Krugman Versus Mankiw on Capital Income Taxation

This morning’s New York Times featured an op-ed from Paul Krugman titled “Wealth Over Work.” In the piece, Krugman warns that we are on a dangerous path towards an oligarchical society, where inequality is rampant and wealth accumulates in the hands of a small group of powerful elite. The government enacts policies that promote the accumulation of this wealth and living off of capital income over deriving income from working in the labor force.

While the inequality argument is certainly a relevant and important topic, Krugman’s finger pointing seems over the top to me. Krugman, in his typical fashion vilifies the GOP:

Despite the frantic efforts of some Republicans to pretend otherwise, most people realize that today’s G.O.P. favors the interests of the rich over those of ordinary families. I suspect, however, that fewer people realize the extent to which the party favors returns on wealth over wages and salaries. And the dominance of income from capital, which can be inherited, over wages — the dominance of wealth over work — is what patrimonial capitalism is all about.

Some of his points are valid but there are two problems I have with Krugman’s argument:

  1. Krugman claims that one of the contributing factors to his claimed shift towards an oligarchical society is the favorable tax treatment capital income receives. Based on my experience studying taxes in Jim Hines’s government revenues class, this statement struck me as off. Taxes on investments such as capital gains and dividends are some of the most inefficient taxes a government can impose. I was happy to see that Greg Mankiw publicly called Krugman out on this on his personal blog. Mankiw points out that it is not class warfare that drives the rationale for lower capital taxes, but rather the fact that it is optimal economically. At its heart economics is about trade offs and governments are faced with a serious tradeoff when designing a tax system: the tradeoff between efficiency and progressivity. Capital taxes are extremely inefficient because capital owners can choose to not sell their assets very easily if they face the tax, distorting economic activity and producing dead weight loss, which is a net loss to society. Therefore having lower capital taxes if efficient. The tradeoff here is that the bulk of capital income goes to the wealthy and so a lower tax is also regressive. Our tax system corrects for this in other areas.
  2. My other problem with Krugman’s article is the borderline conspiracy theorist perspective he advances as to why this shift is occurring, “Why is this happening? Well, bear in mind that both Koch brothers are numbered among the 10 wealthiest Americans, and so are four Walmart heirs. Great wealth buys great political influence — and not just through campaign contributions. Many conservatives live inside an intellectual bubble of think tanks and captive media that is ultimately financed by a handful of megadonors. Not surprisingly, those inside the bubble tend to assume, instinctively, that what is good for oligarchs is good for America.” To me this argument sounds a little too extreme. Yes money can buy power and influence, but politicians ultimately must answer to all of their constituents in our democratic society and ultimately those well off can be heard. The adoption of Obamacare (which the Koch brothers strongly oppose) is one example of a the less powerful majority winning a battle.

Overall, Krugman provides a thought provoking piece but his points seem drastic and overblown, especially from an economic perspective.