Direct Taxation and Economic Growth

8/13/2019 Direct Taxation and Economic Growth

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Direct Taxation and Economic GrowthAuthor(s): Ursula K. HicksSource: Oxford Economic Papers, New Series, Vol. 8, No. 3 (Sep., 1956), pp. 302-317Published by: Oxford University PressStable URL: http://www.jstor.org/stable/2661759

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DIRECT TAXATION AND ECONOMIC GROWTH1By URSULA K. HICKS

DURING the last few years, n country ftercountry, he burden of directtaxation has become a live issue. In the industrialized countries highrates of tax establishedduring he war and largelymaintainedafter t (duemainlyto the needs ofdefence) are a natural cause of this preoccupation.In the less-developed countries nterest n the subject has been no lesskeen,because ofthe fearthat income and profit axes, whose revenue isso necessary o financepublicworks,will deter theindustrialdevelopmentwhich s so ardentlydesired.In this countrydiscussion has naturally centredround the Reports oftheRoyal Commission n the Taxation of Profits nd Income, and mattersarising herefrom.2 lthoughthe scope of the Royal CommissionReportswaswide, subsequent discussion eemsvery argely o have beenconcernedwith questions of equity. Under the circumstances this was probablyinevitable. Minor and unnoticed nequities tend to become major, and toattract attention,when tax rates are heavily increased. A great part ofthe Commission s ime was occupied with mattersof this sort. Secondly,inflation tself s inherentlynequitable, as between some sorts of incomereceivers nd consequently ome sorts of taxpayers,and others. The factthat taxes may have odd effects n a period of rapid inflationdoes not,however, prove that in general and in a more orderlyperiod the taxesthemselves re wrong. This concentration n the equity aspect of ncomeand profits axes seems to me to have been doubly unfortunate. On theone hand it has emphasized differences hich are matters of feeling orpolitics) and forwhich there s little f any quantitative support. On theother t has diverted attention from he economicallymuch more impor-tant aspect ofthe effect f current ncome and capital taxes, or of alter-native methods, on economic growth. In the present paper I shallconsequently eave almost whollyon one side questionsofequity,howeverdefined.In the 1930 s we regarded urselves s a mature or stagnant economyunlikely to develop much further, nd in fact, in spite of ratherhighunemployment much of it a legacy from a very different et-up in the1920 s) we were doing quite well, thanks largely to the very favourable1 The gist of a paper read before the Marshall Society at Cambridge, 10 May 1956.2 Especially the Second Report of theCommission 1954), mainly concernedwithpersonalincome tax, and the Final Report (1955), mainly concerned with company taxation. Mr.N. Kaldor s An Expenditure Tax is a notable by-productof his work on the Commission.Reference should also be made to Dr. I. M. D. Little s review of this book in EconomicJournal,Mar. 1956.


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URSULA K. HICKS 303termsof tradewhichgave us our essential mports ffood nd raw materialsat very ittle cost in termsof our own efforts. But in the post-warworldwe have become an underdeveloped country ourselves, n the strictlyparallel sense of countries like India: first,we are in urgent need todevelop faster (in terms of increased productivity, eal Gross NationalProduct or what you will) than we were, or probably now are doing;secondly,we have got to achieve this against a backgroundofnot verygood indigenousresources of which the 1956 plan of the Coal Board isa sad reminder) nd with a chronic hortage of the most needed skills.2

Naturally the outlinesof a tax structure ailoredfordevelopmentwilllook substantially differentn a conventional underdeveloped countrythan in a highlysophisticatedeconomy like ours. Particularlyrelevantdifferenceseem to me to be three: (i) in an underdeveloped country, nthe usual sense of a backward country, good deal more developmentresponsibilitiesmust be undertakenby the government han is necessarywhere ndustrial kills re alreadymature;hence ii) inbackwardcountriesgovernments eed tax revenue very urgently,moreespeciallyas theyhaveconsiderable difficultyn borrowing, ither at home or abroad (althoughwith higher nterestrates investorsare moreforthcoming); iii) in back-ward countries muchgreater burdenof achievingthe optimumrate ofgrowth alls on fiscalpolicy thanneed be the case in the United Kingdom,because in such countries monetary controls are largely unusable orineffective.But fundamentally he problem s similar n the two typesofeconomy.Mr. Kaldor and the functional financiers 3 efine he prime objectiveof taxation as the avoidance of inflation. In a developing countrythisconsideration s ofprime mportance orgrowth, ince nflationary ressureis likely to be very high where the development programme s largerelatively o the size ofthe economy, nd voluntary aving negligible. AsProfessor Lewis has shown4the prime necessity n such an economy isthat the tax structure hould be geared so that marginalrates oftax arealways higher han average; ifthiscondition s realizedthengovernmentshouldalwaysbe able rathermorethanto containthe nflationary ressuregenerated by the processof development. In principlethe simplesttypeof tax which satisfies his condition s a general progressive ncome tax,but in primitive onditions his is not easy to achieve, and recoursemust

