Capital Taxation inThe 21st Century?
By Mark J. Warshawsky
This article is a review and critique of the new book by Thomas Piketty,
Capital in the Twenty-FirstCentury
. Piketty, a professor at the Paris School of Economics, reviews data on income and wealthinequality in developed countries over the pasthundred years or so. He makes bold projections thatapparent recent trends of increasing inequality willcontinue and deepen. Based on his interpretation of the data, Piketty gives strong prescriptions to sub-stantially increase marginal tax rates on income andto institute a global tax on capital.The book’s political significance is high for
readers because the Obama administrationearly on strongly endorsed Piketty’s claim withUniversity of California, Berkeley professor Em-manuel Saez that U.S. income and wage inequalityhas grown significantly over the last 30 years. Theadministration highlighted Piketty’s findings in itsfirst proposed budget, presented in 2009, tyingmajor parts of President Obama’s domestic policyagenda to the research. More recently, Obama hasstated that inequality is the single most importantpolicy issue in the United States, ‘‘the definingchallenge of our time.’’ The book will also surelyresonate in Europe and among international eco-nomic organizations. The book’s intellectual signifi-cance is high for
readers because thestatistics reported are based mainly on historicaland recent tax records for France, Great Britain, andthe United States (and to lesser extents, Germany,Sweden, and other countries).
Piketty organizes his analysis around two simpleequations that he calls fundamental laws of capital-ism. The first is an accounting definition — theshare of capital in national income equals the prod-uct of the return on capital and the capital/incomeratio. While tautological, the equation is nonethe-less informative because it expresses an importantrelationship among key variables, each of whichcan be measured and explained, sometimes inde-pendently and often by various data sources. Forexample, if the capital/income ratio is 600 percentand the return is 5 percent, the share of capital innational income is 30 percent. Capital is definedand measured as all forms of real property (includ-ing housing) and financial and professional capital(plants, infrastructure, machinery, inventory, pat-ents, and so on) used by companies and govern-ment, all of which can be owned and exchanged, onsome market. Thus, capital is largely measured atmarket prices.The second equation, or fundamental law of capitalism, is that the capital/income ratio is equalin the long run to the savings rate divided by theeconomic growth rate in inflation-adjusted terms.For example, if the savings rate is 10 percent and thegrowth rate is 2 percent, in the long run the capital/income ratio must be 500 percent.While these equations are elementary concepts inthe theories of economic growth and development,their relevance to the study of inequality is that theownership of capital is often concentrated among arelatively small group of the population. Hence, thestudy of the path of capital is considered essential tothe study of inequality. Moreover, labor income can be unequally distributed as well. Finally — andthese are key points — Piketty believes that thereturn on capital has held fairly steady over timeand will continue to do so, while the rate of economic growth declines as the population (that is,labor force) stops increasing and even decreases inmany European and Asian countries. Piketty alsothinks that the savings rate is fairly steady, regard-less of changes in economic conditions, because it ismainly influenced by the desire of the rich to leave bequests to their children. As we will see, these beliefs lead to a strong prediction of an increasingrole for capital in the future, and therefore moreinequality arising from bequests, which Pikettyviews negatively.
Capital Ratios and Income Factor Shares
Measuring the capital/income ratio over threecenturies, Piketty finds that through 1910, the ratioin both Great Britain and France was steady at
Mark J. Warshawsky was formerly Treasuryassistant secretary of economic policy and is avisiting scholar at the Mercatus Center at GeorgeMason University.Thomas Piketty,
Capital in the Twenty-First Cen-tury
(Harvard University Press, 2014), ASIN:B00I2WNYJW (Hardback, $40).
POLICY AND PRACTICE
TAX NOTES, June 30, 2014 1547
( C ) T ax A n al y s t s 2 0 1 4 .A l l r i gh t s r e s er v e d .T ax A n al y s t s d o e s n o t c l ai m c o p y r i gh t i n an y p u b l i c d om ai n or t h i r d p ar t y c on t en t .