Expert's take: Thomas Piketty's economics

While progressives bemoan conservatives for not presenting any new solutions to the war on poverty and inequality, French economist Thomas Piketty has published a new manifesto which presents old ideas with new data. Curtis S. Dubay, senior policy analyst at the Heritage Foundation, sets us straight:

What does Thomas Piketty argue in his new book, “Capital in the Twenty-First Century”?

Piketty and his team constructed a unique and novel data set on income and wealth going back hundreds of years. They created it using tax returns from the U.K., U.S., and France.

Piketty argues the data show over the last few hundred years the rate of return to capital was greater than the rate of economic growth. This is where the now ubiquitous (at least in economic circles) term (r > g) comes from.

Piketty extrapolates his data forward into the next 100 years and shows that the return on capital will continue to outpace economic growth.

What this means is that owners of capital accumulate wealth faster than those that work for a living – no matter how fast the economy grows ??? under capitalism. Hence, economies based on capitalism will see always-increasing levels of wealth inequality.

His estimates show rapidly rising levels of inequality going forward, which he believes will lead to social disintegration because of the ability of wealth capital owners to purchase political systems.

To counteract this effect, Piketty contends a global wealth tax of 2 percent levied annually and steeply progressive income taxes are necessary.

Why is this book so controversial? What does Piketty get wrong, and what, if anything, is he right about?

The first thing Piketty gets right is he put together a unique, never before see set of data. Coming up with unique data sets has been all the rage in economics since the publication of Freakonomics. Piketty has set a high standard with his data set on income because it reaches so far back.

In addition to that, the book is getting so much attention because of its timing. President Obama chose inequality as his preferred policy platform after he realized the economy would not return to robust growth under his stewardship. And the Democratic party has chosen to make it a pillar of their platform already for the 2016 presidential campaign. The book provides an intellectual justification for that platform. The solution Piketty offers, wealth taxes and high income tax rates, is also right in line with the progressive policy agenda. From the author???s perspective of book sales, in the U.S. at least, he got his political timing exactly right.

Whether he???s right about the economics of capitalistic economies remains to be seen. Many have already poked holes in is reasoning. Kevin Hassett of AEI, for one, offered the strong critique that for the return to capital to always outpace economic growth, the substitutability of capital for labor would have to be much higher than economic research has shown it is.

Tyler Cowen of George Mason argued very persuasively that Piketty largely omitted the role risk plays when it comes to the return on capital. As Cowen explains, not all capital has the same return. Those that can better gauge risk can earn higher returns by avoiding catastrophic losses, but not all investors are so skilled. Some will undoubtedly lose on their investments and their wealth will fall.

And one of the central tenets of Piketty???s argument is that incomes of the lower 90 percent will inevitably fall, which will exacerbate the increase in inequality he foresees. But Scott Winship of the Manhattan Institute shows that the median income in the U.S., contrary to widespread conventional wisdom, increased $26,000 for a family of four from 1979 to 2012 when using better metrics. He argues that incomes can rise while inequality rises, which would pose a different problem, if you can call it that, for policy makers.

What solutions would you offer to counter Piketty’s take? 

Whether you agree or disagree with Piketty???s argument, I think most agree we want people down the income scales to both earn more at their jobs and accumulate more wealth. Piketty believes those things won???t happen in the next century under capitalism because of something rotten at capitalism???s core. So it is the job of the government to step in and take from the wealthy and give to the less wealthy.

I believe that Robin Hood mentality will do more harm than good. The disincentives of wealth taxes and steeply progressive income taxation will lead to slower economic growth, less innovation, and less dynamism. That will hurt those further down the income scale more than those already at the top.

I???d rather see policies put in place that encourage economic growth so that, even if inequality is growing, it matters less because everyone is doing better off anyway. People tend to care less about inequality when they are doing better. It only becomes an issue when the economy stagnates and we are fighting over which size piece of pie everyone gets.

Economic growth would come from more predictable, stable, and rules-based policies from Washington. That includes both better fiscal and monetary policy, and no more major changes to large sectors of the economy like occurred early in President Obama???s term when Obamacare re-made the health care sector and the Dodd-Frank finance reform law shook up the financial sector. Such large shakeups create uncertainty that takes years to recover from.

To help combat inequality we must make it possible for those at the bottom of the income scale to access the power of the global economy to create wealth. They are largely cut off from it now because they lack the skills necessary to tap its potential. That means improving education at both primary and secondary levels.

We also need to reform how we treat saving and investment. Right now, the tax code heavily discourages families from saving, which means they own less capital. Eliminating that discouragement means tax reform that would make it possible for families to save and invest without punishment from the tax code.

I also favor more local improvements, such as Tyler Cowen pointed out, to make it easier for lower income families to live in high cost of living locations where better opportunities often reside. This entails changes to local zoning requirements, which would allow housing prices to fall in urban area such as San Francisco, Washington, DC, and New York.

I would also love to see policies that encourage family formation and for families to have more children. More people would lessen inequality. Unfortunately, I haven???t seen policies that are likely to succeed in increasing fertility rates.