The Income Tax of 1913

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THE INCOME TAX OF 1913

SUMMARY

The constitutional amendment of 1913 and the new income tax, 46.

— I. The " normal " and " additional " taxes; the minimum exempt;
the scale of progression, 47. — Dividends exempt from the normal
tax, 49. — II. Limited application of stoppage at the source; its
possible advantages and disadvantages, 50. — How applied as regards
salaries and other single payments, 52. — As regards interest on bonds,
55. — " Fixed and determinable incomes," 56. — III. How mini-
mum exemption is secured, 58. — IV. Return of income required;
yet possible exceptions, 61. — V. The "additional" progressive tax, 65.

— VI. Conclusion, 66.

Among the notable events of the year 1913, one of
the most important in its influence upon the national
finances and constitutional development of the United
States is the adoption of an amendment to the Federal
Constitution giving Congress the 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." The
mere fact that an amendment of any kind has been
adopted is notable, this being the first occasion on
which the Constitution had undergone any change
since the period of the Civil War, and the first amend-
ment adopted in peaceful and normal times since the
early days of the Republic.

It is a little remarkable, altho perhaps not altogether
accidental, that the adoption of this amendment should
coincide with the return to power of the political party
whose attempt to levy an income tax in 1894 was frus-
trated by the decision of the Supreme Court in that year.
Then as now an income tax was a component part of the
program of fiscal and commercial reform to which that

THE INCOME TAX OF 1913 47

party was committed. This program included the
reduction of protective tariff duties and the direct
taxation of incomes. What the Democratic party
failed to accomplish in 1894, it has had a free hand to
do in 1913. Indeed, the national taxation of incomes
might almost be regarded as a mandate of the people
of the United States. At any rate, it was a foregone
conclusion that the adoption of the constitutional
amendment would be immediately followed by the
enactment of an income tax law.

The law instituting the income tax was approved
October 3, together with the law revising the tariff,
both measures being included in one comprehensive
statute entitled " An Act to reduce tariff duties and to
provide revenue for Government, and for other pur-
poses." It is the object of the present article to give
a general description of the income tax. This seems
to be especially well worth while because the tax can-
not be readily understood from a mere perusal of the
involved and sometimes obscure phraseology of the law
itself. For the same reason, however, the task of
interpretation is not easy or entirely safe. The law
has certain novel features; and some of the questions
of detail to which they give rise cannot be answered
until we have the official construction placed upon the
language of the act by the executive branch of the
government and possibly by the courts. At the same
time the main features of the tax become fairly evident
to any one who makes a careful study of the provisions
of the act, even tho its application to specific cases may
remain doubtful.

I

The law provides that incomes shall be subject to a
tax of one per cent on the amount by which they exceed

48 QUARTERLY JOURNAL OF ECONOMICS

the prescribed minimum limit of exemption. This is
designated as the " normal income tax." There is
then an " additional tax " of one per cent on the amount
by which any income exceeds $20,000. The rate is
increased to two per cent on the amount above $50,000,
to three per cent above $75,000, to four per cent above
$100,000, to five per cent above $250,000, and to six
per cent above $500,000. Therefore under the normal
and additional tax combined, the first $20,000 of income,
exclusive of the minimum exemption, will be taxed one
per cent; the next $30,000, two per cent; the next
$25,000, three per cent; the next $25,000, four per cent;
the next $150,000, five per cent; the next $250,000,
six per cent; and all income above that point seven
per cent. This is a rigorous application of the progres-
sive principle.

The minimum exemption, at the same time, is com-
paratively high, — $4,000 for a married person and
$3,000 for everybody else. The higher exemption in
case of the married is conditional upon husband and
wife living together, and applies only to their aggregate
income; that is to say, it cannot be deducted from the
income of each. It may be noted, in this connection,
that in England the exemption allowed under the
income tax is £160 or $800; in Prussia it is 900 marks,
or $225; and in the state of Wisconsin it is $800 for
individuals and $1,200 for a husband and wife, with a
further allowance for children or dependent members
of the family.

