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OUR MONEY AND THE STATE

BY THE SAME AUTHOR

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OUR MONEY AND THESTATE

BY HARTLEY WITHERS

Life is like playin~ a violin solo in publicand learning the instrument as one goes on.

SAMUEL BUTLER, EssCY-J!s on Life, Art and Science

LONDONJOHN MURRAY, ALBEMARLE STREET, W. .

1917

PREFACE

THIS book grew out of a course of lectures on PublicFinance delivered at the London School of Economics in February and March. The subject hadalready been dealt with ably and fully by writerswho had made a special study of it; but thepresent war, by making us spend with such Titanicrecklessness, has supplied us with a huge nlagnifyingglass, by which cause and effect are more clearly seenthan in times of peace. The results of borrowing,inflation of currency, and inequities in taxation areseen at work now on such a scale that if we use theexperiences of the war aright, they may help us tobetter financial methods when the war is over.Students who wish to pursue the subject into itstechnical and scientific details can do so with thehelp of Public Finance, by Prof. Bastable; TheIncome Tax and other works on taxation by Prof.Edwin R. A. Seligman; British Budgets, 1887-1913,by Sir. Bernard Mallet; The System of NationatFinance, by Mr. E. Hilton Young, M.P.; TheFinancial System of the United Kingdom, by H.Higgs, C.B.; and that monument of industry andmine of statistical and other information.. the House

1* v

vi PREFACE

of Commons Return (366) of 1869, on Public Incomeand Expenditure, etc., drawn up by Henry W.Chisholm, sometime Chief Clerk of the Exchequer:it is commonly called Chisholm's Analysis of thePublic Accounts, 1688-1869.

HARTLEY WITHERS.

6, LINDEN GARDENS,

June 1917.

CONTENTS

CHAPTER IPAGE

THE OBJECTS OF GOVERNMENTAL SPENDING. I

Government spends to secure property of citizens,to defend national honour, to increase country'smaterial resources and promote national healthGovernment's theoretical right to take all citizens'property modified by practical irtability-Change inview as to governmental activity-Spencer-Huxley-Adam Smith.

CHAPTER II

MONEY TAKEN BY BORROWING

Borrowing popular owing to belief that it makesposterity pay~This belief delusive-War paid forwhile it goes on-Borrowing only affects distributionof posterity's income-Borrowing at home-Its drawbacks-Borrowing abroad.

CHAPTER III

MONEY WATERED BY INFLATION •

Medieval debasement of currency-Modern inflation-Methods by which currency is increased-Whyit happens-Evil effects.

vii

25

52

viii CONTENTS

CHAPTER IVPAGE

MONEY TAKEN BY TAXES

Does money left with citizens always" fructify" ?Adam· Smith's maxims-Walker's criticism-Graduation and differentiation-The ideal income taxUnfairness of indirect taxes-Import duties.

CHAPTER V

73

THE LIMITS OF GOVERNMENTAL SPENDING 105

Can the State earn revenue by trade enterprise ?Fabian scheme-Imperial Committee's proposalAdverse experiences-Limits to taxation-Willingness of taxpayers essential.

OUR MONEY AND THE STATE

CHAPTER I

THE OBJECTS OF GOVERNMENTAL SPENDING

WHY does the Government take our money? Because government costs· moneYJ and cannot be hadwithout it. Taxation is the price that we pay forgovernment and protection. Most of us do notwant, or need, to be governed ourselves. Respectfor law, or for the duties and customs that lawembodies, is so engrained in us by centuries oftradition, that the presence of the policeman on hisbeat is a fact that never influences our conduct.But. if we do not need to be governed ourselves, wevery much need other people to be governed andprevented from attacking us or our belongings.Protection of our persons and propertyJ from homeand foreign foes, is the first and most importantbusiness of government; and the chief reason thatit can give if we ask it " Why should we pay taxes? 11

is this: " Because, if you don't, you will be in dangerof losing everything that you have got."

Government does so much in these days besidesits first elementary task of protecting us from one

~

2 THE OBJECTS OF SPENDING [CHAP.

another and from outward foes, that we are apt toforget that this is its original business. But as thepoint is very important, as we shall see later, itis well to get it fixed into our heads by readingthe plain words in which it is set forth by JohnLocke. In Chapter I of his Essay concern"ing theTrue Original Extent and End. of Civil Governmenthe says:

II Political Power then I take to be a Right ofmaking Laws with Penalties of Death, and consequently all less Penalties, for the regulating andpreserving of Property, and of emplaying the Forceof the Community in the Execution of such Laws,and in the Defence of the Commonwealth fromForeign Injury, and all this only for the PublickGood."

In Chapter VIII of the same Essay we find:

II The only Way whereby anyone divests himselfof his natural Liberty and puts on the Bonds ofcivil Society, is by agreeing with other men to joinand unite into a Community, for their comfortable,safe, and peaceable living amongst one another, in asecure Enjoyment of their Properties, and a greaterSecurity against any that are not of"it."

And in Chapter IX the matter is summed up thus:

II The great and chief End therefore, of Mensuniting into Commonwealths and putting themselves under Government, is the Preservation of theirProperty."

Locke did not leave theabject of government on

I] THE STATE'S CLAIM 3

this merely businesslike foundation. He did notreally mean that we only submit to being governedin order that we may grow rich and fat and enjoyour riches without fear of burglars or maraudingfoes. He says in another passage that the End ofGovernment is the Good of Mankind. This is amore inspiring ideal, but we shall all acknowledgethat it cannot be secured unless man's materialwants are satisfied, and that as society is afpresentconstituted, this cannot be done unless property isprotected. Some day mankind will perhaps growinto a race of beings who will work for the pleasureof working, and not mind who takes and uses thestuff· that they make and grow. There are alreadymany more of such people than old-fashionedeconomists admit. But in considering present-dayproblems, we have to take human nature as it is,and nations cannot at present increase their wealth,and so their power to secure the Good of Mankind,unless those who increase it are secured in ,theenjoyment of it.

Protection of the property of the citizens beingthus the original, and still a very important, dutyof the State, it follows that the State, in order tocarry it out, can make any claims that it pleaseson the services and property of the citizens. .TheState, as Professor Bastable tells us, It is entitledto claim all the services and property of its subjectsfor the accomplishment of whatever aims it prescribes to itself. When stated in. so rigid a form,"he adds, H the proposition is likely to awaken dis-


sent, and yet, from the strictly legal and administrative point of view, it is a commonplace since thetime of Austin." 1 (Austin was a great authorityon law, who lived ~nd wrote in the first half of thenineteenth century.) It is true enough, as ProfessorBastable suggests, tha~ the average British paterfamilias m~y be startled into an indignant denialqf the great law that the State has a right to take?-ll his work~and ali his goods. But a few moments'thought would convince him that the propositionis quite sound in logic, since the State· cannot doits business if all the citizens are to be able todecide how much, or how little, they are to give,in work or in goods, to its support; and he wouldalso comfort himself with the reflection that, however logical be this power of the State, it cannot beexercised beyond a certain point. On paper, theState may be able to. set us all to work for it, butit cannot make us wor}( hard or well unless we arewilling to do so. On paper, the State may be ableto take/all our property, but if it did, then it wouldnot be worth anyone's while to get property. Thecitizens would cease to accumulate property, thatis, to leave the world richer than they found it.Either the State would have to accumulate on itsown account, which it could only do if the citizenswere willing to work for it, or it would find that ithad come to a standstill.

Professor Bastable's proposition, though absolutely true as a principle, is thus modified by the

1 Public Finance, p. 42 •

TAXPAYERS' STRIKE 5

very real power of the citizen to refuse to produceeither the work or the property that the State hasthe power to take. This power 'of the overtaxedcitizen to strike effectively against taxation is nofanciful suggestion of what might possibly happen.It has happened. Under the R'oman Empire taxation was enormously heavy, for the"'support of theAnny, the Imperial Court, and CI the great numberof clerks made necessary by the bureaucratic formof government." It :\vas also extremely oppressive,since the senatorial class, the Army, Professors ofRhetoric, and the Clergy, were largely freed from it,and so the whole burden fell on the curials, that is,owners of tw~nty-five acres of land, or its equivalent.

CI When the curials were bankrupt and could nolonger pay the taxes, they attempted in every wayto escape from their class. Some of them succeededin rising into the senatorial ranks; many of themdeserted their lands and became slaves, or enteredthe Army or the Church. The Emperors, trying toprevent this, often seized the curial who had runaway and compelled him to take up his old burdenagain." 1

This fact, of the taxpayers' power to strike, isvery relevant to modern problems of finance, because it may come into play long before there isany question of the State's taking the whole of ourgoods. As soon as the pressure of taxation beginsto be heavy, the danger has to be ever present in

1 A General History of Europs (350-1900), by Thatcher andSchwill, 1?P. 9-10,


t4e mind of the Chancellor of the Exchequer, thathe may, by his present exactions, be preventingthe future growth of the country's wealth, and somaking the task of his successors difficult, if notimpossible. Taxation that is resented, beyond acertain point, will be evaded or avoided. The taxgatherer can only work to his own satisfaction ifhe carries the sense of the taxpayers with him.Hence it is of the utmost importance, not only thatour rulers should tax well, but that the citizensshould understand about taxation, recognize it asgood when it is good, and pay it cheerfully whenit is equitable and well distributed.

"All taxes are confiscation," said Mr. JosephHume in the House of Commons inI833. 1 In theoriginal sense of the word confiscation, which meant" putting into the Treasury," this is clearly a platitude. But as it nQ~ is generally taken to mean anarbitrary appropriation, these words sum up a fallacyabout taxation which has to be exorcised and expelledbefore the fiscal arrangements of 'this or.any othernation can be comfortable either for the taxer orthe taxed. In fact, taxation is, or ought to be, theprocess by which the State takes money from us, inproportion to our ability to pay, to spend on thedefence of our property from home or foreigne~emies, on the defence of the national honour, ifneed be, on the increase of the material and otherresources of the country, and on the public health.

-- If this be a true description of taxation, taxation1 Seligmanp The Inoome Tax~ p. 12Z.

I] GOOD TAXATION PA'YS 7

is a process to which we must all submit gladly.All the objects for which the money so taken fromus, with one exception, will literally pay us, if theyare carried out. That exception is the defence ofthe national l:\onour, and he would be a cravenskinflint who would grudge money well spent onthat. Defence of our property clearly pays us.So does the increase of the country's resources, because it will make the burden of taxation lighter.If our particular income does not increase, but thatof others does, and if taxation is taken in proportion to our ability to pay, we shall have to pay lessin proportion. Public health pays us because itlessens infectious and contagious disease, and ,sokeeps down our doctors' bills.

But if this description of taxation be untrue, itis our business to make it true, and this can only bedone if everybody gives careful thought to thematter, so that if our rulers make mistakes, thereshall be a strong body of well,.informed opinion tocriticize and correct them; and also so that wemay learn that it is not the object of every citizento pay as little in taxes as possible, because if thatspirit is abroad, the fiscal machinery of the countrywill never run smoothly and well; we have tolearn to judge whether taxes are fair from thepoint of view of the nation as a whole, and whenwe recognize them as fair, to pay them gladly andreadily. In time of war this readiness to pay isproduced, sometimes, by patriotic enthusiasm. Inthe early days of the present war, taxpayers wrote


to the Chancellor of the Exchequer expressing thepleasure with which they paid income tax. Ifwe could be sure that money taken in taxes wastaken fairly, and used well for the national benefit~

that pleasure ought at all times to be present whenwe pay it.

It has been said that a nation gets the Government that it deserves, and Public Finance is certainlya department in which the pressure of enlightenedpublic opinion can do much. But we shall neverlearn to get our Public Finance on a sound andbusinesslike basis until we understand our owndomestic expenditure better. When we recognizethe responsibility that is attached to the use of ourown money, we shall be able .to begin to see thatour rulets make good use of the money of thenation. As long as there is a common tendencyamong the citizens to waste their incomes on fripperies and vulgarities in obedience to fashion andconvention, and to invest their savings in wild-catspeculations in the hope of getting wealth withouttrouble, we need not expect the national financesto be as well husbanded as they might be. Thesum of the national wisdom, in finance as in otherthings, may be a little greater than the aggregatewisdom of all the citizens, but cannot lead it bymuch.

Going back to our description of what taxationis, or ought to be, we see at once that even if everyone were to agree to it as stated, there are severalexpressions in it about which agreement is not

I] HERBERT SPENCER'S VIEW 9

likely to be reached as long as the present framework of society stands. In the first place, thequestion of ability to pay is full of pitfalls anddifficulties which will be discussed in a later chapter.First of all, we have to try to get something like aclear conclusion about the objects on which theState is entitled to spend our money, when it hastaken it, and on this there has been, is, and alwayswill be, a good deal of divergence of opinion. Asstated above, and with reservations and restrictions to be noted later, I venture to think that, inthese days, most taxpayers would give at least ahesitating and guarded consent to the scope ofState expenditure. But there was a time when itwould have been thought to be much too wide,and many people now will think it much too narrow.The via media is a dull and unromantic path, but ithas a certain safety.

Herbert Spencer may be taken as an extremeexample of those who would limit the spending ofthe State. To him it seemed that the State shouldspend nothing except on public justice and defence.He was the uncompromising apostle of personalfreedom, and he believed that only through it couldprogress and development, of the individual andof the nation, best be achieved. He had an unconquerable objection to anything like discipline orgovernment, so strong that, when a lad of thirteen,he walked home from Bath to· Derby rather thanstay at school. He walked forty-eight miles in oneday, forty-seven on the se;cond, and twenty-five on

2


the third, without sleep, and with very little food. l

In his youth he did not even admit that the Government should spend money on external defence.Either he believed that a mercenary army and navy,hired by private subscription, would suffice to keepout enemies, or else he took the extreme pacifistview that an unarmed nation need not fear attack.But, in his later years, he abandoned this view,and admitted national defence as a proper objectof government expenditure. He still, however,thought that the Postal Service would have beenmuch more cheaply and efficiently managed if ithad been left to private enterprise, which is quitepossibly true, though it is hardly likely that postalfacilities would have been so well distributed. HeU advanced the doctrine that, as we trust the grocer tofurnish us with pounds of tea, and the baker to sendus loaves of bread, so we might trust Heaton & Sonsor some of the other enterprising firms of Birmingham to supply us with sovereigns and shillings attheir own risk and profit." s He even contendedthat sanitation was not a proper object of collectiveactivity, and records with obvious pleasure how theearly effor:ts at drainage, being defective, sometimes produced disease. It need not be said thateducation was a matter which every citizen should,and could best, provide for himself or his children.He is never tired of laughing at our belief in thepower of the State to do anything.

1 Herbert Spencer, by Hugh Elliot.2 Money and the Mechanism oj Exchange, Jevons1 p. 64_

I] HERBERT SPENCER'S VIEW II

U Conceiving [he says], the State-agency, as thoughit were something more than a cluster of men(a few clever, many ordinary, and some decidedlystupid), we ascribe to it marvellous powers of doingmultitudinous things which men otherwise clustered are unable to do. We petition it to procurefor us in some way which we do not doubt it canfind, benefits of all orders; and pray it with unfaltering faith to secure us from every fresh evil.Time after time our hopes are balked. The goodis not obtained, or something bad comes along withit; the evil is not cured, or some other evil as greator greater is produced.... This emotion which isexcited by the forms of governmental power, andmakes governmental power possible, is the root ofa faith that springs up afresh however often cutdown. To see how little the perennial confidenceit generates is diminished by perennial disappointment, we need but remind ourselves of a few Stateperformances in the chief State Departments." 1

He then proceeds to give several examples ofadministrative ineptitude, the most tragical andabsurd, perhaps, of which was the fact that it tooktwo centuries (I593 to 1795) for the Admiralty toadopt the use of lemon-juice as a protection for thecrews of our warships against scurvy.

U And what [he asks] has been the effect of thisamazing perversity of officialism? The mortalityfrom scurvy during this long period had exceededthe mortality by battles, wrecks, and all casualtiesof sea-life put together! "

1 Study of Sociology, ch. vii. p. 160.

12 THE OBJECTS OF SPENDING [CHAP,

Such an example of a waste of gallant lives bythe imperviousness of the official mind to, new ideasgoes a long way towards proving Spencer's contention that Governments, or some Governments, arenot as capable as private individuals or companiesof doing anything which can, on other grounds, beleft to the latter. And we need not turn back overthe pages of ancient history to find such examplesof departmental fatuity. During this very warthere have been plenty of them, though we mayhope that loss of the lives of our fighters has notbeen thus criminally involved.

But when all this is admitted, there are still severalthings to be said on the other side of the question.A nation in which governmental action has long beenrestricted and resented must not complain too loudlyif the. Government', when it is suddenly told to dothings, does them badly. In countries where a trainedbureaucracy has long been encouraged to do much,its efforts are likely to compare better with thoseof private enterprise. The efficiency of the Germangovernmental machine is probably much exaggerated ; but anyone who travelled on the GermanState-owned railways had no reason to complainof their comfort or of their punctuality. In thoserespects they> seemed to me, from a certainly verylimited experience, to compare well with our ownmuch-vaunted railway system, which, in some respects, was unquestionably a disgrace to privateenterprise. Anyone who travelled much on Sundays on the suburban lines of our leading railways

I] THE OTHER SIDE 13

cannot have failed to maryel at the utter contemptfor public convenience with which they conducted~heir service. They stimulated the public desire totravel by cheap tickets-I am speaking, of course,of days before the war-but made no attempt toprovide accommodation for it; a few slow trains,disgracefully unpunctual and more disgracefullyovercrowded, were the only means afforded to jadedLondoners who sought for a few hours of fresh airon the day of rest. Why the public submitted toit was a mystery. If the railways had then beenin the hands of the Governlnent there would havebeen a clamorous outcry against mismanagementby jacks-in-office. As it was companies-" withno body to be kicked, or soul to be damned "-thatwere at fault, there was never a murmur. InAmerica, that other horne of individual enterprise,the unpunctualityof the railroads is often astonishing. I once travelled-it is some years ago-fromPittsburg to New York on Christmas Eve. Thelocomotive was attacked by a malady called" hotbox" and the train was four hours late. It was fullof unfortunate holiday-makers who had connectionsto make in New York, so as to get home in timefor the Christmas gathering, but they all seemed toaccept it as something in the nature of things, andnot a matter that called for protest or complaint.

