Thomas Piketty's Thesis Is Wrong On Logical Grounds
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Thomas Piketty's recent best-selling book, "Capital in the Twenty-First Century," has been hailed by anti-capitalists as proof that a free-market system is rigged in favor of idle "rentiers" at the expense of ordinary citizens.
In Piketty's own words, "the entrepreneur tends to become a rentier, more and more dominant over those who own nothing but their labor. Once constituted, capital reproduces itself faster than output increases. The past devours the future."
This result supposedly holds because "when the rate of return on capital exceeds the rate of growth of output and income, as it did in the nineteenth century and seems quite likely to do again in the twenty-first, capitalism generates arbitrary and unsustainable inequalities that radically undermine the meritocratic values on which democratic societies are based."
So what are we to do? According to Piketty, the solution is an annual wealth tax of 1% on "fortunes" between 1 million and 5 million euros and 2% above 5 million euros. One can well imagine that Piketty's arguments will be raised by sympathetic politicians in the 2016 elections.
In a forthcoming article in May's American Economic Review, Piketty has softened his thesis somewhat. But a mere softening will not do.
The thesis is unequivocally incorrect. It is wrong on logical grounds because he seems to think the rate of return on capital is the same thing as the rate of growth of wealth. It is not.
Wealth holders pay federal and state income taxes, not to mention estate taxes, engage in consumption and make donations. These activities reduce the actual rate of growth of "rentier" wealth far below the rate of return on capital and far below the rate of growth of national income.
The reason "old wealth" is not able to keep up with the growth of the overall economy is readily apparent when one looks at actual data on rates of return, tax rates and economic growth.
Piketty suggests that the historical rate of return on a mixture of assets is 3% to 4% per year in excess of the rate of inflation, a range broadly consistent with generally accepted sources of data. At current inflation rates of 2%, the nominal return would then be about 5.5% per year at the midpoint of Piketty's range. State and federal income taxes on a mix of various types of investment income reduce the average nominal return from 5.5% to 4% or less and the real, after-tax return from 3.5% to 2% or less.
Since 2% per year is below the 3% per year long-term average rate of growth of the U. S. economy, Piketty's typical rentier would be falling behind each year at the rate of 1%, even if he consumed nothing out of wealth, made no charitable donations and paid nothing in estate taxes!
Failure of the Piketty thesis is rather obvious when tested against the best available data. As detailed in my current Cato Journal article, all of these data indicate that rentier wealth has lagged so far behind the growth of the economy as to make the Piketty thesis ludicrous.
For example, a recent survey conducted by Forbes magazine found that only 16 out of 185 billionaire families in the U. S. can trace their fortune back to the 19th century. Nowhere on the Forbes list are the Vanderbilts, the Carnegies, the Morgans or the Astors, even though the initial wealth of each family is thought to have exceeded $100 billion in current dollars.
The wealthiest family of all, the Rockefellers, has apparently fallen from an estimated $340 billion or so in today's dollars to about $10 billion, a decline of 97% in absolute terms and 99.9% in per capita terms when spread over an estimated 4,803 current family members.
Yet if Piketty were correct, the Rockefeller family currently should have several trillion dollars in wealth.
This result supposedly holds because "when the rate of return on capital exceeds the rate of growth of output and income, as it did in the nineteenth century and seems quite likely to do again in the twenty-first, capitalism generates arbitrary and unsustainable inequalities that radically undermine the meritocratic values on which democratic societies are based."
So what are we to do? According to Piketty, the solution is an annual wealth tax of 1% on "fortunes" between 1 million and 5 million euros and 2% above 5 million euros. One can well imagine that Piketty's arguments will be raised by sympathetic politicians in the 2016 elections.
In a forthcoming article in May's American Economic Review, Piketty has softened his thesis somewhat. But a mere softening will not do.
The thesis is unequivocally incorrect. It is wrong on logical grounds because he seems to think the rate of return on capital is the same thing as the rate of growth of wealth. It is not.
Wealth holders pay federal and state income taxes, not to mention estate taxes, engage in consumption and make donations. These activities reduce the actual rate of growth of "rentier" wealth far below the rate of return on capital and far below the rate of growth of national income.
The reason "old wealth" is not able to keep up with the growth of the overall economy is readily apparent when one looks at actual data on rates of return, tax rates and economic growth.
Piketty suggests that the historical rate of return on a mixture of assets is 3% to 4% per year in excess of the rate of inflation, a range broadly consistent with generally accepted sources of data. At current inflation rates of 2%, the nominal return would then be about 5.5% per year at the midpoint of Piketty's range. State and federal income taxes on a mix of various types of investment income reduce the average nominal return from 5.5% to 4% or less and the real, after-tax return from 3.5% to 2% or less.
Since 2% per year is below the 3% per year long-term average rate of growth of the U. S. economy, Piketty's typical rentier would be falling behind each year at the rate of 1%, even if he consumed nothing out of wealth, made no charitable donations and paid nothing in estate taxes!
Failure of the Piketty thesis is rather obvious when tested against the best available data. As detailed in my current Cato Journal article, all of these data indicate that rentier wealth has lagged so far behind the growth of the economy as to make the Piketty thesis ludicrous.
For example, a recent survey conducted by Forbes magazine found that only 16 out of 185 billionaire families in the U. S. can trace their fortune back to the 19th century. Nowhere on the Forbes list are the Vanderbilts, the Carnegies, the Morgans or the Astors, even though the initial wealth of each family is thought to have exceeded $100 billion in current dollars.
The wealthiest family of all, the Rockefellers, has apparently fallen from an estimated $340 billion or so in today's dollars to about $10 billion, a decline of 97% in absolute terms and 99.9% in per capita terms when spread over an estimated 4,803 current family members.
Yet if Piketty were correct, the Rockefeller family currently should have several trillion dollars in wealth.
Read More At Investor's Business Daily: http://news.investors.com/ibd-editorials-perspective/032015-744527-french-economist-piketty-got-it-wrong.htm#ixzz3VBXZJRgg
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