The coming boom in inherited wealth

by John Quiggin on April 16, 2012

As everyone who has been paying attention knows, the news on inequality is nearly all bad. Not only has inequality increased dramatically in the US, but intergenerational economic mobility is declining[1]. And, where the US leads, the rest of the world looks likely to follow. The top 1 per cent lost more than most during the crisis of 2008-09 but, as Stephen Rattner reports here (drawing on work by Piketty and Saez), that was just a blip. A stunning 93 percent of the additional income created in the US in 2010, compared to 2009, went to the top 1 per cent, and there’s no reason to think things were much better in 2011 – average real earnings have fallen yet again, and employment growth, though positive, was still modest. Wealth inequality is also high, though it has not increased as much as income inequality.

The one bright spot mentioned by Rattner is that ” those at the top were more likely to earn than inherit their riches”. Since I’m already noticing that point popping up in the places you might expect to see it (can’t find a link right now), let me point out that Rattner’s explanation, that “the rapid growth of new American industries — from technology to financial services — has increased the need for highly educated and skilled workers” is wrong, and that there is every reason to expect a boom in inherited wealth.

The fact that currently wealthy Americans have not, in general, inherited their wealth follows logically from the fact that, in their parents’ generation, there weren’t comparable accumulations of wealth to be bequeathed.  More generally, starting from the position of relatively (to earlier periods and to the current one) equal income and wealth that prevailed between about 1950 and 1980, growing inequality of income must precede growing inequality of wealth, since wealth is simply the cumulative excess of income over consumption (and US high-income earners have not been notable for restraint as regards consumption). 

So, given highly unequal incomes, and social immobility, we can expect inheritance to play a much bigger role in explaining inequality for the generations now entering adulthood than for the current recipients of high incomes. That will include direct transfers of wealth as well as the effects of increasingly unequal access to education, early job opportunities and home ownership.

 

fn1. More precisely, since intertemporal comparisons are difficult, the chance that a person with parents at the top (or bottom) of the income distribution will end up in the same or a similar position is now higher in the US than in Europe, whereas, until at least the  late 20th century there was good reason to think that the oppositewas true.

{ 45 comments }

1

Harald Korneliussen 04.16.12 at 7:26 am

… there were comparable accumulations of wealth to be bequeathed.

Should that be “weren’t”? Doesn’t make sense to me otherwise.

Fixed now, thanks

2

Conall Boyle 04.16.12 at 9:56 am

This is an idea that has popped up before in relation to UK Housing Wealth (sorry can’t remember the ref.) The upshot was that the inheritors in this case were largely late middle-aged, for demographic reasons, but were also generally already well-off. You tend to leave your stuff to members of your family after all.

3

Eli Rabett 04.16.12 at 10:37 am

Old news, in the US expansion of mortgage loans through the VA and Fanny Mae allowed people to buy houses and build value starting in the 50s. This wealth has been passed on to their children, and it was considerable.

Of course, there were all those red lined areas and southern gentlemen’s agreements which walled off a “small” proportion of the population from this new wealth.

4

dsquared 04.16.12 at 11:42 am

It should also probably be noted in this context that “the debt burden that we leave to our children and grandchildren and blah blah blah”, which forms the basis of about 50% of deficit bellyaching newspaper articles, is the same thing as this inherited wealth, for the most part.

5

BigHank53 04.16.12 at 12:11 pm

I’ve lived in several college towns in the US. It has become unremarkable when parents purchase a house or condominium for their offspring to live in while they go to school. Something tells me those kids aren’t coming out of school with $100,000 of student loans strapped to their back, either. There’s an inheritance that doesn’t even have to wait for a death, and not worrying about money means you can take one of those interesting internships (say, working for Congress) instead of marching into the salt mines.

As an aside, I’d also like to point out that Medicare can function as a wealth destruction tool for lower-income people. Medicare will pick up the cost of a nursing home…once you have less than $5000 in assets. If you weren’t clever enough to set up a trust at least five years ahead of time, wave goodbye to any investments or real estate you might have: your kids will have to treasure their memories, because that’s all they’re going to get.

