In his opening statement for the tax debate sponsored by The Economist, Thomas Piketty argues that we should impose a very high tax rate of about 80 percent on the top income earners in society. The following rebuttal of this idea addresses Piketty’s philosophy of income, and it discusses problems with his political, economic, and historical reasons for tax increases on high earners.
Piketty’s Philosophy of Income
Piketty’s understanding of the nature of income is very European. He implies that there is a fixed income pie, such that any income that high earners receive must come at the expense of others. Because the share of income earned by the top 1 percent has increased, he says that there has been “an income transfer of about 14 points of national income” to the top group. But high earners did not take that money from other people, they generated it by their own efforts.
In a market economy, there is no central pile of money that is distributed out to the citizens. Each person produces value and earns income by voluntary exchange in a decentralised fashion. Compensation follows from people producing items of value to others. Of course there are exceptions, such as those high‐earning CEOs who perform poorly, but it doesn’t make economic sense to impose exorbitant tax rates because of the exceptions.
Those at the top end—the entrepreneurs, doctors, and others with unique skills—often generate benefits that are greater than their reward in compensation. One reason is that there is scope for innovation in top‐end jobs like heart surgery that there isn’t in lower‐income jobs. The trash collector’s wage matches his contribution, but when the surgeon invents a new medical technique, it can create long‐lasting benefits for the rest of us that will only be partly reflected in compensation.
I have people like Apple’s Steve Jobs in mind when I think about designing tax policy for the top 1%. But Piketty seems to think that those at the top end did not earn their compensation, rather their high pay came from amorphous forces such as “gains from globalisation.” However, let’s say Piketty is right, that the innovators behind firms like Apple just happened to be lucky that their products became global bestsellers. It still makes no sense to impose high taxes on them because those entrepreneurs are more likely to use the cash productively than the government. Indeed, from the beginning of Silicon Valley, wave after wave of millionaires have funded the next wave of business successes through angel financing and venture capital. Obviously, that would not have been possible under Piketty’s 80% tax rate.
A final note on income is that Piketty’s calculations on the rising income share of the top 1% are much less precise than he pretends. Piketty’s work is based on income as reported on tax returns, but there have been huge changes in the American tax system since the 1970s that make measuring income over time very difficult. My colleague Alan Reynolds has tackled some of these problems with the Piketty data.1 One issue is that the top federal income tax rate fell from 70% in the late 1970s to 35% today, with the result that high‐income taxpayers are avoiding and evading taxes less, and reporting more income on their returns.
If you look at Piketty’s data showing the share of income received by the top 1% since the 1970s, you will see sudden upward spikes after major tax rate cuts. That suggests that a portion of the income gains at the high end are not based on structural factors, such as globalisation as Piketty suggests, but are simply expected responses to changes in tax law. In a 2009 paper, Emmanuel Saez and co‐authors confirmed that, noting: