Money breeds money: Not just common sense

I described in my previous post that the rich tend to get richer while the poor find it very hard to amass any serious amount of wealth. I mentioned several of the processes that are likely to drive this tendency.

Sometimes things that appear to be common sense don't turn out to be true once they have been properly studied: the sun doesn't go round the earth but the earth rotates as it goes around the sun.

However, an economist, Thomas Piketty, appears to have gone to great pains (600 pages!) to provide the evidence for the trends I mentioned in my last post. The fruits of this work is the book Capital in the twentieth century, and his explanations of it and the reviews I have read make me want to read it.

I tend to agree with Piketty's conclusion that this tendency towards concentration of wealth, along with any other fact about capitalism, does not create the need to have a total revolution. Such anti-capitalist conclusions are clearly too hasty; you would need something better to replace capitalism with. But it does remind us of the need for constant efforts at redistribution to check the undesirable tendencies of free markets.

This provides a further argument against libertarianism. Libertarians support free-market outcomes for at least one of several reasons, but as well as attacking those (wrong-headed) reasons we can also point out that their proposals will have poor consequences. Hugely unequal societies in which a larger and larger share of resources are held by a smaller and smaller minority is not many people's idea of a utopia (bizzarro's such as Ayn Rand excepted).

Furthermore, if such a (dis?)utopia came about it may even be worse for those who are very well off, if Wilkinson and Pickett are to be believed. These authors show that more unequal societies are less successful and happy than more equal societies.

My tax proposals are aimed to providing the most redistribution possible commensurate with good economic performance. This is done by taxing those who get unearned income at much higher rates while encouraging economically useful activities, transfers and exchanges.

Why the rich get richer, and what this means for the tax system

There have been lots of articles in the papers over the past week resulting from the recent Oxfam report into the richest poorest members of society. It seems that the richest five families in the UK have as much wealth as the poorest 20% put together. That is five families against nearly 13 million people. This is unsurprising in that the richest are the richest and have a hell of a lot while the poorest are the poorest and have little or nothing.

However, the scale of the difference does not indicate that some people are saving while others are spending. Richard Seymour’s piece highlights how this difference is largely a result of the adage that “money follows money,” “money begets money” or “money makes money.” These can be understood to mean that people who have money find it easy to make more money, or alternatively that the children of the rich end up rich themselves. Both of these are usually true unless there is a highly redistributive or economically restrictive regime.

There are obvious reasons why the rich can easily get richer while the poor will find it very difficult to get richer. The wealthy can give their spare money to financial institutions, or just sit on their property and watch it increase in value. The poor have to use most if not all their resources on the basic costs of living, leaving little left over for investment. Wealthier people, by contrast have the same amount of time available to them to work and earn in that way, while earning money on invested capital. Meanwhile, any money they earn can be invested rather than used for necessaries. Furthermore, poorer people may need to take jobs with few prospects as they need money quickly while richer people can take a longer view and more easily develop a career.

Of course, you may get rich people who are very bad with their money and blow it all. Occasionally someone from a less wealthy background will build a business or obtain a very highly paid career. But these are anomalies, and the processes described above will tend to lead to greater and greater concentration of wealth over time unless checked. Which leads on (did you guess?) to taxation.

If we are looking at what to tax, there are very clear arguments to tax the returns to capital in preference to taxes on the income and consumption of the less-well-off. Certainly revenues above the change in the value of money should be taxed on a progressive basis. This is not punitive—people should be able to invest and earn something from this after tax. The punitive approach would discourage investment and that would be very bad for the economy. But it still makes sense to be taxing returns to capital at high rates in order to reduce taxes on those with low incomes.

Unfortunately things seem to be going in the opposite direction in many ways, as I will discuss in my following blog.