budget is also advocated by some because of a belief that capital outlays should be financed, in the main, by borrowing, while operating expenses should be taken care of normally from ordinary revenues. The present suggestion for the introduction of a clear distinction in the budget between regular, emergency, and developmental expenditures is not made so much with a view to establishing different methods of financing these expenditures as with a view to establishing different methods of managing them.

It has already been indicated that the methods of financing defense expenditures must vary with economic circumstances. Under certain conditions, borrowing should supply the major portion of the required funds; under others, taxation should do so. Similarly, the methods of financing developmental and ordinary expenditures should vary with changes in economic conditions. During periods of prosperity, for example, both these categories of expenditures should be financed from ordinary revenue, but in the depths of a depression even the ordinary expenditures must be financed at times from borrowing. The character of the expenditures must be given some, but not exclusive, consideration in the determination of the methods of financing them. Attention must be given as well to broad economic and administrative factors. There should be as little earmarking as possible of specific revenues for specific expenditures, because such earmarking would introduce into the budget undesirable rigidity. Some of the earmarking now existing in the budget-such as, for example, the allocation of 30 percent of customs receipts to the disposal of surplus commodities should be abolished. The present unitary character of the budget should be preserved so that the Government's fiscal policy continues to be as flexible as possible.

Consideration should be given to the possibility of making the Federal budget even more comprehensive than it is at present. During recent years a multitude of special governmental corporations and trust funds have been set up, whose operations are not included in the budget. Unquestionably, there are good reasons for having a separate old-age and survivors' trust fund to disburse old-age benefit pay-. ments. There are probably equally good reasons for establishing special corporations for the management of certain quasi-commercial operations of the Government and providing them with special revolving funds which may be administered outside of the regular budget. Nonetheless, a careful examination should be made of every activity carried on by each special corporation, and of every special fund set up so far and every type of revenue directed into it, with a view to finding out whether adequate justification for such separate treatment exists; or whether it might not be preferable, perhaps, to carry on the activity involved by a regular agency of the Government and to redirect the particular revenue into the general fund or even merge the entire fund and subject the expenditures and revenues involved to regular budgetary controls.

Moreover, care should be taken that so far as practicable the receipts and disbursements of all such corporations and special funds are at least included with the receipts and disbursements of the general fund. in a single consolidated statement for purposes of information.

Budgetary reform should move in two directions: (1) It should bring about greater unity and comprehensiveness of the budget and

such improvement in its internal classification of expenditures and means of financing them as will facilitate an intelligent interpretation of current fiscal developments and controls, and (2) it should provide for greater flexibility of the budgetary controls over the developmental and emergency expenditures so that the budget will become a more effective instrument in establishing a fiscal policy designed to promote a steady and high level of national production at all times. Desirable Improvements in Intergovernmental Fiscal Relations.

It has been evident for some time that the respective capacities of the Federal, State, and local governments to raise revenue by taxation do not accord with their respective requirements for revenue. The capacity of the Federal Government to raise additional revenue increased up to the beginning of the depression even more rapidly than its expenditure requirements, with the result that the Federal Government experienced on the whole little difficulty in financing them. The situation in the case of the States, and especially of the local governments, has been the reverse, their respective abilities to raise revenue failing to expand as rapidly as their expenditure requirements.

The resulting difficulties experienced by the States, and especially the local governments, in raising the required additional revenues have been solved in part by a clear recognition of the possession by the larger governmental jurisdiction of superior advantages in the levying of taxes and, accordingly, by the introduction of Federal grants-in-aid to States and State grants-in-aid to local governments for the support of specified functions. These difficulties have also been solved in part, in the case of local governments, by the introduction of a system of State-collected, locally shared taxes. Finally, the problem of the inability of the State and local governments to finance their increasing expenditures out of their own revenue resources has also been solved in part by transferring some of the actual expenditure responsibilities from the local governments to the States, and from both State and local governments to the Federal Government.

