To summarize the argument of Capital thus far, Piketty has found that over long stretches of time and in many different countries economic growth (g) is substantially less than the return to capital or wealth (r). This means that income from wealth grows faster than income from work (which, on average, grows only as fast as the economy grows). Since returns to wealth go mainly to the very wealthy, income inequality and wealth inequality will rise over time.
Piketty (pp. 358-61) is clear that these are contingent and historical relationships; there is no guarantee that they will continue into the future. He produces no economic theory that says this is the way all capitalist economies work. But he is convinced that since such empirical relationships have existed over such a long time in so many different countries (except for the war years during the 20th century, when the war and high taxes destroyed wealth) they will likely to continue in the future—barring any future world wars or major policy changes.
As a huge policy wonk who has written extensively on tax policy, I have particularly looked forward to reading Part IV of Capital in the Twenty-First Century. Yet, I looked forward to its policy solutions with a good deal of trepidation. This part of the book had received by far the greatest attention and most criticism, and this criticism has come from across the entire political and economic spectrum.
Those on the right objected to the high tax rates that Piketty proposes. The worst of these objections engaged in name-calling, deeming anyone a socialist who proposes higher taxes for whatever reason. Almost as bad have been the objections that higher taxes would give the government more money to waste—as if businesses never, ever wasted money and consumers always spent their money cautiously and rationally (e.g., they would NEVER buy homes or be able to obtain mortgages that they couldn’t possibly afford to repay). The more thoughtful and reasonable objections from the right have focused on the bad incentives to work hard, earn money, accumulate wealth, and provide for one’s children and grandchildren as a result of higher taxes.
Those on the left and toward the center of the political spectrum have been fairly consistent in maintaining that the main policy proposal of Piketty was impractical because a global wealth tax would never get enacted. After making this point, the next sentence of these critiques typically push other policies (invariably the personal favorites of those criticizing Piketty), which are just as unlikely to get enacted given the current political situation in the US and elsewhere.
After reading Part IV, I find all these criticisms both disturbing and a little bit off the mark. But before looking at his wealth tax proposals in greater detail, it is worth examining what Piketty has to say regarding monetary policy and fiscal policy. This part of Part IV I was not prepared for, mainly because it was not discussed in the many reviews of his book that I read.
Overall, Piketty has a lot of good things to say about fiscal and monetary policy. But there are many places I wish he had said more and made a stronger argument for his position. Also, there are some places he misses things that are important.
Chapter 16 discusses both fiscal policy and monetary policy. One positive aspect of this chapter is that Piketty downplays monetary policy in favor of fiscal policy. Monetary policy, he contends, cannot deal with the problem of rising inequality. In fact, he contends that we cannot know the impact of monetary policy on income and wealth distribution, although there is no argument for this. My gut instinct is that this is true, but I would have liked to see some data that supports this contention—say, looking at how income and wealth distribution vary based on interest rates. Such a study would make for a great thesis or doctoral dissertation, to say nothing about a nice professional paper.
Regarding fiscal policy, Piketty is fairly critical of government deficits. He spends a good deal of time focusing on the need to tax wealth so that we can repay existing government debt, but he fails to address the issue of whether government deficits and debt may be necessary at times. He also doesn’t address the issue of whether government debt does any actual harm to overall macroeconomic performance. Rather, the focus is mainly (Surprise! Surprise! Surprise!) on the impact of debt on income distribution. Picketty’s main point is that the large majority of government bonds created when the government goes into debt is owned by the very wealthy. They benefit greatly from government debt. With little risk, they receive positive returns on their money. This income generates part of their 5 percent rate of return on wealth or capital.
Unfortunately, the passages on fiscal policy and distribution are too short and too brief. There are two key reasons I wish Piketty had written a good deal more on the relationship between fiscal policy and inequality. First, Piketty argues throughout Capital that one main reason inequality declined from World War I through the 1950s was that there were high marginal tax rates on top incomes. This reduced the after-tax gains from owning wealth. Second, fiscal policy is central to Piketty’s major policy proposals.
Writing more on fiscal policy and distribution would not have been all that difficult to do. Moreover, his entire case for changes in tax policy would have been considerably stronger had Piketty spent more time on this topic and then related it to the beginnings of the revolt of the rentiers in the UK and the US when Margaret Thatcher and Ronald Reagan were elected heads of state.
The story in both cases is rather similar and involved several policy changes. There was a sharp cut in government spending (that hurt the poor and middle class more than wealthy households, which can provide their own benefits) and a sharp cut in taxes focused at the top of the income distribution. Overall, the cuts in government expenditures were less than the tax cuts, and the government had to borrow money by printing and selling bonds. Abstracting a little from the overall process, the Reagan and Thatcher governments gave large tax breaks to the wealthy, and then borrowed the money back from them to pay for the tax cuts. Everyone else got small tax cuts that were funded by cutting the government benefits they received. Or in slightly bolder and simpler terms, the Reagan and Thatcher governments decided to fund a good deal of government spending by borrowing money from the wealthy rather than taxing the wealthy.
