Tuesday, December 22, 2015

Capital in the Twenty-First Century

Having read several reviews touting the great importance of Thomas Piketty’s Capital in the Twenty-First Century, I decided to read it myself. While it does deal with important financial issues, it’s not a page-turner. What surprised me most was Piketty’s embrace of huge government.

Much of the book consists of dry discussions of historical data on income and wealth inequality around the world. Given a choice between a picture and 1000 words, Piketty consistently chooses both. In one memorable discussion, the reader learned that there are 10 times as many people in the top 1% as there are in the top 0.1%.

All the historical information is oddly disconnected from Piketty’s central argument. He says that because the rate of return on capital (r) is greater than the rate of economic growth (g), wealth is destined to become ever more concentrated in the hands of a small number of ultra-wealthy people.

However, it’s not quite this simple. For one thing, the wealthy spend some of their money and pay taxes. For another, they often split their fortunes among multiple heirs. And some heirs mismanage their inheritances. So, return on capital has to be enough bigger than economic growth to compensate for these factors. Maybe it is.

Another fact that does not fit with Piketty’s line of argument is that some of the more prominent ultra-wealthy people (think Warren Buffett and Bill Gates) built their fortunes rather than receiving them as inheritances. It may well be that wealth concentration is likely to increase in the future, but Piketty could have devoted more effort to convincing the reader of this fact.

Proposed new taxes

Piketty’s remedies for the problems of income and wealth concentration surprised me. I expected suggestions for high income tax rates on huge incomes, perhaps 90% on income over $1 million per year. I also expected capital taxes on great wealth, perhaps a 3% per year tax on wealth above $25 million. However, Piketty is more ambitious than this.

I should have realized my guesses were wrong when Piketty declared that he saw as reasonable a tax system where governments control two-thirds to three-quarters of all income. I find the prospect of so much of a nation’s output being centrally controlled and planned frightening.

Piketty proposes a yearly progressive capital tax on everything we own. No assets would be exempted. Your house counts. Your RRSPs count. Everything counts. Here are the proposed tax percentages with wealth amounts converted to Canadian dollars:

0.1% (0 to $300k)
0.5% ($300k to $1.5M)
1% ($1.5M to $7.5M)
2% (over $7.5M)

An example

Let’s take a look at the impact of such a tax. Imagine a couple who are retiring at 65 in a paid off home in Toronto. They have no pensions beyond CPP and OAS, but they have managed to save up $2 million for their retirement. They have saved very well.

Based on the 4% rule, this couple hope the draw $80k per year from their savings. This will be enough to live well and do some traveling. Now let’s hit them with Piketty’s capital tax. Let’s say their house is worth a $1 million so that the capital tax is based on $3 million. Their yearly capital tax works out to $21,300 on top of the roughly $8000 they’ll pay in income taxes.

This couple thought they would be able to spend about $6000 per month from their savings, but can now only spend about $4200 per month. While it is certainly possible to live a good life on this smaller amount, they have to wonder why they worked so hard to save their whole lives.

Of course, this example assumes the capital tax comes into effect just as this couple retires. If the capital tax had been in place through their whole working lives, they would never have come close to $2 million in savings. Young people just starting their careers and facing this tax would be justified in concluding that saving is futile.

In my own case, I’ve crunched some numbers to see the impact such a capital tax would have on my finances, and my conclusion is that I’d quit my job immediately. Trying to build my savings further against such a relentless drain would be pointless. Piketty’s percentages may not look big, but let’s see what they look like as 25-year figures rather than yearly percentages:

2.5% (0 to $300k)
12% ($300k to $1.5M)
22% ($1.5M to $7.5M)
40% (over $7.5M)

If we are trying to prevent wealth concentration, why are we taking money away from people whose net worth is less than $300k? Even the next bracket ($300k to $1.5M) is just middle class people with some equity in their homes and some RRSP savings. In my opinion, a wealth tax should not even kick in until wealth is at least $5 million. Applying Piketty’s wealth tax looks more like a way for governments to confiscate assets from everyone instead of just targeting the very wealthy.

An alternative to a wealth tax

Bill Gates proposed a “progressive tax on consumption as an alternative to a tax on capital. I’m not sure how to make such a tax work, but it seems preferable to Piketty’s proposal. The hypothetical couple above would likely not run afoul of a tax on conspicuous consumption.

