Cyclopædia of Political Science, Political Economy, and the Political History of the United States
FINANCE, Science of, the science of the economy which the state must conduct in order to obtain and apply the commodities or services necessary to the proper performance of its functions. It depends immediately upon two other sciences whose conclusions form its starting point; upon political science in the narrower sense of the term, i.e., the science which determines the functions of the state, and upon political economy, which develops the general principles underlying all social economies. As the prevailing theory or practice in reference to the functions of the state changes, the financial system and consequently the science of finance must change. The science of finance will be comparatively simply in a state which derives all its income, like private individuals, from the profits of its own property, such as domains, and which limits its activity as much as possible to simple protection of the citizen. In such a state neither the income nor expenditure exercises any great influence on the economic condition of the country. But the problems become more complex as society develops, as the functions of the state increase, as the system of domains disappears and the system of taxation takes its place; as the income and expenditure grow larger, and the government by its system of raising and applying revenue begins to exercise an ever increasing influence upon the economic development of the state and upon the distribution of the national income. As a consequence the science of finance must develop, must take up the consideration of an ever increasing number of problems, and will not be completed until society has reached its ultimate economical development. As the term is ordinarily used it includes, as our definition indicates, merely the treatment of the economy which the state conducts, as the highest form of compulsory associative economies, i.e., the science of finance treats only of national finance as opposed to local finance. But the course of its development will soon force it to take up the latter subject also. And rightly too; since each state, for example, in our American Union, each country in the state, and each city in the country, has or may have its own system of finance independent of all the others, the consideration of which ought not to be omitted in any tolerably complete presentation of the subject of finance. The same thing is true of local organizations of other countries. The whole subject of local and particularly of municipal finance forms one of the most important subjects in the whole range of political science, and in no other connection can it be so conveniently and thoroughly treated as in connection with the science of national finance.
—The science of finance is a product of modern thought. The scientific investigation of financial subjects seems to have been entirely unknown to antiquity or even to the middle ages. The work of Xenophon on the revenues of Athens was simply a discussion as to how the city might derive sufficient revenue from its own territory without having to depend on foreign sources. His recommendation of a state monopoly of silver mining, and his opinion that the increase of the amount of silver would not diminish its price, are worthy of notice. But Xenophon was not a practical statesman, nor were the other writers whose occasional remarks are met with in classical literature, and so we have no means of ascertaining the theoretical opinions of ancient financiers except by inferring them from their financial institutions and contrivances. We must be careful in drawing such inferences, however, as the devices adopted depended often upon accident rather than upon a thoughtful consideration of what was best. The large income which the principal ancient states derived from the conquest and continued plunder of foreign nations raised them above the necessity of systematically taxing their own citizens on a large scale, and so they were never forced to a thoughtful consideration of the most economical system of providing public revenue by taxation. Both at Athens and at Rome, it is true, some kinds of taxes and other sources of public income were carefully managed; but their financiers never thought it worth while to elaborate rules on the subject or to seek out general principles. The few writings upon financial subjects, therefore, which have come down to us from antiquity, while possessing considerable value to the historian of finance, are of but little importance to the theory of our science.
—The science of finance is not only the product of modern thought, but it is chiefly the product of the thought of two nations, Germany and England. To German economists we owe its systematic form, to English economists the most valuable portion of its contents. A short sketch of the rise and development of the science is necessary to a full understanding of its present condition and prospects. Its history, like that of political economy in general of which it for a time formed a part, falls naturally into two periods, that before and that after Adam Smith.
—In the transition period from the middle ages to modern times, when the revival of learning took place, and when, among other branches, political science was resuscitated, political writers took up finance also. The wide-spread political and economical changes of the time directed attention to the investigation of financial questions. Among these changes we may mention, as promotive of our science, on the one hand, the growing dissatisfaction with the patrimonial conception of the state, the rise of princely absolutism, by which for the first time a really political life was made possible, the revolution in warfare, the introduction of Roman law, particularly of Roman financial law, and the growing need of the state for an increased revenue; on the other hand, the transition from a barter to a money economy, the depreciation of money in consequence of the exploitation of American mines, the general tendency toward paternalism in the economical policy, as is shown by the rise of the mercantile system and the predilection for monopolies and finally, the secularization of the church property in Protestant lands, which among other changes rendered necessary different poor laws.
—As a matter of course the first literary attempts, both of the more pretentious works on political science and of the monographs devoted exclusively to finance, were, and long remained, very defective. The authors naturally enough began with the concrete institutions of their own countries, and with proposals for reforming particular abuses. But their works testify rather to their zeal in compilation than to their thorough knowledge of the subject. They often gave very good but very trite directions as to economy, justice, etc., but they took their illustrations without discrimination from the most opposite political conditions, and showed little insight into the real condition and wants of their times. Nor did the practical men, who began to treat the subject during the sixteenth century, show any greater tendency toward scientific exactness. From the seventeenth century mercantilistic views began to exercise a more and more marked influence upon financial literature. And even in this early period a marked difference appears between the English and German treatment of the subject, which has remained characteristic even down to the present time. English writers have preferred to devote their attention to the investigation of particular subjects closely connected with the questions which were from time to time of great public interest, neither knowing much nor caring to know much of their relations to other subjects. German writers on the contrary, have made a special effort to systematize the results of their investigations, and by a proper subordination of parts to make their knowledge a science. The very dissimilar political relations of England and Germany led their economists to emphasize very different points. The early German authors discuss finance principally in connection with the system of domains and monopolies then in vogue, and gradually make the science of finance a part of cameralistics. This latter science included all the information considered necessary to an officer of the internal administration, and the science of finance came to occupy a prominent place in it. The system of domains was universally accepted by these writers as the principal element in every financial economy. But the development of nations soon compelled a great change in these views. The growing needs of the state demanded a constantly increasing revenue; the domains became more and more unable to meet this demand. The system of direct taxation was still in a very crude condition and generally unpopular with the rulers, because it depended on obtaining the consent of the estates. As a consequence attention was directed more strongly to the development of monopolies and of indirect taxes, like the excise, etc. These subjects are accordingly extensively discussed in the literature of the time. But little change occurs in this development until after the middle of the eighteenth century. Essentially upon the basis of the previous views, although under the influence of the new political and philosophical tendencies, the theory of finance was gradually systematized and worked out in its details. The better writings of this period are therefore of value even now, because they present the principles of administration which were then accepted and which in part still prevail.
