In no way does the State affect the interests of its citizens more
vitally than in the sphere of taxation. The State in modern society is
the people organized for certain collective purposes, as for the
public defense, the preservation of domestic peace, and the
furtherance of the social and industrial welfare. To carry out these
objects money is needed and the State has therefore to collect from
its citizens sufficient revenue to defray its expenditures. John Fiske
has tersely defined taxes as “portions of private property taken for
public purposes.” Taxation thus implies a certain degree of
compulsion; by it the Government interferes with the free choice of
the individual and expends a part at least of his income for him in
ways that he himself might not have chosen. The social and industrial
consequences of a system of taxation may also be far-reaching and
important. As Professor R. T. Ely says: “Taxation may create
monopolies, or it may prevent them; it may diffuse wealth, or it may
control it; it may promote labor or equality of rights, or it may tend
to the establishment of tyranny and despotism; it may be used to bring
about reform, or it may be used to aggravate existing grievances and
foster dissensions between classes.” It is evident therefore that the
utmost care should be exercised in framing a system of taxation.
Certain canons or rules of taxation were laid down by Adam Smith over
a hundred years ago and have been generally endorsed by economists
ever since. One was that taxes ought to be certain and not arbitrary,
as to amount, time and manner of payment; another was that taxes ought
to be levied in the manner most convenient to the tax-payer; and a
third, that taxes ought to take as little as possible out of the
pockets of the tax-payer over and above what is paid into the public 155
treasury. These three maxims--certainty, convenience, and
economy--have been generally accepted, but less general agreement
exists in regard to the fourth, which states that the subjects of
every state ought to contribute to the support of the Government as
nearly as possible in proportion to their respective abilities. This
rule has given rise to two problems: first, is ability the most just
basis of taxation; and secondly, if so, how is ability to be measured?
The theory of justice generally accepted by legal writers and by the
American courts is expressed in the maxim that taxes should be
proportioned to benefits received. The benefit theory affords a good
rule in the assessment of local property taxes, but fails utterly in
the domain of national and state affairs. Who can measure the benefits
to each individual of an appropriation for a new war ship or for a
state penitentiary or for the public school system? Probably the
benefits are in inverse proportion to the income or wealth of the
individual, and the heaviest taxes would then have to be apportioned
to those least able to pay. Most economists today agree that taxes
should be apportioned according to “faculty” or ability to pay. It
satisfies better our sense of fairness and is more readily applicable
than the benefit theory. In the last analysis, of course, it may be
said that taxation in general must confer real benefits upon society
or it will not be tolerated. Here, however, we are concerned with a
rule of apportionment.
The second practical problem encountered is when we attempt to apply
the faculty principle in practice; how is ability to be measured?
Three measures have been suggested: expenditure, income, and property.
Expenditure is open to the objection that it would place an unduly
large proportion of the tax burdens on the poor, whose expenditures
are larger in proportion to their means than those of other classes of
society. Property is objected to because large classes of society, 156
including professional men with large incomes, would then escape
taxation largely or altogether. Income on the surface seems the
fairest measure of ability, but is objected to because the incomes of
different individuals, both on account of source and size, really
indicate unequal and not similar abilities. In practice, however, all
three methods are employed in all advanced states, so it is not
necessary to decide which is theoretically the fairest.
Still another practical question confronts us after we adopt the
ability theory: Shall the rate of taxation be the same no matter what
the amount of the property or income, or shall it increase as the
amount grows larger? In other words, shall taxation be proportional or
progressive? In general the advocates of the ability theory also
support progression, though there are many exceptions to this
statement. Three main arguments have been urged in support of this
method. First, progression is advocated in order to secure equality of
sacrifice; it is argued that each dollar of a $10,000 income affords
less gratification to the owner than each dollar of a $1,000 income,
and that consequently in order to equalize the sacrifices of the two
individuals a larger proportion of the first income should be taken
than of the second. Objection is made to this, that wants expand even
more rapidly than incomes and therefore the initial assumption is
untrue. Progression is urged, in the second place, by those who desire
to use taxation as a method of introducing social reforms or of
bringing about a more equitable distribution of wealth, as by the
breaking up of large fortunes. It seems inadvisable, however, to use
the machinery of taxation for such purposes. Other writers urge that
the ability to earn or produce wealth increases at an accelerating
rate, and that taxation should therefore keep pace with it. “It is the
first thousand that counts.” The objection is made here that it would
penalize ability and energy. In general, while the arguments are not 157
conclusive, progression certainly secures a nearer approach to the
ideal of the ability theory than does proportional taxation. The
practical application, after we accept it, is still a difficult
matter. It should be applied to the revenue system as a whole by the
careful selection of special taxes. As a matter of fact we have just
the opposite system in the United States, for the poor man undoubtedly
pays out a larger proportion of his income in taxes--principally on
articles of consumption--than do his wealthy neighbors.
