How Should We Understand Capital Income Inequality?


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Last week, Marco Ranaldi and Branko Milanovic published a piece about capitalist systems and income inequality in which they try to determine the relationship between income-factor concentration (IFC) and overall inequality.

IFC is a novel concept developed by Ranaldi that works as follows:

The income-factor concentration index is at the maximum when individuals at the top and at the bottom of the total income distribution earn two different types of income, and minimal when each individual has the same shares of capital and labour income. When the income-factor concentration index is close to one (maximal value), compositional inequality is high, and a society can be associated to classical capitalism. When the index is close to zero, compositional inequality is low and a society can be seen as homoploutic capitalism. Liberal capitalism would lie in-between

Put simply, the IFC measure attempts to distinguish between a society where the bottom labors and the top owns (classical capitalism) and a society where the bottom and top both labor and own in similar proportions to their income (homoploutic capitalism), as well as all the gradations in between.

In order to determine how countries fare under this measure, the authors use the household income surveys provided by the Luxembourg Income Study (LIS). The LIS microdata distinguishes between labor income and capital income and therefore allows researchers to determine how much of each type of income composes the overall incomes of the top and bottom in each country.

This is an interesting exercise, but I do not think it will actually produce the kind of information necessary to accurately taxonomize the economic systems of different countries.

The Problem

The main problem with this approach is that it ignores the capital income that is received by governments and other non-household entities. Insofar as public ownership of capital has historically been one of the main strategies for escaping “classical capitalism,” any measure that does not capture that dynamic will fall short of what the IFC seeks to accomplish.

To understand the nature of this problem, imagine a society in which the nation’s capital stock is entirely owned by the top one percent of individuals. This society would have a very high IFC because capital income would make up a large share of the income of the top one percent while making up none of the income of the bottom 99 percent.

From that starting point, now imagine that the government brings half of the nation’s capital stock into public ownership. This would halve the amount of capital income flowing to the top one percent but would have no effect on the concentration of capital income as defined by the IFC because the top one percent of individuals would still receive all of the capital income that is being paid directly to households.

Any measure of capital income inequality that does not change in response to the nationalization of half of the nation’s capital stock is obviously not suited to the task at hand.

This is not a purely hypothetical problem as countries really do have very different levels of public ownership. For example, in Norway, over half of the nation’s capital is owned by the government while, in the United States, the same number is less than zero, meaning that the government has more debt than assets.

Any reasonable comparison of these countries would conclude that Norway and Finland have gone much further away from “classical capitalism” than the United States has because both countries have much higher levels of public ownership than the US has. Yet the IFC scores of the various countries reported by Ranaldi and Milanovic tell us that Norway and Finland have far more capital income concentration than the US has and that they have higher capital income concentration than every other country in Western and Northern Europe.

This is not just wrong, but totally backwards. In an accounting that took into consideration public ownership of capital, Norway and Finland would probably have one of lowest levels of capital income concentration in the world.

The reason why I am writing this post is because I think public ownership of capital is one of the most overlooked topics in contemporary discussions of inequality. Unlike labor income, which can only be received by individuals, capital income can be received by anyone or anything. This is because it is completely detached from anything having to do with capital owners. Capital may be productive in some sense, but the people who own it are not, which is precisely why anyone can own it, including everyone collectively through an instrument like a democratically-elected government.

For this reason, bringing private capital into public ownership should be considered one of the easiest ways to cut down inequality in society. Building a social wealth fund like the one that Alaska has could quickly trim down wealth inequality in society while also providing new streams of government revenue that could be distributed in a vastly more equal way than capital income is currently distributed. Implicitly disregarding that strategy by adopting inequality measures that do not register public ownership of capital as reducing inequality is a big mistake.