“Unfortunately, for the rich (and for everyone else), real wealth cannot be created in this rabbit-out-of-a-hat manner.”

Thomas Piketty’s Capital in the Twenty-First Century1 has already captured a sizable share of the public’s attention and has prompted a lot of commentary. The commentary has ranged from glowing2 to lukewarm3 to extremely critical.4 Yet despite the many reviews—including my own in Barron’s5—much remains to be said about Piketty’s attention-grabbing analyses of modern capitalism.

Two parts of Piketty’s book—those on government debt and executive pay—deserve closer scrutiny but have largely escaped attention.

I. Piketty on Government Debt

While discussing late 18th- and early 19th-century Britain, Piketty writes:

[I]t is also quite clear that, all things considered, this high level of public debt served the interest of the lenders and their descendants quite well, at least when compared with what would happen if the British monarchy had financed its expenditures by making them pay taxes. From the standpoint of people with the means to lend to the government, it is obviously far more advantageous to lend to the state and receive interest on the loan for decades than to pay taxes without compensation [130].

Wrong. This passage reveals a surprisingly weak grasp of basic public-finance theory.

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.

To see why, first understand that the value of real resources transferred initially by the rich to the government is the same with public-debt issuance as it is with taxation. (I readily accept Piketty’s assumption that it’s the rich who largely pay the taxes and that, with debt financing, it’s largely the rich who buy the bonds.6) If government today gets X amount more real resources to use, then the private sector has X amount fewer real resources to use. This reality holds true regardless of the method government employs to get these resources. Therefore, during the current period (the period when the loans are made and before interest starts to be paid on the debt), the amounts of real resources at the disposal of the rich are reduced by public-debt issuance as much as by taxation.

The difference is that taxation, unlike debt financing, results in the rich receiving neither repayment of principal nor interest on that principal in the future. But this difference is less real than it appears to be at first glance, especially given Piketty’s assumptions (in his discussion of government debt) that (1) the rich are the main targets of the taxman, and (2) families that are currently rich continue to be rich well into the future.

Of course, the government promises to repay all money that it acquires through borrowing, but it offers no such promise on the money that it acquires through taxation. The value of the prospect of repayment of money loaned to the government seems to mean that the present value of a plutocrat’s wealth will be higher if he or she lends X amount to the government than if he or she is taxed X amount by government. Piketty certainly makes this assumption, and he seems to believe that it will be higher by the full size of the public-debt issue.

But we now ask a crucial question that Piketty ignores: Who will be taxed tomorrow in order for government to get the revenue it needs to pay its bondholders? If we continue with Piketty’s own assumption that the rich are the main source of tax revenues, then the present value of tomorrow’s higher taxes must be subtracted from the value of the assets of the rich in order to determine just how rich the rich are today. Piketty does not make this necessary basic adjustment.

In short, because the bonds that the rich hold today must be repaid tomorrow with higher taxes—taxes to be paid mostly by the rich—the rich are not made wealthier by the government debt that they currently own.

For more on Ricardian Equivalence see “Does It Matter How You Pay for a State Dinner? A Lesson on Ricardian Equivalence”, by Morgan Rose. Library of Economics and Liberty, Sept. 24, 2001.

This conclusion does not depend on Ricardian equivalence. That is, this conclusion does not require today’s rich buyers of government bonds to accurately anticipate and fully internalize the burden of the future taxes that they must pay on those bonds and, hence, to be indifferent between funding government’s activities by paying more taxes today or by lending money to the government. Even if today’s rich buyers of government bonds are utterly unaware that government will raise their taxes tomorrow in order to be able to pay interest (and eventually principal) on those bonds, the fact remains that government must eventually extract more real resources from the private sector in order to meet its debt obligations.7 Again, if we continue to assume, as Piketty does when discussing government debt, that nearly all taxes will be paid by the rich, then new issues of government bonds do not make the rich richer (unless the government spends the resources in ways that enrich the nation at large).

While this conclusion holds whether or not Ricardian equivalence describes reality, we can see the validity of this conclusion more easily if we assume Ricardian equivalence. It’s intriguing, therefore, that Piketty explicitly argues that in early 19th-century Britain, Ricardian equivalence did indeed hold.8 This is intriguing because Piketty identifies early 19th-century Britain also as a time and place in which the issuance of government debt made the rich richer by saving them from paying higher taxes. (See the quoted passage above.) Yet if, back then, rich buyers of government bonds truly did anticipate that their and their heirs’ taxes would eventually rise by the full amount required for John Bull to meet his debt obligations, then it’s almost impossible to miss the fact that government-debt issuance does not allow the rich to escape the burden of being taxed to pay for government’s expenditures. Hence, it is also impossible to miss the fact that government debt issued under the conditions assumed by Piketty does not make the rich richer. Yet Piketty manages, inexplicably, to miss this fact.

II. Piketty on the Market for Executive Talent

Another weak part of Piketty’s analysis is his explanation of the recent growth of income inequality in the United States. He blames the bulk of this rising inequality on the surge in the annual incomes of corporate managers.

