I Will Not Stand For This Gross Injustice

When I was a kid I fell in love with J. R. R. Tolkien, devoured all his works, and then moved on to other fantasy authors and series, hungry for more. That's a little like how I am now with books about financial inequality. I adored the two massive Piketty books, but I need more - more! - so I must go further afield to get my fix.

 

But not all that far afield. The Triumph of Injustice is written by Emmanuel Saez and Gabriel Zucman, whose names are familiar to Piketty-heads: they've co-authored various research papers, in various combinations between the three of them, and are major contributors to wid.world, a massive online database tracking various financial statistics around the globe. Saez and Zucman are both professors of economics at UC Berkeley, practically in my back yard; both are originally from France, and Saez has become an American citizen.

The Piketty books have very broad scopes, looking at the entire world over centuries. The Triumph of Injustice is focused on America: every once in a while it will note where America differs from other large and wealthy countries, but otherwise it is entirely focused within our borders. It is temporally more focused as well, looking at what happened in two particular time periods: the New Deal regime from 1932-1980 and then everything that has happened from 1980 to the present.

That focus has a couple of benefits. First of all, a much shorter book, at just under 200 pages compared to the 700 of Capital in the Twenty-first Century or the 1000 of Capital and Ideology. Second, it can be much more specific: where the Piketty books look at overall trends and correlations, TToI looks at what specific laws were passed, what actions Congress or the President took. Or, more often, what actions they did not take. Choosing to not take an action is itself a choice, those choices have enormous consequences.

Saez and Zucman identify a recurring pattern that has been played over and over again to collapse tax bases. First, the administration stops vigorously enforcing tax laws. This causes evasion to proliferate and revenues to drop. Then they "solve" the problem by cutting tax rates, arguing that the evasion flourishes because of expensive and complicated taxes. The whole system resets to a lower rate, the wealthy get much wealthier due to paying fewer taxes, and move on to finding more ways to evade more taxes.

You often hear a distinction drawn between "tax evasion", which is illegal acts like not reporting income, and "tax avoidance", which is taking legal steps to reduce your tax bill like transferring money to a charity you control or to an overseas subsidiary. The authors argue that there is not a meaningful difference between evasion and avoidance. Our law includes a set of provisions called the "economic substance doctrine": in essence, this means that any action you take specifically to avoid taxation is illegal. Investing in an overseas company is of course legal; but if you are investing specifically to dodge US taxes, then that is illegal.

The economic substance doctrine underlies their argument that overall the problem with tax cheats is one of political will and not of inadequate laws. During the New Deal era, the IRS would aggressively prosecute fraudulent tax schemes, the President would publicly chastise misbehaving companies, Congress would hold hearings to shame the worst offenders. And it worked, over and over again, that the spirit of the law was upheld. For example, in the late 1960s it became popular to "donate" money to "charities" that exclusively employed the donor's family members and undertook projects to benefit the donor's lifestyle. Within a short time, the the people running these schemes got dragged into court by angry feds, and then very suddenly rich people stopped using those fake charities and resumed paying the taxes they owed.

In contrast, the Reagan team believed "taxation is theft", which meant they were not at all disposed to put pressure on rich people to pay their taxes. The IRS is nominally independent, but over the long run they are receptive to the priorities and pressures of the federal government, and they have been under enormous pressure to leave wealthy tax cheats alone. And so, when "tax shelters" began to arise in the 1980s, the administration let them flourish. Instead of fighting the fraud, they used the existence of tax shelters to argue for and eventually succeed in slashing the top income tax rates. I'm reminded of Elizabeth Warren's saying that "personnel is policy". For the most part, we have the right laws to combat cheats, and they've been on the books for a century. We just need people who are willing to enforce them.

This book includes some things that I already knew - I wasn't exactly shocked to hear that Reagan was a turning point in American inequality - but I also learned a lot of new stuff. One big thing is concretely how overseas tax shelters work; I've been hearing about them for years but have always been fuzzy on exactly what they are and what they do. Now I know! As an illustrative example, just before Google incorporated and went public, it created a subsidiary in Bermuda and "sold" that subsidiary their core Search intellectual property: the algorithms and concepts and methods behind their technology. Now, in 2018, Google earns, say, $23 billion in the US, mostly by hiring US engineers who build products used in the US to sell US advertising to US consumers. Google will then pay its Bermuda subsidiary $23 billion for the rights to use their Search IP. So Google ends up with a net profit of $0 in the US, resulting in a total US tax of $0. It does owe tax to Bermuda for the $23 billion in profit there. What's the corporate tax rate in Bermuda? 0%. So it pays $0 in tax there as well.

In the last couple of years, there's been more awareness of the leeching effect of high-tech companies, particularly the newer "sharing economy" ones: more people and economists and politicians recognize that what seems like big innovations in efficiency are mostly or entirely built around tax-dodging: the "innovation" is mostly finding ways to avoid paying benefits to your workers, or sales taxes to your state, or supporting the public infrastructure of your cities. Reading TToI makes me think that the problem is even older and deeper than these companies. "Blue-chip" tech companies like Alphabet and Apple are titans of Wall Street with massive market capitalizations, largely because they seem much more profitable than the boring stodgy old industrial companies. But, would Alphabet and Apple still look so great if they paid the taxes they owed? Would GM become a beloved company if they had a subsidiary in the Cayman Islands to which they paid $10 billion for the intellectual property of "having a motor that turns four wheels and pushes a vehicle forward"? Modern companies have the advantage of being born in an "anything goes" era of lax enforcement, making it trivially easy for them to dodge paying their fair share of the tax burden that older companies cannot so easily shrug off.