1 Cf.J. R. Hicks, The Social Framework, h. xxi.2 Since writingthe above the D.S.I.R. Report on Automation has heavily underlinedthis point.3Cf. especiallyA. P. Lerner, The EconomicsofControl.4W. A. Lewis, The Theoryof EconomicControl, . 239.


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304 DIRECT TAXATION AND ECONOMIC GROWTHbe had to outlay taxes whichhave someofthesame effects.Thus expendi-ture taxes have an importantpartto play in curbing nflationnprimitive;conditions, ut to be effective hey must be assessed on thingsof whichpeople buy more as they get richer, nd must cover the purchasesof aslarge a sectionof the population as possible. This is of course farfromMr. Kaldor s expenditure ax.For a country ike the United Kingdom I feel we need to define taxstructuregeared to growthmore carefully. The basic needs are (i) tosecure adequate rewardsforenterprise nd initiative, especially in lineswhich promise a rapid rise in the G.N.P. (the absence of an effectiveincometax in a backward countryprobably mplies that thisproblemwillsettle itself); (ii) to secure sufficientnvestment capital formation ndresearch) n growth-promotingines; and (iii) to secure sufficientontrolof consumption nd investment, oth in the public and private sectors, oenable the authorities to pull back into line the inevitable deviationsabove or below the warranted rate of growth if they show signs ofreaching erious dimensions. This calls forsomethingmuch more subtlethan is possible in a backward country; however, n a country ike theUnited Kingdom taxation is not the only,and not always the best, wayofachieving hese objects. Nevertheless t must clearlyplay an importantpart.At the start I want to emphasize a point that sounds obvious, but isoftenoverlooked: that is that we are now in 1956; it can be dangerouslymisleading o attemptto solve theproblemsof 1956 in termsofthe back-ground f1950 orevenof1954. Eleven yearsago therefinished war whichhad a profound ffect n the world economy, nd more particularly n theBritish economy. Of the changes wroughtby the war and its aftermaththosethat aremost relevant to our discussioncan, I think,usefully e putinto three classes: (a) those which were essentiallytransitory nd whichhave now passed away-in most countries n this sense the war may besaid to have ended about 1952, being slightlydelayed by the Koreanepisode; (b) those which have proved more enduring and which stillexercise ome, although declining ffect,ncontrast o a generaltendencyto return to the pre-war trend; and (c) those changes which must beexpectedto be permanent, romwhich there s no goingback. Naturallythesecategoriesmerge ntoone another t theedges, especially a) and (b).The permanent changes meritfirst ttention, since they are now partofthe data. Ofthese we may single out five: (i) (moreor less) halving ofthe value ofmoney; this is partly,but not wholly,responsiblefor ii) theincrease n the number of income tax payersfrom ome 3 millionto over17million, ogetherwitha tremendous ise in the height nd progression,bothof ncometaxes and of death duties; (iii) a fundamental hange n the


