Capital in the Twenty-First Century (97 page)

This episode is interesting because it illustrates the limits of the central banks
and financial authorities. Their strength is that they can act quickly; their weakness
is their limited capacity to correctly target the redistributions they cause to occur.
The conclusion is that a progressive tax on capital is not only useful as a permanent
tax but can also function well as an exceptional levy (with potentially high rates)
in the resolution of major banking crises. In the Cypriot case, it is not necessarily
shocking that savers were asked to help resolve the crisis, since the country as a
whole bears responsibility for the development strategy chosen by its government.
What is deeply shocking, on the other hand, is that the authorities did not even seek
to equip themselves with the tools needed to apportion the burden of adjustment in
a just, transparent, and progressive manner. The good news is that this episode may
lead international authorities to recognize the limits of the tools currently at their
disposal. If one asks the officials involved why the tax proposed for Cyprus had such
little progressivity built into it and was imposed on such a limited base, their immediate
response is that the banking data needed to apply a more steeply progressive schedule
were not available.
²⁴
The bad news is that the authorities seem in no great hurry to resolve the problem,
even though the technical solution is within reach. It may be that a progressive tax
on capital faces purely ideological obstacles that will take some time to overcome.

The various crises that have afflicted southern European banks since 2009 raise a
more general question, which has to do with the overall architecture of the European
Union. How did Europe come to create—for the first time in human history on such a
vast scale—a currency without a state? Since Europe’s GDP accounted for nearly one-quarter
of global GDP in 2013, the question is of interest not just to inhabitants of the
Eurozone but to the entire world.

The usual answer to this question is that the creation of the euro—agreed on in the
1992 Maastricht Treaty in the wake of the fall of the Berlin Wall and the reunification
of Germany and made a reality on January 1, 2002, when automatic teller machines across
the Eurozone first began to dispense euro notes—is but one step in a lengthy process.
Monetary union is supposed to lead naturally to political, fiscal, and budgetary union,
to ever closer cooperation among the member states. Patience is essential, and union
must proceed step by step. No doubt this is true to some extent. In my view, however,
the unwillingness to lay out a precise path to the desired end—the repeated postponement
of any discussion of the itinerary to be followed, the stages along the way, or the
ultimate endpoint—may well derail the entire process. If Europe created a stateless
currency in 1992, it did so for reasons that were not simply pragmatic. It settled
on this institutional arrangement in the late 1980s and early 1990s, at a time when
many people believed that the only function of central banking was to control inflation.
The “stagflation” of the 1970s had convinced governments and people that central banks
ought to be independent of political control and target low inflation as their only
objective. That is why Europe created a currency without a state and a central bank
without a government. The crisis of 2008 shattered this static vision of central banking,
as it became apparent that in a serious economic crisis central banks have a crucial
role to play and that the existing European institutions were wholly unsuited to the
task at hand.

Make no mistake. Given the power of central banks to create money in unlimited amounts,
it is perfectly legitimate to subject them to rigid constraints and clear restrictions.
No one wants to empower a head of state to replace university presidents and professors
at will, much less to define the content of their teaching. By the same token, there
is nothing shocking about imposing tight restrictions on the relations between governments
and monetary authorities. But the limits of central bank independence should also
be precise. In the current crisis, no one, to my knowledge, has proposed that central
banks be returned to the private status they enjoyed in many countries prior to World
War I (and in some places as recently as 1945).
²⁵
Concretely, the fact that central banks are public institutions means that their
leaders are appointed by governments (and in some cases by parliaments). In many cases
these leaders cannot be removed for the length of their mandate (usually five or six
years) but can be replaced at the end of that term if their policies are deemed inadequate,
which provides a measure of political control. In practice, the leaders of the Federal
Reserve, the Bank of Japan, and the Bank of England are expected to work hand in hand
with the legitimate, democratically elected governments of their countries. In each
of these countries, the central bank has in the past played an important role in stabilizing
interest rates and public debt at low and predictable levels.

The ECB faces a unique set of problems. First, the ECB’s statutes are more restrictive
than those of other central banks: the objective of keeping inflation low has absolute
priority over the objectives of maintaining growth and full employment. This reflects
the ideological context in which the ECB was conceived. Furthermore, the ECB is not
allowed to purchase newly issued government debt: it must first allow private banks
to lend to the member states of the Eurozone (possibly at a higher rate of interest
than that which the ECB charges the private banks) and then purchase the bonds on
the secondary market, as it did ultimately, after much hesitation, for the sovereign
debt of governments in southern Europe.
²⁶
More generally, it is obvious that the ECB’s main difficulty is that it must deal
with seventeen separate national debts and seventeen separate national governments.
It is not easy for the bank to play its stabilizing role in such a context. If the
Federal Reserve had to choose every morning whether to concentrate on the debt of
Wyoming, California, or New York and set its rates and quantities in view of its judgment
of the tensions in each particular market and under pressure from each region of the
country, it would have a very hard time maintaining a consistent monetary policy.

