The flurry of writings that have sprung up in recent weeks from sources both expected and unexpected, all refuting the claims made by Thomas Piketty’s book Capital in the Twenty-First Century, have easily pushed over the cardboard cutout of an economic theory that that book offered. From Martin Feldstein’s excellent piece in the Wall Street Journal to Randall Holcombe at the Independent Institute, Kevin Hassett at AEI, a collaborative effort by scholars at the Sciences Po, undoubtedly the most widely referenced criticism by the FT, and untold others, Piketty’s economics stand tattered after a matter of weeks. My personal favorite was Harry Binswanger’s editorial in RealClearMarkets that went beyond statistics and cut straight to the egalitarian heart of Piketty’s guiding philosophy.
As the controversy over Piketty’s data and the validity of his theory wages on, a key implication of Piketty’s work is being overlooked. As Feldstein notes in the Wall Street Journal, Piketty commits the rather naïve error of basing his whole assessment of US household income on tax returns, treating taxable income as equivalent to total income without the slightest regard for how changes in tax law since the early 1980s have affected Americans’ income structure and encouraged a diversion of their investments from low-yield, non-taxable assets to high-yield and taxable ones. Piketty errantly interprets this as a case of the rich getting richer, but it is, in the end, a clear case of Americans putting their assets to more productive uses once the burden of government is lowered, pursuing more profitable ventures and improving the economy in the process.
It is a textbook example of that time-tested model known as the Laffer Curve (named for one of Feldstein’s colleagues in the Reagan administration, Art Laffer) that teaches us that increasing the tax rate only increases tax revenues up to a point, beyond which people will either divert their incomes into low-yield, non-taxable investments or simply choose not to earn any more—neither of which is good for the economy. Piketty’s data inadvertently validates this. Where his analysis interprets his data as showing an increasing return on the rate of capital (which there likely is in such an economically fearful time as this), what it actually shows is the ability of a lower tax rate and simplified tax and regulatory structure to reach a larger tax base and increase government revenues.
Is an increase in government revenues the ideal toward which we should strive? Not at all. The ideal is, as it always has been, the security of individual rights and the maintenance of a strictly limited government that respects the freedoms of its people. And lowering government spending remains a far more urgent priority than increasing revenues. Nonetheless, the beneficial effects of a lower, simplified tax structure that does not discriminate against higher earners or value-creating activities like capital investment are immense.
Furthermore, at a time when the U.S. national debt has skyrocketed, any tax structure that improves our ability to pay down that debt while decreasing the burden on each individual taxpayer must be viewed as a vast improvement. Contrary to Piketty’s policy prescriptions for higher taxes on capital and a global wealth tax, his own data—the unaltered parts, anyways—tell a story of how lower tax rates broaden the tax base, bring capital back out of the barren shadows, and improve economic growth while lessening the burden on individuals. It may not be the story the left wants to hear, but if they persist in defending his data as valid, they should at least show the integrity of not cherry-picking its implications.