Inequality in the US: (6) Extreme Wealth

Unfortunately, it is the nature of great wealth itself that increases inequality most. Thomas Piketty’s new book, Capitalism in the Twenty-First Century (which in my opinion will probably be the most important economics book in the first half of this century) demonstrates repeatedly how wealth and inequality grow because of this simple term: r > g, where r is the return on investment and g is national growth. When the return on invested wealth is greater than national growth, wealth grows automatically and inexorably. And the greater the difference between the two, the faster wealth grows. This is the normal condition.

For example, if the rate of return is 6% and the rate of growth is 2%, every year investments earn 4%, less costs, which include investment management and living expenses. In the case of extreme wealth, the owner can easily live on a small fraction of his return, and the balance will double his wealth in some two or three decades or less. If the return is higher or growth is lower, his wealth increases faster.

There is no natural limit
to how much the wealth
of the very rich can grow.

The greater the size of the initial wealth, the higher the rate of return will be. This is largely because the very wealthy have investment opportunities that others do not, and can afford costly investment advice.

The effect is clearly illustrated with university endowments, which consist of billions of dollars, even hundreds of billions. Endowments are useful to study because they are one of the few places where the public can see every detail, in contrast to private wealth, which is largely hidden. These reports illustrate clearly that the largest endowments earn double the return available to smaller endowments.

Harvard, with the largest endowment, pays $100M per year management fees—which is only 0.3% of earnings—but consistently earns above 10% return, which would double the endowment size within a decade. The endowment is so huge that the $100M annual management expense is insignificant. By 2024, Harvard’s endowment will likely be roughly the current GDP of Switzerland.

The extremely wealthy
own an increasing amount
of the national wealth.

Spending $100M on investment advice allows Harvard to hire some people who are masters at investing in instruments not available to the public. These investments commonly earn returns considerably higher than what’s available on the market. Besides these exotic investments, great wealth allows huge chunks of investment that can demand better terms than are otherwise available. The overall effect is that the greater the initial wealth the higher the return.

The returns on great private wealth are a bit lower than those on the highest endowments, because $100M is not available to spend on top investment management. But it is still far above what’s available to the rest of us, and the poor are lucky if they can prevent their meager savings from actually losing value.

The extremely wealthy pay very little income tax, because most of their income comes in the form of return on investments, which are not taxed. All those whose income is at the extreme upper end have many ways to avoid paying taxes.

So it is an inherent trait of great wealth that it grows inexorably and at the highest rates, which are available only to the very rich. We don’t know when the natural limit to this concentration of wealth will be reached. Although it obviously cannot be infinite, the implications for democracy and equality are frightening. The inevitable result is that the extremely wealthy, solely because of the size of their initial fortune, control an increasingly large percentage of the national wealth with no apparent limits to their wealth or the percentage of the national wealth they own.

More and more wealth
is becoming
inherited wealth.

As time passes, more and more of this extreme wealth becomes inherited wealth as the elder family heads die off. At the same time, the percentage of national wealth in private hands increases, so that the national wealth is held by fewer and fewer people, all of them vastly rich. Inherited wealth based on land was for all practical purposes the only kind of great wealth in former centuries. Today the percentage of the most extreme inherited wealth is again growing, so that within half a century or less we will surpass the world record inequality last seen in 1910 France. In fact, recent research highlighting the huge amounts of wealth hidden offshore suggests we may already have achieved that dubious honor.

So in deciding what to do about inequality created by great wealth, the question is really how to (1) limit infinite greed, and (2) find equitable ways to control the inherent tendency of great wealth to create a new ruling class and inevitable gross inequality. It doesn’t take a great deal of imagination to realize how fraught with difficulties of all kinds this effort will be. We can be certain that formidable political power will fight each and every effort to improve equality.


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