A capital agenda we can all agree on

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Article Highlights

  • .@stanveuger comes up with some new policy ideas from Piketty's capital analysis

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  • If capital accumulation for middle class is a problem, why not move from pay-go?

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  • If r>g, as Piketty argues, should we reform social security's structure?

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The activities of the federal government anno 2014 fall into two categories, roughly speaking. It maintains a military to defend the nation from threats from overseas (foreign policy) and it maintains a plethora of programs designed to crowd out savings (domestic policy). Pay-as-you-go (PAYGO) programs like Social Security, Medicare and unemployment insurance require a constant influx of tax revenue to fund old-age pensions, health care for seniors, and unemployment benefits. Were it not taken from them, citizens could use this money to save for retirement, for medical outlays, and for stints of unemployment. Under the current regime, none of this is possible and domestic savings are forcefully depressed.

One might think that this would leave the middle class without any kind of wealth, living from paycheck to paycheck and relying upon the government to provide for it in times of reduced incomes or uncommonly high spending. Capital in the 21st Century, the French socialist Thomas Piketty's ambitious book on the past, present and future of capitalism, shows us that that is not the case. (For the sake of argument, I will treat Piketty's data analysis, roughly the first 450 pages of his book, as given here, despite widespread concerns about both his data and his analysis.) Innovations and the free-market system have made middle-class Americans so much more prosperous that they can save even after making their contributions to the aforementioned PAYGO programs. Whereas around the end of the Gilded Age, the middle class, here defined as those between the top 10th and the 50th wealth percentiles, owned about 5 percent of all capital, it now owns five times as much, about 25 percent. And that is 25 percent of a total capital stock that is 16 times larger, or 80 times as much wealth in today's dollars. Astonishingly, at 5 percent, the bottom half of the wealth distribution now owns as large a share of total wealth as the the middle class did 100 years ago.

"This concern creates some much needed room for post-partisan agreement on structural reform to precisely those PAYGO programs mentioned earlier." - Stan Veuger Yet Piketty does not believe that that is enough, and that compared to the wealthiest 10 percent and the wealthiest 1 percent, the middle class has not accumulated enough wealth. This concern creates some much needed room for post-partisan agreement on structural reform to precisely those PAYGO programs mentioned earlier. As Chris DeMuth explained in The Wall Street Journal a few weeks ago, shifting Social Security toward a system of private accounts would do much to expand middle-class capital ownership. Piketty dismisses such an idea out of hand in his book, because he believes that the return to capital is "extremely volatile." Fortunately, the return to capital (r), which equals the return on your contributions to private accounts, is on average higher than the economy's growth rate (g) is likely to be. What determines the return on your contributions, in the absence of tax increases, to a PAYGO pensions system is precisely this g, adjusted for the ratio of retirees to workers. In an aging society, this return will be even lower than g, which, remember, is already lower than r. It is precisely this large gap between the return on private accounts and the return you receive in a PAYGO system that allows us to address understandable worries about risk: Holders of private accounts could sell off some of their upside risk in exchange for insurance that would help them out if they happen to retire after a period of low returns. This logic, which Martin Feldstein of Harvard University developed over a decade ago, would allow for significant wealth accumulation by all workers, at low levels of risk, and would, as a massive side benefit, help address the long-term fiscal challenges facing the nation.

Similar reform ideas could be applied to some of the other large social insurance programs that are currently funded year by year with the tax money of current workers, like Medicare and unemployment insurance. Helpfully, Feldstein has developed blueprints for those programs as well. Again, these reforms would come with important side benefits: Pre-funding Medicare would do even more than privatizing Social Security to alleviate looming budgetary pressures, whereas unemployment insurance savings accounts would end the current practice of improvised congressional decision-making around the livelihood of workers who just lost their jobs. But more to the point of Piketty's concerns: They would add tremendously to the stock of wealth held by the middle class, as total pension, health and unemployment savings would go up by some 150 percent of GDP, or almost 40 percent of total societal wealth. Add that to the amounts of wealth already owned by the "bottom 90 percent," and one would get close to what Piketty refers to as the "ideal society," one in which the top 10 percent owns but 30 percent of the capital stock.

Getting to this point would take quite some time, but there are other, smaller reforms that can speed up the process and produce a more balanced allocation of capital in the near future. For example, to address Piketty's concern that larger capitals reap higher returns, one could reduce the capital gains tax and the dividend tax for middle-class savers. To mitigate increases in the share of wealth dedicated to residential housing, which are responsible for the practical entirety of the capital stock increases Piketty documents, one could eliminate the mortgage interest deduction (and cut an enormous tax expenditure in the process), as well as ease the kind of land-use restrictions that have chased the middle class out of the most prosperous metropolitan areas.

These are important decisions, but they should not distract us from the central lesson that flows from Piketty's data analysis: that his "ideal society," like President George W. Bush's "ownership society," is well within reach. Piketty is not as optimistic, because the policy proposals he came up with in response to his findings are both detrimental to growth and highly unrealistic. The set of policies I have presented here are neither. They are based on ideas that have been around for some time, and not only would they make Piketty's dreams reality, but they would also secure the fiscal health of the federal government for the foreseeable future.

Veuger is a resident scholar at the American Enterprise Institute.

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