Wealth, Inheritance and the Estate Tax

Studies | Taxes

No. 289
Thursday, September 21, 2006
by Jagadeesh Gokhale and Pamela Villarreal


Introduction

The unequal distribution of income in the United States is well-studied.  Less research has been done on the uneven distribution of wealth.  It is important to distinguish between wealth and income.  Wealth is generally the stock of assets owned by a household, and includes material possessions, as well as financial instruments such as stocks and bonds.  Income is a flow of funds such as wages and other sources of income accruing in the present.

The major determinants of an individual's income are skills acquired through education and experience, and the wages received for work. The principal source of wealth is savings from income.  Incomes are highly mobile, generally rising throughout the careers of individual workers and households.  Although there is an association between the incomes of children and their parents, the children of the poor are likely to reach a higher level of income than their parents, and many children of high-income parents end up in a lower-income group by the time they retire.

“Wealth is highly mobile.”

Less well understood is how wealth is acquired and the fact that it is also highly mobile.  It is commonly assumed that inheritances are a source of wealth inequality and the offspring of wealthy families are likely to be very wealthy when they retire.  However, although bequests contribute to wealth, individual behavior is far more important.  Personal choices such as skill acquisition, marriage and the decision to have children can interact in important ways with public policy choices, including the nature of the tax system, capital markets and Social Security.  These factors exert a significantly larger effect on wealth accumulation and intergenerational wealth mobility than bequests alone.  Hence, just as lower-income individuals are not destined to remain in the same income bracket as their parents by the time they reach retirement, the children of the wealthy are not guaranteed to reach retirement wealthy due to inheritances from their parents.

Policymakers who support an estate tax argue that large inheritances passed on to the next generation perpetuate and exacerbate the unequal distribution of wealth.  But is this true?  This study presents evidence that the choices individuals make, especially about their education, work and saving are  largely responsible for the inequality of wealth in the United States.


Read Article as PDF