Capital Punishment
Why
a Global Tax on Wealth Won't End Inequality
By Tyler Cowen
Foreign Affairs, MAY/JUNE 2014 ISSUE
Capital in the Twenty-first Century.
BY THOMAS
PIKETTY.
TRANSLATED BY ARTHUR GOLDHAMMER.
Belknap Press, 2014, 696 pp. $39.95.
Every now and then, the field of economics
produces an important book; this is one of them. Thomas Piketty’s tome will put
capitalist wealth back at the center of public debate, resurrect interest in
the subject of wealth distribution, and revolutionize how people view the
history of income inequality. On top of that, although the book’s prose
(translated from the original French) might not qualify as scintillating, any
educated person will be able to understand it -- which sets the book apart from
the vast majority of works by high-level economic theorists.
Piketty is best known for his
collaborations during the past decade with his fellow French economist Emmanuel
Saez, in which they used historical census data and archival tax records to
demonstrate that present levels of income inequality in the United States
resemble those of the era before World War II. Their revelations concerning the
wealth concentrated among the richest one percent of Americans -- and, perhaps
even more striking, among the richest 0.1 percent -- have provided statistical
and intellectual ammunition to the left in recent years, especially during the
debates sparked by the 2011 Occupy Wall Street protests and the 2012 U.S.
presidential election.
In this book, Piketty keeps his focus on
inequality but attempts something grander than a mere diagnosis of capitalism’s
ill effects. The book presents a general theory of capitalism intended to
answer a basic but profoundly important question. As Piketty puts it:
"Do the dynamics of private capital
accumulation inevitably lead to the concentration of wealth in ever fewer
hands, as Karl Marx believed in the nineteenth century? Or do the balancing
forces of growth, competition, and technological progress lead in later stages
of development to reduced inequality and greater harmony among the classes, as
Simon Kuznets thought in the twentieth century?"
Although he stops short of embracing
Marx’s baleful vision, Piketty ultimately lands on the pessimistic end of the
spectrum. He believes that in capitalist systems, powerful forces can push at
various times toward either equality or inequality and that, therefore, “one
should be wary of any economic determinism.” But in the end, he concludes that,
contrary to the arguments of Kuznets and other mainstream thinkers, “there is
no natural, spontaneous process to prevent destabilizing, inegalitarian forces
from prevailing permanently.” To forestall such an outcome, Piketty proposes,
among other things, a far-fetched plan for the global taxation of wealth -- a
call to radically redistribute the fruits of capitalism to ensure the system’s
survival. This is an unsatisfying conclusion to a groundbreaking work of
analysis that is frequently brilliant -- but flawed, as well.
THE RICH ARE DIFFERENT
Piketty derives much of his analysis from
a close examination of an important but generally overlooked driver of economic
inequality: in contemporary market economies, the rate of return on investment
frequently outstrips the overall growth rate, an imbalance that Piketty renders
as r > g. Thanks to the effect of compounding, if that discrepancy persists
over time, the wealth held by capitalists increases far more rapidly than other
kinds of earnings, eventually outstripping them by a wide margin. To measure
this effect, Piketty focuses on the annual capital-to-income ratio, which
expresses the size of a country’s total stock of wealth relative to the income
generated by its economy in a single year. Capital wealth is generally much
larger than yearly national income -- in the case of today’s developed
economies, about five to six times as large.
Piketty expertly narrates the story of how
that gap has played a major role in economic history since the dawn of the
modern era. The peace and relative stability enjoyed by western Europe during
the second half of the nineteenth century allowed for enormous capital
accumulation. Unprecedented concentrations of wealth arose, boosting
inequality. But two world wars and the Great Depression destroyed capital and
interrupted that trend. Those cataclysms led to a new, more egalitarian era,
shaped by postwar rebuilding, a strong demand for labor, rapidly growing
populations, and technological innovation. The three decades between 1950 and
1980 were truly unusual; the constellation of economic and demographic
variables that produced prosperity during that period will probably not be
re-created anytime soon.
