There is an important debate going on about just how progressive a tax system has to be in order to serve progressive political ends. The debate was instigated by Edward Kleinbard, writing in the New York Times. Kleinbard argues that we should avoid steep increases in taxes on the rich in favor of “boosting revenue over all,” on the grounds that the American tax system is already the most progressive in the world, and that in any case we should focus on the progressivity of the entire fiscal system, not just the taxation side of that system. Some of the more interesting critical discussions of Kleinbard have been produced by Mike Konczal, Steve Waldmann and Matt Bruenig.
From my vantage point, building a bit on the neo-socialist approach I sketched in my previous post, much of the current debate about taxing the rich is misconceived. Contrary to Kleinbard, I believe we do need to tax the rich much more heavily. But the primary point of these taxes is not to finance the spending side of the nation’s fiscal program. Here are the two key points I think need to be made:
The best reason to tax the very rich heavily is, initially, to make them less rich.
The best subsequent reason to tax riches heavily is to prevent people from becoming very rich again.
The long-term goal of neo-socialist political economy is to build a more equal and a more democratic society, a society in which we have done everything we realistically can to level the vast differences in income, wealth, social status, education, political power, cultural participation and human dignity that currently prevail in the United States. Toppling the looming citadels of concentrated private wealth will help to advance democracy, broad prosperity and justice. That’s a good enough reason to do it, all issues of public revenues aside.
Here is a fact: every country in the developed world possesses an economy that combines capitalist and socialist forms of organization. It seems to me that this fact is something that used to be more widely understood and accepted. The economies of the mid-to-late 20th century emerged from long processes of contentious struggle between classical liberal, socialist and traditionalist ideas, and had all arrived at different combinations of those various elements. We used to call these economies “mixed economies”, and almost all educated people understood that we all lived in such economies. We debated which ones were better than others: which produced more prosperity, or more happiness, or more justice.
People disagreed, frequently intensely, but often understood at the same time that these disagreements were mostly practical disagreements about getting the right mix, and that the pure textbook forms of capitalism, socialism, communism, or whatnotism were abstract, purifying ideals that each left out various important aspects of human nature, and were thus too high for humanity.
Most people who pushed in a socialist direction understood that you can’t plan everything all the way down to the smallest pizza shop, and that you shouldn’t eliminate all of the confidence, personal pride and creativity that come from accepting some measure of individual control over private property. Most people who pushed in a capitalist direction didn’t really want private firms running all the law courts, militaries, schools, parks and highways, and recognized that a civilized and harmonious human society shouldn’t be based on the bestial norms of wilderness competition, with its cruel, Sisyphean struggles for dominance and survival. And most traditionalists understood that the kingdom of heaven is not of this earth.
Here are three charts showing what I think are some very important aspects of the economic state of contemporary America. The first shows net stock dividend payments as a share of gross domestic product:
As you can see, the percentage is now higher than it has been at any point since 1929. The second chart shows wages and salaries as a share of gross domestic product:
And in this case, the ratio is lower than at any time since 1929. Finally, here is a chart showing rental income as a share of gross domestic product:
Jonathan McCarthy at Liberty Street Economics flags the slow rebound in consumer spending as one contributor to the sluggish pace of economic growth in the post-2009 recovery. According to McCarthy:
Discretionary expenditures have picked up noticeably over recent quarters but, unlike spending on nondiscretionary services, they remain well below their pre-recession peak.
But perhaps looking to the pre-recession peak as a benchmark for setting our present hopes is unrealistic. Here is a graph of total household fixed residential investment plus personal consumption expenditures, viewed as a share of total personal income:
George Cooper continues to have doubts about Thomas Piketty’s famous inequality r > g, which says that the rate of return to capital is greater than the rate of growth of national income. Cooper raises those doubts in connection with a recent post of mine in which I attempted to dispel some of the confusion surrounding Piketty’s inequality by making it clear that the rate of return to capital is not any kind of growth rate. But Cooper doesn’t raise any serious objections to Piketty’s inequality, at least so far as I can tell. In fact, Piketty’s inequality ought to be regarded as among the least controversial points Piketty makes in Capital in the Twenty-First Century.
