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Taxes have always been politicized. In modern times, no election
passes without each campaign's position on taxes being thoroughly
scrutinized. And with economic inequality now at the heart of so much
political debate, taxes have become an even more polarizing subject.
This is due in no small part to French economist Thomas Piketty's best-selling book, Capital in the Twenty-First Century.
After analyzing an unprecedented collection of historical data on
income and wealth in Europe and North America dating back to the 18th
century, Piketty argued that a global wealth tax is needed in order to
save democracy from the rich.
Piketty's conclusion is stark. The
concentration of wealth in developed, capitalist economies is creating a
world in which the richest sliver of society earns more from what they
own — inheritance, property — than from what anyone else can earn from
work. Thus, according to Piketty's oft-cited "Second Law of Capitalism,"
there is an ever-increasing concentration of wealth in fewer and fewer
hands.
In such a world, according to Piketty, "nation-states… find
that they are too small to impose and enforce rules on [this new]
globalized patrimonial capitalism."
The only way out, he argues,
is a set of globally coordinated taxes on wealth — 80 percent on income
over $500,000 a year, and 50 percent to 60 percent on income over
$200,000 a year. The ultimate purpose would neither be to raise
government revenue nor to eliminate inequality through traditional
redistribution, but to penalize the existence of "excessive" wealth
itself and prevent it from occurring in the first place.
Last year, Paul Krugman called Piketty's work "the most important economics book of the year — maybe the decade." Lawrence Summers, who questioned Piketty's findings, nonetheless called the book "a Nobel Prize worthy contribution"
to the inequality debate. Given the imposing scale of Piketty's data
set, the number of credible challenges to his analysis and findings have
so far been few and far between, and have generally been brushed aside by the author.
Which
makes it all the more noteworthy that the most serious challenge to
Piketty's interpretation of his data came last month from 26-year-old MIT graduate student Matthew Rognlie.
What's
the disagreement about? Let's suppose you're a 19th century capitalist
during the Industrial Revolution. Your "capital" in this example
consists of some land, a couple of factories, and various industrial
machines. You rake in a consistent and hefty income for two reasons.
First, you find it relatively easy to replace the humans who work on
your land and in your factories with more machines — in other
words, more capital — and therefore keep more of the profits for
yourself. Second, the machines have relatively long productive lives, so
you need re-invest only a small proportion of the money they earn you
on fixing and replacing them.
However, standard neoclassical
economics says that over time, you can't just keep adding more capital
to the mix and expect your income to grow at the same rate. There comes a
point when that extra tractor or milling machine doesn't add as much
value to your operation as the first couple of machines did. It becomes
harder and harder to replace people with machines.
Spread over the
whole economy, that means opportunities for investing in capital will
tend to slow down over time. Eventually, labor — albeit more skilled and
therefore more highly paid labor — becomes important again. This is the
reason why we're not all still serfs, and why capitalism has raised
countless millions out of poverty since the Industrial Revolution, and
continues to do so.
Piketty,
however, suggests that in modern high-tech economies, the rules have
changed. He says the ability to replace labor with capital will remain
high and diminish much more slowly than standard economic theory would
suggest. This will cause income earned from owning capital to grow
faster than income from doing work. The future will start to look like
the past.
Rognlie disagrees, and uses software as an
example. Although a piece of efficiency-boosting software today might
generate a large bundle of cash for the company that uses it, its
productive life is much shorter than, say, a cotton gin's was in the
19th century. Software has to be replaced more frequently by highly paid
software engineers — who are not easily replaced by machines, hence
their high salaries. The profit enjoyed by a business owner after he
pays software geeks for the latest version of the software — in other
words, for a rapidly depreciating chunk of capital — is therefore
relatively smaller than his 19th century counterpart, whose machines
were cheaper to maintain, and whose workers were more easily replaced by
machines.
Rognlie then deconstructs Piketty's data to examine
what's behind the resurgent capital returns that seem to be ushering in a
new gilded age. Providing something of an anticlimax to Piketty's epic
story, Rognlie finds that this can mostly be explained by increasing house prices.
The return to non-housing capital actually ends up looking fairly flat
during the period in which Piketty sees the resurgence of gilded age
wealth patterns.
Rognlie's findings would suggest very different
policy responses than those espoused by Piketty. Rather than pursuing
global taxes on wealth, authorities might start more locally by looking
at the factors that inflate house prices. For example, regulations on
planning and land use — generated and maintained by residents solely out
of self interest — that inhibit house building. Or a lack of regional
and national transport infrastructure that could ease the pressure on
urban house prices by allowing people to live farther outside of major
cities while affordably commuting in to work.
Equally
as striking as Piketty's work was the public reaction to it. Coming on
the heels of the 2008 financial crisis and the ensuing Occupy movement,
Piketty's book has been held up as an incontrovertible truth, without
differentiation between his remarkable historical work and his more
questionable interpretations and policy recommendations. Piketty's
supporters seemingly consider the international economic and political
centralization that would be necessary to police a huge global tax
system to be less threatening to democracy than the rich people it would
regulate. This is extremely naive — especially when one considers
that it's the capture of government and public institutions by special
interests that make concentrated private wealth such a problem for
democracy in the first place.
Rather than just taxing the outcomes
of the political, social, and economic dynamics that generate today's
inequality, we need to look at the dynamics themselves, many of which
are underpinned by government. Perhaps the greatest lesson of Rognlie's
rebuttal is that the last thing the world needs in such a polarized
climate is the idea that there exist sure-fire, programmable solutions
to issues as complex as economic inequality.
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