Capital in the Twenty-First Century (65 page)

In addition, the composition of the largest fortunes left them (on average) more exposed
to losses due to the two world wars. In particular, the probate records show that
foreign assets made up as a much as a quarter of the largest fortunes on the eve of
World War I, nearly half of which consisted of the sovereign debt of foreign governments
(especially Russia, which was on the verge of default). Unfortunately, we do not have
comparable data for Britain, but there is no doubt that foreign assets played at least
as important a role in the largest British fortunes. In both France and Britain, foreign
assets virtually disappeared after the two world wars.

The importance of this factor should not be overstated, however, since the wealthiest
individuals were often in a good position to reallocate their portfolios at the most
profitable moment. It is also striking to discover that many individuals, and not
just the wealthiest, owned significant amounts of foreign assets on the eve of World
War I. When we examine the structure of Parisian portfolios in the late nineteenth
century and Belle Époque, we find that they were highly diversified and quite “modern”
in their composition. On the eve of the war, about a third of assets were in real
estate (of which approximately two-thirds was in Paris and one-third in the provinces,
including a small amount of agricultural land), while financial assets made up almost
two-thirds. The latter consisted of both French and foreign stocks and (public as
well as private) bonds, fairly well balanced at all levels of wealth (see
Table 10.1
).
³⁴
The society of rentiers that flourished in the Belle Époque was not a society of
the past based on static landed capital: it embodied a modern attitude toward wealth
and investment. But the cumulative inegalitarian logic of r
>
g
made it prodigiously and persistently inegalitarian. In such a society, there is
not much chance that freer, more competitive markets or more secure property rights
can reduce inequality, since markets were already highly competitive and property
rights firmly secured. In fact, the only thing that undermined this equilibrium was
the series of shocks to capital and its income that began with World War I.

Finally, the period 1914–1945 ended in a number of European countries, and especially
in France, with a redistribution of wealth that affected the largest fortunes disproportionately,
especially those consisting largely of stock in large industrial firms. Recall, in
particular, the nationalization of certain companies as a sanction after Liberation
(the Renault automobile company is the emblematic example), as well as the national
solidarity tax, which was also imposed in 1945. This progressive tax was a one-time
levy on both capital and acquisitions made during the Occupation, but the rates were
extremely high and imposed an additional burden on the individuals affected.
³⁵

In the end, then, it is hardly surprising that the concentration of wealth decreased
sharply everywhere between 1910 and 1950. In other words, the descending portion of
Figures 10.1
–
5
is not the most difficult part to explain. The more surprising part at first glance,
and in a way the more interesting part, is that the concentration of wealth never
recovered from the shocks I have been discussing.

To be sure, it is important to recognize that capital accumulation is a long-term
process extending over several generations. The concentration of wealth in Europe
during the Belle Époque was the result of a cumulative process over many decades or
even centuries. It was not until 2000–2010 that total private wealth (in both real
estate and financial assets), expressed in years of national income, regained roughly
the level it had attained on the eve of World War I. This restoration of the capital/income
ratio in the rich countries is in all probability a process that is still ongoing.

It is not very realistic to think that the violent shocks of 1914–1945 could have
been erased in ten or twenty years, thereby restoring by 1950–1960 a concentration
of wealth equal to that seen in 1900–1910. Note, too, that inequality of wealth began
to rise again in 1970–1980. It is therefore possible that a catch-up process is still
under way today, a process even slower than the revival of the capital/income ratio,
and that the concentration of wealth will soon return to past heights.

In other words, the reason why wealth today is not as unequally distributed as in
the past is simply that not enough time has passed since 1945. This is no doubt part
of the explanation, but by itself it is not enough. When we look at the top decile’s
share of wealth and even more at the top centile’s (which was 60–70 percent across
Europe in 1910 and only 20–30 percent in 2010), it seems clear that the shocks of
1914–1945 caused a structural change that is preventing wealth from becoming quite
as concentrated as it was previously. The point is not simply quantitative—far from
it. In the next chapter, we will see that when we look again at the question raised
by Vautrin’s lecture on the different standards of living that can be attained by
inheritance and labor, the difference between a 60–70 percent share for the top centile
and a 20–30 percent share is relatively simple. In the first case, the top centile
of the income hierarchy is very clearly dominated by top capital incomes: this is
the society of rentiers familiar to nineteenth-century novelists. In the second case,
top earned incomes (for a given distribution) roughly balance top capital incomes
(we are now in a society of managers, or at any rate a more balanced society). Similarly,
the emergence of a “patrimonial middle class” owning between a quarter and a third
of national wealth rather than a tenth or a twentieth (scarcely more than the poorest
half of society) represents a major social transformation.

What structural changes occurred between 1914 and 1945, and more generally during
the twentieth century, that are preventing the concentration of wealth from regaining
its previous heights, even though private wealth overall is prospering almost as handsomely
today as in the past? The most natural and important explanation is that governments
in the twentieth century began taxing capital and its income at significant rates.
It is important to notice that the very high concentration of wealth observed in 1900–1910
was the result of a long period without a major war or catastrophe (at least when
compared to the extreme violence of twentieth-century conflicts) as well as without,
or almost without, taxes. Until World War I there was no tax on capital income or
corporate profits. In the rare cases in which such taxes did exist, they were assessed
at very low rates. Hence conditions were ideal for the accumulation and transmission
of considerable fortunes and for living on the income of those fortunes. In the twentieth
century, taxes of various kinds were imposed on dividends, interest, profits, and
rents, and this changed things radically.

