Friday, October 10, 2014

Tax code progressivity isn't everything. But the top line matters

"Don't soak the rich," Edward D. Kleinbard admonishes U.S. policymakers in today's Times. Countries with less progressive tax systems than the U.S., which tax everyone more and spend more on social services and other public goods, do a better job of reducing inequality (and fostering citizens' welfare) than the U.S. does. Lower income citizens get disproportionately more value from government spending, and an adequate tax base must be broad-based.

I take the point -- made with equal force two days ago by Vox's Cathie Jo Martin and Alexander Hertel-Fernandez [update: Mike Konczal and Matt Bruenig both demonstrate the alleged US progressivity is an illusion -- see below]. But there's a counterpoint. The U.S. may have a more progressive tax system and skimpier social welfare than the wealthy countries of Europe -- that's a longstanding reality. But all these countries have moved in the same direction over the past thirty years, and all have suffered widening income inequality. Here's Thomas Piketty's explanation:

Of course changes in tax laws are themselves linked to changes in social norms pertaining to inequality, but once set in motion they proceed according to a logic of their own . Specifically, the very large decrease in the top marginal income tax rate in the English-speaking countries after 1980 (despite the fact that Britain and the United States had pioneered nearly confiscatory taxes on incomes deemed to be indecent in earlier decades) seems to have totally transformed the way top executive pay is set, since top executives now had much stronger incentives than in the past to seek large raises. I also analyze the way this amplifying mechanism can give rise to another force for divergence that is more political in nature: the decrease in the top marginal income tax rate led to an explosion of very high incomes, which then increased the political influence of the beneficiaries of the change in the tax laws, who had an interest in keeping top tax rates low or even decreasing them further and who could use their windfall to finance political parties, pressure groups, and think tanks (Capital in the Twenty-First Century,  p. 335).
Perhaps Piketty gives undue weight to the Reagan tax cuts. But marginal tax rates on individual income were radically cut across the OECD between 1979 and 1990, the period in which CEO pay went into overdrive. Most countries continued to cut into the early noughts. Here's a selection:

                '79   '90   '02 
Australia 62 48 47
Austria 62 50 50
Belgium 76 55 52
Ontario 58 47 46
Denmark 73 68 59
France 60 52 50
Germany 56 53 49
Ireland 65 56 42
Holland 72 60  52
NZ 60 33 39
Norway 75 54 48
Sing           55 33 26
Spain 66 56 48
Sweden 87 65 56
UK 83 40 40
US 70 33 39
Source: PriceWatehouseCoopers; Int'l Bureau of Fiscal Documentation

Top personal tax rates have risen in the last decade, in the U.S. and much of the OECD. But it seems to me the damage has been done; the culture of megacompensation at the top has been established. All redistribution in an environment where CEO pay averages 300 times that of the average worker is swimming against the tide.

Update, 10/13: Mike Konzcal argues that the alleged US progressivity is a function mainly of wealth being more concentrated at the top than in wealthy European countries:
The problem is, of course, that we get so much of our tax revenue from the rich because we have one of the highest rates of inequality across peer nations. How unequal a country is will be just as much of a driver of the progressivity of taxation as the actual tax polices. In order to understand how absurd this is, even flat taxes on a very unequal income distribution will mean that taxes are “progressive” as more income will come from the top of the income distribution, just because that’s where all the money is
Matt Bruenig, meanwhile, shows that when rates are low across the board, the difference between top and bottom marginal rates will be disproportionately large:
At lower tax levels, tiny tax differences (in dollar terms) yield vastly greater progressivity (in percentage of income terms). The higher the tax levels go, the greater the tax difference (in dollar terms) has to be be in order to maintain the same level of progressivity. It would be nearly impossible for countries with the highest tax levels to match the tax progressivity (in percentage of income terms) of those with the lowest tax levels, but that does not mean that they don't soak the rich.

For less hypothetical evidence, consider Sweden's marginal income tax rates, which top out around 70%...Countries like Sweden have less progressive tax systems, not because they tax the rich less than us (they in fact tax them more), but because they tax the non-rich more than us. Looking only at progessivity regressions (without any regard for tax levels) hides this fact, which is presumably why the authors of the Vox piece totally bungled it.
Bruenig further shows that the Scandinavian countries have lower poverty rates not because they "invest in human capital" more efficiently than the U.S., but because they transfer more income to those who earn little.

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