2. The present income tax law According to the personal income tax law passed in New York in 19191 a moderately progressive tax is imposed on the incomes of residents and on the incomes of non-residents from sources within the state. The rates of taxation and the corresponding classes of income are as follows: Net income Above $50,000 Rate (per cent) I 2 3 In the matter of rates and the degree of progression adopted the New York law failed to follow the federal law or the recommendations of the committee on model taxation. The decision was a wise one with respect to both examples. Such a scale of rates as that used in the imposition of the federal income tax was manifestly absurd if applied to state purposes and taken in conjunction with the decision to include in net income sums paid as income taxes to any jurisdiction. The confiscation of the entire income would be the result in the case of some of the very large incomes the recipients of which are known to be domiciled in New York. Even if such a scale were possible, the result would be so great a revenue to the state that extravagant and wasteful dispositions of the surplus would become the order of the day. The contrast of the scale actually adopted by New York and the scale recommended by the Committee on Model Taxation and illustrated in the draft of a model personal income tax law prepared by that committee is more significant. The progressive scale recommended ranged from one per cent on the first $1,000 of net income to six per cent on net income 1 Laws of New York, 1919, ch. 627. above $5,000. In view of the careful consideration given by the framers of the New York law to the point of view expressed by the committee on model taxation, the introduction of a more moderate scale in the New York law illustrates the trend of the times. The high federal rates must be the background, never to be ignored, of all income taxes of the present. Only the most moderate state rates can operate without injustice as long as the present policy of the federal government is continued. It is an open question as to whether a simple proportional rate, as for example, two per cent on net income, might not be equally satisfactory and accomplish all necessary results, under the present circumstances. Moreover, the states are not in need of such great amounts of revenue at the present time as to necessitate steeply graduated rates. 2 This tax applies to the incomes of individuals only, as the incomes of corporations are subject to a separate tax.1 Personal exemptions were fixed at $1,000 for the individual, $2,000 for the head of a family or for husband and wife together, and $200 additional for each dependent.a In the definition of gross income and in enumerating the deductions which are to be made from gross income in the determination of net income the New York law follows the federal law fairly closely. In addition to the specific personal exemptions, interest on obligations of the United States and its possessions, interest of obligations of the state of New York or of any 1 In 1919 the tax on the net income of corporations was raised from three to four and one-half per cent and extended to apply to all corporations. In the law as passed in 1919 these exemptions were denied to nonresidents. The decision of the United States Supreme Court that such a provision was unconstitutional and the amendment for the New York law in conformance with this decision are described in subsequent pages. municipal corporation or political subdivision thereof; compensation received from the United States; income received by an officer of a religious denomination or by an institution or trust for religious, charitable, philanthropic, educational, or other similar specified purposes and used for such purposes; proceeds of life-insurance policies or annuities; accident or health insurance; and property acquired by gift or bequest were also exempted. Dividends from corporations are included in the income of residents but excluded from the income of non-residents, except as they form part of the income derived by such non-residents from sources within the state. At the time of the passage of the law this provision was vigorously debated. The dividends received by non-residents could have been taxed only if received from domestic corporations, and it was held that New York institutions would have been unjustly discriminated against if this were done. In order to bring about a fair operation of this principle, not only dividends, but interest on bank deposits, bonds, notes, and sums received as annuities were also exempted in the case of nonresidents. The taxation of dividends received by residents of New York is in itself a departure from the federal law, which allows a partial exemption from the income tax of dividends of corporations. It is becoming increasingly evident that a tax on the net income of corporations is a business tax, to be considered as a supplement to the personal income tax rather than as a substitute for it. From this point of view the taxation of the corporate income and the taxation of income received by individuals, even if a part of this latter income is from corporate sources, is no longer regarded as unjust double taxation, unless it operates unequally with respect to different classes of business or different classes of individuals. The real effect of the use 66 of a corporate income tax and an individual income tax in the same jurisdiction is not so much to bring about any unfairness in the tax burden as it is to effect a heavier rate of taxation upon funded incomes than upon unfunded incomes, a policy which is in accordance with the best modern tax theory. Such a policy is particularly adapted to the needs of New York, where the question of a differentiation of the kinds of income and the imposition of a higher rate of tax upon unearned" incomes was decided in the negative. With regard to differentiation produced in the latter way, it was decided that in the interests of simplicity, and in view of the fact that the graduated rates of the federal tax imposed a heavier burden upon those funded incomes which are in fact found among the larger incomes, no discrimination should be made. The discrimination which is actually produced by the system of taxation now employed is probably slighter than that introduced in the ordinary differentiation plans, less irritating to the taxpayer, and less difficult from the administrative point of view. The deductions which are permitted in the determination of net income are business expenses, taxes other than income taxes paid to the United States or to any state, losses, worthless debts, interest on indebtedness, and gifts (to the amount of not more than 15 per cent of net income) to religious, charitable, scientific or educational corporations or associations organized under the laws of New York. The law as passed in 1919 contained a provision for the deduction of interest on indebtedness which differed from that contained in the federal law. The state law allowed the deduction of only such a proportion of interest paid as the net taxable income bore to the total income. This provision corresponds to a provision in the preliminary report of the Committee on Model Taxation. That committee called attention to the fact that the issue by the federal government of large amounts of tax-exempt bonds complicated the question of the taxation of incomes by the states, and in suggesting the above plan for limiting interest deducted, stated its opinion that "any other procedure will tend to make the personal income tax a farce in many cases and will give occasion for legitimate complaint.' This provision has little to recommend it except its intentions, however, for the calculation is impossible to make, since net income cannot be produced until the amount of deductions has been determined. It proved unpopular in New York and the law repealing it was made retroactive to January I, 1920.2 Income taxes were omitted from the list of taxes deductible from gross income. It was felt that the taxable base ought not to be affected by the taxes paid to other jurisdictions. A provision was adopted which was counted upon to prevent burdensome double taxation in a wholly different way. A non-resident subject to the income tax of another state or country is allowed to be credited with such a proportion of the income tax payable to New York as his income taxable by New York bears to his entire income taxed by the other state or country, provided the laws of the latter grant a substantially similar credit to residents of New York. At the time of the passage of the personal income tax law the taxation of intangible personal property as property was abolished, but the taxation of tangible personal property was allowed to continue. In matters of administration the New York income tax law is in most respects in accord with the best modern procedure. The weakness of the older method of local as 1 Preliminary Report, etc., p. 15. 2 Laws of New York, 1920, ch. 693. |