Consequently, the period during which corporate incomes were affected by this act was four years and two months, extending from January 1, 1909, to February 28, 1913, when the 1913 law replaced it.

THE 1913 LAW.-Congress, almost immediately after the ratification of the sixteenth amendment, addressed itself to the task of formulating a general income tax law, and an act was finally approved October 3, 1913, effective as of March 1, 1913 (hereinafter referred to as "the 1913 law"). In spite of its many inconsistencies and ambiguities, this law must be acknowledged to have been on the whole an "intelligent and well-considered effort." 18 It was upheld as constitutional by the Supreme Court.19 Much of the Treasury interpretation, however, has not been upheld by the Supreme Court.

The personal exemption was high: $3,000 to a single person, with an additional $1,000 to a married couple. The former exemption of $5,000 to corporations was, however, eliminated. The rates, compared with those now in effect, were very low. A normal tax of 1 per cent applied to the total net income of individuals and corporations. Surtaxes, levied on individuals only, began with a I per cent rate when the net income reached $20,000, and increased gradually to 6 per cent on those portions of incomes which exceeded. $500,000.20 The yield the first year was approximately $71,000,000.

Eagerness to prevent evasion and to secure a large yield was responsible for several restrictions upon deductions-restrictions which caused endless complications and irritations. Thus, individuals in deducting losses could subtract only those which were incurred "in trade." Deductions for depletion of mines, whether owned by individuals or corporations, were restricted to 5 per cent of the value of the output. Corporations were forced to pay tax on dividends received from other corporations whether or not the other corporations were subject to income tax. The restriction upon interest paid by corporations, mentioned as a characteristic of the 1909 law, was continued by the 1913 law in another form. A corporation could now deduct interest on its indebtedness "to an amount of such indebtedness not exceeding one-half of the sum of its

18

Seligman, The Income Tax, page 430 et seq.

Brushaber v. Union Pacific R. R. Co., 240 U. S. 1, 60 L. Ed. 493, 36 Sup. Ct. 236.

*For a detailed table of the rates, see Chapter IX.

interest-bearing indebtedness and its paid-up capital stock outstanding at the close of the year."

"21

The law granted to corporations the privilege of accounting on the basis of fiscal years rather than calendar years, but withheld it from individuals. Finally, the act adopted the system of collection at the source, which had proved helpful in preventing evasion in Great Britain. This device, however, was the occasion of so much complaint from those charged with the duty of withholding the tax that after four years' experience it was abandoned in 1917.

THE 1916 LAW.-Three years after its establishment the income tax was called upon to produce a much larger revenue. Because of the effect of the European War, receipts from import duties had diminished, while the expenditures of the federal government had greatly increased. To assist in meeting this emergency, income tax rates were raised. The normal rate applying both to individuals and corporations was made 2 per cent and the surtax rates upon individual incomes were made to range from 1 to 13 per cent. The lowest surtax rate applied as before upon income immediately above $20,000, and the highest rate on the portions of income exceeding $2,000,000.22

This law, passed September 8, 1916 (hereinafter referred to as "the 1916 law"), was made applicable to income received after December 31, 1915. Consequently the 1913 law was effective as to income received during a period of two years and ten months, from March 1, 1913, to December 31, 1915.

The 1916 law, although a re-enactment of the 1913 law, was entirely recast in form and changed in a number of particulars. The changes for the most part had the effect of making the statute clearer and more practicable. March 1, 1913, was now definitely set as the date from which appreciations or depreciations of property values were to be measured for purposes of the tax. Stock dividends were specifically included in taxable net incomes,23 whereas the 1913 law had been silent on this point. Proceeds of life insurance policies received upon the death of the insured were declared to be exempt only when paid to individual beneficiaries. The U. S.

21 With several provisos including those designed to cover the cases of corporations with no capital stock and of corporations with indebtedness secured by collateral which was subject to sale as stock in trade. 1913 law, G (b). For a detailed statement of the rates, see Chapter IX.

22

23 For the decision declaring stock dividends non-taxable under this law, see Chapter XXXII.

Supreme Court has held in Supple-Biddle Hardware Co. v. U. S. (advance sheets, 68 L. Ed. 671) that the proceeds of life insurance received by corporations is not taxable.

Deductions were liberalized in two important particulars. Losses in transactions entered into for profit but not connected with an individual's trade or business were made allowable deductions, "to an amount not exceeding the profits arising therefrom." 24 Again, the arbitrary 5 per cent limitation upon depletion allowances, a feature of the 1913 law, was eliminated and the way was opened for the full deduction of items of this character.

The 1916 law continued in effect for two years from January 1, 1916, to December 31, 1917. On October 3, 1917, the war income tax act was passed and had the force of a supplement to the 1916 law, for the year 1917.

