Mankiw on repealing the estate tax

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.

1                    Incidence

“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.

3               Conclusion

“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.

Bob Herbert – The US Economy on the brink

I like Bob Herbert.  He mostly speaks for me in this column about America’s sinking economic fortunes.  I’m not too sure what would be so awful if America were to be like Germany – I guess Herbert means that America would be consigned to lower average growth in GDP.  Herbert says that America’s economic problems have been made worse by trade agreements, but does not specify what he means.  But Herbert’s tone of urgency and concern strike me as apt, and the long list of major problems awaiting solution seems equally apt.

A propos of nothing, I much prefer the earnestness of Herbert to the monotonous light-heartedness of Gail Collins, who nevertheless must be quite smart and who has just published a book about the changed place of women in American society since 1960 that sounds like it is well worth reading.  But I find the tone of her columns insufferable.  If she wrote in that tone 1/3 of the time, I could abide it.

Back to Herbert and my hobby-horse of the moment, America’s outdated constitution, it occurs to me that if there were a major movement of complaint about the excessive powers of the senate and the overrepresentation of a small part of the US population that the senate represents, then senators might be moved to behave differently, even if the constitution cannot be changed.  Civics textbooks should be rewritten in such a way as to make it clear that the powers of the unrepresentative senate are unusual in a contemporary democratic state.

Movie Review, Lakeview Terrace

This post contains a review of the movie “Lakeview Terrace” (2008), starring Samuel Jackson.  The post contains plot spoilers.  I recommend the movie, with some reservations.  It would be better to have seen the movie than to read this post before watching the movie.

The movie, in my judgment, is first about race, second about the American suburbs, and only in a tertiary way to be considered a thriller.  It’s a script about some interesting sociological phenomena that has been wedged into a thriller format.  Considered as a commercial American thriller, it is perhaps slightly above-average in quality, which is to say not very good, because not entirely credible in all of its plot elements, mainly whether the most extreme actions of the characters are credible.  But the sociological aspects of the movie, and the portrayal of the central character by Jackson, rescue the film.  The movie has some things to say about race in America, and about suburban life, at the time at which it was made that are not merely platitudinous.

Opinion about the movie seems to have diverged greatly.  Based upon a glance at Movie Review Query Engine, it would appear that most reviewers found the movie to be a rather pedestrian thriller, but it had its defenders.  Roger Ebert, a notoriously easy grader, gave it 4/4.  I was very pleasantly surprised to find that Anthony Lane gives the movie a mainly positive review in “The New Yorker,” saying that the first hour, and especially Jackson’s performance, are close to riveting and that the action denoument of the last 45 minutes is less than entirely convincing.

One of the reasons I liked this movie, perhaps the main reason, is that Jackson’s character reminds me very much or a next-door neighbor my family had in San Francisco when I was an adolescent, a hard-working blue-collar man who was very strict with his children and probably had rather conservative attitudes regarding virtually everything.  I was invited to dinner at their house a few times, and it was always a tense experience.  One never knew what might arouse the wrath of the patriarch, who was very imposing physically, tall, wiry, and very strong.  He was not a man prone to mirth.   Unlike Abel, as played by Jackson, though, the man I knew had married a white woman, and the couple had four children.  When I later moved away for college, I heard that they had divorced amid rumors of domestic violence.  Abel, a career street cop in Los Angeles, now a sergeant as he approaches retirement, is a particular kind of “race man,” though, who is offended by intermarriage.  This seems very credible to me.

Abel, it transpires, has been thrust over the edge by the fact that his wife was killed in an auto crash three years ago.  Due to the accident, as we only learn well over half the way through the movie, Abel learns that she was probably having an affair with her white boss, who was driving at the time of the accident.  The script’s implicit premise is that Abel has been tormented by the betrayal and by the fact that his wife would have betrayed him with a white man.  The rage that this apparently inspires also seems quite credible to this viewer.  One also has the impression that Abel could not have been easy to live with at any stage, that he has always had a good deal of racial resentment that might have been difficult for his wife to endure.  The wife had sought consolation from someone less tormented, less wound-up, a white man.

