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Economist says U.S. inequality reaching "spectacular" heights

Several factors help explain why economist Thomas Piketty's groundbreaking new book on economic inequality has been such a surprise hit.

First, "Capital in the Twenty-First Century" is based on an unusually sturdy foundation of cold, hard facts -- specifically, two centuries' worth of income and estate tax records covering 20 countries. This has proved vital for a work of economics, a field in which theoretical and ideological disputes often hinder the task of getting concrete answers to difficult questions.

As Piketty writes in the 685-page "Capital," "Intellectual and political debate about the distribution of wealth has long been based on an abundance of prejudice and a paucity of fact."

His book has landed on that debate like a bomb. Piketty's thesis: that the rate of return on capital, such as real estate, dividends and other financial assets, is racing away from the rate of growth required to maintain a healthy economy. If that trend continues for an extended period of time -- if wealth becomes ever more concentrated in the hands of a few -- then inequality is likely to get worse, says Piketty, 43, who started his academic career as an assistant professor at the Massachusetts Institute of Technology and who now teaches at the Paris School of Economics.

Another reason "Capital" has caught the public's attention is that inequality is evident in what are by now a host of familiar symptoms. Stagnant pay, except among the super-rich. Soaring health care and education costs. The diminished expectations among young, especially those lacking college degrees, and old alike, as retirement becomes something to endure rather than to enjoy. And at the bottom of the income distribution, a road to nowhere as the avenues of upward mobility that once led to the American Dream are closed off.

In the U.S., the gap between rich and poor has today reached "spectacular" heights, Piketty says in an interview, rising to levels not seen in a hundred years. And America, a self-described classless society, has been revealed as far more socioeconomically stratified than "old Europe," notwithstanding its ancient history of inherited wealth.

Piketty spoke about this and more with CBS MoneyWatch. The interview has been edited for clarity and length.

CBS MoneyWatch: Rising income and wealth inequality have been documented for some time. Why do you think your book has struck such a chord?

Thomas Piketty: What's different here is that I tried to put together in a single book all the historical evidence that's been collected with many colleagues in over 20 countries and spanning two centuries. That's what's new. I tried to put together evidence from many countries over very long time periods, and this had never been done before.

This historical data was sitting there, but I guess it was too historical for economists and too economic for historians. I think there's a lot of social demand for knowledge in this area, particularly in the U.S. where rising inequality over the past few decades has been quite spectacular. This resonates with the current U.S. debate.

I also tried to write a readable story. The only problem is it's a bit too long, and I certainly apologize for that.

MW: You're suggesting that the book's popularity in the U.S. is related to the surging inequality you document in America.

TP: That's part of the story, but I think it's more than that. Inequality is not new -- there's always been inequality. But people want to know more about the story behind inequality and whether we can make comparisons across time. Can we compare the U.S. of one century ago with the U.S. today, for instance, and with Europe before the French revolution? Do these comparisons make sense, and what can we learn from them?

The U.S. is the country that invented progressive taxation of income and of inherited wealth in the 1910s and '20s. And largely these fiscal institutions were invented in America because the U.S. didn't want to become as unequal as the patrimonial societies of 19th century Europe. There was this strong feeling of American identity, of a country where everyone gets a chance, and you don't want to perpetuate extreme wealth concentration across generations. You want people to be able to become rich, of course. But you also don't want the wealth to perpetuate itself over time and across generations without [constraint]. This is why progressive taxation was first invented in the United States.

People have always been interested in inequality. What's new with this book is that they are able to know a little bit more about what they're fighting about. The book is also doing very well in Europe in spite of the fact that the rise in inequality there has been much less strong than in the U.S.

MW: According to your data, the U.S. experienced a sharp increase in inequality starting in the early 1980s. What was happening at the time that triggered this widening gap between rich and poor?

TP: The book is trying to shift attention from the rise of top income to the dynamics of wealth accumulation. But to begin with, what happened in the 1980s and 1990s is a big rise in top income shares in the U.S. The share of total primary income going to the top 10 percent was about 30-35 percent of total income until the 1970s. That started to increase a lot in the 1980s and is now around 50 percent.

It's a complex phenomenon, and I think there are several explanations. Part of the explanation is the race between education and technology. Starting in the 1980s, you have a decline in the growth rate of the number of kids. If you take the fraction of each generation going to college, the speed at which this increased flattened starting in the 1980s. And because that change has continued to increase the demand for high skills at a very high pace, this has increased wage inequality.

