Un Comment → “Tassare di più i ricchi non serve contro la crisi”

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   Vito Tanzi
   

   12 annoe fa

   The Challenges of Taxing the Big

   The challenges of taxing individuals at the top of the income scale (“the big”) exist in all countries with a market economy. The challenges can be: political, because “the big” normally have a lot of political power; administrative, because the rich can often hide or spread their income easily in activities that are not easy to control, including in foreign tax havens; and legal, because they can hire the best accountants, lawyers and tax experts that can help them exploit the complexities of the tax systems. They can also occasionally bribe the tax administrators, to get favorable treatment.

   This paper will focus on the role that economic theories have played in recent years in reducing the taxes that the big pay. The theories often originate in the developed world, and especially in the United States. However, they end up having major influences in other and especially in developing countries. The paper will have a US bias, but in a concluding section it will focus more directly on the developing countries.

   Some Historical Background

   Two thousands years ago, the great, Greek, historian Plutarch (45-120 AD) wrote that: “An imbalance between rich and poor is the oldest and most fatal ailment of all republics”. Plutarch’s view has been echoed by others over the centuries and, in spite of some dissenting voices, would be endorsed today by many. Closer to our time, a Swedish dramatist, August Strindberg (1849-1912 AD) wrote that: “Economics is the science by which the economic elite remains the economic elite”.

   The Strindberg view has been recently endorsed by a prize-winning documentary, called The Inside Job, on the causes that led to the financial crisis and the “Great Recession”. The documentary attempted to show the role that several highly influential economists had played, before the crisis, in insuring that “the economic elite remains the economic elite”. The accusation of the documentary was that these economists had adjusted their writing to support the positions of the elite, and to promote the interests of those who could be called “the big”. They had done it presumably in exchange for significant financial compensations. Putting it in a more direct and less elegant way, the documentary implied that “they had sold themselves and their intellectual integrity”! The American Economic Association has taken the accusation seriously enough to introduce a policy that requires that people who submit papers for publication in its journals must, from now on, disclose if the authors have received financial support for the work submitted.

   Perhaps, the issue was not one of selling one’s integrity, even though several of the economists interviewed had received significant amounts of money for publishing papers that clearly supported the interests of some elite, but simply of accepting a view that Ron Suskind, Pulitzer Prize winner and author of a highly informative book on the first two years of the Obama Administration, attributes to Larry Summers. See Confidence Men, 2011, p. 231. Summers’ reported position was that, in a market economy, as is that of the United Sates, individuals always “get what they deserve”, regardless of the size of the incomes that they receive from their economic activities. Therefore, “the big”, those who get incomes in the millions, or even in the billions, of dollars, deserve their high incomes because of their greater ability, education, hard work and efficiency, compared with other individuals. The incomes that they receive are just a reflection of the “value” that they contribute with their activities to the national economy.

   Summers’ conclusion would of course apply to those who are at the top of the income distribution as well as to those who are at the bottom. A possible exception might be, those who receive minimum wages, or government subsidies, who, by definition, must contribute less “value” to the economy than the incomes that they receive. There are, of course, many economists, especially in the United States, that would share this conclusion. Presumably the payments for the papers that The Inside Job mentions must also have reflected the real “value” provided by those papers to the economy.

   If individuals always get the incomes that they deserve, and if, by doing so, they generate an income distribution that is highly uneven, it would seem unfair and, many economists would add, inefficient, for governments to interfere with the results of the market. One cannot argue that individuals always get what they deserve while at the same time complain about the market results in terms of income distribution.

   A complication is that societies need governments, and governments need revenue, to cover their spending. Thus, there is the necessity to raise taxes and the problem of deciding what taxes to use and who should pay them. The Italian Scienza delle Finanze, an important “school” that flourished in Italy, from about the time of the Italian Unification, in 1861, until the advent of fascism, in the 1920s, had a simple answer. Some of its major exponents maintained that the government’s provision of public goods benefits the citizens in a relation broadly proportional to their incomes. Thus, on a “benefit received principle”, this would justify proportional taxation. See Tanzi, 2011.

