The irresistible political charm of taxing the rich
Even decades ago, the promises of the political parties in the Western world, whether they were on the right or the left, began to more or less converge: fight against poverty, unjust income distribution and unemployment. Nonetheless, their approaches to these problems and the policies they proposed to solve them were still quite different from each other.
For example, conservatives and liberals used to advocate the idea that rapid growth was the best solution to poverty, unjust income distribution and unemployment. All parties on the left, including social democrats, never believed in such an automatic mechanism and tried to solve the problems by transferring income and wealth from the rich to the poor. The most simple and practical way to do that was through a suitable taxing policy, they thought.
Decades passed and it was understood that poverty, unjust income distribution and unemployment were very complex problems that could not be solved by such simple remedies. In short, neither steady economic growth, nor the efforts of income and wealth transfer from the rich to the poor through a simple tax policy could solve those complex problems. Even before the last crisis, the unemployment rate could not be reduced below 10 percent in most rich, Western countries, while the poverty line stayed at nearly the same level.
However, there is a surprise. The Liberal Democrat Party of the United Kingdom (not the Labour Party) proposed targeting the rich with a “tycoon” tax. The title or the name of the tax might be quite attractive for leftists but naturally not for the coalition partner, the Conservatives (although the top rate for the highest earners has now been lowered somewhat). French President Nicolas Sarkozy’s rival, the Socialist’s François Hollande, has also announced that he will target the rich with a new tax policy if he is elected. The idea, however, is not an original idea for a socialist. At least he is not a liberal or conservative.
The problem is the feasibility of that kind of taxing for balancing income distribution and also increasing tax revenues. Unfortunately, past experiences have proved that even targeting the rich has always been politically a very attractive recommendation but was not successful when it was implemented by almost all leftist political parties in Western Europe, especially after World War II. It neither brought prosperity to the poor, nor increased tax revenues considerably. Instead, it destroyed investment and production incentives, at least for a time, and caused slower growth and higher unemployment - which were, of course, to the disadvantage of the poor.
Every textbook written on public finance begins by explaining two very important taxation principles: “equality” and “justice.” This means an equal tax burden on equal incomes and a higher tax burden on higher incomes. In order to guarantee the implementation of these two principles, a progressive tariff (which means higher tax rates for higher incomes) is used. However, some research has proved that there must be a limit for the maximum tax rate. When this limit is exceeded, tax revenues generally begin to decrease instead of increase. This is called the “Laffer curve” effect, carrying the name of the economist who first observed this contradiction.
The problem is whether the new tax rates proposed for the rich both in the United Kingdom and in France exceed that maximum level. Unfortunately, there is no clear evidence or past experience to indicate that maximum level. Finding which rate is feasible by using the trial-and-error method is also impossible in this case. Then, if it really is implemented, we will learn afterwards which rate is feasible and which is not.
It will be good, of course, for the science of economics but not for the U.K. and France if it fails.