The sharply progressive rates and the comparatively
high exemption have given rise to the criticism that
this is a rich man's income tax and disregards the
principle that all persons should contribute to the ex-
penses of the government in proportion to their several
abilities. It is often said that an income tax ought to

THE INCOME TAX OF 1913 49

reach all incomes with the exception of those which
are close to or below the minimum necessary for sub-
sistence, and that if people generally were called upon
to contribute directly to the government they would
take greater interest in public affairs and show more
concern over any wasteful or unwise expenditure of
public money. In reply it is contended that the limi-
tation of the tax to the wealthy or well-to-do classes is
justified because these classes do not pay their fair
share of the indirect national taxes, or of local property
taxes. These debatable questions lie outside the
scope of the present article. It is evident, however,
that the income tax should not be criticized as if it were
a single tax or formed the only source of revenue for the
Federal government. From the fiscal standpoint it
occupies a subordinate position in the national finances,
being expected to yield about $125,000,000 annually
out of a total estimated tax revenue of $680,000,000.

The normal tax of one per cent is to be levied upon
the income of corporations. In effect this provision of
the law merely continues the corporation or " excise "
tax which was already in existence. But that tax now
becomes an integral part of the income tax, covering the
income which accrues to the stockholder and is distrib-
utable in the form of dividends. On the theory that this
income is reached at the source by the tax upon the net
earnings of the corporation the dividends as such are ex-
empt. They are not to be included, so far as concerns the
normal tax, in the taxable incomes of the individual stock-
holders and the law does not provide that the tax paid by
the corporation shall be deducted from the dividend.

It is perhaps a question whether under these condi-
tions income which consists of dividends should be
considered as subject to the normal tax or as exempt.
It may be contended that a tax upon the net earnings

50 QUARTERLY JOURNAL OF ECONOMICS

of corporations is virtually a tax on the stockholder's
income, and in theory this is true. But so long as the
tax is not actually withheld from the dividends, or the
dividends are not reduced in consequence of the tax,
the stockholder's current income is not affected. The
imposition of the tax might indeed affect his prospective
income and might depreciate the value of his stocks. It
is hardly likely, however, that such effects will be per-
ceptible, at least as regards the stocks of railroads and
other large corporations. If, however, it be considered
that income consisting of dividends pays the tax, it
follows that the stockholder's income is taxed no matter
how small it may be. No minimum is left exempt.
On the other hand, if it be considered that all dividends
are virtually exempt, the stockholder would seem to be
unduly favored under this form of taxation in com-
parison with people whose incomes are derived from
other sources. Doubtless in future the investor will
look upon dividends as a form of income not subject to
the normal income tax.

II

In the levy of the normal income tax there is to be a
limited application of the method of assessment and
collection at the source of the income. This method
is applied very completely in the taxation of income in
Great Britain. It may be well to recall summarily the
essential features of the British system. The tax is
levied upon the property or industrial enterprise which
yields or produces the income. But the person occupy-
ing the property or conducting the enterprise, and pay-
ing the assessment in the first instance, is authorized
and required to deduct the tax from the income as it is
distributed among the persons entitled to share in it
either as proprietors, landlords, creditors, or employees.

THE INCOME TAX OF 1913 51

Under the English system, an industrial corporation,
for instance, pays the income tax upon its gross earnings
and then deducts it from the dividends, interest, salaries,
and rents as these payments are made. The house-
holder pays an assessment levied upon the annual value
of his dwelling (less an allowance for repairs and insur-
ance) and then if he occupies the premises as tenant
deducts the tax from his rent. The income from
agriculture is reached by a similar assessment upon
the farmer, based upon the annual or rental value of the
farm and with the same right of deduction from the
rent if he is a tenant farmer.

From the standpoint of the government, the main
advantage of this mode of assessment as compared with
a tax levied directly upon the recipients of the income is
the greater certainty with which it reaches the income
subject to taxation. The opportunities for evasion by
concealment of income are reduced to a minimum,
partly because the sources of income are, in general,
not easily concealed and partly because, to a consider-
able extent, the persons upon whom the tax is assessed
are not interested in avoiding the tax. The advantages,
however, are not all on the side of the government.
The tax possesses certain advantages from the stand-
point of the tax-payer also, assuming him to be an
honest tax-payer who is not seeking opportunities to
evade taxation. One advantage is that he is relieved
in almost every case from the necessity of revealing to
the tax officials the whole of his personal income. The
tax does not pry into his personal affairs. Another
advantage is that the tax is paid out of current income,
being deducted from the income as it is received. It
is therefore distributed over the year and adjusted to
the flow of income as it comes in. A tax thus collected
is less burdensome in its incidence than a tax paid in

52 QUARTERLY JOURNAL OF ECONOMICS

one lump sum several months after the expiration of the
year to which it relates and after the income on which
it is levied has been all received and perhaps all ex-
pended.

