## Over at the Washington Center for Equitable Growth: The Daily Piketty: Thursday Focus: April 24, 2014

Over at the Washington Center for Equitable Growth: As Thomas Piketty Day at the University of California at Berkeley comes to an end, we eat Hawaiian poke and sausage-stuffed mushrooms catered from the truly excellent Assemble, and watch the sunset over the Golden Gate from the back patio of the Gourinchas/Fourcade palazzino. We muse on the extent to which Thomas Piketty's patterns of movement for the rate of profit r minus the economy's growth rate g are at bottom patterns of changing land valuation, with the fall of European agriculture as a source of wealth and the rise of urban location as the source of wealth.

What was supposed to be a 20-person economics departmental seminar turned into a 400-person public lecture extravaganza--we really should have made him give two talks at least...

This morning's Daily Piketty brings two especially interesting things: a very nice interview from Matt Yglesias, and PEG pointing out that a Benjamin Disraeli-style conservative would see Piketty as an ally pointing the way to how to successfully implement a market economy that was a genuine opportunity society:

One thing that I had not fully realized before yesterday was just how much heavy a lift Piketty has in trying to persuade the American neoclassical growth-economics community within economics departments. Their--our--default view of the world is--very strongly--that it is characterized by a Cobb-Douglas aggregate production function, in which the rate of profit moves inversely with the L ratio and in which as a result the capital income share of total income is constant.

You may say: but if you have a model in which you assume the capital income share is constant, you then have no chance of ever explaining fluctuations in income distribution. How can you use a model in which fluctuations in income distribution do not happen to criticize anyone trying to explain why they do? And this is a more than fair cop. But that the habit of thought is not rational doesn't keep American neoclassical growth-economists in economics departments from doing it: their--our--first reaction to Piketty is: "t That can't be right, because in our model the capital-income share of total income is invariant to shifts in the wealth-income ratio." And they--we--typically do not take the second step in the argument and say: "wait a minute: in our model nothing causes shifts in income distribution, so we need to model"...

And let me draw some links to my and others' scattered reflections on Piketty that I have found useful:

Mine:

Others:

Videos:

Clearly time for somebody to write a comprehensive review-of-the-reviews. Just saying...

Pascal-Emmanuel Gobry: The Conservative Case For Thomas Piketty: "I find myself constantly surprised by how little...

...I find to disagree in his work. I found myself basically agreeing with everything in this excellent interview by Matt Yglesias. His worries about increasing wealth concentration being potentially harmful to the social compact sound a lot more like the reasonable worries of conservatives like Jim Manzi rather than the histrionics of a Paul Krugman.... On his proposals on inequality, I think this quote aptly sums up his project–which happens to be one I share: ”my point is not at all to destroy wealth. My point is to increase wealth mobility and to increase access to wealth.” One point I’ve been making in blog post after blog post is that in economic policy we need to distinguish between flows and stocks. Thankfully, Piketty is now doing this.... vibrant, innovative economy depends on capital chasing higher rates of return, i.e. committing itself to more risk. A tax on capital is really a tax on idle capital. It’s arithmetic.... To be a conservative is to want a vibrant, innovative economy. All else equal, presumably, in order to have such an innovative economy, you want to have risk-taking and risk-bearing capital. The problem with the global economy isn’t, per se, that the rich have a lot of money. It’s that the rich have a lot of money and, instead of investing it in rocket ships to the moon and dotcom ventures, almost all of them are instead investing it in government bonds and ultra-safe corporate bonds....

Looked at it very broadly, the conservative “diagnosis” would say something like this: for the broad middle class, what we usually think of as the components of “the good life”, i.e. housing, a job, affordable healthcare, higher education, and so on, are growing increasingly expensive–and in large part this is because of bad government regulation.... In a world where you do have to tax something, taxing stocks of wealth seems like one of the least-harmful options out there. There is no such thing as a “neutral” monetary or tax policy. All else equal, your option will either encourage wealth hoarding, or wealth sharing–true sharing, driven by the free market, not “sharing” under the threat of a government baton. And it seems to me that a system that encourages wealth mobility is one that free market conservatives should embrace.

Matthew Yglesias: Why did you get interested in switching from looking at income to looking at wealth?

