part of the incidence of the tax. Where the tax is imposed on the occupier more of it will be borne by him than when it is assessed on the owner. That experience undoubtedly proves.

THE TAXATION OF INTEREST 1

2. In the paragraphs on double taxation we had occasion to refer to Adam Smith's remark that "the proprietor of stock is properly a citizen of the world, and is not necessarily attached to any particular country ".2 If there is a tax on interest, theoretically there is a tendency for the capital to be sent abroad, and this will leave, ceteris paribus, less capital in the taxing country. The tax will also be an impediment in regard to the accumulation of capital in two ways, viz. by affecting their will to save and also their power to save. Interest, of course, is one of the factors which determine the accumulation of capital. This reduction in the volume of capital would increase its marginal productivity, and the less productive concerns would receive scantier supplies or no supplies at all. Industry's productive power, therefore, would be decreased. The rise in marginal productivity would increase the rate of interest, and the burden of the tax in these circumstances would be transferred from the owners to the users of capital. After some time the users of capital would shift the tax to the consumers of their goods. The main part of the direct money burden would not permanently fall on the owners of capital, the receivers of interest, but it would be passed to users of capital and ultimately to consumers. If the tax on interest does not fall on the interest yield of all kinds of capital, capital will go into channels that escape taxation. Theoretically, the marginal productivity of the untaxed forms will be lowered and of the taxed forms raised by this until the net yield to the owners becomes equal. Insurance against risk or the return to risk-bearing is a part of the total return to capital, and the tendency is for a tax on risk-bearing to fall on the borrowers of capital and again ultimately on the consumers. Taxes on interest may encourage the creation of consumers' capital in the sense used by Sidgwick at the expense of trade capital, by decreasing the inducement to save.

1 By interest is meant the return to waiting as well as the return to riskbearing. 2 Vide Book V. chap. ii. part ii. art. ii.

THE TAXATION OF PROFITS

3

3. J. S. Mill in his Unsettled Questions,1 and also in his Principles,2 treated profits as the whole of the gains of the capitalist. He indicated, what has been accepted by modern writers, including Marshall, that profits consist of three elements: (1) interest; (2) insurance against risk; and (3) earnings of management. Adam Smith failed, like the other earlier economists, to distinguish these elements, and it is essential in this discussion for these to be kept in mind. "The whole drugs ", wrote the author of The Wealth of Nations in a very well-known passage," which the best employed apothecary in a large markettown will sell in a year may not perhaps cost him above thirty or forty pounds. Though he should sell them, therefore, for three or four hundred or a thousand per cent profit, this may frequently be no more than the reasonable wages of his labour in the only way in which he can charge them, upon the price of the drugs. The greater part of the apparent profit is real wages disguised in the garb of profit. In a small seaport town a little grocer will make forty or fifty per cent upon a stock of a single hundred pounds, while a considerable wholesale merchant in the same place will scarce make eight or ten per cent upon a stock of ten thousand ".4 When this statement of Adam Smith is considered in the light of modern teaching, especially that of Alfred Marshall and the Cambridge school, it is clear that earnings are in some respects analogous to wages. If a tax is imposed on the earnings of management, it will have the same effect as a tax on any normal return to capital or labour. It is, in other words, exactly similar to a tax on interest or wages, and its incidence will depend on elasticity of the supply of and demand for the agent of production in question.

A tax on quasi-rent 5 is, in the short period, similar to a tax

2 Book II. chap. xv.

1 Pp. 107-109. Principles, Book VI. chap. viii. Cf. Boehm-Bawerk, Capital and Interest; The Positive Theory of Capital, translated by Professor W. Smart. Cf. also Supply and Demand, by Henderson, in the Cambridge Economic Handbook Series, chap. vii., "Risk-bearing and Enterprise," especially paragraph vii.; and Stamp on The Special Taxation of Business Profits in Relation to the Present Position of National Finance," Economic Journal, December 1919.

66

Book I. chap. x.

5 Quasi-rent is sometimes misunderstood and defined as the surplus profits secured by owners of a factor of production, say a machine or a house, when

on economic rent. Quasi-rent is the total return a machine and durable goods like houses earn when the supply is inelastic over a short period, and a tax can only be shifted forward if the supply can be quickly adjusted. In the long period, however, a tax on quasi-rent is similar to a tax on interest. The supply can be adjusted in the long period, and producers will not bear the tax. A tax on quasi-rent would reduce the inducement to invest in that particular agent of production. The tendency of quasi-rent is to diverge from interest in the short period, but in the long period to coincide with it. Thus if the quasi-rent from a house was £60 when there was no tax, and a tax were imposed of say 20 per cent, the quasi-rent obtained by the owner would then be only £48. If this is below what normally is obtained from other investments, then the owner would so contract the supply of houses whenever possible (i.e. over the long period) as to bring up the rate of return to the average level, or, as Pigou would say, the marginal individual net product.

THE TAXATION OF WAGES

4. With the exception of John Stuart Mill, the last of the Ricardians, the classical school of economists, with their worthy representatives abroad,1 held that wages were generally immune from taxation. Labourers could not be taxed, as they got no more than the minimum to support themselves and their families. Taxes, therefore, imposed on labourers were shifted on to others.

that factor can only be slowly increased in quantity. This is not so. It is not a surplus return but the total return which the owner gets from an agent of production when the supply is inelastic over a short period. Quasi-rent may be a surplus or a deficit. Cf. Marshall's Principles, Book V., especially chapters viii. and x., and Economics of Industry, Appendix C, p. 426 (third edition).

1 By "classical economists" is usually meant those economists of the first half of the nineteenth century like Ricardo, Senior, James Mill, and McCulloch, who developed the deductive and hypothetical method and treated economics as a body of doctrine immediately applicable to actual life. In Germany, Von Thunen (1780-1850) and Hermann (1795-1868) are good examples. (Von Thunen discovered the modern "marginal" theory of interest.) In France, Say, Dunoyer, and the brilliant Cournot are worthy representatives. The newer deductive school, represented by Cairnes, Bagehot, Jevons, and Marshall in England, by Bastiat, Gide, Leroy-Beaulieu, and Guyot in France, and by the Austrian school, are less dogmatic than the older school. In the text above Adam Smith is included as a classical economist. Adam Smith, however, combines deduction with induction to a degree unknown in the work of his less skilful successors.

Some held, as we shall see, that the taxes (which had the effect of raising wages) were paid by the employer out of profits, just as taxes on necessaries for the same reason had to come out of the same source.

There was a sound stratum of historical truth in this theory. This history of the esne1 or slave who works for hire, and of serfdom generally, shows that the incidence of the tax would in these far-off times not have been on those on whom the tax was levied. There was in addition to that historical fact the doctrine of the normal or natural rate of wages emphasised by Ricardo and Von Thunen, the latter of whom described natural wages as the square root of ap where a represents the necessaries of life and p the product of capital and labour. The iron law of wages is based on the conception of a standard of living which is maintained in such a way that if earnings are increased above the amount required to secure this standard population will increase, and if earnings are decreased below this level population will decrease. Under this "iron and cruel law" a tax would be completely shifted. Lastly, the condition of the labourer in Europe in the last quarter of the eighteenth and the first half of the nineteenth century, especially after the Napoleonic wars, when wages seemed to be at the minimum of subsistence, lent further colour to the truth of this theory. Hasbach speaks of the “demoralisation of the labourer ",2 and Gibbins 3 shows that of the increase of wealth produced by the Industrial Revolution little went into the hands of the labourers, but "went almost entirely into the hands of the great landlords and new capitalist manufacturers, or was spent in the enormous expenses of foreign war". In addition, the burden of the continental wars fell heavily upon him because "taxes had been imposed on almost every article of consumption, while at the same time the price of wheat had risen enormously. Moreover, labour was now more than ever dependent on capital, and the individual labourer was thoroughly under the heel of his employer." Wheat per quarter rose from 49s. 3d. in 1793 to 113s. 10d. in 1800, and at the same time wages were falling. In the year previous to the publication of Ricardo's

1 Stubbs's Constitutional History, i. Cf. Hasbach's History of the English Agricultural Labourer, translated by Ruth Kenyon (London, King & Co.). 2 History of the English Agricultural Labourer, chap. iii.

3 Industry in England (tenth edition), London, Methuen & Co., chap. xxiv., "The Condition of the Working Classes."

Principles of Political Economy and Taxation riots broke out everywhere in England-in Kent, for example among agricultural labourers, in the Midlands among the miners, and at Nottingham among the artisans. With this somewhat portentous proem we may now plunge in medias res.

Adam Smith in the well-known chapter on "Taxes upon the Wages of Labour " 1 differentiates between the wages of ordinary labour and "the recompense of ingenious artists and of men of liberal professions". A tax on wages must, he believed, raise wages by somewhat more than the tax. "Let us suppose, for example, that in a particular place the demand for labour and the price of provisions were such as to render ten shillings a week the ordinary wages of labour; and that a tax of one-fifth, or four shillings in the pound, was imposed upon wages. If the demand for labour and the price of provisions remained the same, it would still be necessary that the labourer should in that place earn such a subsistence as could be bought only for ten shillings a week, or that after paying the tax he should have ten shillings a week free wages. But in order to leave him such free wages after paying such a tax, the price of labour must in that place soon rise, not to twelve shillings a week only, but to twelve and sixpence; that is, in order to enable him to pay a tax of one-fifth, his wages must necessarily soon rise, not one-fifth part only, but one-fourth. Whatever was the proportion of the tax, the wages of labour must in all cases rise, not only in that proportion, but in a higher proportion. If the tax, for example, was one-tenth, the wages of labour must necessarily soon rise, not one-tenth part only, but one-eighth." Adam Smith then holds that the rise in the wages of labour in industry would be advanced by the employers and paid by consumers owing to the rise of wages raising, as he thought, general prices; the rise in agricultural wages would, for similar reasons, be advanced by the farmers and paid by the landlords. A tax on skilled employment, i.e. on the earnings" of ingenious artists and of men of liberal professions"," would be shifted, because their earnings are in "a certain pro

1 Book V. chap. ii. part ii. art. iii. (vol. ii. 348).

2 Curiously enough, salaried officials of Government were excluded by Adam Smith, because the emoluments of office are not, like those of trades and professions, regulated by the free competition of the market, and do not, therefore, always bear a just proportion to what the nature of the employment requires ".