The English system of assessing an income tax at the
source, however, has its disadvantages. It is admirably
suited for a tax levied at a uniform rate on all income
or on all income above a small minimum. But it is not
well suited for the application of progressive taxation or
for the introduction of gradations or distinctions based
upon the size or character of the individual incomes.
Nevertheless the English income tax, besides exempting
a minimum, provides for graded reductions or abate-
ments in favor of the possessors of small incomes above
the minimum, and for a reduced rate on " unearned "
income within certain limits. All this, however, makes
necessary a declaration or complete statement of in-
come from the persons claiming the benefit of these
provisions, and also necessitates refunding a large
amount of the tax collected at the source. Moreover the
progressive principle has recently been applied by
imposing a " super-tax " on incomes in excess of
£5,000, which also requires a declaration, the tax being
necessarily assessed upon the possessor of the income
and not at the source. The super-tax, it may be
observed, occupies a position in the English system
similar to that of the additional tax in the United States,
serving to increase the tax upon the larger incomes in
accordance with the principle of progression.

It has been stated above that the law which has just
been enacted by Congress makes a limited application
of this principle of assessment at the source, as regards
the normal tax. The general rule of the law covering
deduction at the source is of sufficient importance to
be quoted in full. It reads as follows: —

THE INCOME TAX OF 1913 53

All persons, firms, co-partnerships, companies, corporations,
joint-stock companies or associations, and insurance companies,
in whatever capacity acting, including lessees or mortgagors of real or
personal property, trustees acting in any trust capacity, executors,
administrators, agents, receivers, conservators, employers, and all
officers and employees of the UnitedStateshavingthecontrol, receipt,
custody, disposal, or payment of interest, rent, salaries, wages,
premiums, annuities, compensations, remuneration, emoluments
or other fixed or determinable annual gains, profits, and income of
another person, exceeding $3,000 for any taxable year, other than
dividends on capital stock, or from the net earnings of corporations
and joint-stock companies or associations subject to like tax, who
are required to make and render a return in behalf of another, 1
as provided herein, to the collector of his, her or its district, are
hereby authorized and required to deduct and withhold from such
annual gains, profits, and income such sum as will be sufficient to
pay the normal tax imposed thereon by this section, and shall pay
to the officer of the United States Government authorized to receive
the same; and they are each hereby made personally liable for such
tax.

Under this paragraph of the act every person, cor-
poration, etc., making payments of more than $3,000
in interest, rent, salary, etc., to any one person in any
one year must in each instance deduct the normal tax
and pay it to the tax collector. It should be noted,
however, that the rule covers not only " payments "
but also the " control, receipt, custody, or disposal "
of such sums. It is impossible to say just what may
be comprised under these terms. But the word " pay-
ment " doubtless represents the typical or usual case,
and in the discussion which follows will be used in a
generic sense to cover all cases.

The limitation of the operation of the above para-
graph to payments in excess of $3,000 was presumably
deemed necessary, or at least advisable, because income

1 This restrictive clause appears to have very little significance, for the reason that
the persons, firms, etc., " who are required to make and render a return in behalf of
another " are apparently the persons, firms, etc., just enumerated, namely, those having
the control, receipt, custody, etc., of the annual gains, profits, and income of another
person, exceeding $3,000. The paragraph which defines the persons, firms, etc., who
are to make returns in behalf of another person is cited on p. 64.

54 QUARTERLY JOURNAL OF ECONOMICS

up to that limit is exempt. The intention seems to be,
however, that when the normal tax is deducted it shall
be computed on the total payment and not simply on
the excess over $3,000. That being the case it is evi-
dent that the deduction of the tax under this rule, tho
limited to sums of more than $3,000, will nevertheless
reach a certain amount of income which is exempt. It
will do this where the entire income of any person is
derived from a single source or from several sources
each of which yields more than $3,000. On the other
hand, it is evident that a large proportion of the pay-
ments made in sums of less than $3,000 will represent
taxable income, being received by persons whose in-
comes are above the limit of exemption. Many large
incomes are derived wholly or in large part from sources
which yield less than $3,000 each. The adoption of a
$3,000 limit for the application of the method of deduc-
tion at the source therefore appears to be a com-
promise, a half-way measure. It comes far short of
reaching at the source all income subject to taxation,
and at the same time seems likely to reach some income
that is exempt. This does not necessarily mean that
any taxable income will escape assessment or that any
tax-payer will lose the benefit of the exemption. Income
not reached at the source is to be included in the taxa-
ble income of the person who receives it; and the tax-
payer's right to exemption is safe-guarded by special
provisions which are discussed below.

