Sunday, May 18, 2014

Piketty: Rethinking the Progressive Income Tax

The welfare or "social state" of the 20th century was and is good, according to Thomas Piketty in Capital in the Twenty-First Century  It might need a little tweaking and reorganization, but nothing like a radical conversion of pay-as-you-go pension plans into genuine savings plans to deliver real wealth to the workers.

But it is certainly appropriate to rethink the progressive income tax, born in a muddle during and after World War I and jerked around by overwrought Anglo-Saxons.

Typically we consider three types of tax: income, capital, and consumption.  Then there's a fourth, "contributions to government-sponsored social insurance programs", really special income taxes on labor.  We call a tax "proportional" if its rate is the same for everyone, progressive if it is fall more heavily on those who earn own or consume more, regressive if "its rate decreases for richer individuals".

Clearly, a progressive tax on incomes and wealth can have a big effect on inequality.  That's why inequality in the 20th century never returned to its levels in the Belle Époque.  The relaxation of progressive rates in Britain and the US after 1980 "probably explains much of the increase in the very highest incomes."  And tax competition in a world of "free-flowing capital" has led "governments to exempt capital income from the progressive income tax... in a race to the bottom", i.e., regressive taxation at the highest income levels.  In France, for example:
The bottom 50 percent of the income distribution pay a rate of 40-45 percent; the next 40 percent pay 45-50 percent; but the top 5 percent and even more the top 1 percent pay lower rates, with the top 0.1 percent paying only 35 percent.
All signs indicate that taxes elsewhere "follow a similar bell curve", and this "fiscal secession of the wealthiest" could lead the middle class to question the "social state" and ask how come they are left holding the baby.  The consequence is hardly to be borne: "Individualism and selfishness would flourish". Maintenance of a progressive tax system would also help convince the lower-skilled workers impacted by globalization to accede to free trade.

The progressive tax is "crucial". It was central in the reduction of inequality, and is needed to underpin the "social state in the future."  But today it's under attack, intellectually and politically.

The problem is that progressive taxes were introduced in the chaos of World War I and "its various purposes were not sufficiently thought through."  Piketty's chart shows tax rates in the US, Britain, France, and Germany bouncing up during and after the war, then mostly settling down in the 1920s, before ratcheting up by World War II to high levels in Europe and very high levels in the US and Britain.  In Germany and France the top income tax level slowly came down after World War II, but in Britain and the US they stayed above 90 percent from the 40s to the 60s.  Then after 1980 Britain and the US slashed their tax rates to 30-40 percent, below France and Germany.  Inheritance tax rates followed a similar trajectory, going up to 20-30 percent in France and Germany in 1920, ratcheting up to 70-80 percent in Britain and the US before starting down after 1970 and eventually rejoining the Europeans.

It was the Americans that invented the confiscatory income tax.  In the 1910s Irving Fisher, the economist, wrote in favor of a "heavy tax on the largest estates".  And the Great Depression inspired the New Dealers to sock it to the rich.  The Brits were not far behind.

Piketty's key point is that executive salaries exploded after 1980 and that this had nothing to do with greater productivity.  Tax rates were low, so corporate executives could pay themselves more and take their winnings home with them.  And they did.  In collaboration with Emanuel Saez and Stephanie Stantcheva Piketty determined that low marginal tax rates encouraged executives to bargain for "skyrocketing executive pay", that "luck" was more important than "talent", and that the marginal tax rate explains why executive pay went up in some countries and not in others.  If you don't like high executive pay, the solution is to increase executive taxes.

The solution is clear: "the only way to stem the observed increase in very high salaries" is "confiscatory rates on top incomes".  The right confiscatory rate would be about 80 percent, more or less.  Applied on incomes above $500,000 or $1 million it would not collect much in taxes; it would just keep down executive pay.  But Piketty does not expect much change.  "Without a radical shock, it seems fairly likely that the current equilibrium [on tax rates] will persist for quite some time."


I'm inclined to accept Piketty's research that the sky-high executive salaries of the post 1980 age don't represent productivity but pure executive bargaining power.  But does it matter?

It all depends on your faith.  If you think that economic inequality is a nightmare, and likely to bring the people into the streets, then you want to do something about it.

For my part, I'm not exercised by economic inequality, but I am exercised by political inequality.  I'm charmed when I drive down A1A in South Florida and look at all the mansions.  But I don't like politicians, activists, little Hitlers, and their bribed economist apologists ordering me around.  So I'm much more inclined to go to the barricades to fight against big government and crony capitalists and billionaire hypocrites like Tom Steyer than against Bill Gates and the L'Oréal heiress.  But that's just me.


Part One: Income and Capital

Income and Output

End of Growth

Part Two: The Dynamics of the Capital/Income Ratio

Changes in Capital

New World Capital and Slavery

Capital/income Ratio in the Long Run

Capital's Share of Income

Part Three: The Structure of Inequality

Inequality and Its Concentration

Two Worlds: France and the US

Inequality of Labor Income

Inequality of Capital Ownership

Merit and Inheritance in the Long Run

Global Inequality of Wealth in the 21st Century

Part Four: Regulating Capital in the Twenty-First Century

A Social State for the 21st Century | Rethinking the Progressive Income Tax

A Global Tax on Capital | The Question of the Public Debt

Conclusion: Anti-Piketty

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