u« 3 ^, tlo, 3Sg i PG% % . /r T, /^D CIRCULAR No. 358 MAY, 1935* £ UNITED STATES DEPARTMEN1/"QF yy WASHINGTON NT OF AGRICULTURE isi . ^/A. ' — ■ - -- THE FOREST-TAX PROBLEM AND ITS SOLUTION SUMMARIZED By R. Clifford Hall, 1 Assistant Directory Forest Taxation Inquiry, Forest Service CONTENTS Page Introduction.. 1 The nature of the problem.... 1 Causes of the tax obstacle to forestry. 1 Governmental costs and property-tax administration_ 2 Income deferment and the property-tax burden_ 3 Past efforts to obtain tax relief.. 3 Early recognition of the problem. 3 Development of the yield tax- 4 Optional and general classification... 4 Existing forest-tax laws.. 5 •Page Methods used in Europe.... 5 The yield tax.__ 7 The nature of the proposed solution_ 8 Reduction in cost of local government.. 9 Improvement in the operation of the prop¬ erty tax_ 10 Modification of the property tax as ap¬ plied to forests_ 11 The adjusted property tax..... 12 The deferred timber tax.... 14 The differential timber tax_ 18 Taxation, forest taxation, and forestry_ 17 INTRODUCTION The comprehensive report on forest taxation which has been pre¬ pared by the Forest Service, presents in detail the conclusions and recommendations growing out of the investigations of its forest taxa¬ tion inquiry, along with the factual background and reasoning under¬ lying its conclusions. The purpose of this circular is to supply a condensed statement covering only the most important aspects of the forest tax problem and the principal measures proposed for its solution. The reader who desires to explore the subject in more detail and to study the evidence on which the conclusions given here are based is referred to the comprehensive report. THE NATURE OF THE PROBLEM CAUSES OF THE TAX OBSTACLE TO FORESTRY The existing tax obstacle to the practice of forestry on private lands arises in the main from three causes: (1) The high cost of local gov¬ ernment, since, if government expenditures are high, the tax burden must necessarily be heavy; (2) the faulty administration of the prop¬ erty tax, whereby forestry may be bearing more than its fair share of the cost of government; and (3) the inherent disadvantage of the property tax in respect to deferred-yield forests. 1 One of the associate authors of Forest Taxation in the United States, U. S. Department of Agriculture Miscellaneous Publication 218, by Fred Rogers Fairchild and Associates, the principal conclusions of which are condensed in this circular. 126765°—35-1 2 CIRCULAR 358, XT. S. DEPARTMENT OF AGRICULTURE GOVERNMENTAL COSTS AND PROPERTY-TAX ADMINISTRATION The cost of local government is high in many sections because of obsolete organization. The boundaries of the local taxing districts were designed to fit a primitive economic situation and are generally ill-adapted to modern conditions. There is a marked variety in the burden of local government costs, depending chiefly on the wealth and population of the respective communities. The disadvantage lies with those communities which are poor in natural resources and other forms of wealth. The cost of furnishing such communities with standard governmental services is not reduced to correspond with their low taxpaying ability. Even though poverty of resources is accompanied by a small population, as would naturally be the case, the cost of servicing a small population is greater per person than if the population were large, particularly where settlement is not con¬ centrated but is scattered over a wide area. Thus the rapid removal of virgin timber in districts without substantial agricultural, mineral, or other resources has left many sparsely settled and impoverished communities, where governmental costs are disproportionately high even though the public business be conducted with the greatest economy. Another cause of the high cost of local government which is espe¬ cially important in forest areas is lack of a sound land settlement policy. Settlers have been allowed and even encouraged to attempt the development of districts where agricultural communities cannot be expected to become self-supporting. They have established pre¬ carious footholds on “islands” of the better soils where nonagricultural soils predominate and along “shoestring” valleys walled in by rough mountain slopes. The cost of supplying such settlements with the usual public services weighs heavily on the surrounding forest lands, and must often be shared by the State at large. There is also in general a lack of economy and efficiency in adminis¬ tration of local government. Responsibility is diffused among a host of independent elective officials, and the use of trained men in local public service is the exception rather than the rule. In addition to suffering from the high total cost of local govern¬ ment in many of the districts where forests occur, forestry is burdened by an unequal distribution of this cost through faulty administra¬ tion of the property tax. Since, under this form of taxation, the obligation to pay taxes is measured by the possession of property, a fair distribution among the individual property owners of the taxing district depends on the assessment, that is, on the determination of taxable value. An inaccurate assessment results in an inequitable distribution of the tax. It has been found that forest land, particu¬ larly cut-over and other forest property of low price, usually gets the worst of the unequal assessment that generally prevails. It not in¬ frequently happens that cut-over forest land is assessed twice as high relative to actual value as other land in the same district. Even where forest property is not discriminated against as a class, the danger of erratic assessment as between individual properties is a serious hazard to the forest-growing enterprise. Tax-collection procedure under the property tax has always been more or less uncertain in many States. In recent years the heavy and unequal weight of taxation in conjunction with the economic crisis has promoted a tendency to extreme leniency toward delin- FOREST-TAX PROBLEM AND ITS SOLUTION SUMMARIZED 3 quent taxpayers. To the extent that inefficient collection practice has encouraged tax delinquency, it has brought about the levy of additional taxes on taxpaying property. Thus it appears that high cost of local government, antiquated methods of distributing this cost, and faulty administration of the property tax impose a serious burden on forest property and other real estate, particularly in sparsely settled regions where forest lands predominate and where a prosperous community can exist only if forestry is established as the prevailing land use. The uncertainty of this burden because of erratic administration is no small part of the obstacle to forestry. INCOME DEFERMENT AND THE PROPERTY-TAX BURDEN While the above difficulties generally outweigh the inherent dis¬ advantage of the property tax in respect to deferred-yield forests, this inherent disadvantage is still an important element in the cur¬ rent problem. The unmodified property