In addition to the difficulties experienced by the State and local gov ernments in raising required revenues, special difficulties in this respect have been encountered by the poorer States and, within each State, by the poorer local communities. This problem of the unequal ability of different States and different localities to finance needed services has been treated by the Federal and the State Governments by means of grants-in-aid designed to equalize as far as possible the abilities of the States and the local communities involved to maintain certain minimum standards of required services.

Very little has been done, however, toward bolstering up State and local revenue sources through a reallocation of tax sources as between the Federal and State Governments, on the one hand, and the State and local governments, on the other. Yet unquestionably a great deal could be done in this direction, if a concerted effort to that end were made.

The existing system of taxation is defective also in that it is responsible for uneconomic competition between the three levels of government for new revenue resources, resulting in overlapping tax burdens, mutual interferences by the governments concerned with each other's

efforts to levy taxes, and considerable losses of tax revenue for all of them. It is responsible also for considerable duplication in the costs of collection of revenue, unjustifiable divergences in the provisions of the Federal and State tax laws relating to the same taxable objects, and other unnecessary complications of the law resulting in undue harassing of the taxpayers.

Our present tax system is characterized also by troublesome competition for tax revenue between governments operating on the same level. Suffice it only to mention as examples the conflicting claims of different States for jurisdiction to tax the same sources of wealth, which result in cases of unfair double taxation, and the extension by certain States and localities of special exemptions from taxation to certain types of wealth, as an inducement to locate within their boundaries, which results in considerable leakage of revenue for all governments concerned.

It has already been suggested that the existing allocation of expenditure responsibilities among the Federal, State, and local governments · is not uniformly satisfactory. The existing system of public expenditures also suffers from a lack of coordination of efforts between governments operating on different levels, as well as those operating on the same level. There is considerable waste and duplication of effort in the pursuance by different governmental units of conflicting policies which reduce the efficiency of the government taken as a whole. There is also insufficient cooperation between the Federal, State, and local governments in the exercise of their credit.

These are but a few of the problems in the financial relations of the Federal, State, and local governments which urgently require solution. They should be carefully studied by some properly constituted agency from a broad national point of view, so that the required solutions may be found.

TAXATION

The preceding sections of this chapter have pointed out the general role of taxation in adapting fiscal policy to the changing requirements of modern government in the present era. The emphasis is now shifted from the interrelationship of taxation, expenditures, and debt to a somewhat detailed consideration of the various effects of taxation upon the people and upon the industrial economy of the United States. Who pays the taxes? Is the American tax system progressive or regressive and whither is it tending? How do taxes affect savings and consumption? What is the relationship of taxes to the distribution of wealth and income? Does the present tax system prevent or increase the further concentration of economic power? Are investors handicapped by high surtaxes? What is the effect of taxes upon business profits? How is small business treated? Was the undistributed profits tax particularly onerous on it? Are monopolies or holding companies favored? How will the newly enacted excess profits tax work out? Does the pay-roll tax favor mechanized industries? These are the questions for which answers are sought, so far as present knowledge permits.

The tax system is at once a source of public revenue and an instrument for social and economic regulation. Seldom has it been only one

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to the exclusion of the other. The men who make our laws have been ever mindful of the twofold nature of the tax system since the establishment of the Federal constitutional system. The tariff, for instance, is an example of a tax for the collection of revenue as well as for the development of native industry. The corporation income tax was heralded in 1909 by President Taft as at once a Federal tax and "a long step toward that supervisory control of corporations which may prevent the further abuse of power."

The present tax system is an historical product-the result of a variety of political, social, and economic pressures. It is a conglomerate of 1 Federal and 48 State tax systems, developed independently of each other rather than as parts of a single or unified system. Although some features common to all these systems may be discovered, there are many differences between them which appear to be wholly accidental and unexplainable. In selecting new taxes under the pressure of need for additional revenue both the National and the State legislatures as a rule have been guided by considerations of immediate political expediency and not infrequently have been influenced by the prejudices and self-interests of the political and economic groups dominant in the affairs of government at the moment, rather than by any long-run considerations of equity and economic welfare of the National or State community as a whole. As a result of this haphazard development, our American tax system today is replete with inconsistencies and contains many inequitable and uneconomic features.

