Gregory Mankiw, Professor of Economics at Harvard and former Chairman of the Council of Economic Advisors under George W. Bush, gave a speech to the National Press Club in 2003 in which he advocated abolition of the estate tax. This post provides my attempt to rebut his speech. The post is organized to correspond to the organization of the speech.
“Under what circumstances would the estate tax actually fall only on the decedent? That would happen if the tax prompted the decedent to reduce his consumption during his lifetime, so that he could satisfy the tax obligation without diminishing the after-tax bequests left to his loved ones. In other words, the estate tax would have to reduce lifetime consumption and promote estate accumulation.”
What is the contrary to this proposition? It is that the estate tax completely discourages capital and estate accumulation. But this is clearly false, so the truth of the matter is somewhere in between these two extremes. Taxpayers who are likely to have an estate sufficiently large to fall under the estate tax do not reduce consumption during their lifetimes as much as would be necessary to increase their estate by an amount sufficient to allow their heirs to inherit some amount X, net of the estate taxes. But even stating the matter in this way highlights an analytical problem. It is that it is implausible that most people have a specific net amount X that they want to bequeath. One might visit an estate planner, learn that the current bequest, net of estate tax under then current law, would be either higher or lower than desired, and make an adjustment in one’s behavior accordingly. But then again, one might well make no adjustment, and much might depend upon how close death actually seemed at the time.
It seems highly likely that behavior in this regard varies with the size of estates. That is, it might be more important to someone to leave at least $1,000,000, net of taxes, to all of his or her children than to leave $10,000,000 to each. But perhaps not. This is obviously a matter for empirical research, but it does seem likely that beyond some amount of wealth it becomes increasingly less important to decedents to bequeath some precise amount of money. On the other hand, it will often be of paramount importance that a bequest enable heirs to retain control of a business or other important asset, such as some particular real estate or artworks, after having paid the estate tax.
Mankiw places particular emphasis on the fact that the incidence of the estate tax is not upon the decedent alone. But who would ever have thought that this was the case? To the contrary, virtually everyone who has a large enough estate to be subject to the estate tax, and virtually all the heirs of such people, are aware that the tax is being levied upon the heirs, not upon the decedent. So I find this portion of Mankiw’s argument incoherent. Yes, the incidence of the tax is upon the decedent by statute. But no one looks at the actual incidence of the tax in this way, everyone is looking at the net estate available to heirs. It is only the tax rate which is determined by the estate and not by the economic situation of the heirs.
Mankiw is correct to say that heirs are often less wealthy than decedents, but this fact would tend to make the tax more progressive than if tax rates were based upon the situation of the heirs and not upon that of the estate. One of the primary purposes of the tax is to reduce the amount of capital accumulation in a small number of hands. Or, if people are to become wealthy, they should do so by the fruits of their own labor, not by virtue of the labor of their ancestors.
“What would happen if we allocated the estate tax burden to heirs rather than decedents?”
The tax would be somewhat less progressive than it is, as just noted. That is, on balance, the incidence of the tax would fall more upon less wealthy people who might be in lower marginal tax brackets than is the estate.
“The flaws in the distributional analysis of the estate tax also apply to analyses of capital income taxation in general, including the corporate income tax and the taxation of capital gains and dividends under the individual income tax. The burden of these taxes is almost always assumed to fall on the owners of capital. The burden shifted to labor is generally ignored.”
Mankiw maintains that, insofar as the estate tax discourages accumulation of capital, it is actually in part a tax upon labor, since labor will be less productive than it would otherwise be for every theoretical increase in the overall capital stock. This assumes that (i) all increases in capital stock lead to greater productivity of labor and (ii) the fruits of greater productivity of labor are distributed to labor. There is probably some truth in this line of reasoning, but not as much as Mankiw would have us believe. One has to ask oneself whether the estate tax has really led to a perceptible decline in America’s capital stock in the first instance, and, second, whether labor tends to receive a large percentage of increases in productivity, which are presumably distributed between capital and labor.
2 Revenue effects
“The estate tax encourages people to take avoidance actions, such as making gifts to their children. Since their children are almost always in lower tax brackets, these gifts reduce income tax collections. Repealing the estate tax would remove the incentive for such gifts and would thereby boost income tax revenues.”
Almost certainly true. An empirical question.
“Consider the story of twin brothers – Spendthrift Sam and Frugal Frank. Each starts a dot-com after college and sells the business a few years later, accumulating a $10 million nest egg. Sam then lives the high life, enjoying expensive vacations and throwing lavish parties. Frank, meanwhile, lives more modestly. He keeps his fortune invested in the economy, where it finances capital accumulation, new technologies, and economic growth. He wants to leave most of his money to his children, grandchildren, nephews, and nieces.”
Mankiw goes on to argue that the government should not be penalizing the frugal brother, who is contributing to capital accumulation, more than the spendthrift brother.
