6 May 2016

There is less appetite for taxing the rich than you might think


“In this world, nothing can be said to be certain, except death and taxes”. What US founding father Benjamin Franklin didn’t say but surely knew was that death and tax policy are deeply interlinked.

That’s the thesis from Kenneth Scheve and David Stasavage, who have studied the history of taxation in Europe and the United States, in their new book Taxing the Rich – A History of Fiscal Fairness in the United States and Europe. They find that what we think drives high taxes on the rich – inequality, envy and the ability to pay – just doesn’t show up in the data. It wasn’t universal suffrage, or the politics of left and right wing governments, that drove large increases in claims on the rich in the 20th century – but the need for equal sacrifice in a time of war.

In the 19th century John Stuart Mill wrote that taxes should be levied to ensure “equality of sacrifice”, but he left open to question whether taxes should be proportional or progressive. This is an unresolved moral issue that is at least half a millennium old. The introduction of the decima scalata, a progressive tax on land income, in Florence in 1500 created a vigorous debate that Francesco Guicciardini – statesman and friend of Machiavelli – summarised in a brief text. There one can find statements that match sentiment we find across the political spectrum today, where the ideal principle ranges from one that emphasises the ability to pay, to one extolling the virtues of equal treatment, irrespective of means.

But there is another way of looking at “equality of sacrifice” that has entertained recent studies in tax history, not least Thomas Piketty’s seminal work on inequality and capitalism in 2014. Following Piketty, Scheve and Stasavage conclude that the effect of two all-consuming and devastating world wars explains the very large increases in taxes on the rich in the 20th century, before those taxes gradually fell back in the following decades. The 1918 Labour Party manifesto called for a ‘Conscription of Wealth’ from the older members of the British population who made money from the war but were not enlisted to fight in the trenches. Equality of sacrifice here meant short-term confiscations from the wealthy in the form of income and wealth taxes, as well as capital and excess profits levies, to finance the costs of the war and social reconstruction in the years that followed.

Scheve and Stasavage’s major insight is that the countries that mobilised for war – such as the UK, US and France – raised top income taxes on the rich by much more than those that didn’t. While rates were below 10% before the First World War in most industrial countries, they rose to an average 40% by 1919 in the belligerent industrial states, compared to just 15% in those that stayed out of the war. In the UK, top taxes on income rose to 98% and on large estates to 80% in the period after WW2.

As the impact of the wars subsided, so did the demands on the rich – yet the demand for government continued to grow. Average top rates of income tax fell from 65% in 1945 to below 40% in 2010 at the same time as the size of government doubled from 20% of GDP to 40%, funded by a broader tax base. What is surprising about this book is how robustly the authors discount other widely held explanations for the gradual reduction in tax paid by the richest 1% since 1980. The influence of political lobbying, liberalised capital flows and the breakdown of the postwar consensus are, in their view, inadequate answers. What has changed is the focus of ‘equality of sacrifice,’ which has rerurned to a debate about fairness, a concept under which both ‘equal treatment’ and ‘ability to pay’ can coexist and compete on normative terms. Fairness can be invoked to defend taxes that are high or low; flat or progressive.

So in the light of the global financial crisis, the revelations within the Panama Papers, and the intensifying focus on the so-called 1%, what are the likely consequences for tax policy in the US and Europe? Not much, say Scheve and Stasavage. In a 2014 study with YouGov, 2,000 US taxpayers were asked what they believed the marginal tax rate should be for different income levels. For those earning over $375,000, the median preferred rate was 30%, which is less than the 39.6% rate that is actually charged on incomes above $375,000. Even when respondents are informed of the scale of inequality in the US – which is significantly greater than many people imagine– their preferred rate of tax for top incomes does not change very much.

Despite the challenges thrown up by the financial crisis, there is no overwhelming impulse to bring down the rich. There is still an appreciation that the vast majority of wealth is built on good work that improves society, and that sensible progressive taxation gets the balance right between ability to pay and equality for all under the law. But that appreciation is not guaranteed to last. If there’s a reassurance from this work that we’re unlikely to see the emergence of a politics of envy riding on the back of confiscatory taxes, there is a warning that reinforces the urgency of reforming capitalism. We need to promote a popular, inclusive capitalism from which everyone can benefit; and a social contract that offers a level playing field, chances for individual fulfillment, social solidarity, and compassion for the unfortunate.

Public sentiment may change for the worse if taxpayers start to believe the economy is systematically rigged in favour of the rich in a way that is fueling inequality. If electorates feel too much of the burden of funding the state falls on low and middle income earners, especially in the form of indirect taxes, there could well be greater support for higher, compensatory levies on wealth and top incomes. If there is another banking crisis that calls on states to bail out failed actors, there would be calls for retribution. And if the general perception grows that the rich find it easier not just to minimise their tax bill but also to get special treatment by the state when it comes to building a successful career or business, or influencing political and social life, the public mood could easily sour.

The job for capitalists is to make sure that doesn’t happen.

Taxing the Rich – A History of Fiscal Fairness in the United States and Europe. Kenneth Scheve & David Stasavage. Princeton University Press. RRP £19.95

Zac Tate is Deputy Editor of CapX