Our hunter-gatherer past helps explain opposition to free markets.
Marian L. Tupy —
Summary: This article argues that capitalism faces persistent opposition because it goes against some of our innate psychological traits that evolved in the Stone Age. It explains how our ancestors lived in small bands of hunter-gatherers who shared food and resources, and how they developed tendencies toward tribalism, egalitarianism, and zero-sum thinking. It suggests that these tendencies make us susceptible to anti-capitalist ideologies and suspicious of markets, trade, and innovation.
The free market, or, to use a more loaded term, capitalism, produces more wealth and higher standards of living than any other economic system that humanity has conceived and implemented. The differences in economic performance between South and North Korea, West and East Germany, Chile and Venezuela, Botswana and Zimbabwe, not to mention the United States and the Soviet Union, speak for themselves. In spite of that generally recognized fact, capitalism has never enjoyed anything close to universal long-term support. In fact, quite the opposite is true. As the commentator and retired classicist Steven Farron put it:
There have been innumerable political parties called socialist. In the history of the world, there has never been a single political party called capitalist. There is not even a name for a supporter of capitalism. A socialist champions socialism; a democrat champions democracy. But a capitalist is someone who owns and manipulates capital.
Why? The primary reason for the constant struggle to preserve the freedom of the market is that capitalism rubs against some very important parts of human nature. As Jerome H. Barkow, Leda Cosmides, and John Tooby put it in their 1992 book The Adapted Mind: Evolutionary Psychology and the Generation of Culture:
What we think of as all of human history — from, say, the rise of the Shang, Minoan, Egyptian, Indian, and Sumerian civilizations — and everything we take for granted as normal parts of life — agriculture, pastoralism, governments, police, sanitation, medical care, education, armies, transportation, and so on — are all the novel products of the last few thousand years. In contrast to this, our ancestors spent the last two million years as Pleistocene hunter-gatherers, and, of course, several hundred million years before that as one kind of forager or another. These relative spans are important because they establish which set of environments and conditions defined the adaptive problems the mind was shaped to cope with: Pleistocene conditions, rather than modern conditions.
Among the relevant psychological characteristics that humans developed in the Pleistocene were our propensities toward tribalism, egalitarianism, and zero-sum thinking. We evolved in small bands composed of 25 to 200 individuals. We all knew and were often related to one another. Everyone knew who contributed to the band’s survival and who shirked his or her responsibilities. Cheaters and free riders were targets of anger and, sometimes, punishment. Just as important, cheaters and free riders lost valuable cooperative partners. The latter would work with more reliable or generous individuals instead.
In such bands, the sharing of food was common. The storing of food for future consumption, on the other hand, was not practical for seminomadic people. So, when hunters or gatherers acquired more food than their families could consume, they “stored” it in the form of social obligations (i.e., they shared it with other members of the band, in the expectation that the favor would be returned in the future). How widely the foragers shared food was sensitive to whether variation in foraging success was due primarily to luck or to effort.
Luck played a large role in hunting success. Hunters who had worked hard often came home with nothing. So meat was shared widely within the band as a way of pooling risk and buffering against hunger. When effort played a larger role in foraging success, as it did with the gathering of many plant foods, sharing was more targeted. In these cases, the gathered foods were shared primarily within the family and with specific reciprocation partners.
Moreover, the volume of personal possessions was limited by what our ancestors could carry on their backs as they moved from one location to another. In other words, accumulation of property and wealth inequality could not have been major concerns. Also, like other animals, we have evolved to form hierarchies of dominance; an individual’s survival and ability to pass on his genes were enhanced if he could rise within a group and control access to greater resources. But humans also evolved to form coalitions, in which less dominant individuals cooperated to take down the stronger and more successful. Finally, sharing and cooperation among hunter-gatherers ended at the band’s edge, so to speak. In a world without specialization and trade, disproportionate gains by one band often came at the expense of another. By forming aggressive coalitions, men could expand their band’s foraging territory or gain more wives by cooperating to kill men from other bands.
