The Great Leveler, page 20
World War II
1938–1948
0.362
3
Postwar
1948–1989
0.121
These data reveal a uniform pattern. The annual rate of decline of the top income shares in wartime was invariably several times, and indeed often a great many times, higher than in the postwar period, regardless of how the postwar rates are calculated. For many of the main belligerents, the difference in scale is huge. In France, the top income share declined sixty-eight times as quickly during the war as it did during the following thirty-eight years: 92 percent of the country’s total reduction in the top income share since 1938 had occurred by 1945. This proportion is almost as high in Canada, where 77 percent of the overall compression since 1938 took place during the war. Japan leads the pack: wartime leveling was so severe that 1945 was the year with the smallest top income share on record, a record low that has never since been reattained. In the United Kingdom, almost half of the total fall in the top 0.1 percent’s income share between before the Great War and the late 1970s happened during the two world wars proper. In the United States, the annual rate of decline was an order of magnitude higher in both world wars than in the postwar period, and the same is true of Finland in World War II. It is telling that in countries that were less severely affected by the war, such as Denmark, Norway, Australia, and India, the average wartime compression rates were merely three to five times as high as afterward. (Although the British rate of decline during World War II was also relatively modest, much compression had already occurred in World War I.)
Only the German evidence is more complicated. If we take into account deferred leveling by measuring the World War I rate up to 1925, the first year after 1919 for which there is tangible information, then Germany’s “wartime” compression rate was an order of magnitude higher than in the post–World War II period. Another problem arises from the lack of data between 1938 and 1950, which makes it impossible to tell how much of the overall drop in this interval occurred between 1938 and 1945. Especially among industrialized nations, World War II generated a very powerful leveling effect that greatly exceeded anything that has happened since. There is no better way to highlight the fundamental discontinuity in the evolution of income inequality in war and peace. The information for World War I, by contrast, is not only less rich but also more challenging to interpret. I consider the reasons for the observed differences in the timing of war-related leveling hereafter in my survey by country.
Less widely available than information on top income shares, Gini coefficients of national income distributions likewise point to sharp discontinuities in wartime. Thus the entire net decline in market income inequality in the United States that occurred during the twentieth century took place during the 1930s and 1940s: on one measure, after gently declining by about 3 points between 1931 and 1939, the Gini coefficient plunged fully 10 points during the following six years and then stabilized within a very narrow range that lasted until 1980; on another, it fell about 5 points between 1929 and 1941 and another 7 points during the war itself. British after-tax income inequality declined by 7 points between 1938 and 1949—and perhaps by up to twice as much between 1913 and 1949—and subsequently remained flat into the 1970s. The Japanese evidence is poor but indicates an even steeper drop, by at least 15 points, between the late 1930s and the mid-1950s, followed by stability up to around 1980 or beyond.4
Changes in the concentration of wealth further underline the critical importance of the world wars. In eight out of ten countries for which relevant evidence is available, the highest recorded degree of wealth concentration occurred right before the outbreak of World War I. The period between 1914 and 1945 witnessed a severe contraction of top wealth shares (Fig. 5.3).5
In seven countries with usable data that were involved in one or both of the two world wars, the top 1 percent wealth shares fell by an average of 17.1 percentage points (equivalent to a sixth of total recorded private national wealth), a drop of about a third from the mean pre–World War I peak of 48.5 percent. By comparison, the average difference between the earliest reported postwar value and the lowest recorded value overall (dating variously from the 1960s to the 2000s) is 13.5 percentage points. While this may make the postwar compression seem comparable in scale to that of the war period, we must bear in mind that the latter includes the interwar years and often several years after 1945 as well, which impedes meaningful year-on-year comparison. Moreover, considering that wealth deconcentration was sustained by progressive inheritance taxes that were in place for a long time after the wars themselves had ended, it is not surprising that this process should have been more drawn out. What matters here is that this form of taxation was itself a direct outcome of the war effort, as I show hereafter. Moreover, in five of these countries, the drop in the war and interwar years accounts for between 61 percent and 70 percent of the total decline in top wealth shares. In a sixth case, the United Kingdom, the decline in this period was in fact very large (representing more than a fifth of private national wealth). Considering that the country’s pre-1914 degree of wealth concentration had been so extreme, the postwar decline had to be even stronger simply to bring top wealth shares into convergence with the new common standard of around 20 percent.
