Taxation, Redistribution and Regulation:
Fiscal Policy in a Changing World Economy Sven SteinmoMarch 16, 2000
Forthcoming in:
Private Actors and Public Interest:
The Role of the State in Regulated Economies
Edited by:
Jan Ottosson and Lars Magnusson
Sven Steinmo
Department of Political Science
University of Colorado
Boulder, CO 80309-0333
(303) 492-2525
fax: (303) 492-0978
It is widely believed that the internationalization of the world economy must have some important effects on domestic politics. On the extreme end of this view, we find those who effectively argue that the state is dead and that corporations will dominate the world " " " " - "" "" -- "" "" -- " " (1)
The final section of the paper suggests some implications of the empirical findings.
Here I suggest that the changing incentives and constraints facing domestic policy-makers are
likely to provide incentives for policy-makers to yield increasing authority over tax policy to
supra-national authorities.
Tax as a Redistributive Instrument
Before the dawn of this century taxation was not a major instrument of social and economic regulation. Quite the contrary, they instead tended to be collections of an enormous array of various levies on a myriad of specific items and services. Tax systems before the turn of the century were hardly "systems" at all. For the most part, Finance Ministers saw collecting taxes as a necessary duty they had to perform in pursuit of the necessary revenues to finance the state " " " " - - ' - '' '' " "(2)
These political and economic forces were matched by the development of new economic ideas - particularly with respect to taxation policy. Though it would be inaccurate to say that these ideas drove tax policy development, it is fair to say that the policies demanded in this era were supported by the new idea of 'ability to pay.' "Ability to pay" - which meant that tax loads should be related to the taxpayers ability to bear the burden provided a new theoretical justification for progressive income and corporate profits taxes. was that these taxes tax according to the In other words, those who have larger incomes have a greater "ability" to bear a heavier tax burden. It is difficult to overemphasize how radical this concept was in tax policy thinking. To this point, the very idea that the wealthy ought to pay more than the poor was scarcely accepted as a matter of principle. If the wealthy did in fact pay more, this was only because it was difficult collect from the poor. It was widely understood and accepted, at any rate, that landowners, for example would simply pass the taxes down to their tenants.
It could hardly be said, however, that state bureaucracies were simply agents of the ruling class. Who, by centuries end, was 'the ruling class?' Whereas it may have been the case that the ruling class shared more or less common economic interests in the Feudal period, as modernization progressed, the ruling class itself became plural. (3)
When
introduced at the turn of the century these taxes were in fact quite minor in revenue terms but
were to be paid only by the very richest individuals. They were therefore accurately described
as "class taxes"
" "
(4) For most belligerents, income taxes on the
very wealthy were increased to historic levels. By 1918 the top marginal income tax in the
U.S., for example, reached 77%, in Britain the top rate reached a some-what more moderate
60% by 1920. In both cases, it was widely argued that it was unfair to have working class
men fight this "rich man's war" while the rich stayed home and got even richer.(5) In many
countries, these taxes quickly became the major sources of national government finance even
though they were paid only by corporations and by fewer than five percent of citizens.(6)
From Class Taxes to Mass Taxes
World War II marks the next evolutionary step in the development of modern tax policy in the advancing capitalist world. The costs of fighting (or in Sweden's case, staying out of) this war were enormous, and it was clear to virtually all concerned that no one would be able to escape massive increases in their tax burden. Very high taxes on capital and capital income were once again re-introduced everywhere. There was a firm political commitment in all democratic nations to the principle that capitalists should not get rich supplying the instruments of war. In many cases the various profits taxes introduced in these years, reached close to 100% of net earnings. Wealthy individuals were also subjected to very steep increases in their tax burdens. In Britain, for example, the top marginal tax bracket was pushed up to 97.5% in 1941. In the U.S. the top bracket peaked at 94% in 1944. In Sweden, the top marginal tax rate of all taxes combined reached 80%. The fiscal problem, however, was that the rich and corporations simply did not have enough money to tax to finance the costs of the Great War. Modern technology had once again advanced, and even more clearly than during the last war, it was perfectly clear that those who would be victors would need more than simply lots of men who willing to be slaughtered. WWII was to be a new kind of war, fought with new kinds of weapons. Unfortunately, this kind of war was VERY expensive. In short, new sources of revenue were necessary if the country was to have a fighting chance.
