Thomas Piketty is a pretty famous man right now. A French economist, Piketty catapulted himself into the limelight with his book Capital In The Twenty-First Century, which was published last August in French and in April in English. The book is a data-based discussion of wealth inequality in Europe and the U.S. over the past three centuries, and it makes an argument that strikes at the heart of economic and social policy.
Piketty’s main theme is that income and wealth inequality is not a bug in the capitalist operating system, but a feature. That is, it’s not a mistake that capitalism tends to concentrate wealth in the hands of the skilled, talented, and fortunate. And, as most economists would argue, this is not necessarily a bad thing. After all, monetary incentive is a powerful motivator for entrepreneurs, and the market mechanism is an efficient allocator of resources — the success of the American economy is a testament to the power of free market capitalism, and one of the features of free market capitalism is inequality.
But ending the conversation here would be neglectful. Even a cursory examination of income and wealth distribution in the U.S. shows not just inequality, but gross inequality. And, more to the point, inequality is increasing due in large part to the advantages that wealth (specifically, capital, financial or otherwise) provides the already wealthy. Worst of all, if we assume that Piketty is right and that the over-concentration of wealth is a real and present danger, then all but the super wealthy will suffer if the trend is left unchecked.
Here are a couple of ways that wealth is being concentrated.
1. Insufficient taxation
“Tax” is an ugly word, no matter where you fall on the income or wealth spectrum. Arguably, it is most ugly to an anarchist or libertarian, less ugly to conservatives, and least ugly to liberals, but there is at least one common thread linking everybody together: Pretty much everybody believes that the current tax mechanism sucks.
At best, the U.S. tax system is inefficient and ineffective. Not only is the collection of taxes a pain in the ass for both parties — enforcement on the one hand and compliance on the other — but there is little consensus about what should be taxed and by how much, as well as what the revenue should be spent on. The byzantine U.S. tax code is a common enemy to policymakers on both the left and the right. Everybody wants it changed, but there is just little agreement about how that should be done.
Take the issue of taxes on the wealthy. In the past few years, Democrats have championed the creation of a new top income tax bracket of 39.6 percent. The movement to increase the top income tax bracket was born out of a desire that those with the most should pay “their fair share.” Taken broadly, this seems fine, but what share is actually fair is hotly contested, and the actual rate is subject to change periodically. In the U.S., the top personal income tax bracket has swung in a range between 7 percent and 91 percent.
Piketty suggests that the current 39.6 percent is insufficient to prevent the over-concentration of wealth among those with high incomes or with lots of wealth. In order to avoid the over-concentration, Piketty argues that governments should crank the top tax rate up as high as 80 percent and institute a 2 percent wealth tax. If Piketty’s target is in the ballpark, then the current tax scheme is still a long way from “fair.”
Here’s an overly simplified but hopefully illustrative exercise: Imagine you are a chef. Your business is the production of food, and let’s say it costs $5 worth of material and 20 minutes to produce one meal. One way to set a price on your meals is as a function of these costs plus whatever profit margin you could get away with.
Now imagine that someone moves in next door who can produce a good substitute at lower cost. For example, that person could use the same material but do the work in less time, or the newcomer could find a way to procure cheaper ingredients. If the goods are truly substitutes and one costs less, the invisible hand of the market will soon be pulling the shutters on the chef with the higher prices unless he or she innovates. This is competition, which is generally a good thing.
However, competition can also back business owners into a corner. Faced with failure, people can employ dubious tactics, one of which deals with the transfer of costs onto a third party. Perhaps the most easily accessible example of this is pollution.
Theoretically, price should reflect all costs. When external costs are not taken into consideration or are improperly calculated, then producers can earn profits in excess of what is socially optimal. That is, a few could increase wealth at the expense of the many.
Externalization also affects risk related to financial capital, an issue that was at the heart of the financial crisis. Through perversion, corruption, or incompetence, financial engineers were able to design and build products that seemed to magically dispel risk. In reality, risk was simply transferred and then often just ignored.
3. The rate of return on capital
This is an overly simplified synopsis, but in his book, Piketty advances the idea that there is a fundamental divergent force within capitalism that, if left unchecked, will produce greater and greater wealth inequality. This inequality can be summed up as r > g, where “r” is the rate of return on capital and “g” is the rate of economic growth. If the rate of return on capital is greater than economic growth, then those who have already accumulated capital will be able to grow their wealth at a rate faster than the economy at large, claiming an increasingly large share while leaving less and less to those without capital.
A March presentation by Emmanual Saez of the University of California, Berkeley and Gabriel Zucman of the London School of Economics and UC Berkeley provides a good and timely overview of the wealth situation in the U.S., putting additional data behind Piketty’s argument. Slides from that presentation are below.