The hunter-gatherer psychology helps to explain our contemporary attitudes toward the extent and freedom of the market. Consider, for example, the provision of health care. When a hunter got sick or injured, he could not go on hunting. His sickness or injury was a double whammy for the band. Not only did the stricken hunter cease to contribute to the band’s survival, but he also needed to be fed and cared for. Furthermore, no one could guarantee that a stricken hunter would ever be able to hunt again. So humans benefited as they evolved the ability to feel compassion and surrounded themselves with caring individuals. Feelings of compassion and acts of caring contrast with calculated and profit-seeking exchanges in the marketplace. Employers, for example, tend to pay wages and provide benefits to their employees not because they care about their employees’ welfare but because they want to make money. In other words, the employer calculates that the productivity of the employee outweighs the cost of the employee’s compensation.
Market exchanges, then, are signs of social distance, whereas illness or injury activates our hunter-gatherer intuitions about helping others. The notion of socialized medicine as a fix to the problem of bad luck, which is usually the cause of sickness or injury, satisfies those intuitions. Conversely, the notion of market-based health care is completely counterintuitive — and remains so even if it can be shown that people get better results from a market-based health-care system. Note that people are much less sympathetic to the government’s paying for the health care of patients whose illness is not caused by bad luck, such as smokers with lung cancer. When people want to advocate helping patients with lung cancer, they usually turn to arguments about addiction — e.g., he or she could not help smoking; the evil tobacco company knowingly sold an addictive product to him or her as a teenager, etc.
The hunter-gatherer psychology also helps to explain why it was relatively uncontroversial for many governments to pass huge spending bills at the beginning of the COVID-19 pandemic. It was not a lack of effort that prevented most people from working. Instead, government-enforced stay-at-home orders kept them from earning money. Moreover, it helps to explain why later spending bills, such as the $1.9 trillion “American Rescue Plan” that was passed by the Congress after the economy had already largely reopened, were much more controversial. Put differently, many arguments about the various aspects of the welfare state and the extent of market exchanges follow straightforwardly from the different sharing rules that have evolved to deal with the variance of fortunes due to luck and the variance due to effort.
To summarize, the psychology that evolved when our ancestors lived in small hunter-gatherer groups prepared us to cope with a world of personal cooperation and exchange in small communities. It did not prepare us to cope with a world of impersonal cooperation and exchange between millions of people (i.e., a typical advanced economy) or billions of people (i.e., the global economy). In a way, the complexity of the modern economy outran the ability of our Stone Age minds to understand it. Yet it is that transition, from personal simplicity to impersonal complexity, that makes capitalism so effective at producing great wealth. To complicate matters further, the extended marketplace of millions or billions of people enables enterprising individuals with value-creating ideas to amass greater wealth than they would be able to amass while catering to small communities. That resulting wealth inequality rubs against our egalitarian predispositions and zero-sum thinking. Finally, our tribalism helps to explain why, even when we do consent to trade with other nations, we often continue to resent them and suspect them of thriving at our expense.
To understand capitalism — let alone to appreciate its benefits — requires all of us to distinguish between the personal and the impersonal, between the simple and the complex, and between the limited and the extended. Or, as the ever-insightful Friedrich Hayek put it:
Part of our present difficulty is that we must constantly adjust our lives, our thoughts and our emotions, in order to live simultaneously within different kinds of orders according to different rules. If we were to apply the unmodified, uncurbed rules of the micro-cosmos (i.e., of the small band or troop, or of, say, our families) to the macro-cosmos (our wider civilization), as our instincts and sentimental yearnings often make us wish to do, we would destroy it. Yet if we were always to apply the rules of the extended order to our more intimate groupings, we would crush them. So we must learn to live in two sorts of world at once.
Striking a balance between those two sets of rules is a difficult task, and we often fail to do so. When we do fail — as, most recently, in Venezuela — the results can be catastrophic. The predictable collapse of Venezuela’s “21st-century socialism” should provide a warning to future generations; given our inability to learn from the very similar socialist failures of the 20th century, though, it’s unlikely that it will be heeded. I suspect that the defense of free markets will remain, thanks to the predispositions of the Stone Age mind, a never-ending struggle.
