20 



HARDWOOD RECORD 



July 25, lOliJ 



Income Tax Featured at Mackinac 



Members of the Xortlieni Hemlock & Hardwood Association com- 

 bined in joint meeting with the Michigan Hardwood Manufacturers' 

 Association for a midsummer convention at the Grand Hotel, 

 Mackinac Island, the famous resort above the northernmost point 

 of the Michigan peninsula. The meeting is taking place while this 

 issue of Hardwood Eecord goes to press, the tirst day's session 

 being on Thursday, the 24th, and the second day Friday, the 2oth. 

 One of the most interesting papers presented was by E. B. Good- 

 man of Goodman, Wis., who has been actively affiliated with the 

 National Lumber Manufacturers' Association as chairman of the 

 conference committee of the Bureau of Economics. Mr. Goodman 's 

 report follows: 



The proper understaudiug of the problems arising from the application 

 of the various Income tax laws to lumber companies must take into con- 

 sideration the specialized character of the lumber industry as contrasted 

 with the standardized character of the income tax laws. 



The lumber industry has marked differences from other industries, in 

 that it combines a simple, continuous manufacturing process with a liqui- 

 dating process of lixed duration, and from the other wasting industries, 

 in that the property liquidated is at any time measurable and capable of 

 valuation. 



The provisions of the tax laws are framed with respect to continuous 

 operations divided into annual taxing periods, and the provisions in the 

 law for determining the tax on the annual liquidation of assets are ad- 

 mittedly incomplete, vague and awkward in their application. Of neces- 

 sity, much discretion is left to the commissioner of Internal Revenue, and 

 the commissioner naturally seeks to construe the law with a view of claim- 

 ing the greatest amount of tax he can fairly establish, while all of the 

 wasting industries, including the lumber industry, are seeking, either co- 

 operatively or individually, to insist upon a coustruition of the law which 

 will deal fairly with them as compared with all other industries. 



The peculiar features of the lumber industry, affecting this tax problem, 

 are shown in the following description of a typical lumber manufacturing 

 enterprise : 



A small group of men ow'ning timber associate together with a view of 

 blocking their holdings so as to form a possible logging and lumber manu- 

 facturing operation. As soon as they have fixed this plan in their minds, 

 they begin a series of small purchases or trades to still further complete 

 and augment their group of timber. When this process has reached a 

 sufficient stage of completeness the timber owners incorporate. Out of 

 their number they select a manager. This is presumably the originator 

 and guiding spirit of the enterprise, although the other stockholders are 

 usually lumbermen. Plans are now made for the development of the prop- 

 erty, which consists of building a mill, logging railroads and camps. 

 Assuming, for illustration, that the value of the timber blocked was 

 .fLOOCOOO, it might be reasonable to suppose that .$500,000 would build 

 the plant and furnish working capital. 



At this point either a new enterpriser comes in, purchases the timber 

 and furnishes the capital to construct the plant, or else the owners of 

 the timber take into their corporation some banking interest or possibly 

 issue bonds upon their timber, but 99% of these enterprises start with a 

 heavy burden of debt. The planning and financing problem solved, con- 

 struction begins and by the time the mill begins to saw lumber everybody 

 interested has begun to wonder if the company will ever get out of debt, 

 and it is to the great credit of the class of men who have engaged in these 

 enterprises in the past that they were more concerned about paying their 

 debts than they were about dividends. They had a certain amount of 

 timber to cut, certain debts to pay, and what they realized over and above 

 this would be return of capital and profit to thcni, and their fair dealing 

 and good faith are reflected In the fact that every such company kept its 

 account in such a way as to wipe out their assets in the timber by de- 

 pletion charges and their plant accounts by depreciation as rapidly as 

 their annual realization of profit permitted, applying the actual cash to 

 the payment of indebtedness and not even thinking of any substantial 

 profit until their indebtedness was entirely liquidated, so that not only 

 were annual dividends the exception during the early years of the opera- 

 tion, but officers' salaries were also, as a rule, fixed at a low figure. 



This period may be called the liquidating period of the operation and, 

 when it has been completed, the operation enters into the final or sugar- 

 ing-off period, in which the stockholders finally take their profit for the 

 whole period of risk. 