6

Andrew F. 04.16.12 at 12:15 pm

Re: Rattner’s point being wrong:

You and Rattner are talking about different things. His point is that income inequality has increased dramatically due to the greater demand for highly educated and skilled workers in the US and the simultaneous shrinking demand for less educated middle-skilled workers in the US. Your point is that this will lead to future generations where wealth inequality is more a function of inheritance than earnings. The two points are entirely compatible. Of course, your prognosis is more contingent on future policy decisions than his diagnosis is.

7

John Quiggin 04.16.12 at 12:24 pm

Andrew F – please don’t bother commenting any further on my posts. I’m not interested. To others, please don’t reply – I’m sick of having my discussions derailed by trolls.

8

Steve LaBonne 04.16.12 at 12:35 pm

It should also probably be noted in this context that “the debt burden that we leave to our children and grandchildren and blah blah blah”, which forms the basis of about 50% of deficit bellyaching newspaper articles, is the same thing as this inherited wealth, for the most part.

And the next time one of our fine journalists in the “liberal media” explains this simple fact to readers / viewers will be the first.

9

Niall McAuley 04.16.12 at 12:50 pm

And in 50 generations, the beautiful, spoilt, idle children of the 1% will make delicious eating for our Morlocky descendants.

10

Nick L 04.16.12 at 1:56 pm

The current glut of grads in the OECD world is another factor which with accelerate the problem of inherited inequality due to the profusion of internships (making tea at daddy’s office) and other forms of nepotism in a saturated job market.

11

Matt McIrvin 04.16.12 at 2:30 pm

Also, inheritance and gift taxes are dramatically lower in the US than they were in previous decades. (The inheritance tax actually disappeared entirely for a little while, then returned in substantially lighter fashion.)

I suspect that one of the best things Americans can do for the future of the country is to enact a punitively high inheritance tax. But the “death tax” rhetoric of recent years effectively set most Americans against it, even if they had no hope of reaching its target population.

(By the way, does “the rest of the world” as used in this article include Latin America?)

12

Barry 04.16.12 at 2:31 pm

More likely, our descendants will fight bravely to the death for the entertainment of the 1%, with the sole surviving victor of each Game being awarded membership in the 1%.

13

mpowell 04.16.12 at 3:17 pm

I have had this theory that over the past 30 years the fed’s willingness to tighten as soon as they see wage inflation pressure has been a very smart way for them to control inflation (much better than CPI, in my opinion), but that it has led to a lot of the wage inequality that we see today. That’s because unemployment in the labor market is always much higher at the bottom end of the market and if you look at your average recovery, I’ll bet it is quite common to see wage growth at the top end of the market before you see wage growth at the bottom end of the market. And this is going to be especially true in a world without unions, which has basically been the US private sector over the timeframe I am referring to. And when the fed is always clipping off the end of economic expansions when most of that bottom end growth could plausibly occur, that provides a ratchet tool for wage inequality. In that vein, I wonder how 2010 compares to other first recovery years as far as the distribution of wage growth goes.

If policy makers in the US where interested in solving this problem (which of course they aren’t actually), I think it would be very interesting to see the central bank experiment with basically dropping the ‘stable inflation’ goal. You would still want to keep average inflation over the cycle stable, but letting the economy overheat a little at the end of each cycle might prove to be much healthier in the long run. Things would definitely be more volatile, but that could be a lot more tolerable if a V-shaped recovery is always at most 18 months away.

14

Crystal 04.16.12 at 3:30 pm

I remember reading a book called Being Black, Living In The Red by Dalton Conley; one of the points he repeatedly stated was that a huge driver of the black/white wealth gap was that African-Americans receive far less inherited wealth than whites even in the same income groups.

There is also an article by Kai Wright, “Upward Mortality,” about the author’s father, who went from being an affluent physician to living on nothing but Social Security at the end of his life due to chronic health problems. Wright notes that this is sadly typical of many African-American families.

