Live-Blogging Piketty: Reading Pt. IV


To summarize the argument of Capital thus far, Piketty has found that over long stretches of time and in many different countries economic growth (g) is substantially less than the return to capital or wealth (r). This means that income from wealth grows faster than income from work (which, on average, grows only as fast as the economy grows). Since returns to wealth go mainly to the very wealthy, income inequality and wealth inequality will rise over time.

Piketty (pp. 358-61) is clear that these are contingent and historical relationships; there is no guarantee that they will continue into the future. He produces no economic theory that says this is the way all capitalist economies work. But he is convinced that since such empirical relationships have existed over such a long time in so many different countries (except for the war years during the 20th century, when the war and high taxes destroyed wealth) they will likely to continue in the future—barring any future world wars or major policy changes.

As a huge policy wonk who has written extensively on tax policy, I have particularly looked forward to reading Part IV of Capital in the Twenty-First Century. Yet, I looked forward to its policy solutions with a good deal of trepidation. This part of the book had received by far the greatest attention and most criticism, and this criticism has come from across the entire political and economic spectrum.

Those on the right objected to the high tax rates that Piketty proposes. The worst of these objections engaged in name-calling, deeming anyone a socialist who proposes higher taxes for whatever reason. Almost as bad have been the objections that higher taxes would give the government more money to waste—as if businesses never, ever wasted money and consumers always spent their money cautiously and rationally (e.g., they would NEVER buy homes or be able to obtain mortgages that they couldn’t possibly afford to repay). The more thoughtful and reasonable objections from the right have focused on the bad incentives to work hard, earn money, accumulate wealth, and provide for one’s children and grandchildren as a result of higher taxes.

Those on the left and toward the center of the political spectrum have been fairly consistent in maintaining that the main policy proposal of Piketty was impractical because a global wealth tax would never get enacted.  After making this point, the next sentence of these critiques typically push other policies (invariably the personal favorites of those criticizing Piketty), which are just as unlikely to get enacted given the current political situation in the US and elsewhere.

After reading Part IV, I find all these criticisms both disturbing and a little bit off the mark. But before looking at his wealth tax proposals in greater detail, it is worth examining what Piketty has to say regarding monetary policy and fiscal policy. This part of Part IV I was not prepared for, mainly because it was not discussed in the many reviews of his book that I read.

Overall, Piketty has a lot of good things to say about fiscal and monetary policy. But there are many places I wish he had said more and made a stronger argument for his position. Also, there are some places he misses things that are important.

Chapter 16 discusses both fiscal policy and monetary policy. One positive aspect of this chapter is that Piketty downplays monetary policy in favor of fiscal policy. Monetary policy, he contends, cannot deal with the problem of rising inequality. In fact, he contends that we cannot know the impact of monetary policy on income and wealth distribution, although there is no argument for this. My gut instinct is that this is true, but I would have liked to see some data that supports this contention—say, looking at how income and wealth distribution vary based on interest rates. Such a study would make for a great thesis or doctoral dissertation, to say nothing about a nice professional paper.

Regarding fiscal policy, Piketty is fairly critical of government deficits. He spends a good deal of time focusing on the need to tax wealth so that we can repay existing government debt, but he fails to address the issue of whether government deficits and debt may be necessary at times. He also doesn’t address the issue of whether government debt does any actual harm to overall macroeconomic performance. Rather, the focus is mainly (Surprise! Surprise! Surprise!) on the impact of debt on income distribution. Picketty’s main point is that the large majority of government bonds created when the government goes into debt is owned by the very wealthy. They benefit greatly from government debt. With little risk, they receive positive returns on their money. This income generates part of their 5 percent rate of return on wealth or capital.

Unfortunately, the passages on fiscal policy and distribution are too short and too brief. There are two key reasons I wish Piketty had written a good deal more on the relationship between fiscal policy and inequality. First, Piketty argues throughout Capital that one main reason inequality declined from World War I through the 1950s was that there were high marginal tax rates on top incomes. This reduced the after-tax gains from owning wealth. Second, fiscal policy is central to Piketty’s major policy proposals.