We had better admit that in this half-baked worldof ours, in which progress is only at the beginningof its journey, and man is only just beginning tolearn the use of his powers over Nature, not many

2*

14,

THE OBJECTS OF SPENDING [CHAP.

things are yet very well done either by Governmentsor by private enterprise, and the only way forthem to get done better is by everyone of us tryingto do his own little job just as well as ever he can.In some countries Governments do things betterthan anybody else. In others, it is otherwise.Here it is safe to say that Government has not yetdistinguished itself as a practical worker. It hasdone great things in the war, but chiefly with thehelp of men who came in from outside; and whetherthe public's experience of governmental activityduring the war will, or will not, encourage it to giveGovernment more to do when the war is over, is avery open question.

Moreover, even jf Herbert Spencer's view of theineptitude of governmental action were as completely proved as he believed, there are still somethings which have to be done by a public authority,as even he would probably have admitted if hehad lived to this day. His notion of private companies competing for the business of draining ourtowns, and only cleansing those neighbourhoods inwhich they could get enough customers to makeit worth their while, is now commonly recognizedas a fantastic example of overdriving a principle.Huxley, in his great Essay on AdministrativeNihilism, attacks the Spencerian position in thefollowing well-known passage :

tl Suppose, however, for the sake of argument, thatwe accept the proposition that the functions of the

I] HUXLEY ON SPENCER I5

State may be properly summed up in the one greatnegative commandment, I Thou shalt not allow anyman to interfere with the liberty of any other man '-I am unable to see that the logical consequenceis any such restriction of the power of Governmentas its supporters imply. If my next-door-neighbour .chooses to have his drains in such a state asto create a poisonous atmosphere, which I breatheat the risk of typhus and diphtheria, he restrictsmy just freedom to live just as much as if he wentabout with a pistol, threatening my life; if he isto be allowed to let his children go unvaccinated,he might as well be allowed to leave strychninelozenges about in the way of mine; and if he bringsthem up untaught and untrained to earn theirliving, he is doing his best to restrict my freedom,by increasing the burden of taxation for the supportof gaols and workhouses, which I have to pay." 1

Since the days when these two giants threwmountains of arguments at one another, it neednot be said that Huxley's view has prevailed, andmore than prevailed. It has wiped out the Spencerian doctrine, and it has been carried to lengthswhich Huxley himself might well consider absurd ifhe were still alive. The popular cry is now for theGovernment to do everything. An extraordinaryexample, as it happens, is chronicled in the paperof this day on which I am writing, SundaYI February18th, 1917. To-day's Observer records how-

II at a meeting of the Southend Townsmen's Association it was suggested that the Minister of Labour

1 Critiques and Addresses1 p. 10.

16 THE OBJECTS OF SPENDING (CHAP.

should he asked to encourage the production offood by the closing of the churches on Sundaymorning, and so enabling a greater amount of labourto be available. The suggestion had reference tothe large number of Southend business men andclerks who are away frc)In home all the week, andhave only Sunday mornings on which to look aftertheir gardens."

This astonishing paragraph was headed " Churchgoers' Neglected Gardens," and seems to indicatean' extraordinary state of mind prevalent in asuburb inhabited by people who may be taken asaverage spe-cimens of the dwellers in Greater London. Because people work all through the week,and can only dig in their gardens on Sundays, itis proposed, in order to enable them to do so, to getthe Mini?ter of Labour to close tl;1e churches. Ina land that calls itself free and is engaged i~ a greatbattle for freedom, it is really astounding that abody of Southend citizens should have seriouslythought (1) that as long as the churches were open,their frequenters had no freedom of choice aboutstaying in-their gardens and growing food, and(2) that it was the business of the Government tohelp them to do so by depriving all the other members of the various congregations, who have all theweek to dig in, of their freedom to seek ghostlyconsolation by attending divine worship.'-

It is easy to make too much of a wild exampleof this kind. Southend is not England, and probably the. Townsmen's .~ssociation is not Southend.

I] THE PREVALENT TENDENCY

In war-time the babbling busybody gets a chance,in associations and on committees, such as h~ neverenjoyed before. But it will hardly be denied thatthis is only an ,extreme example of a tendency thatis rife. It is high time that we considered thistendency seriously and reckoned its possible effects,if it goes unchecked, on the Government's spendingin the future. It need hardly be pointed out thatthe spread of governmental activity is bound toincrease the cost of government, since everythingthat the Government does costs money, usuallymore than it would if it were done by private individuals or bodies managed thereby. It is veryevident that the present tendency to leave everything to Government is due partly to the war,because war on its present scale demands somethinglike dictatorship, and when it is necessary forvictory that the whole resources of a nation shallbe made available for purposes of defence, individualfreedom takes a very different place in the scale ofimportance. So far, there is good reason for thistendency. But it was also very rife before the war,and was even then showing signs of running toextremes. This was natural and inevitable, because it was only a reaction against the extremelaisser-faire or "leave-people-alone" policy, ofwhich Herbert Spencer was perhaps the doughtiestchampion.

This policy had been dominant in England in theearly part of the nineteenth century. It was wellsummed up in the report of a Commission appointed


by the House of Commons in 18IO, quoted in Mr.and Mrs. Webb's History of Trade Unionism, asfollows:

" No interference of the legislature with the freedom of trade, or with the perfect liberty of everyindividual to dispose of his time and of his labourin the way and on the terms which he may judgemost conducive to his own interest, can take placewithout violating general principles of the first jmportance to the prosperity and happiness of thecommunity."

Such was the view that was maintained by theeconomists who followed Adam Smith .and carriedmuch further than he did the revolt that he hadled against the excessive interference by Government with trade and with the freedom of individualcontract, which had marked the history of the earliercenturies when, for example, justices of the peacefixed wages, or tried to. Supporters of the extreme laisser-faire school based their doctrine onthe assumption-so true in an ideal world composedof ideally educated people, so pathetically untrueas things are-that everybody is the best judgeof his own interest, and that if everyone is left topursue his own interest, the best interest· of thecommunity as a whole will somehow be secured.The practical result of the application of this doctrine, in a community in which employers hadbeen taught that they served the common goodby pursuing their own immediate interests, andthe employed had often been taught nothing, was

I] THE THONG AS PRODUCER 19

that children of five years were sent to work infactories., and in France, according to a reportpublished in 1840 by Dr. Villerme, "the thong~

used for the punishment of children in the spinners'trade appears as an instrument of production." 1

The fact is, that very few of us ever know what isbest to do for our interest. Most people go throughlife mechanically, and without thinking about it,choosing a· prdfessibn for some quite illogical reason,or being pitchforked into a position without attempting to weigh it against other possibilities.l\ioreover, we are obliged to make up our mindsabout the matter, in most cases, long before wehave got a mind to make up. As for the doctrinethat each man by pursuing his own interest helpsto secure the common good, its truth is pleasantlyillustrated by the millions nowadays earned bysellers of worthless medicines and printed trash,which rot the public stomach, bodily and mental.If the economists of the nineteenth century hadforeseen the activities and success of the advertisersof the twentieth, they might have modified theiroptimism.

But there is no need to linger over the absurditiesthought and written by the extremists of the laisser-faire school. Peace with their ashes, for they dida great work in clearing away a mass of rubbish.It was not their fault that thongs were laid in thename of liberty on the backs of bairns who ought

1 Quoted by Messrs. Gide and Rist, History 01 Economic Doctrine•.

20 THE OBJECTS OF SPENDING [CHAP,

to have been playing hopscotch. Liberty is agoddess \vith many shapes, looking quite differentto different 0 bservers. Abraham Lincoln 0 bservedthat-

It with some, the word liberty may mean for eachman to do as he pleases with himself and the product of his labour; while with others, the sameword may mean for some men to do as they pleasewith other men, and the product of other men'slabour.... The shepherd drives the wolf from thesheep's throat, for which the sheep thanks theshepherd as his liberator, while the wolf denounceshim for the same act, as the destroyer of liberty,especially as the sheep was a bla,ck one." 1

It has already been noted that the extreme limitsimposed on Government activity and consequentlyon governmental expetl.diture, by Herbert Spencerand the 'economists who followed Adam Smith,were an exaggeration of the doctrine laid .down byAdam Smith. He took a much more level-headedview of the matter. In his examination (in Chapter I, Book V, of the Wealth of Nations) of the expenses of the Sovereign or Commonwealth, he laysstress on his or its duty-

U of erecting and maintaining those public institutions, and those public works which, though theymay be in the highest degree advantageous to agreat society, are, however, of such a nature, thatthe profit c'ould never repay the expenee· to anyindividual, or small number of individuals, and

. 1 Speech at Baltimore, April 18th, 1864.

I] ADAM SMITH ON SPENDING 21

which it therefore cannot be expected that anyindividual, or small number of individuals, shoulderect or maintain."

Thus, in effect, he gives a free hand to the Stateto spend money on anything that will be advantageous to society, but will not yield a profit.

With regard to education, Adam Smith arrivesat -conclusions which were diametrically opposedto those of Herbert Spencer. He points out thatin cases in which the state of the society does notplace-It the greater part of individuals in such situationsas naturally form in them, without any attentionof Government, almost all the abilities and virtueswhich that state requires,- or perhaps can admit of,"

then-

"some attention of Government is necessary inorder to prevent the almost entire corruption anddegeneracy of the great body of the people."

He goes on to show that, owing to the division oflabour-

H the man whose whole life is spent tn performing afew simple operations has no occasion to exerthis understanding His dexterity at his ownparticular trade seems, in this manner, to be acquiredat the expense of his intellectual, social, and martialvirtues. But in every improved and civilized society, this is the state into which the labouringpoor, that is, the great body of the people, mustnecessarily fall, unless Government takes somepains to prevent it."


A little later he shows that-

" the common people . .,. have little time to sparefor education. The parents can scarce afford tomaintain them even in infancy. As soon as theyare able to work, they must apply themselves tosome trade by which they can earn their subsistence.That trade too is generally so simple and uniform asto give little exercise to the understanding; while,at the same time, their labour is both so constantand so severe that it leaves them little leisure andless inclination to apply to, or even think of, anything else.... For a very small expense the publicc.an facilitate, can encourage, and can even imposeupon almost the whole body of the people, thenecessity of acquiring those most. essential parts ofeducation.' ,

Here we have the Father of Economics, so oftenappealed to, by those who do not read him, as anout-and-out champion of laisser faire, advocatingcompulsory education, at the public expense, nearlyone hundred years before it was introduced inEngland.

It is perhaps even more interesting in these warlike days to note that Adam Smith thought that-

" even though the martial spirit of the people wereof no use towards the defence of the society, yet toprevent that sort of mental mutilation, deformityand wretchedness, which cowardice necessarilyinvolves in it, from spreading themselves throughthe great body of the people, would still deservethe most serious attention of Government; in thesame manner as it would deserve its most serious

I] ADAM SMITH ON SPENDING 23

attention to prevent a leprosy or any other loathsome and offensive disease, though neither mortalnor dangerous, from spreading itself among them.. . . The same thing may be said of the gross ignorance and stupidity which, in a civilised society,seems so frequently to benumb the understandingsof all the inferior ranks of people. [Only the ct inferior" ranks, Doctor?] The more they are in-·structed, the less liable they are to the delusionsof enthusiasm and superstition which, amongignorant nations, frequently occasion the mostdreadful disorders.... In free countries where thesafety of government depends very much upon thefavourable judgment which the people may formof its conduct, it must surely be of the highestin1portance that they should not be disposed tojudge rashly or capriciously concerning it."

I have dwelt at some length on ancient controversies concerning the limits of State action andconsequently of State expenditure, because thequestion is a very burning one to-day, and if we seewhat our forbears thought about it, we may behelped to a right decision in our present difficulties.We have seen the extreme view that the Stateshould do nothing but police and defence give wayto a tendency-even among those who do not profess to be Socialists and to want the State to takeover the whole business of production and distribution-to call on the State to interfere constantlyin the private affairs of citizens; and looking backto the doctrine of Adam Smith, we find that he wasin favour of State expenditure on education for

24 THE OBJEOTS OF SPENDING [CHAP. I

those who could not afford it, on the cultivation ofthe martial spirit, on- checking disease, and on theenlightenment of those classes which, in his opinion,especially needed it. I think it may fairly beclaimed that the formula adopted earlier in thischapter may be taken as representing a safe compromise between the extreme views: that is, thatthe State should spend our money on the defenceof our property from home and foreign enemies,on the defence of the national honour, on the increase of the material resources of the country, andon public health. At first sight, this formula wouldnot appear toinclude education, old-age pensions,or unemployment insurance. But it would be veryeasy to show that all these 0 bjects of expenditurehelp the increase of the rnaterial resources of thecountry, to which nothing can be more importantthan a well-taught community, and a working classwith a feeling of ·security and a knowledge that theState cares for its interests, and is prepared tospend money on its welfare. In fact, all reallyeffective measures of social reform are directly beneficial to the whole community, on the coldest business considerations. . Every man and woman whois not fit in mind and body to be self-supporting hasto be supported, to a greater or less extent, by hisor her neighbours; and so government spendingthat lesseps the number of the unfit, by better carefor the minds and bodies of those wp.o are borninto conditions which do not give them a fair

. chance, is a sound investment.

CHAPTER II

MONEY TAKEN BY BORROWING I

WHATEVER be the duties that a Government isasked to fulfil, it can only perform them by takingto its own use such goods and services as are neededfor them. To keep order at home it must havethe services of policemen and the goods needed tofeed, clothe, and equip them. To build a railwayit must have steel rails, rolling stock, and land andthe services of all the people who lay the railwayout and get it ready for working. To carryon warit must have all the goods needed for the feedingand equipment of an army and the services of thefighters and of those who organize and managethe campaign, the transport service, and all theother items in the problem. These goods and services have to be supplied out of current productionat horne and abroad, and so current production hasto be diverted, to the extent of the Government'sdemand, to supplying those needs, unless (which isunlikely in time of war) it can be increased suffi-

1 Since this chapter was written I have been fortified byseeing its main contention endorsed by Professor Sprague, ofHarvard, in an article in The Economic Journal for April 1917,which embodied an address given by him to the AlnericanEconomic Association.

3

26 1iIONEY TAKEN BY BORROWING [CHAP.

ciently to produce them without this diversion.In order to bring about this diversion, Governmenthas to check the demand of'individuals for goodsand services so tbat k:bour and energy rnay be setfree to work for it ; -and this it does by taking moneyfrom individuals in taxes, which it can only impose on its own citizens, or in loans, or by reducingthe buying power of individllals through the process known as inflation, which consists of undulyincreasing the volume of the currency and sodebasing: its value and raising prices.

We will begin with the borrowing process. Whena Government borrows, it invites people to lend itmoney, and, as a rule, promises to pay them acertain rate of interest for it, and sometimes promises to pay back the money to them or theirheirs and assigns at some more or less distant date.Even when no such promise of repayment is givento the lenders, the fact that the holder of thesecurity, or promise to pay interest, can alwayssell it at a price on the Stock Exchange, enableshim to rely on getting back at least part of themoney that he has lent, if he wishes to do so.

It was stated that when a Government borrowsit promises, as a rule, to pay interest. This is nowSO usual that a loan without interest seems to amodern mind to be almost a contradiction in terms.But such things have-happened. In the good olddays impecunious sovereigns who could not get asmuch as ~they wanted out of their subjects bytaxation, used to write to people of property and

/

II] LOANS WITHOUT INTEREST 27

demand a sum from them· on loan; the latest example of this form of finance occurred in the earlyyears of the reign of James I. A large number ofthese letters-which were called Letters of PrivySeal-dated July 31st, I604, were sent to theprincipal noblemen and gentlemen.in all the countiesof England, and excited great and general dis..satisfaction.Their form was as follows:

it By THE KING:It Trustie and well beloved we greete you well.

Although there be nothing more against our .mindethan to be drawne into any course that may breedin our subjects the least doubt of our unwillingnessto throw any burthen upon them, having alreadypublished both by our speeches and writings, ourgreat desire to avoide it in the whole course of ourGovernment: Yet such is our estate at this timein regarde of great and urgent occasions faIne andgrowing daily upon us, (in no sort to be eschewed)as wee shall be forced presently to disburse greatersummes of money than it is possible for us to provide by any ordinary means, or to want· withoutgreat prejudice, in which consideration . . . wethink it needless to use any more arguments fromsuch a King to such subjects: But that as ournecessitie is the only cause of our request, so yourlove and duety must be the chiefe motive of yourready performance of the same ;, . . That whichwe require, therefore, is that within twelve dayesafter the receipt hereof, you will cause the summeof to be delivered to whom wehave appointed to be our collector in our countieof

28 MONEY TAKEN BY BORROWING [CHAP.

H The loan whereof we do desire to be untill theFaure and Twenty day of March which shall be inthe yeere of our Lord God r605, for assurancewhereof we have directed these our letters of PrivieSeale unto you, which, with the hand of our saydcollector testyfying the receipt of the same summeof shall bind us, our heirs, and successors for the repaiment thereof ... upon thedeliverie of this our Privie Seale unto our saydreceipt." 1

Through all the rambling verbiage of this Letterof Privy Seal, a large part of which has been leftout, there is no whisper or hint of any interestpayment. The loan was for nearly eight months,and from its terms was evidently a re'quisition,leaving the receiver of the letter little or no choiceabout producing the sum required of him.

In modern times, however, these things do notl;1appen. A rate of interest is universal, and adefinite promise of repayment is very usual. It isnotably absent, however, in the case of our ownGovernment's Consols. The holder of Consols hasno right to repayment from the Government, onlythe right to a perpetual annuity of so much a year,originally 3%, converted in r888 to 21% and in1903 to zt%. A very large part of the French 3.%Rentes are also what is called a perpetual debt,with no obligation on the part of the debtor torepay.

When a Government raises money by borrowing

t Chi~holm's Analysis ot,the :public Accounts, p. ~09..

II] ADVANTAGES OF BORROWING

it thus hires certain of its citizens, or those of anyother country who may like to subscribe to theloan, to find money for it, and it does so by promising them a rate of interest, varying accordingto the state of the money market, its own credit,and the circumstances under which the loan ismade. Borrowing thus has this very tempting, butalways dangerous advantage over taxation, that itenables a Government to get moneyfrom the citizensof other countries. Let us leave this consideration on one side for· the time and see \vhat arethe advantages and disadvantages of borrowingat home over taking money in taxes.

