Friday, May 08, 2015

Book: Capital in the Twenty-First Century

"Capital in the Twenty-First Century", Thomas Piketty

This is a 500+ pages book. The first 200 pages were full of very similar looking data and tables. It became interesting after page 200, and riveting after page 300. I like books that show how ignorant I am and this is definitely one of them.

Read it if the following questions are of interest to you:
  • What is the source of income inequality and how does it harm society?
  • How should the income from production be divided between labor and capital?
  • Why is it so difficult to tax the super rich and multinational corporations?
  • Is publicly available financial information enough to form a healthy opinion about financial matters?
Update, January 11th 2016: Paul Graham says that we should not attack inequality (which is an indirect effect), but directly poverty and the questionable ways of getting rich:
My underlinings:
The sharp reduction in income inequality that we observe in almost all the rich countries between 1914 and 1945 was due above all to the world wars and the violent economic and political shocks they entailed (especially for people with large fortunes). It had little to do with the tranquil process of intersectoral mobility described by Kuznets.
There is no fundamental reason why we should believe that growth is automatically balanced.
When the rate of return on capital significantly exceeds the growth rate of the economy (as it did through much of history until the nineteenth century and as is likely to be the case again in the twenty-first century), then it logically follows that inherited wealth grows faster than output and income.
…social inequalities are not in themselves a problem as long as they are justified, that is, “founded only upon common utility,” as article 1 of the 1789 Declaration of the Rights of Man and the Citizen proclaims.
I am interested in contributing, however modestly, to the debate about the best way to organize society and the most appropriate institutions and policies to achieve a just social order.
This obsession [of economists] with mathematics is an easy way of acquiring the appearance of scientificity without having to answer the far more complex questions posed by the world we live in.
The lessons of history are nevertheless useful, because they help us to see a little more clearly what kinds of choices we will face in the coming century and what sorts of dynamics will be at work.
…how should the income from production be divided between labor and capital?
…a country whose firms and other capital assets are owned by foreigners may well have a high domestic product but a much lower national income, once profits and rents flowing abroad are deducted from the total.
…natural capital and damages to the environment are not well accounted for.
…a country that privatized its health and education services would see its GDP rise artificially, even if the services produced and the wages paid to employees remained exactly the same.
…in a quasi-stagnant society, wealth accumulated in the past will inevitably acquire disproportionate importance.
…democratic modernity is founded on the belief that inequalities based on individual talent and effort are more justified than other inequalities—or at any rate we hope to be moving in that direction.
…the upper 10 percent of the labor income distribution generally receives 25–30 percent of total labor income, whereas the top 10 percent of the capital income distribution always owns more than 50 percent of all wealth (and in some societies as much as 90 percent). Even more strikingly, perhaps, the bottom 50 percent of the wage distribution always receives a significant share of total labor income (generally between one-quarter and one-third, or approximately as much as the top 10 percent), whereas the bottom 50 percent of the wealth distribution owns nothing at all, or almost nothing (always less than 10 percent and generally less than 5 percent of total wealth, or one-tenth as much as the wealthiest 10 percent).
…many people belong to the upper class in terms of labor income but to the lower class in terms of wealth, and vice versa.
…a person who all his or her life earns 7,000 euros a month rather than 4,000 (or, even better, 24,000 instead of 10,000), will not spend money on the same things and will have greater power not only over what he or she buys but also over other people: for instance, this person can hire less well paid individuals to serve his or her needs.
…wealth is so concentrated that a large segment of society is virtually unaware of its existence, so that some people imagine that it belongs to surreal or mysterious entities. That is why it is so essential to study capital and its distribution in a methodical, systematic way.
We will not learn any of this by consulting the publications of the international organizations or national statistical agencies who compile these statistics, however, because they usually focus on indices that deliberately ignore the top end of the distribution and give no indication of income or wealth beyond the ninetieth percentile.
