Politics & Policy

French Lessons for the Dems

Tax the vital few, lose the vital few.

While campaigning for president last spring, France’s Nicolas Sarkozy took his message to England. He did so because with over 300,000 French ex-pats working in London, the English city in effect constitutes one of France’s largest cities. As Bloomberg’s Celestine Bohlen recently noted, a tax-cutting Sarkozy is now “rolling out the welcome mat for thousands of rich French people who fled one of Europe’s most onerous tax regimes.” 

The French president today stands in stark contrast to the top-tier Democratic candidates for president in the U.S., politicians who make plain that they will seek to reverse the 2003 Bush tax cuts if elected. Instead of lifting taxes in the knee-jerk liberal tradition, Sarkozy is seeking to reverse the outflow of high-earning Frenchmen with promises of lower rates of taxation on wealth.

In addition to a top income-tax rate of 48.1 percent (one of the highest in Europe), France, since 1995, has had a “fortune” tax of 0.5 percent for assets greater than 760,000 euros, a levy that rises to 1.5 percent on assets greater than 15.8 million euros. As logic suggests, the tax has been very unsuccessful when it comes to raising revenues. Though President Chirac “toughened” the wealth tax in 1995, at 3.7 billion euros in 2006 the tax only accounted for 1.3 percent of total French revenues.

Wealth regularly disappears when it is penalized, as do a nation’s most productive earners. While 370 French households escaped the wealth tax in 1997, 649 did so in 2005. Importantly, the average age of French emigrants who escaped the tax is 53, while the average age of those willing to be exposed to it is 66. According to French senator Phillipe Marini, the outflow of the country’s more youthful and well-to-do citizens foretells “a loss of economic dynamism” for France as a whole.

These statistics reveal only the “seen.” The “unseen” is the loss of younger, more entrepreneurial French citizens who, while not yet rich, know the French government will be waiting to tax them if their future economic activity proves lucrative. Rather than work towards that eventuality, some of France’s best and brightest have shuttled to London, as well as Switzerland, Belgium, and the United States.

A popular view among politicians is that labor costs are based on supply and demand, and that a lower supply of workers accrues to labor wages. The latter thinking is incorrect. In truth, wages are driven by capital, with capital seeking the most skilled workers irrespective of supply-and-demand constraints. When France’s most economically productive citizens move out, capital frequently follows.

Economist Reuven Brenner attributes this redirection of capital to the concept of the “vital few.”  Simply put, countries are blessed by the activities of a very small number of productive people who start successful, job-creating companies. For instance, if Google’s Larry Page and Sergey Brin were to pick up and leave the U.S. tomorrow, the capital funding their innovations would not very likely stay. Instead, it would follow them in a way that would harm U.S. workers, who would suddenly find themselves in a job market that would be less capitalized (resulting in lower wages).

All workers are decidedly unequal when it comes to innovation and wealth creation, so when tax policies either drive the successful out of a country or cause them to quit working altogether, we all lose. Workers, in the end, are capital, and when tax policies penalize the vital few, the result is lower productivity among the very people whose economic activities contribute the most to growth and innovation for all.

It is said that French tax policy is somewhat cultural in terms of the long-held view among the citizenry that the successful in France should be viewed with suspicion. Similarly, the desire of the Democratic presidential candidates in the U.S. to return taxation to last decade’s levels suggests a deep-seated suspicion of wealth creation. But the French experience provides clear evidence of what can happen when the rich are penalized. Very simply, they take their talents elsewhere, pulling capital from our markets. As a result, those who have not yet become financially successful bear the brunt of higher taxes in a less-capitalized market.

If future tax changes cause a number of the vital few in the U.S. to disappear, the supposed “working poor” will suffer the most.

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