—The strictly scientific era of the science of finance did not begin until after the middle of the last century. Three influences affected its development. First, the development of the modern science of political economy, of the theory of free competition, elaborated in the writings of the physiocrats, (Quesnay, Turgot), and more fully in epoch-making work of Adam Smith. Second, the theoretical revolution in jural and political philosophy and in politics effected by Montesquieu, Rousseau and Kant. Finally, the practical revolution in political, social and economical life produced by the French revolution and the events connected with it.
—The physiocrats exercised a stimulating and fruitful influence upon the theory, if not upon the practice, of finance by their one-sided plan of taxation, the principle of an impôt unique, of a single universal tax on land, which was to take the place of all other taxes. Adam Smith, then, threw a new light upon the subject of finance by developing the economical basis of the same in the "Wealth of Nations." Public revenues, from the isolation in which they had been discussed before, were now brought together and treated as a whole, which had the most intimate connection with the greater whole of political economy. Instead of indefinite and variable rules, men were now enabled to lay down definite principles for the preservation of national wealth and national industry. They saw that measures and contrivances were defective, which they had long accepted as perfect. But even Smith, although he had a tolerably complete system of political economy, did not produce a complete science of finance, because he had no fundamental principle upon which to base his theory. This was the natural consequence of his defective theory of the state, particularly of his complete misconception of the universal importance of the state for national life and the limitations of the national economy by the state. But aside from this defect—a very serious one, it is true—Adam Smith made an epoch in this subject by the fifth book of his famous work on the "Wealth of Nations," and exercised a moulding influence, lasting even down to the present day, upon the theoretical conception and treatment of finance, and at least outlined a tolerably complete system of theoretical science. Even the externally close connection into which he brought finance with political economy remains to-day characteristic of all writers except the Germans. And even German thinkers, independent in some respects, are still greatly influenced by Smith.
—The progress of philosophy and the French political revolution led to new investigations in political science as to the functions of the state and the limits of its activity, by which new principles as to the rights of the state were won and preparation was made from another direction for the science of finance. The evil of this movement was the excessive reaction of Kant's school against the eudemonistic tendencies of Wolf and his followers, and against the practice of the state of "good despotism." This reaction led to an unfortunate limitation of the idea of the state which is entirely inconsistent with actualities, and which corresponds with the one-sided and unhistorical opposition of Smithianism to all interference of the state in economical matters. The false theory of Smith and his school in reference to the unproductivity of services, and consequently of the state, favored this fatal tendency. In spite of all, however, the science of finance gained a firmer systematic form, and in consequence of this perfecting of the science a revolution in praxis was begun which is slowly but irresistibly progressing.
—In recent times the Germans have taken the lead in the development of the science. English writers, following Adam Smith, discuss finance as a comparatively unimportant part of political economy, using it principally to afford an application and explanation of economical principles. And although they have done invaluable work in elaborating details, such as the economical effects of taxes and the incidence of various kinds of taxes, the theory of public debts, paper money, coinage, banking, etc., yet they reveal nowhere even down to the present an adequate conception of the importance of finance to political economy. On the contrary, the Germans, although their treatment of the details has been and still is, in many respects, unsatisfactory, have yet elaborated a complete and systematic science of finance which if full of promise for the future.
