Capital in the Twenty-First Century

In other words, Liliane Bettencourt, who never worked a day in her life, saw her fortune grow exactly as fast as that of Bill Gates, the high-tech pioneer, whose wealth has incidentally continued to grow just as rapidly since he stopped working. Once a fortune is established, the capital grows according to a dynamic of its own, and it can continue to grow at a rapid pace for decades simply because of its size. Note, in particular, that once a fortune passes a certain threshold, size effects due to economies of scale in the management of the portfolio and opportunities for risk are reinforced by the fact that nearly all the income on this capital can be plowed back into investment. An individual with this level of wealth can easily live magnificently on an amount equivalent to only a few tenths of percent of his capital each year, and he can therefore reinvest nearly all of his income.16 This is a basic but important economic mechanism, with dramatic consequences for the long-term dynamics of accumulation and distribution of wealth. Money tends to reproduce itself. This stark reality did not escape the notice of Balzac, who describes the irresistible rise of his pasta manufacturer in the following terms: “Citizen Goriot amassed the capital that would later allow him to do business with all the superiority that a great sum of money bestows on the person who possesses it.”17

Note, too, that Steve Jobs, who even more than Bill Gates is the epitome of the admired and talented entrepreneur who fully deserves his fortune, was worth only about $8 billion in 2011, at the height of his glory and the peak of Apple’s stock price. That is just one-sixth as wealthy as Microsoft’s founder (even though many observers judge Gates to have been less innovative than Jobs) and one-third as wealthy as Liliane Bettencourt. The Forbes rankings list dozens of people with inherited fortunes larger than Jobs’s. Obviously wealth is not just a matter of merit. The reason for this is the simple fact that the return on inherited fortunes is often very high solely because of their initial size.

It is unfortunately impossible to proceed further with this type of investigation, because the Forbes data are far too limited to allow for systematic and robust analysis (in contrast to the data on university endowments that I will turn to next). In particular, the methods used by Forbes and other magazines significantly underestimate the size of inherited fortunes. Journalists do not have access to comprehensive tax or other government records that would allow them to report more accurate figures. They do what they can to collect information from a wide variety of sources. By telephone and e-mail they gather data not available elsewhere, but these data are not always very reliable. There is nothing inherently wrong with such a pragmatic approach, which is inevitable when governments fail to collect this kind of information properly, for example, by requiring annual declarations of wealth, which would serve a genuinely useful public purpose and could be largely automated with the aid of modern technology. But it is important to be aware of the consequences of the magazines’ haphazard methods. In practice, the journalists begin with data on large publicly traded corporations and compile lists of their stockholders. By its very nature, such an approach makes it far more difficult to measure the size of inherited fortunes (which are often invested in diversified portfolios) as compared with entrepreneurial or other nascent fortunes (which are generally more concentrated in a single firm).

For the largest inherited fortunes, on the order of tens of billions of dollars or euros, one can probably assume that most of the money remains invested in the family firm (as is the case with the Bettencourt family with L’Oréal and the Walton family with Walmart in the United States). If so, then the size of these fortunes is as easy to measure as the wealth of Bill Gates or Steve Jobs. But this is probably not true at all levels: as we move down the list into the $1–10 billion range (and according to Forbes, several hundred new fortunes appear in this range somewhere in the world almost every year), or even more into the $10–$100 million range, it is likely that many inherited fortunes are held in diversified portfolios, in which case they are difficult for journalists to detect (especially since the individuals involved are generally far less eager to be known publicly than entrepreneurs are). Because of this straightforward statistical bias, wealth rankings inevitably tend to underestimate the size of inherited fortunes.

Some magazines, such as Challenges in France, state openly that their goal is simply to catalog so-called business-related fortunes, that is, fortunes consisting primarily of the stock of a particular company. Diversified portfolios do not interest them. The problem is that it is difficult to find out what their definition of a “business-related fortune” is. How is the ownership threshold defined, that is, when does a portfolio cease being considered diversified and begin to be seen as representing a controlling stake? Does it depend on the size of the company, and if so, how is this decided? In fact, the criteria for inclusion seem thoroughly pragmatic. First, journalists need to have heard of the fortune. Then it has to meet certain criteria: for Forbes, to be worth more than a billion dollars; for Challenges and magazines in many other countries, to be among the five hundred wealthiest people in the country. Such pragmatism is understandable, but such a haphazard sampling method obviously raises serious problems when it comes to international or intertemporal comparison. Furthermore, the magazine rankings are never very clear about the unit of observation: in principle it is the individual, but sometimes entire family groups are counted as a single fortune, which creates a bias in the other direction, because it tends to exaggerate the size of large fortunes. Clearly, this is not a very robust basis for studying the delicate question of the role of inheritance in capital formation or the evolution of inequalities of wealth.18

Furthermore, the magazines often exhibit a rather obvious ideological bias in favor of entrepreneurs and do not bother to hide their wish to celebrate them, even if it means exaggerating their importance. It is no insult to Forbes to observe that it can often be read, and even presents itself as, an ode to the entrepreneur and the usefulness of merited wealth. The owner of the magazine, Steve Forbes, himself a billionaire and twice an unsuccessful candidate for the presidential nomination of the Republican Party, is nevertheless an heir: it was his grandfather who founded the magazine in 1917, establishing the Forbes family fortune, which he subsequently increased. The magazine’s rankings sometimes break billionaires down into three groups: pure entrepreneurs, pure heirs, and heirs who subsequently “grow their wealth.” According to Forbes’s own data, each of these three groups represents about a third of the total, although the magazine also says that the number of pure heirs is decreasing and that of partial heirs increasing. The problem is that Forbes has never given a precise definition of these groups (in particular of the exact boundary between “pure” and “partial”), and the amount of inherited wealth is never specified.19 Under these conditions, it is quite difficult to reach any precise conclusions about this possible trend.

In view of all these difficulties, what can we say about the respective numbers of heirs and entrepreneurs among the largest fortunes? If we include both the pure and partial heirs in the Forbes rankings (and assume that half of the wealth of the latter is inherited), and if we allow for the methodological biases that lead to underestimating the size of inherited fortunes, it seems fairly clear that inherited wealth accounts for more than half of the total amount of the largest fortunes worldwide. An estimate of 60–70 percent seems fairly realistic a priori, and this is a level markedly lower than that observed in France in the Belle Époque (80–90 percent). This might be explained by the currently high global growth rate, which would imply that new fortunes from the emerging countries are rapidly being added to the rankings. But this is a hypothesis, not a certainty.

The Moral Hierarchy of Wealth

In any case, I think there is an urgent need to move beyond the often sterile debate about merit and wealth, which is ill conceived. No one denies that it is important for society to have entrepreneurs, inventions, and innovations. There were many innovations in the Belle Époque, such as the automobile, movies, and electricity, just as there are many today. The problem is simply that the entrepreneurial argument cannot justify all inequalities of wealth, no matter how extreme. The inequality r > g, combined with the inequality of returns on capital as a function of initial wealth, can lead to excessive and lasting concentration of capital: no matter how justified inequalities of wealth may be initially, fortunes can grow and perpetuate themselves beyond all reasonable limits and beyond any possible rational justification in terms of social utility.

Entrepreneurs thus tend to turn into rentiers, not only with the passing of generations but even within a single lifetime, especially as life expectancy increases: a person who has had good ideas at the age of forty will not necessarily still be having them at ninety, nor are his children sure to have any. Yet the wealth remains, in some cases multiplied more than tenfold in twenty years, as in the case of Bill Gates or Liliane Bettencourt.

This is the main justification for a progressive annual tax on the largest fortunes worldwide. Such a tax is the only way of democratically controlling this potentially explosive process while preserving entrepreneurial dynamism and international economic openness. In Part Four we will examine this idea further, as well as its limitations.

The fiscal approach is also a way to move beyond the futile debate about the moral hierarchy of wealth. Every fortune is partially justified yet potentially excessive. Outright theft is rare, as is absolute merit. The advantage of a progressive tax on capital is that it provides a way to treat different situations in a supple, consistent, and predictable manner while exposing large fortunes to democratic control—which is already quite a lot.

All too often, the global debate about great wealth comes down to a few peremptory—and largely arbitrary—assertions about the relative merits of this or that individual. For example, it is rather common to contrast the man who is currently the world’s wealthiest, Carlos Slim, a Mexican real estate and telecom tycoon who is of Lebanese extraction and is often described in the Western press as one who owes his great wealth to monopoly rents obtained through (implicitly corrupt) government favors, and Bill Gates, the former number one, who is seen as a model of the meritorious entrepreneur. At times one almost has the impression that Bill Gates himself invented computer science and the microprocessor and that he would be 10 times richer still if he had been paid his full marginal productivity and compensated for his personal contribution to global well-being (and fortunately the good people of the planet have been the beneficiaries of his “positive externalities” since he retired). No doubt the veritable cult of Bill Gates is an outgrowth of the apparently irrepressible need of modern democratic societies to make sense of inequality. To be frank, I know virtually nothing about exactly how Carlos Slim or Bill Gates became rich, and I am quite incapable of assessing their relative merits. Nevertheless, it seems to me that Bill Gates also profited from a virtual monopoly on operating systems (as have many other high-tech entrepreneurs in industries ranging from telecommunications to Facebook, whose fortunes were also built on monopoly rents). Furthermore, I believe that Gates’s contributions depended on the work of thousands of engineers and scientists doing basic research in electronics and computer science, without whom none of his innovations would have been possible. These people did not patent their scientific papers. In short, it seems unreasonable to draw such an extreme contrast between Gates and Slim without so much as a glance at the facts.20

As for the Japanese billionaires (Yoshiaka Tsutsumi and Taikichiro Mori) who from 1987 to 1994 preceded Bill Gates at the top of the Forbes ranking, people in the Western world have all but forgotten their names. Perhaps there is a feeling that these men owe their fortunes entirely to the real estate and stock market bubbles that existed at the time in the Land of the Rising Sun, or else to some not very savory Asian wheeling and dealing. Yet Japanese growth from 1950 to 1990 was the greatest history had ever seen to that point, much greater than US growth in 1990–2010, and there is reason to believe that entrepreneurs played some role in this.

Rather than indulge in constructing a moral hierarchy of wealth, which in practice often amounts to an exercise in Western ethnocentrism, I think it is more useful to try to understand the general laws that govern the dynamics of wealth—leaving individuals aside and thinking instead about modes of regulation, and in particular taxation, that apply equally to everyone, regardless of nationality. In France, when Arcelor (then the second largest steel company worldwide) was bought by the steel magnate Lakshmi Mittal in 2006, the French media found the actions of the Indian billionaire particularly outrageous. They renewed their outrage in the fall of 2012, when Mittal was accused of failing to invest enough in the firm’s factory in Florange. In India, everyone believes that the hostility to Mittal is due, at least in part, to the color of his skin. And who can be sure that this did not play a role? To be sure, Mittal’s methods are brutal, and his sumptuous lifestyle is seen as scandalous. The entire French press took umbrage at his luxurious London residences, “worth three times as much as his investment in Florange.”21 Somehow, though, the outrage is soft-pedaled when it comes to a certain residence in Neuilly-sur-Seine, a posh suburb of Paris, or a homegrown billionaire like Arnaud Lagardère, a young heir not particularly well known for his merit, virtue, or social utility yet on whom the French government decided at about the same time to bestow the sum of a billion euros in exchange for his share of the European Aeronautic, Defense, and Space Co. (EADS), a world leader in aeronautics.

One final example, even more extreme: in February 2012, a French court ordered the seizure of more than 200 cubic meters of property (luxury cars, old master paintings, etc.) from the Avenue Foch home of Teodorin Obiang, the son of the dictator of Equatorial Guinea. It is an established fact that his share of the company, which was authorized to exploit Guinea’s forests (from which he derives most of his income), was acquired in a dubious way and that these forest resources were to a large extent stolen from the people of Equatorial Guinea. The case is instructive in that it shows that private property is not quite as sacred as people sometimes think, and that it was technically possible, when someone really wanted to, to find a way through the maze of dummy corporations by means of which Teodorin Obiang administered his capital. There is little doubt, however, that it would not be very difficult to find in Paris or London other individuals—Russian oligarchs or Quatari billionaires, say—with fortunes ultimately derived from the private appropriation of natural resources. It may be that these appropriations of oil, gas, and aluminum deposits are not as clear-cut cases of theft as Obiang’s forests. And perhaps judicial action is more justified when the theft is committed at the expense of a very poor country, as opposed to a less poor one.22 At the very least, the reader will grant that these various cases are not fundamentally different but belong to a continuum, and that a fortune is often deemed more suspect if its owner is black. In any case, the courts cannot resolve every case of ill-gotten gains or unjustified wealth. A tax on capital would be a less blunt and more systematic instrument for dealing with the question.

Broadly speaking, the central fact is that the return on capital often inextricably combines elements of true entrepreneurial labor (an absolutely indispensable force for economic development), pure luck (one happens at the right moment to buy a promising asset at a good price), and outright theft. The arbitrariness of wealth accumulation is a much broader phenomenon than the arbitrariness of inheritance. The return on capital is by nature volatile and unpredictable and can easily generate capital gains (or losses) equivalent to dozens of years of earned income. At the top of the wealth hierarchy, these effects are even more extreme. It has always been this way. In the novel Ibiscus (1926), Alexei Tolstoy depicted the horrors of capitalism. In 1917, in St. Petersburg, the accountant Simon Novzorov bashes in the skull of an antique dealer who has offered him a job and steals a small fortune. The antique dealer had become rich by purchasing, at rock-bottom prices, the possessions of aristocrats fleeing the Revolution. Novzorov manages to multiply his initial capital by 10 in six months, thanks to the gambling den he sets up in Moscow with his new friend Ritechev. Novzorov is a nasty, petty parasite who embodies the idea that wealth and merit are totally unrelated: property sometimes begins with theft, and the arbitrary return on capital can easily perpetuate the initial crime.

The Pure Return on University Endowments

In order to gain a better understanding of unequal returns on capital without being distracted by issues of individual character, it is useful to look at what has happened with the endowments of American universities over the past few decades. Indeed, this is one of the few cases where we have very complete data about investments made and returns received over a relatively long period of time, as a function of initial capital.

There are currently more than eight hundred public and private universities in the United States that manage their own endowments. These endowments range from some tens of millions of dollars (for example, North Iowa Community College, ranked 785th in 2012 with an endowment of $11.5 million) to tens of billions. The top-ranked universities are invariably Harvard (with an endowment of some $30 billion in the early 2010s), Yale ($20 billion), and Princeton and Stanford (more than $15 billion). Then come MIT and Columbia, with a little less than $10 billion, then Chicago and Pennsylvania, at around $7 billion, and so on. All told, these eight hundred US universities owned nearly $400 billion worth of assets in 2010 (or a little under $500 million per university on average, with a median slightly less than $100 million). To be sure, this is less than 1 percent of the total private wealth of US households, but it is still a large sum, which annually yields significant income for US universities—or at any rate some of them.23 Above all—and this is the point that is of interest here—US universities publish regular, reliable, and detailed reports on their endowments, which can be used to study the annual returns each institution obtains. This is not possible with most private fortunes. In particular, these data have been collected since the late 1970s by the National Association of College and University Business Officers, which has published voluminous statistical surveys every year since 1979.

The main results I have been able to derive from these data are shown in Table 12.2.24 The first conclusion is that the return on US university endowments has been extremely high in recent decades, averaging 8.2 percent a year between 1980 and 2010 (and 7.2 percent for the period 1990–2010).25 To be sure, there have been ups and downs in each decade, with years of low or even negative returns, such as 2008–2009, and good years in which the average endowment grew by more than 10 percent. But the important point is that if we average over ten, twenty, or thirty years, we find extremely high returns, of the same sort I examined for the billionaires in the Forbes rankings.

To be clear, the returns indicated in Table 12.2 are net real returns allowing for capital gains and inflation, prevailing taxes (virtually nonexistent for nonprofit institutions), and management fees. (The latter include the salaries of everyone inside or outside the university who is involved in planning and executing the institution’s investment strategy.) Hence these figures reflect the pure return on capital as defined in this book, that is, the return that comes simply from owning capital, apart from any remuneration of the labor required to manage it.

The second conclusion that emerges clearly from Table 12.2 is that the return increases rapidly with size of endowment. For the 500 of 850 universities whose endowment was less than $100 million, the average return was 6.2 percent in 1980–2010 (and 5.1 percent in 1990–2010), which is already fairly high and significantly above the average return on all private wealth in these periods.26 The greater the endowment, the greater the return. For the 60 universities with endowments of more than $1 billion, the average return was 8.8 percent in 1980–2010 (and 7.8 percent in 1990–2010). For the top trio (Harvard, Yale, and Princeton), which has not changed since 1980, the yield was 10.2 percent in 1980–2010 (and 10.0 percent in 1990–2010), twice as much as the less well-endowed institutions.27

If we look at the investment strategies of different universities, we find highly diversified portfolios at all levels, with a clear preference for US and foreign stocks and private sector bonds (government bonds, especially US Treasuries, which do not pay well, account for less than 10 percent of all these portfolios and are almost totally absent from the largest endowments). The higher we go in the endowment hierarchy, the more often we find “alternative investment strategies,” that is, very high yield investments such as shares in private equity funds and unlisted foreign stocks (which require great expertise), hedge funds, derivatives, real estate, and raw materials, including energy, natural resources, and related products (these, too, require specialized expertise and offer very high potential yields).28 If we consider the importance in these various portfolios of “alternative investments,” whose only common feature is that they abandon the usual strategies of investing in stocks and bonds accessible to all, we find that they represent only 10 percent of the portfolios of institutions with endowments of less than 50 million euros, 25 percent of those with endowments between 50 and 100 million euros, 35 percent of those between 100 and 500 million euros, 45 percent of those between 500 million and 1 billion euros, and ultimately more than 60 percent of those above 1 billion euros. The available data, which are both public and extremely detailed, show unambiguously that it is these alternative investment strategies that enable the very largest endowments to obtain real returns of close to 10 percent a year, while smaller endowments must make do with 5 percent.

