The following is an excellent excerpt from the book “CAPITAL in the Twenty-First Century” by Thomas Piketty translated by Arthur Goldhammer from Chapter Fourteen titled “Rethinking the Progressive Income Tax” on page 498 and I quote: “The Progressive Tax in the Twentieth Century: An Ephemeral Product of Chaos – To gaze backward for a moment: how did we get to this point? First, it is important to realize that progressive taxation was as much a product of two world wars as it was of democracy. It was adopted in a chaotic climate that called for improvisation, which is part of the reason why its various purposes were not sufficiently thought through and why it is being challenged today.
To be sure, a number of countries adopted a progressive income tax before the outbreak of World War I. In France, the law creating a “general tax on income“ was passed on July 15, 1914, in direct response to the anticipated financial needs of the impending conflict (after being buried in the Senate for several years); the law would not have passed had a declaration of war not been imminent. Aside from this exception, most countries adopted a progressive income tax after due deliberation in the normal course of parliamentary proceedings. Such a tax was adopted in Britain, for example, in 1909 and in the United States in 1913. Several countries in northern Europe, a number of German states, and Japan adopted a progressive income tax even earlier: Denmark in 1870, Japan in 1887, Prussia in 1891, and Sweden in 1903. Even though not all the developed countries had adopted a progressive tax by 1910, an international consensus was emerging around the principle of progressivity and its application to overall income (that is, to the sum of income from labor, including both wage and nonwage labor, and capital income of all kinds, including rent, interest, dividends, profits, and in some cases capital gains). To many people, such a system appeared to be both a more just and a more efficient way of apportioning taxes. Overall income measured each person’s ability to contribute, and progressive taxation offered a way of limiting the inequalities produced by industrial capitalism while maintaining respect or private property and the forces of competition. Many books and reports published at the time helped popularize the idea and win over some political leaders and liberal economists, although many would remain hostile to the very principle of progressivity, especially in France.
Is the progressive income tax therefore the natural offspring of democracy and universal suffrage? Things are actually more complicated. Indeed, tax rates, even on the most astronomical incomes, remained extremely low prior to World War I. This was true everywhere, without exception. The magnitude of the political shock during the war is quite clear in Figure 14.1, which shows the evolution of the top rate (that is, the tax rate on the highest income bracket) in the United States, Britain, Germany and France from 1900 to 2013. The top rate stagnated at insignificant levels until 1914 and then skyrocketed after the war. These curves are typical of those seen in other wealthy countries.
In France, the 1914 income tax law provided for a top rate of just 2 percent, which applied to only a tiny minority of taxpayers. It was only after the war, in a radically different political and financial context, that the top rate was raised to “modern” levels; 50 percent in 1920, then 60 percent in 1924, and even 72 percent in 1925. Particularly striking is the fact that the crucial law of June 25, 1920, which raised the top rate to 50 percent and can actually be seen as a second coming of the income tax, was adopted by the so-called blue-sky Chamber (one of the most right-wing Chambers of Deputies in the history of the French Republic) with its “National Bloc” majority, made up largely of the very delegations who had most vehemently opposed the creation of an income tax with a top rate of 2 percent before the war. This complete reversal of the right-wing position on progressive taxation was of course due to the disastrous financial situation created by the war. During the conflict the government had run up considerable debts, and despite the ritual speeches in which politician after politician declared that “Germany will pay,” everyone knew that new fiscal resources would have to be found. Postwar shortages and the recourse to the printing press had driven inflation to previously unknown heights, so that the purchasing power of workers remained below 1914 levels, and several waves of strikes in May and June of 1919 threatened the country with paralysis. In such circumstances, political proclivities hardly mattered: new sources of revenue were essential, and no one believed that those with the highest incomes ought to be spared. The Bolshevik Revolution of 1917 was fresh in everyone’s mind. It was in this chaotic and explosive situation that the modern progressive income tax was born.
The German case is particularly interesting, because Germany had had a progressive income tax for more than twenty years before the war. Throughout that period of peace, tax rates were never raised significantly. In Prussia, the top rate remained stable at 3 percent for 1891 to 1914 and then rose to 4 percent from 1915 to 1918, before ultimately shooting up to 40 percent in 1919-1920, in a radically changed political climate. In the United States, which was intellectually and politically more prepared than any other country to accept a steeply progressive income tax and would lead the movement in the interwar period, it was again not until 1918-1919 that the top rate was abruptly increased, first to 67 percent then to 77 percent. In Britain, the top rate was set at 8 percent in 1909, a fairly high level for the time, but again it was not until after the war that it was suddenly raised to more than 40 percent.
