Friday, November 28, 2014

Inequality Disaster Prevention

NEW HAVEN – Thomas Piketty’s impressive and much-discussed book Capital in the Twenty-First Century has brought considerable attention to the problem of rising economic inequality. But it is not strong on solutions. As Piketty admits, his proposal – a progressive global tax on capital (or wealth) – “would require a very high and no doubt unrealistic level of international cooperation.”

We should not be focusing on quick solutions. The really important concern for policymakers everywhere is to prevent disasters – that is, the outlier events that matter the most. And, because inequality tends to change slowly, any disaster probably lies decades in the future.

That disaster – a return to levels of inequality not seen since the late nineteenth to early twentieth century – is amply described in Piketty’s book. In this scenario, a tiny minority becomes super-rich – not, for the most part, because they are smarter or work harder than everyone else, but because fundamental economic forces capriciously redistribute incomes.

In The New Financial Order: Risk in the 21st Century, I proposed “inequality insurance” as a way to avert disaster. Despite the similarity of their titles, my book is very different from Piketty’s. Mine openly advocates innovative scientific finance and insurance, both private and public, to reduce inequality, by quantitatively managing all of the risks that contribute to it. And I am more optimistic about my plan to prevent disastrous inequality than Piketty is about his.

Inequality insurance would require governments to establish very long-term plans to make income-tax rates automatically higher for high-income people in the future if inequality worsens significantly, with no change in taxes otherwise. I called it inequality insurance because, like any insurance policy, it addresses risks beforehand. Just as one must buy fire insurance before, not after, one’s house burns down, we have to deal with the risk of inequality before it becomes much worse and creates a powerful new class of entitled rich people who use their power to consolidate their gains.

In 2006, I co-authored a draft paper with Leonard Burman and Jeffrey Rohaly of the Urban Institute and Brookings Institution’s Tax Policy Center that analyzed variations on such a plan. In 2011, Ian Ayres and Aaron Edlin proposed a similar idea.

Underlying such plans is the assumption that some substantial degree of inequality is economically healthy. The prospect of becoming rich clearly drives many people to work hard. But massive inequality is intolerable.

Of course, there is no guarantee that an inequality-insurance plan will actually be carried out by governments. But they are more likely to follow such plans if they are already legislated and take effect gradually, according to a formula known in advance, rather than suddenly in some revolutionary departure from past practice.

To be truly effective, increases in wealth taxes – which fall more on highly mobile retired or other affluent people – would have to include a global component; otherwise, the rich would simply emigrate to whichever country has the lowest tax rates. And the unpopularity of wealth taxes has impeded global cooperation. Finland had a wealth tax but dropped it. So did Austria, Denmark, Germany, Sweden, and Spain.

Increasing wealth taxes now, as Piketty proposes, would strike many people as unfair, because it would amount to imposing a retroactive levy on the work carried out to accumulate that wealth in the past – a change to the rules of the game, and its outcome, after the game is over. Older people who worked hard to accumulate wealth over the course of their lifetime would be taxed on their frugality to benefit people who didn’t even try to save. If they had been told that the tax was coming, maybe they would not have saved so much; maybe they would have paid the income tax and consumed the rest, like everybody else.

Moreover, once the reality of a Piketty-type wealth tax was understood, the rich might procreate more, because wealth in the form of children cannot be taxed away – which is why it would probably be better to tax income and maintain a deduction for philanthropic contributions outside of the family. And, if there are to be wealth taxes, instituting them now to take effect only in the future – and only if inequality becomes much worse – would preempt the perception that the rules had been changed after the game had ended.

The advantage of income-tax increases is that they could be based not just on current income, but on some average of income over the course of years, and could allow deductions for investments, thus sharing some features with wealth taxes without penalizing those who saved more to accumulate more wealth. Moreover, a long-term plan legislated by one or a few countries today, before any substantial impact on actual tax payments occurs, could help to promote an international dialogue about appropriate future policy toward inequality. That would create room for a more uniform tax response among countries, thus reducing the ability of the super-rich to evade taxation by switching location.

Piketty’s book makes an invaluable contribution to our understanding of the dynamics of contemporary inequality. He has identified a serious risk to our society. Policymakers have a responsibility to implement a workable way to insure against it.