From the point of view of the practical andadroit politician, who wants money for the Stateand does not want to make himself or his policyunpopular by increasing the burden of taxation,the advantages of borrowing are obvious and over'Nhelming. To the public the advantages areequally clear and weighty, because the publicthinks· that by means of the borrowing system itis able to avoid being taxed, and to hand on toposterity the task of finding the money that isrequired for its present needs.

This view has been dinned into the public earby economists, financial writers (among whom Imust plead guilty to having done my sn1all share),and business men. 1 But it is largely a delusion.

1 A New York banker's circular, dated April 14th, 1917, says:II Posterity will chiefly benefit from the struggle for freedomand should pay its part."

3*

30 MONEY TAKEN BY ,BORROWING [CHAJ'.

Let us take the example of the present war. Wecannot hand its burden on to posterity. It has tobe paid 'for now by somebody, and all wars havealways been paid for during the time in which theywere fought and finished up. War cannot be carriedon with goods produced or work done either byour ancestors or by our posterity. The goods consumed in war-shot, shells, rifles, food, clothes,horses, motor-lorries, wagons, ships, and everythingelse-have to be new and up to date, and, apartfrom the store of them with which the contendingnations began, are made and produced as the wargoes on. As they clearly have to be in existencebefore they can be used, it is obvious that they cannot be produced by posterity. Our army cannoteat the bread that is going to be sown in t930, orwear boots made out of hides whose original ownersare. yet unborn. Whatever posterity produces willbelong to posterity for its own use, and nothingthat we do now can deprive posterity of a singleear of wheat that it sows and grows. It is truethat when \ve sell part of our accumulated wealth,in the form of securities, to Americans, in order topay for goods wanted for the ,war, or when weborrow in America and contract to pay Americansinterest in the meantime and their money backsome day, 'we thereby arrange that a larger shareof posterity's wealth will go to America and alesser share to us; but the sum of posterity'swealth will not thereby be affected, and this onlyhappens when we borrow from, or sell securities to,

II] GILDING A PILL 31

other countries, and this side of war finance weare not at present considering. Confining ourselvesto that portion-by far the greater-of our warborrowings that are raised at home, we see if welook at the matter steadily that the borrowingpolicy is only a gilding that makes us swallow apill and believe that we are eating something goodand nourishing. The Government wants moneyand offers us a beautiful security, with 5% interest,at 95, repayable in thirty years at par, and wecalculate that these terms give us a net return of5t%for our money. 'Vith the help of a tremendousadvertising campaign, and a very real and patrioticeffort on the part of a large number of good citizens,the nation hands over 1,000 millions to the Government, and the achievement is very justly hailed asthe biggest financial success ever won. It is aperfectly magnificent success. But it does notmean that we have thereby handed to posterity thebusiness of paying for 1,000 million pounds' worthof the war. We have paid now by handing overthose 1,000 millions. In return for them we receive from the Government securities, that is,promises to pay interest and repay capital, andthe Government can only meet these promises outof our pockets. These securities are assets thatwe hold, in return for our money, but they arealso liabilities that we as taxpayers have to meet;we shall only get interest on our money as the taxpayers pay it, and we shall only get our money backin the same way; and we are taxpayers.


But what of the man who did not subscribe tothe loan? . He, as far as this loan· is concerned,appears to have paid nothing towards the war. Ifthis were really so it would not be a good argumentin favour of the borrowing system, for it wouldrilake patriotic people pay and leave the others freeto spend money on themselves, or invest in othersecurities at higher rates. But, in fact, thosewho do not subscribe probably pay more in thelong run, because they have henceforward to paytheir share of taxation to meet the interest onthe loan, and as they do not hold any of it theyget no s1lare of interest payment back into theirown pockets. The borrowing system gives thecitizen the choice of (1) paying up his share of thewar cost now by subscribing to a loan, an9. afterwards being taxed to pay himself interest and topay himself back, or (2 ) paying nothing at thetime when the loan is issued, and being made topay regularly hereafter interest and redemptionmoney to those who subscribed. \Vhen a Government loan is issued, all the taxpayers on whomthe loan charge will fall are, forthwith and at once,jointly poorer by the amount of the loan. Thosewho have found the money, and paid for the objectneeded by making a sacrifice now, have an assetto set against the future increase in taxation.

-But, it -will be objected, a man who has subscribedfor £1,000, of the loan 'will be able to sell it, very'likely at a profit, in a few years', time. Then hewin have ~othis money back~ alld somebody el~e

II] THREE TIMES OVER 33

will have paid it back to him. Quite true, but theresult of his selling will be that he will have gotrid of his asset but not of his liability. He will nolonger receive interest on the stock that he hassold, but he will still pay interest on the debt,and perhaps money for its redemption, all of whichwill go into the pockets of the debt-holders, andnone into his own. He and his estate after him,in whosoever's hands it be, will have to completethe repayment to somebody else of the moneywhich he thought he had got back again when hesold his stock. By borrowing for war a Government sets up a process by which the war is paidfor three times over. First it is paid for as itgoes on by the citizens who subscribe to theloans; then it is paid for by the citizens as a whole,who provide the money needed for this purpose,plus interest, by taxation; and the Governlnentfinally hands the money back (Plus, perhaps, apremium on redemption) to the original subscribers,or their estates.

The unwieldiness of the whole arrangement isseen best if we imagine a nation composed of citizensall with the same income and taxed to the sameextent. Let us suppose that there are ten millionheads of families each with an income of £300 ayear. The Government offers a 5% loan and theyeach, being equally patriotic, subscribe £roo; thisproduces 1,000 millions, and each family has £100

less to spend that year, because its £100 has goneipto the hal1g$ Qf the Government. They will have

34 J\fONEYTAKENBY BORROWING [CHAP.

the interest to spend? By no means. In orderto pay them their S% the Government will haveto raise So millions in taxes (or in another loan),that is, take £5 each out of their pockets and pay itback to them. And. as soon as the war is over theGovernment will set a Sinking Fund to work topay the loan off. A Sinking Fund is money usedfor paying off debt, and has to be provided by abalance of revenue over expenditure. If the Government fixes this Sinking Fund at 1%, it will haveto take another £1 from the pocket of each citizen,and so they will pay themselves back their capital.If, in the meantime, anyone of them sells his £100

stock to a neighbour, he will have got his moneyback, but he will still as a taxpayer have to pay his£6 a year till the loan is e;xtinguished, so that theeffect of getting his money back will be that hewill be paying his neighbour interest and capitalinstead of himself. When we clear the problemby this imaginary example we see at once that thenation paid for the war when it happened, butmerely because it preferred to lend instead of beingtaxed it went through an elaborate process ofpaying itself all over again, so that it might feelhappier about it. I t is fairly safe to say that,.under such circumstances, an intelligent peoplewould soon awake to the fact that it would saveitself and its rulers a good deal of trouble andsome book-keeping expense, by submitting to taxation at the time when the war is in progress andwriting off the cost of the war at once.

II] ELUSIVE POSTERITY 35

But of .course nations do not consist of citizenswith equal incomes, equally taxed, and they do notsubscribe equal amounts to the loans that are raisedby their Governments. This inequality complicatesthe problem, but does not alter the fact that thewar has to be paid for as it goes on, and in so faras it is paid for by raising loans at home, is paidfor out of the nation's current income. If we tryto pay for it. by selling our old investments to oneanother, those who buy the old investments musthave a balance available to pay for them. Thegerieration which lends the money either pays itselfback out of subsequent taxation, or is not paidback at all; it cannot be paid back by posterity,because whatever posterity pays it pays to itself.The whole notion that we can leave posterity thetask of paying for any part of the war, by borrowing at home,. is a delusion. Perhaps it is luckythat we cannot do so, for posterity is likely to haveplenty of problems of its own to face. But whatever it produces it consumes. What we can do,and are doing, is to lessen the power of posterityto produce,because we shall hand on to it a lesswell-equipped industrial and agricultural organIzation, owing to the fact that during the war we arenot saving and putting into capital improvementsas much as we did in peace. Before the war wewere estimated to be saving and investing at homeand abroad some 400 millions a year, so increasingeither the power of our own country to make andgrow things for us, or the debt of other countries

36 l\!-ONEY TAKEN BY BORROWING [CHAP.

to US on which they paid us jllterest in the form ofgoods and services. During the war' nearly alloursavi1!gs ,go into furnishing victory for the causeof liberty and progress and protecting our propertyagainst external attack. On _the oth~r hand l weJnay fairly hope to hand on to posterity a betterorganization 'and a better spirit than we shouldh~ve bequeathed to it, if we had nbt learnt manyuseful lessons from that stern schoolm'aster theGod of Battles, who has chastened and chastised usfor our good.

But as incomes are unequal and taxation likewise,and as people subscribe unequal amounts to loanslevied by Governments, let us see what is actuallythe effect oJ the borrowing policy. If we comparefirst the case of t)yo people with the same incomelending unequal amounts, we find two people withfr,ooo a year, of whom Jones puts £50 into the loanand Sm~th £soo.They will both have their taxesincreased to the same extent 'to pay interest onthe loan and provide a. Sinkin~j Fund to redeem it;but one will get £2 IDS. a year (less income tax) ininterest, and theotheJ; £25. If the circumstancesof both are the same, this is quite just, becauseSmith is :t:ewarded after the war faT the effort

\ that he m~q.e during it by putting half his incomeat the disposal of the Government when it calledon the citizens to subscribe; 'probably the interestthat he gets will more'than offset the higher taxation th%t the existence of the war debt will neces~itate. In the case bf Jones, who continued to

II] AN EVIL AFTERMATH 37

spend most of his income on himself; and only putin a small amount to be spent on powder andshot for the army, he will only get a small sum ininterest, which will almost certainly be less th2.n theextra taxes that he will pay. So that in cases inwhich conditions are equal, the interest payment,by j"ewarding patriotic effort in war time, gives ajust and well-earned guerdon to those who saw theircountry's need and made the right effort to meet it.

But if we find that Jones was educating eightchildren, whereas Smith was a bachelor, it becomesevident at once that Jones's £50 that he subscribedto the loan was a greater effort-cost him more inhealth and comfort for himself and·. his youngsters-than Smith's £500, so that the after-effect of theborrowing system in penalizing Jones and benefi ting Smith is highly inequitable. And this is avery serious evil in the aftermath of borrowing byGovernments, that by its inability to discriminatebetween the effort made by the various subscribers itetnphasizes the inequities of our system of taxation.

If, then, borrowing has this merely stupid effectthat the payment for the object which is securedis carried out thrice, first when the lenders handtheir money over to the Government to spend onthe desired purpose, and later and more graduallywhen they hand their money over to the Government to be paid back again to themselves, whatare the advantages about it which make it sopopular with practical politicians and the public\yhQm they have to keep in a good temper? It

38 :NIONEY TAKEN BY BORROWING [CHAP.

is simply this, that the borrowIng system makesus feel happier and keeps us in a good temperbecause \ve. see the security that we :g,ave receivedand the interest that we get on it, and forget thatthe interest comes, wholly Or ·.partly, out of ourpockets and that-·if the loan is paid back it willbe paid in the same way. When we subscribe tothe loan we either do so out of money that weborrdw~a process· that will be considered in thenext chapter when we corne to deal with the question of inflation-or out of money that we save, orby drawing down our bank balances, in which case,unless we have been stupid enough to keep unnecessarily big ones, we shall save to replenishthem. If we save. we have so much less to spendon our own comforts and amusements, or so muchless to invest in other directions, from which weshould have received interest and repayment thatwould not have come out of our pockets. So bysubscribing we hand over our money to be spenton the )Var and so pay for the war as it goes on.If we do not subscribe but continue to spend asusual, tpen the taxation involved in order to payinterest and redempt~on of the loan comes out6f our pockets and none at it comes back. Sothat the borrowing system gives us this choice, ofpostponing paying our full share of the war's costduring its course, and only meeting it over a periodof years by paying taxes needed for the debt chargeand get~ing none of it back in interest or repayment.If we e;xercise tbis choice and die irnmediately

II] ESCAPE BY DEATH 39

after th,e loan has been brought out, we apparent1yescape paying for our share of the war altogether,because we are never taxed to pay interest toanybody. But, in fact, we die so much poorerbecause the estate that we leave does not containthe amount of war loan to which, if we had doneour duty, we should have subscribed. ,and it doescarry with it the liability which will fall on ourheirs and assigns to pay their share of the debtcharge in taxation. In other words, we have leftthe job of paying for the war to our heirs. and'isnot this the same as leaving it to posterity? Yes;but we can only perform this feat if we die at once.If the Government offers a }oan for war or anyother purpose, all the taxpayers immediately becomeliable to pay interest on it, and anyone who doesnot subscribe for such proportion of it as his incomeand conditions indicate, will consequently be somuch the poorer, as long as he Is alive, until theloan is redeemed, and will be so much the poorerat his death, because his estate will be encumberedby the debt charge and will hold no asset againstit. If he subscribes his fair share he has so muchthe less to spend when he does so, but afterwards,if taxation is fairly apportioned, has his interestand his share of the loan, as repaid, to set againstthe extra taxation.

I t is commonly said that we are still! as a nation,paying for the cost of the war that our ancestorswaged against Napoleon more than a hundredyears ago. But this is not so. As taxpayers we


pay interest on the debt then raised. But we paythat interest to those of us who hQld the debt byinheritance or otherwise. As a nation we enjoynow all that we produce, and the vagaries of ourancestors only affect the manner in which our production is distributed.

But what happens in the case of loans that arenever repaid? Never is a long word, but if wecan really conceive that as long as mankind laststhe existing national debts will be outstanding,then the interest charge will continue to be a burdento the citizens as a whole, and an income to theheirs of those who originally subscribed.

Borrowing at home, then, for war purposes orany other, does not, as is usually supposed, shiftthe burden of payment on to the shoulders ofposterity. Whatever it is that the Government isbuying, whether it be the services and equipmentof an army in the field, or a system of sanitation,or a railway, has to be paid for by somebody atthe time when it is provided. By raising themoney by q. loan instead of by taxation the Government escapes the unpopularity which a great inerease in taxation might produce, and hires someof the citizens to pay now, and then taxes themall to pay interest and redeem the debt. Thosewho have subscribed receive a security which theycan sell, and as long as they hold it receive interestwhich they, in common with the rest of the com..munity, have to find by paying taxes.

The system thus has this advantage in a com..

II] DEBT AND WEALTH 41

munity in which wealth is unequally distributed,that it enables those who have a margin of incomeabove the necessaries of life to pay for whateverbe the object that the Government wants withoutat the time feeling any poorer, because they get asecurity that makes them think they are actuallyricher. If taxation is equitably imposed they willafterwards be taxed to pay themselves interest inproportion to the amount that they ought to haveput into the loan when appealed to by the Government. But here comes in a great 'difficulty, as ~ "veshall see when we come to the question of taxation. If those with a margin, who can save withoutserious discomfort, take up all or the greater partof the loan, and then taxes are imposed on all,whether they have a margin or no, ,then the sy'stemof financing Government spending by loan tendsto accumulate more and more wealth in the handsof those who are well off. The subsequent existence of a national debt, held by the citizens, doesnot affect the wealth of the nation as a whole.The wealth of a nation consists of its material assetsin the way of industrial plant, agricultural estatesand stock, houses, roads, railways, canals, and soon, and its holding, if any, of foreign investments,and its income consists of the annual produce ofthese material assets as organized and worked asa going concern by the nation's brains and sinews.These assets and this working power are no lessproductive because there are some big ledgers atthe Bank of England in which are inscribed the

4


names of certain citizens who have to receive partof the taxes levied on this national produce. Butthe distribution of the national produce is seriouslyaffected, because it means that the debt-holders,without making any further effort, get for all time,as long as the loan is outstanding, a large sliceof the nation's revenue, which has to be foundout of its annual produce: and if this de~t-charge

is heavy and any large part of the nation thinksitself to be overtaxed, there is only too likely tobe discontent and resentment on the part of thosewho pay interest to the holders of war debt andforget that these holders are the people whof,ound the money ,to pay for the war, or theirrepresentatives. If this grievance were acutelyfelt, it might endanger the stability of property. Asystem based on property is not~ of course, theonly conceivable system under, which mankind need\vork for its living. But so far it is the only onethat has been found to work, and it would bedangerous to imperil it before we are ready witha substitute. So that, though we cannot by anyingenuity make posterity pay for war or anythingelse on which we or our Government spend moneynow, we may by the adoption of the borrowingsystem leave some very awkward problems to it.tyhatever posterity produces it will consume ~ butthe fact that certain members of posterity, descendants of those who paid on our account, will therebyhave a prior lien on posterity's produce might haveawkward results.

II] BORH.O\VINGFOR WAR 43

Since, then, the view that borrovving at hOlne putsthe burden on to posterity is a delusion, since thegoods and services needed for war or for anythingelse on which a Government is spending have tobe found and paid for, by somebody, at the timewhen the thing is done, and since the system ofhiring certain of the citizens to do the paying atthat time, and giving them a claim on part of thenation's income in return, may have dangerousconsequences when carried far, does it follow thatborrowing at home is a policy that is never justifiedon economic grounds, though it may be necessitatedby the exigencies of politics and the need for keeping the public in a good temper at a time of crisis?I think it does, f~om the purely theoretical pointof view, except when the object on which themoney is to be spent is an enterprise like a railway,from which a profit may be expected at leasf sufficient to cover the interest on, and redemption of,the debt put into it. But perhaps a case mightbe made out for borrowing "for purposes, such aseducation and health, which, if the money is wellspent on them, may be expected to improve thecountry's productive power.

War is certainly the worst purpose for which theborrowing system can be used, because in war-time,especially when war is on a stupendous scale asnow, taxation (r) is easily raised, (2) is little if anyhindrance to ind-qstry, and (3) produces a beneficial effect on the consumption of the community.Moreover war" especially when on a stupendous


scale, is certain to be followed by a period of disIocation and uncertainty in which industry shouldbe as free as possible to contend with the difficultiesthat face it, and should therefore be as little aspossible burdened by taxes that have to be paidto debt-holders. Let us consider these assertions.