—The science of finance falls naturally into three divisions. The first discusses the organization of the financial economy, and investigates the general principles which must underlie all financial systems. The second treats of public expenditure, and the purposes for which it may be made. The third treats of public income, and the ways and means of obtaining it—I.The Organization of the Financial Economy. 1. In constructing a financial system we must first have regard to the amount to be expended. This will depend upon the number and character of the functions which the state assumes. This last will vary with the political development of the state. We see, then, how idle the attempt is, which many theorists have made, to fix once for all the sum total of expenditure. One state may be justified in making an expenditure many times greater than that which another state of equal area or even of equal population may make. England may with impunity devote a sum to public purposes which would bankrupt many states of greater population and area. Although we may not lay down a cast iron rule for proper expenditure, we may sum up the purposes for which the modern state devotes money, and such a summary will be found at the close of this section. The science of finance, as such, has nothing to do with determining the functions of the state—a problem which belongs to the science of politics, in the narrower sense of the term. But, inasmuch as no important function of the state can be performed without the expenditure of resources in some form, it follows that determining the functions of the state and providing for their proper performance include the determining of a certain expenditure and of the income necessary to cover it. This last is essentially a problem of finance; and financial science, then, requires that in every revenue system there shall be, first, a detailed and efficient supervision and control of expenditure; second, a rigid observance of the principle of economy; and third, a careful regard for the relation between expenditure and national wealth. Most modern nations have attempted to secure a careful supervision by adopting the system of budgets. The administration lays before the legislature a careful estimate of the sums which in its opinion are necessary to the proper performance of the functions of the state. The latter, in voting or refusing to vote the sums proposed, confirms or rejects the views of the former as to the limits of state interference. In this settlement the administration and the legislature represent the two sides of a business transaction. The former represents the supply of governmental interference which in its view would be advantageous; the latter, the demand of the people for such interference. Their views are likely to be very different. The administration is prone to over-estimate the advantages of the services of the state for the people, and to underestimate the cost (in taxation, etc) which they impose upon the people. The legislature shows opposite tendencies. History has shown that by such a device a fair control of the financial system is secured. By the principle of economy is not meant that the state must limit its activity to the narrowest possible bounds; but simply that in the proper performance of any given function (which it has been decided the state should assume) the least possible expenditure should be made. The third point is a very important one. No mathematical ratio between the expenditure and national wealth can be found. All attempts to do this have failed, as they rest upon a false, mechanical view of the relation of the state to the national economy—a relation which is essentially organic. We may lay down the following as a principle: the greater the economical value of the public service, the more it promotes the productive power of all, the greater the net income of the nation, the larger the proportion of public revenue derived from industrial undertakings, the larger may the public expenditure become both absolutely and relatively. The question might be formulated as follows: May the expenditure increase to such as extent that the sacrifices it demands of the people become very oppressive? The answer would be affirmative, if it has reference to a temporary outgo, and the expenditure promises to be successful, and the particular form of state deserves preservation. But if the condition is to be permanent, if no saving can be effected, if the functions of the state can not be diminished, then the impossibility of raising sufficient revenue proves the impossibility of the continued existence of such a state. Even the assistance derived from repudiation, i.e., violation of legal obligations, will not always afford a permanent relief. In such cases public production must, like private production, cease, because the undertaking no longer pays expenses. 2. But in the construction of a financial system regard must be had, in the second place, not merely to the amount to be raised at any given time, but also to the indubitable fact that the total expenditure of a modern civilized state tends constantly to increase. A glance at the budgets of modern states for the last fifty years will afford statistical proof of this so-called law of the ever increasing functions of the state. The governments of nearly all existing states have taken upon themselves within recent times the management of the postal system, of education, etc, in many cases of the telegraph and the railroad. This tendency must be taken into account. A good revenue system, therefore, must be elastic. It must be able to adapt itself to the growing demands of the state, and, hence, we must condemn all those plans which involve the limiting of the state to one or two sources of revenue. Another point should be considered in this connection, viz., the adjustment between the national and local systems of finance. This varies greatly in our modern states according to the historical development and peculiar conditions of the various nations. In some countries each individual city and country and province has or may have its own system of revenue to provide for its own wants. In others the local organizations are permitted to raise money only by a system of additions to the national taxes. In our own country no state may raise revenue by emitting bills of credit or by laying duties on imports or exports. Practically under our present laws the states are also prevented from establishing state banks as sources or revenue. The municipalities are restricted, in many parts of the Union, as to the kinds of taxes they may levy and as to the amount they may raise by taxation. It will be found by experience in the various countries what particular sources of revenue can be best exploited by the national government and what are best adapted for local organizations, although the science of finance has hardly taken the first step toward a satisfactory solution of this question—one of the most important within its whole field. 3. In the third place, provision must be made in every revenue system for securing an equilibrium between income and outgo. This can be secured permanently only by providing a proper system of income. We must endeavor to ascertain some principles, then, which may guide us in selecting proper sources of income. But these can be found only by investigating what sources of income are best adapted to the various kinds of expenditure. We must classify expenditure, therefore, with a view of deciding upon the sources of income appropriate to each class. This classification leads to the distinction between extraordinary and ordinary income, in the various senses of the word. The sources of income in our modern states are principally taxes and public loans. Our investigation will be limited, therefore, chiefly to these two sources of income, and to deciding which is the appropriate one for any given kind of expenditure. The fundamental principle of this portion of our science is, that income must equal outgo—a principle, the very opposite of that which must prevail in a private or individual economy, in which a man, to remain solvent, must regulate his outgo by his income. The government decides what functions the state will assume, what expenditure is necessary to perform them properly, and then aims to raise the required revenue; while the individual must first find out his revenue before he fixes his outgo. A disregard of this principle results in a deficiency, which, if long continued, becomes chronic, and easily leads to national bankruptcy. The best means of avoiding such a deficiency is to insist upon carefully prepared budgets for short periods of time—one, two or three years. If the estimates for one period are wrong, they can easily be corrected for the next. In deciding upon the sources of income to be used, we must have reference to the kind of expenditure. Expenditure may be classed as ordinary and extraordinary expenditure. These terms are applied in three difference senses. In the first sense, ordinary expenditure is such as occurs regularly in the ordinary course of the government, and can be estimated almost exactly beforehand. Extraordinary expenditure is such as must be made in consequence of some special and unexpected necessity, such as war or a great public calamity. The first kind must be met, of course, by an income of equal regularity and quantity. The second may be met by extraordinary measures, such as treasury notes or the use of public credit in some other form; though in many cases it is better to keen a permanent surplus fund in the treasury to use on such occasions. In the second sense, we have reference to the permanence of the results achieved by the expenditure. We apply in our financial system the idea of fixed and circulating capital. Ordinary expenditure is such as is regularly applied in the process of public production within a financial period, which reappears in the value of its products (public services), and must therefore occur periodically to the same amount. It includes all expenditure for the running expenses of the government. Extraordinary expenditure is such as is made at irregular times, and whose effects extend beyond the current financial period. The outlay may form the basis of a permanent advantage, or it may be necessitated by some great obstacle in the way of political progress, such as an unavoidable war. In the first case it becomes an investment of fixed capital, so that in the subsequent financial periods a less expenditure is sufficient and an increased productiveness results. Such an investment may be made for two purposes. It may be a simple commercial undertaking like that of any private individual, for the sake of the profit connected with it, such as investment in domains, railroads, etc; or it may be for the purpose of improving or establishing the means of performing the functions of the state. All great reforms in administration, the building of free public roads, the improvement of the means of defense, etc., etc, require such investments. The money expended in an unavoidable war has very different results from that expended in the last two cases. It involves a real loss of men and capital. Nor does even a really successful war give us any guarantee of no repetition; on the contrary, it is often merely the prelude to longer and more costly wars. In the third and legal sense, ordinary expenditure is that which is granted. Once for all, for certain purposes, and need not be incorporated in the budget. Extraordinary expenditure is that which must regularly receive the consent of the legislative body. Thus, in England the amount supposed to be actually necessary to the existence of the government, is furnished by a permanent income which, although it may be changed by every parliament, is practically changed very seldom. All other expenditure must be voted regularly by parliament. Now, as has been said, in constructing a financial system, regard must be had to the kind of expenditure which is to be provided for by any given source of income. We may lay it down as a principle, that the ordinary expenditure in the second sense of the term must be met in all cases by ordinary income (i.e., in general, income from taxes); while extraordinary expenditure may be met by extraordinary income (i.e., by the use of public credit). Ordinary expenditure in the third sense must of course be met by ordinary income, while extraordinary may be met by temporary devices of a character suited to the particular object in view.