To simplify matters: assume initially that capital income was taxed at an average
rate close to 0 percent (and in any case less than 5 percent) before 1900–1910 and
at about 30 percent in the rich countries in 1950–1980 (and to some extent until 2000–2010,
although the recent trend has been clearly downward as governments engage in fiscal
competition spearheaded by smaller countries). An average tax rate of 30 percent reduces
a pretax return of 5 percent to a net return of 3.5 percent after taxes. This in itself
is enough to have significant long-term effects, given the multiplicative and cumulative
logic of capital accumulation and concentration. Using the theoretical models described
above, one can show that an effective tax rate of 30 percent, if applied to all forms
of capital, can by itself account for a very significant deconcentration of wealth
(roughly equal to the decrease in the top centile’s share that we see in the historical
data).
³⁶

In this context, it is important to note that the effect of the tax on capital income
is not to reduce the total accumulation of wealth but to modify the structure of the
wealth distribution over the long run. In terms of the theoretical model, as well
as in the historical data, an increase in the tax on capital income from 0 to 30 percent
(reducing the net return on capital from 5 to 3.5 percent) may well leave the total
stock of capital unchanged over the long run for the simple reason that the decrease
in the upper centile’s share of wealth is compensated by the rise of the middle class.
This is precisely what happened in the twentieth century—although the lesson is sometimes
forgotten today.

It is also important to note the rise of progressive taxes in the twentieth century,
that is, of taxes that imposed higher rates on top incomes and especially top capital
incomes (at least until 1970–1980), along with estate taxes on the largest estates.
In the nineteenth century, estate tax rates were extremely low, no more than 1–2 percent
on bequests from parents to children. A tax of this sort obviously has no discernible
effect on the process of capital accumulation. It is not so much a tax as a registration
fee intended to protect property rights. The estate tax became progressive in France
in 1901, but the highest rate on direct-line bequests was no more than 5 percent (and
applied to at most a few dozen bequests a year). A rate of this magnitude, assessed
once a generation, cannot have much effect on the concentration of wealth, no matter
what wealthy individuals thought at the time. Quite different in their effect were
the rates of 20–30 percent or higher that were imposed in most wealthy countries in
the wake of the military, economic, and political shocks of 1914–1945. The upshot
of such taxes was that each successive generation had to reduce its expenditures and
save more (or else make particularly profitable investments) if the family fortune
was to grow as rapidly as average income. Hence it became more and more difficult
to maintain one’s rank. Conversely, it became easier for those who started at the
bottom to make their way, for instance by buying businesses or shares sold when estates
went to probate. Simple simulations show that a progressive estate tax can greatly
reduce the top centile’s share of wealth over the long run.
³⁷
The differences between estate tax regimes in different countries can also help to
explain international differences. For example, why have top capital incomes in Germany
been more concentrated than in France since World War II, suggesting a higher concentration
of wealth? Perhaps because the highest estate tax rate in Germany is no more than
15–20 percent, compared with 30–40 percent in France.
³⁸

Both theoretical arguments and numerical simulations suggest that taxes suffice to
explain most of the observed evolutions, even without invoking structural transformations.
It is worth reiterating that the concentration of wealth today, though markedly lower
than in 1900–1910, remains extremely high. It does not require a perfect, ideal tax
system to achieve such a result or to explain a transformation whose magnitude should
not be exaggerated.

Given the many mechanisms in play and the multiple uncertainties involved in tax simulations,
it would nevertheless be going too far to conclude that no other factors played a
significant role. My analysis thus far has shown that two factors probably did play
an important part, independent of changes in the tax system, and will continue to
do so in the future. The first is the probable slight decrease in capital’s share
of income and in the rate of return on capital over the long run, and the second is
that the rate of growth, despite a likely slowing in the twenty-first century, will
be greater than the extremely low rate observed throughout most of human history up
to the eighteenth century. (Here I am speaking of the purely economic component of
growth, that is, growth of productivity, which reflects the growth of knowledge and
technological innovation.) Concretely, as
Figure 10.11
shows, it is likely that the difference
r
>
g
will be smaller in the future than it was before the eighteenth century, both because
the return on capital will be lower (4–4.5 percent, say, rather than 4.5–5 percent)
and growth will be higher (1–1.5 percent rather than 0.1–0.2 percent), even if competition
between states leads to the elimination of all taxes on capital. If theoretical simulations
are to be believed, the concentration of wealth, even if taxes on capital are abolished,
would not necessarily return to the extreme level of 1900–1910.

There are no grounds for rejoicing, however, in part because inequality of wealth
would still increase substantially (halving the middle-class share of national wealth,
for example, which voters might well find unacceptable) and in part because there
is considerable uncertainty in the simulations, and other forces exist that may well
push in the opposite direction, that is, toward an even greater concentration of capital
than in 1900–1910. In particular, demographic growth may be negative (which could
drive growth rates, especially in the wealthy countries, below those observed in the
nineteenth century, and this would in turn give unprecedented importance to inherited
wealth). In addition, capital markets may become more and more sophisticated and more
and more “perfect” in the sense used by economists (meaning that the return on capital
will become increasingly disconnected from the individual characteristics of the owner
and therefore cut against meritocratic values, reinforcing the logic of
r
>
g
). As I will show later, in addition, financial globalization seems to be increasing
the correlation between the return on capital and the initial size of the investment
portfolio, creating an inequality of returns that acts as an additional—and quite
worrisome—force for divergence in the global wealth distribution.