The Pandemic Depression
The Global Economy Will Never Be the Same
Wringing one’s hands about inequality seems like the new national pastime. According to emerging conventional wisdom, those born-rich will hoard all the wealth and leave everyone else behind. It's a new gilded age, the economist Paul Krugman recently declared, “But we've known it for a while.”
In response to the public outcry, several prominent economists are proposing an annual wealth tax, which would apply only to those with assets worth more than a set amount. But there’s limited evidence that wealth inequality has actually worsened in the United States in the last 30 years. And, even if it does eventually get worse, imposing a tax on wealth is a terrible way to promote equality. It actually benefits the super wealthy the most.
Economic inequality might refer to disparities in income or wealth. Although the two are related, they are distinct concepts shaped by different underlying forces. Income inequality represents the inequality in what people are paid each year. This includes earnings and capital income (sometimes called “unearned income”). By all measures, income inequality has become more severe in the United States over the last 30 years, especially at the very top. What is not widely understood is that the growth in income inequality has been driven almost entirely by earned income, that is, what people are paid for their work rather than what they earn on their investments.
Wealth inequality refers to the stock of people’s assets. It represents the accumulation of saved income and returns on investments over the years. Some wealth inequality is inevitable, even desirable, because wealth represents a lifetime of saving and not just luck or opportunity. Extreme income inequality can beget extreme wealth inequality because people with a lot of income, if they save, can amass large fortunes and pass them on to their children. But over time, such wealth can also dissipate as people leave it to multiple children, get married and divorced, develop expensive lifestyles, contribute to charities, or make poor investment decisions. Whereas income inequality has clearly worsened, the recent evidence about wealth inequality is much less convincing.
It is difficult to measure the concentration of wealth because nobody has to report their assets to tax authorities. The only way wealth shows up in tax records is when it’s reported as an estate or as the returns on investments. Studies that rely on estate tax returns show no increase in wealth inequality in the last 30 years. The same goes for numerous studies based off of the Federal Reserve’s own wealth surveys, which it has run every three years since 1983. One recent study attempted to measure wealth indirectly -- by studying investment earnings. It is the first to conclude that wealth inequality is increasing, with the very rich (the top .01 percent) getting richer than everyone else. But these findings rely on assumptions about what investments earn. The researchers assumed that the super wealthy only earn the market return on investments. They also took tax statements at face value. Yet richer people can often find it easier to report their earnings as investment income to lower their tax bill. For both reason, the study might have overestimated the extent of inequality and its growth.
Other data support the view that wealth inequality hasn’t worsened. One of us, in joint work with Columbia economist Lena Edlund, found that the number of people on the Forbes 400 list of the wealthiest Americans whose wealth had come from inheritances halved between 1980s and 2000s. Moreover, since the 1970s, fewer women rank among the very richest estate taxpayers -- another reason to conclude that inheritances are no longer the main path to membership in the super-wealthy club. Although that trend may sound disturbing for women, it reflects that inheritances have become less important: self-made wealth is skewed toward men, whereas inherited wealth is more or less equal between genders.
So what happened? Rather than continuing to grow unbounded, the old wealth generated in the “first” gilded era declined in importance as it dissipated after being passed between generations. Meanwhile, the same dynamics that worsened income inequality (most likely technological change and increased globalization) rewarded some individuals with enormous gains. The new technology may also have favored new capital more than old with higher returns. This new and very successful population came to dominate the ranks of the global elite and ousted people who got their wealth through inheritances. It is tempting to focus on just the new wealth, but the net effect of these two opposing trends -- growing income inequality and the natural dilution of wealth-- resulted in a reasonably stable concentration of wealth, even as the composition of people at the top changed.
Taken together, then, the economic evidence points to increased earnings inequality but to a much more benign picture of changes in wealth inequality. Increasing inequality has been driven by income earners not necessarily by the entrenched wealth holders. To be sure, the increase in income inequality today could yet produce more wealth inequality later. Wealth represents a lifetime of saving and income, so it can reflect decades of income disparity. Although there is no well-established link between the two, it is possible that large concentration of wealth can influence politics, undermining how the economy would normally allocate labor and capital. One only needs to look at the recent history of Russia or Argentina, where policy has been heavily influenced by interests of the wealthiest.
Ultimately, if the risks associated with wealth inequality do become a pressing concern, there are ways to attempt to reduce it, potentially in exchange for lower growth. For example, in his bestselling book, Capital in the Twenty-first Century, the economist Thomas Piketty proposed an annual progressive wealth tax. Even it were possible to implement and enforce such a tax, a wealth tax is a terrible choice because it is both ineffective and entails more economic costs than other kinds of taxes, such as those on capital income or estates.
For one, a progressive wealth tax requires making arbitrary decisions. According to the latest Federal Reserve wealth survey, the 90th percentile of wealth is just under $1 million. That may be a fortune to a 25-year-old starting out, but to a 65-year-old facing uncertain medical expenses, it provides a “middle class” retirement. Taxes on wealth at this level would affect retirement, long-term care, and health care decisions. But it would do little to address whatever negative consequences wealth concentration might have.
Suppose, though, that we could manage to limit wealth taxes to the super wealthy. Even then, a wealth tax is not an effective equalizer. A recent comprehensive study of best taxation practices, headed by the economics Nobel Prize–winner James Mirrlees, explicitly favored taxing the income wealth generates -- capital income -- instead of wealth itself. This is because a tax on wealth automatically preferences the well positioned wealthy relative to others -- and not just because the well-positioned wealthy can set up offshore tax havens.
Imagine that wealth earns a five percent nominal return. A 20 percent tax on income, then, would collect about the same amount of revenue as a one percent tax on wealth. But suppose you earn above the market rate, as wealthier people often do, because of their investment talents or ability to take advantage of opportunities not available to others. The wealth tax is forgiving –- it will tax these extraordinary returns at only one percent –- while a capital income tax would continue to tax them at 20 percent. Disguising labor earnings as capital income, for example, by relying on carried interest, compensation using equity stakes, or certain types of stock options would lead to a similar distortion. In a sense, taxing wealth rather than income gives a subsidy to anyone who earns above market returns either through skills, luck, or privileged market access. In other words, it does just the opposite of what champions of wealth taxation desire.
For now, there is limited evidence that wealth inequality has changed or that we are in a new gilded age. But even if we do get there someday, the proposed cure, taxing wealth, will make the disease worse.