May 12, 2014 8:33AM

Piketty Should Focus on Increasing the Scope of Markets, Not Expanding the Power of Government

In his best-selling book Capital in the Twenty-First Century (Harvard University Press), French economist Thomas Piketty is concerned with equality of outcome, not equality under a rule of law safeguarding one’s unalienable rights to liberty and property. 

He finds that inequality of income and wealth is increasing as the return on capital assets exceeds the growth of real GDP.  His policy for reducing inequality is to use the power of government to impose very high marginal tax rates on the incomes of the rich and near rich, and also impose an annual wealth tax.  His goal is “to put an end to such incomes.”

Piketty’s leveling schemes in the pursuit of “social justice” would undermine the primacy of property rights under the U.S. Constitution, adversely affect incentives to save and invest, stifle entrepreneurship, and slow economic growth. He seems more interested in penalizing the rich than in thinking of ways to create wealth by expanding opportunities for market exchange.

Underlying his approach to equality is the false idea that the rich get richer at the expense of the poor.  He ignores the reality that voluntary exchanges in the marketplace make parties to the trades better off—and wealth is created.

He also ignores the wisdom of the late development economist Peter Bauer who warned: “The unholy grail of economic equality would exchange the promised reduction or removal of differences in income and wealth for much greater actual inequality of power between rulers and subjects.” 

Capital is best understood as a bundle of ownership rights—in particular, the right to sell one’s property and the right to receive the income from that property.  When those rights are attenuated, capital is destroyed. 

Gary Becker, the late Nobel laureate economist, showed the importance of human capital (i.e., the skills individuals acquire through education and training) for a person’s future income and economic growth. High marginal income tax rates and wealth taxes dampen incentives to invest in human and non-human capital—and when investment slows so will economic growth. 

Imposing a 50 percent marginal tax rate on individuals with incomes starting at  $200,000 and increasing that rate to 80 percent at $500,000, as Piketty proposes, would heavily penalize those who have invested in their human capital and discourage others from doing so.

Likewise, Piketty’s proposed wealth tax would translate into a very high tax on the income from non-human capital.  For example, with some simplifying assumptions, a 2 percent wealth tax is equivalent to a tax rate of 67 percent on capital income if the discount rate is 3 percent.  Piketty proposes a 5 to 10 percent annual tax on the net worth of individuals with at least $1 billion in assets.  A 10 percent wealth tax translates into a tax on capital income of 333 percent (assuming a discount rate of 3 percent).

Such confiscatory tax rates would not raise much revenue because the rich would move to low tax regimes like Hong Kong that relish economic freedom.  That is why Piketty wants a global wealth tax—but that’s pie in the sky.

The high taxes on capital would ultimately harm workers in those countries that followed Piketty’s policies, as incomes grew more slowly. Rich capitalists are not the enemy of poor workers.  Capital freedom and private property allow for upward mobility.    

Piketty does the economics profession a disservice by focusing on outcomes rather than institutions, incentives, and processes.  He believes more in the power of government than in the power of markets to transform people’s lives.  History has shown that individuals have a natural desire to improve themselves and that economic freedom—not the redistributive state—is the key to human progress.

 Instead of calling for higher taxes to reduce the return on capital, Piketty would be on firmer ground by arguing for an increase in economic freedom and more limited government to increase the range of choices open to people.