Writing more on fiscal policy and distribution would not have been all that difficult to do. Moreover, his entire case for changes in tax policy would have been considerably stronger had Piketty spent more time on this topic and then related it to the beginnings of the revolt of the rentiers in the UK and the US when Margaret Thatcher and Ronald Reagan were elected heads of state.

The story in both cases is rather similar and involved several policy changes. There was a sharp cut in government spending (that hurt the poor and middle class more than wealthy households, which can provide their own benefits) and a sharp cut in taxes focused at the top of the income distribution. Overall, the cuts in government expenditures were less than the tax cuts, and the government had to borrow money by printing and selling bonds. Abstracting a little from the overall process, the Reagan and Thatcher governments gave large tax breaks to the wealthy, and then borrowed the money back from them to pay for the tax cuts. Everyone else got small tax cuts that were funded by cutting the government benefits they received. Or in slightly bolder and simpler terms, the Reagan and Thatcher governments decided to fund a good deal of government spending by borrowing money from the wealthy rather than taxing the wealthy.

As Piketty’s data demonstrate, these changes led to sharply rising inequality in the UK and US over the past several decades. And it is no wonder why this occurred. Those earning high incomes got to keep a lot more of their income. Yet something had to be done with all this additional money. It could not be kept under the mattress, earning nothing. Bank deposits were insured, but not for balances of the sort that the very wealthy possessed. The result could only be that all this additional disposable income fueled rising asset prices, which also primarily benefited the wealthy. And to finance the borrowing, the government had to print and sell bond, which tended to push up interest rates on these bonds, again to the benefit of those with lots of money to lend to the government.

According to supply-side gospel, which was used to justify these nefarious policy changes, the whole process should have resulted in much greater economic growth and enormous tax collections by the government so that there would be no deficit. However, this claim ignored the famous balanced budget multiplier of Paul Samuelson. Samuelson showed that an equal cut in taxes and in government spending would slow economic growth or reduce GDP by an amount equal to the tax cut (or cut in government spending). The reason for this is very simple. A dollar less in government spending is a dollar less spending while a dollar tax cut was not an additional dollar in spending since some of the spending will be saved. Overall, this will reduce spending and economic growth. Yet, ideology triumphed over economic knowledge. The US government and the UK government gave huge tax cuts to the wealthy, and then borrowed the money back from them in order to fund the tax cut. Economic growth slowed as the balanced budget multiplier predicted it would. This made distributional matters even worse because it increased the gap between r and g by lowering g.

One last thing is worth some additional comments before getting to the issue of income and wealth taxes, especially since this has been one of the most frequent criticisms of Piketty. Many commentators complained that Piketty ignored alternative policies such as supporting unions and raising the minimum wage.

I took these criticisms rather seriously when I first encountered them, which was well before I started reading the book. And they did perplex me a great deal. Every time I read one of these critiques I wondered how and why Piketty could ignore such simple and obvious solutions to the distribution problem.

After reading Capital closely I am now rather perplexed about something else—Piketty actually does discuss these policies. Chapter 9 includes an extensive discussion of the minimum wage. The data Piketty presents and the written text both make it very clear that the distribution of wages has remained relatively equal in France because the French have continually increased the minimum wage and that the French minimum wage is rather high compared to average wages. Piketty even discusses (p. 289) why this happened— Charles de Gaulle was worried about the crisis of May 1968 and used higher minimum wages to deal with a problem that was more cultural and social than economic. Moreover, Piketty clearly supports raising the minimum wage and even provides several justifications for raising the minimum wage (pp. 311ff.). So it is puzzling that so many people would criticize Piketty for not supporting higher minimum wages. At times like this I think people don’t even bother to read the book they are assigned to review, fearing that doing so might influence their opinion of it.

The real problem Piketty has with raising the minimum wage is not that it won’t help equalize wage income, but that it won’t deal with the problem of rising capital income in the long run. He is also skeptical that the minimum wage can be increased enough (5% per year in real terms) over the long haul without generating substantial unemployment. To try to make Piketty’s point as simple and clear as possible, even if wages (and we can add rising union power here) were made completely equal across the board, inequality would be high and would continue to increase because of the immense wealth that is possessed by a few people. To see exactly how and why this is so, see my blog on Part I of Capital, where I present a case with some simple numbers. These computations start out with small amounts of wealth, the value of wealth is just equal to income; soon it soars well above income. Starting with wealth at around 6 times the value of average income, inequality will soar much faster.

