Consider the following order of things. Any year your income exceeds $2 million, you pay 90% in taxes on the excess income. Each year, the President and the Majority Leaders of Congress honor the top ten contributors to tax revenue. They even give them a plaque. Something similar to the annual honors for top achievers in arts and humanities. If you are Bill Gates or Warren Buffet you are proud to show your guests all the plaques you have accumulated over many years of income creation and contributions to taxes.
You think this is a crazy fantasy. It’s not. It happened in the 1950s minus the ceremony and the plaques. The marginal tax rate for personal income over $200,000 (or $2 million in today’s dollars) was 91%. And capitalism in America thrived. But over the years, we started to read out of a different book, according to which high tax rates for even very rich people became an anathema. How did we arrive to the new notion about capitalism and taxes? Was it because high taxes slow (a) the work ethic? Or (b) the rate of corporate investment? Or (c) the rate of innovations? In short, did we discover that high taxes could bring the collapse of capitalism?
The truth of the matter is that we didn’t discover any such tax effects. Take the argument of diminishing work supply and effort if incomes are limited (say, by taxes). Major sport leagues in the US have total salary caps; no such limits exist in European sports. Can anyone credibly argue that American athletes compete less vigorously? Switzerland had a tax holiday and there was no change in work intensity or supply. In the US, changes in welfare benefits have been associated with insignificant changes in work habits. Alaska pays $5,000 per household a year out of its oil fund. No slackers there either. As this year’s Nobel Prize winners in economics, Esther Duflo and Abhijit Banerjee, write: “Financial incentives are nowhere near as powerful as they are usually assumed to be.” Why do people still work and excel in spite of lower financial rewards? Because of personal pride, status in their communities, dignity, and desire to demonstrate social solidarity and cooperative spirit.
And what about boosting corporate investments by giving tax relief to corporate profits? We have seen that the tax relief corporations got from the 2017 tax law was primarily used to buy back stocks than to make new investments. A NYT (Nov. 17, 2019) article featured the story of FedEx, which despite going from a tax bill of $1.5 billion in 2017 to $0 in 2018 (a $1.5 billion tax windfall) made no appreciable addition to its investments. The same elusive evidence about a dependence on lighter taxation holds for the rate of innovation. These examples do not totally invalidate the effect of taxes on economic activity and outcomes, but neither do they support the hysterical claims that taxing very high incomes and wealth is a fatal blow to capitalism.
Over the two hundred years of history with capitalism, people have succeeded in leaving behind lives of subsistence and building more equitable and prosperous societies. For most of that time, economic gains and social progress moved on parallel tracks. That co-movement has, after all, been the main reason behind the endurance and political legitimacy and acceptance of capitalism.
Over the last thirty years, though, we have witnessed a serious loosening of the bonds between capitalism and society, especially in this country. The drive for individual success, epitomized by the accumulation of wealth, has made us much less attentive to the imperative of social progress and cohesiveness. Wealth accumulation is now treated almost like a sport. Every year we are told how rich people are ranked in wealth. There is less interest in how the average Joe ranks in overall human wellbeing.
Thus, we have arrived at a state where the rising aggregate national income and wealth are distributed with unprecedented abundance to the few and great stinginess to the many. How else can we explain that the average tax rate for the 400 richest households dropped from 70% in the 1950s to 23% in 2018 whereas it rose from 16% to 26% for the bottom 10%; that the US minimum wage is 34% of the typical wage (the lowest in the OECD group) versus, for example, 62% in France; that the 1% of richest Americans earned 20% of the national income in 2014 compared to 11% in 1980; and that an estimated $1 trillion per year has been transferred from the bottom 80% to the top 1% since 1979, a result of the redistribution of wages and salaries away from the many and toward the few?
Such tectonic shifts in the distribution of incomes and wealth call into question the economic and moral underpinnings of wealth creation and distribution. One culprit is, of course, the declining progressivity of the tax code complemented by the preferential taxation of certain incomes (like capital gains and carried income) and forms of wealth (estates, in particular). The other culprit is that wages have not kept pace with the gains of productivity, resulting in a shrinking share of wages in the national income in favor of profits. And a third culprit is the breakdown of meritocracy in education. In a new book, The Meritocracy Trap, Daniel Markovits, A Yale Law professor, describes how the admissions process of top colleges has been corrupted to make room for the children of the upper classes and the connected at the expense of equally qualified but underprivileged students. Thus, Markovits argues we have the emergence of an oligarchic elite that can perpetuate its inter-generational advantage. The fact that social mobility in the US is now below that of European nations adds credence to his argument.
The sense of inequity in economic rewards and opportunities along with the deterioration of several critical indicators of human development are reflected in the recent political choices of American voters. And the feeling of inequity explains why a majority of Americans support a wealth tax and even raising the marginal income tax rate to 70%. The erosion of faith in the fairness of the capitalist system among younger Americans ought to be a warning.
Wealth creation is not the problem. How wealth is created and is distributed is the real problem. Its ultimate purpose ought to be the betterment of society not the extravagant aggrandizement of the individual. Instilling social responsibility in the creation and distribution of wealth is the challenge we must meet. Perpetuating policies that seek to create wealth at the expense of fairness and then shield it from fairly sharing in society’s needs is, in my opinion, what can ultimately undermine the moral foundations of capitalism and jeopardize its viability.
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