   The above answer, in turn, created some controversy on whether the proportional taxation should be based on income or on consumption. The latter would exempt from taxation the part of income that is saved by taxpayers. Several major economists, including John Stewart Mill, Luigi Einaudi, Nicholas Kaldor and some others, over the years, argued that saving should not be taxed. Thus, in a way, they created a first bias in favor of richer people, who presumably save a larger share of their incomes, a conclusion that was later challenged by Milton Friedman and some other economists, who believed that, over the long run, the saving behavior of rich and poor people is not distinguishable.

   For much of the 19th century proportional taxation remained the norm, so that the economic positions of higher income individuals, including “the big”, were not endangered by taxation. Also, the tax levels as shares of GDP, remained low, generally below 15 percent and progressive taxes remained unpopular. The prevailing view of the time was, perhaps, best captured by the economist John McCulloch. He was a firm opponent of progressive taxation, on the ground that once proportional taxation is abandoned “you are at sea without rudder or compass, and there is no amount of injustice or folly [that] you may not commit”. He was right, that proportional taxation provides a clearer compass for governments that progressive taxation, that may come in various shapes and forms, does not provide.

   The complications started when the right to vote was extended from a very small proportion of the population to much of the population who wanted more public spending that was beneficial to it. Showing the impact that political winds have on the thinking and the findings of economists, at about the same time, the then very popular German economists, Adolph Wagner, started arguing that governments do not have just the responsibilities of providing public goods (and, perhaps, of assisting the very poor) but also that of redistributing income across classes. This was a view found in Aristotle—Politica, book V, Chapter 1 – and in Montesquieu—Esprit des Lois, book V, Chapter VI and VII — . However only in Wagner’s time this idea found a fertile ground. The socialists, including Karl Marx, were not in favor of redistribution, in the context of a market economy with private property, but in favor of abolishing private property and the private market.

   In Wagner’s time the income distribution suddenly became an important issue, and its measurement an important statistics. The “Gini coefficient” was proposed by the Italian statistician Corrado Gini, in 1912, as a way to measure the income distribution and soon became a popular measure of it. If a more even income distribution was a desirable objective for many governments, the inevitable question arose as to how to promote it. Progressive income taxes entered the stage at this time; in the United States in 1913.

   Slowly the view acquired currency (a) that governments should have access to higher resources than in the past; (b) that income taxes could play a significant and growing role in providing resources to governments; and (c) that income taxes could and should be progressive. By the middle of the 20th century this view had become prevalent. See Tanzi, 2011. At the time when the author of this paper was a graduate student at Harvard, a half century ago, the above view was hardly ever challenged. At that time influential economists, such as Richard Musgrave, Richard Goode, Joseph Pechman and others strongly advocated the use of personal income taxes, applied with highly progressive rates, and on a comprehensive definition of income that, in principle, should include unrealized capital gains. There was almost no attention paid at that time, to the possibility that there could be disincentive effects that accompanied high marginal tax rates. Paul Samuelson, in his Foundation of Economic Analysis, published in 1948, had dismissed this as a serious possibility. At that time, surveys of taxpayers indicated that they considered the highly progressive personal income tax as the “fairest” of all taxes.

   There was also no concern with the view, now frequently heard, that the rich are the ones that create employment and generate growth, so that, as some now argue, it would be good policy to protect their income against high income tax rates. There was also no concern about powerful disincentive effects that could reduce the “economic value” that “the big” might contribute to the economy. There views were also held, by most economists, until the decade of the 1970s.

   In the period up to the 1970s, tax rates went sharply up, and the Gini coefficients remained generally low. They had declined sharply from a peak reached in 1929. The lowest level for the Gini in the United States was reported around the year 1970. It would remain broadly unchanged until it started to increase, first slowly and then at a accelerating pace, in the 1980s. The Tax Foundation has published data that indicate that the effective income tax rates on US millionaires rose from 1.6 percent in 1913, the year the income tax was introduced in the USA, to reach 66.4 percent in 1945 during the war. It was still 55.3 percent in 1965 and 47.7 percent in 1982. It fell rapidly afterwards to reach the current low levels.

   The economists’ challenges against high tax rates started in the 1970s and became more organized and more forceful in later years. The challenges were based on both theoretical arguments and empirical results. Soon the landscape for taxation would change in fundamental ways. See Tanzi, 1988.