I agree with John’s post that “we can expect inheritance to play a much bigger role in explaining inequality for the generations now entering adulthood than for the current recipients of high incomes” and wonder if this will also increase the current wealth divide between whites and blacks (and probably Latinos as well). Conley’s book mentions that many whites don’t even realize how much inheritances and gifts from parents are crucial to their upward mobility (or even staying in the same bracket). That parents will help them out and older relatives leave inheritances is taken for granted.

15

shah8 04.16.12 at 3:31 pm

I don’t seriously expect much of this wealth to persist. So much of it is from the nominal growth in value caused by people who believe that blowing asset bubbles is a great policy.

Policy makes wealth. Determines who is wealthy. Unsustainable policy implies that wealth destruction might be found, just around the corner.

16

chris 04.16.12 at 3:37 pm

It should also probably be noted in this context that “the debt burden that we leave to our children and grandchildren and blah blah blah”, which forms the basis of about 50% of deficit bellyaching newspaper articles, is the same thing as this inherited wealth, for the most part.

So all we really need to do is tax Peter to pay Peter, and the debt will unwind with little effect on the nonfinancial economy? That seems almost too good to be true, except for being politically impossible.

17

Colin Reid 04.16.12 at 4:05 pm

@Conall Boyle: Given current life expectancies among the middle class, it’d make more sense if they bequeathed their inheritance to their grandchildren (at least in countries with decent state health provision). For one thing, in the long run the dynasty pays a lot less inheritance tax. Of course the really wealthy (whose wealth isn’t locked up in their primary residence) will find ways of funnelling almost all their wealth to younger relatives before death in a way that avoids inheritance tax entirely.

18

Marshall 04.16.12 at 4:30 pm

Capturing “93%” of new income doubtless is a demonstration of skill of a sort, but how much of that comes from developing and applying technology to actual problems is open to question. From here it looks more like the 1% amass their piles by application of economies of scale and manipulation of public opinion. Doesn’t sound to me like a bright spot.

Somewhere long ago I read somebody who divided the workforce into Workers, Craftsmen, Managers, Academics, probably others. One point was that Craftsmen, who are people who work directly with technology in skilled and innovative ways, are capable of a comfortable living (better off than Workers), but they are under a ceiling. If you want to get rich, be a Manager; don’t waste your time in science class.

The follow-on generation will occupy the name-brand schools, but they have much less incentive to be actually educated. I suppose we are in for a few decades of dilettantism (space tourism?) before the next cycle gets underway (in the best case). Some good art could come out of that …

19

Barry 04.16.12 at 6:01 pm

“From here it looks more like the 1% amass their piles by application of economies of scale and manipulation of public opinion.”

I would say ‘applications of economies of fraud’, for a large part.

20

Keith Edwards 04.16.12 at 6:21 pm

“the rapid growth of new American industries — from technology to financial services — has increased the need for highly educated and skilled workers”

This claim exists only to further feed the Higher Ed. Bubble. It hasn’t been true in at least 10 years (and I have the grad school debt and unemployment checks to prove it).

21

Matt McIrvin 04.16.12 at 7:21 pm

That parents will help them [white people] out and older relatives leave inheritances is taken for granted.

I think the assumption of significant inheritances from older relatives is going away for everyone other than the very rich (for whom it will be evermore true). For one thing, middle-class retirees are living longer and burning through more of their remaining wealth, and, of course, medical care is more expensive.

But there certainly is still a black/white gap here.

22

JW Mason 04.16.12 at 8:32 pm

It’s important to recognize that the claim that “those at the top were more likely to earn than inherit their riches” depends on a somewhat peculiar choice by Piketty and Saez in handling the data. Their top fractiles are not the top 0.01, 0.1, 1, etc. percent by income, but rather the top 0.01 etc. percent by income excluding capital gains. This is clearly stated in their papers but it is almost never noted, as far as I can tell, by people who cite them.