It is interesting to note that the year-to-year volatility of these returns does not seem to be any greater for the largest endowments than for the smaller ones: the returns obtained by Harvard and Yale vary around their mean but not much more so than the returns of smaller institutions, and if one averages over several years, the mean returns of the largest institutions are systematically higher than those of the smaller ones, with a gap that remains fairly constant over time. In other words, the higher returns of the largest endowments are not due primarily to greater risk taking but to a more sophisticated investment strategy that consistently produces better results.29

How can these facts be explained? By economies of scale in portfolio management. Concretely, Harvard currently spends nearly $100 million a year to manage its endowment. This munificent sum goes to pay a team of top-notch portfolio managers capable of identifying the best investment opportunities around the world. But given the size of Harvard’s endowment (around $30 billion), $100 million in management costs is just over 0.3 percent a year. If paying that amount makes it possible to obtain an annual return of 10 percent rather than 5, it is obviously a very good deal. On the other hand, a university with an endowment of only $1 billion (which is nevertheless substantial) could not afford to pay $100 million a year—10 percent of its portfolio—in management costs. In practice, no university pays more than 1 percent for portfolio management, and most pay less than 0.5 percent, so to manage assets worth $1 billion, one would pay $5 million, which is not enough to pay the kind of specialists in alternative investments that one can hire with $100 million. As for North Iowa Community College, with an endowment of $11.5 million, even 1 percent a year would amount to only $115,000, which is just enough to pay a half-time or even quarter-time financial advisor at going market rates. Of course a US citizen at the median of the wealth distribution has only $100,000 to invest, so he must be his own money manager and probably has to rely on the advice of his brother-in-law. To be sure, financial advisors and money managers are not infallible (to say the least), but their ability to identify more profitable investments is the main reason why the largest endowments obtain the highest returns.

These results are striking, because they illustrate in a particularly clear and concrete way how large initial endowments can give rise to better returns and thus to substantial inequalities in returns on capital. These high returns largely account for the prosperity of the most prestigious US universities. It is not alumni gifts, which constitute a much smaller flow: just one-tenth to one-fifth of the annual return on endowment.30

These findings should be interpreted cautiously, however. In particular, it would be too much to try to use them to predict how global wealth inequality will evolve over the next few decades. For one thing, the very high returns that we see in the period 1980–2010 in part reflect the long-term rebound of global asset prices (stocks and real estate), which may not continue (in which case the long-term returns discussed above would have to be reduced somewhat in the future).31 For another, it is possible that economies of scale affect mainly the largest portfolios and are greatly reduced for more “modest” fortunes of 10–50 million euros, which, as noted, account for a much larger share of total global wealth than do the Forbes billionaires. Finally, leaving management fees aside, these returns still depend on the institution’s ability to choose the right managers. But a family is not an institution: there always comes a time when a prodigal child squanders the family fortune, which the Harvard Corporation is unlikely to do, simply because any number of people would come forward to stand in the way. Because family fortunes are subject to this kind of random “shock,” it is unlikely that inequality of wealth will grow indefinitely at the individual level; rather, the wealth distribution will converge toward a certain equilibrium.

These arguments are not altogether reassuring, however. It would in any case be rather imprudent to rely solely on the eternal but arbitrary force of family degeneration to limit the future proliferation of billionaires. As noted, a gap r − g of fairly modest size is all that it takes to arrive at an extremely inegalitarian distribution of wealth. The return on capital does not need to rise as high as 10 percent for all large fortunes: a smaller gap would be enough to deliver a major inegalitarian shock.

Another important point is that wealthy people are constantly coming up with new and ever more sophisticated legal structures to house their fortunes. Trust funds, foundations, and the like often serve to avoid taxes, but they also constrain the freedom of future generations to do as they please with the associated assets. In other words, the boundary between fallible individuals and eternal foundations is not as clear-cut as is sometimes thought. Restrictions on the rights of future generations were in theory drastically reduced when entails were abolished more than two centuries ago (see Chapter 10). In practice, however, the rules can be circumvented when the stakes require. In particular, it is often difficult to distinguish purely private family foundations from true charitable foundations. In fact, families often use foundations for both private and charitable purposes and are generally careful to maintain control of their assets even when housed in a primarily charitable foundation.32 It is often not easy to know what exact rights children and relatives have in these complex structures, because important details are often hidden in legal documents that are not public. In some cases, a family trust whose purpose is primarily to serve as an inheritance vehicle exists alongside a foundation with a more charitable purpose.33 It is also interesting to note that the amount of gifts declared to the tax authorities always falls drastically when oversight is tightened (for example, when donors are required to submit accurate receipts, or when foundations are required to submit more detailed financial statements to certify that their official purpose is in fact respected and private use of foundation funds does not exceed certain limits), confirming the idea that there is a certain porosity between public and private uses of these legal entities.34 Ultimately, it is very difficult to say precisely what proportion of foundations fulfill purposes that can truly be characterized as being in the public interest.35

What Is the Effect of Inflation on Inequality of Returns to Capital?

The results concerning the returns on university endowments suggest that it may also be useful to say a few words about the pure return on capital and the inegalitarian effects of inflation. As I showed in Chapter 1, the rate of inflation in the wealthy countries has been stable at around 2 percent since the 1980s: this new norm is both much lower than the peak inflation rates seen in the twentieth century and much higher than the zero or virtually zero inflation that prevailed in the nineteenth century and up to World War I. In the emerging countries, inflation is currently higher than in the rich countries (often above 5 percent). The question, then, is the following: What is the effect on returns to capital of inflation at 2 percent or even 5 percent rather than 0 percent?

Some people think, wrongly, that inflation reduces the average return on capital. This is false, because the average asset price (that is, the average price of real estate and financial securities) tends to rise at the same pace as consumer prices. Take a country with a capital stock equal to six years of national income (β = 6) and where capital’s share of national income equals 30 percent (α = 30%), so that the average return on capital is 5 percent (r = 5%). Imagine that inflation in this country increases from 0 to 2 percent a year. Is it really true that the average return on capital will then decrease from 5 percent to 3? Obviously not. To a first approximation, if consumer prices rise by 2 percent a year, then it is probable that asset prices will also increase by 2 percent a year on average. There will be no capital gains or losses, and the return on capital will still be 5 percent. By contrast, it is likely that inflation changes the distribution of this average return among individual citizens. The problem is that in practice the redistributions induced by inflation are always complex, multidimensional, and largely unpredictable and uncontrollable.

People sometimes believe that inflation is the enemy of the rentier and that this may in part explain why modern societies like inflation. This is partly true, in the sense that inflation forces people to pay some attention to their capital. When inflation exists, anyone who is content to perch on a pile of banknotes will see that pile melt away before his eyes, leaving him with nothing even if wealth is untaxed. In this respect, inflation is indeed a tax on the idle rich, or, more precisely, on wealth that is not invested. But as I have noted a number of times already, it is enough to invest one’s wealth in real assets, such as real estate or shares of stock, in order to escape the inflation tax entirely.36 Our results on university endowments confirm this in the clearest possible terms. There can be no doubt that inflation of 2 percent rather than 0 percent in no way prevents large fortunes from obtaining very high real returns.

One can even imagine that inflation tends to improve the relative position of the wealthiest individuals compared to the least wealthy, in that it enhances the importance of financial managers and intermediaries. A person with 10 or 50 million euros cannot afford the money managers that Harvard has but can nevertheless pay financial advisors and stockbrokers to mitigate the effects of inflation. By contrast, a person with only 10 or 50 thousand euros to invest will not be offered the same choices by her broker (if she has one): contacts with financial advisors are briefer, and many people in this category keep most of their savings in checking accounts that pay little or nothing and/or savings accounts that pay little more than the rate of inflation. Furthermore, some assets exhibit size effects of their own, but these are generally unavailable to small investors. It is important to realize that this inequality of access to the most remunerative investments as a reality for everyone (and thus much broader than the extreme case of “alternative investments” available only to the wealthiest individuals and largest endowments). For example, some financial products require very large minimum investments (on the order of hundreds of thousands of euros), so that small investors must make do with less profitable opportunities (allowing intermediaries to charge big investors more for their services).

These size effects are particularly important in regard to real estate. In practice, this is the most important type of capital asset for the vast majority of the population. For most people, the simplest way to invest is to buy a home. This provides protection against inflation (since the price of housing generally rises at least as fast as the price of consumption), and it also allows the owner to avoid paying rent, which is equivalent to a real return on investment of 3–4 percent a year. But for a person with 10 to 50 thousand euros, it is not enough to decide to buy a home: the possibility may not exist. And even for a person with 100 or 200 thousand euros but who works in a big city in a job whose pay is not in the top 2 or 3 centiles of the wage hierarchy, it may be difficult to purchase a home or apartment even if one is willing to go into debt for a long period of time and pay a high rate of interest. As a result, those who start out with a small initial fortune will often remain tenants, who must therefore pay a substantial rent (affording a high return on capital to the landlord) for a long period of time, possibly for life, while their bank savings are just barely protected from inflation.

Conversely, a person who starts out with more wealth thanks to an inheritance or gift, or who earns a sufficiently high salary, or both, will more quickly be in a position to buy a home or apartment and therefore earn a real return of 3–4 percent on their investment while being able to save more thanks to not having to pay rent. This unequal access to real estate as an effect of fortune size has of course always existed.37 One could conceivably circumvent the barrier by buying a smaller apartment than one needs (in order to rent it) or by investing in other types of assets. But the problem has to some extent been aggravated by modern inflation: in the nineteenth century, when inflation was zero, it was relatively easy for a small saver to obtain a real return of 3 or 4 percent, for example by buying government bonds. Today, many small savers cannot enjoy such returns.

To sum up: the main effect of inflation is not to reduce the average return on capital but to redistribute it. And even though the effects of inflation are complex and multidimensional, the preponderance of the evidence suggests that the redistribution induced by inflation is mainly to the detriment of the least wealthy and to the benefit of the wealthiest, hence in the opposite direction from what is generally desired. To be sure, inflation may slightly reduce the pure return on capital, in that it forces everyone to spend more time doing asset management. One might compare this historic change to the very long-run increase in the rate of depreciation of capital, which requires more frequent investment decisions and replacement of old assets with new ones.38 In both cases, one has to work a little harder today to obtain a given return: capital has become more “dynamic.” But these are relatively indirect and ineffective ways of combating rent: the evidence suggests that the slight decrease in the pure return on capital due to these causes is much smaller than the increase of inequality of returns on capital; in particular, it poses little threat to the largest fortunes.

Inflation does not do away with rent: on the contrary, it probably helps to make the distribution of capital more unequal.

To avoid any misunderstanding, let me say at once that I am not proposing a return to the gold standard or zero inflation. Under some conditions, inflation may have virtues, though smaller virtues than is sometimes imagined. I will come back to this when I discuss the role of central banks in monetary creation, especially in times of financial crisis and large sovereign debt. There are ways for people of modest means to have access to remunerative saving without zero inflation and government bonds as in the nineteenth century. But it is important to realize that inflation is today an extremely blunt instrument, and often a counterproductive one, if the goal is to avoid a return to a society of rentiers and, more generally, to reduce inequalities of wealth. A progressive tax on capital is a much more appropriate policy in terms of both democratic transparency and real efficacy.

The Return on Sovereign Wealth Funds: Capital and Politics

Consider now the case of sovereign wealth funds, which have grown substantially in recent years, particularly in the petroleum exporting countries. Unfortunately, there is much less publicly available data concerning the investment strategies and returns obtained by sovereign wealth funds than there is for university endowments, and this is all the more unfortunate in that the financial stakes are much, much larger. The Norwegian sovereign wealth fund, which alone was worth more than 700 billion euros in 2013 (twice as much as all US university endowments combined), publishes the most detailed financial reports. Its investment strategy, at least at the beginning, seems to have been more standard than that of the university endowments, in part, no doubt, because it was subject to public scrutiny (and the people of Norway may have been less willing than the Harvard Corporation to accept massive investments in hedge funds and unlisted stocks), and the returns obtained were apparently not as good.39 The fund’s officials recently received authorization to place larger amounts in alternative investments (especially international real estate), and returns may be higher in the future. Note, too, that the fund’s management costs are less than 0.1 percent of its assets (compared with 0.3 percent for Harvard), but since the Norwegian fund is 20 times larger than Harvard’s endowment, this is enough to pay for thorough investment advice. We also learn that during the period 1970–2010, about 60 percent of the money Norway earned from petroleum was invested in the fund, while 40 percent a year went to government expenses. The Norwegian authorities do not tell us what their long-term objective for the fund is or when the country can begin to consume all or part of the returns on its investment. They probably do not know themselves: everything depends on how Norway’s petroleum reserves evolve as well as on the price of a barrel of oil and the fund’s returns in the decades ahead.

If we look at other sovereign wealth funds, particularly n the Middle East, we unfortunately find that they are much more opaque than the Norwegian fund. Their financial reports are frequently rather scanty. It is generally impossible to know precisely what the investment strategy is, and returns are discussed obliquely at best, with little consistency from year to year. The most recent reports published by the Abu Dhabi Investment Authority, which manages the world’s largest sovereign wealth fund (about the same size as Norway’s), speak of a real return greater than 7 percent a year for 1990–2010 and more than 8 percent for 1980–2010. In view of the returns obtained by university endowments, these figures seem entirely plausible, but in the absence of detailed annual information, it is difficult to say more.

It is interesting to note that different funds apparently follow very different investment strategies, which are related, moreover, to very different ways of communicating with the public and very different approaches to global politics. Abu Dhabi is outspoken about its fund’s high returns, but Saudi Arabia’s sovereign wealth fund, which ranks third after Abu Dhabi and Norway among sovereign wealth funds of petroleum exporting states and ahead of Kuwait, Qatar, and Russia, has chosen to keep a very low profile. The small petroleum states of the Persian Gulf, which have only tiny populations to worry about, are clearly addressing the international financial community as the primary audience for their reports. The Saudi reports are more sober and provide information not only about oil reserves but also about national accounts and the government budget. These are clearly addressed to the people of the Kingdom of Saudi Arabia, whose population was close to 20 million in 2010—still small compared to the large countries in the region (Iran, 80 million; Egypt, 85 million; Iraq, 35 million) but far larger than the microstates of the Gulf.40 And that is not the only difference: Saudi funds seem to be invested much less aggressively. According to official documents, the average return on the Saudi sovereign wealth fund was no more than 2–3 percent, mainly because much of the money was invested in US Treasury bonds. Saudi financial reports do not come close to providing enough information to know how the portfolio has evolved, but the information they do provide is much more detailed than that provided by the Emirates, and on this specific point they seem to be accurate.

Why would Saudi Arabia choose to invest in US Treasury bonds when it is possible to get far better returns elsewhere? The question is worth asking, especially since US university endowments stopped investing in their own government’s debt decades ago and roam the world in search of the best return, investing in hedge funds, unlisted shares, and commodities-based derivatives. To be sure, US Treasuries offer an enviable guarantee of stability in an unstable world, and it is possible that the Saudi public has little taste for alternative investments. But the political and military aspects of the choice must also be taken into account: even though it is never stated explicitly, it is not illogical for Saudia Arabia to lend at low interest to the country that protects it militarily. To my knowledge, no one has ever attempted to calculate precisely the return on such an investment, but it seems clear that it is rather high. If the United States, backed by other Western powers, had not driven the Iraqi army out of Kuwait in 1991, Iraq would probably have threatened Saudi Arabia’s oil fields next, and it is possible that other countries in the region, such as Iran, would have joined the fray to redistribute the region’s petroleum rents. The dynamics of the global distribution of capital are at once economic, political, and military. This was already the case in the colonial era, when the great powers of the day, Britain and France foremost among them, were quick to roll out the cannon to protect their investments. Clearly, the same will be true in the twenty-first century, in a tense new global political configuration whose contours are difficult to predict in advance.

Will Sovereign Wealth Funds Own the World?

How much richer can the sovereign wealth funds become in the decades ahead? According to available (and notoriously imperfect) estimates, sovereign wealth funds in 2013 had total investments worth a little over $5.3 trillion, of which about $3.2 trillion belongs to the funds of petroleum exporting states (including, in addition to those mentioned above, the smaller funds of Dubai, Libya, Kazakhstan, Algeria, Iran, Azerbaijan, Brunei, Oman, and many others), and approximately $2.1 trillion to funds of nonpetroleum states (primarily China, Hong Kong, Singapore, and many smaller funds).41 For reference, note that this is almost exactly the same total wealth as that represented by the Forbes billionaires (around $5.4 trillion in 2013). In other words, billionaires today own roughly 1.5 percent of the world’s total private wealth, and sovereign wealth funds own another 1.5 percent. It is perhaps reassuring to note that this leaves 97 percent of global capital for the rest.42 One can also do projections for the sovereign wealth funds just as I did for billionaires, from which it follows that they will not achieve decisive importance—10–20 percent of global capital—before the second half of the twenty-first century, and we are still a long way from having to pay our monthly rent to the emir of Qatar (or the taxpayers of Norway). Nevertheless, it would still be a mistake to ignore the issue. In the first place, there is no reason why we should not worry about the rents our children and grandchildren may have to pay, and we need not wait until things come to a head to think about what to do. Second, a substantial part of global capital is in relatively illiquid form (including real estate and business capital that cannot be traded on financial markets), so that the share of truly liquid capital owned by sovereign wealth funds (and to a lesser extent billionaires)—capital that can be used, say, to take over a bankrupt company, buy a football team, or invest in a decaying neighborhood when strapped governments lack the means to do so—is actually much higher.43 In fact, the issue of investments originating in the petroleum exporting countries has become increasingly salient in the wealthy countries, especially France, and as noted, these are perhaps the countries least psychologically prepared for the comeback of capital.