tax is not appropriate to the initial stages of forestry now prevailing in this country, because the payment of the tax comes every year, while income is not realized every year but only after a more or less extended period of waiting. To be sure, a forest that is adequately stocked with trees of different ages may be managed to yield an income every year. The larger private forests in countries such as France and Germany where the use of land has been intelligently stabilized are so managed. Accord¬ ingly this disadvantage of the property tax can be met, where condi¬ tions permit, by sustained-yield forest management which will in¬ volve realization of income every year or at least every few years. But in most forest regions of the United States the timber has been so heavily cut that the practice of forestry on the major part of forest land necessarily involves waiting for income while the capital in grow¬ ing trees is being restored. In a few States there are stands of mature timber which, because of location, quality, or species, could best be held intact waiting for future markets. The tax which must be paid during these periods of waiting is a substantial part of the cost of the ultimate sustained-yield forest, and it may be the deciding factor in determining whether the establishment of such a forest would be profitable. In other words, the usual American situation is that a forest is a deferred-yield property, a property the income from which is deferred for a period of years with the expectation that the value will be correspondingly increased. The property tax takes a higher proportion of prospective income from such deferred-yield property than from property yielding a regular annual income. PAST EFFORTS TO OBTAIN TAX RELIEF EARLY RECOGNITION OF THE PROBLEM As early as 1819 Governor Wolcott of Connecticut said in a mes¬ sage to the legislature of that State: Timber and woodland may also be considered as capital, of which the interest and profits are deferred for periods of from 20 to 100 years. If taxed annually, the rates ought to have reference to the remote periods at which the income will be received; it being certain that an excess taxation would accelerate the destruc¬ tion of timber and wood, and occasion ruinous mischief. 4 CIRCULAR 358, U. S. DEPARTMENT OF AGRICULTURE Despite this early recognition of the relation between taxation and the use of forest lands, no practical results affecting tax legislation came from this recommendation. It was not until after the middle of the last century that interest in the planting of new forests, stimu¬ lated by the lack of timber in the prairie States and the waning timber supply in New England, resulted in the enactment of laws in a number of States designed to grant the forest-growing enterprise relief from burdensome taxation. These early measures took the form of prop¬ erty-tax exemptions and rebates and in some cases of direct bounties. They have since been generally abandoned. DEVELOPMENT OF THE YIELD TAX Early in the present century the idea of the yield tax began to attract widespread consideration as a substitute for these cruder methods, which had by that time proved either ineffective or too expensive. In the form usually proposed, the yield-tax plan involved the exemption of timber from the annual property tax and the sub¬ stitution of a tax on its stumpage value when felled. Beginning with Michigan in 1911, a number of States enacted legislation providing for this plan. These laws set up special classifications of lands to which the yield tax should apply. Various expedients were adopted in an effort to make the yield-tax laws both acceptable and effective. These included making classi¬ fication under the law optional with the owner, limiting eligibility for classification to properties not exceeding a specified size or value, and granting the State forestry departments authority to pass on the eligibility of property for classification and to enforce rules and regu¬ lations designed to insure a degree of forestry practice. In some States the land apart from the timber was left under the unmodified property tax, and in others a degree of certainty was sought through fixed or limited assessments or tax rates or through fixing directly the specific amount of tax per acre. The payment by the State to the local communities of stipulated sums annually, to replace in whole or in part the loss in tax revenue through the transfer of forest prop¬ erty from the property-tax to the yield-tax rolls, was another device tried in some States to overcome opposition of local communities where loss of timber from the tax base might otherwise result in a substantial increase of taxes on other classes of rural property. The setting up of a contract between State and owner defining the method of taxation was sometimes authorized, with the purpose of protecting the owner from subsequent legislative changes or from repeal of the special forest-tax law. Some of these expedients were also used in certain States in connection with laws granting limited exemptions without imposing a yield tax. OPTIONAL AND GENERAL CLASSIFICATION Forest-tax laws providing for optional classification, with either a yield tax or limited exemption, failed to effect any widespread sub¬ stantial results in promoting the practice of forestry. This failure led to the idea of segregating, by decision of an appropriate State authority, a general class of forest property which would be given the benefit of appropriate taxation regardless of the action of the owner. It was believed that those owners who were prepared to practice FOREST-TAX PROBLEM AND ITS SOLUTION SUMMARIZED 5 forestry if the tax obstacle were removed, but who would hesitate to seek classification under an optional forest-tax law, would welcome classification initiated by State authority and would proceed to put their plans into effect. It was also hoped that such classification, by offering a moderate tax without imposing any special obligation other than fire protection, would check the tendency to let cut-over forest lands revert to public ownership and would ultimately lead to in¬ creased practice of forestry by private owners not now interested in this form of land use. The idea of general classification has been carried out in the constitutional amendment of California providing for the exemption of immature timber, which was adopted in 1926, and in the yield-tax laws of Oregon and Washington, which were enacted in the years 1929 and 1931, respectively. EXISTING FOREST-TAX LAWS The existing forest-tax laws, leaving out of consideration a number which are limited in application to planted stands, areas of small size, or to properties leased or deeded to the State, include 14 which provide for a yield tax and 6 which provide for the exemption of timber without any yield tax. The number of States involved is 19, since 1 State, Connecticut, has both a yield tax and an exemption law. Most of these forest-tax laws are optional in character, the exceptions being the