…while income from capital is obviously not altogether absent from the income of “the 9 percent,” it is usually not the main source of income but simply a supplement… an 80–20 split between labor and capital is reasonably representative of the structure of income among “the 9 percent”
…within “the 1 percent,” it is labor income that gradually becomes supplementary, while capital increasingly becomes the main source of income.
Actual capital income is therefore underestimated, owing both to tax evasion (it is easier to hide investment income than wages, for example, by using foreign bank accounts in countries that do not cooperate with the country in which the taxpayer resides) and to the existence of various tax exemptions that allow whole categories of capital income to legally avoid the income tax (which in France and elsewhere was originally intended to include all types of income).
…one consequence of increasing inequality was virtual stagnation of the purchasing power of the lower and middle classes in the United States, which inevitably made it more likely that modest households would take on debt, especially since unscrupulous banks and financial intermediaries, freed from regulation and eager to earn good yields on the enormous savings injected into the system by the well-to-do, offered credit on increasingly generous terms.
All signs are that the Scandinavian countries, where wage inequality is more moderate than elsewhere, owe this result in large part to the fact that their educational system is relatively egalitarian and inclusive.
Our democratic societies rest on a meritocratic worldview, or at any rate a meritocratic hope, by which I mean a belief in a society in which inequality is based more on merit and effort than on kinship and rents.
This belief and this hope play a very crucial role in modern society, for a simple reason: in a democracy, the professed equality of rights of all citizens contrasts sharply with the very real inequality of living conditions, and in order to overcome this contradiction it is vital to make sure that social inequalities derive from rational and universal principles rather than arbitrary contingencies. Inequalities must therefore be just and useful to all, at least in the realm of discourse and as far as possible in reality as well.
…all large fortunes, whether inherited or entrepreneurial in origin, grow at extremely high rates, regardless of whether the owner of the fortune works or not.
Liliane Bettencourt, who never worked a day in her life, saw her fortune grow exactly as fast as that of Bill Gates, the high-tech pioneer, whose wealth has incidentally continued to grow just as rapidly since he stopped working.
Note, in particular, that once a fortune passes a certain threshold, size effects due to economies of scale in the management of the portfolio and opportunities for risk are reinforced by the fact that nearly all the income on this capital can be plowed back into investment. An individual with this level of wealth can easily live magnificently on an amount equivalent to only a few tenths of percent of his capital each year, and he can therefore reinvest nearly all of his income.
…inherited wealth accounts for more than half of the total amount of the largest fortunes worldwide.
…no matter how justified inequalities of wealth may be initially, fortunes can grow and perpetuate themselves beyond all reasonable limits and beyond any possible rational justification in terms of social utility.
…wealthy people are constantly coming up with new and ever more sophisticated legal structures to house their fortunes… it is often difficult to distinguish purely private family foundations from true charitable foundations. In fact, families often use foundations for both private and charitable purposes and are generally careful to maintain control of their assets even when housed in a primarily charitable foundation. It is often not easy to know what exact rights children and relatives have in these complex structures, because important details are often hidden in legal documents that are not public. In some cases, a family trust whose purpose is primarily to serve as an inheritance vehicle exists alongside a foundation with a more charitable purpose.
…inflation is indeed a tax on the idle rich, or, more precisely, on wealth that is not invested. But as I have noted a number of times already, it is enough to invest one’s wealth in real assets, such as real estate or shares of stock, in order to escape the inflation tax entirely.
…the redistribution induced by inflation is mainly to the detriment of the least wealthy and to the benefit of the wealthiest, hence in the opposite direction from what is generally desired.
…it is not illogical for Saudia Arabia to lend at low interest to the country that protects it militarily.
…no one knows the precise location of the psychological and political boundaries that must not be crossed when it comes to the ownership of one country by another.
