Carl Sumner Shoup (1902–2000)

Carl Shoup was born in California in 1902 and graduated from Stanford University with a law degree in 1924. He moved to New York where he became a reporter for the New York World. In 1926, he began studying economics at Columbia, becoming an instructor in 1928, earning his doctoral degree in economics in 1930, and becoming a full professor in 1945. He was chair of the Economics Department from 1955 to 1958 and again from 1961 to 1964. He was named the McVickar Professor of Political Economy in 1959 and retired in 1971. Here at Columbia, he was closely associated first with E.R.A. Seligman and Robert Murray Haig, then with William Warren, William Vickrey, Robert Anthoine and Lowell Harriss.

Carl Shoup oversaw the creation of a modern tax system for Japan after WWII, helped invent the value-added tax, and made a major study of ways Americans could be taxed. Professor Shoup also played a crucial role in developing the value-added tax systems used in Europe, Japan, and Canada. In the 1950s, he helped overhaul the tax systems in Cuba, Venezuela, and Liberia. Many of the approaches to taxation that Professor Shoup emphasized in his work focused on making tax systems fair and simple for both individuals and corporations.

In 1934, Treasury Secretary Henry Morgenthau Jr. invited Mr. Shoup to Washington where he and Roy Blough directed a comprehensive 6-volume study of American taxes and potential reforms. Their 1937 “Report on the Federal Revenue System” explored issues that confront Congress to this day.

In 1949, an aide to General Douglas MacArthur invited Professor Shoup to Japan to help overhaul the tax system. In the late 1800’s, the Japanese had adopted both corporate and individual income taxes, but in a tour of the country, Professor Shoup heard complaints that the system was arbitrary. To remedy this, he and six other economists, a team known as the Shoup Mission, proposed a system under which companies that kept detailed records and filed an annual tax report would be freed from onerous audits and could take advantage of various tax breaks, including the ability to carry losses in bad years to offset taxes during highly profitable years. He had the forms printed in blue, after being advised that the Japanese like blue documents, as part of his effort to encourage voluntary compliance. The Japanese Diet enacted his proposals in 1950.

In recognition of his contributions, Emperor Hirohito twice decorated Professor Shoup with the Order of the Sacred Treasure. In 1991, the Toyota Motor Corporation gave $2 million to Columbia to endow a chair in Professor Shoup’s name.

Carl Shoup by David Weinstein

Although I never had the opportunity of meeting Carl Sumner Shoup, anyone studying modern Japan knows of him. While most economists are allowed to affect only a few elements of an existing tax code, Shoup’s experience in Japan is unique in that he was allowed to redesign the entire Japanese tax system in 1949. Furthermore, because this system was implemented under the rubric of the American occupation, the system that Shoup designed was created with a far smaller degree of political wrangling that usually accompanies a major tax overhaul.

In order to understand Shoup’s contribution, one must spend a little time reviewing the history of taxation in Japan prior to his mission. Japanese tax policy had always focused on domestic sources in part because Japan did not have tariff autonomy until 1899. Prior to 1908, changes in Japan’s tax regime primarily had involved a gradual phase out of taxes based on agricultural output in favor of land taxes. Since the output of land was extremely hard to measure, land taxes were seen as more efficient. As Japan moved into the interwar period, land taxes became an increasingly small form of tax revenue, and “sin” taxes became a principle form of government income. Indeed, even as late as 1949, taxes on alcohol, tobacco, and admissions fees constituted 28% of government proceeds.

The Japanese tax system underwent a major reform in 1940 as the entire system was overhauled, and individual income taxes were made the centerpiece. However, tax rates varied by income source, which introduced a number of distortions into the economy as firms and individuals adjusted their economic activities in accordance with varying tax rates.

