Rethinking Liberalism 4: taxing the wealthy

There is a growing view that”inequality is one of the main problems confronting the modern world. This is quite a change. Distribution of income or wealth (or indeed the difference between the two) was not a major concern in the previously dominant neoclassical economic world view. But now that the benefits of growth in the developed world go almost exclusively to a tiny elite, while median incomes stagnate, this view has become complacent. And the work of the French economist Thomas Piketty has drawn attention to the potential power of the very wealthy. This presents a major challenge for liberals.

The problem is that liberals should have no particular problem with inequality of income and wealth in their own right. We believe in individual responsibility and free choices. We have unequal economic outcomes because people want and choose different things. So what? In fact inequality is cover for a series of issues which liberals should care about. Today I am writing about one of them: the wealthy elite.

The problem is known colloquially as the “1%”, because a disproportionate share of developed world income is going to the top 1% (or 10%; or 0.1% depending on how you want to present the figures). Rather than providing evidence for this assertion, and how it specifically might apply to Britain (perhaps less than in some countries), I will take it as a given, and look at some of the issues of principle that it uncovers.

Why does it matter? To some it is a simple matter of social justice. Inequality is one thing, but the justification for these extremes is another. There is more than a suspicion that the lucky few are winning because of unfair advantages, rather than just ordinary luck and talent. But regardless of this is a further problem. This wealthy elite has the chance to consolidate its advantages with political influence, so as to rig the economy in its favour. The growing influence of big money in politics, and the enormous lobby industry in places like Washington DC, points in this direction. There is an economic problem too: excess wealth is deadweight. The wealthy do not consume as high a proportion of their income as poorer people. And only a small proportion of their savings get channelled into constructive investment  (paying people to build things) rather than various forms of speculation in pre-existing assets.

Why is the problem growing? It seems to be a case of a weakening middle. In other words it is not a question of rising poverty, but a hollowing out of the middle class. It is easy to see the culprits: technologies that automate medium-skilled jobs, and globalisation that weakens local bargaining power. Thus we have the problem: the economy becomes more productive, but the benefits do not go to most workers. Can this trend be reversed? That is a central challenge for progressive policymakers, and it is a question I will return to.

But if we take the trend as a given, which I fear we must, then what can be done about it? The answer is clear: redistribution via taxation, public services and transfers. This issue divides politics like no other. On the right, we have “economic liberals”, who think that lower taxes and smaller government will unleash economic growth that will benefit all of society. On the right we have what I will call progressives (not all liberal), who appreciate that with today’s skewed power structures such growth will only benefit an elite, and will in any case be undermined by the deadweight effect of excessive wealth. Like most Liberals, I am in the progressive camp here.

Apart from the deep flaws in the economic liberal logic, progressive thinkers can see something else. The state has no choice but to grow. We have signed up to a society which seeks to (more or less) guarantee minimum levels of access to health care and old-age pensions.  The aging of developed world populations will increase the burden of these. And much of the investment needed to keep a modern economy growing, from education to roads and bridges, requires some level of state support. Meanwhile the ability of the middle classes to fund their own needs through savings is under pressure – both because their own incomes are not keeping pace with inflation, and because returns on saving are diminishing, a little appreciated aspect of the “hollowing out” process – with the exception of those able to own property in prosperous parts of the country.

So this comes back a stark truth. Taxes on the rich must rise. This serves to recycle wealth that would otherwise drop out of productive economic flows, and it helps fund the basics the state has to provide. So how to do this? There are broadly three directions: income, assets and capital gains.

Until now, most of the argument has been over income taxes, and in particular the best top rate of tax. When I started my first accountancy job in 1976, the top rate of tax was 83%, which rose to 98% for investment income. Conventional wisdom turned against the wisdom of such high rates. They dropped to 60% and then to 40% in the UK, before rising to 50% in 2010, and then being clipped to 45%. Economists are less sure about the wisdom of cutting such high rates. They did think that cutting tax rates would mean that rates of pay (for the elite) would fall, as it was cheaper to provide the same net salary. In fact the opposite has happened. This seems to point to senior salaries being more about power politics than market forces. Companies paid their executives more because they could; they did not do so when tax rates were high, because they did not like to see so much of the extra money disappearing in tax.