The reason for doing this is that realized capital gains (what the tax system sees) are lumpy and may vary for a given household quite a bit from year to year. So using total income might exaggerate the share of capital gains by overrepresenting households that happened to have large realizations in that year. This is a legitimate concern, but there is also a danger that if wage and capital gains income have different distributions — and it’s clear they very much do — then this procedure runs the risk of systematically understating the share of capital gains income (and of other capital income, to the extent that it is more closely correlated with capital gains than with wages.) It is not at all clear to me that the distortion that Piketty and Saez have fixed by excluding capital gains from their ranking is greater than the distortion they have created.

If you look at the raw data from the IRS (or the summary on my blog), you will see that the wage share of the actual top fractiles ($10 million income is approximately the cutoff for top 0.01 percent) is much smaller than that reported by Piketty and Saez, in the range of 20-25 percent rather than over 50 percent.

Now, their correction may be appropriate; it all depends on how lumpy capital gains actually are. But it’s possible that their correction is systematically understating the capital share of income at the top, and overstating the wage share. At the very least, people who cite this stuff should be aware that it is NOT a description of the actual top incomes as reported by the IRS. And excluding capital gains from the definition of the top fractile especially problematic for recent decades as the share of capital income distributed as capital gains rather than dividends has risen sharply.

As for the post here, I think John Q. is exactly right.

23

Antoni Jaume 04.16.12 at 8:44 pm

Barry 04.16.12 at 2:31 pm
“More likely, […], with the sole surviving victor of each Game being awarded membership in the 1%.”

I don’t think so, at the best they’ll enter the 10% immediately below the 1%.

24

J. Otto Pohl 04.16.12 at 8:47 pm

I will settle for entering the top 50% of US earners. ;-)

25

John Quiggin 04.16.12 at 11:24 pm

The “graduate glut” idea is misleading. A four-year college degree is necessary, but not sufficient to get into the top 20 per cent, let alone the top 1 per cent, at least until people start receiving really big inheritances. So, if you don’t go, you’re stuck in a group that hasn’t seen any significant income growth in decades.

That means that it’s still a good bet to go to college. But with rising tuition and increasingly onerous terms for student loans, it’s now a bet with a substantial downside. The Hunger Games analogy is a good one – you’re doomed if you don’t participate, but you may well be doomed anyway.

26

lupita 04.16.12 at 11:51 pm

And, where the US leads, the rest of the world looks likely to follow.

Given the US’ performance in Cartagena this past weekend, perhaps the world will be spared.

27

Watson Ladd 04.17.12 at 12:11 am

JQ, looking at the recent unemployment numbers as a function of education, and then according to major, it seems that college actually protected you to a great extent from the Great Recession depending on what your major was. Note that degree quality is often not corrected for in these studies: I doubt very many MIT graduates are on the unemployment line.

28

Terry 04.17.12 at 1:00 am

@5, both good points, but I must correct because vast numbers of Americans don’t realize this: Medicare does not pay for nursing home/long-term care — it’s Medicaid. It would be nice if that fact were stressed to all the Tea Partiers who want to get rid of Medicaid as a hand-out to the poor.

29

Joshua Holmes 04.17.12 at 1:09 am

That means that it’s still a good bet to go to college. But with rising tuition and increasingly onerous terms for student loans, it’s now a bet with a substantial downside.

I think this should be unpacked more. It’s a good bet for STEM majors to go to college. It’s a good bet for scions of upper middle-class or better to go to college. However, it’s becoming a very bad bet for the bottom 25% or so of college grads, folks who started at community colleges, went to a local college with little prestige or alumni connections, and majored in nothing in particular. That grad is pouring coffee and trying to figure out how to cough up $300/month that can’t be discharged in bankruptcy. Learning to cut hair or weld would have done that grad a hell of a lot more good.