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    1. CommentedMichael Harrington

      Unfair? Not if we've already given away the store in terms of unequal outcomes. Perhaps the only way to accomplish this is with a death tax that can be completely avoided if principals distribute their wealth in sizable but reasonable chunks ($3-5 mill) at or before death. Some rich people are already doing this voluntarily.

    2. CommentedMichael Harrington

      Property taxes are the only wealth tax that can't be avoided. Death taxes may also be harder to avoid. The problem is that much of the income of the super-rich accrues to capital assets, which suggests progressive capital income taxes.

      The longer term solution is to design tax policies that mitigate the intergenerational accumulation of capital, capital that should be more widely distributed in terms of ownership and control. The concentration of capital is counterproductive at the extremes. One requires equity to fully participate in a market economy and this also presumes that the risk burden must be broadly shared, managed, and paid for. "Heads we win, tails you lose" means taxpayers are bearing risks for which they are never paid.

    3. CommentedHarlan Green

      Do Tea Partiers and Repubs in general really believe politicians have too much power? DC Pols have none in themselves. It is their wealthiest backers that have created the Inequality Disaster we have today. It's the Oligarchs such as Koch Bros. who have been wielding the real power--to roll back voters, women's rights, educational advantage, pollution regs; you name it! Socialism doesn't even exist anymore--except in China and N. Korea, and now Putin's Russia?

    4. CommentedVictor Beker

      Actually, what Piketty´s book provides is an impressive amount of data which shows that inequality goes hand in hand with economic growth. But growth goes also hand in hand with less poverty. China is a good example of both phenomena. So, do we want less inequality or less poverty? If the latter is our concern, maximizing the income of the poorest quintile of the population should be our target although this does not necessarily mean less inequality.

    5. CommentedK Chandra

      There is no data to show that all or most of the wealth created by the top 1% was accumulated through suspect means. If it is feared that increasing inequality may lead to serious social dislocations, the answer does not lie in an impractical global wealth tax, as the author has alluded to correctly. Increasingly a large part of such wealth is 'paper' wealth. Would it not be better to have all income from such wealth taxed yearly on a progressive basis?
      We must not forget that excluding inheritance of wealth, most people accumulated wealth through hard work (and with some luck) and after paying their due share of taxes - income tax in particular. Why would anyone in his right mind penalise savings and investment by individuals? The world will be better off by sticking with progressive income taxes and if necessary progressive inheritance taxes after allowing for justifiable deductions and allowances. Look at what happened to countries and economic systems that advocated greater equality? We should not allow this debate to be driven by envy. Perhaps we must blame the media for not allowing the very rich to lead their flashy lives without being publicised 24x7.
      Political systems in today's networked information driven world cannot be controlled by the plutocrats without changes being brought about from the 99% if such systems do not offer a widespread decent standard of living for the larger population. Politicians will ignore this at their own peril.
      Where will this comparison stop? Once a country has become reasonably equal, will it thereafter start looking at wealth levels in other countries? Will we start debating equality between nations? Can we have a supra national taxing the wealth of the richer countries to pay the poorer countries? Let's be practical.

    6. CommentedM1ro Br@da

      The society is less diverse in terms of various activities, except money making (or rent seeking). To measure everything with money - creates irrational simplification of reality: the richer the better 'competition'. Some things / activities must be excluded from money-measuring to overcome the crisis.

    7. Portrait of Michael Heller

      CommentedMichael Heller

      All of Thomas Piketty's socialist admirers repeat the empirically unfounded moral fable that wealthy inequality is a "serious risk to our society". Piketty does not provide data to support such a wild assertion. None of the admirers of Piketty moralising put any thought into how the political system can be reformed to prevent massive wealth from acquiring massive political influence. Everyone who studies rent-seeking, cronyism, and money politics knows that the straightforward solutions to the potential political 'bad' of wealth concentration lie in institutional reform rather than in attacks on wealth. The admirers of Piketty's moralising about wealth inequality are helping to bring the economics profession into disrepute. It is lazy and populist to scapegoat wealth inequality for all the ills of capitalism instead of seriously putting capitalism back on the road to recovery using the methods of Schumpeterian economics. But the volubility of the many admirers of Piketty moralising about wealth inequality do usefully serve to remind sensible folk why Schumpeter thought socialism was inevitable. Moral economy is relentlessly regressive, and and populism is powerfully persuasive.
      Heller Economic History Entertainments

    8. CommentedProcyon Mukherjee

      Examples abound around us, only if we apply our minds and try to learn from them. Egalitarian societies do exist in the richer world, like in Switzerland, or Scandinavia, where people live in an unequal world equally; I remember the Bank CEO taking the same train for going to work as any other person and living in the same neighborhood where people with smaller means also lived. The children go to the same school, get the same opportunities till they choose what is best for them; the taxes go to the Canton or the Gemeinde, the community, and how it is to be spent is decided by the community; the taxes by the way are not high.

