„Capital’s” Corpse Is Getting Unrecognizable

A few weeks ago, a financial blogger who shall go unnamed (because he acted like a dunderhead) wrote that there was not one scrap of conservative criticism of Thomas Piketty’s Capital in the 21^st Century that rose above the standard of an Internet comment board.

What a difference a week makes. First Martin Feldstein made very obvious points in the Wall Street Journal that Piketty’s inequality track for the past hundred years does not control for tax regimes. High tax rates or low, Piketty’s interpretation takes seriously whatever people told the taxman was their income. Then the Financial Times pried the Excel spread sheets and found oddities.

A great deal broke loose. Most stunning was the discovery of Phil Magness and Bob Murphy of umpteen Excel and other data problems, some of the fundamental variety. As was once said of the Home Run King, trying to sneak a fastball past Henry Aaron is like trying to sneak the sun past a rooster. That’s what you’re up against when you present not entirely on-the-level historical economic statistics in earshot of these guys. It has not been pretty what theyhave been doing to Capital in the 21^st Century.

Five years ago, I relegated my own dismissal of Piketty’s work to a digressive footnote at the end of Chapter 12 of my history of supply-side economics, Econoclasts. Surely that is all it would take (I figured) to stifle what Piketty was up to, especially after the years of incisive criticism that had been coming from Alan Reynolds.

Here is part of what I wrote: “Piketty and [collaborator] Saez found that income inequality rises with tax cuts and falls with hikes, and argued that tax policy should be set so as to prefer equality. The two economists picked low-hanging fruit. Of course the income gains of the rich inversely track the marginal tax rate. The founding idea of modern accounting, as variously stated by such figures as Andrew Mellon, Frank Knight, and Peter Drucker, is that profit is that portion of cash flow that one is satisfied to submit to taxation.

“In high-tax and high-inflation times, the rich do things such as buy gold (whose appreciation before sale is not subject to taxation), stake the gold as collateral for loans as it appreciates, and take the interest deduction on the tax return. Thus the rich get richer but look poorer in such times.

“In low-tax and low-inflation eras, these strategies are dropped in favor of purchasing financial assets (not to say starting businesses) that inherently are more beneficial than tangibles to other members of the economy….The extent to which Piketty and Saez note these effects is small….

“Regarding inequality—not the flawed concept of “income inequality”—Piketty and Saez have to construct a far more expansive database, one that fully accounts for the trillions in portfolio shifts (and the new immigration) [since 1980]. Once this formidable task is accomplished, then proper conclusions can be drawn about the degree and malignancy of inequality.”

As it turned out, Piketty stuck with the half-baked stuff and now it’s sweeping the land as a bestseller. Poor Harvard University Press can’t keep the book supplied.

To give a sense of scale, Ronald Reagan’s forecaster John Rutledge calculated, in 1980, that the amount of money held by the affluent that stood to be transferred from non-taxable to taxable asset classes, if there came tax cuts and sound money to put away the stagflation decade, was $10 trillion. This means, basically, that in Piketty’s dataset, $10 trillion should be lopped off of the income gained by the top 10% (with most of it clustered in the top 1%) in the 1980s and 1990s in comparison to the 1970s.

$10 trillion is of course an enormous sum, one so cosmic that Rutledge could only perceive it by looking at the Federal Reserve’s reports on the total balance sheet of all assets in the nation. And by the way, there were some companies that, circa 1980, adjusted their strategies and otherwise traded on the idea that $10 trillion might be coming out of hiding into things like stocks and bonds and productive enterprises. General Electric was one. Over the next twenty years, GE had the greatest run in the history of corporations.

As the massive field of tax law has conceded for years (see the foundational work of Stanley Surrey), high tax rates from the 1940s to the 1970s were themselves preferences bought from politicians by the settled rich and blue-chip corporations. High tax rates discouraged entrepreneurialism and thus safeguarded the stodgy; they also made every one of the thousands of exemptions valuable to executive and Congressman alike. A regime of high tax rates salted with politician-procured exemptions (Surrey coined the term “tax expenditures”) is plainly more “unequal” than one of low rates wherein preferences evaporate because they have little value.

The problem with Capital in the 21^st Century concerns not only its flawed perspective on inequality. The book also weakens one’s ability to understand the political and economic history of the 20^th century generally.