Taxation and Natural Law

TAXATION is baffled by natural laws which, in a blind way, it is trying to follow. It is a striking fact that principles which have been respected since the days of Adam Smith call for a complete reversal of the plan of taxation to which they originally led. This is not because changed conditions make a new procedure desirable. Through the long period in which the principles have been known, governments have tried to comply with them; but there is one feature of their mode of assessment which has from the first made success impossible.

Some of the familiar principles have been fairly well followed. That public revenues should do as much good in the spending, and as little harm in the collecting, as possible, is self-evident; and it is equally clear that, both in spending and in collecting, governments should follow some rule of justice. They should deal fairly as between man and man. Just what apportionment of benefits and burdens will do this is, indeed, not clear; and therefore the accurate mode of applying the rule of justice is not apparent. Should we spend money equally on all citizens, regardless of their wealth and their needs? To most minds this would not seem to be ideal justice; and yet, when we try to spend the money in an unequal way, we find trouble in determining just how much one man should have more than another. It is encouraging, therefore, to note, that here, where even theory is at a loss, practice encounters no great difficulty. There is no deep-seated discontent with the general plan of spending revenues. When we try honestly to protect all persons and their property, — when we offer education to all, and make streets, parks, libraries, galleries, and the like, open to every one, and give to all equal privileges so far as public institutions can,—we have no large discontented party to deal with. In this matter people do not look far beyond the practical results, and as they find these quite tolerable, they are contented.

The reverse of this is true concerning the process of collection. Here no great fault is found with theoretical rules, but very much with practice under them. When we have said that direct taxes should rest principally on invested property, and be so imposed that, in the long run, owners should pay in proportion to the income they obtain from it, we encounter no grave criticism on the side of theory. It is, indeed, sometimes said that, the rich should pay not only more than other classes, but proportionately more; and that if a man who is worth a few thousand dollars pays one per cent of his estate, the man who is worth a million should pay two or more. It is also said that, ideally, personal needs should be considered, and that ‘free income,’and not gross income, should be the basis of comparison. According to this, men should pay more or less according to the amounts of income which they have and do not imperatively need for personal uses. It is said, too, with reason, that income from labor, when it is highly paid, should be taken into account. Yet these and other variations from the simple rule of pro-rata paymeat are commonly regarded as refinements, which it is well to take account of after practice shall have come as near to equity as it will when it causes men to be taxed in direct proportion to their income-bearing property. If we can secure such proportionate taxation as a beginning, we can then study the supplementary measures that will bring the result nearer to the ideal standard. We shall have made a long and inspiring march toward our goal, and the remainder of the route will be in sight.

There is no controversy as to present abuses of taxation. It is hard to speak seriously of equity as having any close connection with taxation. The very rich do not come within many leagues of contributing to public revenues in proportion to their ability; and while the very poor naturally escape levies on property, they pay heavily on their consumption. Taxes levied on consumers’ goods tell severely on the real wages of labor. Land and buildings are most heavily taxed; and this fact bears hard on workingmen who own their homes, and harder on those who are struggling to acquire them. Probably the man who has most to complain of is the wage-earner who has just bought a home and is paying the price of it in monthly installments. He is taxed on his consumption in one way, and in another way on the productive property which he has not, at present, but which he hopes to have hereafter.

The present mode of making assessments is further from the rule of morality than the resulting tax is from the rule of equity. It puts a premium on false statements. It accepts a man’s sworn assertion as to his property, and gets untruthful affidavits by the million. It is hard to see in what way the government could do as much to build up character as by this measure it does to break it down. The moral effects of taxation play their part in inducing even some good men to call for the confiscation of land as a substitute for other means of gaining revenue.

Is there any system in sight which is both just and practical? Confining ourselves for the moment to the ethical side of the problem, let us see whether there is any ride of taxation which, if enforced, would give us that first approximation to justice which the public demands. This inquiry is one of pure theory, and we may begin by citing one or two other self-evident principles.

Rights are also personal. Inanimate things have neither rights nor duties, and property, in and of itself, owes nothing and claims nothing. It has no standing before a court as either plaintiff or defendant; and yet property is the basis of both rights and duties. Men’s relations to each other and to the State are affected by what they possess, and the fact that a man has something causes the State to claim something from him. It proceeds against him personally, and utterly fails to collect its dues.

The natural inference from the fact that a man owes something to the State is that the State should find the man and prosecute its claim directly; and this mode of procedure was expected by the writers who early formulated principles of taxation. It has been followed in general practice. First, identify the man against whom the State has a claim, then measure the claim and force him to satisfy it. Such has seemed to be a perfectly natural mode of procedure; but in practice it has come near to being the root of all evil in taxation. It has been impossible to do what the rule calls for, except in the case of the unfortunate persons whose estates are in the hands of the probate courts. It is so easy to evade the claim, that there is a strong disposition to abandon all efforts to tax personal property except in partial and indirect ways. We have never yet tried to tax it in the one way which, on grounds of economic principle, promises success.

