Capital in the Twenty-First Century

by Thomas Piketty

  Why is the goal of transparency so important? Imagine a very low global tax on capital, say a flat rate of 0.1 percent a year on all assets. The revenue from such a tax would of course be limited, by design: if the global stock of private capital is about five years of global income, the tax would generate revenue equal to 0.5 percent of global income, with minor variations from country to country according to their capital/income ratio (assuming that the tax is collected in the country where the owner of the asset resides and not where the asset itself is located—an assumption that can by no means be taken for granted). Even so, such a limited tax would already play a very useful role.

  First, it would generate information about the distribution of wealth. National governments, international organizations, and statistical offices around the world would at last be able to produce reliable data about the evolution of global wealth. Citizens would no longer be forced to rely on Forbes, glossy financial reports from global wealth managers, and other unofficial sources to fill the official statistical void. (Recall that I explored the deficiencies of those unofficial sources in Part Three.) Instead, they would have access to public data based on clearly prescribed methods and information provided under penalty of law. The benefit to democracy would be considerable: it is very difficult to have a rational debate about the great challenges facing the world today—the future of the social state, the cost of the transition to new sources of energy, state-building in the developing world, and so on—because the global distribution of wealth remains so opaque. Some people think that the world’s billionaires have so much money that it would be enough to tax them at a low rate to solve all the world’s problems. Others believe that there are so few billionaires that nothing much would come of taxing them more heavily. As we saw in Part Three, the truth lies somewhere between these two extremes. In macroeconomic terms, one probably has to descend a bit in the wealth hierarchy (to fortunes of 10–100 million euros rather than 1 billion) to obtain a tax basis large enough to make a difference. I have also discovered some objectively disturbing trends: without a global tax on capital or some similar policy, there is a substantial risk that the top centile’s share of global wealth will continue to grow indefinitely—and this should worry everyone. In any case, truly democratic debate cannot proceed without reliable statistics.

  The stakes for financial regulation are also considerable. The international organizations currently responsible for overseeing and regulating the global financial system, starting with the IMF, have only a very rough idea of the global distribution of financial assets, and in particular of the amount of assets hidden in tax havens. As I have shown, the planet’s financial accounts are not in balance. (Earth seems to be perpetually indebted to Mars.) Navigating our way through a global financial crisis blanketed in such a thick statistical fog is fraught with peril. Take, for example, the Cypriot banking crisis of 2013. Neither the European authorities nor the IMF had much information about who exactly owned the financial assets deposited in Cyprus or what amounts they owned, hence their proposed solutions proved crude and ineffective. As we will see in the next chapter, greater financial transparency would not only lay the groundwork for a permanent annual tax on capital; it would also pave the way to a more just and efficient management of banking crises like the one in Cyprus, possibly by way of carefully calibrated and progressive special levies on capital.

  An 0.1 percent tax on capital would be more in the nature of a compulsory reporting law than a true tax. Everyone would be required to report ownership of capital assets to the world’s financial authorities in order to be recognized as the legal owner, with all the advantages and disadvantages thereof. As noted, this was what the French Revolution accomplished with its compulsory reporting and cadastral surveys. The capital tax would be a sort of cadastral financial survey of the entire world, and nothing like it currently exists.2 It is important to understand that a tax is always more than just a tax: it is also a way of defining norms and categories and imposing a legal framework on economic activity. This has always been the case, especially in regard to land ownership.3 In the modern era, the imposition of new taxes around the time of World War I required precise definitions of income, wages, and profits. This fiscal innovation in turn fostered the development of accounting standards, which had not previously existed. One of the main goals of a tax on capital would thus be to refine the definitions of various asset types and set rules for valuing assets, liabilities, and net wealth. Under the private accounting standards now in force, prescribed procedures are imperfect and often vague. These flaws have contributed to the many financial scandals the world has seen since 2000.4

  Last but not least, a capital tax would force governments to clarify and broaden international agreements concerning the automatic sharing of banking data. The principle is quite simple: national tax authorities should receive all the information they need to calculate the net wealth of every citizen. Indeed, the capital tax should work in the same way as the income tax currently does in many countries, where data on income are provided to the tax authorities by employers (via the W-2 and 1099 forms in the United States, for example). There should be similar reporting on capital assets (indeed, income and capital reporting could be combined into one form). All taxpayers would receive a form listing their assets and liabilities as reported to the tax authorities. Many US states use this method to administer the property tax: taxpayers receive an annual form indicating the current market value of any real estate they own, as calculated by the government on the basis of observed prices in transactions involving comparable properties. Taxpayers can of course challenge these valuations with appropriate evidence. In practice, corrections are rare, because data on real estate transactions are readily available and hard to contest: nearly everyone is aware of changing real estate values in the local market, and the authorities have comprehensive databases at their disposal.5 Note, in passing, that this reporting method has two advantages: it makes the taxpayer’s life simple and eliminates the inevitable temptation to slightly underestimate the value of one’s own property.6