World government

Piketty sees the competition among countries to attract business with lower taxes as a problem to be solved with coordination among countries. He recognizes that it is hard for one country to introduce a wealth tax if people can move their assets to a neighbouring country. So, he dreams of coordination that amounts to a quasi-world government setting tax rules everywhere.

I find such a prospect terrifying. At least now if a government becomes grossly inefficient, citizens at least have the difficult option of leaving. But there would be nowhere to hide from a bad world government.

Conclusion

Piketty may be right about wealth concentration being a growing problem. However, I’d prefer remedies that target the truly wealthy. The goal should not be to turn most assets over to the governments of the world.

6 comments:

  1. Key take away, for me, was the point about wealth distribution reverting to the natural mean: rich or poor -- only. That the "middle class" is a post-war anomaly destined to fade away into one of the mentioned groups. This certainly seems to be the trend in North America over the last 40+ years.

    I have limited control over govt policy (e.g. taxation, etc.), but I have complete control over my net money. To avoid becoming poor, or merely struggling to maintain an un-natural between-state, I focus on allocating my money the same way the wealthy concentrate theirs: ownership (beyond common stocks). Be a rentier instead of a renter.

    But it is true, once cost of doing business becomes too high, incl taxation, then people will simply stop doing business; quasi-Atlas Shrugged.

    I guess a question that should be asked, with perhaps no answer, is should there even be an attempt to redistribute wealth? Capitalism is far from perfect, but it seems to be the best system we have so far for advancing society on all levels for everyone (there is far less abject poverty in the world than 100 years ago). I'm as greedy as the next b*stard, but to pursue homogeneous wealth is not only unrealistic, but could very well be severely detrimental on both capitalistic and altruistic/philanthropic levels (e.g. the Gates Foundation would not exist if Bill had the majority of his wealth stripped from him every year).

    If anything, 'Capital' is good for controversial Christmas dinner conversation!

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    1. @SST: I find the "rentier" and "renter" terminology interesting because I don't think it really applies to real estate any more. Where it really applies is with stocks and bonds. The rentier owns stocks and bonds, and the renter borrows money. The returns from owning real estate aren't as good as those from owning stocks. In fact, the best "rentier" may be the one who rents a home and puts all available savings into stocks.

      I think it makes sense to have limited redistribution of wealth. For example, I'm very happy living in a society with universal health care. The other safety nets we have aren't perfect, but at least the desperation level is low enough that it's safe to walk around in most Canadian cities. The part of the current wealth redistribution I don't like is the taxes collected to overpay the subset of government workers who do their jobs poorly.

      I have no interest in seeking homogeneous wealth, but I do like the idea of setting a minimum standard of living. This minimum would rise as society as a whole becomes wealthier.

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  2. Michael, you really red the ENTIRE book?!

    For myself, I red a 21 pages review last year and gave up on reading the book. This guy could write a book about any subjets like "there is to much water in the oceans" with historical datas and graphs and blah blah blah. I think he really wants to get the spotlight and increase his OWN capital.

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    1. @Le Barbu: I don't blame you for not wanting to read the book. While I think Piketty may have been too verbose in over-explaining the historical data, I do understand that he wanted to be academically rigorous. If his aim were to make money by getting into the spotlight, I think he would have written the book very differently.

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  3. I used 'rentier' as a universal term for 'owner of capital', be it real estate, factories, equipment, utilities, services, etc. In other words, the wealthy rentier owns the capital and thus owns a much greater degree of the production (aka profit) than the poor renter/employee.

    Picketty also doesn't get into what you mentioned, the government overseeing the wealth redistribution. Governments are innately inefficient, much more so than a profit-driven entity. Thus, their efforts, and effects, will always be less than optimal.

    Perhaps yet another idea to add even more useless complexity, would be to have the pubic sector collect tax and the private sector redistribute the wealth. This might have a net zero effect, and the profit margin could be equal to the government's cost of inefficiency...or it could very well be viable.

    (I found the book translated online a couple years ago. Went through it with the help of a few different "Coles notes" publications.)

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    1. @SST: I understood your use of "rentier" -- Piketty uses it the same way. I just find it ironic that the origin of the term relates to real estate, but the owner of real estate is now not a very good example of a rentier.

      Yes, Piketty isn't specific about how governments should use all the new money they would get; he just seems to trust that they would do good things. I'm much less optimistic about governments' ability to handle money well. About the only way to let private industry redistribute wealth that I can see would be to give money directly back to the people to spend themselves.

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