BANK OF ENGLAND

BANKING DEPARTMENT

_July 1st, 1914_

Million £ | Million £

Capital 14-1/2 | Government Securities 11

Rest 3-1/4 | Other Securities 49-1/2

Public Deposits 17 | Reserve 28-3/4

Other Deposits 54-1/2 |

------ | ------

89-1/4 | 89-1/4

====== | ======

Any one to whom the Bank of England makes an advance thereby gets a

credit in its books, and so the amount of the deposits at the Bank is

increased by the amount of the advance. If the British Government is

the borrower, the advance is added both to the Government Securities

among the assets and to the Public Deposits among the liabilities; but

as the Government does not borrow money in order to have the pleasure

of contemplating a large balance at its banker’s, it sooner or later

makes payments, out of this deposit, to contractors or other folk to

whom it owes money, by means of cheques on the Bank of England; the

contractors pay these cheques into their own banking accounts, and so

the money originally lent by the Bank of England to the Government is

transferred from the Public to the Other Deposits, to the credit of

the other banks to whom it has been distributed, and henceforward it

figures as cash at the Bank of England in their balance sheets. If

the Bank of England makes an advance to any other borrower, he is

credited with a corresponding deposit. He draws on it and transfers it

to any one to whom he has to make payments, but the deposit remains to

the credit of some one as long as the advance is outstanding. How far

this process has been carried we see from the figures of the Bank of

England’s returns published at the end of last year, comparing with

those at the end of June 1914,[15] given on a previous page:

BANKING DEPARTMENT

_December 27th, 1916_

Million £ | Million £

Capital 14-1/2 | Government Securities 57

Rest 3-1/4 | Other Securities 106-1/2

Public Deposits 52 | Reserve 33

Other Deposits 126-3/4 |

------- | -------

196-1/2 | 196-1/2

======= | =======

Here we see an addition of more than 100 millions to both sides of the

balance sheet, by increases in the securities on one hand and in the

deposits on the other. These deposits are potential currency and more,

for being “cash at the Bank of England,” in the hands of the other

banks they are regarded as just as good a reserve for them as gold or

legal tender. Let us see the effect on the other banks of this increase

in the currency which may be called, in a sense, part of the basis

of their credit operations. I append an aggregate balance sheet of

nineteen of the biggest English banks, showing their position first on

June 30th, 1914, the last date on which they were published before the

war, and then on December 31st, 1916:

AGGREGATE BALANCE SHEETS OF NINETEEN PRINCIPAL ENGLISH BANKS

_June 30th, 1914_

£ £

Capital and Reserves 69,864,000 | Cash in hand and

| at bank 115,242,000

Acceptances and | Investments 114,583,000

Endorsements 37,646,000 | Discounts and Advances

Deposits (including | (including

undivided | Money at

profits, etc.) 747,243,000 | Call, etc.) 571,451,000

| Cover for Acceptances,

| Premises,

| and Sundries 53,477,000

------------ | ------------

£854,753,000 | £854,753,000

============ | ============

_December 31st, 1916_

£ £

Capital and Reserves 72,497,000 | Cash in hand and

| at bank 251,875,000

Acceptances and | Investments 303,461,000

Endorsements 57,498,000 | Discounts and

Deposits (including | Advances (including

undivided | Money

profits, | at Call, etc.) 592,056,000

etc.) 1,095,574,000 | Cover for Acceptances,

| Premises, and

| Sundries 78,177,000

-------------- | --------------

£1,225,569,000 | £1,225,569,000

============== | ==============

[Sidenote: POTENTIAL CURRENCY]

The most notable features in this very instructive comparison are the

increases in the deposits on the liabilities side and in the cash and

investments among the assets, that has taken place during the period.

It will be observed that the deposits, which are potential currency in

the hands of the public, since they give the banks’ customers the power

to draw cheques against them, have risen by 348 millions, while the

cash held by the banks has risen by 136 millions, their investments by

189 millions, and their loans and discounts by 21 millions. How much

of the addition to the cash is due to the Bank of England’s lending

activities, as described above, how much to the issue of Treasury

notes, of which 150 millions sterling were outstanding on December

31st last, and how much to gold paid in by customers, it is impossible

to guess, but it is safe to assume that these three processes between

them have done most of it. But a still larger movement is the increase

in investments, the whole of which, it is safe to guess, has been

due to the big subscriptions made by the banks to the two first War

Loans, and to Exchequer bonds and Treasury bills, by means of which

they increase on the one hand their investments and, on the other, the

deposits of their customers,--by this process. When they subscribe to

War Loans or buy Treasury bills from the Government, the banks pay

for the securities so taken by a draft on their balance at the Bank

of England, and so, for the time being, hold so much less cash at the

Bank of England and so much more investments; but as the Government

uses its increased balances to pay debts, by drawing cheques on them,

and the contractors who get the cheques pay them into their banks, the

banks get back their balances at the Bank of England and also have

their deposits increased, by the cheques on the Bank of England, which

their customers pay in; and so when the transaction is all complete

the banks find themselves with their deposits increased by the amount

that they have subscribed to the new loan, or whatever the security

may be. In other words, they and the Government between them, by this

credit operation, have increased the amount of currency in the hands

of the public, and if at the same time there has been no corresponding

increase in the volume of goods, inflation is thereby produced. The

figures given above are complicated by the addition, during the period,

of two small banks by amalgamation; but if banking figures of the

whole of the United Kingdom could be compared, the total increase in

deposits, that is in potential currency, would be over 400 millions.

[Sidenote: BORROWING FOR WAR LOAN]

A similar process is set to work when a bank makes an advance to a

customer to enable him to take up War Loan, or any other security, or

for any other purpose. As I have shown elsewhere,[16] as long as the

loan is outstanding there is almost certain to be a deposit in some

bank or other against it. The English banks had not, up to the date

of the balance sheet shown above, done much of this business since

the war. In fact, owing to the extent to which industry is now on a

cash basis and owing to the decrease in Stock Exchange speculation,

the increase in loans and discounts of the banks was quite small.

But during the first quarter of 1917 they must have made very large

advances to customers, since every one was urged to anticipate future

savings, borrow from his bank and subscribe to War Loan, and we know

that the public responded very practically to this appeal. This was

quite as it should be, since it was by only anticipating savings that

the huge amount required could be got; but, as was pointed out at the

time by Professor Pigou, in a letter to the London _Times_ of January

19th, 1917, unless the money so subscribed was saved and paid back to

the banks, so canceling the increased credits, as fast as it was spent

by the Government, this system of subscribing out of bank advances

could only lead to inflation.

The banks are, among other things, manufacturers of currency, and as

long as their manufacture does not outstrip the pace at which goods

are being produced, the general level of prices will remain fairly

level. Or if new currency that they create is used by producers to set

to work and make more goods, then by creating it they are helping the

production of goods and so maintaining the equilibrium between goods

and currency. It is when they manufacture currency that is handed

straight over to a great consumer like a Government in war-time, that

inflation can almost be seen getting to work. A new buyer comes into

the markets, with a great mass of currency to draw on, competing with

all other buyers and probably, from what we (in England at least) know

of Government departments, with itself,[17] and up go prices. It is a

subtle, insidious, but very effective way of getting money out of us,

not by taking it from us, but by watering down the value of all the

money that we possess. As the prices of goods rise our buying power

over them declines, and so we have to put up with less of them. This is

right and reasonable if they are wanted for the nation’s needs, but the

inflation process does the job in the worst possible way by throwing

the burden of going without on those who are least able to bear it.

Inflation, however, does not only hit the poorest members of the

community. It is bad finance for the Government that indulges in it

to any extent that suffices to cause any serious rise in prices and

depreciation in the currency. In the first place, the Government drives

prices up against itself and so makes the war, or whatever else be the

object of its spending, more costly. In the second, the Government,

being not only an inflater but a borrower, since it is by the borrowing

process that much of the inflation is done, borrows at a time when the

currency is depreciated by its own action and engages to pay interest

and pay the debt back in years hereafter, when we may fairly hope that

prices will have gone back from their present level. Consequently the

British Government borrows millions of depreciated pounds with a fair

prospect of having to pay back its debtors later on with pounds that

will be much more valuable. Unlike the quality of mercy which blesseth

him that gives and him that takes, the system of financing by inflation

curses both the inflater and the inflatee.

[Sidenote: IS INFLATION INEVITABLE?]

