It is the writer's opinion that one of the most serious faults
of the present income tax law is its failure to reach a certain
element that should be reckoned whit in comparing relative abilities
of taxpayers to contribute to the support of government but that does
not appear as income in a monetary form. This element is the "imputed
income", or non-monetary income, that arises from the possession of a
relatively durable good or the creation, by the taxpayer himself, of
good or services that benefit him. Two examples will serve to
illustrate the point involved.

Hypothetical Example. -- First, suppose that two men, A and B,
each have $20,000 in corporate bonds, from which that each receive
an income of $800 a year. They live in rented houses, each paying
$800 a year rent. A now sells part of his bonds and with the proceeds
buys some urban land of exactly the same value as that that B
occupies and erects thereon a dwelling of exactly the same value as
that B occupies, which he thereafter uses as a residence. B retains
his bonds bonds and on the income therefrom continues to live in a
rented dwelling. Under the present income tax law A pays tax only on
the income from the securities that he has not disposed of, whereas B
must include in his income tax return the interest on the full.
$20.000 of securities that he has retained. The two men are similarly
circumstances except for the legal feature of ownership -- should
they not pay same income tax?

Second, suppose that of two men, C and D, both own their
dwellings, but one is an urban dweller who receives a money wage from
which he pays for his food, while the other is a farmer who gets much
of his from his land by his own efforts. With respect to this
particular matter the two men are virtually in the same position
except that one sells his services for money and with the money buys
food while the other gets food directly as a result of his services,
or effort. The former, however, is subject to income tax on his
monetary receipts; the latter pays no tax on the food-income he gets.

Is the inequity Eliminated by the Property Tax?. -- When other
elements in the tax system are considered, the problem does not
remain so simple as outlined above. In the first case, one may argue,
A pays a property tax, and B pays none. In reply it might be said
that the income tax can stand or fall by itself, and any obvious
inconsistency or inequity therein should not be excused merely
because of some other feature of the tax system. Waiving this reply,
however, -- and the writer believes that is should be waived -- one
discovers upon further examination that the existence of the property
tax is not an answer to the fault in the income tax.

The consensus of opinion among economists who have written on
the subject is that the part of the property tax represented by the
tax on rented buildings is shifted to the tenant, although the
process may take some time and may never be completed in a stagnating
or declining community. Insofar as such shifting occurs, therefore,
B, in the above example, pays at least part of the property tax
indirectly, compared with a who pays it directly. With respect to
that part of the property tax represented by the tax on land, much --
perhaps the greater part of it -- has been taken into account by the
purchaser in deciding what to pay for the land. Had the tax been
lower, he would have paid a higher price for the land; had the tax
been higher, he would have paid a lower price. In this sense A, in
the example above, is not bearing the entire burden of the land tax;
some part of this annual burden, capitalized, has fallen on some
previous owner. As to B, since the land tax is usually considered not
shiftable to the tenant even if it has not been capitalized, he too
bears no part of the burden. Again A and B are somewhat on the same
footing as concerns the property tax. So much is unknown about the
exact operation of the forces of shifting and capitalization that no
high degree of finality can be given to these statements; but at
least it can be said that those who would claim that the operation of
the property tax counterbalances the inequity of the income tax have
not proved their case -- indeed, the evidence, such us it is, is
pretty clearly against their contention. Still stronger would be the
case if the property tax on securities were taken into account, it is
perhaps best to ignore it. In those states where a personal income
tax has replaced the intangibles tax, the inequity is greater than
ever, since all the state taxes are alike the Federal tax in that
they fail to reach imputed income.

Civil War Tax. -- Under the civil war income tax levied by the
Federal Government, the amount paid for the rent of a dwelling house,
was allowed as a deduction: the rental value of dwellings occupied by
owners was specifically excluded from taxable income. /1/ The
commissioner of Internal Revenue recommended that the reverse
procedure be followed: no deduction allowance, and taxation of rental
value of dwellings occupied by owners. /2/ In his report of 1868,
commissioner Wells remarked, that the existing law contained a
"curious anomaly which allows, on the one hand, an unqualified
deduction from income of the amount paid for rent, and on the other
hand does not consider as income in any degree the rental value of
property held or enjoyed by its possessor." The "anomaly" apparently
lay in the fact that, "while in all other department of the revenue
it is accepted as a fundamental privilege that luxuries especially
should be taxed, in this they

/1/ E. R. A. Seligman, The Income Tax. Second Edition, New York, 1921, pp., 438, 511 note.

