Taxing the Rich
A History of Fiscal Fairness in the United States and Europe
In spite of recent welcome news that the incomes of the bottom four-fifths of American households have begun to grow again, there's still a virtual consensus among economists that the great forces driving the economy in the long run — global convergence and technological change, in particular — will disproportionately benefit a lucky minority. Hence their enthusiasm for using tax policy to "lean against the wind." But in Taxing the Rich: A History of Fiscal Fairness in the United States and Europe,* a startling new book by government specialists kenneth scheve (Stanford) and david stasavage (NYU), the researchers conclude that few societies have ever been inclined to redistribute income for this purpose and that contemporary America is no exception. ¶ Their somewhat surprising conclusion is bolstered by the results of cleverly designed contemporary surveys. It seems that redistribution through tax policy can only be sold to the public as a means of counterbalancing unfair advantages conferred on the rich by government. But don't take my word for it — find out for yourself. — Peter Passell
Illustrations by Mark Smith/Salzmanart
Published January 17, 2017
Much of the debate about taxing the rich has focused on the current situation of the United States. Since the U.S. Supreme Court removed restrictions on campaign financing, this must somehow help explain why the rich are so lightly taxed in the United States.
Other people explain the reduction in taxes on the rich by referring to other short-term developments – conservatives often say that U.S. voters have learned the lessons of economic efficiency, while liberals claim that voters have somehow been hoodwinked.
Current developments may be important, but we have learned a lot more by looking at taxation of the rich over the long run across multiple countries. Debates about taxation are mediated by differing interpretations of what it means to treat people as equals.
Three ways to treat people as equals
Fairness can mean many different things, but one common feature of fairness in taxation is the belief that people ought to be treated the same. We have distinguished between three versions of equality: The first, equal treatment, is the idea that everyone should pay the same rate because this mimics basic democratic rights, such as each person having a vote of equal weight. The second, ability-to-pay, is the idea that the rate of tax you pay ought to be conditioned on the resources you have at your disposal. The third variant, the compensatory theory, is the idea that the rate you pay ought to depend on whether the state has taken other actions that have put you in a privileged position.
Going as far back as Renaissance Florence, opponents have argued that progressive taxation violates the norm of equal treatment in a republic. And modern survey evidence shows that many people in the 21st century seem to think exactly the same thing. We even see this view among people who would otherwise have had more income if a progressive rate structure were adopted. We also saw very ample evidence of equal treatment arguments in 19th and early-20th century debates about taxation. Equal treatment arguments clearly resonate in the political arena.
An alternative version of treating citizens as equals is to levy different tax rates based on ability to pay. If the rich have more, then they should not only pay a greater quantity of tax – they can afford to pay a higher tax rate. Though the ability-to-pay doctrine was not presented in formal mathematical terms until the end of the 19th century, it existed as a principle nearly four centuries earlier, as is evident from Francesco Guicciardini's advocacy of progressive taxation in La Decima scalata and in 18th century debates about taxing "luxury." Today the ability-to-pay doctrine provides part of the foundation for optimal tax theory in economics, although in optimal tax theory the objective is to maximize aggregate welfare rather than to see that everyone makes the same sacrifice when it comes to taxation.
The ability-to-pay doctrine is intuitive, and many people have clearly subscribed to it across the centuries. Nineteenth-century advocates of ability-to-pay used the doctrine to argue for progressive taxation. Many 20th-century observers, such as Edwin Seligman, took it as given that the emergence of the ability-to-pay doctrine explained why numerous countries were moving to implement progressive income taxes. We also see evidence of support for ability-to-pay in contemporary surveys. The ability-to-pay doctrine has resonated with many citizens and will continue to do so.
Yet, while ability-to-pay arguments matter to many, they seldom carry the day. Top tax rates have not been altered in response to changing levels of inequality. If they had been altered in this manner, it would be clear in the data that, as inequality rose, top tax rates would also rise. But this isn't what's happened.
