This is the plan of taxing the
corporate excess which is used in Massachusetts. It is
an attempt to assess the real intangible value of the cor-
porate privilege. This intangible value is arrived at by
the tax commissioner from two sets of data: one is the
assessed value of the plant which has been made by the
local assessor; the other is the market value of the shares
of stock which is obtained from detailed reports by the
corporation. The difference between this local valuation
and the valuation of the shares of stock represents the
excess value which can be attributed to the form of or-
ganization, and is taxed at the general tax rate.

Other Methods of Taxation. Various other methods
have been used in other states for reaching the capital
stock. In some cases the bonds have been added to the
capital in order to approach more nearly the true value of
the corporation. Some states use the par value of the
shares of stock, and others use the market value as the
taxable value. Either method is objectionable, and many
cases have arisen where neither would represent the ability
to meet tax payments. Two corporations with exactly
the same income may follow radically different policies,
which would be reflected in the value of the stocks. One
may follow the policy of putting the earnings back into
the business until it becomes immensely undercapitalized,
yet all this time the market value of the stock has been
low because no dividends, or only small ones, were paid.
The other corporation paid large dividends, but has put
nothing back into the business, and its stock would be
selling much higher than that of the first organization.
That the use of capital stock as a measure of taxable
value has not been satisfactory is evidenced by the num-
ber of corporations which have been removed from such
tax laws, and by the number of other plans which have
been used in taxing them.

178. Public Utilities Frequently Have Been Subject to
Special Taxes. The attempt to reach all classes of cor-



344 OUTLINES OF PUBLIC FINANCE

porations by the same methods of taxation soon caused
dissatisfaction. It was found that assessments could not
all be made in the same manner, that much inequality
was resulting, and that much potential revenue was escap-
ing. It was, furthermore, being driven home with in-
creasing evidence that the general laws in application were
not securing justice between the public and certain classes
of corporations. It has gradually developed, therefore,
that some of these classes have been relieved from the
application of the general corporation tax law, and are
taxed in a special manner.

An outstanding example of this situation is the taxing
of public utility companies. More difficulties have arisen
in seeking a satisfactory scheme for taxing this class of
corporations, perhaps, than for any other. The problems
which have arisen, and the methods which have been
used to reach the taxable value of these companies, apply
in degree to all classes of corporations. A discussion of
some of these problems and methods, then, will have a
greater significance than that of its application to cor-
porations of this particular nature.

Problem of Valuation. The outstanding problem, in the
case of public utility taxation, as in the case of other cor-
porate taxation, is to ascertain the proper value upon
which taxes should be levied. This is a local as well as
a state problem, for generally these utilities are taxed
locally, even though special state laws formulate the
methods of taxation for other purposes. This problem of
local valuation is often somewhat different from the larger
valuation of the state, because of the limited extent
of the jurisdiction of local officials. Assessors are con-
fronted with placing a valuation on a small portion of a
railroad, pipe line, telegraph or telephone company, and
the difficulties encountered are at once obvious. Many
schemes have been tried, and many attempts have been
made by the courts to aid in arriving at some satisfactory
solution of the problem of local assessments. Methods



TAXATION OF CORPORATIONS 345

and suggestions have included such bases as the original
cost of the plant; the cost of reproducing the plant; the
cost of reproducing the service; the value of the part of
a plant in a particular district as a proportionate part of
the whole; and the value of the plant as determined from
its earnings. A detailed discussion of each of these proc-
esses of valuation, with its inherent difficulties, would
take us too far afield. A discussion of some of the more
general methods of levying taxes upon public service
corporations, however, will be useful. These either involve
earnings or some form of valuation.

