Friday, May 23, 2014

Anti-Piketty: VA is part of the "social model"

Our liberal friends like to talk vaguely about "working families," although their core voters are often neither workers nor families. But euro-lefties like Thomas Piketty, he of Capital in the Twenty-First Century, are more direct about their agenda.  They call it the European Social Model.  They mean that the state provides basic services like free education, free health care, pay-as-you-go pensions, and income supplement.  And this is a good thing, even if it costs 40, 50 percent of GDP in taxes.

Just like the US Veterans Administration.  It runs a cafeteria of free services for US veterans.  Want health care?  Go to the VA hospital.  It's run just like every government department: for the benefit of the managers and the bureaucrats.

So the VA is hiding its waiting lists.  So President Obama is shocked, shocked that waiting lists are going on.  So everyone is piling on.

Who are we kidding?  The VA operates a government-furnished, government-run "free at the point of delivery" health care system.  Which means that there will be waiting lists.  There's no mystery about this.  It doesn't take dysfunctional bureaucrats or incompetent managers to muck up waiting lists. It's a basic fact of life, courtesy of Economics 101.  Supply and Demand, baby.  If you price some thing at zero, the demand for that thing will be infinite.

Every scarce thing in this world must be rationed.  You can ration it by price, or you can ration it by waiting lists.

And that applies to the VA and everything else in the European Social Model.

Now I know that for our graduates of the French grandes écoles like M. Piketty, there is nothing more progressive or more just or more social that the "social state" and its "social model".  But you may have a tiny little question mark in the back of your mind about it.  I certainly do.

Because there is an interesting thing about the European Social Model and all its brothers and sisters and cousins and aunts.  It's indistinguishable from the Looting and Plunder Model.

So you're the Frankish king sitting in you capital city of Trier, just west of the Rhine, way back in the good old days of the Frankish empire.  It's spring and it's time for the campaigning season.  What do you do?  You say to your noble supporters and your peasants: Hey, pal, want some loot and plunder and free stuff?  Follow the Frankish banner and come and get it.  So when the snows clear and the forest paths harden up you lead your merry band of pranksters into Saxony and teach the Teutons a lesson.  In the fall you return to Trier with your bags full of grain and silver and loot.

You tell me what is different with the modern politician and his supporters.  What does he say once the election campaigning season comes around?  He offers his supporters free stuff. Health care for the uninsured!  New subsidies for community college students!  No cuts to Medicare!  Higher minimum wage! And at the end of the campaign after the office is won, then it's time to divide the spoils.

Now there is a very advanced and sophisticated way to look at this.  It is the pragmatic method that William James taught us over a century ago.  He said: never mind about realism or transcendentalism or any of that stuff.  Think of things pragmatically.  If the way you deal with A is the same as the way you deal with B, then A and B are, for all practical purposes, the same.

So if the European Social Model is indistinguishable from the Looting and Plunder Model, maybe it's because they, for all practical purposes, the same.

Of course, there's a middle way in this, the medieval feudal system.  In those days the supporters were mostly serfs.  They weren't recruited for loot, but served in the feudal host as part of a system of loyalty and obligation.  They served the lord, and the lord protected them from other lords and the Vikings.  And the lord kinda sorta looked after them, throwing them a few bones every now and again.

But today we are trying to blunder a way out of the Loot and Plunder model to a new system. It's not a looting system, or a servile system, or a free-stuff-social-model system.  It's the system of individual responsibility.  It's completely upside down from the old system.

In the old system you were recruited and you joined up for the loot, the free stuff.  And you fought or worked in the fields in order to get your loot, your right as a loyal servitor.

But in the new system you start not with your loot but with your contribution.  You have to figure out: how can I make myself useful, how can I add value in this crazy, complex world?  How can I make a difference?  How can I find a niche to fill?  Then, you hope, the money will follow.  It's a great system because it doesn't need a great lord divvying up the spoils in some complicated administrative system with its waiting lines and waiting lists.  It just requires people eager to serve and people willing to pay them for their service.

The problem at the VA will not be solved with more money and better administrators.  It will be solved only when we abandon the free-stuff model.  Let's offer the veterans a choice.  You can stay with the free-stuff model, or we can give you an equivalent chunk of change so you can buy health insurance on the open market.

Oh dear.  I see there's a problem with that.  President Obama and his Democratic army just overran the open market for health insurance with their centralized bureaucratized costly unaffordable uncaring unprotected Patient Protection and Affordable Care Act.

So the president and his party are making things worse instead of better, for veterans and for everyone else.  They are turning the clock back to the days of serfdom and looting and plunder.

And so it goes.

And so it will continue to go until the advanced progressive ruling class finally gives in and abandons its primitive free-stuff model and joins the modern era and its radical idea of individual responsibility.

When that day dawns we may truly say that the state has become social.

Wednesday, May 21, 2014

Piketty: Anti-Piketty

The "social state" in in a bit of a jam in the aftermath of the Crash of 2008, because public debt in the rich countries is sitting at about 100 percent of national income, according to Thomas Piketty in Capital in the Twenty-First Century.  The best way to pitch out of the jam is to assess the rich 15-20% of their wealth and pay off the debt.  No problem because private wealth is about six to seven times national income.

So Piketty's #1 bestselling book is not really about capital in the 21st century.  It is about getting the project of the global educated ruling class out of the ditch.  Because if the governments have to cut back on benefits, a policy called "austerity," then the poor would pay for the follies of their rulers, and that would never do.

Let's rehearse Piketty's argument backwards, from the goal of his argument back to his premise.  Because, like most things in this world, it is the end that justifies the means.

  1. A progressive tax on capital is the right way to reduce or eliminate rich country public debt.
  2. The heavy public debt is the fault of capitalism run amok in the 2000s and wise government policy to prevent another Great Depression.
  3. Something must be done else the "social state" won't be able to deliver education, health care and pensions.
  4. The richest capitalists can afford it because the capital/income ratio is over 6 in the developed countries.
  5. Tapping the rich is a good idea because wealth inequality is spiraling out of control.
  6. Wealth inequality is spiralling out of control because r > g (r = rate of return on capital greater than g = rate of economic growth) and the rich save a chunk of their income.
  7. So a progressive tax on capital would be a good thing, because inequality.
  8. But first we need a "financial cadaster" of all private wealth so governments know who owns what.
There is in Thomas Piketty an almost sweet naivete that assumes the modern educated class's right to rule, that assumes the moral authority of the authoritarian welfare state, that elides the fundamental fact of government, that government is force.  If there's a problem, such as poverty and ignorance in 1900, then the solution is to force everyone to contribute to a government program of education, health care, and pensions.  If there's a problem of sky-high public debt in 2014, then the solution is to force everyone to pay down the debt.  But first we need to know exactly what everyone owns so we know where to go and get it.

Why is this?  Because the only thing government does is force, government is forever looking for a project that requires force.  Thus everything it does turns into a war.  So the solution to the public debt crisis is a war on wealth.

Let's go down the list of Piketty's assumptions and deal with them one by one.

The large public debt. If you ask me there is only one reason for a government to get into debt: to fight a war.  For government to get itself so indebted in peacetime is a failure of leadership.  What if there were a real war?  What would we do then?

The crash of 2008. Piketty says that governments did a good job in the recent panic.  I say they flunked.  First of all, if central banks are supposed to be "lenders of last resort" then how come Lehman Brothers was allowed to fail?  Second, the same thing happened in the 1929 crash only the bureaucratic bunglers at the central banks were even worse.  That's because it was the political hacks' first try at a big panic since the creation of the Federal Reserve and they whiffed it.  Third, the cause of the crash was not Wall Street speculation or government regulation but US government policy that hosed cheap mortgage money at overleveraged sub-prime borrowers.  Imagine: after the music stopped there were trillions of mortgage debt on which: a) many borrowers couldn't pay and b) the collateral couldn't pay off the loan.

The social state is not social.  It is compulsory.  It is force.  I would say that the education of little children should not be conducted under the color of government force.  I would say that health care should not be parceled out under the color of government force, except basic public health questions like sanitation and clean water and quarantine and vaccination that keep our cities safe.  I would say that people should save for their own pensions, because the intergenerational solidarity of people saving so that they can create jobs for the next generation is higher and nobler than the intergenerational solidarity of the welfare state in which seniors vote to tax the next generation and force them to pay for their parents' pensions.

