§ 1. #Importance of taxation as a public question.# The discussion of taxation has accompanied the growth of free government in England and America from the time of Magna Charta. The control of the public purse has been found to give the key to political power, and therefore it has frequently become the occasion of conflict between the monarch and the people. But in our own national history since the adoption of the Constitution, taxation has not had a leading place in politics except in the one aspect of the tariff. The constitutional question of states' rights long absorbed most of the interest of citizens and of legislators. But with the quickened attention of the public to economic questions, the problem of taxation became of increasing importance.
It has come to be recognized that taxation can be made to play, and is bound to play, a leading part as an agency in the distribution of wealth, and thus it is the center of much of the ardent controversy regarding social reform. Ultimately, almost every proposal of social change and betterment involves some cost. The question then must be answered. Who is to receive the benefits and upon whom and how shall new taxes be levied to pay the cost? Further, it is often urged that this result of taxation in redistributing incomes is in itself (or can be made) a virtue; and some even see in tax reform the answer to the largest social questions of our time. We are now to take up a few of the more important problems of taxation, to see the difficulties, and to suggest the direction in which their solution is to be sought. The tariff having been already separately considered, the chief kinds of taxes we have here to treat are property taxes, general and special, and inheritance and income taxes.
§ 2. #The general property tax; nature and difficulty.# The rates both of assessment and of levy of the general property tax are uniform and equal in proportion to the value of all (or nearly all) property in the taxing district.[1] There are always some exceptions of certain kinds of property, or of the property of certain persons, or of property and things put to certain uses—public, educational, religious, and charitable in their nature.
The federal government levies no general property tax, but the other branches of government[2] receive about three-fifths of all their revenues from it.
At first view nothing would seem to be simpler and juster in principle than such a plan of taxation, but those who have most carefully studied its practical operation, almost with one accord, pronounce it to be "a dismal failure." The chief reason assigned for this failure has been that the assessment of the tax is imperfect and incomplete. The usual thought is that if all property could be assessed the plan would be excellent. Undoubtedly the difficulty of just assessment has its part in the weakness of the tax, but back of, and more important than this, is an inherent fallacy in the apparently simple principle of the tax.
§ 3. #Ambiguity of the term "property."# Unfortunately, the word property is applied, even by the most competent courts, both to the intangible right of ownership (the fundamental meaning) and to the concrete thing that is owned, the source of the income.[3] But evidently the value of the right to the income yielded by a house, for example, is merely the value of the house. The value of the property in the one sense (the abstract ownership, the intangible right) is merely a reflection of the value of the property in the other sense (the concrete wealth). There are not here two independent bodies of economic wealth. Whatever value belongs to the one is subtracted from the other. Nor is it rational to take the paper document called a deed (which is but the evidence of ownership) and call it tangible property having a value in addition to the house itself. Yet, in fact, all these confusions are constantly made in taxation. The term "intangible personal property" is applied to such things as mercantile credits, promissory notes, bonds—in general to the right to collect sums from another person, whether these rights arise out of sales or of loans—and all are treated as parts of taxable property. Sometimes the evidences of indebtedness, the promissory notes or the mortgage papers, are even called tangible property, the same term that is applied to land, houses, and machinery. By universal practice supported by a long line of court decisions, these rights (whether evidenced by paper or not) are made subject to taxation, except as by piecemeal legislation certain grudging exceptions have been made. These views and this practice are supported by the popular desire to tax money-lenders. The result is "double taxation" of many sources of income. This involves a burden that is ruinous in some cases, both to borrowers and to lenders, and that tempts in all cases to the evasion of the tax.
Take, for example, a house assessed at $10,000 which is owned free of debt and which has a rental value of $600. At the rate of 1.5 per cent the tax paid would be $150. Now if the owner borrows $8000 he is still taxable $150 on the full value of the house, and the lender nearly everywhere is taxable $120 on the amount of his mortgage. The total tax payable out of the one source of income, the house, is then $270. The same analysis will show that any credit is but a contractual claim upon some other source of income which is, or should have been, already taxed.
If one person owns all the capital-value invested in a specific piece of wealth, no attempt is made to tax both the capital and the wealth; but if it happens that two or more persons share the capital-value invested in the same wealth, the attempt is made to tax as a unit the full value of the wealth and, in addition, some part of the capital also. It is, however, easy in most cases to conceal this "intangible property" from the assessor's eyes, and a comparatively small amount of it is ever taxed. This means inequality and hardship in the operation of the tax and, as a result, unceasing temptation to perjury by the taxpayer and to favoritism and graft by public officials.
§ 4. #Various temporizing policies.# The general property tax in practice is unjust and demoralizing. What, then, shall be done about it? Various policies have been followed. One has been to declare that the law would be good if it could be enforced, but that as in practice it cannot be, the best thing is to go on as before, catching a few "tax dodgers," and letting the rest go. Another policy is to hire "tax ferrets," paying them large commissions to discover cases where intangible property of this sort has been concealed from the assessors. This method, no matter how stringently applied, has never reached more than a small proportion of the cases, and becomes a potent agency of political favoritism and corruption.
Another policy is to maintain the general principle, but to make exceptions here and there. Usually the exceptions are made just at those points where the law would with earnest effort be most easily enforceable, and therefore where it has become most inconvenient. As a result of these changes the state laws display a bewildering and illogical variety. By constitutional interpretation, United States notes and federal bonds are exempt from state and local taxation; generally, by state law, building and loan association and savings-bank loans are exempt as, in a majority of states, are state and municipal bonds if held within the state. In at least eight states, bonds of the state are exempt, but those of the municipalities are taxable, while in a few states the reverse is the case. In several states both kinds of bonds when issued after specified dates, are exempt, but in Ohio state bonds are exempt only if issued prior to 1913. All but seven of the forty-eight states, however, attempt to tax the resident holders of state and municipal bonds of other states; but the exceptional states are those in which most of the investors in this class of securities reside. In many cases private debts receivable are allowed to be offset against debts payable. In some states mortgages on real estate are exempted or (in Massachusetts) treated as an interest in the real estate. Rarely mortgages are exempted up to a certain amount (in Indiana, to $700, the purpose being to tempt the borrower to reveal the name of the lender). Sometimes a special mortgage registration tax, payable but once (in New York 1/2 of 1 per cent) is levied, and otherwise mortgages are free from taxation. Small as this rate is, the fiscal yield of mortgage taxation under this plan exceeds that under the general property tax.
By the overlapping of these laws, so contradictory in principle, it may happen that securities held by taxpayers residing in other states than those of the issue are taxable two or three or more times; but few if any loans of this kind are made except by those evading all taxation.
§ 5. #A consistent policy of wealth taxation.# These exceptions still leave the law in its general principles as to the taxation of intangible property illogical and unjust. A solution can be found only by abandoning the ambiguous legal concept of property, and making use of economic concepts. A consistent tax law might take either wealth or capital as the basis of assessment, but not sometimes the one and sometimes the other. Wealth is an impersonal basis of taxation; each piece of wealth might be taxed once as a unit no matter how the ownership were divided. Or the other alternative might be chosen. Capital would be a personal basis of taxation; each person's capital might be taxed no matter from what sources the incomes were derived (the concrete wealth, of course, then being left untaxed).
