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April 28 2014

Thomas Piketty and the Inequality Debate

Rachel DiCarlo Currie

When New York Times columnist Paul Krugman says you have written “the most important economics book of the year -- and maybe of the decade,” chances are you’re about to become (or you already have become) a genuine intellectual celebrity. And indeed, French economist Thomas Piketty of the Paris School of Economics is now being celebrated as the hottest thinker on the hottest issue in contemporary left-wing politics -- the issue of income and wealth inequality. His new book, Capital in the Twenty-First Century, is currently number one on Amazon.com, and he’s been meeting with the likes of Treasury Secretary Jack Lew and the White House Council of Economic Advisers, while also doing a blizzard of media interviews.

The thrust of Piketty’s argument is stated on the book’s first page: “When the rate of return on capital exceeds the rate of growth of output and income, as it did in the nineteenth century and seems quite likely to do again in the twenty-first, capitalism automatically generates arbitrary and unsustainable inequalities that radically undermine the meritocratic values on which democratic societies are based.” He goes on to advocate a series of reforms aimed at curbing the rise of inequality, including a global wealth tax and a top income-tax rate of around 80 percent.

Piketty’s book has received thoughtful critiques from, among others, George Mason University economist Tyler Cowen, Bloomberg View columnists Clive Crook and Megan McArdle, Hudson Institute scholar Chris DeMuth, American Enterprise Institute economist Kevin Hassett, Washington Post columnist Robert Samuelson, New York fund manager Daniel Shuchman, French economist Guy Sorman, and Manhattan Institute scholar Scott Winship. For now, I’d like to focus on Winship’s analysis of Piketty’s income dataset, which the author compiled in collaboration with economist Emmanuel Saez (another Frenchman) of UC-Berkeley.

As I’ve discussed in previous posts, long-term income trends can vary significantly based on (1) the inflation measure used, (2) whether or how one adjusts for changes in household size, (3) the inclusion or exclusion of non-cash government transfers (such as Medicaid, Medicare, food stamps, and federal housing assistance), and (4) the inclusion or exclusion of employer-provided fringe benefits such as health insurance. “More subtly,” writes Winship, “it is impossible to get an accurate read on trends in market income concentration when retirees (with little to no market income) are included in the data (as they always are). The share of retirees has been growing for some time, and that puts downward pressure on the market income trend.”

Because the Piketty-Saez data rely on tax returns, they omit all non-cash government transfers, along with a substantial portion of Social Security income. And because they measure pre-tax income, they do not show the effects of progressive and redistributive taxation. Meanwhile, notes Winship, they include retirees but fail to account for employer-provided health insurance and non-taxable capital gains. They also use a less-than-optimal inflation measure -- a version of the Consumer Price Index (CPI) -- as opposed to the Personal Consumption Expenditures Price Index (PCE), the latter of which is “favored by the Congressional Budget Office and targeted by the Federal Reserve Board.” Finally, Piketty and Saez measure income among “tax units” rather than among households, even though many individual tax filers share households and thus share living expenses.

Making all those adjustments -- that is, measuring post-tax, post-transfer income (including non-cash income) among size-adjusted households, using PCE rather than CPI inflation, while controlling for retirees -- yields very different results from those presented by Piketty and Saez. Here’s Winship:

When I incorporate these improvements using the Census Bureau data, I find that median post-tax and -transfer income rose by nearly $26,000 for a household of four ($13,000 for a household of one) between 1979 and 2012. If you don’t like the household-size adjustment, the non-adjusted increase was over $20,000 at the median. If you think that valuing health care as income is problematic, that figure drops to $10,400 under the implausible assumption that third-party health care benefits have no value to households. The income of the bottom 90 percent rose nearly $12,000 under that assumption instead of dropping by $3,000 as in the Piketty and Saez data, and it rose by nearly $21,000 if health benefits are included. For a household of four, median market income for non-elderly households (not counting employer-provided health care as income) rose $9,400.

Now, one could argue that pre-tax, pre-transfer money income among individual tax units is the most important indicator of long-term economic trends. After all, even if government policies have mitigated the effects of wage stagnation, that doesn’t mean wage stagnation is a non-problem. But if we’re looking for the most comprehensive measures of household income, the Piketty-Saez data are woefully inadequate. Moreover, if you’re going to make the case for higher taxes and expanded transfers based on evidence of rising inequality and stagnating incomes, it’s only fair to (1) account for our existing tax and transfer policies and (2) acknowledge the differences between tax-unit income and size-adjusted household income.

In addition, we should remember that many economists believe the best gauge of living standards is, not income, but consumption. As economists Bruce Meyer of the University of Chicago and James Sullivan of Notre Dame have written: “Consumption better reflects the material circumstances of disadvantaged families not only because it more closely captures permanent income but also because it is measured with less error than income among this group, and studies have shown that consumption is a better predictor of well-being than income.” According to their estimates, the consumption-poverty rate in 2010 was only 4.5 percent, down from almost 31 percent in the early 1960s. (By contrast, the Census Bureau’s official income-poverty rate for 2010 was 15.1 percent.) Meyer and Sullivan have also calculated that, between 1980 and 2011, the rise in income inequality (45 percent) was nearly two and a half times greater than the rise in consumption inequality (19 percent). “Furthermore,” they write, “this much smaller percentage increase in consumption inequality started from a considerably lower base.”

More on Piketty and the Great Inequality Debate in subsequent posts.


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