(r) Taxation is more easily raised in war than inpeace, for the obvious reason that, the nation beingpatrio~ally stirred by some cause affecting itshonour or its existence, or both, its citizens arereadier to hand over their money to Government.In an ideally educated nation with an ideal systemof taxation and an ideal Government that could betrusted not to waste its money, this difference wouldperhaps not appear, because under these circumstances the citizens would always be ready andwilling to pay by taxation for objects that thenation had decided to be desirable. But as thingsare, many, people in ordinary times grudge themoney that they have to pay in taxes, partly because they have not been taught to see that thecommon good is their good and that they oughtto contribute to it gladly, partly because theyoften have a suspicion that they are being taxedtoo much and their neighbours too little, andpartly because there is a general suspicion, not tosay conviction, that a large part of any money whichthe Government spends is wasted, owing to theexcessive cost of its cumbrous machinery. In wartime these considerations have much less weight,and the citizens, when they pay an extra price for

II] TAXATION'S ADVANTAGES 45

their tobacco or tea, or draw a bigger cheque forthe King's taxes, feel that they are putting something into the Treasury for a great cause, or forthe national honour, or to C4 keep the old flag flying," or to (t help-the boys at the front II who arefighting for them, or just that q it's war-time,"and there's an end of it. At such a time a Government confident in its cause, and in the readiness ofthe citizens to back it, could, I believe, take amuch greater part of the nation's income in taxesthan has been attempted yet.

(2) Taxationis less hindrance to industry in timeof war, because war in many ways simplifies thetask of industry. Industry knows more exactlywhat it has to produce, and has a better and morecertain market. Its difficulty is to get enough mento do the work, and stuff to put into it. At hornethere is the Government wanting more war"materialthan can be turned out. Abroad there are neutralsfull of money that they are making out of sellingthings to the warring Governments, wanting to buystuff that they used to get from us and our tradecompetitors-now busy on war work-and unableto supply their wants. The manufacturer hasmore certainty that he will be able to sell at a goodprofit whatever he can turn out, and he is consequently less likely to have his enterprise checkedby the existence of high taxation. He is so likelyto be able to take most of his taxes out of his customers that, under such conditions, taxation weighson him much less heavily.

4*


(3) Taxation in war-time is twice blessed. Itgives the Government revenue and it checks theconsumption of the individual, and this is, at sucha time, an equally important economic advantage..Because owing to the enormous demands of theGovernment on the available supply of goods andservices there are not enough to go round, and ifthe citizens try to enjoy their usual allowance ofcomforts and amusements-none of which can beprovided without using up a certain amount oflabour and of stuff, and probably of coal in transport-the result is that the Government and theindividual citizens compete against one another ina limited market and force up the price of everything to their mutual disadvantage, and, what isworse, to the great disadvantage of all whose wagesor· incomes have not risen as fast as the rise inprices has moved. It may be objected that borrowing checks consumption just as efficiently astaxation, since people cannot spend what theylend. This is true if all the money lent is saved,and is not produced by borrowing or inflation, .asubject to be dealt with in the next chapter. Buteven· so, when money is taken in taxes and not in.loans, people are likely to be thereby stimulatedto save something besides. As we have seen, if aman puts f1,000 into a Government loan, he thinkshe has got an asset and forgets that it also involvesa liability. If f1,000 is taken from him in taxes, heis likely, if at all thriftily inclined, to try to putsomething away besides.

II] PENALIZING PATRIOTISM 47

Further, borrowing in war-time has this greatdisadvantage, that it penalizes those who go to thefront. Doctors who give up fine practices andtake a pittance as R.A.M.C. officers, business n1en,mechanics and miners who forsake big profits andhigh wages for the pq.y of officers and privates,come back when the war is over and find that thecomrades al1d competitors whom they left behindha~e made big investments in war loans, and thatthey, whose pay has enabled them to do little ornothing in this direction, will be subj ect to highertaxation to pay them interest. The system thusdirectly fines those who do the most important warwork.

For all these reasons taxation in time of war isgreatly preferable to borrowing, and this is still moreso when we consider war's aftermath. Every millionthat we pay in taxes in war-time means that thereis a million less of debt to be dealt with when peacecomes, and ,consequently so much more taxationto be taken off, just at the very time when taxationwill be the greatest nuisance. Because when. peacebrings the tremendous problem of putting ourindustry back on to peace work, with uncertainmarkets and all kinds of queer problems that arecertain to arise, it is above all necessary that ourproducers and merchants shall feel bold and confi...dent and ready to set the whole machine going inthe good hope of bigger production and readierconsumption than ever have been seen before inpeace time. High taxes, due to a big debt charge

48 ¥ONEY TAKEN BY BORROWING [CHAP.

produced by home borrowing, will only go out ofone pocket into another, but t~e taxpayers will notall recognize this,' and if they are not· also debtholders it will not console them if 'they do. So thatif taxes have to be kept on at the war level, or evenraised, in peace tin1e-as is quite likely if our rulersdo not tax vigorously now-the great recovery intrade with which I hope that we niayastonish theworld even more than by anything that we havedone during the war, may be seriously impeded,especially if there is discontent and bad feeling inthe co~ntry about the manner in which the burdenof taxation is imposed. The Germans, who haveraised,so far, a q-qite contemptible part of the warcost by taxation, are likely to find themselvesseriously ha.-mpered when peace comes by the problemthat they are thus creating for themselves.

For these reasons borrowing at home in war-timeis not a policy that commends itself on economicgrounds. The extent to which it is practised maybe taken as a measure' of the want of confidence ofthe Government in itself or in the readiness of thepeople to nlake sacrifices for the war, or of its merethoughtless following of a bad habit handed downby its predecessors.

A well-informed' and benevolept despot, with aperfectly docile people, would s~e that if there ismoney in the country that he can get by borrowinghe can also get it by taxing if he sets about it in theright way, and that by doing so he not only cheapensthe war by reducing his subjects" demand for goods

n] THE BENEVOLENT DESPOT 49

which competes with that of his War ~v1inister, butalso makes industrial recovery in peace more rapidand hearty, by the absence of after-war taxation.All the money that he wanted for war he would justtake from his people in taxes as the war went on,without going through the cumbrous process ofborrowing it from them and aftenvards taxing themto pay themselves back. But in order to do so hewould have to be able to rely on a truly equitablesystem of taxation, which would curtail the powereven of the richest to waste money on things thatare not really needed at a time of national crisis,without taking food out of the mouths and clothesoff the backs of those who are hungry and ill-clad.

Borrowing at· home in time of peace for somepurpose that is, as Adam Smith said, of great-national advantage, but not likely to pay, is lessobjectionable than war borrowing, since the specialadvantages, .set out above, of taxation over borrowing that prevail in war-time are then absent. Butit is· always dangerous, because it encourages thedelusion that a nation can have things now andpay for them some day, whereas whatever it has nowi t pays for now if it raises the money at home, andthe simplest, cleanest, and most honest way ofpaying for it is by taxation. In the case of revenueearning enterprises there is very little objection toborrowing for their cost if the revenue is likely tocover the debt charge ; but since it is generally ad...mitted that such enterprises are more costly, inmost countries, when managed by Government, the


economic argument against their being so managedis strong.

Borrowing abroad, except for reproductive purposes such as railway building, is so evidently Ie badbusiness" that it is only done by Governments ofeconomically backward countries, or by Governmentswhich are impelled into this course, against theirwill,by the force of circumstances, as happened toours in the present war. The volume of munitionsand war goods required for us and for our Allieswas so great that we had not the plant ready toprovide them fast enough, so we had to buy themfrom neutrals. As our industry was depleted of itsbest men and had more work to do than it couldmanage, it was not possible to pay for these warimports by increasing the volume of goods andservices that we exported. So we were obliged tomake these payments by drawing on our accumulated capital and by pleclging our .future production.Some of our accumulated capital was in the form ofthe bonds and shares of American railroads and ofGovernment and municipal bonds of many neutralcountries, which had been acquired by us and byour fathers through the process of investment abroad,that is by providing goods and services in the pastand taking securities in exchange for them. Theseforeign investments stood us in good .stead since wewere able to ship them back to the country of origin,or to others that would take them, in exchange forwar imports. By this means we, as a nation, paidfor part of the war's cost Qut of work done in

II) BORROWING ABROAD 51

former years, by using it to induce foreigners whobought the securities to pay, during the war, otherforeigners who were supplying us with goods andservices needed for it. By so doing we deprivedourselves for the future of the stream of goods andservices that we used to receive from foreign countries to meet the interest all, and redemption of, thesesecurities that we had acquired in former years.This process has very much the same effect as borrowing abroad, which was another means employed byour Government for financing the war. For exalnple,when it raised a loan of 50 millions in America it,in effect, hired certain American investors to paynow for the munitions, etc., that we were importing;promising to pay them in future so much a year ininterest. This interest we shall have to provide outof our annual production of goods and services.So that both these processes of financing, by sellingsecnrities and by borrowing abroad, mean that weshall have to work harder in future to provide· forour own wants, for one reduces the payments thatfolk abroad have to make to us and the otherincreases the payments that we have to make tothem. But it may be noted that the extent to whichwe have made use of these methods of paying forwar is,sofar,1 roughly balanced by the loans thatwe have made to our Allies and Dominions.

1 Written in March 1917.

CHAPTER III

MONEY WATERED BY INFLATION

IN the good old medieval days rulers who wantedmore money than they could squeeze out of theirsubj ects by taxing used often to solve the problemby debasing the coinage. This was most easilyand effectively done by putting less preciou.s metaland more alloy into coins and then issuing them inpayment with all the appearance of having the samevalue as before. By this process the monarch wasable to make a given amount of gold or ~ilver go somuch further in turning it into .pieces that theirunsuspecting subjects would take in exch~nge forgoods, until the fraud was discovered and pricesadjusted themselves, more or less.

Nowadays most commercial transactions, exceptthe retail purchases on which we spend our pocketmoney, are carried out by means of various formsof paper money. the most important o~ which, inthis country, is the cheque currency with which ourbanking system provides us. Before the war, weused to carry gold and silver coins for retail purposes, but even tIlen all big payments ~ere made

52

CHAP. III] MULTIPLYING PAPER 53

by cheque. Si,nce the war, gold has practicallyvanished from circulation, and its place has beentaken by Treasury notes, issued uuder the Currencyand Bank Notes Act of 1914; and convertible ondemand into gold at the Bank of England. Thispower, that a modern community has gained, ofmultiplying its currency by means of the printingpress and of banking machinery, makes it easy forGover11,1nents when they want money and are shyof taking it directly and openly out of the pocketsof the citizens, to debase the currency, not byfraudulently tampering with it in the medievalmanner, but by merely multiplying the amount ofthe paper instruments that will be taken by thepublic in exchange for goods. The buying power ofthe public is thus watered down by inflation, if thismixture of metaphors may be permitted. This isa very tempting and attractive method of financingany expensive enterprise, especially a war, becauseit does not, at first sight, call upon anyone for anysuch sacrifice as is involved when taxes are raisedor when the citizens are called upon to limit theirspending, save their money and lend it to the State.By increasing the currency a Government does nottake money out of anybody's pocket, but puts newmoney into the pockets of those to whom it has tomake payments. It seems to be a delightfully easyand simple way of paying for things, just to manufacture new money for the purpose, and· this deviceis in fact the basis for all kinds of schemes by whichwen...meaning. currency reformers often believe that

54 1vlQNEY WATERED BY INFLATION [CHAP.

they can make mant1ud rich, by increasing thevolume· of the n1edium by which payments areeffected; whereas the only way by which we canbe made re~lly better off is by increasing the supplyof things that we need and improving the systemby which they are distributed a-mong us. In factthe effect of an increase of currency, unless it is~ccompanied by an increase in the output of goods,is just the same as that of the medieval debasement.It tends to produce a rise in the prices of all commodities of general use, and so throws the burdenof paying for war, or providing whatever be theobject that the Government is trying to secure, onthe shoulders of the people least able to bear itnamely, ill-paid workers and salary earners andpeople witb ~smallfixed incomes. It is a devious,unscientific; and round-the-corner dodge, and canonly be excused on the ground that Governmentsmake use of it without realizing what they aredoing, and then continue it because, when once it isstarted,' it is very difficult to stop it, pr even tocheck its growth.

It is simply finance by inflation. The subject isdifficult and technical, and to 'enter into all itsintricacies would involve us all in much confusionand wearitless of J]lind, and would also fill out aportly volume. But if we keep to the broad outlinesof the matter, it seems to me that the case againstit is plain to the understanding and convincingto common sense. Professor Foxwell, in the courseof a lecture on Inflation, lately gave an excellent

III] DR. JOHNSON ON CURRENCY 55

illustration of the effect of the quantity of currencyon prices from a remark of Dr. Johnson's. Whentold that in Skye twenty eggs might be bought fora penny, Johnson observed: {( Sir, I do not gatherfrom this that eggs are plenty in your miserableisland, but that pence are few." There it is in anutshell. If currency is scarce, prices are low; Ifit is plentiful, prices are high. By inflation I meanan increase in the currency more rapid than in thevolume of commodities and services that the community is producing. When this takes place, ifat the same time whatis called the velocity of thecirculation-that is, the pace at which money isturned over-remains the same, it is impossible toavoid the conclusion that a rise in prices musthappen. Let us see the process at work in animaginary example.

If we all woke up one morning to find that somewell-meaning fairy had doubled the alTIOunt ofmoney in our pockets and in our banking accounts,and if at the same time no more stuff and serviceswere being produced, we should all, probably, feelnice and rich until we found out that everybodyelse's money had also been doubled; then if at thesame time there were no increase in the things thatmoney is used to buy, the stress of competition wouldmake the price of everything shoot up like a rocket.If the price of everything,. including labour, servicesand capital, were exactly doubled, then we shouldall be exactly as we had been before, with regard toour power to buy; but in fact there would be a

p.

56 MONEY WATERED BY INFLATloN [CHAP.

painful process of adjustment in which those whowere strongest in bargaining power would do bestout of the scramble and the weakest would fareworst. Moreover, those who had made investmentsin house property, mortgages or securities, entitlingthem to so many pounds a year for a term of yearsor for all time, would find that the buying power oftheir so many pounds had been greatly lessened, butthat they had no right to make their tenants ortheir debtors pay them more than was stipulatedin the original contract. The result, then, of suchan increase in the currency as we have imaginedwould be a great upsetting of the community'seconomic relations, with a rise in prices followed bya rise in wages for those who were strong enoughto secure it, probably much friction and manystrikes before this adjustment was secured, a gooddeal of injustice to unorganized workers and peoplelike clerks and typists who are too respectable tostrike, and a very unfair advantage to debtors, whowould be· able to pay interest and repay capital tocreditors in currency that had been debased to theextent of about half its value.

If inflation took place on this wholesale scale, weshould all see at once what was happening, but ofcourse it does not. It is usually done, even in timesof acute crisis, so gradually that its effect is notobserved until it is too late to remedy the evil bydrastic measures, without raising a fresh crop ofawkward problems. In normal times inflation is,as a rule, only practised on a very modest scale"

III] THE GUERNSEY MARKET 57

though it is said that there have been examples ofeconomically backward States that worked theprinting press so hard that at last their paper becameso worthless that it did not even pay to print it.If inflation really has the excuse, like the unauthorized baby, of being q only a very little one'/' itseffect is hardly noticeableJ and it appears to worka very comfortable miracle. There is the famousexample, referred to in Jevons' s book on Money,Chapter XVI, of the G,uernsey market, which \-vasH built without apparent cost." The Governor ofthe island wanted to buildamarketl and,. not havingthe wherewithall "issued under the seal of theisland four thousand market notes for one poundeach, with which he paidthe artificers. When themarket was finishep. and the rents came in, thenotes were thereby cancelled." The whole trans..action was completed, and the market had seemingly been built out of nothing. In fact it hadbeen built by means of temporary inflation, theeffect of which would tend to raise the prices of allthe goods that the community was consuming.Jevons indeed considers that the infusion of thosenotes into the currency drove out so much gold.If that really happened, then there would be noinflation, because paper would have taken the placeof gold in circulation and there would have beenno increase in the total currency in the hands ofthe ,Guernsey folk. But Jevons does not statethat gold was, in fact, actually driven out g andwith all deference to his authority, the explanation

S

58 MONEY WATERED BY INFLATION [CHAP.

of the miracle given above seems to me moreprobable.

In order to avoid misunderstanding, I think it isbetter to make it clear that by inflation I meanany increase in any form of currency, whethermetallic, legal tender, or other-coins, bank notes,postal orders, or cheques-that is accepted in payment by the community. It is quite possible tohave inflation by too great an inrush of gold, asseveral neutral countries have found in the courseof the present war. But when it is a matter of toomuch gold, then equilibrium can be restored inordinary times by the export of the gold, becauseit will be taken in payment elsewhere; but acountry's paper money is not available as an articleof export.

In normal times, such inflation as we are liableto is usually corrected by gold exports and theoperation of other economic processes. If a country's currency system is sound, the inflation processshould thus carry its own remedy with it. In ourcase, if we get in too much gold, or our banks createtoo much cheque currency, the consequent rise inprices tends to check our exports and increase ourimports of goods. Thereby in the first place thevolume of goods offered in our home markets in..creases and so the relation between goods and currency is helped to return to the former level, andin. the second, as we are importing more goods andexporting less, there is a tendency for gold to beshipped to pay for some of the extra import~. So

III] UNCHECKED IN WAR-TIME 59

that if we are suffering from too much gold, thecure begins to work ~ or if it is a case of too muchbanking credit, the export of gold calls attentionto the diminished basis of this credit and so helpsto cure it.

In war-time, if the war is big and obtrusive enough,these nice and pretty checks and balances do notwork to keep inflation down. Shipping gold ismade expensive by high rates of freight and insurance; and the people who usually handle thebusiness of shipping gold, and do so, in peacetime, whenever they can see a profit in it andsometimes merely to get the advertisement thatgold shipments usually bring with them, are checkedby patriotic motives and the desire to avoid exporting a financial weapon which has to be keptfor special uses. And so inflation can proceedmerrily without setting to work the automaticmechanism that usually produces the antidote forthe disease.

How merrily inflation can work, when it is t9-11Sgiven its head, the experience of the present warhas well shown. All the warring countries havebeen calling in gold from circulation and replacingit with a much larger quantity of paper. Much ofthe gold that they have called in they have shipped toneutral countries to pay for goods, and so all overthe world there is this common experience of anincrease in currency over and above the supply ofgoods, and a more or less universal rise in prices.The thing has, gone to such a pitch that the Scancli-


navian countries have in effect closed their portsagainst the entry of gold, and in America the dangerof the inflation produced by the great mass of goldimported has long been a commonplace amongecono'mic writers.