After 1980, ongoing capital accumulation,
slower technological progress, and rising inequality heralded a regression to
something akin to the conditions of the nineteenth century. But few notice the
resemblance between now and then, especially in one crucial respect: the role
of inherited wealth. So many nineteenth-century novelists were obsessed with
estates and inheritance -- think of Jane Austen, George Eliot, or Charles
Dickens -- precisely because receiving wealth from one’s parents was such a
common way of prospering during that era. In nineteenth-century France, the
flow of inheritances represented about 20–25 percent of national income during
a typical year. According to Piketty’s calculations, the Western world is
headed toward a roughly comparable situation. The relatively thrifty and
wealthy baby boomers will soon begin to die off in greater numbers, and
inheritance as a source of income disproportionately benefits the families of
the very wealthy.
At the core of Piketty’s story are the
tragic consequences of capitalism’s success: peace and a declining population
bring notable gains, but they also create a society dominated by wealth and by
income from capital. In essence, Piketty presents a novel and somewhat
disconcerting way of thinking about how hard it is to avoid growing inequality.
Yet there are flaws in this tale. Although
r > g is an elegant and compelling explanation for the persistence and
growth of inequality, Piketty is not completely clear on what he means by the
rate of return on capital. As Piketty readily admits, there is no single rate
of return that everyone enjoys. Sitting on short-term U.S. Treasury bills does
not yield much: a bit over one percent historically in inflation-adjusted terms
and, at the moment, negative real returns. Equity investments such as stocks,
on the other hand, have a historical rate of return of about seven percent. In
other words, it is risk taking -- a concept mostly missing from this book --
that pays off.
That fact complicates Piketty’s argument.
Piketty estimates that the general annual rate of return on capital has
averaged between four and five percent (pretax) and is unlikely to deviate too
far from this range. But in too many parts of his argument, he seems to assume
that investors can reap such returns automatically, with the mere passage of
time, rather than as the result of strategic risk taking. A more accurate
picture of the rate of return would incorporate risk and take into account the
fact that although the stock of capital typically grows each year, sudden
reversals and retrenchments are inevitable. Piketty repeatedly serves up the
appropriate qualifications and caveats about his model, but his analysis and
policy recommendations nevertheless reflect a notion of capital as a growing,
homogeneous blob which, at least under peaceful conditions, ends up
overshadowing other economic variables.
Furthermore, even if one overlooks
Piketty’s hazy definition of the rate of return, it is difficult to share his
confidence that the rate, however one defines it, is likely to be higher than
the growth rate of the economy. Normally, economists think of the rate of
return on capital as diminishing as investors accumulate more capital, since
the most profitable investment opportunities are taken first. But in Piketty’s
model, lucrative overseas investments and the growing financial sophistication
of the superwealthy keep capital returns permanently high. The more prosaic
reality is that most capital stays in its home country and also has a hard time
beating randomly selected stocks. For those reasons, the future of capital
income looks far less glamorous than Piketty argues.
RICARDO REDUX
Piketty, in a way, has updated the work of
the British economist David Ricardo, who, in the early nineteenth century,
identified the power of what he termed “rent,” which he defined as the income
earned from taking advantage of the difference in value between more and less
productive lands. In Ricardo’s model, rent -- the one kind of income that did
not suffer from diminishing returns -- swallowed up almost everything else,
which is why Ricardo feared that landlords would come to dominate the economy.
Of course, since Ricardo’s time, the
relative economic importance of land has plummeted, and his fear now seems
misplaced. During the twentieth century, other economists, such as Friedrich
Hayek and the other thinkers who belonged to the so-called Austrian School,
understood that it is almost impossible to predict which factors of production
will provide the most robust returns, since future economic outcomes will
depend on the dynamic and essentially unforeseeable opportunities created by
future entrepreneurs. In this sense, Piketty is like a modern-day Ricardo,
betting too much on the significance of one asset in the long run: namely, the
kind of sophisticated equity capital that the wealthy happen to hold today.
Piketty’s concern about inherited wealth
also seems misplaced. Far from creating a stagnant class of rentiers, growing
capital wealth has allowed for the fairly dynamic circulation of financial
elites. Today, the Rockefeller, Carnegie, and Ford family fortunes are quite
dispersed, and the benefactors of those estates hardly run the United States,
or even rival Bill Gates or Warren Buffett in the financial rankings. Gates’
heirs will probably inherit billions, but in all likelihood, their fortunes
will also be surpassed by those of future innovators and tycoons, most of whom
will not come from millionaire families.