—II. Public Expenditure, and the Purposes for which it may be made. 1. The financial needs of the state may be divided into two classes; first, its need of things in kind; second, its need of money. In the early periods of political development the need of things in kind predominates. The government needs men to fight, and it simply demands their services without paying them anything in return. It expects the soldiers to arm themselves at their own expense and to provide their own rations while in the field. As the state develops, there is a constant tendency to satisfy its necessities by way of purchase, and in consequence of this its need of money becomes more important than its need of things in kind. But even in our modern money economy there are some cases in which the state can better afford to take things in kind than money. In time of war, for instance, it may become necessary to have more horses, or supplies, and it will often be better to take the things wanted than to take money and attempt to purchase them. All instances of the use of the right of eminent domain come under this head. It is often more advisable to take a piece of ground, for instance, and pay what seems to be a fair valuation, than to attempt to raise money enough to satisfy the demands of the owner, which, as is well known, become exorbitant as soon as the government attempts to buy. 2. From another point of view, the financial needs of the state may be classified as its need of personal services and its need of commodities. The science of finance must investigate the various methods of expenditure necessary to satisfy these needs. Several different systems of securing persons to perform the services have been in vogue at different times and in different countries. The following are the most important: 1st, the German system, according to which all public offices are filled from the ranks of persons who have shown their fitness for the places by prescribed tests, and the appointment gives (after a certain period of probation) a right to the office, and there fore its salary, so long as its duties are properly performed, 2d, the French system, in which the salaried officer, although professionally educated, may be removed at pleasure; 3d, the American system, in which the salaried officers are appointed and removed at pleasure, without any necessary regard to their fitness; 4th, the voluntary system, in which the offices are filled from among those able and willing to perform their duties without salaries. The first system, involving, as it does, educated officials and pensions, seems at first thought to be the most expensive. For the salaries must be large enough to attract and retain men of ability and education. They involve, therefore, a restitution of the costs of education. The officers may not be dismissed, so that they must continue to draw their salaries, even if the circumstances should allow a material reduction of the force. If they give out while performing their duties, they must be supported, and they must finally be pensioned after they become too old for the active service. But there are several points in its favor to be considered. In the first place, we must have regard to the value of the service as well as its nominal cost. A professionally educated civil service will furnish better results by far than an uneducated one. An officer who feels sure of his position as long as he does his duty, and reasonably sure of increased salary or of promotion as a result of marked faithfulness, will do his work far better than one who may be removed at the pleasure of an irresponsible superior. The German system will secure a more honest set of public servants than any of the others mentioned, and so less will be lost by peculation and fraud than under the other systems. It is better than the plan of voluntary offices, for under the latter only the wealthy can enter the public service, and the government would receive a too aristocratic coloring. Thus, although the German system seems to be the most costly, yet it is after all the cheapest and consequently financially the best one. We pass over the further discussion of this point at this place. (See
—A a rule the state can better afford in our modern industrial economy to satisfy its need of commodities by purchase in the open market than by manufacturing them itself. There are some exceptions of this, however. If the state needs peculiar commodities which the commercial industry of the country would not produce except for the state, or if special experiments are necessary which private parties would not make, or if the competition among private firms is not very great, and inspection of the commodities difficult, then the state can generally better produce them itself. Military supplies afford a good example of this; although private parties can often furnish even these on better terms than the government could produce them. Krupp, in Germany, and our own rifle factories in this country, are good instances. In all other cases the state in providing its supplies must simply follow the ordinary rules of private business—buying by contract and en gros. Financial considerations must further determine whether the government shall erect buildings for its business or hire them from private parties. 3. Public expenditure may be divided, from a third point of view, into gross and net expenditure. Gross expenditure includes not only what is consumed in performing the functions of the state, but also what is expended in collecting the sums so consumed. Net expenditure includes only the former of these two items. They should both be carefully indicated in the budgets, as the costs of collection reveal the economy of the financial system and of the administration. It goes without the saying that these costs of collection should be as low as possible, and yet they can never become a determining factor in a financial system. They depend upon a great variety of circumstances, some of which we summarize. Those public economies which derive a large portion of their income from industrial sources, such as domains, forests, mines, factories, railroads, etc., etc., will always have a relatively larger gross expenditure than those which depend on taxes. (Compare English with German finance.) Even of two economies which have the same system the budgets will be very different, according to the systems of administration. The relations of time and place and circumstance have very much to do with determining the ration of gross and net expenditure. In addition to the nominal costs of collection there are to be counted all those sacrifices which the public must make beyond their taxes, and which do not result even in a larger gross income to the state; at costs growing out of illegalities, bribery, bad systems of administration, incomplete control, hindrances to production, etc., etc., some of which are characteristic of states in a backward condition of political development, others arising from the kind of taxes (customs duties, excise, indirect taxes in general). The nominal costs of collection depend: 1st, upon the condition of the whole financial, and particularly of the tax, system, the system of collection, whether by farming, by officers, by local authorities, etc., exercises the greatest influence in this respect; 2d, upon the kind of taxes most employed, whether direct or indirect; 3d, upon local and temporal circumstances, even with the same kind of tax. The moral development of a people, its geographical situation, its communications, its economical condition, the prevalence of great industries, etc., are all of great influence in this respect. The more favorable all these items are, the less may be costs of collection become.