The method of inflation differs in each countryaccording to the arrangements of its currencysystem~ During the present war we in England aredqing it in three or perhaps four ways. TheGovernnlent has done it by printing paper currency,much greater in extent than the gold which it hasreplaced in circulation, and by minting a greatquantity of silver. The Bank of England has doneit by lending money to the Government, to Allies,to Colonial Governments, and to private individuals;and the other banks have done it by increasing theirinvestments in Government securities and bymaking advances to customers in order to enablethem to take up Government securities. In otherwords, most of the inflation ha? been due chiefly tothe action of the Government in either directlyincreasing the currency itself by printing or coiningit, or in borrowing money from the Bank of Englandand the other banks iristead of getting it out of thepockets of the public by taxing it or borrowing itssavings. It is entirely natural that the Government should have done this, because in peace timeit does so habitually and as part of its regular schemeof finance. I t borrows' from the Bank of Englandon Deficiency or Ways and Means advances to tideit over a time when taxes are coming in sluggishly"

ItI] CURRENCY MADE BY BANKS 61

, and on the other hand big payments have to bemade, and for like reasons it sells Treasury bills,or temporary promises to pay, to the Bank ofEngland or to other banks. These devices are,usually, on so small a scale, as compared with thevast sum of our monetary turnover, fhat the consequent addition to our currency has no noticeableeffect. But tlie huge, scale on which they havebeen used in this war has had bad results for allparties.

As many people may be puzzled by the assertionthat the Government increases the currency byborrowing from banks, it is better to explain theprocess briefly here, though in another book I havealready shown how loans made by banks producemanufactured money by adding to the banks'deposits, which embody the right of their customersto draw the cheques which are the chief form ofcurrency that we now use. 1

When the Bank of England makes a loan to theGovernment or subscribes to any issue of Government security, it increases its holding of Governmentsecurities as shown in its weekly return. When itmakes advances to any less august borrower, itincreases its holding of what it calls Other Securities.In ,either case it increases, on the other side of itsreturn, the amount of its deposits, which, as theappended specimen shows, are divided into Publicand' Other, the former being the balances of thevarious departments of the British Government,

1 Meaning of Maney, pp. 64 et seq.5*

62 MONE:ri WATERED BY INFLATION [CHAP.

and the latter those of all other depositors, includingthe other banks :

BANK OF ENGLAND

BANKING DEPARTMENT

July 1st, 1914

CapitalRest .Public Deposits •Other

Million £· I4t

31· 17· 54!

891

Million £Government Securities. 1 I

Other Securities. . 49!Reserve . 281

Anyone to whom the Bank of England makes anadvance thereby gets a credit in its books, and sothe amount of the deposits at the Bank is increasedby the amount of the advance. If the Governmentis the borrower, the advance is added both to theGovernment Securities among the assets and to thePublic Deposits among the liabilities; but as theGovernment does not borrow money in order to havethe pleasure of contemplating a large balance at itsbartker's, it sooner or later makes payments, outof this deposit, to contractors or other folk to whomit owes money, by means of cheques on the Bankof England, the contractors pay these chequesinto their own banking accounts, and so the moneyoriginally lent by the Bank of .England to theGovernment is transferred from the Public to theOther Deposits, to the credit of the other banksto whom it has been distributed, and henceforwardit figures as cash at the Bank of England in their

III] CURRENCY MADE BY BANKS

balance sheets. If the Bank of England makes anadvance to any other borrower, he is credited witha corresponding deposit. He draws on it andtransfers it to anyone to whom he has to makepayments, but the deposit remains to the creditof someone as long as the advance is outstanding.I-Iow far this proce,ss has been carried we see fromthe figures of the Bank of England's return published at the end of last year, comparing with thoseat the end of June 1914 1 given on a previous page:

CapitalRest .Public Deposits fi

Other

BANKING: DEPARTMENT

December 27th, 1916

Million £ Million £· 141 Government Securities. 57

31 Other Securities. .. 106!• 52 Reserve • 33• 1261

Ig6i Ig61

Here we see an addition of more than 100

millions to both sides of the balance sheet, byincreases in the securities on one hand and in thedeposits on the other. These deposits are potentialcurrency and more, for being U cash at the Bank ofEngland," in the hands of the other banks they areregarded as just as good a reserve for them as goldor legal tender. Let us see the effect on the otherbanks of this increase in the currency which maybe called, in a sense, part of the basis of their creditoperations. I append an aggregate balance sheet

1 These dates are chosen to fit those· of the balance sheetsQfthe other panks, whiCh are only published half-yearly.


of nineteen of the biggest English banks, showingtheir position first on June 30th, 19I4, the lastdate on which they were published before the war,and then on December 3Ist; 1916 z

AGGREGATE BALANCE SHEEt' OF NINETEEN PRINCIPAL

ENGLISH BANKS

June 30th, 1914

Capital and Re-serves • 69,864,000

Acceptances andEndorsements 37,646,000

Deposits (includ-ing undividedprofits, etc.):. 747,243,000

£854,753,000 f

Cash in hand andat bank . 115,242,000

Investments . 114,583,000Discounts and Ad-

vances (includ-ing money atcall, etc.) • 571,451,000

Cover for Acceptance 5, P remises, and Sun-dries 53,477,000

£854,753,000

December 31St, 1916

Capital and Re-serves 72,497,000

Acceptancesand Endorse-ments 57,498,000

Deposits (includingundivided pro-fits, etc.) 1,095,574,000

Cash in hand andat bank • 251,875,000

Investments • 303,461,000Discountsand Ad-

vances (includ-ing money atcall, etc.) • 592,056,000

Cover for Acceptances, Premises, and Sun-dries 78,177,000

:i),225,569,000.. t.

III] POTENTIAL CURRENCY 65

The most notable features in this very instructivecomparison are the increases in the deposits on theFabilities side and in the cash and investmentsamong the assets, that has taken place during theperiod. It will be observed that the deposits,which are potential currency in the hands of thepublic, since they give the banks' customers thepower to draw cheques against them,have risen by348 millions, while the cash held by the banks hasrisen by 136 millions; their investments by 189millions, and their loans and discounts by 21

millions. How much of the addition to the cashis due to the Bank of England's lending activities,as described above, how much to the issue ofTreasury notes, of which 150 millions were outstanding on December 31st last, and how much togold paid in by customers, it is impossible to guess,but it is safe to assume that these three processesbetween them have done most of it. But a stilllarger movement is the increase in investments, thewhole of which, it is safe to guess, has been due tothe big subscriptions made by the banks to thetwo first War Loans, and to Exchequer bonds andTreasury bills, by means of which they increase onthe one hand their investments and, on the other,the deposits of their customers,- by this process.When they subscribe to War Loans or buy Treasurybills from\ the Government, the banks pay for thesecurities so taken bya dra~t on their balance atthe Bank of England, and so, for the time being,hold ~9 much les§ cC\sh at ~he BC\nk of England


and so much more investments) but as the Government uses its increased balances to pay debts, bydrawing cheques on them, and the contractors whoget the cheques pay them into their banks, thebanks get back their balances at the Bank· of England and also have their deposits increased, by thecheques on the Bank of England, which their customers pay in ~ and so when the transaction is allcomplete the banks find themselves with theirdeposits increased by the amount· that they havesubscribed to the new loan, or whatever the securitymay be. In other words, they and the Governmentbetween them, by this credit operation, have increased the amount of currency in the hands of thepublic, and if at the same time there has been nocorresponding increase in the volume of goods, inflation is thereby produced. The figures givenabove are complicated by the addition, during theperiod, of two small banks by amalgamation; butif banking figures of the whole of the United I{ingdom could be compared, the total increase in deposits,that is in potential currency, would be over 400

millions.A similar process is set to work when a bank

makes an advance to a customer to enable him totake up War Loan, or any other security, or for anyother purpose. As I have shown elsewhere, 1 aslqng as the. loan is outstanding there is almost~~ertain to be a deposit in some bank or otheragainst it. The banks had not, up to the date of

1 Meanin~ 01 Money, lOVe cit,

III] BORROWING FOR WAR LOAN

the balance sheet shown above, done· mucb. of thisbusiness since the war. In fact, owing to theextent to which industry is no\v on a cash. basisand owing to the decrease in Stock Exchange speculalation, the increase in loans and discounts of thebanks was quite small. But during the firstquarter of this year they must have made very largeadvances to customers, since everyone was urgedto anticipate future savings, borrow from his bankand subscribe to vVar Loan, and we know that thepublic responded very practically to this appeal.This was quite as it should be, since it was only byanticipating savings that the huge amount requiredcould be got i but, as was pointed out at the timeby Professor Pigou, in a letter to the Times ofJanuary 19th, 191], unless the money so subscribedwas saved and paid back to the banks, so cancellingthe increased credits, as fast as it was spent bythe Government, this, system of subscribing out ofbank advances could only lead to inflation.

The banks are, among other things, manufacturersof currency, 'and as long as their manufacture doesnot outstrip the pace at which goods are being produced, the general level of prices will remain fairlylevel. Or if new currency that they create is usedby producers to set to work and make more goods,then by creating it they are helping the productionof goods and so maintaining the equilibrium betweengoods and currency. It is when they manufacturecurrency that is handed straight over to a greatconsumer like a Government in war-time, that

68 MONEY WATEI\ED BY INFLATION [CHAP.

inflati0l?- can almost be seen getting to work. A newbuyer c~mes into the markets, with a great massof currency to draw on, competing with all otherQuyers and probably, from what we know of Government depa~tments, with itself,1 'and up go prices.I t is a subtle, insidious, but' very effective way ofgetting ;money out of us, not by taking it from us,but by vvatering down the value of all the moneythat 'rve possess. As the prices of goods rise ourbuying power over them declines, and so we haveto put up with less of them:~ This is right andreasonable if they are wanted for the nation's needs,but the inflation process does the job in the worstnossible way by throwing the burden of goingwithout on those who are least able to bear it.

'Inflation, however, does not only hit the poorestmembers of the community. It is bad finance forthe Government that indulges in it to any extentthat suffices to cause any serious rise in prices anddepreciation in the currency. In the first place, theGovernment drives prices up against itself and somakes the warA or whatever else be the object of itsspending, more costly. In the second, the Government, being not only an inflater but a borrower,since it is by the borrowing process that much oftpe inflation is done~ borrows at a time when thecurrency Is depreciated by its own action andengages to pay interest and pay the debt back in

1 A report of the Committee of Public Accounts quoted inthe Economist of August 26th, 1916, p. 357, shows that theAdmiralty and the War Office were buying against one another.

III] IS INFLATION INEVITABLE? 69

years hereafter, when we may fairly hope thatprices ,vill have gone back from their present level.Consequently it borrows millions of depreciatedpounds with a fair prospect of having to paybackits debtors later on with pounds that will be muchmore valuable. Unlike the quality of mercy whichblesseth him that gives and him that takes, thesystem of financing by il1flation curses both theinflater and the inflatee.

1I But," it is argued, 1I you cannot possibly getaway from inflation in time ofwar. It is inevitable.The rise in prices makes a larger amount of currency necessary." But could there be a generalrise in prices without an increase in the volume ofcurrency? There could, of course, if there had beena decrease in the production of goods. But if theproduction of goods had remained fairly constant,as it probably did if ,ve include war material asgoods, and if there hq.d been no increase in thevolume of currency, then, I think, though certainprices must have risen, others must have fallen.

The price of carriage by sea could not help rising,owing to the demands on the merchant fleets of theworld by the .warring Governments, the shuttingup of Germany's ships in neutral harbours, and thedestruction of Allied and neutral tonnage byGerman submarines. This would have meant thateverything that came by sea would be dearer, sothat food prices must have risen. At the sametime} the more generous diet required by the fighterand the war worker would have had a like effect

70 MONEY WATERED BY INFLATION .[CHAP.

War materials would also have inevitably beendearer. But if there had been no increase in thecurrency, t!1e greater volume of it required for purchases of food and war material would surely havelessened the amount available for buying otherthings and their prices would have fallen, and thedecreased demand for them might have set freelabour employed in producing them and so helpedto increase the production of food and war materialand checked the rise in their prices. Withoutinflation private extravagance would have beenmuch less general. If, for example, the higherprices paid by the Government for the petrol whichit was using in such huge amounts had diminished,by their full extent, the supply of money that otherpeople could pay for it and for other things, wemight have heard less about race meetings throngedwith private cars in the third year of the war. Butas long as the Government and the banks keptladling out fresh supplies of currency, competitionbetween the State and the citizen for the· goodsand services available became ever keener, to thedetriment of both parties. As more money wentinto buying potatoes, owing to the rise in theirprice, less, if it had not been for inflation, mighthave gone into buying flowers, and so ground andlabour used for growing flowers" would much morerapidly have been used for growing potatoes, andthe rise in the price of potatoes would have beenchecked. As more money was needed for oceancarried food, less would have been in buyers' pockets"

III] GOODS AND SERVICES

if there had been no inflation, for ocean-carried fursand feathers and wine and silk dresses, and so moreship space would have been set free for food, and therise in its price would have been checked. In otherwords, if all the money required by the Governmentfor the war had been taken out of the pockets ofthe public in taxes and loans paid for out of savings,instead of much of it being manufactured by theGovernment and the banks between them, then thepublic's buying power would have been reduced bythe full amount spent on the war; and the reductionof consumption, by which alone war's needs can bemet, would have been brought about with muchless friction and economic disturbance.

For, as has been said over and over again in thecourse of the War Savings campaign, the Government makes war with goods and services. Thosethatit needs for war can only be handed over toit if somebody goes without. It cannot by anypossibility, or by any financial sleight of hand, getmore than the country can produce, either by itsown labour and energy or by selling goods abroadin exchange for war goods made abroad, pl,us theamount that it can get abroad by borrowing andselling securities. As a warring country's power toborrow and sell securities abroad is obviouslylimited, it is clear that after a certain point the wardemand for goods and services can only be metby the reduction, enforced or voluntary, of thebuying power of the civilian population. Inflationhelps to effect this in an insidious, roundabout, and

72 MONEY WATERED BY INFLATION [CHAP. III

inequitable manner, laying much· of the war burdenon the wrong shoulders. It is not the sole cause ofall the rise in pri~es, but by encouraging extravagance it helps to raise the prices of goods that neednot necessarily ri~~ at all, and it increases the risein prices in which a rise is inevitable.

As has been said! inflation does not H cut muchice" in normal times. But it is like one of thosediseases I that demoralize the patient into enjoyingthem, and war's experience shows us that we shallhave to be careful to get cured of it as quickly aswe can without starting some other ailment, andthen keep i:t out of'our system.

CHAPTER IV

MONEY TAKEN ByITAXES

'GIVEN a free people with real control over the~con

duct of its affairs, a genuine confidence in the justiceof the system by which money is taken from it andin the wisdom and care with which the money isspent, and th~ citizen would no more object topaying taxes than he objects to paying a bill for abook, or a suit of clothes, or a set of golf clubs thathe has ordered for himself. The prevalent spiriton the subj ect shows how very far we are fromhaving attained these ideals.

"All taxes are confiscation," said Mr. JosephHume as already quoted, so expressing the commonview that the State takes our money in an arbitraryand unjust manner and spends it on purposes whichmay be necessary but are only submitted to reluctantly on that ground, the said expenditure beingnecessarily and inevitably a cause of the impoverishment of the people. In the last century, in theheyday of the simple and satisfactory theory thatevery man knew his own interest best and could betrusted to secure it if left alone, and that by thispleasant process the interest of the whole com...

6 73

74 MONEY TAKEN BY TAXES [CHAP.

munity w~uld certainly be attained, it was afavourite p~rasewith pollticians and polltical writersthat such money as was saved from taxation would" fructify in the pockets of the people."

How much truth is there in this view? I t issurely a very large assumption to suppose that allthe money ~hich Government takes would, if leftin our pockets, have been spent ~n some good anduseful purpose and hava increased the productive'Power of the community. This theory takes itfor granted that the Governx:nent' $ revenue isderived entirely from money which would otherwise haye been saved and well invested in reproductive enterprise. Wherea~ we kno\v that,owing to defects in the machinery of our jointstock system and the ingrained craving in thehearts of most of us for short cuts to fortune, agood deal of the money that is invested gets intothe pocket\s of unsavoury company promoters andthe evil brood employed by them, or is sunk inenterprises that never had a chance of yielding aprofit to their shareholders ,j and further, It by noIneans follows that what the Government takescomes out of what the citizens would have saved.Very probably it comes out of what they wouldhave spent on themselves; and only the most incorrigible optimist, or the most ignorant theorist,could maintain that whatever people spend onthemselves is spent well. The vulgarity andabsurdity and ugliness of many of the objects onwhich t~e rich and middle classes spend their money

IV] (( FRUCTIFYING j, ? 75

are apparent to all: lavish entertainments at whichmost people are bored, theatrical shows whichare a scarifying criticism of the intelligence ofthose who pay money to be amused by them,clothes and gewgaws in which no really civilizedpeople would consent to be found dead,-these area few of the more innocent examples of the mannerin which hundreds of millions of money that theState does not take, H fructifies 11 in the pockets ofits more fortunate citizens. Bad spending amongthe poor is perhaps even commoner, owing to theirignorance of the uses of money, and is much moretragical in its effects owing to the fact that, evenif they spent well, they would seldom 1?-ave enoughto give them a reasonable chance of full development of their faculties and capacities.

Since, then; there is much bad 'spending in allclasses, we have no right to assume, as is oftendone, that all the money taken by the State andspent, well or ill, by it, would have been well spentif left to II fructify in the pockets of the people."It might have gone in race meetings, Tango teas,picture palaces, fashionable fripperies, strong drink,or trashy "literature,'> all of which things havetheir uses in amusing people who do not know howto amuse themselves better, but do not lead tomuch" fructification."

It may also be mentioned here that money takenby Government does not vanish. It is spent by theGovernment on something, and thereby provides alarge number of people with a living. Whep. iti§

MONEY TAKEN BY TAXES [CHAP.

spent on the debt-charge, it is handed straightover to the debt-holders, in interest or redemptionof debt. Spent on education, it· pays those whobuild schools and on the army of patient workerswho teach the rising generation-if spent well, nomoney could be better invested, or fructify morefruitfully. Even when spent on p'ublic defence itprovides wages for those who build our navy andmake our guns, and feeds and clothes those whofight for us. It is true that if we had universalpeace all those good workers might be buildingmerchant ships instead of battleships, or makingand growing useful things instead of learning andpractising the art of destruction. But as things areat present, national security is a thing that mostof us are very willing to pay for, and with privatespending what it is, we cannot be sure that by anymeans all the work of these workers, if set free frommilitary and naval objects, would be put to goodand fruitful use. It is of course absurd to go to theother extreme and contend that taxation createsemployment. It only transfers the power of givingemployment from individuals, who might or mightnot have used it well, to the State, 'which mayormay not use it well.