As Piketty’s data demonstrate, these changes led to sharply rising inequality in the UK and US over the past several decades. And it is no wonder why this occurred. Those earning high incomes got to keep a lot more of their income. Yet something had to be done with all this additional money. It could not be kept under the mattress, earning nothing. Bank deposits were insured, but not for balances of the sort that the very wealthy possessed. The result could only be that all this additional disposable income fueled rising asset prices, which also primarily benefited the wealthy. And to finance the borrowing, the government had to print and sell bond, which tended to push up interest rates on these bonds, again to the benefit of those with lots of money to lend to the government.
According to supply-side gospel, which was used to justify these nefarious policy changes, the whole process should have resulted in much greater economic growth and enormous tax collections by the government so that there would be no deficit. However, this claim ignored the famous balanced budget multiplier of Paul Samuelson. Samuelson showed that an equal cut in taxes and in government spending would slow economic growth or reduce GDP by an amount equal to the tax cut (or cut in government spending). The reason for this is very simple. A dollar less in government spending is a dollar less spending while a dollar tax cut was not an additional dollar in spending since some of the spending will be saved. Overall, this will reduce spending and economic growth. Yet, ideology triumphed over economic knowledge. The US government and the UK government gave huge tax cuts to the wealthy, and then borrowed the money back from them in order to fund the tax cut. Economic growth slowed as the balanced budget multiplier predicted it would. This made distributional matters even worse because it increased the gap between r and g by lowering g.
One last thing is worth some additional comments before getting to the issue of income and wealth taxes, especially since this has been one of the most frequent criticisms of Piketty. Many commentators complained that Piketty ignored alternative policies such as supporting unions and raising the minimum wage.
I took these criticisms rather seriously when I first encountered them, which was well before I started reading the book. And they did perplex me a great deal. Every time I read one of these critiques I wondered how and why Piketty could ignore such simple and obvious solutions to the distribution problem.
After reading Capital closely I am now rather perplexed about something else—Piketty actually does discuss these policies. Chapter 9 includes an extensive discussion of the minimum wage. The data Piketty presents and the written text both make it very clear that the distribution of wages has remained relatively equal in France because the French have continually increased the minimum wage and that the French minimum wage is rather high compared to average wages. Piketty even discusses (p. 289) why this happened— Charles de Gaulle was worried about the crisis of May 1968 and used higher minimum wages to deal with a problem that was more cultural and social than economic. Moreover, Piketty clearly supports raising the minimum wage and even provides several justifications for raising the minimum wage (pp. 311ff.). So it is puzzling that so many people would criticize Piketty for not supporting higher minimum wages. At times like this I think people don’t even bother to read the book they are assigned to review, fearing that doing so might influence their opinion of it.
The real problem Piketty has with raising the minimum wage is not that it won’t help equalize wage income, but that it won’t deal with the problem of rising capital income in the long run. He is also skeptical that the minimum wage can be increased enough (5% per year in real terms) over the long haul without generating substantial unemployment. To try to make Piketty’s point as simple and clear as possible, even if wages (and we can add rising union power here) were made completely equal across the board, inequality would be high and would continue to increase because of the immense wealth that is possessed by a few people. To see exactly how and why this is so, see my blog on Part I of Capital, where I present a case with some simple numbers. These computations start out with small amounts of wealth, the value of wealth is just equal to income; soon it soars well above income. Starting with wealth at around 6 times the value of average income, inequality will soar much faster.
It is wealth inequality for Piketty that is the main force driving inequality to rise under capitalism. A higher minimum wage can slow the process down. So too can stronger unions. So too can government spending policies that equalize after-tax incomes, such as paid parental leave, child allowances, generous unemployment insurance programs, and a large and sturdy social safety net. These are all policies that Piketty, I imagine, would support. But the key insight of Capital is this: the driving force of inequality is that we start with great wealth inequality and the high returns to wealth make things worse over time. Policies that equalize income distribution will help a little, but they ignore the main problem.
Still, Piketty does focus on tax policy to reduce the distribution of wage income. He argues first for a progressive income tax because this (along with inheritance taxes) is the only progressive form of taxation that governments have. Sales or indirect taxes are regressive in nature and insurance taxes (for retirement and for unemployment) tend to be proportional or regressive. Again, Piketty does not make either a strong or forceful case for this policy. I wish he had put a little more emphasis on the fact that high marginal tax rates during the war years and in the decade or so after World War II contributed to the falling inequality in this era. Historically, he contends that high marginal income tax rates have led to lower (before-tax) inequality. It is in the data; it should have been stressed more in the policy section of the book.
On the other hand, Piketty does worry about current trends in individual income taxation. In particular, by exempting capital income from the income tax (or taxing it at lower rates) the income tax becomes regressive at the very top (because that is where they get most of their income) and tends to make the entire tax system regressive in developed countries. But, again, the big issue for Piketty is that progressive income taxes cannot solve the wealth inequality problem. Like progressive spending programs, a progressive income tax would help reduce income inequality, but it does not solve the problem that wealth inequality tends to rise because of the high returns to wealth—much of it, such as stocks and homes that are not sold, are not taxed.
