Inheritance tax and incentives: People will still work

Critics of inheritance taxes often argue that taxing inheritance and gifts would reduce the incentive to work and save, with adverse effects on the economy. If people would not be able to pass on their wealth to their children and other family members, they would lose some of the motivation that makes them work hard and save in the first place, so the theory goes. With high inheritance and gift taxation, people would work less and consume more, which is both detrimental to economic growth and must thus be a bad thing.

We will challenge the incentive line of arguments on two grounds: First, as convincing as the story may sound, empirical evidence suggests there are no or only little incentive effects. Secondly, even where such incentive effects exist, it is questionable how problematic this is. It will be argued that in economically extreme systems such as ours which have gone through excessive economic growth beyond many ecological boundaries, reducing the motivation to work and save may help contribute to stop going ‘full throttle’ and bring back our economies to more sustainable levels and dynamics.

Nice story, but little truth

In general, the empirical evidence in the sense of number of studies is rather low on the question of whether inheritance taxes affect working and saving. There are two rather recent reviews of the literature which come to similar conclusions: Pedersen (2019), reviewing various studies, finds that “the tax burden effect on the donor’s willingness to work and save is minimal”.^[1] Citing from some of the studies reviewed, ‘the consensus seems to be that a tax burden on gifts and bequests has little or no proven impact on donors’ decisions whether to work or save’^[2] and “the existing empirical studies, limited as they are, suggest that inheritance taxation would have modest negative effects on work, savings and capital accumulation”.^[3]

The OECD (2021) largely confirms this reading of the literature but adds two nuances: First, it is found that even where inheritance taxation may have modest effects on saving and working, these effects are smaller than those of other taxes, thus making inheritance and gift taxes a preferred option. Secondly, the OECD sees indications suggesting that the negative incentive effects on donors (reduced work and saving) are more than outweighed by positive incentive effects on heirs. The larger the inheritance tax, the less ‘spoilt’ the heirs are and the more they work and save. This is also referred to as the Carnegie-effect after Andrew Carnegie, one of the richest Americans in history, who held that “the parent who leaves his son enormous wealth generally deadens the talents and energies of the son, and tempts him to live a less useful and less worthy life than he otherwise would”.^[4]

The empirical evidence that inheritance tax may at most have mild consequences for the working and saving motivation is also accompanies by some theoretical underpinning. Gale and Perozek (2000) model different motivations for transfers between parents and children and which effect inheritance taxes play in this regard. They find that “in a surprising number of cases, higher estate taxes appear to raise saving”^[5], thereby challenging the conventional wisdom that estate taxes decrease saving. One intuition that could explain such results is that parents care for the absolute level of support they leave their children, so if you take a larger share of that away through taxes, parents make up for it by increased saving.

When working and saving less might be a good thing

As we have seen, the literature suggests none or only modest effects of inheritance and gift taxation on the working and saving motif. But just for the sake of the argument, let us assume there is a substantial effect. After all, the existing studies are not working with the assumption of a confiscatory inheritance tax which is proposed on this blog. So maybe for small changes in inheritance taxes effects are mild, but in case we would charge 100% inheritance taxes from a certain threshold onwards, maybe the effects on working and saving would indeed be substantially affected. The question is: would that necessarily be bad?

Critics of inheritance tax employ the incentive argument and thereby simply assume that any reduced incentive to work and save is to be regarded as something negative which is to be avoided. This is because less work and less saving cause less economic growth, typically. And economic growth is what we usually want, no? Well, maybe not. Not in all societies, not at all cost. In times where the excessive economic growth of the past hundred years has brought our ecological systems (of which the economy is only small part) close to a collapse and where planetary boundaries in multiple dimensions have been reached already^[6], economic growth is not desirable anymore per se. Simple chain of arguments like “inheritance taxes are bad because they decrease the working and saving motif, thereby decreasing economic growth” do thus not hold any longer. Not in the 20’s of the 21^st century.

We should wonder whether it may actually be a good thing if through confiscatory inheritance taxes people are reminded that they cannot take any wealth with them into their graves or afterlife, so why all this hustle and work? Maybe slightly reduced incentives to work could be accompanied by less stressful lives, more equitable distribution of work (if those who currently earn and work much reduce a bit and those working less than they want to take up some of this work), and an escape out of the economic growth trap and dynamics that we have manoeuvred ourselves in. From an ecological perspective, it would however be dangerous if confiscatory inheritance taxes would lead not only to a reduced working motif, but also massively increased consumption. If in a quest “not to leave anything to the state” wealth would be wasted on consumption only for the sake of spending it until the expected end of one’s life, this would come at high ecological cost. However, such a scenario may not be to worrying. First, death is hard to time, so there will always be some sort of saving to cater for the unknown length of live. Additionally, a reduced bequest motif in conjunction with reduced levels of wealth through previous rounds of confiscatory inheritance taxation will over time lead to less wealth accumulation of individuals in general, so that there is simply less wealth to be ‘wasted’ in consumption.