No chapter on taxation can be complete that doesnot quote Adam Smith's famous fOUf maxims onthe subject :

tt (I) The subjects of every State ought to contribute towards the support of the Government, as

IV] SMITH'S MAXIMS 77

nearly as possible, in proportion to their respectiveabilities; that is, in proportion to the revenue whichthey respectively enjoy under the protection of theState.

u (2) The tax which each individual is bound topay-ought to be certain and not arbitrary. The timeof payment, the manner of payment, the quantity tobe paid, ought all to be clear and plain to thecontributor and to every other person.

H (3) Every tax ought to' be levied at the time, orin the manner, in which it is most likely to bec~nvenient for the contributor to pay it.... Taxesupon such consumable goods as are articles of luxuryare all finally paid by the consumer, and generallyin a manner that is very convenient for him. I-Iepays them little by little, as he has occasion to buythe goods. As he is at liberty, too, either to buy ornot to buy as he pleases, it must be his own faultif he every suffers any considerable inconveniencyfrom such taxes.

u (4) Every tax ought to be so contrived as bothto ,take out and to keep out of the pockets of thepeople as little as possible, over and above what itbrings into the public treasury of the State." 1

These maxims have been generally accepted bylater economists as a summary of the principles onwhich taxation should be based, except the verylucid and sensible American writer General F. A.WalkerJ who decided that q the, first and mostfamous of them cannot be subj ected to the slightesttest without going all to pieces. 1J As to the otherthree, their equity and sound sense can hardly be

1 Wealth of Nations l Book V, Chap. II, Part 2.

6*


disputed (though Walker thought them (f at the-best, tt:jyial "), and it is also pleasant to observethat our system of taxation is not far from securingthem. If we fail in the matter of NO.2, it is ourfault rather than the State's i if we chose we couldall know how much we are paying for government"vhen we bU;y a glass of beer or a pound of tea or apacket of cigarettes, and if n1any_ of us buy thesethings every day without even knowing that we arepaying taxes, that is only because we have nottroubled to think about it. As to NO.3, the convenience of the contributor might be still furtherconsulted if income tax could be paid by instalments, instead of in one lump as it was before thewar, or in two as now arranged. A system ofmonthly instalments would be much more convenient~o a large number of taxpayers, and, though it mightinvolve a good deal of book-keeping l it would, onthe other hand, help to keep the State's incomeeven, whereas the present system leaves long periodsduring which it has to borrow in anticipation oftaxes to be received later. /

But it is in Maxim No. I that the whole question9f the ~quitable apportionment of taxation is really19cked up; and, if we examine the great Americaneconomist's severe criticism of his great Scottishpredecessorl it will help to a clearer understandingof the whole matter.

UThis maxim [says Walker], though it soundsfairly, will not bear examination. What mean

IV] WALKER ON SMITH 79

those last· words t under the protection of theState'? They are either irrelevant, or else theymean that the protection enjoyed affords themeasure of the duty to contribute. But the doctrinethat the members of the community ought to contribute in proportion to the benefits that they derivefrom the protection of the State, or accordingas the services performed in their behalf cost moreto the State, involves the grossest practical absurdities. Those who derive the greatest benefit fromthe protection of the State are the poor and weakwomen and children and the aged; the infirm, theignorant,. the indigent. Even as among the wellto-do and wealthy classes of the community, doesthe protection enjoyed furnish a measure of theduty to contribute? If so, the richer the subjector citizen is, the less, proportionately, should he pay.A man who buys protection in large quantities shouldget it at wholesale prices, like the man who buysflour and meat by the car-load. IVforeover, it coststhe State less to collect a given amount froni onetaxpayer than from n1any." 1

Walker's admirable lucidity endears him toeconomic students, so often baffled by the obscurityin which the masters of the science enfold theirutterances, but, I think, thesF criticisms of AdamSmith only serve to bring out the truth of theprinciples that lay behind his famous first maxim.For Walker implies that the poor and weak, womenand children and the aged, enjoy most revenueunder the protection of the State, which they obvi·

1 Political Economy, Part VI, §§ 588 et seq.


ously do not. It is very true that the poor needprotection, but they do not need it in respect ofany property that they own or of revenue that theyenjoy. The protection of property, which, as wesaw in Chapter I, is the original. and still a mostimportant function of the State, has to be givenin increasing measure as the extent of the propertyowned, and the revenue derived from it, increases.A. small clerk whose property consists of the balancein his pocket of his last month's wages needs littleprotection from the State or anybody else. "Cantabit vacuus coram latrone viator." His employer,with some furniture in a rented suburban hbuse, afew hundreds invested, and a policy on his life,has little that a burglar could get at, though hisinvestments and his business make his revenuedepend on the general stability of society, such asis provided by Governmerit. A great landed proprietor with an agricultural rent-roll and a squaremile or two of house property in cities enjoys hisrevenues only because the State is there to protecthis property and enable him to enjoy it in peaceand safety. As Adam Smith says in anotherpassage:

HIt is only under the shelter of the civiI magistrate that the owner of that valuable propertywhich is acquired by the labour of many years, orperhaps of many successive generations, can sleepa single night in security." 1

1 Book VI Chap. I~ Part III (( Of the Expense of Justice."

IV] WALKER ON SMITH 8r

Walker's contention that those with least property require most protection for it almost looks asif it had· been dictated by a desire to pick holes inhis illustrious predecessor. And his argunlent thatthe physically weak, women and children and theaged, need more protection for their property isvery little sounder. For if we went back to a stateof anarchy ~nd everybody took what he could get,the strong man would certainly have an advantage,but he would not long enjoy much revenue undersuch conditions, because production would promptlybe brought to a standstill. As to the" reductionon taking a quantity" argument-the view thatthe rich should buy protection more cheaply because they need luore of it, on the same principlethat enables a man to buy bread and meat morecheaply by the car-load-here VValker is surelyquoting the principles of the market-place in asphere to which they cannot be applied. The merchant with a big stock of an article, which he mayor may not be able to sell, is naturally willing tomake a concession in price to a buyer who will takea line off his hands, though even in the market-placethis principle, or rule of thumb, does not work',-ahvays, or beyond a certain point. But a Govern-ment providing its people with protection for theirproperty works under quite other conditions. Itknows exactly how much it means to provide, andit ought to be able to find out which of its citizenswill be most benefited by this protection and apportion the cost upon them accordingly by taxation.


So when Walker goes on :tt Returning to the maxim of Dr. Smith, I ask,

does it put forward ability to contribute, or protection enjoyed, as affording the true basis oftaxation?' Which? If both, on what principlesand by what means are the two to be combinedin 'practice ? "-

when he puts these posers we -have an easy answer.Ability to contribute, since it depends on revenueenjoyed (when we have got at the right meaningof that a~biguous phrase), involves also protectionenjoyed, so that both principles lead us to the sameend. And the two can be combined in practice andan~, in a halting manner that needs improvementand expal~sion, in the system of taxation that hasbeen painfully. evolved in this country. Logicallyapplied, Adam Smith's first maxim would confinetaxation to direct taxation, that is taxation paiddirectly by the tax2ayer to the State, assessed ona graduated scale actording to the taxpayer's netincome and differentiated according to the sourcefrom which it is derived. In other words, by layingdown this maxim he anticipated the beauties of theincome ta~ and death duties, and of the principlesof graduation and differentiation that have been soslowly and tentatively introduced into our fiscalsystem. All these things are implied in the prophetic musings of the great Scottish thinker.

Graduation is clearly implied, as was shown byvValker's criticizing Adam Srnlthfor having apparently forgotten it, because he did not actually

IV] WALKER ON SMITH

mention it. We cannot put the proof better thanin Walker's words:

H Is the ability [he asks] of two persons to contribute necessarily in proportion to their respectiverevenues? Take the case of the head of a familyhaving an income of $500 (£IOO) a year, of which$400 (£80) is absolutely essential to the maintenanceof himself and wife and children in health andstrength to labour. Is the ability of such a personwho has only $roo (£20) which could possibly betaken for public uses,- one-half as great as that ofanother head of a family similarly situated in allrespects except that his income amounts to $1,000(£200), and who has therefore $600 (£120) whichcould conceivably be brought under contribution?l\1anifestly not."

Most true, but there is nothing to show that AdamSmith thought that it was. Anyone who has only£100 a year, of which £80 is needed for the barenecessaries of ft health a.nd strength to labour/'can hardly be said to enjoy a revenue at all, forthe whole of his margin is needed for the decenciesand comforts that must be had before he and hischildren can be provided for in such a manner asis necessary to make them efficient citizens of acivilized state, with their intelligence cultivated toa point that will enable them to exercise judgmentconcerning public questions. Those only can besaid to enjoy a revenue who have a margin overwhat is needed to maintain them and their dependents in health and efficiency. To tax anybody

(


below that line is bad business from the State'spoint of view, because by injuring their health andefficiency the State promotes the growth of a classthat is compelled to live, more or less, either onprivate charity or public support, and by its lack ofefficiency impairs that of the nation at a time ofcrisis.

This principle is recognised by the terms on whichour income tax is assessed. It would not be imposed on a man with £80 a year at all. Graduation,the system by which no income tax is imposed belowa certain limit, and varies afterwards according tothe size of the income, is the great advantage thatincome tax carries with it. The release of smallincomes has always, necessarily, been part of it.When it was first introduced in 1798 it was onlyimposed on incomes of £60 and upwards, was graduated between £60 and £200 and was 10% abovethat line 1 j in 1806 the limit of exemption wasreduced to £50. Its medieval predecessor, the polltax, was first raised in 1377, and was graduated.Beggars paid nothing, ordinary folks 4d. a head,and the rate varied from this level up to 10 marks(£6 13S. 4d.) on dukes. a The income tax was, mostunwisely, taken off after the Napoleonic wars, andwhen it was reintroduced in 1842 by Peel, it wasimposed on incomes of £150 and upwards. s Thislevel was later raised to £160, and was reduced in

1 Chisholm's Analysis, P. 42 4.II Ibid. p. 416•3 Seligman1 The Income Tax, p. 132.

IV] DIFFERENTIATION

Mr. McKenna's first War Budget in 1915 andbrqpght down to £130, which seems to be low enoughas it is at present assessed, but by no means as lowas it should go if and when the tax is rid of a greatanomaly that at present mars it, namely, its greatunfairness to those who have families to educate.But before we look further into this and otherdrawbacks that at present clog an otherwise excellent tax, let us consider its other. beauty, that ofbeing differentiated according to the source ofincome, whether If earned or unearned."

This, again, is a principle that ha's only foughtits way with the utmost difficulty into our systemof taxation, though the logical soundness of it isobvioHS. It is clear that two men, each with£r,ooo a year, do not It enjoy" a revenue of thisamount in the same sense, if one of them earns it as asalary by hard work, which will cease at any time if,owing to bad health or advancing years, he has togive his work up, while the other receives it individends on well-chosen securities which he hasinherited or bought out of his own savings, and istherefore certain of enjoying it as long as he livesand of being able to hand it on when he dies to hischildren or anyone else whom he may choose. Ithas not yet been possible to differentiate still furtherand impose a different rate of tax on the incomethat a man receives from investments which he hassaved himself from that which is paid on an inheritedincome. When a taxpayer has created, by saving,his own H unearned" income, it is at first sight


unfair that it should be so called and so taxed.But, eve....fl so, his enjoyment of it is clearly so muchJhe more secure, and- moreover the principle ofdifferentiation is also at work through the deathduties, which take a large and well-graduated sliceout of estates when the demise of their owner givesthe State its periodical opportunity. So that theincomes of those who Iive on inherited wealth, besidespaying income tax', is either diminished every time~n owner of it dies and the State takes toll of thecapital, ·or is lessened each year by the provisionthat the owner makes, through insurance or otherwise, in order to provide against the death duties,and maintain the capital of the estate intact.

. It is commonly objected to the death duties thatthey are a tax on accumulated capital and that, asthe State uses their proceeds for purposes of ordinaryexpenditure, it is paying for current needs out ofcapital and so doing a thing tha-t is vicious in thecase of an' individual or company. But is thisnecessarily true? The tax, it is true, is assessed onC3:pital, but I think it is paid, and.that all taxes haveto be paid, out of current income, either of theprevious owner of the estate, if he insured in orderto provfde for it, or of its inheritors, if they do notrealize any portion of the estate to meet it, or ofthose who buy, with saved money, any part of theestate that is sold to meet the tax. In the lastmentioned case, tpe saved money that is handedover to Government to spend would otherwise havegone into some other investment wbich wo'uld

IV] TAXING CAPITAL

perhaps have increased the community's productive power, but this~ possibility is attached to allmoney that the Government takes out of ourpockets and is one of the reasons why we have to becareful to see that the Government spends it well.A graver objection to the death duties is that theymay tend to check the incentive to accumulation bythe individual, a point that will be dealt with later.

All taxation comes out of somebody's inGome.If vv€ try to tax capital, we can only do so if theowner can pay the. tax out of income or can sell a bitof his capital to someone else who pays for it outof his income. A tax on capital is thus only a wayof assessing income tax according to the amount ofcapital possessed, and is a questionable way ofdoing so because of the difficulty of knovving whatanybody's possessions are really worth until they areoffered for sale in a free market, and also because ofthe great expense and delay involved by making anysuch v;aluation. Moreover, the mistakes made byGovernment valuers, when estates have to bevalued for purposes of taxation, are astonishing.In a certain colony a man once died who had pickedup" in the course of several visits to England, acollection of beautiful and very valuable Turnersand other water-colours. The local official valuerremarked to his heir, (~ I see from the dates on thesepictures that they're all second-hand, so rve putthem in at half a crown each."

But since all taxation falls on income, and sincethe amount of the income, \vith due regard to its

ss MON'EY TAREN BY TAXES [CHAP.

source, is the obvious test of ability to pay, and sincethis ability clearly grows with each increase in theincome above the sum required for the bare necessaries of life, it is evident that the income tax, ifwe could get it into an ideal shape, is the mostequitable form in which taxation can be imposed.Regard to the amount of the income involvesgraduation, and regard to the source of the incomeinvolves differentiation, because it is easier to pay,and more protection by the State is involved, inthe case of income from saved money than in thecase of earned money; and still more protectionfrom the State is involved in the case of incomefrom money that is inherited or received by gift,since the secure transfer of wealth by legacy orotherwise is one of the most obvious of the materialbenefits granted by stable government.

The ideal form of an income tax would thus bethrice differentiated, according to whether it wasimposed on-

(I) An income now being in the technical senseearned, that is a wage or salary or professional or business profit,s ;

(2) An income that is produced by savingsmade by its owner ;

(3) An income that is produced by inheritedwealth or wealth received by gift.

If this triple differentiation could be macle, then weshould be able to do away with the death duties,

IV] THE IDEAL TAX 89

with the great unfairness that they involve, forexample, when one estate changes hands frequently.owing to the accident of death, and another escapesby being held for eighty or ninety years by a specially tough owner who happened to inherit it when aninfant. If the death duties were thus commutedinto the shape of a higher annual income tax onthose who got income from inherited wealth, therewould be a much greater chancel amounting almostto certainty, that they would be met by saving onthe part of the holder of the income.

Thus differentiated, the ideal income tax wouldbe graduated logically and steadily up to the highestrange of incomes, not as it is now with a seri~s ofcapricious jerks, and with the super-tax as ,anexcrescence o~ the top. It would also be purged ofthe inequity which at present lumps together theincome of husband and wife as one for assessmentpurposes, and of the still worse vice that it no\vpossesses of taking little or no account of thechildren whom the taxpayer may have t9 educate.The unfairness of an income tax which is the samein the case of two brothers who eacJ1 earn £1,000

a year, but one of whom has eight children and theother has none, is glaribgly apparentl if we applyAdam Smith's test of ability to pay. Allowancesfor children were introduced during the Napoleonicwar, but were given up in r806, as they had" ledto an astounding official increase of large families." 1

Mr. Lloyd George made a small beginning in his1 Seligman, The Income Tax, p. 103.

7

go MONEY TAKEN BY TAXES [CHAP.

Budget of 1909 towards remedying this great bloton this tax by giving an abatement of flO (fromthe income assessed) for each child under sixteenin the case of incomes under £500. Since then theamount of the abatement has been raised to £25for eacli child, and this relief is given to incomesup to £700. Even so it is pitifully inadequate. Theproposal made by Mr. Sidney Webb and his fellowFabians in their book on How to Pay tor the War ismuch more efficacious, if it could be put into practice.They suggest that the basis of assessment in the caseof-families dependent on one income should be theincome divided by the number of those dependenton it; that is to say, that if a man had £1,000 a yearand a wife and eight children, he would be assessedon ten incomes of £roo each~ and, as incomes of£100 each are at present exempt, he would be freeof tax (but see note), while his bachelor brotherwould pay the full amount on his £1,000. 1

1 The full text of the Fabian suggestion is as follows," What is suggested Is that, so far as incomes not exceeding

/.,2,500 a year are concerned, whether earned or unearned, itshould be open to any person assessed to ask that all thetaxable receipts of aU the members of his family, living in thesame household with him and sharing in its expenses, or maintained elsewhere wholly or partially at his expense, should beaggregated for assessment as a Family Income; and that FamilyIncomes so arrived at should, for income tax purposes, bedivided by the number of members of the fa.mily (husband,wife, children, stepchildren, father and mother, or grandparentsonly) . actually maintained therefrom. There could then beallowed from the combined Family Income, in respect of eachperson maintained therefrom, whatever Abatement each portion of such income would justify if it were that of one persononly/'-How to Pay tor the Wa" pp. 237-8.In order to prevent the suggested abatements and allowances

IV] THE IDEAL TAX

" But wait a minute," says the bachelor. It Idon't quite see why I should be penalised forchoosing, or perhaps being obliged by a hopelesspassion, to Iive in single blessedness. If you letmy brother off, it is clear that I shall have to betaxed higher. But why? He chooses to spend hisincome on the joys of bringing up a family and thedelights of an uproarious nursery. Why should hetherefore be let off while I,- because I prefer keepinga yacht, and collecting blue china, and living a lifeof peace and comfort, or perhaps, if you knewall, giving up my spare cash to good works, amto pay more to encourage his philoprogenitiveproceedings ? "

The answer is obvious to all but confirmedbachelors, and it lies in the fact that the State wantscitizens and<wants them brought up under the bestpossible conditions. To penalize income-tax payerswho are bringing up families, promotes that tendencyto small families, or none, among the professionalclasses, which leaves the business of bringing up theheirs of the race to those who are least likely to givethem the good air, good food, good clothes"and goodteaching in their early years that are all-importantto their efficiency when they are grown up. Economically and in every other respect, a nation can

from exempting too many people altogether from income tax,these writers suggest that U nothing in them should be allowedto reduce the tax actually payable below the minimum of, say,a penny in the pound on the income prior to the de,duction ofany abatement or allowance,Jt

MONEy" TAKEN BY TAXES [CHAP.

only thrive if it is composed of citizens sound inmind and body. and any taxation that makes therniddle class sterile is a bad economic blunder.