Thomas Piketty: In a way, wealth is a deeper issue because wealth is the accumulation of past income. But it's more than that. You also have inheritance. You also have natural resources, which can be part of wealth that was not saved by anyone or not wealth of the previous generation. It's an object that encompasses income, but that is broader and also that is in a way a better indicator of total inequality, lifetime inequality. It's more permanent than income. From the beginning in my work in income, I was very interested in the balance between capital income and labor income. If you really want to study this issue, and capital income declined in the first half of the 20th century, you need to get at capital directly. Because you don’t have income data for the 19th century but you do have wealth data. That’s also the only way to study the 19th century and to put the 20th century short into a longer perspective.

Matthew Yglesias: For a long time, people have looked almost the post‑1980 economy as exceptional. I think your view is that we should see the mid 20th century as the exception. Is that right?

Thomas Piketty: Yes, to some extent. I think one of the lessons of putting this evolution to a longer perspective is that there are some similarities between 1900‑1910 and today, so between the first globalization from 1860‑'70 to 1914, and the second globalization that has started in 1970s‑'80s. I think it's very fruitful to put these two periods into parallel, and to realize that in between was certainly a set of very particular circumstances, with two World Wars, the Great Depression, and a very particular set of institutions and policies that were put in place following these upheavals. There was also an exceptionally high growth rate. That was partly due to the recovery from the war, but also partly due to the demographic transition. There was a Baby Boom in the mid 20th century that was unusually large. That probably won’t happen again. Nobody is sure, of course, but that seems to be behind us.

Matthew Yglesias: I'm sure you're aware of the traditional neoclassical idea that taxing capital is very damaging to the prosperity of society. Why are you not impressed with that result?

Thomas Piketty: I have done work in optimal taxation, so I know this story quite well. 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. Point number two is, whenever you have a capital market imperfection, or whenever you have some imperfect observability of income from really top wealth holders, you find that the very notion of consumption is not very well defined. 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. Wealth is a much better indicator of the ability to pay tax for people who really have a lot of wealth, whereas income is typically not so well‑defined.

Capital market imperfection is another reason why we want to have capital tax. Now, the zero capital tax result which Robert Lucas once called the greatest result in economics. He has this expression in his Nobel lecture where he said, "This is the most genuinely a free lunch I have ever earned, working in economics." So he seemed really to believe in it. In fact, it relies on very strong assumptions that make the result almost abuse. Once you deviate from these assumptions, capital taxation is useful.

Matthew Yglesias: There's still, I think, an intuition that if a society has more wealth, that that's good.

Thomas Piketty: Of course, but my point is not at all to destroy wealth. My point is to increase wealth mobility and to increase access to wealth. The fact that we have a very high wealth‑to‑income ratio is good news. In fact, my book has a lot of good news. I don’t endorse apocalyptic readings of my book. We always talk about public debt. My message is, "Well, look, we have public debt, but we have a lot of wealth." When I talk about the progressive wealth tax, I'm not thinking of increasing the total tax burden. Think of the US right now where you have the property tax, which is a lot of money. That's a very big tax.

Now what I would propose is to transform it into a progressive tax on net wealth. That means that I would reduce the property tax for all those who have low net worth, and increase it on those who have billions. The way it would work is,that 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. My 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.

Matthew Yglesias: What did you think of Paul Krugman’s criticisms in The New York Review of Books that you didn’t adequately discuss the role of financial deregulation?

Thomas Piketty: I agree with him that financial deregulation is an important part of the rise of top managerial income in the US, but that’s only part of a broader picture. From what we know finance is about 10 percent of GDP, and it's about 20 percent of the top 0.1 percent’s income, which is a lot. That's twice as much as the share of GDP, but that still leaves 80 percent of the 31,000 outside finance. So finance is important, but I think the rise of top managerial income in the US is broader than just the finance issue. I think Paul agrees that the rise of top managerial compensation in the US, in finance and outside finance, was certainly stimulated by the huge cut in top marginal tax rates so I'm not sure we really disagree on that....

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....

Matthew Yglesias: What's wrong, exactly, with concentration of wealth?

