The Case for Penal Levels of Taxation

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Budget 2013 drew few surprises. Income tax, including the top rate on high earners, was, as expected, not touched. Somewhat surprisingly for a coalition including Labour, the budget was deemed less progressive than previous budgets.1 With Sinn Féin and the ULA both proposing to increase the top rate of tax (as well as a wealth tax), the debate on how high or low taxes should be is sure to remain around for some time. I propose that not only are high top tax rates justified in general, but actual penal levels of taxation on high earners are too.

Economically, advocates of not increasing the already ‘penal’ rates on high earners any further argue that it would be a disincentive to work and would have adverse economic effects more generally. To be more precise, they argue these high earners or ‘wealth/job creators’ will stop conjuring employment and riches for the masses and pack up and leave for greener pastures. Of course, there’s plenty to say about this. Is it really believable that people would pack-up and leave for a different country – including taking their children out of school – because their tax liabilities have been increased by a few points.

Economic arguments aside, what rate of taxation is fair?

As many readers are no doubt aware, Paul Krugman pointed out in the Irish Times a few weeks ago that during 1950s, the so-called Golden Age of Capitalism, the top tax rate in America was over 90%.2 Is this fair? I suspect many people would say this is indeed penal and point out that business leaders and CEOs excel at what they do, innovate, invest, help create jobs and wealth, and so on. Progressives and leftists who support higher taxation tend to struggle when this argument is put to them because, essentially, the argument has a lot of merit.

Meritocracy?

A person earning €100,000 is likely to be more competent than one earning €30,000 in the same field – or at least better at applying his or her skills to profit-making. As well as perhaps being more competent, the former is likely to be more innovative because he or she is likely to be higher up the hierarchy and, as such, has more decision-making power. Because he or she will have been promoted to get the top, the meritocracy argument carries some weight, though with qualifications.

For one, innate ability and hard work, though important, are not the only determinants of success. A wealthy person is likely to have been born into wealth. As such, he or she will have been given more opportunities and encouragement. A poor person will likely have had fewer education opportunities, and whose way of life – how he or she dresses, speaks etc. – is denigrated by society. If born into poverty, even the very capable (whatever that means) are unlikely to have the confidence and social skills to excel.

Furthermore, many positions and sectors in the economy have little economic use. The wealthy help destroy wealth and jobs through, for instance, financial shenanigans and using their political influence to promote deflationary policies so as to disempower workers (jobs are also destroyed through automation, consolidation, and off-shoring and outsourcing). The wide variation in the number of supervisory positions across countries and the history of cooperatives and labour-managed firms further attests that (at least) many managerial positions are superfluous.3 So being materially successful does necessarily not allow one to claim that they are the wealth and job creators, innovators etc.

The wide disparity in remuneration between comparable men and women, and comparable whites and non-whites is evidence of an incomplete meritocracy.

More, in any event, the idea that one person creates wealth on their own is absurd. Nearly all workplace tasks have some sort of social component to them. The state also provides infrastructure through investment and training through the education system. It does a lot of the heavy lifting in terms of developing new technologies through, for instance, funding research through universities and military procurement (though this is less applicable to Ireland).

Be that as it may, the single most important person responsible for Manchester United’s success over the past two decades has been Alex Ferguson (not a businessman I know). Ditto with Apple and Steve Jobs, and yes, I suspect the same is true of Ryanair and Michael O’Leary, unfortunately. Despite the fact that wealth is socially generated, and that many of activities of the wealthy do little to create wealth and jobs, one cannot reasonably argue the bag handler at Ryanair and the groundskeeper at Old Trafford play as important a role in these institutions’ success (or failings) than those at the top, whatever Marxist theory might say. For better or worse, these businessmen (and they are mostly men), more than most (along with perhaps engineers and scientists), contribute to positive net job and wealth creation4. It is foolish and counterproductive to argue otherwise.

Be that as it may, there are good reasons why I think high rates of taxation, indeed extremely high or penal rates of taxation, are fair. Before tackling the high-tax debate though, it is worth rehashing some old arguments for taxation in general, and perhaps positing some new.

Six reasons for a progressive tax system

First, there’s the uncontroversial, age-old social contract-type arguments. Solidarity necessitates taxation to be used to fund welfare which enables citizens to survive and participate in society when fallen on tough times or for other reasons can’t look after themselves. Further in a wealthy society, some things are just basic rights such as access to education and healthcare and it is immoral to deny these, to anybody.

