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. “… after taking account of incentive effects …”

    I have never understood this proposition. Tax rates were much higher under, for example, Eisenhower’s presidency (91% for income above $200,000 pa at the time) and even higher (92%) under the prior regime (harry Truman) yet as far as I can glean from any and all testimony, none of the ‘wealthy; back then ever went on strike and refused to earn more money.

    So just what is this purported “incentive effect” ? Perhaps a higher marginal tax rate actually “incentivizes” harder work and higher earnings.

    “The ‘too big to jail’ list …”

    I remember Michael Milken and the great surprise expressed at the time that a rich man could somehow end up in jail for a merely ‘financial’ crime. Perhaps, sooner or later, we’ll all be expressing surprise on behalf of ‘financially criminal’ organizations and their senior ‘managers’ ?

    I’m given to understand that basically every species of more complex animals has its ‘free loaders’ and that when times are good, a high percentage of free loaders is tolerated. But when times aren’t so good, the tolerance degrades rapidly. Maybe Homo Sapiens has just hit its tolerance downtrend time.

  2. GrueBleen :
    So just what is this purported “incentive effect” ?

    Reminds me of something (I think) J.K. Galbraith observed that Republicans think the wealthy need to be paid more to incentivise them to work harder, but the poor need to be paid less to similarly incentivise them to work harder.

  3. I think the original post is good in the arena it enters. It covers the main points and makes worthwhile suggestions.

    Now, I will push one old barrow and one new one.

    Old Barrow

    Why the seemingly constant focus on taxes and redistribution to stop, and hopefully reverse, rising inequality? Why is there seemingly less focus on dealing with rising inequality at its source? Why don’t we look more at the private enterprise economic system to determine how it or a replacement could work at least as well productively without generating so much income and wealth inequality in the first place?

    In other words, tax is just one issue. Higher taxes and redistribution are only a palliative, not even a cure. Prevention is better than palliative or cure. How do we prevent the system generating so much inequality in the first place?

    New Barrow

    With electronic money every transaction, at least over a certain size, should have a trace. Thus if money goes through 20 shell companies the data on accounts at every step should go back to a central tracker and repository with SWIFT or the IMF or some such authority. Why can’t this be made a reality?

  4. companies like Apple and Google must generate their revenue, and their economic profit, in markets with large numbers of consumers

    Simply untrue.

    Revenue does not have a one-to-one correspondence to economic profit in any particular jurisdiction. Apple Australia is simply a glorified importer and retailer of (moderately expensive) products. Its economic value is thus that of an importer and retailer that bears no necessary relationship with the economic value of the (overseas) business that produces the products it imports and sells.

  5. a much simpler alternative: increasing the rate of income tax applied to the very rich

    A.k.a. the solution to all tax revenue problems is just to raise the income tax rate and not bother with the other factor in income tax, taxable income. This is pretty strange because the greatest opportunities for increasing income tax revenue lie in increasing the definition of taxable income. The most obvious examples are reconsidering the deductions from taxable income, principally superannuation and negative gearing, the benefits of which overwhelmingly go to the very well off. Less well-understood but at least as valid is economic rent, which in Australia is mainly real capital gain on land.

    It’s OK to propose increasing the highest marginal tax rates, but this is only one part of the equation.

  6. There is certainly an “appetite for change” within the working population at large but not, it seems, within our political machinery.

    The qualifications to get elected are different to the qualifications needed to deal with these issues.

  7. @bjb

    Yes I do recall that statement now that you’ve reminded me. I’ve never actually heard of the CEO (or any other senior manager) of a large corporation claiming that they were slacking off because the marginal tax rate was too high. Maybe they’d have got short shrift if they’d tried it.

    But Hugh Morgan, once of Western Mining Corp, was penalized, if I recall correctly, by the board of Western Mining because he effectively ‘slacked off’ by spending too much time on political activities (eg the H R Nicholls Society) and not enough time and effort on running WMC. I can’t remember the year unfortunately, but WMC was having a bit of a downturn, so the board cancelled Morgan’s bonus for the year.

    That apparently ‘re-incentivized’ him and he went back, for a while anyway, to actually managing WMC.

