In their new book Taxing the Rich, the American political scientists Kenneth Scheve and David Stasavage assert that taxes on the wealthy can rise — and rise sharply — if one condition is satisfied. That condition is war, and indeed a particular kind of war. In this four-part excerpt from the book, the authors describe, first, the three main historical arguments for taxing the rich; second, the roots of taxation; third, the power of the “conscription of wealth” argument; and lastly, the outlook for higher top tax rates.
When and why do countries tax the rich? It’s hard to think of a timelier question today or one for which there are more sharply colliding views. We know that taxes on the rich today aren’t what they were half a century ago, but how did we get from there to here? We know even less about how those high taxes of the 20th century happened in the first place. Was it the effect of democracy, or a response to rampant inequality? Much of what is written today about taxing the rich takes the form of advocacy that is focused above all on the present. But taking a step back and showing the long history of taxing the rich can teach us about our current situation.
What a country decides about taxes on the rich has profound consequences for its future economic growth and the distribution of economic resources and opportunities. Given the stakes, it’s surprising how few comparative studies exist of taxation of the rich over the long run. Many people have asked this question only for recent decades, or for a single country. The last book to treat the question extensively was published more than a century ago, by Edwin Seligman.
We argue that societies do not tax the rich just because they are democracies where the poor outnumber the rich or because inequality is high. Nor are beliefs about how taxes influence economic performance ultimately decisive. Societies tax the rich when people believe that the state has privileged the wealthy, and so fair compensation demands that the rich be taxed more heavily than the rest.
When it comes to thinking of what tax policy is best, few would disagree with the notion that governments should be — in part — guided by fairness. It is a term used frequently by those on both the political left and right. How can this be? History suggests that the concept of fairness is up for grabs. Standards of fairness in taxation vary greatly across countries, over time, and from individual to individual.
When scholars write about fairness and taxation they most often adopt a normative point of view; that is, they ask what governments should do. But fairness isn’t just a normative standard; it also matters for what governments do in practice because it influences the policy opinions of citizens. Ordinary people are more likely to support heavy taxation of the rich if it adheres to the fairness standards that they themselves hold. While many theories of politics assume people are concerned only with maximising their own income, there is abundant evidence that humans are also concerned about issues of equity and fairness. These concerns don’t mean that people aren’t also concerned about self-interest — no one likes paying taxes — or even that self-interest isn’t their prime concern. Individuals may also care about the efficiency of a tax system and whether it taxes people so heavily that they stop producing at all. Opinions about tax policy can be informed by both self-interest and efficiency, as well as fairness.
Political support for taxing the rich is strongest when doing so ensures that the state treats citizens as equals. Treating citizens as equals means treating them with “equal concern and respect,” to use the phrase adopted by the philosopher Ronald Dworkin. The idea that people should be treated as equals is, of course, part of the bedrock of modern democracy. This criterion narrows the field for what counts as an effective fairness justification for a tax. It cannot be an argument that refers to how people are inherently different or how some are inherently more worthy than others. Nor, of course, can it refer to pure self-interest.
Even so, simply saying that people should be treated “as equals” or “with equal concern and respect” does not allow us to proceed deductively to identify the precise tax policies that satisfy this criterion. There are multiple ways to plausibly treat people as equals in taxation, and this is what debating tax fairness is all about. We take an inductive approach and focus on the three arguments that have been the most common and the most persuasive in political debate: equal treatment, ability to pay, and compensatory arguments. We refer to these arguments as three ways to treat people as equals.
The greatest political support for taxing the rich emerges when compensatory arguments can be credibly applied in policy debates.
This happens when it is clear that taxing the rich more heavily than the rest serves to correct or compensate for some other inequality in government action. Compensatory arguments are most likely to emerge in democracies precisely because the very idea of democracy is that citizens should be treated as equals. If the rich have been privileged by some government intervention while others have not, then it is fair that they should be taxed more heavily to compensate for this advantage. Symmetrically, if the state has asked others to sacrifice while the rich have not borne the same burden, then again taxation of the rich can compensate. Compensatory arguments push policy toward heavier taxation of the rich, but in many cases the straightest route to fairness is to remove the initial privilege in the first place.