Also, the massive increase in top tax rates associated with war mobilization cannot be explained by ability-to-pay. If ability-to-pay concerns were the reason governments implemented these policies, we should see statements in parliamentary debates reflecting this fact. Instead, we found a dramatic decrease in the use of ability-to-pay arguments during the war itself. Something else was at work.
The ability-to-pay doctrine has been subject to two persistent criticisms, one better founded than the other. Critics suggest first that the doctrine offers no clear plan for saying just how much more in taxes the rich can afford while still making the same sacrifice as everyone else. But many people, including survey respondents, believe in ability-to-pay in practice, and, in any event, the direction that such arguments imply for taxing the rich is clear enough.
Second, critics suggest that the ability-to-pay doctrine takes no account of how the money is earned in the first place. This may be the main reason we see no clear correlation between levels of inequality and how heavily governments choose to tax the rich. Whether people want to see the rich taxed heavily in a period of high inequality depends on the broader context, and how they think the inequality was generated in the first place.
The third approach to treating people as equals, the compensatory theory, takes direct account of the broader context for state action. If the state has treated people unequally on one dimension, then taxation should be used to compensate. In 14th century Siena [Italy], the city council deemed that if some taxes fell heavily on one group, then other taxes should be set so as to fall on alternative groups.
During the 19th century, similar arguments were made in favor of an income tax. If the weight of indirect taxation (sales and excise taxes, for example) was lighter for the rich than for the rest, then an income tax should be designed and implemented so as to counteract this effect. Finally, compensatory arguments help explain why 20th century governments adopted very high top tax rates at times of mass mobilization for war. Wartime governments certainly needed new revenues to fund their expenditures. But this doesn't explain why they chose to increase taxation by so much on those at the very top. Compensatory arguments, by contrast, do explain why they made this choice.
In considering compensatory arguments, people are most easily persuaded to use the tax system to compensate for the effect of inequalities generated by the state itself. Moreover, in the political arena compensatory arguments are most commonly used in reference to current or recent inequalities created by the state. In principle, one could think of using the tax system to compensate for state actions further in the past, or for a long history of unequal treatment by the state. Though a few 19th-century theorists considered using progressive taxation to achieve precisely this objective, such arguments have not been common in the political arena. Our evidence does not say exactly why this is the case, but it may be because the facts about past inequalities may be more open to dispute.
The compensatory theory is, of course, also related to a broader discussion about the role of good fortune as opposed to virtue (effort) in determining how rich someone is. This is a very prominent subject among those who work on the politics of redistribution. Survey evidence establishes that citizens of most European countries are more likely to say that doing well economically depends on luck, whereas Americans emphasize the role of effort. These biases are then used to explain why the United States provides fewer social benefits than most European countries.
But, as we have emphasized, the United States is hardly exceptional today in taxing the rich less heavily than was once the case. Moreover, it is entirely likely that in the immediate postwar era Americans believed every bit as much in the importance of effort, yet very high top marginal tax rates prevailed in the United States. When citizens think about taxing the rich, they think not just about whether the rich have been lucky, but more specifically about whether the rich were lucky to receive privileges awarded by the state.
The Top Tax Rates People Want
Much of the popular discussion about taxing the rich focuses on rising inequality and the fact that those at the very top seem to be reaping most of the gains. Many conclude that the rich ought to be taxed more heavily. It's not hard to see why people believe this. If you subscribe to the ability-to-pay view of taxation, the rich should be paying more. If you simply disliked inequality, you would think the same. Contemporary surveys in the United States do often show that people are worried about rising inequality. And they do wish the government would do something about it, including raising the taxes of the rich. This latter fact is usually demonstrated by questions asking whether taxes on people earning $250,000 a year (or sometimes $1 million) should increase, though the surveys typically don't ask how much their taxes should increase. The surveys also do not ask whether people believe that taxes should be raised by increasing statutory rates or by reducing exemptions to increase effective rates – a critical issue we discuss below.
