Must Read: “Capital in the 21st Century” by Thomas Piketty

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Well, I finally finished the most talked-about economics book in the last decade, and my overall opinion is that it is worth all the praise and attention that it has received. Piketty has written a serious, well-researched, and well-argued that needs to be read carefully by anyone who cares about the future of Western democracies in general and the U.S. especially.

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It’s impossible to summarize six-hundred pages of economic analysis into a few sentences, but here are the major (convincing) arguments that he makes in support of his major thesis that the Western world is experiencing a period of increasingly dangerous economic inequality:

  • Capital: The nature of traditional capital may have changed in the last two-hundred years (from land to factories and computer hardware) but its role and importance in the economy has not. Just as in the days of Jane Austen, real capital produces and maintains the majority of wealth and, in specific circumstances, creates and perpetuates economic inequality. One of those circumstances is when the income from capital (r) exceeds the growth rate of income (g) — his now famous r > g formula —  which is exactly what has been the case in Western Europe and the U.S. in the past decade or so.
  • Income: The great reduction in marginal tax rates that occurred in the last three decades in the U.K. and U.S. resulted in a push by the highest earners to earn even more, since they are able to retain a higher percentage of any additional income they can generate. Since it is extremely difficult to correlate the income of the highest earners to specific productivity gains, and since the pay of most CEOs is decided by boards that are generally aligned with CEOs’ interests, the pay of the top members of the managerial class has exploded, resulting in an additional driver of inequality.
  • Taxation: The inability or unwillingness to tax wealth in addition to income, along with the reduction in inheritance tax rates, has resulted in a condition where great fortunes are able to perpetuate themselves easily. Since great fortunes generate higher returns that small fortunes (never mind the savings of the average person), the wealthy have grown even wealthier in the last few decades, once again contributing the economic inequality.

Having considered the critiques of Piketty made by Chris Giles in the Financial Times, and the critique of Giles’ critique by Howard Reed in The Guardian, my personal conclusion is that I agree with Piketty’s analysis of inequality and its causes. Moreover, I agree in part with his solution a tax on wealth is the most logical response to this growing problem.

Why is a wealth tax needed? The wealth tax is needed, because if one believes Piketty’s arguments, then it’s imperative that all wealth generating activities and assets be treated equally. What difference is there if I get or stay rich by being a CEO or by being born into a great fortune? The answer, of course, is none, and fairness demands that every society take and give equally from/to its citizens. It is patently unfair that someone making $50,000 a year pays an effective 25% tax rate, someone making $300,000 per year pays 40% and someone making $300,000,000 per year pays 10%. This is pretty much what we have in the U.S. today, and it’s a disgraceful way to apportion the national tax burden on the members of our society. That said, I do not see the need for the tax to be global, as Piketty argues. Rather, it should be applied at the national level, which is the best way for the tax to address the specific imbalances and dynamics of each country.

Returning to the main issue of inequality, even if one does not care about fairness, everyone should care about democracy, and, as Piketty points out, the current economic  trends do not bode well for majority rule:

“…the history of the progressive tax over the course of the twentieth century suggests that the risk of a drift toward oligarchy is real and gives little reason for optimism about where the United States is headed…Without a radical shock, it seems fairly likely that the current equilibrium will persist for quite some time. The egalitarian pioneer ideal has faded into oblivion, and the New World may be on the verge of becoming the Old Europe of the twenty-first century’s globalized economy.

A quick look around at the money flowing in U.S. politics today, the near-poverty awaiting even college graduates, the inability of society’s poorest to find a voice in political discourse, as well as the way in which great wealth can shape political outcomes at the expense of democratic ideals, makes Piketty’s warning real and necessary to address. In the end, economic inequality is more than a question of who gets to be, and stay, rich. It is about power, plain and simple, and who gets to wield it in the future. Will it be the great majority, with their small bundles of savings and earnings, or will it be, as the handwriting on the wall clearly indicates, the grandchildren of today’s billionaires who will be obliged to suffer democracy only as much — or as little — as they see fit.

Read more:

http://www.amazon.com/Capital-Twenty-First-Century-Thomas-Piketty/dp/067443000X

http://www.ft.com/intl/cms/s/2/e1f343ca-e281-11e3-89fd-00144feabdc0.html#axzz35HwEKSjK

http://www.theguardian.com/business/economics-blog/2014/may/29/ft-journalist-errors-thomas-piketty-takedown

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