Last but not least, the key difference between the sovereign wealth funds and the billionaires is that the funds, or at any rate those of the petroleum exporting countries, grow not only by reinvesting their returns but also by investing part of the proceeds of oil sales. Although the future amounts of such proceeds are highly uncertain, owing to uncertainties about the amount of oil still in the ground, the demand for oil, and the price per barrel, it is quite plausible to assume that this income from petroleum sales will largely outweigh the returns on existing investments. The annual rent derived from the exploitation of natural resources, defined as the difference between receipts from sales and the cost of production, has been about 5 percent of global GDP since the mid-2000s (half of which is petroleum rent and the rest rent on other natural resources, mainly gas, coal, minerals, and wood), compared with about 2 percent in the 1990s and less than 1 percent in the early 1970s.44 According to some forecasting models, the price of petroleum, currently around $100 a barrel (compared with $25 in the early 2000s) could rise as high as $200 a barrel by 2020–2030. If a sufficiently large fraction of the corresponding rent is invested in sovereign wealth funds every year (a fraction that should be considerably larger than it is today), one can imagine a scenario in which the sovereign wealth funds would own 10–20 percent or more of global capital by 2030–2040. No law of economics rules this out. Everything depends on supply and demand, on whether or not new oil deposits and/or sources of energy are discovered, and on how rapidly people learn to live without petroleum. In any event, it is almost inevitable that the sovereign wealth funds of the petroleum exporting countries will continue to grow and that their share of global assets in 2030–2040 will be at least two to three times greater than it is today—a significant increase.

If this happens, it is likely that the Western countries would find it increasingly difficult to accept the idea of being owned in substantial part by the sovereign wealth funds of the oil states, and sooner or later this would trigger political reactions, such as restrictions on the purchase of real estate and industrial and financial assets by sovereign wealth funds or even partial or total expropriations. Such a reaction would neither be terribly smart politically nor especially effective economically, but it is the kind of response that is within the power of national governments, even of smaller states. Note, moreover, that the petroleum exporting countries themselves have already begun to limit their foreign investments and have begun investing heavily in their own countries to build museums, hotels, universities, and even ski slopes, at times on a scale that seems devoid of economic and financial rationality. It may be that this behavior reflects awareness of the fact that it is harder to expropriate an investment made at home than one made abroad. There is no guarantee, however, that the process will always be peaceful: no one knows the precise location of the psychological and political boundaries that must not be crossed when it comes to the ownership of one country by another.

Will China Own the World?

The sovereign wealth funds of non-petroleum-exporting countries raise a different kind of problem. Why would a country with no particular natural resources to speak of decide to own another country? One possibility is of course neocolonial ambitions, a pure will to power, as in the era of European colonialism. But the difference is that in those days the European countries enjoyed a technological advantage that ensured their domination. China and other emerging nonpetroleum countries are growing very rapidly, to be sure, but the evidence suggests that this rapid growth will end once they catch up with the leaders in terms of productivity and standard of living. The diffusion of knowledge and productive technologies is a fundamentally equalizing process: once the less advanced countries catch up with the more advanced, they cease to grow more rapidly.

In the central scenario for the evolution of the global capital/income ratio that I discussed in Chapter 5, I assumed that the savings rate would stabilize at around 10 percent of national income as this international convergence process neared its end. In that case, the accumulation of capital would attain comparable proportions everywhere. A very large share of the world’s capital stock would of course be accumulated in Asia, and especially China, in keeping with the region’s future share of global output. But according to the central scenario, the capital/income ratio would be the same on all continents, so that there would be no major imbalance between savings and investment in any region. Africa would be the only exception: in the central scenario depicted in Figures 12.4 and 12.5, the capital/income ratio is expected to be lower in Africa than in other continents throughout the twenty-first century (essentially because Africa is catching up economically much more slowly and its demographic transition is also delayed).45 If capital can flow freely across borders, one would expect to see a flow of investments in Africa from other countries, especially China and other Asian nations. For the reasons discussed above, this could give rise to serious tensions, signs of which are already visible.

FIGURE 12.4. The world capital/income ratio, 1870–2100

According to the simulations (central scenario), the world capital/income ratio might be near to 700 percent by the end of the twenty-first century.

Sources and series: see piketty.pse.ens.fr/capital21c.

To be sure, one can easily imagine scenarios much more unbalanced than the central scenario. Nevertheless, the forces of divergence are much less obvious than in the case of the sovereign wealth funds, whose growth depends on windfalls totally disproportionate to the needs of the populations benefiting from them (especially where those populations are tiny). This leads to endless accumulation, which the inequality r > g transforms into a permanent divergence in the global capital distribution. To sum up, petroleum rents might well enable the oil states to buy the rest of the planet (or much of it) and to live on the rents of their accumulated capital.46

FIGURE 12.5. The distribution of world capital, 1870–2100

According to the central scenatio, Asian countries should own about half of world capital by the end of the twenty-first century.

Sources and series: see piketty.pse.ens.fr/capital21c.

China, India, and other emerging countries are different. These countries have large populations whose needs (for both consumption and investment) remain far from satisfied. One can of course imagine scenarios in which the Chinese savings rate would remain persistently above the savings rate in Europe or North America: for example, China might choose a retirement system funded by investments rather than a pay-as-you-go system—a rather tempting choice in a low-growth environment (and even more tempting if demographic growth is negative).47 For example, if China saves 20 percent of its national income until 2100, while Europe and the United States save only 10 percent, then by 2100 a large part of the Old and New Worlds will be owned by enormous Chinese pension funds.48 Although this is logically possible, it is not very plausible, in part because Chinese workers and Chinese society as a whole would no doubt prefer (not without reason) to rely in large part on a public partition system for their retirement (as in Europe and the United States) and in part because of the political considerations already noted in the case of the petroleum exporting countries and their sovereign wealth funds, which would apply with equal force to Chinese pension funds.

International Divergence, Oligarchic Divergence

In any case, this threat of international divergence owing to a gradual acquisition of the rich countries by China (or by the petroleum exporters’ sovereign wealth funds) seems less credible and dangerous than an oligarchic type of divergence, that is, a process in which the rich countries would come to be owned by their own billionaires or, more generally, in which all countries, including China and the petroleum exporters, would come to be owned more and more by the planet’s billionaires and multimillionaires. As noted, this process is already well under way. As global growth slows and international competition for capital heats up, there is every reason to believe that r will be much greater than g in the decades ahead. If we add to this the fact that the return on capital increases with the size of the initial endowment, a phenomenon that may well be reinforced by the growing complexity of global financial markets, then clearly all the ingredients are in place for the top centile and thousandth of the global wealth distribution to pull farther and farther ahead of the rest. To be sure, it is quite difficult to foresee how rapidly this oligarchic divergence will occur, but the risk seems much greater than the risk of international divergence.49

In particular, it is important to stress that the currently prevalent fears of growing Chinese ownership are a pure fantasy. The wealthy countries are in fact much wealthier than they sometimes think. The total real estate and financial assets net of debt owned by European households today amount to some 70 trillion euros. By comparison, the total assets of the various Chinese sovereign wealth funds plus the reserves of the Bank of China represent around 3 trillion euros, or less than one-twentieth the former amount.50 The rich countries are not about to be taken over by the poor countries, which would have to get much richer to do anything of the kind, and that will take many more decades.

What, then, is the source of this fear, this feeling of dispossession, which is partly irrational? Part of the reason is no doubt the universal tendency to look elsewhere for the source of domestic difficulties. For example, many people in France believe that rich foreign buyers are responsible for the skyrocketing price of Paris real estate. When one looks closely at who is buying what type of apartment, however, one finds that the increase in the number of foreign (or foreign-resident) buyers can explain barely 3 percent of the price increase. In other words, 97 percent of today’s very high real estate prices are due to the fact that there are enough French buyers residing in France who are prosperous enough to pay such large amounts for property.51

To my mind, this feeling of dispossession is due primarily to the fact that wealth is very highly concentrated in the rich countries (so that for much of the population, capital is an abstraction) and the process of the political secession of the largest fortunes is already well under way. For most people living in the wealthy countries, of Europe especially, the idea that European households own 20 times as much capital as China is rather hard to grasp, especially since this wealth is private and cannot be mobilized by governments for public purposes such as aiding Greece, as China helpfully proposed not long ago. Yet this private European wealth is very real, and if the governments of the European Union decided to tap it, they could. But the fact is that it is very difficult for any single government to regulate or tax capital and the income it generates. The main reason for the feeling of dispossession that grips the rich countries today is this loss of democratic sovereignty. This is especially true in Europe, whose territory is carved up into small states in competition with one another for capital, which aggravates the whole process. The very substantial increase in gross foreign asset positions (with each country owning a larger and larger stake in its neighbors, as discussed in Chapter 5) is also part of this process, and contributes to the sense of helplessness.

In Part Four I will show how useful a tool a global (or if need be European) tax on capital would be for overcoming these contradictions, and I will also consider what other government responses might be possible. To be clear, oligarchic divergence is not only more probable than international divergence, it is also much more difficult to combat, because it demands a high degree of international coordination among countries that are ordinarily engaged in competition with one another. The secession of wealth tends, moreover, to obscure the very idea of nationality, since the wealthiest individuals can to some extent take their money and change their nationality, cutting all ties to their original community. Only a coordinated response at a relatively broad regional level can overcome this difficulty.

Are the Rich Countries Really Poor?

Another point that needs to be emphasized is that a substantial fraction of global financial assets is already hidden away in various tax havens, thus limiting our ability to analyze the geographic distribution of global wealth. To judge by official statistics alone (relying on national data collated by international organizations such as the IMF), it would seem that the net asset position of the wealthy countries vis-à-vis the rest of the world is negative. As noted in Part Two, Japan and Germany are in substantial surplus relative to the rest of the world (meaning that their households, firms, and governments own a lot more foreign assets than the rest of the world owns of their assets), which reflects the fact that they have been running large trade surpluses in recent decades. But the net position of the United States is negative, and that of most European countries other than Germany is close to zero, if not in the red.52 All told, when one adds up the positions of all the wealthy countries, one is left with a slightly negative position, equivalent to about −4 percent of global GDP in 2010, compared with close to zero in the mid-1980s, as Figure 12.6 shows.53 It is important to recognize, however, that it is a very slightly negative position (amounting to just 1 percent of global wealth). In any case, as I have already discussed at length, we are living in a time when international positions are relatively balanced, at least when compared with the colonial period, when the rich countries enjoyed a much larger positive position with respect to the rest of the world.54

Of course this slightly negative official position should in principle be counterbalanced by an equivalent positive position for the rest of the world. In other words, the poor countries should own more assets in the rich countries than vice versa, with a surplus on the order of 4 percent of global GDP (or 1 percent of global wealth) in their favor. In fact, this is not the case: if one adds up the financial statistics for the various countries of the world, one finds that the poor countries also have a negative position and that the world as a whole is in a substantially negative situation. It seems, in other words, that Earth must be owned by Mars. This is a fairly old “statistical anomaly,” but according to various international organizations it has gotten worse in recent years. (The global balance of payments is regularly negative: more money leaves countries than enters them, which is theoretically impossible.) No real explanation of this phenomenon has been forthcoming. Note that these financial statistics and balance-of-payments data in theory cover the entire world. In particular, banks in the tax havens are theoretically required to report their accounts to international institutions. The “anomaly” can presumably be explained by various statistical biases and measurement errors.

FIGURE 12.6. The net foreign asset position of rich countries

Unregistered financial assets held in tax havens are higher than the official net foreign debt of rich countries.

Sources and series: see piketty.pse.ens.fr/capital21c.

By comparing all the available sources and exploiting previously unused Swiss bank data, Gabriel Zucman was able to show that the most plausible reason for the discrepancy is that large amounts of unreported financial assets are held in tax havens. By his cautious estimate, these amount to nearly 10 percent of global GDP.55 Certain nongovernmental organizations have proposed even larger estimates (up to 2 or 3 times larger). Given the current state of the available sources, I believe that Zucman’s estimate is slightly more realistic, but such estimates are by nature uncertain, and it is possible that Zucman’s is a lower bound.56 In any event, the important fact is that this lower bound is already extremely high. In particular, it is more than twice as large as the official negative net position of the combined rich countries (see Figure 12.6).57 Now, all the evidence indicates that the vast majority (at least three-quarters) of the financial assets held in tax havens belongs to residents of the rich countries. The conclusion is obvious: the net asset position of the rich countries relative to the rest of the world is in fact positive (the rich countries own on average more than the poor countries and not vice versa, which ultimately is not very surprising), but this is masked by the fact that the wealthiest residents of the rich countries are hiding some of their assets in tax havens. In particular, this implies that the very sharp increase in private wealth (relative to national income) in the rich countries in recent decades is actually even larger than we estimated on the basis of official accounts. The same is true of the upward trend of the share of large fortunes in total wealth.58 Indeed, this shows how difficult it is to track assets in the globalized capitalism of the early twenty-first century, thus blurring our picture of the basic geography of wealth.

PART FOUR

REGULATING CAPITAL IN THE TWENTY-FIRST CENTURY

{THIRTEEN}

A Social State for the Twenty-First Century

In the first three parts of this book, I analyzed the evolution of the distribution of wealth and the structure of inequality since the eighteenth century. From this analysis I must now try to draw lessons for the future. One major lesson is already clear: it was the wars of the twentieth century that, to a large extent, wiped away the past and transformed the structure of inequality. Today, in the second decade of the twenty-first century, inequalities of wealth that had supposedly disappeared are close to regaining or even surpassing their historical highs. The new global economy has brought with it both immense hopes (such as the eradication of poverty) and equally immense inequities (some individuals are now as wealthy as entire countries). Can we imagine a twenty-first century in which capitalism will be transcended in a more peaceful and more lasting way, or must we simply await the next crisis or the next war (this time truly global)? On the basis of the history I have brought to light here, can we imagine political institutions that might regulate today’s global patrimonial capitalism justly as well as efficiently?

As I have already noted, the ideal policy for avoiding an endless inegalitarian spiral and regaining control over the dynamics of accumulation would be a progressive global tax on capital. Such a tax would also have another virtue: it would expose wealth to democratic scrutiny, which is a necessary condition for effective regulation of the banking system and international capital flows. A tax on capital would promote the general interest over private interests while preserving economic openness and the forces of competition. The same cannot be said of various forms of retreat into national or other identities, which may well be the alternative to this ideal policy. But a truly global tax on capital is no doubt a utopian ideal. Short of that, a regional or continental tax might be tried, in particular in Europe, starting with countries willing to accept such a tax. Before I come to that, I must first reexamine in a much broader context the question of a tax on capital (which is of course only one component of an ideal social and fiscal system). What is the role of government in the production and distribution of wealth in the twenty-first century, and what kind of social state is most suitable for the age?

The Crisis of 2008 and the Return of the State

The global financial crisis that began in 2007–2008 is generally described as the most serious crisis of capitalism since the crash of 1929. The comparison is in some ways justified, but essential differences remain. The most obvious of these is that the recent crisis has not led to a depression as devastating as the Great Depression of the 1930s. Between 1929 and 1935, production in the developed countries fell by a quarter, unemployment rose by the same amount, and the world did not entirely recover from the Depression until the onset of World War II. Fortunately, the current crisis has been significantly less cataclysmic. That is why it has been given a less alarming name: the Great Recession. To be sure, the leading developed economies in 2013 are not quite back to the level of output they had achieved in 2007, government finances are in pitiful condition, and prospects for growth look gloomy for the foreseeable future, especially in Europe, which is mired in an endless sovereign debt crisis (which is ironic, since Europe is also the continent with the highest capital/income ratio in the world). Yet even in the depths of the recession, in 2009, production did not fall by more than five percentage points in the wealthiest countries. This was enough to make it the most serious global recession since the end of World War II, but it is still a very different thing from the dramatic collapse of output and waves of bankruptcies of the 1930s. Furthermore, growth in the emerging countries quickly bounced back and is buoying global growth today.

The main reason why the crisis of 2008 did not trigger a crash as serious as the Great Depression is that this time the governments and central banks of the wealthy countries did not allow the financial system to collapse and agreed to create the liquidity necessary to avoid the waves of bank failures that led the world to the brink of the abyss in the 1930s. This pragmatic monetary and financial policy, poles apart from the “liquidationist” orthodoxy that reigned nearly everywhere after the 1929 crash, managed to avoid the worst. (Herbert Hoover, the US president in 1929, thought that limping businesses had to be “liquidated,” and until Franklin Roosevelt replaced Hoover in 1933, they were.) The pragmatic response to the crisis also reminded the world that central banks do not exist just to twiddle their thumbs and keep down inflation. In situations of total financial panic, they play an indispensable role as lender of last resort—indeed, they are the only public institution capable of averting a total collapse of the economy and society in an emergency. That said, central banks are not designed to solve all the world’s problems. The pragmatic policies adopted after the crisis of 2008 no doubt avoided the worst, but they did not really provide a durable response to the structural problems that made the crisis possible, including the crying lack of financial transparency and the rise of inequality. The crisis of 2008 was the first crisis of the globalized patrimonial capitalism of the twenty-first century. It is unlikely to be the last.

Many observers deplore the absence of any real “return of the state” to managing the economy. They point out that the Great Depression, as terrible as it was, at least deserves credit for bringing about radical changes in tax policy and government spending. Indeed, within a few years of his inauguration, Roosevelt increased the top marginal rate of the federal income tax to more than 80 percent on extremely high incomes, whereas the top rate under Hoover had been only 25 percent. By contrast, at the time of this writing, Washington is still wondering whether the Obama administration will be able in its second term to raise the top rate left by Bush (of around 35 percent) above what it was under Clinton in the 1990s (around 40 percent).

In Chapter 14 I will look at the question of confiscatory tax rates on incomes deemed to be indecent (and economically useless), which was in fact an impressive US innovation of the interwar years. To my mind, it deserves to be reconceived and revived, especially in the country that first thought of it.

To be sure, good economic and social policy requires more than just a high marginal tax rate on extremely high incomes. By its very nature, such a tax brings in almost nothing. A progressive tax on capital is a more suitable instrument for responding to the challenges of the twenty-first century than a progressive income tax, which was designed for the twentieth century (although the two tools can play complementary roles in the future). For now, however, it is important to dispel a possible misunderstanding.