These considerations lead naturally to the question of why there seems to be so little in the way of a policy response to today's inequality. Although it is understandable to point to any number of contemporary shortcomings of American democracy as the explanation, there just isn't much historical evidence that inequality alone prompts governments to tax the rich.
How can we reconcile the historical record with recent surveys? One way is to conduct a survey that asks respondents what tax rates they would prefer, rather than simply whether taxes should be increased without any indication whether the increase should be through reducing exemptions or raising rates – and if the latter, what the desired change should be. If people favor raising tax rates on the rich by a couple of percentage points, this is entirely different from the 30 to 40 percentage point increase that would be necessary to get top rates back to where they stood for much of the 20th century.
In work with Cameron Ballard-Rosa and Lucy Martin, we fielded a survey of 2,250 individuals who were representative of the American population. As part of this investigation, each respondent was asked the following question:
Consider the taxes paid in the U.S. by those families making X each year. Please select from the list below which marginal tax rate you would most like to see families making X each year pay: 0, 5, 10, 15, 20, 25, 30, 35, 40, 50, 60, 70 or 80 percent.
There is a possibility that survey respondents might confuse the marginal tax rate – the rate applying to the last dollar of income – with the average tax rate, which is obtained by dividing total taxes paid by total income. In order to limit this possibility, we provided respondents with a definition of the marginal tax rate. The levels of income considered for X in the survey were designed to closely track the cutoffs in the current U.S. income tax schedule.
All respondents were asked to provide a preferred rate for the more-than-$375,000 category. Each of the respondents was then asked to provide a preferred rate for one of the other (randomly assigned) income levels. Put all these responses together and we have a view of how Americans would like to see the rich taxed relative to the rest.
We found that the median preferred marginal rate for a household making more than $375,000 a year is 30 percent (with a mean preferred rate of 33 percent). This is below the marginal rate of 39.6 percent that such a household would actually pay today. Note, too, that the bulk of the responses range from 20 percent to about 40 percent.
The obvious lesson is that there is little support for the idea that Americans would like to see much higher top rates, but aren't getting the policies they want. While we believe that this survey question provides us with a more precise view of opinions on taxation than do the alternative questions often used in surveys, we also conducted a much more extensive series of survey experiments using an entirely different question-wording and methodology – but arrived at very similar conclusions with respect to preferred rates of taxation.
One possible reason people don't want higher tax rates is that the individuals in our survey fail to understand how high inequality is today and how much it has increased in recent years. This is a common argument. A recent survey experiment helps adjudicate this question. The experiment provided a large sample of individuals with a "treatment" that involved provision of accurate information about the income distribution in the United States today. It then observed whether this information prompted individuals to support a higher marginal tax rate on those with high incomes.
There was, indeed, such an effect, but its magnitude was very small. Individuals who received the treatment supported a top marginal rate of income taxation only one percentage point higher than did members of a control group who did not receive the treatment.
The second reason people may not want higher tax rates is the one we have emphasized throughout this book. Over the last two centuries, the most politically powerful arguments in favor of heavy taxation of the rich were compensatory claims made in a context of mass mobilization for war. As countries (including the United States) transitioned away from an era of mobilization, parties of the left were deprived of the compensatory war sacrifice arguments that had proven so powerful. They relied instead on the idea that taxing the rich was necessary because it was fair. But they often lacked strong arguments for why it was fair.
Under pressure from political parties of the right, top tax rates were lowered dramatically. The end result, at least in the United States, is a situation in which top tax rates today are just about where most people would like to see them.
The truth may be that, at least in the United States, there isn't much support for adopting very high top rates of the sort that prevailed in the immediate postwar era – at least not enough support to overcome whatever advantages the wealthy may have in influencing the political process. Building such support would require the construction of a new compensatory argument outside of a wartime context, one that suggested how the rich have benefitted from state privilege while others have sacrificed.