   II. “The Big” Strike Back

   A first theoretical attack against high marginal income tax rates came from economists who recognized that, while the money earned from work and from additional effort was taxed, and often at very high tax rates, the psychic income that came from not working, that is from leisure activities, was not taxed. This implied that leisure was both a desired and a subsidized activity, and that when the government subsidizes, especially a desired activity, it ends up getting more of it, especially in an environment when the welfare states, that had come into existence at that time, gave some or many individuals the option of not working. Faced with having to pay high marginal tax rates, when they worked, some individuals would choose not to work, and claim some public assistance; or they would choose to work less; or they would opt for lesser paid, but less demanding, occupations. It began to be feared, that these decisions would reduce incentives to work and, possibly, economic growth.

   A second theoretical challenge had to do with the consumption function; or better with the response of personal saving to the taxation of interest income. Keynes had dismissed the possibility that the net-of-tax rate of interest could affect the decision to save or consume. For him consumption depended only on income. However, in the 1970s some economists started challenging the Keynesian conclusion. The argument was that the supply of saving is elastic with respect to the net return that individuals get when they save. The choice between present and future consumption depend on the net-of-tax interest rate. High marginal income tax rates on interest income reduced the net of tax rate of return to saving; thus, they reduced the rate of saving, affecting the growth rate. At that time some papers, by Michael Boskin, that used new data and new econometric techniques, claimed to have identified a high response of saving to be interest rate.

   The third challenge against high marginal tax rates came from an unusual source, from a curve drawn on a napkin in a Washington restaurant, in 1974 by an economist called Arthur Laffer. This was the “Laffer curve”, an economic concept that, in spite of its questionable analytics, became one of the best-known concepts in economies. See Tanzi, 2012b. The Laffer curve became a useful “propaganda devise” against the use of high marginal tax rates and was used extensively, by conservative politicians, to push for lower taxes and for lower tax rates. See Malabre, 1994.

   Up to the 1970 there had been little empirical work on the relationship between high marginal tax rates and the supply response by labor and saving to high tax rates, and, indirectly, the relationship between high tax rates and economic growth. In the earlier years, until that time, various governments, including those of the USA and the UK, had not refrained from taxing income at rates that at times reached or exceeded 90 percent. These high rates reflected the governments’ need for revenue and their concerns with equity and their objective of improving the after tax income distribution. They had also the aim of making high income individuals, “the big”, contribute more to the financing of public spending.

   In the 1970s and early 1980s there began to appear what at that time were called “second-generation econometric studies” that using new econometric techniques and new data attempted to measure the impact of high taxes on various economic variables, such as work participation, saving rates, participation of women and second workers in the labor force, hours of work, and so on. This was happening at the same time when the political and intellectual climate with respect to high taxes and tax rates was changing. This implies, or warns, that economic finding are often not random results, from objective research activities, but often responses to political signals. We economists look where the political signals indicate that we should look and often make an extra effort to get results that are more in line with the climate. Often this happens subconsciously. However, it may also happen as the result of financial incentives, as The Inside Job claimed.

   At that time conservative economists, such as Milton Friedman, had become influential and very conservative political leaders had come into powers, in countries such as the USA, the UK, New Zealand and some other countries. This political environment gave traction to some of the new economic findings. For example, the Laffer curve became a major propaganda tool for the Wall Street Journal’s editorial page. In the space of six years, the marginal tax rate for the US Federal income tax was reduced from 70 percent to 28 percent, with the legislation of Ronald Reagan’s “fundamental tax reform” in 1986. The same happened in other countries. See Tanzi, 1987.

   Until 1986 it was the marginal tax rates and the progressively of the tax system that were under attack, not what could be called the architecture of that system. The 1986 fundamental tax reform while sharply reducing the tax rates still accepted the view that income is income, regardless of its source, and that it should be taxed in its entirely.

   However, soon the architecture of the tax system came under attack, facilitated by another ongoing development: the growing globalization of the countries’ economies and the beginning of the globalization of the financial market. This made financial capital, in particular, and capital, in general, more mobile than labor and, thus, its supply potentially more elastic with respect to the tax rates. Therefore, the taxation of capital in its various forms (capital gains, dividends, corporate income taxes, taxation of interest income) started being attacked. See also Keen and Konrad, 2012, for technical details.