Here we see, once again, how the changing structure of modern capitalism offered new fiscal policy solutions (along with new demands). As capitalists economies advanced, an ever larger share of the populace left subsistence farming and moved to industrial work. These workers were of course organizing and thus increasingly better able to champion their own political interests. But equally importantly, these workers were now getting WAGE incomes. These incomes, of course, could be taxed. Thus revenue authorities in all democratic countries found the new source of revenue that they so desperately needed. Whereas up to this point Income Taxes were considered mostly punitive taxes to be imposed on the wealthy, increasingly state authorities saw that this tax could be paid by average workers as well. Thus, along with increasing tax rates on the very rich, revenue authorities began to lower tax thresholds(7) and thereby apply the income tax even to those with lower incomes. It was thus during WWII that the income tax ceased being a "class tax" and became a "mass tax." Whereas until the end of the 1930s income taxes were still paid by only the very richest in society, by the end of the war at least 60% of income earners were now paying this tax. These changes massively increased the revenue raising capacity of central governments in Europe and America. Tax revenues as a share of GDP nearly doubled in most of these countries between 1930 and 1945.
Taken together the revenue reforms of the 1930-1945 era transformed the politics of
taxation in all industrial democracies. By steeply increasing tax rates on companies and the
very wealthy at the same time that they extended the income tax net downward,
central/national governments became responsible for both redistributing wealth and income
across classes and generations and, as we shall see, managing both the macro and micro
economic outcomes.
Tax as a Regulatory Instrument
At the close of the war, most people expected governments to roll back taxes to somewhere near pre-war levels. This, of course, did not happen. Instead, all western democratic governments, held on to the high levels of taxation that the war had made politically possible (8) Unsurprisingly, huge conflicts were common. The traditional arguments used by capitalists and the political Right were evoked with new passion. Tax rates like the ones now in place would surely destroy worker's and capitalist's willingness to work, save, and invest. Foreshadowing arguments we will hear voiced more than a generation later, it was often argued that retaining these very high taxes would evoke massive capital flight " " -- -- " (9) Tax policy was seen as the major instrument with which to accomplish this end. Modern governments discovered that, given the high marginal rates of taxation, the tax structure could be manipulated to provide incentives for a wide range of economic activities. In effect, governments now were in a position to impose a deal on capital: if you invest in places, times, or activities that we determine, you will pay lower taxes. If you chose to ignore our incentives, you pay higher taxes.
Tax policy thus quickly became a major instrument of social and economic regulation. Tax incentives could be (and were) used to affect decisions about where to invest, when to invest, what to invest in and how much to invest. There were far too many complicated incentive mechanisms developed in various nations to discuss here (they ranged from general investment tax credits, to inventory, to reserve funds, to special depreciation allowances, to tax deductions for investments in particular regions, products, and companies). But it is important to note that all countries engaged in these micro-manipulations of the economy via the tax code irrespective of party, ideology, and level of economic wealth. There was, moreover, a considerable amount of international sharing of ideas and specific policies over how to most effectively use the tax code to affect desired social and economic ends (10)
Whatever the specific mechanisms used in different countries, and irrespective of whether they were always used effectively or efficiently (which they were not), there was widespread agreement that governments could and should use their tax systems as instruments of economic policy: that tax incentives could affect the timing, structure and shape of investment and other private economic decisions. Under this regime (high marginal taxes combined with generous tax incentives and strict capital controls regulating the export of capital) capitalists and their money could be used to promote the ends of society as a whole. At the same time this "carrot and stick" approach helped reduced uncertainty in the marketplace and contributed to the postwar economic miracle. This regime was a centerpiece of the post-war compromise between capital and labor in all western industrial democracies - ' - -- -- - -- "" - " " " " "" - " " (11) The OECD' survey Taxing Profits in a Global Economy suggested the following for example:
Taxation is, however, only one and in many cases not the most important determinant
of investment and financing decisions. . . . Nevertheless, the taxation of profits can and
often does have an important impact on marginal investments and their financing, as
well as on location decisions both within a country and across frontiers. Other taxes,
such as those on payroll and social security contributions, may also affect costs and
thus location of investment, particularly in the short to medium term
(12) See Table 1.
Table 1
"Critical Factors" in Foreign Investment Decisions
1. "projected market growth" 61%
2. "host government tax policies" 60%
3. "host pricing controls" 58%
4. "foreign exchange rates and controls on transfers" 58%
5. "competition" 56%
6. "U.S. tax policy" 53%
Source: - - ' ' - (13) "Common intellectual themes [of the tax reform movement]" report Boskin and McClure in their book, World Tax Reform, "included concern about the adverse incentive effects of high marginal tax rates and about distortions caused by differential tax treatment of economically similar activities, and a downplaying of vertical equity as a central objective of tax policy"
| - | |||||
- - - " ' "(14)
As we saw in Table 1, the trend to cut top personal and corporate tax rates has been
universal. It is possible, however, that the cuts in tax rates are being distributed progressively.