/2/ Ibid., p. 439.

are especially exempted". /1/ Certainly there was no inconsistency in
treatment of home owner and home renter, although, it was precisely
the opposite of the policy recommended by the present writer.

Under the Federal income tax of 1894, no deduction was allowed
for dwelling rental, but the law was silent whit respect to imputed
rental income. /2/

"Gross" versus "Net" Imputed Rental. -- The rental that should
be taxable should be net rental, that is imputed gross rental value
less depreciation and repairs. Otherwise A, in the example above,
would be taxed both upon his income and upon the portions of capital
that he would be exhausting.

If it is assumed that depreciation and repairs on the Kind of
house B is renting total $400 a year, then A, to be in the same
position as B after many years have passed, must retain $10,000 in
the 4 per cent securities and spend only $10,000 for the house and
lot. Indeed, if he invested the full $20,000 in his residence, he
would have a much finer place than B.

If A does invest only $10,000, than the imputed gross rental
value of his residence is $800 a year (on the assumption that he
lives in a residence having the same value as the one B lives in),
the depreciation and repairs deduction is $400, the income from the

/1/ Cited in Seligman, op. cit., p. 455.

/2/ Seligman, op. cit., p. 512.

remaining $10,000 in securities is $400; and the net taxable income
is $800 -- the same as B's. If A chooses to live on his capital, in
part, and therefore sells all his securities to buy his lot and build
his house, the imputed gross rental value of his residence is $1,600
(twice as much as B's actual rental, since the residence is twice as
valuable), the depreciation and repairs deduction is roughly twice as
great, or $800, and the net taxable income is still $800, the same as
B's which is as it should be.

Since there is imputed income there any also be imputed loss.
The imputed gross rental value of A's home may so shrink, owing to
business depression, decline in price level, etc., that the
depreciation item alone is greater than the fair imputed gross
income. In this case allowance should be made for a deduction.
Startling as this proposal may appear at first glance, it can be seen
on closer examination to do nothing more than allow A to take account
of a capital loss bit by bit over a period of years, instead of
allowing the loss in one lump sum in one year (the year of
realization) as is done if B sells his securities at a loss.
Obviously the matter here becomes involved with the question of the
treatment of capital gains and losses. This subject cannot be further
treated in this memorandum, but the reader may properly infer that
the present writer does not favor disassociating for income tax
purposes, capital gains and losses from so-called "ordinary" income
and losses.

Extent of Imputed Income. -- The house and lot occupied by the
home owner and the produce consumed by the farmer are not the only
examples of imputed income. Everything that might be rented instead
of being purchased outright furnishes, when purchased out-right, an
example or imputed income. Jewelry, automobiles, and clothes, for
instance, stand in somewhat the same position as houses in this
respect. However, these articles are not seriously considered by the
writer as possible subjects of income taxation on an imputed basis at
the present time, because of difficulties of administration. They are
not; furthermore, so serious as the discrimination with respect to
residence rental values or farm-consumed food. /1/

Treatment in Other Countries. -- Ever since they have had an
income tax, the British have treated as taxable income the annual
value of a house occupied by its owner. /2/ Likewise, if a farmer
elects to be taxable under Schedule D, he must report as income the
value of his own produce that he consumes. /3/ The French income tax
law also requires tax to be paid on the annual value of residences,
whether rented or not; this tax, a long-established one, was carried
over into and made a part of the income tax system established during
the years 1914-1917. Income from farm produce consumed on the farm is
also subject to income

/1/ Cf. Harrison B. Spaulding. The Income Tax in Credit Britain and the United States, pp. 156-161.

/2/ Spaulding, op., cit., p. 156.