Of course it is impossible to say what would have happened had it not been for the shock of 1914-1918. A movement had clearly been launched. Nevertheless, it seems certain that had that shock not occurred, the move toward a more progressive tax system would at the very least have been much slower, and top rates might have risen as high as they did. The rates in force before 1914, which were always below 10 percent (and generally below 5), including the top rates, were not very different from tax rates in the eighteenth and nineteenth centuries. Even though the progressive tax on total income was a creation of the late nineteenth and early twentieth centuries, there were much earlier forms of income tax, generally with different rules for different types of income, and usually with flat or nearly flat rates (for example, a flat rate after allowing or a certain fixed deduction). In most cases the rates were 5-10 percent (at most). For example, this was true of the categorical or schedular tax, which applied separate rates to each category (or schedule) of income (land rents, interest, profits, wages, etc.). Britain adopted such a categorical tax in 1842, and it remained the British version of the income tax until the creation in 1909 of a “supertax” (a progressive tax on total income).
In Ancien Regime France, there were also various forms of direct taxation, of incomes, such as the taille, the dixieme, and the vingtieme, with typical rates of 5 or 10 percent (as the names indicate) applied to some but not all sources of income, with numerous exemptions. In 1707, [Sebastien Le Prestre de] Vauban proposed a “dixieme royal,” which was intended to be a 10 percent tax on all incomes (including rents paid to aristocratic and ecclesiastical landlords), but it was never fully implemented. Various improvements to the tax system were nevertheless attempted over the course of the eighteenth century. Revolutionary lawmakers, hostile to the inquisitorial methods of the fallen monarchy and probably keen as well to protect the emerging industrial bourgeoisie from bearing too heavy a tax burden, chose to institute an “indicial” tax system: taxes were calculated on the basis of indices that were supposed to reflect the taxpayer’s ability to pay rather than actual income, which did not have to be declared. For instance, the “door and window tax” was based on the number of doors and windows in the taxpayer’s primary residence, which was taken to be an index of wealth. Taxpayers liked this system because the authorities could determine how much tax they owed without having to enter their homes, much less examine their account books. The most important tax under the new system created in 1792, the property tax, was based on the rental value of all real estate owned by the taxpayer. The income tax was based on estimates of average rental value, which were revised once a decade when the tax authorities inventoried all property in France; taxpayers were not required to declare their actual income. Since inflation was slow, this made little difference. In practice, this real estate tax amounted to a flat tax on rents and was not very different from the British categorical tax. (The effective rate varied from time to time and departement to departement but never exceeded 10 percent.)
To round out the system, the nascent Third Republic decided in 1872 to impose a tax on income form financial assets. This was a flat tax on interest, dividends, and other financial revenues, which were rapidly proliferating in France at the time but almost totally exempt from taxation, even though similar revenues were taxed in Britain. Once again, however, the tax rate was set quite low (3 percent from 1872 to 1890 and then 4 percent from 1890 to 1914), at any rate in comparison with the rates assessed after 1920. Until World War I, it seems to have been the case in all the developed countries that a tax on income was not considered “reasonable” unless the rate was under 10 percent, no matter how high the taxable income.
The Progressive Tax in the Third Republic – Interestingly, this was also true of the progressive inheritance or estate tax, which, along with the progressive income tax, was the second important fiscal innovation of the early twentieth century. Estate tax rates also remained quite low until 1914 (see Figure 14.2). Once again, the case of France under the Third Republic is emblematic: here was a country that was supposed to nurse a veritable passion for the ideal of equality, in which universal male suffrage was reestablished in 1871, and which nevertheless stubbornly refused for nearly half a century to fully embrace the principle of progressive taxation. Attitudes did not really change until World War I made change inevitable. To be sure, the estate tax instituted by the French Revolution, which remained strictly proportional from 1791 to 1901, was made progressive by the law of February 25, 1901. In reality, however, no much changed: the highest rate was set at 5 percent from 1902 to 1910 and then at 6.5 percent from 1911 to 1914 and applied to only a few dozen fortunes every year. In the eyes of wealthy taxpayers, such rates seemed exorbitant. Many felt that it was a “sacred duty” to ensure that “a son would succeed his father,” thereby perpetuating the family property, and that such straightforward perpetuation should not incur a tax of any kind. In reality, however, the low inheritance tax did not prevent estates from being passed on largely intact from one generation to the next. The effective average rate on the top centile of inheritances was no more than 3 percent after the reform of 1901 (compared to 1 percent under the proportional regime in force in the nineteenth century). In hindsight, it is clear that the reform had scarcely any impact on the process of accumulation and hyperconcentration of wealth that was under way at the time, regardless of what contemporaries may have believed.
