Ad hoc Commentary – a critique of Piketty’s global capital tax

Anyone concerned about the future of the world economy should be reading chapter 15 (A Global Tax on Capital) of Piketty’s book entitled ‘Capital in the 21st Century’. In Piketty’s own words:

“The primary purpose of the [global progressive] capital tax is not to finance the social state but to regulate capitalism. The goal is:
1. to stop the indefinite increase of inequality of wealth, and
2. to impose effective regulation on the financial and banking system in order to avoid crises.”

The first goal is in line with the WBG (World Bank Group) goal of shared prosperity; while the second goal is in line with the IMF (International Monetary Fund) role as the regulator of the global monetary system.

According to Piketty, the most important prerequisite is financial transparency. Financial transparency is required because to administer a meaningful wealth tax, tax authorities need a complete picture of individual’s wealth across the globe. Most of us are familiar with U.S. FATCA (Foreign Account Tax Compliance Act). For the average U.S. person, it is an anti-banking-secrecy act that somehow made Americans pseudo-second-class-citizens in international banking.

The financial transparency that is required by Piketty’s global capital tax will have significant consequences for both tax havens and financial centers of the world. If anything, yours truly expect countries like Singapore to take heed so that they can navigate better in the turbulent financial landscape ahead:

“Very likely the only way to obtain tangible results is to impose automatic sanctions not only on the banks but also on countries that refuse to require their financial institutions to provide the required information [to allow national tax authorities to calculate the net worth of every citizen]. One might contemplate, for example, a tariff of 30% or more on the exports of offending states.”

“Countries that have thrived on financial opacity may find it difficult to accept reform [on banking secrecy], especially since a legitimate financial services industry often develops alongside illicit (or questionable) banking services.”

“The tax havens will undoubtedly suffer significant losses if financial transparency becomes the norm.”

In yours truly humble opinion, it is inevitable that the walls of banking secrecy will be torn down in the coming years. Those who resist will likely be victims of financial sanctions not unlike the one that Vatican City suffered in early 2013: http://www.economist.com/blogs/schumpeter/2013/01/banking-and-vatican

There is really no point resisting. Despite denials that the objective of the new capital tax is not for state financing, the temptation is definitely for fiscally constrained sovereigns to supplement their tax base with a new capital tax. Since the powerful nations are the ones fiscally constrained, Piketty’s capital tax is almost a certainty in yours truly mind.

The best that we can do is to engage into a lively debate on the best type of capital tax. We get inspiration from Adam Smith’s invisible hand:
“By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it.”
Adam Smith, Wealth of Nations

Piketty noted two distinct justification of a capital tax:
1. Contributive – ‘tax the rich’
2. Incentive – ‘tax the lazy’

Contributive justification justifies the tax by virtue of the individuals’ capacity to get taxed. Those who believe in Adam Smith’s invisible hand understands that placing a higher tax burden on the rich simply because they can afford it will likely lead to a leveling down of society where everyone is equally poor.

The wealth of nations is built from he bottom up by each and every individual’s hard work in pursuing one’s own selfish dreams. If we believe that our prosperity is not a given but depends on private initiative of individuals too numerous to count, then the Incentive justification is a much better justification for the global capital tax:
“[according to the Incentive justification,] The purpose of the tax on capital is thus to force people who use their wealth inefficiently [lazy hoarders in government bonds] to sell assets [or forfeit their interest] in order to pay their taxes thus ensuring that those assets wind up in the hands of more dynamic investors [innovative and hardworking entrepreneurs]”

From the Incentive justification perspective of taxing the lazy, it is easy to see that the tax rate should be a flat rate pegged to the average return on the average hoarder – e.g. sovereign debt yields weighted by IMF COFER. We would likely see a leveling up of society in this case because the motivation is to beat the tax hurdle. This is only possible if one does not hoard the means of subsistence initially meant for all, but employ one’s abilities to outperform the baseline return-on-capital. Indirectly, the invisible hand would ensure that these selfish interest would collectively increase the wealth of nations. The lazy would deservingly see his/her fortune redistributed to those who are willing to toil.

In the final calculation, what we need is a good debate on what is the best way forward for a global capital tax. We will almost certainly get a more equal world with such a capital tax. Will we get a leveling up, or a leveling down of society? The answer to that question depends on the policy debates of today. Yours truly prefer to live in a world where everyone is equally rich, and yours truly hope that is the way you prefer it too. Piketty had started the debate and he is getting the attention of world leaders just as Keynesian did in the past – c’mon who does not like a new tax to supplement the old books? It is up to us to direct the debate in the right direction.

Good luck in the markets.