Life of the Operation 



The life of a typical operation of this kind we will assume is between 

 twenty-flve and thirty years, and we will supixise that it began its opera- 

 tion about 1S90 without very definite details as to its stand of timber, 

 this being a matter with which all of its stockholders were more familiar 

 through having seen the timber on the ground rather than its estimates 



on paper. And we will assume further that the stockholders are all 

 practical, busy men familiar with lumbering operations, and that the 

 officers are practic.-ul operators, each busy with Ills own particular problem 

 either of logging, manufacturing or selling the product, that good man- 

 agement, efficiency and economy of operations were obtained by compar- 

 ing other operations through physical observations not through refinement 

 or reflection of these physical operations in the accounts. Reasonable and 

 serviceable statistical records are kept of the amount of logs cut, the 

 amount of lumber in-oduced, in some cases of the amount of each species 

 and even the amount of merchantable as compared with cull. The office 

 also possesses land records with land diagram.s and there has also been 

 a constant purchase and sale and trading in odd forties of timber and 

 these transactions have been accctmpanied by more or less accurate esti- 

 mates. 



Back In 1909 a little conscious effort was made to show a fair state- 

 ment of annual income, and every .year since that date the manager and 

 the accounting department have worked out a more accurate reflection of 

 annual earnings, particularly with respect to inventories and deferred 

 charges and the dropping of unnecessary resen-e charge, the fixing of a 

 definite, unit price for timber depletion, and a uniform annual percentage 

 rate for depreciation of plant. 



I believe that this represents a fair description of the great majority 

 of lumlier companies in all producing regions. 



A Standardized Tax Law 



In 1013 came the passage of the seventeenth amendment to the con- 

 stitution, by which the federal government was authoi'ized to levy a tax 

 on annual income. Whether or not the subsequent revenue acts have 

 abused this privilege is a question for the courts to determine. 



The fixing of depletion charges for the wasting industries is made on 

 the basis of the fair value of property on March 1, 1913. This, with 

 respect to the luml>er industries, raises the question as to what was the 

 fair value of the timber owners' stand as of timber March 1, 1913. 



Similarly, the valuation of depreciation requires the determination of 

 the value of the plant March 1, 1913, together with Its probable lite deter- 

 mined either by the cut of its timber or its obsolescence from other causes. 



The revenue department must also scrutinize every step in the lumber 

 operators' accounts to insure the correctness of his annual income for the 

 reason that the tax rates imposed b,v the revenue acts of various years 

 materially differ. The final complication of the revenue acts is the in- 

 troduction of "invested capital" so that the taxpayer has three kinds of 

 assets-refiectlon to deal with. 



First, cost ; second, value 1913 ; third, present value. 



Irrespective of the varying amount of risk involved In the nature of 

 the liusiuess, evei-y corporation is limited in Its earnings to eight per cent 

 of its invested capital before excess profit taxes are imposed, and the 

 amount of invested capital directly affects the amount of the tax to be 

 paid. 



From an economic it not from a legal point of view, a great injustice 

 is done to Invested industrial capital by this method of determining in- 

 creased rates of income tax. Capital which honestly went to work long 

 years ago when a dollar had 168% its present purchasing power is placed 

 in the eyes of the law on the same plane, as to earning capacity, with 

 the dollar of today's inflated currency, and while the law appears to set 

 eight per cent (less ten per cent normal tax or 7.2%) as the allowable 

 rate of earning before excess taxes are imposed, no, account is taken of 

 the fact that the eight per cent realized is in dollars of depreciated pur- 

 chasing power so that the owner of the old pre-war dollar is only allowed 

 to earn, as the case may be, two or three or four per cent on the actual 

 value of this old pre-war dollar before being subject to punitive rates of 

 taxation of his earnings. 



The revenue act itself recognized the injustice of its definition of in- 

 vested capital and, in what appears to me to be a confession of its weak- 

 ness, are written the relief sections authorizing the commissioner to de- 

 vise a means of administering with fairness a law that is unfair. 



Application to Lumber Industry 



I call attention to these particular characteristics of the revenue law 

 with respect to income tax as they are peculiarly burdensome to the lum- 

 ber industry. I shall say nothing further about the application of in- 

 vested capital or the action of the relief sections of the present revenue 

 act. We are bound to have our fight on this and it will be a fight not 

 only by the lumber industry, but by the other wasting industries. 



What concerns us, as lumbemien and what is a distinct lumber industry 

 problem in connection with the Income tax, is the detennination of the 

 proper depletion charge with respect to timber owned March 1, 1913. 

 The determination of the correct depletion charge affects the amount of 

 Inconxe in each year. The importance of a correct determination may be 

 stated as follows: An undervaluation of the timber subjects the owner to 

 a tax ranging from twelve to eighty per cent (1918) of the amount of 

 such undervaluation and vice versa for overvaluation ; so that the revenue 



