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Taxes
For Revenue Are Obsolete
by
Beardsley Ruml
, Former
Chairman of the Federal Reserve Bank of New York (the Benjamin Bernanke of his
day)
Excerpts:
1. "By all odds, the most important
single purpose to be served by the imposition of federal taxes is the
maintenance of a dollar which has stable purchasing power over the years."
2. "The dollars the government takes by taxes cannot be spent by the people, and
therefore, these dollars can no longer be used to acquire the things which are
available for sale. Taxation is, therefore, an instrument of the first
importance in the administration of any fiscal and monetary policy."
3. "The second principle purpose of federal taxes is to attain more equality of
wealth and of income than would result from economic forces working alone."
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 Reprinted from "American Affairs" January 1946
Mr. Ruml read this paper before the American Bar Association during the last
year of the war. It attracted then less attention than it deserved and is even
more timely now, with the tax structure undergoing change for peacetime.
His thesis is that given (1) control of a central banking system and (2) an
inconvertible currency, a sovereign national government is finally free of money
worries and need no longer levy taxes for the purpose of providing itself with
revenue. All taxation, therefore, should be regarded from the point of view of
social and economic consequences. -- EDITOR
___
Taxes For Revenue Are Obsolete
The superior position of public government over private business is nowhere more
clearly evident than in government's power to tax business. Business gets its
many rule-making powers from public government. Public government sets the
limits to the exercise of these rule- making powers of business, and protects
the freedom of business operations within this area of authority. Taxation is
one of the limitations placed by government on the power of business to do what
it pleases.
There is nothing reprehensible about this procedure. The business that is taxed
is not a creature of flesh and blood, it is not a citizen. It has no voice in
how it shall be governed -- nor should it. The issues in the taxation of
business are not moral issues, but are questions of practical effect: What will
get the best results? How should business be taxed so that business will make
its greatest contribution to the common good?
It is sometimes instructive when faced with alternatives to ask the underlying
question. If we are to understand the problems involved in the taxation of
business, we must first ask: "Why does the government need to tax at all?"
This seems to be a simple question, but, but as is the case with simple
questions, the obvious answer is likely to be a superficial one. The obvious
answer is, of course, that taxes provide the revenue which the government needs
in order to pay its bills.
IT HAPPENED
If we look at the financial history of recent years it is apparent that nations
have been able to pay their bills even though their tax revenues fell short of
expenses. These countries whose expenses were greater than their receipts from
taxes paid their bills by borrowing the necessary money. The borrowing of money,
therefore, is an alternative which governments use to supplement the revenues
from taxation in order to obtain the necessary means for the payment of their
bills.
A government which depends on loans and on the refunding of its loans to get the
money it requires for its operations is necessarily dependent on the sources
from which the money can be obtained. In the past, if a government persisted in
borrowing heavily to cover its expenditures, interest rates would get higher and
higher, and greater and greater inducements would have to be offered by the
government to the lenders. These governments finally found that the only way
they could maintain both their sovereign independence and their solvency was to
tax heavily enough to meet a substantial part of their financial needs, and to
be prepared -- if placed under undue pressure -- to tax to meet them all.
The necessity for a government to tax in order to maintain both its independence
and its solvency is true for state and local government. Two changes of the
greatest consequence have occurred in the last twenty-five years which have
substantially altered the position of the national state with respect to the
financing of its current requirements.
The first of these changes is the gaining of vast new experience in the
management of central banks.
The second change is the elimination, for domestic purposes of the
convertibility of the currency into gold.
FREE OF THE MONEY MARKET
Final freedom from the domestic money market exists for every sovereign national
state where there exists an institution which functions in the manner of a
modern central bank, and whose currency is not convertible into gold or into
some other commodity.
The United States is a national state which has a central banking system,
the Federal Reserve System, and whose currency, for domestic purposes,
is not convertible into any commodity. It follows that our Federal
Government has final freedom from the money market in meeting its financial
requirements. Accordingly, the inevitable social and economic consequences of
any and all taxes have now become the prime considerations in the imposition of
taxes. In general, it may be said that since all taxes have consequences of a
social and economic character, the government should look to these consequences
in formulating its tax policy. All federal taxes must meet the test of public
policy and practical effect. The public purpose which is served should never be
obscured in a tax program under the mask of raising revenue.
