Inherited Wealth–Is It a Problem?

June 21, 2014

Inherited Wealth–Is It a Problem?

Thomas Piketty’s new book Capitalism in the Twenty-First Century argues that inherited wealth is a problem for our future.  A number of journalists and economists are taking exception with this, as well as other of his well documented and analyzed conclusions. The impact of wealth inheritance is one of the most significant of the concerns Piketty addresses. He recommends stronger progressive taxes on inherited wealth, but would be happier with an annual tax on all owned capital.

One of his critics is the very conservative economist Gregory Mankiw, Chairman of the Economics Department at Harvard. His disagreement on wealth inheritance is found in the New York Times of today:

Here is my understanding of Mankiw’s arguments:

1. He reverts to the old argument that if we minimize tax on the wealthy, they will invest their tax savings (capital) in productive facilities, thus stimulating the economy and in the process, creating jobs for those who are not wealthy.  This is the conservative “trickle down” argument–the wealthy get richer and along the way, the rest of us get a little better off. Indeed, this has been a economic argument for sometime, and still has some adherents. It was promoted by Arthur Laffer with great aplomb during the Reagan era. However, this theory has lost a great deal of its support over time. For one thing, it fails to acknowledge that putting more money in the hands of the lesser privileged results in more consumption than putting more money in the hands of those who do not need more consumption (sometimes this is called the supply side vs. demand side argument). More consumption results in more investment and more jobs. For another, studies show that the choices of the wealthy do not now so clearly go to growth producing new companies and jobs. More often these days, the incremental savings of the wealthy seem to go into liquid investments.  It is not at all clear that an additional investment in the stock of a public company does anything for growing the economy or jobs.

2. He argues that increasing capital is subject to decreasing returns. This is true and Piketty devotes a great deal of study and attention to this issue in his book. Mankiw devotes one sentence to his statement of “fact,” as if that closes the issue, implying that the diminishing returns will be falling dramatically, thus implying that the whole Piketty argument r > g is overblown, where r is the rate of return on capital and g the growth rate of the economy.  No one is arguing with the truism that when r exceeds g by 2 or 3 percent annually, wealth grows, rather rapidly. So, argument centers around whether r will decline. Piketty convincingly argues that diminution of returns is likely to be very slow to occur, decades away, if not centuries, before significant in the context of reducing the impact of wealth on inequality.

3. Then, Mankiw makes a final one sentence proclamation–that increased capital increases labor productivity, which inevitably increases labor’s wages. This is an economic theory. But, if this is going to be true in the future, why hasn’t the vastly increased capital across the last 30 years resulted in increased wages to labor? Why should that be different in the future, absent any policies whatsoever to gradually provide for slightly reducing inequality?

I am not an economist. I do not have a Ph. D. I did not graduate from Harvard, much less Chair the Economics department anywhere. I don’t presume to say that I understand economics better than Gregory Mankiw.

But we can all understand issues when presented as Piketty explains. And, more indisputably, we can all see clearly what has happened to the US and the world since 1980.

Instead of defending the status quo, as inequality rises, why don’t the critics explain just exactly why the world would not be better off with some gradual adjustment via taxes and other policies to make the world a little more egalitarian? No one is arguing for socialism, just a little more fairness.

What would be wrong with a progressive estate tax scheme, which might look something like this:
For inheritance over $1 billion, 95 percent tax (that leaves $50 million for heirs); over $500 million, 90 percent; over $100 million 80 percent, etc…under $5 million no tax. Or, smooth out these percentages to avoid unduly penalizing those who barely fall into the next highest tax category.  Or lower all the percentages by 10 percent, etc.

What would be so wrong with such a plan?  Or, better still, a progressive annual tax on all wealth (capital)–and here we could be talking about single digits in percentages.

Of course, additional policy would have to deal with gifts before death–to family (through complex tax avoidance trusts and partnerships) and to foundations. Foundational charity from the wealthy is wonderful, but it comes with two problems if it is to be considered the substitute for the withdrawal of government support to the underprivileged: The amount of philanthropy falls woefully short of what has been withdrawn by government; and, what is philanthropically given, in aggregate (with exceptions) goes first to universities, churches, etc., and a relatively small portion goes to needs of the poor. Incidentally, that which goes to universities is much more likely to go to Harvard or Stanford than to community colleges, as an example. So, that kind of philanthropy probably tends to widen the gap in opportunity between the privileged and the underprivileged.

It’s hard to feel that most Piketty critics are objective. How much is professional jealousy, hoping for recognition by riding on the coattails of this amazing study, nitpicking or reminding of disputed theoretical arguments? And, of course, how much is simply the result of the prejudice of deeply committed neoliberal ideology?  How much of that is captive to the big money on the right, one way or the other?

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