Fine, clobber the rich, but not with a 100% inheritance tax

Abi Wilkinson has a piece at The Guardian making the case for bolstering the UK's welfare state by raising inheritance tax to 100%. She argues that it would be good to do more redistribution, to fund more and better public services, and that unlike other taxes, it does not face objections of moral desert. Perhaps you deserve the sweat off your back, she argues, but it's hard to see how you've earned a pile of cash that simply fell into your lap through luck. And she argues that we cannot infinitely respect the wishes of the dead.

There are some small points that Wilkinson is simply wrong on: she argues that elderly folk retiring earlier and earning less would make space for younguns to fill those spots. This is the Lump of Labour Fallacy: it's wrong for the same reason that immigrants don't steal jobs off natives, and the entry of millions of women in the labour market in the 1970s didn't cause mass male unemployment. When more people work we just produce extra stuff, consume extra stuff, and invest in extra stuff. But this claim isn't crucial to her case, and there's a more important point here.

Libertarians have always been divided on inheritance. If you think that freedom is important because it lets humans express their free wills, then why respect the non-existent wills of dead people. Jim Buchanan, the public choice theorist who suffered at the hands of Nancy Maclean and supposedly ties the whole libertarian right together, advocated an 100% inheritance tax. Robert Nozick switched towards one later in his life. Thomas Jefferson thought similarly. "Even" Adam Smith was against unlimited rights of bequest.

But unlike both Wilkinson and libertarians, I think we should approach this question pragmatically, not based on moral rules. We want to raise money to fund redistribution and public goods. How can we do this at the lowest possible economic cost? Inheritance tax is an inefficient way of raising money, even if we ignore problems of enforcement and loopholes.

When economists analyse taxes they typically use the visors of incidence and behavioural responses. Behavioural responses are what they say on the tin: how households and families adjust their economic behaviour in response to a tax change.

Incidence is who is made worse off by a tax. Money is there for consumption. If you save it or invest it, it is only to spend it in the future, to insure against an unexpected consumption need you might have, or to give it to others to consume later. A tax's statutory burden falls on whoever hands it over, but a tax's incidence is on who eventually has lower consumption in order to fund it. An example is VAT: shops hand it over to the government, but consumers end up paying most of it through higher prices. Similarly, buyers hand over Stamp Duty Land Tax, but sellers are also made worse off by it: about half of it is paid in the form of lower house prices.

Wilkinson's piece implicitly assumes a higher inheritance tax falls entirely on the deceased and their benefactors. But it only falls on the deceased if their behaviour doesn't change in response, and they generate estates of an equal size in their lifetime even given the tax. This is questionable under a 40% tax, but dubious in the extreme under an 100% tax.

The higher the inheritance tax, the higher the implicit income tax, and the more unbalanced the tradeoff between your consumption and your kids'. At 100%, it is infinite: no matter what you do, you cannot make your kids' lives better off after you die. Your incentive, again heroically assuming we are able to deal with all the practical difficulties, is both to generate less wealth, and to consume any you do generate before you die. Why not live out your days at the Ritz like Thatcher?

Less income created means less for public goods and redistribution, not to mention less for their kids, and less for them. And while more holidays and nicer houses for older people is all well and good, more consumption means we have to switch land, labour, and capital towards producing those things, and away from the things the savings of the old were buying. Nearly all of these savings aren't hidden under beds, but are being put to work: lent out by banks, and invested in equities through pension funds. This investment is what funds productivity growth—and productivity growth is what underlies higher wages.

So an 100% inheritance tax would barely make rich old people worse off, but it would clobber workers with no chance of inheriting. This is why I disagree with Wilkinson and a bunch of smart libertarian scholars, including the namesake of my very own think tank. There are very good reasons to tax the rich to improve the well being of the badly-off. But we should do that through consumption taxes that are guaranteed to reduce their Maserati and private jet purchases, not taxes that destroy their incentive to invest in society.