The wealth basis is much nearer to the present general property tax as actually administered. The assessment of general tangible wealth would undoubtedly be more easily done than would that of individual capitals, and likewise be both easier and juster than the present inconsistent policy. Tangible things are comparatively easy to find, measure, and evaluate where they are, and if they are all taxed it is evidently the same as if all the capital values based upon them were taxed in the owners' hands. The various equitable claims of different owners in one source of income could be left to adjust themselves through shifting, mainly in the choice of investments, once the plan had become generally applied.
§ 6. #Needed reform of assessment.# The assessment of the present general property tax is notoriously inefficient and unjust. The root of most of the present evils (other than those above discussed) is the method of local election of assessors, which usually is by townships, but in some cases by counties. The local assessor's estimate of value is used as a basis for taxation not only for his district but for the larger units (county and state). Thus every local assessor is tempted by the conflict of interests not only among the taxpayers in the district which elects him, but by the conflict of interests between his district as a whole and other districts. The lower the ratio of assessment to true valuation in any township compared with that of the other tax districts, the smaller the proportion of county and state taxes that the people of the district have to pay. Willingness to under-assess property often becomes thus the chief virtue of an assessor in the eyes of his political constituents. This has led in many cases to absurd underassessment, which boards of equalization have proved powerless to remedy in any great measure. A sounder plan would be general state assessment, with a permanent expert board of commissioners employing a corps of state assessors under the merit system of appointment. This plan has as yet been applied only to assessment of railroads and some other public-service corporations.
§ 7. #Separation of state and local taxation.# For the reason just indicated the failure of the general property tax has been most conspicuous where it is used as a basis for state taxation. This has led some financial students to advocate the plan of separation of state and local taxation. This means the assignment of certain sources of revenue (such as corporations and the liquor business) primarily or exclusively to the state, leaving all real estate and the general property of non-corporate persons to be taxed by the counties and minor divisions under the general property tax. The plan has been increasingly applied in New York, until, in 1906, it became almost complete. In 1910 the plan was adopted in California; and it is largely used in New Jersey, Connecticut, Delaware, and Pennsylvania, and to a small extent in some other states. An efficient state assessment of general wealth would accomplish most of the advantages claimed for this plan, while avoiding some of its dangers.
§ 8. #Federal taxation of merchandise and acts in commerce.# Tariff and internal revenue duties constitute the two chief revenues of the federal government. Both of these are mainly taxes on wealth. Unlike the general property taxes they are not levied upon the main body of wealth held in possession, but almost entirely upon articles of merchandise and upon acts in course of trade. Stamps on receipts, checks, deeds, bills of sale, and licenses on the sale of liquor and tobacco are taxes on business acts which are necessary to the acquisition, use, or expenditure of wealth. Goods imported are taxed at the time of entering the country; domestic products such as cigars, spirituous or malt liquors, playing cards, and (at times) matches, pig iron, and other products, are taxed usually at the time of exit from the factory. It has already been shown that when the tariff duty prevents the importation of foreign goods and by raising the price encourages domestic manufacture of the article, there is virtually taxation of the consumer to subsidize the private manufacturer. A system of properly adjusted compensatory duties (tariffs and internal duties combined) which would prevent tariff duties from having any prohibitive effect whatever could, in a great country like ours, be made to produce any revenues desired. Such a system, combined with the federal income tax, seems destined to be the chief dependence for the national government.
§ 9. #Proposal of the single tax on land values.# Besides the general property tax there are found in the country as a whole a large number of special property taxes. Some of these have been introduced as substitutes for the general property tax; such is the special taxation (above referred to) of mortgages, and bonds. Other special property taxes have been introduced because they were believed to be good in themselves; such are special franchise taxes on corporations and some kinds of taxes on land.
The special taxation of land, or of land values, has been strongly urged by Henry George and his followers since the publication of the remarkable book "Progress and Poverty" in 1879. The doctrine there set forth is that the state should "appropriate land rent by taxation," should "tax land values, irrespective of improvements." It is maintained that "a single tax" of this kind would be quite sufficient for all the purposes of government. The main arguments adduced for this plan may be reduced to three propositions: first, private property in land is essentially unjust, because land is made by nature, not by men; second, the plan would make assessment simple and certain by limiting it to the unimproved land, and making unnecessary the more difficult assessment both of tangible improvements and of intangible personal property; and third, it would work a marvelous reform in social conditions, abolishing poverty and greatly increasing production.
It is impossible within our limits of space to discuss this proposal further than to indicate that: (1) It assumes an untenable theory of property.[4] (2) It overlooks the difficulty of distinguishing the value of the land "irrespective of improvements," from that of the land as it actually is, a difficulty especially great in the case of agricultural land.[5] The difficulty is present even in the case of urban land when the improvements of filling, draining, and leveling have become incorporated with the site.[6] (3) The plan ignores the stimulus (motivating force) which private ownership has given and still gives to the maintenance and fuller productive use of land. Nowhere has production thriven where the state was the universal landlord.
§ 10. #Various reforms in land taxation.# While the single tax plan is defective in principle, its wide discussion has served to direct attention toward the need of reform in the taxation of land. Some proposals looking toward this end are widely favored by opponents as well as by advocates of the single tax. Such are the following:
(a) The abandonment of the taxation of mortgages.[7]
(b) A more correct assessment, in accordance with the present laws, of lots and lands held for speculative purposes, which in practice are now greatly under-assessed.
(c) More adequate special franchise taxation upon corporations for special privileges in the public highways.
(d) Exemption, in value equal to the costs, of improvements on land, such as buildings, drains, fences, and fertilizers, for a limited time after they are made, perhaps five years.
(e) The separate assessment of urban lands used as mere building sites and of the buildings on them.
(f) Taxation of the increase ("increment") of urban land values, periodically or on the occasion of transfer of ownership.
§ 11. #Difficulties in taxing corporations.#[8] Until near the second quarter of the nineteenth century, business corporations (of which there were few) were taxed just as was the general property of individuals. This still continues to be the case in the main in most of the states. The methods and machinery of assessment were (and still are) essentially local and simple, and have proved to be inadequate to reach or justly assess the larger and more complex corporate enterprises when their equipment and business extend beyond town, then county and, finally, state lines. Moreover, the corporate forms of organization presented in complex and puzzling forms the dual conception of property.[9] Here was the tangible wealth of the corporation and there were the diffused rights of ownership, the capital of individual stockholders and bondholders. Confused by this ambiguity, the men of that time believed (as many still believe) that there were here two separate and justly taxable funds of value. The popular will declared (and still declares) that "all kinds of property ought to bear their fair share of the burdens of taxation." Yet to apply this principle would obviously be double taxation and result in confiscation in many cases. Between this doubt and the practical difficulty of assessment, it turned out that corporate wealth, far from being doubly taxed, was largely escaping even its due single burden.
