The upside of economic inequality is that it makes life better for everyone, especially the poor.

Right now, our economic prospects look grim. To classical liberals like myself, future growth is unsustainable in an age dominated by progressive politics. There are two reasons for this: an extensive system of regulation of all key sectors of economy—including labor, real estate, health care, and financial markets—and a combination of progressive income taxes, specialized levies (like the medical device tax), and a heavy estate tax, whose proceeds are used to fund an ever-expanding system of transfer payments.

Today’s unending cycle of regulation, taxation, and transfer payments induces non-stop political competition, which lets strong voting coalitions take from their adversaries in order to enrich their friends. This dynamic leads to crony capitalism that reduces the return to both capital and labor. States like Texas that work hard to resist these various trends do well in comparison to those states like Illinois that yield to political temptation. The solution requires systematic deregulation coupled with flat taxes to induce higher levels of competition that will in turn produce greater economic growth and human satisfaction.

The Piketty Vision

This vision for a just and prosperous society turns out to be a giant mistake—at least under the doomsday predictions of Thomas Piketty’s bestseller Capital in the Twenty-First Century. Piketty’s key assumption is that the rate of return on capital will always (except of course in wartime) exceed the rate of growth in the economy, so that the long-term trend necessarily leads to a vast concentration of wealth in the hands of a tiny group of rentiers—those investors who reap a return in the form of rents, dividends, and interest payments from capital assets.

Accordingly to Piketty, a French economist, that concentration of wealth in the hands of the few creates the risk “of significant political upheaval. Our democratic societies rest on a meritocratic worldview, or at any rate a meritocratic hope, by which I mean a belief in a society in which inequality is based more on merit and effort than on kinship and rents.” These economic rents, he argues, do not result from some market imperfection, but are instead “the consequence of a ‘pure and perfect’ market for capital, as economists understand it,” so that “each owner of capital, including the least capable of heirs, can obtain the highest possible yield on the most diversified portfolio that can be assembled in the national or global economy.”

The cure for these dangers cannot be stopped by market reforms. Instead, Piketty thinks boldly: “The right solution is a progressive annual tax on capital. This will make it possible to avoid an endless inegalitarian spiral while preserving competition and incentives for new instances of primitive accumulation.” These taxes can range up “to 2 percent between 5 and 10 million euros, and as high as 5 or 10 percent for fortunes of several hundred million or several billion euros.”

The proceeds can be collected locally and spent globally. Combine his wealth tax with a progressive income tax, and these fortunes will surely dissipate, not only for the heirs but also for the long list of wealth creators, including Bill Gates, Warren Buffett, Larry Ellison, Charles & David Koch, Michael Bloomberg, Larry Page, Jeff Bezos, Sergey Brin, and Mark Zuckerberg.

The Upside of Income Inequality

One of the most striking defects of the Piketty analysis is its flawed understanding of the relationship between social wealth and income inequality. The initial point goes to the question of how ordinary people ought to regard the accumulation of vast stores of wealth by the few, much of which gets passed on by inheritance to other people. For Piketty, their greater wealth leaves (all else being equal) poorer people worse off because of their apparent loss of political influence to the great and mighty.

Not so fast. First, as an economic matter, the increase of the wealth of some without a decline of wealth in others counts as a Pareto improvement, which is in general to be welcomed, even if it increases overall levels of inequality. But to egalitarians like Piketty, the increased wealth inequality is bad in itself, as their objective is to minimize differences in wealth and income, rather than to increase their overall totals. Piketty’s assumptions lead to the conclusion that a world in which the rich average 1,000 and the poor average 10 is less desirable than a world in which the rich average 300 and the poor average 5, given that the absolute and relative differences in wealth are lower in the second state of the world than the first.

Piketty does not actually state this conclusion in those bald terms. Instead he makes the argument that the wealth of the rich gives them too much influence over political affairs in a democratic society. But in so doing, he misses the key point that the wealthiest among us include the two Koch Brothers ($40 billion each), and also Bill Gates ($76 billion), Warren Buffet ($58.2 billion), and George Soros ($23 billion) whose political preferences move in decidedly different ways.

