Sources of state revenue

CHAPTER XL

STATE FINANCE

How to obtain the money requisite to carry on the numerous and varied activities mentioned in the preceding chapter, how to apportion the state's revenues among the different administrative enterprises and agencies, how to set and maintain the necessary safeguards against waste and corruption, how to limit the state's borrowing power, if at all, and how to link up state finances, in the narrower sense, with the finances of counties, towns, and other local government areas-these are problems second in importance and difficulty to none which we have thus far encountered in the field of state government. Certain of them, notably those pertaining directly to the raising and spending of money, call for some study at this point.1

With respect to sources of revenue, it is not surprising to find marked differences among the forty-eight states; nor to discover that, in view of the steadily increasing cost of state government, almost every state has been obliged not only to increase the amounts derived from old sources of revenue but to cast about for new ones. In general, the revenues of the states are now somewhat as follows:

(1) Commercial revenues, or income from public property, including revenue obtained by methods and under conditions which are very similar to those prevailing in private enterprises; for example, rents from school lands (especially in the western states), from state-owned canals, docks, or wharves, and from industries carried on in penal institutions.

(2) Fees charged for inspections, charters of incorporation, franchises, automobile licenses, and licenses to conduct a business or practice a profession.

(3) Income accruing from a variety of legal proceedings, such

The constitutional limitations on taxation and indebtedness have been summarized above (Chap. xxxv). On these phases of state finance, see H. Secrist, "An Economic Analysis of the Constitutional Restrictions upon Public Indebtedness in the United States," Univ. of Wis. Bull., VIII, No. 1 (1914).

XL

as fines in criminal cases, the forfeiture of bonds, and charges for CHAP. filing, copying, or recording legal documents.

(4) Subventions or grants by the national government in aid of state activities, notably education and highway construction.1 (5) Taxes. Large as are the sums obtained in many states from the foregoing sources, by far the greatest amount of revenue is derived from taxation.2

kinds of

The most productive kinds of taxation, one or more being found Different in every state, are the following: (a) corporation taxes, which taxes may assume any one of a variety of forms, such as a tax on capital stock, real estate, trackage, franchises, "corporate excess, gross earnings or net earnings, or the gross production or net proceeds of oil-wells and mines; (b) inheritance taxes, which are now found in about forty states, and usually take the form of graduated or progressive taxes applied to both direct and collateral inheritances, although in some states only the latter are taxed; (c) income taxes, which have rapidly come into favor since the adoption of the federal income tax amendment in 1913 and the introduction of improved methods of collection; (d) business and professional taxes, applied to both persons and corporations, which form an important source of revenue in Pennsylvania, Delaware, and a few western states, but are more commonly found in southern states; and (e) the general property tax, which is the main reliance of the majority of states, and which furnishes probably more than half of the income of every state in which it is used for state purposes. Because of its widespread use, the outspoken dissatisfac1J. A. Lapp, "Federal Grants in Aid,” Amer. Polit. Sci. Rev., X, 738-743 (Nov., 1916).

5

In general, it may be said that a state has the right to tax all persons, including corporations, residing or doing business within its bounds, and all forms of property located within the state, except in so far as this right may be restricted by provisions in the state constitution. To this generalization, however, there are important exceptions. For example, states may not tax imports from foreign countries, interstate commerce, or the agencies, instrumentalities, or property of the national government. J. T. Young, The New American Government and Its Work, Chap. xxv.

The corporate excess is the remainder found by deducting the assessed value of the tangible property from the equalized market or actual value of the capital stock, plus bonded indebtedness."' J. M. Mathews, Principles of American State Administration, 250.

Educational, charitable, and religious corporations are almost always exempted, in whole or in part, from the taxes which are imposed upon corporations organized for profit.

"In some states certain sources of revenue have been set aside for taxation for state purposes and other sources have been reserved for local taxation. "The principal sources reserved for state taxation are banks, insurance companies, public service corporations, inheritances, and incomes." In New York and Pennsylvania and a few other states the amount of revenue derived from

CHAP. XL

Theory

of the general

property

tax

Objectionable features

tion with it in many states, and its intimate relation to almost every main problem of tax reform, the general property tax calls for somewhat detailed consideration.1

This tax is an ad valorem levy upon real estate and upon both tangible and intangible personal property. Its original purpose was to spread the public burden as equitably as possible over all persons in accordance with their respective abilities to contribute, measured by the value of the property they owned. Its history goes back to a period in which men were profoundly influenced by a political philosophy which insisted upon the strict equality of all men before the law. It was assumed that the natural equality of men extended not only to their persons but to their property, so that it was regarded as an act of discrimination and fundamental injustice to tax one form of property at a different rate from another.

In early times the application of this theory worked no real injustice. Houses and lands could not, of course, be concealed; and practically all personal property was tangible, consisting mainly of horses, cattle, wagons, farm implements, tools, grain, merchandise, and household furniture. All these could be easily located and their value determined by the tax assessor; so that comparatively little, if any, taxable property escaped paying its just share. In the past seventy years, however, there has been an enormous increase in the amount and variety of intangible personal property, especially in the form of stocks, bonds, and mortgages; so that, taking the country as a whole, the value of intangibles is now greatly in excess of the value of real property sources set aside as special objects of state taxation has been so large as to render almost wholly unnecessary any direct property tax for state purposes. Mathews, op. cit., 263-264. There has also been much discussion in recent years among students of public finance of the desirability of a similar differentiation of the objects of state and national taxation. In 1917 representatives of forty-two states met at Atlanta to propose measures for recommendation to Congress along this line. On this general subject, see E. R. A. Seligman, Essays in Taxation (8th ed., New York, 1913), Chap. XII; Annals Amer. Acad. Polit. and Social Sci., LVIII, 1-11, 59-64, 105-111 (March, 1915); Nat'l Tax Assoc. Proceedings (1919), 128-145; J. E. Boyle, "A Program for Redistributing Sources of Revenue as between Cities, States, and National Government,'' Annals Amer. Acad. Polit. and Soc. Sci., XCV, 272-276 (May, 1921).