It is wealth inequality for Piketty that is the main force driving inequality to rise under capitalism. A higher minimum wage can slow the process down. So too can stronger unions. So too can government spending policies that equalize after-tax incomes, such as paid parental leave, child allowances, generous unemployment insurance programs, and a large and sturdy social safety net. These are all policies that Piketty, I imagine, would support. But the key insight of Capital is this: the driving force of inequality is that we start with great wealth inequality and the high returns to wealth make things worse over time. Policies that equalize income distribution will help a little, but they ignore the main problem.

Still, Piketty does focus on tax policy to reduce the distribution of wage income. He argues first for a progressive income tax because this (along with inheritance taxes) is the only progressive form of taxation that governments have. Sales or indirect taxes are regressive in nature and insurance taxes (for retirement and for unemployment) tend to be proportional or regressive. Again, Piketty does not make either a strong or forceful case for this policy. I wish he had put a little more emphasis on the fact that high marginal tax rates during the war years and in the decade or so after World War II contributed to the falling inequality in this era. Historically, he contends that high marginal income tax rates have led to lower (before-tax) inequality. It is in the data; it should have been stressed more in the policy section of the book.

On the other hand, Piketty does worry about current trends in individual income taxation. In particular, by exempting capital income from the income tax (or taxing it at lower rates) the income tax becomes regressive at the very top (because that is where they get most of their income) and tends to make the entire tax system regressive in developed countries. But, again, the big issue for Piketty is that progressive income taxes cannot solve the wealth inequality problem. Like progressive spending programs, a progressive income tax would help reduce income inequality, but it does not solve the problem that wealth inequality tends to rise because of the high returns to wealth—much of it, such as stocks and homes that are not sold, are not taxed.

In a couple of pages that were pretty much ignored in the reviews of Capital, Piketty calls for a reform of corporate taxation. He proposes that corporate income taxes be assessed based on wages paid in different countries rather than on where in the world the multi-national firm declares its profits to come from (always the country which has the lowest corporate income tax rate). This is not headline grabbing, and tax reform is never as exciting as proposing a new type of tax (this is why there are so many articles on the flat tax and the Tobin Tax and why reviews of this book focused on the global wealth tax), but it is something that needs to receive serious consideration and should be pushed more.

Again, the fact that Piketty does not focus a lot of attention on this proposal probably stems from the fact that (like higher marginal income tax rates) it will affect income distribution but not wealth distribution. When corporations pay higher taxes to governments there is less profit to distribute to the owners as dividends. This will reduce current incomes. However, higher corporate income taxes also reduce future profits after-taxes, which should affect the value of corporate stock. This will lower the price of shares of stock. Since it is mainly the very wealthy who own large amounts of stock, and whose wealth portfolio contains a higher percentage of stock compared to middle-income households, this policy should have significant and substantial effect on wealth inequality.

At last, we come to Piketty’s main policy conclusion, his claim that the way to keep more and more income from going to those at the very top of the distribution is a global wealth tax. The tax needs to be global in order to keep wealth from moving to tax havens where it is not subject to the tax. Piketty also wants to keep the tax rate low (1-2 percent) in order to mitigate negative disincentives. His particular plan is that net assets worth between 1 million Euros ($1.35 million) and 5 million Euros ($6.75 million) be taxed at 1 percent and net assets worth more than 5 million Euros be taxed at 2 percent. The goal in all this, Piketty makes clear, is not to raise money for social programs but to tame the inequality that inevitably results under capitalism.

Piketty provides several different arguments for his progressive and global wealth tax.

First, he resorts to an appeal to authority. He invokes the American Economic Association Presidential address by Irving Fisher, in which Fisher worries about the fact that only 2% of the US population owned more than 50% of the nation’s wealth while two-thirds of the population had no net wealth. Fisher then went on to suggest a steeply progressive wealth tax to remedy this situation.