Therefore, compensatory arguments are most powerful in cases when a government is obliged to take an unequal action that somehow favours the rich.
The compensatory theory is not the only fairness-based argument for taxing the rich. Over the past few centuries, the most common fairness-based argument for taxing the rich has been the ability to pay doctrine. According to this doctrine, a dollar in taxes for someone earning a million dollars a year represents less of a sacrifice than it does for someone earning a more average salary. Ability to pay arguments have existed since at least the 16th century, and they underpin the contemporary theories of optimal taxation most favoured by economists.
For many, the ability to pay doctrine suffices as a reason to tax the rich more heavily than the rest. Others object to this notion. They may question how the ability to pay doctrine can be applied in practice.
How much more should a rich person pay? They may also ask why ability to pay says nothing about how disparities in income or wealth emerged in the first place. Maybe the rich were just more talented or exerted more effort than others? People who criticise the ability to pay doctrine do not deny that a dollar in taxes represents less of a sacrifice for a rich person than for someone else; they simply do not accept that this is the right criterion by which to judge fairness.
In the face of doubts about ability to pay, a salient alternative is to suggest that the fairest system involves equal treatment for all. Both rich and poor should pay the same tax rate — a “flat tax.” We use the phrase “equal treatment” to refer to fairness arguments suggesting that the same exact policy be adopted for all. Since the 16th century, opponents of progressive taxation have suggested that the basis of a republic is equal treatment for all, as illustrated by the norm of one person one vote. Therefore the same exact policy should be applied to taxation. The logic that equal treatment requires a flat tax is not perfect; having all pay a lump-sum tax, where each person pays the same amount, would also respect equal treatment, yet many today would consider such a tax unfair. Nevertheless, arguments based on equal treatment have carried great power in debates about taxing the rich.
The strongest argument
Some of the earliest examples of compensatory arguments involve suggestions that the rich ought to pay a higher rate of income tax because the poor bear the brunt of indirect taxes on common consumption goods. The idea is that to maintain themselves, the poor must consume a greater share of their income each year. However, over the last two centuries the most powerful compensatory arguments have involved a different sort of tax — military conscription.
This one simple fact goes a long way toward explaining both the rise of heavy taxation of the rich in the early and mid-20th century and the subsequent move away from this policy over the last several decades. The mass wars of the 20th century were fought in a way that had a strong economic rationale but which privileged the rich along two dimensions. First, labour was conscripted to fight while capital was not. Second, owners of capital benefited from high wartime demand for their products. Heavy taxation of the rich (owners of capital) became a way to mitigate these effects and to restore at least some degree of equality of treatment by the government.
This was what those on the political left claimed and what those on the right were forced to concede. It was a powerful new argument for progressive forms of taxation, and it shifted mass and elite opinion on the question of taxing the rich in a leftward direction.
Compensatory arguments are less credible in the case of more limited wars of the sort that the United States has fought of late. If the bulk of the population is not sacrificing for war, then how is it credible to ask the rich to pay a special sacrifice as compensation?
Finally, the choice between limited war or mass mobilization has been dependent on the state of military and related technologies. In the 20th century the advent of the railroad made mass mobilization possible. When mass mobilization did eventually occur in 1914, compensatory arguments for taxing the rich emerged. In the twenty-first century the advent of precision weapons and drone technology means that mass armies are no longer necessary and may even be undesirable. Therefore, we are unlikely to see a repeat of the 20th-century forces that led to heavy taxation of the rich. The compensatory theory explains why it was the wars of the early and mid-20th century that brought heavy taxation of the rich and not prior or subsequent wars.
In this passage, we learn that the three main arguments for taxing the rich — equal treatment, ability to pay, and compensatory arguments — appear in various guises in early debates on taxation from Florence to France to the United Kingdom.
