Thomas Piketty, a professor at the Paris School of Economics, has achieved a major coup, to use a word from his native France: catapulting his 600-plus-page book on inequality into the public discourse.
He postulates that when the return on capital is greater than the growth of output, or gross domestic product, societies become more unequal and unstable. Some kind of redistribution, such as a progressive tax on capital, is needed to restore balance, he argues.
Agreed — compensation committees that award multimillion dollar packages to our nation’s CEOs often leave something to be desired. Perhaps they are biased, and perhaps $30 million will do just as well as $40 million. But these are not relevant to most of us, who do not aspire to be CEOs and who just want to pay the bills and pay off college loans — or send the kids to college.
It’s simply untrue that capital is not taxed. It is overtaxed. But to justify higher taxes, Piketty makes at least four errors. (Space constraints prevent the discussion of others.)
Capital benefits all of us. Piketty equates capital and wealth, writing, “I use the words ‘capital’ and ‘wealth’ interchangeably, as if they were perfectly synonymous.” But many people of all incomes benefit from a greater return on capital, not just CEOs. At some time in their lives, most Americans will have retirement accounts or pension plans, which profit from growth in corporate income.
Corporations, venture capitalists and private equity funds generate economic activity through capital. They provide products and services and create jobs. They invent cheaper goods, which raise the value of our paychecks. They invent expensive goods, such as Apple iPhones, which save us time. We all should want want more capital, not less.
Piketty shows that capital as a percent of output declined significantly around the world between 1910 and 1950, before beginning its steady increase. But this was a time when two world wars destroyed much capital. We do not want to return to those days.
Use of pre-tax, pre-transfer income. In discussions of inequality, Piketty uses pre-tax, pre-transfer measures of income based on tax units. As my Manhattan Institute colleague Scott Winship has discussed in Forbes (here and here), tax units are poorer than households. The income measure does not measure well-being, because it does not include money paid in taxes or given back in transfers.
This concept of income is far removed from reality. The top 1% paid 35% of all federal individual income taxes in 2011, and the top half of earners paid 97%. The bottom half of earners paid 3%, and received back a share of the 97% paid by the top half for programs including Medicaid, food stamps, the earned income tax credit, housing vouchers and unemployment insurance.
The idea that inequality can be measured by income irrespective of taxes and transfers makes little sense. Many economists, such as University of Chicago professor Bruce Meyer and University of Notre Dame professor James Sullivan, have included taxes paid and transfers received and computed measures of inequality of consumption, a more realistic guide to well-being. They concluded in a series of papers, including one for the Brookings Institution , that consumption inequality has not increased and that poverty, while not cured, is declining.
Piketty does not even mention the concept of consumption inequality in his 600 pages, nor does he reference Meyer and Sullivan’s work. Neither does he mention the work of Richard Burkhauser, whose extensive research concludes that using different measures of income dramatically reduces observed income inequality.
Mobility. The question of whether people can move around income classes is more important than the difference between rich and poor, but is virtually ignored by Piketty. He writes: “If each individual were to enjoy a very high income for part of his or her life (for example, if each individual spent a year in the upper centile of the income hierarchy), then an increase in the level characterized as “very high pay” would not necessarily imply that inequality with respect to labor — measured over a lifetime — had truly increased.” He complains that “workers at McDonald’s or in Detroit’s auto plants do not spend a year of their lives as top managers of large U.S. firms.”
But this is the wrong measure, because most people do not aspire to the top 1%. They just want to move up a few quintiles. And many do, according to a paper published in the flagship American Economics Review last year by U.S. Treasury Department economists Gerald Auten, Geoffrey Gee, and Nicholas Turner. They find that about half of those in the top and bottom quintiles moved up or down. Piketty does not mention the work of Auten and his team.
Other Treasury data show that of the 3,869 people who appeared in the top 400 U.S. taxpayers by adjusted gross income over the period 1992 to 2009, only 87 people appeared there for 10 or more years. Contrary to what Piketty describes, the top 1% are not static. The Treasury data are not mentioned in the 600 pages.
Role of women in the workplace. One reason for increased household inequality is the movement of women into the workplace. This has changed demographic characteristics of households since the 1980s, the period Piketty cites as showing increased inequality. But nowhere in his 600 pages does he mention the demographic changes that have taken place in the Western world.
In the top fifth of the income distribution, households average two earners per family. In the middle quintile, households have about one earner per household. In the lowest fifth, there is one earner for every two households, with retirees and unemployed.
In 1990, median income for a family with one earner was about $41,800. In 2012, that median income for that one-earner family rose to about $43,300, a 4% difference. But the increase between a family with two earners in 1990 and 2012 was far greater. That family’s income rose from about $71,000 to about $82,600, a 16.5% difference, resulting in a measured increase in inequality.
Piketty tries to make a case for higher taxes on capital. Capital is already heavily taxed, and increasing taxes would slow the economy to no positive end. His supporting arguments for why economies need more taxes on capital, in the end, fail.
Diana Furchtgott-Roth, former chief economist at the U.S. Department of Labor, directs www.Economics21.org at the Manhattan Institute. Follow her on Twitter here.
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