Raphaele ChappeThis week's Worldly Philosopher, Raphaele Chappe, writes on the policy implications of Thomas Piketty's analysis on inequality.

We are in a post-Piketty world. Since my last blog entry, Thomas Piketty has received nothing short of a rock star treatment upon his U.S. visit. What are the policy debates we face if Piketty is right?

As the ratio of capital to income (which Piketty terms "beta") increases, Piketty argues there is no natural mechanism that would lead r (the rate of return on capital) to adjust downwards so as to perfectly compensate the impact on the distribution, placing emphasis on policies that might reduce r.

Taxation is one way to reduce r and Piketty's proposal is a progressive world-wide tax on wealth although many agree that this may prove politically unfeasible, especially in the absence of international legal cooperation. Other tax possibilities for fighting inequality include increasing tax rates on capital gains and dividends (which have been getting favorable treatment in the tax code as compared with labor income1), or simply combating tax evasion for the wealthy (see The Price of Offshore Revisited).2 In my own research, I plan to run simulations to test the effectiveness of such tax proposals, and their impact on the wealth distribution.

We could also consider labor-focused policies designed to increase the share of national income going to labor, such as raising the minimum wage, or giving workers direct participation in management and profit through employee ownership or other means. (For the use of national income and product accounts (NIPA) as a framework for studying how inequality will be affected by fiscal and other initiatives such as raising the minimum wage, see SCEPA working paper 2013-1).

In order to advocate for the best policy solutions, we may wish to understand the drivers for high profit rates in recent decades.

Piketty's proposed wealth tax solution is compatible with the conventional marginal productivity framework, with r equal to the marginal productivity of capital (itself a technical determination, given the existing technology and the shape of the production function, i.e. the elasticity of substitution between capital and labor). Yet the wealth distribution may be shaped by factors other than the technology. In his recent blog entry, Gregor mentions socioeconomic variables such as the globalization of production, the bargaining power of labor, financialization, and changes in production technology as being responsible for the shift to higher profit shares. To be fair, Piketty acknowledges that r might also be socially and politically determined and that factors of production may not necessarily get paid their marginal product, but he does not elaborate further.

This has led some commentators to highlight that some sectors of the economy (such as the financial sector the pharmaceutical industry) could suffer from large economic rents. Dean Baker suggests that policies designed at eliminating such rents (e.g. with a financial transaction tax or a breakdown of patent monopolies) could lower r while at the same time raise g.

Our policy debates cannot ignore existing structures of economic and political power.
If wealth controls government, existing political economic institutions will not necessarily cooperate. In his latest book "The Price of Inequality," Stiglitz raises the issue of political power exercised by lobbies and moneyed interests over legislative and regulatory processes. In his view, politics has shaped the market in ways that advantage the wealthiest at the expense of the middle-class. But politics can change.

1From 2003 to 2012, qualified dividends have been taxed at the same rate as long-term capital gains (15 percent rate, and as low as 0 percent for individuals in low-income brackets). The American Taxpayer Relief Act of 2012 has recently increased this rate to 20 percent (for both capital gains and dividends) for taxpayers that exceed the thresholds for the highest income tax rate (39.6 percent), extending the 0 and 15 percent tax rates for taxpayers below the thresholds. This regime clearly favors wealthy individuals that derive income from financial investments rather than labor.

2According to a study written for the Tax Justice Network by a former chief economist at the consultancy firm McKinsey, a global super-rich elite has accumulated an astronomical amount of financial investments hidden in tax havens, at least $21 trillion and as much as $32 trillion of private offshore wealth (as of the end of 2010).

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