The plot hinges upon the fact that a young biracial couple has moved into a house next to Abel’s in a pleasant but probably remote suburb of Los Angeles.  The movie’s opening sequence is clever, in that both the viewer and Abel probably mistakenly assume that a distinguished older black man who arrives with the couple is in fact the husband, that we are looking at a May-December couple.  But we are quickly disabused of this assumption, as it turns out that the young white man driving a rental moving van is in fact the husband, and the older man is the young wife’s father.  It later transpires that the father is a successful attorney in Oakland.  The interesting part of the young couple’s marriage is that the husband, who went to U.C. Berkeley on a lacrosse scholarship, has married up.  The young husband is apparently a rather uncomplicated jock now making his way in the business world as a mid-level executive for a supermarket chain.  His wife apparently works in computer animation or clothing design, it is not entirely clear, but she seems to have had more money than her spouse, as is clear from the fact that her father had wanted to help the young couple buy a more desirable house than the one they have bought, which is a 3-bedroom suburban home with a swimming pool at the end of a cul-de-sac.  Unfortunately, they have moved nextdoor to a racially obsessed and bereaved psychotic policeman.

A feature of the plot that goes unremarked in the reviews I have read is the prominent part played by a huge, mostly white drug dealer/police informant.  In an early scene, Abel rousts his informant, who plies his trade in South Central LA at Abel’s suffrance, for information.  We learn in this scene that Abel is offended by the drug dealer’s assimilation to black street culture and by his overall racial ambiguity.  The drug dealer, for his part, cannot understand why Abel is so obsessed with biological race as a marker.

In a later scene, Abel, contrary to expectation, agrees to host a bachelor party for a young police colleague, but he has done so only to torment the young couple nextdoor with noise.  But the scene is an interesting one, revealing the police to be as one imagines professional athletes to be when they congregate socially, somewhat contemptuous of the general public and of the law, as well as of women.

Another character in the movie is the suburban neighborhood itself, Lakeview Terrace.  The movie well conveys the sense of pride Abel takes in his home, a pride which has unfortunately veered into obsessive paranoia, as evidenced by the high-powered security lighting he has installed.  Abel can be seen watering the plants in front of his house.  He patrols his cul-de-sac street at night in his own private “Neighborhood Watch.”  Some Asian neighbors host a party for the neighborhood.

An aspect of the plot which is not entirely believable is that the young biracial couple who move into the neighborhood are described as having purchased a “starter home” and have refused financial assistance from the wife’s parents.  Where did they get enough money to purchase this house, which must have cost at least $800,000?

The neighborhood has been built on a hillside and is subject to wildfires.  All too predictably, a wildfire occurs and threatens the neighborhood, which has to be evacuated, in the movie’s concluding scenes.  There is here a somewhat unhappy confluence of implications about development policy and sprawl and the requirements of increasing the suspense and sense of impending doom in the concluding scenes of a suspense film.  These scenes might have been more powerful if the wildfire had been depicted as having threatened Lakeview Terrace without actually reaching it, if it had appeared in TV footage of a similar neighborhood just across the valley, for example.  As things stand, there is just too much contrivance and coincidence.

The movie builds to a happy resolution, as Abel meets his deserved end and the young biracial couple ride off into a presumably happier day.  I was greatly pleased when Abel is finally punished for his racially motivated extravagances.  The message seems to be that Abel had endured racial indignities all his life and had developed elaborate coping mechanisms, a very tough carapace.  That he should have done so to no purpose, because race is no longer deemed to be terribly important in the new society that is dawning, is more than he can bear.  Abel’s defenses were shattered when his wife died under circumstances that were emasculating for him, and his psychological crisis is brought to the breaking point by the arrival of the insouciant and privileged young biracial couple next door.  I have known this man.  He is not someone who exists only in the minds of the script’s writers.

