Capital in the Twenty-First Century (86 page)

One usually distinguishes among taxes on income, taxes on capital, and taxes on consumption.
Taxes of each type can be found in varying proportions in nearly all periods. These
categories are not exempt from ambiguity, however, and the dividing lines are not
always clear. For example, the income tax applies in principle to capital income as
well as earned income and is therefore a tax on capital as well. Taxes on capital
generally include any levy on the flow of income from capital (such as the corporate
income tax), as well as any tax on the value of the capital stock (such as a real
estate tax, an estate tax, or a wealth tax). In the modern era, consumption taxes
include value-added taxes as well as taxes on imported goods, drink, gasoline, tobacco,
and services. Such taxes have always existed and are often the most hated of all,
as well as the heaviest burden on the lower class (one thinks of the salt tax under
the Ancien Régime). They are often called “indirect” taxes because they do not depend
directly on the income or capital of the individual taxpayer: they are paid indirectly,
as part of the selling price of a purchased good. In the abstract, one might imagine
a direct tax on consumption, which would depend on each taxpayer’s total consumption,
but no such tax has ever existed.
¹

In the twentieth century, a fourth category of tax appeared: contributions to government-sponsored
social insurance programs. These are a special type of tax on income, usually only
income from labor (wages and remuneration for nonwage labor). The proceeds go to social
insurance funds intended to finance replacement income, whether pensions for retired
workers or unemployment benefits for unemployed workers. This mode of collection ensures
that the taxpayer will be aware of the purpose for which the tax is to be used. Some
countries, such as France, also use social contributions to pay for other social spending
such as health insurance and family allowances, so that total social contributions
account for nearly half of all government revenue. Rather than clarify the purpose
of tax collection, a system of such complexity can actually obscure matters. By contrast,
other states, such as Denmark, finance all social spending with an enormous income
tax, the revenues from which are allocated to pensions, unemployment and health insurance,
and many other purposes. In fact, these distinctions among different legal categories
of taxation are partly arbitrary.
²

Beyond these definitional quibbles, a more pertinent criterion for characterizing
different types of tax is the degree to which each type is proportional or progressive.
A tax is called “proportional” when its rate is the same for everyone (the term “flat
tax” is also used). A tax is progressive when its rate is higher for some than for
others, whether it be those who earn more, those who own more, or those who consume
more. A tax can also be regressive, when its rate decreases for richer individuals,
either because they are partially exempt (either legally, as a result of fiscal optimization,
or illegally, through evasion) or because the law imposes a regressive rate, like
the famous “poll tax” that cost Margaret Thatcher her post as prime minister in 1990.
³

In the modern fiscal state, total tax payments are often close to proportional to
individual income, especially in countries where the total is large. This is not surprising:
it is impossible to tax half of national income to finance an ambitious program of
social entitlements without asking everyone to make a substantial contribution. The
logic of universal rights that governed the development of the modern fiscal and social
state fits rather well, moreover, with the idea of a proportional or slightly progressive
tax.

It would be wrong, however, to conclude that progressive taxation plays only a limited
role in modern redistribution. First, even if taxation overall is fairly close to
proportional for the majority of the population, the fact that the highest incomes
and largest fortunes are taxed at significantly higher (or lower) rates can have a
strong influence on the structure of inequality. In particular, the evidence suggests
that progressive taxation of very high incomes and very large estates partly explains
why the concentration of wealth never regained its astronomic Belle Époque levels
after the shocks of 1914–1945. Conversely, the spectacular decrease in the progressivity
of the income tax in the United States and Britain since 1980, even though both countries
had been among the leaders in progressive taxation after World War II, probably explains
much of the increase in the very highest earned incomes. At the same time, the recent
rise of tax competition in a world of free-flowing capital has led many governments
to exempt capital income from the progressive income tax. This is particularly true
in Europe, whose relatively small states have thus far proved incapable of achieving
a coordinated tax policy. The result is an endless race to the bottom, leading, for
example, to cuts in corporate tax rates and to the exemption of interest, dividends,
and other financial revenues from the taxes to which labor incomes are subject.

One consequence of this is that in most countries taxes have (or will soon) become
regressive at the top of the income hierarchy. For example, a detailed study of French
taxes in 2010, which looked at all forms of taxation, found that the overall rate
of taxation (47 percent of national income on average) broke down as follows. 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. The high tax rates
on the poor reflect the importance of consumption taxes and social contributions (which
together account for three-quarters of French tax revenues). The slight progressivity
observed in the middle class is due to the growing importance of the income tax. Conversely,
the clear regressivity in the top centiles reflects the importance at this level of
capital income, which is largely exempt from progressive taxation. The effect of this
outweighs the effect of taxes on the capital stock (which are the most progressive
of all).
⁴
All signs are that taxes elsewhere in Europe (and probably also in the United States)
follow a similar bell curve, which is probably even more pronounced than this imperfect
estimate indicates.
⁵

If taxation at the top of the social hierarchy were to become more regressive in the
future, the impact on the dynamics of wealth inequality would likely be significant,
leading to a very high concentration of capital. Clearly, such a fiscal secession
of the wealthiest citizens could potentially do great damage to fiscal consent in
general. Consensus support for the fiscal and social state, which is already fragile
in a period of low growth, would be further reduced, especially among the middle class,
who would naturally find it difficult to accept that they should pay more than the
upper class. Individualism and selfishness would flourish: since the system as a whole
would be unjust, why continue to pay for others? If the modern social state is to
continue to exist, it is therefore essential that the underlying tax system retain
a minimum of progressivity, or at any rate that it not become overtly regressive at
the top.

Furthermore, looking at the progressivity of the tax system by examining how heavily
top incomes are taxed obviously fails to weigh inherited wealth, whose importance
has been increasing.
⁶
In practice, estates are much less heavily taxed than income.
⁷
This exacerbates what I have called “Rastignac’s dilemma.” If individuals were classified
by centile of total resources accrued over a lifetime (including both earned income
and capitalized inheritance), which is a more satisfactory criterion for progressive
taxation, the bell curve would be even more markedly regressive at the top of the
hierarchy than it is when only labor incomes are considered.
⁸

One final point bears emphasizing: to the extent that globalization weighs particularly
heavily on the least skilled workers in the wealthy countries, a more progressive
tax system might in principle be justified, adding yet another layer of complexity
to the overall picture. To be sure, if one wants to maintain total taxes at about
50 percent of national income, it is inevitable that everyone must pay a substantial
amount. But instead of a slightly progressive tax system (leaving aside the very top
of the hierarchy), one can easily imagine a more steeply progressive one.
⁹
This would not solve all the problems, but it would be enough to improve the situation
of the least skilled significantly.
¹⁰
If the tax system is not made more progressive, it should come as no surprise that
those who derive the least benefit from free trade may well turn against it. The progressive
tax is indispensable for making sure that everyone benefits from globalization, and
the increasingly glaring absence of progressive taxation may ultimately undermine
support for a globalized economy.

For all of these reasons, a progressive tax is a crucial component of the social state:
it played a central role in its development and in the transformation of the structure
of inequality in the twentieth century, and it remains important for ensuring the
viability of the social state in the future. But progressive taxation is today under
serious threat, both intellectually (because its various functions have never been
fully debated) and politically (because tax competition is allowing entire categories
of income to gain exemption from the common rules).

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.
¹¹
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
in1903. 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).
¹²
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 for 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.
¹³

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 due to 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.
¹⁴

FIGURE 14.1.
   Top income tax rates, 1900–2013

The top marginal tax rate of the income tax (applying to the highest incomes) in the
United States dropped from 70 percent in 1980 to 28 percent in 1988.