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URSULA K. HICKS 305-positionf ndustrialized ersus non-industrialized ountries save perhapsfor the two giants of the U.S.A. and U.S.S.R.); the independence offormer olonies has brought about a real loss to most West Europeanindustrialized ountries,whileat the same time theprocessof ndustrializa-tion of the primaryproducing countries mpliesboth a greaterfood con-sumptionat home and a wider spread ofmanufacturing kills,all addingup to the virtual certainty hat we shall not in this country enjoy againthe favourabletermsof trade ofthe 1930 s; (iv) the establishment f thewelfarestate-not indeed implying hat the percentageofsocial expendi-ture to thenational income has been drastically ncreased,butrather hatthere has been a change fromnegative social services (concernedwithmoney grants o thepoor and unemployed), o positive servicesofnationalhealth, family allowances, and old-age pensions, all of which greatlydecrease the need forbuilding personal reservesagainst emergencies amatter of relevance to personal saving). Against these fourchanges onthe whole tendingto make thingsmore difficult orgrowth n the Britisheconomymust be set; (v) the muchgreaterunderstanding f the workingofeconomicprocesses, mplicit n the new techniquesofsocial accountingand input/output nalysis.It is important to note that these changes (or the significant art ofthem) took place rather quickly in what is now a considerably longtimeago; hence it must be expected that their mpact effects,ncludingthe short-period djustments which individuals and firmsmade to thechanges,have now been largelyexhausted. Theyhave becomepartof thedata.Turningto the otherextreme, he transitory hangesto which we neednow not pay too much attention re (i) rationing nd themass of war-timecontrols (in otherwords, by and large, the price mechanismhas beenrestored both internally and internationally): this is of fundamentalimportancefor the effects f taxation; (ii) the exceptionally ow interestrateswhichwere establishedduring hewar and subsequently ntensified,partly deliberately, partly as a consequence of a long process of theglutting ofa closed economy with cash in a way that could hardly havebeen avoided. Nevertheless, lthough it has formallypassed away, theeffect f this war-time hange stillcasts its shadow in the excess liquidityof the national debt, making t difficulto exerta creditsqueeze.This latterchange s thusalmost in my (b) category. The most relevantotherchangein thiscategory s concernedwith what has been happeningto the distributionof available incomes. Although the latest figuresare only complete up to 1954, it appears that by then the turning-pointhad already been reached, and the first igns of a return towards the

I Cf.D. Seers inBulletin of Oxfordnstitute f Statistics,Apr. 1956.


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306 DIRECT TAXATION AND ECONOMIC GROWTHnormal patternwere reasserting hemselves. The effect f the war and itsaftermathhad been a tremendous evelling up of distributed ncomes,and of course still more of available (post tax) incomes. This levellingprocess had proceeded both between the different ategories of income,and in each category between the skilled and the unskilled, the leadersand the followers. Although the available breakdown of income cate-gories s not ideal from his point of view, the change s obvious. Between1938 and 1954 property ncomes had risen 40 per cent., mixed (farm ndprofessional)140 per cent., wages 220 per cent., salaries and pensions250 per cent. and social security benefits270 per cent. Since farm n-comes rose heavily, therewas a relative decline in professional ncomes,while salaries are inflatedby the inclusion of a number of new firmspension schemes. By and large a substantial evellingbetween rich andpoor is implied. These changes were heavily reinforced y the effects ftaxation: property nd mixed incomes lost 20 per cent. of theirpre-taxincomes, wages, salaries, and pensions only 8 per cent.The two most striking spects of this levellingprocess have been thedecline n the shareofincomefromproperty n the one hand and the riseofunskilledrelatively o skilled earnings n the other. Property ncome ofcourse s by no means whollythe perquisiteofa rentier lass; most of themiddle and upper incomes are mixed in the sense of being derivedpartly from present labour, partly from the fruit of past labour, andpartly, lthough to a diminishing xtent,from nheritedwealth. Further,thewage-earning entier s a very significant lement n the economy; hisquite extensive savings are largely invested in house property,which,due to rentcontrol,has sufferedhe largestdecline ofany category. It ismore true to say that levellinghas been at the expense ofsaving than atthe expense ofa now relativelyunimportant entier class . A change ofthistypehas been experienced n all Westerncountries; t is an inevitableaccompanimentof war and inflation. The significance orBritain is first,that in 1938 post-tax incomes were already more equally distributedthanin comparable countries, or xampleCanada and the United States;secondly,that thenatural changehas been reinforced o a greaterextentby deliberatepolicy.Not lesssignificanthanthegreater qualitybetweendifferentategoriesof ncome nthe UnitedKingdomis thegreater qualitybetweendifferenttypesof ncome within ategories, specially betweenskilledand unskilledin the weekly wage-earninggroups. Here we can draw on ProfessorLloyd Reynolds s1 elaborate long-period international comparisonsbetween the wage structureof the United Kingdom, United States,France, Switzerland, nd Canada, as well as themoretentativeconclusions

