From Germany to America: A Dialog on Inequality

By Polly Cleveland

At a coffee break between sessions at the annual History of Economics Society meeting, I chatted with D___, a tall, blond young woman, a professor of political science at a German university. On hearing that I work on inequality, she immediately challenged me.

D: “I don’t believe in equality. Inequality is just a statistic, a side effect. What’s relevant is how people actually live. What matters are policies to improve citizen’s wellbeing, like health or education, not policies to reduce inequality.

P: But aren’t those statistics useful in identifying those societies that are or are not doing a good job providing those services? After all, there are many statistical studies showing that more equal societies have grown faster and have a higher GDP per capita.”

D: No. Inequality statistics are just an artifact. They don’t mean anything. We could all be perfectly equal in extreme poverty, like we were in East Germany. [Obviously before she was born.] Is that what you want?”

P: In the United States, our Congress just passed a new tax law reducing income taxes for the rich and for large corporations.  That will surely lead to reduced services and other benefits to poorer people.

D: Well, what do you want? A flat tax? The same tax on each person? That would be a perfectly equal tax.

P: A flat tax would be regressive because it would take a higher percent of the income of poor people—if they could pay it at all. How about a flat percentage tax on wealth? Since wealth is much more unequal than income, that would be more progressive even than an ideal progressive income tax.

D: That’s not the point. We need to focus on ordinary citizens’ wellbeing. If we do that, the rest will take care of itself.

P: OK, how about a basic income grant, that is, the same sum paid monthly to every citizen of a country, man woman and child, rich and poor. A large enough sum to provide a modest living. That idea has become very popular lately. It is being promoted by some Silicon Valley tech entrepreneurs.

D: No, I don’t think that’s a good idea. People should contribute to society. Basic income would give people bad incentives. They would take it easy.

P: Wait a moment, there’s a difference between basic income with no strings attached, and public assistance money. Here and I assume in Germany, public assistance is phased out as people earn more income. What’s amazing is that some people who receive assistance keep on working even though they lose income. The dignity of holding a job is very important.

D: Well you may be right about that, especially in Germany.

P: In the 1970s there was a guaranteed minimum income experiment run for five years in Manitoba, Canada. Recipients received additional income which—as with public assistance—was phased out as they earned more. A few years back Evelyn Forget, who’s here at the conference, analyzed the data. She found that only new mothers and teenagers worked substantially less. The teenagers became more likely to finish school, presumably due to less pressure to support their families. New mothers and school age teenagers are just the people you’d want to stay home. Remember, this was not a fixed basic income, but a guaranteed minimum with a sharp phase-out at 50% or more effective tax.

D: Still, you have to make a choice. Do you want equality of opportunity or equality of outcome? You can’t have both.

P: Actually, I think you can, sort of. A basic income grant, plus the public services we expect in a modern society—health, education, pensions, security, justice –including protection from unfair practices like monopolies—those should guarantee a rough equality of opportunity. Above that, it should be OK for people to earn high incomes by hard work, talent, or even luck. But you need progressive taxes to finance the system.

Whoops, just as I was getting to the punch line, the elevator arrived to take us downstairs to the next sessions. I would have said that as Adam Smith wrote in the Wealth of Nations (1776), taxes should be proportional to benefits received—a notion more radical than any proposed by today’s leftists. Chief among benefits received, Smith included government protection of title to land, in an era when some 2% owned most of the land in England. The tax he favored was a tax on the value of that land, a tax that would capture the “rent” or unearned income England’s “great proprietors” gained from the mere title to land granted and protected by the king. England had a land tax, but at low rates and poorly administered. The French “Philosophe” reformers whom Smith visited in Paris is 1766 advocated land taxes, as did the next generation of economists such as David Ricardo.

A hundred years later, in 1879, the American economist and radical reformer Henry George took Smith’s idea and ran with it. In his world-wide bestseller Progress and Poverty, George argued that all taxes should be replaced with taxes on land values only, and the revenues used for public purposes like schools and infrastructure (including public bath houses!). This was a perfectly practical proposal: property taxes then and now are assessed on land and buildings valued separately. In the heyday of George’s influence in the late 19th and early 20th century, assessors just left out the buildings and raised the rate on land to make up the difference.

Now almost 140 years later, as support for basic income has grown, some advocates have made the obvious connection: why not finance basic income with a land tax? That squares the circle, doesn’t it? Equality of opportunity at the bottom via a basic income grant, financed by a tax that limits inequality of outcome at the top.

That might be too theoretical for my pragmatic German acquaintance. She’s right, though, that we need to be more specific in talking about inequality.