It is pure fantasy to assume that the super rich move as a unified political bloc. Nor should it be assumed that they have disproportionate influence. To James Madison, the great concern with democratic (as opposed to republican) forms of government was that voters with more influence in the political arena could satisfy, as it is put in Federalist 10, “a rage for paper money, for an abolition of debts, for an equal division of property, or for any other improper or wicked project.”

Progressive writers in the twentieth century and after have taken strong exception to Madison’s views. But my point here is descriptive, not normative. The place of large concentrations of capital in a democratic society is deeply vulnerable to majoritarian politics, as evidenced by the strongly progressive income tax rates and estate tax rates. In other words, the great wealth of the few makes them politically vulnerable, not politically unstoppable. In a political climate that treats as a major political objective the rectification of inequalities of fortune, the net transfers in the United States are not to, but from, the financial elites.

What About Social Trends?

Unfortunately, the fixation with economic wealth and income also leads Piketty and other egalitarians to overlook many key social trends of enormous importance. Theoretically, measures of wealth are convenient ways to attack the inequality of individual well-being. Though they are relevant to that question, they are far from the only measure of individual well-being. There are all sorts of other indicators that are distinct from income and wealth, including many measures of the length and quality of life. Piketty does note the dramatic increase in life expectancy throughout the developed world in the modern era, but, oddly enough, he does this only to rebut the point that longer life expectancies reduce the danger of inherited wealth.

            What he should have done is exactly the opposite. There is no way that overall social gains on matters of life expectancy and health can be concentrated in the top one percent of society. To be sure, it is worth noting that infant mortality has always been inversely correlated with wealth. The children of richer people do better than those of poorer people. But look next at the actual numbers. By one British study, infant mortality ranged in 1901 from 247 per 1,000 live births in the poorest group to 94 per 1,000 in the highest group, the so-called “servant-keeping class.” One hundred years later, those numbers dropped to 3.7 per 1000 for the first group and 8.1 per 1000 for the second.

Looking solely at the mortality ratios, you could conclude that, relatively speaking, things have gotten a bit better for the poor, as their children are about 2.19 times as likely to die as the children of rich people, compared to being 2.63 times as likely to die a century before. Yet this analysis misses the forest by looking at the trees. The actual decline in mortality rates at the bottom was about 240 lives per thousand; for the top, it was 90. The huge increases in both areas, where the poor had the most dramatic gains, is the real story. The egalitarian ratio is a side-show.

That same point can be replicated by many other measures of well being. To turn to the United States, life expectancy for the average person born in 1900 was about 47 years. By 1920, that number had jumped to 54 years. By 1998, the number was about 76 years. Throughout this period, life expectancy for females was greater than that for males, even though earned income was greater for men. Try the same experiment by raceand the results are still more dramatic. Black life expectancy in the United States in 1900-1902 lagged white life expectancy by 15.8 years (49.8 versus 33.8). By 2010 the gap had narrowed to 3.6 years (78.7 to 75.1).

These figures tell a story that is wholly concealed by Piketty’s income and wealth figures. They show the huge positive influence of technological advances on human welfare. Sadly, his lengthy book is silent about the massive advances in basic science, public health, and medicine that fueled this revolution, creating widespread benefits for the population at large. It is also worth noting that these increases were more dramatic by far in the first decade of the twentieth century than they were in the first decade of the twenty-first century. Neither technology nor politics can explain the difference, but greater regulations and higher tax rates can. The Piketty obsession with income inequality conceals more than it reveals.

Richard A. Epstein, Peter and Kirsten Bedford Senior Fellow at the Hoover Institution, Laurence A. Tisch Professor of Law at New York University, and senior lecturer at the University of Chicago, researches and writes on a broad range of constitutional, economic, historical, and philosophical subjects. He has taught administrative law, antitrust law, communications law, constitutional law, corporate law, criminal law, employment discrimination law, environmental law, food and drug law, health law, labor law, Roman law, real estate development and finance, and individual and corporate taxation. His publications cover an equally broad range of topics. His most recent book, published in 2013, is The Classical Liberal Constitution: The Uncertain Quest for Limited Government (2013). He is a past editor of the Journal of Legal Studies (1981–91) and the Journal of Law and Economics (1991–2001).

Source URL: http://www.hoover.org/publications/defining-ideas/article/177406