In his book, Capital in the 21st Century, economist Thomas Piketty describes the history of inequality in the 19th and 20th century and forecasts what the current situation implies for the future. The data he uses show that income inequality has increased significantly in the rich countries since the 1970s, especially in the United States. This is the consequence of r > g: the return on capital is higher than the economic growth rate. This causes the inequality gap between the ‘capital’ and the ‘labour’ to grow. The book urges that it is time to take measures and design policies to narrow down the inequality gap to avoid severe problems in the future. In that sense, his analysis is highly political.
What is the problem?
One of Piketty’s conclusions is that the dynamics of wealth distribution show that there are mechanisms pushing alternately towards divergence and convergence. The prevailing theory about inequality states there will eventually be convergence between the highest and lowest end of the distribution. According to this theory, inequality looks like a bell curve (Kuznets curve): increasing when a poor country experiences rapid economic growth, decreasing when the country is rich and has a more stable economic growth rate. Piketty shows that there is no natural force leading to more equality in the long run. His data point to a diverging wealth distribution, with 1914-1945 as a short period of convergence.
As Piketty stated in this interview, not only the shocks of the wars brought about this convergence, but also the pressure of communism. Fearing a pending dominance of communist ideology, elites agreed on compromises, such as increased expenditure on education and the institution of income tax. The lack of a natural economic force leading to convergence implies that political action is necessary to prevent diverging and destabilizing forces to prevail permanently. When a society is very unequal, it becomes instable. This instability can lead to a revolution. To avoid this, capitalism needs to be transcended in a more peaceful and lasting way.
What is the proposed solution?
Piketty suggests that an international progressive tax on capital would help in the quest for more equality. But he adds another important benefit to taxing capital globally: more economic transparency. Because everyone would be required to report ownership of capital assets to the world’s financial authorities, the capital tax would also provide a cadastral financial survey. Because it would become public knowledge who owns what, wealth would be more exposed to democratic scrutiny than it is now.
The focus in our tax system is usually on income rather than wealth. Taxing income has become dominant in the tax systems of our societies, while capital is not always taxed, and rarely progressively. However, wealth is an important factor for inequality. Inherited wealth, for example, becomes more and more important. For the baby-boom generation it was not an issue yet. For the generations born in the 1970s and 1980s, however, inherited wealth plays an important role in the ability of families to buy real estate and finance education for their children. This is the consequence of r > g.
In most countries the tax system is regressive at the top. For example in France in 2010, the bottom 50% of the income distribution paid a tax rate of around 40-45%, and the next 40% pay 45-50%. From there it regressed, until the top 0.1% only paid 35%. This means the tax burden is the heaviest on the middle class, as a consequence of the importance of income tax. This feels socially unjust. When a progressive tax on capital would be implemented, the overall burden would become the heaviest on the top of the distribution. This feels like a better way of dividing social responsibilities.
How to introduce an international progressive tax on capital?
The most efficient and all-encompassing way to introduce this tax would be an international treaty regulating the tax, which all countries in the world would sign. That way, capital could not move to countries that do not impose such a tax. This is, of course, too far-fetched and idealistic at this point in time. In reality it will start with brave politicians in individual countries proposing this, and regional cooperation.
The first thing that is called for is a change in culture. Politicians cannot expect their citizens to accept the middle class and poor to pay taxes, while the people with large amounts of (inherited) capital and multinationals that benefit from citizens’ labour do not contribute to society. Both corporate capital, for example big multinational companies such as Starbucks or Apple, as well as private capital have to make larger contributions. The very rich need to realize that in the long term, they cannot just keep making profits without returning something, proportionally, to the societies they function in, or they might eventually meet the same fate as Marie Antoinette. Progressive taxing is the keyword here. The largest part of the tax revenues should come from the largest capitals, but it should be done in proportion. Key is to benefit from a capitalist system, while still maintaining social justice.
The underlying problem to implementing policies such as a progressive tax on capital, is that many fear a greater amount of state intervention. The prevailing economic paradigm for our societies is still that the market regulates itself. Maybe Piketty’s most important contribution, at least for now, is not the specific idea of introducing the particular policy of a progressive tax on capital (although it is a very good idea), but the paradigm shift he (and his colleagues, such as Joseph Stiglitz) set in motion. From now on, it is just a matter of time before the understanding that the wealth distribution needs to be regulated by a modernized tax system becomes a common belief.
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