/3/ Ibid., p. 161.

taxation to the extent that this item enters into the very rough and
arbitrary estimated of income upon which the real estate tax and the
agricultural taxes have been based. /1/ Under the German income tax
law as revised in 1920, income tax has been payable on the rental
value of the taxpayer's own house or such house as the taxpayer may
occupy without paying rent; and with respect to farm produce consumed
by the farmer, the law stated that subjects or services that the
owner of agricultural property utilized in connection with the
maintenance of his household were to be considered business receipts,
/2/ and hence as items of gross income.

Objections to the Change. -- Several important reasons for not
adopting the change advocated above can be cited.

The change would catch unawares many home owners who have
purchased their homes on the assumption that no drain would be made
on their liquid capital by income taxation on the annual value of the
home, Many home owners find that their liquid capital on their cash
income is very low indeed, largely because they are attempting to own
homes, and the new tax might seriously embarrass them financially.
For a few years the new element in the

/1/ Robert M. Haig, The Public Finances of Post-War France, pp. 315-17.

/2/ Finanz Archiv, vol. 38, 1921 (pars. 6, 31, 32, and 34 of the law), as reported by Dr. Paul Wueller in an unpublished manuscript. The writer does not know whether these provisions are still in force, or when they originated.

tax base might be entered at a fraction of its true value or in some
other way the new burden might be imposed gradually, if upon further
study the point seemed serious enough to warrant such action. A
gradual elimination of the present inequity would be far better than
a complete failure to eliminate it.

The administrative objections are serious. These may have been
instrumental in causing Wisconsin to abandon its attempt to tax
imputed rental values some twenty years ago. Our income tax is self-
assessed, and even the most conscientious taxpayer finds it difficult
not to favor himself unduly when the must estimates: witness the
deduction for partially bad debts, for uninsured property damaged,
destroyed, or lost through fire, storm, shipwreck, or "other
casualty," or theft, and for depreciation and depletion; and the
taxation of compensation or other income paid to the taxpayer in
kind. Aside from bad debts and depreciation and depletion, however,
these items are not important in the aggregate, and the three just
noted are for the most part confined to business income returned by a
taxpayer who is familiar with methods of estimating. Taxation of
imputed dwelling rental and produce value would therefore undoubtedly
add markedly to the present administrative burden.

The task can be easily overemphasized by drawing attention to
the difficulties encountered by State and local officials in valuing
property for purposes of the property tax. In order to set a capital
value, estimates of future income for several years may be made.
Estimating imputed rental for the income tax, on the other hand,
involves only one year at a time and that a past, not a future, year.

Objection might be raised on the grounds that the change would
add heavily to the burden of most farmers, even if the total revenue
to be obtained from the income tax or other taxes was not to be
increased (that is, even though tax rates were reduced to the extent
allowed by the new income tax base). The writer is far from certain,
however, that this would be the result, although he has no data on
hand at the moment to answer the question. Farm tenants and farm
laborers might benefit by the change, insofar as the increase income
tax base allowed a lowering of rates of certain types of taxes. In
terms of absolute amount of revenue, the burden would probably be
borne chiefly by urban home owners, and the writer would not be
surprised if the net result of the change was a shift of income-tax
burden from rural to urban areas.

With respect to urban home owners especially, the change might
be regarded as inconsistent with the administration's policy of
encouraging home building. However, the writer believes that any
subsidy that seems desirable to give for this purpose should be given
as directly as possible. To attempt to grant it indirectly through
the income tax is to favor both rich and poor, both those who have
held homes for a long time and those who have held them for a short
time. In general, this type of indirect subsidy is likely to be far
more costly than a direct grant intelligently distributed.

Revenue Aspects of the Change. -- The increase in the tax base
to be obtained from the policy recommended herein is substantial.
Data from the Fifteenth Census (1930) on the average value per home
of owned non-farm homes indicate that for this group alone a tax base
of over $3 billion would result; and if the over-all weighted income
tax rate applicable to this added income taken as between 5 and 10
per cent, /1/ the tax yield would be between $150 million and $300
million. The accompanying table shows to manner in which these
figures were derived. Similar data for non-business farm buildings
are not at hand as this is written, but the figure above sufficiently
indicates that the problem here involved is a major one with respect
to revenue.