Figure 5.3Top 1 percent wealth shares in ten countries, 1740–2011 (in percent)
It is worth noting that wealth compression at the very top could be much more pronounced than among the richest “1 percent” overall. To pick a particularly striking example, the value of the largest 0.01 percent of estates in France fell by more than three-quarters between the beginning of World War I and the mid-1920s and by another two-thirds during World War II. This represents an overall drop of close to 90 percent during the war period, whereas the wealth share of the top percentile declined by less than half of its prewar high. The key point in all of this is of course the timing of the inflection point right at the beginning of the period of the world wars, when a widespread earlier trend toward ever greater wealth inequality was arrested and forcefully reversed. We must also bear in mind that short of radical expropriation and redistribution, there is no mechanism that could have reconfigured wealth shares anywhere near as rapidly as income shares.6
Figure 5.4Ratios of private wealth to national income in France, Germany, the United Kingdom, and the world, 1870–2010
That much elite wealth was not merely redistributed but effectively wiped out in the war period becomes clear from changes in the ratio of private wealth to national income in three major belligerent countries (Fig. 5.4). The strongest decline took place in World War I, followed by another compression during and around World War II. Mirroring these changes, the share of capital incomes in the earnings of the highest-earning households plummeted (Fig. 5.5). These observations underscore the fact that elite losses were in the first instance a phenomenon of capital and capital income. Why were these wars so detrimental to owners of capital?7
Figure 5.5Capital income share in total gross income for top 1 percent of incomes in France, Sweden, and the United States, 1920–2010 (in percent)
The world wars were unlike any other conflicts the world had ever seen. The mobilization of manpower and industrial production soared to previously unimaginable heights. Almost 70 million soldiers were mobilized in World War I, a figure unprecedented in the annals of warfare. Around 9 million or 10 million of them were killed, alongside some 7 million civilian casualties from war or war-related miseries. France and Germany mobilized about 40 percent of their entire male population, the Austro-Hungarian and Ottoman empires 30 percent, the United Kingdom 25 percent, Russia 15 percent, and the United States 10 percent. Enormous financial resources were required to fund operations. Among the principal belligerents for which we have information, the share of GDP commandeered by the state increased anywhere from four to eight times (Fig. 5.6).8
Figure 5.6The share of government spending in national income in seven countries, 1913–1918 (in percent of GDP)
France and Germany both lost about 55 percent of their national wealth and the United Kingdom 15 percent. And World War II was even worse. Well more than 100 million soldiers were mobilized, and more than 20 million of them died, as did 50 million or more civilians. The main belligerents manufactured 286,000 tanks, 557,000 combat aircraft, 11,000 major naval vessels, and more than 40 million rifles, among many other armaments. Total war costs and losses (including loss of life) have been estimated at $4 trillion in 1938 prices, an order of magnitude greater than annual global GDP at the outbreak of the war. Conquest pushed state shares to astounding levels. In 1943 Germany secured the equivalent of 73 percent of GNP for the state, almost all of it for war and some of it squeezed out of subjugated populations. The following year, by one account, the Japanese state is thought to have spent as much as 87 percent of GDP, likewise drawing on the resources of its doomed empire.9
These gargantuan struggles were for the most part funded by borrowing, printing money, and collecting taxes. Borrowing variously translated to future taxation to service public debt, inflation to erode it, or default. Only the leading Western powers successfully managed inflation. In the United States and United Kingdom, prices rose only threefold between 1913 and 1950. Other belligerents were not as lucky: prices rose 100 times in France and 300 times in Germany during the same period and increased 200 times in Japan between 1929 and 1950 alone. Bondholders and rentiers fell by the wayside.10