What may be the first modern reference to the ability to pay principle dates from Florence in the early 16th century. The first critiques also date from this era. In 1500, the city’s governing council had introduced (or actually reintroduced) a progressive tax on land income known as the decima scalata. The tax was a subject of great controversy, and these debates attracted the attention of Francesco Guicciardini. He wrote a short text, which has become known simply as La Decima Scalata, in which he presented imagined discourses of two orators before the council, one opposed and one in favour.
Guicciardini himself was opposed to the tax, but it is presumed by historians that his text reflects the positions taken by both Florentine proponents and opponents of taxing the rich. The discourse in favour of the decima contains a passage that mirrors ability to pay positions taken centuries later: “However, the equality of a tax does not consist in this, that the rate each person must pay should be the same from one to another, but that the payment should be of a kind that one and the other are inconvenienced to the same degree.”
The opponent of progressive taxation in Guicciardini’s discourse had several responses to this ability to pay claim. The first was that the rich needed to spend more than the poor to maintain their standing.
The second was that, in a republic, people ought to be treated as equals in the sense of having equal political rights without striving to use the tax system to obtain either equality of sacrifice or equality of outcomes:
“I admit that equality is a good thing in a republic, indeed a necessary one, because it is the foundation of liberty. But the equality that we are seeking is as follows: that no citizen may oppress another, that each is equal before the law and its magistrates, and that the vote of each man who is eligible to participate in this Council has the same weight as that of any other.”
Florentine critics of progressive taxation also made one further comment — maybe the rich deserved their money because they had earned it. In other words, ability to pay isn’t the right criterion to judge fairness in taxation. This has been common in critiques of the ability to pay doctrine up to the present day.
After the end of the Revolution all attempts to implement direct and progressive taxation of income were abandoned, but in 1798 the French government did establish a tax on doors and windows. This would join three contributions voted in 1790—1791 and would become the fourth of the quatre vieilles. Some would claim that the incidence of this tax was progressive. However, the final point to remember about the quatre vieilles is that their combined incidence was very low. During the income tax debates of 1907, the French Ministry of Finance produced an estimate showing that French households with high revenues paid only about 2 per cent of their annual income on these four taxes combined.
Following the Revolution, the next significant attempt to create a permanent income tax did not come until the advent of the Second Republic in 1848. This effort turned out to be brief and unsuccessful.
New discussion of the income tax would not occur again until the advent of the Third Republic in 1870. From that point onward the income tax would remain a prominent feature of political debate, but it would take 44 years before France finally passed an income tax law. This occurred on July 15, 1914, on the eve of the First World War.
After the establishment of the Third Republic in 1870 there was a flurry of proposals in the French Chamber of Deputies to establish a general income tax in France. This would be a tax on all income with an assessment. It would supplant or replace the system of the quatre vieilles that relied on external indicators of income and wealth.
The deputy Louis Wolowski defended the idea of a proportional and general income tax in the following terms: “We ask that all revenues, whatever type they may be, pay equally. This is true equality and justice.” In other words a general income tax was the best way to ensure citizens were treated equally. Wolowski argued that the proposed tax of 3 per cent would not be very heavy, nor would it be levied arbitrarily. He also defended the idea of having a subsistence minimum of revenue exempted, even if this would deviate from the principle of equal treatment. Finally, Wolowski referred to the English experience to suggest that an income tax could be used to levy very substantial revenues without this having a negative effect on economic activity.
If many in 1871 supported establishing an income tax, France’s president, Adolphe Thiers, strongly opposed the idea. This was despite the fact that he had been supportive of the idea in 1848. A speech Thiers gave in December 1871 is credited with leading to the failure of the income tax proposal. Like others, Thiers argued that the proposal would lead to arbitrary taxation. However, the most fascinating, and most detailed, part of his speech involved a comparison with the United Kingdom and a compensatory argument against the income tax. Thiers suggested that because the United Kingdom had an open economy, albeit with trade taxes, and because the burden of trade taxes fell heavily on the poor, it was natural that the rich in the United Kingdom should be taxed via an income tax. France, according to Thiers, had a much more closed economy, so the poor logically suffered less from trade taxes. He also argued that many indirect taxes in France were on luxuries and that the rich were taxed more heavily via the doors and windows tax. Therefore the compensatory argument in favour of the income tax did not make sense for France.