And since we are only chasing the rainbow ofthe ideal, we may also add that, in order to makethe income tax perfect, it would, t~ough assessedon the whole income, only be imposed on thatpart of a man's income which he spends, and hewould be allowed abatement in consideration ofany part of it th~t he invested and not only, asnow, on that part invested (within certain limits)in life ~nsurance. This further exemption wouldbe made, under an ideal system, because a Statecannot make economic progress unless its citizenscontinually produce more than they consume onimmediate enjoyment, so that there may be amargin of savings continually available for capitalpurposes, that is, for increasing future productionby putting labour and energy into new equipn1entinstead of into luxuries and amusements. Thiscan only be done if we save, and it is thereforeobvious that no tax can be called ideal which doesnot encourage investment. In time of war, hovvever, this abatement might haye to be modified.

An income tax adorned by the improvementsabove suggested would be so evidently' equitablethat it might be imposed on wage-earners' incomesconsiderab~y below the limit which it touches atpresent, and might be used for raising the greaterpart of the national revenue, however great theextent Qf the revenue required. There would be


no need then to talk about widening the basis oftaxation, for taxation would be based on t~e widestpossible foundation, the aggregate income of allcitizens above the poverty line. Under ideal con..ditions it would be collected, no longer tI at thesource," but from the individual citizen, on hisdeclaratign of all the particulars required. Itwould'not be payable by companies and firms, butonly by their creditors, shareholders, and partnersas they received interest due and profits distributed.Thereby all the evil effects on company financethat are now produced by the close watch that theI:nland Revenue authorities keep on their interpretation of profit would be abolished. Any company or firm that preferred the strait path of goodfinance and took a generous view of the claims ofdepreciation and upkeep, would no longer be deterredby the consideration that it would have to payincome tax on some of the money that it was puttinginto the maintenance and improvement of itsbusiness. Moreover, companies with a large numberof foreign shareholders, and whose profits are earnedqbroad, would no longer be impelled, as they areby the present high rate of income tax, to shifttheir seat of domicile to a foreign clime, because onlythat portion of their profits would be taxed whichis paid into the pockets of British creditors andshareholders. So devised, taxation would not falldirectly upon industry at all, but only on those \vhospent the proceeds of industry. We need notpretend that it would not affect and hamper in-

7*


qustry, since all taxation must do so more or less;but, I think, we can claim that it would do so lessthan any other.

Such a tq.x would meet and fulfil all the require:rp.ents laid down by Adam Smith or added to themby the light of modern experience. We should allknow exactly what we were paying for the mainten...ance of the State; graduation and differentiationwould do all that can be done by human fallibilityto make, the tax work according to the ab~lity ofthe taxpayer with due regard to the degree of protection tl1at the State has to give to secure hhn theenjoyment of his revenue t if the tax were payablein monthly instalments it would cause no inconvenience- .to the man with a small income ~ everypenny of it would go straight into the coffers ofth~ State; and the monthly collection of it wouldensure a comparatively regular revenue againstthe nation's outlay. '

How far is all this mere rainbow chasing andstraining-our eyes after an impossible ideal? Notso far as it looks, 'perhaps, though the acceptanceof such a tax in its entirety requires a degree ofecopomic education and of common honesty in thecommunity that we may not yet have attained.It has long been an argument against all schemesof graduation and differentiation of the incometax that we thereby lose the great hold over thewould-be evader which is given to the tax-gathererby collection at the source. And yet graduationand differen'tiation have been introduced without


any sign of loss· to the revenue, and during the warthe Treasury has gone a step further and issued aloan the interest on which, so far as it is held byregistered or inscribed holders, is to be paid withoutdeduction of the tax, the holder being left toinclude it in his own declaration of the extent ofhis liability.

The fact that if the income tax were worked onthese lines everybody who was believed to be withinits scope would be obliged to make a declaration ofhis income, would be a drawback in the eyes ofthose who still 0 bj ect to the" inquisitorial" require...ment implied by it-that the State should know the

. details of everybody's income. This old-fashionedobjection is, I think, out of date. As it is, themajority of income...tax payers have to declare detailsof their incomes l either in order to secure abatement, or differentiation, or for super-tax purposes.Seeing that the alleged (( inquisition" is alreadyapplied to so many, there would be little or nohardship in clapping it on in all cases, as was actuallydone in 1798.1 Like all the other suggestions mad~above, it is only a further development of a principle already recognized and acted on.

This is true even of the proposal, though it seemsat first sight revolutionary, that the tax should onlybe imposed on that part of the income which isspent, instead of on what is earned. This principle

1 II All persons being required to make returns of the wholeof their income, from whatever source derive<i."-Chisbolm'§4. nalrsis, p. 42~.


is already r.ecognized in the case of life insurance,and it is hard to see why it should not be appliedto all other forms of thrift into which the taxpayerlikes to put his savings. That income tax shouldbe so imposed was urged, over half a century ago,by John Stuart ~iill, and the suggestion also hasthe authority of Professor Pigou behind it, thoughhe admits that there are technical difficulties to beovercome. 1 These difficulties are obvious enough,until the day comes when every citizen can betrusted to make an honest declaration, or when atleast-as may be the case now-the general levelof honesty is high enough. to ensure that the amountof eva-sion by tax-cheaters would be small enoughnot to count. Such an arrangement would, ofcourse, carry with it its contrary; if the tax were --..\not imposed on the net amount invested, it wouldhave to be imposed on the net amount of anyinvestments realized in those years in which the taxpayersold out more than he invested; because otherwiseanyone could escape the tax by investing all his income in one year and selling the securities in the next.If the thing could be worked, its effect in cheapeningcapital, increasing the capital fund of the country,and so adding to its power to produce the good thingsof the earth, would be excellent, and it would be anequitable set-off to put against the high taxationnow imposed on what is called '! unearned " income. It might be possible to do it by means ofevidence in the shape of stockbrokers' contracts,

1 Weq#h ancl Welfare, p. 371, 2,


and evidence by solicitors in the case of invest...ments in mortgages. The thing is not necessarilya pedantic aspiration on the part of academicdreamers, for I have heard it urged, not only asa good thing if it could be done, but as a good thingthat could be done, by a very practical man ofbusiness j and· if .the ingenious experts of SomersetHouse were to decide that-it was worth doing, theycould probably devise the ways and means.

The suggestion that the income tax should bepaid by the individual citizen and not by the com..panies which earn his income for him as shareholdermay be criticized, apart from its parting from theprinciple of collecting at the source, as giving thepower to companies to escape taxation by refrainingfrom paying dividends and putting profits intoimprovement of their plant or into investments.This criticism falls. to. the ground at once if theprinciple is admitted that income tax should notbe paid on saved money, because money that con1panies put into depreciation is saved money inevery sense of the word. The economic progressof the community is helped by every pound thatcompanies keep back· from their shareholders andput into their plant or invest otherwise; and anyencouragement that a fiscal system can give to thisprocess has something to be said for it, though theremay be countervailing drawbacks. If ever a timecame when the productive capacity of the wholeworld were fully equipped and there were a real91ut of capital( this peed to encoura~e savin9 would

98 1vIONEYTAKEN BY TAXEg [CHAP.

no longer exist. But we are not likely to see thathappen just yet. There would, perhaps, be adanger that some companies might try to distributeprofits by devious means-issues of bonus sharesand so on-in order to enable their shareholders toescape taxation. But the k'een blades of the InlandRevenue Department. could very well be trustedto deal faithfully with any such buccaneering.

Still greater is the difficulty involved in makingthe range of the income tax run lower and embraceall the wage:.earnerswho are a ~t subject of taxation. In their easy the precariousness of their earnings ismuch greater than in that of th~ salary-earner oreven of the more precarious professional workers,such as the free-lance journalist. Moreover; theycannot, thanks to the education that has beengiven, or denied, them for many generations, beexpected to keep count of their earnings with anyregularity, and they would be likely to resent beingpestered -about them. It may take a long timebefore tI:ey are ready to recognize that an incometax applied more vigorously to wages 'would befairer to tl~em, if they would' take the necessarytrouble to tackle it, than theheavy charge ofindirect taxation that they now bear. Economiceducation o~ all cla~ses is the only way in whichthe path of the tax-gatherer can be made smoothand easy. The more this education gtows~ thef~ster will be the movement towards graduatedand differentiated d~rect taxation as the fairest wayby which the St~te Y<l~ ta:ke our ~one;y.

IV] INDIRECT TAXATION 99

It is sometimes said that the incolne tax punishes and fines the hard and successful worker.This is so, but what system of taxation doesnot? Whatever device you use, you can onlytax those who are getting and spending money.But a system which taxes more lightly those whoare earning .than those who are getting intereston saved or inherited money, which makes dueallowance for family liabilities and taxes what isspent and not what is saved, seems to give the;hard and successful worker a better chance thanmost others.

When once the beauty and fairness of graduationand differentiation are seen and appreciated, itbecomes clear that all indirect taxation is to acertain extent unfair, because graduation anddifferentiation cannot be applied to it. It mightbe possible, though very difficult, to graduateindirect taxation by increasing its rate accordingto the quantitie! of goods purchased; but thissystem, if applied to necessaries of life, wouldevidently involve hardship by taking no accountof the taxpayer's ability to pay. That the amountof taxation paid by the buyer of a pound oftea should be the same~ whether the tea is to beconsumed by one living on an inherited million, orby a widowed charwoman with five children andearning, with luck and \vhen in good health, perhapstwenty shillings a week, is a gross fiscal blunder anda serious practical injustice. But there is no way~round it, and. this unfairness is necessarily attached

lOO MONEY TAKEN BY ·TAXES [CHAP.

to all forms of indirect taxation. It is true that,as Adam Smith pointed out, taxes upon" such consumable goods as are articles of luxury can beavoided by the taxpayer, as he is at liberty eitherto buy or not to buy as he pleases." But so manythings, such as clothes, are necessaries up to apoint, and become luxuries when that point, sodifficult to decide on, has been passed, that taxingluxuries is not nearly as easy as it is desirable.And even in the case of adrnitted luxuries, such asalcoholic drink, the absence of graduation makesthe tax unfair. Why should I, if I drink a glassof beer in the course of a .country walk, pay nomore taxation on it than a mechanic who partakesof a similar indulgence·after working eight hoursin front of a furnace? Ability to pay is quitedifferent in these two cases, but the amount paidis the same. And yet this inequity attached toindirect taxation, that is so evident as soon as theprinciples of graduation and differentiation areadmitted, has been so slowly recognized, and is stillso much ignored, that it.was once observed by thelate Sir Robert Giffen that" on the whole an equalamount of indirect taxation causes perhaps onlythe half or the third of the privation and sufferingentailed by an equal amount of direct taxation."l\ft. Gladstone's ponderous joke, in which he compared the two forms of taxation to two attractivedamsels, to both of whom, ('whether it be due toa lax sense of moral obligation or not," he paid hisaddresses impartiallYt is well known to all students

IV] STUPIDITy'S PRICE 101

of the subject,l and only shows how little theequities of taxation were studied in the days of thatenlightened fiscal reformer.

Nevertheless, if it be a fact that direct taxationhurts while indirect does not, it is natural andinevitable that the practical politician who has toraise revenue for the State should prefer the latter.If we are really so stupid· as to prefer to be bamboozled out of our money by paying, on a necessarilyinequitable basis, for government, while we thinkwe are paying for groceries or tobacco, instead ofbeing assessed directly according to our ability andthe source of our income and knowing exactly whatwe are paying, then we deserve what we get andget what we deserve, which is unfair taxation. Ina democratic country in which all have politicalresponsibility, it is clear that all, except those whohave only the barest necessaries of life, should paytaxes and so have some share in fiscal responsibilities.To do this in a manner which is specially designedto veil the fact that ta"es are being paid, is hardlyfacing the problem squarely) but until educationhas gone far enough to make everybody ready topay his fair share by means of direct taxation, it isthe only way that can be hit on. The inequitiesconnected with indirect taxes are manifold; notonly can they not be graduated or differentiated,but it is impossible to impose them generally becausetaxes on the necessaries of life are clearly bad, fromthe national point of view, in a community in which

1 Seli~lll.an, Thf InOO'nZB Tax,p. 165'

!02 MONEY TAKEN BY TAXES [CHAP.

many people have not enough to eat. So that indays before the war anyone who escaped incometax and did not smoke or drink alcohol or teacontributed practically nothing to the Governmentunder whose protection he or she lived. Since thewar, taxes on cocoa, mineral waters, and entertainments have widened the fiscal net. The proportionof our re\tenue contributed by indirect taxation hassteadily declined. In 1841-2 it, was 73 %; in1912-13 it was 42 '4%,1 and during the war it isgenerally assumed to have declined still further,though it might be argued that the excess profitstax is an indirect tax, since most of it has beenultimately paid by consumers through the highprices that caused the excess profits.

Indirect taxation, being paid by those who buycertain articles for consumption, has one greatadvantage, which justifies its position in our fiscalsystem until such time as we are able to imposeincome tax only on that part of the income whichis spent. It hits us when we spend and not whenwe earn or save. In time of war, when there isnot enough labour and energy to do all that is neededfor the fighting forces and for the export trade andfor providing necessaries, any tax that checksindividual spending, or takes part of the sum spentfor the Government, is clearly useful and beneficial.And this is almost equally true in time of peace,for then also wasteful spending is economicallyllnsound, checks the material progress of the nation,

1 Briti$h Budgets, by Sir B. Mallet, Pl? 105 and 493.·

IV] IMPORT DUTIES r03

makes the hard lot of the poor still harder, andless~ns the demand for labour. l So that if onlywe < could graduate and differentiate indirect taxation, it would have advantages over direct as thelatter is at present imposed. As we cannot, it hasto be left inits present unsatisfactory state, pressingheavHy on the poorest consumers of such articlesas tea, tobacco, and alcohol, while patriotic ladieswho give 3,000 guineas for a fur coat in time of warpay no taxation in the process except the pennystamp on a cheque. A graduated invoice stamp 011

all retail purchase. of lOS. and over is a way roundthis problem, but there are many practical difficultiesin the way of it and if, as is likely, both shopkeepers and their customers united in resenting anddetesting the tax, it is highly probable that therewould be much evasion.

Of all forms of indirect taxation, the worst,according to the pure principles of taxation, arethose imposed on imported goods of a kind that isproduced in the country, unless a home tax (orexcise duty) \of the same amount is imposed ongoods produced inland. Because the effect of theimport duty is to raise the price of the article and,if the home producer is not similarly taxed, thismeans that part of the higher price will go into hispocket instead of into the coffers of the State.Nearly all nations, including our own colonies, makefree use of this method of taxation, because they

1 I have developed this platitude in a book called Povertyand Waste, published in 1913.

104 MONEY TAKEN BY TAXE5 (CHAP. IV

think it pays them in the long run, or think itnecessary to the dignity or security of the State,that certain industries should be thus protectedat the expense of the consumer. Some peoplethink that when the war is over we also shall adoptthe system of a protective tariff. We shall see.It is beyond the scope of this work to enter on thishighly controversial ground. Everyone will admitthat, if Protection is the only or the best means ofkeeping alive in the country an industry that isessential to national safety, then the most bigotedFree Trader must agree to it. It must also beadmitted that many great, rich nations-includingour richest enemy and our richest aUy-have~ourished under Protection. On the other hand,it warpsa.nd hampers trade, as a whole, and introduces an artifiGial complicat~on into a matterwhich is naturally quite complicated enough; butperhaps the strongest argument against it is itstendency to make questions of taxation an uncleanwelter in which po~tics and business cover oneanother with dirt.

CHAPTER V

THE LIMITS OF GOVERNMENTAL SPENDING

So far we have considered the means by which theState takes our money from us for public purposes-

(1) By borrowing it, and then taxing us to paythe lenders; ,

(2) By diminishing the buying power of ourmoney by increasing its volume, with orwithout the help of bankers;

(2) By taxes.

There is yet another way by which some very cleverpeople who have studied the question with greatcare and diligence think that the State might earna great revenue l and that is by gathering moneyfrom us that we now pay to private undertakers ofenterprise, and they believe that the State woulddo us a great benefit at the same time by giving usbetter service than these private undertakers.And many very earnest and high-minded people,who hate the waste and ugliness involved by thecompetitive system, have long believed that, if thework of gro,ving, making, and distributing the goods

8 103

106 THE LIMITS OF SPENDING [CHAP.

that we need were in the hands of the State, allthe miserable squalor that blots our economicsystem might be washed away, man's labour wouldbe made much more effectiveJ and we should all ofus, instead of wasting most of our lives in a chaoticstruggle to earn our livings which ends in ill-spentaffluence at the top with degraded destitution atthe bottom~ be free to live as civilized human beings i with time and energy to bring out all thatis best in ourselves and others, and to enjoy theendless store of joy and beauty that Nature everspreads before us, generally to be buried. under themass of moral and physical ugliness that is heapedover it by our misguided efforts to better our lot.