Now, there certainly have been cases of late where this has been true. To see this, we need look no further than the bailout of large banks that preceded the Great Recession. But even this involved a privilege enjoyed by only a fraction of the better-off – those with large stakes in these banks – as opposed to the rich as a group. To put it differently, it is not clear why Silicon Valley should be taxed because Wall Street was bailed out. Moreover, a great many citizens opposed the Wall Street bailout to begin with, so their preferences were focused less on compensating for it than on simply opposing it. Drawing on this history, we can see that, much as was the case in the 19th century, successful compensatory arguments today would need to emphasize inequities within the tax system itself.
The Debate Going Forward
When people today think about taxing the rich there is often a tendency to compare current conditions with those that prevailed in the decades following the end of the Second World War, an era with very high top marginal tax rates. Yet as we have pointed out, the era of the two world wars and their aftermath was a particular one because of mass mobilization.
Mass mobilization occurred because of international rivalry and because nations found themselves in a particular state of technological development in which it was both feasible and desirable to field a mass army. Today, the question is what fairness-based arguments for or against taxing the rich remain relevant in an era of limited mobilization. In the absence of compensatory arguments, future debates will follow the usual divide between those who appeal to ability-to-pay as a reason for taxing the rich and those who appeal to equal treatment in order to oppose it while also emphasizing the efficiency costs of high marginal tax rates.
This debate is unlikely to result in much deviation from current trends in tax rates. Earlier in the book, we suggested that change with regard to taxing the rich would instead depend on the ability of proponents to do one of two things. First, proponents could use compensatory arguments compatible with an era of peace. Second, they could appeal to the logic of equal treatment to oppose situations in which, because of exemptions or special privilege, the rich are taxed less heavily than others.
When we ask whether compensatory, or even equal treatment, arguments in favor of taxing the rich more are relevant today, we should recall the tone of the debate during the 19th and early 20th centuries. In other words, we need to look back prior to the era before mass mobilization for war fundamentally changed tax debates.
One thing we see clearly in these earlier debates is that proponents of the income tax didn't only refer to ability-to-pay; they also appealed to equal treatment. Prior to the establishment of general income taxes, direct taxes were often levied on land, or on income from land. In rapidly industrializing societies, this meant that whole new categories of mercantile income went untaxed. Taxes on external manifestations of wealth, such as the number of doors and windows in a home, suffered from many of the same flaws.
Under these conditions, Joseph Caillaux argued in France in 1907 that a general income tax was necessary to reestablish equal treatment.
He saw a general income tax as continuing the work of the French revolutionaries by abolishing new sources of privilege that had emerged since 1789. Caillaux also suggested that each time privileges within a tax system are abolished they gradually reemerge, necessitating periodic efforts to see that equal treatment is restored.
Now consider how the logic of Joseph Caillaux's argument is relevant in the 21st century. Today the advanced industrial countries have general income taxes applying to a broad definition of income. However, the U.S. tax code in particular provides a great many reasons why reported income may not be taxed at the full rate one would expect. There are deductions. There are exemptions. There are opportunities to classify income as capital gains that are subject to a lower rate of tax.
These features of the tax code could arguably be said to play a role analogous to the special privileges of the past. They are also currently producing a system whereby, after a certain point, the higher one's income the lower the effective rate of tax one is likely to pay. In the presence of such a system, there are arguments in favor of taxing the rich that don't have to rely on the principle of ability-to-pay. One can simply insist on respecting equal treatment.
To see this, we can use information on effective tax rates across income categories produced by the IRS.
Data from 2011 show that, up to an income of $2 million per year, the more people earn, the higher the effective rate households are likely to pay. However, as incomes increase above $2 million, effective rates actually decrease. The IRS calculated that, on average, in 2011, those earning between $1.5 million and $2 million a year faced an effective rate of 25.2 percent. In contrast, those earning more than $10 million per year faced an effective income tax rate of only 20.5 percent. Had people making more than $10 million per year been obliged to pay the same effective tax rate as those making $1.5 to $2 million, total tax revenues would have increased by about $15 billion.
