Wednesday 15th, April 2009
In his rebuttal statement, Chris Edwards made a strong point. The reason why we disagree is because "Piketty's understanding of the nature of income is very European". I don't know who suggested him to dig so deeply into the substance of the debate, but this was really well taken. I suggest that next time he uses an even deeper argument: "Piketty is French".
Let me return to the substance. As a matter of fact, confiscatory marginal tax rates on very high incomes are an American invention. Between 1932 and 1980, the top marginal rate of the U.S. federal income tax was on average equal to 80.2%.(1) With the single (and telling) exception of Britain, there exists no European country where top marginal rates have been so high during such a prolonged period. In particular, this simply never happened in Scandinavia, this never happened in Germany, this never happened in France, this did not even happen in the Soviet Union. For instance, in France, the top statutory rate never exceeded 60%, except for very few isolated years. And there are good explanations for this. In continental Europe, governments always favoured direct intervention into the production and income determination process, e.g. via nationalisation or rigid collective wage setting. I actually believe that the American way of redistributing income is more efficient and less distorting than the European way. I think it is smarter to let the market system operate as freely as possible, and to intervene only through simple, transparent and non-discretionary tax and transfer schemes.
Does the fact that the U.S. did it in the past necessarily imply that we should immediately return to 80%-90% top marginal rates? Of course not. But at the very least this should imply that it is possible to have an open-minded, non-ideological debate on this issue. I must confess that I was somewhat provocative by proposing the immediate creation of a 80% top marginal rate. However I made clear in my opening statement that I was not dogmatic about the exact number, and that what I was really talking about is a substantial increase of the current top rate (about 40%). It could be that the right level is 70% or 60%. I firmly believe that we need to experiment and learn from experience. Most importantly, I said very explicitly that I was talking about very, very high incomes, and that at least 99.5% of the population would be unaffected by this new top rate. I proposed a 1 million euros threshold (about 0.2% for the American population, i.e. 99.8% of the population would be unaffected), but I made clear that the right threshold might be 2 million euros (less than 0.1% of the American population). I firmly believe that imposing a 70% or 80% marginal rate on large segments of the population (say, 25% of the population, or even 10%, or even a few percentage points) would lead to an economic disaster. And I made very clear that the reason I propose to focus on the very top end because this is where the labour market and the pay determination process are not working properly-or, more accurately, have completely gotten out of hands. I firmly believe that the marginal product theory provides an adequate description of 99% of the labour market. I find it really depressing that smart people like Chris Edwards do not even want to consider the possibility that less than 1% of the market is not working in line with textbook theory. As far as taxing the rich is concerned, no single number or threshold seems to be acceptable for Mr Edwards. In his view, even a 50% marginal rate on annual incomes in excess of 5m euros would apparently be an insult to the American spirit. Well, this strikes me as depressingly ideological.
Finally, let me just add a few comments about the issue of tax evasion and tax competition between countries. True, tax competition between local jurisdictions creates externalities and distortions. E.g. if progressive tax schedules were set at a very local level (say, at the city level, or at the district level, like in Switzerland), then it would simply be impossible to sustain high top end marginal rates. The neighbouring city or district would cut its top rate and get all the tax base. However this would not imply that this collective equilibrium is socially efficient or desirable in any meaningful sense. Because of the fiscal externality, this collective equilibrium is inefficient, just like an arms race equilibrium, and calls for tax coordination between jurisdictions. In the case of Europe, it is clear that there is substantial tax competition coming from the small countries (both regarding the corporate income tax and the top end individual income tax), not to mention the tax havens. This puts limits on what a single country can do, and this calls for action at the European Union level. This does not mean however that large European countries like Britain, France or Germany cannot do anything: they are large enough to raise tax on very top incomes, with precaution, assuming they put proper pressure on small countries and tax havens. To some extent, this is what they are heading for. Most importantly, this does not apply to the case of the United States, where fortunately both corporate and individual income tax issues are dealt with at the federal level. In case the U.S. Congress decided to vote a 70% or 80% marginal rate on incomes in excess of 1 million euros or 2 million euros, then the federal government of the United States would definitely have the capability of enforcing this law. What happened earlier this year with Switzerland and UBS is a clear sign that we should not underestimate the capability of the U.S. federal government to take action and to enforce law in the area of tax evasion. Of course, following a tax raise on high incomes, a number of corporations and top executives will try to get paid through Bahamas subsidiaries and the like. But if he so wishes, the U.S. government definitely has the power to counteract this effectively. To put it differently, a country that is able to send 150,000 troops 10,000km away from home should not be too frightened by the Bahamas.
(1) To check this fact, one simply needs to compute a 49-year average from the following file: http://www.truthandpolitics.org/top-rates.php
Thomas Piketty est directeur d'études à l'EHESS et professeur à l'Ecole d'économie de Paris.