The General Features Of Taxation.

THE increasing importance of taxation as the mode
of supplying the public wants is a conspicuous feature in
financial development. It is partly attributable to the v
decline of the earlier forms of revenue, but far more to
the great and continuous growth of expenditure. The
modern state is dependent on taxation to an extent
unknown in mediaeval times. Hence all questions con-
nected with this department of Finance have an enhanced
interest. Errors on the subject or mistakes on the part of
practical financiers tend to become more and more serious.
The need of a careful study of the general features of the
tax system is greater. Without a true appreciation of the
conditions under which it works, it is hopeless to expect
the adoption of a wise policy or determination in applying
it. Practical sagacity has its part and no small one in
successful financial management, but it is all,the more
effective when enlightened by the study or principles.
The complications of modern financial systems make it ;
advisable to note their chief characteristics before discuss- \'
ing the comparative merits of the rules proposed for their
regulation. The phenomena are not so simple as to admit
of regulation by a single mechanical rule, and the real
bearing of the different propositions will be best understood
after some acquaintance with the subject-matter to which
they are applied and the difficulties that surround them.
The interaction of state and national economy brought
about by taxation produces further complications that will
not allow of hasty treatment. We shall therefore begin by
a study of some of the general features of the tax-system, a
knowledge of which is essential for forming a correct judg-
ment respecting its regulation.

2. Looked at in a broad general way the first circum-
stance that strikes the observer is the fact that taxation
means the subtraction of so much wealth from individual
enjoyment or use. The definition given in the last chapter
expresses this clearly by pointing out that taxes are con-
tributed by persons from their wealth for the public service.
State expenditure is devoted to the supply of certain wants
of the community or nation by the action of the public
powers. These, like all other agencies, cannot be obtained
without cost partly met by the economic or quasi-private
revenue, but leaving a balance to be supplied by taxation.
It thus appears that there is an element of truth in the
description of taxation as ' the expenses of production of
the State ' ; the phrase, however, suggests too close an
analogy with industrial enterprises, in which the expenses
are repaid out of the product. In respect to public services
the benefits will in normal cases largely exceed the cost,
but the method of calculation is not so easily applied, nor
is the object in view the attainment of profit.

The proposition that taxation is a form of cost or
expense proves that it is so far an evil in the sense that
every sacrifice is such. It may be necessary or advisable,
but could the object be otherwise accomplished it would be
still better. Any saving in the expense of working the
State enables a larger amount to be left in the possession of
the tax-payers, and to that extent improves their economical
position. The formal statement of this very plain fact
might appear superfluous were it not for the existence of
strong popular prejudices in favour of the expenditure of
funds derived from taxation. ; Government expenditure
gives employment and benefits the labourers ' is the com-
monest form in which this belief is asserted. Without
entering into the question how far such expenditure does
really reach the labourers, it is sufficient to reply that the
persons from whom the funds have been taken by the tax-
collector would have certainly made use of them, either in
the employment of labour, or the purchase of commodities.
The belief that taxation returns in ' a fertilising shower ' was
rightly regarded by Bastiat as one of the errors arising from
defective observation 1 . Hardly worthy of refutation as a
theoretic doctrine, its evil effect, particularly in democratic
societies, in producing extravagant expenditure is not to be
overlooked.

The idea that ' taxation is the best form of investment '
is placed by Bastiat in the same category as the gross
fallacy just refuted, but it admits of a more favourable
interpretation. If it be said that the taxation required for
the national defence, the maintenance of justice, and the
necessary functions of the State, has been invested in the
best manner and yields a good return, the assertion is
substantially true, though perhaps expressed in a misleading
way, as the State cannot be regarded as a mere industrial
concern. Further, as Leroy Beaulieu points out, the
proceeds of taxation, if employed in public works, may
yield a satisfactory return, and thus be ' a good investment '
in the literal sense. The expediency of such investment
belongs rather to the subject of expenditure than to that of
taxation, but we may remark that, if public works are likely
to be profitable, it seems better on the whole to raise the
requisite funds by a loan to be repaid through the agency of
a sinking fund. To use taxation for this purpose is almost
equivalent to a ' forced loan 2 .'
3. The consideration of taxation as reproductive in
the way of investment suggests the further* question of the
possibility of its productiveness through reaction on the
national economy. If the use of the funds raised by
taxation can prove beneficial, may not the effect of taxation
itself on production be sometimes good? This view is
expressed in the maxim discussed by Hume, ' that every
new tax creates a new ability in the subject to bear it, and
that each increase of public burdens increases proportion-
ably the industry of the people,' which, he thinks, ' must be
owned, when kept within certain bounds, to have some
foundation in reason and experience V

