More Notes on Inequality of Wealth

I’ve been thinking a bit about why wealth inequality really doesn’t matter – but I think the argument is a little more nuanced than I presented. In particular, what I wrote yesterday is concerned largely with the positive, but in reality this debate is intimately connected with normative action. In the wake of Piketty’s book (which I have not finished) a number of people are talking about taxes on global capital.

I don’t have a very strong opinion on that (other than a negative gut reaction). But there are things we can do closer to home – appealing to both conservatives and liberals – that would be more feasible and possibly more effective. In this debate we are faced with a slurry of terms that are sometimes used to describe the same underlying phenomenon but are each different: wealth, capital, returns on capital, and capital share of income.

While I am unconvinced that just the inequality of net worth (“wealth”) really does much harm to a nation’s socioeconomic fiber – indeed I think concentrated wealth is probably a necessary consequence of capitalism – it is clear that skill-biased technological change, and what that portend’s for labor’s share, is probably an important concern (if nothing else in the discussion of income inequality itself).

And here’s the problem. Government programs, the way they are currently structured, are largely to blame for gaping disparities like this:

(Before I go on, it is worthwhile noting this picture, yet again, confirms my previous point that wealth inequality per se isn’t increasing and was never a problem).

What we see isn’t surprising. The bottom 90% of Americans are basically excluded from the stock market – the most important source of long-run returns for pretty much everyone else. What’s striking here is that this inequality is far worse than inequality of wealth itself. So not only do the rich own more capital, they own the best capital.

To some extent this is unavoidable. Rich, well-connected elite have far better access to the best investment opportunities like secondary private markets and hedge funds that provide alpha. (Chances are if a hedge fund is doing well accounting for management fees, they don’t want you as a client). But the people that benefit from this are the extremely wealthy percent of a percent not even demarcated above, not simply affluent Americans who are still extremely well-represented in stock markets as a whole.

And the reason for this? Perhaps poor government policy.

The real wealth of most Americans is their claim on social security in the future. Social security has been an incredible source of, well, security for many citizens and pretty much the reason many are not in poverty today. But the Social Security Trust, which actually handles all of this money, is basically forcing you to invest in low-return government debt.

This becomes a source of inequality as social security as a portion of total implied wealth (here defined as your claim on future GDP) is far higher for the bottom 95% of Americans, who can barely save, than anybody else. On the other hand, for people that actually manage to save (even if just a little bit) the stock market is a source of real, long-term prosperity.

Furthermore, misguided government programs encouraging homeownership – something many economists have come to agree isn’t a good thing for poorer people – once again distorts private investment choices to relatively low-return stores of wealth like residential real estate. When the productivity growth is coming from financial, informational, and social capital, what value is owning a home in Podunk, Missouri?

Again, mortgages are the primary – and possibly only – source of explicit wealth for middle-class Americans.

Many conservative economists have reached the conclusion that we should probably privatize social security. As a purely financial matter, I am inclined to agree – the justification for our current program is fully predicated on the dangerous assumption that government bonds are the best long-term investment when, in fact, Vanguard Target Retirement 2045 is the way to go.

In fact, what we need is something akin to a Sovereign Wealth Fund that allocates payroll tax receipts in a more productive way. This should have great appeal to conservatives as well as liberals. For conservatives, it frees an immense source of domestic equity away from relatively inefficient projects furnished by the national government to more entrepreneurial and productive ventures in private markets. Indeed the cost of capital (in normal times) would probably fall. For liberals, it is the most logical extension of the welfare state, designed in a way complementary, not opposed, to modern capitalism.

This would solve what I see is the heart of the problem Ezra Klein and others are getting to when they worry about wealth inequality. It isn’t the disparity of wealth itself (which is background noise), but the changing structure of the returns. It is a tragedy that over the past thirty years, the stock distribution was so much more skewed than wealth distribution.

The government is ultimately a bank that can print its own money. What it should be doing is guaranteeing a minimum return in future receipts, as it does today, as well as investing in the option for more explosive growth. If the stock market performs so poorly as to not provide the returns necessary for to meet the obligation (and there’s a very low chance this would happen over the long run) the government can always finance the difference with a deficit. In fact, since returns would be far higher, chances are in a financially-driven recession, the increase in deficits would be lower.

This is probably not enough, but does more to solve inequality than a meaninglessly small increase in capital gains taxes would accomplish. More importantly, it achieves this without further harming private interests, and yet greatly increases capital redistribution. It would also unleash an incredible amount of capital for the investment the private sector desperately needs.

Here’s the short and sweet argument for privatized, but guaranteed, security. Rich people should give poor people equity in their companies rather than taxes to the government to solve issues of capital return disparity. The only role government should play is effectively guaranteeing a minimum return, in other words purchasing a barrier put on the S&P in the event valuations fall below what is promised. That is cheaper, more efficient, and the principle we ought to work on.