Wealth inequality.  Piketty believes in the Marxian fallacy that wealth increases by saving and accumulation. E.g., r > g. No it doesn't.  Wealth comes from innovation and surprise.  A guy invents a steam engine; pretty soon poor people can afford to cross the oceans in steamships.  A bunch of guys develop horizontal drilling and hydraulic fracturing for oil and gas wells.  Pretty soon they have transformed the global energy equation.  But when people don't innovate you get the world from 0-1500 AD.  No innovation.  No wealth "accumulation." No growth.  Stagnation.  The way you get rich in that world is by conquering other peoples' land, enjoying the lamentation of their women, and putting the peasants to work.

Financial cadaster. Thomas Piketty, like many in the ruling class, is disturbed that capital can flow to where it's most welcome, and he hates the tax competition between nations that has led to a race to the bottom.  The solution for him and his pals in the global ruling class is to create a financial cadaaster, a government database of all personal wealth: who owns it and where it's located.  Only then, he argues, will policy-makers have the tools to respond to crises like the Crash of 2008 and the Greece sovereign debt issue and the Cyprus bank meltdown.  But this is nothing new.  Governments have always wanted to make their subjects "legible."  It makes them easier to tax, to control, and to conscript.  And it gives the ruling class the tools it needs to paint an aesthetically pleasing state-scape.  See Seeing Like a State: How Certain Schemes to Improve the Human Condition Have Failed by James C. Scott.

Thomas Piketty's book has been received in certain liberal and lefty circles as a gift from the gods. Here at last is a cogent argument for the fight against inequality.  And so it is, if you want to go to war over inequality.

But the brighter lights on the left know that there is a problem with all this:  Domination.  If the only response to every problem is to call for new measures of political domination, then you must be missing something.  Horkheimer and Adorno realized this in Dialectic of Enlightenment.  They wrote:
What men want to learn from nature is how to use it in order wholly to dominate it and other men.  That is the only aim.
The problem with everything on the left from Marx to Piketty is that they cannot think of any response to domination except counter-domination.  But there is another way.  It has been developed, of all things, by a lefty, Jürgen Habermas.  His solution to the problem of domination is to balance domination with communication.  He imagines two worlds, systems world and life-world.  Systems world is the age-old battle against the world for food and shelter. Life-world is the social world of human-to-human communication and cooperation.  The beginning of a shared life-world is language, of which Wittgenstein said: there is no private language.

When I look at the world using Habermas's ideas, I see that the "social state" of Thomas Piketty is not social, because it is a bureaucratic hierarchical state of command and control.  It is the compulsion state.

There has to be a better idea.  There is. Start here: The Crisis of the Administrative State.

Introduction

Part One: Income and Capital

Income and Output | End of Growth

Part Two: The Dynamics of the Capital/Income Ratio

Changes in Capital | New World Capital and Slavery

Capital/income Ratio in the Long Run | Capital's Share of Income

Part Three: The Structure of Inequality

Inequality and Its Concentration | Two Worlds: France and the US

Inequality of Labor Income | Inequality of Capital Ownership

Merit and Inheritance in the Long Run

Global Inequality of Wealth in the 21st Century

Part Four: Regulating Capital in the Twenty-First Century

A Social State for the 21st Century | Rethinking the Progressive Income Tax

A Global Tax on Capital | The Question of the Public Debt

Conclusion: Anti-Piketty

Tuesday, May 20, 2014

Piketty: The Question of the Public Debt

A global tax on capital is the one thing needful to complete the progressive tax picture, one that would curb the spiraling explosion of large fortunes, according to Thomas Piketty in Capital in the Twenty-First Century.  Now Piketty turns towards the real elephant in the room, the public debt in the developed world that, in the aftermath of the Great Recession, is everywhere hitting 100% of national income.

Governments typically fund themselves with taxation and with debt, and taxation is more appropriate: more just and more efficient.  Debt, significantly, is normally borrowed from those with the means to lend and it must usually be paid back.  So it's "preferable to tax the wealthy rather than borrow from them."  But governments still borrow and accumulate debt, and right now the rich countries have a debt problem.

The current debt level at about one year of national income is not unprecedented: Britain's debt hit twice the national income after the Napoleonic wars and World War II.  But with national wealth hitting five and six times national income the public debt problem is not national poverty. "The rich world is rich, but the governments of the rich are poor."  And Europe is in the worst position.

There are three methods to reduce public debt: "taxes on capital, inflation, and austerity." A tax on capital would be best.
An exceptional tax on private capital is the most just and efficient solution.  Failing that, inflation can play a useful role: historically, that is now most large public debts have been dealt with. The worst solution in terms of both justice and efficiency is a prolonged dose of austerity--yet that is the course Europe is currently following.
 Right now, "national wealth in most European countries is close to six years of national income", with "60 percent of the total owned by the wealthiest 10 percent", so there's plenty of resource to solve the problem.

Since total public assets are about the same as total public debt, the European countries could solve the problem by selling the public assets to pay off the debt, and the wealthiest households "would become the direct owners of schools, hospitals, police stations, and so on."  But this is nonsense: public facilities must be owned by the public.

Piketty would prefer a one time "exceptional tax on private capital", say 15% of private wealth, enough to redeem the entire public debt.  This would be like a debt repudiation only better, because it's hard to know who will pay the cost of debt repudiation.  The tax could be progressive, even with exemptions for the first 100,000 euros. But first, the tax authorities would have to know exactly who owned what. "Without such a financial cadaster, every policy choice would be risky." If the exceptional tax idea is too radical, the debt could be retired gradually with an annual progressive tax on capital capturing about 2 percent of national income per year.

The next option is inflation.  Even a small increase in the inflation rate can "significantly reduce the real value of the public debt."  Without an exceptional tax on capital the alternative is to run a budget surplus for decades, as Britain did after the Napoleonic Wars.  In "this period British taxpayers spent more on the debt than on education."  It was good for the bondholders, but was maybe the educational deficit was "responsible for the country's decline in the decades that followed."  Should today's Europe spend several percent of national income on its debt when it only spends one percent on universities?

But inflation has "undesirable side effects." It can get out of control, and be "hard to stop."  In France after 1945 "millions of small savers were wiped out" leading to "poverty among the elderly in the 1950s."  Germany was "traumatized" by its two inflations.  On the good side, inflation penalizes "idle capital" and encourages people to put their money in "real economic assets".  But inflation is "crude and imprecise"; better to impose a progressive tax on capital.

In the middle of the inflation question are the central banks.  Back under the gold standard, central banks had limited power.  But today the central banks have potentially unlimited power to create money, and "must therefore be strictly limited."  But sometimes central banks take this strict limitation too seriously, as after the Crash of 1929 when "they refused to create the liquidity necessary to save troubled banks".  Since then "everyone agrees" that the central banks must supply liquidity to avoid financial collapse as "'lenders of last resort'".

Milton Friedman, in his Monetary History of the United States, is unequivocal: the restrictive policy of the Federal Reserve turned the stock market crash into the Great Depression. But that encouraged people to think that the only thing needful to balance the economy was a well-run Federal Reserve.  For Piketty, a "properly functioning" Fed should be a complement to "a properly functioning social state and a well-designed progressive tax policy."

In the 2007-2008 crisis the central bankers followed the new consensus and did the right thing, with only Lehman Brothers failing. But there is no consensus about the "unconventional" monetary policies following such a crisis.  Central banks can create trillions in seconds in a financial panic, but then what?  They could buy up "firms and real estate, finance the transition to renewable energy, invest in universities," etc.  But they don't, because they "lack the democratic legitimacy to try them."  So it was the federal government that bailed out General Motors and not the Federal Reserve.

But then there is the whole question of the euro, the currency without a state, epitomized by the Greece and Cyprus crises.

In Europe the recession of 2008-2009 created a sharp rise in public debt (Greece and Italy) and a deterioration in bank balance sheets (Spain). The crises are linked because banks hold government bonds of unknown value.  But the regulators don't have access to banking data, and rich people, e.g., in Greece, could avoid a capital tax by moving their assets.

Then there was the Cyprus mess.  Rich Russians deposited money in Cyprus banks, and the banks invested their money in Greek government bonds, now written down, and real estate, now worthless.  What to do?  Without proper "statistics" and "tools they need to move forward" the Troika of the EC, ECB and IMF came up with a crude tax on bank deposits in Cyprus, with the same rate on small savers and Russian oligarchs.  The Cypriots voted that down, so the first 100,000 euros of deposits was exempted from the tax.

