Thoughts on the Piketty Thesis

As is the case with the vast majority of commentators on this topic, I have not read Thomas Piketty’s book (Capital in the Twenty-First Century). The following is therefore gleaned from other sources, mainly this interview, from which, unless otherwise indicated, the following quotations are taken.

The first thing to say is that, on the face of it, Piketty’s exposition is capitalism-friendly. In fact, his approach would seem to be a capitalist prerequisite, for it requires wealth to be put to work, which is a capitalist imperative. In his own words “my point is not at all to destroy wealth. My point is to increase wealth mobility and to increase access to wealth.” Which sounds like a good thing.

But, for one thing, it would entail the capitalization of resources that otherwise would be kept out of the sphere of what is unkindly referred to as capitalist exploitation. For instance, forestry. Having been an undergraduate forestry student, I recall the discussion in forest economics class with regard to the exigency placed on forests by a property tax. All of a sudden, a landowner must generate a revenue from that forest simply in order to pay the tax, on a piece of land that otherwise might be left undeveloped, hence ecologically undisturbed. This could lead to the application of sustainable multi-use forestry practices, or it could lead to elimination of the forest, depending upon the ecosystem involved. The same thing applies to traditional, less-than-profitable land uses. Followers of the television series Downton Abbey will recall the difficulties put upon the estate by the imposition of a wealth tax, causing Lord Grantham to anguish over having to remove inefficient tenants in order to turn the land to more productive uses.

Furthermore, a wealth tax would penalize saving in favor of consumption. Piketty can argue that consumption is difficult to distinguish from investment: “What’s the consumption or income of Warren Buffett or Bill Gates when they are using their corporate jet? Are they consuming? Are they investing? Nobody knows.” But the fact of the matter is, the imposition of a wealth tax would establish a prima facie incentive to spend income rather than save it, especially given the bias against inheritance Piketty displays (“In order to get a zero capital tax result, you need basically two very strong assumptions. One is that wealth is entirely a life-cycle wealth; you have no inheritance at all. Once you have inheritance, you want to tax it”). The moral will be, “eat, drink, and be merry, for what is not taxed today will be taxed tomorrow, if you try to hold onto it.” In Holland, there already is a wealth tax, on top of the 52% income tax (highest bracket, which begins rather early), the 21% VAT, the gasoline tax that jacks the price of a gallon up over $10, etc. So the money that escapes the fevered clutches of the Belastingdienst the first time around gets hit at the rate of 2.5% a year in perpetuum. The moral: spend it before it gets eaten away. Or at least, invest it for a return in excess of 2.5%, which in this day and age is no mean feat.

Another point is that Piketty’s wealth tax would be tax on “net” wealth, in other words, assets minus liabilities, property owned net of debt. It thus incentivizes indebtedness. “If you own a house worth $500,000, but you have a mortgage of $490,000, then your net wealth is $10,000 so in my system you would owe no tax. Under the current system, you pay as much property tax as someone who inherited his $500,000 home or who paid off his debt a long time ago.” The anti-saving bias is evident here. What is also evident is the built-in incentive to take on debt so as to offset taxable property holdings.

Regarding Piketty’s discussion of inequality: the message is that inequality has been increasing over the past 20-plus years, precisely the period of time in which globalization and international trade have surged forward. While Piketty himself does not argue this point, his findings do prompt the conclusion that globalization and free markets lead to inequality, while protectionism and government intervention are needed to foster income equality. And Piketty’s wealth tax is precisely one form of government intervention.

Piketty argues that income and wealth inequality have been increasing (although his findings are disputed), and blames it on the “huge cut in marginal tax rates.” From the interview: “Matthew Yglesias: How do we know that high executive compensation comes out of the pockets of other wage earners? Thomas Piketty: Well, because the labor share including CEO compensation did not increase. It actually declined. Maybe it would have declined even more without the rise in CEO compensation, but that’s hard to believe. I think the rise of very large CEO compensation came at the expense of the workers.”

This does seem to be the case, but as a matter of fact, I would have been shocked if the effect of the globalization of the post-Bretton Woods period had not led to greater inequality. But that doesn’t entail a critique of globalization per se, nor excessively low marginal tax rates, but the way in which the international trading system has been manipulated. Let me explain.

Ever since Bretton Woods, we have had a system of ostensibly floating exchange rates. Ostensibly — because exporting countries have been resorting to various hooks and crooks to maintain their exchange rates at artificially low levels, thus to manipulate and subvert that float. The dollar being the reserve currency of choice, and the US being the export market of choice (referred to tongue-in-cheek as “the consumer of last resort”), the manipulation is conducted against the dollar, keeping the exporting country’s exchange rate low vis-à-vis the dollar, allowing the exporting country to sell its production to America at ongoing low-wage-maintaining levels. The result is that production capacity shifts towards the low-wage countries, because the exchange rate is not allowed to adjust upward like it should. So the low-wage countries remain low-wage. Meanwhile, production capacity shifts away from the US, leaving only service-economy jobs there, which likewise generally command lower wages than manufacturing jobs. So in both the exporting countries and the consuming countries, the tendency is to depress working-class wages. On the other hand, the profits from the exchange continue to flow, into the hands of exporting country elites and multinational corporation managements, along with (of course) investors in those enterprises. This works to expand the income gap and thus income inequality. No surprise, really.

So the solution to this problem is not to abolish globalization per se, nor to increase marginal tax rates. Rather, it is to get the countries involved to stop manipulating the global system in favor of various special interests and elites, be they domestic or foreign. After all, the working class in the exporting countries suffers just as much from this situation as does the working class in the importing countries. Both are having their wages depressed.

Again, from the interview: “Matthew Yglesias: I thought one of the most interesting graphics in the book is the one where you show the price-to-book ratio in Germany is quite a bit lower than in the other countries. Is there an important lesson the rest of the world can learn there? Thomas Piketty: Yeah. Actually, to me this was quite striking. Previously I didn’t take seriously this idea that there were different ways of organizing capitalism and the property of capitalistic firms. I think the lesson from this graph is that the market value of a corporation and its social value can be two different things. Of course you don’t want the market value to be zero, but the example of the German corporation shows that even though their market value is not huge, in the end they produce some of the best cars in the world. They export a lot, and they are very successful. I think getting workers involved on the board of German corporations maybe reduces the market value for shareholders, but in the end, it forces workers and unions to be a lot more responsible for the future of the company.” I don’t want to speculate as to the reasons why German companies have relatively low valuations, but I will point out that Germany is at the exporters’ end of the export-import imbalance, only this time the import partners are southern Europe. How did the southern European countries run up so much debt? Mainly by paying for imports from, in the main, Germany. Germany’s model parallels Japan’s and China’s, only it functions mainly within the European sphere, with the help of the euro. In essence, Germany’s currency is structurally undervalued, while Spain’s, Italy’s, Greece’s, is overvalued. That’s how Germany can display such favorable economic data. But as Michael Pettis has shown, Germany’s workers are structurally underpaid because of it. The surplus goes to Euro elites.

There is much more to this story than merely the level of marginal tax rates. As long as the causes of inequality are misconstrued, the solutions on offer will always have be more akin to political footballs than actual fixes. Piketty claims that his “point is not to increase taxation of wealth. It’s actually to reduce taxation of wealth for most people, but to increase it for those who already have a lot of wealth.” Which of course appeals to most of us, because most of us don’t have “a lot of wealth.” But this “fix,” like many others past, present, and future, will get nowhere unless based upon a proper evaluation of the causes of the problem it purports to address.