Wealth inequality: Why higher estate taxes make sense

Conventional wisdom tells us that inequality is an inevitable by-product of strong economic growth.

Talent, innovation and entrepreneurship will inevitably capture the lion’s share of the income being generated and efforts to redistribute wealth can only be counterproductive because they weaken the incentives that drive an economy forward.

The truth, of course, is more complicated. Not all sources of wealth -- and by extension not all types of inequality -- are the same.

The wealth that is created when new products, processes and technologies are introduced is, indeed, correlated with faster economic growth.

But wealth obtained by other means has a much smaller effect, if any, on the economy.

So there is no reason it cannot be safely redistributed.

Consider, for example, the rise of a billionaire class which many think represents the most extreme form of inequality.

There are, essentially, four paths to becoming a billionaire.

Company founders and executives, like Bill Gates and Jack Ma, became rich by providing useful products and services.

Financial wizards, like George Soros and Warren Buffet, generated their wealth through smart investments.

Politically connected businessmen, such as the Mexican telecoms tycoon Carlos Slim or LUKoil president Vagit Alekperov, used their influence to make fortunes through resource extraction, state-protected monopolies or privatization of government property.

Finally, many extremely rich people, such as Liliane Bettencourt and Christy Walton, inherited their money.

Company founders and executives make up the largest share of the world’s billionaires -- nearly 40 percent.

This is good news for economic growth as this group creates millions of jobs and helps countries remain competitive in the global economy.

Heirs make up the second largest percentage (30 percent), followed by financial wizards (20 percent) and politically connected business owners (10 percent).

Because the economic benefits from these sources of wealth are more questionable, the argument that these fortunes should be protected from redistribution is far less compelling.

Smart economic policy should aim not only to reduce inequality but also to steer resources toward productive forms of wealth creation, while limiting less productive forms.

And, because inheriting money does little to stimulate growth, an attractive set of measures are estate and inheritance taxes.

Opponents of estate taxes offer three reasons why they could dampen economic growth: entrepreneurs will be reluctant to expand their companies if they cannot leave their wealth to their children; small firms will risk collapse when their owners die if their heirs cannot pay the taxes and companies will flee to lower-tax jurisdictions or engage in costly and unproductive tax avoidance.

All three worries are overblown, at best.

Many countries already apply estate and inheritance taxes.

These taxes tend to exempt the vast majority of wealth, focusing instead on preventing the entrenchment of large fortunes.

The United States, for example, exempts the first US$5.43 million of an estate from taxation.

South Korea applies a progressive tax ranging from 10-50 percent on inheritance worth more than three billion won (US$2.55 million).

In 2015, Japan raised its maximum rate from 50 percent to 55 percent and expanded the base.

And yet, there is little indication that these taxes play a large role in company founders’ decision-making.

Indeed, researchers have found that many elderly rich people start their estate planning only after the onset of a serious illness.

And even when founders do take taxes into consideration, they are just as likely to respond by working harder in order to leave more for their children.

Nor is there compelling evidence that estate taxes cripple small businesses.

From 1983 to 1998, the US levied an estate tax on transfers of wealth that exceeded US$750,000.

Even so, the tax had no significant effect on entrepreneurial activity, according to a study by the economists Donald Bruce and Mohammed Moshin.

Finally, a moderate estate tax is unlikely to be a critical factor in deciding where to locate business or in where the wealthy choose to reside.

One potential exception is when neighboring countries have similar cultural and linguistic heritages but very different tax regimes.

Far from being a drag on productivity, estate taxes could boost economic activity.

As the 19th century industrialist Andrew Carnegie pointed out, the parent who "leaves his son enormous wealth generally deadens the talents and energies of the son and tempts him to lead a less useful and less worthy life than he otherwise would”.

Indeed, US tax data from 1982 and 1983 shows that individuals who receive large inheritances are significantly more likely to leave the labor force.

Unsurprisingly, estate taxes are very effective at reducing inequality.

The difference can be seen in a comparison between the US and Europe.

US estate taxes have historically been higher than European; they peaked at 77 percent in the 1950s and 1960s.

As a result, US fortunes have tended to fade more rapidly.

Just one-third of US billionaires inherited their wealth and fewer than 10 percent of these fortunes date back more than three generations.

By contrast, more than half of their European counterparts inherited their wealth, and 20 percent of those fortunes are more than three generations old.

Tackling inequality is shaping up to be one of the defining challenges of the coming decades.

As policymakers consider their options, there is no reason that estate and inheritance taxes should not be at the top of their list.

Copyright: Project Syndicate

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