/1/ On a conservative basis, it is probably within this range, according to data developed by Mr. Sheer and Mr. Killer in formulating income tax estimates.

Net Annual Rental Value of Owned Non-Farm Homes Derived from
Table 23, p. 17, Fifteenth Census (1930) of U.S., by assuming (a)
that average value was mid-point in value bracket and (b) that net
annual rental value was 5 per cent of value

 Column A        Column B           Column C        Column D

   Number      Average Value       Total Value    Net Annual Rental
  of Homes          per Home       (A times B)    (5 per cent of C) 

   794,724               500         397,362,000         19,868,100
   570,047             1,250         712,558,750         35,627,938
   531,277             1,750         929,734,750         46,486,738
 1,167,325             2,500       2,918,312,500        145,915,625
 2,343,769             4,000       9,375,076,000        468,753,800
 2,297,029             6,250      14,356,431,250        717,821,563
   989,468             8,750       8,657,845,000        432,892,250
   906,557            12,500      11,331,962,500        566,598,125
   339,535            17,500       5,941,862,500        297,093,125
   354,337            30,000 /a/  10,630,110,000        531,505,500
   209,318             4,000 /b/     837,272,000         41,863,600
                                  ______________      _____________
TOTAL                             66,088,527,250      3,304,426,364
/a/ In "$20,000 and over" class; arbitrarily set at $30,000.

/b/ Value not reported; arbitrarily set at modal point ($4,000).


Deductions for Interest, Bad, Debts, and Casualty and Theft Losses. -- The policy with respect to deductions from gross income is for the most part, in the words of Regulations 77, (Article 41 (c)), to restrict deductions to "expenditures, other than capital expenditures, connected with the production of income." This policy is violated, however, in allowing deduction of (a) bad debts, no matter how incurred, (b) interest paid, no matter for what purpose except on debts incurred to purchase or carry certain wholly exempt bonds, (c) losses "of property not connected with the trade or business, if the loss arises from fires, storms, shipwreck, or other casualty, or from theft," /1/ and is not compensated for by insurance or otherwise. There is a general restriction refusing deduction if the deductible item is allocable to wholly exempt income. /2/

There seems to be no reason for allowing deduction of bad debts that have not been incurred in a profit-seeking venture, so long as "personal, living or family expenses " /3/ are not allowable deductions. The same remarks can be made whit respect to interest.

/1/ 1934 Revenue Act, Section 23(e)(3).

/2/ Ibid., Section 24(a)(5). /3/ Ibid., Section 24(a)(1).

Casualty and theft losses may have some justification as deductible items on the ground that they are unexpected events that often cause a severe drain on the taxpayer's liquid capital, but this is an argument for allowing postponement rather than reduction of tax. However, if as recommended in a preceding section, imputed income from a dwelling is to be taxed, capital loss the dwelling should be allowed, whether by depreciation or otherwise.

No estimate on the amount of money to be gained by restricting these deductions is available, but it is probable that the amount involved is not great.

Expenses. -- Section 23(a) of the 1934 Act allows deduction of "traveling expenses (including the entire amount expended for meals and lodging) while away from home in the pursuit of a trade or business." Two points might be raised here: (1) should not the law, or at least the Regulations, be made more specific with respect to what is meant by "traveling" (when does a man "away from home" stop "traveling"? (2) should not the deduction be limited to the EXTRA expense the individual is put to in traveling.

The writer believes that the answer to the first question is "Yes," although he has no specific language to suggest at the moment. Logically, the answer to the second question is also "Yes," but the difficulty of calculating the excess would probably outweigh the advantages, as is indicated by the action of Congress in repealing a limitation of this kind, in 1921. /1/

Interest on United States Government Bonds. -- At present the interest on United States Government bonds issued after September 1, 1917 is exempt only to the extent provided for in the Acts authorizing the issue, according to section 22(b)(4) of the Revenue Act 1934; but section 25(a)(2) of the same law flatly exempts all interest on United States obligations from the normal tax. To avoid possible confusion, in case Congress wishes to subject some future issue to normal tax, it might be well to add to section 25(a)(2) a qualifying phrase such as that is 25(a)(3), where one of the conditions is "if . . . under the Act authorizing the issue thereof . . . such interest is exempt from normal tax."

