In the spring of 2014, the marketing staff at Harvard University Press began to sense that they had a blockbuster bestseller on their hands. This was not a frequent occurrence at the press, a prestigious academic publisher that churns out scores of learned volumes each year in fields like microbial ecology, medieval philosophy, and molecular physiology. But in those early months of 2014, there was enormous prepublication buzz about a forthcoming Harvard book. It was an unlikely blockbuster, to be sure: a 699-page treatise on economics written by a scholar who was hardly a household name even in his own neighborhood in Paris. But Professor Thomas Piketty’s tome Capital in the Twenty-First Century, thick as a brick and somewhat heavier, rocketed to the top of the bestseller lists as soon as it hit America’s bookstores. A New York Times story on the Frenchman’s U.S. book tour was headlined “Economist Receives Rock Star Treatment.”
The reason that an unknown French economist suddenly achieved rock-star stature in the United States was that Piketty’s book focused squarely on an increasingly worrisome issue in the American zeitgeist: the inequality of wealth and income.
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SINCE THE START OF the Great Recession in 2008, Americans have struggled with a nagging new concern: a nation where everybody is supposed to be created equal was, in fact, increasingly unequal, with a widening chasm between a small cohort of extremely rich Americans and everybody else. In 2016, the richest 1% of Americans owned more of the nation’s total wealth than the bottom 90% combined. And only the rich were getting richer. Census data showed that median income for the average American family actually fell by 8.6% in the first fourteen years of the twenty-first century, while a lucky few at the very top were taking in staggering amounts of money.1
Economists had been tracking the imbalance of wealth in the United States and other advanced democracies for several years; indeed, Thomas Piketty was one of the pioneers of this line of research. Inequality as a political issue caught the public’s attention in the summer of 2011, when a ragtag group of protesters in New York City set up tents in a small park not far from the financial district and declared themselves the “Occupy Wall Street” movement. “We Are the 99%,” their banner read; the protesters loudly declared that 99% of Americans were getting the shaft because of the economic and political clout of the richest 1%. Almost overnight, similar encampments with similar banners sprang up in city parks around the country and overseas; by mid-October, the Washington Post tallied more than nine hundred Occupy gatherings in eighty different nations. The protesters generally agreed on what they were complaining about: big business got large government bailouts after the global recession, while ordinary citizens lost their jobs, their homes, and their savings. But the various groups never settled on what they wanted to do about it. There were few if any specific demands for action from the Occupiers. As the urban campers began to leave their muddy tent cities in the cold of winter, it was hard to identify any policy change spurred by this occupation.
And yet the Occupy movement did make a lasting contribution to American political discourse. The notion stuck that the country was divided between a filthy rich 1% and everybody else. Politicians from left to right—from the Democratic senator Elizabeth Warren to the Republican presidential candidate Donald Trump—declared that the American economic system is “rigged” to benefit the rich at the expense of the rest. In the 2012 election, Democrats never missed a chance to remind the voters that the Republican presidential nominee, Mitt Romney, was a certified 1-percenter, with bank accounts in Switzerland and the Cayman Islands. Even some of the superrich deplored the increasingly lopsided distribution of wealth. “Too much of the GDP of the country has gone to too few of the people,” warned Lloyd Blankfein, the CEO of Goldman Sachs, whose net worth, about $450 million, put him in the top one-tenth of the 1%. “If you grow the pie, but too few people enjoy the benefits of it, the fruit, then you’ll have an unstable society.”2
In December 2013, the president of the United States addressed the issue and declared it the most pressing problem facing the nation, “a fundamental threat to the American Dream.”
“I believe this is the defining challenge of our time,” Barack Obama said. “We face . . . a dangerous and growing inequality and lack of upward mobility that has jeopardized middle-class America’s basic bargain—that if you work hard, you have a chance to get ahead.” In recent decades, the president went on, that “basic bargain” had begun to fray.
As a trickle-down ideology became more prominent, taxes were slashed for the wealthiest, while investments in things that make us all richer, like schools and infrastructure, were allowed to wither. And the result is an economy that’s become profoundly unequal, and families that are more insecure.
In fact, this trend towards growing inequality is not unique to America’s market economy. Across the developed world, inequality has increased. But this increasing inequality is most pronounced in our country, and it challenges the very essence of who we are as a people. Understand, we’ve never begrudged success in America. . . . In fact, we’ve often accepted more income inequality than many other nations for one big reason—because we were convinced that America is a place where even if you’re born with nothing, with a little hard work you can improve your own situation over time and build something better to leave your kids.
The problem is that, alongside increased inequality, we’ve seen diminished levels of upward mobility in recent years. A child born in the top 20 percent has about a 2-in-3 chance of staying at or near the top. A child born into the bottom 20 percent has a less than 1-in-20 shot at making it to the top. The idea that so many children are born into poverty in the wealthiest nation on Earth is heartbreaking enough. But the idea that a child may never be able to escape that poverty because she lacks a decent education or health care, or a community that views her future as their own, that should offend all of us and it should compel us to action.3
Obama’s concern was echoed by repeated pronouncements from the most respected man in the world, Pope Francis. In his 2013 apostolic exhortation, Evangelii gaudium, for example, the pontiff argued passionately that tolerating the inequality of income and wealth was both unholy and dangerous.
