327. In reality these various effects commonly merge into one another. It is, however, desirable to distinguish them for the sake of clearness, and the analysis we have made will serve as a point of reference to which any part of the following discussion can be related.

328. It may be desirable to take a further step in definition, by explaining our use of the term "saving " which is often employed ambiguously.

The amount which a man saves depends on the amount of his income and the amount of his outgoings. He may add to the amount of his savings either by increasing the former or by cutting down the latter, so far as they are within his control. In other words, he may produce more or he may consume less, and the result on his cash savings may be exactly the same. It is quite common therefore to look on the making of income as if it were merely part of the process of saving anything that deters a man from effort is sometimes said to have a deterrent effect on his saving.

This way of speaking blurs the distinction between saving and enterprise. When a man is working, he is not directly engaged in saving, but in producing; and it is a fallacy to make production wholly subordinate to saving, as if saving were a supreme end in itself. In discussing the effect of Income Tax on business, the two aspects, production and saving, have to be kept clear. We, therefore, confine our use of the term " saving (in the singular) to the setting aside, out of income which has been made, of a surplus over private expenditure. By so doing, we hope to prevent confusion between saving and enterprise, understanding by the latter the qualities of energy, initiative, &c., that go directly to the making of income, and that in some degree determine the particular use to which savings are applied. Again, it is necessary to distinguish two objects of saving. A man may save in order to meet his tax liability and he may save in order to invest. Thus, if a man with a fixed income saves an additional £50 because his Income Tax liability has increased by £150, the tax may be called favourable to saving in the sense that it has caused him to spend £50 less. At the same time, it is unfavourable in the sense that it has reduced by £100 the amount he would otherwise have invested.

329. The natural order of discussion will perhaps be to deal first with the individual Income Tax payer, who, after all, is at the bottom of all organisations affected by the tax, then with the public limited company, and lastly with the private business. In the first section dealing with the individual, we will not consider him in his capacity as personally engaged in the exercise of trade or business. We will examine only how the tax influences the services of the employee and the professional man to the community; how it acts upon the standard of living; and how it affects the individual as an investor.

From consideration of the individual as an investor we pass by a natural transition to the public joint stock company; for, as investor, the individual is at once linked up with the public company, whose capital he supplies. It is the mark of the public company that the ownership and the business management are in different hands. In the private business, with which we shall deal last, the same persons are responsible both for the supply of capital (other than loan capital) and for the management. Thus the private business, whether individual trader, partnership or private company, is in a sense the more completely unified trade organism.

It may be convenient here to set out the framework of our discussion.

I. Income Tax and the Individual:

(i) The principle of progressive income taxa

(ii) (a) The post-war rates of tax and

Paragraphs.

(b) Residence abroad to avoid tax
(iii) Effect of the Income Tax on the work and
enterprise of the employee and profes-

(iv) The weight of the Income Tax and the

330-333

334-341

342

343-350

351-364

(v) The effect of the Income Tax on saving ... 365-377 II. Income Tax and the Public Joint Stock Company:

(i) The supply of capital from the public 378-391 (ii) Company reserves

...

(iii) Enterprise of companies

...

...

...

392-402 403-404

(iv) Transfer of residence abroad, and allied.

effects

...

...

405-408

III. Income Tax and the Private Business: (i) The classes of private business and their distinction from the public company... 409-411 (ii) Comparison of the private business with the profession, &c.

(iii) The physical effect of the Income Tax on
saving and enterprise

(iv) The psychological effect of the Income
Tax on saving and enterprise

412-415

(v) Transfer of residence abroad and allied

effects

IV. Summary of main conclusions

I.-INCOME TAX AND THE INDIVIDUAL.

(i) The Principle of Progressive Income Taxation.

330. The present system of differentiation and graduation of the British Income Tax dates from the Finance Act 1920,

and owes its being to the Royal Commission on the Income Tax, which was appointed in 1919. In Appendix VIII we quote from the 64th Report of the Commissioners of Inland Revenue (Cmd. 1436), an extract from the account there given of the present system, as compared with the system which it superseded. We need not here enlarge upon this account; further information may be found in the Report of the Royal Commission on the Income Tax (Cmd. 615).

331. The first thing that strikes the eye in any table, such as those in Appendix XIII, comparing the effective rates of Income Tax and Super-tax before and since 1914-15, is that the graduation has become far more progressive. For a simple example, we may cite one or two figures relating to bachelors with investment incomes of different sizes; in 1913-14, when the standard rate of tax was 1s. 2d. in the pound, the same effective rate of 1s. 2d. was payable on any income between £800 and £5,000, while a rate of less than 1s. 8d. was payable on £100,000; in 1925-26, with a standard rate of 4s. in the pound, the effective rate progresses from 2s. 9d. for an income of £800 to 4s. 8d. for one of £5,000, and to 9s. 5d. for one of £100,000.