179. A Tax on Gross Earnings Presents Difficulties.
Extensive use has been made of earnings as a tax base in
an attempt to get away from the difficulty of placing a
taxable value upon public utility corporations. To make
this concrete, the state of New York may again be called
upon to furnish an illustration. Railroads are required to
pay, semiannually, a tax of five tenths of 1 per cent of the
gross earnings from business transacted in the state. All
water, gas, heating, lighting, and power companies, in
addition to a semiannual five tenths of 1 per cent fran-
chise tax upon gross earnings, must pay a 3 per cent
tax on dividends declared above 4 per cent on the capital
employed. Reports are required which show capital, earn-
ings, and dividends. Elevated roads, and surface roads
not operated by steam, must pay an annual tax of 1 per
cent of the gross earnings secured from business within
the state, and 3 per cent of the dividends declared in
excess of 4 per cent on the capital employed. The prin-
cipal basis in this system of taxes, it is easily detected, is
earnings gross earnings directly, and net earnings as
reflected in the amount of dividends declared. Some
states make even a more extensive use of gross earnings
as a base for taxes than does New York.

Advantages of Gross Earnings. Some practical advan-
tages in the use of gross earnings as a base for taxation at
once appear. Gross earnings is a very much more definite



346 OUTLINES OF PUBLIC FINANCE

concept than any other form of earnings. With the ex-
tensive adoption of standard systems of accounting, the
determination of this item is comparatively easy. All
items of expense must be taken from the gross receipts,
a-nd it is not illogical to consider taxes an item of expense
along with rent, interest, and wages. The discretionary
power of officials can be dispensed with, in large measure,
since there is little chance of manipulating the gross re-
ceipts statement, while the tax can be computed by sim-
ple mathematical computation. Expenses of assessment
and collection are likewise reduced to a minimum, so that
the tax " takes out and keeps out of the pockets of the
people as little as possible over and above what it brings
into the treasury of the state." A gross earnings tax has,
moreover, a close conformity to the American idea of a
j ust base for taxation property. The tax would be absent
until a corporation was established upon an operating basis.
It would fluctuate with business conditions increase as
business prospered, and prove a smaller burden in times
of depression. It would eliminate the difficulty of at-
tempting to place an estimate upon all the intangible
franchise values which a company is supposed to possess.
Tax Officials Favor Gross Earnings Tax. Many tax
officials have recognized these advantages and are using
the gross earnings tax, or are strongly urging its adoption.
After a careful investigation and consideration, an On-
tario tax commission recommended it as being undoubt-
edly the best method for taxing railroads. A California
tax commission pointed out that the plan would result in
a closer approximation to justice than any other system
which the state might select. The burden would vary
with the fund out of which it was to be paid. In questions
of taxation, practical considerations naturally outweighed
theoretical ones, and this tax evidently possessed practi-
cal advantages. A Minnesota commission pointed out
that the greatest advantage was the elimination of the
necessity for valuing the complicated and peculiar prop-



TAXATION OF CORPORATIONS 347

erties of the corporation, which had formerly been inac-
curate and but crude guesswork. Many other testimo-
nials could be presented, but, as illustrative of their gen-
eral nature, a brief quotation from a Connecticut report
will not be out of place. It said:

The tax on gross earnings avoids all the difficulties inherent in the
tax on net earnings. No corporation can do business without having
accounts which will at least show the amount of its gross earnings.
Gross earnings are a definite fact, ascertained by a glance at the ac-
counts, and incapable of argument or difference of opinion. The tax
on gross earnings can be evaded only by perjury of the most obvious
sort, and is capable of easy detection. The gross earnings tax, there-
fore, has the greatest advantage of simplicity, certainty, and ease of
administration. This is an advantage both to the corporation and to
the state. The amount of the tax on gross earnings fluctuates with
the prosperity or adversity of the business, and is, therefore, just to
all parties concerned. Moreover, it enters each year into the accounts
in a definite ratio, and can thus be counted on in advance.

A serious question remains to be answered. Will not the tax on
gross earnings be distinctly unfair on account of the great diversity
between different corporations in their ratios of expense to earnings?
The answer is that such injustice is to be avoided by classifying cor-
porations according to the prevailing ratio of net earnings to gross,
and imposing different ratios upon the gross earnings of the different
classes of corporations.