…oligarchic divergence is not only more probable than international divergence, it is also much more difficult to combat, because it demands a high degree of international coordination among countries that are ordinarily engaged in competition with one another. The secession of wealth tends, moreover, to obscure the very idea of nationality, since the wealthiest individuals can to some extent take their money and change their nationality, cutting all ties to their original community. Only a coordinated response at a relatively broad regional level can overcome this difficulty.
A tax on capital would promote the general interest over private interests while preserving economic openness and the forces of competition. The same cannot be said of various forms of retreat into national or other identities, which may well be the alternative to this ideal policy. But a truly global tax on capital is no doubt a utopian ideal. Short of that, a regional or continental tax might be tried, in particular in Europe, starting with countries willing to accept such a tax.
…income support outlays are even smaller (less than 1 percent of national income), almost insignificant when measured against total government spending. Yet this type of spending is often the most vigorously challenged: beneficiaries are suspected of wanting to live their lives on the dole, even though the proportion of the population relying on welfare payments is generally far smaller than for other government programs, because the stigma attached to welfare (and in many cases the complexity of the process) dissuades many who are entitled to benefits from asking for them.
…the average income of the parents of Harvard students is currently about $450,000, which corresponds to the average income of the top 2 percent of the US income hierarchy. Such a finding does not seem entirely compatible with the idea of selection based solely on merit.
In the United States, France, and most other countries, talk about the virtues of the national meritocratic model is seldom based on close examination of the facts. Often the purpose is to justify existing inequalities while ignoring the sometimes patent failures of the current system.
…the upper classes can preserve their political hegemony only by invoking the rights of the most capable.
…defining the meaning of inequality and justifying the position of the winners is a matter of vital importance, and one can expect to see all sorts of misrepresentations of the facts in service of the cause.
…poorly functioning public services undermine confidence in government, which makes it more difficult to raise taxes significantly.
Today’s developed countries reduced their tariffs over the course of the nineteenth and twentieth centuries at a pace they judged to be reasonable and with clear alternatives in mind. They were fortunate enough not to have anyone tell them what they ought to be doing instead. This illustrates a more general phenomenon: the tendency of the rich countries to use the less developed world as a field of experimentation, without really seeking to capitalize on the lessons of their own historical experience.
If the modern social state is to continue to exist, it is therefore essential that the underlying tax system retain a minimum of progressivity, or at any rate that it not become overtly regressive at the top.
If individuals were classified by centile of total resources accrued over a lifetime (including both earned income and capitalized inheritance), which is a more satisfactory criterion for progressive taxation, the bell curve would be even more markedly regressive at the top of the hierarchy than it is when only labor incomes are considered.
The progressive tax is indispensable for making sure that everyone benefits from globalization, and the increasingly glaring absence of progressive taxation may ultimately undermine support for a globalized economy.
The Bolshevik Revolution of 1917 was fresh in everyone’s mind. It was in this chaotic and explosive situation that the modern progressive income tax was born.
In Britain, the top rate was set at 8 percent in 1909, a fairly high level for the time, but again it was not until after the war that it was suddenly raised to more than 40 percent.
The progressive tax is thus a relatively liberal method for reducing inequality, in the sense that free competition and private property are respected while private incentives are modified in potentially radical ways, but always according to rules thrashed out in democratic debate. The progressive tax thus represents an ideal compromise between social justice and individual freedom.
…over the period 1932–1980, nearly half a century, the top federal income tax rate in the United States averaged 81 percent.
…the reduction of top marginal income tax rates and the rise of top incomes do not seem to have stimulated productivity (contrary to the predictions of supply-side theory) or at any rate did not stimulate productivity enough to be statistically detectable at the macro level.
Considerable confusion exists around these issues because comparisons are often made over periods of just a few years (a procedure that can be used to justify virtually any conclusion). Or one forgets to correct for population growth (which is the primary reason for the structural difference in GDP growth between the United States and Europe).