Oregon and Washington yield-tax laws and the California constitutional amendment. The optional laws have had no direct substantial effect on the forest-tax situation, being actually applied to only a negligible portion of privately owned forest lands. The experience with the nonoptional laws has not been long enough to be conclusive. The nonoptional yield-tax laws of Oregon and Wash¬ ington are limited to cut-over lands and are subject to the discrimina¬ tions and dangers of the specific land tax in Oregon and of the uniform fixed assessment in Washington. They also fail to set up any method of adjusting the yield-tax rate to public requirements. These diffi¬ culties are not so apparent now as they will be in the future, since, on the one hand, the specific tax and the fixed assessment are not very far from the present tax and the present assessment on cut-over lands of the grades now being considered for classification, and, what is of still greater importance, the yield taxes are not yet due. Neither can the California plan of exempting all immature timber be set up as a model, not so much because its effect under the present imperfect administration of the property tax is questionable, as because the concession it purports to grant is not justifiable except as a strictly temporary measure. In short, while the forest-tax legislation of the past has given valuable experience, it has been chiefly negative in character. As yet no law has been developed which may be regarded as representing an adequate and positive solution to the forest-tax problem. METHODS USED IN EUROPE Since forestry has been practiced on privately owned lands for a long time in certain countries of Europe, it is proper to inquire into the methods of taxation used in those countries and the possibility of adapting them for use in the United States. These methods were 6 CIRCULAR 358, U. S. DEPARTMENT OF AGRICULTURE studied in France, Germany, Switzerland, Great Britain, Sweden, Norway, and Finland. The ordinary annual taxes in the European countries studied are based either on capital value or on an average or hypothetical income. Taxes on actual income from forests are not generally employed, except as minor supplementary taxes or as part of a general levy on practically all kinds of income like the Federal income tax in the United States. Contrary to the situation in the United States, the ordinary annual taxes on forests as property, prior to the recent economic crisis, were not regarded as a serious obstacle to forestry. There are three reasons for this favorable condition. (1) The forests in the countries studied are generally so organized and managed that income may be realized annually or at short intervals. This is particularly true of the large forests, where other¬ wise the payment of taxes in advance of income would be most burdensome. (2) The European methods of evaluating the tax base where real estate is involved are generally more favorable to forests than in the United States. Selling price is displaced by average money income or income capacity as the usual criterion of taxable value. There are, it is true, some exceptions. Where valuations are still made by local assessors without technical knowledge, there is complaint of inequality and uncertainty. As a rule, however, forests are assessed with a reasonable degree of accuracy according to their earning power as going enterprises, disregarding speculative possibilities as well as such value as may arise from the prestige which their ownership confers or from any other satisfactions than money income. (3) There is relatively less dependence on annual real-estate taxes than in the United States, and consequently the regular annual taxes on forest property as such have in general been at lower rates in proportion to income and value than are applied in this country. Therefore the effect of any tendency to discriminate against forestry as a land use in cases where a degree of income deferment is necessary on account of the character and ownership of the forests is less serious than in the United States. The total weight of taxation on all wealth, including that represented by forest property, is very heavy, but the forms of taxation that prevail do not, with some exceptions, discrim¬ inate against the use of land for forestry. The problems of forest taxation found most troublesome in some of the European countries relate to transfer and inheritance taxes. The continuity of private forest management, never too secure for reasons outside of taxation, is threatened by the necessity of raising substantial sums in cash to pay these taxes. It is only since the World War that the rates of transfer and inheritance taxes have been so high, and some progress has already been made toward mitigating their severity in respect to forests. None of the special forest-tax plans commonly advocated for application in the United States has been tried on a substantial scale in Europe. Immature timber exemption is allowed only as a tem¬ porary and exceptional measure, as in France, for the purpose of encouraging the establishment of new forests. In Sweden a minor adjustment for the excess burden of property taxes on deferred-yield forests is made by means of a reduction in annual taxes in combina¬ tion with a severance tax. This reduction in annual taxes is accom- FOREST-TAX PROBLEM AND ITS SOLUTION SUMMARIZED 7 plished through reducing the base for the communal income-real estate tax and certain other local taxes by lowering the assessed value of the growing stock by one-third. The severance tax, by means of which the owners of operating properties are made to recompense the public for this reduction, is known as “the forest excise tax.” It is imposed at a rate equal to one-fourth of a 5-year average of the local income- tax rates. In Finland there is a temporary increase in the communal income tax based on the stumpage value of products cut during the current year. Nowhere among the countries studied is the yield of the forest used as the principal base for taxation except indirectly as it affects value or average annual net income. So far as is known, severance or yield taxes are not used as a major part of the tax system in any country of the world where forests are of large commercial importance. In all of the countries studied forests must bear substan¬ tial annual taxes regardless of when income is realized. European experience indicates clearly that the payment of substan¬ tial annual taxes on forest property is not of itself a serious obstacle to forestry. On the other hand, the tax systems of all the countries studied in one way or another recognize and make some allowance for the public interest in the maintenance of forests. Great Britain goes far in favoring reforestation through income-tax concessions, and France seeks to increase her already extensive forests by limited exemptions. The general moderation in assessment of forests for property taxation has been mentioned. The country where the property tax is most heavily relied