Investigation shows, for instance, that the ratio of net earnings to
gross is fairly uniform for the railroads of the country. In the same
way there is a general prevailing ratio of net earnings to gross for
telephone companies, for express companies, etc. Having determined
what this prevailing ratio is for each class of corporations, we are
enabled to fix ratios for each class which will make the tax on gross
earnings just to all. It is true that absolute justice as between individ-
ual corporations of the same class is not obtained. The resulting in-
justice, however, is not great. . . . Some inequality is unavoidable, but
the inequality thus resulting is distinctly less than can be easily shown
to result from any of the other schemes of taxation which are before
us. No tax system can be absolutely perfect, and it is not a valid
objection against a proposed scheme to point out a defect which is
present in even greater degree in each of the other possible alternative



1 Report of the Special Commission on Taxation of Corporations, State
of Connecticut, 1913.



348 OUTLINES OF PUBLIC FINANCE

Objections to Gross Earnings. In spite of this wide ad-
vocacy, and its apparent success in many instances, the
gross earnings tax presents serious difficulties. Gross re-
ceipts do not represent earning capacity, and it is earning
capacity that makes a concern valuable and able to pay
taxes. It is what is left after expenses are paid that spells
success or failure. The gross receipts of two street railway
concerns, for example, might be the same, while the net
returns might be such as to make one a success and the
other a failure. The one might be operating under aus-
picious circumstances short lines, heavy traffic, level
streets, etc., while the operation of the other might have
the opposite conditions.

Similar conditions are found in varying degrees in all
classes of corporations, and it is too much to expect that
any system of classification can take them properly into
account. The experiences of Michigan and Wisconsin do
not stand out in support of the gross earnings tax. Both
states, after giving it a thorough trial, have abandoned it.
Wisconsin had used the system for nearly fifty years.
The reasons assigned by the officials of both states for its
failure to give satisfaction were practically the same-
uniformity could not be secured between the corporations,
and there was no relation between the tax paid on cor-
porate property and that paid on other property. The
governors under whose administrations the tax was given
up, had pledged themselves to equality in taxation.

1 80. Taxes on Net Earnings Have Not Been Satisfac-
tory. The difficulties of a gross earnings tax have led
some to advocate and others to refuse to give up net
earnings as the proper base for taxes. Net earnings can
be used, either as the direct base for the tax or as the
basis for finding the value of the company. If the capi-
talized net earnings be taken as the proper valuation of a
concern, then no account need be taken of capital that
may have been issued and squandered; of the different
forms of stock exchange manipulations; or of the watered



TAXATION OF CORPORATIONS 349

stock a company may have. The factor under considera-
tion is what the enterprise is worth as a productive agent
or as a going concern. The original cost, or the cost of
reproduction, is not the controlling item which determines
value; this is determined by the one characteristic-
power to bring in a money return over and above expenses.
The capitalized net income will most nearly correspond
to what a purchaser would be willing to pay at a natural
sale and the courts have held this to be the value of
property.

Mr. W. S. Stevens, of the New York Public Service
Commission, expressed the opinion that the net earnings
tax was the one which would have the support of basic
principle. He said:

The only course open to the investor is to select those attributes
which, in his judgment, would create a desire for the property, and then
estimate how much that desire would induce a prospective purchaser
to surrender for its satisfaction. ... Its one characteristic which gives
it value is its supposed power to yield, directly or indirectly, a moneyed
return equal to the investment, with a profit thereon. Its value lies
not in what it is, but in what it will produce, or what it is believed it
will produce in money. This is the essential proposition upon which
all depends. Generally speaking, what it will produce in money will
depend upon its earning power, directly or indirectly. To the ordinary
investor it is its direct earning power as shown by the excess of revenues
over expenses. . . . This fundamental consideration indicates that the
net earnings rule, when properly and carefully applied with due regard
to all the features of the individual case, is probably the one having
the surest support of basic principle. It is also the one which accords
with the practice of shrewd, broad-minded, and successful men of
business. 1

