CLASSIFICATION AND CHARACTERIZATION OF TAXES.
58. Selection of a Principle of Classification. The most serious difficulty in drawing up a classification to be used in a scientific investigation lies in the selection of a principle or characteristic according to which facts may be grouped. Manifestly the most significant quality of the data under ob servation should be pressed into service, but experience shows it to be no easy task to discover at the outset this character giving element. Taxes have been classified in many ways, but, without passing these several methods in review, much less subjecting them to criticism, it will better serve our pur pose to proceed at once with the classification that fits into the peculiar conception of the subject entertained by this treatise; for, in every work upon taxation not a compilation of other men's ideas, the principle for classification is selected, either consciously or unconsciously, long before the necessity for a formal classification presents itself. That this is true in the present instance will be recognised as our analysis proceeds.
The thought has been presented several times in the fore going pages that public revenue is a part of current social income, and that taxes represent that portion of public revenue which first existed in the form of private income. The ma chinery of taxation is merely a means of getting at that income, and the different taxes represent different methods of approach. All the social, industrial, political, or moral results bound up in a system of taxation come about through the psychology of such an attack upon income. This was seen clearly by the old economists, who classified taxes ac cording as they attached themselves to the various constitu ents of income; that is to say, according as they demanded payment from rent, interest, profits, or wages. In this they were right so far as their method of analysis was concerned; their error lay in their assuming it to be an easy task to determine upon which of the constituents of income a given tax finally rested. The classification here presented, while maintaining this point of view, is based upon the form of the tax rather than upon its incidence. It holds in mind the manner in which income is approached rather than the results which follow that approach. It is not as ambitious as the old classi fication, but it has this advantage, that it separates a study of the question of incidents from a study of the question of form. Indeed, as will be seen later, it prepares the way for merging the question of incidents of taxation into the larger question of commercial and social results of which it in reality is a part.
Coming now to the classification itself, taxes are of three kinds according to the manner in which they approach the income of citizens and demand therefrom a payment for the support of the State. The law creating a tax may come at income in either of three ways : First. The tax may be levied directly on income.
Second. The tax may be levied on property considered as the source of income.
Third. The tax may be levied on business considered as the means of securing an income.
Before proceeding with an analysis of taxes on the lines laid down a word may be said respecting a criticism sure to arise in the minds of those who are familiar with current litera ture upon this subject. What, it will be asked, has become of taxes on consumption? The answer is, there are no such taxes. Taxes usually called taxes on consumption are either " criterion taxes," which are in reality taxes on income, or they are " excise " or " import " duties, which are clearly business taxes. All taxes affect consumption. Through consumption they affect demand; through demand they affect price; through price they affect profits; through profits they affect the distribution of employment, or, we may say, the industrial structure itself. The relation of taxes to con sumption is a fundamental relation; it presents itself when ever the State asks money from the earnings of citizens, and on this account it must be regarded as too comprehensive to be made to stand for a particular group of taxes in a formal classification.
59. Taxes on Ineome. The word income is used in no unusual sense. It is the fund by which the domestic budget is supported or from which property is accumulated. No expenditure (the borrowing of money being dropped as com plicating the statement, though not Changing the situation) and no expansion of one's possessions can take place except it pass through income, and, should one keep a set of books, first make its appearance in an income account. Now, it is a peculiarity of some laws which are designed to secure public revenue that they address themselves directly to this income. They levy taxes on income and aim to demand a payment in proportion to income at either a uniform or a progressive rate.
A tax on income is a very simple tax both in legislative form and in the reasons urged for its support. In form the law demands the cash payment of a certain per cent of the annual clear income of each citizen. The payment is supposed to rest where the charge is placed, and in the vast number of instances this will be the case. Assuming the ability to .pay to be the just measure of payment, income is accepted as the surest test of ability. In years when business is pros perous the payment would be large; in years of depression the payment would be small. From the point of view of the citizen nothing could be more considerate and no tax more easily borne. The demand of the State would increase or decrease as the fund from which the payment is made in creases or decreases. This is not presented as an argument either for or against an income tax, but rather to show the simplicity of the idea underlying it. Speaking logically (not historically), the income tax is the original tax, and all other taxes are complementary to or a substitute for this tax in those points in which it is difficult of application : this as sumption at least permits the student to appreciate most easily and naturally the relation existing between the various sorts of taxes.
The chief embarrassment which arises on account of the income tax lies in the difficulty of obtaining the correct state ment of income. This is not due entirely to dishonesty on the part of citizens, but to the great variety of forms in which incomes exist, and to the confusion that arises when one en deavours to distinguish between a clear and an encumbered income. Were all men farmers, were the State composed solely of merchants, or were salaries the only form of private revenue, incomes would be homogeneous and the same treat ment applicable to all. But in society as it exists incomes are not homogeneous. They do not reflect the same indus trial conditions or measure with accuracy the energy ex pended to secure them. There are at least three different kinds of income, each of which has a character peculiar to itself and on that account demands peculiar treatment. These are as follows : Income from service.
