Progressive Taxation and Wealth (highlighting the US), 2014

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Here we highlight the United States, because it saw dramatic change in the early to mid-twentieth century, and is widely seen as a model of increasing prosperity, widely spread. Yet, it is important to be aware of the historical context, because the past is a different country. The Union States had recently prevailed in the Civil War. Liberty equality and freedom were burning issues for many first and second generation immigrants for whom creating a New World was a literal experience, and escape from repressive inequality a living memory. The Civil War had become in part a war about the abolition of slavery, even though that is not how it started, the motives were mixed, and inconvenient truths must not be overlooked. The genocide of Native Americans is a fact, and the scourge of racism and inequality is a battle still not won. Nevertheless, among the immigrants who prevailed there was no inherited ruling class; far less inherited wealth; the distribution of wealth was far more equitable than in Europe. Prosperity followed this, it did not proceed it — that is why immigrants went there from Europe and Asia to follow the American Dream, and that is why it is an interesting example to look at now. The pull of that history still drives immigration today, even if the outcome is now more uncertain. Although wealth was then accumulating, as elsewhere, excessive wealth in the late nineteenth and early twentieth centuries, especially inherited wealth and unearned income, still touched the national psyche as a deeply ‘Un-American’ activity. So, when in the late 1920s and early 1930s Americans, including the wealthy, saw the consequences of the 1914-18 war, the turmoil and politics Europe and Asia, and the results of the Great Depression at home, family history at least may have made people more disposed to reach a consensus concerning the New Deal and in particular the introduction of progressive taxation, even though it was not the only or the first nation to introduce the idea.

the aim of progressive taxation was to encourage ever more productive investment with increasing wealth

It is also helpful to be aware that ‘Progressive taxation’ is used in a utilitarian sense of progressively increasing tax rates within higher bands of income. It is not necessarily a value judgement, although often used in that sense. The aim was to encourage ever more productive investment with increasing wealth, to overcome the problem that economist Adam Smith had identified in the late eighteenth century, of a wealthy ‘rentier’ spending unearned income primarily on consumption rather than directing the capital towards productive ends. This is actually a nuanced continuum, but broadly consumption creates fewer opportunities for future wealth generation than investment – e.g. buying a book rather than buying a printing press. If the act of spending creates less future wealth than is consumed, taking interest forgone into account, net prosperity is being destroyed.

Paying for … a top chef, or getting football coaching from a top coach, requires more cash, but doesn’t have … any greater impact on the environment

Pursuing this line of thought for the moment, the point is not that consumption is bad — ultimately everything is consumption — but one is looking to get the greatest value from the money one has: the greatest amount of consumption, over ones own life, amongst ones family and friends, and wider society. By deferring some consumption in favour of productive expenditure, one is trading consumption now for more consumption in the future. And the ‘green agenda’ is not (or should not) be anti-consumption, but anti-unsustainable consumption, decoupling GDP from resource use and substituting renewable resources for unrenewable resources. Paying for a meal by a top chef, or getting football coaching from a top coach, requires more cash, but doesn’t have, or need not have, any greater impact on the environment. You might call this ‘enlightened hedonism’.

tax relieves those who do not want, or have no aptitude, for entrepreneurial activity from the burden and time consumed

Returning to the 1930s-1970s ‘American Way’ of capitalism was that of the New Deal: the justification or the ideal, was that the wealthy made a deal with wider society such that active entrepreneurs, venture capitalists and others, who created net economic growth for others as well as themselves, would prosper, while taxation of unearned income would help pay, through progressive taxation, for infrastructure construction, general economic stimulation and welfare. Looked at in a positive light, tax relieves wealthy people who do not want, or have no aptitude, for entrepreneurial activity from the burden and time consumed, and instead allocating it to those who can make better use of it, including for the person being taxed through the general increase in quality of life. It is an argument for a meritocracy that begs questions, but supposedly doesn’t invalidate the proposition.

from the late 1940s until the early 1970s the US economy boomed, overall wealth grew, and became more evenly distributed

All of which would be a radical idea. How much of it is true is a moot point: returning to the specifics, from the late 1930s, but particularly from the 1940s until the early 1970s the US economy boomed, overall wealth grew, and became more evenly distributed, creating the American Dream. But there is a complication, which is that the 1939-45 war, and the enormous additional stimulus from War Bonds (government borrowing at interest) as well as lend-lease borrowing from the UK, all combined to have a massive additional impact on US GDP growth, beyond the peace-time levels of progressive taxation. So it is impossible to now know whether the New Deal could have created the American Dream without that extra stimulus.