Brief discussions of the general subjects of state revenue and taxation will be found in Mathews, Principles of American State Administration, Chaps. X-XI; Young, The New American Government and Its Work, Chaps. XXII, xxv; Ill. Const. Conv. Bull. No. 4 (1920), "State and Local Finance." See also A. Youngman, "The Revenue System of Kentucky; A Study in State Finance,' Quar. Jour. Econ., XXXII, 142-205 (Nov., 1917), and M. L. Faust, "Sources of Revenue of the States, with Special Study of the Revenue Sources of Pennsylvania, Annals Amer. Acad. Polit. and Soc. Sci., XCV, 113-122 (May,

XL

subject to taxation. These newer forms of personal property are CHAP. easily concealed, and the owner has every temptation to conceal them when the rate of taxation, determined primarily with reference to real estate and tangible personal property, would compel him to yield up in taxes from one-fourth to one-half, or even more, of the net income derived from these securities-a result which really amounts to confiscation.

Under present conditions, the uniform general property tax in many states is neither uniform nor general nor equitable. Real property comes the nearest to bearing its fair share of taxation, but even here there is often the greatest lack of uniformity in the valuations placed upon the same class of real estate located in different parts of the same state, and even within the same county. Personal property, on the other hand, either is notoriously undervalued or escapes taxation altogether. For example, in Chicago, the second largest city in the western hemisphere, the full cash value of all the diamonds and jewelry owned was, according to the assessment figures for 1911, the ridiculously low sum of about a half-million dollars. Furthermore, the same tax returns indicated that not a single organ or melodeon was owned within the city limits, and that only one person in every 188 possessed a watch or a clock! Almost ten million hogs, five million sheep, and four million cattle were received and sold in the Chicago markets during the year 1913; yet the tax records show that in the whole of Cook county there were assessed for taxation only 26,500 cattle, 683 sheep, and 8,085 hogs. These records also show that the grain elevators and warehouses of Chicago held in storage on the first day of April, 1918, grain having an assessed value of only $779,644, whereas the actual market value of the millions of bushels held in storage on that date was $17,778,700.1

In many communities the assessment of personal property taxes is almost wholly restricted to those persons whose names are on the assessment rolls as the owners of taxable real estate. It is, of course, physically impossible for the tax authorities to assess all tangible personal property from actual view; hence it has become customary in many places to require the taxpayers themselves to make out sworn statements of their taxable property, a method

Report of the Sub-Committee of the Revenue Committee of the Illinois House of Representatives (1918). See also Mathews, op. cit., 226-227; R. M. Haig, "History of the General Property Tax in Illinois," Univ. of Ill. Studies, III; J. A. Fairlie, Report on the Taxation and Revenue System of Illinois (1910); Ill. Const. Conv. Bull., "Constitutional Conventions in Illinois'' (1920), 76-89; ibid., "State and Local Finance" (1920).

Self

assessment

by owners

of personal property

CHAP.
XL

Substitutes for the general property

tax

which practically amounts to self-assessment. Under such circumstances, instead of being equal in proportion to ability to pay, the tax becomes progressive in proportion to the honesty of the taxpayer in making out his tax-list. "It thus places a premium on dishonesty and has been justly described as a 'school of perjury.'" The upshot is that personal property everywhere fails to bear its proportionate share of the burden of taxation. "The figures of the United States census bureau show that in 1912 the assessed value of real property and improvements subject to ad valorem taxation was, for the entire country, about fifty-two billions of dollars, while that of personal property was only about seventeen billions, though the true value of personal property was doubtless considerably greater than that of real estate."

The foregoing statements indicate in a very general way some of the principal reasons why, in many states, the general property tax has come to be regarded, in the past fifteen or twenty years, as thoroughly unsatisfactory. New York has abandoned it as a source of state revenue, and, among other substitutes, has adopted certain forms of taxation which, like the mortgagerecording and bond-registry taxes, are specially designed to induce the owners of intangibles to report them for the purposes of taxation at a reasonably low rate. In over thirty other states, those defects of the general property tax which are traceable to the uniformity requirement have been greatly reduced, and to a considerable extent eliminated, by express or implied constitutional grants of authority to the legislature to classify different kinds of property and to impose a different rate of taxation upon the various classes, provided the tax is uniform for all property falling within any given class. This classification system makes it possible, among other things, to impose a lower and more equitable rate upon intangibles than upon real estate, with the result that, the motive for concealing such property from the assessors being removed, vastly larger amounts are reported annually for taxation, with a consequent heavy increase in the revenue of the state from this source. This plan of taxing securities at a lower rate has been adopted in Pennsylvania, Maryland, Iowa, Minnesota, Rhode Island, North Dakota, and other states, with generally far more satisfactory results than were obtained under the old uniform tax.1 On the whole, however, the movement for tax reform has

Ill. Const. Conv. Bull., "Constitutional Conventions in Illinois" (1920), 76 ff. See also Fifth Annual Conference on State and Local Taxation, Ad