A substantial tax increase has occurred in recent years, whatever the yardstick used for the measurement of tax collections-be it total dollars, per capita dollars, or in terms of goods and services. Per capita tax payments in the United States were $23.42 in the year 1913. They increased to $84.41 in 1920, $84.69 in 1930, and $114.09 in 1938. The Federal Government's share in these sums was $6.87 in 1913, $53.77 in 1920, $29.45 in 1930, and $46.48 in 1938.

But the same period which witnessed so considerable an increase in tax payments was also attended by a corresponding expansion in the number and nature of Government services. To speak of taxes as a "burden" without giving due consideration to the productive use to which they have been put-for example, highways, schools, sanitation relief, control of disease, police and fire protection, and social security-distorts the facts. Taxes are not collected to be dumped as waste matter into the sea. Like the sales income of a business enterprise, taxes are the operating income with which the Government pays for its manifold activities.

Taxes vary greatly in their form and basis of application. One form of tax is levied on ownership-for example, of a factory, a house, or a corporate charter. These taxes must be paid without the slightest regard to whether, for instance, the factory is humming with activity or standing in idleness. A tax of this description is "fixed cost" that runs on year in and year out without interruption.

A second form of tax is levied on consumption, for example, of a definite unit of production-a package of cigarettes, a bottle of liquor, a gallon of gasoline, a kilowatt-hour-or on the dollar amount of retail sales or on the number of employees in a business. The magnitude of

such a tax rests directly upon the volume of industrial activity-in a word, it is a "variable cost" fluctuating from year to year.

A third form of tax is levied on profits or incomes of an individual or a corporation.

Taxes which enter into the fixed or variable costs of an enterprise do not end their effects with the first person who pays them. It is likely that they will be passed on in whole or in part during the course of business activity to other persons who will do the same in their turn. In the terminology of public finance such taxes are said to be shiftable in character and may move either forward or backward.

Changing Sources of Taxation.

The changing tax sources of the Federal, State, and local governments are pictured in chart XVI. In 1913, the first year for which reliable data by tax sources are available for all three levels of Government, the property tax supplied 56.7 percent of all revenues, while consumption taxes (which include those on customs, liquor, and tobacco) supplied 30.5 percent of the whole. These taxes furnished the principal mainstay for the Federal, State, and local governments. The percentage yield of the property tax has decreased from more than one-half of all revenues in 1913 to less than one-third of the whole. In spite of this shrinkage it still retains its position as the principal source of all public revenue, and continues as the financial foundation of nearly every local government.

The principal sources of public revenues in 1930, before the tax system had felt the fullest effect of the depression, were property taxes (45.7 percent), income taxes (24.1 percent), and highway taxes, including gasoline and motor vehicles (7.6 percent). These three taxes together accounted for 77.4 percent of the total revenue receipts. Income and highway taxes, which supplied 31.7 percent of all the 1930 tax revenues, are taxes of relatively recent origin and hence were scarcely in evidence in 1913. The Federal Government with its extensive jurisdiction over mobile wealth and income placed its principal reliance on the income tax, while the various States depended largely on the highway taxes (on motor vehicles and gasoline).

During the depression years the tax pattern was further transformed. Income taxes declined as revenue producers, while taxes on articles of mass consumption gained widespread favor. The different States freely enacted various retail sales taxes, while the Federal Government renewed its reliance on liquor and manufacturers' excise taxes. Consequently consumption taxes, whose importance had for a time declined, by 1936 once again accounted for a substantial share of the public receipts (21.7 percent), while the income tax yield was only 15.5 percent.

By 1938 the relative importance of consumption taxes had diminished even though they continued to account for a substantial share (18.6 percent) of the total revenue receipts. Taxes on income (19.3 percent) and wealth (3.5 percent), though showing a relative increase, have lagged behind 1930 proportions. The pay-roll tax, enacted in 1936 as a part of the social security program, has emerged as a new and important revenue source (9 percent) to Federal and State Governments alike.