1 The Evolutionof WageStructure, ale UniversityPress.


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URSULA K. HICKS 309is this group, the managerial class with ?1,000-k3,000 before the war,now ?2,000-95,000, which it is probably more importantto help in theinterests f increased productivity, han any other n the country.It should be remembered hat the surtax-exemption imit has neverbeen raised sinceitwas established at ?2,000 after hefirstwar; there s astronga prior case forraising t now in some correspondencewith thefall in the value of money. One of the factorswhich has operated sincethe war to reduce the efficiencyfassessmenthas been the great ncreasein the numberof surtax payers,making it impossibleto deal with eachassessment ndividually n thetraditionalpre-warmanner. This failure oadjust to the change n the value of money s (or should be) the substanceof the annoyance of Dr. Little s academic friendwho complained thatsurtaxwas never intendedforthe likesofhim.2 In a majorityofcases,however,one could retortthat in a developing economy unproductivelabour ofthat sorthas no special claimon economic resources, s arguedby Adam Smith 170 years ago. Anotherrelevantchange (recommendedby the Royal Commission)would be the continuationof earned incomeand family rebates beyond the surtax-exemption imit. Still more im-portant could be the raisingof the ceilingforscholarshipsfrompublicauthorities o the university orthe adoption of a quota system o includeall children), hus discriminatingn favour of the more intelligent n allincome groups,and not as at present,merely n the lower ncomegroups.It may be objected that these are small changes; but they would addup quite substantially, and they would almost certainly mpingewherethey were most wanted-in favour of fairly high earners with smallpropertyendowment. Neverthelesswe should clearly also look at moreadventurous alternatives, uch as Mr. Kaldor s expenditure ax. But herethere s one preliminary ointto settle. In orderto make his expendituretax morepalatable Mr. Kaldor introduces spreading of the tax burdenin two different enses. First, since (unadjusted) an expendituretax ismuchmoreregressive n the large family han an incometax (assumingthatthere s somemarginof saving) the quotient 3 system s introduced,whereby he ncome o be taxed is dividedbythenumber n thehousehold;this goes far beyond any familyrebates that have ever been suggested,but if twereacceptable it couldequallywell be applied to an income tax.Secondly,it is ofcourse obvious that an expenditure ax discriminatesagainst fluctuating expenditure (just as an income tax discriminatesagainst fluctuating ncome,a point whichwe shall have to examine later).But fluctuations n expenditureare likelyto be much morewidely and

1 The Chancellor has recentlygiven figures f the estimated cost of raisingthe surtax-exemption limit. To raise it to ?3,500 would at existing tax rates cost only ?40 million,to?4,000 would cost ?50 million. Cf. The Economist,12 May 1956.2 Little, op. cit. 3 Kaldor, op. cit., pp. 208-9.4520.3 x


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310 DIRECT TAXATION AND ECONOMIC GROWTHfortuitouslypread than fluctuations n income; they will always arisewith the purchaseofconsumersdurables and are likelyto arise whenevera familyemergency ccurs. Mr. Kaldor proposes to deal with the firsttypeoffluctuation y spreading iabilityover a numberofyears,and thesecond by making nsurance easy. If these concessionsare to be assumedpracticalforan expenditure ax they must also be assumed practical foran incometax. The Royal Commission ried veryhard to get the InlandRevenue to agree that a simple spreadingof iabilityof fluctuatingncomewould be practical,but reluctantly hey were persuadedthat thiswas notso, at least not in the foreseeablefuture. Hence, ifwe are comparing hestimulusfordevelopment of the two formsof tax we must treat themsimilarly,which implies, t seems,that we must rule out the benefitsofboth typesof spreading n the expenditure ax. Otherwise t is like cheat-ingin one game of patience and not in another.Even allowing for spreading it is Mr. Kaldor s1 conclusion that, inrespect of work incentives, the only superiority f the expendituretaxoverthepresentBritish ncometax, assuming the same ratesoftax, s thestimulus to saving of the expendituretax. Even this would probablydisappear ifthe same totalrevenuewas to be collected,depending on thetaxpayers outlay habits. Only in the case wheresaving is for ndefiniteaccumulation in which case it never bears any expenditure ax) is therea clear superiority ver the income tax. We musttherefore sk what arethe motiveswhich induce people to save, or more fundamentally,whatare the motiveswhich nduce themto work hard enough to have a surplusover current onsumption,which is available for saving?There appear to be three chief motives behind this phenomenonofextra work; and they are probably of very differentmagnitude. First,there s the desire to save up for arge outlays,a process whichcannotbe generally ubstituted y borrowing xceptat prohibitive ost. Secondly,there is the desire to save for future needs, above all to increase theamenities available in retirement, nd finallythere is presumablysomedesire to accumulate indefinitely, ith no expectationof spending,unlessby one s heirs. It is this lattertype which is especiallyfavouredby theexpenditure ax; but it can hardly be doubted that social and economicforces, s well as theHealth Serviceand extended pensions,and above allthe influence f heavy death duties, have in the presentgenerationmuchreducedthe propensity or spontaneoussaving on this account. There isno evidencethat the effect f the expendituretax would be sufficientoovercome hese forces, ven ifwe are preparedto agreethat the concentra-tion ofwealthwhich it would promote s in itselfa good thing.The work motive of the desire to save forretirementhas also been