“Just as the commandment ‘Thou shalt not kill’ sets a clear limit in order to safeguard the value of human life, today we also have to say ‘thou shalt not’ to an economy of exclusion and inequality,” the pope wrote. “How can it be that it is not a news item when an elderly homeless person dies of exposure, but it is news when the stock market loses two points? This is a case of exclusion. Can we continue to stand by when food is thrown away while people are starving? This is a case of inequality.”
There are people, of course, who disagree with the president and the pope, arguing that inequality is a boon to society at large. “The great growth of fortunes in recent decades is not a sinister development,” wrote the business historian John Steele Gordon in the Wall Street Journal. “All our lives have been enriched and enhanced” by the products we buy from billionaires. In the Times of London, the Conservative Party parliamentarian Matt Ridley called on his colleagues to “start spreading the good news on inequality.” The good news, he said, is that everybody is getting better off; it just happens at different rates. “Any increase in wealth inequality or pre-tax income inequality in Britain or America is caused by the rich getting disproportionately richer, not by the poor getting poorer.”4
With all the talk of inequality, some of the 1% began moaning out loud about the focus on their wealth, giving birth to a curious new American species: the whining billionaire. “From the Occupy movement to the demonization of the rich . . . I perceive a rising tide of hatred of the successful one percent,” the Silicon Valley magnate Tom Perkins wrote in an open letter. “I would call attention to the parallels of fascist Nazi Germany in its war on its ‘one percent,’ namely its Jews, to the progressive war on the American one percent, namely the ‘rich.’”5 The Nazi parallel was taken up by the investment banker Stephen Schwarzman, who was unhappy with proposals to reduce inequality by ending a lucrative tax break for his industry. “It’s a war,” Schwarzman was quoted as saying. “It’s like when Hitler invaded Poland in 1939.”6
There have always been differences between the rich and the poor. But today, the most striking gap is between the very rich and everybody else. In the United States, the median household income has been about the same—about $55,000—since the start of the century. But the top earners have seen big increases in income since 2000; as of 2015, the top 1% of American families had income of $405,000. To make the top one-tenth of 1% took income of $1.9 million.
Using the standard international measure of inequality, President Obama was basically correct when he said that among the advanced democracies the imbalance is “most pronounced” in the United States. The customary gauge of economic inequality is called the Gini coefficient, named for the Italian economist who thought it up. In the Gini rankings, a nation where everybody had the same amount of wealth and the same income would get a Gini score of 0; a country where one person took in all the income, and nobody else earned a cent, would get a score of 1. That is, the lower the Gini number, the smaller the gap between that nation’s rich and poor. Generally, the world’s poor countries—where a few families control the wealth, and tens of millions live in squalor—have high Gini coefficients. Nations like Lesotho, Botswana, Honduras, and Haiti have Gini numbers near 0.6, making them the least economically equal societies on the planet. Among the rich countries, the democracies of western Europe tend to score around 0.3; the world champions at economic equality include Sweden, Denmark, and Norway, where high wages for working people and high taxes on the rich bring the Gini index down to about 0.25.
The United States had a Gini coefficient in 2014 of 0.4—the worst rating among rich countries. Among the thirty-four members of the OECD, the club of industrialized democracies, only Mexico and Chile ranked higher than the United States on the inequality scale.
As these facts became more widely known, inequality emerged as a matter of broad concern among Americans, the stuff of kitchen-table and watercooler conversations all over the country. In New York, Washington, Cambridge, and Palo Alto, every self-respecting think tank—right, left, center, or far out—held erudite seminars on the issue. Magazines did cover stories; cable channels produced special reports. People began describing the United States as a “winner take all” society. A nation that had long cherished the belief that anybody can make it big began to mock that very idea. In 1960, John F. Kennedy had famously said that economic growth would benefit everybody: “A rising tide lifts all boats.” Half a century later, the joke was that “a rising tide lifts all yachts,” because only those with multimillion-dollar pleasure craft of their own were riding the economic wave.
Widespread concern over this trend was the reason Piketty’s heavy economics tome became a number one bestseller in the United States. Still, it was not exactly beach reading. Because you, gentle reader, have been kind enough to read this book, I will repay the favor by providing a summary of the professor’s argument, thus saving you the $40 price of the book and the hours required to read it.
Capital in the Twenty-First Century is actually more like three books than one. First, it’s a history of the rich/poor divide, based on three centuries of wealth and income data that Piketty and his colleagues gathered from the United States, the U.K., France, and Sweden. Piketty relies heavily on mathematical models and statistical tables, but he thoughtfully spares his readers all that stuff, sticking it in a “technical appendix” on the Internet. In the book, he draws lessons from literature. He studies “the nature of wealth” as described in the nineteenth-century social-climbing novels of Jane Austen and Honoré de Balzac, where the economic classes were essentially set in concrete and the only way to move up in the world was to inherit from Uncle Moneybags or to marry well. This social dynamic explains the famous opening line of Austen’s Pride and Prejudice: “It is a truth universally acknowledged, that a single man in possession of a good fortune, must be in want of a wife.”
