How inheritances influence wealth inequality

Mikael Elinder, Oscar Erixson, Daniel Waldenström

The distributional effect of inherited wealth has been a long-standing question in economics. This column presents new evidence on the issue using population-wide register data from Sweden. The findings show that inheritances decrease wealth inequality but increase the absolute dispersion of wealth. The equalising effect of inheritances is diluted, however, by the fact that less wealthy heirs consume most of their inherited wealth, whereas wealthier heirs tend to save theirs.

How do inheritances influence the distribution of wealth? This long-standing question (asked already by Wedgwood in 1929) has received a renewed interest after recent studies indicating that wealth inequality and the importance of inherited wealth are both on the rise in Western societies (e.g. Piketty 2011, Saez and Zucman 2016). Studies analysing the link between inheritance and wealth inequality have used different methods and data sources, ranging from simulated distributions to individual observations in surveys or data on wealth from tax records (e.g. Davies 1982, Wolff 2002, 2015, Boserup et al. 2016). Consensus has not yet been reached over the exact relationship. However, a recurrent result, which Wolff (2002) was the first to find, is that, perhaps surprisingly, inheritances tend to decrease wealth inequality.

While these studies indeed offer many important insights, various constraints in the data used have limited the ability to make causal claims or uncover the relevant mechanisms and relationships.

Inheritance reduces wealth inequality, but absolute dispersion increases

In a recent study (Elinder et al. 2016) we examine how inheritances affect wealth inequality using a new population-wide register database. The database contains detailed accounts on wealth and inheritances (including zeros) for all family and non-family heirs of every deceased person in Sweden during several years in the early 2000s. These rich data enable us to estimate the causal effect of inheritances on the distribution of wealth and, importantly, to also uncover the mechanisms underlying this effect. We are also able to study the distributional consequences of inheritance taxation and the effect of inheritances on wealth mobility.

Our main results establish what previous studies have pointed to, namely that inheritances decrease the inequality of wealth.

The Gini coefficient decreases by 6%, a relatively large effect which is roughly in line with the wealth compression following the burst of the dotcom bubble in 2000 when stocks in internet companies, held mostly by the wealthy, lost their value.1

We also find that inheritances increase the absolute dispersion of wealth among heirs, measured as the difference in wealth between the heirs in the 25th and 75th percentiles of the distribution.

Figure 1 shows how these two results can coexist, i.e. why relative inequality could decrease while dispersion increases. Wealthier heirs indeed tend to inherit larger amounts, a finding that reflects the high correlation of wealth across generations, but bequests are relatively more important compared to pre-inheritance wealth for less wealthy heirs, and this explains why relative inequality is reduced while dispersion increases.

Figure 1. Absolute and relative importance of inheritance

Poorer heirs consume most of their inheritance

What do heirs do with the money they inherit? While we cannot directly observe how the inheritances are used, our data allow us to calculate how much of the inheritance that heirs in different parts of the wealth distribution have saved or consumed one year after the receipt. Figure 2 depicts the share of inheritance saved by heirs in different wealth deciles, and there is a clear increase in this share over the distribution.

In fact, the equalising effect of inheritances gets diluted as less wealthy heirs tend to consume most of the inherited wealth whereas wealthier heirs tend to save it.

Figure 2. Consume or save? Share of inheritance remaining one year after inheriting

Note: Remaining share of inheritances in T + 1 across pre-wealth deciles of heirs

Role of inheritance taxation

Sweden had an inheritance tax during the studied period. We observe the exact amount of inheritance taxes paid by each heir (some pay nothing), and when we examine how the tax payments affect the wealth distribution we find that the tax has a dis-equalising effect. That is, all else equal, the tax by itself tends to increase wealth inequality. This effect works largely in the same way as the inequality effect described above; while richer heirs inherit more and pay more in taxes, the tax payments are, relative to wealth, comparably more important for the less wealthy heirs.

However, when we account for the possibility that the government may redistribute the tax revenues to decrease inequality, the result is reversed. This means that if tax revenues are redistributed to the less wealthy, the total effect of inheritance taxation works as to make the wealth distribution more equal.

Concluding discussion

Making a full account of the distributional impact of inheritances is demanding, and while we have tried to empirically establish some important facts and relationships, our study does not address all interesting aspects. Other outcomes, such as consumption, leisure or health would also be useful to analyse in the context of the distributional effects of inherited wealth.

References

Boserup, S, W Kopczuk, C Thustrup Kreiner (2016), “The Role of Bequests in Shaping Wealth Inequality: Evidence form Danish Wealth Records,” American Economic Review Papers & Proceedings, in press.

Davies, J B (1982), “The Relative Impact of Inheritance and Other Factors on Economic Inequality” Quarterly Journal of Economics, 97, 471‒498.

Elinder, M, O Erixson, and D Waldenström (2016). “Inheritance and Wealth Inequality: Evidence from Population Registers”, CEPR Discussion Paper No. 11191.

Piketty, T (2011), “On the Long-Run Evolution of Inheritance: France 1820‒2050,” Quarterly Journal of Economics, 126,1071–1131.

Wedgwood, J (1929), The Economics of Inheritance. London: George Routledge and Sons.

Wolff, E N (2002),“Inheritances and Wealth Inequality, 1989‒1998,” American Economic Review, 92, 260–264.

Wolff, E N (2015), Inheriting Wealth in America. Future Boom or Bust?, Oxford: Oxford University Press.

Endnotes

[1] We also look at other measures of inequality, e.g., top wealth shares, wealth percentile ratios or the coefficient of variation, and find the same main results.