Wednesday, 25 June 2014

Capital, income and Piketty

There is, it seems, plenty to say about Thomas Piketty's book. Below are some thoughts - longish, but slightly leavened by evil twins - prompted by a response to it.

Here is a bit from Piketty:

"To be sure, there is something astonishing about the notion that capital yields rent, or income that the owner of capital obtains without working. There is something in this notion that is an affront to common sense and that has in fact perturbed any number of civilizations . . ."

Let us accept that there is something to that. One has a feeling that sitting on your bottom and doing nothing all day does not entitle you to an income just because you are already rich (i.e. have capital). But I suggest it's a weak intuition: we'll withhold final judgment until we see what other implications our theory has.

Against that, here's a point from Scott Sumner:

"Let's suppose that two identical twins each make $100,000/year for 40 years. One spends the money right away, and the other saves half the money, pushing consumption far into his future, and to some extent his children's future. In both cases the present value of consumption is identical. Resources are identical."

So should Mr Careful be punished - by a tax on wealth/capital - for having saved his money, while Mr Wastrel gets a lower overall tax rate? Again, I think we have a weak intuition that Mr Careful is more worthy of encouragement, by tax policy if necessary, than Mr Wastrel: when they get asked "which one is the evil twin?", it's not a hard question to answer. But again, I suggest that we are happy to withhold a final judgment until we see where the argument is going.

Sumner's post also makes some general comments about where the state of the art in public finance theory is. So, for example, he says that economic inequality should be measured by consumption inequality, not income or wealth inequality and that a conventional centre-left view is to favour a progressive consumption tax. He also suggests that: "A tax on residential real estate is a good way of taxing consumption. It can also be made progressive. It should not exclude mortgage debt, as people derive the same consumption from a house that is owned free and clear as they do from one on which there is a mortgage."

Let's take all of this and go back to our contrasting twins, Mr Careful and Mr Wastrel. Lifetime wealth (by and large, for most people, etc etc) consists of (a) the house you have saved up for and paid a mortgage on for years and years plus (b) the pension fund that you have accumulated by saving for years and years. It might consist of some other savings, a second home or a buy-to-let property, but your cars, wine, paintings, furniture and knick-knacks are unlikely to be a material store of value.

When Mr Careful and Mr Wastrel both come to retirement age, Mr Careful has a mortgage-free house and a comfortable pension. Mr Wastrel has neither. Two questions:

(a) How do you feel about Mr Careful's wealth being taxed to pay for Mr Wastrel's living expenses? Not only is Mr Careful being punished for having been sensible, but Mr Wastrel is being rewarded for having been wild. Over their lifetimes, Mr Wastrel gets to consume more than Mr Careful.

(b) As it happens, Mr Careful's house is an ex-council house. The council puts Mr Wastrel in the house next door, essentially for free (he gets housing benefit that covers the rent). Mr Careful and Mr Wastrel now 'consume' identical housing. Should they pay the same tax on that consumption? You might say that it makes a difference that Mr Careful can pass his house on to his children, but: (i) does that make a difference to him or to his children? and (ii) let's assume that the rules on council houses mean that Mr Wastrel's children can't be kicked out of their house - what is the material difference in wealth or consumption between the two families now?

You've seen questions like (a) before and people have their answers ready, normally to do with Mr Wastrel not being allowed to starve and the difficulties in distinguishing between the unlucky and the prodigal. (Or, from a different political persuasion, involving Mr Careful's familial obligations.) Question (b) looks superficially different, but I've linked it to question (a) because they are both questions about what wealth really is. Isn't question (a) really about whether Mr Wastrel can sit on his bottom and doing nothing all day and yet be entitled to an income - i.e. isn't about his capital? Isn't a council house, that you can't be kicked out of, equally a form of wealth?

It is this sort of thing that Sumner is getting at with his comment that we "actually should be talking about total wealth, including the present value of future government benefits like Social Security and Medicaid, as well as human capital" rather than marketable wealth. E.g., what difference did the introduction of the NHS make to the distribution of wealth in the UK? The answer is not just that everyone, young and old, received the capitalised value of a lifetime's future health insurance payments (which was of proportionately greater value to poorer and younger people and so reduced wealth inequality): surely we also need to take into account the consumption to be experienced during the future additional (quality-adjusted) life years? Those are pretty big effects, but it's not clear that marketable wealth distribution changed at all.

I suppose what I am saying is that Piketty is right in that we don't like rentiers much, whether they come in the form of the idle rich or welfare scroungers, but once their income comes in a non-marketable form, we suddenly become much less antipathetic to them. I find it hard to believe that someone who lives in a council flat in Central London is really rich - and should be taxed as such - even though they are consuming the same living as their next door neighbour who has bought the flat. I don't think I am alone in that belief. But if you really care about economic inequality, don't you have to grapple with that sort of question? 

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