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Two More Piketty Problems

This month’s lead article at EconLib is by me.  In it, I explore two flaws in Thomas Piketty’s analysis of wealth and income differences – two flaws that have drawn relatively little attention thus far in the public conversation sparked by his book.  The two flaws that I address in this article involve, first, an error that Piketty makes when discussing the burden of government debt versus that of taxation, and second, a weakness in Piketty’s analysis of the market for executive talent.  A slice:

Piketty reasonably assumes that if government finances its expenditures with taxes, then the rich would pay a disproportionately large share of those taxes. But he unreasonably assumes that debt financing of government expenditures not only allows the rich to escape higher taxes, but also gives them a lucrative stream of returns that adds to their net wealth. Unfortunately, alas, for the rich (and for everyone else), real wealth cannot be created in this rabbit-out-of-a-hat manner.

To see why, first understand that the value of real resources transferred initially by the rich to the government is the same with public-debt issuance as it is with taxation. (I readily accept Piketty’s assumption that it’s the rich who largely pay the taxes and that, with debt financing, it’s largely the rich who buy the bonds.6) If government today gets X amount more real resources to use, then the private sector has X amount fewer real resources to use. This reality holds true regardless of the method government employs to get these resources. Therefore, during the current period (the period when the loans are made and before interest starts to be paid on the debt), the amounts of real resources at the disposal of the rich are reduced by public-debt issuance as much as by taxation.

The difference is that taxation, unlike debt financing, results in the rich receiving neither repayment of principal nor interest on that principal in the future. But this difference is less real than it appears to be at first glance, especially given Piketty’s assumptions (in his discussion of government debt) that (1) the rich are the main targets of the taxman, and (2) families that are currently rich continue to be rich well into the future.