Chapter IV. Money Taken by Taxes

CHAPTER IV MONEY TAKEN ByITAXES 'GIVEN a free people with real control over the~con duct 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 th~ 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 subj ect 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 reluc tantly on that ground, the said expenditure being necessarily and inevitably a cause of the impoverish ment of the people. In the last century, in the heyday 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 com...

6 73 74 MONEY TAKEN BY TAXES [CHAP. munity w~uld certainly be attained, it was a favourite p~rase with pollticians and polltical 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? I t is surely a very large assumption to suppose that all the money ~hich Government takes would, if left in our pockets, have been spent ~n some good and useful purpose and hava increased the productive 'Power of the community. This theory takes it for granted that the Governx:nent'$ revenue is derived entirely from money which would other wise haye been saved and well invested in re productive enterprise. Wherea~ we kno\v that, owing to defects in the machinery of our joint stock system 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 pocket\s of unsavoury 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 ,j and further, It by no Ineans 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 in corrigible 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 t~e rich and middle classes spend their money IV] (( FRUCTIFYING j, ? 75 are apparent to all: lavish entertainments at which most people are 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, H fructifies 11 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 1?-ave enough to give them a reasonable chance of full develop ment of their faculties and capacities.

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 II 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. Whep. iti§ MONEY TAKEN BY TAXES [CHAP. 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 p'ublic defence 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 practising 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 mayor may not use it well.

No chapter on taxation can be complete that does not quote Adam Smith's famous fOUf maxims on the subj ect : tt (I) The subjects of every State ought to contri bute towards the support of the Government, as IV] SMITH'S MAXIMS 77 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. u (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. H (3) Every tax ought to' be levied at the time, or in the manner, in which it is most likely to be c~nvenient 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. I-Ie 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 every suffers any considerable inconveniency from such taxes.

u (4) Every tax ought to be so contrived as both to ,take out and to 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." 1 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. WalkerJ who decided that q the, first and most famous of them cannot be subj ected to the slightest test without going all to pieces. 1J As to the other three, their equity and sound sense can hardly be 1 Wealth of Nations l Book V, Chap. II, Part 2. 6* MONEY TAKEN BY TAXES [CHAP. disputed (though Walker thought them (f at the -best, tt:jyial "), and it is also pleasant to observe that our system of taxation is not far from securing them. If we fail in the matter of NO.2, it is our fault rather than the State's i if we chose we could all know how much we are paying for government "vhen we bU;y a glass of beer or a pound of tea or a packet of cigarettes, and if n1any_ of us buy these things every day without even knowing that we are paying taxes, that is only because we have not troubled to think about it. As to NO.3, the con venience of the contributor might be still further consulted if income tax could be paid by instal ments, instead of in one lump as it was before the war, or in two as now arranged. A system of monthly instalments would be much more convenient ~o a large number of taxpayers, and, though it might involve a good deal of book-keepingl 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. I that the whole question 9f the ~quitable apportionment of taxation is really 19cked up; and, if we examine the great American economist's severe criticism of his great Scottish predecessorl it will help to a clearer understanding of the whole matter.

UThis maxim [says Walker], though it sounds fairly, will not bear examination. What mean IV] WALKER ON SMITH 79 those last· words t 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 con tribute 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 absurdi ties. 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 car-load. IVforeover,it costs the State less to collect a given amount froni one taxpayer than from n1any." 1 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, thesF 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 obvi· 1 Political Economy, Part VI, §§ 588 et seq.

80 MONEY TAKEN BY TAXES [CHAP. ously 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. small clerk whose property consists of the balance in his pocket of his last month's wages needs little protection from the State or anybody else. "Can tabit vacuus coram latrone viator." His employer, with some furniture in a rented suburban hbuse, 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 Governmerit. A great landed pro prietor 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: HIt is only under the shelter of the civiI magis trate that the owner of that valuable property which is acquired by the labour of many years, or perhaps of many successive generations, can sleep a single night in security." 1 1 Book VI Chap. I~ Part III (( Of the Expense of Justice."

IV] WALKER ON SMITH 8r Walker's contention that those with least pro perty require most protection for it almost looks as if it had· been dicta ted by a desire to pick holes in his illustrious predecessor. And his argunlent 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 ~nd 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 be cause they need luore of it, on the same principle that enables a man to buy bread and meat more cheaply by the car-load-here VValker is surely quoting the principles of the market-place in a sphere to which they cannot be applied. The mer chant 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',- ahvays, 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 appor tion the cost upon them accordingly by taxation.