—The purposes for which expenditure is made in the modern state may be classed under three heads; 1, for the executive and legislative departments; 2, for justice and defense; 3, for the general welfare. The executive head must receive an allowance which will not only allow him to live, but to maintain an establishment in some degree of elegance if not of splendor. It is necessary to connect a salary with the office of chief executive in a republic, or it would limit the choice of the people to wealthy men able and willing to undertake the expense. It is also usual in free states to pay a salary to the members of the legislature, for the same reason. In monarchies the income of the sovereign is largely derived from private property, though in many modern states the legislature, considering that royal estates belonged to the government, has taken possession of them and allowed the king a salary, so to speak, instead. Under the head of justice fall all expenses for the courts, for prisons, and penitentiaries; under defense, all outlay for police, detective force, workhouse, foreign representatives, and, most important of all, for the army. In most modern states the army is a necessity, and the best way to provide it is one of the most difficult questions of finance. "In peace prepare for war," is a direction which European states have been following so thoroughly for the last generation that some of them are already on the verge of bankruptcy, and nearly all are seriously impeded in their material progress by the enormous cost of their armies. The militia system is exceedingly costly, because exceedingly inefficient, and can be adopted only by those nations that are reasonably free from war. The American rebellion was the most costly war of modern times, largely because a vast army had to be raised and an enormous fleet built within a short time by a nation practically unacquainted with either. But it may well be doubted whether any great saving would have been effected by having spent large sums for fifty years preceding the conflict, in order to be ready for it, to say nothing of the fact that one party would have had as much advantage from the preparation as the other. But a European nation, such as Germany, may well find it cheaper to keep a large standing army and a still larger reserve (of all able-bodied men) than to rely upon a standing army and conscription, or upon a militia system. The amount of expenditure a nation can apply to its army is measured solely by the value it sets on its national existence.
—Expenditure for the general welfare includes expenditure for inner administration, for economical administration, and for education. Statistics, public health and poor laws belong to the first; coinage, the postoffice, telegraph, state railways, public highways, etc., to the second; schools, art and religion to the third.
—III. Public Revenue, and the Sources from which it may be derived. The ordinary revenue of modern governments is derived from three sources: 1, from agricultural, industrial or commercial enterprises; 2, from fees: 3, from taxes. These three sources must be carefully distinguished, and their relative and historical importance emphasized. When a state manages a public farm, conducts a great commercial institution, like a bank, upon the same principles and for the same purpose as private individuals, viz., to secure a pure income which it may apply to other purposes, it derives revenue from the first source. When it undertakes the exclusive performance of certain functions for its citizens, and charges the persons especially benefited a certain sum, which it fixes without reference, possibly, to the value of the service to the person served, or its cost to the government, it derives revenue from the second source. The postoffice is an excellent example of this source. The postage is the fee. The government charges three cents for forwarding a latter to the address. It may not cost the government one-tenth of that sum, or it may cost ten times that sum. The person served might be willing to pay one hundred times the postage charged, or he might prefer to hire somebody else to forward it because it would be cheaper. But the government fixes its own price and insists upon being allowed to perform the service, and accomplishes its aim by refusing to allow any one to perform it more cheaply. When the state exacts a sacrifice of a citizen without performing any service of a citizen without performing any service for him other than affording the general protection and opportunities which come from his enjoying the privileges of citizenship, it derives revenue from the third source. The fundamental distinction between a fee and a tax lies in the nature of the return made by the government to the individual paying it. Both are contributions to the government, but for the former the payer receives in return a special service, which is not performed for anybody except those who pay for it; while for the latter he receives only a general return which everybody living in the state enjoys, whether he pays for it or not. The revenue from fees is intended to cover the expenses of performing the service. In case the government charges more than private parties would charge, the surplus becomes a tax levied only on the persons availing themselves of these services. In case the revenue is insufficient to pay the cost of service the deficit must be made up by general taxation, and is in so far a gift from the state as a whole to the portion of the community profiting by these services. The same thing is true of the individuals in these classes. Under free competition a man in New York might get his letter carried to Boston for one cent, a man in Texas might have to pay twenty-five cents for the same service; under the present system the former is taxed two cents, which are given to the latter to apply on his postage. A fee, therefore, may contain a tax for the individual, whenever it is higher than what he would have to pay for the same service under free competition, and we must carefully distinguish in every contribution to the government between the fee and the tax.