“But,” it is argued, “you cannot possibly get away from inflation in

time of war. It is inevitable. The rise in prices makes a larger amount

of currency necessary.” But could there be a general rise in prices

without an increase in the volume of currency? There could, of course,

if there had been a decrease in the production of goods. But if the

production of goods had remained fairly constant, as it probably did if

we include war material as goods, and if there had been no increase in

the volume of currency, then, I think, though certain prices must have

risen, others must have fallen.

The price of carriage by sea could not help rising, owing to the

demands on the merchant fleets of the world by the warring Governments,

the shutting up of Germany’s ships in neutral harbors, and the

destruction of Allied and neutral tonnage by German submarines. This

would have meant that everything that came by sea would be dearer, so

that in England food prices must have risen. At the same time, the

more generous diet required by the fighter and the war worker would

have had a like effect. War materials would also have inevitably been

dearer. But if there had been no increase in the currency, the greater

volume of it required for purchases of food and war material would

surely have lessened the amount available for buying other things and

their prices would have fallen, and the decreased demand for them

might have set free labor employed in producing them and so helped to

increase the production of food and war material and checked the rise

in their prices. Without inflation private extravagance in England

would have been much less general. If, for example, the higher prices

paid by the British Government for the petrol which it was using in

such huge amounts had diminished by their full extent the supply of

money that other people could pay for it and for other things, we might

have heard less about English race meetings thronged with private cars

in the third year of the war. But as long as the British Government

and the banks kept ladling out fresh supplies of currency, competition

between the State and the citizen for the goods and services available

became ever keener, to the detriment of both parties. As more money

went into buying potatoes, owing to the rise in their price, less, if

it had not been for inflation, might have gone into buying flowers,

and so ground and labor used for growing flowers, would much more

rapidly have been used for growing potatoes, and the rise in the price

of potatoes would have been checked. As more money was needed for

ocean-carried food, less would have been in buyers’ pockets, if there

had been no inflation, for ocean-carried furs and feathers and wine and

silk dresses, and so more ship space would have been set free for food,

and the rise in its price would have been checked. In other words, if

all the money required by the British Government for the war had been

taken out of the pockets of the public in taxes and loans paid for out

of savings, instead of much of it being manufactured by the Government

and the banks between them, then the public’s buying power would have

been reduced by the full amount spent on the war; and the reduction of

consumption, by which alone war’s needs can be met, would have been

brought about with much less friction and economic disturbance.

[Sidenote: GOODS AND SERVICES]

For, as has been said over and over again in the course of the British

War Savings campaign, the Government makes war with goods and services.

Those that it needs for war can only be handed over to it if somebody

goes without. It cannot by any possibility, or by any financial sleight

of hand, get more than the country can produce, either by its own

labor and energy or by selling goods abroad in exchange for war goods

made abroad, _plus_ the amount that it can get abroad by borrowing

and selling securities. As a warring country’s power to borrow and

sell securities abroad is obviously limited, it is clear that after a

certain point the war demand for goods and services can only be met

by the reduction, enforced or voluntary, of the buying power of the

civilian population. Inflation helps to effect this in an insidious,

roundabout, and inequitable manner, laying much of the war burden

on the wrong shoulders. It is not the sole cause of all the rise in

prices, but by encouraging extravagance it helps to raise the prices of

goods that need not necessarily rise at all, and it increases the rise

in prices in which a rise is inevitable.

As has been said, inflation does not “cut much ice” in normal times.

But it is like one of those diseases that demoralize the patient into

enjoying them, and war’s experience shows that England will have to be

careful to get cured of it as quickly as she can without starting some

other ailment, and then keep it out of her system.

CHAPTER IV

MONEY TAKEN BY TAXES

Given a free people with real control over the conduct of its affairs,

a genuine confidence in the justice of the system by which money is

taken from it and in the wisdom and care with which the money is spent,

and the citizen would no more object to paying taxes than he objects to

paying a bill for a book, or a suit of clothes, or a set of golf clubs

that he has ordered for himself. The prevalent spirit on the subject

shows how very far we are from having attained these ideals.

“All taxes are confiscation,” said Mr. Joseph Hume as already quoted,

so expressing the common view that the State takes our money in an

arbitrary and unjust manner and spends it on purposes which may be

necessary but are only submitted to reluctantly on that ground, the

said expenditure being necessarily and inevitably a cause of the

impoverishment of the people. In England in the last century, in the

heydey of the simple and satisfactory theory that every man knew his

own interest best and could be trusted to secure it if left alone, and

that by this pleasant process the interest of the whole community would

certainly be attained, it was a favorite phrase with politicians and

political writers that such money as was saved from taxation would

“fructify in the pockets of the people.”

How much truth is there in this view? It is surely a very large

assumption to suppose that all the money which Government takes

would, if left in the people’s pockets, have been spent on some good

and useful purpose and have increased the productive power of the

community. This theory takes it for granted that the Government’s

revenue is derived entirely from money which would otherwise have been

saved and well invested in reproductive enterprise. Whereas we know

that, owing to various defects in the machinery of the laws governing

joint stock companies and the ingrained craving in the hearts of most

of us for short-cuts to fortune, a good deal of the money that is

invested gets into the pockets of unsavory company promoters and the

evil brood employed by them, or is sunk in enterprises that never had

a chance of yielding a profit to their shareholders; and further, it

by no means follows that what the Government takes comes out of what

the citizens would have saved. Very probably it comes out of what

they would have spent on themselves; and only the most incorrigible

optimist, or the most ignorant theorist, could maintain that whatever

people spend on themselves is spent well. The vulgarity and absurdity

and ugliness of many of the objects on which the rich and middle

classes spend their money are apparent to all: lavish entertainments

at which everybody is bored, theatrical shows which are a scarifying

criticism of the intelligence of those who pay money to be amused by

them, clothes and gewgaws in which no really civilized people would

consent to be found dead,--these are a few of the more innocent

examples of the manner in which hundreds of millions of money that the

State does not take “fructifies” in the pockets of its more fortunate

citizens. Bad spending among the poor is perhaps even commoner, owing

to their ignorance of the uses of money, and is much more tragical in

its effects owing to the fact that, even if they spent well, they would

seldom have enough to give them a reasonable chance of full development

of their faculties and capacities.

[Sidenote: “FRUCTIFYING”?]

Since, then, there is much bad spending in all classes, we have no

right to assume, as is often done, that all the money taken by the

State and spent, well or ill, by it, would have been well spent if left

to “fructify in the pockets of the people.” It might have gone in race

meetings, Tango teas, picture palaces, fashionable fripperies, strong

drink, or trashy “literature,” all of which things have their uses in

amusing people who do not know how to amuse themselves better, but do

not lead to much “fructification.”

It may also be mentioned here that money taken by Government does

not vanish. It is spent by the Government on something, and thereby

provides a large number of people with a living. When it is spent on

the debt charge, it is handed straight over to the debt-holders, in

interest or redemption of debt. Spent on education, it pays those

who build schools and on the army of patient workers who teach the

rising generation--if spent well, no money could be better invested, or

fructify more fruitfully. Even when spent on public defense it provides

wages for those who build our navy and make our guns, and feeds and

clothes those who fight for us. It is true that if we had universal

peace all those good workers might be building merchant ships instead

of battleships, or making and growing useful things instead of learning

and practicing the art of destruction. But as things are at present,

national security is a thing that most of us are very willing to pay

for, and with private spending what it is, we cannot be sure that by

any means all the work of these workers, if set free from military and

naval objects, would be put to good and fruitful use. It is of course

absurd to go to the other extreme and contend that taxation creates

employment. It only transfers the power of giving employment from

individuals, who might or might not have used it well, to the State,

which may or may not use it well.

[Sidenote: SMITH’S MAXIMS]

No chapter on taxation can be complete that does not quote Adam Smith’s

famous four maxims on the subject:

“(1) The subjects of every State ought to contribute towards the

support 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.

(2) The tax which each individual is bound to pay ought to be certain

and not arbitrary. The time of payment, the manner of payment,

the quantity to be paid, ought all to be clear and plain to the

contributor and to every other person.

(3) Every tax ought to be levied at the time, or in the manner, in

which it is most likely to be convenient for the contributor to pay

it.... Taxes upon such consumable goods as are articles of luxury

are all finally paid by the consumer, and generally in a manner that

is very convenient for him. He pays them little by little, as he has

occasion to buy the goods. As he is at liberty, too, either to buy or

not to buy as he pleases, it must be his own fault if he ever suffers

any considerable inconveniency from such taxes.