Wage Inequality Declined in Most Countries Since Start of 21st Century
“The Global Wage Report 2024-25 finds that since the early 2000’s, on average, wage inequality, which compares the wages of high and low wage earners, decreased in many countries at an average rate that ranged from 0.5 to 1.7 per cent annually, depending on the measure used. The most significant decreases occurred among low-income countries where the average annual decrease ranged from 3.2 to 9.6 per cent in the past two decades.
Wage inequality is declining at a slower pace in wealthier countries, shrinking annually between 0.3 and 1.3 per cent in upper-middle-income-countries, and between 0.3 to 0.7 per cent in high-income countries”
In some ways, this is perhaps a somewhat boring answer about facts, but that’s what makes it important; we have to get the facts straight. The numbers that people’s opinions are based on are not correct. There are various ways in which they aren’t, but two big ones.
The first is that when the US census measures income, it doesn’t count two-thirds of what are called transfer payments, or money that the government gives to people for not doing anything. In other words, a transfer payment is not what we pay civil servants or the military. Transfer payments are things like food stamps or Medicaid, which are also two examples of things that the census does not count. They also don’t count 88 percent of the transfer payments that go to people who are classified as poor. They don’t count Medicare for the senior population. They don’t count what is called Supplemental Security Income. They don’t count many state and local transfer payments to poor people. They count some housing subsidies, the so-called Section 8 subsidies, but they don’t count others.
When you add all the pieces up, two-thirds of the total amount of transfer payments aren’t counted. So that’s one big piece.
The other big piece is they don’t adjust for taxes. At the bottom end of the income scale, people pay about seven and a half percent of their income in taxes, mostly sales taxes and excise taxes. At the upper end of the income scale, people pay between 35 and 40 percent of their income in taxes, mostly income taxes. So, if you don’t adjust for those taxes, you end up with a very skewed view of the income distribution.
The census splits US households into five groups based on income. The bottom quintile has the least income, and the top quintile has the most. Using the official census definition of income, the ratio between the top and the bottom is 16.7 to 1, so the top quintile has 16.7 times more income than the bottom.
Now, the first thing we did was ask what income was missing. Well, the first thing we found that was missing was capital gains. Capital gains are not counted as income for reasons that aren’t clear. That, of course, is missing mostly from the top half of the income distribution. At the low end of the distribution, there’s all sorts of income misreporting. Not terribly large, but there is some, people just don’t report all their income. And in the middle, employer-paid benefits are missing. So, adding all that earned income data made the ratio between the top and bottom much bigger. The top quintile earns 60 times more income than the bottom quintile.
But we’re still missing two-thirds of the transfer payments. If we add all the transfer payments, the difference between the top and bottom drops to 5.7 to 1.
So that’s all the money coming in, but the census also ignores the money the government takes through taxes. If we compare after-tax income and after-transfer payment income, the difference drops to only 4 to 1.
So, we’ve gone from 16.7 to 1 to 4 to 1 after counting all the money. We didn’t have to redefine anything.
Let me hit a couple of other points here.
It’s not only that the difference between the top and the bottom became smaller after adding all the income data and accounting for taxes. The differences between the bottom, the next to the bottom, and the middle virtually disappear. The bottom 60 percent of Americans all have almost the same amount of income. Let me explain that a bit.
Income in the second quintile is only 8 percent larger than in the bottom quintile. And yet there are 2.8 times more people working in second quintile households. And when they work, they work 1.8 times more hours. They work nearly 40 hours, and people in the bottom quintile work less than 20. And in the middle quintile, there is 32 percent more income, but over three times more people are working, and they work more than twice as many hours. They put out a whole lot more effort and don’t get much more income.