§ 12. #Special taxes on banks.# Attempts to deal with the difficulty without clear perception of its cause took the form of legislative tinkering and patching. Taxes were gathered from corporations by any device that seemed workable. The banks, being the earlier important corporations, were first experimented upon. Taxes on capital stock and on circulation were tried first (in 1805, by Georgia), then a tax on dividends (in 1814, in Pennsylvania, and in 1815 in Ohio), examples which were followed or modified by a number of states. After the national banking system was started in 1864, attempts to tax both the capital of the banks and the stock in the hands of individuals led to federal court decisions and then to state legislation by which now in many of the states the banks are separately taxed on their real estate and the shares are assessed to the individual holders (by various rules), but the taxes deducted from dividends and paid by the bank. There are, besides, special franchise taxes and fees paid by banks in various states.
§ 13. #Special taxes on insurance companies#. Insurance companies present in a striking manner the complexities of the ambiguous property concept. The assets of the insurance companies (we refer here particularly to the reserve companies), which belong in equity to the policy holders (less the claim of the stockholders in the case of the stock companies), are nearly all invested in stocks and bonds of corporations and in mortgages on real estate. Now under the general property tax, strictly interpreted, the policies are assessable at their surrender or reserve valuation in the hands of the policy holders; secondly, the securities and credits which compose the assets are assessable to the company; and, thirdly, the railroads, factories, and houses, built with the outstanding loans made by the insurance companies, are assessable as tangible wealth, to the owners. If such an interpretation were practically enforced it would result in triple taxation to be drawn from the same economic source, and would be utterly prohibitive of the insurance business. The enforcement has, however, been impossible in practice. Insurance companies have comparatively little tangible wealth excepting real estate for offices. This is taxed locally. Several methods have been tried (beginning as early as 1824) to make insurance companies pay taxes (usually for state purposes) on something besides tangible wealth. A tax on receipts from premiums proved most workable, first as applied to "foreign corporations" (that is, to those of other states) and later, generally, to domestic companies also. Now, amid bewildering variety and interstate rivalries in tax laws, the most usual rate is two per cent on gross (in a few cases on net) premiums collected. The taxes on premiums, with various licenses and fees, now amount to 2.15 per cent of the total receipts from life insurance premiums in the United States. This is taxation not on an existing body of accumulated wealth, but upon the process of accumulation, a tax directly on the act of saving. A consistent policy of wealth taxation combined with income taxation would require the abandonment of the present forms of special insurance taxes.
§ 14. #Special taxes on transportation.# Another great group of businesses whose taxation has been especially complex, because they are distributed throughout different taxing districts, are agencies of transportation and communication, especially railroad, sleeping car, express, telegraph, and telephone companies. A state tax on railroad tonnage (Pennsylvania, 1860) was declared unconstitutional by the United States Supreme Court. But many other plans have been tried to compel the railroads to contribute, the chief being by taxes on dividends, gross earnings, equipment, and valuation of capital stock, taxed either to the company or to the stock-holders, (Connecticut since 1849). About a third of the states no longer make the physical plant the basis of taxation, except that in most of them some part or kinds of real estate are taxed locally.[10]
Telegraph companies are still locally assessed in most states, but in over a third of the states are taxed either on gross receipts, or on mileage of wire. Telephone companies are similarly taxed, but sometimes on the number of transmitters, or of subscribers, or on each plant, or otherwise. In a similar manner, express and sleeping car companies are taxed, in the same group of states, on mileage, or on capital stock proportional to mileage, or by license and privilege taxes.
In the case of these corporations, and also of various other miscellaneous kinds of companies, no clear-cut principles serve to guide. The result is "a chaos in practice—a complete absence of principle."[11]
§ 15. #Alternative policies as to corporate taxation.# If the taxation of corporations is not to continue to be treated in a mere hit-or-miss manner, with every possible kind of inconsistency among the various states, some general principles must be recognized and some clear policy be formulated. But there is no general agreement to-day among jurists and economists upon a definite and consistent plan in this matter.
Two alternative policies appear. The first is to make the scheme for taxing corporations quite different in principle and plan from that for taxing natural persons. The assumption in this is that the "general property tax" is an irremediable failure, and is particularly inapplicable to corporations. This plan goes along with the separation of state and local taxation.[12] An unfortunate result of this is to relieve the great mass of taxpayers of the state from, any apparent and measurable part of the tax burden for state purposes and thus to separate responsibility and power in state government. This policy nevertheless is favored by some of the leading authorities on finance.
The other policy is to tax the wealth and business of corporations (excepting those enjoying special privileges) in essentially the same way as other wealth and business. The improvement of corporate taxation would thus be but a part of the transformation of the "general property tax" into a general tax on tangible wealth.[13] If first there is recognized the error of assessing the equitable ownership interests in addition to the body of wealth, and secondly there is created an efficient agency of assessment, the taxation of corporations can be logically and easily brought into accord with a harmonious system of state and local taxation.[14]
§ 16. #General plan for corporate taxation.# The main features in such a plan of reform would be as follows:
(a) Assessment of all wealth by a state agency, with expert nonlocal assessors, appointed and serving only under the merit system.
(b) The assessment of the value of each enterprise and body of wealth as a unit for the whole state, and apportioned to the minor divisions as the basis for levying local taxes.
(c) Apportionment of the total value in the state among the localities by general rule, in the case of transportation and transmission companies, by mileage with due regard to the presence of local real estate and of special industrial equipment such as repair shops and power plants.
(d) Taxation of interstate enterprises only in due proportion to the whole business, by mileage or other rules; inter-state comity to be further developed in this matter.
(e) Account to be taken, in assessment, of various factors determining the earning power, such as good will, patents, and other monopolistic elements, pertaining to and helping to determine the value of the tangible plant of the enterprise.
(f) Account to be taken of the market value of securities and notes owned by a corporation, in determining the taxable value of the whole business, but these not to be treated as a separately assessable "property" (in addition to the tangible plant).
(g) Exemption of the holders of securities and evidences of indebtedness of corporations.{15}
(h) Treatment of special privileges granted to public-service corporations for the use of streets and public highways on the principle of rent-payment to the community rather than by levying a percentage on an assessment.
[Footnote 1: For example, the constitution of Alabama declares: "All taxes levied on property in this state shall be assessed in exact proportion to the value of such property," etc. And the constitution of Indiana declares: "The general assembly shall provide, by law, for a uniform and equal rate of assessment and taxation of all property, both real and personal, excepting," etc. Similar statements occur in most state constitutions.]
[Footnote 2: The general property tax in the United States constitutes:
Of the revenue receipts of the states 38 per cent.
Of the revenue receipts of the counties 76 per cent.
Of the revenue receipts of the incorporated places. 60 per cent.
The total amount collected in this way in 1913 was over $1,083,000,000.]
[Footnote 3: See above, ch. 2, secs. 2, 3, and reference there to Vol.