According to Piketty, high executive compensation in the United States today has little to do with managers’ productivity and almost everything to do with the cozy relationship between managers and corporate boards. Managers and board members are clubby friends scratching each other’s backs and setting each other’s exorbitant salaries. Specifically, Piketty blames (what he assumes to be) excessively high and wasteful executive pay on lax American “social norms” [332] that tolerate very high salaries, combined with cuts in top income-tax rates. Piketty reasons that, because tax cuts mean that executives keep more of what they’re paid, they give managers stronger incentives to lobby corporate boards harder for higher pay. Ironically, this is one of the few instances when Piketty recognizes that cutting taxes causes people to work harder to raise their incomes!

Mysteriously, Piketty never asks the obvious question: Why do shareholders continue to invest in corporations that so wastefully spend their funds? Here’s an even deeper mystery: If current patterns of executive compensation serve no purpose other than to enrich unproductive corporate oligarchs, what explains the high and rising market value of the capital that Piketty believes to be the main driver of increasing wealth inequality? How can it be that the value of capital invested in corporations continues to grow if boards of directors are consistently inattentive to the productivity of their management teams? Piketty does not ask these questions because, for him, wealth perpetuates itself. Wealth grows automatically, for the most part independently of human creativity, risk-taking, effort, and entrepreneurial gumption.

In reality, of course, wealth does not grow automatically. It must be carefully, skillfully, and continually nurtured. Therefore, if Piketty’s peculiar theory of executive compensation were an accurate description of today’s reality, corporations’ market values would at best have stagnated over the past few decades. Yet in fact they grew. Capitalist plutocrats would not have reaped the ever-greater wealth that Piketty takes such pains to show that they in fact have reaped. These plutocrats (as well as the masses) would today be far less prosperous than in fact they are.

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.”9

For more on Piketty’s book, see “The Python That Eats Itself by the Tail: A Self-Contradictory Theory of Capitalism”, by Anthony de Jasay, Library of Economics and Liberty, Jul. 7, 2014; and “Piketty Fever”, by Pedro Schwartz, Library of Economics and Liberty, Jun. 5, 2014.

There’s no doubt that contrary data can be cited on the relationship between compensation and productivity. Yet this fact makes it all the more important that a scholar bring sound economic reasoning to the table. A skilled and careful scholar, when confronted with the claim that executive compensation is untethered from executive productivity, would ask questions that, again, Piketty ignores. This skilled scholar would ask, “Why do shareholders continue to invest in corporations?” He would also ask, for example: “Why do no profit-hungry, entrepreneurial capitalists try to exploit this market failure by setting up corporations that pay their executives more sensibly and in ways that induce increased productivity?” “Why do the values of corporate shares continue to grow?” “Why is the real value of the Dow Jones Industrial Average today about 650 percent higher than it was, say, in 1981—the year before the top marginal personal income-tax rate in the United States was cut from 69 percent to 50 percent?”

Piketty’s failure to ask such questions is part of the larger, overarching flaw in his book: it contains far too little microeconomic analysis. And that flaw is fatal.


Thomas Piketty, Capital In the Twenty-First Century (Cambridge, MA: Belknap Press of Harvard University Press, 2014), Arthur Goldhammer, trans.

Paul Krugman, “Why We’re In a New Gilded Age,”New York Review of Books, May 8, 2014.

Lawrence H. Summers, “The Piketty Puzzle,”Democracy, Summer 2014.

Garett Jones, “Living with Inequality,” Reason.com, April 26, 2014.

Donald J. Boudreaux, “Piketty: A Wealth of Misconceptions,”Barron’s, May 31, 2014.

I assume also, along with Piketty, that the method of financing—taxation or borrowing—affects neither the amount nor the kinds of spending undertaken by government.

I here assume that government does not reduce its spending in order to get the resources needed to meet its debt obligations. This assumption is also one made implicitly by Piketty in his discussion of government debt.

Piketty writes that David Ricardo “had intimate knowledge of the British capitalism of his time.” Therefore, Ricardo saw—Piketty believes accurately—that the “increase in public debt [to finance Britain’s war against Napoleon] seemed to have been financed by an increase in private savings.” [134]. I note, only in passing, that Piketty is wrong to suppose that Ricardo believed that Ricardian equivalence held for early 19th-century Britain. See Gerald P. O’Driscoll, Jr., “The Ricardian Nonequivalence Theorem,” Journal of Political Economy, Feb. 1977, vol. 85, pp. 207-210.

Steven N. Kaplan, “The Real Story Behind Executive Pay,”Foreign Affairs, May/June 2013.


*Donald J. Boudreaux is a professor of economics at George Mason University and Getchell Chair at the Mercatus Center. He is the author of Globalization (2008), Hypocrites & Half-Wits (2012); and The Essential Hayek (forthcoming). He blogs (with Russ Roberts) at Cafe Hayek.

For more articles by Donald J. Boudreaux, see the Archive.