Second, as alluded to, much income that is earned is done through little exertion of effort and does little for the economy. Rental income, income from mere ownership of assets, bequests, and much of the income earned in the financial sector fall in to this category. Conversely, much poorly paid work such as caring is highly valued. Progressive taxation reduces these inequities.

Third, luck is a large determinant of one’s success. As mentioned if one is born into affluence one has a better chance of success. The genetic lottery also plays a part. A  maths wiz or a gifted athlete can reap large rewards. Progressive taxation therefore offsets the degree to which good fortune determines income.

Fourth and related to the third reason, progressive taxation makes society more equal. As well as leading to lower crime and better health outcomes, more equal societies tend to have greater social mobility.5 So if one believes in meritocracy, one way of achieving this is through progressive taxation.

Fifth, the higher-paid a person is, the more pleasant their working conditions are. This may go against the received wisdom of high-paying, high-flying jobs being the most stressful. However, the more poorly paid a person is, the more likely it is they are order-takers at the bottom of the hierarchy, do rote, repetitive, often degrading work and whose conditions of work are generally more likely to be disempowering and diminishing of their confidence and dignity. For example, how many doctors and CEOs would choose to clean toilets if all jobs were paid equally?

Sixth, the government plays a key role in affecting the distribution of income before people are paid, and is therefore justified in intervening after with taxes. For instance, blue, and to a lesser extent white-collar workers are subject to international competition through trade. Some workers, though, such as doctors, solicitors, and so on are protected, largely by government  policy. This is done in part through allowing some professions to restrict new entrants.6 Another way is through immigration control. If the government truly believed in free trade it would allow free mobility of (cheap) labour, not just for Eastern European construction workers and finance administrators, but for doctors and solicitors too (yes solicitors too – if Indian students, for instance, could study Irish law in India and work in Ireland, legal fees would fall dramatically). A similar argument can be made in relation those in the upper echelons of  finance in that they would not be able to earn their large incomes were it not for government bailouts.

Why penal top rates of taxation are fair

While these points establish the legitimacy for government intervention and taxation in general, they say little about why high or indeed penal levels of tax on the wealthy are appropriate (except that perhaps the more unequal the distribution of income is before taxes, the more progressive the tax system ought to be). Of course, one need only take a cursory glance at popular culture to see people instinctively feel the riches amassed by the wealthy are ill-gotten gains. It is for this reason (what may be called the Mr. Burns argument) that forms the basis for why penal levels of tax are fair. In essence, penal top rates of taxation are fair because the nature of our economic institutions – specifically competitive markets and corporations – implies that, to become rich, one needs to trample on others.

The nature of competitive markets

A market is an exchange-based institution for allocating resources in which the participants in a transaction bargain for price based on the principle of self-interest. For example, when we buy goods at a supermarket we look for the best deal for ourselves. When a worker sells and a firm hires labour, there is a tendency for each party maximise what they can extract from the other. Competition among businesses allows the consumer to choose or bargain for the best product and price, and competition among workers allows firms to choose the best and cheapest employees.

Competitive markets can be contrasted to public/state allocation. For instance, government, with public money, provides health services – often at low costs – in theory based on the needs of the public. Similarly, a family might allocate its resources based on its members’ needs rather than through bargaining.

So what is so bad about markets? As large disparities in power often exist between market participants – for example, an individual consumer taking a loan from a large bank, or a small third world government negotiating drug prices with a pharmaceutical multinational – and allocation is based, essentially, on what one can take from the other, the economy takes on a thuggish quality. Like the mafia don extorting the lowly shopkeeper because he has the power, the multinational company hires slave workers in sweatshops because, in essence, it too has the power. As a general rule then, the more successful or powerful one is in a competitive market economy – i.e. the richer – the more thuggish their behaviour.

Another aspect of markets is that the effects of a transaction on the rest of society are generally ignored. When one buys a car, for example, self-interest necessitates the price does not reflect the fact that there will be increased congestion and pollution or other social costs, but reflects the deal that has been struck between the buyer and seller. This can have calamitous consequences. The recent economic crisis is in large part attributable to the fact that the financial system operates according to market principles. When banks, investors, and others make bets, they calculate the risk to themselves rather than the risk to the public of the bet going wrong. As we know though, if one bank fails, this can crash the system and as such the social cost far outweighs the private loss.

Similarly, the problem of global warming can also be traced to markets. The fact that the social or environmental costs of production and consumption are in general not factored in to economic transactions almost by definition dooms the environment. As a general rule then, the more successful one is in a market economy, the greater disregard they have shown for others.