When the US occupation first began implementing changes in the first few years after Japan’s surrender, they tried unify some of the tax rates and implanted a turnover tax. This latter tax was problematic because in taxing each transaction, it created incentives for companies to eliminate transactions and vertically integrate. The tax system of the early occupation was problematic on other grounds as well. In an effort to be progressive, the occupation implanted marginal tax rates of as high as 85% on individuals, 52.5% on firms, and even higher windfall profits taxes. On top of this firms had difficulty writing off depreciation against their tax liabilities. When Shoup arrived in Japan in 1949, along with two other Columbia professors, William Warren and William Vickrey, his objective was to give Japan “the best tax system in the world.” Shoup was fully cognizant of the fact that taxes determined relative prices and hence that it was critical that the entire system be implemented. Indeed in the very outset of the report he emphasized that,

What we are recommending here is a tax system, not a number of isolated measures having no connection with one another. All of the major recommendations, and many of the minor ones, are interconnected. If any of the major recommendations are eliminated, some of the others will thereby become of less value, or even harmful. Consequently, we disclaim responsibility for the results that may follow the adoption of only part of our recommendations.

In some sense, the Shoup mission proposed what it saw as an ideal tax system with tradeoffs made for equity or efficiency reasons but not for political ones.

Indeed, despite all of the criticism that is made of economists for focusing on efficiency rather than equity, it is noteworthy that Shoup placed such a heavy emphasis on equity. Shoup had toured Japan by rail in the months leading up to the writing of the report and had heard many complaints about the arbitrariness of the current tax system. The high marginal taxes coupled with inadequate enforcement resulted in some people being heavily taxed while others paid little. In particular, Shoup was concerned about differences in taxation of wage, agricultural and asset income and believed that a simpler system of direct taxation would be easier to monitor and more progressive. In his proposed system, all sources of income would be taxed comprehensively and rates would not depend on the income source. In this way, he hoped to raise sufficient revenue for the Japanese government and develop a sense among taxpayers that the code was fair.

The Shoup plan as implemented by the Americans in 1949 and 1950 consisted of several important elements. First, a simple withholding system eliminated the need for 80% of Japanese to file income tax returns. Corporate returns for small firms were also simplified in the so-called “blue return.” (The tax forms were printed on blue paper because of a supposed Japanese affinity for blue documents!) Companies that kept detailed records and filed an annual tax report could file blue returns that would be free them from onerous audits. In addition they would be allowed to take advantage of various tax breaks, including generous allowances for the depreciation of equipment and the ability to carry forward losses in bad years to offset taxes during profitable years. Both of these provisions persist to this day.

In addition many of the provisions of the tax code were also changed. Maximum marginal taxes were also lowered to 55% for individuals and 35% for corporations; tax collection was also centralized away from local government and toward the national government; the turnover tax was eliminated; and improvements were made to the deductibility of capital losses. In addition, a number of measures were imposed that served to increase tax revenues. In particular the plan instituted new capital gains taxes, interest taxes, accessions taxes, net worth taxes (coupled with a new land assessment), and a value added tax.

Once the occupation ended, Japan regained control of its tax laws. Not surprisingly politics began to intervene in design of the system. In 1953, the net worth and accessions taxes were repealed, and most of the capital gains and interest taxes were either eliminated or greatly reduced over the next few years. Furthermore, the comprehensiveness of the Shoup system, one of the main features of the plan, was substantially curtailed. Ironically, in 1989 the Japanese government implemented a consumption tax precisely because it felt that the existing system of income taxation was insufficiently comprehensive. Thus, to some extent, Shoup’s ideas were vindicated forty years later.

There are a number of important legacies of the Shoup mission today. Most Japanese still do not need to file returns and the blue return continues to be used. Moreover Japan continues to rely heavily income taxation relative to other forms of taxation in Japan today. Secondly, the Japanese economy benefited from receiving a far more sophisticated tax code and administrative system than what had existed before. It is therefore not surprising that Shoup was awarded the Order of the Sacred Treasure twice by Japan’s Emperor Hirohito for what is probably the most successful tax system ever implemented by an economist.