WHAT TAXES ARE REALLY FOR
Federal taxes can be made to serve four principal purposes of a social and
economic character. These purposes are:
1. As an instrument of fiscal policy to help stabilize the purchasing power
of the dollar;
2. To express public policy in the distribution of wealth and of income,
as in the case of the progressive income and estate taxes;
3. To express public policy in subsidizing or in penalizing various
industries and economic groups;
4. To isolate and assess directly the costs of certain national benefits, such
as highways and social security.
In the recent past, we have used our federal tax program consciously for each of
these purposes. In serving these purposes, the tax program is a means to an end.
The purposes themselves are matters of basic national policy which should be
established, in the first instance, independently of any national tax program.
Among the policy questions with which we have to deal are these:
Do we want a dollar with reasonably stable purchasing power over the years?
Do we want greater equality of wealth and of income than would result from
economic forces working alone?
Do we want to subsidize certain industries and certain economic groups?
Do we want the beneficiaries of certain federal activities to be aware of what
they cost?
These questions are not tax questions; they are questions as to the kind of
country we want and the kind of life we want to lead. The tax program should be
a means to an agreed end. The tax program should be devised as an instrument,
and it should be judged by how well it serves its purpose.
By all odds, the most important single purpose to be served by the imposition
of federal taxes is the maintenance of a dollar which has stable purchasing
power over the years.
Sometimes this purpose is stated as "the avoidance of inflation"; and without
the use of federal taxation all other means of stabilization, such as monetary
policy and price controls and subsidies, are unavailing. All other means, in any
case, must be integrated with federal tax policy if we are to have tomorrow a
dollar which has a value near to what it is today.
The war has taught the government, and the government has taught the people,
that federal taxation has much to do with inflation and deflation, with the
prices which have to be paid for the things that are bought and sold. If federal
taxes are insufficient or of the wrong kind, the purchasing power in the hands
of the public is likely to be greater than the output of goods and services with
which this purchasing demand can be satisfied. If the demand becomes too great,
the result will be a rise in prices, and there will be no proportionate increase
in the quantity of things for sale. This will mean that the dollar is worth less
than it was before -- that is inflation. On the other hand, if federal taxes are
too heavy or are of the wrong kind, effective purchasing power in the hands of
the public will be insufficient to take from the producers of goods and services
all the things these producers would like to make. This will men widespread
unemployment.
The dollars the government spends become purchasing power in the hands of the
people who have received them. The dollars the government takes by taxes
cannot be spent by the people, and therefore, these dollars can no longer be
used to acquire the things which are available for sale. Taxation is, therefore,
an instrument of the first importance in the administration of any fiscal and
monetary policy.
TO DISTRIBUTE THE WEALTH
The second principle purpose of federal taxes is to attain more equality of
wealth and of income than would result from economic forces working alone.
The taxes which are effective for this purpose are the progressive individual
income tax, the progressive estate tax, and the gift tax. What these taxes
should be depends on public policy with respect to the distribution of wealth
and of income. It is important, here to note that the estate and gift taxes have
little or no significance, as tax measures, for stabilizing the value of the
dollar. Their purpose is the social purpose of preventing what otherwise would
be high concentration of wealth and income at a few points, as a result of
investment and reinvestment of income not expended in meeting day-to-day
consumption requirements. These taxes should be defended and attacked in terms
of their effects on the character of American life, not as revenue measures.
The third reason for federal taxes is to provide a subsidy for some industrial
or economic interest. The most conspicuous example of these taxes is the tariffs
on imports. Originally, taxes of this type were imposed to serve a double
purpose since, a century and a half ago, the national government required
revenues in order to pay its bills. Today tariffs on imports are no longer
needed for revenue. These taxes are nothing more than devices to provide
subsidies to selected industries; their social purpose is to provide a price
floor above which a domestic industry can compete with goods which can be
produced abroad and sold in this country more cheaply except for the tariff
protection. The subsidy is paid, not at the port of entry where the imported
goods are taxed, but in the higher price level for all goods of the same type
produced and sold at home.
The fourth purpose served by federal taxes is to assess, directly and visibly,
the costs of certain benefits. Such taxation is highly desirable in order to
limit the benefits to amounts which the people who benefit are willing to pay.
The most conspicuous example of such measures are the social security benefits,
old-age and unemployment insurance. The social purposes of giving such benefits
and of assessing specific taxes to meet the costs are obvious. Unfortunately and
unnecessarily, in both case, the programs have involved staggering deflationary
consequences as a result of the excess of current receipts over current
disbursements.
