Media Briefings

TAX CUTS FOR THE RICH: New analysis of social transfers and the politics of top income taxation

  • Published Date: September 2015

Twentieth century programmes of social insurance in the UK, the United States and Sweden have improved the quality of life for most people – but by making social conflict less attractive for ‘the bottom 99%’, they have given ‘the top 1%’ the opportunity to push for tax cuts.

That is the central message of a new study by Francisco M. Gonzalez and Jean-François Wen, published in the September 2015 issue of the Economic Journal. Their view is in sharp contrast with the common perception that the welfare state is purely about redistributing from the rich to the poor, at the cost of making the economy less efficient.

The researchers note that the growth of the welfare state coincided with a puzzling pattern of top income taxation that is common across countries with very different social policies – from the UK to Sweden to the United States. While social transfers grew spectacularly between 1930 and 1990, tax rates on the top 1% of the income distribution increased sharply in the 1930s and 1940s, but then decreased gradually after 1960, even as social transfers continued rising.

What explains the simultaneous tax cuts for the top 1% and the rise in social transfers for the bottom 99% during the latter part of the last century? The answer to this question is very much relevant today. The remarkable decline of top income taxes during the last decades of the twentieth century made it easier for the wealthy to accumulate capital, so it is likely to underlie the rising gap between the incomes of the top 1% and the bottom 99% in the twenty-first century.

The new study re-examines the policy histories of the UK, the United States and Sweden, and argues that social policy over the twentieth century was in effect the outcome of a grand political bargain between the top 1% and the bottom 99% in each country.

That the wealthy have political power beyond their numbers is neither a myth nor an anomaly. It is a structural feature of the modern political process. Moreover, it is crucial to recognise that the actual political power of the bottom 99% lies not only in their right to vote, but also in their potential capacity to generate social unrest.

From this perspective, the historical evolution of top income taxation is hardly a puzzle. The catastrophes of the Great Depression and the Second World War obliged the wealthy to bear a remarkable increase in taxation to avoid social conflict. But as social insurance programmes were created and expanded – providing families with increasingly comprehensive protections against economic risks – the political quid pro quo for the rich was a reduction in their effective tax rates.

This process occurred over several decades. Consequently, top income taxes declined as social transfers continued to increase, while effective tax rates faced by the bottom 99% rose. In effect, the provision of social insurance and the taxation of the top incomes became substitutes for averting inefficient social conflict.

This theory of the politics of top income taxation over the twentieth century seems just as relevant today. Many people are distressed at the rising gap between the incomes of the top 1% and the bottom 99%.

This is perhaps the main reason underlying the unexpected success of the recent account of rising inequality documented in Capital in the Twenty-First Century by Thomas Piketty. Whatever one’s opinion of the ideas in the book, the proposition that one of the factors contributing to this trend toward inequality is the dramatic decline of top income taxes during the last part of the twentieth century is disturbing.

Critics of Piketty’s work see no reason for higher taxes on the very top incomes today. This new research suggests otherwise, as the authors comment:

‘If the history of social policy is of any guidance and if the rising gap between the incomes of the top 1% and everyone else continues to exacerbate the threat of social conflict, we may be left with this choice: either top income taxes are increased or we must prepare to embrace social conflict.’

ENDS


Notes for editors: ‘A Theory of Top Income Taxation and Social Insurance’ by Francisco M. Gonzalez and Jean-François Wen is published in the September 2015 issue of the Economic Journal.

Francisco Gonzalez is at the University of Waterloo. Jean-François Wen is at the University of Calgary.

For further information: contact Francisco Gonzalez on +1-519-888-4567 ext. 32136 (email: francisco.gonzalez@uwaterloo.ca); Jean-François Wen on +1-403-220-2478 (email: wen@ucalgary.ca); or Romesh Vaitilingam on +44-7768-661095 (email: romesh@vaitilingam.com; Twitter: @econromesh).