Should the 1% have a 75% Bracket?

March 3rd, 2012
in Op Ed

by Dirk Ehnts

As the WSJ reports, French Socialist candidate Francois Hollande proposes a marginal tax rate of 75% on the super-rich:

French presidential hopeful Francois Hollande floated the idea of creating a new 75% tax bracket for top earners if he wins the elections this spring, toughening his leftist rhetoric with another attack against the super rich.

“I’ve been told about the considerable increase of the paychecks of CAC40 executives, two million euros per year on average. How to accept it?” Hollande said late Monday on a television show.

The Socialist candidate has already said he plans raise taxes on high incomes, cut tax on profit for small and medium-sized companies and scrap billions of euros of tax breaks introduced by President Nicolas Sarkozy.

 

Follow up:

Before cries of socialism are uttered, let me point out that Mr Hollande is, in fact, a socialist. Let me then point out that the same policy was conducted during the Civil War in the US, as Marc Egnal, a professor of history of Toronto’s York University, reports in the NY Times today on his blog about the birth of the greenback:

Instead, leadership came from a small group of Congressional Republicans, including representatives Elbridge Spaulding and Thaddeus Stevens and Senator John Sherman of Ohio. Before the war these men had been strong advocates of the economic measures – such as a protective tariff and internal improvements – that marked the Republican Party. They now set forth a bold program: It began with printing $150 million of legal tender Treasury notes, which bankers and soldiers alike would receive in payment for their services. These bills would be supported by extensive taxes, including an income tax. Once those initiatives were in place, Congress would implement Secretary Chase’s plan for a national banking system.

Spaulding, Sherman, Stevens and others who worked with them had a broad vision of American growth, built on a vibrant national economy with a strong central government. They extolled a harmonious nation of free farmers and manufacturers, with special interests kept in check by national laws. And they emphasized the need for sacrifice in the common cause: Spaulding, for example, made clear that the next step – heavy taxation – must soon follow the emission of Treasury notes. “Direct taxation, excises, and internal duties are new features within the United States,” he remarked. “They will be heavy burdens on the people, but essential to sustain the circulation of demand Treasury notes. The tax-gatherer will be an unwelcome visitor to most people, but his face must soon be familiar.”

If funds need to be raised, either for financing a war or a government deficit, an increase in taxes is often the only way out. After all, budget deficits are the result of the past’s tax incomes that have failed to cover expenses. In the end, a distributional problem is in the background. Government spent money, but politically could not bring about a balanced budget. As a result, government debt rises over times. There might be a point when government debt becomes a problem. In France, the government cannot print itself out of government debt problems, therefore it poses a real problem. (For most developed countries, the central bank can always help to pay the government debt. No action is necessary, the problem will play out with a bit of inflation and should not lead to bigger economic troubles, like a hyperinflation).

At the background of this you find that there is a certain view of what money is. While some people think that there is something of intrinsic value in money, the tax-driven money theory seems to be closer to the truth. We don’t accept money because it is of value or because we expect that others think it has some value, but we accept money because we and others can pay taxes with it. Period.

If the economic problem diagnosed in our economy is a zero interest rate caused by the rich wanting to save but the poor not being eligible to borrow, then increasing taxes on the rich will be the right thing to do. This will produce a drop in savings of the rich, and therefore the amount of funds available for borrowing will be smaller. This will surely lead to interest rates moving back up again (although France is part of the euro zone and perhaps foreign capital will flow in and stop a rise in interest rates). At the same time, lowering taxes on the non-rich should increase (expected) demand and, therefore, new investment opportunities should spring up. Also, government spending can increase. I think that it should not be that difficult to find projects that would transform social problems into opportunities for people (banlieu, anyone?). This should make the cake bigger, although the distribution will change.

If the diagnosis above is right, then the idea of high taxes leading to growth can work. Even more so since the rich have more incentives to invest in risky projects. Think of a 50-50 chance of a project returning either 0% or 220% on your investment of a million euros. With tax rates at, say, 40%, the unsuccessful outcome means that at least you get a tax deduction of 0.4 times a million euros, which is €400,000. If tax rates are 75%, however, then the tax reduction would go up to €750,000!  Therefore, high tax rates increase incentives to invest into risky projects. That is just what we would need now. If tax payers go offshore or move to Monaco in huge numbers, all of this would probably not work as nicely. But then, diminishing the amount of capital available was exactly the point, wasn’t it?

 

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About the Author

Dr. Dirk Ehnts is a research assistant at the Carl-von-Ossietzky University of Oldenburg (Germany). His focus is on economic integration and economic geography, covering trade, macro and development. He is working at the chair for international economics since 2006 and has recently co-authored a book on Innovation and International Economic Relations (in German). Ehnts has written at his own blog since 2007: Econblog 101. Curriculum Vitae.
















