The silent economic miracle

Over the past century, the distribution of wealth in Western industrialised nations has changed significantly: not only have people become considerably wealthier, but wealth inequality has also decreased.

In his essay, the Swedish economist Prof. Daniel Waldenström analyses the development of wealth over a period of 130 years and, drawing on new research findings, shows how this ‘silent wealth revolution’ came about, what role home ownership and pension provision in particular played in it, and why a long-term perspective calls into question widespread assumptions about steadily increasing wealth inequality.

How has prosperity been created over time?

Widespread prosperity did not arise through redistribution, but primarily through growth. Per capita wealth in Western societies has increased almost tenfold in real terms over the last 130 years. Since 1980 alone, this figure has risen two- to three-fold. Growth and falling inequality went hand in hand.

The decisive impetus came from the democratic changes at the beginning of the 20th century: these expanded property rights and triggered reforms in education and the labour market, which boosted productivity and the incomes of the working class, thereby enhancing their ability to build up wealth in the first place. The most important forms of wealth in this context were home ownership and pension provision, partly supported by targeted policy measures.

Does the market economy automatically encourage the concentration of wealth?

No, this study challenges this widely held view. In free-market economies, wealth accumulation is a positive force that increases prosperity and is closely linked to the growth of successful companies. These companies create jobs, higher incomes and greater tax revenue. In doing so, they also enable wealth accumulation amongst the general population. The key drivers of wealth convergence between richer and poorer sections of society are home ownership and pension provision. The market economy therefore makes people both richer and more equal.

Is inheritance tax an effective tool for reducing wealth inequality?

No, it is not really an effective tool for reducing wealth inequality.

In practice, it rarely works as intended. Valuations are difficult for many assets, particularly in the case of unlisted companies. Heirs may face high tax liabilities on assets that cannot be easily liquidated because, for example, they are tied up in businesses. This can put companies under strain or even threaten their very existence. Consequently, exemptions and allowances are frequently granted, though the accuracy of these is a recurring subject of debate.

The study’s findings also show that inheritance tax neither generates significant revenue nor noticeably alters the distribution of wealth. Consequently, many countries have abolished it: since 1975, the number of countries levying inheritance tax has fallen significantly – from 63 to 45 worldwide and from 28 to 18 within the OECD.

What recommendations for action can be drawn from the findings?

There are five implications for the design of policy measures aimed at further driving this positive trend:

1. The assumption of a distributional conflict, whereby the gains of some inevitably mean losses for others, falls short. The wealth of the rich and the rest of society can grow simultaneously – and often do. This realisation forms the basis for all further recommendations.
2. Private home ownership should be actively promoted, for example through the construction of owner-occupied flats or the subsidisation of mortgages. Property has historically proved to be a profitable investment and contributes to wealth creation amongst the middle class.
3. Pension provision must shift more towards funded schemes. Unlike pay-as-you-go pension schemes, which come under pressure during periods of economic downturn, funded schemes invest in the financial markets and achieve stable long-term returns whilst broadly diversifying risk.
4. The taxation of labour must play a constructive role in the context of wealth equalisation: whilst taxes on labour are necessary for the financing of public services, they do, however, slow down wealth accumulation across the board. A higher net income accelerates wealth accumulation amongst the middle class.
5. Finally, the taxation of capital needs to be reconsidered. Wealth and inheritance taxes have historically done little to promote equality and are difficult to implement in practice. Taxes on capital gains, which are based on the owner’s actual ability to pay and also capture windfall gains, are more effective.