The historical data show that inequality of wealth in the United States and Europe grew sharply toward the end of the nineteenth century, the so-called Gilded Age, and into the first two decades of the twentieth. Then, because of policy innovations (like the income tax), the Great Depression, and the leveling effect of world wars, the gap between the rich and ordinary working people grew smaller through much of the twentieth century. By the 1970s, the wealth disparity was the smallest it had been for a hundred years. But inequality began to grow again in the 1980s and has continued to do so into the twenty-first century, particularly in the United States. By 2012, the top 1% of American households took 22.5% of the nation’s total income—the highest share since 1928.
Piketty then says the renewed growth of inequality in recent decades is due partly to “the explosion of wage inequality in the United States (and to a lesser extent Britain and Canada) after 1970.” It became the norm for the top brass in American corporations to be paid annual salaries and bonuses that would have been deemed embarrassing, indeed disgraceful, in the past. In the 1950s, the CEO of an American industrial or retail company was paid about twenty times as much as the average worker at the firm, and those CEOs were considered “rich.” Today, the boss is routinely paid two hundred, four hundred, six hundred times as much as her typical employee and is “superrich.” In recent years, the Walmart CEO has earned about $25 million annually; that’s a thousand times what an hourly clerk on the retail floor will make in the same year. The CEO of the Chipotle restaurant chain, Steve Ells, was paid $13.8 million for 2015, about seven hundred times as much as a cashier in his stores.
This “explosion” in compensation often has little to do with performance, Piketty notes. For the year 2014, Yahoo’s CEO, Marissa Mayer, was paid more than $42 million, even though the company’s sales and profits fell every year under her leadership. Chipotle’s sales and profits plummeted in 2015 due to food poisoning problems at several outlets, but its CEO still collected that $14 million.
But developments in the private sector, Piketty says, are not the only cause of the burgeoning financial imbalance. A key contributor to inequality, he says, is government policy. When governments decide to bail out big banks while millions lose their homes to foreclosure action by the same banks, the policy exacerbates the problem of inequality. Such policies transfer wealth from middle-class homeowners to upper-bracket bankers and their shareholders—not through private markets, but because of decisions by governments. Similarly, tax policies that give generous breaks to the wealthiest—like that $7,500 giveaway to people who can buy a $105,000 car—exacerbate the trend toward concentration of wealth in a lucky few. When the national tax code says that money earned from trading securities will be taxed at a much lower rate than money earned from working at a job, the tax law itself is adding to inequality. This is not surprising, Piketty says, because the government officials who approve corporate bailouts and write the tax laws are often beholden to the financial elites for political contributions.
But the major reason for growing inequality, Piketty argues, is that rich people today make most of their money not from wages but from capital investments—stocks, bonds, commodity trades, real estate, patents, and so on. And earnings from capital (that is, from financial transactions) are growing faster than earnings from labor (that is, from working at a job). That is, you can make some money cooking hamburgers or serving hamburgers, but you won’t make as much as a guy who buys and sells the stock in a hamburger chain.
In other words, Piketty says, “the rich get richer” has become a fundamental law of economics, especially in the United States. Because our Supreme Court has defined donating money as a form of political speech, economic clout in the United States turns quickly into political clout. Rich political donors can get the politicians whom they finance to champion tax and regulatory policies that increase the wealth of the wealthy. The “forces of divergence,” in Piketty’s phrase, are stronger than any influences that might reduce inequality. Piketty maintains that the notion of a nation where all are basically equal is dying; as the book states it, “The egalitarian pioneer ideal has faded into oblivion.” And if current patterns of inequality in income and wealth continue for a few decades, “the consequences for the long-term dynamics of the wealth distribution are potentially terrifying.”
But Piketty offers a series of solutions. The basic answer, he says, is tax. He proposes significantly heavier taxes on the rich. This would reduce their wealth, and the revenues could be used for education, jobs, or handouts to increase the wealth of everybody else. The income tax burden, he says, should fall more heavily on those who make their money on financial dealing; he says the U.S. system, in which the tax on capital gains is much lower than the tax on wages and salaries, is simply upside-down and thus counterproductive for dealing with the growth of inequality.
Income taxes on the rich, he says—both on their salaries and on their capital gains—should be substantially higher than they are now. How high? “According to our estimates, the optimal top tax rate in the developed countries is probably above 80 percent.” That’s a tax rate more than double what the highest earners pay today in the United States. If this 80% top marginal rate were applied to earnings over $500,000, Piketty says, the tax regime would help to even out inequality without stunting economic growth.
Beyond the income tax, though, Piketty proposes a tax on wealth. It would work like the property tax that most American homeowners pay already. For the property tax, the county sends around an assessor to appraise the value of your house, and the tax due is some percentage of the appraised value. In a wealth tax regime, the assessor appraises not just your house but all your wealth—your cars, your boat, your jewelry, your bank accounts, your investment portfolio, the art on your walls, your vacation home, and the Persian rug on the floor of your vacation home. If the total wealth exceeds a certain amount, you pay a tax on the whole thing. If the assessor finds that all the money and stuff you own is worth a total of $5 million, and the wealth tax rate is 2%, you’d have to fork over $100,000 in wealth tax. And the assessor will come around next year to bill you again.