1 Kaldor, op. cit., pp. 134 ff.


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URSULA K. HICKS 311substantiallyweakenedbythespreadofpensions. Muchtherefore ependson the revenueto be taken respectively y the two alternativetaxes. Anunspread expenditure ax would be verytough at the momentof retire-mentwhen a new mode of lifehas to be established. British ncometaxleaves this form f spendingcompletelyuntaxed so far as it is met out ofaccumulatedearnings or according o themostrecentbudget concessions)out of funds accumulated by insurance. Finally, if saving is mainlysaving up an unspread expenditure ax would be muchtougher han anincome tax, especially if, as seems likely, because of the narrowertaxbase, its rates and progressionwere higher. That saving up is a veryimportant lement n extra working oday can hardlybe doubted in thisage of durable consumers goods. Indeed the dissaving since the creditsqueeze was tightened s a strong ndication that consumerswereheavilyinvolved in this process.We musttherefore, think, oncludefirstly,haton balance an expendi-ture tax (especiallyan unspread expenditure tax) is less work incentivethan British income tax; and secondly,that British income tax is notseriouslydisincentive, nd could be made considerablymoreincentive fthe quite feasiblesmall reforms uggestedabove were introduced; hencefordevelopment t would be the superior nstrument.The mainobject of an expenditure ax, however, s not to make peopleworkmore but to make themspend less, especiallyto stopthemspendingin excess of theircurrent ncomes. From the point of view of economicgrowth, or even of stability without growth, such dissaving can be anuisance since it draws resources away frommoreproductive uses andmay set up an inflationary ressurewhichrequirescorrection. t is there-foredesirable to investigatehow far British income and capital taxesstimulate forms fdissavingwhichare undesirable n the sense that theyare either nconvenientlyargefrom hepointofviewofapplying correc-tive, or are related to non-functional eceipts. It cannot reasonably beclaimed that this is true of dissaving the accumulated savings of a life-time in retirement,ince the anticipationof being able to do this is oneof the strongestwork ncentivesduring ctive life.The two typesofdissavingwhich do seem to fit nto this categoryare(i) the spendingofcapital gains due to speculation (which, however, snot necessarily devoid of economic function), nd methods of avoidingsurtax, such as over-retentionfprofitsn a closelycontrolledfirm, nd(ii) the deliberatedissipationof an estate in anticipationof death duties,through iotous iving. Since I have latelywritten nthesubjectofcapitalgains taxation at some length2 I onlywant to emphasizeone pointhere:the opportunities ormaking capital gains just afterthe war were quite

I Finance Act, 1956. 2 Cf. The Banker, Apr. 1956: Alternativesto Surtax .


