Passing down wealth

Posted: Nov 14, 2003 12:00 AM

One of the fundamental justifications for the estate tax is that bequests often have negative effects on recipients. Receiving large wealth without working for it can be ruinous. Heirs who might otherwise lead useful and productive lives instead lead lives of waste and debauchery.

Paris Hilton (of the Hilton Hotels fortune) comes to mind. She fills the gossip columns almost daily with her exploits, which usually involve appearances at extravagant parties wearing little clothing. Had she been born poor instead of rich, perhaps she might be a useful member of society instead of an embarrassing stain on her family's good name.

I don't mean to pick on Hilton. The gossip pages have been filled with her ilk for years. The sight of extremely wealthy people blowing the family fortune on $3,000 pairs of shoes or similar excesses has always titillated the hoi polloi. That is why page 6 in the New York Post is so much fun to read.

Over 100 years ago, Andrew Carnegie, probably the second richest man in America (after John D. Rockefeller), argued strenuously, "He who dies possessed of enormous sums ... will die disgraced." In part, that is because he viewed the receipt of great wealth by mere dint of being related to those who made it, without having contributed at all to its creation, to be severely debilitating to the receiver.

Said Carnegie, "That the parent who leaves his son enormous wealth generally deadens the talents and energies of the son, and tempts him to lead a less useful and less worthy life than he otherwise would, seems to me capable of proof which cannot be gainsaid."

For this reason, estimates of the amount of wealth that will be transferred to future generations are a matter of macroeconomic importance. If the numbers are as large as some calculations suggest, we could be looking forward to a generation that will do little more than sit on its collective butt.

The issue got started 10 years ago, when economists James Avery and Michael Rendell calculated that the Americans stood to receive some $10 trillion in inheritances by 2040. In 1999, Boston College economists John Havens and Paul Schervish raised this figure to between $41 trillion and $136 trillion by 2052. Earlier this year, they concluded that this estimate is still on track, despite the large stock market losses of recent years.

As large as these numbers are, however, they need to be viewed in context. A study by the Federal Reserve Bank of Cleveland concluded that, as a practical matter, they don't mean much. First, it noted, the population has grown a great deal, so the pie must be divided up into smaller slices. Moreover, bequests are highly skewed, with the vast majority of people receiving little or nothing. According to the study, 92 percent of the population receives nothing at present, and most of those that do receive very little, a trend that is unlikely to change.

The Cleveland Fed study also noted that today's elderly are spending down their assets at a faster rate than previous generations, and have converted their wealth into annuities in greater numbers, leaving less of an estate to pass on. A 2002 National Bureau of Economic Research study estimates that those ages 70 to 74 will bequeath just 39 percent of their wealth. Furthermore, today's elderly are living longer and have a reduced desire to leave an estate. According to a study by Phoenix Wealth Management last year, only 4 percent of seniors say that leaving an estate to their heirs is a high priority.

A new study by AARP confirms the gloomier outlook for baby boomers and their children. Since 1989, the percentage of baby boomers who have received or expect to receive an inheritance has fallen from 37 percent to 27 percent. Among those who have ever received an inheritance, the median amount was just $48,000 (2002 dollars). By contrast, the pre-baby boom generation got much more: $108,885 (also 2002 dollars). Two-thirds of inheritances, in dollar terms, went to those in the top 40 percent of families based on wealth.

Interestingly, studies don't show that large inheritances reduce the work ethic to the extent one would imagine. Children of the wealthy mostly work and lead productive lives, perhaps out of a sense of noblesse oblige or because our jobs define us to a greater extent than our wealth today. Even Paris Hilton has a television show forthcoming on Fox. Studies of lottery winners have shown that the bulk of them continue working even when they don't have to for economic reasons.

The AARP study concludes that inheritances are not likely to make much of a splash, will not significantly reduce the need for boomers and post-boomers to save for retirement, and won't have much impact on work.