One obvious problem with a national wealth tax is that wealthy people can, and do, switch nations to avoid the tax. You can’t move your city mansion or your mountain condo to a different state, but a rich person facing a $100,000 tax bill each year might well pack up his art, rugs, and jewelry and move to a country that doesn’t tax wealth. Piketty has a solution: make the wealth tax a global tax. That is, all countries should agree to a standard tax on wealth so that a zillionaire can’t cut his tax bill by moving across the border. Being a fairly down-to-earth economist, Piketty freely admits that this “global wealth tax” is not a realistic possibility at the moment. He holds out hope, though, that the member nations of the European Union might agree on a continent-wide wealth tax, and maybe the idea would spread from there.
It’s hardly surprising that Thomas Piketty would propose taxing the rich as the primary solution to the problem of inequality. Piketty is French, and France is the world champion at soaking the rich through taxes. In the United States and other rich democracies, those who worry about inequality routinely argue for higher tax rates on the upper brackets and other changes designed to reduce the gap between the rich and the rest. In his “defining challenge of our time” speech, Barack Obama called for tax reforms and invoked the concept of BBLR—getting rid of tax breaks for the wealthy in order to broaden the taxable base and thus lower rates. “And by broadening the base,” the president said, “we can actually lower rates to encourage more companies to hire here and use some of the money we save to create good jobs rebuilding our roads and our bridges and our airports, and all the infrastructure our businesses need.”
The Nobel laureate Joseph Stiglitz—probably the only American economist whose books sell as well as Piketty’s—also makes the case for tax increases to counter inequality. Stiglitz would get rid of the reduced tax rate for capital gains. “A fair tax system would tax speculators at at least the same rate as those who work for their income,” he argues. “To provide revenues for public investment and other public needs, to help the poor and the middle class, to ensure the existence of opportunity for all segments of the population, we’ll have to impose progressive taxes, and, most importantly, do a better job in closing loopholes.”7
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BUT FRANCE HAS GONE further than the other rich democracies when it comes to imposing a variety of taxes on les riches. “We have a long tradition in this country of going after the rich,” Professor Martin Collet told me at a charming outdoor café near the Place de la Bastille one sunny Paris afternoon in late June. “In a couple of weeks, we will celebrate Bastille Day. It’s a national holiday; we remember when the peasants rose up—it was just down the street from here—against the rich and the monarchy, in 1789. Back then, we cut off their heads. Today, we try to cut a hole in their bank accounts.”
Dr. Collet, a professeur des universités at Université Panthéon-Assas, is one of the country’s leading tax economists. He took me through the history of taxation in France, going back to the post-Bastille First Republic. France has always been a high-tax country, even compared with its neighbors in western Europe; today, it ranks second among the world’s richest countries in total tax burden, with taxes taking about 45.5% of the nation’s total wealth, or GDP. That places it just behind Denmark (49.58%) but far ahead of the United States, where taxes total about 26% of GDP.
The French support this heavy rate of taxation partly because the revenue funds an expansive list of government services, including universal health insurance, generous old-age pensions, free universities, cheap public transit, and free exercise clubs. The World Bank reported that France spent 24% of its GDP on government in 2015—as much as big-government meccas like Sweden (25.9%) and Denmark (26.1%). As we’ve seen earlier in this book, the United States is downright thrifty by comparison, spending 15.5% of its wealth on all levels of government combined in 2015. (The World Bank reports for government spending don’t include transfer payments like Social Security and food stamps.)
In France, though, taxation is not merely a way to provide money for government to spend. It’s considered an element of social cohesion, a symbol of fundamental French values. The First Republic, in its zeal for new terminology, replaced the standard word for “tax” (impôt) with the French word contribution, and to this day French politicians routinely talk about taxes as “social contributions,” as a way to maintain the essential French ideal of égalité. “For most of the French left, and a chunk of the right, high taxes are a hallmark of a decent society that puts fairness before profit and public service before business,” the Economist noted. In terms of égalité, at least, this tax regime seems to have worked; France has always had a lower Gini coefficient (that is, a more even distribution of wealth) than most of its European neighbors or the United States.
When the Great Recession hit France in 2008, Nicolas Sarkozy, a center-right politician, was president. (Sarkozy supports free higher education, a complete ban on handguns, and unemployment compensation that never ends, but in European terms that makes him “center-right.”) Along with other leaders across Europe, Sarkozy opted for a policy of austerity—tax cuts, reduced government spending, limits on labor unions—as the proper course for economic revival. This didn’t work. Sarkozy lost his bid for reelection in 2012, and the Socialist candidate, François Hollande, raced to victory by promising to increase public spending and to pay for it with a “supertax” just for the rich: a tax of 75% on income over €1 million ($1.25 million) per year. (This proposal actually made Hollande something of a moderate in the presidential race; the candidate from the Left Front pledged to impose a tax of 100% on incomes over $375,000.) Hollande’s supertax on what he called “the arrogant and grasping rich” drew strong support from liberal newspapers and from prominent economists, including Thomas Piketty. Looking across the Atlantic to the demonstrations by “the 99%” in America, Piketty said that “Hollande’s 75-percent tax is the right response to the Occupy movement. The irony is that the street movement is happening in the United States, while the political response is coming in France.”8
Although the supertax actually touched only a minute fraction of French taxpayers, it ran into furious resistance. The Conseil Constitutionnel, a sort of Supreme Court, ruled that a tax rate of 75% amounted to a “confiscation” of wealth, in violation of the French Constitution. Hollande went back to the drawing board and came up with a slightly different implementation of the 75% rate; the Constitutional Council threw that one out as well. Eventually, Hollande was able to impose his supertax by requiring that employers pay the additional tax on incomes over €1 million, rather than directly imposing the top rate on high-earning individuals. Professor Collet argued that this alteration reflected the basic reason for the supertax in the first place. “It was never designed to bring in a great deal of revenue,” he told me. “The goal was to convince companies to rein in the compensation of their top officers. It’s insane that any CEO would earn more than a million euros in one year, in a country where the average worker makes less than one-twentieth as much.”
