Piketty's Numbers Don't Add Up


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Thomas Piketty has recently attracted widespread attention for his claim that capitalism will now lead inexorably to an increasing inequality of income and wealth unless there are radical changes in taxation. Although his book, "Capital in the Twenty-First Century," has been praised by those who advocate income redistribution, his thesis rests on a false theory of how wealth evolves in a market economy, a flawed interpretation of U.S. income-tax data, and a misunderstanding of the current nature of household wealth.

Mr. Piketty's theoretical analysis starts with the correct fact that the rate of return on capital—the extra income that results from investing an additional dollar in plant and equipment—exceeds the rate of growth of the economy. He then jumps to the false conclusion that this difference between the rate of return and the rate of growth leads through time to an ever-increasing inequality of wealth and of income unless the process is interrupted by depression, war or confiscatory taxation. He advocates a top tax rate above 80% on very high salaries, combined with a global tax that increases with the amount of wealth to 2% or more.

His conclusion about ever-increasing inequality could be correct if people lived forever. But they don't. Individuals save during their working years and spend most of their accumulated assets during retirement. They pass on some of their wealth to the next generation. But the cumulative effect of such bequests is diluted by the combination of existing estate taxes and the number of children and grandchildren who share the bequests.

The result is that total wealth grows over time roughly in proportion to total income. Since 1960, the Federal Reserve flow-of-funds data report that real total household wealth in the U.S. has grown at 3.2% a year while the real total personal income calculated by the Department of Commerce grew at 3.3%.

The second problem with Mr. Piketty's conclusions about increasing inequality is his use of income-tax returns without recognizing the importance of the changes that have occurred in tax rules. Internal Revenue Service data, he notes, show that the income reported on tax returns by the top 10% of taxpayers was relatively constant as a share of national income from the end of World War II to 1980, but the ratio has risen significantly since then. Yet the income reported on tax returns is not the same as individuals' real total income. The changes in tax rules since 1980 create a false impression of rising inequality.

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