goods. Thus it is the consumers of the goods, and not the manufacturers, out of whose pockets the tax is sup-posed ultimately to come. If every commodity which is used by the community is thus taxed, it will be the whole community which will pay, no matter how few the manufacturers. The tax is called indirect because it is paid by the consumers, not to the government directly, but through the men who sell goods at the increased price.
Economically this classification is imperfect, because it is scarcely possible to determine in all cases whether a tax can or cannot be transferred by the person paying it charging more for his services or commodities. A tax on city real estate, for ex-ample, will lead to its owners charging a higher rental, so that it might be regarded as indirect. But if the owner of a house lives in it, he can scarcely charge to others the tax which he pays on his house. Again, a manufacturer may not be able to collect his tax from others for the simple reason that he cannot sell his goods at all after he raises their prices. He may therefore be obliged to sustain the loss himself, or go out of business.
The Double Classification of Taxes. The fact is that the methods and systems of taxation are so varied as not to admit of an absolutely exhaustive classification. But the great mass of those which are collected in the United States, and perhaps in other civilized communities, may divide into three classes, as follows :
I. Taxes levied on individuals. Under this head we include all taxes which any individual is required to pay irrespective of his wealth or the amount of his income. The following are examples :
A poll-tax is a designated sum of money which every male adult of a community is required to pay annually. One dollar was the common amount of such a tax. Being levied without reference to ability, it was extremely obnoxious and has become nearly obsolete. In the few States where it still exists it naturally costs more than its value to collect it forcibly from the individual. Its payment is therefore generally made, as in Virginia, a condition of exercising the right of suffrage.
Licenses to practise particular trades or professions afford another example. In most of our cities, bankers, tradesmen, and managers of nearly every kind of business are required to pay a certain sum annually for the privilege of exercising their avocations. The payments for this license, being fixed without regard to the extent of the business, constitute a purely individual tax.
II. Taxes on production. The distinguishing feature of a tax on production is that it is a percentage of the value of something which the individual produces. For example, an excise duty on spirituous liquors is a tax of so much per gallon produced. Those who do not produce the articles taxed have no tax to pay directly to the government. Customs duties on foreign imports belong to the same class, because the fact that the production is that of a foreigner does not change the application of the general principle. So far as we are concerned, any person who imports goods stands to us in the relation of a producer of the goods. The tax he has to pay is proportional to the amount of goods he supplies us with.
Taxes on production are of two kinds, according to whether they are levied on specially designated articles, or on the total productivity of the individual. Those which we have already mentioned as examples are levied upon special products. The total productivity of the individual is measured by his income, so that a tax on this basis is an income-tax. When such a tax is levied, the individual is required to make known to the government his total profits and earnings for the year, and to pay a designated percentage of them into the treasury.
III. Taxes levied on accumulated wealth. These differ from taxes on production in this very important respect: that the former are paid once for all, while in the case of the latter the same wealth has to pay over and over as long as it is kept. When a keg of beer has once paid the excise duty it is free ever thereafter. When an income-tax only is levied, an individual who gains a surplus income of $1000 year after year has only to pay the same annual tax year after year. But if he invests this income in any form of capital, then for every thou-sand dollars he invests and keeps he has to pay an annual tribute.
A tax on accumulation may be levied on the same two systems as one on production. That is to say, it may be levied only on certain designated kinds of wealth, such as bank-stocks, houses, lands, carriages, watches, etc., or it may be levied on one's whole possessions without regard to their character.
It follows that there is a double classification of taxes. The one classification turns upon the general condition which determines the amount of the tax, whether the latter is purely personal or depends upon production or accumulation. The other division depends upon whether the tax is levied on sums total or is confined to certain designated objects.
Results of levying a Tax. Although, as already stated, the economic questions involved in the expenditure of a tax are more important than those involved in its levy, yet the latter are most in need of investigation. There are two reasons for this. In the first place, the objects for which revenue is to be expended are generally determined by circumstances, and not by the arbitrary will of the government or of the citizens. There are certain officials to be employed and paid, certain supplies to be furnished, certain debts to be liquidated, irrespective of the will of the government for the moment. But the method in which the tax shall be levied is altogether a matter for the decision of the public.