The Cyprus episode "illustrated the limits" of central bank operations.
Their strength is that they can act quickly; their weakness is their limited capacity to correctly target the redistributions they cause to occur.
Obviously, a progressive tax on capital would have solved the problem.  But let's not forget the bigger problem.
What is deeply shocking... is that the authorities did not even seek to equip themselves with the tools needed to apportion the burden of adjustment in a just, transparent, and progressive manner. 
That's why Piketty wants a complete financial cadaster of personal wealth.

But that still does not resolve the problem of the euro, a multistate currency without a state.  How did this disaster happen?  Mainly because people thought, after the 1970s, that the central bank's job was to control inflation.  The crisis of 2008 changed all that and revealed that the current setup can't do the job.  The European Central Bank (ECB) has a unique problem because it must deal with 17 public debts and 17 national governments, but nobody thought before 2008 that interest rates could start to diverge and people would start to "speculate on national interest rates" and trigger large and destablizing capital flows.

The only way out is for the Eurozone countries to "pool their public debts."  Then the question is how to pay down the pooled debt; it would need a "European 'budgetary parliament'" different from the current European Parliament to make decisions about the debt problem in a "public, democratic, and sovereign manner".  Without such a change, or a "progressive tax on capital", the Eurozone crisis would have no end.

Another possibility is a "tax on corporate profits" and an end to tax competition in Europe.  Corporations would make a "single declaration of their profits at the European level" and be taxed in a way "less subject to manipulation" than the current system where corporations can assign profit to subsidiaries where taxes are low.  Piketty's tax on capital could be administered the same way, taxed in the nation where the business activity occurs.  The goal is to "construct a continental political authority" to control "patrimonial capitalism" and "advance the European social model".  Otherwise the current tax competition and race to the bottom will continue.

Let us now think about how much capital accumulation is appropriate for the rest of the century. Ideally we would want to eliminate the inequality r > g and (r = rate of return on capital and g = growth rate) approach the "golden rule of capital accumulation" where r = g. But that would require a capital/income ratio of 20-30 times national income.  Piketty thinks that the best option is to tax capital and reduce the inequality r > g that way.

If the golden rule on capital accumulation is misleading what about the Maastrict stipulations that "deficits would be less than 3 percent of GDP and that total public debt would remain below 60 percent of GDP"?  The rule was an attempt to finesse the problem of the stateless euro.  With a budgetary parliament, "sovereign and democratic", it would not be appropriate or necessary "to enshrine budgetary restrictions in statutory or constitutional stone."  Think of a new crisis, or conservative "constitutional judge".  Policy-makers would need the power to act.

Anyway, with Europe so rich, solving the debt problem is not that hard.  It's time for a "sovereign parliament" to make the decision: a "progressive one-time tax on capital" or inflation.

Another big issue is climate change.  Under the Stern report in 2006 governments are supposed to spend several percent of GDP per year to mitigate climate change in the future.  Should governments implement an "ecological stimulus" with interest rates so low? On this view the public debt is not such a problem. What is needed is to "increase our educational capital" and stop damage to "natural capital." But "[d]o we really know what we ought to invest in and how we should organize our effort?"  No one knows.

More broadly, it's time to develop "new forms of property and democratic control of capital" in between the "polar paradigms of purely private capital... and purely public capital".  But Piketty's real interest is to increase transparency, not merely of individual income and wealth, but the "detailed accounts of private corporations (as well as government agencies)."  Only that, and "the right to intervene in corporate decision-making" would allow democracy "someday to regain control of capitalism".

Discussion

In this chapter Thomas Piketty reveals his real agenda.  His progressive project, the "social state," has run aground and needs money to refloat itself.  Since the current sources of revenue are maxed out it's time to find a new one: a progressive tax on capital.  Since his faith declares that the lower 50 percent never has to pay, the money must come from the rich, and since their wealth is spiraling upwards out of control, it just makes sense to tap the wealthy to bring things back to normal.

Governments need money to dial back their public debt, to do useful things like expand universities and combat climate change.  But first governments need much more information about their citizens, so they can make them legible, and, though Piketty is too modest to admit it, secure the means to seize assets without warning.

A couple of quibbles.  The failure of the Fed in 1929 was that monetary policy was in the hands of political hacks that didn't know what they were doing.  Ever since Walter Bagehot's Lombard Street in the 19th century everyone knew that the central bank's role was to be the "lender of last resort" to maintain liquidity.  But the Fed of 1929 whiffed it.  And if it comes to that so did the monetary authorities of 2008.  How come that Lehman Brothers was allowed to fail?  Where was the "lender of last resort?"  Bernanke?  Paulson? The US political system wandered around for a couple of weeks getting Congress to pass the TARP bill while the financial system fell through the floor.  What was that all about?  Without the TARP delay the Crash would probably have been half as big.

Let us grant Piketty's argument, that capital accumulates, and spirals up into the moneybags of the rich, increasing already unjust inequality.  So let's increase democratic control of "patrimonial capitalism" just like he says.

Very good.  Let's open a conversation on a different argument, that elite political power accumulates, and spirals up, giving today's rather unimpressive ruling class more and more power to fix things after messes like the financial crisis of 2008.  Here's a radical idea. Let's increase democratic control of "patrimonial elitism" and curb the ever-increasing power of governments to resort to force, to regulation, and seizure in order to cover up their corruption and their incompetence.

Introduction

Part One: Income and Capital

Income and Output

End of Growth

Part Two: The Dynamics of the Capital/Income Ratio

Changes in Capital

New World Capital and Slavery

Capital/income Ratio in the Long Run

Capital's Share of Income

Part Three: The Structure of Inequality

Inequality and Its Concentration

Two Worlds: France and the US

Inequality of Labor Income

Inequality of Capital Ownership

Merit and Inheritance in the Long Run

Global Inequality of Wealth in the 21st Century

Part Four: Regulating Capital in the Twenty-First Century

A Social State for the 21st Century

Rethinking the Progressive Income Tax

A Global Tax on Capital

The Question of the Public Debt

Conclusion: Anti-Piketty

Monday, May 19, 2014

Piketty: A Gobal Tax on Capital

What is needed to stop the vice of spiraling "supermanager" compensation is an income tax rate of 80% on incomes over $500,000 to $1 million, according to Thomas Piketty in Capital in the Twenty-First Century.  Now it's time to let the other shoe drop and consider the advantage of a global tax on capital, both to raise revenue and also prevent the uncontrolled spiral of wealth inequality that Piketty has developed in previous chapters.

But how would it work?  Obviously it would require a "very high degree and no doubt unrealistic level of international cooperation."  But it would avoid dangerous capital controls and protectionism.  A global tax on capital is "an ideal form of regulation... preserving economic openness... and justly distributing the benefits among and within nations."  And all it requires is some sort of international cooperation similar to the present "automatic sharing of banking information".

The global tax on capital would be a tax on net assets, the "market value of all financial assets... and non-financial assets" like real estate.  It could be zero below 1 million euros, 1% below 5 million, and 2 percent above 5 million.  It could be made more progressive, of course, with a rate of 5-10% tax on fortunes above 1 billion euros.  The tax would differ from current "property" taxes which are taxed at a flat rate on gross value without taking debt into account.

The revenue would not be that much, 3-4% of national income, for its primary job is not to raise money but to regulate capitalism.  Its first goal is to "stop the indefinite increase of inequality of wealth". But it will also "impose effective regulation on the financial and banking system to avoid crises."
To achieve these two ends, the capital tax must first promote democratic and financial transparency: there should be clarity about who owns what assets around the world.
We need to know the "distribution of wealth." National, international and statistical organizations "would at last be able to produce reliable data about the evolution of global wealth." Needless to say, "truly democratic debate cannot proceed without reliable statistics."

The whole thing could start with a 0.1% tax on capital that amounted to a "compulsory reporting law".  People would need to make the report to be "recognized as the legal owner" of their assets as after the French Revolution.  It's all quite simple: "national tax authorities should receive all the information they need to calculate the net wealth of every citizen."  Banks already have to inform tax authorities about bank accounts; all that is needed is an expansion of this system, but it would have to overcome the objections of tax havens.  A model of this is the US Foreign Account Tax Compliance Act (FATCA).  But "automatic sanctions not only on banks but also on countries" would be needed to get universal compliance.