   The initial attacks came from economists such as Robert Lucas, Larry Summers and some others. By 1990 Lucas had concluded that “neither capital gains nor any of the income from capital should be taxed at all”, a position that was soon endorsed by some other conservative economists. Lucas believed that the elimination of capital income taxation would lead to an increase by about 35 percent in the US capital stock, that would stimulate growth, and that this elimination would be “the largest genuinely true free lunch…”. How in the meantime, the government spending commitments would be financed was not discussed by Lucas. Summers also theorized the existence of large income gains for the United States that could come from the elimination of taxes on capital, because capital not taxed would not have an incentive to emigrate. The higher capital-labor ratio that would result would in turn raise the workers’ productivity and their wages making everyone better off.

   These and related attacks, including papers by other economists that believed that taxes on capital income should be reduced, possibly to zero, started the attack on the architecture of the tax system. In these new rounds of attacks, it was not just the marginal tax rates (and the progressivity) of the whole tax system that was under attack, but its architecture. The principle of equal treatment of income, regardless of the source, went out of the window and the need for, or the benefit of, discrimination in favor of capital incomes (capital gains, dividends, corporate income taxed, and, progressively, other kinds of capital incomes came in) came to be accepted. Of course large capital incomes often go to “the big” so that “the big” were the, direct and immediate , beneficiary from the changes. The workers could benefit, indirectly and with potentially long lags, from these changes.

   Tax Rate Reductions and Income Distribution

   There is no controversy that the income distribution has become much less even in the Untied States and in several other, and especially Anglo Saxon, countries in the past 25 or so years. The worsening of the income distribution has accompanied closely the tax changes described earlier. Although, the income distribution of a country can change for several reasons, and various theories have been advanced to explain the changes, it would be indeed strange if the changes in the tax systems described above did not play a significant role. In this section we describe some of the changes in the income distribution in the USA

   The lowering of tax rates on high incomes and especially the separate and much lower rates applied to dividends, capital gains, “carried trade”, and some other forms of income, received by high income individuals, led to (a) immediate net-of-tax income gains to those with high incomes, and especially to “the big”, (b) to increasing attempts on the part of the latter (CEOs of corporations, heads of hedge funds, and of private-equity firms) to reclassify the income that they received as long term capital gains, taxed at only 15 percent, and (c) led to a dramatic increase in the share of total net-of-tax income received by the top income players, and especially by those in the top 0.1 percent of the income distribution. “Carried trade,” a term that did not exist in the past, became a popular, and an increasingly contentions, one. Some individuals, who earned millions, or even billions, of dollars, paid only 15 percent on that income and ended up paying lower tax rates than their drivers or secretaries, as Warren Buffet has often stated.

   Apart from the problems related to the attempts to reclassify incomes, in order to make “the big” benefit from the lower tax treatments of capital incomes, there was the problem that while the benefits of these tax changes to the super rich were certain and immediate, the expected or predicted advantages to the working class, as theorized by Lucas, Summers, Boskin, and others, were highly uncertain. If they did occur, for sure they were much delayed. In the Untied States, the predicted advantages seem to have remained mostly in the theoretical papers of those who had predicted them, and the working, middle, class suffered the most.

   The share of total taxable income that the top 0.1 percent in the US received in 2005 reached almost 8 percent, and that received by the top one percent reached 17.42 percent. See Atkinson et al, 2011. It should be recalled that unrealized capital gains are not included in these statistics so that the share of the top income earners were probably even higher. According to data issued by the Congressional Budget Office, 2011, the top one percent, that in the 1960, and 1970s had received about 10 percent of total income, by 2007 was receiving close to 25 percent of total income. These were extraordinary increases and percentages. They were much higher than in any other industrial country, for which data are available. The behavior, but not the size, of the income going to the top one percent in the USA was duplicated by that of other Anglo-Saxon countries, (Canada, Ireland, United Kingdom, Australia and New Zealand), which had followed tax policies that were broadly similar to those followed by the United States, but much less by most non Anglo-Saxon countries.