(4) Every tax ought to be so contrived as both to take out and keep

out of the pockets of the people as little as possible, over and

above what it brings into the public treasury of the State.”[18]

These maxims have been generally accepted by later economists as a

summary of the principles on which taxation should be based, except

the very lucid and sensible American writer General F. A. Walker, who

decided that “the first and most famous of them cannot be subjected

to the slightest test without going all to pieces.” As to the other

three, their equity and sound sense can hardly be disputed (though

Walker thought them “at the best, trivial”), and it is also pleasant

to observe that the British system of taxation is not far from securing

them. If Englishmen fail in the matter of No. 2, it is their fault

rather than the State’s; if they chose they could all know how much

they were paying for government when they buy a glass of beer or a

pound of tea or a packet of cigarettes, and if many of them buy these

things every day without even knowing that they are paying taxes, that

is only because they have not troubled to think about it. As to No. 3,

the convenience of the contributor might be still further consulted in

England if income tax could be paid by installments, instead of in one

lump as it was before the war, or in two as now arranged. A system of

monthly installments would be much more convenient to a large number of

taxpayers, and, though it might involve a good deal of bookkeeping, it

would, on the other hand, help to keep the State’s income even, whereas

the present system leaves long periods during which it has to borrow in

anticipation of taxes to be received later.

But it is in Maxim No. 1 that the whole question of the equitable

apportionment of taxation is really locked up; and, if we examine the

great American economist’s severe criticism of his great Scottish

predecessor, it will help to a clearer understanding of the whole

matter.

“This maxim [says Walker], though it sounds fairly, will not bear

examination. What mean those last words ‘under the protection of

the State’? They are either irrelevant, or else they mean that the

protection enjoyed affords the measure of the duty to contribute. But

the doctrine that the members of the community ought to contribute

in proportion to the benefits that they derive from the protection

of the State, or according as the services performed in their behalf

cost more to the State, involves the grossest practical absurdities.

Those who derive the greatest benefit from the protection of the

State are the poor and weak--women and children and the aged; the

infirm, the ignorant, the indigent. Even as among the well-to-do and

wealthy classes of the community, does the protection enjoyed furnish

a measure of the duty to contribute? If so, the richer the subject or

citizen is, the less, proportionately, should he pay. A man who buys

protection in large quantities should get it at wholesale prices,

like the man who buys flour and meat by the carload. Moreover, it

costs the State less to collect a given amount from one taxpayer than

from many.”[19]

[Sidenote: WALKER ON SMITH]

Walker’s admirable lucidity endears him to economic students, so often

baffled by the obscurity in which the masters of the science enfold

their utterances, but, I think, these criticisms of Adam Smith only

serve to bring out the truth of the principles that lay behind his

famous first maxim. For Walker implies that the poor and weak, women

and children and the aged, enjoy most revenue under the protection

of the State, which they obviously do not. It is very true that the

poor need protection, but they do not need it in respect of any

property that they own or of revenue that they enjoy. The protection

of property, which, as we saw in Chapter I, is the original and still

a most important function of the State, has to be given in increasing

measure as the extent of the property owned, and the revenue derived

from it, increases. A junior clerk whose property consists of the

balance in his pocket of his last week’s wages needs little protection

from the State or anybody else. “_Cantabit vacuus coram latrone

viator._” His employer, with some furniture in a rented suburban house,

a few hundreds invested, and a policy on his life, has little that a

burglar could get at, though his investments and his business make his

revenue depend on the general stability of society, such as is provided

by Government. A great English landed proprietor with an agricultural

rent-roll and a square mile or two of house property in cities enjoys

his revenues only because the State is there to protect his property

and enable him to enjoy it in peace and safety. As Adam Smith says in

another passage:

“It is only under the shelter of the civil magistrate that the owner

of that valuable property which is acquired by the labor of many

years, or perhaps of many successive generations, can sleep a single

night in security.”[20]

Walker’s contention that those with least property require most

protection for it almost looks as if it had been dictated by a desire

to pick holes in the work of his illustrious predecessor. And his

argument that the physically weak, women and children and the aged,

need more protection for their property is very little sounder. For if

we went back to a state of anarchy and everybody took what he could

get, the strong man would certainly have an advantage, but he would not

long enjoy much revenue under such conditions, because production would

promptly be brought to a standstill. As to the “reduction on taking

a quantity” argument--the view that the rich should buy protection

more cheaply because they need more of it, on the same principle that

enables a man to buy bread and meat more cheaply by the carload--here

Walker is surely quoting the principles of the market-place in a

sphere to which they cannot be applied. The merchant with a big stock

of an article, which he may or may not be able to sell, is naturally

willing to make a concession in price to a buyer who will take a line

off his hands, though even in the market-place this principle, or

rule of thumb, does not work always, or beyond a certain point. But

a Government providing its people with protection for their property

works under quite other conditions. It knows exactly how much it means

to provide, and it ought to be able to find out which of its citizens

will be most benefited by this protection and apportion the cost upon

them accordingly by taxation.

So when Walker goes on:

“Returning to the maxim of Dr. Smith, I ask, does it put forward

ability to contribute, or protection enjoyed, as affording the true

basis of taxation? Which? If both, on what principles and by what

means are the two to be combined in practice?”--

when he puts these posers we have an easy answer. Ability to

contribute, since it depends on revenue enjoyed (when we have got at

the right meaning of that ambiguous phrase), involves also protection

enjoyed, so that both principles lead us to the same end. And the two

can be combined in practice and are, in a halting manner that needs

improvement and expansion, in the system of taxation that has been

painfully evolved in English-speaking countries. Logically applied,

Adam Smith’s first maxim would confine taxation to direct taxation,

that is taxation paid directly by the taxpayer to the State, assessed

on a graduated scale according to the taxpayer’s net income and

differentiated according to the source from which it is derived. In

other words, by laying down this maxim he anticipated the beauties of

the income tax and death duties, and of the principles of graduation

and differentiation that have been so slowly and tentatively introduced

into our fiscal systems. All these things are implied in the prophetic

musings of the great Scottish thinker.

Graduation is clearly implied, as was shown by Walker’s criticizing

Adam Smith for having apparently forgotten it, because he did not

actually mention it. We cannot put the proof better than in Walker’s

words:

“Is the ability [he asks] of two persons to contribute necessarily in

proportion to their respective revenues? Take the case of the head of

a family having an income of $500 a year, of which $400 is absolutely

essential to the maintenance of himself and wife and children in

health and strength to labor. Is the ability of such a person who has

only $100 which could possibly be taken for public uses, one-half

as great as that of another head of a family similarly situated in

all respects except that his income amounts to $1,000, and who has

therefore $600 which could conceivably be brought under contribution?

Manifestly not.”

Most true, but there is nothing to show that Adam Smith thought that

it was. Any one who has only $500 a year, of which $400 is needed for

the bare necessaries of “health and strength to labor,” can hardly be

said to enjoy a revenue at all, for the whole of his margin is needed

for the decencies and comforts that must be had before he and his

children can be provided for in such a manner as is necessary to make

them efficient citizens of a civilized state, with their intelligence

cultivated to a point that will enable them to exercise judgment

concerning public questions. Those only can be said to enjoy a revenue

who have a margin over what is needed to maintain them and their

dependents in health and efficiency. To tax anybody below that line is

bad business from the State’s point of view, because by injuring their

health and efficiency the State promotes the growth of a class that is

compelled to live, more or less, either on private charity or public

support, and by its lack of efficiency impairs that of the nation at a

time of crisis.

This principle is recognized by the terms on which an income tax is

assessed. It would not be imposed on a man with $400 a year at all.

Graduation, the system by which no income tax is imposed below a

certain limit, and varies afterwards according to the size of the

income, is the great advantage that income tax carries with it. The

release of small incomes has always, necessarily, been part of it.

When it was first introduced in Britain in 1798 it was only imposed on

incomes of $300 and upwards, was graduated between $300 and $1,000 and

was 10% above that line[21]; in 1806 the limit of exemption was reduced

to $250. Its medieval predecessor, the poll tax, was first raised in

1377, and was graduated. Beggars paid nothing, ordinary folks 4_d._ a

head, and the rate varied from this level up to 10 marks (£6 13_s._

4_d._) on dukes.[22] The income tax was, most unwisely, taken off after

the Napoleonic wars, and when it was reintroduced in 1842 by Peel, it

was imposed on incomes of $750 and upwards.[23] This level was later

raised to $800, and was reduced in Mr. McKenna’s first War Budget in

1915 and brought down to $650, which seems to be low enough as it is

at present assessed, but by no means as low as it should go if and when

the tax is rid of a great anomaly that at present mars it, namely, its

great unfairness to those who have families to educate. But before we

look further into this and other drawbacks that at present clog an

otherwise excellent tax, let us consider its other beauty, that of

being differentiated according to the source of income, whether “earned

or unearned.”