Of course, and to jump ahead of ourselves, if there had been another existential threat that demanded a similar scale of response and urgency as the war, but without the horror and destruction, that would be the ideal scenario …

supporters of the economist Simon Kuznets … concluded that this was the ‘American Way’ of capitalism

But, returning to what actually happened, supporters of the economist Simon Kuznets, who in the 1950s first documented the consequences of this early example of trend bending, concluded that this was the ‘American Way’ of capitalism: the most advanced stage of its evolution, where wealth becomes equitably spread. It is undeniable, from the graphs here, that the wealth in ‘Middle Class America’ was more evenly spread down that before or since. GDP, even after the war, continued to grow as fast as any time since. But, regarding the Civil Rights movement at home (and afterwards), and also regarding US foreign policy, many would warn about painting too rosy a picture. Nevertheless, in the Cold War, American politicians were not slow to contrast the ‘Kuznets Curve’ with the failures of Communism.

Europeans today might have been three times wealthy … had Europe not been at the centre of three decades of conflict

It is true that a similar approach was adopted, primarily post-war, in western Europe, albeit with a ‘Socialist’, ‘Social Democratic’ or ‘Rhenish capitalism’ twist, and their economies also boomed, particularly in continental Europe, in an ‘economic miracle’ — although, again, it shouldn’t be overlooked that this came in significant part from repairing infrastructure and recreating a peace-time economy following two wars and an intervening economic depression. The physical destruction and loss of life may fade, but the destruction of accumulated wealth in Europe between 1914-45 (shown in the final graph in the drop-down) was truly phenomenal and has never been regained. Europeans today might have been three times wealthy than they actually are, had Europe not been at the centre of three decades of conflict.

However … the narrative of the 1980s … was that progressive taxation stifled the entrepreneurial activity of the wealthy

However, the economic miracle in the US and Europe began to fade to what might be regarded as a more normal rate of growth in the 1970s, the war-time and post-war reconstruction stimulus being over. The narrative of the 1980s Reagan administration in the US, and the Thatcher government in the UK, was that progressive taxation stifled the entrepreneurial activity of the wealthy, causing the slow-down, high inflation and increasing unemployment. Once taxes on the wealthy was reduced, it was reasoned, they would invest more, work harder, and create jobs and prosperity that would trickle down to revive the American Dream. So it was the opposite of the reasoning and circumstances leading to the New Deal. Some might excuse this because, by the time of Reagan and Thatcher, progressive taxation had long since reduced the share of national income of the rich (ca. 30% of total income for the top 10%, as indicated in the graphic above), so earlier experience of the combination of low taxation, vast wealth and unproductive consumption had been forgotten.

The wealth of the US elite now rivals that of pre-revolutionary French aristocrats

Indeed, even the analysis of statistics on the distribution of wealth had become unfashionable, and it was only when Piketty and colleagues recently updated Kuznets’s data that the extraordinary increase in wealth inequality became fully apparent. In America, by in 2010 the top ten percent were accumulating 50% of annual income (including capital gains, see drop-down), and the top 1% were accumulating at least 20%. These are still rapidly increasing levels of US wealth. But already, the wealth of the US elite now rivals those of the pre-revolutionary eighteenth century French aristocrats, the domestic British elite pre-1914 and of the British Raj in India pre-1939. It is already apparent as an emerging trend in developing economies, including India and China.

we have gone from Adam Smith’s Invisible Hand Guiding the Economy to an Invisible Hand in the Till