  It is essential—and perfectly feasible—to extend this reporting system to all types of financial assets (and debts). For assets and liabilities associated with financial institutions within national borders, this could be done immediately, since banks, insurance companies, and other financial intermediaries in most developed countries are already required to inform the tax authorities about bank accounts and other assets they administer. In France, for example, the government knows that Monsieur X owns an apartment worth 400,000 euros and a stock portfolio worth 200,000 euros and has 100,000 euros in outstanding debts. It could thus send him a form indicating these various amounts (along with his net worth of 500,000 euros) with a request for corrections and additions if appropriate. This type of automated system, applied to the entire population, is far better adapted to the twenty-first century than the archaic method of asking all persons to declare honestly how much they own.7

  A Simple Solution: Automatic Transmission of Banking Information

  The first step toward a global tax on capital should be to extend to the international level this type of automatic transmission of banking data in order to include information on assets held in foreign banks in the precomputed asset statements issued to each taxpayer. It is important to recognize that there is no technical obstacle to doing so. Banking data are already automatically shared with the tax authorities in a country with 300 million people like the United States, as well as in countries like France and Germany with populations of 60 and 80 million, respectively, so there is obviously no reason why including the banks in the Cayman Islands and Switzerland would radically increase the volume of data to be processed. Of course the tax havens regularly invoke other excuses for maintaining bank secrecy. One of these is the alleged worry that governments will misuse the information. This is not a very convincing argument: it is hard to see why it would not also apply to information about the bank accounts of th
ose incautious enough to keep their money in the country where they pay taxes. The most plausible reason why tax havens defend bank secrecy is that it allows their clients to evade their fiscal obligations, thereby allowing the tax havens to share in the gains. Obviously this has nothing whatsoever to do with the principles of the market economy. No one has the right to set his own tax rates. It is not right for individuals to grow wealthy from free trade and economic integration only to rake off the profits at the expense of their neighbors. That is outright theft.

  To date, the most thoroughgoing attempt to end these practices is the Foreign Account Tax Compliance Act (FATCA) adopted in the United States in 2010 and scheduled to be phased in by stages in 2014 and 2015. It requires all foreign banks to inform the Treasury Department about bank accounts and investments held abroad by US taxpayers, along with any other sources of revenue from which they might benefit. This is a far more ambitious law than the 2003 EU directive on foreign savings, which concerns only interest-bearing deposit accounts (equity portfolios are not covered, which is unfortunate, since large fortunes are held primarily in the form of stocks, which are fully covered by FATCA) and applies only to European banks and not worldwide (again unlike FATCA). Even though the European directive is timid and almost meaningless, it is not enforced, since, despite numerous discussions and proposed amendments since 2008, Luxembourg and Austria managed to win from other EU member states an agreement to extend their exemption from automatic data reporting and retain their right to share information only on formal request. This system, which also applies to Switzerland and other territories outside the European Union,8 means that a government must already possess something close to proof of fraud in order to obtain information about the foreign bank accounts of one of its citizens. This obviously limits drastically the ability to detect and control fraud. In 2013, after Luxembourg and Switzerland announced their intention to abide by the provisions of FATCA, discussions in Europe resumed with the intention of incorporating some or all of these in a new EU directive. It is impossible to know when these discussions will conclude or whether they will lead to a legally binding agreement.

  Note, moreover, that in this realm there is often a chasm between the triumphant declarations of political leaders and the reality of what they accomplish. This is extremely worrisome for the future equilibrium of our democratic societies. It is particularly striking to discover that the countries that are most dependent on substantial tax revenues to pay for their social programs, namely the European countries, are also the ones that have accomplished the least, even though the technical challenges are quite simple. This is a good example of the difficult situation that smaller countries face in dealing with globalization. Nation-states built over centuries find that they are too small to impose and enforce rules on today’s globalized patrimonial capitalism. The countries of Europe were able to unite around a single currency (to be discussed more extensively in the next chapter), but they have accomplished almost nothing in the area of taxation. The leaders of the largest countries in the European Union, who naturally bear primary responsibility for this failure and for the gaping chasm between their words and their actions, nevertheless continue to blame other countries and the institutions of the European Union itself. There is no reason to think that things will change anytime soon.

  Furthermore, although FATCA is far more ambitious than any EU directive in this realm, it, too, is insufficient. For one thing, its language is not sufficiently precise or comprehensive, so that there is good reason to believe that certain trust funds and foundations can legally avoid any obligation to report their assets. For another, the sanction envisioned by the law (a 30 percent surtax on income that noncompliant banks derive from their US operations) is insufficient. It may be enough to persuade certain banks (such as the big Swiss and Luxembourgian institutions that need to do business in the United States) to abide by the law, but there may well be a resurgence of smaller banks that specialize in managing overseas portfolios and do not operate on US soil. Such institutions, whether located in Switzerland, Luxembourg, London, or more exotic locales, can continue to manage the assets of US (or European) taxpayers without conveying any information to the authorities, with complete impunity.

