Many believe that taxation is Robin Hood-like, that is, progressive. Meanwhile, growing frustration with declining living standards in recent years has risen further with the Covid-19 recessions. Economic reforms in recent decades have seen regression in the impact of government taxation, mainly from the middle to the top.
The Triumph of Injustice, the recent book by Emmanuel Saez and Gabriel Zucman, both associates of “rock-star” economist Thomas Piketty, calls for a US return to progressive taxation. The duo shows that the US previously had one of the world’s most progressive tax systems, but now, the richest pay a lower tax rate than the poorest.
The two French economists at Berkeley consider the two major competing US ideologies on taxation based on rival claims with contemporary echoes. The socially regressive, ostensibly libertarian tradition has its roots in property, including slaves, who once accounted for 40% of the population of the US South.
Plantation owners and slaveholders opposed property taxes in the name of freedom and liberty. Meanwhile, the myth of the wealthy that low taxes have long been part of US history and tradition has become far more influential.
Another more progressive tax ideology can be traced to more egalitarian traditions, including some involving wealth taxation. The US has actually had some of the highest tax rates on the rich in world history, as taxation became more progressive from the 1930s, especially after World War II.
Those most responsible for the U-turn from the 1980s have been US presidents Ronald Reagan and Donald Trump. The authors attribute the great recent increase in US economic inequality to the “negative spiral” involving regressive tax reforms over the last four decades.
However, empirical support for their claim is suspect as the “primary” distribution of income before taxation is hardly egalitarian. Besides the traditional division between capital and labour, rentier incomes and much higher executive remuneration have become far more significant in recent decades. While regressive tax incidence has undoubtedly made things worse, exaggerating the fiscal system’s redistributive impact detracts from a more comprehensive understanding of contemporary inequality.
Successive US governments have also enabled tax evasion and avoidance by not investing enough to effectively enforce what remains of the US tax code. These have been portrayed by beneficiaries and their propagandists as “unavoidable”.
They then claim that the best option to ensure greater compliance is to lower “headline” tax rates. Thus, instead of greater efforts to reduce tax avoidance and evasion, they urge further reduction of tax rates.
Saez and Zucman insist that governments, especially the world’s most powerful one in Washington, DC, must come down hard on tax dodgers, pointing out that not doing so is due to political choices made. They propose a Federal Protection Bureau to enhance capacity against tax evasion and avoidance.
The duo shows that corporate taxes were crucial in narrowing the gap between rich and poor during the Keynesian Golden Age for a quarter century or so in the mid-20th century after World War II.
While very high top personal income tax rates and much more inheritance and property taxes can help, they show that corporate taxation was crucial. The corporate income tax rate then was 50%, taking half of firms’ profits.
The high tax rate also encouraged re-investing profits, rather than paying dividends and bonuses, encouraging firm growth with higher capital accumulation in the long term. Meanwhile, progressive government expenditure complemented progressive taxation, including more direct taxes, for a comprehensively progressive fiscal system, reducing overall economic inequality.
Saez and Zucman persuasively offer a comprehensive set of proposals to reverse the downward spiral to rebuild a much more progressive US tax system, with many lessons very relevant elsewhere as well. Importantly, they discuss various options for the US, including many not requiring international cooperation.
They acknowledge that the US has already shown the way with its Foreign Account Tax Compliance Act (FATCA). FATCA compels all US citizens, both at home and abroad, to file annual reports on all their foreign holdings, ensuring greater financial transparency in the age of globalisation.
Nevertheless, they insist it is not enough, arguing that “when it comes to regulating the tax industry, the Internal Revenue Service (IRS) brings a knife to a gunfight”, instead of enhancing US tax capacities and capabilities.
The first principle of taxation for them is that all income should be taxed equally, whether from work or assets. Today, capital income is taxed much less than labour income, increasing inequality contrary to the popular presumption that taxation is progressively redistributive.