82 MONEY TAKEN BY TAXES [CHAP. So when Walker goes on : tt Returning to the maxim of Dr. Smith, I ask, does it put forward ability to contribute, or pro tection 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 a~biguous phrase), involves also protection enjoyed, so that both principles lead us to the same end. And the two can be combined in practice and an~, in a halting manner that needs improvement and expal~sion, in the system of taxation that has been painfully. evolved in this country. Logically applied, Adam Smith's first maxim would confine taxation to direct taxation, that is taxation paid directly by the tax2ayer to the State, assessed on a graduated scale actording 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 ta~ and death duties, and of the principles of graduation and differentiation that have been so slowly and tentatively introduced into our fiscal system. All these things are implied in the pro phetic musings of the great Scottish thinker.

Graduation is clearly implied, as was shown by vValker's criticizing Adam Srnlthfor having appar ently forgotten it, because he did not actually IV] WALKER ON SMITH mention it. We cannot put the proof better than in Walker's words: H Is the ability [he asks] of two persons to con tribute necessarily in proportion to their respective revenues? Take the case of the head of a family having an income of $500 (£IOO) a year, of which $400 (£80) is absolutely essential to the maintenance of himself and wife and children in health and strength to labour. Is the ability of such a person who has only $roo (£20) 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 (£200), and who has therefore $600 (£120) which could conceivably be brought under contribution? l\1anifestly not."

Most true, but there is nothing to show that Adam Smith thought that it was. Anyone who has only £100 a year, of which £80 is needed for the bare necessaries of ft health a.nd strength to labour/' 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 depen dents in health and efficiency. To tax anybody ( MONEY TAKEN BY TAXES [CHAP. 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 recognised by the terms on which our income tax is assessed. It would not be im posed on a man with £80 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 1798 it was only imposed on incomes of £60 and upwards, was gradu ated between £60 and £200 and was 10% above that line 1 j in 1806 the limit of exemption was reduced to £50. Its medieval predecessor, the poll tax, was first raised in 1377, and was graduated. Beggars paid nothing, ordinary folks 4d. a head, and the rate varied from this level up to 10 marks (£6 13S. 4d.) on dukes. a 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 £150 and upwards. s This level was later raised to £160, and was reduced in 1 Chisholm's Analysis, P. 42 4.

II Ibid. p. 416• 3 Seligman 1 The Income Tax, p. 132.

IV] DIFFERENTIATION Mr. McKenna's first War Budget in 1915 and brqpght down to £130, 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 excel lent tax, let us consider its other. beauty , that of being differentiated according to the source of income, whether If earned or unearned." This, again, is a principle that ha's only fought its way with the utmost difficulty into our system of taxation, though the logical soundness of it is obvioHS. It is clear that two men, each with £r,ooo a year, do not It 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 well-chosen 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 anyone 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 H unearned" income, it is at first sight 86 MONEY TAKEN BY TAXES [CHAP.

unfair that it should be so called and so taxed. But, eve....fl so, his enjoyment of it is clearly so much Jhe more secure, and-moreover the principle of differentiation is also at work through the 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 incomes of those who Iive on inheri ted wealth, besides paying income tax', is either diminished every time ~n 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 other wise, in order to provide against the death duties, and maintain the capital of the estate intact . . 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 tha-t is vicious in the case of an' individual or company. But is this necessarily true? The tax, it is true, is assessed on C3:pital,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 provfde 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, tpe saved money that is handed over to Government to spend would otherwise have gone into some other investment wbich wo'uld IV] TAXING CAPITAL perhaps have increased the community's produc tive 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 inGome. If vv€ 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 someone 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 knovving 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 v;aluation. Moreover, the mistakes made by Government valuers, when estates have to be valued for purposes of taxa tion, are astonishing. In a certain 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-colours. The local official valuer remarkedto his heir, (~ I see from the dates on these pictures that they're all second-hand, so rve put them in at half a crown each."

But since all taxation falls on income, and since the amount of the income, \vith due regard to its ss MON'EY TAREN BY TAXES [CHAP. 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 neces saries 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(I) An income now being in the technical sense earned, that is a wage or salary or pro fessional or business profit,s ; (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 macle, then we should be able to do away with the death duties, IV] THE IDEAL TAX 89 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 speci ally 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 chancel amounting almost to certainty, that they would be met by saving on the part of the holder of the income.