It is striking, moreover, how frequently opponents of progressive taxation, who were clearly in the majority among the economic and financial elite of Belle Epoque France, rather hypocritically relied on the argument that France, being a naturally egalitarian country, had no need of progressive taxes. A typical and particularly instructive example is that Paul Leroy-Beaulieu, one of the most influential economists of the day, who in 1881 published his famous Essai sur La repartition des richesses et sur la tendance a une moindre inegalite des conditions (Essay on the Distribution of Wealth and the Tendency toward Reduced Inequality of Conditions), a work that went through numerous editions up to the eve of World War I. Leroy-Beaulieu actually had no data of any kind to justify his belief in a “tendency toward a reduced inequality of conditions.” But never mind that; he managed to come up with dubious and not very convincing arguments based on totally irrelevant statistics to show that income inequality was decreasing. At times he seemed to notice that his argument was flawed, and he then simply stated that reduced inequality was just around the corner and that in any case nothing of any kind must be done to interfere with the miraculous process of commercial and financial globalization, which allowed French savers to invest tin the Panama and Suez canals and would soon extend to czarist Russia. Clearly, Leroy-Beaulieu was fascinated by the globalization of his day and scared stiff by the thought that a sudden revolution might put it all in jeopardy. There is of course nothing inherently reprehensible about such a fascination as long as it does not stand in the way of sober analysis. The great issue in France in1900-1910 was not the imminence of a Bolshevik revolution (which was no more likely than a revolution is today) but the advent of progressive taxation. For Leroy-Beaulieu and his colleagues of the “center right” (in contrast to the monarchist right), there was one unanswerable argument to progressivity, which right-thinking people should oppose tooth and nail: France, he maintained, became an egalitarian country thanks to the French Revolution, which redistributed the land (up to a point) and above all established equality before the law with the Civil Code, which instituted equal property rights and the right of free contract. Hence there was no need for a progressive and confiscatory tax. Of course, he added, such a tax might well be useful in a class-ridden aristocratic society like that of Britain, across the English Channel, but not in France.
As it happens, if Leroy-Beaulieu had bothered to consult the probate records published by the tax authorities shortly after the reform of 1901, he would have discovered that wealth was nearly as concentrated in republican France during the Belle Epoque as it was in monarchical Britain. In parliamentary debate in 1907 and 1908, proponents of the income tax frequently referred to these statistics. This interesting example shows that even a tax with low rates can be a source of knowledge and a force for democratic transparency.
In other countries the estate tax was also transformed after World War I. In Germany, the idea of imposing a small tax on the very largest estates was extensively discussed in parliamentary debate at the end of the nineteenth century and beginning of the twentieth. Leaders of the Social Democratic Party, starting with August Bebel and Eduard Bernstein, pointed out that an estate tax would make it possible to decrease the heavy burden of indirect taxes on workers, who would then be able to improve their lot. But the Reichstg could not agree on a new tax: the reforms of 1906 and 1909 did institute a very small estate tax, but bequests to a spouse or children (that is, the vast majority of estates) were entirely exempt, no matter how large. It was not until 1919 that the German estate tax was extend to family bequests, and the top rate (on the largest estates) was abruptly increased from 0 to 35 percent. The role of the war and of the political changes it induced seems to have been absolutely crucial: it is hard to see how the stalemate of 1906-1909 would have been overcome otherwise.
Figure 14.2 shows a slight upward tick in Britain around the turn of the century, somewhat greater for the estate tax than for the income tax. The rate on the largest estates, which had been 8 percent since the reform of 1896, rose to 15 percent in 1908—a fairly substantial amount. In the United States, a federal tax on estates and gifts was not instituted until 1916, but its rate very quickly rose to levels higher than those found in France and Germany.”
(THIS SECTION MAINLY TALKS ABOUT WHAT HAPPENED WHEN OUR COUNTRY JOINED ENGLAND AND FRANCE TO FIGHT WORLD WAR I, WHICH WAS FOUGHT OVER ONE COUNTRY TRYING TO GAIN COLONIES AND WE HAD TO DECIDE ON WHOSE SIDE WE WERE ON, MAINLY BASED ON THE FACT OF WHAT COUNTRY WAS DEMOCRATICALLY RUN FOR THE BENEFIT OF THE PEOPLE. IN THOSE DAYS, A LOT OF COUNTRIES HAD KINGS AND THE MONARCHY RULED, WITH EVERYTHING MAINLY BENEFITING THE ONE PERCENT, WHO LIKED BEING PUT UP ON A PEDESTAL BUT DIDN’T TREAT THEIR FOLLOWERS WITH ANY HUMAN COURTESIES TO KEEP THEM SATISFIED WHICH LED TO CIVIL WARS. THIS SAME PATTERN GOES ON TODAY ONLY THEIR WEAPONS HAVE BECOME SO BIG AND DANGEROUS THAT THEY CAN DESTROY THE WHOLE WORLD. WOULDN’T YOU THINK, AFTER ALL THESE RIDICULOUS CYCLES WE GO THROUGH, THAT WE COULD LEARN FROM OUR MISTAKES? WELL, WE BETTER OR WE’LL ALL DESTROY OURSELVES POLITICALLY OR THROUGH RIDICULOUS RELIGIONS WHO FEEL ONLY THEY HAVE THE PROPER GOD TO RULE THE WORLD.
LaVern Isely, Overtaxed Independent Middle Class Taxpayer and Public Citizen and AARP Members