Some taxing solutions on Piketty thesis

Matt Rognlie is a fun and a very smart guy. 

An economics doctoral student at Massachusetts Institute of Technology, Rognlie had a blog. As proof that blogs can be an important part of the research process, Rognlie turned a blog comment into the most biting critique of Thomas Piketty yet produced.

Piketty is the French economist who became a celebrity for his work on inequality. In his blockbuster book, Capital in the Twenty-First Century, he asserts that the rate at which capital owners’ wealth increases is almost always larger than the rate of economic growth. If that’s true, it means that the rich get richer, and wealth inequality never stops increasing.

Rognlie has three observations that cast doubt on Piketty’s thesis.

The first is that Piketty doesn’t take depreciation into account. As capitalists accumulate more and more machines, buildings, and other hard assets, they have to pay more to maintain that physical capital. Nowadays, capital goods are often in the form of computers, software, and other hi-tech products that go obsolete quickly.

That means capitalists have to spend more money replacing these things. A lot of what looks like more money going into owners’ pockets is really just an increased cost of doing business.

His second point is that much of the income that went to capital owners in the last six decades has been from capital gains — from stock prices going up, rather than from an increase in book value. When you look at book value, the increase was much more modest.

It might be that what looks like the start of a permanent explosion in the wealth of shareholders is really just the end of the “equity premium” that has fascinated financial economists for decades.

Rognlie’s third point is perhaps the most interesting. Economists combine a lot of different things into “capital”, such as machines, buildings, and land. Rognlie points out that almost all of the increase in the value of capital over Piketty’s timeline comes from land instead of from other forms of capital.

In other words, it is landlords, not corporate overlords, who are sucking up the wealth in the economy. It’s a dramatic, startling insight that was somehow overlooked before Rognlie came along.

This is a different story from the one we usually think of. Didn’t we relegate all-powerful landlords to the dustbin of history when we got rid of feudalism? Maybe not.

Urban economists believe that as density increases, productivity rises. This is what is known as an “agglomeration economy”.

As it becomes more valuable for people to work and live near each other, the value of central locations — of land — goes up. Landlords, who are producing no more than they used to, but who were sitting on advantageous locations, reap huge benefits.

In general, this will mean cities tend to be too small — the incentive to cluster together for higher productivity is choked off by the high price of land.

The drain of urban income to landlords will tend to increase as the economy grows and the productivity advantage of cities increases. Just look at San Francisco, where the soaring price of land, and the accompanying surge in rent, has absorbed much of the wealth created by the new tech boom.

Rognlie’s results, and the theory of agglomeration economies, suggest that to fight wealth inequality, what we really need to do is not to redistribute income from corporations but to redistribute income from land. How do we do that? Well, allowing more development in urban areas is a good start.

The real weapon here is the Henry George tax, or land value tax (LVT). This is like a property tax, but it taxes only the value of land, not the value of the structures built on the land. It encourages efficient use of land, while providing the most efficient method of wealth redistribution. Milton Friedman called it the “least bad tax”.

Rognlie shows that if we really want to counter the inequality Piketty warns about, we will need tools like the LVT. Most importantly, our cities will need to find ways to counter the political power of landlords. The most important redistribution policy may now be urban land-use policy.


Lifestyle

I wish I could write us all back in time, when we could pop to the shops without fear, when grandparents did not have to wave through a window at their grandchildren.Michelle Darmody: Recipes with simple ingredients

It’s not always possible to produce enough vitamin D through sun exposure. Fortified foods are an option but you need to choosecarefully, says Clodagh FinnCovid-19 lockdown mean you're not getting enough Vitamin D?

More From The Irish Examiner