THE RELATIONS OF STATE AND FEDERAL

FINANCE.

BY EDWIN R. A. SELIGMAN, MCVICKAR PROFESSOR OF POLITICAL ECONOMY, COLUMBIA UNIVERSITY.

THE existence of several concurrent or overlapping tax jurisdictions has always been a source of more or less difficulty. It is especially, however, in federal states that the problem assumes its most acute form, and it is primarily in recent years that the complications have been vastly increased by the new developments of economic life. The problem is not peculiar to the United States, for the relations of local and imperial finance have long agitated the minds and taxed the abilities of British statesmen ; while in federal states like Germany, Switzerland, Canada and Australia we have, as in the United States, the threefold complications of local, state and federal fiscal adjustments. The problems are with slight variations everywhere analogous.

In the United States it is only of late that the difficulties have presented themselves in full force. Local expenditures were at first of slight importance; State revenues were derived from tacking on an addition to the well-nigh sole source of local revenue— the general property tax; Federal revenues were by constitutional arrangement and by well-settled custom restricted, as a rule, to import duties and to a few categories of internal revenue taxation. Of late years, however, a threefold change has occurred. In the first place, the growing inadequacy of State and local revenues has led to the selection of new sources of income, some of which were also occasionally utilized by the Federal government. Secondly, the vast economic changes which have broken down State lines and made industry national have disclosed to a great degree the inherent weaknesses of certain forms of State taxation, and have led to the demand for some method of national

supervision or regulation in order to secure uniformity. In the third place, the well-nigh complete failure of the general property tax in State and local finance and the growing belief that large fortunes are evading their share of the public burdens has engendered a wide-spread demand for some more effective method of reaching the wealthier classes of the community. These three causes have conspired to bring the subject of the relations of State and Federal finance to a focus, so that it is now in the forefront of popular interest.

It behooves us, therefore, to give careful attention to this topic, and to endeavor to ascertain whether there do not exist some underlying principles of wide-spread application which may serve as a guide to the legislator and the administrator.

Looking at the subject in its largest aspect, it may be stated that there are at least three general considerations which must be borne in mind in the attempt to make a permanent choice of revenues for each of the competing tax jurisdictions. These are, respectively, the considerations of efficiency, of suitability and of adequacy. Let us take these up in turn.

The problem of efficiency in taxation is naturally of vital importance. No matter how well intentioned a scheme may be, or how completely it may harmonize with the abstract principles of justice, if the tax does not work administratively it is doomed to failure. It is clear that the effectiveness of different taxes depends upon the nature of the tax as well as upon the character of the administration. A tax on land, for instance, is apt to be best administered by local authorities; for it is, after all, the local assessors who may be presumed to possess the most exact knowledge of the local conditions upon which the value of the land depends. State supervision may, indeed, be desirable for certain purposes, but into that question we do not propose here to enter. In the main a locally administered land tax will be relatively efficient.

Other taxes are less obviously local in character or are less well fitted for local assessment because of administrative difficulties. A good example, for instance, is to be found in the liquor-license tax known in New York as the Excise Tax. When the assessment of the tax was transferred a few years ago from local to State officials, the effectiveness of the administration was so enhanced as vastly to increase the revenue. The administration was

removed from local politics, but was not plunged into State politics. Centralization of administration here, as in many other domains of political life, has been found to approve itself to the popular mind.

Just as the State-administered revenues have been found in some cases to be superior to locally administered revenues, it may be expected that Federally administered revenues will in some cases be superior to State-administered revenues. For not only is the Federal administration in some respects superior in efficiency to that of the State, but the very character of the tax may render effective supervision far easier in the one case than in the other. The administration of the income tax, for instance, would undoubtedly be far more effective in the hands of the Federal government than in those of the State government because of the difficulty, as we shall sec, of localizing and adequately controlling incomes. Other instances of this distinction between administrative efficiency and inefficiency might be multiplied.

