The main source of rising inequality in the US has been the rising incomes of the top 1% richest Americans relative to everyone else. Sure, the top 25% highest-income households have been doing fine, but their incomes haven’t been rising much faster than GDP. Only the richest 1% have really seen their incomes soar. This is partly because they get more of their income from owning stuff than from working and this is also one of the themes of Thomas Piketty’s 2013 book, Capital in the Twenty-First Century. The most famous part of the book was this simple equation:
r = rental rate on capital = growth rate of the value of capital
g = growth rate of GDP = growth rate of total income.
Generally speaking, when r>g, capital income is growing faster than total income and in this situation inequality will rise because capital, broadly defined, is simply wealth and wealthy people own most wealth by definition. Thus if wealthy people’s incomes are growing faster than workers’ incomes, inequality will rise.
Piketty’s equation would have been clearer if Piketty had included the major part of the economy that he left out of the equation: labor income. GDP = (income from capital) + (income from labor). This is related to Piketty’s equation because the growth of GDP (g) is equal to the weighted average of the growth of capital income and labor income. When capital income is growing faster than labor income, inequality rises. That is what Piketty’s oversimplified equation actually means.
There is disagreement about whether it is really an inevitable long run law of economics that capital income must grow faster than labor income (r>g), but Piketty shows that capital incomes did indeed grow faster than labor income during most of history (for which data is available) except for a half century or so in the middle of the 1900s and during the aftermath of the black death in the late 1300s.
So for most of history when wealthy people got richer and workers got poorer, it wasn’t because the wealthy were being more virtuous or working harder. The wealthy just got lucky. They weren’t saving more of their wages, they were earning more from their wealth without having to lift a finger. This should be clear for most of history because until the industrial revolution, very little capital was created by labor. It was mostly created by God in the form of land or slaves. This graph shows that in 1770 (the left edge of the graph), the bottom two categories of capital was real estate in the north of the United States.
And in the slave states, most of the wealth was in the form of slaves and land.
In 1770 the biggest fraction of the total value of capital was created by God (or nature if you prefer), not by people because it was mostly agricultural land and slaves. Of course SOME of the value of agricultural land and slaves is due to improvements people made as they cleared the land and trained their slaves. But much of the value of housing and other domestic capital is also just natural resources like land. For example, Karl E. Case estimated that between about 20% and 30% of the value of real estate in America from 1975-2005 was due to the value of land, and a significant fraction of the rest of the value of each house is the value of the raw natural resources they are composed of too. For example, a stone house is made out of stone from a quarry which has value in large part because it was created by nature.
Very little capital was created by workers at a sacrifice in 1770. That is best measured by the dark grey area at the top of each graph, and part of this portion of domestic capital is the value of natural resources. For example, when the value of capital rises without the owner lifting a finger, there is little reason why the owner should get the increase in value.
For example, when a new school is built, nearby properties soar in value, but the real creation of value was the school, not anything that the nearby property owners did. Why should the nearby property owners reap additional wealth for the luck of being located near the new school? This is particularly galling when the school is created using tax revenues from renters in the neighborhood who will subsequently have to pay higher rents because of the increase in property value.
Rising rents is the fundamental problem of gentrification and it could be ameliorated by taxing the unearned increase in the value of real estate so that the real estate doesn’t appreciate in value. Then that tax revenue could be used to build more amenities that improve other neighborhoods and generate more revenues from the properties becoming more desirable.