Regardless of who actually paid, the supertax meant that France would have the highest top income tax rate in the world. As if that weren’t enough, les riches also face the wealth tax, which Professor Piketty called for in his book. In France, this is formally called “l’impôt de solidarité sur la fortune”—that is, “the tax on fortunes for the good of society”—but it is broadly known as the ISF, the tax on fortunes. If the tax assessor determines that your bank accounts, real estate, stocks, cars, jewelry, and so on have a total value greater than about $1.5 million, you have to pay the ISF. The least rich of the rich are taxed at 0.5%—that is, about $7,500 on a “fortune” of $1.5 million. The tax goes up from there; the top rate, 1.5%, applies to any French family with total wealth around $12 million or more. In total, the ISF is paid by half of 1% of all French families. It raises less than 2% of tax revenues. It could be eliminated with minimal impact on the national budget. “It brings in perhaps €4 billion per year—essentially nothing!” Professor Collet explained. “But if any government were to drop it, you’re sure to lose the next election.”
This is a Willie Sutton approach. Sutton, a Depression-era crook, was asked why he kept robbing banks and famously answered, “Because that’s where the money is.” Still, this form of tax has been decidedly out of favor for the last ten years or so. It used to be common for developed countries to have a wealth tax that worked like the French ISF; in 1990, more than half of the members of the rich nations’ group, the OECD, had a wealth tax in place, in addition to the normal income, property, corporate, and sales taxes. But most nations repealed the wealth tax around the start of the twenty-first century.
In 2016, only a handful of countries still imposed an annual tax on overall wealth. France, Norway, Switzerland, and India all have permanent wealth tax regimes. In France and Switzerland, the tax only hits millionaires. In contrast, Norway imposes the tax at a fairly low level; anybody with total wealth greater than about $130,000 gets hit with the wealth tax. The widest definition of “wealthy” is in India, where a 1% wealth tax kicks in for anybody whose net worth is more than 3 million rupees, which comes to about $45,000. (In India, that still means a small percentage of the population.)
Responding to the economic strictures of the Great Recession, Iceland and Spain reinstituted the wealth tax in 2008, but both governments called this a “temporary” measure. When Cyprus faced a collapse of its banking system in 2013, the government imposed a onetime wealth tax on bank deposits; it simply seized between 4% and 20% of the savings of anybody who had more than €100,000 (about $130,000 at the time) in a Cypriot bank. (This was unpopular, of course, but less so than it might have been because many of the biggest depositors in the banks of Cyprus were rich Russians trying to evade taxes back home.)
One big problem with a wealth tax is that it is intrusive—much more so than the familiar property tax. A county appraiser trying to gauge the value of your house for property tax purposes can get a decent estimate just from public records—like how much that house down the street sold for last month. But if the government decides to tax everything you own, the appraiser has to probe your bank accounts, investment accounts, safe-deposit box, living room, closet, jewelry drawer, garage, and so on. It’s offensive enough to have government snooping around like that for any reason, let alone to increase your tax bill.
That’s why another form of wealth tax, different from the ISF, is much more common. This is the inheritance tax. Sometimes it takes the form of a tax on the dead person’s “estate”—a legal entity that holds the wealth of the deceased until it is distributed to the heirs. Sometimes it’s a tax the lucky daughters or nephews have to pay after they inherit the money. Any jurisdiction that has an estate or inheritance tax also has to put in place a gift tax at roughly the same tax rate; without that, a rich person on his deathbed would give away all the money in the form of gifts to avoid the inheritance tax.
The United States, naturally, has made this whole process more complicated than any other country by adding yet another variation, the generation-skipping transfer tax, with its own five-page form (Form 709), two worksheets, and nineteen pages of instructions. Whether it’s an “estate tax,” an “inheritance tax,” a “gift tax,” or a “transfer tax,” the result is the same: the government gets some of the money that was meant for the heirs. This is considered preferable to an ISF-style wealth tax for several reasons. First, it’s less intrusive. When somebody dies, a court—in the United States, it’s called a probate court—has to determine the precise value of his entire estate. So the appraisal is being done anyway; it’s not just for tax purposes. Second, it doesn’t penalize people for their hard work. By definition, you pay inheritance tax only on money you didn’t work for at all. Third, because almost every country imposes the tax only on wealthy people—in the United States, it only applies to estates of about $11 million or more—the heirs will come out just fine, thank you, even after the estate tax is paid. If some rich American leaves $100 million to his granddaughter, the estate tax could be as high as $41 million. That’s a hefty tax bill, but it still leaves the lucky kid $59 million to scratch by on. It’s hard to feel sorry for a sudden millionaire because the tax man took a share before she got her windfall.