upon is Switzerland. Most of the Swiss Cantons prescribe a method of determining taxable value that is favorable to forest property, and some require the assessment of forests at a lower ratio to actual value than other property. THE YIELD TAX The complexity of the forest-tax problem in the United States has led many to look for a radical change in the method of taxing forests. The yield tax has seemed to meet this requirement. It has appeared ideal from the forestry viewpoint, since the tax is paid only when the timber is felled, and the rate is specified by law, presumably at a figure low enough to permit profitable forest management. While the usual yield-tax plan involves leaving the land value subject to annual taxation, it often stipulates that even this payment be rescued from the ordinary operation of the property tax by imposing a specified uniform tax such as 5 or 10 cents an acre. If the success of these measures could be relied upon, the taxation of forest property would thus be satisfactorily adjusted, but at the expense of being completely divorced from public revenue needs and from the tax burdens imposed on other real estate. Before discussing other plans, the yield tax deserves careful consideration. The most serious difficulty with the conventional yield-tax program, with rates fixed primarily in the interest of forestry, is that it cannot be successfully defended as just taxation and is not likely to be ac¬ cepted by the public if it promises to be widely applied. Agriculture as well as forestry is properly regarded as of great public importance, and the owner of farm land will be found unwilling to shoulder an additional burden in the interest of forestry. Other classes of tax¬ payers will also be found in opposition. In most cases where special forest-tax laws have been passed granting exceptional favors to forest 8 CIRCULAR 358, U. S. DEPARTMENT OF AGRICULTURE property, they have been loaded with offsetting restrictions and obligations, with the result that they could be expected to affect only an insignificant portion of the privately owned forest lands. In some States laws granting special favors to forest property without offsetting restrictions w 7 ere repealed as soon as their effect became apparent to the general public. A yield tax of general application would also have to overcome the opposition of many forest-land owners. So far this kind of tax has never been extended to mature timber except on an optional basis, and it is doubtful whether it could be made generally applicable to mature timber in the larger lumber-producing States against the opposition of operators wdiose tax burden it would increase. Even some of the nonoperating timber owners recognize that a general yield tax, however favorable at the start, would subject them to a grave danger, in that the rate of the yield tax, not being related to tax rates on other property, might be raised by some succeeding legis¬ lature to a ruinous level. Furthermore, the specific tax on the land, always inequitable because of differences in productivity among dif¬ ferent kinds of land, would also be subject to arbitrary changes by future legislatures. If left undisturbed in absolute amount, its rela¬ tive burden would be subject to marked variations because of changes in the monetary system or in the tax burden on real estate in general. On the whole, many forest-land owners feel that they need the pro¬ tection that comes from having their property taxed in the same manner and at the same rate as all other real estate within the taxing district. Even from the forest owners’ standpoint the yield-tax plan has serious drawbacks. From the standpoint of public finance, the yield-tax plan is open to serious objection. The amount of revenue from this tax would vary with changes in realization of income from forest property, both from one year to the next and among different taxing districts. Its adoption would cause, even in normal years, an immediate dislocation of local finance in those communities wdiere timber formed an im¬ portant part of the tax base, unless at the same time radical changes W'ere made in the division of public functions between the State and the counties or towns, or unless the proceeds of the yield tax were distributed in some w T ay satisfactory to the local governments. The development of either alternative would be confronted by serious practical difficulties. Finally, the property tax, throughout the history of the United States, has been the chief source of State and local revenue, and in 6pite of its recognized defects it is likely to continue as an important source of revenue for most of the State governments and as the chief source of local revenue in practically all of the States. It seems almost certain that real estate wdll remain subject to some form of the property tax. Therefore the presumption is against the feasibility of perma¬ nently removing standing timber from the property-tax base, wdiere such timber is an important part of real estate. THE NATURE OF THE PROPOSED SOLUTION It should be clear that it is useless to seek an easy and simple solution of the forest-tax problem. This problem is closely related to the shortcomings of the prevailing system of local government and cannot be solved by any one-sided attack. Neither is the problem FOREST-TAX PROBLEM AND ITS SOLUTION SUMMARIZED 9 the sole concern of forest-land owners and of those who rightly ap¬ preciate the public interest in forestry. Many of its aspects are of direct concern to all real-estate owners and in particular to owners of rural real estate. Unless the problem is attacked in a broad way and with the interests of all taxpayers in view, whatever results are accomplished are likely to be of little or no lasting benefit. A broad attack upon the forest-tax problem would consist of three different parts: (1) Reduction in the total cost of local government, particularly in the forest regions, (2) improvement in the operation of the property tax, and (3) modification of the property tax as applied to forests, by permitting adjustment of the tax burden to deferment of income. It is now in order to consider under each of these headings some of the methods which may be employed to make such an attack effective. REDUCTION IN COST OF LOCAL GOVERNMENT Relief from burdensome taxes on forest property through reduction in public expenditures, without dispensing with essential services, depends largely on the reorganization of local governmeilt. The existing forms of local government, inherited from pioneer days, have in many cases been rendered unnecessary and inappropriate under modern conditions by the growth of transportation facilities and by other changes in economic relationships. To consolidate some of these governmental units and get rid of others would promote both economy and genuine local self-government. The complete disorganization of local governments in very sparsely settled forest districts would be desirable. A section of about 10 million acres in northern Maine gets along