Thus differentiated, the ideal income tax would be graduated logically and steadily up to the highest range of incomes, not as it is now with a seri~s of capricious jerks, and with the super-tax as ,an excrescence o~ the top. It would also be purged of the inequity which at present lumps together the income of husband and wife as one for assessment purposes, and of the still worse vice that it no\v possesses of taking little or no account of the children whom the taxpayer may have t9 educate. The unfairness of an income tax which is the same in the case of two brothers who eacJ1 earn £1,000 a year, but one of whom has eight children and the other has none, is glaribgly apparent l 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 r806, as they had" led to an astounding official increase of large families." 1 Mr. Lloyd George made a small beginning in his 1 Seligman, The Income Tax, p. 103.

7 go MONEY TAKEN BY TAXES [CHAP. Budget of 1909 towards remedying this great blot on this tax by giving an abatement of flO (from the income assessed) for each child under sixteen in the case of incomes under £500. Since then the amount of the abatement has been raised to £25 for eacli child, and this relief is given to incomes up to £700. Even so it is pitifully inadequate. The proposal made by Mr. Sidney Webb and his fellow Fabians in their book on How to Pay tor 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 £1,000 a year and a wife and eight children, he would be assessed on ten incomes of £roo each~ and, as incomes of £100 each are at present exempt, he would be free of tax (but see note), while his bachelor brother would pay the full amount on his £1,000. 1 1 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 aU the members of his family, living in the same household with him and sharing in its expenses, or main tained 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 fa.mily (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 por tion of such income would justify if it were that of one person only/'-How to Pay tor the Wa" pp. 237-8.

In order to prevent the suggested abatements and allowances IV] THE IDEAL TAX " But wait a minute," says the bachelor. It I don't quite see why I should be penalised for choosing, or perhaps being obliged by a hopeless passion, to Iive 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 philoprogeni tive 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. Eco nomically and in every other respect, a nation can from exempting too many people altogether from income tax, these writers suggest that U 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 de,duction of any abatement or allowance,Jt MONEy" TAKEN BY TAXES [CHAP.

only thrive if it is composed of citizens sound in mind and body. and any taxation that makes the rniddle 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, t~ough 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 th~t he invested and not only, as now, on that part invested (within certain limits) in life ~nsurance. 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 labour and energy into new equipn1ent 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, hovv ever, this abatement might haye 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 considerab~y 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 Qf the revenue required. There would be IV] THE IDEAL TAX 93 no need then to talk about widening the basis of taxation, for taxation would be based on t~e widest possible foundation, the aggregate income of all citizens above the poverty line. Under ideal con.. ditions it would be collected, no longer tI at the source," but from the individual citizen, on his declaratign 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 I:nland Revenue authorities keep on their inter pretation of profit would be abolished. Any com pany 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, companies with a large number of foreign shareholders, and whose profits are earned qbroad, 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 \vho spent the proceeds of industry. We need not pretend that it would not affect and hamper in7* 94 MONEY TAKEN BY TAXES [CHAP.

qustry, 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 tq.x would meet and fulfil all the require :rp.entslaid 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 mainten ... ance of the State; graduation and differentiation would do all that can be done by human fallibility to make, the tax work according to the ab~lity of the taxpayer with due regard to the degree of pro tection tl1at the State has to give to secure hhn the enjoyment of his revenue t if the tax were payable in monthly instalments it would cause no incon venience-.to the man with a small income ~ every penny of it would go straight into the coffers of th~ State; 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 ecopomic education and of common honesty in the community that we may not yet have attained.

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 differen'tiation have been introduced without IV] THE IDEAL TAX 95 any sign of loss·to the revenue, and during the war the 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 0 bj ect to the" inquisitorial" require ... ment 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 income...tax payers have to declare details of their incomes l either in order to secure aba te ment, 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 1798.1 Like all the other suggestions mad~ above, it is only a further development of a prin ciple already recognized and acted on. 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 1 II All persons being required to make returns of the whole of their income, from whatever source derive<i."-Chisbolm'§ 4. nalrsis, p. 42~.