In the next place, the very fact that taxes paid into the public treasury come out of the monetary circulation makes the public very critical in inquiring into them, and it is necessary not only to consider what is theoretically the best kind of a tax, but also what method of taxation is least displeasing to the public. Thus the question of the best method of raising a government revenue becomes a very delicate one, involving not only purely economic considerations, but questions of political expediency. The success of a system of taxation depends so largely upon the condition of the people taxed that no system founded solely on a general theory can be relied upon. Still we should have some guiding principles to start with. Four such principles were laid down by Adam Smith, of which the first was in the following words:
"The subjects of every state ought to contribute to the sup-port of the government, as nearly as possible in proportion to their respective abilities; that is, in proportion to the revenue which they respectively enjoy under the protection of the state."
The remaining three principles were : (1) that the ,tax to be paid by each individual should be certain and not arbitrary ; (2) that it should be payable at the time and in the way most convenient to the payer; (3) that the cost of collection should be as small as possible.
The tax which most directly accords with the first maxim is one upon gross income. In fact, since Smith defines ability to pay as measured by the revenue which the citizen enjoys under the protection of the state, and as this revenue is neither more nor less than his income, it follows that an income-tax is the very one indicated. Such a tax is levied by deter-mining every man's income from all sources year by year, and requiring him to pay a certain percentage of it into the public treasury. In Great Britain the imposition of such a tax is the most common method of meeting an unusual demand upon the public resources. It was levied by the United States during several years after the termination of the civil war.
It follows that if an income-tax could be justly levied, it would be the only one which we should impose. But when we come to the question of levying it we meet with a practical difficulty at the very outset. In order to determine how much a man must pay, the government must learn first what his total income is. Now, although the amount of one's income can be defined with all necessary precision, its actual calculation in dollars by government agency involves difficulties which are quite insurmountable. The result of these difficulties is that, in practice, an income-tax is among the most unjust and demoralizing that the Government of the United States has ever at-tempted to levy. Why this is so will be seen by looking more closely into the conditions.
In the first place, it is impossible for any government agency to know much of the business of the individual by any investigation which that agency can conduct. The government must therefore depend very largely on the man's own statements. If the man can avoid making any statement at all, which he may perhaps do by keeping away from the assessor's office, the latter will have but little material for a conclusion. It is true that in such cases the law requires the assessor to determine the man's income in the best way he can, and then to add a considerable percentage to his estimate, and tax the man accordingly. But it has been decided that this law does not mean that the assessor may arbitrarily guess anything he pleases as the man's income, but that his estimate must be founded on some sufficient data. The result is that if no data can be found, or if those found do not correctly indicate the income, the conditions required by the law are not fulfilled. What is yet more demoralizing, even if the man is caught and brought to the assessor's office, it is to his interest to estimate his income as low as possible. Thus a premium is at once offered to dishonesty, an act which every government should do all in its power to avoid.
But granting that the government has every facility for investigating every man's business, new inequalities arise from the fact that the income proper, as defined in economics, may be very different from income as determined by legal calculations. In the case of persons in receipt of fixed salaries or fees the income is perfectly definite, and if the government can determine it, it affords a correct basis for the tax. The in-equality enters in the case of establishments where several producers work together in unison, and consume a part of their own products. An extreme case is that of a large farm with a wealthy owner consuming its products. The farmer may, from an economic standpoint, be in the actual enjoyment of a large income. For example, he has a retinue of servants whom he feeds from the produce of his farm. He has his own horses and cattle, and feeds them from his farm. He owns his house, barns, stables, etc., and pays no rent for them. His economic income, on which he should be taxed, includes the money value of all these sources of enjoyment. But the assessor can only levy upon the products of his farm which he has actually sold, and from these sales the farmer must be al-lowed to subtract all that he has paid for cultivation.
The result of all this is that in practice the agricultural class are almost exempt from an income-tax, which is levied mainly upon the residents of cities. Among these, salaried and professional men pay. much more than their proper share.
