Do we need a global tax to stop rising inequality (crosspost from Crooked Timber seminar on Piketty)

One of the more depressing features of Capital in the 21st Century is the air of inevitability attached to the much-discussed r > g inequality. This is exacerbated, on the whole, by the fact that Piketty’s proposed policy response, a progressive global tax on wealth, seems obviously utopian.

What about a much simpler alternative: increasing the rate of income tax applied to the very rich, and removing preferential treatment of capital income? Piketty’s own work with Saez yields the conclusion that the socially optimal top marginal rate of taxation, after taking account of incentive effects, would be 70 per cent or more. Such rates prevailed, at least nominally, in the mid-20th century, without obvious ill effects. Again, Piketty provides the relevant evidence.

So, is there something about a globalised world economy that renders a return to high marginal rates of taxation impossible?

One crucial objection has been tested and refuted. Over the course of the 20th century, numerous small countries and some larger ones (notably Switzerland) established themselves as tax havens, willing to accept bank deposits and other capital flows from citizens of other countries and shield them from the efforts of the governments of those countries to collect taxes, or penalise tax evasion. Given the benefits of being a tax haven, it seemed likely that some jurisdictions would simply reject any attempt at an international effort to combat tax evasion.

The OECD put this proposition to the test when, in 2000, it listed a number of jurisdictions, such as Andorra and Liechtenstein as un-cooperative tax havens, because they declined to implement proposed standards of transparency and exchange of information. All of these jurisdictions ultimately capitulated and were “whitelisted”. The label “tax haven”, once sought-after, is now repudiated by all governments, however keen they may be to attract and retain hot money.

Even more symbolically important has been the end of Switzerland’s famous (or notorious) system of bank secrecy, as a result of agreements signed with the EU and other national governments over the past year. Under these agreements, the parties will automatically exchange information on the financial accounts of each other’s residents.

A bigger problem, central to Piketty’s larger concerns, is the deeply ingrained criminality of the financial sector, including participation in tax evasion. Despite repeated exposure, the big banks have got away with financial penalties that have barely dented their earnings and with occasional criminal charges against underlings. As long as major international banks retain their immunity from any kind of effective punishment, they will continue to facilitate both aggressive tax avoidance and criminal tax evasion. The ‘too big to jail’ list over the last year or so includes HSBC, Deutsche Bank and Credit Suisse, but others, like UBS, are even worse.

But with something like $200 billion in penalties levied over the past five years alone, the excuses are wearing thin, as is the theatre of ritual wrist-slapping. “Too big to jail” has become a public scandal so notorious that sooner or later, someone will be forced to act, and actually put one of these recidivists into receivership. That implies, breaking up their operations, sacking the entire management and wiping out the shareholders. With a few examples, “pour encourager les autres”, we might see some actual changes in behavior.

Corporate taxation presents some more difficult problems. National governments, such as those of Singapore and Ireland, have proved much more protective of corporate tax dodgers than of individuals. Resistance to measures to combat tax avoidance has been correspondingly stronger. Still, the OECD is slowly grinding its way through measures to combat BEPS (Base Erosion and Profit Shifting), its unlovely acronym for an array of corporate devices including transfer pricing and abuse of tax treaties. At some point, perhaps, the secrecy achieved through webs of shell companies may become as obsolete as numbered Swiss bank accounts.

A more serious objection is that, rather than notionally shifting their money, wealthy individuals and corporations might physically shift themselves and their productive activities to low-tax jurisdictions. On the whole, this problem does not look to be too severe. For example, despite a very attractive tax regime, and easy proximity to European capitals, the Channel Islands have not attracted English tax-dodgers in the numbers that might be expected. As regards corporations, the capacity to move is limited by economic realities. Whatever their organizational structure, companies like Apple and Google must generate their revenue, and their economic profit, in markets with large numbers of consumers. If the conduits they have used to shift that profit to tax havens are shut down, they have little choice but to pay up.

Finally, there’s the question of political practicality. For those whose views were formed by the tax revolts of the 1970s and 1980s, and by the capitalist triumphalism of the 1990s, substantial increases in tax rates, even for the very wealthy, are simply unthinkable. This is the intellectual background for the great majority of the political class, including the notional left, in most developed countries. But those days are fading into the past. The surprising success of Capital in the Twenty-First Century is one among many indications of an appetite for change.

