Why inequality matters and how to tackle

it
By Bill Gates
Oct 16 2014
A 700-page treatise on economics translated from French is not exactly a light
summer readeven for someone with an admittedly high geek quotient. But
this past July, I felt compelled to read Thomas Pikettys Capital in the TwentyFirst Century after reading several reviews and hearing about it from friends.
Im glad I did. I encourage you to read it too, or at least a good summary,
like this one from The Economist. Piketty was nice enough to talk with me
about his work on a Skype call last month. As I told him, I agree with his most
important conclusions, and I hope his work will draw more smart people into
the study of wealth and income inequalitybecause the more we understand
about the causes and cures, the better. I also said I have concerns about some
elements of his analysis, which Ill share below.
I very much agree with Piketty that:

High levels of inequality are a problemmessing up economic incentives,

tilting democracies in favour of powerful interests, and undercutting the ideal
that all people are created equal.

Capitalism does not self-correct toward greater equalitythat is, excess wealth
concentration can have a snowball effect if left unchecked.

Governments can play a constructive role in offsetting the snowballing

tendencies if and when they choose to do so.
To be clear, when I say that high levels of inequality are a problem, I dont want
to imply that the world is getting worse. In fact, thanks to the rise of the middle
class in countries like China, Mexico, Colombia, Brazil and Thailand, the world
as a whole is actually becoming more egalitarian, and that positive global trend
is likely to continue.
But extreme inequality should not be ignoredor worse, celebrated as a sign
that we have a high-performing economy and healthy society. Yes, some level
of inequality is built in to capitalism. As Piketty argues, it is inherent to the

system. The question is, what level of inequality is acceptable? And when does
inequality start doing more harm than good? Thats something we should have
a public discussion about, and its great that Piketty helped advance that
discussion in such a serious way.
However, Pikettys book has some important flaws that I hope he and other
economists will address in the coming years.
For all of Pikettys data on historical trends, he does not give a full picture of
how wealth is created and how it decays. At the core of his book is a simple
equation: r > g, where r stands for the average rate of return on capital
and g stands for the rate of growth of the economy. The idea is that when the
returns on capital outpace the returns on labour, over time the wealth gap will
widen between people who have a lot of capital and those who rely on their
labor. The equation is so central to Pikettys arguments that he says it
represents the fundamental force for divergence and sums up the overall
logic of my conclusions.
Other economists have assembled large historical datasets and cast doubt on
the value of r > g for understanding whether inequality will widen or narrow.
Im not an expert on that question. What I do know is that Pikettys r >
g doesnt adequately differentiate among different kinds of capital with
different social utility.
Imagine three types of wealthy people. One guy is putting his capital into
building his business. Then theres a woman whos giving most of her wealth to
charity. A third person is mostly consuming, spending a lot of money on things
like a yacht and plane. While its true that the wealth of all three people is
contributing to inequality, I would argue that the first two are delivering more
value to society than the third. I wish Piketty had made this distinction,
because it has important policy implications, which Ill get to below.
More important, I believe Pikettys r > g analysis doesnt account for powerful
forces that counteract the accumulation of wealth from one generation to the
next. I fully agree that we dont want to live in an aristocratic society in which
already-wealthy families get richer simply by sitting on their laurels and
collecting what Piketty calls rentier incomethat is, the returns people earn
when they let others use their money, land or other property. But I dont think
America is anything close to that.