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312 DIRECT TAXATION AND ECONOMIC GROWTHabnormally large, and the chances that the methods used would bechallenged by the Inland Revenue were quite abnormally small. Thismustbe regarded s a situationof whichthe impact effect as nowpassed,althoughto be suresome of the gains then made may stillbe being spent-thereis little evidence available either for or against. Abnormaloppor-tunitiesof this special naturemust be expected to recurfrom ime to time;the use which J. M. Keynes put to such an opportunity n the 1930 s iswell known 1 but the greaterpart of themcould and should be broughtwithin the range of surtax. A further trengthening f the hands of theInland Revenue is by no means impossible, while in normal times atleast the ingenuity f the government s dvisersfollows lose on the heelsof the lawyers who advise taxpayers.On thematterofdissaving by the new poor whichevery nflationaryperiod brings n its train,two points seem worthmaking: first, he suddendrastic rise in surtax rates in 1940 required n the longerperioda drasticreshapingof the mode of life of those affected. In the short period thegap could only be bridged by dissaving. It must be presumedthat theimpact effect f this change has now passed away, and adjustments havebeen made. They would doubtless have been made more rapidly ifartificiallyowyields on securitieshad not made it especially nnocuous nincome terms to consume one s capital. Secondly (and this is a morecontinuing rouble), much more erious ncentive o dissaving s providedby the present rates and structure f death duties. In the higher rangesof estates it is possible to proceed a long way in consumingone s capitalwhile eaving one s heirs post tax) hardly any worse off han they wouldhave been if the estate had been handed down intact. There is a veryclear remedyfor his state of affairs,which would be rathermore costlytoadminister han thepresent ystemof death duties,but whichcan hardlybe said to be impracticable: namely,to assess death dutiesprogressivelynot on the whole estate but on the main legatees-very small legacieswouldhave to be exempted. Thiswouldimplyperhapsthree o fivevalua-tionsofcapital inplace of one at present;but itwouldbe more efficaciousthan the presentsystem n redistributingroperty. On the face of it thechange would lose revenue, but this could easily be more than compen-sated by thereductionof tax avoidance throughdissaving. It is ofcoursea delusion to thinkthat revenue fromdeath duties, comingout ofprivatecapital accounts, makes any real contribution o thebudgetbalance in aneconomicsense. IIIWe must now turn fromthe promotionof incentives to work to thepromotionof incentives to venture. We need to consider three different

1 Cf.R. F. Harrod, Life ofKeynes.


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URSULA K. HICKS 313aspects; private portfolio nvestment (purchase of securities), privatedirect nvestment in the personally managed firm), nd companyincen-tives to venture nd innovate. Space does not allow of more than a glanceat the most salient points.In respectofprivate portfolio nvestment he exclusion of capital gainsand unrealized capital appreciation n British income tax does impartadiscriminationn favourofbuying securitieswith a low presentyieldbutgood prospects of growth. This no doubt does not always lead to anoptimumallocation of resources n the economy (as when the expectedimprovement akes the form fa fall n the rate of nterest, r a beliefbythe investorthat he is cleverer than the market). There is, however,adefinitepresumption hat the rightsort of riskwill also be backed, notnecessarily ndeed in the very small firm except by those with insideknowledge)but in the medium and large firm,whichtoday are responsiblefor quantitativelyby far the greaterpart of nnovationand experimenta-tion. (The strong backing and rapid expansion experienced by smallmachine-toolfirms ince the war is a good illustration f the operationofthis incentive.)Recent easements in company taxation, especially the more rapidwrite-off llowed on capital formation nd research and the indefinitecarry-forwardf losses, reinsurethe lender as well as reducingthe risksofa company embarkingon untried nvestments. Further,under Britishincome tax, only stamp duties stand in the way of a free switchingofinvestmentsfdesired,once thegrowth tage ofa venturehadpassed. Thisimpartsa verydesirableflexibility.The oppositeside to these advantagesis that there s nothing n the tax systemto curba stock exchange boom,and consequent realization of capital gains. Apart fromthe effect f acreditsqueeze, ofwhichundermodernconditionswe have as yet too littleexperience, hereare, however, wo possibilities fmoderating he oppor-tunitiesforstock exchange speculation if it becomes excessive. Stampduties could be drastically ncreased, and on the otherhand the powersof the Inland Revenue to charge intended evasion of surtax throughcapital gainsat surtax rates could be extended. Since 1920therehas beensteady progress n thisdirection, nterrupted nly duringthe exceptionalsituationofthe war and its immediate aftermath.2Comparedto British ncome tax an expenditure ax (unaccompanied bya capital gains tax) would probably also favour nvestmentfor apprecia-tion,at least wherever highvalue was placed on long-period ccumula-tion. Since, however, here s little evidence that this form f nvestment

1 Cf. C. M. Kennedy, Stamp Duties as a Capital Gains Tax , R.E.S., June 1956.2 Cf. Inland Revenue Memo. on The Taxation of Capital Gains, Final Report of R.C.Appendix.