I can see no harm in reinstituting the 50% top rate of tax, though experience suggests that this won’t bring in a huge amount of extra revenue. Such high rates create a tax avoidance industry. There is a problem with very high rates of income tax though: they tend to entrench a wealthy elite, because they make it more difficult for outsiders to join them. The way to become wealthy becomes to to inherit rather than earn. This was the rather interesting conclusion of a quite wonderful contemporary study of the British tax system of the 1970s by Mervyn King and John Kay – which was recommended as a model piece of economic writing 30 years later by the UCL Economics department.

So should we not look at taxing wealth? This is the recommendation of Mr Piketty, who worries that the rate of return on the elite’s assets is too high, and entrenches their dominance. Such a tax would probably be about 1 or 2% per annum – which may not sound much, but is enough to dent annual returns significantly. Such a tax exists in the Netherlands, hardly as basket-case economy. A variation on this general idea is just to tax land – an idea (Land Value Tax) that has an ancient history in the Liberal movement. I personally have a difficulty with taxing a theoretical value of an asset, rather than a realised one – given that the reliability of asset valuations is weakening. But I have to admit the idea is growing on me, especially the land-only version.

A further way of taxing assets is at death. This is theoretically very sound, but too easy to avoid in practice. The rates here can be very high. In order to make this more watertight such taxes should no doubt be applied to large gifts as well. This used to be the case in the UK. But taxing legacies and gifts seems to attract a particular political opprobrium, and we have to tread carefully.

Finally we should mention capital gains: where assets and incomes meet. These are the commonest loopholes in tax systems. Aligning such taxes with income tax seems the best way of dealing with this. But this may undermine the case for an asset tax: the Netherlands does not tax capital gains.

But in discussing such details we must not miss two big and interrelated issues. The first is that our elites tend to be globally mobile. Taxing them will require growing levels of transnational cooperation. And indeed the need to tax such mobile elites puts greater importance on such transnational cooperation. The EU’s tax dimension should grow. Such bodies as the G20 need to focus on the matter too. It is not particularly surprising that so many rich businessmen are in favour of the UK leaving the European Union.

Which brings me to the second issue: politics. The rich seem to be of an economically liberal mindset (which is actually a recent development, as this article in the New Yorker observes). They increasing fund political movements with an economically liberal agenda. This is already poisoning the politics of the USA. It will make taxing the wealthy harder. But not impossible. If the public understands that the alternative is to cut basic pension and health systems the economic liberals will lose. But whereas we used to think that politics in the developed world was getting dull, this growing clash of economic interests will inject real conflict into it. Class war is back.

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2 thoughts on “Rethinking Liberalism 4: taxing the wealthy”

  1. You said that “We have signed up to a society which seeks to (more or less) guarantee minimum levels of access to health care and old-age pensions”.
    But the coalition government condone the denial of the indexation of the state pension to pensioners living in some countries abroad but not others. Those affected being mainly the Commonwealth countries. Why ?
    Steve Webb was all blather about it when in opposition and the LibDem’s were opposed to it (apparently but mot seriously obviously).
    No justification for this irrespective of the fact that it has a long history and should have been addressed many years ago but that is no reason to do nothing now.
    You had the chance and blew it thanks to Mr Webb and his reneging on what he knew to be wrong. To add to the fire, he then introduces clause 20 into the Pensions Bill which further discriminates future pensioners in the same way.
    And this is a 21st century civilised democracy ? Give me a break.
    Further to this the introduction of clause 20 goes against the recent Charter of the Commonwealth which is implacably opposed to discrimination of any kind signed by the Queen and making her be seen to agree to discriminate against her own citizens.
    A great legacy for this government I don’t think !
    What are the party going to do about it ? Nothing ? There has already been a show of hands in the EU elections so what about the coming general election ?

    1. I must admit that I have not seen any analysis of the issues here. I would suspect that the difference between the countries that do and don’t have indexation is the state of treaty obligations with the countries concerned, which usually involve a degree of give and take. The obligations for other EU members would be quite stringent.

      It all rather sounds like the dead hand of the Treasury who would have told Mr Webb two things: the money spent on extra payments would need to be paid for by cuts elsewhere. And second payments of British currency overseas would adversely affect the balance of payments.

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