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.
This is from Don Boudreaux, “Thomas Piketty’s Flawed Analyses of Government Debt and Executive Compensation,” the Econlib Feature Article for August.
In a book that is almost 700 pages, Piketty deals with many issues besides the main one of wealth inequality. Professor Boudreaux highlights two: government debt and executive compensation.
Another excerpt:
Piketty appears to be untroubled by this inconsistency between his theory of executive compensation and the reality of the great growth in corporations’ market values over the past few decades. Nevertheless, had he more carefully examined the empirical literature on executives’ compensation, he might have been more reluctant to assert that their pay is unrelated to managerial productivity. As the University of Chicago’s Steven Kaplan reported last year in Foreign Affairs, when he and co-author Joshua Rauh analyzed 1,700 firms, they “found that compensation was highly related to performance: the companies that paid their CEOs the most saw their stocks do the best, and those that paid the least saw their stocks do the worst.”
The whole piece, which is relatively short, is worth reading.
READER COMMENTS
happyjuggler0
Aug 4 2014 at 4:28pm
DH, thanks for the heads up.
DB, excellent piece; both parts.
I realize that the point of your article (DB) was to point out those two (of many) errors that Piketty made. However I would like to point out something that you no doubt already are aware of, but for reasons of space and perhaps staying on topic, you did not cover.
The issue is wasteful government spending enabled by borrowing, and its unseen (cue France’s Bastiat, link at bottom of my post) consequences, especially when it is unsustainable spending due to promising greater future outputs than can be collected in future taxes and/or borrowing.
Take modern Greece for example. The Greek government defaulted on its bonds. The lenders got royally skewered (was Piketty paying attention? I think not), but they were not the only ones. Since they were unwilling or unable to raise enough in new tax revenues to cover the shortfall, government spending per force had to fall. This left people (needy, poor, middle income, the elderly) who had naively counted on government checks/benefits to also get skewered because they also received less than they had planned on.
The net result is that:
People who might otherwise have worked at an older age before retiring are now dramatically worse off than they would have been in the absence of such unsustainable promises enabled by government borrowing.
People who might otherwise have saved more via non-governmental avenues (i.e. not buying government bonds) are now dramatically worse off than they would have been in the absence of such unsustainable promises enabled by government borrowing.
People who might otherwise have worked longer hours earning more money are now dramatically worse off than they would have been in the absence of such unsustainable promises enabled by government borrowing.
People who might otherwise have gone to college to get a degree, and get a useful one, and take their learning seriously instead of partying, are now dramatically worse off than they would have been in the absence of such unsustainable promises enabled by government borrowing.
People who might otherwise have taken grade school more seriously, and who might have had parents pushing them to take it more seriously, are now dramatically worse off than they would have been in the absence of such unsustainable promises enabled by government borrowing.
In short (oops, too late), if not for such government borrowing there would have been a lot more productive investment in private sector businesses, a lot productive investment in human capital, and a lot more productive work done. It is this “unseen” aspect that made the Greek people in general, as well as “the 1%”, a lot worse off than they otherwise would have been without such government borrowing.
The same lesson also holds for Piketty’s France and here in the US and everywhere else for that matter.
http://bastiat.org/en/twisatwins.html
PJC
Aug 4 2014 at 5:19pm
The issue of executive compensation and stock performance is far from settled. This article (surveying 200 firms) finds no correlation.
http://www.businessweek.com/articles/2014-07-22/for-ceos-correlation-between-pay-and-stock-performance-is-pretty-random
ThomasH
Aug 5 2014 at 1:07pm
The percent of taxes paid by the “rich” probably depends a lot more on before tax income distribution than on tax rates. It’s one of the less interesting ways to describe a tax system because it has almost no independent normative force. [A system that raised most of its revenue from taxes on the poor would be bad for other reasons.] Pinkety’s bad if he argues for higher taxes on the rich on those grounds.
It’s an odd stance, in that in my experience, it is usually “conservatives” who bring up the percent of income paid by the rich, usually as a way to argue AGAINST higher taxes on the rich.
Also, it is difficult to see which policy issue Pinkety has in mind that trades off higher deficits against higher taxes on the rich. In the US, at least, arguments have been around higher/lower taxes on the rich as a means to reduce/increase deficits.
Mark Brady
Aug 5 2014 at 11:21pm
“Piketty reasonably assumes that if government finances its expenditures with taxes, then the rich would pay a disproportionately large share of those taxes.”
But does he? And more pertinently, does he assume that this was the case in late eighteenth and early nineteenth century Britain?
In any event, my understanding is that the British tax system at that time, and more especially that administered by central government, was regressive, not progressive, and thus it would seem that Don’s critique does not hold up.
Don Boudreaux
Aug 6 2014 at 5:49am
Mark,
Piketty does indeed make such an assumption. (He argues, specifically, that had the British government then not issued bonds to finance its expenses, the rich would have not only not gotten this source of wealth (bonds) but would have been taxed instead.
You might well be correct about the actual state of British taxation during the late 18the and early 19th centuries, but Piketty – correctly or incorrectly – assumed (at least for purposes of his discussion of the public debt) that the rich are (or were then) the chief targets of the taxman.
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