We have made efforts to secure revenue from the personal property of individuals, and have tried to tax their bonds, mortgages. and promissory notes. We have usually sought to tax the shares they hold in corporations. Back of all the paper instruments which represent value, there are material things; but most of these we have scarcely tried to find. Our chief effort has been to establish the fact that certain persons hold titles representing value, and to tax those persons; and since that has failed, we have reverted to a plan of taxing corporations and inheritances, and so, in a very partial way, have reached the elusive forms of property.

In dealing with the living men who own the productive wealth other than land and buildings, and who derive an income from it, we encounter a fatal obstacle, in that it is impossible to ascertain how much of such wealth the particular persons possess. The paper certificates of ownership flit from the field of vision like a flock of frightened birds. Ownership, then, is what the State cannot identify; and so long as the law requires this identification it will fail. We can find men, and we can find taxable material objects; but the thing that baffles us is establishing the relation between the two.

What assessors cannot do, economic law can do, and that in an unerring way: it can find the virtual owner of property and make him pay the tax on it. There is an impersonal but real detective agent, whose work outdoes that of t he most skillful assessor armed with full powers of inquisition. This agent is not in sight, and officers who should employ it in collecting public dues might be unconscious of its existence; yet, if it were employed, the assessors would not need to inquire what any particular man is worth. They would not need to know or care who owns the capital of any business whose material assets they are appraising. Especially might they throw to the winds all thought of taxing claims of one man against another, — the paper titles that now cut so large a figure. They would and should give up, once for all, the effort to identify the owners of capital. That the impersonal economic agent can do for them. If we tax the visible and material instruments of production, this economic agent will find the men who virtually own them. The capitalist who has furnished the money with which to stock a department store, or to build a mill and fill it with machines and raw materials, will have to pay the tax on these things, though he cross the seven seas or bury himself in an African jungle; and the assessor will not need to ask who or where he is.

Put a tax on all material and visible instruments of production, and economic law will make the real owner pay it. We discriminate here between the so-called entrepreneur and the capitalist: the former being the user of capital, and the latter the owner of it. If a man has borrowed half a million dollars, and has built a mill and begun to run it, using no capital of his own, he is an entrepreneur pure and simple. As an English term expresses it, he is the undertaker of the business and nothing more. Our thesis is that, in this case, the proposed tax on the mill and its contents will fall, not on him, but altogether on the lender of the money.

If the man has a quarter of a million dollars of his own, and has borrowed as much more; he is of course both entrepreneur and capitalist, and he and the other possessor of capital will bear the tax, share and share alike. If the entire million dollars were his own, he would not only advance the tax to the government, but would finally pay it. There would be no other capitalist on whom he would be able to shift it; and we shall later see that there would be no other class of persons on whom he could place the burden. In general, the entrepreneur, as such, is the proper agent for advancing the tax to the assessor; but the capitalist is the man who would recoup him for this advance.

It is time that we find by what mechanism this result would be brought about; and here the inquiry takes us again to a basic principle. What, at bottom, fixes the rate of interest? For any one man who secures a loan it is, of course, the rate which lenders are in the habit of charging. But what fixes the habit? Evidently it is the rate which they can succeed in making the general class of borrowers pay. Just as men buy more goods when the prices are low than when they are high, so, other things being equal, they borrow more money when the interest is low. The most that they will pay for any length of time is what they can afford to pay, which is another way of saying that it is what the capital in their hands produces.

It has come to be a perfectly familiar fact that, with a certain supply of goods to be sold, merchants must place the prices at a level that will carry off the final or marginal units of it. To get rid of a whole crop of wheat, farmers have to sell it all at a rate per bushel that will induce the public to buy and use the last and least necessary part of it. So, in order to lend the whole of a great fund of capital, the owners must accept a rate of interest that will induce business men to borrow and use the last and least necessary part of it. There is some elasticity in the amount which almost any one of them can find use for. A manufacturer can always add to his facilities for making shoes, or cotton goods, or jewelry, or steel, and so turn out a greater quantity and a larger variety in the year. A carrier can add to his appliances for transportation, and a merchant can keep a fuller stock of goods and secure a larger volume of total sales. In some way most of the men to whom a loan is tendered can make more money in the year by the use of it; and such extra gains are due to this ‘final increment’ of borrowed funds. The value of that extra product is all that any one of them can afford to pay for the loan that enables him to create it. Interest always tends to equal the product that can be got from the marginal part of social capital. If competition is active, the rate of interest closely conforms to this standard; and it always fluctuates in the general vicinity of it. It is seldom much less, and never, for long, any more.