In the main there has been a clear division in the United States
between the sources of income of the Federal Government on the one
hand and those of the state and local governments on the other. The
Federal Treasury has derived its revenue almost entirely from indirect
taxes--excise and customs--while the other governments have depended
chiefly upon direct taxes upon persons, property, business,
corporations, and inheritances. The division rests upon the
constitutional allotment of powers, but it also corresponds very
closely to the industrial and political functions of each in their
relations to the individual citizens. The chief duty of the Federal
Government is that of national defense and foreign intercourse,
relations which are national in extent but which affect the individual
only remotely; so, too, its taxing area is national and its exactions
are felt only distantly. Few persons, it has been said, taste the tax
in their tea or their whisky, yet over one-third of all the taxes
collected in the United States are derived from either customs or
excise duties. Whisky and tobacco contribute most of the internal
revenue, while import duties are levied on practically everything
brought into the country which could compete with any home product.
These two sources yield over $500,000,000 a year to the Federal
Treasury. During the Civil War these sources of revenue were
supplemented by a federal income tax, but as such a tax was later
declared unconstitutional by the Supreme Court, further recourse to 158
this in the near future seems improbable. From a purely economic and
financial point of view this is very regrettable, for the Federal
Government should unquestionably have at its command the means of
quickly raising large additional revenue with as little disturbance to
industry as possible. Such a means would be afforded by the income
tax, which moreover can be administered only by the Federal
Government, as it must be national in its operations to be fair.
The main reliance of the state and local governments in this country
is the general property tax, which amounted in 1902 to over
$700,000,000 or almost half of all the taxes collected. This really
consists of two very distinct parts, which present quite different
problems, namely, the tax on real property and that on personal
property. Under our peculiar system, by which property is assessed
locally, and upon the basis of that assessment its share of the state
taxes distributed to each locality, there is every incentive offered
to the local assessor to under-value the land in his jurisdiction,
thereby escaping part of the state burdens. This evil of inequality
between localities could be obviated by the simple expedient of
relieving real estate of all state taxes and leaving it solely to the
counties and cities for purposes of taxation. In the case of personal
property the great evil is evasion. Much of our modern wealth exists
in the form of securities, stocks, bonds, mortgages, etc., and this is
practically undiscoverable by assessors except by the voluntary
declaration of the tax-payer, which is only truthfully made by
trustees and a few conscientious persons. Most of our laws have been
directed to the discovery of this intangible property, as it is
called, but without avail. In a few of the most progressive states the
effort has at last been recognized as futile, and the attempt is now
being made to reach these sources of income indirectly, by taxes on
corporations, on business, franchises and other tangible evidences of
wealth.
Not only are corporation, business, license and similar taxes being 159
developed, but increasing resort is had to inheritance taxes, over
thirty states now making use of this form of taxation. They are more
frequently imposed on collateral than direct inheritances, and in many
states are progressive, both as to amount and as to nearness of
relationship. Thus in Wisconsin the rates advance from one per cent
for bequests under $25,000 to husband, wife, or lineal relation, to 15
per cent for sums over $500,000 to very distant relatives or
strangers. These various forms of taxation are necessary to secure the
needed revenues for the state governments, especially if these forego
further resort to taxation of realty. The tendency is now sufficiently
marked to make it possible to indicate with some certainty the future
of taxation in this country. To a certain extent, however, this must
be regarded as the expression of an ideal rather than the description
of an existing system. The Federal Government should have customs and
excise duties, supplemented by an income tax. The state governments
should have corporation and inheritance taxes. The cities and minor
civil divisions should have taxes on realty, and license and franchise
taxes. Such a division is logical and avoids duplication of taxation
of the same source by two or more grades of government. In view of the
pre-emption of the field of corporation taxation by the states, it is
therefore doubly regrettable that the Federal Government should now
(August, 1909) have adopted a tax on income of corporations for
federal purposes.
Other problems connected with finance are suggested in connection with
the universal tendency to increase in governmental expenditures and in
public debts. The former is an expression of the growth and expansion
of state functions, which will be discussed in the next section. The
latter is due in part to this same fact, in part also to the
development of credit and the creation of a market for the sale of 160
public and other securities, and finally to the growth of
constitutional government, which has made the people willing to
entrust their capital to a government which they themselves as
citizens really control.