[Sidenote: DIFFERENTIATION]

This, again, is a principle that has only fought its way with the

utmost difficulty into England’s system of taxation, though the logical

soundness of it is obvious. It is clear that two men, each with $5,000

a year, do not “enjoy” a revenue of this amount in the same sense if

one of them earns it as a salary by hard work, which will cease at

any time if, owing to bad health or advancing years, he has to give

his work up, while the other receives it in dividends on Government

securities which he has inherited or bought out of his own savings, and

is therefore certain of enjoying it as long as he lives and of being

able to hand it on when he dies to his children or any one else whom he

may choose. It has not yet been possible to differentiate still further

and impose a different rate of tax on the income that a man receives

from investments which he has saved himself from that which is paid on

an inherited income. When a taxpayer has created, by saving, his own

“unearned” income, it is at first sight unfair that it should be so

called and so taxed. But, even so, his enjoyment of it is clearly so

much the more secure, and moreover the principle of differentiation

is also at work through the British death duties, which take a large

and well-graduated slice out of estates when the demise of their owner

gives the State its periodical opportunity. So that the income of those

who live on inherited wealth, besides paying income tax, is either

diminished every time an owner of it dies and the State takes toll of

the capital, or is lessened each year by the provision that the owner

makes, through insurance or otherwise, in order to provide against the

death duties, and maintain the capital of the estate intact.

[Sidenote: TAXING CAPITAL]

It is commonly objected to the death duties that they are a tax on

accumulated capital and that, as the State uses their proceeds for

purposes of ordinary expenditure, it is paying for current needs out

of capital and so doing a thing that is vicious in the case of an

individual or company. But is this necessarily true? The tax, it is

true, is assessed on capital, but I think it is paid, and that all

taxes have to be paid, out of current income, either of the previous

owner of the estate, if he insured in order to provide for it, or of

its inheritors, if they do not realize any portion of the estate to

meet it, or of those who buy, with saved money, any part of the estate

that is sold to meet the tax. In the last-mentioned case, the saved

money that is handed over to Government to spend would otherwise have

gone into some other investment which would perhaps have increased the

community’s productive power, but this possibility is attached to all

money that the Government takes out of our pockets and is one of the

reasons why we have to be careful to see that the Government spends it

well. A graver objection to the death duties is that they may tend to

check the incentive to accumulation by the individual, a point that

will be dealt with later.

All taxation comes out of somebody’s income. If we try to tax capital,

we can only do so if the owner can pay the tax out of income or can

sell a bit of his capital to some one else who pays for it out of his

income. A tax on capital is thus only a way of assessing income tax

according to the amount of capital possessed, and is a questionable

way of doing so because of the difficulty of knowing what anybody’s

possessions are really worth until they are offered for sale in a free

market, and also because of the great expense and delay involved by

making any such valuation. Moreover, the mistakes made by Government

valuers, when estates have to be valued for purposes of taxation,

are astonishing. In a certain British colony a man once died who had

picked up, in the course of several visits to England, a collection of

beautiful and very valuable Turners and other water-colors. The local

official valuer remarked to his heir, “I see from the dates on these

pictures that they’re all second-hand, so I’ve put them in at half a

crown[24] each.”

But since all taxation falls on income, and since the amount of the

income, with due regard to its source, is the obvious test of ability

to pay, and since this ability clearly grows with each increase in the

income above the sum required for the bare necessaries of life, it is

evident that the income tax, if we could get it into an ideal shape, is

the most equitable form in which taxation can be imposed. Regard to the

amount of the income involves graduation, and regard to the source of

the income involves differentiation, because it is easier to pay, and

more protection by the State is involved, in the case of income from

saved money than in the case of earned money; and still more protection

from the State is involved in the case of income from money that is

inherited or received by gift, since the secure transfer of wealth by

legacy or otherwise is one of the most obvious of the material benefits

granted by stable government.

The ideal form of an income tax would thus be thrice differentiated,

according to whether it was imposed on--

(1) An income now being in the technical sense earned, that is a wage

or salary or professional or business profits;

(2) An income that is produced by savings made by its owner;

(3) An income that is produced by inherited wealth or wealth received

by gift.

If this triple differentiation could be made, then England would be

able to do away with the death duties, with the great unfairness that

they involve, for example, when one estate changes hands frequently

owing to the accident of death, and another escapes by being held

for eighty or ninety years by a specially tough owner who happened

to inherit it when an infant. If the death duties were thus commuted

into the shape of a higher annual income tax on those who got income

from inherited wealth, there would be a much greater chance, amounting

almost to certainty, that they would be met by saving on the part of

the holder of the income.

[Sidenote: THE IDEAL TAX]

Thus differentiated, the ideal income tax would be graduated logically

and steadily up to the highest range of incomes, not as it is now in

England with a series of capricious jerks, and with the super-tax as an

excrescence on the top. It would also be purged of the inequity which

at present in England lumps together the income of husband and wife

as one for assessment purposes, and of the still worse vice that it

now possesses of taking little or no account of the children whom the

taxpayer may have to educate. The unfairness of an income tax which is

the same in the case of two brothers who each earn $5,000 a year, but

one of whom has eight children and the other has none, is glaringly

apparent, if we apply Adam Smith’s test of ability to pay. Allowances

for children were introduced during the Napoleonic war, but were given

up in 1806, as they had “led to an astounding official increase of

large families.”[25] Mr. Lloyd George made a small beginning in his

Budget of 1909 towards remedying this great blot on this tax by giving

an abatement of $50 (from the income assessed) for each child under

sixteen in the case of incomes under $2,500. Since then the amount of

the abatement has been raised to $125 for each child, and this relief

is given to incomes up to $3,500. Even so it is pitifully inadequate.

The proposal made by Mr. Sidney Webb and his fellow-Fabians in their

book on _How to Pay for the War_ is much more efficacious, if it could

be put into practice. They suggest that the basis of assessment in the

case of families dependent on one income should be the income divided

by the number of those dependent on it; that is to say, that if a man

had $5,000 a year and a wife and eight children, he would be assessed

on ten incomes of $500 each, and, as incomes of $500 each are at

present exempt, he would be free of all income tax, while his bachelor

brother would pay the full amount on his $5,000.[26]

“But wait a minute,” says the bachelor. “I don’t quite see why I

should be penalized for choosing, or perhaps being obliged by a

hopeless passion, to live in single blessedness. If you let my brother

off, it is clear that I shall have to be taxed higher. But why? He

chooses to spend his income on the joys of bringing up a family and the

delights of an uproarious nursery. Why should he therefore be let off

while I, because I prefer keeping a yacht, and collecting blue china,

and living a life of peace and comfort, or perhaps, if you knew all,

giving up my spare cash to good works, am to pay more to encourage his

philoprogenitive proceedings?”

The answer is obvious to all but confirmed bachelors, and it lies in

the fact that the State wants citizens and wants them brought up under

the best possible conditions. To penalize income tax payers who are

bringing up families, promotes that tendency to small families, or

none, among the professional classes, which leaves the business of

bringing up the heirs of the race to those who are least likely to give

them the good air, good food, good clothes, and good teaching in their

early years that are all-important to their efficiency when they are

grown up. Economically and in every other respect, a nation can only

thrive if it is composed of citizens sound in mind and body, and any

taxation that makes the middle class sterile is a bad economic blunder.

And since we are only chasing the rainbow of the ideal, we may also

add that, in order to make the income tax perfect, it would, though

assessed on the whole income, only be imposed on that part of a

man’s income which he spends, and he would be allowed abatement in

consideration of any part of it that he invested and not only, as now

in England, on that part invested (within certain limits) in life

insurance. This further exemption would be made, under an ideal system,

because a State cannot make economic progress unless its citizens

continually produce more than they consume on immediate enjoyment, so

that there may be a margin of savings continually available for capital

purposes, that is, for increasing future production by putting labor

and energy into new equipment instead of into luxuries and amusements.

This can only be done if we save, and it is therefore obvious that no

tax can be called ideal which does not encourage investment. In time of

war, however, this abatement might have to be modified.

