How to solve the rising income inequality? 80 per cent tax rate…?: Georg Wilhelm Friedrich Hegel
FORCES OF DIVERGENCE: Is surging inequality endemic to capitalism? BY JOHN CASSIDY, The New Yorker
In the stately world of academic presses, it isn’t often that advance orders and publicity for a book prompt a publisher to push forward its publication date. But that’s what Belknap, an imprint of Harvard University Press, did for “Capital in the Twenty-first Century,” a sweeping account of rising inequality by the French economist Thomas Piketty. Reviewing the French edition of Piketty’s book, which came out last year, Branko Milanovic, a former senior economist at the World Bank, called it “one of the watershed books in economic thinking.” The Economist said that it could change the way we think about the past two centuries of economic history. Certainly, no economics book in recent years has received this sort of attention. Months before its American publication date, which was switched from April to March, it was already the subject of lively online discussion among economists and other commentators.
Part of Piketty’s motivation in returning home was cultural. His parents are politically engaged Parisians who took part in the 1968 riots. When he was growing up, his intellectual role models were French historians and philosophers of the left, rather than economists. They included members of the Annales school, such as Lucien Febvre and Fernand Braudel, who produced exhaustive analyses of everyday life. Compared with this scholarship, much of the economics that Piketty encountered at M.I.T. seemed arid and pointless. “I did not find the work of U.S. economists entirely convincing,” he writes. “To be sure, they were all very intelligent, and I still have many friends from that period of my life. But something strange happened: I was only too aware of the fact that I knew nothing at all about the world’s economic problems.”
In Paris, he joined the French National Center for Scientific Research, and, later, the Écoles des Hautes Études en Sciences Sociales, where some of his heroes had taught. The main task he set himself was exploring the hills and valleys of income and wealth, a subject that economics had largely neglected. At first, Piketty concentrated on getting the facts down, rather than interpreting them. Using tax records and other data, he studied how income inequality in France had evolved during the twentieth century, and published his findings in a 2001 book. A 2003 paper that he wrote with Emmanuel Saez, a French-born economist at Berkeley, examined income inequality in the United States between 1913 and 1998. It detailed how the share of U.S. national income taken by households at the top of the income distribution had risen sharply during the early decades of the twentieth century, then fallen back during and after the Second World War, only to soar again in the nineteen-eighties and nineties.
The question is what’s driving the upward trend. Piketty didn’t think that economists’ standard explanations were convincing, largely because they didn’t pay enough attention to capital accumulation—the process of saving, investing, and building wealth which classical economists, such as David Ricardo, Karl Marx, and John Stuart Mill, had emphasized. Piketty defines capital as any asset that generates a monetary return. It encompasses physical capital, such as real estate and factories; intangible capital, such as brands and patents; and financial assets, such as stocks and bonds. In modern economics, the term “capital” has been purged of its ideological fire and is treated as just another “factor of production,” which, like labor and land, earns a competitive rate of return based upon its productivity. A popular model of economic growth developed by Robert Solow, one of Piketty’s former colleagues at M.I.T., purports to show how the economy progresses along a “balanced growth path,” with the shares of national income received by the owners of capital and labor remaining constant over time. This doesn’t jibe with modern reality. In the United States, for example, the share of income going to wages and other forms of labor compensation dropped from sixty-eight per cent in 1970 to sixty-two per cent in 2010—a decline of close to a trillion dollars.
In the nineteen-fifties, the average American chief executive was paid about twenty times as much as the typical employee of his firm. These days, at Fortune 500 companies, the pay ratio between the corner office and the shop floor is more than two hundred to one, and many C.E.O.s do even better. In 2011, Apple’s Tim Cook received three hundred and seventy-eight million dollars in salary, stock, and other benefits, which was sixty-two hundred and fifty-eight times the wage of an average Apple employee. A typical worker at Walmart earns less than twenty-five thousand dollars a year; Michael Duke, the retailer’s former chief executive, was paid more than twenty-three million dollars in 2012. The trend is evident everywhere. According to a recent report by Oxfam, the richest eighty-five people in the world—the likes of Bill Gates, Warren Buffett, and Carlos Slim—own more wealth than the roughly 3.5 billion people who make up the poorest half of the world’s population.
Some people claim that the takeoff at the very top reflects the emergence of a new class of “superstars”—entrepreneurs, entertainers, sports stars, authors, and the like—who have exploited new technologies, such as the Internet, to enlarge their earnings at the expense of others in their field. If this is true, high rates of inequality may reflect a harsh and unalterable reality: outsized spoils are going to go to Roger Federer, James Patterson, and the WhatsApp guys. Piketty rejects this account. The main factor, he insists, is that major companies are giving their top executives outlandish pay packages. His research shows that “supermanagers,” rather than “superstars,” account for up to seventy per cent of the top 0.1 per cent of the income distribution. (In 2010, you needed to earn at least $1.5 million to qualify for this élite group.) Rising income inequality is largely a corporate phenomenon.
