Income Inequality - An Issue That Won’t Go Away

The stock market is hitting new highs, real estate prices are recovering and consumer balance sheets are healthier than ever.  But in the face of this happy news, a growing body of research is highlighting that much of America is not participating in the prosperity. 

French economist Thomas Piketty is the latest to weigh in on the issue of income and wealth inequality.  In his latest book, Capital in the 21st Century,  Piketty spells out the results of his extensive research on global income and wealth trends over the last 300 years.  Historically, he finds that unequal distributions of wealth and income are not unusual and only during periods following war or depression when accumulated wealth is wiped out has the gap actually narrowed. 

Piketty contends that income and wealth inequality are byproducts of capitalist systems.  Those who hold excess capital (the rich) earn money on investments while those without excess funds do not.  This observation is backed up by Piketty’s research showing that returns on capital have indeed outstripped economic growth rates over time (see chart below). 

After tax rate of return versus growth rate at the world level, from Antiquity until 2100  Source: Capital in the 21st Century               

After tax rate of return versus growth rate at the world level, from Antiquity until 2100

Source: Capital in the 21st Century               

The idea that income and wealth are unequally distributed in capitalist societies shouldn’t shock many people.  But the fact that inequality has been increasing particularly in this country may come as a surprise. The chart below is based on data from the Luxembourg Income Database shows that median income levels in the U.S. barely budged over the 2000-2010 time period while incomes in many western countries moved ahead nicely.  This outcome occurred despite the fact that U.S. economic growth over the period was as strong as, or stronger than its competitors. 

Source: International New York Times

Source: International New York Times

Should we be concerned? Rising income inequality challenges the idea of meritocracy where anyone can get ahead through the application of skill and effort, a key principal on which this nation was built.  And you don’t need to be a historian to understand that once large numbers of society feel unable to share in rising levels of prosperity - watch out. But raising taxes on the rich, a common prescription, has its costs as well.  Penalizing profits, the right claims, thwarts innovation and job creation. Piketty comes down firmly on the side of the left.  In addition to raising taxes on ultra-high incomes, he proposes a global progressive tax on capital. 

Piketty’s historical research is unprecedented and his work is stirring an important debate.  But his policy prescriptions are narrow.  Education as well as capital has traditionally been key to moving ahead so policies to improve access to affordable education should be on the table as well. Efforts to support capital accumulation through vehicles such as enhanced retirement savings accounts are not considered and should be. 

His prescriptions, which require tax policy coordination on a global basis, are unlikely to be implemented easily.  But politicians who dismiss his thinking as liberal ranting should be careful.  Capital has been a top selling title on Amazon this spring and his message will likely hit a nerve with much of America’s middle class.  Whatever your position on this issue, you can be sure that Piketty’s latest work will influence policy both on the left and on the right going forward.