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How Higher Taxes Can Fight Inequality While Promoting Growth

Two new books on economic history and theory suggest the limits of the Austrian school—and the vital importance of progressive taxation.
money inequality

According to the latest World Inequality Report, inequality is like the world's oceans: almost everywhere, and rising all the time. The United States is no exception. Its wealth gap today is as large as it's been since the turn of the 20th century. The authors of the report sound genuinely alarmed. "If rising inequality is not properly monitored and addressed," they warn us, "it can lead to various sorts of political, economic, and social catastrophes."

One of the report's authors is the French economist Thomas Piketty, whose 2014 doorstop Capital in the Twenty-First Century argued that free-market capitalism, left to its own devices, creates a hereditary aristocracy of wealth. As a solution, he proposed a worldwide wealth tax. Top Incomes in France in the Twentieth Century: Inequality and Redistribution, 1901-1998, his latest book in English (first published in France in 2001), is also about taxation. It charts the historical ups and downs of France's income and inheritance taxes. His conclusion is modest: Taxation can tame inequality if we want it to.

But such a conclusion might still prove controversial. It clashes with fundamental truisms of pro-market, right-wing political movements that decry progressive taxation as inefficient, unjust, and even opposed to the laws of human evolution. Among the intellectual architects of the pro-market movement, ascendant since the 1970s, was Friedrich August von Hayek, an Austrian economist, philosopher, and the subject of Naomi Beck's new book, Hayek and the Evolution of Capitalism. Taken together, Piketty and Beck's books address some of the most vital political questions of our young century. Can we do anything about runaway income inequality? And, if so, should we?

Fair warning: Piketty's book is a hardcore history of the French economy. It devotes hundreds of pages to demographic data and the fine print of French tax law. And while Capital had charming asides on the novels of Jane Austen and Honor de Balzac, Top Incomes is enlivened only by the occasional paragraph on the prices of French milk and butter. Still, the basic outline of the story is pretty clear. Over the course of the 19th century, a few hundred French families accumulated massive fortunes. The tax system was rather quaint, based on indicators like the number of doors and windows on a landowner's chateau. In 1914, however, right before its entrance into World War I, France levied a tax on incomes. Light as the tax was (a mere 2 percent on top earnings), it set a precedent. By the end of the war, the top tax rate was 20 percent, and it rose to 70 percent during World War II before settling between 60 and 65 percent until the 1980s.

The years between 1948 and 1978 were a period of robust economic growth and falling income inequality, colloquially known as the Trente Glorieuses. But, Piketty cautions, taxation alone did not decrease inequality. Two devastating wars, sandwiching the financial panic of the 1930s, destroyed the old fortunes. Steep income and inheritance taxes only prevented the growth of new ones—at least for a time.

In the 1980s, inequality started to rise again, in France as well as in the U.S. and United Kingdom. It is no coincidence that it rose along with the fortunes of right-wing political movements, headed by Ronald Reagan in the U.S., Jacques Chirac in France, and Margaret Thatcher in England. Although they had practical concerns about taxation, their objections were passionately philosophical. Thatcher announced as much in 1975, when she slammed a fat book down on a table during a Conservative Party debate and declared, "This is what we believe!"

Top Incomes in France in the Twentieth Century: Inequality and Redistribution, 1901-1998.

Top Incomes in France in the Twentieth Century: Inequality and Redistribution, 1901-1998.

The book in Thatcher's hands was Friedrich Hayek's The Constitution of Liberty, in which Hayek assailed progressive taxation as inefficient and unjust. Hayek thought that social engineering, like redistributive income taxation, exalted the wisdom of central planners over the diffused wisdom of the market. "No human mind can comprehend all the knowledge which guides the actions of society," he declared. Consequently, legislators must bow to "an impersonal mechanism, not dependent on individual human judgments, which will co-ordinate the individual efforts."

The "impersonal mechanism" was the market, through which wealth grew, but in Hayek's account, the market actually reflected an even deeper mechanism: evolution. Based on his idiosyncratic reading of Charles Darwin, Hayek developed a theory of "group selection," in which the values and habits of certain societies allowed them to flourish, grow, and overwhelm other, weaker groups. Social solidarity and altruism, he thought, were effective in small tribes, but self-interest allowed a society to grow far larger and more complex. Attempts to redistribute income, therefore, were regressive, contrary to the advance of civilization. "To [Hayek]," Beck writes, "inequality was an inevitable corollary of progress, and the latter was well worth the price of the former."

In light of Piketty's history, every part of Hayek's argument now looks doubtful. Although even Piketty might not comprehend all the knowledge "which guides the actions of society," the tremendous amount of data he gathers and analyzes (from tax rates to the price of butter) point to unavoidable conclusions. High taxes on income and inheritances can keep inequality in check, or even make it fall. But "in a world without taxes, [the] process of accumulation can be extremely rapid." Inequality is not incomprehensible or uncontrollable. It is the result of political decisions. As for the supposed opposition between growth and taxation, the Trente Glorieuses saw astonishing growth despite high income taxes, in France and in the U.S. In fact, during the entirety of the Trente Glorieuses, American tax rates were even higher than those of the French. Piketty further points out that inequality might actually hamper growth, "since such inequality causes key decisions (on new investments, the creation of new firms, etc.) to be concentrated within a small fraction of the population and excludes a fair number of those who have worthwhile projects." And despite Hayek's contention that the free market produces strong and stable societies, in Piketty's estimation, "the experience of the 20th century suggests that societies that are too obviously unequal are inherently unstable."

American society is already pretty obviously unequal. If Piketty is right, it's about to get worse too. Last year's tax bill trimmed the top income tax rate from 39.6 to 37 percent and the raised threshold of the estate tax from $5.6 to $11.2 million. Under these conditions, great fortunes will accumulate even faster than before. That's the bad news of Piketty's book. The good news is that it doesn't have to happen. Piketty makes clear, at great length, exactly what would stem the tide.