I have found no evidence, however, to suggest that this has happened. It appears instead, as
Williams has noted in a survey of tax reforms in the EC conducted for the accounting firm
Price Waterhouse:
At the same time as some disillusion was spreading about the efficacy of our main taxes, other pressures were building up . . . Our objective now is to be neutrality [sic], with taxes that do not penalize one person rather than another. They give equality of opportunity rather than equality of result . . . A 'fair' tax is one which presents us with a 'level playing field' and does not concern itself with the quality of the teams . . . This shifting appears to be occurring now to an extent few could have foretold a few years ago. As we move to the post-1992 Single European market . . . [Western as well as Eastern European states] are adjusting to reflect these same ideas of neutrality rather than equity "" - " " " " ' ' - - " " " " " " ' -- -- - - - "" " " " " - ' " " " " (15)
The answer is, clearly, yes. Moreover, policy elites are clearly aware of this problem.
In a recent survey of changes in economic policy evoked by global competition the OECD
observed, for example:
One clear lesson is the importance for countries of paying due attention to developments and policies abroad. The majority of situations considered were, or would if left untended have become, unsustainable in their own domestic terms -- although it is hardly possible in today's world to visualize any national situation in purely closed-economy context. But many of the cases considered . . . bear eloquent witness to the realities of interdependence: what is sustainable can depend upon what is happening abroad. This conclusion should not be thought of merely as expressing the constraints on national performance; it can, in principle be built on to devise internationally co-operative sets of policies for a better (and sustainable) global outcome - -- - -- " " - " " å " " " " " " - " " " " " " - " " - " " - " " - " " - " " - " " - " " - " - " - " " - " " "" - " " - " " - " " - - - " " - - " " - " - " " - " " " " " - - - - - - - - " " " "
2. There were exceptions, however. In Sweden and Germany, for example, progressive taxes were introduced by the ruling bureaucratic oligarchy in advance of mass participation in politics. These rulers hoped that they could stem the tide of democratization by offering both social insurance and progressive taxation.
3. In Sweden and Germany, for example, progressive taxes were introduced by the ruling bureaucratic oligarchy in advance of mass participation in politics. These rulers hoped that they could stem the tide of democratization by offering both social insurance and progressive taxation.
4. There were several different types of "excess profits" taxes used in these years in these countries. They are far too complicated to explain here, but in each case an attempt was made to tax all, or nearly all, the profits made as a result of the hostilities.
5. In the U.S. the income tax was called "rich man's conscription"
6. In 1918, income and profits taxes contributed 44.8 percent of total state and local government revenue in Sweden. In the same year, the income and profits taxes contributed 63.1% the federal government's ordinary receipts in the U.S.. In Britain these taxes contributed 64.9% of total tax revenue in 1920.
7. The income at which the individual begins to pay income tax.
8. In most cases the wartime "Excess Profits" duties and taxes were scaled back and/or folded into more permanent corporate profit tax systems.
9. For a specific analysis of the evolution of this regulatory logic in economic affairs see (Magnusson, 1997: 410-445). See also
10. Of course, the character and structure of these tax expenditures could differ quite dramatically between nations. The U.S., for example, tended to write very specific tax incentives designed to benefit specific (politically powerful) industries, firms and individuals. Other countries designed broader and less complicated) incentive mechanisms which could be used by anyone who invested in the ways determined by the government. Two of the countries which perfected these incentive mechanism the most were Germany and Sweden
11. There is a very substantial debate over the quality of these analyses at this point. A thorough discussion of these arguments lies outside the scope of this paper. A general conclusion, however, would be that while it was in no way proven that high taxes negatively effect economic growth, the dominant economic theories used for public policy recommendations suggested that high taxes should negatively effect economic performance. See, for example
12. In my interviews with policy makers and business people alike, it has become clear that as capital becomes more mobile, capitalists become more sophisticated in their investment decisions. The following is typical: When I asked a CEO of a large American automobile parts manufacturing corporation if his company considered taxes when deciding where to place new investment, he looked at me with obvious surprise and said, "Are you kidding? Taxes affect my bottom line. Obviously, taxes aren't the only thing that we take into account . . . but they sure as hell matter." (Interview with author July 1996. Similar comments have been made in over fifty interviews I have conducted with multi-national business executives over the past two years.) See also,
13. Vertical equity usually implies that those with greater incomes should pay a larger share of their income in taxes.
14. Interview with author, May 1988.
15. For an interesting discussion of these issues at the U.S. state level, see Federal Reserve Bank of Minneapolis 1996.