Why Piketty is wrong about inheritance

The buzz over Thomas Piketty’s book Capital in the Twenty-First Century may have subsided somewhat, but the analysis of its conclusions is far from complete. Consider its discussion of inheritance, which emphasizes its rising share in household wealth over time. This seems like a shocking revelation, implying ever-rising wealth inequality. But is it correct?

For many people, inherited wealth evokes moral repugnance. They associate it with the Rockefellers and Vanderbilts, whose great fortunes have supported generation after generation, and more generally with “trust-fund babies,” who inherit so much money that they never have to work.

Critics are right that inheritances and gifts – collectively known as “wealth transfers” – are distributed unevenly. Only about one-fifth of families in the United States in 2007 had ever received a wealth transfer. In general, recipients of any wealth transfer are likely to have larger incomes and to be in a higher wealth class. And the wealthiest young people tend to have wealthy parents and to have received larger wealth transfers than their poorer counterparts.

There is also significant inequality among those who receive wealth transfers. In 2007, only 7.4% of beneficiaries had received more than $1,000,000. The top 1% received 35% of all wealth transfers, and the top 20% received 84%. In other words, wealth transfers are about as unequal among recipients as their household net worth.

But these figures do not speak to Piketty’s thesis that inheritance has accounted for an increasing share of household wealth and exacerbates wealth inequality. In fact, the figures for the US from 1989 to 2010 – taken from the Federal Reserve Board’s triennial Survey of Consumer Finances – contradict both claims.

For starters, the average value of inheritances (in constant dollars) increased by only 24% over that period, which translates into an annual growth rate of 1% – less than the 1.7% annual growth in net worth. This means that wealth transfers as a proportion of net worth actually fell, from 29% to 26%.

Likewise, the share of a wealthy person’s net worth attributable to wealth transfers is, on average, less than 20% – that is, less than the one-third ratio for the middle class. And, for the wealthiest 1%, the ratio fell sharply, from 23% in 1989 to 11% in 2010.

Several factors have contributed to this decline. One is increased lifespans, which have led to a decline in the number of bequests per year and forced people to finance more years of life (including higher health-care expenses). Moreover, the share of estates dedicated to charitable bequests has risen over time, particularly among the wealthiest group. In this sense, wealth transfers have an equalizing effect.

At first blush, this statement may seem counter-intuitive – not least because wealthier households receive larger wealth transfers than poorer ones. But, when taking into account existing wealth, even a relatively small transfer to a poorer household would have a greater impact, in percentage terms, than a much larger gift to a wealthy household. This means that net worth excluding wealth transfers and wealth transfers themselves are negatively correlated, and the addition of transfers to net worth reduces overall wealth inequality.

It helps that wealth transfers generally flow toward poorer individuals or households, especially from richer parents to poorer children. This effect becomes even more pronounced when the estate of a single person or household is divided among multiple heirs – a very common occurrence. The massive wealth of the original plutocrat is thus dissipated over several generations – as has occurred with the Rockefellers – with the rate of dissipation depending on how many children each heir has.

In short, the overarching claim that the share of wealth transfers in household wealth is rising is not accurate in all cases – and certainly not in the world’s richest economy. Even if it were true, it would not be particularly problematic, given that, in the long term, inheritances and gifts help to reduce wealth inequality. In fact, we might all be better off if people transferred more of their wealth to others, if just to members of their own families.

Published in collaboration with Project Syndicate

Author: Edward N. Wolff is Professor of Economics at New York University and the author of the forthcoming book Inheriting Wealth in America: Future Boom or Bust?

Image: Luxury yachts are moored in the port of Cannes before the start of the 64th Cannes Film Festival in Cannes May 9, 2011. REUTERS/Yves Herman