The possibility of greater state intervention in the economy raises very different issues today than it did in the 1930s, for a simple reason: the influence of the state is much greater now than it was then, indeed, in many ways greater than it has ever been. That is why today’s crisis is both an indictment of the markets and a challenge to the role of government. Of course, the role of government has been constantly challenged since the 1970s, and the challenges will never end: once the government takes on the central role in economic and social life that it acquired in the decades after World War II, it is normal and legitimate for that role to be permanently questioned and debated. To some this may seem unjust, but it is inevitable and natural. Some people are baffled by the new role of government, and vehement if uncomprehending clashes between apparently irreconcilable positions are not uncommon. Some are outspoken in favor of an even greater role for the state, as if it no longer played any role at all, while still others call for the state to be dismantled at once, especially in the country where it is least present, the United States. There, groups affiliated with the Tea Party call for abolishing the Federal Reserve and returning to the gold standard. In Europe, the verbal clashes between “lazy Greeks” and “Nazi Germans” can be even more vitriolic. None of this helps to solve the real problems at hand. Both the antimarket and antistate camps are partly correct: new instruments are needed to regain control over a financial capitalism that has run amok, and at the same time the tax and transfer systems that are the heart of the modern social state are in constant need of reform and modernization, because they have achieved a level of complexity that makes them difficult to understand and threatens to undermine their social and economic efficacy.

This twofold task may seem insurmountable. It is in fact an enormous challenge, which our democratic societies will have to meet in the years ahead. But it will be impossible to convince a majority of citizens that our governing institutions (especially at the supranational level) need new tools unless the instruments already in place can be shown to be working properly. To clarify all this, I must first take a look backward and briefly discuss how taxation and government spending have evolved in the rich countries since the nineteenth century.

The Growth of the Social State in the Twentieth Century

The simplest way to measure the change in the government’s role in the economy and society is to look at the total amount of taxes relative to national income. Figure 13.1 shows the historical trajectory of four countries (the United States, Britain, France, and Sweden) that are fairly representative of what has happened in the rich countries.1 There are both striking similarities and important differences in the observed evolutions.

FIGURE 13.1. Tax revenues in rich countries, 1870–2010

Total tax revenues were less than 10 percent of national income in rich countries until 1900–1910; they represent between 30 percent and 55 percent of national income in 2000–2010.

Sources and series: see piketty.pse.ens.fr/capital21c.

The first similarity is that taxes consumed less than 10 percent of national income in all four countries during the nineteenth century and up to World War I. This reflects the fact that the state at that time had very little involvement in economic and social life. With 7–8 percent of national income, it is possible for a government to fulfill its central “regalian” functions (police, courts, army, foreign affairs, general administration, etc.) but not much more. After paying to maintain order, enforce property rights, and sustain the military (which often accounts for more than half of total expenditures), not much remained in the government’s coffers.2 States in this period also paid for some roads and other infrastructure, as well as schools, universities, and hospitals, but most people had access only to fairly rudimentary educational and health services.3

Between 1920 and 1980, the share of national income that the wealthy countries chose to devote to social spending increased considerably. In just half a century, the share of taxes in national income increased by a factor of at least 3 or 4 (and in the Nordic countries more than 5). Between 1980 and 2010, however, the tax share stabilized everywhere. This stabilization took place at different levels in each country, however: just over 30 percent of national income in the United States, around 40 percent in Britain, and between 45 and 55 percent on the European continent (45 percent in Germany, 50 percent in France, and nearly 55 percent in Sweden).4 The differences between countries are significant.5 Nevertheless, the secular evolutions are closely matched, in particular the almost perfect stability observed in all four countries over the past three decades. Political changes and national peculiarities are also noticeable in Figure 13.1 (between Britain and France, for example).6 But their importance is on the whole rather limited compared with this common stabilization.7

In other words, all the rich countries, without exception, went in the twentieth century from an equilibrium in which less than a tenth of their national income was consumed by taxes to a new equilibrium in which the figure rose to between a third and a half.8 Several important points about this fundamental transformation call for further clarification.

First, it should be clear why the question of whether or not there has been a “return to the state” in the present crisis is misleading: the role of the government is greater than ever. In order to fully appreciate the state’s role in economic and social life, other indicators of course need to be considered. The state also intervenes by setting rules, not just by collecting taxes to pay its expenses. For example, the financial markets were much less tightly regulated after 1980 than before. The state also produces and owns capital: privatization of formerly state-owned industrial and financial assets over the past three decades has also reduced the state’s role in comparison with the three decades after World War II. Nevertheless, in terms of tax receipts and government outlays, the state has never played as important an economic role as it has in recent decades. No downward trend is evident, contrary to what is sometimes said. To be sure, in the face of an aging population, advances in medical technology, and constantly growing educational needs, the mere fact of having stabilized the tax bill as a percentage of national income is in itself no mean feat: cutting the government budget is always easier to promise in opposition than to achieve once in power. Nevertheless, the fact remains that taxes today claim nearly half of national income in most European countries, and no one seriously envisions an increase in the future comparable to that which occurred between 1930 and 1980. In the wake of the Depression, World War II, and postwar reconstruction, it was reasonable to think that the solution to the problems of capitalism was to expand the role of the state and increase social spending as much as necessary. Today’s choices are necessarily more complex. The state’s great leap forward has already taken place: there will be no second leap—not like the first one, in any event.

To gain a better understanding of what is at stake behind these figures, I want to describe in somewhat greater detail what this historic increase in government tax revenues was used for: the construction of a “social state.”9 In the nineteenth century, governments were content to fulfill their “regalian” missions. Today these same functions command a little less than one-tenth of national income. The growing tax bite enabled governments to take on ever broader social functions, which now consume between a quarter and a third of national income, depending on the country. This can be broken down initially into two roughly equal halves: one half goes to health and education, the other to replacement incomes and transfer payments.10

Spending on education and health consumes 10–15 percent of national income in all the developed countries today.11 There are significant differences between countries, however. Primary and secondary education are almost entirely free for everyone in all the rich countries, but higher education can be quite expensive, especially in the United States and to a lesser extent in Britain. Public health insurance is universal (that is, open to the entire population) in most countries in Europe, including Britain.12 In the United States, however, it is reserved for the poor and elderly (which does not prevent it from being very costly).13 In all the developed countries, public spending covers much of the cost of education and health services: about three-quarters in Europe and half in the United States. The goal is to give equal access to these basic goods: every child should have access to education, regardless of his or her parents’ income, and everyone should have access to health care, even, indeed especially, when circumstances are difficult.

Replacement incomes and transfer payments generally consume 10–15 (or even 20) percent of national income in most of the rich countries today. Unlike public spending on education and health, which may be regarded as transfers in kind, replacement income and transfer payments form part of household disposable income: the government takes in large sums in taxes and social insurance contributions and then pays them out to other households in the form of replacement income (pensions and unemployment compensation) and transfer payments (family allowances, guaranteed income, etc.), so that the total disposable income of all households in the aggregate remains unchanged.14

In practice, pensions account for the lion’s share (two-thirds to three-quarters) of total replacement income and transfer payments. Here, too, there are significant differences between countries. In continental Europe, pensions alone often consume 12–13 percent of national income (with Italy and France at the top, ahead of Germany and Sweden). In the United States and Britain, the public pension system is much more drastically capped for those at the middle and top of the income hierarchy (the replacement rate, that is, the amount of the pension in proportion to the wage earned prior to retirement, falls rather quickly for those who earned above the average wage), and pensions consume only 6–7 percent of national income.15 These are very large sums in all cases: in all the rich countries, public pensions are the main source of income for at least two-thirds of retirees (and generally three-quarters). Despite the defects of these public pensions systems and the challenges they now face, the fact is that without them it would have been impossible to eradicate poverty among the elderly, which was endemic as recently as the 1950s. Along with access to education and health, public pensions constitute the third social revolution that the fiscal revolution of the twentieth century made possible.

Compared with pension outlays, payments for unemployment insurance are much smaller (typically 1–2 percent of national income), reflecting the fact that people spend less time in unemployment than in retirement. The replacement income is nevertheless useful when needed. Finally, income support outlays are even smaller (less than 1 percent of national income), almost insignificant when measured against total government spending. Yet this type of spending is often the most vigorously challenged: beneficiaries are suspected of wanting to live their lives on the dole, even though the proportion of the population relying on welfare payments is generally far smaller than for other government programs, because the stigma attached to welfare (and in many cases the complexity of the process) dissuades many who are entitled to benefits from asking for them.16 Welfare benefits are questioned not only in Europe but also in the United States (where the unemployed black single mother is often singled out for criticism by opponents of the US “welfare state”).17 In both cases, the sums involved are in fact only a very small part of state social spending.

All told, if we add up state spending on health and education (10–15 percent of national income) and replacement and transfer payments (another 10–15 or perhaps as high as 20 percent of national income), we come up with total social spending (broadly speaking) of 25–35 percent of national income, which accounts for nearly all of the increase in government revenues in the wealthy countries in the twentieth century. In other words, the growth of the fiscal state over the last century basically reflects the constitution of a social state.

Modern Redistribution: A Logic of Rights

To sum up: modern redistribution does not consist in transferring income from the rich to the poor, at least not in so explicit a way. It consists rather in financing public services and replacement incomes that are more or less equal for everyone, especially in the areas of health, education, and pensions. In the latter case, the principle of equality often takes the form of a quasi proportionality between replacement income and lifetime earnings.18 For education and health, there is real equality of access for everyone regardless of income (or parents’ income), at least in principle. Modern redistribution is built around a logic of rights and a principle of equal access to a certain number of goods deemed to be fundamental.

At a relatively abstract level, it is possible to find justifications for this rights-based approach in various national political and philosophical traditions. The US Declaration of Independence (1776) asserts that everyone has an equal right to the pursuit of happiness.19 In a sense, our modern belief in fundamental rights to education and health can be linked to this assertion, even though it took quite a while to get there. Article 1 of the Declaration of the Rights of Man and the Citizen (1789) also proclaims that “men are born free and remain free and equal in rights.” This is followed immediately, however, by the statement that “social distinctions can be based only on common utility.” This is an important addition: the second sentence alludes to the existence of very real inequalities, even though the first asserts the principle of absolute equality. Indeed, this is the central tension of any rights-based approach: how far do equal rights extend? Do they simply guarantee the right to enter into free contract—the equality of the market, which at the time of the French Revolution actually seemed quite revolutionary? And if one includes equal rights to an education, to health care, and to a pension, as the twentieth-century social state proposed, should one also include rights to culture, housing, and travel?

The second sentence of article 1 of the Declaration of the Rights of Man of 1789 formulates a kind of answer to this question, since it in a sense reverses the burden of proof: equality is the norm, and inequality is acceptable only if based on “common utility.” It remains to define the term “common utility.” The drafters of the Declaration were thinking mainly of the abolition of the orders and privileges of the Ancien Régime, which were seen at the time as the very epitome of arbitrary, useless inequality, hence as not contributing to “common utility.” One can interpret the phrase more broadly, however. One reasonable interpretation is that social inequalities are acceptable only if they are in the interest of all and in particular of the most disadvantaged social groups.20 Hence basic rights and material advantages must be extended insofar as possible to everyone, as long as it is in the interest of those who have the fewest rights and opportunities to do so.21 The “difference principle” introduced by the US philosopher John Rawls in his Theory of Justice is similar in intent.22 And the “capabilities” approach favored by the Indian economist Amartya Sen is not very different in its basic logic.23

At a purely theoretical level, there is in fact a certain (partly artificial) consensus concerning the abstract principles of social justice. The disagreements become clearer when one tries to give a little substance to these social rights and inequalities and to anchor them in specific historical and economic contexts. In practice, the conflicts have to do mainly with the means of effecting real improvement in the living conditions of the least advantaged, the precise extent of the rights that can be granted to all (in view of economic and budgetary constraints and the many related uncertainties), and exactly what factors are within and beyond the control of individuals (where does luck end and where do effort and merit begin?). Such questions will never be answered by abstract principles or mathematical formulas. The only way to answer them is through democratic deliberation and political confrontation. The institutions and rules that govern democratic debate and decision-making therefore play a central role, as do the relative power and persuasive capabilities of different social groups. The US and French Revolutions both affirmed equality of rights as an absolute principle—a progressive stance at that time. But in practice, during the nineteenth century, the political systems that grew out of those revolutions concentrated mainly on the protection of property rights.

Modernizing Rather Than Dismantling the Social State

Modern redistribution, as exemplified by the social states constructed by the wealthy countries in the twentieth century, is based on a set of fundamental social rights: to education, health, and retirement. Whatever limitations and challenges these systems of taxation and social spending face today, they nevertheless marked an immense step forward in historical terms. Partisan conflict aside, a broad consensus has formed around these social systems, particularly in Europe, which remains deeply attached to what is seen as a “European social model.” No major movement or important political force seriously envisions a return to a world in which only 10 or 20 percent of national income would go to taxes and government would be pared down to its regalian functions.24

On the other hand, there is no significant support for continuing to expand the social state at its 1930–1980 growth rate (which would mean that by 2050–2060, 70–80 percent of national income would go to taxes). In theory, of course, there is no reason why a country cannot decide to devote two-thirds or three-quarters of its national income to taxes, assuming that taxes are collected in a transparent and efficient manner and used for purposes that everyone agrees are of high priority, such as education, health, culture, clean energy, and sustainable development. Taxation is neither good nor bad in itself. Everything depends on how taxes are collected and what they are used for. There are nevertheless two good reasons to believe that such a drastic increase in the size of the social state is neither realistic nor desirable, at least for the foreseeable future.

First, the very rapid expansion of the role of government in the three decades after World War II was greatly facilitated and accelerated by exceptionally rapid economic growth, at least in continental Europe.25 When incomes are increasing 5 percent a year, it is not too difficult to get people to agree to devote an increasing share of that growth to social spending (which therefore increases more rapidly than the economy), especially when the need for better education, more health care, and more generous pensions is obvious (given the very limited funds allocated for these purposes from 1930 to 1950). The situation has been very different since the 1980s: with per capita income growth of just over 1 percent a year, no one wants large and steady tax increases, which would mean even slower if not negative income growth. Of course it is possible to imagine a redistribution of income via the tax system or more progressive tax rates applied to a more or less stable total income, but it is very difficult to imagine a general and durable increase in the average tax rate. The fact that tax revenues have stabilized in all the rich countries, notwithstanding national differences and changes of government, is no accident (see Figure 13.1). Furthermore, it is by no means certain that social needs justify ongoing tax increases. To be sure, there are objectively growing needs in the educational and health spheres, which may well justify slight tax increases in the future. But the citizens of the wealthy countries also have a legitimate need for enough income to purchase all sorts of goods and services produced by the private sector—for instance, to travel, buy clothing, obtain housing, avail themselves of new cultural services, purchase the latest tablet, and so on. In a world of low productivity growth, on the order of 1–1.5 percent (which is in fact a decent rate of growth over the long term), society has to choose among different types of needs, and there is no obvious reason to think that nearly all needs should by paid for through taxation.

Furthermore, no matter how the proceeds of growth are allocated among different needs, there remains the fact that once the public sector grows beyond a certain size, it must contend with serious problems of organization. Once again, it is hard to foresee what will happen in the very long run. It is perfectly possible to imagine that new decentralized and participatory forms of organization will be developed, along with innovative types of governance, so that a much larger public sector than exists today can be operated efficiently. The very notion of “public sector” is in any case reductive: the fact that a service is publicly financed does not mean that it is produced by people directly employed by the state or other public entities. In education and health, services are provided by many kinds of organizations, including foundations and associations, which are in fact intermediate forms between the state and private enterprise. All told, education and health account for 20 percent of employment and GDP in the developed economies, which is more than all sectors of industry combined. This way of organizing production is durable and universal. For example, no one has proposed transforming private US universities into publicly owned corporations. It is perfectly possible that such intermediary forms will become more common in the future, for example, in the cultural and media sectors, where profit-making corporations already face serious competition and raise concerns about potential conflicts of interest. As I showed earlier when discussing how capitalism is organized in Germany, the notion of private property can vary from country to country, even in the automobile business, one of the most traditional branches of industry. There is no single variety of capitalism or organization of production in the developed world today: we live in a mixed economy, different to be sure from the mixed economy that people envisioned after World War II but nonetheless quite real. This will continue to be true in the future, no doubt more than ever: new forms of organization and ownership remain to be invented.

That said, before we can learn to efficiently organize public financing equivalent to two-thirds to three-quarters of national income, it would be good to improve the organization and operation of the existing public sector, which represents only half of national income (including replacement and transfer payments)—no small affair. In Germany, France, Italy, Britain, and Sweden, debates about the social state in the decades to come will revolve mainly around issues of organization, modernization, and consolidation: if total taxes and social spending remain more or less unchanged in proportion to national income (or perhaps rise slightly in response to growing needs), how can we improve the operation of hospitals and day care centers, adjust doctors’ fees and drug costs, reform universities and primary schools, and revise pension and unemployment benefits in response to changing life expectancies and youth unemployment rates? At a time when nearly half of national income goes to public spending, such debates are legitimate and even indispensable. If we do not constantly ask how to adapt our social services to the public’s needs, the consensus supporting high levels of taxation and therefore the social state may not last forever.

Obviously, an analysis of the prospects for reform of all aspects of the social state would far exceed the scope of this book. I will therefore confine myself to a few issues of particular importance for the future and directly related to the themes of my work: first, the question of equal access to education, and especially higher education, and second, the future of pay-as-you-go retirement systems in a world of low growth.

Do Educational Institutions Foster Social Mobility?

In all countries, on all continents, one of the main objectives of public spending for education is to promote social mobility. The stated goal is to provide access to education for everyone, regardless of social origin. To what extent do existing institutions fulfill this objective?