Second, Piketty argues that the rewards going to the very top are not justified by traditional economic arguments (that they depend on the marginal productivity of the worker). Instead, Piketty makes the case that CEO pay is due to luck to a large degree and that a bargaining model fits the data better than marginal productivity theory. He argues that when the government takes a very large chunk of any extra income, it is not worth it for a CEO to bargain with a compensation committee or shareholders to get higher pay. And he points to empirical evidence that high marginal tax rates keep down CEO pay while not hurting the economic performance of the firm.

Finally there is the main argument—that a global wealth tax is the only way to limit the growth of wealth accumulation and a return to 19th-century levels of inequality. Or, this is the only way we can avoid all the negative economic, social, and political consequences of great inequality. A tax on income will not achieve this end because much income is tied up in stocks and bonds and real estate that generally do not get taxed. The gains from these investments are taxed when assets are sold. This allows the gains to accumulate at the top and to keep doing so. Only a wealth tax can stop this process.

Finally, while his many critics fault Piketty for making such an unrealistic proposal, Piketty (p. 513f.) himself recognizes that a global wealth tax (or even higher taxes on income from capital in the United States) is not likely to happen anytime soon and perhaps will never happen. He has no unrealistic illusions about this policy being passed in the US or Europe.

The alternative policy proposals made by critics of Piketty, as noted above, are probably unrealistic as a global wealth tax. But the strong case against them, as Piketty points out, is that only a progressive wealth tax deals with the problem of rising inequality in income and wealth under capitalism. A higher minimum wage and greater support for labor unions cannot reduce the concentration of capital. Nor can progressive government programs such as paid parental leave and generous unemployment insurance. Even reforming individual and corporate income taxes will be of limited help (although, as I argue above, global corporate tax reform can do a lot of good). We are left with few options if we want to halt a return to the gilded age.

After finishing Capital, I have come to understand all the fuss about the book and why Piketty has become a rock star among economists. It is one of the most stimulating books in economics that I have read in many, many years. It is a book that, if read seriously, changes one’s views of the nature of capitalism in fundamental ways. And I managed to read the entire book and make sense of it while I was enjoying Paris.

Still, there is much more for me to do and think about. One next step is to look more carefully at the numbers in Piketty’s database, examine how he actually derived his computations, and determine whether he made reasonable adjustments to raw data. Who knows, maybe you will be subject to more blogs from me on this issue.

Then there is the final step. I need to write a review of Capital in the Twenty-First Century for the next issue (July/August) of Dollars & Sense. For those of you who have been following my blog posts in Paris, and think that I couldn’t possibly have anything else to say about the book—think again. And for those of you who have been following my reviews in Dollars & Sense over the past several years, I already have a great pun that I am going to use as my review title. So stay tuned!

–Steve Pressman

Live-Blogging Piketty: An Interlude (Response to Chris Giles)

Should We Count Out Piketty Due to Sum Math Errors?

While I am here in Paris reading Capital in the Twenty-First Century carefully, the book has dominated the headlines again. Having just spent a good deal of time thinking about its numbers (see my Dollars & Sense blog posts at, I thought it would be useful to reflect on the piece published this past weekend in the Financial Times.

There, Chris Giles provides a detailed and lengthy argument against Piketty. He claims there are many instances where Piketty has used the wrong numbers in making his calculations and that many assumptions Piketty makes in doing his research are incorrect.

First, an important point– data transcription and math errors occur all the time in economics. It is a sort of dirty and hidden secret. Typically errors are not discovered and don’t make front page news. One cost of being an economic rock star is that the data Paparazzi hang on to your every number.

But the gotcha reception of finding math mistakes is worth reflecting on. I have been amused by smug claims that Piketty supporters unthinkingly accepted his numbers, and that Giles has proven Piketty to be totally wrong. Even before examining any numbers, it is easy to see that these claims succumb to the same mistake that they accuse Piketty’s supporters of making. I cannot think of any better evidence that Capital in the Twenty-First Century has hit a raw nerve in the socio-economic psyche.