THE BAD TAX
The federal tax on corporation profits is the tax which is most important in its
effect on business operations. There are other taxes which are of great concern
to special classes of business. There are many problems of state and local
taxation of business which become extremely urgent, particularly when a
corporation has no profits at all. However, we shall confine our discussion to
the federal corporation income tax, since it is in this way that business is
principally taxed. We shall also confine our consideration to the problems of
ordinary peacetime taxation since, during wartime, many tax measures, such as
the excess- profits tax, have a special justification.
Taxes on corporation profits have three principal consequences -- all of them
bad. Briefly, the three bad effects of the corporation income tax are:
1. The money which is taken from the corporation in taxes must come in one of
three ways. It must come the people, in the higher prices they pay for the
things they buy; from the corporation's own employees in wages that are lower
than they otherwise would be; or from the corporation's stockholders, in lower
rate of return on their investment. No matter from which source it comes, or in
what proportion, this tax is harmful to production, to purchasing power, and to
investment.
2. The tax on corporation profits is a distorting factor in managerial judgment,
a factor which is prejudicial to clear engineering and economic analysis of what
will be best for the production and distribution of things for use. And, the
larger the tax, the greater the distortion.
3. The corporation income tax is the cause of double taxation. The individual
taxpayer is taxed once when his profit is earned by the corporation, and once
again when he receives the profit as a dividend. This double taxation makes it
more difficult to get people to invest their savings in business than if the
profits of business were only taxed once. Furthermore, stockholders with small
incomes bear as heavy a burden under the corporation income tax as do
stockholders with large incomes.
ANALYSIS
Let us examine these three bad effects of the tax on corporation profits more
closely. The first effect we observed was that the corporation income tax
results in either higher prices, lower wages, reduced return on investment, or
all three in combination. When the corporation income tax was first imposed it
may have been believed by some that an impersonal levy could be placed on the
profits of a soul-less corporation, a levy which would be neither a sales tax, a
tax on wages, or a double tax on the stockholder. Obviously, this is impossible
in any real sense. A corporation is nothing but a method of doing business which
is embodied in words inscribed on a piece of paper. The tax must be paid by one
or more of the people who are parties at interest in the business, either as
customer, as employee, or as stockholder.
It is impossible to know exactly who pays how much of the tax on corporation
profits. The stockholder pays some of it, to the extent that the return on his
investment is less than it would be if there were no tax. But, it is equally
certain that the stockholder does not pay all of the tax on corporate income --
indeed, he may pay very little of it. After a period of time, the corporation
income tax is figured as one of the costs of production and it gets passed on in
higher prices charged for the company's goods and services, and in lower wages,
including conditions of work which are inferior to what they otherwise might be.
The reasons why the corporation income tax is passed on, in some measure, must
be clearly understood. in the operations of a company, the management of the
business, directed by the profit motive, keeps its eyes on what is left over as
profit for the stockholders. Since the corporation must pay its federal income
taxes before it can pay dividends, the taxes are thought of -- the same as any
other uncontrollable expense -- as an outlay to be covered by higher prices or
lower costs, of which the principal cost is wages. Since all competition in the
same line of business is thinking the same way, prices and costs will tend to
stabilize at a point which will produce a profit, after taxes, sufficient to
give the industry access to new capital at a reasonable price. When this finally
happens, as it must if the industry is to hold its own, the federal income tax
on corporations will have been largely absorbed in higher prices and in lower
wages. The effect of the corporation income tax is, therefore, to raise prices
blindly and to lower wages by an indeterminable amount. Both tendencies are in
the wrong direction and are harmful to the public welfare.
WHERE WOULD THE MONEY GO?
Suppose the corporation income tax were removed, where would the money go that
is now paid in taxes? That depends. If the industry is highly competitive, as in
the case of retailing, a large share would go in lower prices, and a smaller
share would go in higher wages and in higher yield on savings invested in the
industry. If labor in the industry is strongly organized, as in the railroad,
steel, and automotive industries, the share going in higher wages would tend to
increase. If the industry is neither competitive or organized nor regulated --
of which industries there are very few -- a large share would go to the
stockholders. In so far as the elimination of the present corporation income tax
would result in lower prices, it would raise the standard of living for
everyone.