Summing things up, Thiers concluded with this:
“Wealth in England owed something to the country; it was natural that the burden of the income tax should be placed on wealth. In France, in contrast, the propertied and comfortable classes do not owe something to the French people because they are [already] paying three quarters of the taxes. There, sirs, is the strongest argument, from the point of view of truth, I would say honestly, that can be invoked against the income tax in France.”
3. United Kingdom
The most important 19th-century reform shaping taxation in the United Kingdom was the re-establishment of the income tax in 1842 by a Conservative government led by Robert Peel. The 1842 debate shows how compensatory arguments can influence tax debates even in a time of peace. The United Kingdom had successfully implemented an income tax during the Napoleonic Wars but then abandoned it after the wars ended. The tax system at this time relied substantially on trade and an extensive set of other indirect taxes. Since many of these taxes were unpopular, there was considerable debate, especially in the 1830s, about the possibility of reducing these taxes and substituting them with new property taxes or a general income tax. Even so, no significant policy changes were made.
Faced with both a persistent fiscal deficit and popular objections to existing indirect taxes, in 1842 Peel proposed re-establishing the income tax. Peel’s budget speech had two main sets of arguments for this reform. The first was primarily an efficiency argument — the income tax was the best alternative for raising more revenue in order to balance the budget and revive the economy. The second was a compensatory argument. An income tax was necessary to equalise the tax burden because existing taxes were most burdensome for lower income citizens. As Seligman points out, Peel early in the speech noted the high prevailing level of indirect taxes and stated, “I
cannot consent to any proposal for increasing taxation on the great articles of consumption by the labouring classes of society.” He then argued for the income tax:
“ … for the purpose of not only supplying the deficiency in the revenue, but of enabling me with confidence and satisfaction to propose great commercial reforms, which will afford a hope of reviving commerce, and such an improvement in the manufacturing interests as will re-act on every other interest in the country; and, by diminishing the prices of the articles of consumption, and the cost of living, will, in a pecuniary point of view, compensate you for your present sacrifices.”
The subsequent debate was also noteworthy, highlighting the importance of arguments about the impact of the income tax on economic growth, expected administrative problems, the need to save the income tax for times of war, and the supposed inquisitorial nature of the tax.
Importantly, fairness-based arguments featured in these debates across many issues related to the tax, and they were employed by both those in favour of and those opposed to the tax. Some made appeals to equal treatment because the government had proposed to treat different types of income differently by including an exemption for individuals with lower incomes. It was also suggested that the tax was unequal because it favoured landowners over merchants. Other speakers made ability to pay or compensatory arguments in favour of adopting the tax.
The 1842 debate also illustrates another dynamic that would be repeated later in the 19th century in the UK and elsewhere; supporters of trade liberalisation sometimes accepted the need for an income tax to replace lost revenue from reduced custom duties.
There are at least three important points common to 19th-century tax debates. First, there was an explicit compensatory argument that taxing the rich was justified because of other taxes that fell on the poor and working classes. Second, this phenomenon was also an efficiency argument made by free traders who thought that substituting modest income taxation for trade taxation would improve economic performance. Third, these compensatory arguments did not result in heavy taxation of the rich. They should instead be viewed as contributing in some cases to the adoption of income tax systems with relatively low rates.
Although Peel did not succeed in passing all of his proposed reforms, the income tax was reinstated in 1842 with a single rate of almost 3 per cent. For the remainder of the 19th century the income tax remained in place, with the rate varying between just below 1 per cent to just below 5 per cent.
Mass warfare is the most powerful argument for taxing the rich. This is the core finding of professors Scheve and Stasavage, as detailed in the following passage.
The reason wartime governments increased taxes on the rich more than the rest was because war mobilization changed beliefs about tax fairness. It created an opportunity for new and compelling compensatory arguments that increased support for taxing the rich. In public tax debates before, during, and immediately after World War I in the United Kingdom, France, Canada, and the United States, as a result of the war both elites and ordinary people changed the type of fairness arguments they employed when justifying their preferred tax system.