Natural disadvantages sometimes stimulate industry,
why then should not artificial ones have the same effect ?
Economic progress has been most remarkable in countries
where man has to exert himself in consequence of the
parsimony of nature, not in the richest and most fertile
lands. A judicious use of the engine of taxation would, it
might be thought, have a similar effect on the disposition
of the people. Such was the opinion of McCulloch who
maintained that the heavy taxation of England, during the
French wars (1793-1815) was one of the causes of the
growth of wealth at that time, since it stimulated industry
and the spirit of enterprise and invention 2 .

The doctrine in this rather extreme form is open to an
easy refutation, for if taxes create a new ability on the part
of the payers there can be no determinable limit to their
useful employment. A wise government would increase
taxation indefinitely, and thereby augment the national
possessions. The process of creating fresh wealth by
simply taking it from the producers is so evidently im-
possible that its advocates hesitate to carry their view to
its logical outcome. In truth there is a two-fold fallacy in
the argument. In the first place natural obstacles do not,
in general, stimulate exertion ; economic development is
not greatest among the Eskimos, or the Fuegians, as it
ought to be on this hypothesis. Some natural difficulties
urge man to action, but others reduce him to torpor, and
check the first steps towards civilization. The influence of
natural disadvantages in promoting the growth of wealth is
rather by their indirect effect on the physical and mental
qualities of those subject to them, not by the economic
loss that they occasion. Secondly, the analogy between
natural and artificial obstacles is unsound. It does not
follow that because men work more strenuously (and this
is doubtful) to till a barren soil, that, therefore, they will
exert themselves the harder the more they suffer from the
incursions of marauders. The greatest promoter of in-
dustry is security, and protection from arbitrary taxation
is but one form of that ' protection against the Govern-
ment ' on which Mill justly insists as more important even
than ' protection by the Government V

Later on, however, Mill appears to, adopt a milder form
of McCulloch's view. When examining the effect of a tax
on profits, he declares that * It may operate in different
ways. The curtailment of profit, and the consequent increased
difficulty in making a fortune, or obtaining a subsistence by
the employment of capital may act as a stimulus to in-
ventions, and to the use of them when made. . . . Profits
may rise . . . sufficiently to make up for all that is taken
from them by the tax. In that case the tax will have been
realized without loss to anyone 2 .' Such a result, though
possible, is extremely unlikely, as the additional production
in consequence of the tax would itself be subject to taxation.
A low rate of profit may lead to the introduction of
economizing expedients, but the expectation of a high rate
is far more effective in increasing production. There is
just as much and just as little truth in the belief that low
profits encourage industry, as in the similar beliefs that
low wages make the workman and high rents make the
farmer industrious I . Some special examples have been
brought forward in support of the position that certain
forms of taxation stimulate invention. McCulloch cites
that of the Scotch distillers, who, under the influence of a
spirit duty assessed according to the contents of the vessels,
so improved their processes by economy of the time spent
in distilling, that instead of taking a week they, in a few
years, required only three minutes, and thereby were able
to bear a duty nearly forty times as great as at first.
Somewhat similar improvements have been introduced into
the continental beet-root sugar industry in consequence of
the method of imposition, which assumes a certain yield
and charges duty only on that amount leaving any excess
free 2 . In these cases what is really striking is the fact that
invention has been stimulated, not by the duty but by the
possibility of escaping it : the imperfect form of assessment
has encouraged efforts in this direction that would cease if
the true return were brought under taxation. They do not
show in the slightest that the progress of invention in a
taxed industry is greater than that in one free from tax-
ation. All antecedent probability, and all actual ex-
perience go to prove the opposite 3 . One great impediment
to the use of new processes is the surveillance that taxation
renders necessary.