I think this is an important part of the story. But it's not sufficient to explain why the rise in inequality is so concentrated at the very top. Because a very large part of this rise was really due to the top 1 percent or even the top 0.1 percent -- it's not as if these people have a lot more education than the next 5 percent. You need specific other explanations for what's been going on at the top.

MW: Do you see inequality as having contributed to, or worsened, the 2008 financial crisis?

TP: Inequality made the financial system more fragile. If you have stagnant median income and a huge rise in incomes at the top, then this is going to put a lot of pressure on the financial system because the average household will tend to borrow and accumulate a lot of debt. So this has certainly exacerbated the tendencies in the financial system to borrow a lot of money among median income, below median or lower median income households.

On the other hand, our modern financial systems are sufficiently fragile to crash by themselves. Even without rising inequality, the booming balance sheets in the financial sector, both in the U.S. and maybe even more so in Europe, make the financial system very fragile even in the absence of rising inequality. Rising inequality did contribute, but it's certainly not the only reason.

MW: You describe the relationship between the rate of return on capital and the rate of economic growth as a "contradiction." Where does that contradiction lie?

TP: In fact it's not a contradiction. From a purely logical viewpoint, this is what you have in every standard textbook economic model. It's even a condition for economic efficiency. It would be stupid to accumulate so much capital that the rate of return falls below the growth rate. That would be very inefficient.

What's new is to show that r > g is not only something you have in textbooks [Piketty describes the main force he says is driving inequality through the formula r > g, where "r" stands for the average annual rate of return on capital and "g" represents the rate of overall economic growth.]

This is something that we find throughout most of human history. And the reason maybe we forgot about it is because during the 20th century, there were unusual shocks and events that transform this relationship between the [rate of return on capital and rate of growth] -- namely the rate of return dropped to very low levels, and also the growth rate increased to unusually high levels. So this relationship between r and g was completely transformed during a large part of the 20th century.

What I think is new in the book is to pinpoint that r > g is actually real -- it's not just a textbook curiosity -- and that leads to a very large concentration of wealth. Not an infinite concentration of wealth. It will stop somewhere, and that depends on many other important economic barometers.

But if you do a simple simulation, what you find is that all things being equal, a small change in the relationship between r and g can lead to a very large increase in the concentration of wealth. And what the book does is to pinpoint that this is, in my view, one of the main explanations for the very large concentrations of wealth in pretty much every society until World War I.

Nobody knows how far this can go. I don't know how far it will go, but it's a problem. It calls for more financial transparency and more information about wealth dynamics so we can, in particular, adjust our tax system in case we need to.

MW: But are you suggesting that there is something inherent in capitalism that fosters inequality?

TP: It's really a matter of the choices that are available to us as a society. Capitalism and market forces are very powerful in producing wealth and innovation. But we need to ensure that these forces act in the common interest. We want capitalism and market forces to be the slave of democracy rather than the opposite.

Market forces and capitalism by themselves aren't sufficient to ensure the common good and to limit the concentration of wealth at levels that are compatible with democratic ideals. We need to make sure that we use these forces in a way that's consistent with our common interests and, in particular, the interests of disadvantaged groups. Ultimately, that's a matter of political choices and political institutions.

MW: Speaking of the choices we make as a nation, you write that a progressive tax on capital -- property, stock holdings and corporate profits, for instance -- is a better way of reducing inequality than a progressive tax on income. How so?

TP: In the past, there have been many debates between people who want only a wealth tax and no income tax and some people who want only an income tax and no wealth tax. And in fact, this debate goes beyond left and right. You have some people on the right who hate income taxes and who just have a tax on the stock of wealth, and some people on the left who feel the same. It's been a very hot debate forever. What I try to emphasize in the book is a more balanced view in the sense that both a tax on the income flow and a tax on the wealth stock have merit. We need both.

In particular, a progressive income tax is a better way to try to control the rise of managerial compensation at the very, very top. That's useful particularly in the U.S.

Now, in the future, taxation of wealth is going to become more and more important because wealth is likely to become more and more important. So the quantity of wealth that you accumulate relative to one year of national income or one year of GDP tends to rise in countries with a slowing growth rate or slowing population growth.