In Part Three, I showed that even with the considerable increase in the average level of education over the course of the twentieth century, earned income inequality did not decrease. Qualification levels shifted upward: a high school diploma now represents what a grade school certificate used to mean, a college degree what a high school diploma used to stand for, and so on. As technologies and workplace needs changed, all wage levels increased at similar rates, so that inequality did not change. What about mobility? Did mass education lead to more rapid turnover of winners and losers for a given skill hierarchy? According to the available data, the answer seems to be no: the intergenerational correlation of education and earned incomes, which measures the reproduction of the skill hierarchy over time, shows no trend toward greater mobility over the long run, and in recent years mobility may even have decreased.26 Note, however, that it is much more difficult to measure mobility across generations than it is to measure inequality at a given point in time, and the sources available for estimating the historical evolution of mobility are highly imperfect.27 The most firmly established result in this area of research is that intergenerational reproduction is lowest in the Nordic countries and highest in the United States (with a correlation coefficient two-thirds higher than in Sweden). France, Germany, and Britain occupy a middle ground, less mobile than northern Europe but more mobile than the United States.28

These findings stand in sharp contrast to the belief in “American exceptionalism” that once dominated US sociology, according to which social mobility in the United States was exceptionally high compared with the class-bound societies of Europe. No doubt the settler society of the early nineteenth century was more mobile. As I have shown, moreover, inherited wealth played a smaller role in the United States than in Europe, and US wealth was for a long time less concentrated, at least up to World War I. Throughout most of the twentieth century, however, and still today, the available data suggest that social mobility has been and remains lower in the United States than in Europe.

One possible explanation for this is the fact that access to the most elite US universities requires the payment of extremely high tuition fees. Furthermore, these fees rose sharply in the period 1990–2010, following fairly closely the increase in top US incomes, which suggests that the reduced social mobility observed in the United States in the past will decline even more in the future.29 The issue of unequal access to higher education is increasingly a subject of debate in the United States. Research has shown that the proportion of college degrees earned by children whose parents belong to the bottom two quartiles of the income hierarchy stagnated at 10–20 percent in 1970–2010, while it rose from 40 to 80 percent for children with parents in the top quartile.30 In other words, parents’ income has become an almost perfect predictor of university access.

This inequality of access also seems to exist at the top of the economic hierarchy, not only because of the high cost of attending the most prestigious private universities (high even in relation to the income of upper-middle-class parents) but also because admissions decisions clearly depend in significant ways on the parents’ financial capacity to make donations to the universities. For example, one study has shown that gifts by graduates to their former universities are strangely concentrated in the period when the children are of college age.31 By comparing various sources of data, moreover, it is possible to estimate that the average income of the parents of Harvard students is currently about $450,000, which corresponds to the average income of the top 2 percent of the US income hierarchy.32 Such a finding does not seem entirely compatible with the idea of selection based solely on merit. The contrast between the official meritocratic discourse and the reality seems particularly extreme in this case. The total absence of transparency regarding selection procedures should also be noted.33

It would be wrong, however, to imagine that unequal access to higher education is a problem solely in the United States. It is one of the most important problems that social states everywhere must face in the twenty-first century. To date, no country has come up with a truly satisfactory response. To be sure, university tuitions fees are much lower in Europe if one leaves Britain aside.34 In other countries, including Sweden and other Nordic countries, Germany, France, Italy, and Spain, tuition fees are relatively low (less than 500 euros). Although there are exceptions, such as business schools and Sciences Po in France, and although the situation is changing rapidly, this remains a very striking difference between continental Europe and the United States: in Europe, most people believe that access to higher education should be free or nearly free, just as primary and secondary education are.35 In Quebec, the decision to raise tuition gradually from $2,000 to nearly $4,000 was interpreted as an attempt to move toward an inegalitarian US-style system, which led to a student strike in the winter of 2012 and ultimately to a change of government and cancellation of the decision.

It would be naïve, however, to think that free higher education would resolve all problems. In 1964, Pierre Bourdieu and Jean-Claude Passeron analyzed, in Les héritiers, more subtle mechanisms of social and cultural selection, which often do the same work as financial selection. In practice, the French system of “grandes écoles” leads to spending more public money on students from more advantaged social backgrounds, while less money is spent on university students who come from more modest backgrounds. Again, the contrast between the official discourse of “republican meritocracy” and the reality (in which social spending amplifies inequalities of social origin) is extreme.36 According to the available data, it seems that the average income of parents of students at Sciences Po is currently around 90,000 euros, which roughly corresponds to the top 10 percent of the French income hierarchy. Recruitment is thus 5 times broader than at Harvard but still relatively limited.37 We lack the data to do a similar calculation for students at the other grandes écoles, but the results would likely be similar.

Make no mistake: there is no easy way to achieve real equality of opportunity in higher education. This will be a key issue for the social state in the twenty-first century, and the ideal system has yet to be invented. Tuition fees create an unacceptable inequality of access, but they foster the independence, prosperity, and energy that make US universities the envy of the world.38 In the abstract, it should be possible to combine the advantages of decentralization with those of equal access by providing universities with substantial publicly financed incentives. In some respects this is what public health insurance systems do: producers (doctors and hospitals) are granted a certain independence, but the cost of care is a collective responsibility, thus ensuring that patients have equal access to the system. One could do the same thing with universities and students. The Nordic countries have adopted a strategy of this kind in higher education. This of course requires substantial public financing, which is not easy to come by in the current climate of consolidation of the social state.39 Such a strategy is nevertheless far more satisfactory than other recent attempts, which range from charging tuition fees that vary with parents’ income40 to offering loans that are to be paid back by a surtax added to the recipient’s income tax.41

If we are to make progress on these issues in the future, it would be good to begin by working toward greater transparency than exists today. In the United States, France, and most other countries, talk about the virtues of the national meritocratic model is seldom based on close examination of the facts. Often the purpose is to justify existing inequalities while ignoring the sometimes patent failures of the current system. In 1872, Emile Boutmy created Sciences Po with a clear mission in mind: “obliged to submit to the rule of the majority, the classes that call themselves the upper classes can preserve their political hegemony only by invoking the rights of the most capable. As traditional upper-class prerogatives crumble, the wave of democracy will encounter a second rampart, built on eminently useful talents, superiority that commands prestige, and abilities of which society cannot sanely deprive itself.”42 If we take this incredible statement seriously, what it clearly means is that the upper classes instinctively abandoned idleness and invented meritocracy lest universal suffrage deprive them of everything they owned. One can of course chalk this up to the political context: the Paris Commune had just been put down, and universal male suffrage had just been reestablished. Yet Boutmy’s statement has the virtue of reminding us of an essential truth: defining the meaning of inequality and justifying the position of the winners is a matter of vital importance, and one can expect to see all sorts of misrepresentations of the facts in service of the cause.

The Future of Retirement: Pay-As-You-Go and Low Growth

Public pension systems are generally pay-as-you-go (PAYGO) systems: contributions deducted from the wages of active workers are directly paid out as benefits to retirees. In contrast to capitalized pension plans, in a PAYGO system nothing is invested, and incoming funds are immediately disbursed to current retirees. In PAYGO schemes, based on the principle of intergenerational solidarity (today’s workers pay benefits to today’s retirees in the hope that their children will pay their benefits tomorrow), the rate of return is by definition equal to the growth rate of the economy: the contributions available to pay tomorrow’s retirees will rise as average wages rise. In theory, this also implies that today’s active workers have an interest in ensuring that average wages rise as rapidly as possible. They should therefore invest in schools and universities for their children and promote a higher birth rate. In other words, there exists a bond among generations that in principle makes for a virtuous and harmonious society.43

When PAYGO systems were introduced in the middle of the twentieth century, conditions were in fact ideal for such a virtuous series of events to occur. Demographic growth was high and productivity growth higher still. The growth rate was close to 5 percent in the countries of continental Europe, so this was the rate of return on the PAYGO system. Concretely, workers who contributed to state retirement funds between the end of World War II and 1980 were repaid (or are still being repaid) out of much larger wage pools than those from which their contributions were drawn. The situation today is different. The falling growth rate (now around 1.5 percent in the rich countries and perhaps ultimately in all countries) reduces the return on the pool of shared contributions. All signs are that the rate of return on capital in the twenty-first century will be significantly higher than the growth rate of the economy (4–5 percent for the former, barely 1.5 percent for the latter).44

Under these conditions, it is tempting to conclude that the PAYGO system should be replaced as quickly as possible by a capitalized system, in which contributions by active workers are invested rather than paid out immediately to retirees. These investments can then grow at 4 percent a year in order to finance the pensions of today’s workers when they retire several decades from now. There are several major flaws in this argument, however. First, even if we assume that a capitalized system is indeed preferable to a PAYGO system, the transition from PAYGO to capitalized benefits raises a fundamental problem: an entire generation of retirees is left with nothing. The generation that is about to retire, who paid for the pensions of the previous generation with their contributions, would take a rather dim view of the fact that the contributions of today’s workers, which current retirees had expected to pay their rent and buy their food during the remaining years of their lives, would in fact be invested in assets around the world. There is no simple solution to this transition problem, and this alone makes such a reform totally unthinkable, at least in such an extreme form.

Second, in comparing the merits of the two pension systems, one must bear in mind that the return on capital is in practice extremely volatile. It would be quite risky to invest all retirement contributions in global financial markets. The fact that r > g on average does not mean that it is true for each individual investment. For a person of sufficient means who can wait ten or twenty years before taking her profits, the return on capital is indeed quite attractive. But when it comes to paying for the basic necessities of an entire generation, it would be quite irrational to bet everything on a roll of the dice. The primary justification of the PAYGO system is that it is the best way to guarantee that pension benefits will be paid in a reliable and predictable manner: the rate of wage growth may be less than the rate of return on capital, but the former is 5–10 times less volatile than the latter.45 This will continue to be true in the twenty-first century, and PAYGO pensions will therefore continue to be part of the ideal social state of the future everywhere.

That said, it remains true that the logic of r > g cannot be entirely ignored, and some things may have to change in the existing pension systems of the developed countries. One challenge is obviously the aging of the population. In a world where people die between eighty and ninety, it is difficult to maintain parameters that were chosen when the life expectancy was between sixty and seventy. Furthermore, increasing the retirement age is not just a way of increasing the resources available to both workers and retirees (which is a good thing in an era of low growth). It is also a response to the need that many people feel for fulfillment through work. For them, to be forced to retire at sixty and to spend more time in retirement in some cases than in a career, is not an appetizing prospect. The problem is that individual situations vary widely. Some people have primarily intellectual occupations, and they may wish to remain on the job until they are seventy (and it is possible that the number of such people as a share of total employment will increase over time). There are many others, however, who began work early and whose work is arduous or not very rewarding and who legitimately aspire to retire relatively early (especially since their life expectancy is often lower than that of more highly qualified workers). Unfortunately, recent reforms in many developed countries fail to distinguish adequately between these different types of individual, and in some cases more is demanded of the latter than of the former, which is why these reforms sometimes provoke strong opposition.

One of the main difficulties of pension reform is that the systems one is trying to reform are extremely complex, with different rules for civil servants, private sector workers, and nonworkers. For a person who has worked in different types of jobs over the course of a lifetime, which is increasingly common in the younger generations, it is sometimes difficult to know which rules apply. That such complexity exists is not surprising: today’s pension systems were in many cases built in stages, as existing schemes were extended to new social groups and occupations from the nineteenth century on. But this makes it difficult to obtain everyone’s cooperation on reform efforts, because many people feel that they are being treated worse than others. The hodgepodge of existing rules and schemes frequently confuses the issue, and people underestimate the magnitude of the resources already devoted to public pensions and fail to realize that these amounts cannot be increased indefinitely. For example, the French system is so complex that many younger workers do not have a clear understanding of what they are entitled to. Some even think that they will get nothing even though they are paying a substantial amount into the system (something like 25 percent of gross pay). One of the most important reforms the twenty-first-century social state needs to make is to establish a unified retirement scheme based on individual accounts with equal rights for everyone, no matter how complex one’s career path.46 Such a system would allow each person to anticipate exactly what to expect from the PAYGO public plan, thus allowing for more intelligent decisions about private savings, which will inevitably play a more important supplementary role in a low-growth environment. One often hears that “a public pension is the patrimony of those without patrimony.” This is true, but it does not mean that it would not be wise to encourage people of more modest means to accumulate nest eggs of their own.47

The Social State in Poor and Emerging Countries

Does the kind of social state that emerged in the developed countries in the twentieth century have a universal vocation? Will we see a similar development in the poor and emerging countries? Nothing could be less certain. To begin with, there are important differences among the rich countries: the countries of Western Europe seem to have stabilized government revenues at about 45–50 percent of national income, whereas the United States and Japan seem to be stuck at around the 30–35 percent level. Clearly, different choices are possible at equivalent levels of development.

If we look at the poorest countries around the world in 1970–1980, we find that governments generally took 10–15 percent of national income, both in Sub-Saharan Africa and in South Asia (especially India). Turning to countries at an intermediate level of development in Latin America, North Africa, and China, we find governments taking 15–20 percent of national income, lower than in the rich countries at comparable levels of development. The most striking fact is that the gap between the rich and the not-so-rich countries has continued to widen in recent years. Tax levels in the rich countries rose (from 30–35 percent of national income in the 1970s to 35–40 percent in the 1980s) before stabilizing at today’s levels, whereas tax levels in the poor and intermediate countries decreased significantly. In Sub-Saharan Africa and South Asia, the average tax bite was slightly below 15 percent in the 1970s and early 1980s but fell to a little over 10 percent in the 1990s.

This evolution is a concern in that, in all the developed countries in the world today, building a fiscal and social state has been an essential part of the process of modernization and economic development. The historical evidence suggests that with only 10–15 percent of national income in tax receipts, it is impossible for a state to fulfill much more than its traditional regalian responsibilities: after paying for a proper police force and judicial system, there is not much left to pay for education and health. Another possible choice is to pay everyone—police, judges, teachers, and nurses—poorly, in which case it is unlikely that any of these public services will work well. This can lead to a vicious circle: poorly functioning public services undermine confidence in government, which makes it more difficult to raise taxes significantly. The development of a fiscal and social state is intimately related to the process of state-building as such. Hence the history of economic development is also a matter of political and cultural development, and each country must find its own distinctive path and cope with its own internal divisions.

In the present case, however, it seems that part of the blame lies with the rich countries and international organizations. The initial situation was not very promising. The process of decolonization was marked by a number of chaotic episodes in the period 1950–1970: wars of independence with the former colonial powers, somewhat arbitrary borders, military tensions linked to the Cold War, abortive experiments with socialism, and sometimes a little of all three. After 1980, moreover, the new ultraliberal wave emanating from the developed countries forced the poor countries to cut their public sectors and lower the priority of developing a tax system suitable to fostering economic development. Recent research has shown that the decline in government receipts in the poorest countries in 1980–1990 was due to a large extent to a decrease in customs duties, which had brought in revenues equivalent to about 5 percent of national income in the 1970s. Trade liberalization is not necessarily a bad thing, but only if it is not peremptorily imposed from without and only if the lost revenue can gradually be replaced by a strong tax authority capable of collecting new taxes and other substitute sources of revenue. Today’s developed countries reduced their tariffs over the course of the nineteenth and twentieth centuries at a pace they judged to be reasonable and with clear alternatives in mind. They were fortunate enough not to have anyone tell them what they ought to be doing instead.48 This illustrates a more general phenomenon: the tendency of the rich countries to use the less developed world as a field of experimentation, without really seeking to capitalize on the lessons of their own historical experience.49 What we see in the poor and emerging countries today is a wide range of different tendencies. Some countries, like China, are fairly advanced in the modernization of their tax system: for instance, China has an income tax that is applicable to a large portion of the population and brings in substantial revenues. It is possibly in the process of developing a social state similar to those found in the developed countries of Europe, America, and Asia (albeit with specific Chinese features and of course great uncertainty as to its political and democratic underpinnings). Other countries, such as India, have had greater difficulty moving beyond an equilibrium based on a low level of taxation.50 In any case, the question of what kind of fiscal and social state will emerge in the developing world is of the utmost importance for the future of the planet.

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Rethinking the Progressive Income Tax

In the previous chapter I examined the constitution and evolution of the social state, focusing on the nature of social needs and related social spending (education, health, retirement, etc.). I treated the overall level of taxes as a given and described its evolution. In this chapter and the next, I will examine more closely the structure of taxes and other government revenues, without which the social state could never have emerged, and attempt to draw lessons for the future. The major twentieth-century innovation in taxation was the creation and development of the progressive income tax. This institution, which played a key role in the reduction of inequality in the last century, is today seriously threatened by international tax competition. It may also be in jeopardy because its foundations were never clearly thought through, owing to the fact that it was instituted in an emergency that left little time for reflection. The same is true of the progressive tax on inheritances, which was the second major fiscal innovation of the twentieth century and has also been challenged in recent decades. Before I examine these two taxes more closely, however, I must first situate them in the context of progressive taxation in general and its role in modern redistribution.

The Question of Progressive Taxation

Taxation is not a technical matter. It is preeminently a political and philosophical issue, perhaps the most important of all political issues. Without taxes, society has no common destiny, and collective action is impossible. This has always been true. At the heart of every major political upheaval lies a fiscal revolution. The Ancien Régime was swept away when the revolutionary assemblies voted to abolish the fiscal privileges of the nobility and clergy and establish a modern system of universal taxation. The American Revolution was born when subjects of the British colonies decided to take their destiny in hand and set their own taxes. (“No taxation without representation”). Two centuries later the context is different, but the heart of the issue remains the same. How can sovereign citizens democratically decide how much of their resources they wish to devote to common goals such as education, health, retirement, inequality reduction, employment, sustainable development, and so on? Precisely what concrete form taxes take is therefore the crux of political conflict in any society. The goal is to reach agreement on who must pay what in the name of what principles—no mean feat, since people differ in many ways. In particular, they earn different incomes and own different amounts of capital. In every society there are some individuals who earn a lot from work but inherited little, and vice versa. Fortunately, the two sources of wealth are never perfectly correlated. Views about the ideal tax system are equally varied.