In the United States, the estate tax is designed so that it affects only a tiny fraction of American families. There’s no tax at all on an estate worth less than $5.45 million; if you leave your money to your spouse, the exemption is doubled, which means there’s no estate tax due unless you leave behind more than $10.9 million. About 2.6 million Americans die each year, but only 4,700 leave behind a legacy large enough to incur an estate tax; that’s about two-tenths of 1% of all the decedents. In the United States, at the start of 2017, there was a single tax rate (40%) for all estates over $10.9 million, and the same rate applied to all heirs. (In many countries, a sibling or a child inheriting money pays a lower rate of tax than a friend or a distant relative.) With the $10.9 million exclusion, a lucky spouse inheriting $50 million from her late husband would lose $15.64 million to the estate tax, but she’d still have a hefty $34.36 million left. About twenty states and the District of Columbia have an estate tax that has to be paid in addition to the federal levy.
Many other developed countries tax estates. Most of them have a tax that kicks in at a much lower point than the $5.45 million minimum in the United States. The rates vary widely, as this chart shows:
|
Country |
Tax begins at (in U.S. dollars) |
Tax rate |
|
France |
106,000 |
5% to 45% |
|
Netherlands |
128,620 |
10% to 40% |
|
Germany |
423,782 |
30% |
|
Japan |
247,000 |
55% |
|
U.K. |
488,280 |
40% |
|
Spain |
872,000 |
34% |
|
Finland |
1,009,000 |
19% to 35% |
In the United States, the estate tax has been hotly controversial, even though it touches only one out of every seventy thousand Americans. In the 1990s, a group of wealthy families hired a consultant, Frank Luntz, to wage a political campaign against this form of wealth tax. Luntz is a master of political euphemism; when the George W. Bush administration agreed to let timber companies clear-cut the trees on sizable stretches of federal land, Luntz named the initiative “Healthy Forests.” To battle the estate tax, he came up with the label that has stuck: the “death tax.” He designed a campaign around the idea that government shouldn’t penalize you for dying. (Of course, the tax burden falls on the living heir, not the decedent, but those who campaign against the “death tax” ignore this nuance.) Supporters of the tax have come up with politically charged labels of their own; they call the estate tax the “lucky rich kids’ tax” or the “Paris Hilton tax”; in his stump speeches during the 2016 presidential campaign, the Democratic contender Bernie Sanders used to remind his audiences that “Paris Hilton never built a hotel.”
Under George W. Bush, opponents of the “death tax” won a temporary victory. Bush’s 2001 tax-reform plan phased out the estate tax over the following decade so that the rate fell to zero in the year 2010. For budget reasons, though, the death of the “death tax” was short-lived; the zero rate lasted only one year. This led to anecdotes (none proven, so far) about financial advisers’ telling their rich clients, “If you’re going to die anyway, it would make fiscal sense to do it in 2010.” After Barack Obama’s reelection in 2012, the “lucky rich kids’ tax” was made permanent at the current rate of 40%; the minimum estate that triggers this tax (as noted, it was $5.45 million in 2016) goes up slightly every year.
The tax on a large inheritance used to be a standard element of revenue raising in all developed countries. In recent years, though, several nations—including high-tax venues like Austria, the Czech Republic, Norway, and Sweden—have eliminated the tax. In general, the reasons for dumping this tax are related to the “death tax” idea; that is, enough is enough. If some poor guy paid taxes for sixty years, we ought to give him a break when he’s dead. In Canada, the argument against the inheritance tax was a clever slogan: “No taxation without respiration.” (Canada, though, imposes a capital gains tax and a “probate fee” that heirs have to pay; these increase with the amount inherited, so the impact is roughly equal to an inheritance tax for large estates.) After Sweden repealed its inheritance tax in 2005, the economist Henry Ohlsson explained, perhaps tongue in cheek, that Sweden taxes rich people so heavily in their lifetime that there was not much revenue to be gained by taxing what little they had left when they died.9
France, of course, had both the inheritance tax and the wealth tax—not to mention the health insurance tax, the Social Security tax, the carbon tax, the income tax, the capital gains tax, and a national sales tax of 20% on almost everything you could buy—when François Hollande finally imposed the 75% top income tax rate in 2013. Although the “supertax” was popular with Frenchmen earning an average income, some of the wealthiest French taxpayers viewed it as the last straw in a relentless effort by the national government to milk them dry. Near the end of 2012, with the new tax due to take effect with the New Year, Hollande came face-to-face with a basic fact about high taxes: at some point, people just refuse to pay. When rates get too high, it’s cheaper to hire a lawyer who can design some intricate scheme of tax avoidance than it is to pay the tax. Or, it’s cheaper just to flee the tax altogether. For Hollande, this predictable backlash took the form of l’affaire Depardieu.
