Capital in the Twenty-First Century

by Thomas Piketty

  This episode is interesting because it illustrates the limits of the central banks and financial authorities. Their strength is that they can act quickly; their weakness is their limited capacity to correctly target the redistributions they cause to occur. The conclusion is that a progressive tax on capital is not only useful as a permanent tax but can also function well as an exceptional levy (with potentially high rates) in the resolution of major banking crises. In the Cypriot case, it is not necessarily shocking that savers were asked to help resolve the crisis, since the country as a whole bears responsibility for the development strategy chosen by its government. What is deeply shocking, on the other hand, is that the authorities did not even seek to equip themselves with the tools needed to apportion the burden of adjustment in a just, transparent, and progressive manner. The good news is that this episode may lead international authorities to recognize the limits of the tools currently at their disposal. If one asks the officials involved why the tax proposed for Cyprus had such little progressivity built into it and was imposed on such a limited base, their immediate response is that the banking data needed to apply a more steeply progressive schedule were not available.24 The bad news is that the authorities seem in no great hurry to resolve the problem, even though the technical solution is within reach. It may be that a progressive tax on capital faces purely ideological obstacles that will take some time to overcome.

  The Euro: A Stateless Currency for the Twenty-First Century?

  The various crises that have afflicted southern European banks since 2009 raise a more general question, which has to do with the overall architecture of the European Union. How did Europe come to create—for the first time in human history on such a vast scale—a currency without a state? Since Europe’s GDP accounted for nearly one-quarter of global GDP in 2013, the question is of interest not just to inhabitants of the Eurozone but to the entire world.

  The usual answer to this question is that the creation of the euro—agreed on in the 1992 Maastricht Treaty in the wake of the fall of the Berlin Wall and the reunification of Germany and made a reality on January 1, 2002, when automatic teller machines across the Eurozone first began to dispense euro notes—is but one step in a lengthy process. Monetary union is supposed to lead naturally to political, fiscal, and budgetary union, to ever closer cooperation among the member states. Patience is essential, and union must proceed step by step. No doubt this is true to some extent. In my view, however, the unwillingness to lay out a precise path to the desired end—the repeated postponement of any discussion of the itinerary to be followed, the stages along the way, or the ultimate endpoint—may well derail the entire process. If Europe created a stateless currency in 1992, it did so for reasons that were not simply pragmatic. It settled on this institutional arrangement in the late 1980s and early 1990s, at a time when many people believed that the only function of central banking was to control inflation. The “stagflation” of the 1970s had convinced governments and people that central banks ought to be independent of political control and target low inflation as their only objective. That is why Europe created a currency without a state and a central bank without a government. The crisis of 2008 shattered this static vision of central banking, as it became apparent that in a serious economic crisis central banks have a crucial role to play and that the existing European institutions were wholly unsuited to the task at hand.

  Make no mistake. Given the power of central banks to create money in unlimited amounts, it is perfectly legitimate to subject them to rigid constraints and clear restrictions. No one wants to empower a head of state to replace university presidents and professors at will, much less to define the content of their teaching. By the same token, there is nothing shocking about imposing tight restrictions on the relations between governments and monetary authorities. But the limits of central bank independence should also be precise. In the current crisis, no one, to my knowledge, has proposed that central banks be returned to the private status they enjoyed in many countries prior to World War I (and in some places as recently as 1945).25 Concretely, the fact that central banks are public institutions means that their leaders are appointed by governments (and in some cases by parliaments). In many cases these leaders cannot be removed for the length of their mandate (usually five or six years) but can be replaced at the end of that term if their policies are deemed inadequate, which provides a measure of political control. In practice, the leaders of the Federal Reserve, the Bank of Japan, and the Bank of England are expected to work hand in hand with the legitimate, democratically elected governments of their countries. In each of these countries, the central bank has in the past played an important role in stabilizing interest rates and public debt at low and predictable levels.

  The ECB faces a unique set of problems. First, the ECB’s statutes are more restrictive than those of other central banks: the objective of keeping inflation low has absolute priority over the objectives of maintaining growth and full employment. This reflects the ideological context in which the ECB was conceived. Furthermore, the ECB is not allowed to purchase newly issued government debt: it must first allow private banks to lend to the member states of the Eurozone (possibly at a higher rate of interest than that which the ECB charges the private banks) and then purchase the bonds on the secondary market, as it did ultimately, after much hesitation, for the sovereign debt of governments in southern Europe.26 More generally, it is obvious that the ECB’s main difficulty is that it must deal with seventeen separate national debts and seventeen separate national governments. It is not easy for the bank to play its stabilizing role in such a context. If the Federal Reserve had to choose every morning whether to concentrate on the debt of Wyoming, California, or New York and set its rates and quantities in view of its judgment of the tensions in each particular market and under pressure from each region of the country, it would have a very hard time maintaining a consistent monetary policy.