We conclude, therefore, that, instead of attempting directly to determine the revenue which each man enjoys under the protection of the State, a tax must be levied on such visible indications of revenue as the agents of the government can find. It has already been pointed out that whenever a tax is levied upon a manufactured product the manufacturer can, to a greater or less extent, collect the tax from his customers by charging a higher price. It is therefore very generally assumed that, however a tax may be levied, it comes ultimately out of the pockets of the community in proportion to their ability to pay.
On the other hand, all taxes on production are often considered burdens upon industry. By making the product cost more they discourage its consumption, and thus the regular operations of commerce may be greatly interfered with. We have now to consider the relative merits and demerits of different systems of taxation from this point of view.
The system in vogue in the different States of the Union differs from that generally adopted in Europe in that taxes are mostly of that class and order which are levied on one's whole possessions without regard to their character, while such taxes are little known in Europe. There are two reasons for this. The strongest one is that taxes on production would immediately place the manufacturers of each State levying them at an apparent disadvantage in competing with those of the neigh-boring States, where the same tax might not be levied. The result is that such a tax should be uniform throughout the whole country, and this requires that it should be levied by the general government. This leaves only the first and third classes open to the States. The personal taxes of the first class are wholly insufficient. Hence States fall back upon those of the third class by taxing accumulation. It is very natural to measure one's ability to pay by his accumulated wealth; and if we regard only this ability, without reference to the indirect con-sequence to society, or the practical difficulties in the way of determining his wealth, this kind of tax is a, very fair one.
Such a tax is, however, subject to the same kind of objections which have been brought against the income-tax. The system has proved such a failure that it is wonderful how our State legislatures persist in trying to enforce it. The objections are these:
In the first place, it is impossible to find out what wealth every man possesses. The assessors can see and value his houses and lands, and can guess at the value of his furniture. They may readily find out whether he has horses and carriages, and can guess at their value. When they attempt to do more than this, difficulties begin to arise.
It is obviously necessary that every man shall have the right to subtract the debts be owes from the amount of the property which he possesses, in order to determine his actual owner-ship. This he is sure to do. On the other hand, the amount of the debt should be charged as a part of the property of the creditor. This is something which the creditor may or may not do, and which it is probable that in the majority of cases he does not do. It will cost more to learn the amount due him than the labor is worth. U. S. bonds are not taxable under our laws. It is said that in the city of New York there is an in-creased demand for these bonds at the time when the assessors perform their annual duty, caused by the great number of men who at that time put their wealth into the form of bonds in order to lessen the amount of their taxable property.
The next objection to this system is that it makes no distinction between property employed in reproduction for the benefit of society, and that employed in one's own private consumption. Here it is that the system adopted by our States shows at its worst. No doubt the idea that this is a poor man's country lias to a certain extent given color to our system. But if so, the idea has not been intelligently carried out. Since a tax must always be levied on something which the assessor can find, it follows that the most rational system is that which taxes the visible manifestations of wealth. Abroad this principle is fully recognized. The public exhibition of everything which indicates rank and position is heavily taxed in England. For domestic servants above a certain class, gold and silver plate, carriages and horses, the privilege of emblazoning a coat of arms, and other indications of wealth, family, and social position, heavy payments must be made. In the United States no notice is taken of these exhibitions, but, in-stead of doing so, our assessors are engaged in a futile effort to learn the sum total of a man's debts, credits, stocks, and bonds.
We shall close with a few general ideas on our system of taxation. The great defect of this system is that it is founded only on our natural ideas of what is equitable, and that our legislators totally ignore the results of experience as to what is really practicable.
The first step in improving our system will be to give up entirely every attempt to tax a man's total possessions, and in-deed to give up every idea of an abstractly equitable system. Our policy should then be :
I. To tax nothing the possession of which cannot readily be discovered by the assessors.
II. To tax all visible manifestations of wealth in what the old geometers called a duplicate ratio ; that is, in a ratio yet higher than that of the amount of wealth manifested.
III. To tax real estate and other forms of wealth which cannot be concealed.
IV. To tax all products which are designed for the indulgence of the appetites.
We need scarcely fear that any tax levied according to a general law will be permanently inequitable. Take for example the case of real estate. No one is compelled to own it, but as all are compelled to use it, it is probable that the owners can divide the tax equally among the community. The fact is that there is little danger that any reasonable system of taxation will be inequitable in the long-run.