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314 DIRECT TAXATION AND ECONOMIC GROWTHis very common,the stimulatingeffects f an expendituretax on risk-bearing would probably be less definite han those of British ncometaxThe presenceof a capital gains tax would be definitely isincentive tothis type ofrisk-bearing, ince whenevera switchofholdingstook placethe capital appreciation would be taxed, whetheror not the funds werereinvested. This of course assumes thatthe capital gainstax is setat a ratehigh enough to be deterrent,which is almost certainlynot the case withthe American tax.On the otherhand,when we consider he effect f British taxes (incometax and death duties) on direct nvestment, ay in a familybusiness, t isevident that the situation is not so good. If the reformn death dutiessuggestedabove were carried out this would be a tremendous mprove-ment; but the difficultyfbuilding up reserveswhentheyare subject tohigh rates of profits ax would still remain. In this one case long-periodaccumulation withoutthe intentionto realize is of real importance, ndconsequently he advantages ofan expenditure ax would be substantial.This problem,however,needs to be seen against the wide backgroundofthe structureof industry, nd the contribution o growthwhich can beexpected from he small firm.This is a matteron whichopinionsdiffervery much; on the whole Americans seem to take a more rosyview ofthe contribution f the small companythan is usual in this country. Inany case the importanceofthe problem hardly seemsto warranta majorchange in the tax structure.

IVWe come finallyto the vexed question of the taxation of companyprofits, hat is mainlyofprofitsnot intended fordistribution.Of all thechangeswhich have taken place in direct taxation since the beginningofthe war none is more striking nd significant han the changed relation

betweenpersonal and impersonaltaxation. In spite of the extensionofpersonal ncometax from to 17millionpersonstherevenue derived fromprofits axation has increased by a much higher percentage than thatderivedfrompersonalincomes. This is even morestrikingn the U.S.A.and Canada than in this country. The heavy taxation of undistributedprofits tarted withwar excess profits axes and continuedin post-warprofits axes. Such heavytaxationof fundsreadyand available forgrowthhas littlerationale, except the consideration hat companiesdo not havevotes. This being so, as the Royal Commissionfoundto their chagrin,there s littlehope of a substantial reduction n companytaxation unlesseconomicprospects urndrasticallyfor heworse, nd theaim ofa growthtax should rather be to encouragea highrate of investment n general,withprovisionsfor a curb if it should temporarily ecome too high, and


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URSULA K. HICKS 315with especial stimulus to research and innovation. Before discussingmeasures which might be taken along these lines we must glance brieflyat the implicationsof the presentform f company taxation.Companydirectors ll agree in hating profits ax, not deterredby theunwillingnessof chancellors to listen to their plaints. As Mr. Kaldorshows,1 they tend to argue somewhatinconsistently i) on the one handthat profits ax tends to raise prices (if so it cannot lower profits, r atleast not proportionately) nd thus injures our export position. Thisof course implies that the tax is shifted o consumers. (ii) On the otherhand they contend hat because of the high axation ofreserves, nsufficientfunds are available for expansion. It could of coursebe the case that anexperienced shortage of funds was the result of personal progressivetaxation and not of impersonal taxation, but that is quite anotherargument.Unfortunately,n spiteof all the effortsy thestatisticians,2here s notsufficientvidence n the post-wardata to draw any conclusions s to theavailability of fundswhich wouldbe valid for less abnormalperiod. Mr.Kaldor agrees with most economists n holding that,save in exceptionalcircumstances, rofits axes are not passed on in higherprices, althoughhe claims that in the very long period they probably are in an indirectway (thissounds to me suspiciously ike the long period in whichwe areall dead). The distinction,however, s importantfor Mr. Kaldor s argu-ment,because he finds he rationale ofthe taxationofundistributed rofitsto be as a means of taxing the capital appreciationof securityholdings.If in fact (even if only after years and years) a rise in prices puts thecharge on consumers and not on shareholders, he tax is ineffective orthis supposed purpose.I would maintain that the prospectofappreciation s something o beencouraged rather than taxed, since it is a powerfulstimulus to risktaking,and hence ndirectly f hardwork. Ifwe do want a rationalizationof profits axation (other than mere convenience) would prefer o findit in the completion of personal income tax. The undistributedprofitsbelong to the shareholders; it would be unjust if they were untaxed(incidentally t would also give such a strong timulus o the over-retentionof profits n the firm hat the Inland Revenue mightfind t difficultocontrol). But since non-distributed rofits re more like forced savingthan available income, t is onlyreasonable that the shareholders houldbe taxed on themat less than surtax rates. In this connexion t should benoticed (as often eems to be forgotten) hat ordinary shareholders are1 Kaldor, op. cit., p. 146.2 EspeciallyP. Redfern, Net Investment n Fixed Assets n the U.K. 1938-1953 ,J.R.S.S.,1955.


