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Introduction: The Importance of Inheritance
This small inheritance my father left me
Contenteth me, and worth a monarchy.
I seek not to wax great by others waning;
Or gather wealth, I care not with what envy:
Sufficeth that I have maintains my state,
And sends the poor well pleased from my gate.
William Shakespeare, King Henry VI, Part II
Men of wealth and power are often the subject of admiration, envy and suspicion. Society does not quite know whether to regard them as heroes or as villains. This is partly because of uncertainty about the extent to which economic progress depends upon the drive for the acquisition of personal wealth by individuals. It is also because of doubt about the means whereby wealth is acquired – i.e. whether through inheritance or as a result of a man’s own activities.
The Importance of Inheritance
Economists have become interested in matters of distribution as well as of resource allocation in recent years as a result of the failure of traditional economics to provide policy guidance about efficiency independent of distribution. Their interest reflects also the values of a society where distributive shares are a matter of mass concern, whether because of the prominence they receive in discussions of incomes policies, because of the realisation that certain goods and services are inherently limited in supply and cannot be shared out (Hirsch, 1977), or because of new views of philosophers and political scientists on the nature of distributive justice (Rawls, 1972). The appointment of a standing Royal Commission on the Distribution of Income and Wealth (henceforth referred to as the Diamond Commission) is another obvious sign of general concern with this subject.
A subsidiary feature of the interest in distribution in present-day Britain is that it relates not only to income but also to wealth. Indeed, research into wealth shares has recently enjoyed a vogue greater than at any time since the 1920s. There seem to be two main reasons for this. The first is that it is much more unequally distributed than is income. The second is that the structure of taxation in Britain until relatively recently discriminated heavily against income and in favour of wealth, wealth acquisitions and capital gains. This benefited those people who could switch back and forth between income, wealth and capital gains to reduce their tax liabilities and penalised others, largely wage earners, who could not.
The appearance first of the capital gains tax in 1962, and then of the capital transfer tax (CTT) in 1974 (and even of the promise of a wealth tax) are all indicative of the view that the basis for taxation should be extended to wealth.1 There is, moreover, a further feature of the interest in wealth distribution that is underlined by CTT – the first major and direct tax on gifts this country has known. This is that it recognised that wealth acquired by inheritance and other gifts should be the subject of special taxation and treated differently from wealth acquired in other ways. This reflects a view, widely held, that society benefits from the efforts of self-made men in the accumulation of capital, and that this should therefore be encouraged.2 Indeed the very words ‘inherited’ and ‘earned’ carry with them the overtones of society’s current moral values. To recognise the strength of this feeling is not, of course, to admit that all inherited wealth is reprehensible while all the activities of self-made men are meritorious. It is obvious that some fortunes have been amassed at great cost to society. At the same time one can allow that some highly enjoyable attributes of our culture might well not exist were it not for the presence of, for example, patrons of the arts with inherited wealth.
We are not concerned here to argue the various sides of the moral issue.3 It is sufficient to observe the strength of feeling that inherited wealth should be differentially heavily taxed. Such a view is not a new one. Over fifty years ago Rignano (1926) was able to persuade some of the members of the Committee on National Debt and Taxation (Cmd 2800) that the principle underlying his scheme for encouraging saving and thrift by raising the rate of death duties every time wealth passed from one generation to the next was attractive. Rignano’s proposals were regarded as impracticable at the time. Today they would be even more difficult to operate since the rapid changes in the price level would make it virtually impossible to identify most inheritances as they passed down the line from generation to generation. A specific piece of property is not always even reliably identified at the first passage. Yet if one wishes to tax inherited wealth differently from that which is ‘earned’, it is essential to be able to quantify the portion of wealth that is inherited.
Quantifying Inheritance
There are three broad ways in which one can try to estimate the importance of inheritance in the distribution of personal wealth – as a residual, by the use of proxies and directly.
The residual approach makes use of the life cycle hypothesis discussed by Atkinson and others (Atkinson, 1971; Diamond, 1975, 1977). If one can account for the extent to which the distribution of personal wealth at any particular time can be explained by saving and the age (and sex) distribution of the population, then the remainder can be attributed, inter alia, to inheritance. Unfortunately the quantification of inheritance using this method is greatly hindered by data deficiencies and is very sensitive to differing assumptions, particularly about earnings and savings profiles in the period over which the life cycle model extends.
Recently the Diamond Commission (1977) have attempted to quantify the proportion of inherited to total personal wealth by aggregating the flow of total inheritances over a number of years by means of the perpetual inventory method in order to arrive at the stock of inherited wealth.
Another approach is to tackle the issue more directly by estimating the relationship between wealth of different generations of the same family. Given the problems of obtaining reliable data on personal wealth holdings, there is a case for using proxies for wealth in the process, so long as there is reason to believe that they are associated with size of wealth holdings. A very recent important contribution using this approach for the USA is by Brittain (1977) whose study relies heavily on such details as the income, occupation, education and residential characteristics of different members of the same family. The advantages of the method are largely in the availability of data. The disadvantages relate to the extent to which proxy measures are associated with wealth. The inadequacy of wealth data itself makes it hard to know whether the correlations would be high. The need to distinguish and quantify separately the association between wealth of fathers and sons and between their incomes is one important reason why direct evidence on wealth is of value.4 That is why the approach adopted in this book employs estimates of personal wealth.