Competition precludes going against the tide. If a CEO decided to be altruistic; for instance using cleaner, more expensive technology or providing essential medicines at low cost to save millions of lives, he or she will be quickly outcompeted by those with less social conscience. Competitive markets therefore tend to penalise moral behaviour and encourage thuggish and callous behaviour. There is thus something to the old adage of nice guys finishing last. The callous, thuggish behaviour that is required for a rich to become rich is therefore good reason for penal top rates of taxation.

The internal nature of corporations

Imagine you lived in a society in which you cannot vote. One individual, Dear Leader, has almost absolute power. Dear Leader delegates power to other members who in turn delegate to others in a strict hierarchy. Surveillance is widespread with CCTV monitors and the like. Members are expected to follow orders and work in the public interest, which, in practice, means enriching Dear Leader and those who appointed him or her. Dear Leader was appointed by and is accountable to a small clique of other powerful people who generally aren’t members of the society, but are rather rulers of different societies. Any talk of democracy is likely to lead to members being kicked out of that society. Similarly, public criticism of Dear Leader or other superiors is not tolerated. In any event, such an event is unlikely given the strict hierarcy and the indoctrination programs Dear Leader and other high ranking members run.

This archetypal description of a totalitarian society is most likely to evoke images of Stalinist Russia or modern-day Saudi Arabia. It is, though, an equally apt description of a modern corporation, at least those of the Anglo-Saxon variety. Dear Leader, the CEO, is appointed by the board and answerable only to them and the shareholders, who tend to come from the same privileged backgrounds. Further, corporations are completely hierarchical chain of command systems, in which appropriate deference is shown to superiors. Workers are indeed surveilled with CCTV and swipe systems. Slogans such as ‘Excellence and Integrity’ adorn the walls of corporate edifices. Democracy amounts to suggestion slips in boxes.

In fact, of any other institution in developed societies only really the military compares in terms of its authoritarianism. For instance, members of a football or tennis club, while appointing managers to run its activities, can decide to (or delegate members to decide to) sack the mangers. Not even the most authoritarian or patriarchal families have anything approaching the corporate chain of command. Even the education system, which conditions the populaiton for the workplace, doesn’t really compare. A student gets away with a lot more backchat to a teacher than a worker does to his or her manager.

Dissent, if any exists, is quickly quashed in the modern corporation. Workers who attempt to unionise are quickly dismissed, unless the firm still happens to recognise unions. Criticising Dear Leader is also a no-go area as in the Ryanair pilot who, after publicly criticising CEO Michael O’Leary, was ‘sent to Siberia’.7 The situation is worse in third world countries where trade unionists can get murdered for their troubles.8

Most high-earners earn their wealth through the corporate system. As a general rule then, the richer one is the more dictatorial they are in their work life. Assuming dictatorships are undesirable, this is another reason why imposing penal levels of taxation is fair.

In sum, given the nature of competitive markets and the corporate form of organisation, the road to riches is paved with the public. To walk it, one needs to step on them. Penal taxes are therefore a start in rectifying the injustices in the economy.

 

Notes

1. The ESRI analysis of the budget’s distributional impact can be seen here http://www.esri.ie/__uuid/f1394f7f-aae3-49a6-94b1-c44c5edc60ac/Budget2013_Distributional_Impact_7Dec12.pdf

2. http://www.irishtimes.com/newspaper/finance/2012/1120/1224326838201.html

3. For cross country data on supervisor/managers to employees see Tilly, C. and Tilly, C. (1999) Work Under Capitalism. From memory, Ireland has a high number of managers and supervisors

4. One could also reasonably argue that policymakers or the state who, for example, decide to promote productive industry through tax breaks and subsidies play an even more important role. The general point that those at the top are the most important actors still holds though.

5. For evidence on societies with more equal income distributions having lower crime, being more healthy and socially mobile, see Wilkinson, R. and Pickett, K. (2009). The Spirit Level: Why Greater Equality Makes Societies Stronger

6. For restrictions to the legal profession in Ireland see http://www.tca.ie/EN/News–Publications/News-Releases/The-Competition-Authority-finds-the-legal-profession-in-need-of-substantial-reform-.aspx. For restrictions to the medical profession, see

http://www.tca.ie/en/promoting-competition/market-studies/Professions/General-Medical-Practitioners.aspx

7. http://www.guardian.co.uk/business/2010/dec/07/ryanair-pilo-transfer-michael-o-leary-criticism

8. http://left-out.net/2012/06/06/worldwide-violations-of-trade-union-rights-worsen-in-2011/

 

 

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