      There may be flaws in this, but the Swiss have found a way out, although the scale of problems could be smaller, but they have found a solution in a smaller scale at least. The success of the Swiss is in the community living in Gemeinde, which is so simple, but whether it is replicable is another matter.

    9. CommentedZsolt Hermann

      It is understandable that economists try to solve problems with economic tools.
      After all when someone has a nail and a hammer he constantly wants to hammer that nail into something.

      But inequality is not an economic problem thus it has no economic solution.
      And trying to solve any problem through taxation is even more futile.

      The problem is rooted in the self-calculating, self-serving, egocentric human nature which has driven and still driving any initially benevolent, well intended human invention, institution into corruption, when those benefiting from the system most start to twist the system in their own favor to keep their preferable position in place.

      Although we are all driven by the same inherent desire, since each and human being is different, with different level, strength of the egoistic desire, how much one would sacrifice to achieve pleasure, humanity always renders alongside a pyramid model. And those on top then wants to make sure they always remain there.

      Taxation is a coercive measure, people only agree to it reluctantly while immediately trying to work out how to go around it, again as a direct result of our driving force.

      Unless human nature itself is adjusted it does not matter what political, economical, or financial system we try it will fail and fail again as it has been all through human history.

      And from the above example on taxation it is clear this adjustment has to happen in a non-coercive way, without trickery, only through positive motivation.

      Only changes achieved through positive motivation, people joining in willingly, can be sustainable.

      So what leaders and the public mutually together has to figure out how to implement a global, integral education system/program, information exchange and with it a complete value change in the media and in society in general to help people understand the following:
      - how do global, interdependent systems we evolved into function,
      - the nature of a closed and finite natural systems that are based on homeostasis and harmony, existing on natural necessities and available means
      - what is our own inherent human nature how is it incompatible with the conditions around us
      - and finally how we can re-adjust our nature so we adapt to the conditions and build a new, qualitative higher, sustainable and more prosperous human system/future.

      When we have laid the foundations by this adaptation will a new economy, new governing structure emerge as a result.

    10. Commentedhari naidu

      Wealth taxation is not going to pass political litmus test in US Congress. Comparatively speaking EU is better off due to political acceptance of VAT which is levied at different rates by the sovereigns. Now, just imagine trying to legislate introduction of VAT in US. Wealthy consumers would naturally end up paying VAT at a higher rate than the average Joe. And it might be just a good first step – before one starts thinking of wealth taxation, per se.

      Piketty is not good on how to prevent the disaster of inequality principally because the economic matrix will inevitably demand different solution depending on respective social system – developed and/or emerging markets.

    11. CommentedLuke Ho-Hyung Lee

      I would suggest our economic leaders seriously consider “The Lack of Appropriate Infrastructure in the Modern Supply Chain Process” as soon as possible. Strangely enough, no publicly available IT-based supply chain process (or infrastructure) has been developed - not even a single one in the whole world. If this is true, I believe it is the main structural cause of the current jobs crisis and thereby economic inequality. Please see:

    12. CommentedEdward C D Ingram

      Robert Shiller, Sir,
      Your ideas are good but mine may be fundamentally better. Why? Because like all economists you look to interventions and they help ‘here’ whilst creating a disturbance ‘there’. That is not good.
      What we have to do is to explore those things that we are doing wrong in the design of the economic structure.

      They are all pretty obvious but the solutions are not those which economists are trained to create. I can teach you quite quickly and my solutions are almost ‘too good to be true’. Why? Because if there is one thing done wrong in an economy, the disturbances ripple out and go everywhere. So when my solutions are adopted all of those ripples vanish.