I.]
[Footnote 4: See above, ch. 2.]
[Footnote 5: See Vol. I, pp. 116, 117, 145, 445-455.]
[Footnote 6: See Vol. I, pp. 117, 146, 453.]
[Footnote 7: See above, sec. 4.]
[Footnote 8: No reference is made in what follows to fees payable but once for the incorporation of new companies or at times of increasing the capital stock of an old one, variously called taxes on corporate charters, license taxes, incorporation fees, organization fees, and charter fees.]
[Footnote 9: See above, sec. 3.]
[Footnote 10: E.R.A. Seligman, "Essays on Taxation" (1895), p. 156.]
[Footnote 11: Seligman, op. cit. p. 136.]
[Footnote 12: See above, sec. 7.]
[Footnote 13: See above, sec. 5.]
[Footnote 14: The assessment feature of this proposal is exemplified more nearly than anywhere else, tho still imperfectly, in the "Indiana plan," in which, however, the true concept of property is recognized only in so far as the shares of corporations of which all the wealth is taxed are not assessed to the shareholders.]
[Footnote 15. This need not prevent a supplementary system of graduated taxation on incomes. See below, ch. 18, sec. 10.]
CHAPTER 18
PERSONAL TAXES
§ 1. Inheritance tax laws. § 2. Fiscal importance of inheritance taxes. § 3. Income taxes; general nature. §4. Income taxation by the states. § 5. History of federal income taxation. § 6. Events leading up to the law of 1913. § 7. Main features of the law. § 8. Exemptions and stoppage at source. § 9. The graduation principle. § 10. A system of taxation.
§ 1. #Inheritance tax laws.# There remain to be considered at least two important forms of taxation that are essentially personal in their unit of assessment, in contrast with the foregoing which are (or should be, if consistent) essentially impersonal[1] These are the inheritance and the income taxes.
Until 1916 little use had been made of inheritance taxation for federal purposes. In that year, however. Congress passed a law which was expected to obtain about $20,000,000 a year from inheritances.
Forty-one states in America have inheritance tax laws (in 1915) which apply generally to property passing either by will or under the intestate laws of the state. The tax is for state purposes. These laws differ in many ways, but are nearly all alike in certain respects:
(1) In applying to the separate legacies rather than to the estate as a whole.[2]
(2) In taxing legacies to relatives in the direct line at a lower rate (or even exempting them entirely) than those to collateral relatives.[3]
(3) In exempting legacies below a certain amount.[4]
(4) In having rates progressing with the size of the legacy; (this feature is less general, but is prominent in most of the later laws).
§ 2. #Fiscal importance of inheritance taxes.# The fiscal importance of inheritance taxes has been comparatively not very great (except in New York State), but it has rapidly grown. In 1903 the receipts from this source (in 27 states) were over $7,000,000; in 1913 they were (in 35 states) $26,000,000. The spread of inheritance taxes and the higher and progressive rates applied are an expression in part of the need of additional revenues and in part of the growing popular concern regarding the concentration of wealth. Yet the actual legislation is something of a compromise between fiscal policy (to get revenues) and social policy (to reduce or to distribute the larger fortunes).[5] In New York legacies of over $1,000,000 are now taxable at 4 per cent to relatives in the direct line and to all others at 8 per cent. In Washington the tax to relatives in the direct line is but 1 per cent, but to others it may go as high as 12 per cent on legacies over $100,000. In Wisconsin, somewhat similarly, the tax may rise to 15 per cent on the excess above $500,000.
§ 3. #Income taxes; general nature.# All taxes, whether assessed upon the capital value of goods or not, come out of (reduce) the incomes now or later available for individuals. But there are various ways of attacking incomes, i.e., of apportioning the tax burden. Income taxation is that form in which the basis of the assessment and levy is the income of the taxpayer as it arises (not accumulated wealth, or capital, or business processes, or expenditures). Of the various conceptions of income[6] the one mainly employed in income taxation is monetary income arising in the course of business, supplemented occasionally (but not consistently) by some items of material income that are expected to come to the person. There is not in the long run such a contrast between wealth taxation and income taxation in their ultimate burden and effect as is usually supposed.
Indeed wealth (or capital) taxation as applied to accumulated wealth is more far-reaching than income taxation, for it falls upon the present worth alike of monetary and of psychic incomes (e.g., the value of a house whether it is let to a tenant or occupied by the owner). But, on the other hand, income taxation attacks directly the monetary incomes from labor, coming as wages, salaries, fees, and profits in business. This feature goes naturally with the fact that the income tax is essentially a personal tax, grouping the items of assessment about a person, whereas the "property" taxes are mainly (tho not consistently) impersonal, making the piece of wealth the primary object of assessment. This summation of each person's income makes income taxation peculiarly suitable for progressive taxation with the social-welfare motive of equalizing the distribution of wealth. It is doubtless this technical assessment feature, rather than any essential advantage as a mode of taxation, that has led to its recent growth in popular favor.
§ 4. #Income taxation by the states#. Income taxes have been used widely in European countries, but not so much in the United States. Numerous attempts have been made by the states to tax incomes, but with small results. Personal incomes, when sought by local assessors, proved to be most elusive. There are (in 1913) but seven states with anything resembling a personal income tax.[7] These are Virginia, North Carolina, South Carolina, Mississippi, Oklahoma, Massachusetts, and Wisconsin. Of these states Wisconsin has the most recent law, and one the widest in its application and the most important fiscally. The law applies a progressive rate to all incomes (with exemption of $700 from wages and salaries) and contains elaborate provisions for corporate taxation. The proceeds are distributed 10 per cent to the state, 20 per cent to the county, and 70 per cent to the municipality in which the tax is collected. In the six other states the tax is on incomes only exceeding a certain amount (North Carolina, $1000, the other states from $2000 to $3500 exemption); some apply to incomes from any source but others do not apply to incomes from property otherwise taxed. The total receipts from these state income taxes in 1913 were but $314,000.
§ 5. #History of federal income taxation.# The income tax seems destined to play a more important part in the fiscal system of the federal government. Until 1913, however, its part had been small. It began to be used under the law of 1867 (when the law passed in 1861 was replaced before it went into effect). This was repeatedly amended and finally repealed in 1870, to continue in force until the year 1872. The rate was 3 per cent on the excess of incomes over $600, and 5 per cent on the excess over $10,000. This law was repeatedly upheld by the United States Supreme Court as not in conflict with the Constitution. Its fiscal results were not large, as it was never effectively administered.
The next income tax law was that of 1894, enacted in connection with the tariff revision of that year. It was declared unconstitutional before it had gone into effect. The main ground for the decision was that a tax on incomes from rent of land as well as on incomes from personal property is direct, and must therefore be apportioned among the states according to population.