The thought experiment I introduced was designed to clarify certain fundamental points about the conceptual relationship between wealth, income, the rates at which wealth and income grow, and the rate at which the ownership of capital is rewarded by income. Without going back over the whole thought experiment, let me summarize what I take to be the essential takeaway points:
Several people have asked me for a more mathematically precise formulation of Thomas Piketty’s Second Fundamental Law of Capitalism, as well as a more careful statement of its proof and of the boundary conditions over which the proof applies, with some attention to the unusual and exceptional cases. I have written up some notes that are an attempt to comply with those requests. While I have attempted to be as precise as possible in laying out the proof, I have tried to avoid introducing any more rigor than is absolutely necessary for an informed reader to understand how the proof goes through. I have assumed a familiarity with reasoning about limits at the level of elementary calculus.
The notes can be downloaded here.
Justin Wolfers has posted some slides purporting to deal with the arguments of Thomas Piketty’s Capital in the Twenty-First Century. Unfortunately, the discussion outlined in Wolfers’s slides suggests that while he has read some of the more prominent recent responses to Piketty – including Lawrence Summers’s review of Piketty in Democracy: A Journal; a recent paper by Per Krussel and Tony Smith on Piketty’s second fundamental law of capitalism; and some posted comments on Piketty by Debraj Ray – he doesn’t seem to have read much of Piketty himself. I say this because Wolfers repeats some of the same interpretive errors that appear in those other works, despite the fact that the errors are quite easy to avoid, and even obvious, to anyone who has worked directly with Piketty’s text.
I commented on some of Debraj Ray’s criticisms of Piketty in my post “Why Is r > g So Significant for Piketty?” And I dealt obliquely with some of the Krussel and Smith arguments in “Piketty’s Second Fundamental Law and Some Fallacious Reasoning about Savings.” I will likely return again to these critics’ arguments again in future posts. I also dealt with the interpretive errors springing from Summers’s review in my post “Summers’s Review of Piketty: Underestimating the Argument for the Forces Driving Inequality.” Summers errs in attributing to Piketty (i) the view that wealth grows at the rate of return to capital, (ii) the view that as long as the return to capital exceeds an economy’s growth rate, wealth-to-income ratios will tend to rise and (iii) the tacit presupposition that returns to capital are 100% reinvested. Matt Bruenig has posted two fine new pieces this week, here and here, that challenge Wolfers on errors that seem to have their source in Summers, and has already dealt with most of the key points I would make on that score. But I would like to add just a bit to his discussion of the relationship (or rather lack of relationship) between the growth of wealth and the rate of return to capital.
Neil Irwin, looking at the latest US economic data, finds an ugly fly in the ointment of our economic recovery – such as it is – that lends a stinking savour to the odors wafting from the labor scene:
The latest economic data out Tuesday morning was generally good. Home building activity rebounded nicely in May after weak results in April. Consumer prices rose 0.4 percent in May, such that inflation over the last year is now 2.1 percent, about in line with what the Federal Reserve aims for.
But that inflation news carried with it a depressing side note. Now that the May Consumer Price Index has been published, it is possible to determine inflation-adjusted hourly earnings for the month. And the number isn’t good.
Average hourly earnings for private-sector American workers rose about 49 cents an hour over the last year, to $24.38 in May. But that wasn’t enough to cover inflation over the year, so in “real” or inflation adjusted terms, hourly worker pay fell 0.1 percent over the last 12 months. Weekly pay shows the same story, also falling 0.1 percent in the year ended in May.
Pause for just a second to consider that. Five years after the economic recovery began, American workers have gone the last 12 months without any real increase in what they are paid.
Strangely, faced with these indications that our soi-disant recovery is a completely bogus affair as far as American workers are concerned, Irwin’s mind immediately turns, as so many mainstream minds seem to turn in these days of social and political paralysis, to yet more neurotic worrying about deliberations inside the conclave of monetary alchemists who run the Fed:
J. D. Alt writes:
How would Thomas Piketty propose to save the city of Norfolk, Virginia? He teaches us, ad-nauseum, that what the U.S. collective state has to spend on such things as sea walls, flood gates, elevating infrastructure and roadways, buying-out property owners so they can relocate to higher ground, etc., etc., is limited to the number of tax dollars that can be collected from U.S. citizens—as if the collective state itself were like a club, and if the clubhouse needs repairing, the club members must first pay a special assessment of dues—or, alternatively, the club can borrow dollars from the supply of Capital owned by the wealthiest 1% of its membership, or (as a creative alternative) the rebuilding effort could be structured in such a way that the newly elevated Norfolk would pay rent to the one percent in perpetuity for the privilege of living above sea-level.