An income tax adorned by the improvements above suggested would be so

evidently equitable that it might be imposed on wage-earners’ incomes

considerably below the limit which it touches at present, and might

be used for raising the greater part of the national revenue, however

great the extent of the revenue required. There would be no need then

to talk about widening the basis of taxation, for taxation would be

based on the widest possible foundation, the aggregate income of all

citizens above the poverty line. Under ideal conditions it would

be collected, no longer “at the source,” but from the individual

citizen, on his declaration of all the particulars required. It would

not be payable by companies and firms, but only by their creditors,

shareholders, and partners as they received interest due and profits

distributed. Thereby all the evil effects on company finance that

are now produced by the close watch that the British Inland Revenue

authorities keep on their interpretation of profit would be abolished.

Any company or firm that preferred the strait path of good finance

and took a generous view of the claims of depreciation and upkeep

would no longer be deterred by the consideration that it would have

to pay income tax on some of the money that it was putting into

the maintenance and improvement of its business. Moreover, British

companies with a large number of foreign shareholders, and whose

profits are earned abroad, would no longer be impelled, as they are by

the present high rate of income tax, to shift their seat of domicile

to a foreign clime, because only that portion of their profits would

be taxed which is paid into the pockets of British creditors and

shareholders. So devised, taxation would not fall directly upon

industry at all, but only on those who spent the proceeds of industry.

We need not pretend that it would not affect and hamper industry, since

all taxation must do so more or less; but, I think, we can claim that

it would do so less than any other.

Such a tax would meet and fulfill all the requirements laid down by

Adam Smith or added to them by the light of modern experience. We

should all know exactly what we were paying for the maintenance of the

State; graduation and differentiation would do all that can be done by

human fallibility to make the tax work according to the ability of the

taxpayer with due regard to the degree of protection that the State has

to give to secure him the enjoyment of his revenue; if the tax were

payable in monthly installments it would cause no inconvenience to the

man with a small income; every penny of it would go straight into the

coffers of the State, less the cost of collection; and the monthly

collection of it would ensure a comparatively regular revenue against

the nation’s outlay.

How far is all this mere rainbow chasing and straining our eyes after

an impossible ideal? Not so far as it looks, perhaps, though the

acceptance of such a tax in its entirety requires a degree of economic

education and of common honesty in the community that we may not yet

have attained. In England it has long been an argument against all

schemes of graduation and differentiation of the income tax that we

thereby lose the great hold over the would-be evader which is given

to the tax-gatherer by collection at the source. And yet graduation

and differentiation have been introduced without any sign of loss to

the revenue, and during the war the British Treasury has gone a step

further and issued a loan the interest on which, so far as it is held

by registered or inscribed holders, is to be paid without deduction of

the tax, the holder being left to include it in his own declaration of

the extent of his liability.

The fact that if the income tax were worked on these lines everybody

who was believed to be within its scope would be obliged to make a

declaration of his income would be a drawback in the eyes of those who

still object to the “inquisitorial” requirement implied by it--that the

State should know the details of everybody’s income. This old-fashioned

objection is, I think, out of date. As it is, the majority of British

income tax payers have to declare details of their incomes, either

in order to secure abatement, or differentiation, or for super-tax

purposes. Seeing that the alleged “inquisition” is already applied to

so many, there would be little or no hardship in clapping it on in all

cases, as was actually done in 1798.[27] Like all the other suggestions

made above, it is only a further development of a principle already

recognized and acted on in England.

This is true even of the proposal, though it seems at first sight

revolutionary, that the tax should only be imposed on that part of the

income which is spent instead of on what is earned. This principle is

already recognized in England in the case of life insurance, and it is

hard to see why it should not be applied to all other forms of thrift

into which the taxpayer likes to put his savings. That income tax

should be so imposed was urged, over half a century ago, by John Stuart

Mill, and the suggestion also has the authority of Professor Pigou

behind it, though he admits that there are technical difficulties to

be overcome.[28] These difficulties are obvious enough, until the day

comes when every citizen can be trusted to make an honest declaration,

or when at least--as may be the case now--the general level of honesty

is high enough to ensure that the amount of evasion by tax-cheaters

would be small enough not to count. Such an arrangement would, of

course, carry with it its contrary; if the tax were not imposed on the

net amount invested, it would have to be imposed on the net amount of

any investments realized in those years in which the taxpayer sold out

more than he invested; because otherwise any one could escape the tax

by investing all his income in one year and selling the securities

in the next. If the thing could be worked, its effect in cheapening

capital, increasing the capital fund of the country, and so adding to

its power to produce the good things of the earth, would be excellent,

and it would be an equitable set-off to put against the high

taxation now imposed in England on what is called “unearned” income.

It might be possible to do it by means of evidence in the shape of

stockbrokers’ contracts, and certificates from lawyers in the case

of investments in mortgages. The thing is not necessarily a pedantic

aspiration on the part of academic dreamers, for I have heard it urged,

not only as a good thing if it could be done, but as a good thing

that could be done, by a very practical man of business; and if the

ingenious taxgathering experts were to decide that it was worth doing,

they could probably devise the ways and means.

The suggestion that the income tax should be paid by the individual

citizen and not by the companies which earn his income for him as

stockholder may be criticized, apart from its parting from the

principle of collecting at the source, as giving the power to companies

to escape taxation by refraining from paying dividends and putting

profits into improvement of their plant or into investments. This

criticism falls to the ground at once if the principle is admitted

that income tax should not be paid on saved money, because money that

companies put into depreciation is saved money in every sense of the

word. The economic progress of the community is helped by every dollar

that companies keep back from their stockholders and put into their

plant or invest well otherwise; and any encouragement that a fiscal

system can give to this process has something to be said for it, though

there may be countervailing drawbacks. If ever a time came when the

productive capacity of the whole world were fully equipped and there

were a real glut of capital, this need to encourage saving would no

longer exist. But we are not likely to see that happen just yet. There

would, perhaps, be a danger that some companies might try to distribute

profits by devious means--issues of bonus stock and so on--in order to

enable their stockholders to escape taxation. But the keen blades of

the Revenue Department could very well be trusted to deal faithfully

with any such buccaneering.

[Sidenote: INDIRECT TAXATION]

Still greater is the difficulty involved in making the range of the

income tax run lower and embrace all the wage-earners who are a

fit subject of taxation. In their case (in England, at least) the

precariousness of their earnings is much greater than in that of the

salary-earner or even of the more precarious professional workers,

such as the freelance journalist. Moreover, they cannot, thanks to the

education that has been given, or denied, them for many generations,

be expected to keep count of their earnings with any regularity, and

they would be likely to resent being pestered about them. It may take a

long time before they are ready to recognize that an income tax applied

more vigorously to wages would be fairer to them, if they would take

the necessary trouble to tackle it, than the heavy charge of indirect

taxation that they now bear. Economic education of all classes is the

only way in which the path of the tax-gatherer can be made smooth and

easy. The more this education grows, the faster will be the movement

towards graduated and differentiated direct taxation as the fairest way

by which the State can take our money.

It is sometimes said that the income tax punishes and fines the hard

and successful worker. This is so, but what system of taxation does

not? Whatever device you use, you can only tax those who are getting

and spending money. But a system which taxes more lightly those who

are earning than those who are getting interest on saved or inherited

money, which makes due allowance for family liabilities and taxes what

is spent and not what is saved, seems to give the hard and successful

worker a better chance than most others.

When once the beauty and fairness of graduation and differentiation

are seen and appreciated, it becomes clear that all indirect taxation

is to a certain extent unfair, because graduation and differentiation

cannot be applied to it. It might be possible, though very difficult,

to graduate indirect taxation by increasing its rate according to

the quantities of goods purchased; but this system, if applied to

necessaries of life, would evidently involve hardship by taking no

account of the taxpayer’s ability to pay. That the amount of taxation

paid by the buyer of a pound of tea should be the same (as it is

in England), whether the tea is to be consumed by one living on an

inherited million, or by a widowed charwoman with five children and

earning, with luck and when in good health, perhaps ten dollars a

week, is a gross fiscal blunder and a serious practical injustice. But

there is no way round it, and this unfairness is necessarily attached

to all forms of indirect taxation. It is true that, as Adam Smith

pointed out, taxes upon “such consumable goods as are articles of

luxury can be avoided by the taxpayer, as he is at liberty either to

buy or not to buy as he pleases.” But so many things, such as clothes,

are necessaries up to a point, and become luxuries when that point, so

difficult to decide on, has been passed, that taxing luxuries is not

nearly as easy as it is desirable. And even in the case of admitted

luxuries, such as alcoholic drink, the absence of graduation makes the

tax unfair. Why should I, if I drink a glass of beer in the course

of a country walk, pay no more taxation on it than a mechanic who

partakes of a similar indulgence after working eight hours in front of

a furnace? Ability to pay is quite different in these two cases, but

the amount paid is the same. And yet this inequity attached to indirect

taxation, that is so evident as soon as the principles of graduation

and differentiation are admitted, has been so slowly recognized, and is

still so much ignored, that it was once observed by the late Sir Robert

Giffen that “on the whole an equal amount of indirect taxation causes

perhaps only the half or the third of the privation and suffering

entailed by an equal amount of direct taxation.” Mr. Gladstone’s

ponderous joke, in which he compared the two forms of taxation to two

attractive damsels, to both of whom, “whether it be due to a lax sense

of moral obligation or not,” he paid his addresses impartially, is well

known to all students of the subject,[29] and only shows how little

the equities of taxation were studied in the days of that enlightened

fiscal reformer.