very well without organ¬ ized local government. Property in that section enjoys moderate taxes, paid directly to the State. The few residents get the benefit of all essential governmental services, provided in large part directly by State agencies. The remainder of the State is in the happy position of not being obliged to pay taxes to help support the sparsely settled section as is generally required in other States, where such sections have the ordinary forms of local government. Public control of land settlement would also tend to reduce the cost of local government in forest regions. Such control would divert settlement to sound developments and permit discontinuing support of schools and roads in many districts where they are now provided at excessive cost. The forest districts which are now overburdened with taxes because vital public functions of general concern, such as education, rest too heavily on local support, would benefit greatly if the State would assume responsibility for certain functions now supported locally. Not every State would be prepared to go so far as North Carolina, which took over the public schools for the minimum term prescribed by its constitution and all the roads in the State as well, but there is a distinct tendency in that direction. Favorable results may also bo accomplished in a different manner by an extension of the system, which has grown up in many States, of State aids to local districts for schools and other purposes. Such aids must be carefully safe¬ guarded, however, or they may promote extravagant spending and serve to perpetuate uneconomic units of government. 1267G5°—35-2 10 CIRCULAR 358, U. S. DEPARTMENT OF AGRICULTURE Aside from the advantages to be gained from reorganization of local government, more efficient and economical administration can be brought about through the greater use of trained administrators, through better financial practices, and through a larger degree of State supervision and guidance. More responsible self-government can be attained through the short ballot, the budget, full publicity, and other instrumentalities of citizen control. Gains in efficiency and responsibility will be reflected either in reduced cost or in greater service at the same cost. The desirability of reducing the burden of taxation through the elimination of waste and the promotion of efficiency is clear. Beyond that the question is, what scale of government activity can the community afford? There must be provision for a strong, construc¬ tive, aggressive public service covering activities that are justified by the public interest. If the consequent tax burden is heavy, forest owners, like all other classes, must accept heavy taxation. It is recognized that reforms of the kind which have just been sug¬ gested c<)me slowly. The attainment of efficient government under a democracy is a difficult, uphill task. But there has been a general awakening in recent years to the need for progress along these par¬ ticular lines. More progress toward substantial and lasting relief from the heavy burden of taxation on forest lands will be made through cooperation with the organizations that are working for more efficient and less costly local government than by confining efforts to special legislation for the sole benefit of forestry. IMPROVEMENT IN THE OPERATION OF THE PROPERTY TAX There is some tendency to diminished reliance on the property tax through the introduction of other sources of revenue, and this tend¬ ency is generally favorable insofar as forest property is concerned. Nevertheless there is no assurance that this movement will go far enough to contribute to the improvement of the forest-tax situation in more than a minor degree. The most important aspect of forest- tax reform, after reduction in cost of local government, is improve¬ ment in the operation of the property tax. The importance of the assessment process in the correct application of the property tax has been pointed out. Thorough-going changes in assessment organization and personnel are required. Assessment should be centralized under control of jurisdictions large enough to maintain an efficient organization of full-time, well-paid, expert as¬ sessors appointed on a merit basis. In general, assessment by the State would appear to be the ideal procedure and, next best, central¬ ization by groups of counties or towns. Where neither one of these measures can be obtained, local assessment may be improved by an increased degree of State control and assistance. Along with organization and personnel improvements, the most approved aids for arriving at sound assessment should be introduced. These include maps, surveys, and records of sales. Scientific methods of assessment, already developed in many cities, should be adapted to rural property. It would be helpful to have more cooperation be¬ tween the taxpaying public and the assessing officials. Instead of the misfit, illegal assessment that now serves, the goal should be the correct assessment of all property, in most States at its full value as FOREST-TAX PROBLEM AND ITS SOLUTION SUMMARIZED 11 now required by law, and elsewhere at the fraction of full value speci¬ fied in the law. The procedure of tax collection should be made as simple, regular, and undeviating as possible. The practice of extreme leniency, m addition to embarrassing the public treasury, intensifies the problem of the delinquent taxpayer by allowing his taxes and penalties to pile up to a hopeless total. The period allowed for redemption of tax- forfeited land should not be extended unduly, so that land which cannot be restored to the tax roll by sale may be definitely transferred to public ownership without remaining too long as “no man’s land.” If there is much land so unpromising that it cannot be held under private ownership, the sooner it gets under public administration the better. The details of procedure in tax collection have been given careful study by tax experts and administrators. The measures known to be effective should be adopted everywhere. MODIFICATION OF THE PROPERTY TAX AS APPLIED TO FORESTS "S As stated before, the property tax is inherently a handicap to forestry in this country wherever deferment of income is necessary to building up an adequate growing stock or wherever sustained-yield management with income realized annually or at short intervals is otherwise impracticable. The most direct way of adjusting the tax burden on forest property to deferment of income would be to exempt such property from the property tax and apply an income tax instead. Since it is impossible to determine net income of the irregular forests characteristic of this country by any method adapted to tax adminis¬ tration, it might seem well to turn to the yield tax which, as previously indicated, is a tax on gross income measured by the stumpage value of the felled timber. This remedy has been shown to involve serious disadvantages, and the substitution of the yield tax for the property tax in respect to forest property is not