One usually distinguishes among taxes on income, taxes on capital, and taxes on consumption. Taxes of each type can be found in varying proportions in nearly all periods. These categories are not exempt from ambiguity, however, and the dividing lines are not always clear. For example, the income tax applies in principle to capital income as well as earned income and is therefore a tax on capital as well. Taxes on capital generally include any levy on the flow of income from capital (such as the corporate income tax), as well as any tax on the value of the capital stock (such as a real estate tax, an estate tax, or a wealth tax). In the modern era, consumption taxes include value-added taxes as well as taxes on imported goods, drink, gasoline, tobacco, and services. Such taxes have always existed and are often the most hated of all, as well as the heaviest burden on the lower class (one thinks of the salt tax under the Ancien Régime). They are often called “indirect” taxes because they do not depend directly on the income or capital of the individual taxpayer: they are paid indirectly, as part of the selling price of a purchased good. In the abstract, one might imagine a direct tax on consumption, which would depend on each taxpayer’s total consumption, but no such tax has ever existed.1

In the twentieth century, a fourth category of tax appeared: contributions to government-sponsored social insurance programs. These are a special type of tax on income, usually only income from labor (wages and remuneration for nonwage labor). The proceeds go to social insurance funds intended to finance replacement income, whether pensions for retired workers or unemployment benefits for unemployed workers. This mode of collection ensures that the taxpayer will be aware of the purpose for which the tax is to be used. Some countries, such as France, also use social contributions to pay for other social spending such as health insurance and family allowances, so that total social contributions account for nearly half of all government revenue. Rather than clarify the purpose of tax collection, a system of such complexity can actually obscure matters. By contrast, other states, such as Denmark, finance all social spending with an enormous income tax, the revenues from which are allocated to pensions, unemployment and health insurance, and many other purposes. In fact, these distinctions among different legal categories of taxation are partly arbitrary.2

Beyond these definitional quibbles, a more pertinent criterion for characterizing different types of tax is the degree to which each type is proportional or progressive. A tax is called “proportional” when its rate is the same for everyone (the term “flat tax” is also used). A tax is progressive when its rate is higher for some than for others, whether it be those who earn more, those who own more, or those who consume more. A tax can also be regressive, when its rate decreases for richer individuals, either because they are partially exempt (either legally, as a result of fiscal optimization, or illegally, through evasion) or because the law imposes a regressive rate, like the famous “poll tax” that cost Margaret Thatcher her post as prime minister in 1990.3

In the modern fiscal state, total tax payments are often close to proportional to individual income, especially in countries where the total is large. This is not surprising: it is impossible to tax half of national income to finance an ambitious program of social entitlements without asking everyone to make a substantial contribution. The logic of universal rights that governed the development of the modern fiscal and social state fits rather well, moreover, with the idea of a proportional or slightly progressive tax.

It would be wrong, however, to conclude that progressive taxation plays only a limited role in modern redistribution. First, even if taxation overall is fairly close to proportional for the majority of the population, the fact that the highest incomes and largest fortunes are taxed at significantly higher (or lower) rates can have a strong influence on the structure of inequality. In particular, the evidence suggests that progressive taxation of very high incomes and very large estates partly explains why the concentration of wealth never regained its astronomic Belle Époque levels after the shocks of 1914–1945. Conversely, the spectacular decrease in the progressivity of the income tax in the United States and Britain since 1980, even though both countries had been among the leaders in progressive taxation after World War II, probably explains much of the increase in the very highest earned incomes. At the same time, the recent rise of tax competition in a world of free-flowing capital has led many governments to exempt capital income from the progressive income tax. This is particularly true in Europe, whose relatively small states have thus far proved incapable of achieving a coordinated tax policy. The result is an endless race to the bottom, leading, for example, to cuts in corporate tax rates and to the exemption of interest, dividends, and other financial revenues from the taxes to which labor incomes are subject.

One consequence of this is that in most countries taxes have (or will soon) become regressive at the top of the income hierarchy. For example, a detailed study of French taxes in 2010, which looked at all forms of taxation, found that the overall rate of taxation (47 percent of national income on average) broke down as follows. The bottom 50 percent of the income distribution pay a rate of 40–45 percent; the next 40 percent pay 45–50 percent; but the top 5 percent and even more the top 1 percent pay lower rates, with the top 0.1 percent paying only 35 percent. The high tax rates on the poor reflect the importance of consumption taxes and social contributions (which together account for three-quarters of French tax revenues). The slight progressivity observed in the middle class is due to the growing importance of the income tax. Conversely, the clear regressivity in the top centiles reflects the importance at this level of capital income, which is largely exempt from progressive taxation. The effect of this outweighs the effect of taxes on the capital stock (which are the most progressive of all).4 All signs are that taxes elsewhere in Europe (and probably also in the United States) follow a similar bell curve, which is probably even more pronounced than this imperfect estimate indicates.5

If taxation at the top of the social hierarchy were to become more regressive in the future, the impact on the dynamics of wealth inequality would likely be significant, leading to a very high concentration of capital. Clearly, such a fiscal secession of the wealthiest citizens could potentially do great damage to fiscal consent in general. Consensus support for the fiscal and social state, which is already fragile in a period of low growth, would be further reduced, especially among the middle class, who would naturally find it difficult to accept that they should pay more than the upper class. Individualism and selfishness would flourish: since the system as a whole would be unjust, why continue to pay for others? If the modern social state is to continue to exist, it is therefore essential that the underlying tax system retain a minimum of progressivity, or at any rate that it not become overtly regressive at the top.

Furthermore, looking at the progressivity of the tax system by examining how heavily top incomes are taxed obviously fails to weigh inherited wealth, whose importance has been increasing.6 In practice, estates are much less heavily taxed than income.7 This exacerbates what I have called “Rastignac’s dilemma.” If individuals were classified by centile of total resources accrued over a lifetime (including both earned income and capitalized inheritance), which is a more satisfactory criterion for progressive taxation, the bell curve would be even more markedly regressive at the top of the hierarchy than it is when only labor incomes are considered.8

One final point bears emphasizing: to the extent that globalization weighs particularly heavily on the least skilled workers in the wealthy countries, a more progressive tax system might in principle be justified, adding yet another layer of complexity to the overall picture. To be sure, if one wants to maintain total taxes at about 50 percent of national income, it is inevitable that everyone must pay a substantial amount. But instead of a slightly progressive tax system (leaving aside the very top of the hierarchy), one can easily imagine a more steeply progressive one.9 This would not solve all the problems, but it would be enough to improve the situation of the least skilled significantly.10 If the tax system is not made more progressive, it should come as no surprise that those who derive the least benefit from free trade may well turn against it. The progressive tax is indispensable for making sure that everyone benefits from globalization, and the increasingly glaring absence of progressive taxation may ultimately undermine support for a globalized economy.

For all of these reasons, a progressive tax is a crucial component of the social state: it played a central role in its development and in the transformation of the structure of inequality in the twentieth century, and it remains important for ensuring the viability of the social state in the future. But progressive taxation is today under serious threat, both intellectually (because its various functions have never been fully debated) and politically (because tax competition is allowing entire categories of income to gain exemption from the common rules).

The Progressive Tax in the Twentieth Century: An Ephemeral Product of Chaos

To gaze backward for a moment: how did we get to this point? First, it is important to realize that progressive taxation was as much a product of two world wars as it was of democracy. It was adopted in a chaotic climate that called for improvisation, which is part of the reason why its various purposes were not sufficiently thought through and why it is being challenged today.

To be sure, a number of countries adopted a progressive income tax before the outbreak of World War I. In France, the law creating a “general tax on income” was passed on July 15, 1914, in direct response to the anticipated financial needs of the impending conflict (after being buried in the Senate for several years); the law would not have passed had a declaration of war not been imminent.11 Aside from this exception, most countries adopted a progressive income tax after due deliberation in the normal course of parliamentary proceedings. Such a tax was adopted in Britain, for example, in 1909 and in the United States in 1913. Several countries in northern Europe, a number of German states, and Japan adopted a progressive income tax even earlier: Denmark in 1870, Japan in 1887, Prussia in 1891, and Sweden in1903. Even though not all the developed countries had adopted a progressive tax by 1910, an international consensus was emerging around the principle of progressivity and its application to overall income (that is, to the sum of income from labor, including both wage and nonwage labor, and capital income of all kinds, including rent, interest, dividends, profits, and in some cases capital gains).12 To many people, such a system appeared to be both a more just and a more efficient way of apportioning taxes. Overall income measured each person’s ability to contribute, and progressive taxation offered a way of limiting the inequalities produced by industrial capitalism while maintaining respect for private property and the forces of competition. Many books and reports published at the time helped popularize the idea and win over some political leaders and liberal economists, although many would remain hostile to the very principle of progressivity, especially in France.13

Is the progressive income tax therefore the natural offspring of democracy and universal suffrage? Things are actually more complicated. Indeed, tax rates, even on the most astronomical incomes, remained extremely low prior to World War I. This was true everywhere, without exception. The magnitude of the political shock due to the war is quite clear in Figure 14.1, which shows the evolution of the top rate (that is, the tax rate on the highest income bracket) in the United States, Britain, Germany, and France from 1900 to 2013. The top rate stagnated at insignificant levels until 1914 and then skyrocketed after the war. These curves are typical of those seen in other wealthy countries.14

FIGURE 14.1. Top income tax rates, 1900–2013

The top marginal tax rate of the income tax (applying to the highest incomes) in the United States dropped from 70 percent in 1980 to 28 percent in 1988.

Sources and series: see piketty.pse.ens.fr/capital21c.

In France, the 1914 income tax law provided for a top rate of just 2 percent, which applied to only a tiny minority of taxpayers. It was only after the war, in a radically different political and financial context, that the top rate was raised to “modern” levels: 50 percent in 1920, then 60 percent in 1924, and even 72 percent in 1925. Particularly striking is the fact that the crucial law of June 25, 1920, which raised the top rate to 50 percent and can actually be seen as a second coming of the income tax, was adopted by the so-called blue-sky Chamber (one of the most right-wing Chambers of Deputies in the history of the French Republic) with its “National Bloc” majority, made up largely of the very delegations who had most vehemently opposed the creation of an income tax with a top rate of 2 percent before the war. This complete reversal of the right-wing position on progressive taxation was of course due to the disastrous financial situation created by the war. During the conflict the government had run up considerable debts, and despite the ritual speeches in which politician after politician declared that “Germany will pay,” everyone knew that new fiscal resources would have to be found. Postwar shortages and the recourse to the printing press had driven inflation to previously unknown heights, so that the purchasing power of workers remained below 1914 levels, and several waves of strikes in May and June of 1919 threatened the country with paralysis. In such circumstances, political proclivities hardly mattered: new sources of revenue were essential, and no one believed that those with the highest incomes ought to be spared. The Bolshevik Revolution of 1917 was fresh in everyone’s mind. It was in this chaotic and explosive situation that the modern progressive income tax was born.15

The German case is particularly interesting, because Germany had had a progressive income tax for more than twenty years before the war. Throughout that period of peace, tax rates were never raised significantly. In Prussia, the top rate remained stable at 3 percent from 1891 to 1914 and then rose to 4 percent from 1915 to 1918, before ultimately shooting up to 40 percent in 1919–1920, in a radically changed political climate. In the United States, which was intellectually and politically more prepared than any other country to accept a steeply progressive income tax and would lead the movement in the interwar period, it was again not until 1918–1919 that the top rate was abruptly increased, first to 67 and then to 77 percent. In Britain, the top rate was set at 8 percent in 1909, a fairly high level for the time, but again it was not until after the war that it was suddenly raised to more than 40 percent.

Of course it is impossible to say what would have happened had it not been for the shock of 1914–1918. A movement had clearly been launched. Nevertheless, it seems certain that had that shock not occurred, the move toward a more progressive tax system would at the very least have been much slower, and top rates might never have risen as high as they did. The rates in force before 1914, which were always below 10 percent (and generally below 5), including the top rates, were not very different from tax rates in the eighteenth and nineteenth centuries. Even though the progressive tax on total income was a creation of the late nineteenth and early twentieth centuries, there were much earlier forms of income tax, generally with different rules for different types of income, and usually with flat or nearly flat rates (for example, a flat rate after allowing for a certain fixed deduction). In most cases the rates were 5–10 percent (at most). For example, this was true of the categorical or schedular tax, which applied separate rates to each category (or schedule) of income (land rents, interest, profits, wages, etc.). Britain adopted such a categorical tax in 1842, and it remained the British version of the income tax until the creation in 1909 of a “supertax” (a progressive tax on total income).16

In Ancien Régime France, there were also various forms of direct taxation of incomes, such as the taille, the dixième, and the vingtième, with typical rates of 5 or 10 percent (as the names indicate) applied to some but not all sources of income, with numerous exemptions. In 1707, Vauban proposed a “dixième royal,” which was intended to be a 10 percent tax on all incomes (including rents paid to aristocratic and ecclesiastical landlords), but it was never fully implemented. Various improvements to the tax system were nevertheless attempted over the course of the eighteenth century.17 Revolutionary lawmakers, hostile to the inquisitorial methods of the fallen monarchy and probably keen as well to protect the emerging industrial bourgeoisie from bearing too heavy a tax burden, chose to institute an “indicial” tax system: taxes were calculated on the basis of indices that were supposed to reflect the taxpayer’s ability to pay rather than actual income, which did not have to be declared. For instance, the “door and window tax” was based on the number of doors and windows in the taxpayer’s primary residence, which was taken to be an index of wealth. Taxpayers liked this system because the authorities could determine how much tax they owed without having to enter their homes, much less examine their account books. The most important tax under the new system created in 1792, the property tax, was based on the rental value of all real estate owned by the taxpayer.18 The income tax was based on estimates of average rental value, which were revised once a decade when the tax authorities inventoried all property in France; taxpayers were not required to declare their actual income. Since inflation was slow, this made little difference. In practice, this real estate tax amounted to a flat tax on rents and was not very different from the British categorical tax. (The effective rate varied from time to time and département to département but never exceeded 10 percent.)

To round out the system, the nascent Third Republic decided in 1872 to impose a tax on income from financial assets. This was a flat tax on interest, dividends, and other financial revenues, which were rapidly proliferating in France at the time but almost totally exempt from taxation, even though similar revenues were taxed in Britain. Once again, however, the tax rate was set quite low (3 percent from 1872 to 1890 and then 4 percent from 1890 to 1914), at any rate in comparison with the rates assessed after 1920. Until World War I, it seems to have been the case in all the developed countries that a tax on income was not considered “reasonable” unless the rate was under 10 percent, no matter how high the taxable income.

The Progressive Tax in the Third Republic

Interestingly, this was also true of the progressive inheritance or estate tax, which, along with the progressive income tax, was the second important fiscal innovation of the early twentieth century. Estate tax rates also remained quite low until 1914 (see Figure 14.2). Once again, the case of France under the Third Republic is emblematic: here was a country that was supposed to nurse a veritable passion for the ideal of equality, in which universal male suffrage was reestablished in 1871, and which nevertheless stubbornly refused for nearly half a century to fully embrace the principle of progressive taxation. Attitudes did not really change until World War I made change inevitable. To be sure, the estate tax instituted by the French Revolution, which remained strictly proportional from 1791 to 1901, was made progressive by the law of February 25, 1901. In reality, however, not much changed: the highest rate was set at 5 percent from 1902 to 1910 and then at 6.5 percent from 1911 to 1914 and applied to only a few dozen fortunes every year. In the eyes of wealthy taxpayers, such rates seemed exorbitant. Many felt that it was a “sacred duty” to ensure that “a son would succeed his father,” thereby perpetuating the family property, and that such straightforward perpetuation should not incur a tax of any kind.19 In reality, however, the low inheritance tax did not prevent estates from being passed on largely intact from one generation to the next. The effective average rate on the top centile of inheritances was no more than 3 percent after the reform of 1901 (compared to 1 percent under the proportional regime in force in the nineteenth century). In hindsight, it is clear that the reform had scarcely any impact on the process of accumulation and hyperconcentration of wealth that was under way at the time, regardless of what contemporaries may have believed.

It is striking, moreover, how frequently opponents of progressive taxation, who were clearly in the majority among the economic and financial elite of Belle Époque France, rather hypocritically relied on the argument that France, being a naturally egalitarian country, had no need of progressive taxes. A typical and particularly instructive example is that of Paul Leroy-Beaulieu, one of the most influential economists of the day, who in 1881 published his famous Essai sur la répartition des richesses et sur la tendance à une moindre inégalité des conditions (Essay on the Distribution of Wealth and the Tendency toward Reduced Inequality of Conditions), a work that went through numerous editions up to the eve of World War I.20 Leroy-Beaulieu actually had no data of any kind to justify his belief in a “tendency toward a reduced inequality of conditions.” But never mind that: he managed to come up with dubious and not very convincing arguments based on totally irrelevant statistics to show that income inequality was decreasing.21 At times he seemed to notice that his argument was flawed, and he then simply stated that reduced inequality was just around the corner and that in any case nothing of any kind must be done to interfere with the miraculous process of commercial and financial globalization, which allowed French savers to invest in the Panama and Suez canals and would soon extend to czarist Russia. Clearly, Leroy-Beaulieu was fascinated by the globalization of his day and scared stiff by the thought that a sudden revolution might put it all in jeopardy.22 There is of course nothing inherently reprehensible about such a fascination as long as it does not stand in the way of sober analysis. The great issue in France in 1900–1910 was not the imminence of a Bolshevik revolution (which was no more likely than a revolution is today) but the advent of progressive taxation. For Leroy-Beaulieu and his colleagues of the “center right” (in contrast to the monarchist right), there was one unanswerable argument to progressivity, which right-thinking people should oppose tooth and nail: France, he maintained, became an egalitarian country thanks to the French Revolution, which redistributed the land (up to a point) and above all established equality before the law with the Civil Code, which instituted equal property rights and the right of free contract. Hence there was no need for a progressive and confiscatory tax. Of course, he added, such a tax might well be useful in a class-ridden aristocratic society like that of Britain, across the English Channel, but not in France.23

FIGURE 14.2. Top inheritance tax rates, 1900–2013

The top marginal tax rate of the inheritance tax (applying to the highest inheritances) in the United States dropped from 70 percent in 1980 to 35 percent in 2013.