96 MONEY TAKEN BY TAXES [CHAP. is already r.ecognized 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 ~iill, and the suggestion also has the authority of Professor Pigou behind it, though he admits that there are technical difficulties to be overcome. 1 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 invest ments realized in those years in which the taxpayer sold out more than he invested; because otherwise anyone could escape the tax by investing all his in come 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 on what is called '! unearned " in come. It might be possible to do it by means of evidence in the shape of stockbrokers' contracts, 1 Weq#h ancl Welfare, p. 371, 2, IV] THE IDEAL TAX 97 and evidence by solicitors in the case of invest ... ments 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 j and· if .the ingenious experts of Somerset House 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 com.. panies which earn his income for him as shareholder 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 con1 panies put into depreciation is saved money in every sense of the word. The economic progress of the community is helped by every pound that companies keep back· from their shareholders and put into their plant or invest 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 91ut of capital( this peed to encoura~e savin 9 would 98 1vIONEYTAKEN BY TAXEg [CHAP.

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 shares and so on-in order to enable their shareholders to escape taxation. But the k'een blades of the Inland Revenue Department. could very well be trusted to deal faithfully with any such buccaneering. Still greater is the difficulty involved in making the range of the income tax run lower and embrace all the wage:.earnerswho are a ~t subject of taxation. In their easy the precariousness of their earnings is much greater than in that of th~ salary-earner or even of the more precarious professional workers, such as the free-lance 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 tI:ey are ready to recognize that an income tax applied more vigorously to wages 'would be fairer to tl~em, if they would' take the necessary trouble to tackle it, than thehea vy charge of indirect taxa tion that they now bear. Economic education o~ all cla~ses is the only way in which the path of the tax-gatherer can be made smooth and easy. The more this education gtows~ the f~ster will be the movement towards graduated and differentiated d~rect taxation as the fairest way by which the St~te Y<l~ ta:ke our ~one;y.

IV] INDIRECT TAXATION 99 It is sometimes said that the incolne tax pun ishes 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 taxa tion 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 quantitie! 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~ 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 \vhen in good health, perhaps twenty shillings 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 lOO MONEY TAKEN BY ·TAXES [CHAP.

to all forms of indirect taxation. It is true that, as Adam Smith pointed out, taxes upon" such con sumable 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 adrnitted 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."

l\ft. Gladstone's ponderous joke, in which he com pared the two forms of taxation to two attracti ve damsels, to both of whom, ('whether it be due to a lax sense of moral obligation or not," he paid his addresses impartiallYt is well known to all students IV] STUPIDITy'S PRICE 101 of the subject,l and only shows how little the equities of taxation were studied in the days of that enlightened fiscal reformer. 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 bam boozled 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 ta"es 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 because taxes on the necessaries of life are clearly bad, from the national point of view, in a community in which 1 Seli~lll.an, Thf InOO'nZB Tax,p. 165' !02 MONEY TAKEN BY TAXES [CHAP. many people have not enough to eat. So that in days before the war anyone who escaped income tax and did not smoke or drink alcohol or tea contributed practically nothing to the Government under whose protection he or she lived. Since the war, taxes on cocoa, mineral waters, and entertain ments have widened the fiscal net. The proportion of our re\tenue contributed by indirect taxation has steadily declined. In 1841-2 it, was 73%; in 1912-13 it was 42 '4%,1 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 our fiscal system until such time as we are 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 labour 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 llnsound, checks the material progress of the nation, 1 Briti$h Budgets, by Sir B. Mallet, Pl? 105 and 493.· IV] IMPORT DUTIES r03 makes the hard lot of the poor still harder, and less~ns the demand for labour. l So that if only we < could graduate and differentiate indirect taxa tion, it would have advantages over direct as the latter is at present imposed. As we cannot, it has to be left inits present unsatisfactory state, pressing heavHy on the poorest consumers of such articles as tea, tobacco, and alcohol, while patriotic ladies who give 3,000 guineas 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 011 all retail purchase. of lOS. 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 shop keepers and their customers united in resenting and detesting the tax, it is highly probable that there would be much evasion.

Of all forms of indirect taxation, the worst, according to the pure principles of taxation, are those 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 our own colonies, make free use of this method of taxation, because they 1 I have developed this platitude in a book called Poverty and Waste, published in 1913.

104 MONEY TAKEN BY TAXE5 (CHAP. IV 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. Some people think that when the war is over we also shall 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. Everyone 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 our richest enemy and our richest aUy-have ~ourished under Protection. On the other hand, it warpsa.nd hampers trade, as a whole, and in troduces an artifiGial complicat~on into a matter which is naturally quite complicated enough; but perhaps the strongest argument against it is its tendency to make questions of taxation an unclean welter in which po~tics and business cover one another with dirt.