[Sidenote: STUPIDITY’S PRICE]

Nevertheless, if it be a fact that direct taxation hurts while indirect

does not, it is natural and inevitable that the practical politician

who has to raise revenue for the State should prefer the latter. If we

are really so stupid as to prefer to be bamboozled out of our money by

paying, on a necessarily inequitable basis, for government, while we

think we are paying for groceries or tobacco, instead of being assessed

directly according to our ability and the source of our income and

knowing exactly what we are paying, then we deserve what we get and get

what we deserve, which is unfair taxation. In a democratic country in

which all have political responsibility, it is clear that all, except

those who have only the barest necessaries of life, should pay taxes

and so have some share in fiscal responsibilities. To do this in a

manner which is specially designed to veil the fact that taxes are

being paid, is hardly facing the problem squarely; but until education

has gone far enough to make everybody ready to pay his fair share

by means of direct taxation, it is the only way that can be hit on.

The inequities connected with indirect taxes are manifold; not only

can they not be graduated or differentiated, but it is impossible to

impose them generally, in a country like England, because taxes on the

necessaries of life are clearly bad, from the national point of view,

in a community in which many people have not enough to eat. So that in

days before the war any Englishman who escaped income tax and did not

smoke or drink alcohol or tea contributed practically nothing to the

Government under whose protection he lived. Since the war, taxes on

cocoa, mineral waters, and entertainments have widened the fiscal net.

The proportion of British revenue contributed by indirect taxation has

steadily declined. In 1841-2 it was 73%; in 1912-13 it was 42.4%,[30]

and during the war it is generally assumed to have declined still

further, though it might be argued that the excess profits tax is an

indirect tax, since most of it has been ultimately paid by consumers

through the high prices that caused the excess profits.

Indirect taxation, being paid by those who buy certain articles for

consumption, has one great advantage, which justifies its position in

England’s fiscal system until such time as she is able to impose income

tax only on that part of the income which is spent. It hits us when

we spend and not when we earn or save. In time of war, when there is

not enough labor and energy to do all that is needed for the fighting

forces and for the export trade and for providing necessaries, any

tax that checks individual spending, or takes part of the sum spent

for the Government, is clearly useful and beneficial. And this is

almost equally true in time of peace, for then also wasteful spending

is economically unsound, checks the material progress of the nation,

makes the hard lot of the poor still harder, and lessens the demand

for labor.[31] So that if only we could graduate and differentiate

indirect taxation, it would have advantages over direct as the latter

is at present imposed. As we cannot, it has to be left in its present

unsatisfactory state, pressing heavily, in England, on the poorest

consumers of such articles as tea, tobacco, and alcohol, while

patriotic ladies who give $15,000 for a fur coat in time of war pay no

taxation in the process except the penny stamp on a cheque. A graduated

invoice stamp on all retail purchases of $2-1/2 and over is a way round

this problem, but there are many practical difficulties in the way of

it and if, as is likely, both shopkeepers and their customers united in

resenting and detesting the tax, it is highly probable that there would

be much evasion.

[Sidenote: IMPORT DUTIES]

Of all forms of indirect taxation, the worst, according to the pure

principles of taxation, is that imposed on imported goods of a kind

that is produced in the country, unless a home tax (or excise duty)

of the same amount is imposed on goods produced inland. Because the

effect of the import duty is to raise the price of the article and,

if the home producer is not similarly taxed, this means that part of

the higher price will go into his pocket instead of into the coffers

of the State. Nearly all nations, including the British colonies, make

free use of this method of taxation, because they think it pays them in

the long run, or think it necessary to the dignity or security of the

State, that certain industries should be thus protected at the expense

of the consumer; or because they hope thus to maintain the standard

of comfort of their wage-earners. Some people think that when the war

is over England also will adopt the system of a protective tariff. We

shall see. It is beyond the scope of this work to enter on this highly

controversial ground. Every one will admit that, if Protection is the

only or the best means of keeping alive in the country an industry that

is essential to national safety, then the most bigoted Free Trader

must agree to it. It must also be admitted that many great, rich

nations--including England’s richest enemy and her richest ally--have

flourished under Protection. On the other hand, it warps and hampers

trade, as a whole, and introduces an artificial complication into a

matter which is naturally quite complicated enough; but perhaps the

strongest argument against it is its tendency to make questions of

taxation, especially in a democratically governed country, an unclean

welter in which politics and business cover one another with dirt.

CHAPTER V

THE LIMITS OF GOVERNMENTAL SPENDING

So far we have considered the means by which the State takes our money

from us for public purposes--

(1) By borrowing it, and then taxing us to pay the lenders;

(2) By diminishing the buying power of our money by increasing its

volume, with or without the help of bankers;

(3) By taxes.

There is yet another way by which some very clever people who have

studied the question with great care and diligence think that the State

might earn a great revenue, and that is by gathering money from us that

we now pay to private undertakers of enterprise, and they believe that

the State would do us a great benefit at the same time by giving us

better service than these private undertakers. And many very earnest

and high-minded people, who hate the waste and ugliness involved by the

competitive system, have long believed that, if the work of growing,

making, and distributing the goods that we need were in the hands of

the State, all the miserable squalor that blots our economic system

might be washed away, man’s labor would be made much more effective,

and we should all of us, instead of wasting most of our lives in a

chaotic struggle to earn our livings which ends in ill-spent affluence

at the top with degraded destitution at the bottom, be free to live as

civilized human beings; with time and energy to bring out all that is

best in ourselves and others, and to enjoy the endless store of joy and

beauty that Nature ever spreads before us, often to be buried under

the mass of moral and physical ugliness that is heaped over it by our

misguided efforts to better our lot.

[Sidenote: WAR’S LESSONS]

If these views are right, they have now a better chance than ever

before of winning their way to action. War has shown us, first, how

astonishingly great is our power to make and do things if we really

want and mean to. Man has put all the prophets wrong who said that a

great war could not last more than a few months, by proving that he

could concentrate his energies on destruction with results that have

appalled and astounded us, while at the same time producing all that

was required for his material welfare; so much so that during the

first two years of the war the general level of well-being in England

was actually improved, owing to the more even distribution of the

output, which was an economic incident of the war; so great was her

margin of unused productive power and so great was the proportion of

her productive power that was put into turning out things that were

not necessary to the nation’s welfare. Secondly, the war has shown how

short-sighted it is for any great and rich nation to allow a large part

of its population to be stunted in mind and body. The voice of the

social reformer is now raised in harmony with that of the recruiting

sergeant, who wants sturdy men for the Army, of the employer, who wants

strong and intelligent workers and of the statesman, who wants a nation

behind him every member of which can understand the tremendous issues

for which we are fighting and see and act on the need for the measures

taken to secure victory. Never has there been a time when it has been

seen more clearly that a nation, to be strong, must be strong from top

to bottom. In other words, the war has shown us how much we can do and

how much needs to be done. But the question still remains, whether

what needs to be done can be best done by the development of the

individual’s sense of national duty in work and spending, or by handing

over to the State a continually growing share of the task of producing

and distributing.

At a time when a brighter era is undoubtedly dawning for mankind,

though it is only too possible that much turmoil and struggle may

yet lie between us and its achievement, there seems to be something

squalid in dwelling on the purely material side of the matter. After

all, the human soul is the only thing that really counts. If everybody

were pleasant to live with, all other things would be added unto us;

if we were all honest and kindly and courteous and fair-minded and

intelligent and unselfish, there would be no need to fash ourselves

about output and distribution, because we should all be doing our

best to make things better, and all these sordid problems would solve

themselves. But as things are, material considerations are of the

greatest possible importance, because it is so much easier for the

necessary qualities to be acquired by people who are not expected

to spend most of their lives in trying to get a better share of the

world’s goods than their neighbors. If we can produce plenty for all

and can prevent people from believing that getting more than plenty

for themselves is the chief object of life, then there would be some

chance for the rudimentary and atrophied human soul, which is now often

treated very like the vermiform appendix--ignored if possible, and if

not, cut out.

