WEALTHblog: The New Inheritors

If you were asked what seems more unfair to you - that one person inherits a penthouse and half a million pounds from their parents while another one doesn’t; or that a person who earns a below average income but inherits an expensive house from their parents has to pay almost half of its estimated value in taxes – what would you say? The past decades have seen the revival of a form of wealth which had somewhat decreased in importance in the second half of the 20th century, namely inherited wealth. The latter is one of the driving forces behind the increase in inequality at the top of the wealth and income distributions observed in the developed economies of the United States and Western Europe, according to Piketty (2014). Inheritance and lifetime wealth transfers tend to crystalize debates because, perhaps more so than other types of wealth or income, they appeal to deeply rooted fairness and equity notions – beyond any economic efficiency considerations. Yet, we still know fairly little about what affects the relation between inheritances, the taxation thereof, and wealth inequality.

 

To inherit or to merit. Inherited wealth, in the form of financial or non-financial assets, differs from other forms of wealth in that it is “unearned” by the individual upon whom it is bestowed, be it during lifetime as an inter-vivos transfer, or at the time or death.[1] For this reason, it is seen as a source of inequality. An individual who inherits a house from her parents starts off with a considerable head-start in life since she will never have to make that investment using her own resources. Further, this person never had to work to “earn” this house, which makes for a meritocratic rationale against inheritances as they foster an inequality in opportunities which is likely to translate in aggravated inequalities in outcomes.[2] The most common way to deal with this has been through inheritance and gift taxes, most often levied on beneficiaries.[3] The rise in inheritance taxes can itself be linked to fairness considerations: Scheve and Stasavage (2012) argue that mass mobilization for war has been a major driving force behind their implementation. Since the poor were paying for the war through military conscription, there were pressures on the rich to share the burden through the “conscription of wealth”. Today, a majority of OECD countries still levy gift and inheritance taxes (26 countries in 2017) – though many countries have reduced or abolished them since the 1990s, such as Austria in 2008. Although there are wide differences in design across countries, common features include high rates, low revenues, and numerous exemptions and reliefs.

 

The politics of wealth inequality and the taxation of inherited wealth. Paradoxically enough, inheritance taxes are also often considered unfair – and not just by the super-rich. Indeed, even if one believes that there is a strong rationale for the progressive taxation of inherited wealth based on an equity motive, some argue that it may not be an efficient or fair way to reduce wealth inequality – for several reasons.[4] The inefficiencies stem from the complex design of inheritance taxes, their high collection costs and low revenue generation, as well as their somewhat arbitrary features – as people with the same amount of wealth end up being taxed at very different rates based on what they decide to do with that wealth. Another issue often raised is that of “double taxation”, as the donor may have already paid taxes on his savings or on the capital gains generating the bequeathed wealth, which is then taxed again. Further, there are typically numerous reliefs and exemptions – in the form of thresholds or with respect to which assets are subject to the tax – which generate avoidance behaviour, often through inter-vivos transfers. This is seen as a source of inequality because those who resort to these strategies in practice have the information and means necessary to transfer part of their wealth tax-free during their lifetime. Ultimately, the burden of the tax may therefore fall on middle-class inheritors, who tend to have their capital tied up in their house for instance, rather than on the very wealthy. Intergenerational considerations also come into play: intuitively, it is fairly easy to understand that most people may want small bequests and high inheritance taxation for their own generation – so that they have equal opportunities – while being able to leave large bequests taxed at low rates to their children. So, are inheritance taxes “more unfair” than inheritance itself; and should they be abolished, or replaced by other types of wealth taxes more apt to tackle wealth inequality? The taxation of bequests remains a highly political question, as exemplified for instance by the outrage over the 2007 reform in France when right-wing President Sarkozy considerably cut inheritance taxes, or by the debates over the constitutionality of the exemptions for corporate assets in Germany in 2014. This has triggered a renewed interest on the part of researchers on the impact of the taxation of gifts and inheritance, which has yielded ambiguous results.[5]

 

Experimental approaches to measuring attitudes toward the taxation of inherited wealth. If one wishes to reconcile the apparent paradox of widespread opposition to both inheritance and inheritance taxes on fairness grounds, it seems essential to consider how information, individual perceptions and attitudes shape preferences for taxation of one form of wealth rather than another. There is evidence suggesting that individuals’ attitudes toward inheritance taxes are affected by whether their attention is drawn to the changes in other taxes necessary to compensate for the abolition of the tax.[6] Bastani and Waldenstrom (2019) have also explored how attitudes toward inheritance taxation are shaped by information about the role of inherited wealth in Sweden, exposing different subsampled of individuals to different “information treatments” about the distribution of capital income. They find that once people know how much inherited wealth there is in society and how it affects inequality of opportunity, they tend to support more inheritance taxation. Is it just a matter of information then? To shed light on these issues, the WEALTHPOL team will soon be running an innovative lab experiment testing how individual preferences for the taxation of different forms of wealth and income are affected by whether individuals know how wealth and income are distributed among other participants. Stay tuned.

 

References

 

Bastani, Spencer, and Daniel Waldenström. 2019. Salience of Inherited Wealth and the Support for Inheritance Taxation. CESifo Group Munich. https://ideas.repec.org/p/ces/ceswps/_7482.html (February 13, 2019).

Piketty, Thomas. 2014. Capital in the Twenty-First Century. Cambridge Massachusetts: The Belknap Press of Harvard University Press.

Scheve, Kenneth, and David Stasavage. 2012. “Democracy, War, and Wealth: Lessons from Two Centuries of Inheritance Taxation.” The American Political Science Review 106(1): 81–102.

 

[1] Unlike self-made wealth, which comes from the accumulation and investment of capital over time by an individual, and is in that sense “earned”.

[2] Although some a prompt to respond that while the recipient did not work toward accumulating this wealth, her parents or grandparents most likely did, and that the beneficiary did not actively seek the bequest.

[3] Exceptions include the UK and the US, which have a donor-based system.

[4] For a more thorough review of these issues in the case of the UK, see Boadway et al. (2010).

[5] See for instance Elinder et al. (2018); and Hood and Joyce, (2017).

[6] See Martin Weale’s commentary of Boadway et al. (2010).

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