of great importance in the case of so-called "factory mutuals' which pay to their policy holders "dividends" amounting in some cases to ninety or ninety-five per cent of the premium received. It is fortunate that this amendment prevailed, as in a recent decision of the Supreme Court it has been held that the inclusion of such "dividends" in the income of corporations under the corporation tax law of 1909 was invalid. The elimination of "dividends," however, does not dispose of all the difficulty, as there still remain some socalled earnings of insurance companies which are really nothing but a return of capital to the policy holders.1 Mr. Hull was quite emphatic in his statement that there was no intention of taxing capital rather than income, but he was not thoroughly clear in his own mind as to the exact distinction to be made, and he maintained that the accounts of the insurance companies were not so kept as to permit the legislature to distinguish between the two conceptions.

The fourth difficulty connected with the concept of income is presented in determining the deductions to be made from gross income in order to arrive at net income. With respect to certain of these items, there is no controversy. Such are the provisions of the law for deducting necessary business expenses, interest on personal indebtedness, losses actually sustained during the year, including worthless debts charged off, and a reasonable allowance for exhaustion, wear and tear of the property arising out of its use in the business (not ex

1 The objections of the insurance companies are presented in a series of memoranda printed in Tariff Schedules, Briefs and Statements filed with the Committee on Finance, United States Senate. — Income Tax and Customs Administration. Washington, 1913. See esp. pp. 1947–1986, 2119–2126. This whole subject is well treated by K. K. Kennan in a monograph entitled The Federal Income Tax in its Relation to Life Insurance Companies, Milwaukee, 1913.

The accountant's point of view is summed up in W. A. Staub, Income Tax Guide, 1913, p. 50, as follows: "Only the income derived from the investment of premiums between the time they are received from the policy holders and the time they are returned to them or their beneficiaries in the form of death claims, annuities, endowments, surrender values, dividends,' less the expense of conducting the business, represents real income derived from the amounts placed in a company's hands by the policy holders for insurance purposes."

ceeding in the case of mines five per cent of the gross value of the year's output at the mine). Nor is there room for dispute as to the propriety of the permission to deduct from gross income of individuals, not only dividends from corporations which have paid a tax on their net income but also any income on which, as will be explained later, the tax has been withheld at the source. The real difficulty in the matter, apart from the question of actual fact as to the difference between repairs and permanent improvements, relates to the question of taxes and of interest on corporate debts.

As to the former, the law permits deduction for all taxes, not including, however, in the case of individuals, assessments for local benefits. Why this deduction should be allowed is not clear. It might indeed be claimed that so far as taxes on business are concerned, this ought to be put on a par with other outlays incurred in order to secure a net profit. But where the income is derived from other sources than purely business transactions, the legitimacy of the deduction seems questionable. It is to be conceded, however, that herein lies. a real difficulty in the theory of income.

In considering the deduction of interest on corporate debt, it should be remembered that the theory of corporate indebtedness differs, as we have elsewhere pointed out,1 in some important respects from that of individual indebtedness. In the case of the individual, taxable property consists in the surplus above indebtedness, and the taxable income consists in the corresponding surplus of receipts. Capital stock of a corporation, however, usually represents only a portion of the property, while the remainder is represented by the bonded indebtedness. Strictly speaking, indeed, the proper distinction is not between corporate and individual credit, but between production and consumption credit. In the case of corporations, however, while debts are sometimes contracted to meet pressing exigencies and may thus in a way be considered a kind of consumption credit, mortgage bonds, at least, are al

1 Seligman, Essays in Taxation, 8th edition, 1912, pp. 106–107; and supra, P. 513.

most exclusively issued in order to provide capital. Economically speaking, the corporate capital consists of the bonds and the stock. Theoretically, therefore, the income from interest on corporate bonds ought not to be deducted. As a matter of fact, it is not so deducted in European incometax laws. In the corporation tax law of 1909, however, interest on indebtedness was deducted, but only on an amount of debt not exceeding the capital stock. In the present law we find a compromise. Interest paid is allowed as a deduction from income on an amount of indebtedness not exceeding one-half the sum of the corporation's interest-bearing debt and its paid-up capital stock. Thus it will be seen that the new tax is more favorable to the corporations than was the excise tax. The compromise, however, is entirely arbitrary. Either there should have been no deduction at all, or the deduction should have been permitted on all the indebtedness which might be regarded as a result of purely consumption credit.