This is the idea that made Henry George by the most famous American economist in history in the decades around 1900. He believed that the value of capital that is created at a sacrifice by labor should not be taxed, but that capital that is created by nature should be so highly taxed that its value falls towards zero. One reason for his logic was that unearned wealth was not created by humans and so humans don’t deserve to profit from ownership. Secondly, there is no civilization without tax revenues and the most efficient source of tax revenues is something that is perfectly inelastic with respect to the tax rate. An inelastic supply means that an increase in the tax rate will not cause people to reduce their supply and if owners aren’t actually sacrificing to supply something, then a tax won’t cause them to supply less. For example, if you tax the value of land, it won’t change the quantity of land because land is not created by humans. On the other hand, our government mainly taxes the wages of workers and that kind of taxation can change the amount of work that people do. If the income tax rate on wages is 100%, people will do very little work, but if the income tax rate on land income is 100% of its imputed rental value, there will still be just as much land for people to use. As Noah Smith says:
Unlike income taxes, sales taxes, or corporate taxes, the Henry George Tax has no chance of choking off economic activity; after all, the amount of land is fixed, so you can’t tax it out of existence. Also, unlike the property taxes we have now, a Henry George Tax actually encourages landlords to build useful, valuable stuff on top of the land they own. Conventional property tax pays people not to build things on their land, since doing so will mean having to pay more tax. But the Henry George Tax—which would replace conventional property taxes—makes buildings and other productive structures tax-free, thus encouraging landowners to build more of them. And, as Henry George himself pointed out, the tax redistributes wealth from the rich to the poor without punishing rich people for creating wealth. …It appeals to our principles of fairness.
In addition to taxing the value of land and related natural resources like minerals and fisheries, in order to prevent rising inequality we should increase the taxes on other forms of capital that isn’t created at a sacrifice. Inheritance is another form of wealth that is unearned and it is a surprisingly large portion of total wealth according to Piketty’s data:
Inheritance [now] accounts for ~12% of national income annually (compared to ~20% in 1900) and is projected to stabilize at ~15-25%. Most shocking, inherited wealth as a percentage of wealth was 90% in 1900, 45% in 1970, is already back to 70% and projected to rise to 80-90%.
Inheritance taxes could rise back to where they were in 1970 without hurting growth. Indeed, economic growth was faster in America when inheritance taxes were higher and higher inheritance taxes could help rich children work harder because they wouldn’t count on getting a billion dollar welfare check from their parents’ estate upon death. Taxing inheritance rather than taxing workers would increase work and increase GDP.
When wealth grows in real value, that capital gain is mostly unearned because most wealth is not created at a sacrifice by saving. Most wealth was either created by nature or was inherited or has been created by the magic of compounding interest. Wealth simply tends to grow in value at 5% per year without its owners lifting a finger. We need a tax system that can prevent inequality by helping boost the growth of wages, while reducing the unearned income of wealth. This is tricky to accomplish without reducing the incentives to create capital which would hurt wages, but two no-brainers that would reduce inequality and boost efficiency would be increasing the taxes on natural resources like land and increasing the inheritance tax.
Radical Markets is a book that explains this idea and ways to tax many other forms of wealth like intellectual property. Anyone who owns a copyright or patent should be required to pay annual fees that rise over time to encourage them to pass the intellectual property on to the public domain. Disney shareholders are still reaping profits from inheriting intellectual property that was created nearly a century ago and there is little difference between century-old intellectual property and land at this point because both were inherited, not created. If copyright owners are allowed to keep others from using ideas, they should pay a tax, and the tax should be especially high on century-old intellectual property because no tax could possibly cause it to be destroyed nor would it cause less to be produced.
I had one of my students write a computer program that would crawl through Amazon.com and pull 2,500 fiction titles at random. … The findings are absolutely fascinating.
We broke these out by decade. … You would expect that if you can crawl through Amazon looking at only new books and only books sold by Amazon …of course, the biggest number of books is from the decade 2000-2010. That’s what you’d expect; they’re more recent, more popular. Drops off really quickly for books in the 1990s, 1980s, 1970s, ’60, 1950, 1940, 1930 — here’s the point in time where books start falling in the public domain. Suddenly it goes up and up and up. There’s as many books [that] Amazon is selling brand new right now from the 1900s to 1910 as from the 2000s to 2010. You go all the way back to 1850 — there’s twice as many books from the 1850s being sold on Amazon right now as the 1950s.
There is a spike for books published before 1922 because copyright ran out for all books published before then. The graph would be even more dramatic if we controlled for the number of books published in each year because there are were far more books published per year after 1922 than before 1922, but most of the more recent books published have been disappeared due to copyright. Although most economists look for problems with the tragedy of the commons, there seems to be a bigger problem with the tragedy of the private in book publishing. Weaker copyright would be better for society and one way to do that would be to increase the tax on copyright owners for every year that they keep it as private property.