There is an intellectual storm sweeping through the corridors of academia and power in Western countries. New Zealand will no doubt catch up in time and a good thing too. It’s a revolution in understanding about inequality, wealth and the role of tax.
In his pioneering 2014 opus, Capital in the 21st Century, French economist Thomas Piketty has come up with a captivating explanation of why the rich are getting richer, why they will continue to get richer and why this is bad news for society. At the heart of it all lies wealth and especially inherited wealth. Piketty explains that we can expect wealth to produce returns for its owners that exceed the growth rates of economies and that means inequality will get ever wider over time. In other words, the income gap between those at the bottom (in the low paying jobs) and those at the top (living off their income from wealth) will grow and grow. That is a problem because, as the 19th and early 20th centuries show amply, rising economic inequality is typically associated with rising political inequality and escalating social unrest.
Piketty’s primary message is that except under special circumstances the natural tendency of capitalism is to concentrate capital and wealth, rather than to spread it around. This leads not just to gross inequity but also hampers the ability of capital markets to sustain economic growth. The crutch of the Piketty argument is that productivity gains (due to technology and the like) have both a distributive effect – to move income toward the owners of capital – and an income effect – to raise the income of all, including employees. However his view is that most commonly the distributive effect is the strongest. The resulting concentration of wealth risks stifling the growth of effective demand in the economy and with that employment and the wage share of income.
Piketty’s analysis is a direct affront to the neoclassical model which holds that so long as we have competitive markets then the allocation of income and wealth will be relatively stable. It is this model that has had most of us conventional economists advocating competitive markets over our careers and the trust-busting of concentrated markets. The counter argument in the main has been that on occasion the gains to national income from economies of scale outweigh the gains from competition, so we can turn a bit of a blind eye to market concentration on occasion. This can be particularly relevant in a small market like New Zealand where the conditions for full competition cannot always be met.
But the Piketty model confronts the belief that even in large markets competitive conditions will ensure the ability of capitalism to spread the gains from economic growth – commonly called “trickle down” in the vernacular of politics. Piketty’s thesis is worth taking very seriously because it has a very strong empirical backing. He unpicks the circumstances underlying the rise and fall of concentrated wealth in developed economies over 200 years of history. In essence that evidence shows that that special one-off factors such as the two World Wars lead to the dispersion of wealth – the dispersion is the exception, not the norm. In the absence of special factors capitalism leads to a rising concentration of wealth.
Piketty’s solution is an annual tax on wealth. His idea is to collect 1% or 2% from wealth each and every year. He has a minimum wealth threshold of Euros 1.0 million in mind, so only those really worth something will be caught. Piketty believes wealth taxes like this are capable of stabilising inequality, essentially because they haul back the (post-tax) returns to capital to match the pace at which the economy is growing. Piketty’s book has risen to the top of the best sellers – not bad for a 500-odd page economic tome!
In 2011 in the book The Big Kahuna we said that New Zealand should be collecting an annual tax based on capital assets. We called it the ‘compehensive capital tax’ or CCT. We could equally have called it a wealth tax as our ‘capital’ and Piketty’s ‘wealth’ are essentially the same thing.
The details of our proposal differ from Piketty’s but the end goal is the same. Our intention was to haul wealth into the tax net too – addressing the fact that our income tax system only recognises regular cash receipts as income yet wealth often produces non-cash (and therefore untaxed) financial returns such as capital gains and in-kind (again untaxed) rewards such as the rent-equivalent of home ownership. Our proposal amounted to collecting 1.8% of the value of wealth each year using the CCT, taking account of any income tax already paid on the regular cash returns generated by that wealth. It’s worth taking a second to look at the failings of our current tax system.
The standard properties of a good tax are simplicity, equity, neutrality and efficiency. When GST was first mooted one of the reasons was that it encouraged savings, it was simple and it was very efficient (it was hard to avoid, had low compliance costs and so long as there were no exemptions it had a neutral effect on decision-making). For an economy that had a deep-seated savings insufficiency GST has largely been regarded as a successful part-substitute for the major revenue-earning tax, income tax. GST enabled the progressivity of income tax to be reduced and one rationale for that was that high income taxes are considered a disincentive to work and effort.
But there are other problems with our main tax type. Income tax is riddled with inequity because, as we’ve explained, it fails to tax all effective income. This in turn causes all manner of distortions. These include manifestly imposing the highest effective tax rate on PAYE income – that’s typically wage earners; distorting investment patterns as investors seek out tax-light options rather than investing where the economic return is greatest; because of the interface with targeted welfare benefits, inflicting prohibitive effective marginal tax rates on people who try to supplement income support with paid work (‘poverty traps’); and despite a flattening of tax rates over recent decades, encouraging income shifting in order to minimise tax payable bringing with it a whole host of costly policing costs. So all properties of a good tax – simplicity, equity, neutrality and efficiency are violated.
To the popular response that wealth taxes are just another way to milk the rich, it is constructive to consider that those most successful under the status quo, the rich do not typically seek lower taxes. A recent survey in the US indicated that 67% top 1 percent of American earners support higher income taxes and another study indicates that the richer you are, the more likely you are to support higher tax rates . Whether that attitude extends to wealth taxes remains to be seen.