June 04, 2002
From the desk of Jane Galt:Ask the MBA
Ask the MBA
Reader Jane Z. asks this question regarding my maunderings on the estate tax: "Are there economic reasons, as opposed to moral ones, for opposing the estate tax?"Interesting question.
First of all, the estate tax certainly impedes capital formation. We can argue about the extent: supporters argue a little, detractors argue a lot; but there is some effect, particularly on small businesses and family farms. Smaller firms can't afford estate planning the way big firms can, which is why my grandparents' estates, and probably yours, will pay a higher percentage of total wealth to tax than Bill Gates or his Dad (I refuse to listen to one more rich idiot advocating for the estate tax unless and until they eschew all estate planning and allow Uncle Sam to take his full 55% bite. Even one tax-free foundation dedicated to providing six-figure salaries to your dimwitted descendants invalidates any claim you may have to speak on the subject. But I digress.) There are transaction costs associated with the breakup or transfer of these assets that are a net economic loss to society. But it's probably not going to put us in the poorhouse, as a nation.
More costly is the re-allocation of assets to lower-valued uses because of their tax-advantaged status. (Sorry -- just proving to myself that I can still talk like an MBA). In other words, setting up a "Save the Guppies" foundation which is partially devoted to its stated goal of Making the World Save for Pet Fish, and partially devoted to providing the aforementioned jobs for your dimwitted descendants.
Maybe you like charitable foundations. But even if you do, you note that perhaps there are other people more qualified to hand out charity than the eighty-zillion little Fordettes employed by the Ford Foundation. Charity money is artificially diverted into the pockets of people who have done nothing to deserve it, pretty much exactly the way that it would be if they, say, inherited it. All at a considerable transaction cost to create and run the foundation. As well as the cost of stupid projects initiated by stupid heirs who show up at the office once a week in order to see how things are getting along without them, and thereby justify their salary to the IRS.
Oh, those aren't the only drawbacks. Blind trust, generation skipping trusts, more different kinds of gimmicks to escape the estate tax than you can shake a stick at. All are expensive to set up and maintain -- activity that generates absolutely no net economic wealth; in fact, destroys wealth. Those people we pay to tell us how not to give all our wealth to Uncle Sam could be out dreaming up ways to make a really good fat-free ice cream. And because in many cases the kinds of assets that these funds can hold, or the way that they can dispose of them, or manage them, are limited, these asset concentrations reduce liquidity, and thus efficiency, in asset markets. It's also an invitation to fraud (although of course big piles of money often need no invitation) -- the structure of the trusts often makes it hard to remove an executor who you think is crooked or incompetent, especially when that executor is, as it often can be, your Dad.
Finally, let's think about why society would have estates in the first place. Remember, property rights enshrine earlier customs: why would this particular one come about?
I would argue that in large part, its advantage is twofold. First of all, it reduces the risk inherent in savings. Not investment risk; the risk that you will save too much. You laugh, but it's a real risk. Without inheritance, the only purpose of saving is to defer consumption to some period when you will enjoy it more. One of the chief reasons we do this is so that we can enjoy leisure at a time when working is particularly unattractive -- when we're old and tired. So we give up some consumption now, so that we can consume more later, when our relative enjoyment of leisure will be particularly high, or when we may not be able to work due to infirmity.
But we don't know exactly when we're going to die, or whether the cost of living will rise, or we'll have a lot of medical expenses. . . we therefore should be conservative in our savings, and accumulate the maximum amount of assets that might be necessary to care for us in our old age.
But this is risky. Imagine no estates -- 100% of your wealth passes to the governmetn when you die. This makes it very risky to save conservatively; get hit by a bus when you're 50, and you're a big loser in life's lottery. Without estates, then, and with a minimal safety net such as we have, people will eschew savings in favor of current consumption, and let the government pick up the tag when they run out of dough. Note that this is exactly what a lot of people are doing now.
But if you allow people to pass on accumulated wealth to their children, you allay the fear of oversaving and denying yourself consumption you could have enjoyed -- because the ability to pass on wealth to your children is an economic good from which many people get a lot of pleasure. So in some sense, all the wealth saved is fully consumed -- that which is not spent on retirement is spent on passing an inheritence to the kids.
The other way in which estates provide a positive economic good is that it encourages people to keep working when they would otherwise retire.
Couple of basic economic concepts. First, there are basically only two inputs into an economy: capital and labor. Increasing the labor supply increases the net economic wealth we all enjoy (although of course this increase may not be evenly distributed). And second, leisure is a consumption good, just like anything else; the cost of leisure is the lost wages that you could have earned during the time you spent loafing around watching television and arguing with your husband about who was going to drive to the picnic. This cost is known as the opportunity cost: the value of the next best alternative use of your time.
Again, let's imagine a world with no estate tax. You're fifty, very successful, and you've accumulated enough money to pretty much replicate your current lifestyle -- less the money which goes to cover work-related expenses -- for the rest of your expected life.
Why wouldn't you quit? Of course, there are people who just enjoy working. But someone who has, say, accumulated three convenience stores might not feel so compelled to spend another ten years heading in to fix the slushy machine at 3 am because the night manager called in sick. Not when he has more than he really wants to spend now -- and when, with age creeping up and those 3 am trips ever harder on the body, leisure has become much more valuable relative to the extra consumption goods he could purchase if he doesn't retire.
But people like this -- people who have built up wealth through their own efforts -- have valuable skills and experience that create wealth for society. Their early retirement is, for us, a big loss, especially right at their peak years of experience. So how do we prevent it?
By allowing them to pass on any wealth they accumulate in excess of their consumption needs to their children, since most people are willing to exert a tremendous amount of effort to improve their children's lives. In this sense, the dimwitted children of the wealthy are actually doing the rest of us a favor, by making it utterly necessary for their clever parents to work as long as possible to make sure that they are taken care of.
So, to sum up: the estate tax has several economic costs. It discourages small- and medium- sized businesses from capital formation. It moves assets to less-valuable uses because they are not subect to the estate tax. It creates considerable transaction costs, both in breaking up and selling taxable assets, and in avoiding the tax. And it discourages personal savings. So the objections to the tax aren't just moral; they're financial as well.
Posted by Jane Galt at June 4, 2002 12:51 PM | TrackBack | Technorati inbound links