Ellsworth Toohey Lives

In Ayn Rand’s novel The Fountainhead, Dominque Francon and Ellsworth Toohey are in a high rise apartment, looking out at the evening lights of New York City. Toohey speaks:

Look at it. A sublime achievement, isn’t it? A heroic achievement. Think of the thousands who worked to create it and of the millions who profit by it. And it is said that but for the spirit of a dozen men, here and there down the ages, but for a dozen men — less, perhaps — none of this would have been possible. And that might be true. If so, there are — again — two possible attitudes to take. We can say that these twelve were great benefactors, that we are all fed by the overflow of the magnificent wealth of their spirit, and that we are glad to accept it in gratitude and brotherhood. Or, we can say that by the splendour of their achievement which we can neither equal nor keep, these twelve have shown us what we are, that we do not want the free gifts of their grandeur, that a cave by an oozing swamp and a fire of sticks rubbed together are preferable to skyscrapers and neon lights — if the cave and the sticks are the limit of our own creative capacities. Of the two attitudes, Dominique, which would you call the truly humanitarian one? Because, you see, I’m a humanitarian.

Until recently, I thought that the latter attitude had become completely disreputable. The idea that we should tear down the good just because they are good or the successful just because they are successful is bad economics, bad ethics and an embarrassingly childish form of envy.

But it has recently re-emerged in large part because of Thomas Piketty’s new book, Capital in the Twenty First Century. Piketty argues that we have been experiencing and will continue to experience growing inequality of income and wealth. To prevent this he argues for punitive taxes on high incomes and a worldwide tax on wealth.

Piketty’s book has created near ecstasy on the political left, where it is taken as an unquestioned article of faith that inequality of income and wealth is bad. See gushing praise from Paul Krugman here and gloating over the right’s ineffectual response to the book here. Among other economists, Robert Solo praises the book in The New Republic (“Piketty is Right”), but Greg Mankiw has a more measured response.

What is more interesting than the book itself is that the left now seems free to say things they previously would have been embarrassed to say.

Taxing the rich just for the spite of it. Until now, the main focus of reducing inequality has been to lift up those at the bottom. The new focus is on pushing down those at the top. As Daniel Shuchman explains:

Mr. Piketty urges an 80% tax rate on incomes starting at “$500,000 or $1 million.” This is not to raise money for education or to increase unemployment benefits. Quite the contrary, he does not expect such a tax to bring in much revenue, because its purpose is simply “to put an end to such incomes.”

Matt Yglesias is more than willing to pile on:

…[I]n an era of surging inequality…Maybe at least some taxes should be really high. Maybe even really really high. So high as to [be] useless for revenue-raising purposes — but powerful for achieving other ends.

What he has in mind is a 90% tax on large inheritances and a 90% tax on incomes in excess of $10 million a year. Not to raise revenue mind you, but to discourage their existence in the first place:

Very high taxation of inheritances would mean fewer big inheritances, not more tax revenue. Very high taxation of labor income would mean fewer huge compensation packages, not more revenue. Precisely as Laffer pointed out decades ago, imposing a 90 percent tax rate on something is not really a way to tax it at all — it’s a way to make sure it doesn’t happen.

As I wrote previously, people may care about inequality, but it isn’t obvious that income inequality is what they care most about. Would you rather have more income or more social status? Or a higher IQ? Or better looks? Or a longer life expectancy?

If we applied the Piketty/Yglesias approach to reducing inequality along these other dimensions, we would try to reduce the life expectancy of women in order to make it more equal to men — or at least we would tax women so that they couldn’t enjoy their longer lives as much. In order to create more equality of intelligence, we would try to lower the average IQ of the Mensa Society — or, again, at least tax them so they would get less enjoyment from their higher IQs.

If these ideas appeal to you, you are not in the mainstream.

Does it matter who owns capital? For those of us who haven’t bought into the religion, it’s fair to ask: what’s wrong with inequality? There are lots of economic studies showing that capital is good. More capital means higher wages and higher incomes for everybody. There are plenty of studies showing it’s important for capital to be owned. Unowned capital can lead to the tragedy of the commons. But I don’t know of any studies that show who owns capital is important.