If, therefore, it is the fact that, by handing over great industries

to be worked by the State for profit, we can make the State a great

revenue earner, and at the same time do away with some of the

competition that is a source of much waste and mendacity, without

thereby producing a system of organized and hidebound efficiency that

would kill all freedom and initiative, it is clear that we shall be

relieving the taxpayer’s burden and perhaps clearing a way towards a

social system that will stand daylight better than our present one.

[Sidenote: A FABIAN SCHEME]

A great scheme of nationalization has been put before the British

public by Mr. Sidney Webb and his Fabian lieutenants, in a book,

already referred to, called _How to Pay for the War_, published in

1916. They propose to increase very greatly the scope of the activities

of the Post Office, making it do much of the work that is now done by

bankers, and to nationalize the railways, the coal industry, and life

insurance; and they urge, with a wealth of detail that is evidently

the result of laborious investigation, that, if these things are

done, the public will get a better and cheaper service, the workers

employed will get better treatment, and the State will earn a revenue

that will supply a mouth-filling number of millions for paying off the

war debt. This attractive argument, of course, is only a development

of the Socialist contention and an application of it to the needs of

the moment; and for this reason will be refused a hearing by many to

whom the mere name of Socialism is a terror. But a little later, as

if to show how widely and in what unexpected quarters the idea of

collectivist enterprise is being stimulated by war problems, there

arises a new portent in the British economic sky in the shape of a body

called the Empire Resources Development Committee, which also wants to

help to pay off the war debt by means of State enterprise in industry

and production, chiefly applied to overseas enterprise, though one of

its manifestos also includes the coal and light and power industries

at home among the means by which the after-war debt charge can be met

without anybody having to pay it; because the State will be able to do

business so cleverly that it will find the money out of net profits.

The really interesting thing about this Committee is that it bristles

with names that have been hitherto renowned for Imperialist rather than

for Socialist zeal, such as Mr. Rudyard Kipling, Sir Starr Jameson,

Lord Grey (not the late Secretary for Foreign Affairs), Lord Selborne,

Lord Desborough, and Mr. H. Wilson Fox, M.P., a distinguished officer

of the Chartered Company of British South Africa; and with them is Mr.

Vassar-Smith, the highly respected chairman of Lloyds Bank. That names

such as these should be found on a manifesto advocating what one used

to think was pure Socialism shows at least how people’s minds have been

shaken up by the war. The gist of their contention is that the immense

latent resources of the British Empire can be worked for State purposes

and under State auspices in such a way that we shall be able to “lift

from the peoples of the Empire the burdens caused by the war.” And

they, like Mr. Webb and his colleagues, think that the State can not

only perform this financial feat, but at the same time cheapen the cost

to consumers of articles that it provides and distributes.

[Sidenote: A LARGE ASSUMPTION]

It is a most alluring prospect and, if there is any chance of its

being realized, the most bigoted Individualist will hardly let his

dislike of State enterprise stand in its way. But is it not an enormous

assumption to suppose that the State can manage an enterprise with

so much more success than a private undertaker that it can afford to

buy him out, then provide a better service or a better article, pay

everybody better, and finally make a thumping net revenue? In the case

of new Imperial enterprises, there might be no one to be bought out,

though vested interests sometimes are discovered in the most unlikely

corners when a chance of compensation arises. The Imperial Development

Committee expressly states that the proposed enterprises should not be

managed by Civil Service Departments; but it does not explain how the

managers can help becoming civil servants and so being involved with

the attributes of those who work the State machine, so admirably within

certain limits, but not so admirably when it is a matter of conducting

business enterprise at a profit and with satisfaction to customers

and employees. They make a profit out of the Post Office? Yes; but

in discussing the tangled question whether what Englishmen pay for

postal service should be considered as taxation or payment for services

rendered, at least one distinguished economist has decided that postal

revenue is taxation only in so far as they pay more for this service

than we should if it were managed privately. Every one agrees that it

is impossible to gauge this amount, but no one seems to doubt that

it exists, and that postal facilities would be cheaper if they were

provided by private enterprise. Mr. Harold Cox, that stern, unbending

foe of State enterprise, dealt faithfully with the proposals of the

Imperial Development Committee in an editorial in the _Edinburgh

Review_ for April 1917, and incidentally gave two examples of cases in

which the State had taken over profitable enterprises and had totally

failed to work them at a profit:

[Sidenote: A DOUBTFUL POLICY]

“In 1870 the State acquired possession of the electric telegraph

system of the country, which had been built up by various private

companies. The purchase was recommended to the House of Commons as a

splendid bargain for the State. The permanent officials who prepared

the scheme assured the House that the whole of the capital cost would

be repaid in fifteen years out of profits and that after that period

there would be an ever-increasing revenue to relieve the burdens of

the taxpayer. That was the promise. What actually happened was that

the whole of the profit disappeared after the second year of working

by the State; that year by year the financial position has grown

worse, till in the last years of peace the telegraphs were costing

the taxpayer a sum which cannot be put at less than £1,400,000 per

annum.

“Meanwhile, the telephone had been invented. During many years the

State, in order to protect its telegraph monopoly, did its utmost

to stifle the development of the new invention. Finally, the State

bought up the telephones, completing the purchase in the year 1911.

Again there were the prophecies--though in a somewhat minor key--of

a lucrative bargain. These prophecies have gone the way of the old

ones. The whole of the handsome tribute of over £350,000 a year,

which the National Telephone Company was gratuitously paying to the

State, vanished at once, and within three years the income collected

by the State barely covered outgoings.”

With these actual examples before them Englishmen may well hesitate

before embarking on a large policy of State enterprise, especially if

it is to be directed to the provision of necessaries of life such as

food and coal. Posts and telegraphs and telephones hardly touch the

life of the very poorest, and though if they are bad and dear they are

a hindrance and burden to business, their extra cost is a small item

in the expense of industry; but it would be a different matter if the

actual cost of living were raised through an attempt at revenue-earning

by State enterprise in a country in which the test of experience has

shown it to be dear and inefficient.

Nevertheless, we have no right to shut any door on a possibility

of economic reform. We know that there are countries in which the

State can manage some enterprises well and profitably, and even in

England certain municipalities have earned good profits for their

ratepayers and also served their customers well with comparatively

simple businesses, such as tramway transport. It may be that Government

departments, like the rest of us, have learnt much from the war and may

now be able to tackle problems of enterprise with a new freedom and

success. Strongly divergent views are expressed on this point, and no

one who has not been in touch with the facts has any right to be sure

about it. Some say that the British Munitions Department has been a

miracle of official competence and success; others that it was a costly

chaos, only saved by the efforts of the business men, trained in the

school of competitive enterprise, whom it called in to help it. But

since there is a doubt and a new atmosphere, and since imaginative folk

with big new ideas want to give England a lead, there seems to be no

reason why they should not be allowed to try an experiment on a small

scale, to be widened if the experiment succeeds. Freedom and individual

initiative have so long been the life-blood of her national development

that one is loth to see them encroached on even by the most efficient

form of machine-made bureaucratic enterprise; and the ideal of progress

through the improvement of the individual, and a widening and deepening

of his sense of national duty, seems to be a much higher and more

hopeful one than through the expansion of State regulation to a point

which implies the crippling of the soul of the citizen. Some of us hope

that when the war is over we shall get rid of Government control as far

and as fast as possible, except where previous experience had shown

it to be necessary in the interests of the weaker parties to economic

bargains.

“My experience [said Sir Alfred Booth to the Cunard Company’s

shareholders in April 1917] of Government control has only served to

convince me more firmly than ever that individual enterprise is the

only spirit which can quicken the dead bodies of capital and labor

into life.... But I am not at all alarmed. When the war is over,

commercial freedom will win in England just as political freedom has

won in Russia, and we shall be quite content to leave the bureaucrats

and the Romanoffs to cultivate their roses together in some suitable

rural atmosphere.”

