Confiscatory Taxation of Excessive Incomes

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 505 and I quote: “Confiscatory Taxation of Excessive Incomes: An American Invention – When we look at the history of progressive taxation in the twentieth century, it is striking to see how far out in front Britain and the United States were, especially the latter, which invented the confiscatory tax on “excessive” incomes and fortunes. Figures 14.1 and 14.2 are particularly clear in this regard. This finding stands in such stark contrast to the way most people both inside and outside the United States and Britain have seen those two countries since 1980 that it is worth pausing a moment to consider the point further.
Between the two world wars, all the developed countries began to experiment with very high top rates, frequently in a rather erratic fashion. But it was the United States that was the first country to try rates above 70 percent, first on income in 1919-1922 and then on estates in 1937-1939. When a government taxes a certain level of income or inheritance at a rate of 70 or 80 percent, the primary goal is obviously not to raise additional revenue (because these very high brackets never yield much). It is rather to put an end to such incomes and large estates, which lawmakers have for one reason or another come to regard as socially unacceptable and economically unproductive—or if not to end them, then at least to make it extremely costly to sustain them and strongly discourage their perpetuation. Yet there is no absolute prohibition or expropriation. The progressive tax is thus a relatively liberal method for reducing inequality, in the sense that free competition and private property are respected while private incentives are modified in potentially radical ways, but always according to rules thrashed out in democratic debate. The progressive tax thus represents an ideal compromise between social justice and individual freedom. It is no accident that the United States and Britain, which throughout their histories have shown themselves to value individual liberty highly, adopted more progressive tax systems than many other countries. Note, however, that the countries of continental Europe, especially France and Germany, explored other avenues after World War II, such as taking public ownership of firms and directly setting executive salaries. These measures, which also emerged from democratic deliberation, in some ways served as substitutes for progressive taxes.
Other, more specific factors also mattered. During the Golden Age, many observers in the United States worried that the country was becoming increasingly inegalitarian and moving farther and farther away from its original pioneering ideal. In Willford King’s 1915 book on the distribution of wealth in the United States, he worried that the nation was becoming more like what he saw as the hyperinegalatarian societies of Europe. In 1919, Irving Fisher, then president of the American Economic Association, went even further. He chose to devote his presidential address to the question of US inequality and in no uncertain terms told his colleagues that the increasing concentration of wealth was the nation’s foremost economic problem. Fisher found King’s estimates alarming. The fact that “2 percent of the population owns more than 50 percent of the wealth” and that “two-thirds of the population owns almost nothing” struck him as “an undemocratic distribution of wealth,” which threatened the very foundation of US society. Rather than restrict the share of profits or the return on capital arbitrarily—possibilities Fisher mentioned only to reject them—he argued that the best solution was to impose a heavy tax on the largest estates (he mentioned a tax rate of two-thirds the size of the estate, rising to 100 percent if the estate was more than three generations old). It is striking to see how much more Fisher worried about inequality than Leroy-Beaulieu did, even though Leroy-Beaulieu lived in a far more inegalitarian society. The fear of coming to resemble Old Europe was no doubt part of the reason for the American interest in progressive taxes.
Furthermore, the Great Depression of the 1930s struck the United States with extreme force, and many people blamed the economic and financial elites for having enriched themselves while leading the country to ruin. (Bear in mind that the share of top incomes in US national income peaked in the late 1920s, largely due to enormous capital gains on stocks.) Roosevelt came to power in 1933, when the crisis was already three years old and one-quarter of the country was unemployed. He immediately decided on a sharp increase in the top income tax rate, which had been decreased to 25 percent in the late 1920s and again under Hoover’s disastrous presidency. The top rate rose to 63 percent in 1933 and then to 79 percent in 1937, surpassing the previous record of 1919. In 1942 the Victory Tax Act raised the top rate to 88 percent, and in 1944 it went up again to 94 percent, due to various surtaxes. The top rate then stabilized at around 90 percent until the mid-1960s, but then it fell to 70 percent in the early 1980s. All told, over the period 1932-1980, nearly half a century, the top federal income tax rate in the United States averaged 81 percent.
It is important to emphasize that no continental European country has ever imposed such high rates (except in exceptional circumstances, for a few years at most, and never for as long as half a century). In particular, France and Germany had top rates between 50 and 70 percent from the late 1940s until the 1980s, but never as high as 80-90 percent. The only exception was Germany in 1947-1949, when the rate was 90 percent. But this was a time when the tax schedule was fixed by the occupying powers (in practice, the US authorities). As soon as Germany regained fiscal sovereignty in 1950, the country quickly returned to rates more in keeping with its traditions, and the top rate fell within a few years to just over 50 percent (see Figure 14.1). We see exactly the same phenomenon in Japan.
