Between his blog, his New York Times columns and his textbooks, Greg Mankiw has probably contributed more than anyone else alive to the cause of economic literacy. But his most recent column is, I think, a rare miss.
The thrust of the column is that the estate tax is a bad idea because it violates the principle of horizontal equity by imposing substantially different tax burdens on substantially similar people:
Consider the story of two couples. Both start family businesses when they are young. They work hard, and their businesses prosper beyond anything they expected. When they reach retirement age, both couples sell their businesses. After paying taxes on the sale, they are each left with a sizable nest egg of, say, $20 million, which they plan to enjoy during their golden years.
Then the stories diverge. One couple, whom I’ll call the Frugals, live modestly. Mr. and Mrs. Frugal don’t scrimp, but they watch their spending. They recognize how lucky they have been, and they want to share their success with their children, grandchildren, nephews and nieces.
The other couple, whom I’ll call the Profligates, have a different view of their wealth. They earned it, and they want to enjoy every penny of it themselves. Mr. and Mrs. Profligate eat at top restaurants, drink rare wines, drive flashy cars and maintain several homes. They spend their time sailing the Caribbean in their opulent yacht and flying their private jet from one luxury resort to the next.
So here’s the question: How should the tax burdens of the two couples compare? Under an income tax, the couples would pay the same, because they earned the same income. Under a consumption tax, Mr. and Mrs. Profligate would pay more because of their lavish living (though the Frugals’ descendants would also pay when they spend their inheritance). But under our current system, which combines an income tax and an estate tax, the Frugal family has the higher tax burden. To me, this does not seem right.
The problem with this argument is that it’s not an argument against the estate tax. It’s an argument against any tax (other than a pure $X-per-person-per-year head tax). Try it:
Consider the story of two couples. Both start family businesses when they are young. They work equally hard, and their businesses prosper equally well, bringing in the same $200,000 per year. The Joneses spend their money as it comes in, while the Engermans place half their earnings in interest-bearing accounts. They are both subject to the same 50% annual income tax — which means the Joneses pay $100,000 a year in taxes, but the Engermans pay more.
Note that the Joneses and the Engermans are as similar and as different as the Frugals and the Profligates. In each case, the two couples work equally hard, prosper equally well, and spend their earnings at different rates. So if horizontal equity by itself is all that matters, then the income tax is as bad as the estate tax.
Or:
Consider the story of two couples. Both start family businesses when they are young. Both businesses prosper equally, in that they each earn $10,000 a month. The Barneses operate their business twelve months a year, earn $120,000 and pay $60,000 tax. The Nobles operate their business six months a year, enjoy six months of leisure, earn $60,000 and pay $30,000 tax.
This too fails to meet the criterion of horizontal equity, because the Barneses pay twice as much as the Nobles. You might argue that the Barneses and the Nobles, unlike the Frugals and Profligates, actually earn different incomes. But that’s only because they’ve chosen different tradeoffs between leisure and income, just as the Frugals and Profligates have chosen different tradeoffs between current and future consumption. If the Frugals and Profligates count as “similar” in this discussion, then so should the Barneses and the Nobles.
Okay, then, maybe Mankiw’s argument is an argument against all taxes. But even then it won’t do as an argument against estate taxes insofar as the alternative to an estate tax is some other tax to which the argument applies equally well.
Mankiw has in fact made some pretty eloquent arguments against estate taxes in the past, and I am very sympathetic to those arguments. This is not one of them.
I think the argument was (or could be) that behavior of Frugals is preferable, not just similar.
As you know, the rules of the game are that head taxes (or taxing innate but unobserved characteristics like ability) are not allowed, so the goal is to find the best tax among consumption, income, wealth, etc. “Horizontal equity” by definition refers to income or consumption. By those rules, I think Mankiw is ok, though I think your example of interest income suggests that a consumption tax is better. But horizontal equity is not the strongest argument against the estate tax anyway. The strongest is the principle that capital should not be taxed.
Is the Frugal family a relevant taxable unit? For purposes of the estate tax, no.
Under the hypothetical, Mr. and Mrs. Frugal pay zero estate tax; by the time the tax applies, they’re dead. They may have paid estate tax when their parents died and the Frugals received income in the form of inheritance–but the hypothetical does not mention this.
So, to understand the hypothetical as phrased, you’d have to ask how fairly the system applies to the heirs of the Frugals and the Profligates. And since these heirs are in no sense in a similar circumstance, it’s hardly surprising that they’d face different consequences. Those receiving higher income would pay more tax. Is that really inequitable?
As James Kahn suggests, Mankiw’s argument applies reasonably well to a pure consumption tax. Under such a tax, we’d ignore income entirely. The Profligates would consume more, and pay more tax. The Frugals would consume less and pay less tax, leaving more for their heirs; their heirs could then consume more, and pay more tax, or refrain and leave more for their heirs; etc. Doesn’t seem especially inequitable, at least at this level of abstraction.
The challenge with the consumption tax is that we tax only the consumption we realize–that is, that we can measure. And as Landsburg observes, it’s hard to put a dollar figure on the consumption of leisure, or labor provided for your own benefit. And that’s where the inequity arises.