Les grandes bouches

We have just heard a wonderful concert by a jazz vocal group from Toulouse called “Les grandes bouches.”  They performed in our little nonprofit café spectacles called La Tannerie in Agen.  The concert was undersubscribed, but as is ususally the case with real professionals, the group seemed to take it in stride and to enjoy themselves.  It was a great privilege to hear them in such intimate surroundings.  The streets of downtown Agen were virtually deserted on this chilly and drizzling night in February.   You can hear the group on Myspace:

Perhaps the greatest group ever to sing in this genre of harmonized jazz was French, the great Double Six de Paris.  I don’t know how many similar French groups have intervened between les Double Six and Les grandes bouches.

Music is life; life is music.  Music is an international language.  I have always been moved by the popularity of jazz in France.  Quite by chance, the region of France in which we live, Gascony, became home to the biggest jazz festival in France, the Marciac Jazz Festival, which occurs in the small town of Marciac, in a very remote corner of our department of the Gers.  I sometimes think that we were drawn here by some magnetic force, because the availability of music that I love is quite disproportionate to the small population living here.  But this also attests to the greatness of jazz music.

Healthcare reform, a question

I have heard that Obamacare would be the most redistributionist federal program since…since what, I’m not too sure.  But one does not hear, not very often, that opposition to the plan, from whatever quarter, is based upon opposition to economic redistribution.  One could say that this motive is implicit in much of what one does hear.  The insured are generally happy and outnumber the uninsured.  There is therefore no great political impetus for reform at the popular level.  I would nevertheless have thought that there would be more discussion of the redistributionist aspect of health-care reform and of the extent to which unhappiness about income redistribution motivates opposition to reform.

The state of the Union is bad, continued

I am a self-identified progressive.  My favorite economists in the public arena are Paul Krugman and Robert Reich.  But I am also a deficit hawk.  Today, I received an email from Nouriel Roubini’s consulting business that addresses America’s likely long-term fiscal deficit.  The picture is bleak.  This is the main reason that I think America’s political system is broken.  There is an inability or unwillingness to address major problems that are known to be problems.  America simply cannot afford to continue to fund its current military spending levels, which should be reduced for both economic and political reasons.  A combination of tax increases and spending reductions should be passed.  On the spending side, neither entitlements nor defense can be sacrosanct, but in Obama’s proposed spending freeze, both are exempt.

Here are representative quotations from the Roubini group’s email (I receive only the free email and am not a subscriber to the paid service).  “…The fiscal deficit is likely to remain near US$1 trillion and exceed 5.0% of GDP over the next decade (and trend higher thereafter). Near-term spending on fiscal stimulus and defense will remain high at least until 2011, as Obama’s proposed three-year freeze on discretionary spending excludes defense and entitlements…Obama simply lacks the political support to implement aggressive fiscal reforms. The Senate recently voted against Obama’s proposals on spending freezes and the establishment of a fiscal commission, whose role would be to send fiscal reform legislation to Congress that would have to be voted on or thrown out without the possibility of amendments. Moreover, if policymakers extend the 2001 and 2003 tax cuts beyond 2011, when they are scheduled to expire, the impact on the fiscal deficit and U.S. fiscal credibility would be immense. Washington has not signaled strong support for wider tax reforms, such as introducing a value-added tax (VAT)… Despite the ticking fiscal bomb, mid-term and presidential elections in November 2010 and 2012 respectively will further constrain political will to undertake necessary reforms.”

As I recently posted, I believe that the senate has outworn its usefulness as an institution in its present form and that this anachronism is a deficiency of the US Constitution.   Towards the end of a recent bloggingheadstv conversation between Brook Lindsey of the Cato Institute and Mark Schmitt of “The American Prospect,” Lindsey, a libertarian/conservative,  characterizes the view that there is a structural polticial problem preventing necessary action to address the long-term federal deficit as a progressive one, and it is a view that he does not share.

If this really is primarily a progressive view, that seems odd to me.  It was only about thirty years ago that conservatives were proposing a new constitutional convention.   It is not odd that people who are deeply frustrated with political events should look to constitutional reform.  But it is odd that progressives are at least as worried about America’s long-term fiscal deficit as conservatives, if not more so.