  8. @Chris O’Neill

    I don’t think you understand the concept of economic profit. Apple earns an economic profit because of its exclusive assets (essentially the operating systems). That profit is earned on each unit sold.

  9. Given the many cases of corporate tax avoidance, suspiciously low tax paid by businesses, the excess remuneration of CEOs and the continuing scandals of under-paying workers is not time for a Royal Commission?

    We have had the Royal Commission into Trade Union Governance and Corruption.

    We now need the Royal Commission into Business Governance and Corruption.

    Since we have even-handed government which does not favour capital over labour (sarcasm alert!), I am sure will now see a Royal Commission into Business Governance and Corruption. If I don’t see it I will know what it means.

    I notice that “Business Group Chartered Accountants Australia and New Zealand has warned that authorities and companies in both countries are too laidback about corruption, bribery and fraud.”

    It seems very clear that a new RC is needed. If the Labor Party gets back into power and don’t run a Royal Commission into Business Governance and Corruption they will show (once again) what a pack of gutless, servile swine they are.

  10. @GrueBleen Christina Romer studied the incentive effect of taxation and found that it does have an effect but this effect is greater on the poor and diminished on the wealthy. So the question should be, does raising taxes for the wealthy diminish their incentive to work?

    The evidence indicates not much at all.

  11. GrueBleen

    Christina Romer studied the incentive effect of taxation and found that it does have an effect but this effect is greater on the poor and diminished on the wealthy. So the question should be, does raising taxes for the wealthy diminish their incentive to work?

    The evidence indicates not much at all.

  12. JQ, you forgot Goldman-Sachs, JP Morgan and a few UK banks.

    There seems to be no law against selling junk bonds, rated by rating agencies, as investment bonds.

    (The only logical reason I can think of for abolishing all holidays for each and every person who ‘makes money in the financial sector’ is that securitisation requires continuous trading.)

    The idea of letting the big financial institutions fail and shareholders will get a hair cut works if ‘shareholders’ are a class of exclusively very high positive net wealth individuals. This is empirically not true. Superfunds do invest in bank shares too. Some of these indirect investors have negative net wealth (mortgages and personal loans and car loans).

    It seems to me a better way to reintroduce personal liability is to prevent investment bankers from incorporating. This used to be the case at least in the USA. In this case the partners’ own equity is a risk.

  13. There seems to be no law against selling junk bonds, rated by rating agencies, as investment bonds.

    As a layman it seems to me that this would fall under the category of crime called fraud. Can’t the laws be written in such a way that we don’t need to make a law for every type of fraud that the criminal class dream up?

  14. bjbthe wealthy need to be paid more to incentivise them to work harder, but the poor need to be paid less to similarly incentivise them to work harder.

    Yes, because obviously people who choose to be poor aren’t motivated by the love of money in the same way that people who choose to be rich are. Otherwise they’d choose to be rich.

    On the nominal topic, one advantage of a transaction tax is that it increases visibility of transactions and also increases their friction – shuffling money from A to B to C to D in order to reduce tax paid stops working if the number of transaction tax hits gets high enough.

  15. Yes, because obviously people who choose to be poor aren’t motivated by the love of money in the same way that people who choose to be rich are. Otherwise they’d choose to be rich.

    This is actually true! People who want to be rich can wind up rich or poor or in-the-middle, but people who don’t hugely want to be rich, who aren’t seeking the immunity-from-the-concerns-of-others that extreme wealth brings, well, they don’t wind up that rich. They might wind up pretty wealthy or they might wind up dirt poor, but they don’t wind up on the top of the heap.

    The top of the heap is made up entirely of people who fought tooth-and-nail to get there, and, well… the reasons for wanting to get to the top of the heap, the drives that pushed these people to the social role they sought and succeeded in attaining, none of them are that nice.

  16. @Collin Street

    The top of the heap is made up entirely of people who fought tooth-and-nail to get there

    To some extent, yes, but then you have George Bush the Lesser and Gina Reinhart as counterexamples. They may have fought to stay on top, but they didn’t claw their way to the top.

    Either way, we should tax them based both on wealth and income.