This $3,000 limit, however, and the general rule of
the law as regards deducting the tax at the source
are materially modified by the exceptions or provisos.
It is to be noted, in the first place, that in the paragraph
just cited, dividends are altogether excepted from the
classes of payments which are subject to the deduction
of the tax. The exception applies only to dividends

THE INCOME TAX OF 1913 55

paid by corporations " subject to like tax," but these
include practically all corporations either located or
doing business in the United States. The source of
this income is supposed to have been reached by the
tax on the earnings of the corporations.

Again, the application of the method of collecting
the tax by deduction is very materially affected, and
in quite a different way, by a proviso which removes
the $3,000 limit as regards interest payments made by
corporations. The normal tax is to be deducted and
withheld from the " interest upon bonds and mortgages,
or deeds of trust or other similar obligations of corpora-
tions, joint-stock companies or associations, and insur-
ance companies, whether payable annually or at shorter
or longer periods, altho such interest does not amount to
$3,000." A large proportion of the bondsissued by cor-
porations, however, guarantee the payment of interest
without deduction on account of taxes. In such
cases the corporations will undoubtedly assume the
burden of the tax, as the provisions of the law just cited
are hardly likely to be construed as requiring the viola-
tion of contracts. At one stage in the preparation of
the law, a clause was inserted providing that the interest
in such cases as this should be included in the taxable
income of the bondholder and assessed to him. This
clause, however, was not retained in the act as passed.
But a proviso was inserted that no " contract entered
into after this act takes effect " shall be " valid in
regard to any Federal income tax imposed upon a
person liable to such payment"; it is intended to
prohibit any future issue of bonds guaranteeing exemp-
tion from the income tax.

Considering the various provisos and exceptions in
connection with the general rule of the act, the scope
of the application of the method of collecting the tax

56 QUARTERLY JOURNAL OF ECONOMICS

at the source may perhaps be safely stated thus : the
normal tax is to be deducted (1) from all interest pay-
ments made by corporations on bonds and the like,
without regard to the amount; (2) from all other
interest payments when the amount is more than
$3,000 in any one year; (3) from all payments of rents,
salaries, or wages amounting in any one case to over
$3,000 annually; (4) from all other payments of over
$3,000 (excepting dividends) which may be comprised
under the designations " premiums, compensations,
remuneration, emoluments, or other fixed or deter-
minable gains, profits, or income."

One general restriction upon the application of the
method of deducting the tax at the source should per-
haps be mentioned. It is indicated by the words
" fixed and determinable." That these words are not
unimportant would seem to be indicated by their recur-
rence in other connections, and particularly by a pro-
viso in the paragraph defining the deductions which
may be made in computing taxable income. This
proviso reads:

Provided that whenever the tax upon the income of a person is
required to be withheld and paid at the source as hereinafter required,
if such annual income does not exceed the sum of $3,000 or is not
fixed or certain, or is indefinite, or irregular as to amount or time of
accrual, the same shall not be deducted in the personal return of
such person.

This proviso emphasizes the fact that there are at
least two general conditions to be met before deduction
at the source is required: first, as already explained,
the amount of income paid out must (with exceptions
already noted) exceed $3,000; and second, it must be
fixed, certain, definite, and regular. Strictly speaking
there would seem to be very little income which is
fixed and certain in advance of its actual receipt and
very little which is not fixed and certain after it has

THE INCOME TAX OF 1913 57

been received. Doubtless, the terms here used are
intended to cover periodical payments of income, such as
salaries or interest, made in fixed or stipulated amounts.
But even as regards such payments there is usually
no certainty in any given instance that they will con-
tinue to be made to the same person throughout the
year. Interest bearing notes and mortgages are
usually transferable, and salaried positions are not
always permanent. It will often not be possible to say
in advance whether the aggregate payments will
amount to $3,000. Instructions already issued by the
Treasury Department provide that no tax shall be
withheld until the accumulated payments of the cur-
rent year pass the $3,000 limit, and that the person
making these payments shall thereafter deduct the
tax, the first deduction covering the tax on all pay-
ments up to date. But simple as such a procedure
may be in theory, in the complicated and shifting
relationships of the business world it will not always
be easy to follow. The payer of income as well as the
payee may change, and change more than once, during
the same calendar year.