Income from property.
Income of property.
(I) Income from Service. The distinction between per sonal incomes and incomes from property, and the reason for rating the latter higher than the former, have been already presented in the discussion on progressive taxation. Per sonal incomes such as wages, salaries, professional fees, undertakers' profits, and the like, are both terminable and uncertain, while rent and interest are by comparison con sidered as perpetual and certain. This statement applied to rent and interest is not of course absolutely true, but it represents the situation with sufficient accuracy to warrant a distinction in the law of taxation by which income from property is rated higher than income from effort.
Another reason also may be urged in support of this dis tinction. It is not possible in matters of taxation to con sider the individual alone; the family is in fact the social unit, and as such should receive consideration in the framing of tax laws. While it is doubtless undesirable that great family properties should be built up, it is of the highest im portance that provision should be made out of current earn ings against destitution or serious inconvenience of a family on account of the death or incapacity of the head of the house hold. Industrial as well as social arguments might be pre sented in support of this assertion, the conclusion from which is that an abatement should be made from the tax on personal incomes as compared with property incomes equal at the least to the premium upon a life policy conformable to the needs of the family in question, its standing in society and accus tomed rate of living being taken into consideration.
One might proceed further and show that sociologically, and from the point of view of the relative importance of in comes to families in the different grades of life and employ ment, personal incomes themselves are not of the same quality as property incomes, but the distinctions to which such an analysis would lead do not so much pertain to the character as to the amount of income. Should it be deemed wise for a revenue system to recognise this distinction, it can more easily be done by applying the rule of progressive rating to incomes of different amounts than to classify incomes and apply the rule of uniform rating to incomes within the class. Nothing new in principle would emerge from such a discus sion beyond what has already been suggested in the discussion on progressive taxation.
(2) Income from Property. Coming now to a consideration of income from property as distinguished from income from service or employment, yet more serious difficulties arise in the administration of the income tax. Incomes from property do not present homogeneity, but vary in character according to the property from which they spring. Land, for example, is essentially different from capital, and in equity demands a different treatment. It is universally recognised that social progress works upon rent to increase it and upon interest to decrease it. Rent from a given piece of rent bearing property grows with the growth of society, while interest from a given amount of interest-bearing capital dwindles with the development of industry. This means that a given quantity of money received as income is no measure of what one citizen should pay for the support of government, as compared with another citizen, without taking into the account the source from which the income arises. This is generally recognised as between personal and property in comes; it is equally true as between property incomes from various sorts of property. And it is pertinent to inquire if the rule of payment according to ability does not demand a different tax adjustment for incomes of different economic qualities. Does it not require, for example, a higher impost on an income that accrues fortuitously to the citizen, which tends to increase " while he sleeps," to employ the phrase of John Stuart Mill, than upon an income arising from prop erty which if used tends to economic deterioration, and if not used ceases to be of value? It certainly seems that these two classes of income stand for economic conditions and social tendencies sufficiently diverse to justify special treatment at the hands of the legislature in the framing of tax laws.
A comparison of rent and interest as forms of revenue by no means exhausts the significant differences between the various kinds of property incomes. That class of income-bearing property called capital is not homogeneous, and the interest accruing from it reflects its variable economic qualities. It is not true, as was assumed in the analysis immediately preced ing, that industrial progress depresses interest in the case of all capitals. Capital itself must be classified as capital that is and capital that is not subject to the deteriorating influence of competition. It is true that the rate of interest tends to fall on all capital, but, provided the property upon which the interest accrues can be capitalized at a proportionally higher figure, the fall in the rate may not affect the income. Indeed, it is possible that the capitalization may proceed at a relatively more rapid pace than is necessary to compensate the owner for the fall in the rate of interest, in which case an income in the form of interest partakes of the peculiar advantages that attach to an income in the form of rent.
It is not necessary to pursue this analysis further. Suffi cient has been said to make clear the impression which it is designed to leave upon the mind of the student. Not only is there a difference between personal and property incomes, but property incomes themselves reflect diverse economic conditions and are subject to varying economic tendencies. This being the case, the amount of money received during the twelve months is no satisfactory measure of the relative ability of citizens to pay for the support of the State. The conclusion from this analysis is that the theory of the income tax errs in its fundamental premise.
