Originally Published 2014-05-16 05:39:40 Published on May 16, 2014
To correct the trend of agglomeration of wealth, young economist Thomas Picketty has suggested an annual progressive tax on wealth. He also says it will be difficult to implement it because there will always be flight to tax havens. In India, any type of wealth tax would be hardest to implement because a huge amount of wealth is already stashed away abroad.
Widening income inequalities
"A young French economist, Thomas Picketty, is creating waves with his new book 'Capital in the Twenty First Century', which is on Inequalities of income. He has been hailed by top economists of Harvard and MIT as having completed a monumental and exhaustive research endeavour. His work deals with historical data that covers a long of time and goes deep into the economic histories of nations to determine their wealth and income patterns. His theory is somehow familiar to all of us in India who are witnessing how inequality is growing. And though he has examined the data of mostly western developed countries, it is the same story in the case of India. He said recently in an interview that the top 1 per cent in India owns 8 to 9 per cent of the national income. With 61 dollar billionaires and 200,000 dollar millionaires, India has a top layer of very rich and a bottom layer of very poor comprising of around 300 million people.

His book is all about how capital begets capital and people who have capital to begin with, will always earn more than those who are trying to earn their living by working on salaries. However hard one may work, he or she will never be able to compete with people with capital and assets. As is well known, capital is uniquely and unequally distributed throughout the world. He explains why income inequality is worsening in the US and around the world since the 1970s. Currently in the US, the top 10 per cent own about 70 per cent of all the capital and half of that belongs to the top 1 per cent, the next 40 percent who compose the middle class own about a quarter of that total (mostly in the form of housing) and the remaining half of the population owns next to nothing or about 5 percent of total wealth.

The causes are well known-the deterioration of labour unions and collective bargaining, erosion of minimum wages and the impact of globalization which has led to intensified competition from low wage workers in poor countries, technical changes and shifts in demand that have led to low demand for unskilled jobs and rising demand for highly educated, skilled jobs at the top. The pattern is universal.

He divides wealth measured in local currency of the time by national income also in the local currency and arrives at wealth income ratio. For example the total wealth of France in 1850 amounted to about 7 years of income but only 4 years for US in 1950.

According to Picketty, income from wealth is concentrated because large blocks of wealth tend to earn a higher return than small ones. It is because big investors have access to a wider range of investment instruments than smaller investors. Income from work on the other hand is less concentrated than income from wealth. In the US the top 1 per cent earns 12 percent of all labour incomes, the next 9 per cent earn 23 per cent, the middle class gets about 40 per cent and the bottom half gets about 25 per cent from working in various occupations. In India the wealthy will remain rich for generations even though the middle class is growing in size. This is because if a person's income comes entirely from accumulated wealth, he or she is likely to be very wealthy because she will consume only a small fraction of her income. The rest is saved and accumulated, and her wealth will increase and so will the income. Thus as long as the rate of return on capital exceeds the rate of economic growth, the income and wealth of the rich will grow faster than the typical income coming from working in other occupations. This will naturally increase the trend towards increasingly inequality.

People also save from their incomes derived from labour and thus a fair amount of accumulation of capital takes place in the hands of wage and salary earners. But given the small initial wealth and relatively low saving rate of people below the top group plus the fact that small savings earn a relatively low rate of return, calculations have shown that this mechanism is not capable of offsetting the forecasted widening of inequality.

Thus it is an unequal society everywhere and the rich get richer and the dynamics of change strongly suggest that it will get more so in the future. In the twenty first century, there will be slower growth of population and productivity and a rate of return on capital will be distinctly higher than the growth rate of countries. As a result the wealth income ratio will rise back to nineteenth century heights.

Already it is true that agglomeration of wealth has tended to grow faster than incomes from work, it is likely that role of inherited wealth in society will increase relative to that of recently earned and more hard worked fortunes of the labouring class. Though the aggregate of wage incomes grow only at a relatively slow rate, there are cases of outstanding people who are successful innovators ( Bill Gates), managers, entertainers ( Bollywood stars), entrepreneurs who can accumulate large amounts of wealth in a lifetime and join the ranks of the 'rentier' class and live on rents. It is likely that their children will also enjoy the wealth. But if economic growth is slow, such success stories are less likely. Already there is ample proof that the concentration of wealth and its ability to grow will give an increasing weight to inheritance as compared to talent and hard work.

To correct this trend Picketty suggests an annual progressive tax on wealth worldwide but realizes that will be difficult to implement because there will always be flight to tax havens. In India any type of wealth tax would be hardest to implement because a huge amount of wealth is already stashed away abroad. Widening of inequality is inevitable in India in the future.

(The writer is a Senior Fellow at Observer Research Foundation, Delhi)
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David Rusnok

David Rusnok

David Rusnok Researcher Strengthening National Climate Policy Implementation (SNAPFI) project DIW Germany

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