James Kahn (#2): “Horizontal equity” by definition refers to income or consumption. By those rules, I think Mankiw is ok
I don’t see it. The only difference between Mankiw’s Frugals and Mankiw’s Profligates is that they chose different consumption paths. The only difference between my Barneses and my Nobles is that they chose different labor paths and different consumption paths. In each case, they differ only because of their choices. So it still seems to me that if one situation calls for horizontal equity, then so does the other.
Applause for your final two sentences.
nobody really made the same point I was about to. Once you are dead you pay no tax.
Other matters “which means the Joneses pay $100,000 a year in taxes, but the Engermans pay more” Why do they pay more? Are you assuming interest is also charged at 50%, or am I missing something?
I think Mankiw misses the central point. In an estate tax, the activity being taxed is not the earning of income, nor the spending of it. The activity being taxed is the act of passing the wealth on to your children.
Mankiw acts as if that is an oversight, or a result of a poorly thought-out attempt at income tax, which it is not. The estate tax was created specifically so that America’s permanent “nobility”, (who now own roughly 90% of everything), would pay their fair share toward the country that helped create their wealth.
Moreover, as you alluded to, Mankiw misunderstands the purpose of taxes. The purpose is not to make everything fair, the purpose is to fund the government. The fact that it fails to make everything fair is a straw-man argument at best. At no point did the IRS ever say that the intent was to tax all activities equally.
Although the IRS sometimes uses the tax code to encourage savings, the IRS has never implied that saving $20 million per family is more virtuous than saving $1 million per family. In fact, they have implied the exact opposite, when they raised the minimum estate subject to tax.
Although the roughly 40% estate tax (on high-value estates) is nowhere near drastic enough to curtail the inheritance of, for example, Walmart Corporation, it is enough to encourage billionaires to think, however fleetingly, about the effects of income inequality.
Since income inequality has quantifiable effects on the economy of a country, and on the wellbeing of citizens, the estate tax could be viewed as a Pigovian tax, pure and simple. If we viewed it that way, though, Mankiw and Trump, who both have said that America should lower the estate-tax rate, would not be able to pose silly arguments that misconstrue the purpose of taxes.
Dave H – a little confused – if the purpose of taxes is to fund govt not fairness (wish that it were), what does “fair share” have to do with it? We would just go with the tax with the least economic distortion per $ raised. Which would certainly rule out the estate tax (Larry Lindsey recently wrote about how HRC’s plan to expand it is almost certainly a revenue *loser*). Pretty sure Mankiw (who taught me macro 102 back in the day :)) understands all of this, would applaud it, and knows that’s not what we do. If Landsburg’s point is that all taxes involve disparate impacts, Mankiw’s is presumably that the estate tax ranks particularly poorly in terms of efficiency and/or “fairness” (admittedly “doesn’t seem right to me” isn’t a super helpful criterion). The activities that the estate tax *incentivizes* are “frivolous” spending / conspicuous consumption, and purely wasteful avoidance schemes.
Re: this “permanent nobility” (that owns 90% of everything?), I would offer that all inequality is not equal; the distributional implications of a kleptocracy or formal caste system are (should be) a very different matter from a system based on voluntary exchange.
The tale of the Joneses and the Engermans is not an argument against the income tax in toto. It is an argument that interest received on savings should not be taxed. (Yes I realize this can get complicated and I would support a consumption tax alternative.)
Taxing the Barnes and Nobles equally is a good reason to move away from an income tax that ignores the value of leisure, but probably not good enough to justify the cost of tracking all leisure time the way money income is tracked.
Taxing the Frugals and the Profligates equally just requires shifting from an estate tax to a higher income tax.
I think it implies that people with the same lifetime ability to earn should pay the same lifetime tax. I have no idea how to implement that. A consumed-income tax might approximate, but that still leaves out leisure.
Obviously late to the party here… but I don’t think anyone has addressed Goblin’s very first point. I agree with Steven’s arguments as they pertain to *horizontal equality*, but think that this is some what stronger than what Mankiw intends by *horizontal equity*. I think, for example, that Mankiw would be quite happy with the similar *inequality* under a pure consumption tax. The point of the profligates versus frugals is not so much that they are unequal, but that they are favored precisely contrary to their deserts.
I am not sure where this kind of moral judgement comes in – don’t they all just maximize their utility function?
Yeah, I’m not sure what “favored precisely contrary to their deserts” means.
I think the Profligates wanted to consume. Thus they would value a tax policy that doesn’t interfere with their consumption–and they largely have it. I think the Frugals wanted to save (so as to enjoy the option of consuming in the future?) They wanted a tax policy that would not interfere with that–and they largely have it.
Now, perhaps I’m mistaken and the Frugals wanted to consume (buy), but what they wanted to buy was options for their heirs. And if so, they still largely achieved their purposes–at least, relative to a world in which they consumed their resources themselves. Pretty much any estate tax less than 100% would promote that end. Sure, the Frugals would prefer a world with NO taxes (yet a continuing flow of government services). Would’t we all?
James Kahn:
“But horizontal equity is not the strongest argument against the estate tax anyway. The strongest is the principle that capital should not be taxed.”
Can you elaborate on this?
I see a tax dollar as a tax dollar. The victim is a
dollar poorer, and the label makes no difference.
Richard D.
SL has posted on this, for example here. I am guessing that this is what James Kahn is getting at.
http://www.thebigquestions.com/2012/01/18/mitt-romneys-taxes/