Saez and Zucman also show that the rich can afford to pay 4% of national income, or US$750 billion (RM3.1 trillion) more in tax. Four sets of taxes would double their current average tax rate from 30% to 60%. They propose a steeply progressive income tax, arguing that a top rate of 75% is most viable. The duo also recommends strongly enforced corporate tax, doubling inheritance tax revenues and introducing a wealth tax.
Wealth tax necessary
The duo also insists that it will be impossible to reduce inequality in the contemporary world only by raising corporate, inheritance and income taxes, as important as these are to the overall effort.
At the rates recommended, a wealth tax would raise significant sums but still would not radically reduce inequality or extreme wealth concentration. Hence, the authors argue for higher rates, not only to raise more government revenue but also to reduce extreme wealth inequality and concentration.
Saez and Zucman argue that extreme wealth concentration has led to growth benefits being captured by a few. They argue for taxing the rich, not only to enhance revenue but also to reduce extreme wealth concentration.
For them, “a radical wealth tax would lead to a reduction in the number of multi-billionaires. More than collecting revenue, it would deconcentrate wealth”. They suggest a 10% rate on fortunes over US$1 billion.
This would not only make it harder to be a billionaire, but also much harder to become and remain a multi-billionaire. If their proposed wealth tax were in place from 1982, most of the 400 richest Americans would still be billionaires, but worth much less.
Their wealth shares would be closer to what they were in 1982, before the rapid rise of wealth inequality. Mark Zuckerberg would still have US$21 billion, instead of US$61 billion, while Bill Gates would be worth US$4 billion, instead of US$97 billion.
Under president Franklin Delano Roosevelt in the 1930s, an income tax top rate of 94% was introduced, apparently not to raise revenue but rather to limit high incomes and wealth concentration. This effectively limited income differentials between the highest and lowest paid to far more reasonable levels. As top tax rates have drastically fallen since, executives now get several hundred times more than their lowest paid employees.
In a recent interview, Gates commented, “I’m all for super-progressive tax systems… I’ve paid over US$10 billion in taxes. I’ve paid more than anyone in taxes. If I had to pay US$20 billion, it’s fine. But when you say I should pay US$100 billion, then I’m starting to do a little math about what I have left over.”
During the British colonial period, taxes were levied to cover colonial government spending. In the Straits Settlements and Johor, the main revenue sources were “sin taxes” imposed on opium, alcohol and gambling, even prostitution.
British commercial interests in tin, rubber and land were taxed much less, even though colonial public spending mainly benefited the empire, including transport infrastructure provision — for example, railways, roads and port facilities — and “security” spending to keep imperial rivals and the public in check.
As the late economist and academician Ismail Mohd Salleh showed, post-colonial taxation was not only regressive, but also became more regressive during the 1960s and 1970s. Economist Wee Chong Hui has showed that despite many changes, overall tax incidence has not become more progressive since, as direct, especially income, taxation has become less progressive since the mid-1980s while regressive indirect taxation has become more significant.
There is little evidence of greater overall progressivity since then as subsequent trends have favoured investment incentives, often through tax breaks. Unsurprisingly, a survey found that half the owners of luxury cars in Malaysia did not even pay income tax!
Public expenditure has not been progressive either, despite much poverty-reducing rhetoric, as a World Bank study by economist Jacob Meerman showed for the 1970s. Poverty and inequality reduction since — due to economic growth and employment numbers, with foreign labour taking the most undesirable jobs but largely ignored in most official statistics — has taken pressure off the government to do more and better.
Meanwhile, in most of the world, government Covid-19 relief and recovery measures have been constrained by diminished tax revenue. Refusing to spend more to protect credit ratings despite “black swan” Covid-19 will see recessions now threatening to become depressions.
Jomo Kwame Sundaram, a former economics professor, was United Nations assistant secretary-general for economic development. He is the recipient of the Wassily Leontief Prize for Advancing the Frontiers of Economic Thought.