Dr. Piketty's Prescriptions

This is the third of what I think will turn out to be four posts on Capital in the Twenty-First Century, and it will deal with Piketty's specific policy prescriptions.  The fourth one will appear late next week, when I'll be on vacation, and it is probably the most important one I will have to contribute to the general discussion of the book.  It will deal in some detail with the period 1914-1980 (and more especially 1933-1980) when,. as Piketty agrees, things were different--and it will ask why.

I cannot begin, by the way, without making a generational point.  When Generations and The Fourth Turning came out, I took the lead in applying their insights to Europe.  Strauss and Howe had simply assumed that Europe was on virtually the same identical cycle as the United States.  I thought that was broadly true, but that the last crisis, in particular, had begun later in Britain and France than in the US, and that it had lasted longer.  Britain had remade itself economically and socially in 1945-51, not 1933-41 as in the US.  France's political crisis, it seemed to me, had not reached its climax until 1958-62, when de Gaulle returned to power, left Algeria, and had to face down a series of military coups and create a new constitutional framework that has lasted until this day.  At one time I thought the French crisis might in fact have lasted until 1968, but I had decided, until I read Piketty, that I might have gone too far with that date.  Now, thanks to him, I think I might have been right the first time: 1968, it turns out, was a lot more than a student revolt, it was a key year in French economic and social history as well, after which wages began to rise.

But I am more convinced that I was right for another reason: Thomas Piketty himself.  He was born in France in 1971, meaning that his American contemporaries would be Gen Xers, of the Nomad archetype, but he very clearly is not.  He is a Prophet, like a Baby Boomer.  He is fascinated by the long-term movement of history, and by general principles.  He has spent years putting together an amazingly complete picture of worldwide economic growth, and he has a strong sense of what is wrong and what should be done about it.  I am glad that French academic life--unlike American academic life--can still produce, and reward, such a thinker.  Now, on to how he hopes to change the world.

Piketty's specific proposals have to be understood in terms of his view of the world.  Although he is deeply concerned with the rise of inequality over the last 35 years or so, he credits the twentieth century with two remarkable achievements. The first is the creation of what he calls the "patrimonial middle class," that is, the 90th to the 50th percentiles of income and wealth in most advanced countries.  In the United States that group now owns 30% of the wealth, compared to 70% for the top 10% and essentially nothing for the bottom 50%.  The second is what he calls the "social state," an advance over states in the 18th and 19th centuries, because it provides basic services for free, including health care and education, as well as pensions for all.  To be sure, the social state is considerably larger in Europe than in the United States, since it generally includes health care for all and, except in Britain, almost free higher education.  (Piketty never mentions this, but because higher education in the U.S. is increasingly financed by loans, it is yet another factor increasing the rapid accumulation of capital at the expense of economic growth.)  Piketty clearly wants to preserve, if not extend, the social state, and he is also concerned, as I am, that the emerging nations of the Third World have much smaller states that do not provide such services.  His policy proposals are designed to preserve the social state as well as to attack inequality directly.

His first proposal is to return top marginal income tax rates to 80%, which he would apply to incomes of either half a million or a million dollars a year in the U.S., and corresponding incomes in Europe and Japan.  This is not in the least unprecedented. Both the United States and Britain imposed higher rates in the mid-century decades, and US occupation authorities also imposed such rates in Germany and Japan after the war.  What is rather fascinating, however, is why Piketty wants to do this.  He does not claim that an 80% rate would bring in a great deal of revenue--far from it.  In the United States, he thinks marginal rates would also have to be raised on those making $200-500,000 or so as well to pay for a more generous social state.  But he thinks, and I agree, that the 80% top rate would transform our salary structure, for the simple reason that it would make it absurd to pay salaries of millions or tens of millions a year annually to anyone, since 80% of them would go straight into the coffers of the federal government.  Executive salaries are high, he claims, because executives themselves set them and their directors and shareholders rarely protest. That would immediately change if most of them were going to taxes.