Now, there’s another important wrinkle: adjusting households for size. Households in the bottom quintile tend to be single individuals, retired individuals, people who’ve just graduated from college, and so on. Households become larger as you go up the income scale. When you adjust for size, the bottom quintile actually receives 5 percent more income than the second quintile does. And only 7 percent less than the middle.
There’s also the issue of change over time. There’s something called the Gini coefficient. It’s a measure that’s set up so that at zero, you have perfect equality. Every household has the same income. And at 1, all the income is in one household. The census publishes this measure, and it has risen over the long term. When President Obama or Chuck Schumer says income inequality is awful and it’s getting worse, this is what they’re referring to. But they don’t count all the transfer payments, which have gone from being like 10 percent of our federal budget to 75 percent over time. If you count all the transfers and take away the taxes, the Gini coefficient has actually fallen.
There’s also the question of economic mobility. In a previous paper, you found that two-thirds of children reared in the lowest quintile at some point escape to a higher quintile as adults. I don’t think people realize just how economically mobile Americans are.
Your last point there is really important. Almost all income distribution data are a slice in time. So, the statement that “the poor are getting poorer and the rich are getting richer” is just wrong because these categories are not static: people who were poor ten years ago are rich today, and some previously rich folks have fallen into lower income levels. Now, there are studies that track the same people through time, and during one’s lifetime, you generally move up. Almost everyone’s income goes up, except for those who choose not to participate in the labor force. Although their income goes up too because we keep raising the transfer payments.
The same also applies to income groups. In 1967, the top quintile of households were those that made around $60,000 or more in 2017 dollars. The people in the bottom quintile made between zero and $15,000 in 2017 dollars. In 2017, 77 percent of the population was making incomes that would have placed them in the top quintile 50 years earlier. That’s inflation-adjusted. And fewer than 2 percent of the people in the bottom quintile in 2017 would have been in the bottom quintile 50 years ago. So, throughout the income distribution, we’re all a whole lot better off.
Now, are we better off than five years ago? Well, some of us are, and some of us aren’t, but the overwhelming majority of us are better off than our parents and grandparents were. Far better off.
What is another hopeful fact about the US economy right now that people may not be aware of?
If you measure it right, the share of Americans in poverty has dropped from about 14 percent back when the war on poverty began to 1.1 percent.
So, when Lyndon B. Johnson declared the war on poverty in 1964, the poverty rate had declined from over 30 percent in the 1940s and 50s to around 17 percent. Now, what happened after that? Well, poverty continued to decline at the same rate for another four or five years. Then, it stopped going down and started rising and falling with the business cycle.
Why do you suppose that happened?
Mismeasurement.
Exactly. We declared a war on poverty. We started giving people a lot of money, but we didn’t measure that money as income. And so, it bounced between 11 percent and 15 percent, back and forth, back and forth. It dropped below 11 percent last year, but it’s still in the same range. But if we count all the transfer payments, it’s only 2.5 percent. And if we correct for the CPI overstating inflation, poverty would be less than 2 percent.
So, poverty has virtually disappeared. The people in that 2 percent are people who are especially challenged, either mentally or physically, and they may need help. But most people who are called poor are simply getting lots of money from the government, and they’re not poor anymore.
Johnson had two objectives for the war on poverty. One was to alleviate the suffering of those who were poor, but the other was to enable them to become productive citizens. We completely failed at that one. Only one third of work-age adults in the bottom quintile have a job. Back when Johnson started the war on poverty, two-thirds of them did.
Why? The government’s paying them to do nothing. So, they do nothing.
Get John Early’s book, The Myth of American Inequality: How Government Biases Policy Debate, here.
John Early, a mathematical economist and adjunct scholar at the Cato Institute, joins Chelsea Follett to discuss popular misconceptions about inequality in the United States and the measurement errors behind them. To see the slides that accompany the interview, watch the video on YouTube or the Spotify app.
The Rise of Wealth Equality in the West | Podcast Highlights
Chelsea Follett interviews Daniel Waldenström about the decline of wealth inequality in the western world.
Daniel Waldenström —
Read the full transcript or listen to the podcast here.
