A version of this op-ed was originally published in UnHerd on August 28, 2019.
On both sides of the Atlantic, economic inequality has rocketed up the political agenda and inspired a new wave of populism. Wealth inequality is high and rising in the UK and staggeringly so in the US. The top 1% of American households now have more wealth than the bottom 90%. In the UK, the top 10% holds over half the wealth. The richest 400 individuals in the US average a net worth of $7.2 billion.
How did we get to this point? As Thomas Piketty, in his book Capital, famously argued, a capitalist economy left to its own devices will tend to produce not just inequality but ever-rising inequality of wealth – and the income derived from wealth. The main reason is because the returns earned on assets such as stocks and bonds normally exceed the growth of wages.
Imagine an economy with one capitalist and one wage earner. If the annual rate of return to financial assets is, say, 3%, but wages are only growing by 2%, more and more income ends up in the hands of the capitalist. Wealth then begets more wealth as the capitalist, not needing to spend all of his added income, adds to his existing wealth and reaps ever-growing income from that wealth. Unless a war or other shock destroys his wealth (think depression or the devastation in Europe after the Second World War), or government decides to tax it away, we end up with the rise in wealth inequality that we are now seeing in many rich countries – the US in particular.
There is something deeply disturbing about Piketty’s work. If one takes his thesis seriously, it means that the inequality of wealth and its corollary, income inequality, along with their continued growth, is the new normal. They are baked into a capitalist economy.
Of course, some financial capital gets invested in productive assets that help the economy grow. But productive investment and growth have slowed in recent decades, making it hard to argue that the rise in wealth at the top has benefited everyone. In the meantime, the accumulation of wealth in high-income households is one reason that income inequality is rising so sharply at the very top. While the richest 20% of US households, which benefit from a lot of human capital but not a lot of wealth, saw their market incomes rise by 96% between 1979 and 2016, the top 1% – which receives far more of their income from wealth – saw their incomes rise by a staggering 219%.
In short, growing wealth inequality spawns growing income inequality, so if we care about the latter, we cannot focus only on redistributing income. We need to tackle the accumulation of wealth as well.
What to do? Senator Elizabeth Warren, a serious contender for the US presidency, has proposed a wealth tax. She would levy a tax of 2% on households with net worth over $50 million and 3% on households with net worth over $1 billion. This proposal is now being fiercely debated.
One counter-argument is that taxing the rich will slow economic growth. However, the idea that low taxes on the rich are the key to economic growth has been undermined by the repeated failures of supply-side economics and the tax cuts enacted under that banner to move the growth needle in a significant way. (They do provide a temporary stimulus to the economy.)
Finally, no one with less than $50 million would be affected by the Warren proposal; there would still be an incentive to save and invest, and if the revenues from the tax were invested in public goods such as more effective education and infrastructure, growth would probably be higher. Businesses need educated workers, good transportation and communication systems to function efficiently.
Another concern with a wealth tax is the ability of individuals to avoid it by leaving the country or parking their money in untaxed assets. Many European countries used to have wealth taxes but rescinded them because of their administrative complexity. They require detailed and challenging audits, an exit tax on those seeking to avoid the tax by leaving the country, and annual valuations of closely-held businesses. In the US there is, in addition, a serious question about the constitutionality of a wealth tax.
On the positive side, a wealth tax would not just reduce inequality of both wealth and income but would also raise significant revenue from a group that can easily afford to pay more. Warren’s proposal is estimated to raise $2.75 trillion over ten years, according to Emmanuel Saez and Gabriel Zucman, economists at the University of California, Berkeley. This estimate has been disputed, and so likely represents an upper bound: Lawrence Summers and Natasha Sarin have warned that the Saez and Zucman estimate is overly optimistic: the rich will find myriad ways to avoid the tax.
Either way, a wealth tax can raise substantial revenue. Were that revenue invested in education, infrastructure, clean energy to combat climate change, or used to reduce deficits and debt, the benefits would almost surely exceed any costs.
A tax on wealth is also politically popular – at least in the US. Two-thirds of Americans support Warren’s wealth tax. Six out of ten Americans say that the rich do not pay their fair share in federal taxes and seven out of ten say the same of corporations. While the rich cannot foot the bill for all of a nation’s needs, they can certainly pay more.
Not only could increased taxes on the rich fund sorely needed public investments, they could also reduce the political influence of the rich. While this fact is often overstated, the political scientists Martin Gilens and Benjamin Page have documented that US economic elites and business interest groups are much more likely to see their preferred policies enacted than are mass-based interest groups or the average citizen.
Rising inequality together with the undue political influence of the rich suggests a distributing tendency for inequality to beget more inequality through a political feedback loop. Even if wealth does not buy as much political influence as people assume, the perception matters and is causing people to lose faith in democracy — instead turning to would-be oligarchs dressed in populist clothes.
Warren’s proposal or others like it deserve a hearing. While a true wealth tax has not been proposed by the Labour Party in the UK, other proposals that approach a wealth tax are being debated. These include a mansion tax, which was seriously considered by the Coalition government, and a new band on the council tax for the richest Britons.
Other proposals that target the rich, such as raising the capital gains rate to match the tax rate on income, and placing a limit on tax-free capital gains earned from primary residences, are also promising. Linking a tax increase on the rich to broad-based benefits, such as infrastructure or education, would increase its chances of enactment – the popularity of tax and spend is at a 15-year high in the UK, with six in ten Britons in support.
A market economy may, by its very nature, produce increasing inequality. And increasing inequality leads to monied interests having more ability to sway political outcomes while simultaneously leaving the average citizen frustrated by the large and growing gap between their incomes and assets and those of the rich.
There is nothing intrinsically wrong with individual wealth. Many wealthy individuals are making important contributions to society via their enterprise or their philanthropy. Some, such as Warren Buffet, Ray Dalio, and George Soros, are calling for greater taxation of what they have earned. But societies with too much wealth at the top may not be politically sustainable or the kind of society most of us want to inhabit. The optimal level of wealth inequality is not just an economic question, but a political and social question as well.