So why does Piketty think the distribution of ownership of capital matters?  Apparently he views the world through the lens of Victorian novels. As a review in The New Yorker explains:

Eventually, Piketty says, we could see the reemergence of a world familiar to nineteenth-century Europeans; he cites the novels of Austen and Balzac. In this “patrimonial society,” a small group of wealthy rentiers lives lavishly on the fruits of its inherited wealth, and the rest struggle to keep up. For the United States, in particular, this would be a cruel and ironic fate. “The egalitarian pioneer ideal has faded into oblivion,” Piketty writes, “and the New World may be on the verge of becoming the Old Europe of the twenty-first century’s globalized economy.”

This is a strange way for an economist to talk. If you have to make your case by pointing to novels is your bottom line based on fiction? The likelihood of our living in an Upstairs/Downstairs future world is somewhere between zero and none. Capital in the modern world is invested in the capital market. Since the way it is invested is usually determined by investment managers, what happens to capital is largely independent of who owns it.

Someone who takes an active role in the investment of his own capital is Warren Buffet. The last time I checked, Forbes said he was worth almost $70 billion. Is anyone seriously going to argue that society would be much worse off if Buffet were worth $100 billion? Or that we would all be better off if he were worth only $10 billion?

Among other major holders of capital, we would have to count Harvard University, the Catholic Church, the Ford Foundation and public and private sector pension funds. Would any of us be better off or worse off if we gave Harvard’s wealth to Buffet? Or Buffet’s wealth to a pension fund? Or if the Catholic Church’s wealth were given to some other nonprofit organization? Ok, Buffett would care. Harvard would care. The beneficiaries of the pension fund would care. The Church would care. But there is no reason for anyone else to care.

What we should be concerned about is any proposal to redistribute capital to those who are likely to consume it rather than hold it. For example, if we redistribute income from investors to Food Stamp recipients, we are likely to get more consumption and less saving and investment. That would mean a smaller capital stock and that would make all the rest of us worse off. Similarly, because politicians are present oriented rather than future oriented, any proposal to tax wealth and give the government discretion over what to do with the new revenue would probably lead to a smaller capital stock and more entitlement spending.

Inequality of wealth vs. inequality of consumption.As it turns out Warren Buffet agrees with Thomas Piketty to a point. Buffett thinks he should pay higher taxes. But as I pointed out before:

You and I should not be indifferent about the taxes Warren Buffett pays. How he is taxed and how much he pays affects our own economic future…

Consider that when Warren Buffett is consuming, he’s benefiting himself. When he’s saving and investing, he’s benefiting you and me. Every time Buffett forgoes personal consumption (a pricey dinner, a larger house, a huge yacht) and puts his money in the capital market instead, he’s doing an enormous favor for everyone else. A larger capital stock means higher productivity and that means everyone can have more income for the same amount of work.

So it’s in our self-interest to have very low taxes on Buffett’s capital. In fact, capital taxes should be zero. That means no capital gains tax, no tax on dividends and profits — so long as the income is recycled back into the capital market. We should instead tax Buffett’s consumption. Tax him on what he takes out of the system, not what he puts into it. Tax him when he is benefiting himself, not when he is benefiting you and me.

Scott Sumner is about the only commenter who has made this point with respect to the Piketty book. His is the best commentary I have seen.

Why it is foolish to tax capital.The idea that if you want to help workers, the best tax rate on capital is zero has been long known in the economics profession. Garrett Jones explains:

Market-oriented economies that learn to live with inequality will reap the rewards: More domestic capital for workers to use on their jobs, more foreign capital flowing in to a country perceived as a safe investment, and a political and cultural system that can spend its time on topics other than the 1 percent. Market-oriented economies that instead follow Piketty’s preferred path — taxing capital heavily, preferably through international consortiums so the taxes are harder to evade — will end up with less domestic and foreign capital, fewer lenders willing to fund new housing projects, fewer new office buildings, and a cultural system focused on who has more and who has less.