   In the United State an unusual situation developed, whereby about half of the population (mostly lower income individuals), does not pay any income taxes, because of claims to high deductions and of high personal exemptions, or because of low incomes. According to the IRS, in 2009, this non paying group included anywhere between 10080 and 35061 households that reported adjusted gross incomes that were at least $200,000 but that paid no Federal income taxes. Of course, they also did not pay value added taxes, because the USA is the only OECD country without some version of such a tax. Thus, the bottom half of the population pays little taxes while “the big” pay much lower taxes than in the past. Inevitably a larger share of the tax burden has fallen on the working middle class, that has seen real wages stagnate for decades.

   In 2010, mainly rich, US taxpayers reported $310 billion in (realized) capital gains, mostly taxed at 15 percent. The Congressional Joint Committee on Taxation has estimated that the preferential taxation of (realized) capital gains and of dividends in 2010 cost the US Treasury $93.1 billion.

   As mentioned, the reduction in taxes at the top and, in part, at the bottom has led to a larger contribution to taxation by the middle class and, more importantly from a macro economic point of view, also to a reduction in total tax revenue. The United States is now the only OECD country in which the present total tax level, as a share of GDP, is the same as it was 50 years ago, surely a remarkable result. In all other OECD countries the total tax level has increased significantly.

   Unfortunately, for good or bad reasons, public spending is not what it was 50 years ago. This disparity between spending and tax revenue has created enormous fiscal deficits and a fast growing public debt that has reached dangerous levels. There are also enormous future government liabilities that, somehow, must be dealt with. Without some major policy changes in the near future, the US may be fast moving toward a fiscal disaster. The policy changes in the short run cannot be limited to expenditure cuts. Taxpayers, especially those at the top, must bear some of the burden of the needed adjustment. The rest must bear some of the burden, over the medium and long run, when public spending can be reduced. See Tanzi, 2012c.

   Table 1, provides data reported by the OECD for different periods, for Gini coefficients, before taxes and transfers, and after taxes and transfers, for the United States, and effective tax rates on millionaires reported by the Tax Foundation.

   Should the income of the Big be Protected?

   In the question of whether the income of “the big” should be subjected to high marginal tax rates, there are some major issues that have attracted little attention, but that may be important. One is the relevance of the incentive question, that seems to attract much of the attention of economists. An other is whether the incomes that these high income individuals receive truly reflect “what they deserve”, as measured by the true value of what they contribute to society.

   The question of incentives, as seen by economists, was discussed earlier in this paper where references were made to various, mostly theoretical, studies that have argued that high tax rates are likely to create disincentives to work, save, and invest, especially when the rates are high. Especially since the early 1990s some studies, have focused on the incentives that economic agents have in taking their capital, and occasionally even themselves, out of the country, and into lower-taxing countries, to reduce, or avoid, the high taxes.

   Capital can emigrate on a large scale. Occasionally, high -income individuals who, because of their activities, are able to operate from different places, can also choose and be able to move. These individuals can use their skills and talent to continue operating from places where taxes are lower. The fact that some activities have become global, including those in the financial market, and that the internet facilitates contracts and transactions, among individuals located in different places, together with the existence of many low-tax, or even zero-tax jurisdictions, have encouraged individuals’ mobility. Attempts to avid taxes can involve different reactions: (a) migration abroad; (b) migration to leisure activities; and (c) migration toward underground, or explicit, tax evading activities within the same countries.

   In the analysis of the impact of income taxes on the behavior of individuals, many economists have given much weight to the (highest) marginal tax rate, regardless of the level of income at which it is applied, and regardless of how many individuals are affected by it. However, not all the taxed individuals are affected by the highest marginal tax rate. If that rate applies only at very high income levels, so that most taxpayers face lower rates on the last dollar that they earn, the disincentive effects of the (highest) marginal tax rates on the whole population of taxpayers would be much reduced. There are a few countries in which most of the taxpayers are subjected to broadly proportional rates while a relatively small number, with very high incomes, the really “big,” face a much higher rate. When this happens the potential disincentive effect of the high rates are limited to a numerically small, though economically important, share of the population. It could be argued that the extra revenue that is collected from the top income taxpayers, if it is used to reduce the marginal tax rates for the larger group that has lower incomes, might even increase total incentives. It is the tax rate that applies at levels of income that most workers receive that may be particularly important, not the highest, marginal tax rate.

