Friday, June 17, 2016

Significant flaws in Piketty’s methodology for estimating future inequality and in his suggested reforms to the tax code

See Review and Critique of Piketty's Capital in the Twenty-First Century by Mark J. Warshawsky of Mercatus.
"Thomas Piketty’s Capital in the Twenty-First Century has ignited a debate over inequality that has significantly impacted public perceptions and policy debates in the United States. Piketty uses hundreds of years of income data to make bold predictions about future income inequality and justify aggressive policy reforms—including a global tax on capital—to tackle the issue. But are Piketty’s conclusions and policy prescriptions really grounded in economic theory and solid empirical results?

In a new study from the Mercatus Center at George Mason University, economist Mark J. Warshawsky reviews and critiques Piketty’s analysis and proposals. Warshawsky finds several significant flaws in Piketty’s methodology for estimating future inequality and in his suggested reforms to the tax code. Warshawsky’s review also summarizes the criticism of Piketty’s book by other academics and Piketty’s responses to this criticism.

KEY POINTS

Piketty’s critique of inequality is based on his analysis of capital, but this analysis consists of rough estimations and bold projections that do not withstand scrutiny.
  • Piketty’s projection of a 670 percent world capital/income ratio in the year 2100 relies on simplistic and unrealistic assumptions regarding savings and growth.
  • Piketty claims the return on capital is between 4 and 5 percent—an assessment that downplays the significantly lower return on capital in recent years and the effect of inflation on the real return on capital throughout history.
  • The class divisions that Piketty uses in his analysis are arbitrary and may not accurately represent the same groups over long periods of time, particularly in economies with high levels of mobility or volatility.
  • In contrast to most scholarly evidence on the subject, Piketty suggests that the elasticity of substitution between capital and labor exceeds one.
  • Piketty’s research relies heavily on tax data, leading to assumptions about the incomes of nonfilers that likely overstate the growth in inequality.
Piketty’s prescriptions for tax policy include increasingly progressive taxation of income and inheritances, as well as a direct global tax on capital.
  • There are multiple examples of high wealth and inheritance taxes coinciding with increased inequality. This empirical evidence casts doubt on the efficacy of Piketty’s proposals. 
  • Piketty’s demand for financial transparency—even public transparency of certain individuals’ and corporations’ financial records—threatens the privacy rights of everyone."

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