Once the 0.1% tax reporting law is in place, what next?  What is the point of a progressive tax on capital?  There are two: contributory and incentive.  Many wealthy people -- for instance the L'Oréal heiress -- declare income that is 1% or less of their wealth.  Taxing their capital gets to tax their real ability to contribute.  Other wealthy people are content to park their wealth in investments making at most 2-3% a year. A capital tax would force the idle rich to sell assets to more dynamic investors.  There is a caveat: a capital tax would fall heaviest on individuals and corporations experiencing losses.  Thus the tax system should balance an incentive logic (taxing capital) and an insurance logic (taxing realized income from capital).

A capital tax cannot be levied at a high rate, like the once-a-generation estate tax or the French tax on capital in 1945. But a tax in Europe maxing out at 2% per year for fortunes over 5 million euros would affect about 2.5% of people and collect about 2 percent of GDP: not enough to finance the social state, but significant.  But there must be no escape, else countries will not be able to establish a tax that raises serious money.  And only after the tax is established will it be possible to talk about higher rates on the largest fortunes.

How has capital been taxed down the ages?  The Greek philosophers "were in two minds about interest" but laws against usury usually created problems.  The church never had a problem with land rent, from which the church benefited.  It was worried about infinite accumulation, and "commercial and financial adventures" tempting people from the true faith.  With Marx and abolition of private ownership of the means of production the private rate of return on capital could be reduced to zero and was reduced to zero in the Soviet Union.  No more r > g as capital was eliminated and growth was everything.
Unfortunately... private property and the market economy do not serve solely to ensure the domination of capital over those who have nothing to sell but their labor power. They also play a useful role in coordinating the actions of millions of individuals.
In other words, without that "useful role" you find that under socialism r is zero and so is g. Piketty's tax on capital would avoid the disaster of Marxist communism while asserting control over capitalism in the name of the general interest.  The idea of a tax on wealth is nothing new; the only innovation is the progressive idea, child of the 20th century.

Is there no other way to control capitalism, such as by capital controls and protectionism?  No.  Protectionism does not deliver prosperity and does not reverse the inequality spiral.  Capital controls are another thing, since many countries need to insulate themselves from financial crisis.  China has a peculiar system, with a non-convertible currency and strict controls on incoming and outgoing capital.  Chinese billionaires cannot take their money and move to Switzerland. Its capital controls "are one way of regulating and containing the dynamics of wealth inequality."

The question of "petroleum rents" is a special problem of capitalism and inequalities.  Ideally there would be a global tax to redistribute these rents "in an equitable manner."  Since there isn't, we get redistribution in less peaceful ways, such as Middle East wars.  And we get Saudi Arabia with trillions and Egypt next door spending a mere $5 billion a year on education in a nation of 85 million people.

Of course, one way to achieve redistribution is through immigration.  The US is less unequal than Europe because it has redistributed its wealth to successive waves of immigration.  But with all the immigration in the world, the problem of inequality remains.
Redistribution through immigration postpones the problem but does not dispense with the need for a new type of regulation: a social state with progressive taxes on income and capital.
Piketty imagines that the "less advantaged members of the wealthier nations" will accede to immigration if there are institutions in place "to insure that the benefits of globalization are shared by everyone."

Discussion

In developing his idea for a global tax on capital, Thomas Piketty proposes without irony a vast new apparatus of penetration into the lives of every person on the planet.  It's necessary to peer into every life, he says, to provide proper transparency and democratic oversight of the rich.  And of course, once you have convinced yourself that inequality is the problem, that wealth accumulation without limit is already in progress, and that capitalists are sneaking away into tax havens to hide from their democratic responsibilities, then a global program of reporting and control only makes sense.

There is a counter view.  It was developed in Seeing Like a State by James C. Scott.  A state always wants to know more about its people, to make them "legible." Once the people are legible then you can tax them, control them, and conscript them into your wars.  Every state, everywhere wants to do this, and it usually does.  It seldom lacks for bribed apologists to write books making its program of power the very height of reason and justice.  And that is exactly what Thomas Piketty does, for the modern ruling class, without any sense of shame or irony.

But suppose he is wrong.  Suppose that his r > g is rubbish.  Suppose that fortunes don't increase without limit, but instead rise and fall like the tides.  Suppose that the capitalists, for all their financial power, merely get rich from giving the consumer what she wants, and lose their fortunes as soon as they fail to do so.  Suppose the real problem was politicians and their technical experts building staggeringly inefficient schools and second-class health care and paying their functionaries outrageously high salaries and pensions while letting the poor moulder away in want and ignorance.

If that were true then Piketty and his pals would be the most exploitative and unjust rulers the world has ever seen, and hanging, in the words of Agatha Christie's Captain Hastings, would be too good for them.

Introduction

Part One: Income and Capital

Income and Output

End of Growth

Part Two: The Dynamics of the Capital/Income Ratio

Changes in Capital

New World Capital and Slavery

Capital/income Ratio in the Long Run

Capital's Share of Income

Part Three: The Structure of Inequality

Inequality and Its Concentration | Two Worlds: France and the US

Inequality of Labor Income | Inequality of Capital Ownership

Merit and Inheritance in the Long Run

Global Inequality of Wealth in the 21st Century

Part Four: Regulating Capital in the Twenty-First Century

A Social State for the 21st Century | Rethinking the Progressive Income Tax

A Global Tax on Capital | The Question of the Public Debt

Conclusion: Anti-Piketty

Sunday, May 18, 2014

Piketty: Rethinking the Progressive Income Tax

The welfare or "social state" of the 20th century was and is good, according to Thomas Piketty in Capital in the Twenty-First Century  It might need a little tweaking and reorganization, but nothing like a radical conversion of pay-as-you-go pension plans into genuine savings plans to deliver real wealth to the workers.

But it is certainly appropriate to rethink the progressive income tax, born in a muddle during and after World War I and jerked around by overwrought Anglo-Saxons.

Typically we consider three types of tax: income, capital, and consumption.  Then there's a fourth, "contributions to government-sponsored social insurance programs", really special income taxes on labor.  We call a tax "proportional" if its rate is the same for everyone, progressive if it is fall more heavily on those who earn own or consume more, regressive if "its rate decreases for richer individuals".

Clearly, a progressive tax on incomes and wealth can have a big effect on inequality.  That's why inequality in the 20th century never returned to its levels in the Belle Époque.  The relaxation of progressive rates in Britain and the US after 1980 "probably explains much of the increase in the very highest incomes."  And tax competition in a world of "free-flowing capital" has led "governments to exempt capital income from the progressive income tax... in a race to the bottom", i.e., regressive taxation at the highest income levels.  In France, for example:
The bottom 50 percent of the income distribution pay a rate of 40-45 percent; the next 40 percent pay 45-50 percent; but the top 5 percent and even more the top 1 percent pay lower rates, with the top 0.1 percent paying only 35 percent.
All signs indicate that taxes elsewhere "follow a similar bell curve", and this "fiscal secession of the wealthiest" could lead the middle class to question the "social state" and ask how come they are left holding the baby.  The consequence is hardly to be borne: "Individualism and selfishness would flourish". Maintenance of a progressive tax system would also help convince the lower-skilled workers impacted by globalization to accede to free trade.

The progressive tax is "crucial". It was central in the reduction of inequality, and is needed to underpin the "social state in the future."  But today it's under attack, intellectually and politically.

The problem is that progressive taxes were introduced in the chaos of World War I and "its various purposes were not sufficiently thought through."  Piketty's chart shows tax rates in the US, Britain, France, and Germany bouncing up during and after the war, then mostly settling down in the 1920s, before ratcheting up by World War II to high levels in Europe and very high levels in the US and Britain.  In Germany and France the top income tax level slowly came down after World War II, but in Britain and the US they stayed above 90 percent from the 40s to the 60s.  Then after 1980 Britain and the US slashed their tax rates to 30-40 percent, below France and Germany.  Inheritance tax rates followed a similar trajectory, going up to 20-30 percent in France and Germany in 1920, ratcheting up to 70-80 percent in Britain and the US before starting down after 1970 and eventually rejoining the Europeans.

It was the Americans that invented the confiscatory income tax.  In the 1910s Irving Fisher, the economist, wrote in favor of a "heavy tax on the largest estates".  And the Great Depression inspired the New Dealers to sock it to the rich.  The Brits were not far behind.