From the introduction of the euro in 2002 to the onset of the crisis in 2007–2008,
interest rates were more or less identical across Europe. No one anticipated the possibility
of an exit from the euro, so everything seemed to work well. When the global financial
crisis began, however, interest rates began to diverge rapidly. The impact on government
budgets was severe. When a government runs a debt close to one year of GDP, a difference
of a few points of interest can have considerable consequences. In the face of such
uncertainty, it is almost impossible to have a calm democratic debate about the burdens
of adjustment or the indispensable reforms of the social state. For the countries
of southern Europe, the options were truly impossible. Before joining the euro, they
could have devalued their currency, which would at least have restored competitiveness
and spurred economic activity. Speculation on national interest rates was in some
ways more destabilizing than the previous speculation on exchange rates among European
currencies, particularly since crossborder bank lending had meanwhile grown to such
proportions that panic on the part of a handful of market actors was enough to trigger
capital flows large enough to seriously affect countries such as Greece, Portugal,
and Ireland, and even larger countries such as Spain and Italy. Logically, such a
loss of monetary sovereignty should have been compensated by guaranteeing that countries
could borrow if need be at low and predictable rates.

The only way to overcome these contradictions is for the countries of the Eurozone
(or at any rate those who are willing) to pool their public debts. The German proposal
to create a “redemption fund,” which I touched on earlier, is a good starting point,
but it lacks a political component.
²⁷
Concretely, it is impossible to decide twenty years in advance what the exact pace
of “redemption” will be—that is, how quickly the stock of pooled debt will be reduced
to the target level. Many parameters will affect the outcome, starting with the state
of the economy. To decide how quickly to pay down the pooled debt, or, in other words,
to decide how much public debt the Eurozone should carry, one would need to empower
a European “budgetary parliament” to decide on a European budget. The best way to
do this would be to draw the members of this parliament from the ranks of the national
parliaments, so that European parliamentary sovereignty would rest on the legitimacy
of democratically elected national assemblies.
²⁸
Like any other parliament, this body would decide issues by majority vote after open
public debate. Coalitions would form, based partly on political affiliation and partly
on national affiliation. The decisions of such a body will never be ideal, but at
least we would know what had been decided and why, which is important. It is preferable,
I think, to create such a new body rather than rely on the current European Parliament,
which is composed of members from twenty-seven states (many of which do not belong
to the Eurozone and do not wish to pursue further European integration at this time).
To rely on the existing European Parliament would also conflict too overtly with the
sovereignty of national parliaments, which would be problematic in regard to decisions
affecting national budget deficits. That is probably the reason why transfers of power
to the European Parliament have always been quite limited in the past and will likely
remain so for quite some time. It is time to accept this fact and to create a new
parliamentary body to reflect the desire for unification that exists within the Eurozone
countries (as indicated most clearly by their agreement to relinquish monetary sovereignty
with due regard for the consequences).

Several institutional arrangements are possible. In the spring of 2013, the new Italian
government pledged to support a proposal made a few years earlier by German authorities
concerning the election by universal suffrage of a president of the European Union—a
proposal that logically ought to be accompanied by a broadening of the president’s
powers. If a budgetary parliament decides what the Eurozone’s debt ought to be, then
there clearly needs to be a European finance minister responsible to that body and
charged with proposing a Eurozone budget and annual deficit. What is certain is that
the Eurozone cannot do without a genuine parliamentary chamber in which to set its
budgetary strategy in a public, democratic, and sovereign manner, and more generally
to discuss ways to overcome the financial and banking crisis in which Europe currently
finds itself mired. The existing European councils of heads of state and finance ministers
cannot do the work of this budgetary body. They meet in secret, do not engage in open
public debate, and regularly end their meetings with triumphal midnight communiqués
announcing that Europe has been saved, even though the participants themselves do
not always seem to be sure about what they have decided. The decision on the Cypriot
tax is typical in this regard: although it was approved unanimously, no one wanted
to accept responsibility in public.
²⁹
This type of proceeding is worthy of the Congress of Vienna (1815) but has no place
in the Europe of the twenty-first century. The German and Italian proposals alluded
to above show that progress is possible. It is nevertheless striking to note that
France has been mostly absent from this debate through two presidencies,
³⁰
even though the country is prompt to lecture others about European solidarity and
the need for debt mutualization (at least at the rhetorical level).
³¹

Unless things change in the direction I have indicated, it is very difficult to imagine
a lasting solution to the crisis of the Eurozone. In addition to pooling debts and
deficits, there are of course other fiscal and budgetary tools that no country can
use on its own, so that it would make sense to think about using them jointly. The
first example that comes to mind is of course the progressive tax on capital.

An even more obvious example is a tax on corporate profits. Tax competition among
European states has been fierce in this respect since the early 1990s. In particular,
several small countries, with Ireland leading the way, followed by several Eastern
European countries, made low corporate taxes a key element of their economic development
strategies. In an ideal tax system, based on shared and reliable bank data, the corporate
tax would play a limited role. It would simply be a form of withholding on the income
tax (or capital tax) due from individual shareholders and bondholders.
³²
In practice, the problem is that this “withholding” tax is often the only tax paid,
since much of what corporations declare as profit does not figure in the taxable income
of individual shareholders, which is why it is important to collect a significant
amount of tax at the source through the corporate tax.

The right approach would be to require corporations to make a single declaration of
their profits at the European level and then tax that profit in a way that is less
subject to manipulation than is the current system of taxing the profits of each subsidiary
individually. The problem with the current system is that multinational corporations
often end up paying ridiculously small amounts because they can assign all their profits
artificially to a subsidiary located in a place where taxes are very low; such a practice
is not illegal, and in the minds of many corporate managers it is not even unethical.
³³
It makes more sense to give up the idea that profits can be pinned down to a particular
state or territory; instead, one can apportion the revenues of the corporate tax on
the basis of sales or wages paid within each country.