Up to 1914, marginal tax rates on income even in the most developed countries were very low, if income taxes existed at all. High taxes and steep progressivity were born of the war effort. Top rates surged in World War I and its immediate aftermath before falling back later in the 1920s, although never all the way down to prewar levels. They were raised again in the 1930s, often to cope with the fallout of the Great Depression, and reached new heights in World War II, from which they have been very gradually sliding down more or less ever since (Fig. 5.7).11
Averaging these developments across different countries clarifies the underlying trend and highlights how the two world wars were the critical junctures of fiscal evolution (Fig. 5.8).12
Fig. 5.8 neatly illustrates the critical importance of war. We can see that Japan, uniquely among all these nations, introduced a higher top income tax rate in response to the demands of the Russo–Japanese War of 1904 to 1905, which was in some ways a dress rehearsal for World War I. Sweden, a nonbelligerent, largely missed out on the World War I surge in top taxation and continued to lag behind until the next war. Most strikingly, Argentina, which remained shielded from both world wars, shows a completely different pattern. Kenneth Scheve and David Stasavage find a strong fiscal war effect among belligerents and a much weaker response among other countries in their sample (Fig. 5.9).13
Figure 5.7Top marginal tax rates in nine countries, 1900–2006 (in percent)
Military mass mobilization, progressive graduation of tax rates, and the targeting of elite wealth on top of income constituted the three main ingredients of fiscal leveling. Scheve and Stasavage argue that mass mobilization wars are different in terms of taxation strategies not simply because they are very expensive but also, more specifically, because they increase the need for societal consensus that translates to political pressure for disproportionately heavy extraction of resources from the rich. Mass conscription was not by itself an equalizing force, considering that wealth elites were less likely to serve due to age or privilege and stood to profit from commercial involvement in the war industry. Fairness concerns required military conscription, as a tax in kind, to be accompanied by what the British Labour Party Manifesto of 1918 called the “conscription of wealth.” Particular emphasis was placed on the taxing of war profits: in World War I top rates of tax on what were deemed “excess” profits reached 63 percent in the United Kingdom and 80 percent in France, Canada, and the United States. In 1940, President Roosevelt called for similar measures “so that a few do not gain from the sacrifices of the many.” Wartime preoccupation with fairness also justified heavier burdens on unearned incomes: although progressive income taxes were a potent means of compressing inequality, it was estate taxes that had a disproportionately strong effect on the rich.14
Figure 5.8Average top rates of income and inheritance taxation in twenty countries, 1800–2013 (in percent)
Figure 5.9World War I and average top rates of income taxation in seventeen countries (in percent)
The leveling effects of fairness concerns were significantly mediated by regime type. In World War I, the democracies of the United Kingdom, the United States, and Canada were prepared to “soak the rich,” whereas more autocratic systems such as Germany, Austria-Hungary, and Russia preferred to borrow or print money to sustain their war effort. The latter, however, later paid a high price through hyperinflation and revolution, shocks that likewise compressed inequality. Especially during World War I, before a common template for funding mass mobilization warfare had been established, the mechanisms of leveling therefore varied considerably between countries.15
France was among the countries hardest hit by both world wars, having endured fighting on its soil throughout World War I, as well as two invasions and occupation during World War II. During the first war and in its immediate aftermath, a third of the French capital stock was destroyed, the share of capital income in national household income fell by a third, and GDP contracted by the same proportion. Taxation was slow to take off: at the beginning of the conflict, the top inheritance tax rate stood at a paltry 5 percent, and although an income tax was first introduced in 1915, effective top rates remained low for the remainder of the war and rose significantly only in 1919. A war profit tax created in 1916 likewise began to yield large revenue only once the war was over, as did increased estate taxes. This lag effect, together with rampant postwar inflation, accounts for the fact the compression of top income shares was primarily a phenomenon of the 1920s instead of the actual war years, whereas war profits briefly had the opposite effect. By the middle of that decade, the average value of the largest 0.01 percent of estates had dropped by more than three-quarters compared to the prewar level.16