But, in the first place, is it obvious that the government is penalizing the frugal brother more than the spendthrift, simply because there is an estate tax that will fall upon the frugal brother? We have already established that the tax falls upon the heirs of the frugal brother, not upon the frugal brother himself, so there is a sense in which he is not being penalized at all. Secondly, the spendthrift brother has presumably been paying higher income, sales, and property taxes than the frugal brother throughout their lifetimes. It is just with respect to the estate tax itself that the frugal brother is penalized, relatively speaking, and even here, it is his heirs who are penalized directly, not he himself. So this whole line of argument, of which Mankiw appears to be particularly proud, because he restates it in a blog post of 2006, is quite weak, in my opinion.
To make matters worse, nowhere in the course of this speech does Mankiw even mention the disincentive to work exerted upon heirs to estates by their inheritances. There is presumably no easy way of measuring this effect, but it is an obvious effect that most people who have known trust-fund babies have observed. How can we know how much capital accumulation is lost due to such disincentives?
Moreover, Mankiw would apparently have us believe that government revenues make no contribution to capital accumulation in the society. That is, implicit in his argument is the idea that money bequeathed to heirs leads to capital accumulation, while money raised by the estate tax is simply spent. But obviously, government also leads to capital accumulation, in the form of both infrastructure and human capital formation. So one would have to make a very difficult comparison between capital formation by heirs in the private sector and capital formation by government.
“The estate tax unfairly punishes frugality, undermines economic growth, reduces real wages, and raises little, if any, federal revenue.”
It is not clear that the estate tax punishes frugality at all, let alone that it does so unfairly. The estate tax punishes frugality, if the basis of comparison is a world in which there are no federal taxes. Otherwise, it is not clear, at least not from Mankiw’s speech, that frugality is penalized relative to its opposite. It is even less clear that this is so when one realizes that the government revenues which are raised due to this hypothetical tax on frugality do not vanish into the ether. They are themselves used for economic purposes, a portion of which include capital accumulation.
It is not clear that the estate tax undermines economic growth. This assertion rests on two assumptions: (i) capital accumulation will be greater in the absence of the estate tax and (ii) capital will be more productive in private than in public hands. Not taken into account is the disincentive to work and entrepreneurship implicit in large private inheritances. Even if it could be demonstrated that capital accumulation would be greater in the absence of the estate tax, it is not obvious that other social goals should not override this fact. In particular, the goal of establishing a more equal starting point for economic competition than is provided in a society in which there are large intergenerational transfers of wealth might override any abstract economic advantage conveyed by greater capital accumulation.
It is not clear that the estate tax reduces real wages. This is true if all of Mankiw’s assumptions are true. But while the productivity or labor did rise in the period 1985-2005, say, in America, real wages did not rise for many people. So even were it the case that abolition of the estate tax would lead to greater overall capital accumulation, and hence to greater productivity of labor, it is not obvious that this would produce higher real wages. And it would still remain to be proved that the two assumptions are true.
Mankiw says that the estate tax raises little, if any, federal revenue. This is the only part of his argument which strikes me as very likely to be true. We know it is true in an absolute sense, because this tax accounts for a very small portion of federal revenues. Mankiw argues that the estate tax largely represents income tax revenues that would otherwise have been collected if, for example, people did not make tax-free gifts to beneficiaries in lower income tax brackets than their own. This would have to be tested empirically.
The remarkable thing is that Mankiw nowhere addresses the main goal of the estate tax, which is to make a gesture towards the goal of equality of economic opportunity. The entire point of the tax is to reduce somewhat the amount of wealth that can be inherited and that gives some people, namely heirs, a distinct advantage in economic competition. Inherited wealth conveys economic advantages while, simultaneously, acting as a disincentive to entrepreneurship in the class of heirs. It cannot be known what the effects of the estate tax upon economic growth and economic accumulation are, if comparison is made to a society in which there is no estate tax, or to a society in which estate taxes are confiscatory. I think the truth is that most people think that the estate tax has relatively little effect upon any of the things that Mankiw says he is worried about, viz. frugality, capital accumulation, and real wages. What it does do, in its current form, is to provide some symbolic evidence that America does not believe in the unbridled accumulation of capital in private hands based upon the accidents of birth.
There are two principal oddities in Mankiw’s argument in this speech. The first is that he implies that the savings or frugality effect of the estate tax is negligible, that wealthy people do not reduce consumption at all in order to provide for the tax liability that will fall upon their heirs. But this seems very unlikely to me. It is difficult to know what effects the estate tax has upon the consumption and savings behavior of wealthy people, but it seems to me virtually certain that there is a large “frugality effect,” especially towards the lower end of the spectrum of estates that are subject to the tax. Secondly, but relatedly, Mankiw completely ignores the disincentive to work of inheritances upon heirs. So the entire exercise seems disingenuous, if not dishonest.