  17. Ikonoclast, regarding Labor being gutless servile swine, I just today came across this article titled Labor’s Accord: How Hawke and Keating began a neo-liberal revolution, which fully details how Labor is worse than gutless and servile. Not only are they treacherous in their sellout of the working man but quite stupid in allowing the erosion of their base. The only thing that has saved Labor from irrelevance a la the Democrats is the incredible lurch to the Right of the Coalition. You may notice that there are other articles in the series. Keating’s role post Hawke is particularly feculent.

  18. We definitely need taxes on wealth (not on retained earnings of sole traders) to redress equality. And we can do this in the context of reducing non-welfare non-infrastructure spending. But what we don’t need is to make it a global tax. Making it a global tax means it will be looted by elite criminals and used for malicious undertakings.

    The extra taxes should come in the form of total assets taxes, with high tax free thresholds for real human beings. And no threshold ever for artificial persons. In practice this will be a wealth tax as people seek to divest themselves of trusts, and as companies sell off assets to individuals to bring those assets under the tax free thresholds.

    The reason the income tax never lead to greater equality is that these taxes were founded by banking dynasts, the motive being that they would in-debt every government body and then use the income tax to service these debts. So the motive was wrong. An income tax COULD be part of the package for greater equality. But it won’t be if the intention is not there. In practice in Australia, with the use of trusts and other artificial persons … almost nobody pays more than about $100 000 (a few years ago it was quoted by a tax expert at $70 000) per year in taxes. This is an outrage since it means people with hundreds of millions of dollars in assets and pulling in many millions of revenues per year, pay very little taxes.

    Somehow the left and right both have it in their heads that higher government spending means more equality. And when someone like Huey Long comes out for small government egalitarianism he’s shouted down or worse. In fact it could be that the massive killings associated with communism were engineered from the the West in order to associate any feelings towards equality with bloodshed.

    I would want strong infrastructure owned publicly and a sole trader economy. With no taxes on retained earnings for the sole trader. With that sort of setup there would be far less problems with market failure that critics of the Austrian and British Classical schools rightly point out.

    Why the need to push equality as part of some global revenue slush fund? More equality is a good thing in and of itself and I’d like to see it come about even as we close down government departments by the bakers dozen. Its small government egalitarianism that the oligarchy just has no time for. They need to set up false dichotomies to keep us fighting each-other. They want conflict so that we never realise that they are stealing off us and denying us our right to thrive as a normal reward for hard work and business reinvestment.

  19. @rog

    I looked at the Christina Roma post you referenced, rog, but try as I might, I couldn’t find anywhere she’d actually said that “this effect is greater on the poor “. Maybe it was said in one of the references she points to, but I didn’t chase them down. Can you point me to where she said this ?

    But she did say: “Workers may choose to work additional hours, or a stay-at-home spouse may decide to work outside the home.” I found that quite entertaining. I don’t know what world Christina Roma lives in, but in the world I live in not very many people are (a) paid by the hour and (b) the number of hours they work is entirely by their own choice. Or a world in which people can just walk out their front door and get a suitable ‘ex stay-at-home-spouse’ job.

    How about your world ? When I worked, I worked for an annual salary paid monthly and I could work all the additional hours I wanted, but I wouldn’t get any extra pay.

    Though there is, of course, the well known ‘welfare trap’ where people who might otherwise try to get a job don’t because the take home pay (after taxation) is only marginally (if at all) more than their welfare benefit (and they lose welfare extras such as rent assistance).

  20. @GrueBleen

    You have to read between the lines eg “Finally, income inequality has surged in recent decades. Raising marginal rates on the wealthy is a straightforward, effective way to counter this trend”

    In the below article Romer puts the top rate for the wealthy at 80%!

    Economist seem to agree that you can tax the rich hard before impacting on GDP. However, there are ethical and political arguments against this.

  21. @rog

    “You have to read between the lines …”
    “Reading between the lines” is just a form of written ‘dog whistle’, isn’t it. In short, what you hear or see is what you’re looking for, not whatever, if anything at all, might actually be there. So, I beg your pardon, but I try very hard to only pay attention to what is actually said. Not always completely successfully, but I try.