[Sidenote: THE DOUBTFUL FUTURE]

But with taxation what it will have to be, all is fish that comes into

the net, and if the State can learn to produce and distribute better

and more profitably than private enterprise, no prejudice should stand

in its way. But it ought to win its spurs, if it can, in a fair field

and not with the support of privileges and monopolies and subsidies,

still less with the help of tariffs.

[Sidenote: THE IMPORTANCE OF TEMPER]

Apart from this possible source of revenue, concerning which one is

justified in doubting whether it will ever be realized and in feeling

sure that in any case it will be slow in growth, taxation is the

means by which the State will have to divert from our use so much

of our annual output of stuff and work that has to be devoted to

national purposes. As to the extent to which it can do this, there are

conflicting opinions. Some say that, owing to the enormous weight of

the after-war debt charge and our impoverishment by war, it will not,

for years to come, be possible to find any money, that is divert any

part of our output, to purposes of social improvement. On the other

hand, there is the opinion, which the huge figures of our war spending

have helped to stimulate, that now that we have learnt to think in

millions and in hundreds of millions, the State will never again be

checked by any consideration of a few millions more or less in the cost

of any reform that is accepted as needing to be done; and that the

reformer will henceforward have a bottomless purse to draw on since he

will always, when the war is over, be able to say, “What I ask is only

the cost of one day, or one week, or one month--as the case may be--of

the late war, and just consider how much good it will do!”

As to the first and pessimistic view, we cannot know how far it will be

right until we know how much capital equipment will have been impaired

and how much is owed to foreign nations by the time the war is over.

If by the destruction of ships and the depreciation of industrial

plants and of the soil’s fertility, the State’s output is seriously

diminished, and if at the same time, owing to borrowings abroad and

sales of securities, the country has a much smaller sum to receive

every year on balance from foreigners in interest, which comes in the

form of imported goods; then the total income, in the shape of goods

produced at home and received from abroad, will be less, and any part

of it diverted to national needs will involve a greater sacrifice than

before. In so far as it is held at home debt involves no absorption of

the national output, but only a transfer of part of it, by taxation,

to the use of certain members of the nation who hold the debt. It is

therefore only necessary to be sure that the taxation involved by it is

imposed on the people who ought to have subscribed to the loans. Then

those who did their duty in subscribing will get their taxes back,

those who pinched themselves and did more than their duty will get more

than their taxes back, and those who did not do their duty will get

nothing back, which is just as it should be. This arrangement is easier

to describe as desirable than to put into practice, which is one of the

objections to finance by borrowing.

But even if the State’s total income, in goods produced at home and by

its debtors abroad, is materially less, which has yet to be proved, it

does not follow that the amount of it available for national purposes

will be less if we are resolved to make a greater sacrifice for them.

Everything will depend on the temper and state of mind with which we

set to work and turn out goods in the first place, and in the second,

regard the claim on our work that the State may make for purposes

of national development and improvement, such as health, education,

housing, and the dozens of other things that, in the opinion of some,

need to have work put into them. If we go to work in a bad temper and

have strikes, lock-outs, and quarrels about methods of production and

distribution of the output, then it is likely that our output will

give us little chance of drawing on it for social reform. And there is

also another enormous question to be answered. Shall we have to spend

in future a much greater amount on defense, or will swords be hammered

into plowshares? The hope, which was so strong in the early days of

the war, of secure peace and freedom from the burden of armaments

has lately looked sickly, but the intervention of the United States

has certainly revived it, and it seems now at least possible that the

League of Honor may ripen into a League of Peace that will rid mankind

of war’s nightmare.

[Sidenote: NO SHORT CUTS]

These considerations apply also to the optimistic view which holds that

we shall never again be stopped by lack of money. It is only true if

the taxpayers are persuaded that the objects for which they are asked

to make sacrifices are a national need and ought to be paid for out

of the national purse. If a people makes up its mind that a thing is

worth paying for, it can and will pay for it, up to the extent of half

its income and more, as the war has shown. But this cannot be done

if the burden of taxation is unfairly imposed, or if a considerable

minority--especially if they are those who are asked to pay most--are

opposed to the objects for which taxation is raised. “Taxing the rich”

looks easy, but it cannot be done indefinitely unless the rich pay

willingly. The taxpayer’s power to strike, referred to in Chapter I, is

still a real one. If the rate of taxation takes more from the producer

and from the owner of accumulated or inherited wealth than they believe

to be just, then the incentive to production and accumulation will be

checked, and the tree which bears the plums will have been killed, or

weakened in its fruitfulness. For national defense every one is ready

to have his money taken, and in war-time there is much less tendency

than usual to grumble about the manner in which the money is raised.

For national improvement and for what Mr. Lloyd George once called a

“War Budget against poverty and squalidness” there may some day be the

same cheerfulness and readiness on the part of those who pay. It may

be that war will have taught them this lesson. If so, in spite of all

its horrors, the war will have opened the way to a great stride forward

along the road of progress. But there are no short-cuts on this road,

and only by the education of the individual to a just view of his

duty as a producer and worker, and of the claim of the State upon his

product for national needs, can full use be made of wealth for purposes

worthy of any nation that intends to be a leader in human progress.

FOOTNOTES:

[1] _Public Finance_, p. 42.

[2] _A General History of Europe_ (350-1900), by Thatcher and Schwill,

pp. 9-10.

[3] Seligman, _The Income Tax_, p. 122.

[4] _Herbert Spencer_, by Hugh Elliot.

[5] _Money and the Mechanism of Exchange_, Jevons, p. 64.

[6] _Study of Sociology_, ch. vii, p. 160.

[7] _Critiques and Addresses_, p. 10.

[8] Quoted by Messrs. Gide and Rist, _History of Economic Doctrines_.

[9] Speech at Baltimore, April 18th, 1864.

[10] Since this chapter was written I have been fortified by seeing

its main contention endorsed by Professor Sprague, of Harvard, in an

article in _The Economic Journal_ for April 1917, which embodied an

address given by him to the American Economic Association.

[11] Chisholm’s _Analysis of the Public Accounts_, p. 509.

[12] A New York banker’s circular, dated April 14th, 1917, says:

“Posterity will chiefly benefit from the struggle for freedom and

should pay its part.”

[13] Written in March 1917.

[14] _Meaning of Money_, pp. 64 _et seq._

[15] These dates are chosen to fit those of the balance sheets of the

other banks, which are only published half-yearly.

[16] _Meaning of Money, loc. cit._

[17] A report of the Committee of Public Accounts quoted in the London

_Economist_ of August 26th, 1916, p. 357, shows that the British

Admiralty and the War Office were buying against one another.

[18] _Wealth of Nations_, Book V, Chap. II, Part 2.

[19] _Political Economy_, Part VI, §§ 588 _et seq._

[20] Book V, Chap. I, Part II, “Of the Expense of Justice.”

[21] Chisholm’s _Analysis_, p. 424.

[22] _Ibid._, p. 416.

[23] Seligman, _The Income Tax_, p. 132.

[24] About sixty cents.

[25] Seligman, _The Income Tax_, p. 103.

[26] The full text of the Fabian suggestion is as follows:

“What is suggested is that, so far as incomes not exceeding £2,500

a year are concerned, whether earned or unearned, it should be open

to any person assessed to ask that all the taxable receipts of all

the members of his family, living in the same household with him and

sharing in its expenses, or maintained elsewhere wholly or partially

at his expense, should be aggregated for assessment as a Family

Income; and that Family Incomes so arrived at should, for income tax

purposes, be divided by the number of members of the family (husband,

wife, children, stepchildren, father and mother, or grandparents only)

_actually maintained therefrom_. There could then be allowed from the

combined Family Income, in respect of each person maintained therefrom,

whatever Abatement each portion of such income would justify if it were

that of one person only.”--_How to Pay for the War_, pp. 237-8.

In order to prevent the suggested abatements and allowances from

exempting too many people altogether from income tax, these writers

suggest that “nothing in them should be allowed to reduce the tax

actually payable below the minimum of, say, a penny in the pound on the

income prior to the deduction of any abatement or allowance.”

[27] “All persons being required to make returns of the whole of their

income, from whatever source derived.”--Chisholm’s _Analysis_, p. 425.

[28] _Wealth and Welfare_, p. 371, 2.

[29] Seligman, _The Income Tax_, p. 165.

[30] _British Budgets_, by Sir B. Mallet, pp. 105 and 493.

[31] I have developed this platitude in a book called _Poverty and

Waste_, published in 1913.

Transcriber’s Notes

Perceived typographical errors have been silently corrected.

Odd-page headers have been rendered as sidenotes and moved to

appropriate locations.