Capital in the Twenty-First Century (part 4)

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The twenty-first century state

The final part of Piketty’s book deals with the role of the state in 21st-century capitalist society. He focuses on two main objectives:

  • modernizing–but not dismantling–the modern “social state”
  • controlling the trend toward economic inequality by increasing the taxation of capital

The social state

The relatively strong economic growth and greater social equality of the 20th century was accompanied by–and promoted by–a larger government with greater power to tax and spend. Taxes consumed a much larger share of national income: 31% in the US, 40% in Britain, 46% in France and 54% in Sweden at their peak around 1980. (The share had been less than 10% in those same countries in the 19th century.) Public support for such high rates was easier to come by when economies were growing rapidly. High taxes enabled the state to take on new social functions. Governments invested more in the health and education of their citizens, and they provided more income security through retirement systems and support for the disabled, unemployed or otherwise economically needy.

Piketty does not expect to see a further expansion of the social state, since “the state’s great leap forward has already taken place.” He also acknowledges the need to re-examine what we already have: “The tax and transfer systems that are the heart of the modern social state are in constant need of reform and modernization, because they have achieved a level of complexity that makes them difficult to understand and threatens to undermine their social and economic efficacy.”

Piketty notes that modern taxation is no longer very progressive when all types of taxes are taken into account. He believes that how government taxes the largest incomes and fortunes is important for either reinforcing or reducing economic inequality. In the United States, tax rates on the top bracket of income averaged 81% between 1932 and 1980. Today, the top rate is 39.6% for income over $400,000 ($450,000 if married, filing jointly). As noted earlier, the recent reduction in top rates gave executives more incentive to fight for pay increases, since they could now keep most of them. Piketty does not advocate a return to the “confiscatory” rates of the past, but he would like to see a rate of at least 50% for all income over $200,000, “in order for the government to obtain the revenues it sorely needs to develop the meager US social state and invest more in health and education (while reducing the federal deficit)….”

In the US, the maximum rate for capital gains is only 20%, so the effective tax rate on total income is often lower for rich taxpayers than middle-income taxpayers. Countries have been competing against each other in a race to the bottom, trying to attract capital by taxing it lightly. Piketty hopes that more European cooperation can eventually reverse that trend. As for the United States, he ends his discussion of taxes on a pessimistic note:

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.

By “Old Europe,” he means, of course, the land of inherited wealth and extreme inequality.

A global tax on capital

What is most needed to curb excessive inequality and make taxation fairer is “a progressive annual tax on individual wealth–that is, on the net value of assets each person controls.” Since it is a tax on accumulated wealth, not just current income, it would need to be set rather low, just “a few percent.” Like a property tax, it would be small, but much fairer because it would include the financial assets that make up the bulk of large fortunes. Ideally it would be imposed all over the world, but since that is unlikely to happen, the next best thing is to impose it in large areas such as the United States and a more united Europe. Otherwise capital can too easily move around to avoid it. Several European countries have taxes on capital, but they have too many loopholes to be effective.

The main justification would be “contributive”. Net assets is a fairer measure of a wealthy person’s capacity to support government than current income, which doesn’t count unrealized capital gains. A secondary justification would be giving the owners of capital more incentive to seek the best possible return. Those who earned too low a return would have to sell assets to pay their taxes, “thus ensuring that those assets wind up in the hands of more dynamic investors.”

Private wealth, public debt

Piketty finds it shameful that the richest countries in the world have such poor, indebted governments. Virtually all the capital in these countries is private capital, since whatever assets governments hold are offset by their liabilities. Financing the operations of government by borrowing rather than taxing works fine for wealthy people who would rather buy government bonds than pay taxes, but it is less efficient and less just.

Piketty’s preferred method for reducing government debt is higher taxation of capital. A second method is inflation of the money supply, which shrinks the value of the debt while spreading the cost widely through society. Inflation was the main way of reducing public debt in the 20th century, but it has to be used sparingly or it can spiral out of control. The worst method of reducing debt is austerity, which hits the poor the hardest, inhibits economic growth and increases the advantage of capital over labor, in accordance with the book’s main argument. Piketty says that “if the choice is between a little more inflation and a little more austerity, inflation is no doubt preferable.”

Economic conservatives would vigorously disagree. They place the highest priority on fighting inflation and opposing tax increases, so that austerity becomes the preferred method, at least by default. Milton Friedman and the monetarist economists saw regulation of the money supply as the central economic function of government and social spending as dangerously inflationary. “The work of Friedman and other Chicago School economists fostered suspicion of the ever-expanding state and created the intellectual climate in which the conservative revolution of 1979-1980 became possible.”

The European Union developed as a “currency without a state and a central bank without a government” at a time when inflation-fighting was coming to the forefront of public policy. The European Central Bank’s focus on controlling inflation works well for a creditor country like Germany, which can count on low inflation to preserve the value of their loans. It narrows the options of debtor countries like Greece, especially at a time when financial crisis has reduced their tax revenues and undermined confidence in their bonds. They cannot borrow at low interest rates. They cannot devalue the euro to reduce the value of their debts. They cannot effectively tax capital, or capital will just leave the country. So they are forced to prolong recession with unpopular austerity measures.

Piketty wants to see a European Union that is more of a real government, with a fiscal policy as well as an inflation-fighting monetary policy, giving it the capacity to share the debt burden and raise taxes on capital to alleviate that burden.

While the trend of the last few decades has been to deregulate capital and defund the social state, Piketty advocates a different approach for the 21st century: “Although the risk is real, I do not see any genuine alternative: If we are to regain control of capitalism, we must bet everything on democracy–and in Europe, democracy on a European scale.”

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