To be sure, outside the realm of the
ultra-elites, the United States suffers from unfairness in terms of who gets
ahead in life, and a lack of upward mobility profoundly affects the prospects
of lower-income Americans. Still, the success of certain immigrant groups
suggests that cultural factors play a more significant role in mobility than
does the capital-to-income ratio, since the children and grandchildren of
immigrants from those groups tend to advance socioeconomically even if their
forebears arrived without much in the way of accumulated fortunes.
It is also worth noting that many wealth
accumulators never fully diversify their holdings, or even come close to doing
so. Gates, for example, still owns a lot of Microsoft stock -- perhaps out of a
desire for control, or because of a sentimental attachment to the company he
co-founded, or maybe just due to excessive optimism. Whatever the reasons, over
time such concentrations of financial interest hasten the circulation of elites
by making it possible for the wealthy to suffer large losses very rapidly.
And in the end, even the most successful
companies will someday fall, and the fortunes associated with them will
dissipate. In the very long run, the most significant gains will be reaped by
institutions that are forward-looking and rational enough to fully diversify.
As Piketty discusses, that category includes the major private U.S.
universities, and indeed the list of the top schools has not changed much over
many decades. Harvard and other elite universities might, in fact, emerge as
the true rentiers of the contemporary era: as of 2008, the top 800 U.S.
colleges and universities controlled almost $400 billion in assets.
DOING WELL, THEN DOING GOOD
Piketty fears the stasis and sluggishness
of the rentier, but what might appear to be static blocks of wealth have done a
great deal to boost dynamic productivity. Piketty’s own book was published by
the Belknap Press imprint of Harvard University Press, which received its
initial funding in the form of a 1949 bequest from Waldron Phoenix Belknap,
Jr., an architect and art historian who inherited a good deal of money from his
father, a vice president of Bankers Trust. (The imprint’s funds were later
supplemented by a grant from Belknap’s mother.) And consider Piketty’s native
France, where the scores of artists who relied on bequests or family support to
further their careers included painters such as Corot, Delacroix, Courbet,
Manet, Degas, Cézanne, Monet, and Toulouse-Lautrec and writers such as
Baudelaire, Flaubert, Verlaine, and Proust, among others.
Notice, too, how many of those names hail
from the nineteenth century. Piketty is sympathetically attached to a
relatively low capital-to-income ratio. But the nineteenth century, with its
high capital-to-income ratios, was in fact one of the most dynamic periods of
European history. Stocks of wealth stimulated invention by liberating creators
from the immediate demands of the marketplace and allowing them to explore
their fancies, enriching generations to come.
Piketty’s focus on the capital-to-income
ratio is novel and worthwhile. But his book does not convincingly establish
that the ratio is important or revealing enough to serve as the key to
understanding significant social change. If wealth keeps on rising relative to
income, but wages also go up, most people will be happy. Of course, in the past
few decades, median wages have been stagnant in many developed countries,
including the United States. But the real issue, then, is wages -- not wealth.
A high capital-to-income ratio might be one factor depressing wages, but it
hardly seems central -- and Piketty does not claim, much less show, that it is.
Two other factors have proved much more
important: technological changes during the past few decades that have created
a globalized labor market that rewards those with technical knowledge and
computer skills and competition for low-skilled jobs from labor forces
overseas, especially China. Piketty discusses both of those issues, but he puts
them to the side rather than front and center.
Of course, income and wealth inequalities
have risen in most of the world’s developed nations, and those processes will
likely continue and perhaps intensify in the immediate future. But for the
world as a whole, economic inequalities have been falling for several decades,
mostly thanks to the economic rise of China and India. Growth in those
countries has depended in part on policies of economic liberalization, which
themselves were inspired and enabled, to a certain extent, by capital
accumulation in the West. The relative global peace of the postwar period might
have bred inequality in rich countries, but it has also led to reform and
economic opportunity in poorer countries. It is no accident that communism was
the product of war and civil conflict.
TAXMAN
The final chapters of the book, which
contain Piketty’s policy recommendations, are more ideological than analytic.