The question of the tariff involves such important economic as well as
financial consideration that it seems best to discuss this form of
taxation somewhat more fully. For it has been used not merely as a
means of raising revenue but also as an instrument to develop
particular industries and prevent foreign competition. Any detailed
discussion of this subject therefore involves a statement of the pros
and cons of protection and free trade. It should be said, however, in
advance that the real issue is not free trade, for that is demanded by
only a few doctrinaires, but freer trade through an intelligent
revision of the tariff downward. The system of protection has
prevailed in the United States for virtually one hundred years, and
could not be suddenly changed and abolished if one would. From the
financial standpoint, too, import duties are absolutely essential to
the support of our Federal Government; the question here is not
absolutely free trade, but the choice of articles for revenue
purposes. Shall they be those which are not produced in this country
or those which enter into competition with domestic products? If
financial considerations alone prevailed, the former would undoubtedly
be selected as the more convenient, certain, and economical. But in
the determination of the tariff policies of the United States economic
considerations have been paramount and to an examination of these we
must now turn.
Historically the following arguments have played the main role in
support of protection at different times in the United States. The
infant industries argument was advanced by Hamilton in his celebrated
Report on Manufactures in 1791 and has always been important until
recently when the infants had grown to be so lusty that it was evident
that other reasons for protecting them must be discovered. This was 161
found in the plea for diversified production, which was necessary for
a well-rounded economic development; the need of creating a strong
national government and national spirit also played their part. In
order to win over the farmers the home market argument was early
urged; this has taken various forms. In the first place it was urged
that the building up of manufacturing centers and the consequent
increase in population would give the farmers a better market than the
fluctuating foreign one. As set forth by Carey, it would keep within
the country the elements taken from the soil. It would also save the
freights on the transportation of goods back and forth across the
ocean. Each of these arguments has lost force with the development of
the country and the decrease in the cost of transportation. More
important today is the wages argument; at first protection was urged
because wages were high in the United States and the manufacturer
needed to be protected against his foreign competitor who employed
cheap labor. Today it is argued that protection has raised wages and
must be continued in order to protect the laborer against the pauper
labor of Europe. Curiously enough, in France protection is urged for
French workmen against the highly paid and efficient American. The
effect of the tariff on wages has been greatly exaggerated; wages are
high in the United States because the productivity of labor is high.
Indeed so far as the tariff raises prices it may be argued that the
real wages of labor are lowered. More generally accepted as defensible
grounds for protection are the political arguments that a nation
should be able to produce its own military armaments and supplies, and
that it should be able to use the tariff as a retaliatory measure.
Recently this latter has received considerable force from the practice
of “dumping,” by which is meant the occasional sale of products abroad
at prices lower than those charged at home. Domestic manufacturers in
the country thus treated are of course seriously injured and have 162
insisted upon protection against this procedure which has been
authorized in Canada.
In answer to these various arguments the free traders, or those
desiring a modification of present high rates, make their main appeal
to the doctrine of comparative costs. Briefly stated this asserts that
nations, like individuals, can do some things better than others. Like
the individual lawyer therefore who pays to have his boots blacked
while he devotes himself to the law, the nation should produce the
things it is best fitted for and pay others to produce other things
which it can do less well. In this way each will obtain the largest
possible return. Protection, which interferes with this natural
international division of labor, simply diverts labor and capital from
more into less profitable industries. Practically, this purely
abstract economic argument has had little influence on the commercial
policy of nations, which have been moved more by political and
industrial considerations. Today, however, there is no question but
that the freer movement of capital and industry throughout the world
would be advantageous. In answer to the home market argument it is
pointed out that with the growth of large-scale production the
profitable area of manufacture has greatly widened and now in many
cases transcends national boundaries. As home producers seek foreign
markets, as they are beginning to do, they themselves will demand a
reduction of the tariff, especially in the matter of raw materials.
Free traders also deny the need of artificially diversifying industry
in a country as large and varied as the United States, or of building
up infant industries. Indeed, on the latter point, they urge that many
of our trusts are the result of the tariff, and that the attempt to
grant legislative favors has resulted only in wholesale demoralization
and a debauching of our national politics.
In conclusion it may be said that under certain conditions the 163
policy of protection is relatively defensible; that it has undoubtedly
hastened the industrial development of the United States, though it
has not caused it; and that, on the other hand, it is responsible for
not a few evils in our political and industrial life. The struggle of
particular interests during the framing of the Payne bill shows the
impossibility of deciding this issue upon academic grounds. It may be
prophesied, however, that as our manufacturers reach out more
seriously after the foreign markets the tariff will be modified so as
to make this possible; but he would be a rash prophet who should
predict a sudden or great change in our tariff policy within the
present generation.