The result of the preceding discussion is, briefly, that
any compensating effect of taxation in increasing pro-
duction is extremely doubtful, and is at best so small, and
occurs in so few cases as not to form an element worthy of
entering into the rational calculations of the financier.
The raising of compulsory revenue means so much loss to
the payers and to the community for which the only return
obtained is the benefit resulting from the efficient execution
of state functions. Any doctrine that removes attention
from this cardinal fact is erroneous in principle and may
lead to serious practical evils.

4. Nor does taxation only mean the withdrawal of the
amount required by the public powers from the disposable
funds of the subjects of taxation. It may, and often does,
take much more. In all countries the cost of collection is
no inconsiderable item, which must be added to the actual
amounts needed by the state departments, unless it be
regarded as an additional state function. In either view it
increases the burden to the payers. Consequently one of
the most generally recognised maxims of Finance is that
which prescribes that ' 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 V This rule, declared
by Wagner 2 to be simply the application of the general
principle of economy to Public Finance, has two distinct
applications: (i) As regards the State itself, the aim of
securing the best return in amount of taxation for the
expense incurred in collection is very plain, but even when
this is realized there is (2) the still more important object
of not inflicting indirect loss on the subjects, either by the
obstruction of industry that taxation causes, or by the
inconvenience that the regulations of the system of collec-
tion may produce. Some forms of taxation are much
more oppressive in these respects than others, and one
of the principal tasks of financial practice is to discover
the least burdensome modes,

The public economy depends ultimately on the national
economy; anything that reduces the economic power of the
individual citizens is an injury to the State. A system of
taxation that diminishes the revenue of the subject without
a corresponding return to the public treasury is certain
before long to show its effect in reduced receipts from
taxation.

A comparison of English taxation as it existed in 1820,
with that now in force proves how much may be gained by
a determination to conform to the rule of ' economy V But
even in the best existing systems of Finance there is a large
amount of waste, some of it unavoidable. The raising of
such a sum as .70,000,000 in the course of a year cannot
be accomplished without much interference with industry
and trade, and a great deal of annoyance to individuals.
From the purely material point of view the canon of
economy is probably the most important in Finance, and
no efforts should be spared to secure the closest observance
of it that existing conditions permit.

5. The supply of state wants by taxation is then, it is
plain, a charge on the collective resources of the com-
munity. In Finance, as everywhere else, there is no method
for obtaining something out of nothing. Prudent manage-
ment may make the available resources go further than
they otherwise would. The financier, like the mechanician,
proves his ability by the direction not by the creation of
force, and especially by reducing to a minimum the loss
through friction. But having decided that taxation is a
charge on the national resources, there is room for further
inquiry as to the precise fund on which it falls. We have
already mentioned Adam Smith's opinion that it must
be derived from the shares of revenue. Ricardo declares
that ' Taxes are always ultimately paid either from the
capital or from the revenue of the country V and expands
his statement by pointing out that the proceeds of a tax
must curtail consumption, increase production, or reduce
capital, i. e. ' impair the fund allotted to productive con-
sumption.' From this he concludes that taxation should
be imposed on revenue rather than on capital, since the
latter form of tax tends to check future production. Some
writers have even raised this into a maxim of Finance 1 .
The danger of hindering the growth of capital is apparent,
though as capital is derived from revenue it is not easy to
avoid taxing it to some extent. ' To provide that taxation
shall fall entirely on income and not at all on capital is,' says
Mill, ' beyond the power of any system of fiscal arrange-
ments 2 . In actual economic life the line between capital
and non-capital is not so fixed and rigid as the text-book
definitions would make us believe. Any tax is certain to
take some wealth that would otherwise have been devoted
to the aid of production, and also some that, if left to the
taxpayers, would have been consumed unproductively.
How much will come from each source is not always easily
determinable.