recommended. Instead, it is proposed that the property tax be so modified that it will impose a tax burden about equal to that of a tax on income or net yield at a rate equivalent to the property-tax rate. An income-tax rate is considered equivalent to a property-tax rate when the two rates would give the same amount of tax if applied to a property yielding an annual income after taxes equal to the interest on the capital. For example, a capital of $100 yielding an annual income, before deduction of the tax, amounting to $4, would be taxed $1 (1 percent of $100) under a 1-percent property-tax rate and the same amount (25 percent of $4) under a 25-percent income-tax rate. In this case, the tax-free interest would be $3. Thus, with a tax-free interest rate of 3 percent, an income-tax rate of 25 percent is considered equivalent to a property-tax rate of 1 percent. Wien applied to a deferred-yield property, however, an unmodified property tax of 1 percent will constitute a heavier burden than an income tax of 25 percent, because the property tax must be paid in advance of income. It is proposed that the property tax be modified in one of three ways in order to remove the excess burden inherent in that form of tax. The first is to reduce the current property tax on the deferred-yield forest property by an amount proportioned to the extent of income defer¬ ment in each individual case. The second is to defer the payment of property taxes until income is received. The third is to apply a flat- rate reduction to the property tax based on the degree of income de- 12 CIRCULAR 358, U. S. DEPARTMENT OF AGRICULTURE ferment which may be considered typical or average for the State. The adjusted property tax follows the first plan of a tax reduction related to the deferment of income. The deferred timber tax follows the second plan of deferring taxes until receipt of income. The differential timber tax embodies the third alternative of a flat reduc¬ tion. These three plans will be described briefly at this point. THE ADJUSTED PROPERTY TAX The adjusted property-tax plan is based on the fact that if a de¬ ferred-yield property is relieved from that part of the property tax which is levied upon the increase in value that is expected to come with the payment of taxes and the accumulation of interest in ad¬ vance of receipt of income, it will bear a tax burden approximately equal to that which it would have borne under an income or net- yield tax (were such a tax practicable) at a rate equivalent to the property-tax rate. Accordingly it requires that the current tax base of a deferred-yield forest be adjusted by deducting from the current assessed value of the forest the amount of interest and taxes accumu¬ lated to the end of the preceding year. As income is realized, this deduction would be gradually eliminated. Thus the deduction in any given year (termed the “adjusted value increment”) would be equal to: (1) The adjusted value increment accumulated to the beginning of the preceding year, plus (2) the adjusted value increment of the preceding year, composed of (a) the “pure” interest (approxi¬ mately the rate paid on long-term, tax-free Government bonds) on the assessed value of the preceding year, plus (6) taxes paid during the preceding year, minus (c) gross income or yield (from stumpage, etc.) received during the preceding year. When the income exceeds the sum of the other items no deduction is required. The tax on this reduced tax base is to be paid at the same rate as that applied to other real estate in the taxing district. An illustration showing how the tax for a given year (1934) is computed under this plan follows: Assessed value, 1934___$1, 100. 00 Deduction: (1) Adjusted value increment accumulated to the begin¬ ning of 1933_$45. 00 (2) Adjusted value increment of 1933: (a) Interest on assessed value of 1933 ($1,000)_$30.00 ( b ) Taxes in 1933_ 19. 10 49. 10 (c) Less yield in 1933_ 0. 00 - 49. 10 Total, being the adjusted value increment - accumulated to the beginning of 1934_ 94. 10 Adjusted tax base of 1934_ 1, 005. 90 Tax in 1934 at 1.5 percent_ 15. 09 In case of an unanticipated fall in value, whether caused by fire, decline in stumpage prices, or any other unforseen event, the total accumulated adjusted value increment should be reduced by an amount which bears the same ratio to this total as the ratio of the fall in value to the assessed value at the beginning of the year in which the fall occurred. For practical reasons, an unanticipated loss in FOREST-TAX PROBLEM AND ITS SOLUTION SUMMARIZED 13 value would be assumed to have occurred whenever the assessed value had declined by more than the amount of the yield, even though this decline might have been the net result of a loss and a gain in the same year. An example of the manner in which a fall in value is accounted for may be constructed by continuing the previous illustration for the succeeding year, 1935. It is assumed that a fire occurred between the assessment dates of 1934 and of 1935, as a result of which the assessed value of 1935 was $850. The loss is the difference between $1,100 (the 1934 assessed value) and $850, or $250. The adjusted value increment must therefore be reduced by 2 %oo. The tax rate in 1935 is assumed to be 2 percent. The tax payable in 1935 is calculated as follows: Assessed value, 1935_ $850. 00 Deduction: (1) Adjusted value increment accumulated to the begin¬ ning of 1934_ $94. 10 (2) Adjusted value increment of 1934: (а) Interest on assessed value of 1934 ($1,100)_$33.00 (б) Taxes in 1934_ 15. 09 48. 09 ( c ) Less yield in 1934_ 0. 00 - 48. 09 (3) Total_ 142. 19 (4) Less 25 %ioo of (3)_ 32. 32 Difference, being the adjusted value increment accumulated to the beginning of 1935_ 109. 87 Adjusted tax base of 1935- 740. 13 Tax in 1935 at 2 percent_ 14. 80 The method of calculating the tax under this plan may be expressed in general terms, where T is the taxes, V the assessed value, Y the gross yield, L the loss, r the tax rate, p the interest rate, and D the total accumulated adjusted value increment to date or the difference between the assessed value and the adjusted tax base. The sub¬ scripts indicate the year to which the above symbols refer; for example, 0 is the year prior to the adoption of the plan; 1 is the first year; 2 the second year; and 3 the third year. Formula (1) T 0 =r 0 V 0 . Formula (2) Ti=ri[Vi— (pV 0 -{- T 0 — F 0 )]. (pVo-t-To—Yo) is the adjusted value increment at the beginning of the first year or the deduction from the assessed value of the first year. It is always a positive amount, and is designated as D x . Formula (3) T 2 =r 2 [V 2 — (A+pb r i+ T x — Fj)]. (Di~\-pVi-\- T x — Yi) is the adjusted value increment accumulated to the beginning of the second year and is designated as I) 2 . Formula (4) T 3 =r 3 ^V 3 — (D 2 -\-pV 2 + T 2 —Y 2 ) (D 2 - s rpV 2 -{-T 2 —Y 2 ) is the adjusted value increment accumu- V 2 lated to the beginning of the third year, or D 3 . This adjusted value increment is computed in the same way as in formula (3) and then 14 