Sources and series: see piketty.pse.ens.fr/capital21c.

As it happens, if Leroy-Beaulieu had bothered to consult the probate records published by the tax authorities shortly after the reform of 1901, he would have discovered that wealth was nearly as concentrated in republican France during the Belle Époque as it was in monarchical Britain. In parliamentary debate in 1907 and 1908, proponents of the income tax frequently referred to these statistics.24 This interesting example shows that even a tax with low rates can be a source of knowledge and a force for democratic transparency.

In other countries the estate tax was also transformed after World War I. In Germany, the idea of imposing a small tax on the very largest estates was extensively discussed in parliamentary debate at the end of the nineteenth century and beginning of the twentieth. Leaders of the Social Democratic Party, starting with August Bebel and Eduard Bernstein, pointed out that an estate tax would make it possible to decrease the heavy burden of indirect taxes on workers, who would then be able to improve their lot. But the Reichstag could not agree on a new tax: the reforms of 1906 and 1909 did institute a very small estate tax, but bequests to a spouse or children (that is, the vast majority of estates) were entirely exempt, no matter how large. It was not until 1919 that the German estate tax was extend to family bequests, and the top rate (on the largest estates) was abruptly increased from 0 to 35 percent.25 The role of the war and of the political changes it induced seems to have been absolutely crucial: it is hard to see how the stalemate of 1906–1909 would have been overcome otherwise.26

Figure 14.2 shows a slight upward tick in Britain around the turn of the century, somewhat greater for the estate tax than for the income tax. The rate on the largest estates, which had been 8 percent since the reform of 1896, rose to 15 percent in 1908—a fairly substantial amount. In the United States, a federal tax on estates and gifts was not instituted until 1916, but its rate very quickly rose to levels higher than those found in France and Germany.

Confiscatory Taxation of Excessive Incomes: An American Invention

When we look at the history of progressive taxation in the twentieth century, it is striking to see how far out in front Britain and the United States were, especially the latter, which invented the confiscatory tax on “excessive” incomes and fortunes. Figures 14.1 and 14.2 are particularly clear in this regard. This finding stands in such stark contrast to the way most people both inside and outside the United States and Britain have seen those two countries since 1980 that it is worth pausing a moment to consider the point further.

Between the two world wars, all the developed countries began to experiment with very high top rates, frequently in a rather erratic fashion. But it was the United States that was the first country to try rates above 70 percent, first on income in 1919–1922 and then on estates in 1937–1939. When a government taxes a certain level of income or inheritance at a rate of 70 or 80 percent, the primary goal is obviously not to raise additional revenue (because these very high brackets never yield much). It is rather to put an end to such incomes and large estates, which lawmakers have for one reason or another come to regard as socially unacceptable and economically unproductive—or if not to end them, then at least to make it extremely costly to sustain them and strongly discourage their perpetuation. Yet there is no absolute prohibition or expropriation. The progressive tax is thus a relatively liberal method for reducing inequality, in the sense that free competition and private property are respected while private incentives are modified in potentially radical ways, but always according to rules thrashed out in democratic debate. The progressive tax thus represents an ideal compromise between social justice and individual freedom. It is no accident that the United States and Britain, which throughout their histories have shown themselves to value individual liberty highly, adopted more progressive tax systems than many other countries. Note, however, that the countries of continental Europe, especially France and Germany, explored other avenues after World War II, such as taking public ownership of firms and directly setting executive salaries. These measures, which also emerged from democratic deliberation, in some ways served as substitutes for progressive taxes.27

Other, more specific factors also mattered. During the Gilded Age, many observers in the United States worried that the country was becoming increasingly inegalitarian and moving farther and farther away from its original pioneering ideal. In Willford King’s 1915 book on the distribution of wealth in the United States, he worried that the nation was becoming more like what he saw as the hyperinegalitarian societies of Europe.28 In 1919, Irving Fisher, then president of the American Economic Association, went even further. He chose to devote his presidential address to the question of US inequality and in no uncertain terms told his colleagues that the increasing concentration of wealth was the nation’s foremost economic problem. Fisher found King’s estimates alarming. The fact that “2 percent of the population owns more than 50 percent of the wealth” and that “two-thirds of the population owns almost nothing” struck him as “an undemocratic distribution of wealth,” which threatened the very foundations of US society. Rather than restrict the share of profits or the return on capital arbitrarily—possibilities Fisher mentioned only to reject them—he argued that the best solution was to impose a heavy tax on the largest estates (he mentioned a tax rate of two-thirds the size of the estate, rising to 100 percent if the estate was more than three generations old).29 It is striking to see how much more Fisher worried about inequality than Leroy-Beaulieu did, even though Leroy-Beaulieu lived in a far more inegalitarian society. The fear of coming to resemble Old Europe was no doubt part of the reason for the American interest in progressive taxes.

Furthermore, the Great Depression of the 1930s struck the United States with extreme force, and many people blamed the economic and financial elites for having enriched themselves while leading the country to ruin. (Bear in mind that the share of top incomes in US national income peaked in the late 1920s, largely due to enormous capital gains on stocks.) Roosevelt came to power in 1933, when the crisis was already three years old and one-quarter of the country was unemployed. He immediately decided on a sharp increase in the top income tax rate, which had been decreased to 25 percent in the late 1920s and again under Hoover’s disastrous presidency. The top rate rose to 63 percent in 1933 and then to 79 percent in 1937, surpassing the previous record of 1919. In 1942 the Victory Tax Act raised the top rate to 88 percent, and in 1944 it went up again to 94 percent, due to various surtaxes. The top rate then stabilized at around 90 percent until the mid-1960s, but then it fell to 70 percent in the early 1980s. All told, over the period 1932–1980, nearly half a century, the top federal income tax rate in the United States averaged 81 percent.30

It is important to emphasize that no continental European country has ever imposed such high rates (except in exceptional circumstances, for a few years at most, and never for as long as half a century). In particular, France and Germany had top rates between 50 and 70 percent from the late 1940s until the 1980s, but never as high as 80–90 percent. The only exception was Germany in 1947–1949, when the rate was 90 percent. But this was a time when the tax schedule was fixed by the occupying powers (in practice, the US authorities). As soon as Germany regained fiscal sovereignty in 1950, the country quickly returned to rates more in keeping with its traditions, and the top rate fell within a few years to just over 50 percent (see Figure 14.1). We see exactly the same phenomenon in Japan.31

The Anglo-Saxon attraction to progressive taxation becomes even clearer when we look at the estate tax. In the United States, the top estate tax rate remained between 70 and 80 percent from the 1930s to the 1980s, while in France and Germany the top rate never exceeded 30–40 percent except for the years 1946–1949 in Germany (see Figure 14.2).32

The only country to match or surpass peak US estate tax rates was Britain. The rates applicable to the highest British incomes as well as estates in the 1940s was 98 percent, a peak attained again in the 1970s—an absolute historical record.33 Note, too, that both countries distinguished between “earned income,” that is, income from labor (including both wages and nonwage compensation) and “unearned income,” meaning capital income (rent, interests, dividends, etc.). The top rates indicated in Figure 14.1 for the United States and Britain applied to unearned income. At times, the top rate on earned income was slightly lower, especially in the 1970s.34 This distinction is interesting, because it is a translation into fiscal terms of the suspicion that surrounded very high incomes: all excessively high incomes were suspect, but unearned incomes were more suspect than earned incomes. The contrast between attitudes then and now, with capital income treated more favorably today than labor income in many countries, especially in Europe, is striking. Note, too, that although the threshold for application of the top rates has varied over time, it has always been extremely high: expressed in terms of average income in the decade 2000–2010, the threshold has generally ranged between 500,000 and 1 million euros. In terms of today’s income distribution, the top rate would therefore apply to less than 1 percent of the population (generally somewhere between 0.1 and 0.5 percent).

The urge to tax unearned income more heavily than earned income reflects an attitude that is also consistent with a steeply progressive inheritance tax. The British case is particularly interesting in a long-run perspective. Britain was the country with the highest concentration of wealth in the nineteenth and early twentieth centuries. The shocks (destruction, expropriation) endured by large fortunes fell less heavily there than on the continent, yet Britain chose to impose its own fiscal shock—less violent than war but nonetheless significant: the top rate ranged from 70 to 80 percent or more throughout the period 1940–1980. No other country devoted more thought to the taxation of inheritances in the twentieth century, especially between the two world wars.35 In November 1938, Josiah Wedgwood, in the preface to a new edition of his classic 1929 book on inheritance, agreed with his compatriot Bertrand Russell that the “plutodemocracies” and their hereditary elites had failed to stem the rise of fascism. He was convinced that “political democracies that do not democratize their economic systems are inherently unstable.” In his eyes, a steeply progressive inheritance tax was the main tool for achieving the economic democratization that he believed to be necessary.36

The Explosion of Executive Salaries: The Role of Taxation

After experiencing a great passion for equality from the 1930s through the 1970s, the United States and Britain veered off with equal enthusiasm in the opposite direction. Over the past three decades, their top marginal income tax rates, which had been significantly higher than the top rates in France and Germany, fell well below French and German levels. While the latter remained stable at 50–60 percent from 1930 to 2010 (with a slight decrease toward the end of the period), British and US rates fell from 80–90 percent in 1930–1980 to 30–40 percent in 1980–2010 (with a low point of 28 percent after the Reagan tax reform of 1986) (see Figure 14.1).37 The Anglo-Saxon countries have played yo-yo with the wealthy since the 1930s. By contrast, attitudes toward top incomes in both continental Europe (of which Germany and France are fairly typical) and Japan have held steady. I showed in Part One that part of the explanation for this difference might be that the United States and Britain came to feel that they were being overtaken by other countries in the 1970s. This sense that other countries were catching up contributed to the rise of Thatcherism and Reaganism. To be sure, the catch-up that occurred between 1950 and 1980 was largely a mechanical consequence of the shocks endured by continental Europe and Japan between 1914 and 1945. The people of Britain and the United States nevertheless found it hard to accept: for countries as well as individuals, the wealth hierarchy is not just about money; it is also a matter of honor and moral values. What were the consequences of this great shift in attitudes in the United States and Britain?

If we look at all the developed countries, we find that the size of the decrease in the top marginal income tax rate between 1980 and the present is closely related to the size of the increase in the top centile’s share of national income over the same period. Concretely, the two phenomena are perfectly correlated: the countries with the largest decreases in their top tax rates are also the countries where the top earners’ share of national income has increased the most (especially when it comes to the remuneration of executives of large firms). Conversely, the countries that did not reduce their top tax rates very much saw much more moderate increases in the top earners’ share of national income.38 If one believes the classic economic models based on the theory of marginal productivity and the labor supply, one might try to explain this by arguing that the decrease in top tax rates spurred top executive talent to increase their labor supply and productivity. Since their marginal productivity increased, their salaries increased commensurately and therefore rose well above executive salaries in other countries. This explanation is not very plausible, however. As I showed in Chapter 9, the theory of marginal productivity runs into serious conceptual and economic difficulties (in addition to suffering from a certain naïveté) when it comes to explaining how pay is determined at the top of the income hierarchy.

A more realistic explanation is that lower top income tax rates, especially in the United States and Britain, where top rates fell dramatically, totally transformed the way executive salaries are determined. It is always difficult for an executive to convince other parties involved in the firm (direct subordinates, workers lower down in the hierarchy, stockholders, and members of the compensation committee) that a large pay raise—say of a million dollars—is truly justified. In the 1950s and 1960s, executives in British and US firms had little reason to fight for such raises, and other interested parties were less inclined to accept them, because 80–90 percent of the increase would in any case go directly to the government. After 1980, the game was utterly transformed, however, and the evidence suggests that executives went to considerable lengths to persuade other interested parties to grant them substantial raises. Because it is objectively difficult to measure individual contributions to a firm’s output, top managers found it relatively easy to persuade boards and stockholders that they were worth the money, especially since the members of compensation committees were often chosen in a rather incestuous manner.

Furthermore, this “bargaining power” explanation is consistent with the fact that there is no statistically significant relationship between the decrease in top marginal tax rates and the rate of productivity growth in the developed countries since 1980. Concretely, the crucial fact is that the rate of per capita GDP growth has been almost exactly the same in all the rich countries since 1980. In contrast to what many people in Britain and the United States believe, the true figures on growth (as best one can judge from official national accounts data) show that Britain and the United States have not grown any more rapidly since 1980 than Germany, France, Japan, Denmark, or Sweden.39 In other words, the reduction of top marginal income tax rates and the rise of top incomes do not seem to have stimulated productivity (contrary to the predictions of supply-side theory) or at any rate did not stimulate productivity enough to be statistically detectable at the macro level.40

Considerable confusion exists around these issues because comparisons are often made over periods of just a few years (a procedure that can be used to justify virtually any conclusion).41 Or one forgets to correct for population growth (which is the primary reason for the structural difference in GDP growth between the United States and Europe). Sometimes the level of per capita output (which has always been about 20 percent higher in the United States, in 1970–1980 as well as 2000–2010) is confused with the growth rate (which has been about the same on both continents over the past three decades).42 But the principal source of confusion is probably the catch-up phenomenon mentioned above. There can be no doubt that British and US decline ended in the 1970s, in the sense that growth rates in Britain and the United States, which had been lower than growth rates in Germany, France, Scandinavia, and Japan, ceased to be so. But it is also incontestable that the reason for this convergence is quite simple: Europe and Japan had caught up with the United States and Britain. Clearly, this had little to do with the conservative revolution in the latter two countries in the 1980s, at least to a first approximation.43

No doubt these issues are too strongly charged with emotion and too closely bound up with national identities and pride to allow for calm examination. Did Maggie Thatcher save Britain? Would Bill Gates’s innovations have existed without Ronald Reagan? Will Rhenish capitalism devour the French social model? In the face of such powerful existential anxieties, reason is often at a loss, especially since it is objectively quite difficult to draw perfectly precise and absolutely unassailable conclusions on the basis of growth rate comparisons that reveal differences of a few tenths of a percent. As for Bill Gates and Ronald Reagan, each with his own cult of personality (Did Bill invent the computer or just the mouse? Did Ronnie destroy the USSR single-handedly or with the help of the pope?), it may be useful to recall that the US economy was much more innovative in 1950–1970 than in 1990–2010, to judge by the fact that productivity growth was nearly twice as high in the former period as in the latter, and since the United States was in both periods at the world technology frontier, this difference must be related to the pace of innovation.44 A new argument has recently been advanced: it is possible that the US economy has become more innovative in recent years but that this innovation does not show up in the productivity figures because it spilled over into the other wealthy countries, which have thrived on US inventions. It would nevertheless be quite astonishing if the United States, which has not always been hailed for international altruism (Europeans regularly complain about US carbon emissions, while the poor countries complain about American stinginess) were proven not to have retained some of this enhanced productivity for itself. In theory, that is the purpose of patents. Clearly, the debate is nowhere close to over.45

In an attempt to make some progress on these issues, Emmanuel Saez, Stefanie Stantcheva, and I have tried to go beyond international comparisons and to make use of a new database containing information about executive compensation in listed companies throughout the developed world. Our findings suggest that skyrocketing executive pay is fairly well explained by the bargaining model (lower marginal tax rates encourage executives to negotiate harder for higher pay) and does not have much to do with a hypothetical increase in managerial productivity.46 We again found that the elasticity of executive pay is greater with respect to “luck” (that is, variations in earnings that cannot have been due to executive talent, because, for instance, other firms in the same sector did equally well) than with respect to “talent” (variations not explained by sector variables). As I explained in Chapter 9, this finding poses serious problems for the view that high executive pay is a reward for good performance. Furthermore, we found that elasticity with respect to luck—broadly speaking, the ability of executives to obtain raises not clearly justified by economic performance—was higher in countries where the top marginal tax rate was lower. Finally, we found that variations in the marginal tax rate can explain why executive pay rose sharply in some countries and not in others. In particular, variations in company size and in the importance of the financial sector definitely cannot explain the observed facts.47 Similarly, the idea that skyrocketing executive pay is due to lack of competition, and that more competitive markets and better corporate governance and control would put an end to it, seems unrealistic.48 Our findings suggest that only dissuasive taxation of the sort applied in the United States and Britain before 1980 can do the job.49 In regard to such a complex and comprehensive question (which involves political, social, and cultural as well as economic factors), it is obviously impossible to be totally certain: that is the beauty of the social sciences. It is likely, for instance, that social norms concerning executive pay directly influence the levels of compensation we observe in different countries, independent of the influence of tax rates. Nevertheless, the available evidence suggests that our explanatory model gives the best explanation of the observed facts.

Rethinking the Question of the Top Marginal Rate

These findings have important implications for the desirable degree of fiscal progressivity. Indeed, they indicate that levying confiscatory rates on top incomes is not only possible but also the only way to stem the observed increase in very high salaries. According to our estimates, the optimal top tax rate in the developed countries is probably above 80 percent.50 Do not be misled by the apparent precision of this estimate: no mathematical formula or econometric estimate can tell us exactly what tax rate ought to be applied to what level of income. Only collective deliberation and democratic experimentation can do that. What is certain, however, is that our estimates pertain to extremely high levels of income, those observed in the top 1 percent or 0.5 percent of the income hierarchy. The evidence suggests that a rate on the order of 80 percent on incomes over $500,000 or $1 million a year not only would not reduce the growth of the US economy but would in fact distribute the fruits of growth more widely while imposing reasonable limits on economically useless (or even harmful) behavior. Obviously it would be easier to apply such a policy in a country the size of the United States than in a small European country where close fiscal coordination with neighboring countries is lacking. I say more about international coordination in the next chapter; here I will simply note that the United States is big enough to apply this type of fiscal policy effectively. The idea that all US executives would immediately flee to Canada and Mexico and no one with the competence or motivation to run the economy would remain is not only contradicted by historical experience and by all the firm-level data at our disposal; it is also devoid of common sense. A rate of 80 percent applied to incomes above $500,000 or $1 million a year would not bring the government much in the way of revenue, because it would quickly fulfill its objective: to drastically reduce remuneration at this level but without reducing the productivity of the US economy, so that pay would rise at lower levels. In order for the government to obtain the revenues it sorely needs to develop the meager US social state and invest more in health and education (while reducing the federal deficit), taxes would also have to be raised on incomes lower in the distribution (for example, by imposing rates of 50 or 60 percent on incomes above $200,000).51 Such a social and fiscal policy is well within the reach of the United States.