James Galbraith Tells Us What Everyone Needs to Know About Inequality

By Polly Cleveland

Inequality has surged in the U.S. over the last forty years; many observers now blame the deregulation and tax cuts for the rich starting with the presidency of Ronald Reagan in 1980. In his new short book, Inequality: What Everyone Needs to Know, James Galbraith explains how this happened through the change in U.S industrial structure:

“In the early postwar period, the dominant American industrial corporation–such as General Motors, General Electric, American Telephone & Telegraph, International Business Machines–was an integrated behemoth that contained within itself not only production, but every phase of basic research, product design, and marketing that was relevant to its mission. Therefore incomes were distributed within the corporation by administrative decisions, governed by the bureaucratic imperatives and prerogatives of those in charge, and strongly responsive to the incentives of a highly progressive income tax structure. Top scientists and engineers, as well as top executives, were paid salaries, and salaries were regulated by the corporation. Tax structures also gave strong incentives for the corporation to retain profits, rather than pay them out as dividends, and to reinvest the proceeds–whether in factories or in the palatial towers that grew up in Manhattan, San Francisco, and Chicago in those years.

All of this changed with the tax “reform” movements of the 1970s and 1980s, which pushed for lower top marginal tax rates, fewer special exemptions from the tax, and for a “shareholder-value” model of corporate compensation. And a special feature of this change was that it created strong incentives to restructure the corporation itself.

“In particular, as the digital revolution came into view, the top technologists in the big corporations realized that they would be far better off if they set off on their own, incorporated themselves as independent technology firms, and then sold their output back to the companies for which they had formerly worked in salaried jobs.…

The effect of this structural transformation on the distribution of household incomes in the United States, as recorded in the tax records, is astonishing. For there were created, mainly in the 1990s, a handful of citadels of stratospheric incomes, previously unknown in the country and concentrated in the tiny handful of locations. One of these was Manhattan, the home of Wall Street and the source of finance. A second was Silicon Valley, a cluster of counties in Northern California. And the third was Seattle, Washington, and its near suburbs.”

Galbraith is describing the same phenomenon that Barry Lynn documented at length in his chilling 2010 exposé: Cornered: The New Monopoly Capitalism and the Economics of Destruction. That is, the transformation from vertically integrated firms to horizontally-integrated monopolistic trading companies, buying inputs from all over the world, squeezing both their suppliers and their customers. But Galbraith adds a new insight: not only did the postwar high-tax regime induce corporations to keep executive pay in check, it also induced them to retain profits and reinvest them in the corporation. With the 1980’s “greed is good” transformation, rates of reinvestment slowed as executives started taking more for themselves—surely helping slow the overall rate of growth.

Wait a moment! High taxes on income and profit produced more investment and growth? That’s the exact opposite of today’s Republican, and often Democratic, mantra that high taxes kill investment and growth. But the postwar taxes that tamed the corporate behemoths were in fact high marginal rates, top rates in a steeply progressive system. These were the very taxes imposed at the beginning of World War II to prevent war profiteering. These were taxes designed to capture the “unearned income” or “economic rent” of powerful corporations and wealthy individuals. It was perfectly logical for such corporations and individuals to “avoid” such taxes by investing money they would otherwise lose.

If high marginal income and profit taxes are so beneficial, is there any prospect—given the political will— of returning to such tax levels? Unfortunately, now that so many multinational corporations and wealthy individuals are registered or domiciled in tax haven countries, any simple effort to impose truly high marginal rates on profits or income will simply lead to more creative evasions, corruption (see Panama), and tax wars.

But, assuming the political will, are there other approaches? Galbraith proposes:

A much older and yet, to this day, still more promising alternative to taxing financial wealth is to tax land value, including the value of mineral and energy resources in the ground. The economic concept behind this idea is that of Ricardian rent–the argument that rents (which are inherently unproductive) flow to the owners of the fixed and non-reproducible asset, namely land. By taxing land and minerals, one reaches the least defensible forms of accumulated wealth, while at the same time doing the least to distort market decisions as between capital investment and hiring of labor. And there is another advantage: unlike financial wealth, land stays put. It exists in fixed jurisdictions with registered ownership; all the taxing authorities need to do is to send an appraiser, and then a bill. Local property taxes already work this way; however, in the United States landowner opposition to land taxes has been fierce, and many states are barred by their constitutions from levying property tax on a statewide basis. In California, notoriously, even local property taxes were capped in the late 1970s by a ballot measure strongly supported by wealthy landholding interests.

Land taxation has been for a century the program of the followers of the 19th century American economist Henry George, whose influence was vast around the world a century ago. One of his followers was the Chinese revolutionary Sun Yat-Sen, founder of the Republic of China in 1911. And Maoist China, by conducting an early war against landlords, ended up having the world economy most like the Georgist program in the modern age. But instead of taxing land value, the Chinese state actually owns it, and collects the land rent for itself. By doing this, Chinese municipalities and provinces have enjoyed ample revenue from which to make capital improvements, which is why Chinese cities have been able to grow like weeds in the reform era…

To this I would add that land taxes weren’t new in China: they financed Chinese empires as early as 2000 BC. Stiff land taxes of four shillings to the pound of assessed value financed the transformation of British finance in 1688; Adam Smith deemed them “the most equitable of all taxes.” Taxes on high profits and incomes and on land values all capture unearned income, or rents, forcing taxpayers to invest productively to pay the tax.