Piketty's key point is that executive salaries exploded after 1980 and that this had nothing to do with greater productivity.  Tax rates were low, so corporate executives could pay themselves more and take their winnings home with them.  And they did.  In collaboration with Emanuel Saez and Stephanie Stantcheva Piketty determined that low marginal tax rates encouraged executives to bargain for "skyrocketing executive pay", that "luck" was more important than "talent", and that the marginal tax rate explains why executive pay went up in some countries and not in others.  If you don't like high executive pay, the solution is to increase executive taxes.

The solution is clear: "the only way to stem the observed increase in very high salaries" is "confiscatory rates on top incomes".  The right confiscatory rate would be about 80 percent, more or less.  Applied on incomes above $500,000 or $1 million it would not collect much in taxes; it would just keep down executive pay.  But Piketty does not expect much change.  "Without a radical shock, it seems fairly likely that the current equilibrium [on tax rates] will persist for quite some time."

Discussion

I'm inclined to accept Piketty's research that the sky-high executive salaries of the post 1980 age don't represent productivity but pure executive bargaining power.  But does it matter?

It all depends on your faith.  If you think that economic inequality is a nightmare, and likely to bring the people into the streets, then you want to do something about it.

For my part, I'm not exercised by economic inequality, but I am exercised by political inequality.  I'm charmed when I drive down A1A in South Florida and look at all the mansions.  But I don't like politicians, activists, little Hitlers, and their bribed economist apologists ordering me around.  So I'm much more inclined to go to the barricades to fight against big government and crony capitalists and billionaire hypocrites like Tom Steyer than against Bill Gates and the L'Oréal heiress.  But that's just me.

Introduction

Part One: Income and Capital

Income and Output

End of Growth

Part Two: The Dynamics of the Capital/Income Ratio

Changes in Capital

New World Capital and Slavery

Capital/income Ratio in the Long Run

Capital's Share of Income

Part Three: The Structure of Inequality

Inequality and Its Concentration

Two Worlds: France and the US

Inequality of Labor Income

Inequality of Capital Ownership

Merit and Inheritance in the Long Run

Global Inequality of Wealth in the 21st Century

Part Four: Regulating Capital in the Twenty-First Century

A Social State for the 21st Century | Rethinking the Progressive Income Tax

A Global Tax on Capital | The Question of the Public Debt

Conclusion: Anti-Piketty

Saturday, May 17, 2014

Piketty: A Social State for the 21st Century

Globally, wealth inequality might easily spiral out of control.  That's what Thomas Piketty asserts in Capital in the Twenty-First Century by assuming that the rich accumulate capital almost without limit.  Something must be done, of course, and to build his case for high taxes for the global rich on their capital and income he now proposes the outlines of a ideal "social state" for the rest of the century.
"Can we imagine a twenty-first century in which capitalism will be transcended in a more peaceful and more lasting way"?

To Piketty, the "ideal policy for avoiding an endless inegalitarian spiral... would be a progressive tax on capital."  The reports and form-filling needed for such a tax "would expose wealth to democratic scrutiny" necessary for "effective regulation" of international capital. Since a global tax is hardly likely, a "regional or continental tax might be tried".

The crisis of 2008 might have been as bad as the crash of 1929 but it wasn't because "this time the governments and central banks... agreed to create the liquidity" necessary to avoid the widespread bank failures of the 1929-33 collapse. There were no "liquidationists" like President Hoover this time.  But the response to the crisis did not resolve the problems -- lack of transparency and inequality -- that led to the "first crisis of the globalized patrimonial capitalism of the twenty-first century."

Of course there is enormous disagreement about what to do, and those that want to increase the role of the state are hindered by its current "level of complexity".  If nobody understands what the modern state is doing how can reformers persuade citizens that "new tools" are needed? So Piketty undertakes to tell us the social democratic Story So Far.

In the 70 years after 1910, taxation in the rich countries went from a steady level of 10% of national income to new higher levels: 55% in Sweden, 50% in France, 40% in Britain, and 30% in the United States.  See chart.  At 10%, taxation supported a "regalian" state with "police, courts, army, foreign affairs, general administration". At the new stabilized levels government provides an array of services that breaks down into two major sectors: "one half goes to health and education, the other to replacement incomes and transfer payments."  The first half covers much of the cost of education and health care; the second part mostly goes to pensions.  In Europe "public pensions are the main source of income for at least two-thirds of retirees".  The remainder of the transfer payments go for unemployment and other income support, but this is the most controversial, with welfare questioned in both the US and Europe.  All told, state spending on health and education can hit 10-15% of national income and transfer payments 10-20% of national income. This amounts to the establishment of a "social state."

The social state of the 20th century was built on a foundation of rights, writes Piketty.
Modern redistribution is built around a logic of rights and a principle of equal access to a certain number of goods deemed to be fundamental.
The classic articulation of these rights can be found in the US Declaration of Independence of 1776 and the French Declaration of the Rights of Man and the Citizen of 1789.  For Piketty, the "statement that 'social distinctions can be based only on common utility'" is decisive, if "broadly" interpreted.  Actually everyone agrees working for "real improvement in the living conditions of the least advantaged".  The disagreement is how to do it "through democratic deliberation and political confrontation."  But whatever the disagreements, the modern state "is based on a set of fundamental rights" to education, health, and retirement." No important political force proposes paring down the state to "its regalian functions" at 10-20% of national income.  But few people support expanding the social state at its 1920-1980 growth rate.  When income was increasing at 5% a year it was easy to get people to agree to social spending; not so when growth is much smaller.

There is a need for a fairer tax system and there are growing needs for education and health, but people also have real personal needs.  And a large public sector has "serious problems of organization."  Issues of organization are legitimate but beyond the scope of the book.  Piketty proposes only to discuss access to education and the future of pay-as-you-go retirement systems.

Supposedly, state education is to promote social mobility.  But does it?  It's hard to measure, but generational mobility seems highest in Scandinavia and lowest in the United States, the land of "American exceptionalism".  Perhaps this is due to high tuition fees at elite US universities.  Income for Harvard parents is currently $450,000 per year, in the top 2%; parents of Sciences Po students (Institut d'études politiques de Paris) earn €90,000, putting them in the top 10% in France. National meritocracy doesn't seem to hold up on examination of the facts.

Now for retirement. Today's PAYGO retirements systems are based on a "principle of intergenerational solidarity" where "today's workers pay benefits to today's retirees in the hope that their children will pay their benefits tomorrow".  But these systems are facing problems from the falling growth rate while the return from capital goes up. Piketty rejects the idea that the PAYGO systems should be replaced by a capitalized system where worker contributions are invested rather than paid out immediately to retirees. Firstly, the generation of retirees in the middle "is left with nothing."  Then he worries "that the return on capital is in practice extremely volatile."  It would "bet everything on a roll of the dice."  A PAYGO system based on wage growth would be "5-10 times less volatile" than one based on capital appreciation. With the French system so complex, the important thing to do is "to establish a unified retirement scheme" with equal rights for everyone.

In the emerging countries there is a real question whether they can create the social state enjoyed by the rich countries, but part of the blame lies with rich countries.  First there was the disaster of decolonization and then the post-1980 neo-liberal wave "forced poor countries to cut their public sectors".  At any rate, today's poor countries seem to have difficulty moving to the high-tax state of the rich countries.

Discussion

The postmodernists have taught us that "narratives" are usually an apology for power.  Thomas Piketty, graduate of a "grande ecole" and darling of the French establishment, is nothing if not good at pushing the center-left official French narrative.  So the Crash of 2008 is the fault of capitalism and the growth of the welfare state is a program of rights not a cynical grand strategy of power by the emerging educated ruling class.

Piketty's analysis of crashes is disappointing.  It's true that the Federal Reserve System (not President Hoover) failed in its task as a lender of last resort.  Perhaps that's because it was staffed by political place-men instead of people that had read Walter Bagehot's Lombard Street. Back in the Crash of 2007, banker J.P. Morgan got the richest men in the US into a room and got them to fund his triage plan: no money for winners, no money for losers, but help for companies that could be saved by an injection of capital.  But Piketty seems to have no clue about the follies of the 2000s Fed lashed to the time-bombs of Fannie and Freddie.  These geniuses, bullied by the political ruling class, were forcing the banks to lend low down-payment loans to sub-prime borrowers.