(3) Income of Proterty. The third form in which the in come tax presents itself is termed the tax on income of prop erty as distinguished from the tax on income from property. This phrase is designed to suggest the inheritance tax in all of its forms. Many reasons have been urged in support of the inheritance tax as a special tax. By some it is justified as a means of correcting the evasion of taxation during the life of the testator, that is to say, while the fortune bequeathed was in process of accumulation. Others regard it as a pro bate fee, and still others urge its necessity as a means of pre venting permanent inequalities of fortunes. Whatever the degree of truth in these several theories, and others that might be mentioned, it is most natural, as well as most helpful in framing a revenue system, to regard the inheritance tax as a special form of the income tax. That the inheritance is an
income to him who secures it there can be no doubt; that it increases the recipient's ability to pay for the support of the State is equally beyond question; while the fact that it is an accidental or fortuitous income to the individual, and from the social point of view represents a transfer of property and not an increase of wealth, supplies a reason for treating it dif ferentlyin the framing of tax laws from the manner in which the ordinary constantly recurring personal or property incomes are treated. The inheritance tax is peculiar in two respects. First. the rate is usually higher than on periodic incomes; and second, the rate is graduated according to relationship, beginning with a low rate for direct heirs, and increasing as the degree of relationship becomes less direct. The unusually high rate is due to the non-periodic character of the income, while the variation in rate from direct to remote heirs is justified by the fact that the dependence of the former on the property is not changed by the death of the testator. For remote heirs also the bequest is an accidental gratuity. Both of these distinctions follow naturally from the assumption that the inheritance tax is a form of the income tax. It is a tax on revenue.
80. Taxes on Property as the Source of Inoome. The second group of taxes, according to the classification accepted by this treatise, selects property as the object upon which assessments are to be levied. This brings to notice what is technically known as the property taxes, either in their general form or their specific manifestation. The General Property Tax has played and still plays the chief role in the revenue system of the several States of the United States, and for this reason is of special interest to the American student.
(t) THEORY OF THE PROPERTY TAX. The theory of a pro perty tax is simple. Property is regarded as the source of in come, and such value as it possesses rests upon this fact. The value of property is assumed to be the income arising from it capitalized at the current rate of interest, and in so far as this is true, and provided the amount assessed cannot be thrown off for payment on to some one else, it is a matter of indifference whether the government impose its fiscal ob ligations on property or on income. It is essential, in order to appreciate the economic character of the property tax, as also to provide for its intelligent discussion, that this relation between property and income be clearly appreciated.
It would be an error, however, to assume that as a matter of history the property tax developed along the lines sug gested by this classification. Its historic significance goes much deeper, and it may be well, before proceeding with the analysis, to call attention to the conditions under which it originated and for which it seems to have been fairly well adapted. In no other way can its true character be so well presented, and by no other means can its limitations, when applied to modern conditions, be so successfully pointed out.
The form of society immediately preceding the one with which we are familiar, that is to say, feudalism, recognised land as the basis of the social structure. Land was originally the only " productive " property known; and the significant fact for one who desires to appreciate the development of the property tax is that social duties, as well as social privi leges, were in large part determined by the amount of land assigned, whether to the noble or to the serf. This was true of the internal organization of the manors, where labour on the demesne was the " contribution " of the villain to the support of the State; it was also true of the national organi zation when the lords acknowledged their holdings by render ing military service. It thus appears that feudalism regarded the holding of land as the measure of social service. Not only was this true of the constantly recurring payments, such as labour on the demesne land, or military service to the king, but whenever the king, in order to repel invasion or carry on foreign wars, found it necessary to command larger re sources than came to him as the result of ordinary feudal obligations, the supplemental requisitions, which he did not hesitate to levy, were imposed upon subjects in proportion to the land assigned to them, that is to say, in proportion to their property. Scutage, for example, was a land tax on the knight's fee, the tax being a definite assessment on each twenty pounds annual value. It thus appears that the prin ciple of payment for support of the State in proportion to property is much older than the modern conception of pro perty; and it was necessary that the class system of feudal organization should give place to the idea of political equity for all members of the State, and that the idea of property valuable for the social privileges which it carried with it should be supplanted by the idea of property valuable for the income which it brings, before the modern theory of the property tax could establish itself.
The above explanation of the historic origin of the pro perty tax extends no farther than to suggest how a tax on land came to be substituted for feudal obligations, without necessitating any radical modification of the rule of appor tionment. The land tax, however, is a special form of the property tax; it is not the " General Property Tax " known to the statute books of the nineteenth century. The general property tax consists in the listing of all property according to its value, and the taxation of the proprietor on the basis of that value. Thus property, real or personal, is converted into money, and its money value is accepted as the basis of taxation. This is something quite different from the first appearance of the land tax, which; after all, was nothing more than the commutation of feudal dues into money pay ments.