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5 comments

  1. ECB-Watch says :
    *----

    "At the background of this you find that there is a certain view of what money is. [...] but we accept money because we and others can pay taxes with it. Period."

    That's an admonition, not an argument, but even if it is correct, I don't see how it relates to the rest of the article.

    "then the idea of high taxes leading to growth can work. Even more so since the rich have more incentives to invest in risky projects."

    What's the link between rich French residents investing in risky projects and growth? I don't see it.

    "Think of a 50-50 chance of a project returning either 0% or 220% on your investment of a million euros. With tax rates at, say, 40%, the unsuccessful outcome means that at least you get a tax deduction of 0.4 times a million euros, which is €400,000. If tax rates are 75%, however, then the tax reduction would go up to €750,000! Therefore, high tax rates increase incentives to invest into risky projects. That is just what we would need now."

    I'm not convinced by this reasoning. Is there at least a reference to support its conclusion? As presented here, it only considers the downside of the investment. Furthermore, tax deductions on losses are usually thought of as capital losses. Is this what is implied here? If so, only realized, not latent losses are tax deductible, which makes the demonstration even less credible.

    "But then, diminishing the amount of capital available was exactly the point, wasn’t it?"

    Incomprehensible. Some reference to national accounts needed.

    Except for the news of the proposal itself, there is nothing that adds to my understanding of economics in this article.

    BTW there's probably more political calculation than conviction behind the proposal because it has been the most salient proposal of the far left wing candidate.

  2. Admin (Member) Email says :

    @ECB-Watch - - -

    I agree that the author left a lot between the lines and could have written a significant thesis on the topic. However I don't think he was being unreasonable in the expectation that the reader could do the simple calculation that the after tax result for his hypothetical investment was 50% chance of losing €250,000 and a 50% chance of gaining €550,000. The expected gain/loss ratio is 2.2/1, after tax.

    Of course the discussion could continue to the hypothetical behaviors likely in the lower tax environment, etc. But the author may not have had time to write a book.

    I found the short essay gave me lots of things to think about.

    John Lounsbury

  3. ECB-Watch says :

    "If the diagnosis above is right, then the idea of high taxes leading to growth can work"

    It turns out Hollande himself had once reasoned it would be demagogy. To be sure, Sarkozy's party is enthusiastically milking the blunder. In fact his economic adviser was caught off guard on TV as, or soon after, the announcement made news [1].

    But never mind that the diagnosis is not even right in the mind of its proponent, as long as the next idea provides food for thought (take it from John):

    "Even more so since the rich have more incentives to invest in risky projects."

    I suspect the author had in mind something along the lines of Domar & Musgrave. If that is the case, stating it would have made this comment

    "author may not have had time to write a book"

    which is a bit of an extrapolation as it is, completely irrelevant at the onset. There would have been no need to write a book because this seminal work has engendered 65+ years of research that could fill multiple volumes of books.

    If it's not the case, then Dirk Ehnts is perhaps on to something of his own creation, and he definitely has my encouragements to dig deeper.

    Notes:

    [1] http://www.challenges.fr/elections-2012/20120301.CHA3848/quand-hollande-s-opposait-a-une-tranche-d-impot-confiscatoire.html

  4. Dirk Ehnts says :

    @ECB-watch

    Thank you for your comments. I think that my main point - which is at the background only - is that if the ECB does not control the money supply, it cannot cannot control investment directly. It can only influence expectations via interest rates - which it does - and the banks endogenously create money when investment is created. More or less, demand is the key in the short run in today's France.

    Now it seems to be that the interest rate is zero in the real economy because there is a lack of demand for funds. People that supply funds for others to borrow now are not virtuous, since nobody wants to borrow and the money should be spend instead of hoarded. That would do the economy good.

    The idea then about the 75% tax rate was indeed based on Domar and Musgrave (1944). I should have given the source. Given that France is left without monetary policy, (expansionary) fiscal policy and an exchange rate, only fiscal (redistributive) tools remain. If they can be used to spur investment, good. If there is no policy tool left, then what does sovereignty mean for a member of the euro zone?

  5. ECB-Watch says :

    The reply of the author does not acknowledge the factual context: not even Hollande expects that this will spur growth/close de deficit gap significantly, and, previous to that, the tax bracket (> $1 million) was not even mentioned. Worse, the author persists in supporting this : "The idea then about the 75% tax rate was indeed based on Domar and Musgrave (1944)." w/o responding to the criticism targeted at it. This is micro-economics, yet the diagnosis is supposed to be based on macro-economics. Misleading. This article was written haphazardly w/o proper consideration for the readers.







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