    “Raising marginal rates on the wealthy is a straightforward, effective way to counter this trend” [the “trend” of inequality]

    But of course it isn’t, it’s only a way to attempt to decrease the disparity in spendable (and hence discretionary) money – the large disparity in income remains, and the options still remain for the higher paid to minimize and/or avoid tax. For instance by having ‘salary’ converted to share options which are taxed at the lower rate of capital investment versus earned income. Or, instead of salary, to get various ‘company benefits’ that may even be altogether untaxed.

    “… there are ethical and political arguments against this.”

    But there always are, aren’t there. That’s the glory of the opinionated opinionism that is “politics” and “ethics” – if you try hard enough, you can make an argument for or against anything.

    I tried to read that post that you referenced, but it was too rambling for me – taking 1000 words to say what 100 plus an occasional chart could have said. So I gave up.

    But not before I encountered this: “…a marginal tax rate increase will modestly decrease labor supply, and the response is generally quite stable across the income distribution (although lower-income households eligible for the Earned Income Tax Credit are more responsive, as intended).”

    That bemused me totally; somehow the poor have, and exercise, greater control over how many hours they work and/or how many jobs they work than the ‘wealthy’. And this despite that a marginal tax rate increase doesn’t affect the EITC folks at all, since a ‘marginal tax rate increase’ only applies to the very high earners and doesn’t cut in on anybody who qualifies for EITC. Or should I be trying to do some more “reading between the lines” do you think ?

  22. @GrueBleen I took the epi article at face value and until I know different believe that it was written in good faith. Without having to strain ones deductive abilities this section seems fairly straightforward

    Beyond pushing back against widening inequality, there is an abundance of evidence that raising top tax rates above and beyond their Clinton-era levels would substantially improve the long-term fiscal outlook, only negligibly impede productive economic activity, and perhaps boost long-run economic growth to the extent that they preclude deeper cuts to public investment and reduce crowding out of private investment whenever the economy eventually returns to full employment. Raising top ordinary income tax rates from currently suboptimally low levels would ameliorate two of the three interrelated, pressing economic challenges facing the United States of ensuring long-run fiscal sustainability and pushing back against ever-widening income inequality. Crucially, it would do so without unduly hampering economic growth, particularly in the prevailing economic context.

  23. @rog

    Straightforward, but not particularly believable. For starters, there’s not much about the “long term fiscal outlook” – either here or in the USA – that needs to be “substantially improve[d]”

    And secondly, if we’re talking about actual “widening inequality”, then how about this (from a Gawker post of a couple of years ago on the ratio of CEO pay to the average employee’s pay):

    “It depends on whether you embrace the crass, cutthroat capitalist vision of our society (objectively true) or the fair, democratic, equality-driven vision of our society (something to work for). Most working people, I’d wager, would feel that a ratio of 230-1 goes against common fairness. To put that figure in perspective: in 1965, the ratio was more like 20-1. Also: “From 1978 to 2011, CEO compensation increased more than 725 percent, a rise substantially greater than stock market growth and the painfully slow 5.7 percent growth in worker compensation over the same period.”

    Now that describes actual inequality, and somehow increasing the marginal tax rate by a few percent is supposed to fix that all up ?

  24. There is a change. Few years back my every mentioning of increase of marginal tax was met with furious response. Now, it is a common proposal. It is a big change.

    But having 90% MTR is not for state funding purposes, that is irelevant.
    90% MTR is a part of solution to inequality, without it it puts menagement into fight for part of income for larger share of the pie and workers always loose. With 90% rate there is no incentives for menagemant to hoard income against other employees.
    Another part to inequality solution is minimum wage. Australia and Canada are the prime example of eficacy of minimum wage.

    Not only does 90% MTR is preventing the pitting management against workers for income share but also prevents management to loot the company they work for. Banking crisis is the obvious example of managers looting their own banks, an even betting against them. Enron and other exacutives previously sold their shares before anyone else and with that contributed to panic about their own companies.

    Sure, any income should be treated as any other income, no capital gains exemptions.

    Many managers looted their own companies forcing them, and also suggesting to switch to operating expenses from loans, not from accumulation, and then when crisis hit and value of shares as colateral droped, these companies colapsed.
    90% MTR is also preventing some of the bankrupcies. Short term thinking of executives is prevented too.

  25. 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.

  26. 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.

  27. 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.

  28. @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?

  29. @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.

  30. @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

  31. 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.

  32. 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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