the hands of the partners, more or less heavily according to their several incomes. On the other hand, in the case of a private company, even if it be a family concern or a "one-man company," the profits retained in the business are normally not regarded as personal income at all. Under recent legislation, however (Section 21 of the Finance Act, 1922), these profits may in some cases be so regarded, if it is held by the Special Commissioners of Income Tax that a less than reasonable amount has been distributed. The provision applies to private companies registered since the 5th April, 1914, which are under the control of not more than five persons; its avowed object is that of " preventing the avoidance of the payment of Super-tax through the withholding from distribution of income of a company which would otherwise be distributed." Apart from this exception, the profits kept in a private company bear Income Tax at the standard rate, just in the same way as the reserves of a public company, and are similarly not brought within the charge to Super-tax. 411. The partnership and the private company may, however, properly be treated together, and marked off from the public concern. The essential difference is quite simple. The individuals controlling a private business-firm or company-are practically the sole persons financially interested in the result of its trading; as a corollary, they bear the brunt of taxation upon the profits, not having outside shareholders to whom they can pass it on. Again, since they cannot offer shares to the public, they are thrown back much more upon their own reserves. The only way in which they can build up their capital, unless they are in a position to increase their individual interests in the business from other resources, is by saving from their profits. Thus, the private business is much more self-contained, and therefore more personal, than the public; equally, its conduct is. more liable to be determined by individual motive. (ii) Comparison of the Private Business with the 412. The man engaged in the conduct of private business has not only personal and family motives for saving and enterprise similar to those of other individuals, e.g., professional men and employees. He has strong additional incentives or deterrents due to the nature of his work; they arise from the continuing need for capital, and the continuing possibility of loss. 413. A good deal of capital may have been sunk in the education and training of the professional man, but, generally speaking, once his career has started, he relies mainly on his immaterial "brain capital." The doctor or the lawyer, in order to succeed, may have to work hard against competition, but, SO far as success in his own profession is concerned, he will not necessarily have to save hard; even when he has won a reputation and his position is more secure, while he may still be spurred to effort by pride or interest in his work, he may not feel any corresponding stimulus to save. Again, he may work hard simply because he wants an outlet for his energy apart from any other motive. There is, indeed, no intrinsic reason why the virtue of thrift, which is allied to caution, should go hand in hand with energy or enterprise; and the professions, since they are so little dependent on material capital, do not exert any very compelling influence to bring them together. 414. In the case of the man personally engaged in business thrift and enterprise are much more interdependent. In the struggling business the necessity for fresh capital may be no less urgent than the necessity for hard work and initiative; the trader may have to save in order that the business in which he depends for a livelihood may survive. Again, in the prospering, go-ahead business the will and the ability to expand require to be backed by a continual flow of savings, if they are to be effective. 415. The possibility of loss, to which we have alluded as one of the springs of action for the business man, varies, of course, indefinitely from industry to industry, from one time to another in the same industry, and so on. Its psychological effect on saving and enterprise may be in either direction. Sometimes it will spell the need for caution and economy, particularly in the small business which has not much reserve strength. Sometimes it will be merely one side of the coin, the other side of which is the possibility of large gain; the balance of chance against risk may then call out the spirit of adventure. Since saving and enterprise are so closely linked in the private business, we propose to consider them together, looking first at the physical effect of the Income Tax, and then at the psychological effect. (iii) The Physical Effect of the Income Tax on Saving and Enterprise. 416. We have already discussed the weight of the Income Tax on individual incomes. In summarising the effect of the Income Tax on the savings of the general public (as distinct from persons engaged in business of their own), we concluded that it did not appear to be appreciable in the range of incomes up to £500; in the range from £500 to £2,000 it appeared to be quite considerable (subject to a contrary tendency on the psychological side); above £2,000 it became more serious, especially when in conjunction with effects which proceed from the absence of any real return on investments in the debt (para. 377). In dealing with the effect of the Income Tax on public companies, we have stated that when the tax falls (at the standard rate, in all cases) on company reserves, it entrenches upon a form of saving which is of special value to the community (para. 400). 417. As regards the small trade corresponding to the group of incomes up to £500, the burden is not heavy. If the trade is increasing its profits from year to year, it benefits by the three years' average basis of assessment. 418. We have seen that in the range of incomes up to £2,000, family and old age provision by life insurance, &c., makes a strong claim on the individual's savings. In the case of the trader, particularly if married, this claim will come into conflict with that of his business, and of necessity will often take precedence. The Income Tax reduces the fund available for saving in the two directions, and the savings for the business may particularly suffer. The extent of the damage depends very much on the efficiency of the individual. Where the business has little push and little power for growth, it will not be great. The effect of the tax levied on the inefficient business man is, from the point of view of the community, less directly harmful than that of the tax on members of the public who invest with reasonable sagacity. On the other hand, small businesses capable of expansion suffer a real hindrance, even after allowance has been made for benefits from tax revenue, so far as applied in service of the debt. 419. In the case of the larger businesses owned by Super-tax payers (other than private companies, whose reserves are normally not liable to Super-tax), the damage is in some degree accentuated, although due allowance must again be made for benefits from the service of the debt. The effective rate of tax becomes very high; in 1925-26 it approached towards 10s. in the pound in the largest incomes. It exceeded the standard rate of 4s., payable on public company reserves, at an income in the neighbourhood of £4,000. Thus it would seem very difficult to increase the disparity by a special relief in favour of the public company, leaving the large private business on the existing tax basis; a case could be made for corresponding relief to the private concern on the ground not only of equity but also of the value of its saving to the community. Even in existing circumstances, Mr. E. B. Tredwen, representing the London Chamber of Commerce (Merchants' Section), advocated that private firms should be placed on identically the same footing as companies (E. in C ; 14 and Q. 7369). 