The distinction between capital and revenue is, besides,
not quite the same when considered from the national
instead of the individual point of view. Much of indivi-
dual capital is not national capital, and this is likewise
true of revenue ; now for the financier it is the national
capital and revenue that need attention. Any pressure on
the most important auxiliary of production is so far as
possible to be avoided ; but where capital is rapidly in-
creasing a tax that appears to trench on individual capital
as e. g. the PZnglish Death Duties, is not open to the
objection of reducing national capital in the same degree
as it would be in a poor and unprogressive country. Taxa-
tion is drawn from the total stock of wealth, including
at any given time both capital and revenue. The real
aim should be to so direct it, as to interfere to the smallest
extent with the action of the forces that promote accu-
mulation. Heavy taxation will always be injurious in this
respect. If imposed on revenue it reduces the fund from
which capital comes, and may even lead to direct en-
croachments oh individual capital : if on capital it leaves
revenue free to partially fill up the gap that it has made.
There is no impassable barrier between the two categories
of wealth ; any action on one must extend to the other.

In addition to the productive capital and annual new
production, all civilized societies possess a large mass of
wealth in process of use, ' Stock reserved for immediate
consumption ' as Adam Smith calls it, * consumers' capital '
in Dr. Sidgwick's phrase. There is in this * stock ' a
further source on which taxation may fall without in-
juriously affecting the productive powers of the com-
'munity. In fact we can fairly say that no less compre-
hensive term will suffice to describe the source of taxation
than that already employed, viz. * the collective wealth '
of the country. But in actual societies in their normal
condition taxation is derived from the national revenue,
some of which would have been transformed into capital.
Nothing but a national crisis would justify taxation so
heavy as to absorb the free income of the society and
reduce the sum of its accumulated wealth.

6. A celebrated doctrine has carried still further this
limitation, and maintained that all taxation should be
levied on the net, as opposed to the gross, income. The
net income is asserted to be the only disposable fund for
the purpose. Gross income includes the necessary ex-
penses of maintaining the citizens, and replacing the na-
tional capital. To touch on that part of the gross receipts
would be a blow to the industrial organization, inasmuch
as it is an essential requisite for the society being continued
in its full efficiency as ' a going concern.' A tax that takes
away a part of the labourer's necessary subsistence, or lowers
profits below the minimum for which men will consent to
take the risk of investment is indefensible and in the long
run defeats its own object.

The earliest appearance of this doctrine is with the
Physiocrats. Their theory of the ' Produit net' has its
chief application in respect of taxation. The fifth of
Quesnay's maxims lays down * that taxation should not
be destructive, or disproportioned to the sum of the na-
tional revenue ; that its increase should follow the in>
crease of revenue ; that it should be imposed immediately
on the net product of land.' According to Du Pont de
Nemours, ' the portion of the returns called the net product
is the sole contributory to taxation, the only one that
nature has prepared to meet it. It is of the essence of
taxation to be a part of the net product of cultivation.'
Mercier de la Riviere is, if possible, clearer, 'Taxation
is nothing but a part of a net product, and can be levied
only on a net product V The conception of the net '
product as consisting of nothing but the rent of land
appears to a modern absurd, but the way in which Ques-
nay and his followers reached that startling result is not
hard to follow. The labourer requires a definite amount
of commodities for his subsistence, more than that he
will not receive, and so much he must get under penalty
of starvation. This ' subsistence theory ' of wages was
fully accepted by the Physiocrats 2 , and fairly accorded
with the fact in the France of the Ancien Regime. Pre-
cisely analogous is the position of the capitalist. The
rate of interest is just sufficient to keep up the existing
supply of capital. The interest on capital advanced is,
Turgot tells us, ' the price and the condition of that
advance, without which the undertaking could not con-
tinue. If that return is diminished, the capitalist will
withdraw his money, and the undertaking will cease.
That return ought then to be sacred and enjoy an entire
immunity
When wages and profits are removed by the nature of
things from the tax-collector's power, it goes without
saying that rent is the only remaining source on which
he can draw, and we are compelled, their premises being
given, to accept the Physiocratic conclusion. Adam Smith
declined to follow this seemingly rigorous deduction. He
holds that both wages and profits may contribute to taxa-
tion, though the amount to be obtained from the former
is very small. Ricardo takes the same view. While
asserting formally that it is only from profits and rent
; that any deduction can be made for taxes,' wages ' if
moderate, constituting always the necessary expenses of
production,' he qualifies his statement by the admission
that labourers may receive more than their necessary
expenses, in which case the surplus is a part of ' net pro-
duce V J. S. Mill emphasizes the share of the labourers
in ' net produce, 1 and seems to desire to amend Ricardo's
doctrine on this point 2 .