For more than four decades, Gérard Depardieu was a shining light of French cinema, as leading man, national heartthrob, producer, and financial angel. He played in or produced more than 170 films. This made him an extremely rich man, and he became even richer through wise investments in real estate, works of art, vineyards, and so on. Like many self-made millionaires, Depardieu grew more conservative politically as he grew more rich. He supported Sarkozy in that 2012 election and was already complaining about the heavy taxes he had to pay long before Hollande targeted his ilk with the supertax. When the 75% tax rate took effect, Depardieu swore that he would never pay it. To prove that he was serious about this, he left France and took up official residence in Néchin, Belgium, a farm village just north of the French border. In a letter to a Paris newspaper, Depardieu declared himself finished with French taxation. “I have paid €145 million in taxes over 45 years,” he said. With the advent of the supertax, he concluded that enough is enough. He would give up his French passport rather than pay another centime to a voracious government determined to penalize hard work and success.
Hollande and his backers fired right back, arguing that Depardieu would be nothing without France and noting that dozens of his films, like many French business ventures, had received financial help from the national government—that is, from French citizens who willingly paid their taxes. Hollande’s second-in-command, Prime Minister Jean-Marc Ayrault, pronounced Depardieu a “pathetic” (minable) figure. That comment in particular seemed to sting. A few weeks later, Depardieu showed up in Russia and accepted a Russian passport directly from the hand of Vladimir Putin. Russia, the Frenchman announced, “is a great democracy and not a country where the prime minister gets to call one of its citizens ‘pathetic.’”10
But there was little political profit for the French president in a long-running contretemps with a famous matinee idol. And Gérard Depardieu was not the only prominent figure to gripe about the new levy. Once the 75% tax took effect, in 2013, other prominent representatives of les riches began to talk about giving up their passports as well. The Union of Professional Football Clubs, the French equivalent of our National Football League, announced that it would cancel several weekend matches to protest the tax on its top players. In the end, the supertax, which never raised any significant amount of revenue, proved costlier to the politician who imposed it than to the few wealthy citizens who had to pay it. A beleaguered Hollande announced that he would terminate the 75% tax bracket in 2015, just two years after it took effect. The whole experiment seemed to demonstrate clearly that there is a limit to how high any government—even in France—can raise tax rates.
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THE UNITED STATES PROBABLY doesn’t have to worry about its wealthiest citizens fleeing the country to avoid high taxes, because of a strange quirk of American taxation: the richest generally pay lower rates than those who earn less. As a general rule, the rich pay a higher rate of tax than the poor or the average earner. This is the principle that Jesus Christ enunciated in the parable of the widow’s mite. The United States has adhered to this rule since the first days of the income tax a century ago; at its birth, Teddy Roosevelt declared that the progressive income tax would serve as “a cure for the disease of wealth.” Indeed, in those first years the income tax was much more about reducing inequality than raising revenue; for the first decade of its existence, only the richest 4% of Americans had to pay the new federal income tax. Edwin R. A. Seligman called the income tax a manifestation of “tax justice,” which he defined as “the principle that each individual should be held to help the state in proportion to his ability to help himself.” Even among the wealthiest Americans, Seligman wrote in 1914, “it is rare to find a cynical disregard of all considerations of equity.”11
But today this basic principle does not apply to the so-called superrich—that is, to the tiny group of taxpayers who report adjusted gross income (Line 37 on Form 1040) of $10 million or more. In 2011—that’s the latest year for which we have data on this—an American family at the median annual income (just over $51,000 then) paid about 6% of adjusted gross income in federal income tax. A family earning double the median income paid about 13% in federal income taxes. In the higher brackets, a family with adjusted gross income of about $200,000 had an average income tax bite of 17.9%. And the “rich”—that is, taxpayers making between $500,000 and $10 million per year—paid federal income tax at an average rate of 24.5% of their adjusted gross income.12
This fits the pattern of progressive taxation. But the pattern falls apart when we get to the tiny smidgen of the population with an annual income over $10 million—about twelve thousand taxpayers in all. They paid an average of 20.4% of their adjusted gross income in federal income taxes in 2011. That’s a lower rate of tax than the so-called rich. An even tinier segment—the four hundred or so taxpayers reporting more than $100 million in income—paid income tax at an average rate of 18%. Many taxpayers in the “superrich” category actually paid a lower rate of tax than people making 1% of their income.
This strange peculiarity of the American tax code has been reduced to a popular bumper sticker: “Warren Buffett paid a lower tax rate than his secretary” (a statement that Buffett has confirmed). The explanation takes us back to the distinction that lies at the heart of Thomas Piketty’s bestseller—the difference between the return on capital investments (stocks, bonds, real estate, derivatives, and so on) and income from wages.
The superrich get most of their income from capital. Capital income is taxed at a lower rate than “earned income,” which comes from labor. As of 2016, the highest tax rate on capital income was 23.8%; the highest tax rate on labor was almost twice as high: 39.6%. If you make most of your income from capital, you pay tax at a lower rate than people who make most of their income from working for wages. For the superrich, return on capital amounts to half their income; for average families, capital represents less than 2% of their income. The Tax Policy Center in Washington estimates that 75% of the savings due to the lower rate on capital gains in 2013 went to taxpayers with income over $1 million. That’s why the wealthiest of all Americans pay lower rates of tax than many people who get their income from wages.
Most of the world’s industrialized democracies have a lower rate of tax for capital gains than for labor income, although each country has its own set of rules on the definition of “capital” and the length of time the investment must be held to get the lower rate. A few countries—for example, Belgium, Malaysia, and of course New Zealand, the home of BBLR—don’t tax capital gains at all. The argument for a lower tax rate on capital income—an argument supported by many economists—runs as follows: (1) economies need capital investment to grow and create new jobs; (2) capital investment by definition is risky (you could lose it all); and (3) therefore, a lower rate of tax on potential gains is necessary to encourage people to make those essential, but risky, investments.