Your book, Richer and More Equal: A New History of Wealth in the West, reveals a surprisingly upbeat story: ordinary citizens in the Western world are now richer and more equal than before. Tell me about that and why the prevailing narrative of increasing inequality seems to be overstated or wrong.
One key aspect to this question is how we interpret economic outcomes in society. How do we interpret wealth creation? How do we interpret entrepreneurs creating new firms that make profits and build enormous fortunes? Is that something positive or a problem for society?
My view is that within a democratic market economy, I see very few problems with having such value-creating activities. Of course, that is different in autocratic countries. We have examples of oligarchs in Eastern Europe that have become rich through theft or dictatorships in developing countries where people gain wealth through political connections. But within democratic market economies, value-creating activities generally improve human well-being. Whether you’re a worker or a tax collector, everything begins with value creation in the private sector. People start firms, hire people, and pay wages and taxes. So, when some people become very successful at this, I think that is inherently positive.
This view contrasts with that of some of my research colleagues, who see rich people as a problem.
I departed from that view, and I challenged that view using data. The previous narrative argued that equalization—the reduction in inequality during the 20th century—was mainly due to the destruction of the capital of the rich, either through war or taxes. My data show that the main force that has created equality over the 20th century is lifting the bottom, allowing normal people to save and build wealth. And that equalization goes hand in hand with value creation and capital accumulation. So, equalization doesn’t rely on the destruction of capital but on the creation of capital.
You discuss the changing nature of wealth and how it has increasingly moved into housing and pension funds. Tell me about this shift.
So, there are different kinds of assets that we can own. We can own a house, stocks, bank deposits, bonds, land, or a summer cottage. This differs across households, but when we add up all the households in the economy and analyze the aggregate composition, we see that the wealth stock in all the rich nations has transformed profoundly.
One hundred years ago, most wealth was stuff that the rich people owned: things like industrial corporations and large agricultural domains. The stuff that the middle-class or workers owned, like houses and their long-term savings, composed just a fourth of all assets. But during the 20th century, we started establishing structures and institutions that made people more engaged in the economy. We saw educational reforms allowing more people to get better trained. We had better rules in the labor market with structures for working hours and so on. And all of that made workers more productive. So, they had a safer work environment, and they were better trained. And then, therefore, they got better paid. That allowed them to start saving privately. And the first thing they started saving in was housing.
We saw during the middle of the 20th century a virtual explosion in homeownership, going from 20 to 30 percent of the population to maybe 60 to 70 percent. Alongside this development, people started living longer—way past retirement age. And what did that imply? Well, they started to save for retirement.
These two kinds of assets, housing wealth and pension funds, have grown in importance and value over time. Today, they have become the most important part of total private wealth in all Western societies. Maybe 75 to 80 percent of all wealth is in housing or long-term savings. Wealth has transformed from being mainly composed of the stuff that the elite own to being mainly composed of stuff that regular people own, and that explains why we have a much more equal society in terms of wealth ownership today.
Part two of the book shifts the focus to the distribution of wealth over the past 130 years or so in various Western nations. What did you find?
So, over the last 20 years, we’ve built comparable, longitudinal wealth inequality series for several countries. How do you do this? How do we measure wealth inequality? It’s difficult. But mainly, we use data on the holdings of those with wealth, the rich people. We rank all households from the poorest to the richest and then look at the richest ten percent. Then, we divide the sum of their wealth by the total wealth in the economy. And we can also do this for the top 1 percent. So, we have data on the top wealth shares over the entire 20th century up to today: around 130 years of comparable wealth inequality trends.
And what they say is quite clear: we are much more equal today than in the past. In the European countries, the richest tenth of society once held around 90 percent of all wealth. That share has been halved over the 20th century. The first fascinating thing is that this great wealth equalization occurred in all Western countries, even the US, over the 20th century up to the 1970s and ’80s. That kind of consistency is very interesting.