420. Mr. McKenna, in speaking of taxation for the redemption of debt, urged that "the danger of excessive taxation" lies in the fact that "most is taken from those whose capital is being used most efficiently." He pointed out that He pointed out that "the rule with successful enterprises is to build up reserves. Heavy This basis is, however, to be superseded from 1927-28 onwards by the basis of the preceding year's profits. taxation retards the growth of these reserves, and it is no compensation to the highly efficient firm or to the country that the total of the capital in other hands less capable of using it well is not diminished." (Ev., p. 132; E. in C.; Ans. 1 (b).) In relation to the private business of enterprising character but without a wide public appeal, the argument merits particular attention this class of business is qualitatively important, if not numerically so. Income Tax revenue distributed to the public in debt interest and in repayment of debt may largely be available to industry, but it will tend to flow rather to the big public companies. It will be less easily attracted back, as loan capital, by the little-known private business, whose power to build up reserves has been impeded by the tax. The business may in consequence be compelled to have resort to its bankers. 421. Here, however, it is important to remember that the taxpayer who has a large private business may also have resources outside his business rendering him less dependent on the public and or his banker. In this connection, memoranda supplied by the Board of Inland Revenue are of exceptional interest (Appendices XIX and XX). They show that normally the partners in a large private firm, or the proprietors of a large private company, have a high proportion of their means invested outside their own concern. It is thus within their power to strengthen the basis of the business by sinking in it, or lending to it, further capital. If there are great prospects of developing the business, they will naturally do this, for the free personal use of capital in such a case is likely to be the most profitable use open to them. They are not as a rule forced to fall back upon the banks, and the figures provided by the Board relating to the bank credits and debits of private concerns are evidence against the present taxes having in fact driven them to a state of dependence for permanent capital. There will, of course, be occasional exceptions when a particular business will have been injured. 422. We think, then, that Mr. McKenna has indicated a potential danger of high taxation rather than one which has been widely realised. The present Income Tax and Super-tax would have to be very substantially higher, before the typical large and progressive private business would be in a state of actual distress owing to the depletion of its resources. (iv) The Psychological Effect of the Income Tax on Saving and Enterprise. 423. On the Committee's question how far taxation acts as a deterrent to saving and enterprise, Mr. Hirst replied, "I should say that taxes do not so much deter as prevent savings. Graduated taxation encourages the enterprise of a poor business man; but as he becomes richer it acts as a deterrent to further extension." (E. in C., 16.) The Income Tax, as at present graduated, does, we think, confer a differential advantage on the very small trader which is a slight offset to the economic advantages of a large personal aggregation of capital. But we doubt whether it is effective after the point where the tax begins to be really felt. Generally speaking, we should regard the psychological effect as neutral for traders with profit up to £500 per annum. If, however, the graduated Income Tax is compared with a flat rate tax, it may certainly be said to be favourable to the small man, and in particular to the man commencing business. The tax is too light to deter him, or to figure prominently in his business anxieties. 424. In the case of the rather more prosperous trader-up to, say, the £2,000 limit-the question is very largely a matter of individual psychology, as was emphasized by the Association of British Chambers of Commerce (Ev., p. 291; E. in C. 54 et seq.). Through lack of ability, energy or opportunity it may not be open to a trader to obtain a larger gross profit and so to neutralise the burden of the tax with the same gross profit he will only have the alternatives of reduced saving or reduced consumption, and his choice will depend on all the varying elements of character and circumstance. The trader of reasonably good ability and enterprise will, we think, in the normal case be impelled by an Income Tax at a high or fairly high rate to increase his efforts: we have stressed his need of all the savings he can make (para. 418), and we think that the tax will as a rule exert quite a powerful driving force. It is true that the sort of impulsion which proceeds from necessity has not the same tonic value as encouragement due, for instance, to good prospects: it may be coupled with depression and not with enthusiasm, and it is possible that, if the extra effort does not show early signs of success, it may be partially relaxed. Nevertheless, in this range of incomes and for some distance beyond the £2,000 limit, we think it probable that the present income taxation definitely increases the business man's output of effort. 425. It is in the higher ranges of income that the question. assumes its main importance. When the physical effect of the tax on the larger trade incomes was considered, the rate of tax which required attention was the effective rate on the income as a whole. In dealing with the psychological effect, we have also to pay regard to the rate applying to the last increment of income. To take two examples: under the 1925-26 scale the effective rate on the income of a trader (unmarried) with £5,000 is 4s. 63d., and, if he had £6,000, would be 4s. 113d.; the rate on each pound of income between £5,000 and £6,000 is 7s. Again, the effective rate on an income of £30,000 would be 8s. 1d., and on £40,000, 8s. 7d.; the rate on each intervening pound would be 10s., i.e., the sum of the standard rate of Income Tax and the highest rate of Super-tax. |