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.
Follow Alaa al-Ameri on Twitter: @AlaaAmeris
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