Then, in recent decades, if you continue from 1980 onwards, one of the most surprising facts is that in the European countries, wealth inequality has not increased since the 1980s. It’s been hovering around the same historically low level that they landed on in the 1970s. And this is in spite of the fact that wealth values have increased tremendously around the Western world. Housing has become more expensive; stock markets have boomed. We are richer today than we were in 1980, and yet, in Europe, wealth inequality has not increased. The reason is that most of the wealth that has increased in value is held by the middle class or the ordinary people. So, they’ve been lifted up by these asset price increases and the positive economic developments.
In the US, there has been an increase in wealth concentration. In the US, the wealth holdings of middle-class households have increased in value a lot, but the wealth of the top groups has increased even faster. Mind you, even in the US, there hasn’t been much of a wealth concentration increase since 2010. Over the last 10 to 15 years, US wealth concentration has been relatively stable.
Yet, even in the US, you note that inequality is lower than pre-war levels. What explains this pattern of inequality?
We can see that mechanically, the main explanation for the long equalization during the 20th century is that we’ve been lifting the bottom. We’ve been expanding wealth ownership and wealth growth in the lower parts of the wealth distribution, and the lower parts have experienced higher wealth growth than the top.
The reasons why we’ve seen this are, to a large extent, institutional. Political and economic institutions expanded opportunities, allowing people to get educated, gain access to the labor market, and take loans for starting enterprises. Basically, entering the economic market and possibly succeeding. So, as I said before, capital destruction or taxing the rich has been relatively unimportant to wealth inequality change.
Then, of course, taxes matter, and they can prevent people from wanting to invest and so on. We’ve seen examples of that in the economic histories of all of these Western countries. But, mind you, much of the growth of government that we’ve seen over the 20th century has actually been built by increasing labor taxes. So workers have borne the biggest burden of increased taxation, meaning that their opportunity to save privately is what has been prevented the most by tax increases.
You go into greater detail in the book about the different kinds of wealth, including offshore wealth, to public sector wealth, and inheritance. Tell me about all of these things.
The concept of wealth is a little bit complicated if we compare it to, for example, income. So, income from labor is quite clear in its definition, whereas wealth is the stock value of assets that need to be defined and valued. One complication is that some wealth is held offshore. Of course, this wealth should be part of people’s portfolios and the standard wealth measurement. The problem is that some offshore wealth is hidden for tax reasons. There is research trying to measure the size of those hidden assets, and the main conclusion is it doesn’t change much. On the aggregate, when it comes to measuring wealth inequality, it doesn’t change a lot. And it does not change the historical developments at all.
You also mentioned social security wealth. When we get sick, we get an income, or when we retire, we have a pension. Some of that is then based on our savings, but some is also based on promises from employers or, most of the time, from the state. You can think about those future pension incomes as wealth because you would need to save more money privately in the absence of a pension system. These wealth amounts are huge, and they are much more evenly distributed than other types of wealth. So, whereas many workers don’t own much property or have a lot of private savings, they have a lot of expectations of future pension incomes. So, when we add the present value of future pensions, we see that the equalization of wealth inequality over the 20th century is much larger. This is true for both the US, which is one of the lowest-taxing market economies, and for Sweden, which was, during parts of the 20th century, close to a socialist command economy.
Finally, you asked about inheritance. When we look at the aggregate picture, looking at the aggregate flows of inheritance compared to GDP, and how has that changed over time, we see that over the last 120 years, the relative importance of inheritance was the largest at the beginning of the 20th century and has since become less and less important. We don’t have that much data for many countries, but data for the UK, France, Sweden, and the US show basically the same picture. We see that even though richer heirs receive larger inheritances, the relative importance of inheritance is larger for less wealthy heirs. So, in fact, inheritance has an equalizing effect.
Another section of the book discusses how many of the super-rich are self-made and how many are rich heirs. And I have data there for the US and Sweden showing clearly decreasing trends in the relative importance of inheritance. So, there have been more and more self-made billionaires in our economies over the last 30 and 40 years. This is a signal that the book’s overall message that we are getting richer and more equal is not changed when we also account for inheritance.