More seriously, some bloggers and even some economists have compared the Giles “discoveries” to the recent Rogoff and Reinhart brouhaha. In this case, a University of Massachusetts graduate student, trying to replicate empirical results as a class assignment, found several errors in the Excel spreadsheet that Rogoff and Reinhart used to claim that when debt-to-GDP figures exceed 90%, economic growth slowed. Once these errors were corrected, the 90% tipping point disappeared. Since there was no tipping point, governments could stimulate the economy, fight unemployment and increase debt levels without worrying about a slowdown in economic growth.

There was another scandal involving Martin Feldstein back in the 1970s. Feldstein published a paper in the Quarterly Journal of Economics (regarded as one of the top half dozen economics journals) in 1974 showing that Social Security reduced the US personal savings rate. Feldstein then used his results to push for privatizing Social Security in order to increase savings in the US. When two research economists at the Social Security Administration obtained Feldstein’s data to do additional analysis, the first thing they tried to do was replicate the study. What they found was a programming error; when corrected this changed the conclusion of Feldstein’s paper—Social Security tended to increase the individual savings rate.

Such mistakes are rarely intentional. Rather, the problem is a human tendency to believe the things that confirm your expectations and the human tendency to make mistakes. When results turn out as expected, economists do not look for errors in their numbers or their calculations. On the other hand, when results turn out contrary to one’s intuitions, the first thing that economists do is seek out the errors in their math and their data. So there is always a bias in empirical work; you tend to confirm your intuitions.

Just because errors are inevitable is no reason to dismiss all empirical results. Be skeptical; but do not dismiss. In other words, the question is not (as Neil Irwin titles his column in the New York Times on May 25th) “Did Thomas Piketty Get His Math Wrong?”. Rather, the important question is how much do the math mistakes matter. Do they affect the main results significantly? Or, worst of all, do they require a totally different story (as in the Rogoff-Reinhart and Feldstein cases)? If Piketty made some errors and this has little impact on his results, it is not a big deal.

To be honest, I have not looked at the actual computations on Piketty’s website since I am still working my way through his book. However, I do have some concerns with the methodology he employs to arrive at some of his figures. These are all spelled out in my previous blogs on Capital. But before addressing the claims of Giles, let me summarize the main argument of Piketty.

Piketty makes the case that inequality tends to rise in developed capitalist economies as a result of three empirical facts. First, a slow annual growth rate (1 percent, maybe close to 2 percent). Second, returns on wealth of around 5 percent per year (as has existed over long stretches of history). And third, the fact that the distribution of wealth is more concentrated than the distribution of income. This being the case, it follows that those with lots of wealth will see (on average) their annual gains (or their income) rise around 5 percent each year, while those without much wealth will see their incomes (on average) grow only 1 percent or so annually (the growth rate of the economy). Income inequality rises as does wealth inequality.

There should be no dispute that wealth is distributed more unequally than income. This has long known to be the case thanks to the Federal Reserve’s Survey of Consumer Finances and the work of Edward Wolff at NYU. Not even Giles questions this.

The key figures are the 5% and 1-2%. The 1-2% annual growth rates come from standard government data sources. Yes, there are problems with these figures. The way we compute GDP is flawed (e.g., we exclude the underground economy). But these flaws are similar from year to year, so the measured growth of GDP is a reasonably good figure. Since our numbers are not perfect, economists sometimes tweak the data to account for changes in the size of the underground economy over the business cycle. But these are minor issues. The GDP data is ok to measure economic growth over time. The more contentious and more salient issue is whether economies can grow faster than 1-2%. Robert Solow, who won a Nobel Prize in Economics for his work on growth theory, claims this is possible in his review of Capital; Giles is silent on the question of economic growth rates.

This brings us to the final figure—the 5% return on wealth. This is the key figure in Capital. If this number actually is closer to 2% percent than 5%, wealth and income grow at the same rate, and we don’t have to fear growing inequality. Unfortunately, Giles does not discuss this number either and so he ignores the entire argument of Piketty.

Instead, what Giles shows, and what he takes as a refutation of Piketty, is that the share of wealth received by the top 10% and top 1% are not growing as fast as Piketty estimates. But, and this is the important point, as long as wealth inequality is increasing, this supports Picketty. Maybe it does not support Piketty as much as Piketty’s own calculations, but it does support him. Unlike the Rogoff-Reinhart and Feldstein cases, there is no refutation of Piketty here. That would require a clear demonstration that wealth shares owned by the very rich have been falling over a long period of time.