  From the introduction of the euro in 2002 to the onset of the crisis in 2007–2008, interest rates were more or less identical across Europe. No one anticipated the possibility of an exit from the euro, so everything seemed to work well. When the global financial crisis began, however, interest rates began to diverge rapidly. The impact on government budgets was severe. When a government runs a debt close to one year of GDP, a difference of a few points of interest can have considerable consequences. In the face of such uncertainty, it is almost impossible to have a calm democratic debate about the burdens of adjustment or the indispensable reforms of the social state. For the countries of southern Europe, the options were truly impossible. Before joining the euro, they could have devalued their currency, which would at least have restored competitiveness and spurred economic activity. Speculation on national interest rates was in some ways more destabilizing than the previous speculation on exchange rates among European currencies, particularly since crossborder bank lending had meanwhile grown to such proportions that panic on the part of a handful of market actors was enough to trigger capital flows large enough to seriously affect countries such as Greece, Portugal, and Ireland, and even larger countries such as Spain and Italy. Logically, such a loss of monetary sovereignty should have been compensated by guaranteeing that countries could borrow if need be at low and predictable rates.

  The Question of European Unification

  The only way to overcome these contradictions is for the countries of the Eurozone (or at any rate those who are willing) to pool their public debts. The German proposal to create a “redemption fund,” which I touched on earlier, is a good starting point, but it lacks a political component.27 Concretely, it is impossible to decide twenty years in advance what the exact pace of “redemption” will be—that is, how quickly the stock of pooled debt will be reduced to the target level. Many parameters will affect the outcome, starting with the state of the economy. To decide how quickly to pay down the pooled debt, or, in other words, to decide how much public debt the Eurozone should carry, one would need to
empower a European “budgetary parliament” to decide on a European budget. The best way to do this would be to draw the members of this parliament from the ranks of the national parliaments, so that European parliamentary sovereignty would rest on the legitimacy of democratically elected national assemblies.28 Like any other parliament, this body would decide issues by majority vote after open public debate. Coalitions would form, based partly on political affiliation and partly on national affiliation. The decisions of such a body will never be ideal, but at least we would know what had been decided and why, which is important. It is preferable, I think, to create such a new body rather than rely on the current European Parliament, which is composed of members from twenty-seven states (many of which do not belong to the Eurozone and do not wish to pursue further European integration at this time). To rely on the existing European Parliament would also conflict too overtly with the sovereignty of national parliaments, which would be problematic in regard to decisions affecting national budget deficits. That is probably the reason why transfers of power to the European Parliament have always been quite limited in the past and will likely remain so for quite some time. It is time to accept this fact and to create a new parliamentary body to reflect the desire for unification that exists within the Eurozone countries (as indicated most clearly by their agreement to relinquish monetary sovereignty with due regard for the consequences).

  Several institutional arrangements are possible. In the spring of 2013, the new Italian government pledged to support a proposal made a few years earlier by German authorities concerning the election by universal suffrage of a president of the European Union—a proposal that logically ought to be accompanied by a broadening of the president’s powers. If a budgetary parliament decides what the Eurozone’s debt ought to be, then there clearly needs to be a European finance minister responsible to that body and charged with proposing a Eurozone budget and annual deficit. What is certain is that the Eurozone cannot do without a genuine parliamentary chamber in which to set its budgetary strategy in a public, democratic, and sovereign manner, and more generally to discuss ways to overcome the financial and banking crisis in which Europe currently finds itself mired. The existing European councils of heads of state and finance ministers cannot do the work of this budgetary body. They meet in secret, do not engage in open public debate, and regularly end their meetings with triumphal midnight communiqués announcing that Europe has been saved, even though the participants themselves do not always seem to be sure about what they have decided. The decision on the Cypriot tax is typical in this regard: although it was approved unanimously, no one wanted to accept responsibility in public.29 This type of proceeding is worthy of the Congress of Vienna (1815) but has no place in the Europe of the twenty-first century. The German and Italian proposals alluded to above show that progress is possible. It is nevertheless striking to note that France has been mostly absent from this debate through two presidencies,30 even though the country is prompt to lecture others about European solidarity and the need for debt mutualization (at least at the rhetorical level).31

  Unless things change in the direction I have indicated, it is very difficult to imagine a lasting solution to the crisis of the Eurozone. In addition to pooling debts and deficits, there are of course other fiscal and budgetary tools that no country can use on its own, so that it would make sense to think about using them jointly. The first example that comes to mind is of course the progressive tax on capital.

  An even more obvious example is a tax on corporate profits. Tax competition among European states has been fierce in this respect since the early 1990s. In particular, several small countries, with Ireland leading the way, followed by several Eastern European countries, made low corporate taxes a key element of their economic development strategies. In an ideal tax system, based on shared and reliable bank data, the corporate tax would play a limited role. It would simply be a form of withholding on the income tax (or capital tax) due from individual shareholders and bondholders.32 In practice, the problem is that this “withholding” tax is often the only tax paid, since much of what corporations declare as profit does not figure in the taxable income of individual shareholders, which is why it is important to collect a significant amount of tax at the source through the corporate tax.