Another thing Saez and Zucman write about that I hadn't previously deeply considered is corporate profits. First of all, they make the (very reasonable) argument that every dollar can ultimately be traced back to a real flesh-and-blood person who owns it. That dollar might be on the books of some company, that's owned by a conglomerate, that's owned by a private trust, that's controlled by a family, but ultimately some real person owns that dollar. With this principle in mind, they have a different view of income from what I (and I think most people) usually think of. As they see it, if you own stocks in a company, and that company makes money but doesn't distribute the profits in dividends, then you still own the increased value in the company. Or, to put it in other words, if your net work increased by $1,000 over the last year due to an increase in the value of shares of stock that you own, then you had $1,000 of income, even if you have not yet sold the stock: that money is still yours, just sitting on the corporation's ledger instead of yours.

That might seem kind of esoteric, but it turns out to have really profound impacts on the very, very wealthiest people in the country. The vast majority of us don't really have a choice in how we realize income: we get a paycheck and a W-2, full stop. But wealthy people can pick and choose whether they hold their money in a company or receive it as pay. Many of the wealthiest people, like Mark Zuckerberg and Jeff Bezos, would not be impacted at all if we drastically raised the top marginal tax rate to, say, 90%. Why not? Because they don't earn much regular income that's subject to the income tax. It's the "$1 salary" that Steve Jobs made famous, which shifts your income from labor to capital. The ultimate effect is that you can become personally worth billions of dollars without paying tax on your billions.

Theoretically, that money will eventually get taxed: as a capital gain (at a far lower rate than regular income), or as a sales tax (if you, like, buy a corporate jet through your company), or as an estate tax for your heirs. But, again unlike regular wage earners, you get to pick when and how to pay your tax. Of course, this opens up the door for all sorts of shenanigans to obscure your wealth, to hide it from taxation, to claim paper losses or shift it overseas or otherwise break the law.

So, big-picture, the upshot of the first part of the book is basically:

• In America, we used to have robber barons and incredibly wealthy and powerful people who ran roughshod over our democracy.
• Starting in the 1930s, we established extremely high progressive tax rates and vigorously enforced them, while simultaneously investing in social programs, education and infrastructure. As a result, growth was more equally spread throughout the entire income spectrum, with the incomes of working class and middle class families rising at about the same rate as the wealthy.
• Starting in 1980, a series of policy changes have removed the high tax rates on the wealthiest people while also making it easier than ever to avoid paying even their lower taxes. As a result, the incomes of the bottom 50% of the population have flatlined while the wealthiest have reclaimed their Gilded Age status.

But they don't end on this doom-and-gloom note. They remind us that it wasn't that long ago that we had a different tax policy, and different outcomes, so we know that there are possible solutions to our problems. Of course, the world of 2020 is different from the world of 1930, and some of the new challenges, like globalization, call for new solutions. Saez and Zucman close with a variety of concrete steps we can take to make life more fair here. It's thrilling to realize that at least one of their proposals is already coming to fruition: Janet Yellen, our new Treasury secretary, is working with other major economies to establish a global minimum corporate tax rate, which will be hugely instrumental in curbing the use of offshore tax havens like Ireland and Bermuda. The authors also propose a wealth tax, with some fairly stark differences from what Piketty and Warren have proposed: the Saez/Zucman wealth tax wouldn't start to kick in until much higher wealth levels, and would impose higher rates.

Why is that? Well, channeling Bernie Sanders, late in the book they start to question whether we should even have billionaires. Going back to the Laffer curve, they crunch some numbers and come up with an "optimal" tax rate to extract the most money from the wealthiest citizens: any higher and those people will choose not to work, any less and we collect less potential revenue. This works out to a top marginal income tax rate of about 75%, which results in an overall average tax rate of 60% across the top 1%. But, they offer, there might be social and democratic reasons why we want to go higher than that, with a goal not so much of maximizing government revenue as a goal of reducing the power and influence of billionaires.

Money is power. The wealthiest Americans have enormous resources that can pose huge danger to our republic: tying up important reforms in endless court litigation, funding astroturf campaigns to stoke media coverage, outright buying media companies to shift public opinion, hiring armies of lobbyists to block necessary legislation, using accountants and lawyers to devise new schemes of tax evasion, funding the campaigns of sympathetic political candidates, and on and on. We can try to beef up our laws and enforcement agencies to block these attacks. Or... we can just take away their power. We did it before! Small is beautiful, whether you're a company or a personal fortune.

Elizabeth Warren's wealth tax is kind of designed as a permanent wealth tax, with a slightly broader base and less punishing at the top. It could generate a lot of revenue over multiple generations and use that revenue to fund long-running worthy programs. That isn't really the goal of Saez and Zucman's wealth tax. It's more like the 90% marginal income tax rates of the mid-century, or a carbon tax: it's a tax to perform a specific social good by discouraging bad behavior, with the goal of eventually collecting no money at all.

Like Piketty, Saez and Zucman stress that this is only one of many ways, and there are lots of good ideas out there. But it's crucially important that it's a democratic debate, not an oligarchic one. We get to choose our leaders, choose our laws, choose what sort of society we want to live in. We now have 40 years of hard evidence from our experiment with Reaganomics. The result is dismal. It's long past time to change course.