If these views are right, they have now a betterchance than ever before of winning their way toaction. War has shown us, first, how astonishinglygreat is our power to make and do things if wereally want and mean to. Man has put all theprophets wrong who said that a great war couldnot last more than a few months, by proving thathe could concentrate his energies on destructionwith results that have appalled and astounded us,while at the same time producing all that was required for his material welfare; so much so thatduring the first two years of the war the generallevel of well-being in this country has been actuallyimproved, owing to the more even distribution ofthe output, which was an economic incident ofthe war; so great was our margin of unused productive power and so great was the proportion of

v] WAR'S LESSONS I07

our productive power that was put irito turningout things that were not necessary to the nation'swelfare. Secondly, the war has shown how sho~t

sighted it is for a great and rich nation to allow alarge part of its population to be stunted in mindand body. The voice of the social reformer is nowraised in harmony with that of the recruitingsergeant, who wants sturdy men for the Army, of theemployer, who wants strong and intelligent workers,and of the statesman, who wants a nation behindhim every member of which can understand thetremendous issues for which we are fighting andsee and act on the need for the measures taken tosecure victory. Never has there been a time whenit has been seen more clearly that a nation, to best.rong, must be strong from top to bottom. Inother words, the war has shown us how much wecan do and how much needs to be done. But thequestion still remains, whether what needs to bedone can be best done by the development of theindividual's sense of national duty in \vork. andspending, or by handing over to the State a continually growing share of the task of producingand distributing.

At a time when a brighter era is undoubtedlydawning for mankind, though it is only too possiblethat much turmoil and struggle luay yet lie betweenus and its achievement, there seems to be something squalid in dwelling on the purely materialside of the matter. After all, the human soul isthe only thing that really counts! If everybody


were pleasant to live with; ~11 other things wouldbe addeff unto us; if we were"all honestand kindlyand courteous and fair-minded and unselfish, therewould be no need to fash ourselves about outputand distribution, because weshould an be doingour best to make things better, a,nd all these sordidproblems would solve themselves. But as thingsp,re, rnaterial considerations are of the greatestpossible importance, because it is so much easierfor the necessary qualities to be acquired by peoplewho are not expected to spel?-d most of their livesin trying to get a better share of the world's goodsthan their neighbours. If we can produce plentyfor all andean prevent people from believing thatgetting more than plenty f-or themselves is thechief obj e~t of l~fe, then there would be somechance for the rudimentary and atrophied humansoul, which is now often treated very like thevermiform appendix-+-ignored if possible, and ifnot, cut out.

If, therefore, it is the fact that, by handing overgreat ir:-dustries to be worked by the State for profit,we can "make the State a great revenue earner, andat the same time do away with some of the competition that is a source of much waste and mendacity,without thereby producing a system of organizedand hidebound efficiency that would kill all freedomand initiative, it is c1~ar that we shall be relievingthe taxpayer's burden and p~rhaps clearing a \vaytowards a social syst~m that will stand daylightbetter than. our p~eserit one.

v] A FABIAN SCHEME

A great scheme of nationalization ha~ been putbefore an interested public by Mr. Sidney Webband his Fabian lieutenants, in a book,already referredto, called How to Pay for the War, published in 1916.They propose to increase very greatly the scopeof the activities of the Post Office, making it domuch of the work that is now done by bankers,and to nationalize the railways, the coal industry,and life insurance; and they urge, with a wealthof detail that is evidently the result of laboriousinvestigation, that, if these' things are done, thepublic will get a better and cheaper servicel theworkers employed will get better treatment" andthe State will earn a revenue that will supply amouth-filling number of millions for paying off thewar debt. This attractive argument~ of course, isonly a development of the Socialist contention andan application of it to the needs of the moment;and for this reason will be refused a hearing by manyto whom the mere name of Socialism is a terror.But a little later, as if to show how widely and inwhat unexpected quarters the idea of collectivist

. enterprise is being stimulated by our war problems,there arises a new portent in the economic sky inthe shape of a body called the Empire Resourc~s

Development Committees which also wants to helpto payoff the war debt by means of State enterprisein industry and production, chiefly applied to overseas enterprise, though one of its manifestos alsoincludes the coal and light and power industries athome among the means by which the after-war debt

8* '

Itb THE LIMITS OF SPENDING [CHAP.

charge can be met without anybody having to payit; because the State will be able to do businessso cleverly that it will find the money Qut of netprofits. The really interesting thing about thisCommittee is that it bristles with names thathavebeen hitherto renowned for Imperialist rather thanfor Socialist zeal, such as Mr. Rudyard Kipling,Sir Starr Jameson, Lord Grey (not the late Secretaryfor ForeignAffairs), Lord Selborne, Lord Desborough~

and Mr.H. Wilson Fox, M.P., a distinguished officerof the Chartered Company of British South Africa;and with them is Mr. Vassar-Smith, the highlyrespected chairman of Lloyds Bank. That namessuch as these should be found on a manifestoadvocating what one used to think was pureSocialism shows at least how people's minds havebeen shaken up by the war. The gist of theircontention is that the immense latent resourcesof the Empire can be worked for State purposesand under State auspices in such a way that weshall be able to II lift from the peoples of the Empirethe burdens caused by the war." And they, likeMr. Webb and his colleagues, think that the Statecan not only perform this financial feat, but at thesame time cheapen the cost to consumers of articlesthat it provides and distributes.

I t is a most alluring prospect and, if there is anychance of its being realized, the most bigoted

~Individualist will hardly let his dislike of Stateenterprise stand in its way. But is it not an enormous assumption to suppose that the State. can

v] A LARGE ASSUMPTION lIt

manage an enterprise with so much more successthan a private undertaker that it can afford tobuy him out, then provide a better service or. abetter article, pay- everybody better, and finallymake a thumping net revenue? In the case ofnew Imperial enterprises, there might be no one tobe bought out, though vested interests sometimesare discovered in the most unlikely corners when achance of compensation arises. The Imperial Development Committee expressly states that theproposed enterprises should not be managed byCivil Service Departments; but it does not explainhow the managers can help becoming civil servantsand so being involved with the attributes of thosewho work the State machine, so admirably wfthincertain limits, but not so admirably when it is amatter of conducting business enterprise at a profitand with satisfaction to customers and employees.They make a profit out of the- Pqst Office? Yes;but in discussing the tangled question whether whatwe pay for postal service should be considered astaxation or payment for services rendered, at leastone distinguished economist has decided that postalrevenue is taxation only in so far as we pay morefor this service than we should if it were managedprivately. Everyone agrees that it is impossibleto gauge this amount, but no one seems to doubtthat it exists, and that postal facilities would becheaper if they were provided by private enterprise.Mr. Harold Cox, that stern, unbending foe of Stateenterprise, dealt. faithfully with the. proposals of

112 THE LIMITS OF SPENDING [CHAP

the Imperial Development Committee in an editorialin the Edinburgh Review for April 1917, and incident..ally gave two examples of cases in which the Statehad taken over profitable enterprises and had totallyfailed to work them at a profit:

It In 1870- the State acquired possession of theelectric telegraph system of the conntry, which hadbeen built up by various private 'companies. Thepurchase 'Was recommended to the House of Com..mons as a splendid bargain for the State. Thepermanent officials who prepared the scheme assuredtlie House that the whole of the c~pitalcbst wouldbe repaid in fifteen' years out of profits and thatafter that period there would be an ever-increasingrevenue to relieve the burdens of the taxpayer.That was the promise. What actually happenedwas that the whole of the profit disappeared afterthe second :¥~ar of vv'orking by the State} that yearby year the financial position has grown worse, tillin the last years of peace the telegraphs were costingthe taxpa.yer a sum which cannot be put at less than£i,400,oOO per annum.

U Meanwhile, the- telephone had been invented.During many years the State, in order to protect itstelegraph monopoly, did its utmost to stifle thedevelopment of the new invention. Finally) theState bought up the telephones, completing thepurchase 'in the year 1911. Again: there were prophecies-though in a somewhat minor key-of alucrative bargain. These prophecies have gone theway of the old ones.' The whole of the handsometribute of over £350 ,000 a year, which the NationalTelephone Company was gratuitously paying to- the

v] A DOUBTFUL POLICY II3

State, vanished at once, and within three years theincome collected by the State barely covered outgoings."

With these actual examples before us we shouldhesitate before embarking on a large policy of Stateenterprise, especially if it is to be directed to theprovision of necessaries of life such as food, andcoal. Posts and telegraphs and telephones hardlytouch the life of the very poorest, and though ifthey are bad and dear they are a hindrance .andburden to business, their extra cost is a small itemin the expense of industry; but it would be adifferent matter if the actual cost of living wereraised through an attempt at revenue-earning byState enterprise in a country in which the test ofexperience has shown it to be dear and inefficient.

Nevertheless, we have no right to shut any dooron a possibility of economic reform. We know thatthere are countries in which the State can managesome enterprises well and profitably, and even inEngland certain municipalities have earned goodprofits for their ratepayers and also served theircustomers well with comparatively simple businesses,such as tramway transport. It may be thatGovernment departments, like the rest of us, havelearnt much from the war and may now be able totackle problems of enterprise with a new freedomand success. Strongly divergent views are expressedon this point, and no one who has not been in touchwith the facts has any right to be sure about it.

II4 THE LIMITS OF SPENDING [CHAP.

Some say that the Munitions Department has beena miracle of official competence and success; othersthat it was a costly chaos, only saved by the effortsof the business men, trained in the school of competitive enterprise, whom it called in to help it.But since there is a doubt and a new atmosphere,and since imaginative folk with big new ideas wantto give us a lead, there seems to be no reason whythey should not be allowed to try an experiment ona small scale, to be widened if the experiment succeeds. Freedom and individual initiative have solong been the life-blood of our national developmentthat one is 10th to see them encroached on evenby the most efficient form of machine-made bureaucratic enterprise; and the ideal of progress throughthe improvement of the individual, and a wideningand deepening of his sense of national duty, seemsto be a much higher and more hopeful one thanthrough the expansion of State regulation to apoint which implies the crippling of the soul of thecitizen. Some of us hope that when the war isover we shall get rid of Government control as farand as fast as possible, except where previousexperience had shown it to be necessary in the· interests of the weaker parties to economic bargains.

"My experience [said Sir Alfred Booth to theCunard Company's shareholders in April 1917] ofGovernment control has only served to convince memore firmly than ever that individual enterprise isthe only spirit which can quicken the dead bodies

v] THE DOUBTFUL FUTURE 115

of capital and labour into life. . . . But I am notat all alarmed. When the war-is over, commercialfreedom will win in England just as political freedomhas won in Russia, and we shall be quite contentto leave the bureaucrats and the Romanoffs tocultivate their roses together in some suitable ruralatmosphere. II

But with taxation what it will have to be, all isfish that comes into the net, and. if the State canlearn to produce and distribute better and moreprofitably than private enterprise, no prejudiceshould stand inits way. But it ought to win it~

spurs, if it can, in a fair field and not with thesupport of privileges~~:.and monopolies and subsidies,still less with the help of tariffs.

Apart from this possible source of revenue,concerning which one is justified in doubting whetherit will ever be realized and in feeling sure that inany case it will be slow in growth, taxation is themeans_by which the State will have to divert fromour use so much of our annual output of stuff andwork that has to be devoted to national purposes.As to the extent to which it can do this, there areconflicting opinions. Some. say that, owing to theenormous weight of the after-war debt charge andour impoverishment by war, it will not, for years tocome, be possible to find any money, that is-divertany part of .our output, .to purposes of social improvemente On the other hand, there is the opinion,which the huge figures of our war spending havehelped to stimulate, that now that we have learnt

116 THE LIMITS OF SPENDING [CHAP. -

to think in millions and in hundreds of millions, weshall never again be .checked by any consideration0-£. a few millions more or less in the cost of anyreform that is accepted as needing to be done; andthat the reformer will henceforward hav'e a bottomless purse to draw on since he will always, whenthe -war is ~ver, be able to say, "vVhat I ask isonly the cost of one day, or one week, or one month-as the case may be-of the late waf, and justconsider how much good it will do 1"

-As to the first and pessimistic view I we cannotknow how far it will be right until we know howmuch our capital equipment will have been impairedand how much we shalf owe abroad by the time the,var is over. If by the destruction of our ships andthe depreciation of our industrial-plant and of oursoil's fertility, our output is seriously diminished,and if at the same time, owing '\0 our borrowingsa"!Jroad an~ sales of securities to foreigners, we shallhave a much smaller sum to receive every year onbalance from foreigners in interest, which comesto us in the fprm of imported goods; then our totalincome, in tl1e shape of goods produced by us and byour foreign debtors, will be less, and any part of itdiverted to national needs will involve a greatersacrifice than before. In so far as it is held at homeour debt involves no absorption of the nationaloutput, but only a transfer of part of it, by taxation,to the use' of certain members of the naHon whohold the debt. It is therefore only necessary tobe sure that the taxati~n involved by it is imposecJ

v] THE IMPORTANCE OF TEl\IPER 1I7

on the people who ought to have subscribed to theloans. .Then those who did their duty in subscribingwill get their taxes back, those who pinched themselves and did more than their duty will get morethan their taxes back, and those who did not dotheir duty will get nothing back, which is just as itshould be. This arrangement is easier to describeas desirable than to put into practice, which is oneof the 0 bjections to finance by borrowing.

But even if our total income, in goods producedby ourselves at home and by our debtors abroad,is materially less, which has yet to be proved, itdoes not follow that the amount of it available fornational purposes will be less if we are resolved tomake a greater sacrifice for them. Everything willdepend on the temper ~nd state of mind with whichwe set to work and turn·out goods in the first place,and in the second, regard the claim on our workthat the State may make for purposes of nationaldevelopment and improvement, such as health,education, housing, and the dozens of other thingsthat, in the opinion of some of us, need to havework put into them. If we go to work in a badtemper and have strikes, lock-outs, and quarrelsabout methods of production and distribution ofthe output, then it is likely that our output willgive us little chance of drawing on it for socialreform. And there is also another enormous question to be answered. Shall we have to spend infuture a much greater amount on .defence, or willswords be hammered into plough-shares? The


hope, which was so strong in the early days of thewar, of secure peace and freedom from the burdenof armaments -has lately looked sickly, but theintervention of the United States has certainlyrevived it, and it seems now at least possible thattheL,eagueof Honour may ripen into a League ofPeace that will rid mankind of war's nightmare.

These considerations apply also to the optimisticview which holds that we shall never again bestopped by lack of money. It .is only true if thetaxpayers are persuaded that the objects for whichthey are asked to make sacrifices are a national needand ought to be paid for out of the national purse.If a people makes up its mind that a thing is worthpaying for, it can and will pay for it, up to theextent of half its income and more, as the war hasshown.. But this cannot be done if the burden oftaxation is unfairly imposed, or if a considerableminority-especially if they are those who are askedto pay most-,are oppo~~d to the objects for whichtaxation is raised. "Taxing the rich" looks easy,but it c~nnot be done 'indefinitely unless the richpay willingly. The taxpayer's power to strike,referred to in Chapter I, is still a real one. If therate of taxation takes more from the producer andfrom the owner of accumulated or inherited wealththan they believe to be just, then the incentiveto production and accumulation will be checked, andthe tree which bears the plums will have been killed,or weakened in its fruitfulness. For nationaldefence everyone is ready tQ have his money taken,

v] NO SHORT CUTS 1t9

and in war-time there is much less tendency thanusual to grumble about the manner in which themoney is raised. For national improvement andfor what Mr. Lloyd George once called a ff WarBudget against poverty and .squalidness ' I. theremay some day be the same cheerfulness and readi...ness on the part of those who pay. It may be thatwar will have taught them this lesson. If so, inspite of all its horrors, the war will have opened theway to a great stride forward along the road ofprogress. But there are no short cuts on this road,and only by the education of the individual to ajust view of his duty as a producer and worker, andof the claim of the State upon his product for nationalneeds, can full use be made of our wealth for purposesworthy of a nation that has always been a leader inhuman progress.

INDEX

BANK OF ENGLAND as currencymaker, 61 seq.

BANKS as currency makers,64 seq.

BASTABLE, PROF., on State'sclaim, 3

BOOTH, SIR A., on State control,II4

BORROWING ABROAD, effects of,50 seq.

BORROWING AT HOME:advantages of, 3 8, 41, 43evils resulting from, 42 seq.,

47 seq.CAPITAL, objections to taxing, 87CHILDREN, abatements for, 89 seq.CONSOLS carry no claim to re-

payment, 28Cox, HAROLD, on State enter

prise, 112

DEATH DUTIES imply differentiation, 86

DIFFERENTIATION of income tax,85

EDUCATION, public spending on,10, 21 seq.

EMPIRE RESOURCES DEVELOPMENT, as revenue earner, 109

FOXWELL} PROF., on inflation, 54.

GIFFEN, SIR R., on indirect taxation, 100

GI.ADSTONE, MR., on forms of taxation, roo

GRADUATION:applied to income tax, 82 seq.impossible in indirect taxation,

99

9

GUERNSEY MARKET, miracle of,57

HUME, JOSEPH, on taxes as confiscation, 6

HUXLEY on State interference, 15

INCOME TAX:advantages of, 82 seq.ideal form of, 88 seq.

INDIRECT TAXATION:advantage of, 102decline in, 102unfairness of, 99 seq.

INFLATION:effects of 68meaning of, 55, 58methods of, 60

IMPORT DUTIES, objections to,103, 104

J AMES I borrows without interest,27

JOHNSON, DR., on currency, 55

LAISSER-FAIRE:domination of,. 18results of, 19

LIBERTY, Abraham Lincoln on, 20LOCKE on government, 2LUXURIES, difficulty of taxing,

100

MILL, J. S., advocates exemptionof savings, 96

PATRIOTISM and taxation, 7PIGOU, PROF. :

advocates exemption of savings,96

on inflation, 67

121

122 INDEX

POLL TAX, graduated, 84POSTERITY:

how our spending affects it, 35will not pay our debts, 30 seq.

PRIVY SEAL, letters of, 27PROPERTY, protection of, I

ROMAN EMPIRE drives taxpayersto strike, 5

SINKING FUND, how provided, 34SMITH, ADAM:

on governmental spending, 20seq.

on taxation, 76 seq.SPENCER, HERBERT, on State

action, 9 seq.

STATE ENTERPRISE .C¥' revenueearner, IO.') seq. "-

STRIKE, taxpayers' power to, 5

TAXATION, advantages of, in war,44 seq.

TREASURY NOTES:amount of, 65issue of, 53

WAGE EARNERS and income tax,98

WALKER, F. A., on Smith'smaxims, 77 seq.

WEBB, SIDNEY:on family incomes, 90on State enterprise, 109

P,inted by Ha~ell, Watson 0- Viney, Ld., London and AylesbufY, England_

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