Capital in the Twenty-First Century (85 page)

When PAYGO systems were introduced in the middle of the twentieth century, conditions
were in fact ideal for such a virtuous series of events to occur. Demographic growth
was high and productivity growth higher still. The growth rate was close to 5 percent
in the countries of continental Europe, so this was the rate of return on the PAYGO
system. Concretely, workers who contributed to state retirement funds between the
end of World War II and 1980 were repaid (or are still being repaid) out of much larger
wage pools than those from which their contributions were drawn. The situation today
is different. The falling growth rate (now around 1.5 percent in the rich countries
and perhaps ultimately in all countries) reduces the return on the pool of shared
contributions. All signs are that the rate of return on capital in the twenty-first
century will be significantly higher than the growth rate of the economy (4–5 percent
for the former, barely 1.5 percent for the latter).
⁴⁴

Under these conditions, it is tempting to conclude that the PAYGO system should be
replaced as quickly as possible by a capitalized system, in which contributions by
active workers are invested rather than paid out immediately to retirees. These investments
can then grow at 4 percent a year in order to finance the pensions of today’s workers
when they retire several decades from now. There are several major flaws in this argument,
however. First, even if we assume that a capitalized system is indeed preferable to
a PAYGO system, the transition from PAYGO to capitalized benefits raises a fundamental
problem: an entire generation of retirees is left with nothing. The generation that
is about to retire, who paid for the pensions of the previous generation with their
contributions, would take a rather dim view of the fact that the contributions of
today’s workers, which current retirees had expected to pay their rent and buy their
food during the remaining years of their lives, would in fact be invested in assets
around the world. There is no simple solution to this transition problem, and this
alone makes such a reform totally unthinkable, at least in such an extreme form.

Second, in comparing the merits of the two pension systems, one must bear in mind
that the return on capital is in practice extremely volatile. It would be quite risky
to invest all retirement contributions in global financial markets. The fact that
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on average does not mean that it is true for each individual investment. For a person
of sufficient means who can wait ten or twenty years before taking her profits, the
return on capital is indeed quite attractive. But when it comes to paying for the
basic necessities of an entire generation, it would be quite irrational to bet everything
on a roll of the dice. The primary justification of the PAYGO system is that it is
the best way to guarantee that pension benefits will be paid in a reliable and predictable
manner: the rate of wage growth may be less than the rate of return on capital, but
the former is 5–10 times less volatile than the latter.
⁴⁵
This will continue to be true in the twenty-first century, and PAYGO pensions will
therefore continue to be part of the ideal social state of the future everywhere.

That said, it remains true that the logic of
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cannot be entirely ignored, and some things may have to change in the existing pension
systems of the developed countries. One challenge is obviously the aging of the population.
In a world where people die between eighty and ninety, it is difficult to maintain
parameters that were chosen when the life expectancy was between sixty and seventy.
Furthermore, increasing the retirement age is not just a way of increasing the resources
available to both workers and retirees (which is a good thing in an era of low growth).
It is also a response to the need that many people feel for fulfillment through work.
For them, to be forced to retire at sixty and to spend more time in retirement in
some cases than in a career, is not an appetizing prospect. The problem is that individual
situations vary widely. Some people have primarily intellectual occupations, and they
may wish to remain on the job until they are seventy (and it is possible that the
number of such people as a share of total employment will increase over time). There
are many others, however, who began work early and whose work is arduous or not very
rewarding and who legitimately aspire to retire relatively early (especially since
their life expectancy is often lower than that of more highly qualified workers).
Unfortunately, recent reforms in many developed countries fail to distinguish adequately
between these different types of individual, and in some cases more is demanded of
the latter than of the former, which is why these reforms sometimes provoke strong
opposition.

One of the main difficulties of pension reform is that the systems one is trying to
reform are extremely complex, with different rules for civil servants, private sector
workers, and nonworkers. For a person who has worked in different types of jobs over
the course of a lifetime, which is increasingly common in the younger generations,
it is sometimes difficult to know which rules apply. That such complexity exists is
not surprising: today’s pension systems were in many cases built in stages, as existing
schemes were extended to new social groups and occupations from the nineteenth century
on. But this makes it difficult to obtain everyone’s cooperation on reform efforts,
because many people feel that they are being treated worse than others. The hodgepodge
of existing rules and schemes frequently confuses the issue, and people underestimate
the magnitude of the resources already devoted to public pensions and fail to realize
that these amounts cannot be increased indefinitely. For example, the French system
is so complex that many younger workers do not have a clear understanding of what
they are entitled to. Some even think that they will get nothing even though they
are paying a substantial amount into the system (something like 25 percent of gross
pay). One of the most important reforms the twenty-first-century social state needs
to make is to establish a unified retirement scheme based on individual accounts with
equal rights for everyone, no matter how complex one’s career path.
⁴⁶
Such a system would allow each person to anticipate exactly what to expect from the
PAYGO public plan, thus allowing for more intelligent decisions about private savings,
which will inevitably play a more important supplementary role in a low-growth environment.
One often hears that “a public pension is the patrimony of those without patrimony.”
This is true, but it does not mean that it would not be wise to encourage people of
more modest means to accumulate nest eggs of their own.
⁴⁷

Does the kind of social state that emerged in the developed countries in the twentieth
century have a universal vocation? Will we see a similar development in the poor and
emerging countries? Nothing could be less certain. To begin with, there are important
differences among the rich countries: the countries of Western Europe seem to have
stabilized government revenues at about 45–50 percent of national income, whereas
the United States and Japan seem to be stuck at around the 30–35 percent level. Clearly,
different choices are possible at equivalent levels of development.