It is now time to say a few words about the Giles article itself.

Giles claims that Piketty made lots of math mistakes and bad assumptions in his work, and that this has led to incorrect estimates of wealth shares. Rather than correcting these mistakes, and then recalculating final figures (as happened in the Rogoff-Reinhart and Feldstein cases), Giles is content to point out the errors and then present his own numbers.

Giles notes that Piketty’s estimate of the share of total wealth held by the top 10 percent (77%) in the UK is much higher than the official government estimate (44%). Giles also compares Piketty’s estimates with other estimates of the share of wealth held by the top 10% and the top 1% in the UK. All show high levels of wealth inequality before World War I, then a sharp decline until around 1970 or 1980, and then an increase in the wealth shares of the richest 10% and 1%. Piketty’s data shows a larger increase than all the other sources at the end of the 20th century; but all sources show an increase.

Giles then provides his own estimates, which sort of follow Piketty and the other estimates until 2010. Then, wealth shares for the very wealthy fall according to Giles. Given the sharp drop in stock values in the late 2000s, I am inclined to lean toward Giles’s figures for 2010 rather than the Piketty figures. However, it needs to be remembered that this is only one data point, and it is for a point in time when stock values (an asset held mainly by those at the very top of the wealth distribution) fell sharply. The issue concerns long-term trends, and the 2010 data (or any one year of data for that matter) does not answer this question. In fact, it really does not address this question at all. It is like picking a cold day in winter and using this as proof that global warming is a myth.

But there is a much bigger problem with this whole endeavor.

All the alternative estimates that Giles presents of wealth shares are based on household survey data (including the 44% government estimate of the wealth held by the top 10% in the UK). Economists recognize that survey data underestimate wealth inequality and income inequality because the very wealthy are more likely to lie about their wealth and income than everyone else.

This was why Piketty sought better sources to measure wealth and income distribution (estate tax returns and individual income tax returns). Of course, people lie on tax forms too. Income from wealth hidden in off-shore tax havens will not get reported on tax forms. But tax forms are more reliable sources than what people say when asked about their wealth. So, it is hard not to give the benefit of the doubt to Piketty here. Even if the two sources were equally good (or equally flawed), the truth should lie close to halfway between the government survey estimate of wealth shares and the estimate of Piketty. This would show a clear upward trend during the past several decades, confirming Piketty’s views of capitalism. But even if Giles figures are correct, the best we can say is that maybe wealth inequality has not increased as much as Piketty estimates. As long as wealth inequality has increased in the second half of the twentieth century, this confirms the main argument of Piketty. All the data seems to point in this direction.

Giles identifies a number of other flaws and condemns Piketty for these. He notes some transcription errors, which are inevitable, as noted above. Giles also complains about how Piketty sometimes tweaks numbers from other sources. But this is something all economists do when they know that some numbers are wrong because of problems such as a non-representative sample or because some important information (e.g., the underground economy) is missing from standard measures. Most of these seem to me rather trivial. Errors can always be corrected and tweaks done in different ways.

The important issue, the bottom line, is always whether these changes lead to a different empirical conclusion. This does not seem to be the case for the transcription problems and data tweaking. Presenting numbers based on worse data refute Piketty also does not change the story.

In sum, Giles has offered up a weak critique of Piketty. At best, he shows that wealth inequality is increasing less than Piketty says it is. At his worst, he ignores the argument made in Capital. To repeat, the problem is that Giles does not mention and does not question of the 5% returns on wealth. Piketty’s point is that because wealth is distributed so unequally (a point that virtually no one objects to), high returns to wealth (relative to economic growth) will push up inequality. This is not an empirical matter that may contain lots of mistakes. It is a fundamental property regarding how capitalist economies work. This is the brilliant insight of Capital. Giles has not refuted it. Even worse, he does not even attempt to do so. In many respects, and in retrospect, it is hard to see what all the fuss has been about.

–Steve Pressman