In a couple of pages that were pretty much ignored in the reviews of Capital, Piketty calls for a reform of corporate taxation. He proposes that corporate income taxes be assessed based on wages paid in different countries rather than on where in the world the multi-national firm declares its profits to come from (always the country which has the lowest corporate income tax rate). This is not headline grabbing, and tax reform is never as exciting as proposing a new type of tax (this is why there are so many articles on the flat tax and the Tobin Tax and why reviews of this book focused on the global wealth tax), but it is something that needs to receive serious consideration and should be pushed more.
Again, the fact that Piketty does not focus a lot of attention on this proposal probably stems from the fact that (like higher marginal income tax rates) it will affect income distribution but not wealth distribution. When corporations pay higher taxes to governments there is less profit to distribute to the owners as dividends. This will reduce current incomes. However, higher corporate income taxes also reduce future profits after-taxes, which should affect the value of corporate stock. This will lower the price of shares of stock. Since it is mainly the very wealthy who own large amounts of stock, and whose wealth portfolio contains a higher percentage of stock compared to middle-income households, this policy should have significant and substantial effect on wealth inequality.
At last, we come to Piketty’s main policy conclusion, his claim that the way to keep more and more income from going to those at the very top of the distribution is a global wealth tax. The tax needs to be global in order to keep wealth from moving to tax havens where it is not subject to the tax. Piketty also wants to keep the tax rate low (1-2 percent) in order to mitigate negative disincentives. His particular plan is that net assets worth between 1 million Euros ($1.35 million) and 5 million Euros ($6.75 million) be taxed at 1 percent and net assets worth more than 5 million Euros be taxed at 2 percent. The goal in all this, Piketty makes clear, is not to raise money for social programs but to tame the inequality that inevitably results under capitalism.
Piketty provides several different arguments for his progressive and global wealth tax.
First, he resorts to an appeal to authority. He invokes the American Economic Association Presidential address by Irving Fisher, in which Fisher worries about the fact that only 2% of the US population owned more than 50% of the nation’s wealth while two-thirds of the population had no net wealth. Fisher then went on to suggest a steeply progressive wealth tax to remedy this situation.
Second, Piketty argues that the rewards going to the very top are not justified by traditional economic arguments (that they depend on the marginal productivity of the worker). Instead, Piketty makes the case that CEO pay is due to luck to a large degree and that a bargaining model fits the data better than marginal productivity theory. He argues that when the government takes a very large chunk of any extra income, it is not worth it for a CEO to bargain with a compensation committee or shareholders to get higher pay. And he points to empirical evidence that high marginal tax rates keep down CEO pay while not hurting the economic performance of the firm.
Finally there is the main argument—that a global wealth tax is the only way to limit the growth of wealth accumulation and a return to 19th-century levels of inequality. Or, this is the only way we can avoid all the negative economic, social, and political consequences of great inequality. A tax on income will not achieve this end because much income is tied up in stocks and bonds and real estate that generally do not get taxed. The gains from these investments are taxed when assets are sold. This allows the gains to accumulate at the top and to keep doing so. Only a wealth tax can stop this process.
Finally, while his many critics fault Piketty for making such an unrealistic proposal, Piketty (p. 513f.) himself recognizes that a global wealth tax (or even higher taxes on income from capital in the United States) is not likely to happen anytime soon and perhaps will never happen. He has no unrealistic illusions about this policy being passed in the US or Europe.
The alternative policy proposals made by critics of Piketty, as noted above, are probably unrealistic as a global wealth tax. But the strong case against them, as Piketty points out, is that only a progressive wealth tax deals with the problem of rising inequality in income and wealth under capitalism. A higher minimum wage and greater support for labor unions cannot reduce the concentration of capital. Nor can progressive government programs such as paid parental leave and generous unemployment insurance. Even reforming individual and corporate income taxes will be of limited help (although, as I argue above, global corporate tax reform can do a lot of good). We are left with few options if we want to halt a return to the gilded age.
After finishing Capital, I have come to understand all the fuss about the book and why Piketty has become a rock star among economists. It is one of the most stimulating books in economics that I have read in many, many years. It is a book that, if read seriously, changes one’s views of the nature of capitalism in fundamental ways. And I managed to read the entire book and make sense of it while I was enjoying Paris.
Still, there is much more for me to do and think about. One next step is to look more carefully at the numbers in Piketty’s database, examine how he actually derived his computations, and determine whether he made reasonable adjustments to raw data. Who knows, maybe you will be subject to more blogs from me on this issue.
Then there is the final step. I need to write a review of Capital in the Twenty-First Century for the next issue (July/August) of Dollars & Sense. For those of you who have been following my blog posts in Paris, and think that I couldn’t possibly have anything else to say about the book—think again. And for those of you who have been following my reviews in Dollars & Sense over the past several years, I already have a great pun that I am going to use as my review title. So stay tuned!