If we look at the poorest countries around the world in 1970–1980, we find that governments
generally took 10–15 percent of national income, both in Sub-Saharan Africa and in
South Asia (especially India). Turning to countries at an intermediate level of development
in Latin America, North Africa, and China, we find governments taking 15–20 percent
of national income, lower than in the rich countries at comparable levels of development.
The most striking fact is that the gap between the rich and the not-so-rich countries
has continued to widen in recent years. Tax levels in the rich countries rose (from
30–35 percent of national income in the 1970s to 35–40 percent in the 1980s) before
stabilizing at today’s levels, whereas tax levels in the poor and intermediate countries
decreased significantly. In Sub-Saharan Africa and South Asia, the average tax bite
was slightly below 15 percent in the 1970s and early 1980s but fell to a little over
10 percent in the 1990s.

This evolution is a concern in that, in all the developed countries in the world today,
building a fiscal and social state has been an essential part of the process of modernization
and economic development. The historical evidence suggests that with only 10–15 percent
of national income in tax receipts, it is impossible for a state to fulfill much more
than its traditional regalian responsibilities: after paying for a proper police force
and judicial system, there is not much left to pay for education and health. Another
possible choice is to pay everyone—police, judges, teachers, and nurses—poorly, in
which case it is unlikely that any of these public services will work well. This can
lead to a vicious circle: poorly functioning public services undermine confidence
in government, which makes it more difficult to raise taxes significantly. The development
of a fiscal and social state is intimately related to the process of state-building
as such. Hence the history of economic development is also a matter of political and
cultural development, and each country must find its own distinctive path and cope
with its own internal divisions.

In the present case, however, it seems that part of the blame lies with the rich countries
and international organizations. The initial situation was not very promising. The
process of decolonization was marked by a number of chaotic episodes in the period
1950–1970: wars of independence with the former colonial powers, somewhat arbitrary
borders, military tensions linked to the Cold War, abortive experiments with socialism,
and sometimes a little of all three. After 1980, moreover, the new ultraliberal wave
emanating from the developed countries forced the poor countries to cut their public
sectors and lower the priority of developing a tax system suitable to fostering economic
development. Recent research has shown that the decline in government receipts in
the poorest countries in 1980–1990 was due to a large extent to a decrease in customs
duties, which had brought in revenues equivalent to about 5 percent of national income
in the 1970s. Trade liberalization is not necessarily a bad thing, but only if it
is not peremptorily imposed from without and only if the lost revenue can gradually
be replaced by a strong tax authority capable of collecting new taxes and other substitute
sources of revenue. Today’s developed countries reduced their tariffs over the course
of the nineteenth and twentieth centuries at a pace they judged to be reasonable and
with clear alternatives in mind. They were fortunate enough not to have anyone tell
them what they ought to be doing instead.
⁴⁸
This illustrates a more general phenomenon: the tendency of the rich countries to
use the less developed world as a field of experimentation, without really seeking
to capitalize on the lessons of their own historical experience.
⁴⁹
What we see in the poor and emerging countries today is a wide range of different
tendencies. Some countries, like China, are fairly advanced in the modernization of
their tax system: for instance, China has an income tax that is applicable to a large
portion of the population and brings in substantial revenues. It is possibly in the
process of developing a social state similar to those found in the developed countries
of Europe, America, and Asia (albeit with specific Chinese features and of course
great uncertainty as to its political and democratic underpinnings). Other countries,
such as India, have had greater difficulty moving beyond an equilibrium based on a
low level of taxation.
⁵⁰
In any case, the question of what kind of fiscal and social state will emerge in
the developing world is of the utmost importance for the future of the planet.

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Rethinking the Progressive Income Tax

In the previous chapter I examined the constitution and evolution of the social state,
focusing on the nature of social needs and related social spending (education, health,
retirement, etc.). I treated the overall level of taxes as a given and described its
evolution. In this chapter and the next, I will examine more closely the structure
of taxes and other government revenues, without which the social state could never
have emerged, and attempt to draw lessons for the future. The major twentieth-century
innovation in taxation was the creation and development of the progressive income
tax. This institution, which played a key role in the reduction of inequality in the
last century, is today seriously threatened by international tax competition. It may
also be in jeopardy because its foundations were never clearly thought through, owing
to the fact that it was instituted in an emergency that left little time for reflection.
The same is true of the progressive tax on inheritances, which was the second major
fiscal innovation of the twentieth century and has also been challenged in recent
decades. Before I examine these two taxes more closely, however, I must first situate
them in the context of progressive taxation in general and its role in modern redistribution.

Taxation is not a technical matter. It is preeminently a political and philosophical
issue, perhaps the most important of all political issues. Without taxes, society
has no common destiny, and collective action is impossible. This has always been true.
At the heart of every major political upheaval lies a fiscal revolution. The Ancien
Régime was swept away when the revolutionary assemblies voted to abolish the fiscal
privileges of the nobility and clergy and establish a modern system of universal taxation.
The American Revolution was born when subjects of the British colonies decided to
take their destiny in hand and set their own taxes. (“No taxation without representation”).
Two centuries later the context is different, but the heart of the issue remains the
same. How can sovereign citizens democratically decide how much of their resources
they wish to devote to common goals such as education, health, retirement, inequality
reduction, employment, sustainable development, and so on? Precisely what concrete
form taxes take is therefore the crux of political conflict in any society. The goal
is to reach agreement on who must pay what in the name of what principles—no mean
feat, since people differ in many ways. In particular, they earn different incomes
and own different amounts of capital. In every society there are some individuals
who earn a lot from work but inherited little, and vice versa. Fortunately, the two
sources of wealth are never perfectly correlated. Views about the ideal tax system
are equally varied.