Fascinating. You mentioned globalization. Your book focuses on the West, but how generalizable are your results to the rest of the world?
So, yes, I have some discussion about this in the book. If we start with the global level, looking at all the wealth in the world and how it is distributed, we can see that it’s very unequally distributed, more unequally distributed in the world than in any country. However, we also see that the measures of wealth inequality have decreased every year from the year 2000 up until the 2020s. So, the world is much more equal today than it was 20 years ago. The equalization has been much faster for poverty and for incomes than for wealth.
Given these trends toward more equality, why do you think there is this prevailing narrative to the contrary?
It’s a difficult question. One reason is that the discussion has been quite narrowly focused on certain years, especially comparing outcomes to the early 1980s. So, the early 1980s were a turning point in the global economy, especially in the Western world, where we started leaving a very bad period of stagnation. Our production systems became less productive, and manufacturing industries were evaporating. They left the rich world because we were outcompeted by upcoming countries, especially in Asia.
But we learned our lessons. Our economic struggles were explained by regulations and high taxation. In Sweden, for example, the top marginal tax rate on labor income was above 90 percent. So, we started deregulating and lowering taxes and developed a better understanding of the role of technological change and economic incentives.
That, of course, lead to growth and also greater income inequality. But much of that was a normalization. Most Western countries went from historically low levels of income inequality, which resulted from extremely high taxes on productive people, to higher levels of income inequality as economic growth led to higher incomes. People interpret this fact negatively, but this normalization improved general welfare through things like better medical care and technology. So that’s a kind of a misinformed narrative, but it’s based on observations of increasing inequality since the 1980s.
Let me also say this. People on the right side of the political spectrum are generally less interested in discussing and understanding inequality, what is happening to it, and how it is measured. And in many cases, they basically left a vacuum in these discussions. People on the left have an interest in inequality, but their problem is that they already know the answers. They don’t care about data or measurement; they take for granted that inequality is high and increasing. So, it’s a very strange debate with many strong but misinformed statements.
What insights can we learn from this new history of wealth?
One very important lesson is that we can build wealth broadly in the population by enabling more people to become owners. We have seen that home ownership has been the main pillar of household wealth. I cite a research paper in the book showing that the long-term returns in home ownership have been almost as high as the long-term returns in the stock market, but at half the risk. I think another pillar is mutual funds. Mutual funds have democratized the stock market, allowing people to own shares that give high returns but with a low level of risk. Luckily, we understood this and guided many of our pension savings or investments into mutual funds.
There is also a lesson when it comes to the taxation of capital. There’s one big group of capital taxes that work well. These are capital income taxes, so capital taxes on flows of returns. The biggest one is the corporate tax. So, the profit tax of corporations. Corporate taxes amount to around half of all capital taxes in total. Then, we have taxes on dividend income. We have taxes on rental income. We have taxes on realized capital gains. Whenever you, as an owner, take out cash from your company, we tax that as income, just like any labor earner.
The other kind of capital taxes, which are much more problematic, are the taxes on wealth and stocks of capital. Maybe there is a stock market valuation, and you pay taxes based on your company’s value. The problem is that if you make little profit, you won’t have any money to pay the tax with. What should you do then? Should you sell parts of the firm? That’s going to create corporate governance problems. It’s very clear from economic research that we don’t want those kinds of effects of taxation. It’s a very negative outcome of taxation. Another problem with wealth taxes is that we don’t know exactly how to value assets that are not actively traded. Many companies are not on a stock exchange that lists how much they’re worth. We could guess, but I would suppose we would have maybe 50 percent error margins. A 50 percent error margin on your tax bill is not so fun and could be very costly.
These problems are why very few countries today still have wealth taxes. These taxes also haven’t worked historically. The revenues that they have generated are also very small compared to capital income taxes. So, I recommend not taxing wealth or “unrealized capital gains.” I think those proposing these kinds of taxes lack a basic understanding of entrepreneurship and the economy.
Get Daniel’s book, Richer and More Equal: A New History of Wealth in the West, here.
