Originally Published May 8, 2013

With the exception of theft, inheritance might be the most inefficient economic transaction that humanity has devised. Consider this: with both theft and inheritance, the recipient of wealth does not have to create any amount of economic benefit in order to be rewarded. At best, the heir receives compensation for effectively doing nothing (being born). At worst, the thief receives compensation for doing something harmful (injuring someone during a robbery). Both transactions serve as examples of how the free market naturally creates pockets of inefficiency: rewarding individuals who haven’t economically earned a reward. Both are problems, but only theft is actually addressed as such.

Though certainly not deserving of criminalization, the problem of inheritance does demand action. If unchecked, the inefficiency it creates will continue to generate negative ripple effects throughout our economy and social unrest within our culture.

Before discussing inheritance’s harmful effects, it is useful to understand its development. The problem of inheritance was nurtured by the advent of money. Under a barter-based economy, wealth was passed-on in the form of physical goods, animals, or land – things that are naturally harder to store, transfer, and maintain. On top of that, it was more difficult to pass on the income–generating properties of these goods because the activities that create further wealth (e.g. turning commodities into finished goods, running a farm, developing land, etc.) require a certain amount of ability and business acumen – traits which, unlike wealth, cannot be transferred to an heir.

With money, the impediments to wealth transfer and the skill requirements for additional wealth creation are sharply lessened. The lines of numbers in modern banking computer systems require no maintenance to store, nor effort to transfer. Moreover, a large wealth management industry now exists, the sole purpose of which is to turn big pools of money into bigger ones, without the owners of them having to lift a finger. The result of these innovations is self-sustaining dynastic wealth on a large scale, such that many fortunate families than thrive in grandiloquent fashion from birth, never burdened by the necessity to create any semblance of economic benefit.

In this way, the fears of one of America’s greatest self-made titans of business, Andrew Carnegie, have been realized. Carnegie, who ascended to the pinnacle of prosperity atop an empire of steel, was, and remains to this day, one of the foremost creators of amassed fortunes, as well as one of their most cogent critics.

In his messianically titled book, The Gospel of Wealth, Carnegie plainly laid out the ills associated with dynastic wealth and provided a plan for its proper dispensation. Notably, he called inheritance an “improper use” of one’s fortune and argued that the act of passing riches onto heirs only serves to tarnish the morality and character of those who receive it. “The parent who leaves his son enormous wealth,” Carnegie wrote, “generally deadens [his] talents and energies… and tempts him to lead a less useful and less worthy life than he otherwise would.” Carnegie’s assertions have been born out by studies.[1]

The undermining of an individual’s enterprising spirit is but one of the harmful effects of inheritance. Unfortunately, its worst effects are not rendered upon isolated individuals, but rather upon entire economies and cultures.

In an economy where inheritance is unchecked, significant inequality of wealth and income is more likely. With such polarity, businesses have significantly reduced incentives to produce a diverse array of goods and services. For instance, if only a small portion of the population has most of the disposable income, while the rest has very little, producers will make goods or provide services on a smaller scale since relatively few people or families can actually compensate them for their work, and wealthy people can only consume so much. As a result, mass-market innovations that push costs down and production yields higher will occur much more slowly or not at all. Employment opportunities will be sharply reduced, economies will be prone to more and longer spells of reduced activity, growth will slow or cease altogether.

History is fraught with examples of this type of inequality-induced malaise. In Europe, the “Dark Ages” was a period of economic and cultural stagnation that lasted for hundreds of years. During this time, a limited cadre of lords and kings commanded most of the wealth and land, while most people had nothing. In America, before the Civil War, a slave-owning aristocracy in the Southern States controlled a vast amount of land and human lives. From their plantation perches, the slavers idly watched as their economy was vastly outperformed by the free-labor North – a fact that contributed greatly to the South’s eventual defeat.

Cultural languishing often haunts a country that has sluggish growth and significant inequality. In an economy where most of the disposable wealth and income is passed down within select families, a sense of unfairness could become pervasive. If people believe that one’s economic future is more determined by fate rather than by work, a lethargy of mind and body – not dissimilar to that seen in countries during periods of Communist rule – may follow on a grand scale. This sense of unfairness could later cause social unrest to the point of violent revolution.

The potential ills of inheritance-bolstered inequality are clear. As such, policies to mitigate inter-generational wealth transfer and to ensure an efficient market should be enacted. Here are a few that should be considered:

1. Stronger Estate Tax: The Estate Tax is a tax assessed upon the transfer of the property of a deceased individual to his or her heirs. In order to mitigate the inefficiency caused by inheritance, the current tax rates on estates should be increased ­– perhaps from the current top rate of 40% to the 2001 rate of 55%, if not higher. By doing so, we would also unlock other benefits, like the promotion of market-driven philanthropy – as wealthy individuals find creative ways to distribute their wealth in order to avoid taxation upon their death.
2. More Robust Gift Tax: The Gift tax is assessed upon transfers of property made during one’s life and was created to prevent individuals from avoiding the estate tax by transferring all of their assets before death. Its rate should be increased to match the proposed changes to the Estate Tax.
3. Generous Exemption Level: Before enacting any reforms regarding inheritance, it is ironically imperative that generous protections for it be put in place. Just as high wealth and income inequality can stymie economic expansion, so, too, can too little. By ensuring that relatively large fortunes can continue to exist across generations, we incentivize the creation of luxury goods and services that could help to spark innovation throughout the economy. Thus, a lifetime exemption of $5 million on gifts and estates (recurrently adjusted for inflation) should be implemented, with taxes only being assessed on the value of property transferred beyond the exemption level.
4. Elimination of Investment Income Subsidy: Surprisingly, large inheritances and income inequality are actually subsidized by current government policies because income earned by selling stocks or collecting dividends is taxed proportionally lower than salaries or wages. Since most amassed fortunes are comprised of investments, this means that wealthy families often pay a smaller portion of their income in taxes than poor or middle-class ones. By eliminating the current tax subsidy for investment income from collecting dividends or selling stocks, we reaffirm in our laws what we already know from our lives: that a dollar earned by wage or salary is worth no less than a dollar earned by investing or stock trading.

Just as welfare can breed indolence and economic stagnation, so, too, can wealthfare. By enacting laws to limit the inefficiency that is created by inheritance and inequality, we make ourselves a stronger nation economically and culturally.

 

[1] http://www.aei.org/article/society-and-culture/inheritance-and-sloth/

© 2013 P.D. Nym