In these sections, Piketty’s preconceptions lead to some untenable conclusions.
His main proposal is a comprehensive international agreement to establish a
progressive tax on individual wealth, defined to include every kind of asset.
Piketty concedes that this is a “utopian idea” but also insists that it is the
best possible solution to the problem. He hedges a bit on the precise numbers but
suggests that wealth below 200,000 euros be taxed at a rate of 0.1 percent,
wealth between 200,000 and one million euros at 0.5 percent, wealth between one
million and five million euros at 1.0 percent, and wealth above five million
euros at 2.0 percent.
Although he recognizes the obvious
political infeasibility of such a plan, Piketty has nothing to say about the
practical difficulties, distorting effects, and potential for abuse that would
inevitably accompany such intense government control of the economy. He points
to estimates he has previously published in academic papers as evidence that
such a confiscatory regime would not harm the labor supply in the short term.
But he neglects the fact that in the long run, taxes of that level would surely
lower investments in human capital and the creation of new businesses. Nor does
he recognize one crucial implication of his own argument about the power of
nondiminishing capital returns: if capital is so mobile and dynamic that it can
avoid diminishing returns, as Piketty claims, then it will probably also avoid
being taxed, which means that the search for tax revenue will have to shift
elsewhere, and governments will find that soaking the rich does not really
work.
Piketty also ignores other problems that
would surely stem from so much wealth redistribution and political control of
the economy, and the book suffers from Piketty’s disconnection from practical
politics -- a condition that might not hinder his standing in the left-wing
intellectual circles of Paris but that seems naive when confronted with broader
global economic and political realities. In perhaps the most revealing line of
the book, the 42-year-old Piketty writes that since the age of 25, he has not
left Paris, “except for a few brief trips.” Maybe it is that lack of exposure
to conditions and politics elsewhere that allows Piketty to write the following
words with a straight face: “Before we can learn to efficiently organize public
financing equivalent to two-thirds to three-quarters of national income” --
which would be the practical effect of his tax plan -- “it would be good to
improve the organization and operation of the existing public sector.” It would
indeed. But Piketty makes such a massive reform project sound like a mere
engineering problem, comparable to setting up a public register of vaccinated
children or expanding the dog catcher’s office.
Worse, Piketty fails to grapple with the
actual history of the kind of wealth tax he supports, a subject that has been
studied in great detail by the economist Barry Eichengreen, among others.
Historically, such taxes have been implemented slowly, with a high level of
political opposition, and with only modestly successful results in terms of
generating revenue, since potentially taxable resources are often stashed in
offshore havens or disguised in shell companies and trusts. And when
governments have imposed significant wealth taxes quickly -- as opposed to,
say, the slow evolution of local, consent-based property taxes -- those
policies have been accompanied by crumbling economies and political
instability.
Recent wealth-tax regimes in the European
Union offer no exceptions to this general rule. In 2011, Italy introduced a
wealth tax on real estate, but Rome retracted the plan after the incumbent government
was dealt a major blow in elections last year, partly owing to public
dissatisfaction with the tax scheme. Last year, the government of the Republic
of Cyprus imposed the equivalent of a tax on bank deposits, only to see the tax
contribute to, rather than reverse, the island’s economic struggles.
The simple fact is that large wealth taxes
do not mesh well with the norms and practices required by a successful and
prosperous capitalist democracy. It is hard to find well-functioning societies
based on anything other than strong legal, political, and institutional respect
and support for their most successful citizens. Therein lies the most
fundamental problem with Piketty’s policy proposals: the best parts of his book
argue that, left unchecked, capital and capitalists inevitably accrue too much
power -- and yet Piketty seems to believe that governments and politicians are
somehow exempt from the same dynamic.
A more sensible and practicable policy agenda for reducing inequality
would include calls for establishing more sovereign wealth funds, which Piketty
discusses but does not embrace; for limiting the tax deductions that
noncharitable nonprofits can claim; for deregulating urban development and
loosening zoning laws, which would encourage more housing construction and make
it easier and cheaper to live in cities such as San Francisco and, yes, Paris;
for offering more opportunity grants for young people; and for improving
education. Creating more value in an economy would do more than wealth redistribution
to combat the harmful effects of inequality.
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