—1. Revenue from business enterprises. In an early stage of civilization or of industrial development the public revenue must be largely derived from the profits of public property. Land is the most common form at first. Mines are also a common form in early as well as in latter times. A period soon comes in a progressive state when the income from such sources is no longer sufficient, and the main dependence must be placed upon taxation. But even under such conditions the state may retain its domains and even develop similar source of revenue, such as smelting works, factories, banks, canals, railroads, etc. Down to a late date the domains furnished the greater portion of the national revenue in many of the European states, and even at the present time they form an important element in the financial systems of most continental states. The general tendency has been toward selling the farm domains and retaining the forest domains. Of late years the questions of state banks and state railways and canals and telegraphs have been growing more and more important. There has been a marked and growing tendency toward government ownership of all such agencies. The purely financial element, however, has rarely led to government ownership in these cases, although such enterprises generally make good returns on the investment. The income of several European countries from such sources is steadily growing, and it is likely to become more and more important with every advance in industrial development. (See
—2. Revenue from fees. The modern state derives a large income from fees, which, as already defined, are contributions made to the state in return for a special service rendered the individual. The theoretical justification of fees lies in the nature and in the results of various functions of the state; their actual existence and historical development are closely connected with the prevailing views of law, of the state, of society and of the national economy, and with the conditions of the same, and charge, therefore, with those views and conditions. The principles laid down, therefore, with reference to fees are not absolute, but temporal, local, and historically relative. What functions the state ought to assume is not a financial question, nor has the science of finance to decide which of its functions it should discharge at general expense of the whole state and which at the expense of the individual most benefited. Historically, in the economically progressive state, a growing tendency has shown itself toward the public assumption of functions performed hitherto by private parties. Such, for example, are the paving and lighting of streets, the furnishing of means of instruction, the establishment of water works, of asylums, etc, etc. At first all such institutions are generally supported by the fees of those most concerned; in course of time, however, a tendency shows itself toward lessening the fee more and more, until, a deficit occurring, the state must support the institution by taxation. The following principle may be laid down in reference to what functions should be supported by fees, and what by general taxation. The more clearly the performance of a certain function redounds to the benefit of particular individuals who can be easily ascertained, the greater the proportion of expense which said individuals should defray by their fees; the less clearly it accrues to the benefit of one individual more than another, and the greater the difficulty of ascertaining the parties benefited, the greater the proportion of expense which the state should bear by general taxation. As has been said above, the fee must not amount to more than the charge private parties would make for performing the service; otherwise it becomes a tax. Many taxes are levied under the form of fees. In all cases where the government requires the performance of a certain act merely for the sake of taxing it, as, for instance, the stamping of deeds, contracts, etc., the so-called fee is really a tax, and should be considered such.
—3. Revenue from taxes. Taxation is the most important and most difficult department of modern finance, and the theory of taxation the most important and the most difficult portion of the science of finance. The latter falls naturally into two divisions—a general and a special: the former treating of the general principles of taxation; the latter, of particular taxes and their special characteristics. The remainder of this article will be devoted to the general division; the special will be treated in the article entitled TAXATION. We shall discuss the general principles of taxation under two heads: 1st, the basis, nature and development of taxation in general; 2d, the fundamental principles of taxation. 1st, The right of taxation, i.e., the right of collecting from subjects compulsory contributions for public ends and purposes, finds its theoretical justification in the absolute necessity for the state, and therefore in its right to existence. From which it follows, that the justification of this right does not belong to the service of finance, but in its economical aspects and connection with the organization of property and industry to political economy, in its political and legal aspects to the science of the state, and in its philosophical aspects to jural philosophy. This point will be further considered, however, at the end of our second division. The nature of a tax has been fully explained in a preceding portion of this article. The development of taxation has kept pace with the industrial development of society. In a primitive and undeveloped state taxes are not to be found. The only thing corresponding to them is the voluntary contribution or gift to the head of the state (prince, chief, etc.), on special occasions. "The government is expected to pay expenses." The conquest of other nations, the proceeds of the public domains, etc., are ordinarily fully adequate to meet all financial necessities. On the other hand, society makes but few demands upon the government. Its members depend more upon themselves, rarely expecting more from the government than protection of life and property. As the industrial order of society is developed, greater demands upon government aid and interference are made. The functions of the government are rapidly multiplied. At first those who expect this aid must pay for it themselves, i.e., the expenses of the additional functions are defrayed by fees. But in course of time the number benefited by these advantages increases, until the want has become "public," i.e., can be satisfied at the expense of the state as a whole. But the more such wants are multiplied, the more impossible it becomes for the domains to furnish the requisite funds. Taxes become necessary, and the greater the amount of money needed, the more extensive and complex does the tax system become. 2d. The fundamental maxims of taxation laid down by Adam Smith have become classical. We produce them here for the sake of convenient reference in our discussion of the subject. They are as follows: 1. The subjects of every state ought to contribute toward the support of the government as nearly as possible in proportion to their respective abilities, that is, in proportion to the revenue which they respectively enjoy under the protection of the state 2. The tax which each individual is bound to pay ought to be certain and not arbitrary. The time of payment, the manner of payment, the quantity to be paid, ought all to be clear and plain to the contributor and to every other person. 3. Every tax ought to be levied at the time and in the manner in which it is most convenient to the contributor to pay it. 4. Every tax ought to be so contrived as both to take out and keep out of the pockets of the people as little as possible, over and above what it brings into the treasury of the state. The last three are simply principles of proper administration and will be discussed later. The first maxim contains implicitly three distinct principles. It finds the justification of taxation in the protection accorded by the state. It lays down a principle of just distribution of taxation, viz., upon every one according to his ability. It proposes a method taxation by which this equal distribution is to be reached, viz., the income tax. It may be safely said of these last that the second is a contradiction of first, and that the third is by no means an axiom, and is not easily demonstrable. The maxim is really a begging of the question, and yet it has been copied and recopied and paraphrased by nearly three generations of successors.
