expenses, which may be necessary and just. For example, when the cost of building a railroad is great, its gross earnings must be correspondingly large in order to enable its owners to realize any fair return on the investment. A tax on gross earnings does not recognize this distinction. It discriminates unfairly between companies, and makes a line built at great expense and with great risk pay a penalty for the enterprise of its constructors. Again, a gross earning tax takes no account of expenses. Of two corporations which have equally large gross receipts, one may be in a naturally disadvantageous position which increases unduly the cost of operation or management. Clearly its ability to pay is not so great as that of the rival company in possession of natural advantages. In short, the gross receipts tax is like the old tithe on land, the most primitive and the most unjust of all land taxes. For two pieces of land may yield the same product and yet, owing to difference in the expenses of cultivation, may bring in very different profits to the owner. The very first development in all early tax systems is to replace the tithe by a tax on the value or the profits of the property.

The dividends or the capital stock according to dividends. The dividends tax, it may be said, is good so far as it goes. But it does not go far enough. It is indeed true that objections have sometimes been raised which are of little weight. Thus it has been contended that this tax fails to reach the profits which are not divided but simply put into a reserve fund. Some commonwealths have even sought to obviate this supposed difficulty by providing that the tax should apply to the dividends, whether declared or merely earned and not divided. But this objection is of no importance. For even if the undivided earnings are not taxed, they go into the reserve or surplus fund. As this increases the corporate capital, it must in the long run lead to increased earnings on the larger capital. And as the surplus cannot be increased indefinitely, it will ultimately find its way to the shareholders as dividends, and thus become liable to the tax.

Another objection which might be urged is that a corporation may devote a portion of its earnings to new construction or to new equipment. This expense may be defrayed out of profits, instead of from the capital or construction fund. The dividends in such a case, it might be said, do not represent the actual earning capacity of the enterprise. But while this is true temporarily, the improvements made by the corporation necessarily enhance the value of the property and lead to ultimately increased dividends. So that in the long run a tax on dividends would still reach the corporation.

The real objection to the dividends tax is of quite a different character. The taxation of dividends is utterly inadequate when applied to those corporations which have bonded indebtedness. One corporation may have only a capital stock with earnings or dividends of five per cent. Another corporation, with the same earnings, may have collected an identical amount of money, of which one-half, however, is represented by five per cent. bonds. A tax on dividends, while normally equal, would then be actually most unequal. The one corporation would pay just twice as much as the other. This objection has been recognized, but only once, in American legislation. The United States internal revenue law of 1864 provided for a five per cent. (raised from three per cent. in 1862) tax, which, in the case of railroads, canals, turnpike, navigation and slackwater companies, was imposed on all dividends, as well as on all coupons or interest on evidences of indebtedness and on all profits carried to the amount of any fund. While in the case of those companies which were not presumed to have any bonded debt, like banks, trust companies, savings institutions and insurance companies, the tax was imposed only on dividends and surplus. The federal law, indeed, violated strict consistency in imposing a gross earnings tax also on transportation and on certain insurance companies. But the correct implication in the law was the inadequacy of a tax on dividends alone. In fact, the objections to the dividends tax are closely analogous to those that we found in the capital stock tax as over against

the tax on stock plus debt. It reaches only a part of the corporate earning capacity.

We thus come finally to the tax on net earnings, or rather on net receipts, profits or income. Net receipts form the most logical basis for corporate taxation. The tax is not unequal in its operation like the gross earnings tax. It holds out no inducement to check improvements, like the general property tax. It is just; it is simple; it is perfectly proportional to productive capacity. In short, it satisfies all the requirements of a scientific system. .

If it should be desired to obtain a more exact definition of net receipts or income in the case of railroad companies, the following would be an economically sound method of proceeding: Gross receipts consist of all earnings from transportation of freight and passengers, receipts from bonds and stocks owned, rents of property and all miscellaneous receipts from ancillary business enterprises or otherwise. From these aggregate gross receipts we should deduct what are classified by the Interstate Commerce Commission as operating expenses, that is, expenses for conducting transportation, for maintenance. of roadway, structures and equipment, and general expenses of management. But no deduction should be made for fixed charges, i. e., for taxes or for interest on the debt, nor should any deduction be allowed for the amount used in new construction, betterments, investments, new equipment or any of the expenditures that find their way into profit and loss account. The method here suggested would lead to the abolition of one of the greatest abuses of American railway management-that of putting all possible expenses into the construction account. Our railways, for example, frequently fail to charge the maintenance and repair of their rolling stock to current expenses. When the equipment has become unserviceable, new stock is bought and charged to the construction or the profit and loss account. But in the meantime the nominal earnings of the railway will seem to have been large, and the managers will have reaped whatever temporary benefit they may have desired. The

taxation of net profit in the sense that I have indicated would tend to check this practice, since deductions would be allowed for maintenance, but not new equipment. A tax on net receipts would possess not only a financial, but also a wider economic advantage.

81. THE INCOME TAX AMENDMENT TO THE FEDERAL CONSTITUTION.

The question of levying a federal income tax was not abandoned when the law of 1894 was declared void. The recent movement toward tariff reform has witnessed an insistent demand for the reenactment of an income tax law. When the tariff act of 1909 was under consideration an income tax was proposed and was abandoned only because it was found impossible to so frame the provision that it would not meet the fate of that of 1894. To avoid this difficulty and open the way for the future enactment of such a law, Congress thereupon adopted the following joint resolution which, having been ratified by three-fourths of the states, became a part of the Constitution February 3, 1913;

Resolved by the Senate and House of Representatives of the United States of America in Congress assembled (two-thirds of each House concurring therein), That the following article is proposed as an amendment to the Constitution of the United States, which, when ratified by the legislatures of three-fourths of the several States, shall be valid to all intents and purposes as a part of the Constitution:

"Article XVI. The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration.'

ADDITIONAL READINGS

1-Direct and Indirect Taxation Compared, Ely, R. C., Taxation in American States and Cities, 79-93.

2-Taxation of Incomes, Ibid., 287-311.

3-The Inequalities of the Direct Federal Tax, Bullock, C. J. Political Science Quarterly, XV, 470–81.

CHAPTER XIX

GOVERNMENT FINANCE

82. CONGRESSIONAL FINANCE.

Since 1886, when the expenditures of the Federal Government began to increase by leaps and bounds, Congress has often been charged with extravagance. A large part of the time of each Congress is, in fact, taken up with the business of discussing and adjusting the several appropriation bills which provide for the expenditures of the enormous sums required to carry on the work of the various departments. Mr. James Bryce makes the following very just criticism of the manner in which this work is performed: 1

The Secretary of the Treasury sends annually to Congress a report containing a statement of the national income and expenditures and of the condition of the public debt, together with remarks on the system of taxation and suggestions for its improvement. He also sends what is called his Annual Letter, enclosing the estimates, framed by the various departments, of the sums needed for the public services of the United States during the coming year. So far the Secretary is like a European finance minister, except that he communicates with the chamber on paper instead of making his statement and proposals orally. But here the resemblance stops. Everything that remains in the way of financial legislation is done solely by Congress and its committees, the executive having no further hand in the matter.

The business of raising money belongs to one committee only, the standing committee of Ways and Means, consisting of eleven members. Its chairman is always a leading man in the party which commands a majority in the House. This 1 See above page 261, note.