The second bad effect of the corporation income tax is that it is a distorting
factor in management judgment, entering into every decision, and causing actions
to be taken which would not have been taken on business grounds alone. The tax
consequences of every important commitment have to be appraised. Sometimes, some
action which ought to be taken cannot be taken because the tax results make the
transaction valueless, or worse. Sometimes, apparently senseless actions are
fully warranted because of tax benefits. The results of this tax thinking is to
destroy the integrity of business judgment, and to set up a business structure
and tradition which does not hang together in terms of the compulsion of inner
economic or engineering efficiency.
PREMIUM ON DEBT
The most conspicuous illustration of the bad effect of tax consideration on
business judgment is seen in the preferred position that debt financing has over
equity financing. This preferred position is due to the fact that interest and
rents, paid on capital used in a business, are not deductible as expense;
whereas dividends paid are not. The result weighs the scales always in favor of
debt financing, since no income tax is paid on the deductible costs of this form
of capital. This tendency goes on, although it is universally agreed that
business and the country generally would be in a stronger position if a much
larger proportion of all investment were in common stocks and equities, and a
smaller proportion in mortgages and bonds.
It must be conceded that, in many cases, a high corporation income tax induces
management to make expenditures which prudent judgment would avoid. This is
particularly true if a long-term benefit may result, a benefit which cannot or
need not be capitalized. The long- term expense is shared involuntarily by
government with business, and under these circumstances, a long chance is often
will worth taking. Scientific research and institutional advertising are
favorite vehicles for the sue of these cheap dollars. Since these expenses
reduce profits, they reduce taxes at the same time; and the cost to the business
is only the margin of the expenditure that would have remained after the taxes
had been paid -- the government pays the rest. Admitting that a certain amount
of venturesome expenditure does result from this tax inducement, it is an
unhealthy form of unregulated subsidy which, in the end, will soften the fiber
of management and will result in excess timidity when the risk must be carried
by the business alone.
The third unfortunate consequence of the corporation income tax is that the same
earnings are taxed twice, once when they are earned and once when they are
distributed. This double taxation causes the original profit margin to carry a
tremendous burden of tax, making it difficult to justify equity investment in a
new and growing business. It also works contrary to the principles of the
progressive income tax, since the small stockholder, with a small income, pays
the same rate of corporation tax on his share of the earnings as does the
stockholder whose total income falls in the highest brackets. This defect of
double taxation is serious, both as it affects equity in the total tax
structure, and as a handicap to the investment of savings in business.
SHORTLY, AN EVIL
Any one of these three bad effects of the corporation income tax would be enough
to put it severely on the defensive. The three effects, taken together, make an
overwhelming case against this tax. The corporation income tax is an evil tax
and it should be abolished. The corporation income tax cannot be abolished until
some method is found to keep the corporate form from being used as a refuge from
the individual income tax and as a means of accumulating unneeded, uninvested
surpluses. Some way must be devised whereby the corporation earnings, which
inure to the individual stockholders, are adequately taxed as income of these
individuals.
The weaknesses and dangers of the corporation income tax have been know for
years, and an ill-fated attempt to abolish it was made in 1936 in a proposed
undistributed profits tax. This tax, as it was imposed by Congress, had four
weaknesses which soon drove it from the books. First, the income tax on
corporations was not eliminated in the final legislation, but the undistributed
profits tax was added on top of it. Second, it was never made absolutely clear,
by regulation or by statute, just what form of distributed capitalization of
withheld and reinvested earnings would be taxable to the stockholders and not to
the corporation. Third, the Securities and Exchange Commission did not set forth
special and simple regulations covering securities issued to capitalize withhold
earnings. Fourth, the earnings of a corporation were frozen to a particular
fiscal year, with none of the flexibility of the carry- forward, carry-back
provisions of the present law.
Granted that the corporation income tax must go, it will not be easy to devise
protective measures which will be entirely satisfactory. The difficulties are
not merely difficulties of technique and of avoiding the pitfalls of a perfect
solution impossible to administer, but are questions of principle that raise
issues as to the proper locus of power over new capital investment.
Can the government afford to give up the corporation income tax? That really is
not the question. The question is this: Is it a favorable way of assessing taxes
on the people -- on the consumer, the workers and investors --- who after all
are the only real taxpayers? It is clear from any point of view that the effects
of the corporation income tax are bad effects. The public purposes to be served
by taxation are not thereby well served. The tax is uncertain in its effect with
respect to the stabilization of the dollar, and it is inequitable as part of a
progressive levy on individual income. It tends to raise the prices of goods and
services. it tends to keep wages lower than they otherwise might be. It reduces
the yield on investment and obstructs the flow of savings into business
enterprise. |