In the face of such powerful existential anxieties, reason is often at a loss, especially since it is objectively quite difficult to draw perfectly precise and absolutely unassailable conclusions
…skyrocketing executive pay is fairly well explained by the bargaining model (lower marginal tax rates encourage executives to negotiate harder for higher pay) and does not have much to do with a hypothetical increase in managerial productivity.
…a rate on the order of 80 percent on incomes over $500,000 or $1 million a year not only would not reduce the growth of the US economy but would in fact distribute the fruits of growth more widely while imposing reasonable limits on economically useless (or even harmful) behavior.
It was war that gave rise to progressive taxation, not the natural consequences of universal suffrage.
…no hypocrisy is too great when economic and financial elites are obliged to defend their interests—and that includes economists, who currently occupy an enviable place in the US income hierarchy.
The primary purpose of the capital tax is not to finance the social state but to regulate capitalism. The goal is first to stop the indefinite increase of inequality of wealth, and second to impose effective regulation on the financial and banking system in order to avoid crises. To achieve these two ends, the capital tax must first promote democratic and financial transparency: there should be clarity about who owns what assets around the world.
…it is very difficult to have a rational debate about the great challenges facing the world today—the future of the social state, the cost of the transition to new sources of energy, state-building in the developing world, and so on—because the global distribution of wealth remains so opaque… truly democratic debate cannot proceed without reliable statistics.
The most plausible reason why tax havens defend bank secrecy is that it allows their clients to evade their fiscal obligations, thereby allowing the tax havens to share in the gains. Obviously this has nothing whatsoever to do with the principles of the market economy. No one has the right to set his own tax rates. It is not right for individuals to grow wealthy from free trade and economic integration only to rake off the profits at the expense of their neighbors. That is outright theft.
Nation-states built over centuries find that they are too small to impose and enforce rules on today’s globalized patrimonial capitalism. The countries of Europe were able to unite around a single currency (to be discussed more extensively in the next chapter), but they have accomplished almost nothing in the area of taxation.
Protectionism does not produce wealth, and free trade and economic openness are ultimately in everyone’s interest, provided that some countries do not take advantage of their neighbors by siphoning off their tax base. The requirement to provide comprehensive banking data automatically should have been part of the free trade and capital liberalization agreements negotiated since 1980. It was not, but that is not a good reason to stick with the status quo forever.
…income is often not a well-defined concept for very wealthy individuals, and only a direct tax on capital can correctly gauge the contributive capacity of the wealthy.
…If some people are taxed on the basis of declared incomes that are only 1 percent of their economic incomes, or even 10 percent, then nothing is accomplished by taxing that income at a rate of 50 percent or even 98 percent. The problem is that this is how the tax system works in practice in the developed countries.
…stocks, which were totally exempt[from tax]
…largest fortunes consist mainly of financial assets and especially stocks… without automatic sharing of bank information among European countries, which would allow the tax authorities to obtain reliable information about the net assets of all taxpayers, no matter where those assets are located, it is very difficult for a country acting on its own to impose a progressive tax on capital.
Since the real returns on the largest fortunes in Europe and around the world are 6 to 7 percent or more, it would not be excessive to tax fortunes above 100 million or 1 billion euros at rates well above 2 percent. The simplest and fairest procedure would be to set rates on the basis of observed returns in each wealth bracket over several prior years.
What is certain is that it makes little sense to take the yield on public debt as a reference, as is often done in political debate. The largest fortunes are clearly not invested in government bonds.
International inequalities of wealth—and national destinies—are determined by the way borders were drawn, in many cases quite arbitrarily. If the world were a single global democratic community, an ideal capital tax would redistribute petroleum rents in an equitable manner… For example, if, tomorrow, someone were to find in her backyard a treasure greater than all of her country’s existing wealth combined, it is likely that a way would be found to amend the law to share that wealth in a reasonable manner (or so one hopes).