In the active discussion of social legislation in the years following this decision public sentiment developed favoring a renewed attempt to get such legislation by amending the Constitution. This was shown by the remarkable fact that a bill for the sixteenth amendment to the Constitution was passed unanimously by the Senate, and almost unanimously by the House. It was ratified by three-fourths of the states and became a law in 1913.[8]
§ 6. #Events leading up to the law of 1913.# Meantime, in 1909 and excise tax law had been passed, applying to corporations in a manner not open to the objections found by the Supreme Court to the law of 1894. The Democratic party, which had passed the law of 1894, was pledged to the passage of an income tax law when it came into power again in 1913. The reduction of the tariff, as well as growing expenditures, moreover, made necessary the development of new sources of revenue for the national government. In other countries the income tax had been found to be a part of a system of taxation especially valuable as "a balance wheel" to equalize the revenues and expenditures. It was deemed by some to be an additional advantage of an income tax that it would make the richer citizens better realize the nature and burden of public expenditure. Most other federal revenues, being derived from the tariff and from taxes on merchandise, are borne mainly by the purchasers and consumers.
An income tax was opposed as sectional taxation by many in the Eastern states where the owners of most of the larger fortunes reside. But to this Senator Elihu Root replied that the states where there was the greatest ownership of wealth pay the largest taxation under any scheme, and ought to.
§ 7. #Main features of the law.# The law as enacted[9] imposes (a) a "normal" tax of 1 per cent on the entire net income of every corporation (engaged in business for profit);
(b) a "normal" tax of 1 per cent on the excess above $3000 of every unmarried individual's income (or $4000 for husband and wife, as indicated in the next section); (c) an "additional tax" (often called a super-tax) ranging from 1 to 6 per cent on individual incomes of larger amounts than $20,000. There are thus eight classes of persons, those entirely exempt, those paying only at the normal tax rate, and six different classes paying a super-tax.[10]
A person with an income of $1,000,000 thus pays $60,020, this being the amount indicated, $25,020 for the first half million plus 7 per cent on the second half million.
§ 8. #Exemptions and stoppage at source#. There are various exemptions, the first being that of $3000 on every individual income and of $4000 on the aggregate income of husband and wife living together.[11] Among other exceptions are sums paid for taxes (except assessments for local benefits), necessary business expenses, losses sustained, and (for the normal tax only) those parts of individual incomes derived from corporations which have paid the tax on them.
The difficulty of getting an honest and complete assessment of incomes is great. All taxation is deemed by the taxpayer to be "inquisitorial" in some degree, and this is particularly true of an income tax. In England had been developed the plan called "stoppage at source." In our law the taxation of corporations at the rate of the normal tax, while requiring them to report the names of those receiving dividends and interest payments, affords an ingenious way of checking up the returns of individuals in respect to a class of investments which is steadily increasing in importance.
§ 9. #The graduation principle#. The most disputed feature of the income tax is the principle of graduation, or of progression. It is upheld in part because in this case it but offsets regression, that is relatively heavier taxation on the smaller incomes, in the case of the other kinds of taxes (tariff, property taxes, etc.). It is urged further that those of larger incomes, especially the largest, have marked advantages over others in making investments. Further it is urged that the higher the income the less does a certain rate cut into "the amount necessary for good living" (as was said in Congressional debate). This is in accord with the psychological principles of choice, of value, and of diminishing gratification. Finally, there is a widespread approval of the progressive rate just because it in so far acts as a leveling influence upon fortunes. The "additional" tax is already important fiscally, yielding over one-half of the total paid by individuals and one-fourth of the total from corporations and individuals.
The income tax returns for the first ten months of the law (March to December, 1913) showed 356,598 taxable individual incomes, equal to about 1 per cent of the taxable population (considering minors to be usually not taxable). Even this proportion, small as it is, is much larger than that of the European countries having a general income tax.
The first ten months' yield (March 1, 1913, to December 31, 1913) was over $60,000,000. A remarkable fact is that 21 per cent of all taxable incomes (not persons) were in the single Borough of Manhattan (the main part of New York City). The receipts from the income tax in 1913 were nearly 10 per cent of the ordinary receipts of the federal government, and about 2 per cent of total revenue receipts of all branches of government, the income taxes paid by individuals being about 1 per cent of the same total, and the super-tax about 1/2 per cent of the same.
The receipts from the income tax during the fiscal year ending June 30, 1915, were $80,000,000, of which $39,000,000 was paid by corporations and $41,000,000 by individuals. Of the latter sum, over $24,000,000 was from the super-tax.
§ 10. #A system of taxation.# The task of reforming and developing the various kinds of taxes and of uniting them into a just and consistent plan for each of the divisions of government in the United States is a vast and difficult one. There are many conflicting interests among states, between states and nation, among the various minor political divisions, and among individuals and classes. There are also conflicting opinions regarding many features of the possible practical plans. Because of these it is safe to predict that progress will not be made quickly, steadily, nor always directed toward a clear ideal. If progress is to be rapid, the public must, however, have consistent principles by which its steps may be guided. In the foregoing kinds of taxation are the various elements which may be united into a system of taxation. It is useful to consider how this might be done.
At the basis of the whole tax structure is taxation, by value, of concrete wealth at the place where it is situated (in situ). This should be regardless of the distribution of ownership or of the residence of the owner. The present misnamed "general property tax" already presents the main outlines of this form of taxation and the general changes necessary in law and method of assessment have been indicated above.[12] Corporation taxation may be adjusted to this either by separate treatment and assignment to state purposes only, or more simply for most states, by assimilating it with the general taxation of wealth and allotting due shares of the proceeds to the various taxing divisions.[13] The national government can, because of its exclusive power of levying tariff duties and also because of its exclusive control over interstate commerce, reach the tax-paying ability of the nation effectively by a combination of tariff and internal revenue taxes. These become a part of business costs, and are diffused over the whole population in general prices.[14]
This system of impersonal wealth taxation may then be supplemented by personal taxation, applied through inheritance and income taxes. These forms of taxation extend over and reach many of the same persons and incomes as do ultimately the impersonal taxes. But the summation of personal incomes gives the necessary condition for applying the principle of progression so far as this is, by public opinion, deemed desirable either for fiscal or for social reasons.
[Footnote 1: See above, ch.17, sec. 3, note, and sec. 5, on this distinction. The poll tax also is personal: see ch. 16, sec. 9.]
[Footnote 2: In Utah the tax is 5 per cent on all estates over $10,000.]
[Footnote 3. Exception, Utah.]
[Footnote 4: Exceptions are Missouri, New Hampshire, Vermont,
Virginia.]
[Footnote 5: It would be more consistent with the purpose of equalizing fortunes to vary the rate not according to the size of the legacy but according to the size of the fortune which the legatee has, or would have, after receiving the legacy.]
[Footnote 6: See Vol. I, p. 26.]
[Footnote 7: In addition, certain items of receipts of companies or incomes of individuals are arbitrarily defined as property for purposes of taxation in a few cases in about fifteen other states. See Wealth, Debt, and Taxation, Report of the Bureau of the Census, 1907, p. 622.]
[Footnote 8: Article XVI. The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several states, and without regard to any census enumeration.]