The Anglo-Saxon attraction to progressive taxation becomes even clearer when we look at the estate tax. In the United States, the top estate tax rate remained between 70 and 80 percent from the 1930s to the 1980s, while in France and Germany the top rate never exceeded 30-40 percent except for the years 1946-1949 in Germany (see Figure 14.2).
The only country to match or surpass peak US estate tax rates was Britain. The rates applicable to the highest British incomes as well as estates in the 1940s was 98 percent, a peak attained again in the 1970s—an absolute historical record. Note, too, that both countries distinguished between “earned income,” that is, income from labor (including both wages and nonwage compensation) and “unearned income,” meaning capital income (rent, interests, dividends, etc.). the top rates indicated in Figure 14.1 for the United States and Britain applied to unearned income. At times, the top rate on earned income was slightly lower, especially in the 1970s. This distinction is interesting, because it is a translation into fiscal terms of the suspicion that surrounded very high incomes: all excessively high incomes were suspect, but unearned incomes were more suspect than earned incomes. The contrast between attitudes then and now, with capital income treated more favorably today than labor income in many countries, especially in Europe, is striking. Note, too, that although the threshold for application of the top rates has varied over time, it has always been extremely high: expressed in terms of average income in the decade 2000-2010, the threshold has generally ranged between 500,000 and 1 million euros. In terms of today’s income distribution, the top rate would therefore apply to less than 1 percent of the population (generally somewhere between 0.1 and 0.5 percent).
The urge to tax unearned income more heavily than earned income reflects an attitude that is also consistent with a steeply progressive inheritance tax. The British case is particularly interesting in a long-run perspective. Britain was the country with the highest concentration of wealth in the nineteenth and early twentieth centuries. The shocks (destruction, expropriation) endured by large fortunes fell less heavily there than on the continent, yet Britain chose to impose its own fiscal shock—less violent than war but nonetheless significant: the top rate ranged from 70 to 80 percent or more throughout the period 1940-1980. No other country devoted more thought to the taxation of inheritances in the twentieth century, especially between the two world wars. In November 1928, Josiah Wedgwood, in the preface to a new edition of his classic 1929 book on inheritance, agreed with his compatriot Bertrand Russell that the “plutodemocracies” and their hereditary elites had failed to stem the rise of fascism. He was convinced that “political democracies that do not democratize their economic systems are inherently unstable.” In his eyes, a steeply progressive inheritance tax was the main tool for achieving the economic democratization that he believed to be necessary.
The Explosion of Executive Salaries: The Role of Taxation – After experiencing a great passion for equality from the 1930s through the 1970s, the United States and Britain veered off with equal enthusiasm in the opposite direction. Over the past three decades, their top marginal income tax rates, which had been significantly higher than the top rates in France and Germany, fell well below French and German levels. While the latter remained stable at 50-60 percent from 1930 to 2010 (with a slight decrease toward the end of the period), British and US rates fell from 80-90 percent in 1930-1980 to 30-40 percent in 1980-2010 (with a low point of 28 percent after the Reagan tax reform of 1986) (see Figure 14.1). The Anglo-Saxon countries have played yo-yo with the wealthy since the 1930s. By contrast, attitudes toward top incomes in both continental Europe (of which Germany and France are fairly typical) and Japan have held steady. I showed in Part One that part of the explanation for this difference might be that the United States and Britain came to feel that they were being overtaken by other countries in the 1970s. This sense that other countries were catching up contributed to the rise of Thatcherism and Reaganism. To be sure, the catch-up that occurred between 1950 and 1980 was largely a mechanical consequence of the shocks endured by continental Europe and Japan between 1914 and 1945. The people of Britain and the United States nevertheless found it hard to accept: for countries as well as individuals, the wealth hierarchy is not just about money: it is also a matter of honor and moral values. What were the consequences of this great shift in attitudes in the United States and Britain?
If we look at all the developed countries, we find that the size of the decrease in the top marginal income tax rate between 1980 and the present is closely related to the size of the increase in the top centile’s share of national income over the same period. Concretely, the two phenomena are perfectly correlated: the countries with the largest decreases in their top tax rates are also the countries with the largest decreases in their top earners’ share of national income has increased the most (especially when it comes to the remuneration of executives of large firms). Conversely, the countries that did not reduce their top tax rates very much saw much more moderate increases in the top earners’ share of national income. If one believes the classic economic models based on the theory of marginal productivity and the labor supply and productivity. Since their marginal productivity increased, their salaries increased commensurately and therefore rose well above executive salaries in other countries. This explanation is not very plausible, however. As I showed in chapter 9, the theory of marginal productivity runs into serious conceptual and economic difficulties (in addition to suffering from a certain naivete) when it comes to explaining how pay is determined at the top of the income hierarchy.