I think that Piketty is right about this, but I think the consequences could easily be far more beneficial than even he imagines.  The American and world economies have been transformed over the last thirty years--and especially since the 1990s--by hedge fund managers and private equity firms, who pay very high compensation.  If such compensation were no longer available, it seems to me that that sector of the economy would rapidly shrink, which would be a very good thing.  As it is, our current economic system and our elite institutions of higher learning seem designed to funnel a high percentage of our smartest young men and women into businesses that specialize in the pure accumulation of capital.  That simply has to be connected to the rapid growth in the capital-income ratio which is at the heart of Piketty's whole analysis.  Indeed,. if salaries were capped in that way, well educated people might rediscover some of the real joys of life, including being more useful to their fellow citizens, since they would be more or less forced to make the pursuit of unlimited wealth the focus of all their attention.  That, as I shall show next week, is what Franklin Roosevelt called upon  Americans to do in March 1933, and he persuaded many of them to do so.

Piketty's second proposal is the one that has gotten even more attention, largely, I would suggest, because the right wing sees it as easier to attack. He wants a progressive tax on all capital assets.  Ideally, he argues--speaking as  Prophet--the tax should be global, but he recognizes that to be a utopian project, and he would be more than happy to begin in the European Union, the United States, and Japan.  He has in mind a rate of 0% for fortunes below 1 million euros (about $1.4 million), 1% on fortunes between one and five million euros, and 2% for fortunes over five million euros.  He suggests that it might be better to have an even higher rate of 5-10% on fortunes of over one billion euros, and an even lower rate--perhaps half a per cent--on more modest fortunes of 200,000-1,000,000 euros.

Piketty wants to levy these taxes annually, which sounds confiscatory, until one remembers that capital is still returning 4-5% a year in the long run, and, crucially, that the largest fortunes tend to grow considerably more rapidly than that.  (It is not clear, and I think this is a legitimate question to raise, what plans he might have for existing American capital gains taxes.  These are much lower than they used to be, but they are still higher than any corresponding taxes in Europe.)  He makes very clear, however, that an additional step is needed before any of this can be done.  The world, including the small nations of Switzerland, Austria, and certain third world nations who serve as tax havens, must be forced to accept new reporting requirements on bank deposits, capital income, and other forms of assets.  Under current conditions, he makes clear, this tax could not possibly be implemented effectively because so much income is hidden.  The scale of the problem is staggering.  To cite just one of his examples (p. 466), the rich countries of Europe, the Americas, and Japan show in their balance sheets foreign debts totaling about 5% of annual world output--but the best estimates say that about 8% of annual world output is hidden in assets overseas. That is why, Piketty argues, the sum of the world's nations balance of payments is strongly negative.  A great deal of the accumulating capital in the world is now invisible, and it cannot be taxed until its owners are forced to disclose it. just as Americans have to do for their domestic assets.

Although Piketty may not know this, his proposals reflect the thinking of a 19th-century American economic theorist, now forgotten, named Henry George.  Having seen a land boom in the San Francisco area first hand, George argued that when the value of a property increased fivefold in a few years, the owner had not created this extra wealth--the growth of the economy had created it.  He therefore proposed a high tax on land values, especially unused land.  Piketty, it seems to me, is saying essentially the same thing: that too few people are monopolizing the extra wealth which everyone has helped to create.

A capital tax, Piketty argues, is by far the best way to deal with the sovereign debt crises in Europe and the lesser debt problem in the United States.  (The extent of our debt problem, as I have mentioned repeatedly here, is much exaggerated; the debt we have to worry about is only about half of the reported figure, which is about 100% of GDP.)  Trying to solve the problem through austerity will hurt the social state and further enrich holders of capital, making the inequality problem even worse.  That is almost surely why austerity is so popular in the financial community, even though everyone knows that it hurts economic growth.

It is much too soon to know how much traction Piketty's ideas will get within the political systems of advanced countries.  Piketty knows politics are important, but he devotes relatively little attention to them.  The question of whether such ideas can be implemented raises the most interesting historical question of why they were implemented, in various ways, in the decades around the middle of the twentieth century, and whether that experience could be repeated.  That is one question, if I may say so, where I think I am better informed that Piketty, and that will be the subject of next week's post.