Are inheritances really that bad?

On the surface, inheritances are a source of moral repugnance. When we think of inheritances, we tend to think of families like the Rockefellers and Vanderbilts whose great fortunes were passed from one generation to the next. We also tend to think of “trust fund babies” – those rare individuals who have received enough money in inheritances or gifts (often in the form of a trust fund) so that they have no need to work over the course of their lifetime. As a result, many individuals feel that inheritances are morally wrong. Consequently, they advocate any measure that will eliminate inheritances and other wealth transfers, such as a confiscatory estate tax.

It is true that inheritances and gifts (collectively, “wealth transfers”) are incredibly unequal.  Calculations from the Federal Reserve Board’s 2007 Survey of Consumer Finances show that only about a fifth of families had ever received a wealth transfer. Among recipients alone, only a very small percentage received substantial wealth transfers – 48 percent more than $100,000, 16 percent more than $500,000, 7.4 percent more than $1,000,000, and 4.2 percent more than $2,000,000.  The top-one-percent received 35 percent of all wealth transfers in 2007, the top five percent received 61 percent, and the top 20 percent received 84 percent. The bottom 80 percent collected only 16 percent. The inequality of wealth transfers among recipients is about the same as that of household net worth.

It is also true that today’s rich have received more in the way of inheritances and gifts than the middle class or poor. This relation holds by income class, by wealth class, and by level of educational attainment (particularly between college graduates and all others). It is also the case that even among young people today the richest of these generally have richer parents and receive higher wealth transfers than those who are poorer. The evidence based on the Federal Reserve Board’s triennial survey, the Survey of Consumer Finances, over years 1989 to 2010 for the United States suggests that inheritances do not actually exacerbate household wealth inequality nor do they account for an increasingly larger share of household wealth. It is true that the average value of inheritances in constant dollars did increase by 24 percent, but this works out to a meager annual growth rate of 1.0 percent per year, less than the 1.7 percent per year annual growth in net worth, which occurred despite the steep recession of 2007 to 2010. As a result, wealth transfers as a proportion of current net worth actually dipped over these years from 29 to 26 percent. In sum, the evidence does not support the hypothesis that there has been an inheritance boom in the U.S. over the last few decades.

Likewise, contrary to popular belief, the proportion of net worth of the very rich attributable to wealth transfers is surprisingly low—less than 20 percent—at least according to direct survey evidence. This figure compares to a ratio of about a third for the middle class. Moreover, the proportion of net worth attributable to wealth transfers fell very sharply between 1989 and 2010 for the very rich (the top income and wealth class) and for college graduates. In particular, the share among the top one percent of the wealth distribution fell from 23 percent in 1989 to 11 percent in 2010, or by 12 percentage points.

There are several possible explanations for these results. First, mortality rates among elderly people were declining, and, as a result, the number of bequests per year went down. Second, as people live longer, their medical expenses would likely increase as they age and, as a result, less money is transferred to children at time of death. Third, the share of estates dedicated to charitable contributions might be rising over time. This trend may be particularly true for the extremely rich. Likewise, the very rich while alive may be giving more money away to charitable organizations (think of the Bill Gates Foundation).

Despite seeming counter-intuitive, wealth transfers actually tend to be equalizing. Indeed, the addition of wealth transfers to other sources of household wealth had a sizeable effect on reducing the inequality of wealth. Richer households do receive greater inheritances and other wealth transfers than poorer ones. In particular, the proportion of households receiving a wealth transfer climbs sharply with both household income and wealth, as does the value of these transfers. However, as a proportion of their current wealth holdings, wealth transfers are actually greater for poorer households than richer ones. In other words, a relatively small transfer to poorer households counts more in percentage terms than a large gift to the rich. As a result, net worth excluding wealth transfers and wealth transfers themselves are negatively correlated.

Since wealth transfers and net worth have a negative correlation, adding transfers to net worth actually reduces overall wealth inequality. The calibration results indicate that eliminating inheritances either in full or in part actually increases overall wealth inequality.

In general wealth transfers flow from richer to poorer, satisfying the so called Pigou-Dalton principle. This is notably the case with gifts but also characterize most inheritances as well. This is also generally true when the very wealthy make a wealth transfer to their children. While the children are typically better off than others of their age group, still their parents are richer than they are and the transfers are made from richer to poorer. These transfers redistribute and reduce overall wealth inequality

In the case of gifts, transfers are almost always made from the more to the less wealthy, as the great majority of such transfers are from an older (and likely richer) to a younger (and likely poorer) person – in particular, from parent to child. Such inter-vivos transfers will reduce measured wealth inequality. Inheritances are similar, generally flowing from a (richer) parent to a (poorer) child. Of course, the most basic way in which inheritances reduce wealth inequality is through estate splitting. In a world without primogeniture (a system by which the eldest son inherits the entire estate by law), estates are normally split among heirs. The more children a family has, the more the estate is split. In this case, the net worth of the heirs is each less than that of the original decedent. The massive wealth of the original plutocrat is dissipated over several generations as the original estate is further and further split – think of the Rockefellers, for example. This process also reduces wealth inequality.

Between 1989 to 2010 there was a downward trend in the share of wealth transfers in household wealth, at least in the United States. Even if the opposite were the case, inheritances and gifts do not lead to ever rising wealth inequality but quite the opposite. Thus, a world with rising wealth transfers would not raise wealth inequality but lower it. Indeed, maybe society should encourage people to give greater gifts and leave more money in inheritances.

Feature image credit: “Torn & Cut One Dollar Note Floating Away in Small $ Pieces,” by photosteve101. CC-BY-2.0 via Flickr