The second consideration is that of suitability. Are there any sources of revenue which are naturally more suitable for utilization by one tax jurisdiction rather than another? This is really a problem as to the basis of taxation. Is the basis of a given tax wide or narrow? Obviously in proportion as the basis of a tax is more and more extended the argument in favor of its utilization by the broader tax jurisdiction becomes correspondingly strong. Thus one of the principal reasons, in addition to that previously mentioned, why the tax on real estate is not employed by the central government is because the basis is so narrow a one. It is chiefly because the tax on real estate is unsuitable for the general revenue system that it is everywhere becoming more and more relegated to the local jurisdictions. This tendency is universal throughout the civilized world, and the seeming counter-tendencies which are illustrated by some of the proposals in the new British budget could easily be explained away for entirely different reasons. So far as the relations between State and Federal finance at all events are concerned, there is no doubt that a tax on real estate is obviously unfitted for the Federal government. We in the United States have had but three instances of such a tax, of an entirely ephemeral nature, and in the main so unsuccessful that its repetition is exceedingly doubtful.

While real estate, with its narrow basis, stands at one extreme of the scale, we find at the other extreme, with a very wide basis, articles of general consumption. The widest possible basis is afforded by commodities of so-called mass consumption, like tobacco and spirituous beverages; and we accordingly find that in the United States, as everywhere else, taxes on these commodities are reserved for the use of the broadest tax jurisdiction. Almost without exception the American States have voluntarily refrained from utilizing this source of revenue because of the obvious unsuitableness of these taxes on consumption for State purposes. The same is true to a still greater extent of customs duties, which are almost everywhere kept for national or Federal use. So strongly were these conditions of suitability present in the minds of our forefathers that the American Constitution not only expressly reserves the employment of import duties to the Federal government, but provides in effect that the indirect tax should be uniform throughout the country. It is clear that this desirable uniformity would be completely lost if the separate States were to arrogate to themselves this important source of revenue.

The problem of suitability, however, with its considerations of wide versus narow basis, has become of special importance to us in connection with three great classes of revenue the corporation tax, the inheritance tax and the income tax. In each of these cases various reasons, as we shall see, have conjoined to put them forward as desirable constituents of a Federal tax system; but it is beyond question that one of the controlling factors in this demand is the proven unsuitability, from some essential points of view at least, of this tax for State purposes. This is due, above all, to the existence of interstate complications and to the fact that the economic basis of each of these three taxes is a wide one, while the State administrative basis is a narrow one.

With reference to corporations this statement scarcely needs any further proof. There are, indeed, still to be found many small businesses in corporate form supplying primarily local needs. But the striking characteristic of modern business life is the existence of corporations whose products are consumed throughout the country and whose very location, as in the case of the transportation companies, is interstate in character. From the economic point of view, interstate lines have been completely broken down, and the attempt to elaborate a successful system

of State taxes on corporations has been frustrated in large measure by the existence of these interstate complications. It is well known, for instance, that the new national tax on corporations is due almost exclusively to the endeavor to secure an adequate and uniform administrative supervision of corporations. As a purely fiscal measure the new tax is open to almost every conceivable objection.

The corporation tax is, for instance, repugnant to the principles of accounting, because it deducts taxes before arriving at taxable net earnings, a proceeding as little justifiable as would be a State tax on corporations which deducted from the taxable basis the locally assessable taxes, or vice versa. It is repugnant to the principles of justice in taxation in that it provides for the deduction of all sums payable as interest on bonded indebtedness. This practically means that the tax is a tax only on the stockholder and not on the bondholder. Why the man who invests $10,000 in railroad stock should pay taxes and another who invests $10,000 in bonds should go scot-free has never yet been shown. The old argument that the bond represents indebtedness while the stock represents property is, as every student knows, of no economic weight. It is a legal and not an economic consideration. Economically the mortgage is a part of the property; the stock and bonds together constitute the property, the stock being worth so much the less because of the existence of the bonds. If the real intent of the tax was to reach the people who owned the property there would be no justification in taxing only the class of property-owners known as bondholders. The legal situation is not the economic situation. The exemption of bondholders may, indeed, be necessary as a result of the judicial decisions on the income tax; but the economic consequence is lamentable in the extreme in causing the corporation tax to remain a torso.

Finally, thirdly, even if the intent is to reach only the stockholders, the corporation tax is repugnant to sound principles of finance. For, as is familiar to all students, a special tax on a particular class of capital invested in corporations will lead to a so-called amortization of the tax-that is, the market value of the corporate shares will fall by an amount equivalent to the capitalized value of the tax, so that the future purchaser of corporate shares will have bought them free of the tax, discounting