In the U.S., population growth has been a key driver of the overall growth of the country. Population in the U.S. used to be 3 million at the time of independence, and it's now 300 million. Is the rate of population growth going to be the same in the future -- is America's population going to be 900 million a century from now? Nobody knows. It could be that the rate of growth will continue. But if it slows down, this will have important implications for the relative importance of wealth and annual income.

I can't make predictions about the immigration patterns in the U.S., but it is likely that at some point population growth will slow down, as it did in Europe and Japan. Immigration can counter this for a long time. But if it happens that you have this growth slowdown, then the quantity of wealth accumulated in the past relative to one year of national income or GDP will tend to rise.

The other reason it's important is because our system of property taxation both in the U.S. and in Europe comes directly from the early 19th century. Property taxes in the U.S. aren't progressive -- it's proportional. Also, it doesn't take into account financial assets or liabilities. It's only based on the value of your real estate. This is because in the early 19th century, most wealth was based on real estate and land. Few people had financial assets and liabilities.

But this isn't appropriate for the the 21st century. For instance, you now have people whose home value is below their mortgage, which means they have a negative net wealth. Yet they keep paying the same property tax as people with no mortgage and those who have a very high net wealth. So this system isn't working well.

MW: You also endorse the idea of a global tax on capital as a way of reducing inequality, while at the same time conceding that such a remedy is "no doubt a Utopian ideal." Isn't it unrealistic to think that countries around the world will use tax policy specifically to combat inequality?

TP: If we're talking about a global tax administered by a global government, then it's not realistic. But there's a lot that can be done at the national level. Particularly in the U.S., you can have a more progressive income tax and a more progressive wealth tax. It's not like everybody is going to go to Mexico or Canada.

The U.S. is sufficiently large that you can go a long way toward the kind of progressive wealth tax that I describe in the book without any problem. The U.S. represents one-quarter of world GDP, so there's a lot you can do when you're that big. The U.S. doesn't have to ask permission of the United Nations or the European Union to change it's tax system.

The reason it's difficult to change the U.S. tax system lies elsewhere. The problem isn't international competition or whatever. It has more to do with the U.S. political system. In particular, property taxes are local, not federal, so that makes it difficult. But this is more a problem of internal political organization.

In fact, it was exactly the same problem with the income tax a century ago, which is that the U.S. Constitution made it impossible for the federal government to have an income tax. Then the Constitution was changed and the income tax was adopted. So the history of income, wealth and taxation is full of surprises. I am reasonably optimistic about the future. Democratic institutions can respond to threats, as they have in the past.

MW: A core belief in the U.S. -- one that kids are taught from a very early age -- is that there's no class system in this country. Does your work refute that belief?

TP: My work puts this belief in a broader historical and international perspective. One of my main conclusions is that very high population growth is the key force that has made the structure of inequality in the U.S. different than in Europe. In particular, inherited wealth has been less important historically in the U.S. and, to some extent, is still less important. That's because of this constant renewal of the population. Because migrants don't come with a lot of wealth and inheritance, in effect the overall importance of inherited wealth has been less of a factor in the U.S. than in Europe.

So to some extent, this belief in U.S. exceptionalism is justified. But what I conclude in my book is that, first, this might not last forever, because at some point population growth in the U.S. could slow, so the U.S. will face the same problem as countries with stagnant population growth.

Secondly, it's not enough to rely only on this constant renewal of the population and constant population growth to have a meritocratic system. Even if inheritance is less important in the U.S. than in traditional patrimonial societies, you can have huge inequality in earnings as a result of, for instance, a very large rise in top managerial compensation. Also, you can have huge inequality in access to education.

Each country has its own history and belief system regarding inequality, and these beliefs are always partly justified and partly self-serving because people's national pride and identity are tied up in how their country deals with inequality.

This is certainly true in France, and it's also true in the U.S. I'm trying in this book to put all these national experiences into a broad perspective so we can learn from each other. At the end of the day, there's a lot to learn from each country's experience.

MW: Beyond a global capital tax, what policies do you favor for reducing inequality in the U.S.?

TP: Better access to education -- that's really the key. In the book, I talk about access to top U.S. universities, and I give some numbers on the average income of the parents of Harvard undergraduates. Right now, this corresponds with the average income of the top 1 percent of the U.S. distribution.

This is quite extreme when you think about it. It's really hard to believe that, just on the basis of merit, it should be this way.