  The right approach would be to require corporations to make a single declaration of their profits at the European level and then tax that profit in a way that is less subject to manipulation than is the current system of taxing the profits of each subsidiary individually. The problem with the current system is that multinational corporations often end up paying ridiculously small amounts because they can assign all their profits artificially to a subsidiary located in a place where taxes are very low; such a practice is not illegal, and in the minds of many corporate managers it is not even unethical.33 It makes more sense to give up the idea that profits can be pinned down to a particular state or territory; instead, one can apportion the revenues of the corporate tax on the basis of sales or wages paid within each country.

  A related problem arises in connection with the tax on individual capital. The general principle on which most tax systems are based is the principle of residence: each country taxes the income and wealth of individuals who reside within its borders for more than six months a year. This principle is increasingly difficult to apply in Europe, especially in border areas (for example, along the Franco-Belgian border). What is more, wealth has always been taxed partly as a function of the location of the asset rather than of its owner. For example, the owner of a Paris apartment must pay property tax to the city of Paris, even if he lives halfway around the world and regardless of his nationality. The same principle applies to the wealth tax, but only in regard to real estate. There is no reason why it could not also be applied to financial assets, based on the location of the corresponding business activity or company. The same is true for government bonds. Extending the principle of “residence of the capital asset” (rather than of its owner) to financial assets would obviously require automatic sharing of bank data to allow the tax authorities to assess complex ownership structures. Such a tax would also raise the issue of multinationality.34 Adequate answers to all these questions can clearly be found only at the European (or global) level. The right approach is therefore to create a Eurozone budgetary parliament to deal with them.

  Are all these proposals utopian? No more so than attempting to create a stateless currency. When countries relinquish monetary sovereignty, it is essential to restore their fiscal sovereignty over matters no longer within the purview of the nation-state, such as the interest rate on public debt, the progressive tax on capital, or the taxation of multinational corporations. For the countries of Europe, the priority now should be to construct a continental political authority capable of reasserting control over patrimonial capitalism and private interests and of advancing the European social model in the twenty-first century. The minor disparities between national social models are of secondary importance in view of the challenges to the very survival of the common European model.35

  Another point to bear in mind is that without such a European political union, it is highly likely that tax competition will continue to wreak havoc. The race to the bottom continues in regard to corporate taxes, as recently proposed “allowances for corporate equity” show.36 It is important to realize that tax competition regularly leads to a reliance on consumption taxes, that is, to the kind of tax system that existed in the nineteenth century, where no progressivity is possible. In practice, this favors individuals who are able to save, to change their country of residence, or both.37 Note, however, that progress toward some forms of fiscal cooperation has been more rapid than one might imagine at first glance: consider, for example, the proposed financial transactions tax, which could become one of the first truly European taxes. Although such a tax is far less significant than a tax on capital or corporate profits (in terms of both revenues and distributive impact), recent progress on this ta
x shows that nothing is foreordained.38 Political and fiscal history always blaze their own trails.

  Government and Capital Accumulation in the Twenty-First Century

  Let me now take a step back from the immediate issues of European construction and raise the following question: In an ideal society, what level of public debt is desirable? Let me say at once that there is no certainty about the answer, and only democratic deliberation can decide, in keeping with the goals each society sets for itself and the particular challenges each country faces. What is certain is that no sensible answer is possible unless a broader question is also raised: What level of public capital is desirable, and what is the ideal level of total national capital?

  In this book, I have looked in considerable detail at the evolution of the capital/income ratio β across space and time. I have also examined how β is determined in the long run by the savings and growth rates of each country, according to the law β = s / g. But I have not yet asked what β is desirable. In an ideal society, should the capital stock be equal to five years of national income, or ten years, or twenty? How should we think about this question? It is impossible to give a precise answer. Under certain hypotheses, however, one can establish a ceiling on the quantity of capital that one can envision accumulating a priori. The maximal level of capital is attained when so much has been accumulated that the return on capital, r, supposed to be equal to its marginal productivity, falls to be equal to the growth rate g. In 1961 Edmund Phelps baptized the equality r = g the “golden rule of capital accumulation.” If one takes it literally, the golden rule implies much higher capital/income ratios than have been observed historically, since, as I have shown, the return on capital has always been significantly higher than the growth rate. Indeed, r was much greater than g before the nineteenth century (with a return on capital of 4–5 percent and a growth rate below 1 percent), and it will probably be so again in the twenty-first century (with a return of 4–5 percent once again and long-term growth not much above 1.5 percent).39 It is very difficult to say what quantity of capital would have to be accumulated for the rate of return to fall to 1 or 1.5 percent. It is surely far more than the six to seven years of national income currently observed in the most capital-intensive countries. Perhaps it would take ten to fifteen years of national income, maybe even more. It is even harder to imagine what it would take for the return on capital to fall to the low growth levels observed before the eighteenth century (less than 0.2 percent). One might need to accumulate capital equivalent to twenty to thirty years of national income: everyone would then own so much real estate, machinery, tools, and so on that an additional unit of capital would add less than 0.2 percent to each year’s output.