   The current political rhetoric, especially in the United States, gives enormous importance to the small share of taxpayers who have the highest incomes. It is often repeated that these are the individuals who create jobs and promote growth. Therefore, they need to be protected against high tax rates. This belief is not supported by any existing, formal, theory of economic growth, even though it is popular with many conservative Americans, and with members of the Tea Party, who repeat it at nauseam.

   Another point to recognize is that the group of high income taxpayers is a very diverse group, likely to have different motivations for working hard. This group includes top athletes, artists, highly successful professionals (doctors, lawyers, successful actors and writers, television personalities, architects, and others) and CEOs, and financial market operators. It also includes some people whose income comes from inherited wealth. It would be strange if all these individuals responded to the same motivation.

   Many of the people who make up the group of the very high incomes, “the big”, have achieved a level of success that has not only given them high incomes but also high social statuses or even fame in the society in which they live. These statutes must give them pride and a large “psychic income”. While high tax rates reduce the money incomes, they do not reduce the “psychic income” as long as the effort and the social positions are maintained. It would be stretching reality, and it would require a crass sociological assumption, to believe that all these people respond, in a robot like fashion, only to the money incentives and to nothing else, including the effects on their reputation. Few sociologists or philosophers or common citizens would share this view, a view that seems to be accepted acritically by many economists.

   It seems highly unlikely that successful athletes, artists, or professionals, that have reached a high social, or professionals, status, would reduce their work and effort, and risk losing their professional and social position, because the income that they receive, above some level, were taxed at higher tax rates. On the way to the top these individuals would not have faced the (highest) marginal tax rates, especially if the high rates were applied at a level of income that, for professional and athletes, implied that a high level of success has been achieved. The economists view of the behavior of these individuals puts them in the position of mercenary, willing to give their best only in exchange for money. This is not a realistic, or complimentary, view of how individuals operate.

   Obviously among the high income groups there are some whose motivation is, mainly, or only, money. What proportion these individuals constitute among the very high income individuals, among “the big,”, is difficult to tell. Recent developments and reports would suggest that these individuals are likely to be found mainly, or in larger proportions, within the financial and business community. Bankers, hedge fund managers, traders, and high level managers of business enterprises are more likely to dominate this group.

   This takes us to the important and related issue of whether the incomes that the very highly compensated individuals receive for their market participation can always be assumed to reflect “what they deserve”, because of the value that they contribute to national income. The sanguine view of the operations of a market economy, that justifies the incomes of the individuals who operate in it, is a view that requires blinds and a “suspension of disbelief” to be accepted, especially after the series of scandals reported almost daily in recent years.

   In recent years the financial market has been rocked by reports of enormous abuses that included, but were not limited to, those connected with the sub-prime disaster, that plunged the world in the “Great Recession”. The reports included: Ponzi schemes, insiders trading, manipulating information, promotion of faulty information, etc. The sub-prime disaster has been followed by the evolving Libor scandal. The above were not always rare individual failures but systemic failures. All these abuses had created huge incomes for some of the people involved, and in many cases large costs for the society at large. Libor has been a benchmark for a $360 trillion market in mortgages, credit cards and other contracts in the world. It has played a major role in determining or justifying the high incomes of “the big”.

   The abuses in Libor were perpetuated with the implicit cooperation of accounting firms and central banks. Robert Diamond, who received $186 millions in salary, benefits and bonuses since 2005 and who was the CEO of Barclays, the bank at the center of the Libor scandal, claimed to be unaware of what the traders in his bank were up to. One wonders what justified his compensation if he is telling the truth. It seems that underlings make “mistakes”, CEOs do not, and are not responsible for the mistakes made by their underlings! In an other area, Glaxo Smith Kline was fined $3 billion for misleading the public on the effects of these drugs. This misleading must also have justifies high incomes for some “big”.

   In recent years there have been so many abuses and acts of corruption, reported daily, by newspapers such as The Financial Times and the Washington Post, that these newspapers could legitimately change their names to The Corruption Times and the Corruption Post. The bottom line is that, slowly, “market capitalism” is becoming “crony capitalism”, where whom you know, and what access you have to connections, and to what could be described as “institutional capital,” is what determines, in many areas of activity success and incomes. It can be concluded that, for both, the bottom and the top of the income distribution it is a stretch of reality to conclude that people “get what they deserve”.