CIRCULAR 358, U. S. DEPARTMENT OF AGRICULTURE reduced by the ratio of the loss, L 2 , occurring in the second year, to the value of the second year, V 2 . A general formula, where n is any year and n- 1 is the year preceding the nth year, may also be written: Formula (5) T n =r n [V„- (D n _ 1 +pV„_ 1 + IV,) where (ZU-i+;pU n _i + T n -i— U„_i) is never less than 0, and obviously Z„_i can never be greater than T /T „-i. To guard against evasion on the part of the taxpayer through the concentration of cutting on one parcel and the consequent retention of the accumulated adjusted value increment on other parcels, all property belonging to a single ownership in one tax-billing district should be considered as a unit for the computation of gross income, regardless of the manner in which the property is subdivided into parcels for assessment and levy. That is, each subdivision of the property within the district would be subject to a proportionate reduction in the adjusted value increment in any year when a yield is obtained. Ownerships differing in form but the same in fact would be treated as the same for this purpose. This plan would give every forest property the income from which is deferred for more than one year a tax that would be less than the usual property tax. The amount of the reduction would be pro¬ portional to the deferment of income. Forests yielding substantial annual income (equal to or greater than the interest and taxes on their current values) would be taxed exactly as under the unmodified property tax. THE DEFERRED TIMBER TAX Another plan which proceeds toward the same goal as the adjusted property tax but by a quite different route is called the “deferred timber tax.” As the name suggests, this plan approaches the equivalent of an income or net-yield tax by providing for the defer¬ ment of property taxes on timber. The first step in applying the plan would be to segregate the assessed value of forest property into land value and timber value. The annual property taxes determined in the ordinary manner would be paid on the land value. The annual taxes on the timber value would be deferred so far as the owner was concerned until income was realized through the cutting or sale of timber and other forest products. The annual taxes on the timber value would be paid by the State to the local units of government which levied them. A special fund, known as the State timber-tax fund, would be set up and drawn upon for this purpose. In this way disturbance to local government revenues would be avoided. Upon receipt of income from timber and forest products, the owner would be required to pay to the State timber-tax fund the deferred timber taxes, accumulated without interest, which had been paid by the State on his property, together with the taxes of the current year. The amount of this payment in any one year would be limited to a fixed portion, stated in the law, of the stumpage value of the products cut or sold. Any deferred taxes in excess of this amount would be carried forward as a charge against the income of succeeding years. The limiting rate, which would thus regulate the rapidity with which deferred taxes would be paid on receipt of income and which would FOREST-TAX PROBLEM AND ITS SOLUTION SUMMARIZED 15 set a maximum for timber taxes, should be high enough to cover the accumulated property taxes under all but the most unfavorable con¬ ditions. It is suggested that where the property-tax rates do not exceed 1% percent of actual value, 30 percent would be a limiting rate high enough to give adequate protection to the interest of the general public. In short, the essence of the deferred timber-tax plan is that the State pays the taxes on the timber until the owner obtains income from stumpage, when he repays the State (without interest) by in¬ stallments which may not exceed 30 percent (or some other "fixed portion) of the value of the stumpage cut in any year. In the case of extraordinary loss through fire or other casualty, or through changes in economic conditions, the value of the timber might possibly be so greatly reduced in comparison with the liability for deferred taxes, if this liability were not also reduced, as to render continued private ownership of the property unattractive and invite abandonment. Therefore it is proposed that in case such a loss occurs the deferred taxes carried over from the preceding year should not exceed the current assessed value of the timber. Thus the public might have to assume a part of the extraordinary losses from fire and other causes, though a smaller part than in the case of an income tax. It is expected that this provision would become applicable only in a very few exceptional cases. Analogous to the proposed operation of the adjusted property tax, an essential part of this plan is the treatment of all property under one ownership in a tax-billing district as a unit so far as deferment of income is concerned. The deferred timber taxes collected on account of income from any part of the entire ownership would be allocated to the individual parcels comprising that ownership in proportion to the amount of deferred timber taxes charged against each, except that if all the merchantable timber on any parcel had been cut off, the payment would be applied first to the cancellation of the deferred taxes charged against that parcel. Ownerships differing in form but the same in fact would be treated as the same. This plan involves the transfer of the burden of financing property taxes on timber in advance of income, which has hitherto rested on the timber owner alone, to the taxpayers of the State at large. The State timber-tax fund, according to such very rough estimates as can be made on the basis of existing information, could be established in all States except Oregon by a tax of 1 to 1% mills or less on the actual value of all taxable property, taking into account the fact that part of the additional tax on the timber would also be deferred. It might well be initiated by proceeds of some other tax than the property tax or it might be feasible to borrow the required sums. The timber-tax fund would eventually be self-supporting except for interest on the deferred taxes and loss of a part of the deferred taxes in exceptional cases. The method of establishing and maintaining the fund would have to be considered and decided upon in the case of each individual State, but in any case the cost would be borne eventu¬ ally by all taxpayers on a State-wide basis. This plan, like the adjusted property tax, would give every deferred- yield forest property a tax burden lower than that of the usual prop¬ erty tax, the amount of this reduction being proportional to the defer¬ ment of income. Forests yielding substantial annual income (equal 16 CIRCULAR 358, U. S. DEPARTMENT OF AGRICULTURE to or greater than the interest and taxes on their current values) would be taxed exactly as under the unmodified property tax. THE DIFFERENTIAL TIMBER TAX The third plan of adjusting the property-tax burden on forest property