New Study: Estate Tax Unlikely to Reduce Concentration of Wealth

September 22, 2006

Economist Jagadeesh Gokhale and Pamela Villarreal have published a provocative new study with the National Center for Policy Analysis undermining a central argument made by proponents of the federal estate tax—that estate taxation helps reduce the concentration of wealth in the economy.

The study reports that the contribution of inheritances to the distribution of wealth in the U.S. is surprisingly small. Given the small number of taxpayers with net estate tax liabilities each year, that’s not a surprising finding. From the study:

It is commonly assumed that inheritances are a major source of wealth inequality and that the offspring of wealthy families tend to be as rich as their parents due to bequests. This perception is one reason why many people support taxing estates at death. But an individual’s skills and personal choices are far more important in determining household wealth than inheritances. In fact, the contribution of inheritance is surprisingly small…

To understand the reasons for wealth inequalities, this paper relies on a model of wealth accumulation that spans individual lifetimes. It focuses on that point in the life cycle when wealth accumulation tends to peak, as married households reach retirement age (60 to 69) and have accumulated all the wealth they will during their lifetimes…

The principal argument for the estate tax is the notion that without it wealth would become more concentrated in the hands of financial dynasties. However, wealth is highly mobile — being raised in a rich family does not guarantee that these children will be rich themselves when they retire:

● Only one in five children of the rich will themselves be rich when they reach retirement age. ● On the other hand, more than half of the children whose parents are in the bottom half will end up in the top half by the time they retire.

The estate tax is ostensibly designed to reduce wealth disparities, but it has proven to be ineffective for several reasons:

● Estate tax revenues account for only 3 percent of federal tax revenues, yielding very little money to redistribute. ● For most estates larger than $5 million, the effective tax burden is only 13.5 percent to 17 percent of estates; in fact, the burden tends to fall primarily on smaller estates. ● Additionally, the estate tax lowers the capital stock while raising the return on existing capital, making the rich richer.

Economists have called the estate tax a voluntary tax, since people can avoid it if they make a large enough effort. There are social costs of tax avoidance, however. In return for trivial effects on wealth distribution, there is likely a large misallocation of resources caused when people allocate large amounts of capital based on tax law rather than on the basis of economics.

Read the full study here. For our own recent overview of the economics of estate taxation, click here. For all of our past scholarship on estate taxes, see our “Estate and Gift Taxes” section.

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