Historically, it’s not clear that the third part of this argument bears out. In 1986, none other than Ronald Reagan endorsed a new internal revenue code that taxed capital gains at the same rate (28%) as the top rate on labor income. For the next decade or so, investment soared and stock markets went through the roof, even without a reduced capital gains tax. Just after his election to a second term, Barack Obama signed into law tax changes that significantly raised the capital gains rate (from 15% to 23.8% for the wealthiest taxpayers). Again, it would be hard to argue that this increase suppressed capital investment. In the first four years of the higher capital gains rate, all American stock indexes hit new records over and over again. The S&P 500 index rose from 1,438 on December 1, 2012, to 2,191 on the same date four years later.
Whether or not the preferential rate makes sense for investors who risk their capital in the markets, it is much harder to justify the special-case capital gains preference that gives investment bankers, hedge fund managers, and other salaried workers in the financial industry a generous tax break not available to employees in any other field. This giveaway is known as the “carried interest” rule; the name evokes a time when a clipper ship captain held a financial interest in the cargo he carried across the sea. It says that a broker or banker who invests other people’s money can count his own salary as “capital gains” and thus pay tax on it at the reduced, capital gains rate. Some of the biggest earners in the nation take advantage of this provision every year to save tens of millions of dollars in federal income tax. That explains why Warren Buffett pays a lower rate than his secretary (and it’s legal). The secretary’s pay is taxed as “ordinary income.” Much of Buffett’s pay is taxed as “capital gains”—at about half the rate. And this is a major reason why the superrich end up paying tax at a lower rate than workers making far less.
For decades, economists and politicians from left and right have attacked the carried-interest rule as a distortion of the basic capital gains proposition. “Why should someone who does not put any of their own money at risk pay the lower tax rate that Congress intended to reward those who do win such risky bets?” argues the business professor Peter Cohan, himself a former hedge fund manager. In the 2016 presidential campaign, politicians from Bernie Sanders and Hillary Clinton on the left to Donald Trump and Jeb Bush on the right called for termination of this loophole. “The hedge fund guys didn’t build this country,” Trump said. “These are guys that shift paper around and they get lucky.”13
One smart line of investment that the hedge fund guys make every year is their contribution to members of Congress. The politicians, in turn, serve their funders by protecting the carried-interest preference from all challengers. Despite its unpopularity, this particular tax break has proven so hard to eliminate that Barack Obama sought to circumvent it instead: he proposed to keep the carried-interest provision but to add a new requirement—it’s been dubbed the Buffett Rule—that says anybody with adjusted gross income over $1 million must pay at least 30% of it in income tax. It was this presidential initiative that prompted the financier Stephen Schwarzman to evoke the Nazis: “It’s like when Hitler invaded Poland in 1939.” Warren Buffett himself has supported the Buffett Rule, but it has never been enacted. Because Obama knew when he proposed the idea that it had no chance of passage, he was (fairly) criticized for promoting a “rule” that was more political posturing than actual policy.
Generally, we don’t get to see the benefits of the carried-interest preference for any specific taxpayer. But that changed, briefly, in 2012, when the Republican presidential nominee, Mitt Romney, was pressured into releasing a couple of his tax returns. In the year 2010, Ann and Mitt Romney reported adjusted gross income of $21.6 million; most of this was deferred salary paid by the investment firm from which Romney had retired twelve years earlier. The couple gave generously to charity—about $7 million—and reported capital losses on various transactions. This reduced their taxable income to $17.1 million. Had this income been reported as salary, they would have paid more than 35% of it in income tax. But under the tax code, almost all of the Romney income was deemed carried interest. Consequently, their tax rate fell to 13.9%—a lower rate than taxpayers earning less than 1% of their income. To add to the candidate’s embarrassment, the return showed that Romney held some of his money in the Cayman Islands, a famous haven for people trying to hide money from the tax authorities. Romney conceded that he had accounts in the Cayman Islands but said this was not for tax purposes. To which the attorney Frank Schuchat responded, “To say you put money in the Caymans, but not for tax purposes, is like saying you bought a condom, but not for sex.”
The carried-interest tax break is one of those things that make the United States exceptional when it comes to tax policy. “Most other countries would never think of a dodge like ‘carried interest,’” notes the tax expert Richard Bird. “It’s proof—as if any more proof were needed—that big money gets its way in the U.S. Congress.” And this mammoth tax gift to the richest Americans is one of the reasons that the problem of inequality is so much “more pronounced” in the United States than in other developed democracies. As Thomas Piketty’s unlikely bestseller said, government principles, including tax policy, contribute in major ways to inequality of income and wealth.
This is why stiffer taxes would be the most powerful antidote to the venom of inequality. But there’s clearly a balance to be drawn. As the French Socialists discovered amid the ruin of their “supertax” idea, if personal taxes get too stiff, people find ways not to pay them—or simply flee, à la l’affaire Depardieu. And it’s not just multimillionaire film stars who cross a border to duck high taxes. Corporations do the same thing, using “convoluted and pernicious strategies.”