If, for instance, the education system, that was supposed to deliver social mobility, has failed then maybe the problem is with government-run education.

If "divergence", the notion of the rich getting richer because they make so much money on their filthy capital, is a problem, then maybe the answer is to get the working class into the game with a true retirement savings program that build actual personal capital and -- cover your eyes, girls -- lets them will actual red-in-tooth-and-claw capital to their children when they die.  But no, Piketty can't get past the transition problem between a pay-as-you-go system and a capitalized system.  And the risk!

I've actually thought about these issues.  First, education.  Back before government education young people without fortune didn't moulder away their teenage years in schools being drugged out of their gourds to keep them quiet.  They went out into the world and worked at apprenticeships.  They worked for nearly nothing while they learned a trade.  Imagine!

Second, pensions.  The current system sequesters the savings of workers for their entire working life.  There is a word for this, and maybe slavery is too strong a word.  But "indentured servitude" isn't too far off the mark.  What about volatility and risk?  It's really not that hard.  If you want to retire, say, at the bottom of the market in 2009, you say to yourself: forget it, I must keep working for a couple of years until the economy and the stock market improves.  How hard is that?  It is a system of real intergenerational solidarity where people don't retire until they can support themselves as rentiers.  If the economy is toast, and stays that way, it means that nobody can retire; everyone must work and contribute to get the economy back on track.

Come on lefties!  If the rich are getting rich on their stinking riches, because r > g, how about giving the wage workers a chance at stinking riches and a shot at the magic of compound interest?  The workers have nothing to lose but their chains!

Introduction

Part One: Income and Capital

Income and Output

End of Growth

Part Two: The Dynamics of the Capital/Income Ratio

Changes in Capital

New World Capital and Slavery

Capital/income Ratio in the Long Run

Capital's Share of Income

Part Three: The Structure of Inequality

Inequality and Its Concentration

Two Worlds: France and the US

Inequality of Labor Income

Inequality of Capital Ownership

Merit and Inheritance in the Long Run

Global Inequality of Wealth in the 21st Century

Part Four: Regulating Capital in the Twenty-First Century

A Social State for the 21st Century | Rethinking the Progressive Income Tax

A Global Tax on Capital | The Question of the Public Debt

Conclusion: Anti-Piketty

Friday, May 16, 2014

Piketty: Global Inequality of Wealth in the 21st Century

Mostly, under advanced capitalism, people get rich by inheritance, writes Thomas Piketty in Capital in the Twenty-First Century.  In other words, inequality of wealth is perpetuated by inheritance. Now he turns to the question of global wealth inequality.  "Is there a danger that the forces of financial globalization" will lead to an unprecedented "concentration of capital"?  Unfortunately we lack global wealth data equivalent to the French record-keeping inspired by the French Revolution, so Piketty will examine global wealth through proxies, like magazine rankings of rich businessmen and fragmentary data on sovereign wealth funds and US university endowments.

You would think that capital is capital, and that "the return on capital is the same for all owners".  But Piketty will show that there are economies of scale in wealth, and that richer capitalists get a bigger return than small capitalists, and that "such a mechanism can automatically lead to a radical divergence in the distribution of capital."  Piketty appeals once again to his r > g inequality.

According to Forbes magazine's annual list of billionaires published since 1987 there were "over 140 billionaires in 1987" but "more than 1,400" in 2013.  A Japanese billionaire led the list in the late 1980s, an American in the late 1990s.  Since 2010 the richest billionaire has been a Mexican.  And those billionaires have been making billions on their billions. Piketty shows a table in which the top wealth holders have made a post inflation 6.8% per year on their money while the average world wealth per adult has gone up 2.1% a year.  So the share of the global richest has been going up.  Where could this end?  How about "impoverishment of the middle class", "explosive trajectories and uncontrolled inegalitarian spirals."

In his analysis of the Forbes rankings Piketty intuits that "all large fortunes" grow at extremely high rates.  Entrepreneur Bill Gates went from $4 billion to $50 billion, and L'Oréal heiress Liliane Bettencourt -- "who never worked a day in her life" -- went from $2 billion to $25 billion.  That's 11% rate of return after inflation.  Beyond a certain size "capital grows according to a dynamic of its own", maybe for decades and "nearly all the income on this capital can be plowed back into investment."

There isn't much data for global wealth, but Piketty estimates that "inherited wealth accounts for more than half of the total amount of the largest fortunes worldwide."  Regardless of "sterile debate about merit and wealth" "fortunes can grow and perpetuate themselves beyond all reasonable limits" and justification in "social utility." An entrepreneur may have amazing ideas at 40, but hardly any at 90, and forget the children.  So a "progressive annual tax on the largest fortunes worldwide" would control a "potentially explosive process."  The return on capital comes partly from "true entrepreneurial labor... pure luck... and outright theft" as suggested by examples from Carlos Slim, Bill Gates, and Lakshmi Mittal.   It is arbitrary.  "[P]roperty sometimes begins with theft, and the arbitrary return on capital can easily perpetuate the initial crime."

It's not just big businessmen that get outsized returns on capital.  The endowments of US universities averaged a real rate of return of 8.2% from 1980 to 2010.  And the biggest earned the most, with Harvard, Yale and Princeton coming in at a return of 10.2%.  The reason the biggest do the best seems to be that they employ more sophisticated investment strategies, "such as shares in private equity funds and unlisted foreign stocks... hedge funds, derivatives," etc. Harvard, with an endowment of $30 billion, spends $100 million a year managing its portfolio.  Of course, the very high returns of 1980-2010 may not continue. But, for Piketty, the institutions have one up on family wealth because of the "ability to choose the right managers."  Families end up sooner or later with the prodigal son.

How does inflation enter into all this?  Probably by helping the people that can afford professional help on their investments, so inflation probably works against the small investor.  But not enough to justify "a return to the gold standard or zero inflation."

Today there are a number of sovereign wealth funds generally in oil-rich states, from Norway with $700 billion in assets to less transparent funds in the Persian Gulf.  According to estimates there is $5.3 trillion in these funds, compared with $5.4 trillion owned by the Forbes billionaires. It is natural to worry that these sovereign wealth funds might end up owning the world, and it is natural for people to fear this, particularly as today's $100 a barrel oil "could rise as high as $200 a barrel by 2020-2030." But these funds have already "begun to limit their foreign investments" and spend money at home.

What about China and India?  Could they end up owning the world?  Probably not, because they "have large populations whose needs... remain far from satisfied."  But imagine China saving 20% of national income until 2100!  Then a large part of the world "could be owned by enormous Chinese pension funds."

Really, the specter of oil and China owning the world is less threatening than "oligarchic" divergence, with countries owned by their own billionaires as the rich pull ahead of the rest.  People in Paris think that "rich foreign buyers" are buying up all the real estate in the city.  Actually, it is rich French buyers.  So it is the spending of the domestic rich that creates a sense of "dispossession" and "helplessness" that could be tapped by the government of the EU.  And don't forget that a substantial fraction of global wealth is hidden away in tax havens.

Discussion

The problem with Piketty's notion of "divergence," of the rich making money hand over fist forever, is that it fails the sanity test. Capitalists make money by financing world-beating innovations that billions of people want to buy.  When they stop coming up with world-beating innovations they stop making money. Bill Gates became rich because PCs running his operating system on a $2,000 computer could do financial spreadsheets incomparably better than a minicomputer costing $30,000.  But now Microsoft is struggling because people are migrating from the desktop computer to the smartphone and the tablet and Microsoft is left playing catch-up.  There is no rate of return on capital when it is used to finance an idea that fails to deliver.

And as for the idea that university foundations and sovereign wealth funds have a leg up on the rest of us with their top-notch professional managers, what about the geniuses at Fannie and Freddie?  What about the big banks that went bust in 2008?  What about the state government pension funds that lost half a trillion dollars in 2008-09?  And what about a middling sort of capitalist like me?  I just ran the numbers on Quicken and my net worth has increased at 8.75% after inflation from 1987 to 2013.  So I'm doing better than Forbes' loser billionaires and their paltry 6.8%!

The bottom line is that the only way for billionaires to make tons of money -- other than by cronying up to governments -- is by coming up with brilliant ideas that people want to buy. What is Piketty's problem with that?