Income from investments in foreign countries is, of
course, derived from sources which are inaccessible to
this government. The law, however, undertakes to
intercept the tax on certain classes of income of foreign
origin by providing that the normal tax " shall be
deducted and withheld from coupons, checks, or bills
of exchange for or in payment of interest upon bonds
of foreign countries and upon foreign mortgages or
like obligations (not payable in the United States),
and also from coupons, checks, or bills of exchange for
or in payment of any dividends upon the stock or
interest upon the obligations of foreign corporations,
associations, and insurance companies engaged in

58 QUARTERLY JOURNAL OF ECONOMICS

business in foreign countries." This deduction of the
tax is to be made by " any banker or person who shall
sell or otherwise realize coupons, checks, or bills of
exchange drawn or made in payment of any such
interest or dividends (not payable in the United
States), and any person who shall obtain payment
(not in the United States), in behalf of another of such
dividends and interest by means of coupons, checks,
or bills of exchange, and also any dealer in such coupons
who shall purchase the same for any such dividends
or interest (not payable in the United States), otherwise
than from a banker or another dealer in such coupons."

Ill

In so far as the law requires the taxation of incomes
at the source, some special provision must be made to
ensure to the recipients of the incomes thus taxed the
benefits of the minimum exemption and of any other
deductions to which they may be lawfully entitled.
The procedure to be followed is set forth in the following
provisions of the law, the letters and numerals which
mark subdivisions of the paragraph being inserted by
the writer.

(1) In all cases where the income tax of a person is withheld and
deducted and paid or to be paid at the source, as aforesaid, such
person shall not receive the benefit of the deduction and exemption
allowed in paragraph C of this section, except (a) by an application
for refund of the tax unless he shall, (6) not less than thirty days
prior to the day on which the return of his income is due, file with
the person who is required to withhold and pay tax for him, a signed
notice in writing claiming the benefit of such exemption and there-
upon no tax shall be withheld upon the amount of such exemption;
(2) nor shall any person under the foregoing conditions be allowed
the benefit of any deduction provided for in subsection B of this
section unless he shall, not less than thirty days prior to the day on
which the return of his income is due, either (a) file with the person
who is required to withhold and pay tax for him a true and correct

THE INCOME TAX OF 1918 59

return of his annual gains, profits, and income from all other sources,
and also the deductions asked for, and the showing thus made shall
then become a part of the return to be made in his behalf by the
person required to withhold and pay the tax, or (6) likewise make
application for deductions to the collector of the district in which
return is made or to be made for him.

The first part of this paragraph prescribes the steps
which must be taken in order to secure the benefits
of the general exemption of $3,000 or, in case of a
married man, of $4,000. The second part relates to
the deductions on account of business expenses, interest
on indebtedness, taxes, losses, dividends and the like,
which, as set forth in subsection B of the act, are per-
mitted in computing the net income subject to taxation.
The procedure to be followed does not seem to differ essen-
tially in the two cases. The initiative rests with the
tax-payer, or person from whose income the tax will,
in absence of any action on his part, be deducted at
the source. The law apparently gives the tax-payer
the option of two alternatives — either to forestall the
deduction of the tax or to secure a refund of the tax
after it has been collected. The right to have the tax
refunded in order to secure the benefits of the minimum
exemption is clearly implied by the clause, " except
by an application for the refund of the tax," appearing
in the first part of the paragraph. That the deductions
allowable on account of expenses and interest may
likewise be obtained by a refund of the tax collected
at the source is indicated by the clause at the end of
the paragraph giving the tax-payer the option of making
" application for deductions to the collector of the
district in which return is made or to be made for him."