—The fundamental principles of taxation are to serve as a guide in the practical levying of taxes, especially in the choice of the various taxes and in the organization of the tax system as a whole. Every tax is to be tried by these principles, and as far as possible that one chosen which will best satisfy their demands. On account of the great difference in these demands and on account of the practical difficulty of reconciling them with one another, it is very exident that no one tax should be adopted as the sale source of public revenue. On the contrary, a judicious combination of several different kinds of taxes, i.e, a real rax system, seems best adapted to realize our ideal, viz., the greatest practicable agreement of actual taxation with our fundamental principles. These principles are nine in number, divided into four groups as follows: I. Politico financial principles: 1. Adequateness of taxation; 2. Elasticity of taxation. II. Economical principles: 3. Choice of proper sources of taxation, i.e., particularly, discussion of the question whether taxation is to draw only from individual and national income, or also from individual and national capital; 4 Regard for the incidence of taxation, particularly of the various kinds of taxes, upon the tax payer, and a general investigation of the "shifting of taxation." III. Principles of justice or of the just distribution of taxation; 5. Universality: 6. Equality of taxation. IV. Administrative principles: 7. Definiteness as to time, place, manner and equality; 8. Convenience of the same; 9. Economy in collection. It is not usual to include the first two principles in such a summary; but they should be placed first of all, as they are most important of all. They follow from the very nature of the financial economy, and from the principle upon which that is based, viz., that income is determined by expenditure, and must be sufficient to meet it. For not, as the Smithian school of political economy from their particularistic standpoint teach, not "justice toward the individual," not the maxim of universality and equality of taxation, but the fulfilling of the conditions of social life and union, is our fundamental principle—the securing of the means for the preservation of the state and for the performance of its functions.
—1. By" adequateness of taxation" we mean that the income iron taxes must be sufficient to cover the expenses of a financial period, so far as other means are lacking or are impermissible. Taxation must be resorted to after the income from industrial undertakings and the surplus from the fee system have been exhausted, and it must meet the rest of the expenditure.
—2. By " elasticity" is meant that a tax system must contain such component parts (i.e., kinds of taxes) us can adapt themselves to charges in expenditure or can supplement possible deficiencies of other taxes or other sources of income. In consequence of the law of the ever-widening functions of the state, we must demand of the tax system that it shall be able to furnish a constantly increasing revenue.
—3. The "source of taxation" is that economical quantity from which the tax is really paid, and is to be carefully distinguished from thebasis of assessment. The latter term denotes that on which the tax is nominally laid and according to which it is assessed. Thus the so-called property tax, levied on and according to property, is ordinarily is reality an income tax, i.e., it is paid by the property owner out of his income. Where the property is actually diminished from year to year in order to pay the tax, the latter becomes a real as well as a nominal property tax. There are three possible sources of taxation: income or profits; capital, i.e., property used as a means of production; and finally, property in use. It is possible for a tax to be collected from the commodities belonging to each of these three classes of property, or from the money which represents them in the market, in such a way that the sum total of these commodities shall be diminished by the tax.
—The normal source of taxation is national income. By national income we mean the total amount of commodities which come newly into the possession of a nation within a year, and which might have been consumed without lessening the total amount of national wealth at the beginning of the year. In the long run this is the only source from which taxation may draw. A constant or even frequent encroachment on national wealth or capital would soon be stopped by the diminution of the latter. A taxation of national capital, i.e., of the supply of material means of production—or capital in the purely economic sense as opposed to capital in the historico-legal sense—leads necessarily to a limitation of production and to a keenly felt reduction in the standard of comfort. The "sparing of property and capital," the verdict against real taxes on property and capital (i.e., taxes which really diminish property and capital) is, therefore, a universal and highly important principle of the modern theory of taxation. We must keep in mind, however, that a taxation of private or individual capital is not always a taxation of national capital, and that the same objections, therefore, do not apply to a tax a individual which apply to taxes on national capital. Thus a tax on inheritance, while it really diminishes private may not diminish national capital a particle, as it may result in a mere difference of distribution among the citizens. A temperary tax even on national capital or property may be justifiable, in order to support great undertakings on which the existence or continued properity of the nation may depend; as, for instance, to prosecute a necessary war or to introuce much needed reforms in national politics or economy, just as in private business the sacrifice of a portion of the capital or property may be necessary to save the rest.
—4. Regard for the incidence of taxation. The government may determine the basis of assessment or the object upon which the tax is laid, and thereby the person who is to advance this tax in the first place, i.e., the tax payer; but under a system of free competition it has no power to determine the source of taxation or the person who must ultimately bear the tax, i.e., the tax bearer. In reference to the last it may have wishes and intentions, and by its choice of taxes and objects for taxation may do much to realize its wishes and intentions. But what particular private income or property shall ultimately become the real source of taxation, or what particular person shall become the real tax bearer, is determined by the economic process which we call the "shifting of taxation." The latter is the result of a reaction of taxation upon the tax payer. He attempts to get rid of the burden of taxation, either by increasing his income (and therefore regularly by increasing his activity of production) or by collecting from another the tax which he has advanced. This endeavor appears in industry as the shifting of taxation, and expresses itself ultimately in certain changes in production and distribution in the whole national economy. Taxation often distributes itself ultimately, therefore, among the sources of taxation and tax bearers, in a very different way from that in which it was originally levied on the objects of taxation and the tax payers. This ultimate distribution is the important point. It should be consistent with economical principles and with principles of justice. The important problem, therefore, of the theory and praxis of taxation consists in finding out, as accurately as possible, what effects a given tax system or particular kinds of taxes have upon the ultimate distribution of taxation which results from this shifting process.