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316 DIRECT TAXATION AND ECONOMIC GROWTHnota class apart (to be identified erhaps with stock exchange tycoons ?).Anyonewith a littlesurplusover currentneeds can buy ordinary hares;if he buys through unit trust he enjoys as good a risk spread as a largeinvestor; if he takes out an insurance policy the company gives him theadvantage ofits accumulated expertise.Hence apart from he fact that I regard the presenttaxation of profitsas uncomfortably igh (and if t could be substantially reduced it mightbe possibleto get rid ofthat new incubus the separate profits ax), thereare in my view two separate, but linked, mistakes about the presenttreatment f company profitswhen considered n relationto growth. Inthe firstplace the differential etween distributed and undistributedprofits s an encumbrancewhich s almost certainlyharmful and shouldbe abolished as fast as can be managed in view of possible hardshiponfirmswhichhave distorted heirdistribution olicy on account of it. Thiswas one of the points on which the whole Royal Commissionwas mostemphaticallyunited.Secondly, voluntary dividendrestraint hould not be encouraged. Iftheeconomicsituation calls for sudden reduction n investment et it bedone fairly nd squarely by a temporary ncreased tax on total profits.Reform n this matter would make it easier to controlthe volume ofinvestment n threeways. If firmswere never allowed to become veryliquid they would have to go to the public for a large expansion of thebusiness; theywould then be subject directly o credit controlsand themarket mechanism. Secondly, the abolition of the discrimination nfavourof undistributed rofitswould restore he positionin which thereis no tax induced distortionof the economic calculus of firms. Finally,in respectof the closely controlled irm t would make it very much easierfor the Inland Revenue to challengethe over-retention fprofitswith aview to avoidingsurtax.

If, however,we cannot look forward o a substantial reduction n thetotal taxation of profits, s seems to be the case, it is of the utmostimportance o see that every means is taken withinthe tax to encourageinvestmentwhichpromotesgrowth. In thisrespectBritishtaxes are nowverymuch more sensible than theywere beforethe war. The indefinitecarry-forwardf losses makes it almost certain that capital will notultimately e lost; theshortening ftheperiodofdepreciation s an impor-tant re-insurance gainst unforeseeableobsolescence,as well as againstprice changes. Finally, the tacit permission o use either traight-linerreducing-balance epreciation or even a combinationofboth), accordingto the circumstances nd type of the business, gives additionalflexibilityto investment olicy.There remains lso the deviceofvarying hepace of nvestment hrough


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URSULA K. HICKS 317alterations in the allocation of depreciationallowances over time (initialallowances). It is clear that firms o not care for this device, and muchprefer the steady investment allowance which also gives them a netreduction in liability and not only an interest-freeoan. The varyingallowance can obviously be upsetting o businesscalculations,but it is notclear that it need cause a major upset to plans. The opposite side of this stheflexibilitymparted o investment ontrol both generaland selective),which is too convenienta weapon to sacrifice ightly. A much greaterupset to businessprospects an easily be causedby carelessover-investmentin the public sector,necessitating creditcontraction ater. All of theseinducements o invest orto undertakeresearch) n lines promoting rowthwould naturally operate as well or betterwith lower taxation of profitsin general. On all of this I think Mr. Kaldor is in complete agreement,if we grant as I thinkhe would) that the complete abolition of the tax onundistributedprofits nd the substitutionof a tax (subsidy) fallingonlyon investment s not practical.If I might now sum up my prioritiesfor gearing British direct taxesmoredirectly o stimulate economicgrowth han theydo at present, heywould be these: (i) measuresto increase the inequality of incomesfunc-tional fordevelopment, speciallya softeningfthe ncometax progressionin the middle ncome ranges throughraisingthe ceilingon earned incomerelief nd family llowances, includingan abolition of the means test foruniversityor technical scholarships if desired above a certain point thescholarshipcould be taxed withtheparents income); (ii) measures withinsurtax to reducenon-functionalnequalitiesofspendingpower, especiallythemanomuvringfcapital gainsto avoid surtax; (iii) the formalncidenceofdeathdutiesto be transferredo legatees,where they would be assessedprogressively n their otal estates; (iv) thedifferentialetweendistributedand undistributed rofits o be abolished and the fullworking f variableinitial allowances to be restored. These are modest requests, and nonewould appear to implyadministrative nknowns. The sacrifice f revenuewould be small, except perhaps in respectof death duties,and that as weknow has no real functional ignificancen its presentform.The cumula-tive effect f the reforms ould well be decisive.

Direct Taxation and Economic Growth

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