If the tax-payer prefers to forestall the deduction of
the tax, the procedure prescribed by the law as applied
to exemptions and as applied to deductions of income
on account of expenses differs in one particular. As

60 QUARTERLY JOURNAL OF ECONOMICS

regards the exemption all that he need do is " to file
with the person who is required to withhold and pay
the tax for him, a written notice claiming the benefit
of such exemption." But if he wishes to forestall
the retention of the tax on any income which is not
taxable because it is offset by allowable deductions,
he must file " a true and correct return of his annual
gains, profits, and income from all other sources and
also the deductions asked for." This return likewise
is to be filed with the person " required to withhold and
pay the tax." It would seem hardly possible, however,
to make such a return prior to the completion of the
calendar year for which the income is to be computed;
and therefore it is difficult to see how the tax-payer can
exercise this right in such a way as actually to forestall
the retention of the tax at the source, unless the tax
officials construe the law as permitting the acceptance
of a statement of prospective income filed in advance
of the actual receipt of the income. It may be noted
in this connection, however, that the person retaining
the tax at the source apparently is not required to pay
it over to the government until the expiration of six
months after the completion of the year for which the
tax was assessed. 1 It is conceivable, therefore, that
the tax-payer, instead of attempting to forestall the
retention of the tax, might file his claim and return of
income after the close of the tax year, not with the tax
collector but with the person withholding the tax, so
as to obtain a refund of it before it has been paid over
to the tax collector. This possibility is suggested by
the provision as to the period within which the claim

1 As to time of payment there is no provision in the law except the general provision
that all assessments shall be paid on or before the 30th of June. This would seem to
cover assessments at the source, in view of the fact that the special provision requiring
deduction of the tax simply states that the person withholding the tax shall pay it to
officers of the government authorized to receive it, without specifying when it shall be
paid.

THE INCOME TAX OF 1913 61

may be filed, namely, " not less than thirty days before
the day on which his return of income is due." The
" return of income " is due on March 1st and therefore
the claim may be filed at any time prior to the 29th or
perhaps 30th of January following the year in which
the income accrues.

No similar difficulty stands in the way of forestalling
the retention of the tax when it concerns the exemption
of a minimum. Here, as previously explained, the
tax-payer's application need not be accompanied by a
statement of income, presumably because this exemp-
tion is not dependent upon the amount of his income.
He is entitled to the relief whatever his income may be.
It would seem, therefore, entirely practicable in most
cases to forestall the retention of the tax at the source
where it affects the tax-payer's right to exemption.

The claim to exemption or deduction, with the accom-
panying return of income, when filed with the person
who would otherwise retain the tax, is to be submitted
by the latter, in making his own returns to the tax col-
lector as his authorization for not having collected or re-
tained the tax. This appears to be the meaning of the
provision that " the showing thus made shall then become
a part of the return to be made in his [the claimant's]
behalf by the person required to withhold and pay the
tax."

IV

The principle of assessing income at its source as
applied in this act does not relieve the individual from
the necessity of making a full revelation to the tax
officials of his personal income from all sources. Tho
this statement needs to be qualified in one or two
particulars, the law provides in general that every
person subject to the tax and having an income of

62 QUARTERLY JOURNAL OF ECONOMICS

$3,000 or over shall make a true and accurate return
under oath or affirmation " setting forth specifically
the gross amount of income from all separate sources
and from the total thereof deducting the aggregate
items or expenses and allowance " authorized by the
law. Altho income from which the tax has been with-
held is not included in the net personal and taxable
income of the tax-payer, it must, nevertheless, be
accounted for and included in his declaration as a part
of his gross income, forming one of the specified items
which are to be deducted from the gross income in
arriving at the income subject to taxation.

As already intimated, the general requirement of the
full and complete statement of income is subject to
certain exceptions. One relates to the income from
dividends, the law providing that " persons liable to
the normal tax only . . . shall not be required to
make return of the income derived from dividends on
the capital stock or from the net earnings of corpora-
tions, joint-stock companies or associations, and insur-
ance companies taxable upon their net income." It
will be noted that this proviso is restricted to persons
who are " liable for the normal tax only," i. e., persons
having net incomes under $20,000. It would seem,
therefore, that the tax-payer claiming and securing this
privilege must in some way, without revealing the
amount received from dividends, satisfy the tax asses-
sors that his total net income including the dividends
(amount not stated) does not exceed $20,000. Of
course a form of statement can easily be devised to
cover the situation. But whether the law will be
administered in such a way that this provision affords
some relief from the general obligation of making a
detailed and complete statement of income remains
to be seen.