[Footnote 9: It constitutes sec. 2 of the tariff act of 1913 entitled "An act to reduce tariff duties and to provide revenue for the government and for other purposes."]
[Footnote 10: This may be seen in the following table:
Normal Rate on excess Total
tax on in next class tax on
lower Nor- Addi- upper Total rate
limit mal tional limit per cent
Under $3,000 0 0 0 0 0.00 to 0.00
$3,000-$20,000 0 1 0 170 0.00 to 0.85
$20,000-$50,000 170 1 1 770 0.85 to 1.54
$50,000-$75,000 770 1 2 1,520 1.54 to 2.02
$75,000-$100,000 1,520 1 3 2,520 2.02 to 2.52
$100,000-$250,000 2,520 1 4 10,020 2.52 to 4.00
$250,000-$500,000 10,020 1 5 25,020 4.00 to 5.00
In excess of $500,00 25,020 1 6 upwards 5.00 to 7.00
By legislation in the summer of 1916, after the foregoing was in type, the "normal" rate was doubled and the additional rates were raised.]
[Footnote 11: The exemption is $3000 for each if they are not living together. Thus the law offers a reward of $20 to make marriage a failure.]
[Footnote 12: See above, ch. 17, sec. 5.]
[Footnote 13: See above, ch. 17, secs. 15, 16.]
[Footnote 14: See above, ch. 15, sec. 14, first paragraph.]
PART V
PROBLEMS OF THE WAGE SYSTEM
CHAPTER 19
METHODS OF INDUSTRIAL REMUNERATION
§ 1. Workers subordinate in early societies. § 2. Workers in the Middle Ages. § 3. Growth of the wage system. § 4. Practicability of the wage system. § 5. Time work. § 6. Task work. § 7. Piece work. § 8. Premium plans. § 9. Aim of profit-sharing. § 10. Examples of profit-sharing. § 11. Difficulties in profit-sharing. § 12. Defective theory of profit-sharing. § 13. Purpose of producers' coöperation. § 14. Limited success of the plan. § 15. Its main difficulty.
§ 1. #Workers subordinate in early societies#. As far back as the history of settled and populous communities can be traced, the masses of workers have been subordinate. Civilization began with direction, with obedience to superiors on the part of the mass of men. Even in the rudest tribes, the women and children were subject to the will of the stronger, the head of the family. Among the Aryan races the family system was widened, and the patriarch of the tribe secured personal obedience and economic services from all members of the community. Chattel slavery, the typical form of industrial organization in early tropical civilization, seems to have been one of the necessary steps to progress from rude conditions; students to-day incline to view it as an essential stage in the history of the race. But as conditions changed with industrial development, chattel slavery became an inefficient form of industrial organization and a hindrance to progress.
§ 2. #Workers in the Middle Ages#. Serfdom for rural labor and many limitations on the workman's freedom in the towns were the prevailing conditions in medieval Europe. Serfdom was both a political and an economic relation. The self was bound to the soil; the lord could command and control him; but the serf's obligations were pretty well defined. He had to give services, but in return for them he got something definite in the form of protection and the use of land. Between the lord and the serf there continued an implied contract, which passed by inheritance from father to son, in the case both of the master and of the serf. In the towns conditions were better for the free master class of the artisans who owned their tools and often a little shop where they both made and sold their products. But the mass of the workers, shut out from special privileges, bore a heavy burden. There were strict rules of apprenticeship; gild regulations forbidding the free choice of a trade or a residence; laws against migration into the town; settlement laws making it impossible for poor men to remove from one place to another; arbitrary regulation of wages, either by the gilds in the towns or by national councils and parliaments, forbidding the workmen to take the competitive wages that economic conditions would have forced the employers to pay; combination laws forbidding laborers to combine in their own interest. These conditions prevailed even in the periods and in the countries often referred to as particularly favorable for the working classes (such as England in the fifteenth century).
§ 3. #Growth of the wage system#. Throughout the Middle Ages these conditions were gradually changing, and the changes were hastened by the discovery of America, by the social unrest accompanying the Reformation, and by other forces. Servile dues in the rural districts were, by the sixteenth century, commuted for cash payments in England and had begun to disappear in the other Western countries of Europe. The agricultural work was done partly by the peasant landowners, partly by yeomen farmers on their own land, and partly by laborers hired by landowners or by tenant farmers (enterprisers with some capital for equipment). The growth of commerce and of the mechanical trades in the towns required larger ships, factories, and shops, and increasing investments. This required in the towns an increasing proportion of hired laborers having little or no capital invested in industry, and living on wages. This change went on more and more rapidly with the introduction of machinery in the eighteenth and nineteenth centuries, and "the wage system" grew steadily to be a more and more important part of the whole economic structure.[1]
§ 4. #Practicability of the wage system#. This change has brought with it grave problems of social organization and social welfare, which it is not the place here to discuss. But whatever be the difficulties of the wage system it has certain practical merits of workableness which account for its progress and dominance.[2] The larger the market and the longer the waiting period in industry, the greater the element of uncertainty and financial risk. Under the wage contract the employer, as the one best prepared to do it, takes the risk as to the future selling price of the product; the worker gets in a definite sum at once the market value of his services. Wage payment, therefore, is a form of insurance to the workingman; he gets something definite instead of taking chances he is ill prepared to take. Wage payment is a form of credit to the laborer whose labor is applied to producing the goods for customers distant in time and in place. The employer advances to the workman the present value of the future sale, discounting it at the prevailing rate of interest.
Wage payment implies a contract by which the employee on his part agrees to render service and the employer on his part agrees to pay for it. The methods of determining and measuring the amount of service of the employee are called "methods of industrial remuneration." The many varieties may be grouped in two classes: time payment and piece payment, corresponding with the two modes of measuring labor, time work and piece work.
§ 5. #Time work.# Time work came first and was long almost the only method. In time work the employee is paid by the hour, day, week, month, or year, as the case may be. This is very satisfactory for small enterprises, where the master works with his own hands alongside of the employee, overseeing him, teaching him, and stimulating him by his own presence and example of industry. This method prevails still in nearly all farming work, in many kinds of manufacturing, in most transportation, in clerical positions in trade, and in general where the employee must perform a variety of tasks.
Considering a brief period, it might seem that in time work the worker is paid by time regardless of his effort or performance. However, in every industry there is a recognized, fairly definite standard of accomplishment for those getting the regular market rates of wages, so that the time-standard implies some performance- or piece-standard also. But this is judged by the employer only in a general way, and very commonly men of different degrees of efficiency continue for some time to receive the same money wage. Still, where any differences become noticeable to the employer in quantity of work, quality of work, or personal qualities of honesty, reliability, and good temper, the better workman is likely to obtain a better position, higher pay, more regular employment, or some other form of reward. The employer is more likely at the end of any period of employment, to discharge the man who falls short either in quantity or quality of work, and to retain and advance the better worker. The method of time-payment does not directly tempt the workman to slight the quality of his work by haste. It does not keep constantly before the worker the thought of his own interest in rapid work, often with an accompanying nervous and mental strain. In most occupations, therefore, the workers prefer time work. It does not take exclusive account of the quantity of material product, but leaves place for estimating various personal qualities of the employee which are of value in a business.