      For example, there is no way to protect wealth? Why? If I lend you my wealth why would you not agree to repay it? Why would you instead, want me to repay money plus interest at a rate that depends upon unpredictable interest rates? Would you not prefer it if we could agree that I would repay the wealth at a steady rate, high at first and lower as time passes?
      For example, why would we ask the price of the currency to balance trade? Why not? But then we also ask it to balance foreign investment flows. What for? There is no need to be stupid. There is a simple way to solve that problem.
      For example, why would we want the banks to have 100% reserves in order to stop them from over-lending. There is a much cheaper and simpler way that will even put an end to runs on the banks whilst letting banks go bankrupt when they ‘lose it’ and lend recklessly.
      These ideas are all approved at my Think Tank. We just do not have any academic papers published yet.

    13. CommentedEugene Devany

      The U.S, Constitution requires that direct taxes (like an income tax) be apportioned among the states. The 16th Amendment eliminated this requirement for the income tax. Attorneys disagree about whether a wealth tax would be a "direct" tax and it may depend on how it is drafted. Net wealth can be used as an optional adjustment to the income tax an fall within the 16th Amendment.

    14. CommentedPeter Burgess

      I am frustrated by most of the socio-economic analysis that originates with high profile economists in large part because the analysis is quite simple on top of extremely complex systems. The mathematics of complex system analysis is inherently problematic and in the end inconclusive.

      But there are ways to get the right answers. Rather than to seek a really big policy solution, there should be a myriad of little initiatives all of which result in a step in the right direction.

      So then the question arises, how to get behavior change for everyone so that in aggregate we get a better socio-economic trajectory. The advertising industry has worked for its whole existence to do this ... but arguably only for the benefit of the corporation (and owners) rather than for the benefit of society as a whole. The advertising industry specializes in behavior change.

      I argue for some radical reform of the way we do accounting and reporting of corporate performance. There are initiatives that are heading in this direction so that there is reporting of impact on people and planet as well as just the profit performance ... but the techniques still need strengthening.

      I also argue that the purpose of economic activity is not simply to make a profit for corporate owners, but to sustain and improve quality of life and standard of living of people while doing the least possible damage to the natural environment. The corporate organization is subsidiary to people, not the other way round.

      The amazing progress of technology in the last 50 years is impressive. The mixed results for people progress is a disaster. In the developed economies the backsliding of the middle class is disappointing, and in the developing world progress out of poverty should be universal. Shortages and violence are endemic in too many places. It should not be a surprise that for profit economics is failing. On the other hand a system that thinks in terms of for good could get very different results.

      Peter Burgess - TreuValueMetris
      Multi Dimension Impact Accounting

    15. CommentedHarlan Green

      The real contribution of R Shiller to this discussion is his belief that historical data collecting now possible by Piketty, Shiller, et. al., will make it possible to establish Macro Markets for these insurance outcomes, eg, such as his futures market for housing prices!.

    16. CommentedEdward Ponderer

      Professor Shiller is indeed quite right about Piketty's work being strong on analysis of the problem, but weak on solution. For according to the general economic factors it talks too, it is impossible to find solution. Similarly, guaranteed, Prof. Shiller's erudite solution will prove similarly of no real value--and in fact, if orthogonal to the real problem, the result will be further drift from the goal of equality--an inevitable drunkard's walk away from target.

      We are marionettes trying to figure the complex of strings with no note given to the puppeteer, egoism. Inequality will exist in any system that imagines it will rule over ego with a gun, or imagine that if the reigns get some laisez-faire loosening, the horse will be happy with providing hey for the whole stable as long as it gets the most handsome portion. The true powers that be behind the party leadership and the great financial houses laugh their heads off at both Communism and Capitalism--for they will find the means for the most clever and aggressive to rule the whole under any -ism. This, with or without the "People's" or "Republic" or "Democracy" label on the title as so many $99.99 price tags saving us from spending our hundred dollar bill on an overpriced competitor's product.

      And a tell-tale sign of human ego beyond its insidious cleverness, and subconscious manipulative intrigue, is that if uneducated it does want what is “good” for it in healthy measure—it wants anything that anyone conceives of as good, it wants it all, and it judges how much it’s got, by how much others have. In short, the most powerful dimension of its “enjoyment” is that others don’t have—unless those others are identified with the self —this point is crucial.

      For the problem was never with communism or laisez-faire, it was with their exclusivity, and most particularly exclusion of the ego’s partnership. This opens up a particular new opportunity, now approaching the 1/6th point of the 21st century.