7. The doctrine of net income as the sole source of
taxation, whose history we have just traced, has met with
strenuous opposition in Germany. For the last thirty years
the fact that taxation is a duty incumbent on the citizen
and to be paid by him, not by the pure abstraction called
' net income,' has been loudly proclaimed. Hermann's
theory of ' use capital ' (Nutz-capital] has been employed
to show that there is an enjoyment revenue to be added
to the economic revenue derived from production in the
strict sense. ' It is,' says. Cohn, ' undoubtedly income that
the owner of a house enjoys from his residence in it, the
owner of a park from his enjoyment of the park, that a
third enjoys in his own hunting-ground, in his own picture
gallery. It is income in the specific form of enjoyment
of property 3 .' Such an extension would give a larger
fund on which to draw, though it seems preferable to
regard these forms of wealth in the way adopted in a
preceding section of the present chapter, as property or
capital, and so far liable in exceptional cases to taxation.
J Of greater force is the argument that the cost of main-
taining the State is itself a part of the necessary expenses
of the society. * The protection of person and property,'
the duty of the public powers even in the opinion of the
extremest individualists, is almost as indispensable as feed-
ing or clothing. So far then from taxation being depen-
dent on the surplus produce of the community it may /
with justice be looked on as one of the first charges on
the gross production, coming next to that minimum of
food and covering that is needed for the preservation
of life.

The apparent contradiction between two such plausible
opinions can, we believe, be escaped by taking a broader
view of the subject than the disputants on either side have
done. Necessary expenses are in no case a fixed amount.
Each standard demands a certain minimum outlay, but the
standard can be varied. The necessary subsistence of the
English labourer has always been higher than that of the
Hindoo. What is true of labour is equally true of the
other factors of production. The amount of capital can
be reduced to suit a less intensive method of production,
and the smaller the quantity needed the less caeteris paribus
will be the rate of interest. And so is it also with state
wants. Their amount and cost can and must be adjusted
to the general position of the society. The difficulty of
laying down any definite rule as to the proportion of
national income, gross or net, that ought to be devoted
to the public service has been shown at an earlier stage
of our inquiry *. Here it will suffice to distinguish between
that part of taxation that conduces directly or indirectly
to the production of wealth, and that which produces non-
economic advantages. The former is beyond dispute a part
of the cost of production ; without it the amount of wealth
would be smaller, and the payment of this part cannot be
1 Bk. i. ch. 8. 2.
said to come from the net income or surplus after neces-
sary expenses are met. The latter, like all other forms of
enjoyment, can be dispensed with, and yet leave the
amount of production as great as before. It may, there-
fore, be said to come out of the net produce in the wider
sense given to that term by Mill. This separation is,
however, very hard to carry out. All forms of public
expenditure have some effect in promoting industry 1 , and
some retrenchment might be made in all without econo-
mical loss to the society. Still the principle of the separa-
tion is intelligible, and within limits can be usefully em-
ployed 2 .

8. Inquiries respecting the derivation of the tax
revenue from gross or net income, or from the sum total
of the national wealth, may appear at first a piece of
unnecessary subtlety. They have, however, important prac-
tical bearings. Until the normal source of taxation has
been determined, it is impossible to estimate the pressure
that it places on a community. The taxable capacity of
India would be very different, according as the gross or the
net revenue is taken as its measure ; and in a comparison
between Great Britain and the United States, the test of
income would probably give the first place to the latter,
while that of property would assign it to the former 3 .
In another important question of Finance the problem of
the true source of taxation becomes of moment. The
justice of any particular system of taxation cannot be
estimated without a knowledge of the fund from which
the tax revenue is derived. According as taxation has
its source in net or in gross income our view of the equity
of existing systems must vary.