§ 6. #Task work#. There are thus both advantages and disadvantages in time work, and their relative importance varies in different industries and industrial conditions. Especially is the difficulty of supervising workers and of ensuring the performance of a certain standard, or minimum, amount and quality of work great in larger enterprises. Various methods of measuring the performance of the worker directly by some other than the time-standards have been developed. All of these, in a general way, involve the piece work principle.
Task work is nominally time work, with a penalty if a certain amount of product is not turned out within a given period. The agreement may be that if the specified task is not done within the regular time, it must be completed in overtime without additional pay. This is also called "doing a stint." This method has been extensively used in the ready-made clothing business in America, and is to some extent involved in many cases of wage payment in manufacturing.
§ 7. #Piece work.# Piece work of the simpler, or ordinary kind, is that where the payment varies just according to the amount of the product, by some physical measurement, as yards of cloth woven, number of pieces turned on a lathe, or amount of type set by a printer. Usually careful inspection by some agent of the employer serves to keep the quality up to a certain standard. The rejected pieces are not paid for, and sometimes also the workmen are required to pay for the materials wasted by their poor work. Piece payment is convenient for home work, such as that of rural peasants weaving cloth for commission merchants or as that of tenement workers in cities. It is also employed very widely in the larger factories in textile and mechanical industries. Selling on commission is a form of piece work.
In piece work the motive to activity is ever present to the worker, and almost always the worker turns out a larger product when paid by the piece than when paid by time. The employer benefits by the more efficient use of his machinery and equipment even when the price per piece is not reduced with the larger output per worker. The worker's earnings may increase rapidly under this plan, but as the manual dexterity acquired is usually of a very special kind which can be used only on one particular machine, the worker has little opportunity to resist a cut in his wages. For this reason and because of the undue strain upon the worker that often occurs, piece work is in many trades not favored by the workers.[3]
§ 8. #Premium plans.# Various modifications of piece work have been developed of late, all involving the features of a minimum task and of a premium for performance beyond that point. These plans are called "premium plans," "progressive wage systems," and "gain sharing." One of the first of these, Halsey's premium plan, fixes a standard time for a job and if the worker falls short of, or merely attains to, that standard he gets the regular pay; but if he takes less than the standard time he receives a fixed premium per hour for the time saved. For example, if the standard time is 10 hours for a $3.00 job and the premium for speed is ten cents per hour, the worker would receive 20 cents premium if he did the work in 8 hours ($2.40 +.20, total $2.60), and 50 cents premium if he did it in 5 hours ($1.50 + 50, total $2.00). His average wage per hour thus rises as his speed increases; it becomes 32.5 cents per hour when the job is done in 8 hours, and 40 cents per hour when the job is done in 5 hours. The reduction of cost per job to the employer evidently would be 40 cents in the first case, and $1.00 in the second. This is Halsey's plan, by which the worker gets one-third and the employer two-thirds of the time saved.
The same plan has been applied (Weir's method) with a premium that equally divides between the workman and the employer the time saved. By Rowan's method the premium is not a fixed sum but a percentage of the standard rate per hour equal to the percentage of reduction in time consumed. For example, if in the foregoing example the time were reduced 20 per cent (to 8 hours) the premium would be 20 per cent of 30 cents, and the workman would receive 36 cents per hour. By this plan the premium becomes less for the later reductions than in either of the other plans. The utmost possible wages would be double the standard rate.
A number of other variations have been worked out by the promoters of recent scientific management, and are known as Taylor's, Gantt's, and Emerson's plans. The authors of all these plans agree as to the importance of fixing the standard rate so that it will leave a possibility of considerable improvement with unusual effort, and of leaving the standard rate and premium unchanged as long as no new process or new machinery is introduced into the business. If this is not done the employees lose faith in the plan and refuse to make the necessary effort to earn the premium. Most of these plans of payment recently have been connected with experiments and studies in scientific management to reduce the time and increase the ease of the operations.
In a variety of ways a bonus or a premium may be paid for quality, or for economy in the use of materials (as to a fireman for using less coal), or for various other results. Every business has its peculiar conditions, which make certain results especially desirable, and certain methods of reward practicable. In some industries, for example, the various plans of piece work and of premium payment are applied to groups of workers (as in collective piece work), the total payment being then divided among the members of the group in some agreed proportion.
§ 9. #Aim of profit-sharing.# Profit-sharing is rewarding the laborer with a share of the profits in addition to his usual contract wages. Payments by the piece and premiums for output are solely dependent on the efforts of the particular workman (or collective group), but in the plan of profit-sharing a premium is given in addition to the regular wage if, at the end of the year, the business as a whole has yielded a profit above a certain amount. Profit-sharing is not merely a gift; it is done usually in accordance with a definite promise in advance. The employer adopting the plan does not intend to lose by it. His purpose is to stimulate the industry of the workers, thus reducing waste and cost of labor and supervision, and thereby increasing profits. He offers to divide with the workman the additional profits which are expected to result from their efforts. There is, in every factory, greater or less waste of materials, destruction of tools, and loss of time, that no rules or penalties can prevent. If the worker can be made to take a strong enough personal interest he will use care when the eye of the foreman is not upon him. The product also can be slightly increased in many ways by the workman's exertions or suggestions. In some cases the quality of the work cannot be insured by the closest inspection as well as it can be by a small degree of personal interest. Either responsibility for the fault cannot be fixed, or the defect is one not measurable by any easily applied standard. Strikes may be averted, good feeling promoted, and contentment furthered if the interest of the worker can be made to approach, and in large measure to become in harmony with, that of the employer. The economic result of the plan, if it can be made to work, should be to reduce the costs of these establishments below what they are. The crucial question is whether profit-sharing alone in any particular case will insure that the costs will be less than those of competitors, thus giving a source out of which an increased amount, really a wage, can be paid to the laborer. For the amount of profits is affected not only by the amount of output, but also by a number of other things that are quite outside the control of the workmen.
§ 10. #Examples of profit-sharing.# The profit-sharing plan seems first to have been successfully tried in Paris, in 1842, by Leclaire, a house-painter. In house-painting there is often a great waste of materials and time by men working singly or in small groups in different parts of the city. By this new method Leclaire enlisted the aid of the workmen, reduced the costs, and increased the profits. It is a remarkable fact that the plan has been continued successfully by the same firm to the present time. It has been tried in many hundreds, possibly thousands, of cases, and is operating in some form or another in more than a hundred firms in Europe and America. The most notable examples of profit-sharing in the United States are the Pillsbury Mills in Minneapolis, Procter and Gamble's soap-factories, in Ivorydale, Ohio, the Nelson Mfg. Co., in Leclaire, Ill., and the Ford Automobile Works, in Detroit. In some cases both manufacturer and workmen value the system highly. It probably has its greatest success when applied in prosperous establishments where profits are regular and large, and where a steady working force is especially desired. The proportion of business done in this way is not large. One hundred firms is a very small fraction of 1 per cent of the total number of firms in Germany, France, England, and America. A still more important fact is that true profit-sharing has spread little since 1890, tho various practices have developed under that name. The most noteworthy of these is the selling of stock, usually at a somewhat lower price, to the employees of a corporation so that, as stockholders, they may have a motive to work for the success of the company (e.g., the United States Steel Corporation). This method as applied to a select few of the employees, who are advanced to official positions in a corporation, is very widely adopted.
