Inheritance Tax Is Largely Irrelevant to the Problem of Economic Inequality

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Lots of people think that a few people controlling a very large share of a society's economic power is a bad thing. It is unfair that some should have so much while so many have so much less. It is inefficient that so much wealth lies in the hands of people who already have everything they could reasonably desire. It gives some people an outsized influence on decisions that affect the whole society, and on democratic politics itself (previously). And so on.

These people often also worry that economic inequality is increasing and becoming entrenched as the rich pass their excessive wealth on to their children and more and more wealth ends up concentrated in ever fewer hands. Many of them think increasing inheritance tax is necessary to stop this. But this solution relies on a mistaken understanding of how wealth is actually transmitted between generations.

Many leftist commentators seem to believe something like the following argument:

Premise 1: Rich people passing on their wealth to their children after they die is an important cause of rising economic inequality

Premise 2: Rising economic inequality is bad

Premise 3: Without higher inheritance taxes economic inequality will continue to rise

Conclusion: Therefore, inheritance taxes should be raised

I accept premise 2, but reject premises 1 and 3 because they are based on significant misunderstandings of how the world actually works.

I. Rich Parents Don't Make Their Children Rich By Dying

When we talk about the rich we should not limit ourselves to the very rich 1% or super-rich 0.1%. As Richard Reeves argues very convincingly, this too easily lets the larger upper middle class off the hook: the top 20% or so of the population who run our key institutions (universities, newspapers, philanthropic trusts, politics, government agencies, corporations, and so on), and use their influence to stack the odds in favour of themselves, their friends and their children, while blocking routes to social mobility by those beneath them.

The rich do pass on enormous economic advantages to their children, but they do not wait until their death to do so. They acquire houses in the best school districts (while blocking rezoning efforts that would allow poorer people to afford to live there); pay for high quality extra-curriculars and child care; use their networks to access elite university and job opportunities; fund unpaid internships and post-grad vocational education (med/law school); subsidise the first step on the housing ladder; bail their children out when they make terrible mistakes; and so on. Thanks to all this parental help - which is made possible only by their special wealth - these children enjoy outsized opportunities to become as wealthy and successful as their parents. If life is a lottery then the children of the rich start off with a lot more tickets than the children of the poor - so it is not surprising that they generally win.

The key point is that all these forms of assistance depend on parental wealth, but none are dependent on a transfer of assets after the parents' death. By the time that happens, these children are usually aged between 50 and 60 - already well into the gilded lives that their parents' money has opened to them, and often already 'independently' wealthy in ways that they have already endeavored to transmit onwards to their own children. The intergenerational transfer has already taken place.

If this intergenerational transmission of unearned privilege is the problem one cares about, then the solution will have nothing to do with inheritance tax. The focus should be elsewhere.

First, measures to prevent unfair and unjustified concentrations of wealth from being created in the first place. For example, much higher taxes on property and capital gains, and fewer of the loopholes that the slippery professional middle classes are so good at using to escape paying their fair share for the upkeep of the society that has given them so much.

Second, measures to reduce the special advantages that people with money are now so easily able to buy for their children. For example, bans on unpaid internships, legacy admissions to universities (and perhaps elite universities in general, since they seem to have been entirely captured by the rich), and so on. Or at least, taxes on those purchases of privilege at rates high enough to make the self-serving behaviour of the rich serve the rest of us.

II. Inheritances Actually Reduce Wealth Inequality

My point here is more technical, although rather obvious once noticed.

Suppose that 1 person has assets valued at $1 billion. Then that person dies and the assets are inherited by the next generation. Will this increase the concentration of wealth in society?

It is hard to see how.

Suppose the billionaire had one child and left everything to them. Then that 'child' (who is by now late middle-aged) gets the billion dollars and wealth inequality is unchanged.

Suppose instead that the billionaire had more than one child. Then the billion dollars will presumably be divided up between them (and perhaps others too, such as grandchildren and charitable foundations). In this case wealth inequality will actually decline as a result of inheritance. Since the rich tend to have more children than the average (because being rich means being able to afford expensive things without having to sacrifice anything important), most actual inheritances will be shared among multiple beneficiaries. Inheritances therefore usually reduce the concentration of wealth, whether or not they are taxed.

The same goes for the merely upper middle-class rich, whose shares and large house in a good neighbourhood will be divided up between their children, creating a bonanza, but one split several ways.

The diluting character of inheritance also applies to concentrations of economic power - which is often what people complaining about excessive concentrations of wealth are actually concerned about. For example, when the billionaire media mogul Rupert Murdoch retired he could use his huge holding of voting shares to appoint his favoured son, Lachlan, to take over running his media empire, with its profitable but obnoxious rightist leanings. But when Murdoch senior dies, Lachlan will likely lose his position and hence power, as all those voting shares will be split 4 ways with his other siblings (who don't particularly like him).

 

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I have argued that taxes on inheritance substantially miss the point. They miss the moment when problematic transfers of intergenerational wealth actually take place. And they are not necessary to prevent wealth inequality from rising.

Of course, this does not mean that inheritance tax can't play a role in reducing inequalities of wealth further. It is not unreasonable to want a society in which the Murdoch siblings in line for 25% each of their father's voting class shares get substantially less than that. Inheritance tax can also be thought of more conventionally, as just another way of raising money to fund government activities and social services, rather than as a device for social engineering.

Notes: 

This essay was previously published on 3 Quarks Daily

Also on Substack! I am migrating this blog to my new Substack, but for now I am duplicating posts in both places.