Focusing on World War I has several advantages. No governments expected the long, expensive mass mobilised conflict that followed.
The timing of the conflict was determined by the assassination of the Archduke Ferdinand of Austria in late June 1914. The war was an unexpected shock to the political environment that created new inequities in terms of what states asked of the mass of its citizens — manpower to fight the war — and how the state privileged the rich — increased war profits for many sectors of the economy.
How did these new war-induced inequities change debates about taxation?
Prior to the outbreak of hostilities, the UK coalition government’s 1914 budget proposal would have slightly reduced the income tax rate, and it proposed a combination of increased customs and excise taxes and reduced spending to balance the accounts. It is clear that at least for 1914, the UK was not going to have a more progressive tax system absent the war. With the war, however, the first and second war budgets in 1914 and 1915 increased income tax rates significantly with a top rate in 1915 of 17.2 per cent, while the top rate of inheritance taxation rose to 20 per cent. These two changes made the system substantially more progressive. The UK began the war with an effective and massive volunteer mobilization effort. Nonetheless, in January 1916, the government’s Military Service Bill, which adopted conscription, passed quickly into law and was expanded several times throughout the remainder of the war. Once conscription was adopted, it became central to political debates about how the war was to be financed. It certainly appeared to lead to policy changes that made taxation even more progressive. For example, the Labour MP George Wardle argued in parliament:
“The sacrifice which the soldier is called upon to make is far greater than that asked of the man who has to part with part of his income, even though it be 5 shillings. in the pound, and there is a growing feeling, intensified again and again by the passing of this compulsory measure, demanding that a bigger proportion of the wealth of the country should be mobilised for the service of the nation in order to win this War, and mobilised at once … If it be necessary to mobilise the men, the munitions, the factories and the businesses of the country in order to win it, it is equally necessary to mobilise the wealth of the country, and the Chancellor of the Exchequer, bold as he may think he has been and bold as some people certainly think he has been, might have gone even further than he has, and if he had gone further he would have done a great deal more to bring the end of the War nearer, to bring that sense of equality and sacrifice closer, and to have made a feeling in this country which would have enabled us all to be more united even than we are at present in securing a final victory.”
United Kingdom policy responded to demands for greater progressivity in income taxation. The third war budget, introduced in April 1916, just after the conscription bill was passed, increased the income tax, with revenues from higher income taxes expected to generate more than twice as much additional revenue as increases in indirect taxes. The capital levy debate also intensified following the introduction of conscription, though the levy was never adopted. These remained the principles that informed tax policy to the end of the war and in the years immediately after as the country struggled to repay its war debts and meet the increased expectations of its citizens who had sacrificed so much to win the war. Top income tax rates peaked at 60 per cent in 1920 and 1921. The top inheritance tax rate reached 40 per cent.
An immediate impact
When the United States entered World War I in April 1917, the Wilson administration decided quickly that a large army and conscription were required. The impact on fairness arguments about taxation was almost immediate and was evident across the country.
Leading academics, such as Oliver Sprague, Seligman, and Irving Fisher, argued in the press and in congressional testimony that conscription was a tax-in-kind on the masses. Therefore it was necessary to tax high incomes and wealth so as to better approximate equality of sacrifice in the war effort. In a message sent to Congress after war was declared, a committee of economists argued for funding the war primarily with taxes, especially taxes on war profits and high incomes, rather than debt. They argued:
“The citizen who contributes even his entire income, beyond what is necessary to subsistence itself, does less than the citizen who contributes himself to the nation … If conscription of men is just and right, conscription of income is the more so; conscription of both is just and right when the nation’s life and honour are at stake.”
The economists ended their statement with four general policy recommendations: “a tax which will take substantially all of special war profits; a material lowering of the present income tax exemption; a drastic increase in the rates of the income tax, with a sharper progression in rates as incomes become larger; and high consumption taxes on luxuries.” These same arguments were repeated by many different interest groups, political parties, and politicians across the country. Other compensatory arguments from the prewar period, especially those based on inequalities in the benefits of the war, also continued to be used to justify higher taxes on income, wealth, and profits. Ability to pay arguments were still made, but less frequently than before the war.