A more realistic explanation is that lower top income tax rates, especially in the United States and Britain, where top rates fell dramatically, totally transformed the way executives’ salaries are determined. It is always difficult for an executive to convince other parties involved in the firm (direct subordinates, workers lower down in the hierarchy, stockholders, and members of the compensation committee) that a large pay raise—say of a million dollars—is truly justified. In the 1950s and 1960s, executives in British and US firms had little reason to fight for such raises, and other interested parties were less inclined to accept them, because 80-90 percent of the increase would in any case go directly to the government. After 1980, the game was utterly transformed, however, and the evidence suggests that executives went to considerable lengths to persuade other interested parties to grant them substantial raises. Because it is objectively difficult to measure individual contributions to a firm’s output, top managers found it relatively easy to persuade boards and stockholders that they were worth the money, especially since the members of compensation committees were often chosen in a rather incestuous manner.
Furthermore, this “bargaining power” explanation is consistent with the fact that there is no statistically significant relationship between the decrease the top marginal tax rates and the rate of productivity growth in the developed countries since 1980. Concretely, the crucial fact is that the rate of per capita GDP growth has been almost exactly the same in all the rich countries since 1980. In contrast to what many people in Britain and the United States believe, the true figures on growth (as best one can judge from official national accounts data) show that Britain and the United States have not grown any more rapidly since 1980 than Germany, France, Japan, Denmark, or Sweden. In other words, the reduction of top marginal income tax rates and the rise of top incomes do not seem to have stimulated productivity (contrary to the predictions of supply-side theory) or at any rate did not stimulate productivity enough to be statistically detectable at the macro level.
Considerable confusion exists around these issues because comparisons are often made over periods of just a few years (a procedure that can be used to justify virtually any conclusion). Or one forgets to correct for population growth (which is the primary reason for the structural difference in GDP growth between the United States and Europe). Sometimes the level of per capita output (which has always been about 20 percent higher in the United States, in 1970-1980 as well as 2000-2010) is confused with the growth rate (which has been about the same on both continents over the past three decades). But the principal source of confusion is probably the catch-up phenomenon mentioned above. There can be no doubt that British and US decline ended in the 1970s, in the sense that growth rates in Britain and the United States, which had been lower than growth rates in Germany, France, Scandinavia, and Japan, ceased to be so. But it is also incontestable that the reason for this convergence is quite simple: Europe and Japan had caught up with the United States and Britain. Clearly, this had little to do with the conservative revolution in the latter two countries in the 1980s, at least to a first approximation.
No doubt these tissues are too strongly charged with emotion and too closely bound up with national identities and pride to allow for calm examination. Did Maggie Thatcher save Britain? Would Bill Gates’s innovations have existed without Ronald Reagan? Will Rhenish capitalism devour the French social model? In the face of such powerful existential anxieties, reason is often at a loss, especially since it is objectively quite difficult to draw perfectly precise and absolutely unassailable conclusions on the basis of growth rate comparisons that reveal differences of a few tenths of a percent. As for Bill Gates and Ronald Reagan, each with his own cult of personality (Did Bill invent the computer or just the mouse? Did Ronnie destroy the USSR single-handedly or with the help of the pope?), it may be useful to recall that the US economy was much more innovative in 1950-1970 than in 1990-2010, to judge by the fact that productivity growth was nearly twice as high in the former period as in the latter, and since the United States was in both periods at the world technology frontier, this difference must be related to the pace of innovation. A new argument has recently been advanced: it is possible that the US economy has become more innovative in recent years but that this innovation does not show up in the productivity figures because it spilled over into the other wealthy countries, which have thrived on US inventions. It would nevertheless be quite astonishing if the United States, which has not always been hailed for international altruism (Europeans regularly complain about US carbon emissions, while the poor countries complain about American stinginess) were proven not to have retained some of this enhanced productivity for itself. In theory, that is the purpose of patents. Clearly, the debate is nowhere close to over.