  Very likely the only way to obtain tangible results is to impose automatic sanctions not only on banks but also on countries that refuse to require their financial institutions to provide the required information. One might contemplate, for example, a tariff of 30 percent or more on the exports of offending states. To be clear, the goal is not to impose a general embargo on tax havens or engage in an endless trade war with Switzerland or Luxembourg. Protectionism does not produce wealth, and free trade and economic openness are ultimately in everyone’s interest, provided that some countries do not take advantage of their neighbors by siphoning off their tax base. The requirement to provide comprehensive banking data automatically should have been part of the free trade and capital liberalization agreements negotiated since 1980. It was not, but that is not a good reason to stick with the status quo forever. Countries that have thrived on financial opacity may find it difficult to accept reform, especially since a legitimate financial services industry often develops alongside illicit (or questionable) banking activities. The financial services industry responds to genuine needs of the real international economy and will obviously continue to exist no matter what regulations are adopted. Nevertheless, the tax havens will undoubtedly suffer significant losses if financial transparency becomes the norm.9 Such countries would be unlikely to agree to reform without sanctions, especially since other countries, and in particular the largest countries in the European Union, have not for the moment shown much determination to deal with the problem. Note, moreover, that the construction of the European Union has thus far rested on the idea that each country could have a single market and free capital flows without paying any price (or much of one). Reform is necessary, even indispensable, but it would be naïve to think that it will happen without a fight. Because it moves the debate away from the realm of abstractions and high-flown rhetoric and toward concrete sanctions, which are important, especially in Europe, FATCA is useful.

  Finally, note that neither FATCA nor the EU directives were intended to support a progressive tax on global wealth. Their purpose was primarily to provide the tax authorities with information about taxpayer assets to be used for internal purposes such as identifying omissions in income tax returns. The information can also be used to identify possible evasion of the estate tax or wealth tax (in countries that have one), but the primary emphasis is on enforcement of the income tax. Clearly, these various issues are closely related, and international financial transparency is a crucial matter for the modern fiscal state across the board.

  What Is the Purpose of a Tax on Capital?

  Suppose next that the tax authorities are fully informed about the net asset position of each citizen. Should they be content to tax wealth at a very low rate (of, say, 0.1 percent, in keeping with the logic of compulsory reporting), or should a more substantial tax be assessed, and if so, why? The key question can be reformulated as follows. Since a progressive income tax exists and, in most countries, a progressive estate tax as well, what is the purpose of a progressive tax on capital? In fact, these three progressive taxes play distinct and complementary roles. Each is an essential pillar of an ideal tax system.10 There are two distinct justifications of a capital tax: a contributive justification and an incentive justification.

  The contributive logic is quite simple: income is often not a well-defined concept for very wealthy individuals, and only a direct tax on capital can correctly gauge the contributive capacity of the wealthy. Concretely, imagine a person with a fortune of 10 billion euros. As we saw in our examination of the Forbes rankings, fortunes of this magnitude have increased very rapidly over the past three decades, with real growth rates of 6–7 percent a year or even higher for the wealthiest individuals (such as Liliane Bettencourt and Bill Gates).11 By d
efinition, this means that income in the economic sense, including dividends, capital gains, and all other new resources capable of financing consumption and increasing the capital stock, amounted to at least 6–7 percent of the individual’s capital (assuming that virtually none of this is consumed).12 To simplify things, imagine that the individual in question enjoys an economic income of 5 percent of her fortune of 10 billion euros, which would be 500 million a year. Now, it is unlikely that such an individual would declare an income of 500 million euros on her income tax return. In France, the United States, and all other countries we have studied, the largest incomes declared on income tax returns are generally no more than a few tens of millions of euros or dollars. Take Liliane Bettencourt, the L’Oréal heiress and the wealthiest person in France. According to information published in the press and revealed by Bettencourt herself, her declared income was never more than 5 million a year, or little more than one ten-thousandth of her wealth (which is currently more than 30 billion euros). Uncertainties about individual cases aside (they are of little importance), the income declared for tax purposes in a case like this is less than a hundredth of the taxpayer’s economic income.13

  The crucial point here is that no tax evasion or undeclared Swiss bank account is involved (as far as we know). Even a person of the most refined taste and elegance cannot easily spend 500 million euros a year on current expenses. It is generally enough to take a few million a year in dividends (or some other type of payout) while leaving the remainder of the return on one’s capital to accumulate in a family trust or other ad hoc legal entity created for the sole purpose of managing a fortune of this magnitude, just as university endowments are managed.