30

John Quiggin 04.17.12 at 3:53 am

@Joshua I agree. Unless you’re already from the upper middle-class, the risks of doing any kind of degree that doesn’t lead directly to a job are very high. And there’s a further catch that some degrees sound vocational but actually aren’t – in Australia for example, most jobs in media are filled through contacts, or on the apprenticeship/cadetship model, while university degrees in media/journalism have a lot of theory, and not much that promotes actual employability.

31

Rogers 04.17.12 at 6:17 am

That means 7% is still trickling down/on? the Undeserving Poor. Let’s get a move on Galtian Overlords, put your shoulders to it and finish the job. Those damn Proles aren’t going to exploit themselves!

32

Nick L 04.17.12 at 10:21 am

@John Quiggin

Yes I accept that the evidence suggests that grads are still in a better position than non-grads in the labour market, but there seems to have been a significant longitudinal fall in the employment prospects for new graduates – in the context of rising tuition fees in some OECD nations. Furthermore, the increase in the volume of graduates being churned out by the university system does seem to have created a glut of applicants for certain professions such as academia and law. As Joshua states in 30 there seems to be a large cohort of graduates for whom university attendance was of marginal benefit before the great recession. Post-recession this group finds itself in unemployment (25% of UK university leavers unemployed 6 months after graduation according to latest figures) or waiting tables, significantly worse off than many of their peers who took a vocational route.

33

John Quiggin 04.17.12 at 12:07 pm

@Nick – I’ll try to write something more comprehensive on this. A lot depends on the alternative – the classic example is the German system of technical education. In general, the English-speaking countries still seem to be stuck in an apprenticeship model that has ceased to work very well, but it’s hard to get really good information on this.

But, generally I’d agree that, if you can get it, training leading to a skilled trade job is at least as good a choice as a mediocre university degree. I usually try to mention this in a full-length post, but didn’t spell it out in my comments.

34

Steve LaBonne 04.17.12 at 12:29 pm

I thank the FSM that my daughter is a chemical engineering major. And is at a university that requires co-op (practical work experience) for all engineering majors, and has an excellent track record of placing them with co-op employers (who often end up offering them their first “real” job.) And has a generous scholarship that, together with the income she can expect from co-op employment, minimizes her need for borrowing. I feel for the millions of kids (and their parents) who are not nearly so lucky.

35

Barry 04.17.12 at 1:02 pm

Terry 04.17.12 at 1:00 am

” @5, both good points, but I must correct because vast numbers of Americans don’t realize this: Medicare does not pay for nursing home/long-term care—it’s Medicaid. It would be nice if that fact were stressed to all the Tea Partiers who want to get rid of Medicaid as a hand-out to the poor.”

As a 50-something (i.e., younger than most Tea Party members), I can’t believe that they don’t know that. It’s the one thing which allowed them to inherit their parents’ houses in the past two decades, and the one thing which will allow them to pass down their own houses to their children.

I think that in the end these people are so messed up that conscious thought explains little.

36

mpowell 04.17.12 at 3:26 pm

JW Mason@ 22: I’ve always thought that these studies of the top end had issues from looking at only one year. Does the data exist to track income returns on families over a multi-year period to see who is in the top 0.1% or whatever over a 5 year time horizon?

37

BigHank53 04.17.12 at 5:14 pm

Terry @ 28: Thanks for the correction; the one time I’ve had to deal with the situation I was, of course, way too stressed out to remember the correct program name. I could have been filling out forms for Martian Medicare for all I know.

Barry @ 35: Seeing as one of the common Tea Party protest signs was “Keep the government out of my Medicare” I can easily believe that many Tea Party members have no idea what they stand to lose if social welfare programs are defunded. It’s always those icky people over there that are wasting all that money, you know–I need my Rascal electric scooter.

38

Barry 04.17.12 at 7:44 pm

And one of the tricks is to grandfather in cuts, so that the people currently receiving (or soon to receive) won’t be hurt.

Won’t be hurt, that is, until the next election cycle, when the right whips out the ‘you don’t have it, so why should they’ slogan, which is really effective.

