William J. Bernstein
The Estate Tax Does It Really Matter?
After abortion and gay marriage, few topics polarize the body politic as does the looming repeal of the federal estate tax early in the next decade. The right wing excoriates the "death tax" as an unfair double levy on our societyís most productive members, while the left worries about the erosion of the very fabric of the nation through the creation of a vast and powerful class of hereditary wealth. Less well-noticed is the fact that the venerable common-law strictures against the creation of perpetual family trusts are slowly falling by the wayside; recent statutory changes in Illinois, Alaska, Delaware, Idaho, North Dakota and Wisconsin now allow these perpetual trusts in one form or another.
I do have definite opinions on the matter, but I shanít reveal them here. Thatís because I donít believe estate taxation matters very much.
The reason is simple: even if the estate tax is permanently abolished, and even if perpetual trusts become the norm nationwide, long-lasting hereditary wealth is a pipe dream. Five powerful factors militate against it. While none is sufficient in and of itself to prevent permanent family wealth, together they virtually preclude its existence. The factors are as follows:
Security returns will be low. With a real bond yield of one percent; a real stock-dividend growth rate of about one percent; and stock yields somewhat south of two percent, a two-percent overall real portfolio return seems likely. And thatís before taxes. After taxes, figure a one-percent real portfolio return, at most.
Expenses will be incurred. Figure a loss of one percent, including transactional expenses, even in the best-run portfolios.
People breed. Even in a stable, non-growing population, the number of our ancestors and heirs doubles with each generation: everyone has two parents, four grandparents, eight great-grandparents, and so on. And the average person will have about two children, four grandchildren, etc. So, excepting for the very unlikely instance where an individual has not one, but two or more, fabulously wealthy progenitors, the wealth of individuals dependent upon inherited wealth will fall by half each generation. Since the average age at childbirth is around 29 years, this translates into an erosion of individual wealth of more than two percent per year.
Beneficiaries spend. This varies widely from generation to generation. However, none but the thriftiest of trust-funders will consume less than a few percent per year.
The real standard of living rises (along with per capita GDP and productivity) at about two percent per year. While in the short term, we tend to be content with keeping up with inflation, in the long run, this is inadequate. Most of us would not be happy with a 1950s standard of living, and weíd be downright horrified with a 1900 standard of living.
So letís tote up the damage. In a best-case scenario, we begin with a long-term after-tax portfolio return of one percent. Subtract out one percent for expenses, two percent for generational attrition, two percent for spending by thrifty beneficiaries, and two percent slippage of the relative standard of living because of increasing productivity. That totals up to a loss of six percent of relative spending power each and every yearóin other words, a halving of relative standard of living every dozen years or so.
And thatís the best case. How many families are able to maintain efficient and successful portfolio management for generations at a time? And how likely is it that the third and fourth generations of unearned wealth will be happy with distribution rates of a couple percent? Toss in a decade or two of lax or unlucky portfolio management and a few generations of spendthrift heirs, and familial wealth shrinks faster than the prawn plate at a Cajun wedding.
True, there are several blueblood lines that have cheated the ages, the Rockefellers coming most easily to mind. But the continued wealth of that storied family has as much to do with the transmission of old John Dís strength of character as with the transmission of his bank accounts. (The anomalously high security returns of the twentieth century didnít hurt either.) And even so, itís highly likely that a hundred years from now, the phrase "rich as Rockefeller" will draw blank stares.
Sic transit pecunia: While the permanent abolition of the estate tax, should it come to pass, will carry with it enormous symbolic impact, we donít have much to fear from an all-powerful class of hereditary wealth.
Copyright © 2005, William J. Bernstein. All rights reserved.
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The right to download, store and/or output any material on this Web site is granted for viewing use only. Material may not be reproduced in any form without the express written permission of William J. Bernstein. Reproduction or editing by any means, mechanical or electronic, in whole or in part, without the express written permission of William J. Bernstein is strictly prohibited. Please read the disclaimer.