33 thoughts on “Do we need a global tax to stop rising inequality (crosspost from Crooked Timber seminar on Piketty)

  1. There is an easy solution to preventing tax shelter tax avoidance. Impose capital controls toward capital that is mved to those shelters.
    Simply, introduce tax on transfers to Cayman Islands as if it is income.
    Any transfer to tax shelter can be taxed as profit or income. No matter what the money is for.
    For transfers to Ireland, reduce the tax by 10% as that is the rate of tax in Ireland.

    Upon implementation of this tax, all transfers to tax shelters will stop. It would be useless to use them.

  2. Rather then strugling with Pikkety’s calculations and mostly neoclasical theories, I consider institutional distribution of income as having more importance than anything else.
    Minimum wage is one such institution.
    Another one is credit score. Poor have to endure higher interest rates then rich when buying on credit. If that practice is reversed and poorness raises the score then over long term it would have much of the effect on inequality.

    Thisr institution that contributes to inequality is taxation, middle class pays the highest percentage of their income to tax, while richest can pay for skilled tax avoiding lawyers. Capital gains examption is also the cause of rising inequality.

  3. We need to look at changing how we tax earnings. Too many are able to reduce their taxable income to close to zero.

    A solution is to disentangle the rate at which expenses are deducted and income is taxed.

    Expenses should be deducted at a flat rate, say 25%, and would be effectively be a tax credit that low income earners would receive back from the tax office.

    Income would be taxed at progressively higher marginal rates. This removes the incentive for the rich to contrive expenses to benefit from the higher marginal income tax rates.

    At the moment there is a large inequity with the incentive to ‘invest’ in earnings being skewed to the rich.

    This approach also removes some of the incentives to game ‘taxable income’ to meet various social security cut-offs.

    By removing tax deductability at the higher marginal rate reduces the extent to which marginal income tax rates need to be increased.

  4. @Jordan from Croatia

    Our current economic system (late stage capitalism) is crisis-ridden and maladaptive. Those heavily invested in this system, financially or intellectually, are largely incapable of contemplating anything else. To them capitalism is indeed the end of history. This is the best possible system and we will never develop a better one… according to them. I wonder what we would call such an attitude if applied to science and technology?

  5. @Jordan from Croatia

    According to the WSJ the top 20% of income earners in the US pay an astounding 84% of all income taxes collected. The top 1% pay 45% of all income tax. Not sure where you get your figures for middle class paying the most, as the WSJ show the middle fifth of income earners paying only 5.9% of the total.

  6. @Joe – which just goes to show you should never trust the WSJ, or any News Limited paper. The trick (known to everyone who follows the debate by now, but apparently still worth pulling) is that they are counting the personal income tax, mostly paid by high income earners, but not the Social Security tax, the main tax on low incomes, which is capped for high income earners. I suggest you get some better figures, for example from Wikipedia

  7. Joe

    I did not say that Middle class pays the most, i said: “middle class pays the highest percentage of their income to tax”

    While WSJ is correct that top earners contribute the most to total income received by a state, it is also true that individualy, the highest burden is on middle class. Precentage of burden on middle class is 40% of their income, while the burden on top earners is around 8%.
    Your numbers are right, but i am concerned about the burden of tax on people, individually, not about the income to state.

    8% of $10 M earners accumulate much more then 40% of $200,000 earners to the state, even tough there is fewer of top earners.

    I used to watch those numbers yearly when i worked as office menager at tax preperation company.

  8. One method for dealing with corporations offshoring their tax bases is to commute or compound corporation tax for a proportion of shares held by governments; that way, the revenue stream is unaffected by such manoeuvres, transfer pricing issues turn into things that can be treated as “fraud on the minority”, and so on. There were serious problems of governance with this approach when it was tried a century or so ago, but these are political and institutional, and so should not worry anyone who trusts governments as much as most reformers do; there are no economic or financial problems with it, as such.

    By the way, the Channel Islands don’t pull in economic immigration because other measures stop that; I think a reply at the Crooked Timber cross post brought that out. When the rules tightened up it really hurt people who had already bought homes there in anticipation of being allowed to retire there.

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