39

Peter T 04.18.12 at 10:44 am

The ceiling mentioned at 18 is interesting. My son’s a machinist (good choice – interesting work, constant demand, no student debt), currently fixing machines which cost some tens of millions to buy and also cost lots when they are off-line (mine machinery, major road plant and so on). Yet a really good machinist, one with 20 years experience who can line-bore a 2 metre bearing in one pass, gets paid on the same scale as essentially unskilled office work. You can get big money, but only if you work 12 hour shifts in hell-holes. In this case, there’s a good argument that reward correlates with social rank more than anything else.

40

Dr. Hilarius 04.20.12 at 3:54 am

Whether the current generation of the wealthy can avoid losing their wealth in boom-bust asset fluctuations is beyond my ken. What is clear is that more people, including people of modest means, are using financial/estate planning attorneys to shelter assets from taxation. That includes avoidance of medicaid liens on property and inheritance taxes. Keeping grandma’s house in the family even as she qualifies for medicaid can make a large difference in whether a family can maintain a middle-class lifestyle or send kids to college. (The really rich, Mitt Romney comes to mind, can have large incomes from capital gains and pay no more than 15% in federal taxation on that income. Truly sophisticated estate planning can drop taxation down to almost nothing.)

To engage in advance planning for tax avoidance requires both an awareness of the possibilities and the available money to pay a lawyer to do the necessary work. The ability to engage in asset protection can be expected to increase inheritance inequality.

41

ajay 04.20.12 at 10:20 am

39: but your son, since as you mention he doesn’t have any student debt, is actually taking home a lot more money than his office-working graduate peers.

That’s a striking differential even so.

42

liberal 04.20.12 at 4:56 pm

39: “In this case, there’s a good argument that reward correlates with social rank more than anything else.”

Agreed. IMHO there’s a slightly more general empirical observation about this: why is it that “bosses” are almost always paid more than the people they oversee? Of course, economists will trot out all their theories about marginal productivity. Given how bad most managers are (in my experience), I find that hard to believe, and a simple “social rank” explanation much more compelling.

43

Substance McGravitas 04.20.12 at 4:59 pm

why is it that “bosses” are almost always paid more than the people they oversee?

There’s a neaky attempt to make it seem as if workers might get more in Congress right now.

44

Substance McGravitas 04.20.12 at 5:00 pm

A sneaky one too.

45

Eli 04.22.12 at 4:59 pm

39, 42… This is a question that has always perplexed me: To what degree is compensation related to skill (investment in training), value, sheer difficulty, and then of course, social rank.

The really creepy thing in this equation is the degree to which one’s position is socially determined, having to do with privilege of human and societal capital. The free marketeer would argue the market is an objective arbiter of what is fair. Yet a more sophisticated mind would acknowledge the multiple ways in which the market merely enforces inherited privileges reinforced through institutional norms.

Regarding acquisition of skill via college vs. trade, the bias towards social rank has no doubt something to do with how we perceive the value-added component of college. In other words, the attainment of knowledge outside a specific skill-set is thought of as worth something to society apart from labor value. In this way, does college’s conferral of social rank represent an enforcement of enlightenment as a social norm, rewarding those who pursue this value so as to uphold its continued social aspiration?

Or is this a story we, the college-educated elite tell ourselves? I for one admit my bias – I consider my time in college as foundational to how I have learned to think about the world. I have been exposed to the highest traditions of civilized thought. I can’t help but imagine that had I not gone to college, I would be a lesser man for it. How can I not be biased then against those who have not gone to college, at least in terms of a general lack of contextual knowledge and or critical thinking skills. Let me put it to you this way: one is a better man for having read Plato and Marx, and engaged in its critical analysis. There may be no direct correlation to a specific workplace skill, but there is no doubt that one’s mind is at least marginally better at understanding the world and better contributing to it.

So again, is the added compensation for a college degree to some extent enforcing this broad social value of the expansive mind?

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