Let us now take the market as we find it, with interest-charges ranging at or near the amounts produced by the final units of capital; and in this condition let us put a tax on all instruments of production alike. It will take so much from the net return that an entrepreneur can get from any one of them. We shall make the user of an instrument pay a very small part of its value annually to the government, and this tax will diminish by a slight degree the amount of money he can make by using the instrument. We shall have made what may be called a ‘ horizontal reduction’ in the product of capital, and users can no longer afford to pay the same rate of interest on it as before. With a slightly smaller interestcharge they will continue to use it; but if they must pay as much as before, they will let some of it go. The outcome of the situation is that, as lenders find the market for capital weakening, they promptly reduce their charges. The capital all remains in use, and all of it, even the marginal part, recoups the users for what they now have to pay for it. Entrepreneurs’ gains are not reduced.

There are few propositions of economic theory which a man may more safely undertake to defend than the one which asserts that putting a tax on every instrument of production and taking annually for the government a small percentage of the value it creates, takes nothing permanently from entrepreneurs. The burden must, in the end, all fall on the owners of the capital. On the original imposition of this tax, the rate of interest would not instantly respond to the new condition. A little time would be required for the adjustment, and the entrepreneurs would temporarily feel the tax; but the shifting of it, when once accomplished, would be permanent; the impost would rest on the capitalist forever, and no other class would afterwards share it with him.

We must be careful here. It is not unlikely that some one will say at once that a tax on producers is shifted in another direction. The prices of the products, it may be said, are raised, and those who use them pay the tax. Laborers, landlords, public officers, professional men, and capitalists alike pay more for goods than before, and the excess goes to the State. The producer is thought of as either wholly or mainly ridding himself of the burden.

Something like this is true where only a single product is taxed. The maker of it adds the impost to his prices, or all of it that he can consistently so add, and the public pays most of the bill. But what will happen if we increase very slightly the price of every product that the public uses? Can the people somehow conjure out of non-existence the enlarged income with which to buy the products that are offered? On the contrary, their purchasing power is not affected. They are unable to buy everything at an increased price. The general volume of money is no larger than before, and that fact is inconsistent with an undiminished volume of business at enlarged prices. We must state these things more briefly than they deserve to be stated; but it is a safe proposition which says that the maker of one article can shift to the public the greater part of a tax on it, provided that other articles are not similarly taxed; but nobody could do this if the impost were universal.

This carries the important inference that laborers would not feel a tax imposed on the instruments that they use, provided that these are the property of other persons. The tools of trade would yield to their just owners a little less than formerly, and the users of them, in turn, would pay the capitalist a shade less than before; but the workers’ entire position would be unaffected. There is no way in which employers could make them take any smaller wages than before.

A probable plan of procedure would be to leave unchanged the high rate of taxation which now rests on real estate, and thus to get a revenue which would grow pari passu with the increase of the value of such property. A very small rate would then suffice in the case of other varieties of material wealth. Bonds, stocks, promissory notes, and moneys on deposit would not be called for by the assessor, and the low and uniform tax on actual and visible ‘capital goods’ would be a welcome substitute, even in the capitalist’s view, for the effort to collect a revenue from such mere titles to property. Low as the rate of the new impost would be, the amount of wealth which would be subject to it would make it yield far more than the unequal and exasperating taxes which now rest on a fraction of the fund; and the investor,escaping the whole inquisitorial process which now compels him to choose between marring his fortune by one line of action and marring his character by another, might well feel that he had escaped from a world of tribulation into something like the ‘Happy Valley’ of Rasselas.

But would not the assessment be difficult and laborious, and would it not take a very large force of expert assessors? Would these men not need to be honest as well as capable, and would not graft exist with any force we could command? It may safely be asserted that the difficulty of assessing productive instruments in actual use is less than that encountered in assessing imported merchandise; and that the detection of frauds in the former process would be easier than in the latter. But the purpose of this article does not require that we go into these difficulties at all. We should rejoice when the objection to the proposed system takes this shape. If the choice lies between the system that rests on a wrong basic principle, even though it be easy of execution, and another built on the right principle but hard of execution, our choice is a clear one. No amount of energy and faithfulness can make a system succeed if its bottom principle is wrong; but a people should, and in most cases do, have enough energy and faithfulness to make any system succeed when its basic principle is right.

What we claim, however, is that, the right tax is also the practicable one. A principle of ethics requires that the owner of invested wealth should pay the tax on it; and a principle of economics reveals a sure way to compel him to do it. An earnest effort to tax all visible instruments of production would have nature in its favor, and man would be a weaker creature than he is if, with such coöperation, he could not succeed.