Nevertheless, it seems quite unlikely that any such policy will be adopted anytime soon. It is not even certain that the top marginal income tax rate in the United States will be raised as high as 40 percent in Obama’s second term. Has the US political process been captured by the 1 percent? This idea has become increasingly popular among observers of the Washington political scene.52 For reasons of natural optimism as well as professional predilection, I am inclined to grant more influence to ideas and intellectual debate. Careful examination of various hypotheses and bodies of evidence, and access to better data, can influence political debate and perhaps push the process in a direction more favorable to the general interest. For example, as I noted in Part Three, US economists often underestimate the increase in top incomes because they rely on inadequate data (especially survey data that fails to capture the very highest incomes). As a result, they pay too much attention to wage gaps between workers with different skill levels (a crucial question for the long run but not very relevant to understanding why the 1 percent have pulled so far ahead—the dominant phenomenon from a macroeconomic point of view).53 The use of better data (in particular, tax data) may therefore ultimately focus attention on the right questions.

That said, the history of the progressive tax over the course of the twentieth century suggests that the risk of a drift toward oligarchy is real and gives little reason for optimism about where the United States is headed. It was war that gave rise to progressive taxation, not the natural consequences of universal suffrage. The experience of France in the Belle Époque proves, if proof were needed, that no hypocrisy is too great when economic and financial elites are obliged to defend their interests—and that includes economists, who currently occupy an enviable place in the US income hierarchy.54 Some economists have an unfortunate tendency to defend their private interest while implausibly claiming to champion the general interest.55 Although data on this are sparse, it also seems that US politicians of both parties are much wealthier than their European counterparts and in a totally different category from the average American, which might explain why they tend to confuse their own private interest with the general interest. Without a radical shock, it seems fairly likely that the current equilibrium will persist for quite some time. The egalitarian pioneer ideal has faded into oblivion, and the New World may be on the verge of becoming the Old Europe of the twenty-first century’s globalized economy.

{FIFTEEN}

A Global Tax on Capital

To regulate the globalized patrimonial capitalism of the twenty-first century, rethinking the twentieth-century fiscal and social model and adapting it to today’s world will not be enough. To be sure, appropriate updating of the last century’s social-democratic and fiscal-liberal program is essential, as I tried to show in the previous two chapters, which focused on two fundamental institutions that were invented in the twentieth century and must continue to play a central role in the future: the social state and the progressive income tax. But if democracy is to regain control over the globalized financial capitalism of this century, it must also invent new tools, adapted to today’s challenges. The ideal tool would be a progressive global tax on capital, coupled with a very high level of international financial transparency. Such a tax would provide a way to avoid an endless inegalitarian spiral and to control the worrisome dynamics of global capital concentration. Whatever tools and regulations are actually decided on need to be measured against this ideal. I will begin by analyzing practical aspects of such a tax and then proceed to more general reflections about the regulation of capitalism from the prohibition of usury to Chinese capital controls.

A Global Tax on Capital: A Useful Utopia

A global tax on capital is a utopian idea. It is hard to imagine the nations of the world agreeing on any such thing anytime soon. To achieve this goal, they would have to establish a tax schedule applicable to all wealth around the world and then decide how to apportion the revenues. But if the idea is utopian, it is nevertheless useful, for several reasons. First, even if nothing resembling this ideal is put into practice in the foreseeable future, it can serve as a worthwhile reference point, a standard against which alternative proposals can be measured. Admittedly, a global tax on capital would require a very high and no doubt unrealistic level of international cooperation. But countries wishing to move in this direction could very well do so incrementally, starting at the regional level (in Europe, for instance). Unless something like this happens, a defensive reaction of a nationalist stripe would very likely occur. For example, one might see a return to various forms of protectionism coupled with imposition of capital controls. Because such policies are seldom effective, however, they would very likely lead to frustration and increase international tensions. Protectionism and capital controls are actually unsatisfactory substitutes for the ideal form of regulation, which is a global tax on capital—a solution that has the merit of preserving economic openness while effectively regulating the global economy and justly distributing the benefits among and within nations. Many people will reject the global tax on capital as a dangerous illusion, just as the income tax was rejected in its time, a little more than a century ago. When looked at closely, however, this solution turns out to be far less dangerous than the alternatives.

To reject the global tax on capital out of hand would be all the more regrettable because it is perfectly possible to move toward this ideal solution step by step, first at the continental or regional level and then by arranging for closer cooperation among regions. One can see a model for this sort of approach in the recent discussions on automatic sharing of bank data between the United States and the European Union. Furthermore, various forms of capital taxation already exist in most countries, especially in North America and Europe, and these could obviously serve as starting points. The capital controls that exist in China and other emerging countries also hold useful lessons for all. There are nevertheless important differences between these existing measures and the ideal tax on capital.

First, the proposals for automatic sharing of banking information currently under discussion are far from comprehensive. Not all asset types are included, and the penalties envisioned are clearly insufficient to achieve the desired results (despite new US banking regulations that are more ambitious than any that exist in Europe). The debate is only beginning, and it is unlikely to produce tangible results unless relatively heavy sanctions are imposed on banks and, even more, on countries that thrive on financial opacity.

The issue of financial transparency and information sharing is closely related to the ideal tax on capital. Without a clear idea of what all the information is to be used for, current data-sharing proposals are unlikely to achieve the desired result. To my mind, the objective ought to be a progressive annual tax on individual wealth—that is, on the net value of assets each person controls. For the wealthiest people on the planet, the tax would thus be based on individual net worth—the kinds of numbers published by Forbes and other magazines. (And collecting such a tax would tell us whether the numbers published in the magazines are anywhere near correct.) For the rest of us, taxable wealth would be determined by the market value of all financial assets (including bank deposits, stocks, bonds, partnerships, and other forms of participation in listed and unlisted firms) and nonfinancial assets (especially real estate), net of debt. So much for the basis of the tax. At what rate would it be levied? One might imagine a rate of 0 percent for net assets below 1 million euros, 1 percent between 1 and 5 million, and 2 percent above 5 million. Or one might prefer a much more steeply progressive tax on the largest fortunes (for example, a rate of 5 or 10 percent on assets above 1 billion euros). There might also be advantages to having a minimal rate on modest-to-average wealth (for example, 0.1 percent below 200,000 euros and 0.5 percent between 200,000 and 1 million).

I discuss these issues later on. Here, the important point to keep in mind is that the capital tax I am proposing is a progressive annual tax on global wealth. The largest fortunes are to be taxed more heavily, and all types of assets are to be included: real estate, financial assets, and business assets—no exceptions. This is one clear difference between my proposed capital tax and the taxes on capital that currently exist in one country or another, even though important aspects of those existing taxes should be retained. To begin with, nearly every country taxes real estate: the English-speaking countries have “property taxes,” while France has a taxe foncière. One drawback of these taxes is that they are based solely on real property. (Financial assets are ignored, and property is taxed at its market value regardless of debt, so that a heavily indebted person is taxed in the same way as a person with no debt.) Furthermore, real estate is generally taxed at a flat rate, or close to it. Still, such taxes exist and generate significant revenue in most developed countries, especially in the English-speaking world (typically 1–2 percent of national income). Furthermore, property taxes in some countries (such as the United States) rely on fairly sophisticated assessment procedures with automatic adjustment to changing market values, procedures that ought to be generalized and extended to other asset classes. In some European countries (including France, Switzerland, Spain, and until recently Germany and Sweden), there are also progressive taxes on total wealth. Superficially, these taxes are closer in spirit to the ideal capital tax I am proposing. In practice, however, they are often riddled with exemptions. Many asset classes are left out, while others are assessed at arbitrary values having nothing to do with their market value. That is why several countries have moved to eliminate such taxes. it is important to heed the lessons of these various experiences in order to design an appropriate capital tax for the century ahead.

Democratic and Financial Transparency

What tax schedule is ideal for my proposed capital tax, and what revenues should we expect such a tax to produce? Before I attempt to answer these questions, note that the proposed tax is in no way intended to replace all existing taxes. It would never be more than a fairly modest supplement to the other revenue streams on which the modern social state depends: a few points of national income (three or four at most—still nothing to sneeze at).1 The primary purpose of the capital tax is not to finance the social state but to regulate capitalism. The goal is first to stop the indefinite increase of inequality of wealth, and second to impose effective regulation on the financial and banking system in order to avoid crises. To achieve these two ends, the capital tax must first promote democratic and financial transparency: there should be clarity about who owns what assets around the world.

Why is the goal of transparency so important? Imagine a very low global tax on capital, say a flat rate of 0.1 percent a year on all assets. The revenue from such a tax would of course be limited, by design: if the global stock of private capital is about five years of global income, the tax would generate revenue equal to 0.5 percent of global income, with minor variations from country to country according to their capital/income ratio (assuming that the tax is collected in the country where the owner of the asset resides and not where the asset itself is located—an assumption that can by no means be taken for granted). Even so, such a limited tax would already play a very useful role.

First, it would generate information about the distribution of wealth. National governments, international organizations, and statistical offices around the world would at last be able to produce reliable data about the evolution of global wealth. Citizens would no longer be forced to rely on Forbes, glossy financial reports from global wealth managers, and other unofficial sources to fill the official statistical void. (Recall that I explored the deficiencies of those unofficial sources in Part Three.) Instead, they would have access to public data based on clearly prescribed methods and information provided under penalty of law. The benefit to democracy would be considerable: it is very difficult to have a rational debate about the great challenges facing the world today—the future of the social state, the cost of the transition to new sources of energy, state-building in the developing world, and so on—because the global distribution of wealth remains so opaque. Some people think that the world’s billionaires have so much money that it would be enough to tax them at a low rate to solve all the world’s problems. Others believe that there are so few billionaires that nothing much would come of taxing them more heavily. As we saw in Part Three, the truth lies somewhere between these two extremes. In macroeconomic terms, one probably has to descend a bit in the wealth hierarchy (to fortunes of 10–100 million euros rather than 1 billion) to obtain a tax basis large enough to make a difference. I have also discovered some objectively disturbing trends: without a global tax on capital or some similar policy, there is a substantial risk that the top centile’s share of global wealth will continue to grow indefinitely—and this should worry everyone. In any case, truly democratic debate cannot proceed without reliable statistics.

The stakes for financial regulation are also considerable. The international organizations currently responsible for overseeing and regulating the global financial system, starting with the IMF, have only a very rough idea of the global distribution of financial assets, and in particular of the amount of assets hidden in tax havens. As I have shown, the planet’s financial accounts are not in balance. (Earth seems to be perpetually indebted to Mars.) Navigating our way through a global financial crisis blanketed in such a thick statistical fog is fraught with peril. Take, for example, the Cypriot banking crisis of 2013. Neither the European authorities nor the IMF had much information about who exactly owned the financial assets deposited in Cyprus or what amounts they owned, hence their proposed solutions proved crude and ineffective. As we will see in the next chapter, greater financial transparency would not only lay the groundwork for a permanent annual tax on capital; it would also pave the way to a more just and efficient management of banking crises like the one in Cyprus, possibly by way of carefully calibrated and progressive special levies on capital.

An 0.1 percent tax on capital would be more in the nature of a compulsory reporting law than a true tax. Everyone would be required to report ownership of capital assets to the world’s financial authorities in order to be recognized as the legal owner, with all the advantages and disadvantages thereof. As noted, this was what the French Revolution accomplished with its compulsory reporting and cadastral surveys. The capital tax would be a sort of cadastral financial survey of the entire world, and nothing like it currently exists.2 It is important to understand that a tax is always more than just a tax: it is also a way of defining norms and categories and imposing a legal framework on economic activity. This has always been the case, especially in regard to land ownership.3 In the modern era, the imposition of new taxes around the time of World War I required precise definitions of income, wages, and profits. This fiscal innovation in turn fostered the development of accounting standards, which had not previously existed. One of the main goals of a tax on capital would thus be to refine the definitions of various asset types and set rules for valuing assets, liabilities, and net wealth. Under the private accounting standards now in force, prescribed procedures are imperfect and often vague. These flaws have contributed to the many financial scandals the world has seen since 2000.4

Last but not least, a capital tax would force governments to clarify and broaden international agreements concerning the automatic sharing of banking data. The principle is quite simple: national tax authorities should receive all the information they need to calculate the net wealth of every citizen. Indeed, the capital tax should work in the same way as the income tax currently does in many countries, where data on income are provided to the tax authorities by employers (via the W-2 and 1099 forms in the United States, for example). There should be similar reporting on capital assets (indeed, income and capital reporting could be combined into one form). All taxpayers would receive a form listing their assets and liabilities as reported to the tax authorities. Many US states use this method to administer the property tax: taxpayers receive an annual form indicating the current market value of any real estate they own, as calculated by the government on the basis of observed prices in transactions involving comparable properties. Taxpayers can of course challenge these valuations with appropriate evidence. In practice, corrections are rare, because data on real estate transactions are readily available and hard to contest: nearly everyone is aware of changing real estate values in the local market, and the authorities have comprehensive databases at their disposal.5 Note, in passing, that this reporting method has two advantages: it makes the taxpayer’s life simple and eliminates the inevitable temptation to slightly underestimate the value of one’s own property.6

It is essential—and perfectly feasible—to extend this reporting system to all types of financial assets (and debts). For assets and liabilities associated with financial institutions within national borders, this could be done immediately, since banks, insurance companies, and other financial intermediaries in most developed countries are already required to inform the tax authorities about bank accounts and other assets they administer. In France, for example, the government knows that Monsieur X owns an apartment worth 400,000 euros and a stock portfolio worth 200,000 euros and has 100,000 euros in outstanding debts. It could thus send him a form indicating these various amounts (along with his net worth of 500,000 euros) with a request for corrections and additions if appropriate. This type of automated system, applied to the entire population, is far better adapted to the twenty-first century than the archaic method of asking all persons to declare honestly how much they own.7

A Simple Solution: Automatic Transmission of Banking Information

The first step toward a global tax on capital should be to extend to the international level this type of automatic transmission of banking data in order to include information on assets held in foreign banks in the precomputed asset statements issued to each taxpayer. It is important to recognize that there is no technical obstacle to doing so. Banking data are already automatically shared with the tax authorities in a country with 300 million people like the United States, as well as in countries like France and Germany with populations of 60 and 80 million, respectively, so there is obviously no reason why including the banks in the Cayman Islands and Switzerland would radically increase the volume of data to be processed. Of course the tax havens regularly invoke other excuses for maintaining bank secrecy. One of these is the alleged worry that governments will misuse the information. This is not a very convincing argument: it is hard to see why it would not also apply to information about the bank accounts of those incautious enough to keep their money in the country where they pay taxes. The most plausible reason why tax havens defend bank secrecy is that it allows their clients to evade their fiscal obligations, thereby allowing the tax havens to share in the gains. Obviously this has nothing whatsoever to do with the principles of the market economy. No one has the right to set his own tax rates. It is not right for individuals to grow wealthy from free trade and economic integration only to rake off the profits at the expense of their neighbors. That is outright theft.

To date, the most thoroughgoing attempt to end these practices is the Foreign Account Tax Compliance Act (FATCA) adopted in the United States in 2010 and scheduled to be phased in by stages in 2014 and 2015. It requires all foreign banks to inform the Treasury Department about bank accounts and investments held abroad by US taxpayers, along with any other sources of revenue from which they might benefit. This is a far more ambitious law than the 2003 EU directive on foreign savings, which concerns only interest-bearing deposit accounts (equity portfolios are not covered, which is unfortunate, since large fortunes are held primarily in the form of stocks, which are fully covered by FATCA) and applies only to European banks and not worldwide (again unlike FATCA). Even though the European directive is timid and almost meaningless, it is not enforced, since, despite numerous discussions and proposed amendments since 2008, Luxembourg and Austria managed to win from other EU member states an agreement to extend their exemption from automatic data reporting and retain their right to share information only on formal request. This system, which also applies to Switzerland and other territories outside the European Union,8 means that a government must already possess something close to proof of fraud in order to obtain information about the foreign bank accounts of one of its citizens. This obviously limits drastically the ability to detect and control fraud. In 2013, after Luxembourg and Switzerland announced their intention to abide by the provisions of FATCA, discussions in Europe resumed with the intention of incorporating some or all of these in a new EU directive. It is impossible to know when these discussions will conclude or whether they will lead to a legally binding agreement.

Note, moreover, that in this realm there is often a chasm between the triumphant declarations of political leaders and the reality of what they accomplish. This is extremely worrisome for the future equilibrium of our democratic societies. It is particularly striking to discover that the countries that are most dependent on substantial tax revenues to pay for their social programs, namely the European countries, are also the ones that have accomplished the least, even though the technical challenges are quite simple. This is a good example of the difficult situation that smaller countries face in dealing with globalization. Nation-states built over centuries find that they are too small to impose and enforce rules on today’s globalized patrimonial capitalism. The countries of Europe were able to unite around a single currency (to be discussed more extensively in the next chapter), but they have accomplished almost nothing in the area of taxation. The leaders of the largest countries in the European Union, who naturally bear primary responsibility for this failure and for the gaping chasm between their words and their actions, nevertheless continue to blame other countries and the institutions of the European Union itself. There is no reason to think that things will change anytime soon.