More excerpts from my recently published review of Thomas Piketty’s Capital in the Twenty-First Century.

For those who are worried about growing wealth inequality because their own wealth is not growing, there is a simple solution: save more and invest in stock market index funds. And, to the extent possible, do so with tax-favored 401(k) and 403(b) plans and Individual Retirement Accounts (Roth or non-Roth.) When a friend who studies saving patterns of various ethnic groups in America visited me some years ago, I told him that my wife and I normally save between 15 and 20 percent of our before-tax income. His eyes grew wide. “You’re Korean,” he said, jokingly. Of course, hitting that saving rate meant that we didn’t go to Europe or Asia, didn’t buy $40,000 cars or $200 shoes, didn’t buy expensive clothes, and didn’t drink alcohol when we went to restaurants. What a tough life!

Piketty does not give any space in his tome to making that point. He writes as if he is the central planner making decisions from the top down and essentially disregards the fact that people are individuals who want to deal with their individual situations.

But even as central planner, Piketty fails. The driver of his model is his strongly held assumption that the rate of return on stocks will substantially exceed the growth rate of the economy and the growth rate of real wages. Under Social Security, your benefits will grow at no more than the growth rate of real wages because your benefits are paid by Social Security taxes on current workers. So, wouldn’t it make sense to let people invest their Social Security taxes in stocks rather than get only the low rate of return that they get now? Piketty says no. He makes one good argument for this, one I myself have made: the transition problem out of the Social Security Ponzi scheme is wicked. But his other argument is that investing in stocks is “a roll of the dice.” What happened to his confidence about the rate of return on stocks?

Given his emphasis on–and distaste for–inequality and his conclusion that owners of capital will get an increasing share of an economy’s output, it is not surprising that Piketty favors much higher taxes on wealthy people. He argues briefly that the optimal top income tax rate in richer countries is “probably above 80 percent.” He claims that such a rate on incomes above $500,000 or $1 million “will not bring the government much in the way of revenue”–I agree–but will drastically reduce the pay of high-paid people. He also suggests an annual “global tax on capital,” with rates that would rise with wealth. “One might imagine,” he writes, “a rate of 0 percent for net assets below 1 million euros, 1 percent between 1 million and 5 million, and 2 percent above 5 million.” One might imagine many things: I take it, as virtually every reviewer pro or con has, that Piketty is not just “imagining” those taxes, but actually advocating them. He adds that “one might prefer” a stiff annual tax of “5 or 10 percent on assets above 1 billion euros.”

But if there is anything we know in economics, it is that incentives matter. An annual tax on capital will reduce the incentive to create capital. With less capital than otherwise, the marginal product of workers will be lower than otherwise. Bottom line: Piketty’s proposed tax on capital would hurt labor.

Next: More on how Piketty handles this incentive problem–and Robert Solow’s thoughts on the matter.