President Obama highlighted inequality in his State of the Union address Tuesday, remarking “let’s close the loopholes that lead to inequality by allowing the top one percent to avoid paying taxes on their accumulated wealth.” Much of the inequality debate over the past year has been over French economist Thomas Piketty’s best-selling inequality tome, Capital in the Twenty-First Century.
The chair of Obama’s own Council of Economic Advisers questioned Piketty’s ideas in May 2014. Yet Obama is pushing forward with his fight against inequality by proposing tax hikes targeted against the wealthy. He wants to raise the top capital gains tax rate to 28 percent on couples who earn more than $500,000 annually, and also wants to make inherited capital gains subject to taxation. The Washington Post’s Matt O’Brien called the plan “Piketty with an American accent.”
The problem? Piketty’s work is being increasingly scrutinized by academics, exposing its flawed premises and attacking its solutions.
The latest academic work from the National Bureau of Economic Research criticizes Piketty’s data for not accounting for taxes and welfare payments in calculating inequality. Transfer payments as a share of gross domestic product have doubled since 1970, rising to 14.7 percent of GDP. Piketty ignores this factor in his analysis, exaggerating his descriptions of inequality. “This paper takes issue with the facts, logic, and policy conclusions in Piketty’s book, suggesting that the factors needed to support the inexorable rise in capital’s share and concentration are lacking, and that among tax policy reforms aimed at dealing with economic inequality, a wealth tax finds little support either in Piketty’s own work or elsewhere in the literature,” the paper said.
Piketty’s proposal for a global wealth tax rate of up to 10 percent also gets criticized. “If the disproportionate political power of the wealthy is the concern, a consumption tax is potentially a more powerful tool,” the authors wrote. “Tax policy can play an important role in addressing inequality, but we find little support for Piketty’s particular approach either in Capital or elsewhere in the literature of recent decades.”
Alan Auerbach, an economics professor at the University of California, Berkeley, and Kevin Hassett, the Director of Economic Policy Studies at the American Enterprise Institute, co-authored the paper.
Past NBER research also criticized Piketty’s book, with one paper exposing historical flaws and manufactured data in assertions about the United States. Piketty made mistakes in describing which presidents increased the minimum wage and the top income tax rate. The historical mistakes alone do not nullify his conclusions, but it suggests Piketty may have played fast and loose with his data.
Another NBER working paper criticized Piketty’s suggestion that inequality rises when the rate of return on capital is greater than the rate of economic growth. Data show no relationship between the two factors. The authors note cases where Piketty’s indicators present a distorted view of inequality. For example, under Piketty’s definition, inequality in South Africa was low during apartheid, but then rose after apartheid ended. Alternative measures show inequality was high during the oppressive apartheid era and then fell after apartheid ended in 1991.
It is clear that Piketty’s analysis is not credible enough to provide support for public policy. Inequality may still be on the rise in the U.S., but there is scant evidence that Obama’s State of the Union tax proposal will actually close the wealth gap.