THE 1917 LAW.25-Although the 1916 law yielded about 360 millions, such a sum was insufficient as the contribution from this source toward the expenses caused by our entry into the war. Consequently an act was passed on the fourth anniversary of the passage of the 1913 law, October 3, 1917 (hereinafter referred to as "the 1917 law"), which raised the income tax rates to a level never before approached in the history of civilization.26 Thus after only four years of administrative experience the income tax was put to the most severe test which a government ever had the courage to impose. It is greatly to the credit of both taxpayers and the Treasury that the system stood the test as successfully as it did.

This 1917 amendment was effective as of January 1, 1917, and remained valid for the period of one year.

The object of enacting the 1917 law as an amendment to the 1916 law, was apparently to make possible the speedy repeal of the former without disturbing the law proper. This policy must now be declared to have been a mistaken one, for the confusion and difficulty caused by operating under the 1916 law, with its elaborate amendments, including two separate schedules of rates and two sets of personal exemptions, more than counterbalanced any advantages of the plan.

In addition to the 1916 taxes, a new normal tax of 2 per cent

24

1916 law, section 5, fifth.

For a complete analysis, see Income Tax Procedure, 1918.

'Seligman, "The War Revenue Act," Political Science Quarterly, March, 1918, page 18.

was imposed on individuals and a new 4 per cent rate on corporations, making the total normal rate 4 per cent, except on the income between $1,000 and $2,000, on which the rate was 2 per cent, and making the corporation tax rate 6 per cent. The surtaxes on individual incomes, which were to be levied in addition to the surtaxes existing under the 1916 law, ranged from 1 to 50 per cent and applied to all persons with taxable incomes of $5,000 or more. Consequently a tax rate of 67 per cent was applied to all taxable income accruing to an individual in excess of $2,000,000—2 per cent normal and 13 per cent surtax under the 1916 law, plus 2 per cent normal and 50 per cent surtax under the 1917 law.27 For the purposes of the 1917 amendment the personal exemption was reduced from $3,000 to $2,000 to married couples and to $1,000 to single persons, and, for the first time, a deduction of $200 was permitted for each dependent.

Various other changes were made in the law. The system of collection at source was virtually abandoned and a plan of "information at source" was substituted, thus removing a prolific source of irritation and embarrassment. The deduction of gifts by individuals to charitable, religious and educational institutions was permitted to an amount not over 15 per cent of the net taxable income as calculated without making this deduction. On the other hand, limitations. were imposed in several cases, income and excess profits taxes being made non-deductible, as was interest on money borrowed for the purchase of tax-exempt securities. For the purpose of the new 4 per cent tax on corporations, however, permission was given to deduct the dividends on stock in other corporations.

The high rates established as the result of the passage of the 1917 law were, of course, expected to be temporary. To discourage corporations from avoiding the heavy 1917 surtaxes on the income of their stockholders, through the simple device of postponing declarations of dividends until a period of lower rates arrived, Congress wrote a provision into the law which prescribed that dividends should be "taxed to the distributee at the rates prescribed by law for the years in which such profit or surplus was accumulated by the corporation." 28 The years of accumulation could not be arbitrarily selected by the corporation and, under the Treasury interpretation, the precise position of the distributions in the surtax scales of the

For a detailed statement of rates, see Chapter IX. 28 1917 law, section 1210,

29

previous years was determined by adding them to the net income of the current year. This provision was repealed by the 1918 law,2 but in the short period during which it was in force it greatly complicated the administration of the law. Nevertheless it was essentially a just provision, even though the prescribed method of applying the rates is open to criticism, and, having enacted it, Congress should have evolved some method of safeguarding the interests of the corporations which acted under it in good faith.

In 1917, also, excess profits taxes were introduced into the federal system. A law of this nature was passed March 3, 1917, but was displaced by the act of October 3, 1917, which itself imposed a heavy levy on supernormal profits as judged by the standard of invested capital. A full treatment of this act as well as of its successor of 1918 will be found in the author's Excess Profits Tax Procedure, 1921.30

THE 1918 LAW.-The need for still greater revenues to meet the growing demands of the war and an anxiety on the part of the Treasury to be relieved of some of the responsibility it had assumed by its liberal interpretation of the excess profits tax law of 1917, united with other causes to bring about a new Revenue Act for 1918. The law (hereinafter referred to as "the 1918 law") although not finally approved until February 24, 1919, affected income arising after December 31, 1917. It remained in force until the effective date of the Revenue Act of 1921, which, for most of the provisions, was January 1, 1921.

The 1918 law was a complete statute, and replaced entirely the 1916 and 1917 acts, which had existed concurrently during 1917. It was a comprehensive law which imposed a new version of profits tax, certain luxury taxes, and other internal revenue charges. The technical task of drafting was well done, the language being for the most part clear, and the arrangement convenient; the form, in general, was greatly superior to that of the earlier laws.

Rates applied to 1918 income exceeded even the record schedules of 1917. The normal rate and the corporation tax rate both were made 12 per cent, with a reduction to 6 per cent on the first $4,000

Except in the case of certain stock dividends which have since been held to be non-taxable.

* Supplements to this volume appear in Income Tax Procedure, 1922, pages 1564-1670, 1923, pages 1511-1533; 1924, pages 1641-1659; and in Appendix A of this book.