To be sure, not everyone agreed with the compensatory theory, and the excess profits tax especially met considerable resistance from business interests. Opponents primarily focused on efficiency arguments, yet as in the UK, there also was an appeal to equal treatment.
These considerations were used to support further lowering of the income tax exemption level in lieu of higher rates and to object generally to excessive reliance on taxes targeted at the rich.
Finally, some, such as the banker Otto Kahn, claimed that the idea of a “Rich Man’s War” was simply a myth.
A resonant phrase
Arguments about the “conscription of income” or the “conscription of wealth” were not confined to elite and academic circles within the United States. They also resonated with the broader American public. As this period predates the arrival of opinion polls and surveys gauging mass opinion, one of the best ways to demonstrate this is with evidence from small-town newspapers. One can find thousands of references to the phrase “conscription of wealth” deriving from local newspapers spread very widely across the American continent.
Many of these references involve discussions of parliamentary debates either in the United Kingdom or in the US. Congress, so we cannot really use them as an independent indicator of mass opinion.
However, many others do seem to reflect the policy opinions of citizens across the country. These come in several categories.
Within the set of newspapers, there are many reports of local groups adopting resolutions in favour of the conscription of wealth.
As just one example, on July 1, 1918, the Commoner, published in Lincoln, Nebraska, reported that the Nebraska Non Partisan League (a successor to the populists) had adopted a resolution in favour of the war effort and in favour of the conscription of wealth.
In addition to resolutions, many newspapers also published pieces in which individuals expressed opinions favourable to the conscription of wealth. For example, on August 31, 1917, a writer for the Washington Standard in Olympia, Washington had this to say:
“History of former wars has shown, as everyone knows, that quite a number of people, although actually a very small percentage of the population, made enormous wealth out of each war, while the great body of the people of the country not only fought the war but had to pay for it, too. That is not right, of course, and in this present conflict, when the nation has rightly adopted the democratic idea of compelling the young men of the country to do their patriotic duty whether or no, so the ordinary person thinks that wealth, and particularly war-created wealth, should be compelled to serve likewise.”
Though the opinion expressed in the Washington Standard was reflected in many other papers, it is also abundantly clear that some people vigorously opposed the idea of a conscription of wealth, and that the concept was contested. On September 3, 1917, the Grand Forks Herald published a piece in which it was suggested that the phrase “conscription of wealth” made “a convenient mouthful for the professional agitator.” However, this and other critiques point to the underlying power of conscription of wealth arguments. Opponents may have disliked the phrase, but they readily emphasised its effect on mass opinion. Speaking of the phrase “conscription of wealth,” a writer from the New York Tribune made the following commentary:
“It is heard everywhere, on the street and in the press. To the unthinking masses the epigram, ‘You conscript men’s bodies, why not their money?’ has a great appeal.” This quote laments the power of a phrase in the same way that those on the left today might lament the effect of conservative anti-tax slogans of recent years. It is a further indication of mass opinion.
In the end, in the United States the conscription of income and wealth view won the day. Policy outcomes responded with a tax system that was unimaginable prior to the war. The top rate for the income tax reached 77 per cent; the top rate for the inheritance tax was raised to 25 per cent; and legislation vastly increased the use of the excess profits tax.
In this final section, the writers ask what might, in coming years, prove to be powerful arguments for increasing taxes on the rich.
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 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 states found themselves in a particular state of technological development where 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 a new 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 emphasising efficiency costs. This debate is unlikely to result in much deviation from current trends in tax rates.
We have suggested that change with regard to taxing the rich would instead depend on the ability of proponents to do one of two things. First, they could use compensatory arguments compatible with an era of peace. Second, they could appeal to the logic of equal treatment to oppose those situations where, because of exemptions or special privilege, the rich are taxed less heavily than others. We close by considering these two possibilities.