Introduction

Part One: Income and Capital

Income and Output

End of Growth

Part Two: The Dynamics of the Capital/Income Ratio

Changes in Capital

New World Capital and Slavery

Capital/income Ratio in the Long Run

Capital's Share of Income

Part Three: The Structure of Inequality

Inequality and Its Concentration

Two Worlds: France and the US

Inequality of Labor Income

Inequality of Capital Ownership

Merit and Inheritance in the Long Run

Global Inequality of Wealth in the 21st Century

Part Four: Regulating Capital in the Twenty-First Century

A Social State for the 21st Century

Rethinking the Progressive Income Tax

A Global Tax on Capital

The Question of the Public Debt

Conclusion

Thursday, May 15, 2014

Piketty: Merit and Inheritance in the Long Run

The ownership of capital is getting more unequal every day, and may end up as bad as the years before World War I writes Thomas Piketty in Capital in the Twenty-First Century. But how do people get to own capital?  By savings or inheritance?  In Piketty's view it is mostly by inheritance.  So nothing has changed since Jane Austen and Balzac.

Here is his argument:
Whenever the rate of return on capital is significantly and durably higher than the growth rate of the economy, it is all but inevitable that inheritance (wealth accumulated in the past) predominates over saving (wealth accumulated in the present).  
So, "the inequality r > g in one sense implies that the past tends to devour the future". (See Discussion in Inequality of Capital Ownership where Piketty gets to this position by whiffing the measured phenomenon of time preference as "theory" "tautology" and "simplistic").

On this view "inheritance will... probably again be as important as it was in the nineteenth century", provided that demographic and economic growth slow, as Piketty expects.  Of course it won't be quite the same, because there will be more medium rentiers and supermanagers to reduce the share of the very wealthy, although this won't help the "low- and medium-wage workers".

Piketty now produces another chart, of inheritance and gifts in France as a percent of national income from 1820 to 2010.  Inheritances amounted to about 20% of national income in 1820, rose to 24% in 1880 to 1900 and plunged to 8% in 1920 after World War I.  After World War II inheritances collapsed again to 4% of national income and then began a slow rise to about 14% today.  Piketty has two ways of computing this, by "fiscal flow" and "economic flow"; economic flow comes in a little higher than fiscal flow.

Now Piketty comes up with another identity to show what is going on with inheritance.
Annual flow of inheritance = (average wealth at death)/(average wealth of living) * (mortality rate) * (capital/income ratio)  
For instance, if the dying are twice as wealthy as the living, and two percent of the living die each year, then four percent of the national wealth gets transferred each year.  If you factor in Piketty's capital/income ratio at 600% then you get 24% of the national income transferred by gift and inheritance per year.

In Modigliani's life-cycle theory of wealth the average wealth at death would be almost zero because the aged would all live on "annuitized wealth" from pension funds or insurance.  But they don't.  The chart shows that people are not turning their wealth into annuities, as people thought they would do in the mid 20th century.  They are saving it and giving it to their children.

Another reason people give for discounting the importance of inheritance is that people live longer: that should reduce the size of legacies.  In fact it doesn't seem to make much difference.  When people die later they leave more to their legatees.  In fact people do not save just for retirement.  They also save to leave wealth to their children both in death and with gifts during life.  Gifts made during life, in France, have increased substantially since 1980.

Piketty shows us an interesting table showing the age-wealth profile by decade in France.  Under normal conditions people get richer the older they get, right up into their 80s.  In 2010 twentysomethings in France owned about 25% of the average 50-60 year-old.  By their 80s they were worth 134% of the average fiftysomething!  The only exception to this rule was the "rejuvenation of wealth" from the shocks to capital and owners in 1914-45.  The war years cleaned out the capitalists, so that in 1947 in France the average 80-something owned 67% of the wealth of the average fiftysomething.

So what about inheritance in the future? This is where Piketty's inequality r > g comes in.  If the rate of return on capital is low he expects the inheritance level to flatten out at 16% of national income.  But if the rate of return on capital is high then his chart shows that the inheritance level could climb back up to the level at the end of the 19th century.

Piketty's numbers allow him to come up with a chart of the cumulated value of inherited wealth as a percent of the total wealth of the living.  It's about 85% in 1850 and rises to nearly 90% by 1910.  The inherited share of wealth collapsed to 45% in 1970, but now it is climbing again, back up to 67% in 2010.  Piketty forecasts it leveling out at 80% by 2100 if the rate of return on capital is low, or 92% if the rate of return on capital is high.

Piketty takes a look at what the mid-century collapse in inheritance has meant to actual people in a chart of inheritances for each age cohort.  Basic advice: don't be born between 1900 and 1920, because you won't get to inherit much.  (This rings true, because my father's family in Russia was wiped out by World War I and the Bolshevik Revolution, and my mother's family in Japan was wiped out by World War II).  Thus, in another chart, Piketty shows that the best way to succeed in life for those born between 1890 and 1970 was to get a job.  For the rest of us, Piketty shows that it pays to follow the criminal Vautrin's advice to the young penniless aristocrat de Rastignac in Père Goriot and marry a rich heiress!

Thus, Piketty can say, if the capital/income ratio goes much above 300% you will get a society in which "top incomes from capital will predominate over top incomes from labor by a wide margin."  And you will get a Jane Austen/Balzac/Henry James world where ambitious people are looking for inherited money to marry rather than a greasy career pole to climb.

Even though inheritance is returning to its 19th century importance the culture still celebrates a "hierarchy of labor and human capital", as in TV programs like House, Bones, and West Wing, celebrating a "just inequality, based on merit, education, and the social utility of elites."  This cultural meme is based on two misunderstandings.  First, inheritance has not disappeared; inheritance is back.  Second, there is r > g, that capital growth overwhelms income growth.  Human capital will get overwhelmed by non-human capital.

So much for inheritance in France.  What about the rest of the world?  Piketty shows that inheritance is up in Germany, but not as much, perhaps, in Britain.  In the United States the data is not too good, and demographic growth means that inheritance must be a lower factor than in Europe.  But don't be fooled: "inheritance also plays an important role in the United States."

Discussion

Piketty's picture of inheritance shows that, when you use up all of a nation's capital in war and revolution everyone has to get to work and rebuild what was destroyed.  That, you'd think, would be obvious.

But Piketty affects to be shocked that people are still people.  They work to provide for their families, and when they die they want a chunk of wealth to go to their children.  After a disaster, like 1914-45 people work to rebuild what was lost.  No kidding!

The invidious part of his analysis is the unspoken assumption that the top 1% of 1810 that passes on fortunes to their heirs is the same 1% that passes on wealth to their heirs in 1910.  I doubt it.  If we take, e.g., the Churchills, we see the warrior of 1700 raised to great wealth.  But 200 years later Lord Randolph Churchill had to marry a Wall Street heiress, Jenny Jerome, in order to stay in politics.  Today, the Churchill family has reverted to the mean.  The fact that the capital/income ratio has returned roughly to the level it showed back before 1914 is probably not a scandal.  It is probably just the way that advanced capitalism (aka free enterprise) works.

Piketty's model also contradicts the findings of sociologists that Thomas J. Stanley and William D. Danko popularized in The Millionaire Next Door. Millionaires are typically people that have built up a few nondescript businesses by luck and hard work and modest living.  But they worry about their children; they don't want them to become wasters.  So they push them through school into the professions, because they know that a professional life supported by a salary is not as risky as a business life supported by an ever evanescent profit.

Introduction

Part One: Income and Capital

Income and Output

End of Growth

Part Two: The Dynamics of the Capital/Income Ratio

Changes in Capital

New World Capital and Slavery

Capital/income Ratio in the Long Run

Capital's Share of Income

Part Three: The Structure of Inequality

Inequality and Its Concentration

Two Worlds: France and the US

Inequality of Labor Income

Inequality of Capital Ownership

Merit and Inheritance in the Long Run

Global Inequality of Wealth in the 21st Century

Part Four: Regulating Capital in the Twenty-First Century

A Social State for the 21st Century

Rethinking the Progressive Income Tax

A Global Tax on Capital

The Question of the Public Debt

Conclusion

Wednesday, May 14, 2014

Piketty: Inequality of Capital Ownership

Labor income inequality is on the rise again, according to Thomas Piketty in Capital in the Twenty-First Century. Now he looks at capital inequality since the turn of the 19th century.  This is important because the compression of inequality in the 20th century came from a "collapse of high incomes from capital."