This is a tiny fraction (less than one-half of 1 percent) of the total federal budget, but it is not an inconsequential sum. It is, for example, roughly twice the total salaries of all kindergarten teachers in the United States.
Equal-treatment logic can also apply to payroll taxes and the question of whether to raise the income ceilings applied to them. In 2014, the Social Security tax was levied on employees at a rate of 6.2 percent, but only up to $117,000 in annual earnings. This ceiling clearly results in regressive incidence. The story of regressive payroll taxes in a number of European countries is even more dramatic. In France, the lowest earners pay approximately 25 percent of their income in payroll taxes, while the highest earners pay less than 5 percent.
We are not saying that these equal-treatment arguments necessarily should be accepted, or that they represent the whole story. With the income tax, many deductions and exemptions exist for good reasons, and there are efficiency arguments for taxing capital gains less heavily than regular income. Likewise, ceilings on payroll taxes can be justified if one claims that these are not part of general taxation, but separate payments for services (pensions, medical care) that are not financed out of the general government budget. What we are suggesting is that, rather than focusing on high top statutory rates, supporters of taxing the rich would probably be more successful if they appealed to equal treatment.
Let's consider next the current relevance of compensatory arguments for higher taxes on the rich.
For centuries, people have emphasized that if one tax has an unequal incidence, then another tax can be used to balance things out. During 19th-century debates this same compensatory argument was used to defend the income tax. Robert Peel used it in the United Kingdom in 1842 to support reintroducing the income tax. John Stuart Mill advocated an income tax targeted at higher incomes for precisely the same reason. We also saw evidence from the United Kingdom that, thanks to the existence of a progressive income tax, by the first decade of the 20th century, the overall burden of taxation across income groups was essentially flat. This was not an ideal outcome as far as ardent advocates of taxing the rich were concerned, but it was certainly better than the regressive tax system based on indirect taxation that had existed prior to that date. In sum, compensatory arguments appear to have made a difference even outside a wartime context.
Now think about whether it would be possible for proponents of taxing the rich today to use peacetime compensatory arguments. Such claims can still be made because lower income groups continue to bear the principal burden of indirect (or consumption) taxation. As UCLA law professor Steven A. Bank has emphasized, this also has direct implications for the fairness of "flat-tax" schemes on income. He suggests flat-tax schemes should take into account how much citizens pay from all sources, and not just from one tax.
In Europe, value-added taxes constitute a very significant fraction of the taxes paid by poorer households, even though basic necessities are taxed at lower rates. In France those with the lowest incomes pay fully 15 percent of their income in consumption taxes, whereas the highest earners pay only 5 percent of their income in such taxes.
The regressive incidence of consumption taxes creates a potential argument for taxing the rich more heavily as a means of restoring equal treatment. The United States does not have a value-added tax. However, individual states and localities do, of course, levy general sales taxes. All the evidence suggests that, even though basic necessities are often exempted from these sales taxes, their overall incidence is still regressive. This again provides a compensatory argument for a progressive income tax. It could also provide an argument for applying progressive rates to consumption taxes.
The examples above suggest ways in which future debates about taxing the rich might deviate from a simple dispute between those who claim that the rich can afford to pay more and others who emphasize equal treatment and efficiency. Overall, this could lead to some increase in the taxes of the rich in the coming years. But it is very unlikely to lead to a repeat of 20th-century patterns.
To have that happen, one of two things would need to occur. The first possibility is a massive political or economic shock that put new compensatory arguments on the table, as happened in 1914 in Europe. Alternatively, proponents of progressive taxation would need to make a compelling case that current government policies are heavily biased toward the rich. That prospect seems uncertain and sure to be contested. In the end, the one certain thing is that taxation of the rich will continue to be a fundamental source of social conflict.