Estate Taxation--Posner's Response to Comments

My posting precipitated an interesting debate in the comments about the ethical, political, and economic issues presented by inequality of wealth, which has become very great in twenty-first century America. These issues are important, but estate taxation is only peripherally related to them. Without unforeseeable increases in estate tax rates, coupled with extremely stiff gift taxes, estate taxation will continue to have negligible effects on wealth inequality. I agree with Becker, moreover, that even without explicit gifts wealthy people can transfer substantial wealth to their children by investing in the children's human capital (earning capacity)--not to mention the genetic endowment that high-IQ parents transfer to their children. I believe that these transfers are increasingly important, for two reasons. First, with the decline in the importance of strength and stamina as factors of production, the economic return to intelligence has risen. And second, with the breakdown of traditional barriers, such as religion and ethnicity, to assortative mating (likes with likes), there is more matching of IQs in marriage and so a greater production of highly intelligent people. I do not think there would be an ethical objection to efforts to reduce the inequality of wealth. Even if one does not regard one's genetic endowment as a form of unearned luck (as I do not--"luck" to me refers to purely adventitious factors in one's success or failure in life), luck plays an enormous role in wealth; stated differently, the variance in wealth is much greater than the variance in intelligence, character, effort, or all these things combined. And if wealth could be equalized costlessly, there would be a net gain in economic welfare because of the phenomenon of declining marginal utility of income--that last dollar is worth more to a poor person than to a rich, so transferring a dollar from the rich to the poor will increase aggregate utility, and this effect could continue until incomes were equalized. The objection to efforts to equalize wealth, including by drastic changes in estate and gift taxation, is that they are very costly. The have adverse incentive effects on both rich and poor, and a variety of other negative consequences as well. Paradoxically, equalizing wealth can increase envy, because one is more likely to envy someone who is slightly better off than one is than someone who is unimaginably better off. Few people envy Bill Gates, because they cannot imagine what they would do with so much money; but they know very well what they would do with the additional income of their slightly wealthier next-door neighbor. It is important to recognize, moreover (a point that Oliver Wendell Holmes, Jr. stressed repeatedly), that personal wealth, no matter how great, is a part, and a constructive part, of aggregate social wealth. The rich do not burn their money, or put in boxes under their beds. If saved, the money is invested; if consumed, it provides incomes to the people who produce the goods that the rich buy; if given to charity or to politicians, it affects, not necessarily for the worse, the social, cultural, and political character of the society. The opportunity to amass wealth also channels the ambitions of aggressive people into relatively harmless channels, even if Samuel Johnson exaggerated when he said that people are rarely as innocently engaged as when they are making money.

Comments

[N.E.Hatfield]

Do I detect a hint of a naturally occuring, but latent "eugenics" program at work in the modern economic order? If so, is it moving forward or in reverse? And that is about as close as I'mm going to get to the issue. This could be a real can of worms. ;)

[jeem]

My Social Darwinist detector is beeping too.

First of all, this issue is only partly about economics. It's more about the political and social influence of an hereditary aristocracy. These things are hard to quantify and their influences are no doubt nonlinear and thus imperfectly predictable (to an economist, that means they don't exist). Implicit in Posner's argument are two things: mean reversion in IQ takes several generations and therefore isn't important, and the super-rich are few in number and thus aren't important. In a linear world these are probably reasonable assumptions; in the real world they are not.

Most Americans would probably agree that hereditary dynasties are bad and that the fortunes of the rich and powerful should dissipate and dilute over the course of a few generations. By the time the genetic endowments revert to the mean, the fortune should have also. Room is made at the top for more newly rich people, and the dead wood is cleared out. This is not what happens to the super-rich. Bill Gates' heirs could remain wealthy for a century or more without lifting a finger if Daddy wills it. Maybe Bill won't, but others will.

This is not about getting a free Ivy League education, it's a matter of scale. Compound interest is scale invariant, but living expenses aren't. If I was born with a hundred million dollars, all I'd have to do is avoid making any dumb mistakes and make one smart decision sometime in the course of my life. One 20% gainer gives me a cool 20 million, which could pay my bills for my entire life. I could afford to hire the best experts to help me do even better. Only extreme stupidity could endanger my heirs' fortune passing into perpetuity.

This is unfair, but fairness isn't the issue. What matters is the way it distributes power and thus the incentives of others. Wealthy incompetents begin to believe they are different/better than others and lose touch with the rest of the population. They become arrogant and feel entitled to what they have and use their power to protect their position. Boardrooms and executive suites become populated with people who don't really belong there but were given positions because of who they are, rather than what they are. Hell, they might even become president and get us into a disastrous war, destroy the nation's finances, and turn the nation into a global pariah!

Reading this post, one thing rings loud and clear. Becker and Posner are rich, have mostly rich friends, and have been that way for some time.

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