—Very many theorists, and nearly all practical men, in this sphere of our science have hitherto attributed an undue importance to this process. They see in it a universal panacea for all inequality of taxation, and maintain that every tax, no matter how unjust when first imposed, if it be retained, will in course of time be equalized by this process of adjustment, and hence cease to be unjust. We may call this the optimistic theory. It is well summed up in the motto, "Every old tax is a good one; every new tax, a bad one." However, neither reason nor observation sustains this view. While in many cases such an adjustment as furthers equality does undoubtedly take place, yet in many others it meets very great difficulties, and in some, unsuperable obstacles. It may also be urged against this view that the adjustment often occurs in such a way as to increase inequality. The economically weaker elements of society, being oftentimes unable to shift any portion of their taxation, are further burdened by whatever portion the stronger elements are able to shift from their own shoulder. In any case it is exceedingly difficult to determine what the effect of this shifting process has been, and we have therefore no security that a harmful and unequal system of taxation will distribute itself justly by any process of shifting or reshifting. It is necessary, therefore, to make our system of taxation, from the first, consistent with the principles of economy and justice.—5 and 6. Universality and equality of taxation. The idea of justice in taxation is a purely relative one. A system may be essentially just at one period and under one set of conditions, which under different circumstances would lack every element of justice. In the following we shall speak of just taxation with reference to the conditions of modern industrial life. Our idea of just taxation will depend very largely on our idea as to the present distribution of wealth which has taken place under the régime of so-called free competition. Whoever regards our present system as absolutely right and the only just one, must regard the present distribution of property and income which has taken place under it, as the only proper one. His theory of just taxation will be a system which interferes as little as possible with the actual distribution of wealth in our society. Universality means to him that every citizen, whether his income be large or small, whether it be derived from funds or daily labor, shall be taxed. He must refuse all proposals to remit taxes. Equality of taxation means that every one shall pay an equal numerical proportion of his income as tax, and implies, therefore, a rejection of progressive taxation. But the claim that the existing distribution effected under free competition is the only just one, is, on the one hand, a begging of the question, and, on the other, it ignores the influence of the existing laws of private property which have been inherited from entirely different conditions. The conclusion, therefore, that the present distribution of wealth is a noli me tangere, is unfounded. A second principle has been making its way into theory and practice, which we may call the politico-social principle, according to which taxation is not merely a means of providing revenue for the government, but, in addition, a means of correcting the existing distribution of property. According to this, the rule of universality admits of some exceptions, such as leaving a certain minimum income untaxed. Equality means equal sacrifice; not attempting to realize that, however, by demanding a numerically equal proportional part of all incomes, but by taking a numerically larger proportion with every increase in income, a least within certain limits.
—Two principles have been proposed by which taxation is to be justified and according to which it is to be levied. The first we may call the industrial principle, which would adjust taxation according to "interest," or "service and counter-service." This views the relation of the tax-paying subject to the state as a purely business one. The state performs certain functions, and the individual pays it for such performance. This, of course, is a mere generalization of the fee principle, and is entirely untenable as a general basis for taxation. The second, which we may call the organic principle would regulate taxation according to the ability of the taxed to sustain it. The degree of taxation is determined by the relation between the economic condition of the taxed and the amount of the tax. The justification of taxation lies, accordingly, in the nature of the state and in the relation of the taxed to the state, from which taxation results not as a special counter-service for advantages from the body politic, but as a duty of a member toward the fulfillment of the conditions of the existence and prosperity of the whole to which he belongs. This theory considers the tax as a sacrifice, and equality of taxation is to be established by so adjusting the taxes that they will require an equal sacrifice of all. This is to be accomplished by a system of progressive taxation, i.e., one in which the rate increases with the income. For it is evident that the day laborer who barely earns enough to sustain his family, we will say $400 a year must make a greater sacrifice to pay a 3 per cent. tax, than a capitalist whole income is $10,000 a year, i.e., that $12 is more for the former than $300 for the latter. The first of these principles is naturally the predominating one in all primitive conditions, the second becomes more and more important the more highly the industrial economy is developed.—7, 8 and 9. Definiteness, convenience, economy. These may be called administrative axioms. From our conception of a tax as a sacrifice, it follows, as a matter of course, that every device ought to be adopted to diminish the burden as much as possible consistent with accomplishing our purposes. Definiteness and convenience are really of value only so far as they contribute to economy. Economy in this connection means economy in costs of collection, using that term in its widest sense. We refer to what was said on this point at the close of division II. of this article.
—LITERATURE. At the head of systematic works upon the subject we rank the Finanzwissenschaft, by Adolph Wagner, Leipzig, 1877-82, which was taken as the basis of the foregoing article and largely used in its preparation. It is a revision and rewriting with large additions of the Finanzwissenschaft of Rau. It contains admirable summaries of the literature upon special points as well as upon the subject as a whole. Stein's Lehrbuch der Finanzwissenschaft, Leipzig, 1860; Bergius Grundsatze der Finanzwissenschaft, Berlin, 1865; von Malchus' Handbuch der Finanzwissenschaft, Stuttgart, 1830; von Jakob. die Staatswissenschaft, Halle, 1821; may be mentioned among German works. De Parien, Traité des impots, Paris, 1862-5; J Garnier, Eléments des finances, Paris, 1858; L. Cossa, Elem di scienza della fin., Milan, 1876; are all worthy of notice, and contain summaries of all valuable literature on finance. The English works bearing on this subject will be mentioned at close of article on TAXATION.
E. J. JAMES.
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