      Why this period is different can be expressed in one word—globalization, or perhaps by the Yin to this Yang, interdependence—the former is the boundary condition, the latter is the differential equation, and this will force the rise of a resultant new economics already discovered—behavioral economics.

      Mutually responsible relationship has become the key. The fact that our fates are irrevocably intertwined means that there is at last something to teach the ego that it needs to, and will want to learn. This is integral education—not competition and temporary us-vs.-them collaboration for what the individual ego gets out of it. No, rather learn that entwined fates are permanent, we are one, and therefore let all egos recognize themselves as one permanent whole—the new common enemy being death, nonexistence.

      This is not communism, it is not capitalism – it is family, common sense, common agreed, voluntary, unified FAMILY. It is communist in concern that all get what they need and provide all that they can. It is laissez-faire because with ego unified, it can trust to the individual to go full steam ahead for the sake of the common good, allow creativity and brilliance full authority to move ahead per its natural capabilities, to do what it love for All that it loves.
      Sound like paradise, a dream? Paradise yes, a dream—no, cold hard necessity.

      Its time for the ego to grow up and go to school. All it has had till now is a pre-school of untutored free play, attempts at useless moralizing save some temporary corralling value—fear plus a sense of the powerful ego of self-image. These work for a baby, not a rowdy teen growing up fast.

      Its sink or swim. But let’s have some faith in the human spirit when truly educated and directed—it will swim!

    17. CommentedMatthew Lykken

      In a capitalist economy all money flows to capital save to the extent that labor has the power to demand a share. When labor loses market power, income concentrates in the hands of capital and inequality widens. Thus the solution lies in boosting the market power of labor. Minimum wage laws and labor unions cannot do this when companies can relocate jobs in another jurisdiction. In the United States, then, the key is to create a strong incentive to locate high-value jobs in America. This can be done without increasing deficits through the tax system via the Shared Economic Growth proposal. See , which is also endorsed at and and

    18. CommentedNathan Weatherdon

      As Paul points out, it would be difficult to take a political commitment so seriously when planning one's personal finances, in particular in the absence of any precedent to see how things worked out.

      However, I don't see why this would be a challenge. It amount to passing legislation that says "if it gets x bad, we do y mitigation". Arriving at "x bad", then could always pass new legislation. But if it's "x bad", probably they won't be able to pass that legislation at that time.

    19. CommentedEugene Devany

      Thomas Piketty has not considered an "optional" wealth tax (which does not require a constitutional amendment for the apportionment issue). It is the reduced share of wealth at the bottom that causes more trouble than the growing concentrations at the top. Half the families in the U.S. lost a staggering 70% of their net wealth between 1995 and 2010 while all profits on average were confined to the top 10%.
      But what taxpayer (in their right mind) would want to pay a wealth tax?
      In fact, most taxpayers would choose to pay a 2% tax on net wealth (excluding $500,000 retirement savings and $15,000 cash per taxpayer) if their income tax rate were lowered to a flat 8% (with no payroll tax). The standard no-wealth-tax alternative would be a flat 26% income rate (plus estate taxes when the time comes). A complementary business tax of 8% (for C corporations) and a 4% VAT would complete the 2-4-8 Tax Blend and produce as much tax revenue (or a bit more) than the current income-only system. [Note that the 2-4-8 Tax Blend was originally scored based on 2010 data of $53 trillion in individual wealth and current individual wealth just four years later is about $82 trillion].
      An "optional" wealth tax permits wealth concentrations at the top while spreading growth to the bottom 99% through (wealth adjusted) tax liability. It is politically feasible because it divides the most powerful. Is it unfair to expect the wealthy to pay the same rates as the poor?

    20. CommentedGunnar Eriksson

      New taxes do create resistance and arguments of unfairness.
      Values do change over time as far as arguments are sound.
      A new wealth tax needs to address both inequality and lack of capital for R&D and investment.
      Wealth for taxation should be valued after usage so that idle and highly speculative capital is taxed the most.
      The tax need to be levied on a federal level and built into the WTO rules so that duties can be levied on those opting out.

    21. CommentedVal Samonis

      Why not simply continue with the old and much simpler idea (no actuarial unknowns, etc.) of the guarantied citizen's income? Another idea is job sharing using ICT. It seems to me that people would not trust insurance companies that much, esp. in the wake of the US health-care finance crisis.

      Val Samonis
      Vilnius University