embodies simplicity of operation rather than close adjust¬ ment in every individual case. Under this plan, the land would be left subject to the ordinary property tax, but the timber would be classified for differential assessment. In describing the method of differential assessment, it will be convenient to treat separately the second-growth and old-growth forests. In the case of second-growth forests, the excess burden inherent in the property tax would be offset by reducing the assessed value of the timber determined in the ordinary way by specified rate or “reduc¬ tion factor.” This factor would usually be uniform throughout the State and would be so calculated as to give forest properties subject to a standard or typical degree of income deferment a tax burden equivalent to that of a net-yield tax. The standard degree of income deferment for a given State would of necessity be determined by qualified foresters. The resulting reduction factor would be pre¬ scribed by law. 2 Forests with income cycles closely approaching the standard would thus bear a tax approximately equivalent in burden to that of a net-yield tax. Forests subject to a deferment of income greater than normal would be obliged to bear a somewhat heavier tax burden than that of a net-yield tax, but less than that of the property tax. On the other hand, forests which were so regulated as to receive substantial income at shorter intervals than indicated by the standard income cycle would enjoy a fighter tax burden than that of a net-yield tax. For old-growth timber two methods are proposed, depending upon the conditions. In those States where such timber is not a sufficiently important element in the tax base to warrant different treatment from that accorded second-growth, old-growth forests would be given the benefit of differential taxation using the same reduction factor which had been determined for second-growth timber. Where old-growth timber is an important element in the tax base, a transition period of 20 years, possibly longer in exceptional cases, would elapse before the general differential would apply to such timber. During this transition period, old-growth timber properties, as long as the} 7 were completely withheld from commercial operation, would be granted the benefit of a reduction factor applicable to the assessed value of the timber. This reduction factor would be in any year 5 percent times the number of years which had elapsed since the basic date when the plan became effective, up to a maximum equal to the second-growth reduction factor. Operated forests would be taxed under the ordinary property tax during the transition period. The determination of the reduction from the usual property tax under the differential timber-tax plan is not so accurately suited in amount to each individual ownership as the reduction under either of the other two recommended plans. However, this plan has the 3 Fifty percent is regarded as the maximum reduction factor. The method of determining the factor and the reasons for setting this maximum are fully explained in pt. 12 of Forest Taxation in the United States. FOREST-TAX PROBLEM AND ITS SOLUTION SUMMARIZED 17 advantage of greater simplicity. It requires but little modification of the existing tax system, no material change in tax procedure and records, and no carrying forward from year to year of tax liabilities or allowances. Nevertheless it would accomplish a reasonable adjust¬ ment for deferment of income of the tax burden on forest property. TAXATION, FOREST TAXATION, AND FORESTRY In closing this condensed account of the findings of a comprehensive study of forest taxation, it may be well to remind the reader that the forest-tax problem cannot be solved apart from general improvement in local government and taxation. The passage of a special forest-tax law embodying one of the three proposed plans which have been outlined, or some other plan directed to the same end, may be expected to produce real and substantial benefits, but such legislation alone is not a solution of the forest-tax problem. Obviously such legislation would not be a remedy for unsuitable allocation of public functions, inefficient organization, and wasteful operation of local government, or for inaccurate assessment of property and haphazard collection of the property tax. The advocates of forest-tax reform would do well to give active support to measures designed to correct conditions of this kind and to supply with the greatest possible economy the type of governmental service the public interest requires. In such endeav¬ ors, they should be able to enlist the cooperation of other taxpayers in forest districts and of those who desire to promote better govern¬ ment in rural districts. It should also be pointed out that the removal of the tax obstacle cannot by itself be expected to bring about the general application of forestry principles to privately owned forests. Nevertheless, the removal of this obstacle would be well worth while. Forest-tax reform would give the forestry use an equal opportunity, so far as the tax burden is concerned, with competing land uses, and would offer investments in forestry a degree of security against the hazards of the property tax as now administered. The accomplishment of these results would constitute an important part of a well-rounded program designed to promote the productive use of private forest lands. ORGANIZATION OF THE UNITED STATES DEPARTMENT OF AGRICULTURE WHEN THIS PUBLICATION WAS LAST PRINTED Secretary of Agriculture _Henry A. Wallace. Under Secretary _ Rexford G. Tugwell. Assistant Secretary _ M. L. Wilson. Director of Extension Work _C. W. Warburton. Director of Personnel _ W. W. Stockberger. Director of Information _ M. S. Eisenhower. Director of Finance _ W. A. Jump. Solicitor _Seth Thomas. Agricultural Adjustment Administration. _ Chester C. Davis, Administrator. Bureau of Agricultural Economics _ A. G. Black, Chief. Bureau of Agricultural Engineering _ S. H. McCrory, Chief. Bureau of Animal Industry _John R. Mohler, Chief. Bureau of Biological Survey _J. N. Darling, Chief. Bureau of Chemistry and Soils _H. G. Knight, Chief. Office of Cooperative Extension Work _ C. B. Smith, Chief. Bureau of Dairy Industry _O. E. Reed, Chief. Bureau of Entomology and Plant Quaran- Lee A. Strong, Chief, tine. Office of Experiment Stations _James T. Jardine, Chief. Food and Drug Administration _Walter G. Campbell, Chief. Forest Service _ Ferdinand A. Silcox, Chief. Grain Futures Administration _J. W. T. Duvel, Chief. Bureau of Home Economics _Louise Stanley, Chief. Library _ Claribel R. Barnett, Librarian. Bureau of Plant Industry _Fredrick D. Richey, Chief. Bureau of Public Roads __Thomas H. MacDonald, Chief. Weather Bureau _ Willis R. Gregg, Chief. This circular is a contribution from Forest Service _ Division of Research 18 Ferdinand A. Silcox, Chief. E. H. Clapp, Assistant Forester , in Charge. U. S. GOVERNMENT PRINTING OFFICE: 19 3 3 For sale by the Superintendent of Documents, Washington, D. C. Price 5 cents