Taxing capital risks underinvestment in our future

Opinion: Thomas Piketty’s proposals could effectively abolish capitalism

Fans of capitalism are a vanishing breed. In the wake of the great financial crisis, few people are willing to put their heads above the parapet to defend a system that has generated so much misery. Indeed, critics are in the ascendant.

The new darling of the left, Thomas Piketty, says he does not want to abolish capitalism but his policy suggestions could result in precisely that outcome. In what looks like a Piketty-inspired policy proposal, the left wing think tank, the Nevin Economic Research Institute, in its pre-budget submission this week called for "redistribution of excess returns to capital". Nobody, it seems, likes profits.

All very understandable: our flirtation with a second Great Depression has laid bare many of capitalism’s weaknesses. Reform is necessary but there is little agreement on the what that means. For some, it is a matter of small tweaks; others see a chance for the resurrection of hard left policies, long thought buried under the rubble of the Berlin Wall.

An orthodox defence of capitalism starts with history. Until we adopted the habits and methods of the market economy, economic growth was, on average, zero. That’s from the time we lived in caves up until the industrial revolution: average per capita economic growth, globally, was noticeable only by its absence.


Yes, there are economic historians who have made valiant attempts to construct global GDP data spanning our dim and distant past. And the numbers are pretty stark: growth did occasionally occur, in places, but was always reversed for one reason or another. War, disease and Malthusian population dynamics prevented the world from becoming better off. Capitalism changed all that. Critical to understanding just why this happened is the role played by saving, investment and the returns to both – the return on capital.

Piketty and the Nevin Institute are right to focus on this. The creation of markets that enabled saving to become more than accumulating gold trinkets in turn enabled economic growth. Saving and its logical counterpart, investing, create the economic future: without them there cannot be any growth.

If it is accepted that saving and investment are the keys to our future, the only question is just who is in charge? Do we leave the critical decisions to markets or assume that government is best placed to know how much we need to save and where best we can invest.

Flabby liberal (in the European sense) economists have traditionally accepted a role for both: markets, when they work, are the best allocators of capital but governments need to step in when there is clear evidence of market failure. Historically, the observed links between high levels of government intervention in the economy and low levels of political freedom have also influenced modern thinking. The interventions proposed by Piketty and the Nevin Institute are for increased taxation of the returns to capital. It is explicitly assumed that returns are excessive.

In terms of data, the longest and best source of numbers is the US economy. There, the long run return on an investment in the stock market is, not by coincidence, almost exactly the same as long-run real per capita GDP growth (roughly 2 per cent since 1900).

This is only one measure of the return on capital. We get the Piketty result – returns in excess of GDP growth – only by assuming our capitalist never spends any of his returns and reinvests them back in the stock market. None of this looks to me consistent with the idea that capitalism’s returns are excessive: the US stock market has been the best place to invest, but even there it is only over the very long run that these returns are available.

There are plenty of ways, time periods, asset classes and countries where returns are feeble or even negative. Just think of property, for example, or an investment in German government bonds during the 1920s or technology stocks in 1999. The problem today is not the return on investment but rather the lack of investment. Capitalism isn’t working as it should: in many countries there are obvious investment needs and opportunities but the mechanism for delivering the necessary capital spending is broken. The cash is there but it cannot find the right home.

Government can do something about this, but taxing capital is, at best, beside the point and probably dangerous in a world that is suffering from an investment shortfall.