If past experience is a guide, such levels of inequality risks stalling the richest economies. They are certainly iniquitous. So, Piketty argues, that, to avoid a wider catastrophe, it is time to re-introduce progressive taxation. It is irrational to instead create paper money that goes to the wealthy, becomes real money and then — when they fail to invest in entrepreneurial activity in the real economy — to attempt to borrow it back at interest, when the very cause of the crisis was the accumulation of private wealth and the recreation of a rentier (unearned income) class. In effect we may have gone from Adam Smith’s Invisible Hand guiding the economy to an Invisible Hand in the till, where a social network of top executives, occupying all sectors of business (not just bankers), now extract unearned wealth from their companies in excessive pay settlements, to the detriment of those intrinsically talented senior executives who could add value, to other shareholders such as the pension funds, and other employees. Their children go to exclusive schools and universities, access filtered by fee-structures whose educational opportunities are likely, but whose unique benefit is the net-working. They then go to work-experience placings facilitated by parental connections. In essence, after a pause of a century or more, a self-organising and self-generating system of preference has adjusted to the source of inherited unearned income now comes from limited-liability commerce rather than land. That, at least is the charge. It may be completely, or partly over-blown — it is rare for anything to have a single cause. But if substantially true, it would be a serious impediment to bending the trends so that ten billion can live well. It is likely to be a major issue emerging from the pregnant pause of the 2007/08 crash unless growth resumes.

The wealth hasn’t trickled down … for most, the American Way wasn’t just better than Communism, it was better than America today

In essence this is re-learning the lessons of the New Deal and recreate the American Dream adapted for a modern age. US GDP this grew no faster after 1980, nor did returns on investment from the stock market increase above the long term average (see previous section). The dramatic increase in the wealth of the affluent no longer trickled down to the middle class and the poor: for most Americans, Cold War era American Way of capitalism wasn’t just better than America today. And from the drop-down it is evident that while America led, the rest of the world is now following.

From all of which one could draw three points:

First, a recognition that a combination of the economics of Keynes, the policies of the New Deal, the economic and social virtues of mutuals and cooperation, and aspects of the mid-century ‘American Dream’ or ‘American Way’ of capitalism, based on progressive taxation of wealth to distribute this optimally for maximum overall sustained growth was at least ‘more right’ than the Neoclassical economics and policies that followed. It provides a jumping off point to learn how to do better;

Second, the world can improve on the American Way, and the post-war economic miracle by not waiting until the damage is done but instead by investing pro-actively and directly in the real economy without delay, to bend the trends towards sustainable ends. This must be sustainable prosperity: economic, social and environmental sustainability are one and the same, responding to the Future Business agenda of WBCSD’s Vision 2050 and others. Every crisis is an opportunity: we are fortunate that these two needs (urgent need for global economic stimulation and urgent action to bend the trends) are complementary. We anticipate that this initial stimulus will be as significant in impact and duration as the post war ‘economic miracle’ that lasted for two decades from the late 1940s. The changes identified, such as in Vision 2050, to achieve a world where 9-10 billion can live well by 2050 are so great it seems unlikely that it can be achieved without a stimulus at least as great in intent and result as that following the 1914–45. But at least we have that to look back to—this is not a theory.

Third, taxation on unearned income such as investments, savings, pensions and rental should be progressive. But if ‘True Value’ is to be embedded in price (again a ‘must have’ in Vision 2050) it seems that this can most efficiently be done if taxation is primarily centred on the act of consumption, on taxing bads and rewarding goods, so making tax evasion a civic duty, not a crime. It may even be that income and corporation tax becomes a barrier to progress and a thing of the past. As elaborated in the drop-down, we would also want to explore it being part of a wider ‘True Value’ system, based on the principle of Tax Bads, not Goods, via a Value Subtracted Tax (or Variable Sales Tax), VST, similar in operation to a variable consumer sales tax or European VAT. It would vary from zero to high, based on environmental, social and economic impact of the unearned income, including the supply chain, calculated using ESE-MRIO data. For consumer savings or pension products the tax is simply integrated into the rate of return, so buyers don’t have to deal with tax issues at all, they simply select on the basis of the best returns. The progressive element of taxation comes from automatic rebates at the time of interest payment. Earned income — wages — rather than attracting income tax, would be taxed either at the point of consumption, using the same VST principle of taxing bads, or when invested as described here. Underlying all of this is another principle, of making taxation as simple as possible — VST, like current sales or VAT requires no tax returns, and tax avoidance would become a virtue.

Source, Bending the Trends, modus vivendi, 2014