When we ask whether compensatory, or even equal treatment arguments, in favour of the rich 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 early 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 presumed income from land. In rapidly industrialising societies this meant that whole new categories of mercantile income went untaxed. Taxes on external manifestations of wealth, such as doors and windows, suffered from many of the same flaws. Under these conditions, the politician Joseph Caillaux argued in France in 1907 that a general income tax was necessary to reestablish equal treatment. He saw the establishment of 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 re-emerge, necessitating periodic efforts to see that equal treatment is maintained.
Now consider how the logic of Joseph Caillaux’s argument applies in the twenty-first century. Today the advanced industrial countries have a general income tax applying to a broad-based definition of income. However, the US 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 class income as capital gains that are subject to a lower rate of tax. These features of the tax code today could arguably be said to play an analogous role 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 favour 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 produced by the Internal Revenue Service on effective tax rates across different income categories.
Data from 2011 show that up until an income of $2 million per year, the more people earn, the higher the effective rate that people tend to pay. However, as incomes increase above $2 million per year, the effective income tax rates filers face actually decrease. The IRS calculated that on average in 2011, those earning between $1.5 million and $2 million a year faced an effective income tax rate of 25.2 per cent. In contrast, on average those earning more than $10 million per year faced an effective income tax rate of only 20.5 per cent. Had those making more than $10 million per year been obliged to pay the same effective tax rate as those making between $1.5 million and $2 million, this would have brought in about 15 billion extra dollars in revenue. This is a tiny fraction of the total federal budget (less than one-half of 1 per cent), but it is not an inconsequential sum. It is equivalent to roughly twice the total salaries of all kindergarten teachers in the United States today.
Equal treatment logic can also apply to payroll taxes and the question of whether to raise the ceilings applied to them. In the United States in 2014, the social security tax was levied on employees at a rate of 6.2 per cent up to $117,000 in annual earnings. This limitation clearly results in a 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 per cent of their income in payroll taxes, while the highest earners pay less than 5 per cent.
We are not saying that these equal treatment arguments are ones that necessarily should be made, or that it is the whole story. For 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 instead separate payments for services rendered 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 will probably be more successful if they look elsewhere in the tax system and appeal to equal treatment.
Let’s consider next the current relevance of compensatory arguments.
For centuries people have emphasised that if one tax has an unequal incidence across citizens, then another tax can be used to balance things out. This argument was made in 14th-century Siena. During 19th-century debates this same compensatory argument was levied in support of the income tax. Peel used it in Great Britain in 1842 to support reintroducing the income tax. John Stuart Mill advocated an income tax targeted at higher incomes for precisely the same reason. In Great Britain by the first decade of the 20th century, thanks to the existence of a progressive income tax, the overall burden of taxation across different 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 of a wartime context.
Now think about whether it might 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, as has always been the case, to bear the principal burden of indirect (or consumption) taxation. As the UCLA tax-law professor Steven Bank has emphasised, 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 European countries, value added taxes constitute a very significant fraction of the taxes paid by poorer households, and this is true even though basic necessities are taxed at special, low rates. In France today those with the lowest incomes pay fully 15 per cent of their income in consumption taxes whereas the highest earners pay only 5 per cent of their income in such taxes. The regressive incidence of consumption taxes creates a potential argument for taxing the rich more heavily so as to restore equal treatment.
The United States does not have a value added tax. However, individual states and localities within the United States do of course implement 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 having progressive rates apply to consumption taxes.
All of the above examples 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 emphasise equal treatment and efficiency. Overall, this could lead to some degree of increased taxation 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 that there might be massive political or economic shocks that put new compensatory arguments on the table, just as happened in 1914. Alternatively, proponents of progressive taxation would need to make a credible and compelling claim that current government policies are heavily biased toward the rich. That prospect seems uncertain and sure to be contested. In the end, one thing that is certain is that taxation of the rich will continue to be a fundamental source of social conflict, and when we seek to understand this conflict, we can learn a great deal from history.
Extract taken from Taxing the Rich by Kenneth Scheve and David Stasavage. Copyright © 2016 by Princeton University Press and the Russell Sage Foundation