Wealth is always more concentrated that income. Down the ages the "least wealthy half... own virtually nothing".  Generally the top 10% own 60% or more of the wealth and the folks in the middle from 5% to 35%.  The significance of the modern era is the emergence of a "patrimonial middle class" owning between 25% and 33% of national wealth.  How did this middle class emerge?

Of course, it is difficult to estimate historical wealth trends because France only started to record property transfers after the Revolution and Britain and the US a century later after the shock of World War I.  Piketty shows the wealth of the top 10% and 1% in France from 1810 to the present in a chart. It shows wealth inequality going up in France throughout the 19th century.  The top 10% owned 80% of wealth in 1810 and 89% of wealth by 1910.  The top 1% owned 46% of wealth in 1810 and 60% by 1910.

Now, of course, the content of wealth was totally transformed over this period, with land being replaced by "industrial and financial capital and real estate" -- not to mention vast political changes -- but the capital/income ratio stayed pretty constant throughout.

Then came the world wars and the top 10% wealth share in France declined from 89% in 1910 to 62% in 1970 and then started a slow recovery.  For the top 1% wealth declined from 60% to 22% over the same period, recovering to about 24% by 2010.

Wealth inequality in Britain and Sweden followed a similar path, but the US started with less inequality and ended up with more as you can see in the following tables from Piketty's charts.

Wealth Share of the Top 10%
Country1810191019702010
France80%  89%  62%  63%
Britain83%92%64%70%
Sweden83%88%54%59%
United States58%81%65%71%

So you can see that the US started out more equal and ended up more unequal.  Now let's look at the top 1%.

Wealth Share of the Top 1%
Country1810191019702010
France46%  60%  22%  24%
Britain55%69%22%28%
Sweden57%61%18%21%
United States26%45%29%33%

Piketty wants to ask why wealth inequality was so extreme before World War I, and why is it today significantly below its high.  Is this "irreversible?"  In any case, we clearly see the emergence of a "patrimonial middle class" with about 33% share of the wealth.

Now we come to the center of Thomas Piketty's argument.
The primary reason for the hyperconcentration of wealth... prior to World War I... is that these were low-growth societies in which the rate of return on capital was markedly and durably higher than the rate of growth.
Or, as Piketty likes to show in the following inequality: r > g.

In a world of low growth, say 0.5% to 1% per year, the rate of return on capital is much higher, say 4% to 5% per year. If the capitalist saves a good part of his income, his capital can grow faster than the economy.
For example, if g=1% and r=5%, saving one-fifth of the income from capital... is enough to ensure that the capital inherited from the previous generation grows at the same rate as the economy.  If one saves more... then one's fortune will increase more rapidly than the economy, and inequality of wealth will tend to increase[.]
Piketty shows a couple of charts here and here to show the history of r and in France in the 19th century. They shows that the rate of return on capital is typically "10 to 20 times greater than the rate of growth of output (and income)."  He shows a chart of r and g since antiquity that forecasts r and g through 2100.  In another chart, Piketty forecasts that the return on capital, which collapsed in the 20th century, will return by 2200 to near historical levels while economic growth declines.  This is not a "plausible hypothesis, precisely because its inegalitarian consequences would be considerable and would probably not be tolerated indefinitely."

But what about "time preference"?  Isn't the rate of return on capital mostly time preference, "that measures how impatient they are and how they take the future into account"?  Well, yes, but this "theory" is "somewhat tautological".
[A]ssuming a zero-growth economy, it is not surprising to discover that the rate of return on capital must equal the time preference[.]
The problem is that the time preference theory "is too simplistic and systematic" because we can't reduce all savings behavior to one parameter.  And it requires that during rapid growth the gap between r and should be greater than during zero growth. There are a lot of other things to consider, including "precautionary savings, life-cycle effects" and the prestige of wealth itself.

On the validity of Piketty's ideas, that the inequality r > g allows the capitalists to increase their share of wealth without limit, and that time preference is just one of many factors in the rate of return on capital, hangs the entire argument of Capital.  See the Discussion below.

Of course, Piketty admits, if the capitalists save without limit, the only thing that can avoid "an indefinite inegalitarian spiral" is that eventually, the rate of return on capital would go down.  But this could "take decades to operate."  Alternatively "shocks of various kinds" whether demographic or economic, can deplete capital.  No doubt that's why many aristocratic societies were based on primogeniture "to conserve the family's wealth."  Since 1800, of course, western societies have progressively abandoned primogeniture.

Primogeniture was abolished in the French Revolution, but inequality in France continued for another century.  That's where the inequality r > g comes in.  When the rate of return of capital is as high as it was in France in the 19th century you can expect an increase in inequality.  And beyond a certain threshold "inequality of wealth will increase without limit".

In the event, though, inequality today is still less that the peak at the end of the 19th century.  Why is that?  Piketty admits that he doesn't have a good answer to this.  Obviously the shocks of 1914 to 1945 destroyed a lot of wealth, and probate records show that many rentiers failed to reduce their expenditure to match their reduced income.  And many of the largest fortunes were plundered by expropriation, as with the nationalization of the Renault fortune after World War II and the French "national solidarity tax" of 1945.

One answer is that "governments in the twentieth century began taxing capital and its income at significant rates" and also taxed estates.  The highest estate tax in Germany is "15-20 percent, compared with 30-40 percent in France" and 50 percent in the United States.

Piketty does not expect inequality to return to the level of the Belle Époque, principally because he expects the return on capital to come down and the rate of growth to stay high compared to pre-modern rates.

But if there are no shocks from war and if the taxation of capital and high incomes continue to come down then there is a "high risk" of inequalities of wealth returning to the extremes of the Belle Époque at the turn of the 20th century.

Discussion

Piketty argues that his inequality r > g means that when the rate of return on capital is a lot bigger than the rate of growth then inequality can increase without limit, because if the capitalists save a decent part of their capital income their share of wealth keeps going up.  But this is belied by his own numbers.

  1. He shows that the return on capital was about 4.5% for centuries before the modern growth spurt.  This implies, according to his way of looking at things, that it takes more than 4.5% return to spark any growth at all.
  2. If you look at the history, the aristocracy didn't see wealth as something to be increased by savings.  They saw their wealth as a necessary support of their political power and they typically used their wealth for that purpose.  Savings was something you did in the generational tournament of acres where the fortunate increased their land ownership by an arranged marriage.  The idea was to combine the acres of the eldest son with a rich heiress.  She could be a young woman with a large dowry or she could be the beneficiary, like Trollope's Lady Glencora, of a family without a male heir.
Piketty rather carelessly brushes off time preference as a tautology and a "theory," and simplistic to boot.  In fact researchers have studied time preference not just theoreetically, but empirically in actual human experiments.  Here is Nicholas Wade in A Troublesome Inheritance introducing the idea.
When inflation and risk are subtracted, an interest rate reflects the compensation that a person will demand to postpone immediate gratification by postponing consumption of a good from now to a future date.
This business of time preference is extreme in young children, a demonstrated in Walter Mischel's marshmallow test, where young children were offered a choice between "one marshmallow now or two in fifteen minutes."
[T]hose able to hold out for a larger reward had higher SAT scores and social competence in later life... American six-year-olds, for instance, have a time preference of about 3% per day, or 150% per month; this is the extra reward they must be offered to delay instant gratification.
According to Wade, society's time preference has been about 10% per year down to 1400 AD. "Interest rates then entered a period of steady decline, reaching about 3% by 1850." Note that Piketty's chart asserts that the rate of return on capital was 4.5% from antiquity until 1800.

Obviously Thomas Piketty must brush aside the notion of time preference.  Otherwise his entire thesis collapses.

Introduction

Part One: Income and Capital

Income and Output

Growth

Part Two: The Dynamics of the Capital/Income Ratio

Changes in Capital

New World Capital and Slavery

Capital/income Ratio in the Long Run

Capital's Share of Income

Part Three: The Structure of Inequality

Inequality and Its Concentration

Two Worlds: France and the US

Inequality of Labor Income

Inequality of Capital Ownership

Merit and Inheritance in the Long Run

Global Inequality of Wealth in the 21st Century

Part Four: Regulating Capital in the Twenty-First Century

A Social State for the 21st Century

Rethinking the Progressive Income Tax

A Global Tax on Capital

The Question of the Public Debt

Conclusion