I recently completed reading Thomas Piketty’s new book entitled Capital in the Twenty-First Century. Piketty explains why the distribution of capital is becoming increasingly unequal, why we need higher tax rates on upper income individuals, and also a wealth tax on the affluent.

You probably won’t be surprised to hear that I was not persuaded by his arguments. I didn’t expect to be persuaded. But here’s what did surprise me; the book made no real attempt to persuade me. This claim requires some explanation.

Like monetary economics, the field of public finance implies that the world is full of cognitive illusions. For example, many public finance theorists believe:

1. Economic inequality should be measured by consumption inequality, not income or wealth inequality.

2. It makes no sense to add capital and labor income. Talking about that sort of composite is like discussing the number of “fruits,” when the basket includes blueberries and watermelons.

3. Relative to a progressive consumption tax, a progressive income tax is both unfair and inefficient.

4. In the long run a payroll tax is equivalent to a consumption tax.

5. Misers are more altruistic than big spenders.

My views on public finance are pretty mainstream, or at least pretty close to where the mainstream was in 2007. Like many center-left economists, I favor a progressive consumption tax, and believe that taxes on capital should be zero. Piketty clearly disagrees with this, which is not surprising as there are many other economists who also disagree with my interpretation of the public finance literature. There are good (second order) arguments against my policy views. But Piketty doesn’t make them.

Going into the book I expected Piketty to try to persuade people like me that income and capital are the right variables to consider, not consumption. But he didn’t do so; indeed he didn’t even make an attempt to do so. The book is aimed at thoughtful non-specialists who don’t know about all the cognitive illusions in the public finance literature. People who think it “obvious” that a fair and efficient tax would treat wage and capital income equally, even though a tax on interest income effectively taxes the same wage income twice. Taxes on capital income impose higher lifetime tax rates on thrifty people, as compared to less thrifty people with exactly the same lifetime resources to work with.

I didn’t notice any discussion of a progressive consumption tax. The only discussion I recall of the sort of consumption tax that could easily be made progressive was the following (page 494):

In the abstract, one might imagine a direct tax on consumption, which would depend on each taxpayer’s total consumption, but no such tax has ever existed.

This is an awfully dismissive remark on the tax system that many public finance experts regarded as ideal. Keep in mind that Piketty favors a global tax on wealth, but no such global tax regime has ever existed. More importantly, payroll taxes have existed, and are economically equivalent to a consumption tax, in the long run. (A more exact equivalence occurs if they are accompanied by a one-time tax on wealth at the point of implementation.)

You might wonder why this is important, given that we have other forms of consumption tax such as VATs. But the VAT is difficult to make progressive, whereas it is easy to make a payroll tax progressive. I’m left with no real understanding of why Piketty believes that taxes on capital are superior to progressive consumption taxes. Again, there are certainly arguments in favor of taxing capital instead of consumption, but he doesn’t make them.

Piketty starts the book with some sweeping generalizations, such as the claim that r > g is a central contradiction of capitalism, or that only marketable wealth counts as “wealth.” It is acceptable to simplify things at the beginning, as long as you return to these issues in a more realistic way later on the book. Unfortunately he doesn’t do so. He never really justifies the claim about the implications of r > g, and he repeatedly uses the term ‘wealth’ to refer to marketable wealth, when he actually should be talking about total wealth, including the present value of future government benefits like Social Security and Medicaid, as well as human capital. To be sure, there are some purposes for which singling out marketable wealth might be appropriate, but discussing changes in economic inequality over time is not one of those purposes.

Here’s another example (discussing a wealth tax):

This would replace the property tax, which in most countries is tantamount to a wealth tax on the propertied middle-class. The new system would be both more just and more efficient, because it targets all assets (not only real estate) and relies on transparent data and market values net of mortgage debt.

This seems completely wrong. A tax on residential real estate is a good way of taxing consumption. It can also be made progressive. It should not exclude mortgage debt, as people derive the same consumption from a house that is owned free and clear as they do from one on which there is a mortgage. On the other hand, wealth taxes should not apply to capital goods, for all the usual public finance reasons. Indeed even the more left-leaning countries of Western Europe exclude capital goods from VATs.

Let’s suppose that two identical twins each make $100,000/year for 40 years. One spends the money right away, and the other saves half the money, pushing consumption far into his future, and to some extent his children’s future. In both cases the present value of consumption is identical. Resources are identical. It’s a simple public finance example involving two freely made choices. (The concept of “choice” rarely appears in Piketty’s book.) So what does Piketty think of this example. I’m not quite sure, but here’s a typical comment (p. 423):

To be sure, there is something astonishing about the notion that capital yields rent, or income that the owner of capital obtains without working. There is something in this notion that is an affront to common sense and that has in fact perturbed any number of civilizations . . .

It’s not clear to me that this “rent” is actually as unearned as the Piketty seems to assume. People who live near airports are “rewarded” with cheaper home prices—so why shouldn’t people who defer consumption into the future be “rewarded” with cheaper future consumption?

I find it difficult to provide an overall evaluation of this book, because I found things on nearly every page that annoyed me. (I’ll cover a few of these in additional posts, some at TheMoneyIllusion.) On the other hand, I am obviously not the intended audience for this book. And if I look beyond my annoyance, I can understand why many readers found the book to be impressive, even a tour de force. If my book on the Great Depression ever comes out, I’d obviously rather someone say “it’s an impressive work of scholarship, although I didn’t buy the central argument about the importance of the global gold market,” rather than “it’s 600 pages of drivel.” Piketty’s book is impressive in some ways. I like his approach to methodology. He might well be correct about some of his predictions. As we saw with the General Theory, a book can contain many individual arguments that don’t hold up, and still be a milestone in the intellectual debate.