Of course, no country has found the ideal system when it comes to combining efficiency and equal opportunity in its education and university system. Speaking as a Frenchman and a European, I'm certainly not pretending that the university system in France is working well, because in fact it's not efficient and not fair. I'm not trying to say it's easy to solve the problem. The point is that it's a major challenge for every country to have better access and more equal access to skills and higher education.

More transparency also would be useful. One problem with the admission system in a number of universities is that there's no transparency -- we don't know the role that merit exams play, versus parental [influence] -- it's pretty opaque.

MW: You argue in the book that education isn't the panacea in reducing inequality that many people seem to think it is. What makes you say that?

TP: We need both education and progressive taxation. We don't want to choose -- we want both. As I say in the book, education is probably the main force behind a reduction in inequality both between countries and within countries. That has to do with the diffusion of education, the diffusion of skills and knowledge. That's absolutely central.

But that's not enough. If you try to explain what happens at the very top of the pay distribution with just education and skill-based explanations, it isn't enough to explain the kind of cross-country variation and historical variation that we observe in the data. And if you're concerned not only with the diffusion of labor income, but also with the dynamics of wealth distribution, then there are other processes, such as the rate of return [on wealth] versus the growth rate, which are important and which need to be taken care of by progressive taxation. So education is key, but it's not sufficient. We need both.

MW: What role do you see for government in reducing inequality in the U.S.?

TP: The most obvious ways government can help by is by providing better access to education, more progressive taxation of income and wealth, and a higher minimum wage.

MW: Of course, politics in the U.S. today are deeply polarized. Can the government form a meaningful response to inequality given this partisan environment, or do politics in America have to change?

TP: That's a very difficult question. It could be that with the kind of campaign finance system you have now in the U.S., it's indeed difficult to make progress. But around 1900 or 1910, many people would have said that democratic institutions and universal suffrage would never be strong enough to respond to inequality. And yet the progressive federal income tax was eventually created, a progressive estate tax was created, and for a long time those did their job. To some extent, the system is still working today.

The challenges that have to be addressed in the future aren't any more complicated than the challenges of the past. I'm not as pessimistic as a number of observers seem to believe. Certainly, it's difficult to organize a large federation -- there's always a temptation for localism. And I can tell you that, speaking from a European perspective, organizing a federation with 500 million inhabitants within nation-states that are very touchy about their power, that's a complicated matter.

At the end of the day, you're doing a better job in the U.S. than the EU, even if federal institutions in the U.S. aren't always responding to fiscal challenges as efficiently as we'd like, but you're certainly doing a better job than in Europe.

MW: Some have suggested that your book has broken through in part because you're solidly in the economic mainstream today and arguably not as far to the left as others who have studied inequality. Is there any truth to that view?

TP: Maybe that's right, but at the end of the day the problem isn't one of being mainstream or not mainstream. What's new in this book, and what didn't exist in previous books, is that it's based on the largest historical database on income and wealth inequality that's ever been collected. I didn't collect it all by myself -- this was a collective research project that involved more than 30 colleagues from every part of the world.

Sometimes the conflicts within the economics profession between mainstream and heterodox economists... I feel this is often a waste of time. To me the main problem is to focus on the issue, and to try to break some of these barriers between and within disciplines that we have constructed and that prevent us from addressing these issues.

Certainly, I had a great time at MIT as a young assistant professor 20 years ago. And, as you say, I've never been at war with mainstream economists. I don't find them perfect, and I find a lot to criticize -- I think they should do more historical research. But having gotten some early recognition by the mainstream of the profession helped me not to be at war with economics. I just tried to make progress on collecting data and addressing the issue rather than joining internal battles within the profession.

MW: "Capital" has become a big hit on these shores. Do you think Americans are opening their eyes to the rising inequality you describe in the book?

TP: The good thing about America is that it's big, so in principle this means that the American government can do a lot of good things. The bad news is that, because America is so large, sometimes people tend to forget about the rest of the world and to be U.S.-centered in approaching the issues. And I think there's a lot to learn from other countries' experience.

For a long time, America defined itself as a counter-model to the sort of patrimonial societies associated with "old Europe." And it's a bit paradoxical that the U.S. is now reaching the kind of inequality that we saw in pre-World War I Europe. The structure of that inequality is different -- today's inequality in the U.S. relies more on very high managerial compensation and less on high levels of inherited wealth. But it could be that in the future you're going to combine both.

So, yes, this should be a matter of concern in the U.S. To some extent it already is a matter of concern, but we need to look more at other countries' experience.

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