Inheritance tax is, by far, my favorite tax. If you concede that there’s any reason for government spending, spending the money of people who don’t eat, work, spend money, recreate or procreate is the best scenario of all. Which is why I was surprised to read un-stupid Harvard economist Greg Mankiw defending massive inheritance in the New York Times.
The way Mankiw goes about it is also perplexing. He begins with the idea of “consumption smoothing.” I find this odd since consumption smoothing and a related concept, diminishing marginal utility, are powerful ideas for justifying heavy taxes on the rich and even brazen wealth redistribution. Mankiw explains it clearly
People get utility from consuming goods and services, but they also exhibit “diminishing marginal utility”: The more you are already consuming, the less benefit you get from the next increase in consumption. Your utility increases if you move from a one- to a two-bathroom home. It rises less if you move from a four- to a five-bathroom home.
An extension of this is that taking $1000 from a very wealthy person and giving it to a very poor person increases the overall happiness of the universe. To the rich man $1000 might mean an extra day in Vail with the family–a nice thing. To the poor man it might mean dental work, college tuition or not getting evicted–all quite essential things. So, taking that extra vacation day from the rich man to fix the poor man’s teeth is a net gain for the universe. So far Mankiw is off to a poor start in justifying massive, inter-generational wealth accumulation.
A common response to this idea, and the one Mankiw employs, is that wealthy people, on average, use their money more wisely. That’s how they got so wealthy. Speaking about a collective average, rich people make better financial decisions. They watch their dollars carefully and hustle when those dollars need it. They have the skills to turn those dollars into more dollars, often by producing the things you and I need and want. Again, I’d like to be very clear that this is not the case 100% of the time. A serious discussion could be had about whether it’s even true most of the time. But I think a strong case can be made that “rich people” are a group selected for their ability to make the things and render the services people are willing to give the most money for. This is, however, not the discussion I want to have here. My point is much simpler.
Dead, wealthy people do not do any of those things.
They don’t make financial decisions. They don’t invest or hustle or manage or innovate. They haven’t any “sweat equity” left to give. So, the discussion here is about the children of wealthy people. The statement that people with wealthy parents are better users of money is a much more tenuous proposition. Mankiw himself does not shy away from this proposition and it’s here that he goes thoroughly off the reservation. His contention is that large accumulations of money are necessary for economic growth and that the poor do not accumulate capital because they count on “regression to the mean” improving the standard of living of their children. Because of diminishing marginal utility, they prefer to spend money on themselves immediately over saving it for their children who will most likely be richer.
Wrong on all counts. Firstly, many small accumulations of capital are every bit as effective as one large lump. A basket watched by 100 eyes is much safer. Many studies have shown that the collective wisdom of many individuals is often more accurate and reliable than that of experts (isn’t this your line, free marketeers?). One tremendous point of progress in our financial system is the democratization of finance. Ironically, even as middle-class incomes have stagnated and financial instruments have become more opaque, the ability of ordinary folk to participate in markets has grown. Today, anyone with $500 can invest in a wide variety of equities and derivatives cheaply and quickly. Most recently, we’ve seen pooled “small money” beginning to replace “angel” money and venture capital on peer lending sites and kickstarter. Employee-owned businesses are making a comeback as well. Small money is the future. What we need is more investor education on how to make your small money work for you. Ours would be a much healthier economy if more people were investing small amounts.
With all thy getting, get understanding
Next, when you count investments in human capital, the poor are great savers. Education is a capital investment. And the poor and middle class do it with abandon. I’ve watched families mortgage to the hilt to land in the right school district or to make outrageous tuition payments. It’s even clearer when you include all of the unpaid labor that goes into raising and education children. This exchange of money and time for human capital is every bit as valid as the investments of the super-rich. Even families raising children at a subsistence level are providing a necessary future resource to the economy. The poor tend to have more children and they make less money, so they spend a much larger fraction of their wealth on tomorrow’s workforce. The question I would rather have heard Mankiw address is whether our national investment portfolio includes too much or too little of these human capital investments.
The first sign of under-investment in workers and education would be a wide gap between employment rates for skilled and unskilled workers. In 2013, workers with just a high school diploma are unemployed at a rate of 7.5%. In that same year, just 2% of workers with a professional or doctorate degree were unemployed. Adding to this, the under-educated make up a much larger fraction of the unused potential workforce on disability or in prison who are not counted in the unemployment statistics. Given the importance of education in our information economy, there’s a strong case to be made that the ways the poor spend their money (on raising and educating children) are exactly what our economy needs more of and that their tax burden should be reduced to boost long-term growth.
I think what Mankiw is trying to say is that inheritance taxes discourage saving by taxing those most prone to save (at least in the sense of saving actual dollars). It is important to pay attention to how public policy affects individuals’ decisions to save or consume. However, there are many ways to encourage saving and not many of them are as disgusting as giving someone tens of millions of dollars because of the circumstances of her birth. If we’re interested in encouraging saving and investment over consumption, why not take a page from our gentle socialist friends across the pond? In UK, everyone is allowed the equivalent of $16,000 per year in tax-free capital gains. This means that most of the working middle class do not pay any tax on their investment income in their younger years since most of their income is wages. Talk about an incentive to save! Why not pay for at least some of this via a heavy tax on inheritances and “let each receive accord to her merits”?
The inheritance tax has almost no downside. It is, in every way superior to every other tax I can think of. Tax the dead. They don’t even vote!