Defenders of big pay packages like to claim that senior managers earn their vast salaries by boosting their firm’s profits and stock prices. But Piketty points out how hard it is to measure the contribution (the “marginal productivity”) of any one individual in a large corporation. The compensation of top managers is typically set by committees comprising other senior executives who earn comparable amounts. “It is only reasonable to assume that people in a position to set their own salaries have a natural incentive to treat themselves generously, or at the very least to be rather optimistic in gauging their marginal productivity,” Piketty writes.
That’s a pretty shocking figure. Piketty calls the tendency for inequality to rise during periods when the rate of return on capital is higher than the economy’s rate of growth “the central contradiction of capitalism.” Of course, the logic can also run in reverse. If the rate of growth exceeds the rate of return, wages and salaries will grow more rapidly than income from capital, and inequality will fall. That’s what happened in much of the twentieth century. The problem, Piketty argues, is that this state of affairs is unlikely to be maintained. “A concatenation of circumstances . . . created a historically unprecedented situation, which lasted for nearly a century,” he writes. “All signs are, however, that it is about to end.”
Given that inequality is a worldwide phenomenon, Piketty aptly has a worldwide solution for it: a global tax on wealth combined with higher rates of tax on the largest incomes. How much higher? Referring to work that he has done with Saez and Stefanie Stantcheva, of M.I.T., Piketty reports, “According to our estimates, the optimal top tax rate in the developed countries is probably above eighty per cent.” Such a rate applied to incomes greater than five hundred thousand or a million dollars a year “not only would not reduce the growth of the US economy but would in fact distribute the fruits of growth more widely while imposing reasonable limits on economically useless (or even harmful) behavior.”
Piketty is referring here to the occasionally destructive activities of Wall Street traders and investment bankers. His new wealth tax would be like an annual property tax, but it would apply to all forms of wealth. Households would be obliged to declare their net worth to the tax authorities, and they would be taxed upon it. Piketty tentatively suggests a levy of one per cent for households with a net worth of between one million and five million dollars; and two per cent for those worth more than five million. “Or one might prefer a much more steeply progressive tax on large fortunes (for example a rate of 5 to 10 percent on assets above one billion euros),” he adds. A wealth tax would force individuals who often manage to avoid other taxes to pay their fair share; and it would generate information about the distribution of wealth, which is currently opaque. “Some people think that the world’s billionaires have so much money that it would be enough to tax them at a low rate to solve all the world’s problems,” Piketty notes. “Others believe that there are so few billionaires that nothing much would come of taxing them more heavily. . . . In any case, truly democratic debate cannot proceed without reliable statistics.”
Economists can debate whether such a wealth tax would reduce incentives to invest and innovate, or whether it would be punitive enough to make a real dent in inequality. A more immediate problem is that it isn’t going to happen: the nations of the world can’t agree on taxing harmful carbon emissions, let alone taxing the capital of their richest and most powerful citizens. Piketty concedes as much. Still, he says, his proposal provides a standard against which to judge other proposals; it points to the need for other useful reforms, such as improving international banking transparency; and it could be introduced in stages. A good place to begin, he thinks, would be a European wealth tax that would replace the property tax, which “in most countries is tantamount to a wealth tax on the propertied middle class.” But that may be utopian, too. If the European Union moved ahead with Piketty’s proposal, it would produce a rush to tax havens like Switzerland and Luxembourg. Previous efforts to introduce wealth taxes at the national level have run into problems. Spain, for example, adopted a wealth tax in 2012 and abolished it at the start of this year. In Italy, a wealth tax proposed in 2011 never went through. Such difficulties explain why governments still rely on other, admittedly imperfect, tools to tax capital, such as taxes on property, estates, and capital gains.
In the United States, the very idea of a new wealth tax looks like a nonstarter politically, as would the notion of raising the top rate of income tax to eighty per cent. That’s not a knock on Piketty, though. The proper role of public intellectuals is to question accepted dogmas, conceive of new methods of analysis, and expand the terms of public debate. “Capital in the Twenty-first Century” does all these things. As with any such grand prognostication, some of it may not withstand the test of time. But Piketty has written a book that nobody interested in a defining issue of our era can afford to ignore.
Inequality & Capitalism in the Long-Run
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