Tax Analysts Blog

Raising Taxes on the Rich Won't Balance the Budget -- But It's Still Important

Posted on Mar 25, 2014

Over the last decade or so, economist Thomas Piketty has made his name central to serious discussions of inequality. Along with his frequent collaborator, Emmanuel Saez, he has provided the empirical foundation for most political arguments about the danger of growing wealth and income disparities.

Now, Piketty, who teaches at the Paris School of Economics, has published a new book, Capital in the Twenty-First Century. In it, Piketty expands upon his empirical work of the last 10 years, while also setting forth a political theory of inequality. This last element of the book gives special attention to tax policy and makes some provocative suggestions -- new and higher taxes on the very rich.

Piketty devotes considerable attention to the role of the income tax in ameliorating inequality. He observes, among other things, that income taxes in the modern fiscal state often tend to be roughly proportional, rather than steeply progressive. “This is not surprising,” he writes. “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.”

(This point seems particularly apt for explanations of European tax policy, in which welfare states are large and tax revenue, measured as a share of GDP, tends to range from the OECD average of 36 percent up to nearly 50 percent (France comes in around 45 percent). Its explanatory power is somewhat less compelling in the United States, where the tax burden is generally lower and the welfare state considerably smaller.)

But even when proportional, Piketty insists, income taxes (and other progressive levies) are still an important weapon in the battle to remedy – or at least slow – surging inequality. Even if taxation overall is proportional, he argues, that doesn’t mean that tax burdens are proportional through every income range. And when rates are progressive near the top, they can make a real difference in altering "the structure of inequality."

In particular, Piketty argues that progressive taxes on the rich helped keep inequality in check during the decades after World War II. "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.” And conversely, the decline in high bracket rates since the 1980s -- a phenomenon particularly evident in the United States and Great Britain -- has helped boost incomes for the very rich in both countries. Piketty goes on to suggest that in many countries, rates may eventually become regressive near the top of the income scale – except in countries where they already have.

There are many problems that might flow from the phenomenon of high-bracket tax relief, particularly if it is allowed to continue. But the worst may be a decline in fiscal consent, defined as the willingness of the population to actually pay their taxes. “Clearly such a fiscal secession of the wealthiest citizens could potentially do great damage to fiscal consent in general,” Piketty writes. “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.”

Piketty is on to something here, but it's not a new thing. Indeed, it goes to the much maligned notion of making sure that everyone pays a "fair share" of the overall tax burden. This concern was central to the formulation and enactment of American tax policy during the postwar decades. It was a direct outgrowth of the New Deal insistence that burdens be distributed more progressively -- not principally for the sake of raising revenue, but for keeping the tax system fair.

The modern American fiscal state is predicated on a bargain. During World War II, lawmakers were forced to expand the personal income tax to help pay for the fighting. Over the course of just a few years, they added millions of middle-class Americans to the tax rolls for the first time, transforming the income tax from a rich man's burden to a middle-class millstone. In return, however, these same lawmakers offered the middle class an implicit (and sometimes nearly explicit) guarantee -- rich people would be asked to pony up, too. The steeply progressive wartime rate schedule was the statutory manifestation of this bargain. Taxing superwealthy Americans at 94 percent was not intended to raise a lot of money, at least not directly. Rather, it was designed to ensure that money could be raised from taxpayers in the lower brackets, who would agree to new tax burdens as long as rich Americans were taking it on the chin at the same time.

This bargain proved both effective and durable -- as evidenced by the persistence of high tax rates throughout the supposedly conservative 1950s and well into the 1960s. Indeed, the legacy of those rates was still much in evidence until Ronald Reagan pushed through his landmark tax cut of 1981.

If Piketty had his way, America would return to the tax rates of the early postwar era -- he has repeatedly suggested that a top rate in the neighborhood of 80 percent would be reasonable and ultimately beneficial for most nations. I have my doubts about that -- if you think aggressive and creative forms of tax avoidance are a problem now, just imagine what they'll be like when top rates double.

But Piketty is certainly right to underscore the social importance of taxing the rich. In America, we take tax consent for granted. In particular, we depend on a relatively high level of voluntary compliance. (God knows, we don't give the IRS enough resources to really enforce the income tax on its own.) This consent depends on some socially constructed and politically validated notion of fairness. And taxing the rich -- adequately, if not extravagantly -- is a vital part of that idea.

Read Comments (6)

amt buffMar 25, 2014

80% or 90% tax rates are on the wrong side of the Laffer curve. They actually
lose revenue. However that's the problem with increasing tax rates on the rich
somewhat. We are still definitely on the good side of the Laffer curve.

The problem is politicians. They insist they every tax change be "progressive",
as measured by collections without regard to the distribution of spending. This
ratchet will soon constrain our ability to increase taxes on the middle class
without losing revenue from higher income taxpayers. Revenue would be maximized
if we waited to increase the top rates until the package includes a substantial
increase in middle class tax rates. Either that or progressives will need to
accept large, regressive tax increases later.

Eat your dessert now and all that will be left is vegetables. It's better to
save the dessert for last.

edmund dantesMar 25, 2014

I doubt that anyone ever hit the 94% tax bracket, and if they did they arranged
their affairs so it never happened again. I have read that over the decades the
effective tax rate on the top 10% of earners has been pretty steady,
independent of high or low marginal rates. The effective rate has been in the
25%-30% range all along. But with high marginal rates you have to jump through
more hoops to get there.

If you really want to tax the rich, which I doubt, you will eliminate the
tax-free status of muni bonds. That's how Warren Buffett gets his effective
rate down to where his secretary's is. You will also start to tax, for the
first time, the enormous endowments of the Harvards and Yales, pots of tax-free
capital that benefit only the very rich. If you won't do these things, you are
spouting politics, not advocating for actually taxing the rich in a meaningful
way.

BTW, I believe that we now spend about half as much each year on the IRS as we
spent over a decade to send a man to the moon. You don't think that's enough?
I do. You could spend dramatically less on the IRS by simplifying the tax
code, and improve compliance to boot. But then you'd have to give up social
engineering through tax discriminations, aka "loopholes".

But in any event, nothing will be more destructive to the "fiscal consent" than
the continued implementation of the "Lois Lerner rule" that Republicans must
pay taxes and Democrats don't have to. Look for more and more taxpayers to
assert the Lois Lerner defense against the IRS.

amt buffMar 25, 2014

"I doubt that anyone ever hit the 94% tax bracket, and if they did they
arranged their affairs so it never happened again."

The Beatles hit the 95% rate once in England and wrote a song about it. Then
they sheltered their income from that and all their other songs.

"You could spend dramatically less on the IRS by simplifying the tax
code, and improve compliance to boot."

I doubt that. I don't find the cost of IRS operations out of line at all. I
only find their complicity in partisan actions (including illegal Obamacare
revisions) out of line.

We cannot afford to have a partisan IRS: That's very third world.

amt buffMar 26, 2014

Oops. Second sentence above should start "However that's not the problem"

edmund dantesMar 26, 2014

@amt buff--I concede that I can't prove that simplification would reduce IRS
cost of operations, but conceptual I still believe that it would have to slow
the growth of those costs.

But I absolutely agree with you, we cannot afford to have a partisan IRS.

D CarthagoApr 9, 2014

It is curious how we have "tax exempt" institutions little of whose income is UBTI even while they run sports teams and pay generous salaries and pensions to many professors that otherwise would not have found employment anywhere else. BTW anyone know Piketty and Saez'
rate? Maybe we should start there lest the noble authors be accused of hypocrisy

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