§ 11. #Difficulties in profit-sharing.# It seems at first difficult to explain this comparative failure of a plan that looks so attractive in spirit and of which so much was hoped. Yet objections come from the side both of the workman and of the employer. The workman lacks knowledge of the business and is suspicious of the bookkeeping. If at the end of the year the books show no profits, the workman loses confidence, considers the plan to be mere deception, and rejects it. The working of the plan remains in the employer's hands, and the workman really is not a partner in the business. Moreover, the plan puts a limitation upon the workman's freedom to compete for better wages by changing his place of work. It is indispensable to make length of service in some degree a condition to the sharing of profits. Workmen, coming and going, cannot be allowed to share; the percentage given to the others increases with length of employment. Whenever men are thus practically subject to a fine (equal to the amount of shared profits) if they accept a better position, there is danger of a covert lowering of wages. The plan tends to break up the trade-unions, which is one of the reasons that the employers like it, and is the main reason that organized labor opposes it.
The employer on his part objects to the interference with his management, the troublesome inspection of the books, and the constant complaints of the workmen. He dislikes to have the profits known; if they are large, the advertisement of success invites competition; if they are small, publicity may injure credit and depress the value of the enterprise. In view of all these difficulties it is not surprising that while the plan often starts promisingly, it usually fails after a short trial. Business methods are severely subject to the principle of the survival of the fittest. Through competition and the survival of the firms that adopt improvements, better methods must eventually supplant poorer ones. If a method fails to spread when it has been tried for seventy-five years and all are free to adopt it, the strong probability is that it has serious defects inherent in it.
§ 12. #Defective theory of profit-sharing.# It is usually better to make wages depend on the worker's efficiency rather than on the profits of the whole business. The strongest motive to efficiency is present when reward is connected immediately and directly with effort, not with some result only slightly under the worker's control. Any change in the amount of profits is only partially and indirectly related to increased effort of the worker. The "profits" may be nothing, tho all the manual workers may be exerting themselves to the utmost. The wage bill is but one of the groups of costs. Profits are the net result of many influences. Chief among these is the skill in planning and conducting the business. This function of management is either performed by the same person that is carrying the financial risk, or by some salaried employee selected by him. It is this management function the reward of which should, in theory, be made to vary with the amount of profits; and in fact such an arrangement (managerial profit-sharing, so to speak) is undoubtedly in operation in thousands of cases, but is not included in the usual conception of profit-sharing. Many salaried managers are in receipt of a share of profits and are gradually acquiring an interest in partnerships or a larger share of ownership in the enterprise for which they work. But ordinary profit-sharing is not in accord with the general trend toward the centralization of responsibility in the hands of competent managers, ensuring to the worker a definite amount in advance, as high as conditions make possible. The system of premiums, or bonus payments, for output, where it can be safeguarded against abuses, gives in most cases better results and is rapidly spreading. It is sounder in conception and works better in practice as a method of remuneration for most of the workers.
§ 13. #Purpose of producers' coöperation.# Since the early part of the nineteenth century many well-wishers of humanity have cherished high hopes that the whole wage system might gradually be replaced by the plan of producers' coöperation among workingmen. Producers' coöperation is the union of workers in a self-employing group, performing for themselves the enterpriser's function. The workers hope to get what seems to them to be a needless drain of profits into the pockets of the employer and unnecessarily high salaries to managers. To do this they must perform the enterpriser's function as to investment and risk. Collectively or through their representatives they must undertake to furnish capital and management as well as hand-work. The capital may be supplied either by the members, individually or collectively, or may be borrowed from outsiders, who are thus merely passive investors. Usually the return to capital invested by members is limited to 5 or 6 per cent, so that this part of the capital likewise is treated as a passive investment, and all the real variable profits are distributed to the members as wages. The hope has been as in profit-sharing to increase the amount of profits through the stimulus the plan might give to the workers and by saving in friction, disputes, and strikes.
§ 14. #Limited success of the plan.# Practically the plan has been made to work in a comparatively few simple industries. The most notable example of successful coöperation in America was in the cooper-shops in Minneapolis. There were few and uniform materials, patterns, and qualities of product, few machines and much hand-labor, simple well-known processes, a simple problem of costs, a sure local market. After more than thirty years the main shop was still in operation, but with a membership of the older men and with no growth, A number of the less skilled workers receive ordinary wages. In America a few of the productive coöperative companies are found operating small factories. In England, there have been numerous successful societies, but all in small enterprises, mostly connected with agriculture. Within the whole field of industry, this method of organization makes little if any progress. Most experiments have failed and the successful ones have become or are tending to become ordinary stock companies with most of the stock in the hands of a few men. Therefore, whether losing or making money, they nearly all cease to exist as coöperative enterprises. This result has disappointed the hopes and prophecies of many well-wishers of the working classes.
§ 15. #Its main difficulty.# The main difficulty in producers' coöperation is to get and retain managerial ability of a high order. Failure to do this results in inability to maintain and keep in repair the equipment and to pay the ordinary returns to the passive investment, and financial failure follows. There is no touchstone for business talent, no way of selecting it with any certainty in advance of trial. This selection is made hard in coöperative shops by jealousies and rivalries, and by politics among the workmen. A man selected by his fellows finds it difficult to enforce discipline. In coöperation there is occasionally developed good business ability that might have remained dormant under the wage system; some work-men showing unusual capacity cease to be handicraftsmen. But the unwillingness on the part of the workers to pay high salaries results in the loss of able managers. Having demonstrated their ability, the leaders go to competing establishments where their function is not in such bad repute, and where they are given higher salaries, or they go into business independently, being able easily to get the needed backing from passive capitalists.
Coöperative schemes thus suffer from the workers' inability to appreciate the functions of enterprise and management. Most men make a very imperfect analysis of the productive process. They see that a large part of the product does not go to the workmen; they see the gross amount going to the enterpriser, and they ignore the fact that this contains the cost of materials, interest on capital, and incidental expenses. Further, they fail to see that the investment function is an essential one. The theory of exploitation, as explaining profits, is very commonly held in a more or less vague way by work-men. With a body of intelligent and thoroughly honest work-men, keenly alive to the truth, the dangers, and the risks of the enterprise, coöperation would be possible in many industries where now it is not. Producers' coöperative schemes usually stumble into unsuspected pitfalls. When a heedless and over-confident army ventures into an enemy's country without a knowledge of its geography, without a map, and without leaders that have been tested on the field of battle, the result can easily be foreseen.