Another point, and one in which the corporations appear to have a just cause for complaint, is the disappearance of that provision of the law of 1909 which permitted corporations to deduct from gross income the dividends received from the stock of other corporations held by them. The result of the disappearance of this provision will be a great burden on the so-called holding companies, as the same income will be taxed once to the subsidiary companies and again to the parent company. The reason for this change was obviously to interpose obstacles to the formation or to the continuance of holding companies. While this is not the place to express any opinion as to desirability or the economic legitimacy of holding companies in general, it is quite clear that, in the case of railroads at least, some form of holding company of noncompetitive lines may be entirely compatible with the best public interests; and in any event the attempt to combine fiscal and prohibitive ends in the same measure is of doubtful wisdom.

III. The Tax Rates

In discussing the question of tax rates the two chief problems are those of exemption and of graduation.

The most important point to be noted under the head of exemption is the fact that the tax applies to individual incomes only when they exceed $3000. In the law of 1894, it will be remembered, the exemption was placed at $4000, and in this bill, as originally drafted, the exemption was also kept at the higher figure. In the course of the discussion, however, and partly as a concession to the feeling that the limit was excessive, it was reduced to $3000, with additional exemptions of $500 or $1000 for children. In the final draft, while the figure of $3000 was retained, the exemption for children was eliminated and was replaced by an additional exemption of $1000 for a married couple. A total exemption, however, of $4000 only is permitted in the case of the aggregate income of husband and wife when living together. It is to be noted, moreover, that the exemption applies to the first three or four thousand dollars respectively of any amount of income; that is to say, three or four thousand dollars respectively are always to be deducted from the net income, in order to reach the taxable income.

In the discussion of the law, several attempts were made to reduce the exemption to a lower limit. It was repeatedly pointed out, however, that this exemption did not mean so much the minimum of subsistence, as a minimum of comfortable existence according to the desirable American standard of life. An American family of from three to five children living in decent comfort, and desirous of giving the children a college education would, it was maintained, need all of $4000, or in the case of a widow, certainly all of $3000, for meeting the necessary family expenses. It was further urged that the recipients of smaller incomes are already bearing more than their share of the burden, through the federal indirect taxes, and that this comparatively high exemption would only redress the inequality. Finally it was argued

that the administrative advantages of the high exemption in averting needless expense and endless complications, such as are found in the English system, would far outweigh any objections to the higher exemption. While, however, these considerations were prominent in the minds of the framers of the measure, there is little doubt that the controlling reasons for so high an exemption were primarily political. One of the congressmen ingenuously asked, in reply to a proposition to reduce the exemption: "Does the gentleman not think it would defeat every member who would vote for this amendment if the fact were known at home?' "1 And another member said: "I venture the assertion that if Congress at the first opportunity which it has had of levying a direct tax upon the people without apportionment, should levy a tax which would fall upon every citizen of the land, that tax would not stay upon the statute books longer than the first election which followed the first call of the tax collector."2 In justice, however, to the majority, we must quote the statement made by Mr. Murray, of Oklahoma: "There are those who would say that we should begin at $1000, in lieu of $4000. They forget the principle upon which this tax is founded, and that is that every man who is making no more than a living should not be taxed upon living earnings, but should be taxed upon the surplus that he makes over and above that amount necessary for good living. We also recognize the assumption that $4000 will reach the highest grade of good living. . . . The purpose of this tax is nothing more than to levy a tribute upon that surplus wealth which requires extra expense, and in doing so, it is nothing more than meting out even-handed justice." 3

The other exemptions may be passed over rapidly. The salaries of the present President of the United States and of the federal judges now in office are exempt out of regard for the constitutional provision prohibiting any diminution of their compensation while in office. This, however, does not 1 Congressional Record, p. 1215, May 6, 1913. 2 Ibid., p. 1218.

8 Ibid., p. 1219.