Steep graduation is so much a mark of the existing Income Tax that we must, at the outset, briefly consider the principle which underlies it.

332. Progressive taxation of income is justified, in the main, by the general rule that the marginal utility of income to the individual diminishes as the income grows. For instance, the last pound of an income of £10,000 has less personal utility than the last pound of an income of £2,000; consequently, it has greater capacity to bear taxation.

The rule is only valid in a general way. It is impossible to refine upon it and to say how much the utility decreases between any two points. So far as differences of individual taste and outlook can be ignored, it may no doubt be said that the utility of the last pound diminishes rather rapidly in the early increments of income, after the essential needs of life have been satisfied; then the rate of diminution tends to be slower, as the distinction between bare sufficiency and elementary comfort gives way to the slighter distinctions between lesser and greater comfort, and between comfort and luxury.

In actual fact, however, the value of money depends to a very great extent on individual outlook, on family responsibility and on social standards. There cannot be any uniform rate of diminution; the marginal utility to the man with, say, £600 may quite frequently be greater than to the man with £400. All that can be said is that normally the utility of income tends to diminish, and its taxability pari passu to increase, and that, on the whole, the process will be first at a more rapid and then at a slower rate. In the matter of taxation the State is bound

to take a more or less objective standard; it has to regulate its. policy largely by reference to the normal case.

333. But there is a complementary aspect which imposes a check on the application of the ability to pay principle. Money in the free disposition of the citizen has a utility to the State as well as to himself. Saved and invested, it supplies the financial and industrial needs of the community. From this point of view, it cannot be said that there is diminishing utility in the individual's income. The utility, in fact, only begins when the income is sufficient to leave a margin over necessary expenditure; in other words, the special utility to the community only begins, when the greatest utility to the individual has creased. The larger the increase, the more room is there for saving; and the State, when putting a heavy tax on incomes with the greater margin, has to consider the risk of doing too much damage to savings.

(ii) (a) The Post-war Rates of Tax and Graduation.

334. General.-The standard rate of tax, and the estimated total net produce of the Income Tax and the Super-tax for the six years 1920-21 to 1925-26 were as follows:

Under the system of graduation in force over these years, reliefs from tax have not depended as they did formerly on the limits within which the individual's income has fallen. Consequently, the administration of the tax has not provided data for an estimate of the proportion contributed to the total yield by incomes of different sizes. A roughly approximate idea may, however, be obtained from figures which were prepared by the Board of Inland Revenue for the year 1919-20, and which are reproduced in the table in Appendix XIV to this Report. The graduation for 1919-20, although less evenly adjusted to increases of income, was not dissimilar in general effect (as may be seen from the graphs in Appendix XIII) to that of succeeding years.

For 1919-20 the normal rate of Income Tax was 6s. in the pound; the net produce of the tax (including the Super-tax for the corresponding year 1920-21) was £403,055,563. It should be remembered that, as regards trade, the figures repre

sent the average profits of the years 1916 to 1918, after deduction of Excess Profits Duty, but for which they would have been a great deal higher.

335. The table in Appendix XIV conveys a two-fold impression-the high yield on the large incomes, and the inequality of the distribution of income even within the limits of the Income Tax paying classes. The same impression is given, in greater or less degree, however the figures of the table may be grouped; the following arrangement will perhaps be interesting:

336. When the tables of effective rates and the graphs in Appendix XIII are examined, it will be noticed that, with minor exceptions, the graduation becomes less steep, the higher the range of income. This is inevitable; an ascent continued from any point on the scale at a progressive steepening of a few pence in the pound per hundred pounds would soon result in the perpendicular wall of 20s. in the pound being reached. Moreover, a slackening of the rate of progression accords with theory, since we have seen (para. 332) that, as the individual's income grows, its taxability tends to increase first at a more rapid and then at a slower rate.

Nevertheless, the steepness of the graduation in the lower part of the scale, and the comparative slightness of the increase for incomes above, say, £8,000 or £10,000, and particularly for the highest incomes, is striking. It produces a first impression quite different from that conveyed by the absolute figures of yield quoted in the preceding paragraph. A closer scrutiny of the Income Tax scale appears to be needed. It will be convenient to divide incomes up into three groups, those not exceeding £500, those between £500 and £2,000, and those exceeding £2,000.