The birthplace of modern taxation, according to Professor Seligman, is the medieval town. Upon this point he says : " Every inhabitant was compelled to bear his share of the local burdens, his proportion of the scot and the lot. The scot, or tax, was almost from the very outset the general property tax, combined with the subordinate poll tax, exactly as in the earliest days of the New England colonies. The town, as such, generally paid its Aare of the national burdens in a lump sum, the firma burgi. But this lump sum was al ways distributed among the townsmen in proportion to the property of each. On the Continent it was the same. In the German towns the taxes were at first levied only on land. But at the close of the twelfth century the land tax had al ready been merged into the general property tax—or, as it was called, the tax on property in possessionibus, agris, dotni bus, censibus et rebus quibuscumque. In some towns it was called simply a tax of so much per posse or pro bonorum facul tate. Most of the German towns by this time combined the general property tax with the poll tax, and in the Swiss cantons the tax was even called the Hab-, Gut-, and Kopf steuer. The only distinction between England and the Con tinent was that in England the property tax remained for centuries the sole local tax, while in France and Germany local excises or octrois were soon added. But for some time at least the general property tax was the measure of the individual's capacity." It is undoubtedly true that the extension of the feudal principle of service in proportion to land to payment in pro portion to property is one of the results of the development of town life. This is true because in these towns lived the artisan of the middle ages, and, as the process of manufacture developed, property incident to that process presented itself in a visible form. Moreover, the growth of towns marked an era in industrial development; they were the result of industrial differentiation; their rise was a step in the appli cation of the principle of division of labour. In so far as the work of the artisan was not an incident in the agricultural life of the community, the primitive feudal manor paid him as well as the agricultural labourer in land. His duty to serve (that is to say, the amount of his labour taxes), like theirs, was in proportion to land; and when, through the growth of the towns, he separated 'himself from land, and secured a liveli hood by working exclusively at his trade or craft, it lay in the nature of the case that his property, as well as land, should be made the object of taxation; otherwise this class of citizens would evade all payment for the support of the State. Speaking historically, therefore, the general property tax is the old land tax (which, on its part, struck its roots into the Feudal organization), supplemented by the listing of other property as soon as such property came to have an independent significance of its own.
The above explanation of the general property tax is his torically correct, but it pertains to the form rather than to the essence of the tax. Neither the assignment of feudal service, the land tax into which this service was commuted, nor the general property tax which grew out of the land tax, was conscious of regarding property as the source of income. Indeed, confining the statement to England, it was not until the sixteenth century that the industrial significance of pro perty, by which is meant its ability to command an income, took precedence in the minds of men over its social signi ficance. This is what is understood by the student of English industrial history when he says that capital originated in the sixteenth century. Such a phrase does not mean that there were no material helps to labour before this time, but that the capitalistic regime of industry, the regime that accepts profit rather than product as the test of success, and which imputes a value to property in proportion to the annual profit it bears or income which it guarantees, was not until then consciously recognised by men. The capitalistic regime implies freedom on the part of the worker, and property as an instrument of work. It implies the right of contract in business affairs. It con ceives of property as homogeneous, its homogeneity consist ing in the fact that it bears a value because it is the source of an income; and the significance of the genera. property tax is that it accepts this economic quality of property, value, as the common denominator of all forms of possessions ac cording to which the duty of proprietors to pay to the support of the State may be measured. While, therefore, the above quotation from Professor Seligman is formally correct, it does not seem to be complete. It omits mention of the step by which the property tax allied to the feudal conception of society came to be the property tax of the capitalistic order of industry. The truer generalization, because more compre hensive, is that the property tax is sure to emerge whenever society passes from a condition of status to a condition of contract.
An appreciation of the theory of the general property tax makes it clear why it has never been subjected to extended classification. Classification implies analysis, and analysis im plies that the thing analyzed exists in several forms or is made up of several parts. Now, the chief attractiveness of the theory of the general property tax is that it rests upon a quality of property which is the same for all property no matter what the form or the use; that is to say, that it rests on the economic quality value, which is conceived to be the one homogeneous element common to all property. It is of the utmost importance, therefore, in judging of the theory of the general property tax, to inquire if value is homo geneous. Can it be used as a denominator common to all possessions of commercial significance for the purpose of as signing to each possessor his relative duty to pay for the support of the State? It has been commonly argued that the theory of the property tax is sound, but that the employ ment of this tax is impracticable because invisible property escapes assessment. Without denying that the difficulties to the full and free assessment are so great as to warrant the abandonment of the tax, a fact which will be considered in its proper place, the statement is ventured that the theory itself is untenable; and in proof of this is urged the necessity of the analysis and classification of property in order that jus tice may be done between citizens should value of property be accepted as the basis of taxation. The integrity of the theory rests upon the homogeneity of value as an economic quantity.
In what manner should property be classified to enable the State to levy its contributions with equal weight upon all? Answering this question directly, property should be classed in two ways : first, according to the nature of the income; and second, according to grade of the property taxed in the orderly development of consumption. Each of these will receive a moment's consideration.