The destruction of elite wealth continued in World War II as France suffered four years of predatory German occupation and major damage from allied bombing and liberation. This time, two-thirds of the capital stock was wiped out, twice the rate of attrition of the first war. Foreign assets, which had accounted for a quarter of the largest French fortunes, evaporated. Top income shares fell precipitously in this period, and postwar inflation subsequently eroded the value of bonds and war debt within just a few years. As Piketty has argued, the entire reduction of the top 1 percent income share between 1914 and 1945 was due to losses in nonwage income, as capital was buffeted by combat, bankruptcies, rent control, nationalization, and inflation. Cumulative leveling across the two wars was massive: 10,000 percent inflation expropriated bondholders, real rents fell by 90 percent between 1913 and 1950, and a nationalization program in 1945 and a one-off tax on capital holdings of up to 20 percent for large fortunes and of 100 percent for those that had grown much during the war helped reset capital accumulation to close to zero. The value of the top 0.01 percent estates consequently declined by well more than 90 percent between 1914 and 1945.17
In the United Kingdom, top income tax rates rose from 6 percent to 30 percent during World War I, and a new war profits tax levied on companies—raised to 80 percent by 1917—became the single most important tax in terms of revenue. On this occasion, the country lost 14.9 percent of its national wealth, and it lost another 18.6 percent in World War II. The threshold for the top 0.1 percent of incomes fell from forty to thirty times mean income in World War I and from thirty to twenty times in World War II. The drop in after-tax top income shares (reported only from 1937) was even more pronounced—almost half for the top 1 percent and two-thirds for the top 0.1 percent between 1937 and 1949. The share of the largest 1 percent of fortunes in all private wealth contracted from 70 percent to 50 percent—less dramatic than the concurrent collapse from 60 percent to 30 percent in France, but nonetheless significant.18
Across the Atlantic, the experience of the United States demonstrates that considerable war-induced leveling could occur in the absence of physical destruction and serious inflation. The country’s top 1 percent income share fell on three separate occasions, by almost a quarter during World War I, by the same proportion during the Great Depression, and by about 30 percent of what remained during World War II. Overall, this top bracket lost some 40 percent of its share in total income between 1916 and 1945. As in other countries, this trend was more extreme in the uppermost tiers: thus the share of the top 0.01 percent of incomes declined by 80 percent during the same period. Decomposition of income shares shows that much of this attrition was driven by a dwindling of gains from capital. Top wealth shares suffered more during the Great Depression than in World War II but cumulatively fell by a third from their pre-Depression peak. In the United States, the Great Depression played a greater role in equalizing income and wealth disparities relative to the wars themselves than among the other main belligerents: I return to this in chapter 12.19
Even so, wartime leveling was considerable, and steeply progressive taxation to fund the war effort was instrumental in this process. The War Revenue Act of 1917 raised surtax top rates from 13 percent to 50 percent and taxed profits above 9 percent of invested capital at 20 percent to 60 percent. As war expenses continued to rise, the Revenue Act of 1918, passed only after the end of the war, imposed even higher rates on the largest incomes and on excess profits. Effective tax rates went from 1.5 percent in 1913 and 1915 to 22 percent in 1918 for incomes of $50,000 and rose from 2.5 percent to 35 percent for those of $100,000. The top rate for the estate tax, newly created in 1916, rose from 10 percent to 25 percent in the following year. War was the sole cause of these aggressive interventions: “the highly contingent politics of mobilizing for World War I drove the creation of a democratic-statist tax regime.” Although the Revenue Acts of 1921 and 1924 repealed the excess profits tax and greatly lowered surtax rates, remaining top rates were still far above the prewar level, and, most important, the estate tax remained in place. We thus observe both a degree of postwar fiscal relaxation, which coincided with a renewed surge in top incomes, and a ratchet effect in terms of the share of income and wealth claimed by the government, even as growing loopholes were hollowing out the progressive tax regime.20