THE INCOME TAX OF WIS 63

Another exception to the general requirement of a
complete declaration of income covers the case of the
tax-payer whose entire income has been assessed and
the tax on it deducted at the source. The law relieves
such persons from the obligation of making any declara-
tion of income ; altho it is not certain that this privilege
can be secured without foregoing or sacrificing the
benefits of any abatements to which the individual
tax-payer might be entitled on account of business
expenses, interest payments, losses, etc. It seems
probable that where the income is all assessed at the
source the tax-payer may obtain the benefit of the
minimum exemption without making a declaration of
income.

It appears, therefore, that assessment at the source
does not, under this law, operate in such a way as to
afford the tax-payer any substantial relief from the
necessity of making a revelation of his income to tax
officials. Whatever basis there may be for the common
criticism or complaint that an income tax is inquisitorial
remains under the operation of this law to nearly the
same extent that it would if the tax were levied wholly
and directly upon the recipients of the income, with no
resort to taxation at the source.

In addition to the returns which the individual is
required to make covering his own income, every
individual, firm, or corporation is required to make a
return covering payments on which the tax has been
deducted and giving the name and address, if known,
of the persons to whom such payments were made.
As regards the scope and application of this require-
ment, the law is not altogether clear or explicit. It
seems best, therefore, to cite again the exact language
of the statute:

64 QUARTERLY JOURNAL OF ECONOMICS

All persons, firms, companies, co-partnerships, corporations,
joint-stock companies or associations, and insurance companies,
except as hereinafter provided, in whatever capacity acting, having
the control, receipt, disposal, or payment of fixed or determinable
annual or periodical gains, profits, and income of another person,
subject to tax, shall in behalf of such person deduct and withhold
from the payment an amount equivalent to the normal income tax
upon the same and make and render a return, as aforesaid, but
separate and distinct, of the portion of the income of each person
from which the normal tax has been thus withheld, and containing
also the name and address of such person or stating that the name
and address or the address, as the case may be, are unknown: . . .
Provided, That ... no return of income not exceeding $3,000 shall
be required.

The introduction of the last proviso (that no return
should be made of payments of income not exceeding
$3,000) was probably thought necessary in order to be
consistent with the general rule that the tax shall be
withheld and deducted only from payments exceeding
that amount; but to that general rule there is one
important exception, as already noted, covering interest
payments made by corporations. The tax on such
payments is to be deducted in all cases without regard
to the amounts. There is no corresponding exception
to the rule as to returns. The language of the statute,
strictly interpreted, would seem to mean that the cor-
porations, altho required to deduct the tax from all
payments of interest, are not required to make a return
of the names and addresses of persons to whom annual
interest payments are made in amounts not exceeding
$3,000.

It is, in fact, hardly possible in advance of the official
interpretation and actual enforcement of the law to
say how far this requirement of a return of payments
of income taxed at the source extends or to whom it
will apply. But as regards the deduction of the tax
and the returns to be made in connection with the pay-

THE INCOME TAX OF 1918 65

ment of the interest on corporation bonds, Treasury
regulations have already been published, indicating
the procedure to be followed. The case of registered
bonds presents no especial difficulty, the officers of the
corporation being in a position to make the required
return giving the name of the bondholder and the
amount of interest paid to him. But the procedure
that would be followed in connection with the large
amount of interest paid out on coupon bonds was not
so obvious. In this case the corporation issuing the
bonds and ultimately paying the interest has, as a
rule, no knowledge who the bondholders are or how
much interest they individually receive. The only
person who can give this information is the person who
cashes the coupons for the bondholder in the first
instance. Usually coupons are redeemed through
the banks; and the Treasury regulations above referred
to provide that the coupons when presented to banks
or other agencies for redemption or collection must be
accompanied by a certificate of ownership signed by
the owner of the bonds. In this case, presumably,
the bank will collect from the corporation the interest
less the tax and the corporation will pay the tax to the
government. The failure to supply such a certificate
places upon the bank accepting the coupons the
obligation of retaining the tax and, at the same time,
attaching to the coupons its own certificate giving the
name and address of the owner of the coupons or of
the person presenting them. Here the intention seems
to be that the bank shall deduct and withhold the tax,
collect the interest in full from the corporation, and
ultimately pay the tax to the government. The
corporations are to deliver all certificates to the tax
collector on or before the 20th of the month following
that in which they were received.