   This transformation raises realistic and valid questions as to whether the incomes of the big should be protected against high taxes, because “they get the incomes that they deserve”. As an example, when Tony Blair, the former British Prime Minister joined the board of J.P. Morgan International he was paid $2.5 million a year (sic), to give “strategic advice” to senior clients and to the bank’s board. Reported by The Financial Times, June 30, Life and Arts Section, p. 1. It is obvious that what Blair provided were “connections” useful in “crony capitalism”. The connections and the set of rules that protect some high incomes (patents, copywrites, trademarks, difficult access to enter areas, complex rules that can be interpreted to favor some groups, use of lobbyists, etc.) have created an “institutional capital” that some individuals can use far more easily than others. There is no equality of opportunity in “crony capitalism”.

   The institutional capital has created, for some individuals, situations that can be described by the general rule of “head I win, tail you lose” This rule applies to executive compensation and to the compensation of hedge funds’ managers and of CEOs of companies. An idea of the operation of this rule is provided by Table 2, which reports for five large banks total pay in 2011 for selected CEOs against the change in bank share prices. It would be difficult to argue that the pays of the individuals reported in the table reflect “what they deserve”. It would be easier to argue that, increasingly, the growth in the productivity of workers in corporations has been diverted to the benefit of the managers. Workers and shareholders are likely to have been the losers.

   An extended survey of Executive Pay produced by Equilar Inc. for 2011, was published by The New York Times, on June 17, 2012. The survey shows the extraordinary compensations for 200 CEOs in what was supposed to be a crisis year and when unemployment was very high. The average compensation was $19.8 million. It had increased by 20 percent since 2010. Those just below the CEO level did equally well. The lady that was recently fired by J.P. Morgan, for losing about $6 billions to the Bank in bad trades, the previous year had earned $15 million.

   Taxing the Big in Developing Countries

   Many of the issues discussed in this paper have relevance for most countries. However, some distinguishing features of developing countries’ economies call for specific comments. There are some major differences between a typical developing country’s economy and a typical advanced country’s economy.

   In the first place developing countries tend to have income distributions that are much less even than advanced countries. This means that the top percentiles of the income distribution contain more potential taxing capacity than in advanced countries.

   In the second place these countries tend to have far more informality in their economies than the advanced countries. This increases the difficulties of extracting high tax revenue from the middle and the lower income classes.

   Third, the administrative capacities of the governments of these countries is generally more limited than that of advanced countries.

   Fourth, the individuals at the top of the income distribution tend to have more political power and to be better integrated globally than those in advanced countries. They often have studied abroad or may even have married foreign spouses.

   Fifth and most important there is a very large difference in the shares of national income that goes to labor versus the share that goes to capital, between developing and advanced countries. Broadly speaking, the share that goes to labor is much smaller in developing countries than in advanced countries. Normally this share is less than 30 percent, in developing countries, and over 60 percent, in advanced countries. This means that to raise a significant level of taxation, the developing countries need to rely more than the advanced countries on the taxation of non labor income sources, such as consumption and incomes from capital. Corporate income taxes contribute more taxes in developing countries than in advanced countries. Other taxes on capital seem to contribute less.

   Capital mobility and the political power of the elite in developing countries have made it difficult to impose high tax rates on the incomes of the rich. Taxes on real property including land and houses have provided little revenue. Much attention has been directed at tax evasion and not enough at the tax laws that have generally favored excessively the high income groups. As these countries become more urbanized and as the increase of human capital makes the income of labor go up, the differences between developing countries and advanced countries will become less accentuated. In the meantime more effort should be made at making the laws less favorable to the rich in spite of the concerns about incentives.

   Finally, a word of caution. The view that to develop and grow governments need more revenue must be qualified by a discussion of the use of tax revenue. If revenues are used inefficiently, the arguments for high tax levels lose some of their validity. But even in these circumstances it is preferable to try to collect the taxes in as equitable way as possible. The inefficient and inequitable collection of taxes may produce the worst of the possible world.