Compounding of Depreciation Allowance. -- In the House hearings on the Revenues Bill, 1934, Representative Lewis seemed to suggest that, if one takes account of the interest accruing on a depreciation allowance, the value of the property is recovered long before the depreciation allowance ceases (pp. 31-32). The correct reply to this seems to be that, if the depreciation fund is in fact

/1/ Cf. R. H. Montgomery, Income Tax Procedure, 1921, p. 672, and 1922, p. 864.

invested and does earn interest, the interest is taxable; if it is not so invested, there is no accretion to tax. In either case it does not affect the proper amount to be allowed annually for depreciation.

Earned Income. -- A verbal change should be made here (section 25(a)(5)(A)), so that in the phase, "compensation derived . . . . for personal services," the word "for" becomes "from."

Information at the Source. -- Since the Federal income tax relies almost entirely upon self-assessment, having abandoned the collection-at-source method after a short trial of a few years before the war, the means of checking upon self-assessment in order to prevent evasion is of paramount importance. The chief means at present is by "information at source." Sections 147, 148 and 149 of the Revenue Act of 1934 contain the chief provisions on this point.

Study of the law and regulations, and conversations with officials of the Internal Revenue Bureau, have led the writer to the following conclusions:

(a) Those who are supposed to file information returns but do not should be subject to adequate penalties, strictly enforced. At present the only penalty is that carried under the misdemeanor provision of section 145(a), which applies only to one who "wilfully" fails to supply the information; and only one misdemeanor charge has been pressed under this section in the past four years. It is estimated that fully 85 per cent of the 3 to 4 million information returns (form 1099) filed each year are filed by corporations. The presumption is that large numbers of non-corporate employers are failing to fulfill their duties in this respect. It is not possible to state, statistically, how useful the information returns have been in discovering either taxpayers or added amounts due by known taxpayers, but there seems little doubt that the returns have amply proved their value.

(b) Information returns should be filed by salary -- and wage -- disbursing officers of the Federal Government. True, the information can be obtained whenever it is wants, but this view seems to misconceive the practical functioning of the information-return system. If information slip is sent in, the Bureau cannot without tending to disorganize its system, check the entire Governmental pay roll.

(c) The writer is not aware of any valid reason for exempting from the information return requirements the payment of interest on obligations of the United States (Section 147(d)). No such obligations are subject to the normal tax, but many of them are subject, in part at least, to the surtax.

(d) Compulsory registration of all bonds (referred to in Memorandum H on death and gift taxes) is apparently not at this moment considered necessary by administrative officials with respect to the income tax. Payees, under a recent Treasury decision (4460), must report bond interest when the amount is $20 or more, and this minimum is probably low enough to warrant no further change until it can be seen how effective this plan is. However, abolition of bearer bonds is a point to be kept in mind if the problem of evasion of tax on bond income becomes serious.

(e) The present general provision (Section 147(a)) requires information in the case of payments of "$1,000 or more in any taxable year." Hence, itinerant employees, or persons working for more than one employer at once, may receive $1,000 or more in the course of a year, yet never be reported. If the law were to require information concerning payments made at the rate of $1,000 or more per year, these employees would in theory be reported. The only administrative official with whom the writer has discussed this question voiced strong objection to any such proposal on the grounds that it would flood the Treasury with so many information returns of relatively little value that work on the more important returns might seriously disrupted. Furthermore, it is argued, it would be difficult to reach the itinerant employees to collect the tax. If Bureau's staff were sufficiently enlarged, the first objection would be answered, and, to some extant, the second also. The writer suggests that such enlargement be given serious consideration, but not until a strenuous effort has been made to obtain information returns from all those supposed to file them under the present law (see (a) above).