In an attempt to make some progress on these issues, Emmanuel Saez, Stefanie Stantcheva, and I have tried to go beyond international comparisons and to make use of a new database containing information about executive compensation in listed companies throughout the developed world. Our findings suggest that skyrocketing executive pay is fairly well explained by the bargaining model (lower marginal tax rates encourage executives to negotiate harder for higher pay) and does not have much to do with a hypothetical increase in managerial productivity. We again found that the elasticity of executive pay is greater with respect to “luck” (that is, variations in earnings that cannot have been due to executive talent, because, for instance, other firms in the same sector did equally well) than with respect to “talent” (variations not explained by sector variables). As I explained in Chapter 9, this finding poses serious problems for the view that high executive pay is a reward for good performance. Furthermore, we found that elasticity with respect to luck—broadly speaking, the ability of executives to obtain raises not clearly justified by economic performance—was higher in countries where the top marginal tax rate was lower. Finally, we found that variations in the marginal tax rate can explain why executive pay rose sharply in some countries and not in others. In particular, variations in company size and in the importance of the financial sector definitely cannot explain the observed facts. Similarly, the idea that skyrocketing executive pay is due to lack of competition, and that more competitive markets and better corporate governance and control would put an end to it, seems unrealistic. Our findings suggest that only dissuasive taxation of the sort applied in the United States and Britain before 1980 can do the job. In regard to such a complex and comprehensive question (which involves political, social, and cultural as well as economic factors), it is obviously impossible to be totally certain: that is the beauty of the social sciences. It is likely, for instance, that social norms concerning executive pay directly influence the levels of tax rates. Nevertheless, the available evidence suggests that our explanatory model gives the best explanation of the observed facts.”

(THIS IS THE SAME SUBJECT THAT I READ ABOUT IN SENATOR ELIZABETH WARREN’S NEW BOOK “A FIGHTING CHANCE” WHERE SHE MENTIONS A FINANCIAL TRANSACTIONS TAX (ALSO KNOWN AS THE ROBIN HOOD TAX) TO PUT A SMALL FEE ON EACH STOCK TRANSACTION TO HELP PAY FOR THE GROWING DEBT. ELLEN BROWN ALSO TALKS ABOUT THIS SUBJECT IN HER BOOK “WEB OF DEBT” WHERE SHE MADE A STATEMENT THAT IF WE HAD THE FINANCIAL TRANSACTIONS TAX, WE WOULDN’T HAVE TO PAY ANY INCOME TAX BECAUSE IT WOULD BRING IN THAT MUCH REVENUE AND THAT’S SOMETHING WE DEFINITELY NEED TO REDUCE THE DEBT BECAUSE OUR COUNTRY DOESN’T BELIEVE IN PRESIDENT FRANKLIN ROOSEVELT’S THEORY OF INCOME TAX, BASED ON ABILITY TO PAY, ANYMORE, WHICH HE ENFORCED, WHICH I REMEMBER MYSELF, RIGHT UP TO THE TIME WHEN PRESIDENT KENNEDY LOWERED IT DOWN TO 70 PERCENT AND FINALLY WHEN PRESIDENT REAGAN LOWERED IT TO 28 PERCENT, WHICH REALLY MADE IT A BONANZA FOR THE WEALTHIEST BILLIONAIRES. THE PROBLEM IS, IT NEVER REALLY GOT THE BILLS PAID AND WE HAD TO BORROW MONEY FROM CHINA, JAPAN, KOREA. ANY COUNTRY THAT WOULD LOAN US MONEY, MAKING OUR GREAT NATION UNDER FDR A CREDITOR NATION TO NOW A DEBTOR NATION UNDER BUSH AND CHENEY, WITH A SLIGHT IMPROVEMENT UNDER PRESIDENT OBAMA.

LaVern Isely, Overtaxed Independent Middle Class Taxpayer and Public Citizen and AARP Members

 

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About tim074

I'm a retired dairy farmer that was a member of the National Farmer's Organization (NFO). Before going farming, I spent 4 years in the United States Air Force where I saved up enough money to get my down payment to go farming. I also enjoy writing and reading biographies and I write about myself as well as articles and excerpts I find interesting. I'm specifically interested in finances, particularly in the banking industry because if it wasn't for help from my local Community Bank, I never could have started farming which I was successful at. So, I'm real interested in the Small Business Administration and I know they are the ones creating jobs. I have been a member of Common Cause and am now a member of Public Citizen as well as AARP. I have, in the past, written over 150 articles on the Obama Blog (my.barackobama.com) and I'd like to tie these two sites together. I'm also on Twitter, MySpace and Facebook and find these outlets terrifically interesting particularly what many of these people did concerning the uprising in the Arab world. I believe this is a smaller world than we think it is and my goal is to try to bring people together to live in peace because management needs labor like labor needs management. Up to now, that hasn't been so easy to find.
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