Objections to Net Earnings. In spite of the apparent
logical and theoretical soundness of net earnings as a tax
basis, many practical difficulties are met in its adminis-
tration. One which has proved most troublesome is in
determining the true net earnings. Accounting systems
have been anything but uniform, and no comparison can
be had between net earnings of different enterprises. Even

1 Quoted in State and Local Taxation, 1912, p. 194,



350 OUTLINES OF PUBLIC FINANCE

with uniform accounting, the difficulty still remains of
separating the earnings of a corporation from those of
its investments or subsidiary undertakings. Neither
would this system secure equality in assessment between
corporations and other forms of taxable property. The
difficulties which Wisconsin and Michigan found with the
gross earnings tax would be magnified here. A man's
farm and buildings are taxed, even though they are pro-
ducing no more than expenses. Yet a railroad with an
investment of several million dollars would not be taxed
until it became operative to the extent of having a sur-
plus above expenses. Because of the fluctuation of earn-
ings, moreover, the tax could not be counted upon as
being in any degree stable. The Connecticut commission,
quoted above, characterized the net earnings tax as fol-
lows:

To avoid serious inequality and evasion the tax On net earnings
would require for administration a thorough examination into the
accounts of every corporation taxed, together with strict rules as to
how these accounts should be kept. ... It would be a continual source
of irritation between the corporation and the taxing officials. It would
involve the most disagreeable inquisition into the accounts and busi-
ness of the corporations, and in the end would still remain room for
personal judgment, thus leaving open the door to political intrigue
and corrupt influence. . . . The practical difficulties in the way of
imposing a tax upon net earnings seem overwhelming. A further ob-
jection arises from the fact that a corporation might have no net earn-
ings whatever within a given year, and therefore escape taxation en-
tirely. While it is true that this might be perfectly just under a tax
system based fundamentally upon income, we should bear in mind
that the American tax system is to-day based upon property. The
individual whose property has yielded him no income in a given year
cannot offer that as a reason why he should not pay taxes upon his
property. While the importance of treating corporations and individ-
uals upon the same footing must not be stretched, there can be little
doubt that a tax system which would allow corporations having no
net earnings to escape taxation entirely, would be out of harmony
with the general tax system prevailing in America.

181. Taxes upon Value Are Becoming More Popular.
Many objections have been made to what has been known.



TAXATION OF CORPORATIONS 351

as the ad valorem basis for taxing corporations. These
objections have arisen, largely, because of a misunder-
standing of the term, and because of the discrepancies
which arose in attempting to use different methods of
valuation. The discrepancies arose because of the limited
powers and abilities of the assessors, and because too few
factors were taken into account in arriving at the valua-
tion. The excess value of the stocks and bonds over real
estate has been tried; the average selling price of the
securities over a period of years has also been adopted.
In using these as bases for value, all the manipulations
of the market and outside influences must be considered,
which makes accurate results difficult. Likewise, in seek-
ing to determine the original cost, the cost of reproduction,
capitalized earnings, or the amount of business, the ad-
ministrative difficulties become so great as to forestall
satisfactory results in many cases. A value basis for tax-
ing corporations has consequently been condemned as
unusable.

Present Meaning of Ad Valorem. As the expression is
now used, however, an ad valorem tax means one placed
upon a corporation as a piece of property, rather than as
divided into several elements. The system further im-
plies a more or less expert valuation of the corporation
by some centralized state board. The fiscal officials of
Michigan and Wisconsin, upon discarding the earnings
basis, adopted the ad valorem plan, and have given their
unqualified approval of the results. The Virginia Joint
Committee on Tax Revision, after a careful analysis of
the different tax bases, said: "We believe that under an
ad valorem system, administered by a competent board,
untrammeled by any single prescribed standard or rule,
it is easier to establish justice in taxation than under any
other method.