…The Boston University economist Christophe Chamley and the Stanford economist Kenneth Judd came up independently with what we might call the Chamley-Judd Redistribution Impossibility Theorem: Any tax on capital is a bad idea in the long run, and that the overwhelming effect of a capital tax is to lower wages. A capital tax is such a bad idea that even if workers and capitalists really were two entirely separate groups of people — if workers could only eat their wages and capitalists just lived off of their interest like a bunch of trust-funders — it would still be impossible to permanently tax capitalists, hand the tax revenues to workers, and make the workers better off.

In defense of inequality. Would you rather live beside the millionaire next door or someone who has the same amount of wealth that you have? Some time back I wrote this:

I know I would much rather live around billionaires than people who earn what I do. People with a lot of money create business opportunities, employment opportunities and even social opportunities that I would otherwise miss out on. If there were no rich people around, I would never have been able to sit in a box at Cowboy Stadium, or sail in a yacht, or drive an Aston Martin. In fact, if there were no rich people, there wouldn’t be any sports boxes or yachts or Aston Martins.

For almost any skill or attribute, think of a bell curve distribution. Most people are near the middle of the distribution, while the most accomplished 2% are way out on the right tail. Now think about how your life is richer and more fulfilling and enjoyable because of the 2%. If you could take a magic wand and remove the 2% who are the best football payers, how enjoyable would Sunday’s TV football games be? Would you watch at all if the players on the field were all of “average” ability?

…The most important inequality, however, is intelligence. What we loosely call “genius” is a person…in the top 2% of the IQ distribution. Have you ever thought what would have happened if some freak accident of nature prevented the top 2% from ever being born. If nature’s distribution of IQ were only slightly narrower than the one we experience, we never would have had a Euclid, a Galileo, a Newton or an Einstein. In the business world, we never would have had a Thomas Edison, a Steve Jobs or a Bill Gates.

Not everyone with a high IQ is a high flyer. In fact the vast majority are not. But all the great scientific discoveries and all the great innovations came from people out there on the right tail. Without them, life for you and me today would be little different than it was in medieval times.

So the next time you say a prayer of thanks be sure to thank whatever gods may be for the fact that we are not all the same.

The psychology of the Ellsworth Toohey types. When I first read The Fountainhead, I wondered whether there really were such people as Ellsworth Toohey. What accident of evolution could have produced such an aberration?

It seems there are the producers and those who comment on the producers. David Brooks explains how the latter think:

You [the commenters] go to fund-raisers or school functions and there are always hedge fund managers and private equity people around. You get more attention than them at parties, but your whole apartment could fit in their dining room. You struggle with tuition, but their kids go off on ski weekends. You wait in line at the post office, but they have staff to do it for them.

You see firsthand the explosion of wealth at the tippy-top. It really doesn’t help that you have to spend your days kissing up to the oligarchs and their foundations to finance your research, exhibition or favorite cause.

The situation is ripe for the sort of class conflict the French sociologist Pierre Bourdieu used to describe: pitting those who are rich in cultural capital against those who are rich in financial capital.

Brooks goes on to tie this phenomenon to Piketty:

The reaction to Piketty is an amazing cultural phenomenon. But it says more about class rivalry within the educated classes than it does about how to really expand opportunity.

Postscript. Even though the Piketty book is being treated by almost everyone as a breakthrough in understanding income and wealth inequality, it turns out that a decade ago another paper was able to explain the distribution of income and wealth in the United States quite well without any reference to the theoretical constructs proposed by Piketty. Furthermore this paper was completely ignored by Piketty and has been ignored by just about everyone else who has been commenting on his book.

For the reference, I thank Tyler Cowen, who writes:

So much of the current Piketty debate is simply forgetting that…science exists and has already offered a wide range of insights on these topics, as well as having rendered some of the more extreme claims unlikely.

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