66 QUARTERLY JOURNAL OF ECONOMICS

Regarding the assessment of the additional tax not
much need be said in the way of explanation. It is,
in theory at least, a comparatively simple matter.
There is no attempt here to make any application of
the principle of collection at the source. The tax is
all levied directly upon the recipients of the individual
incomes and the assessment is based upon the tax-payer's
declaration, which for the purposes of this tax must
cover the " entire net income from all sources, corporate
or otherwise." The tax is thus largely distinct from
the normal income tax as regards both the method of
assessment and the rates. It is, however, to be admin-
istered through the same machinery, and no doubt to
some extent the information obtained as to the sources
of income in connection with the assessment of the
normal tax will prove useful as a check upon the returns
of income required for assessment of the additional
tax. Every person whose income exceeds $20,000 will
be subject to both taxes, the normal and the additional,
but presumably will be required to make only one
declaration. For the purposes of the additional tax
he will be required to declare his income from all
sources, and therefore any relief from the obligation
of making a complete revelation of income which may
be secured to him through the application of the prin-
ciple of assessment at the source in connection with
the normal tax will be entirely sacrificed.

VI

The administration of a direct personal income tax —
using that term to describe a tax levied directly on
individual incomes — is a comparatively simple matter,
however ineffective it may prove to be in reaching the

THE INCOME TAX OF 1913 67

income subject to it. Under this method of taxation
it is easy to exempt a minimum, to apply progression
in the rates, or to make any other adjustments that may
be deemed equitable with reference either to the size or
character of the income or to the circumstances of the
tax-payer. But as soon as we depart from this simple
method and resort to taxation at the source, we encoun-
ter difficulties in varying the rates, allowing exemptions,
or making any similar adjustments. In the English
income tax, these difficulties are squarely met and
surmounted. As previously explained, that tax is in
the first instance levied indiscriminately on all acces-
sible sources of income and the adjustments are effected
by refunding the tax collected at the source so far as
may be necessary. No provision is made for fore-
stalling the deduction of the tax, and no returns are
required of the names and addresses of persons to
whom payments of income are made. The exemption,
however, is small ($800) and the abatements extend
only to incomes below $3,500. Above that point the
entire income is taxable.

A tax which provides for the exemption of $3,000 or
$4,000 from every individual income places a formid-
able barrier in the way of a thoro-going application
of assessment at the source. It is evident that with a
universal exemption as high as this, a very large amount
of tax withheld and collected at the source would
ultimately have to be refunded. The law as enacted
indicates an intention to secure in part the advantage
of assessment at the source and at the same time avoid
in part the attendant disadvantage of having to refund
the tax. The measure might be characterized as one
which as regards the " normal tax " applies the prin-
ciple of assessment at the source to corporate income
completely and to other income in spots. The " addi-

68 QUARTERLY JOURNAL OF ECONOMICS

tional tax " is simply the direct personal tax. The
normal tax will doubtless be successful in reaching the
large amount of income earned or created by enter-
prises conducted under the corporate form of organiza-
tion, much of which would probably escape assessment
under a direct personal income tax. But beyond this
it is questionable whether the method of assessment
at the source as here applied will be of sufficient advan-
tage to justify the administrative complications which
it involves.

It seems useless, however, as well as unwise, to
venture any predictions as to how successful the tax
will be in reaching the income subject to it or how well
it will work in actual practice. We can afford to wait
and see. Much depends upon the way in which the
law is administered. After it has been in operation
for a year or two, after its novel features have been
tested by actual experience and those provisions which
are complicated or obscure have been interpreted by
administrative rulings or possibly by court decisions,
we shall have a better understanding of the merits
or defects of the measure than is at present possible.
The law will doubtless require amendment in many
particulars even if it does not need to be radically
revised. That the income tax in some form will be
perpetuated as a permanent part of our system of
national finance may safely be predicted. Properly
adjusted and wisely administered it should greatly
strengthen the financial resources of the government,
make possible a closer adjustment of revenue to expen-
diture, and secure a more equitable distribution of the
burden of taxation.

Joseph A. Hill.
Washington, D. C.