I find this characterization puzzling, and do not understand where these teachings are to be found in Piketty. Piketty has very little to say about the factors that both determine and limit the capacities of government in carrying out ambitious projects. Far from issuing teachings on this subject “ad nauseum”, as Alt puts it, reflections of these kinds are simply not a significant component of Piketty’s work on distribution and economic inequality.
For Mr. Piketty, the calculation is: what is the availability of “Capital”? His entire book is an exercise in quantifying and compartmentalizing in various ways the distribution of “Wealth” throughout the world—and projecting how its historical 5% growth rate might be distributed in the future. Presumably, he would use these calculations to arrive at some number of Dollars that theoretically could be made available to the effort of saving Norfolk.
But at this point, I have little idea what Alt is talking about. First of all, I don’t know where Alt’s figure for a 5% historical growth rate for wealth comes from. For Piketty, wealth grows at the annual rate s/β, where s is the national savings rate for that year and β is the capital-to-income ratio in the same year. A more typical rate of wealth growth would be something like 2%, which is the rate we would get with a national savings rate of 10% and a capital-to-income ratio of 500%. Perhaps Alt is confusing the rate of wealth growth with the rate of return on capital. The rate of return on capital, for which Piketty does indeed find historical values of around 5% in many periods, is a very different animal, and is not any kind of growth rate at all.
Fallacious arguments springing from careless reading of Thomas Piketty’s Capital in the Twenty-First Century continue to abound. This note is aimed at clearing up one especially tricky and seductive type of fallacy.
If you have been reading Piketty carefully, you know that two fundamental concepts lie at the logical foundation of his study of the dynamics of inequality in capitalist systems: wealth and income. You know that he defines the term “capital” in such a way that it can be used interchangeably with the term “wealth.” You also know that Piketty divides all income into two types: income from capital and income from labor.
There is a simple rule which describes the growth of wealth in a society from any year i to the next year i+1:
- Wi+1 = Wi + Si
where Si is that society’s total savings in year i. The savings in year i can always be expressed as some percentage si of the total national income for that year. That latter number is the savings rate. So we can rewrite equation 1 as:
- Wi+1 = Wi + siYi
In fact, we could treat equation 2 as an implicit definition of the savings rate:
- si = (Wi+1 – Wi)/Yi
The rate at which a society saves in any given year is just the change in its wealth from that year to the next year, expressed as a proportion of national income for the first year. We also know there is always a rate at which national income changes from year i to year i+1. Like any rate of annual change, we can define it in this familiar way:
- gi = Yi+1/Yi – 1
For example, if national income grows from $1 trillion to $1.02 trillion from one year to the next, then income has grown at a rate of 0.02 or 2%. The quantity gi is usually called the national income growth rate. But, of course, it is possible for gi to be negative, in which case the income in year i+1 is smaller than the income in year i, and the economy is not growing, but shrinking.
Another important quantity that can be defined in terms of the two fundamental concepts of wealth and income is the capital-to-income ratio β:
- βi = Wi/Yi
As we said, national income is the sum of income from capital or wealth and income from labor:
- Y i = YWi + YLi
(Note that ‘YW’ and ‘YL’ are not multiplications, but single variables refering to income from wealth and income from capital respectively.) From the values of income from capital and total capital in year i, we can define the rate of return to capital in that year like this:
- ri = YWi/Wi
And from the values of income from capital and total national income in year i, we can also define the capital share of national income for that year:
- αi = YWi/Yi
From equations 5, 7 and 8, the following identity immediately follows:
- αi = ri βi
This is the law Piketty calls the First Fundamental Law of Capitalism. Some have wondered what this law has to do with capitalism specifically, since it is an identity that is true of any economic system. That’s a fair enough criticism. But notice that the law only has important application to any system for which there is a kind of income that can be called “return to capital”. These are economic systems in which there is wealth that is privately owned, where some of that wealth has an economic use that goes beyond personal consumption, and where there are market exchanges that provide the owners of the wealth with a flow of income in exchange for the use of the capital. If a system lacks these features, then equation 9 will only be vacuously true, since α and r will both be zero.