Take a look at the Forbes 400 list of the wealthiest Americans. About half the
people on the list are entrepreneurs whose companies did very well (thanks to
hard work as well as a lot of luck). Contrary to Pikettys rentier hypothesis, I
dont see anyone on the list whose ancestors bought a great parcel of land in
1780 and have been accumulating family wealth by collecting rents ever since.
In America, that old money is long gonethrough instability, inflation, taxes,
philanthropy and spending.
You can see one wealth-decaying dynamic in the history of successful
industries. In the early part of the 20th century, Henry Ford and a small number
of other entrepreneurs did very well in the automobile industry. They owned a
huge amount of the stock of car companies that achieved a scale advantage
and massive profitability. These successful entrepreneurs were the outliers. Far
more peopleincluding many rentiers who invested their family wealth in the
auto industrysaw their investments go bust in the period from 1910 to 1940,
when the American auto industry shrank from 224 manufacturers down to 21.
So instead of a transfer of wealth toward rentiers and other passive investors,
you often get the opposite. I have seen the same phenomenon at work in
technology and other fields.
Piketty is right that there are forces that can lead to snowballing wealth
(including the fact that the children of wealthy people often get access to
networks that can help them land internships, jobs etc.). However, there are
also forces that contribute to the decay of wealth, and Capital doesnt give
enough weight to them.
I am also disappointed that Piketty focused heavily on data on wealth and
income while neglecting consumption altogether. Consumption data represent
the goods and services that people buyincluding food, clothing, housing,
education and healthand can add a lot of depth to our understanding of how
people actually live. Particularly in rich societies, the income lens really doesnt
give you the sense of what needs to be fixed.
There are many reasons why income data, in particular, can be misleading. For
example, a medical student with no income and lots of student loans would
look in the official statistics like shes in a dire situation but may well have a
very high income in the future. Or a more extreme example: some very
wealthy people who are not actively working show up below the poverty line in
years when they dont sell any stock or receive other forms of income.
Its not that we should ignore the wealth and income data. But consumption

data may be even more important for understanding human welfare. At a

minimum, it shows a different - and generally rosier - picture from the one that
Piketty paints. Ideally, Id like to see studies that draw from wealth, income and
consumption data together.
Even if we dont have a perfect picture today, we certainly know enough about
the challenges that we can take action.
Pikettys favorite solution is a progressive annual tax on capital, rather than
income. He argues that this kind of tax will make it possible to avoid an
endless inegalitarian spiral while preserving competition and incentives for new
instances of primitive accumulation.
I agree that taxation should shift away from taxing labour. It doesnt make any
sense that labour in the United States is taxed so heavily relative to capital. It
will make even less sense in the coming years, as robots and other forms of
automation come to perform more and more of the skills that human labourers
do today.
But rather than move to a progressive tax on capital, as Piketty would like, I
think wed be best off with a progressive tax on consumption. Think about the
three wealthy people I described earlier: One investing in companies, one in
philanthropy, and one in a lavish lifestyle. Theres nothing wrong with the last
guy, but I think he should pay more taxes than the others. As Piketty pointed
out when we spoke, its hard to measure consumption (for example, should
political donations count?). But then, almost every tax systemincluding a
wealth taxhas similar challenges.
Like Piketty, Im also a big believer in the estate tax. Letting inheritors consume
or allocate capital disproportionately simply based on the lottery of birth is not
a smart or fair way to allocate resources. As Warren Buffett likes to say, thats
like choosing the 2020 Olympic team by picking the eldest sons of the goldmedal winners in the 2000 Olympics. I believe we should maintain the estate
tax and invest the proceeds in education and researchthe best way to
strengthen our country for the future.
Philanthropy also can be an important part of the solution set. Its too bad that
Piketty devotes so little space to it. A century and a quarter ago, Andrew
Carnegie was a lonely voice encouraging his wealthy peers to give back
substantial portions of their wealth. Today, a growing number of very wealthy

people are pledging to do just that. Philanthropy done well not only produces
direct benefits for society, it also reduces dynastic wealth. Melinda and I are
strong believers that dynastic wealth is bad for both society and the children
involved. We want our children to make their own way in the world. Theyll
have all sorts of advantages, but it will be up to them to create their lives and
careers.
The debate over wealth and inequality has generated a lot of partisan heat. I
dont have a magic solution for that. But I do know that, even with its flaws,
Pikettys work contributes at least as much light as heat. And now Im eager to
see research that brings more light to this important topic.
Published in collaboration with LinkedIn
Author: Bill Gates is a Co-founder and Chairman of Microsoft Corporation and
Co-chair of Bill & Melinda Gates Foundation.
Posted by Bill Gates - 02:02
All opinions expressed are those of the author.