Thomas Piketty: Well, I think our modern democratic institutions rely on some notion of reasonable inequality. Of course, some inequality is necessary for growth, to create incentives, but it must not become completely extreme. It was a view in the 19th century that democracy could flourish better in America (or at least in white America) than Europe, in part because you had a more equal distribution of wealth in America. This is something Tocqueville was very impressed by when he visited America. Until the early 20th century, this was a real difference between the US and Europe. First, because America had a lot of land available for everyone, so everyone can access land. Second, because you have higher population growth and new inflow of population coming in to the United States, the r-bigger-than-g effect was weaker than in Europe. So I think it was easier for democratic institutions to work properly. In Europe prior to World War I, you had 90 percent of national wealth in Britain or France belonging to the top 10 percent. You had basically no middle class.

The historical evidence we have is that our democratic institutions can be captured by the top groups much more easily when you have such an extreme concentration of wealth. To me this is really the main concern. I think one of the big lessons of the 20th century is that you don't need 19th century inequality to grow. The kind of extreme inequality of wealth that we had, particularly in Europe, in the 19th century and until World War I was just not useful. It was not useful in the sense that the inequality was destroyed in the 20th century and that didn't prevent growth from happening. Quite the opposite. It probably helped a little bit post world wars. And even if it didn’t help that much, even if growth would have happened anyway, the point is that it did not hurt. Extreme inequality was just not useful. If it's not useful for growth, and if it's bad for democracy, we just don't want it.

Matthew Yglesias: Precisely because it's bad for democracy, I think we'd look at the politics of the Third Republic or the United States today, and it seems unlikely that anything will change.

Thomas Piketty: Yes. People would say the same in 1900, 1910. Everybody will say, "The progressive income tax will never happen. This will never pass." Then this happened, so sometimes things happen. I'm not terribly impressed by the claims that are saying, "Nobody can happen. Nobody will ever take place." Of course it is true that, in particular in Europe, the wars played a large role in making this happen. Also the Bolshevik Revolution changed the political landscape quite a lot. Many people in the '20s and '30s in Europe accepted tax progressivity because they felt that after all it's better to have taxes than a Bolshevik Revolution. But if you look in the United States, I'm not sure these things were as important. And still the huge rise in income tax progressivity happened. It happened in spite of the huge inequalities that you had in the US at that time. The democratic system did respond. The Constitution of the US made it, in principle, impossible to have an income tax, and yet it happened.

If you think of the progressive wealth tax today, people say, "This will never happen because property tax is a state matter." But it was the same for the income tax and still it happened. I'm not saying this will happen in the next five years, but I'm just saying that we should be careful about making predictions of what can or cannot happen, and we should just try to think about the issues and try to see what's desirable and what's not desirable. I think a system with a progressive tax on net wealth is preferable to a system with a property tax that we have today, and I think the middle class and the lower class would agree.

If you only talk about raising the tax on the rich, I think of course it's more complicated than if you say what you want to do with the money, and who is going to gain from that. That's a standard strategy of the rich, "I don't want higher tax." They forget to find out the benefits at the bottom and the middle. I think it's a big trick, and it's possible to do away with it....

Matthew Yglesias: Right now, people have the impression in the United States, that wealthy people are mostly like Bill Gates — founders of enterprises rather than inheritors.

Thomas Piketty: Well, when you take the top 50 or top 100 list, you have a lot of inheritors as well. The Walton family, the Koch brothers, etc. The quick answer is that we don't really know because the wealth rankings of magazines are very much biased in favor of entrepreneurs. First, they are biased in an ideological sense. They have been created in order to celebrate the entrepreneur, although Steve Forbes himself is a grandson of the founder of Forbes. But in addition, the methodology is biased simply because it's much easier to spot large entrepreneurial wealth than large inherited wealth. Large inherited wealth typically takes the form of a more diversified portfolio, whereas large entrepreneurial wealth, when you have created a Microsoft or Facebook, it's difficult to hide.

When people have a more diversified portfolio, it's harder to spot. When I’ve tried to see how the journalists at Forbes or in other magazines in Europe get their numbers, basically they make phone calls, and they try their best. They don't have any systematic registry from which to draw. I think they are missing the bigger part of top inherited wealth and top entrepreneurial wealth...