…the unequal distribution of wealth in this region [Middle East] has attained unprecedented levels of injustice, which would surely have ceased to exist long ago were it not for foreign military protection. In 2012, the total budget of the Egyptian ministry of education for all primary, middle, and secondary schools and universities in a country of 85 million was less than $5 billion. A few hundred kilometers to the east, Saudi Arabia and its 20 million citizens enjoyed oil revenues of $300 billion, while Qatar and its 300,000 Qataris take in more than $100 billion annually.
[Europe] has both the highest level of private wealth in the world and the greatest difficulty in resolving its public debt crisis—a strange paradox.
…the primary function of central banking is to ensure the stability of the financial system, which requires central banks to assume the role of “lenders of last resort”: in case of absolute panic, they must create the liquidity necessary to avoid a broad collapse of the financial system.
The weakness of central banks is clearly their limited ability to decide who should receive loans in what amount and for what duration, as well as the difficulty of managing the resulting financial portfolio.
Everyone is insisting that Greece collect more taxes from its wealthier citizens. This is no doubt an excellent idea. The problem is that in the absence of adequate international cooperation, Greece obviously has no way to levy a just and efficient tax on its own, since the wealthiest Greeks can easily move their money abroad, often to other European countries. The European and international authorities have never taken steps to implement the necessary laws and regulations, however. Lacking tax revenues, Greece has therefore been obliged to sell public assets, often at fire-sale prices, to buyers of Greek or other European nationalities, who evidently would rather take advantage of such an opportunity than pay taxes to the Greek government.
The problem with the current system is that multinational corporations often end up paying ridiculously small amounts because they can assign all their profits artificially to a subsidiary located in a place where taxes are very low; such a practice is not illegal, and in the minds of many corporate managers it is not even unethical. It makes more sense to give up the idea that profits can be pinned down to a particular state or territory; instead, one can apportion the revenues of the corporate tax on the basis of sales or wages paid within each country.
The inequality r > g is the basis of a society of rentiers.
…debt often becomes a backhanded form of redistribution of wealth from the poor to the rich, from people with modest savings to those with the means to lend to the government (who as a general rule ought to be paying taxes rather than lending).
…historical experience suggests that in a serious crisis it is often necessary to make emergency budget decisions on a scale that would have been unimaginable before the crisis. To leave it to a constitutional judge (or committee of experts) to judge such decisions case by case is to take a step back from democracy.
Private wealth rests on public poverty, and one particularly unfortunate consequence of this is that we currently spend far more in interest on the debt than we invest in higher education… This is the main reason why the debt must be reduced as quickly as possible, ideally by means of a progressive one-time tax on private capital or, failing that, by inflation.
When it comes to organizing collective decisions, the market and the ballot box are merely two polar extremes. New forms of participation and governance remain to be invented.
The essential point is that these various forms of democratic control of capital depend in large part on the availability of economic information to each of the involved parties. Economic and financial transparency are important for tax purposes, to be sure, but also for much more general reasons. They are essential for democratic governance and participation.[Power is ultimately about making investment decisions]
The accounting data that companies are currently required to publish are entirely inadequate for allowing workers or ordinary citizens to form an opinion about corporate decisions, much less to intervene in them… Conversely, without a real right to intervene in corporate decision-making (including seats for workers on the company’s board of directors), transparency is of little use.
…it took two world wars to wipe away the past and significantly reduce the return on capital, thereby creating the illusion that the fundamental structural contradiction of capitalism (r > g) had been overcome.
The world is not divided between a political elite on one side and, on the other, an army of commentators and spectators whose only responsibility is to drop a ballot in a ballot box once every four or five years.
It is possible, for instance, to spend a great deal of time proving the existence of a pure and true causal relation while forgetting that the question itself is of limited interest. The new methods often lead to a neglect of history and of the fact that historical experience remains our principal source of knowledge… the imperfect lessons that we can draw from history, and in particular from the study of the last century, are of inestimable, irreplaceable value, and no controlled experiment will ever be able to equal them.

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