The Fortunes of Fathers, Sons and other Relatives
The chapters which follow are largely devoted to comparisons of the wealth at death of fathers and sons during the period 1902–73. In addition, certain data are presented on wealth association between members of the same family other than fathers and sons including grandfathers, husbands, fathers-in-law, mothers, daughters etc.
It is important to emphasise that our concern is almost exclusively with estimating the inherited component in the distribution of personal wealth and not with other non-pecuniary inherited characteristics. To the extent that parents pass on to their children advantages of education, genetic talents, social contacts, etc., money wealth is clearly a limited measure of what may be inherited, though the limits should not be exaggerated. Many of the excluded advantages that a privileged child inherits may lead him to accumulate above average wealth himself through, for example, the possession of ‘superior’ education or genes or through social contacts made at school which lead to business opportunities in later life, or even to a wealthy spouse.
The Nature of Wealth
It will become clear in Chapter 2 that the estimates of wealth that are used in this study are, perforce, based on a concept that is neither as complete nor as comprehensive as would be ideal. It is useful, however, to consider whether it is possible to set up a notional standard of wealth against which others can be judged. It can be argued that there is no single unambiguous definition of wealth of universal application. Rather are there several alternative wealth concepts, each of which is more or less suited to a particular purpose or policy issue. Take, for example, the macro-economic policy objectives of growth, price stability and full employment. These are liable to be influenced by the distribution of wealth. The effectiveness of investment may be illustrated by capital output ratios, for the estimation of which real rather than financial assets are then mainly relevant. There is likely to be more interest too in assets such as plant and equipment than in the stock of dwellings. Nevertheless, financial assets are also relevant to such matters as savings propensities when the effectiveness of counter-inflationary policies are under discussion.
More relevant than the stock of real and tangible assets to matters of inheritance is the total of personal wealth and its size distribution. For such distributive issues the appropriate wealth concept is at once broader though it may also, in another sense, be narrower. It is broader in that a person’s wealth should embrace all real or financial assets, the possession of which provide purchasing power over goods and services, and include therefore even paper claims like the national debt, which do not of themselves give a title to a real asset. At the same time the relevant concept may be narrower if it is thought proper to exclude corporate, publicly owned and other assets. To take an example for purposes of illustration, if one is mainly interested in the distribution of economic power among wealth holders, one might consider excluding all assets other than voting shares in the major corporations in the country.
Estimation Problems
Recognition that real and financial assets which give purchasing power should be included in personal wealth does not eliminate difficult problems. These are broadly of three kinds:
(1) those related to the distinction between wealth and income;
(2) those associated with the inclusion or exclusion of so-called non marketable assets;
(3) valuation problems.
Wealth and Income
Economists, not to mention incidentally tax lawyers, have traditionally differentiated wealth from income by reference to the fact that the former is a stock and the latter a flow. The distinction is designed to draw an appropriate dividing line between them and causes difficulties only when one tries to measure either. A parallel distinction is that between consumption expenditure and capital expenditure in the national accounts. In principle all consumer durable goods should be counted as wealth until they are consumed. But as virtually all goods (as distinct from services) are to an extent durable and have positive lives, it is necessary to adopt conventions to provide reasonable working rules. In the National Accounts, for example, houses happen to be counted as investment goods, and television sets as consumption. The problem is not of great practical significance in this study, because the coverage of household goods in personal wealth is fairly comprehensive. But the issues should not be ignored mainly because the value of chattels is thought at times to be considerably understated in the inventories of assets on death – a major source of data. For individuals with relatively low wealth this can lead to a proportionately serious undervaluation of their assets.
Non-Marketed Assets
The types of problem discussed so far relate to the treatment of assets which are bought and sold, i.e. for which there is a market. A more serious issue, however, is the extent to which non-marketed assets should figure in an individual’s wealth. Such assets include the human capital embodied in an educated person, personal pension rights, and even the psychic assets incorporated in a nation’s ‘cultural heritage’. There are two main reasons why assets may not be marketed. They may be non-transferable, or they may consist of rights to certain publicly provided goods or services.
Non-transferability may, for instance, be related to person-specific assets, such as annuities and pension rights, which cannot be sold. Although it is possible to imagine a market-place for such assets, difficulties would arise from the distinctively individual risk element attaching to each of them. Another explanation of non-transferability is that the current social mores may deem the sale of certain assets to be reprehensible, not to say illegal, though this may not, in itself, prevent their reaping a reward for their owners – as with prostitution.
A rather different type of asset which is person-specific and inherently non-transferable is the capital value of education. Its quantification is so fraught with difficulties that one is tempted to exclude it from the estimates of the net worth of an individual. The implications of such a decision may, however, be important. For example, if one is considering whether to impose a wealth tax, the decision to exclude human capital is likely to result in a heavier burden being placed on higher age groups (Sandford et al., 1975; Neild, 1976). Education is, of course, supplied both in the private and public sectors. The latter provision raises also the wider issue of access to public goods and services such as state subsidised council housing. It is not generally thought desirable to allow those who qualify for this kind of low price service on grounds of residence, family circumstances etc. to sell their rights to others. Yet, if such rights are not included in personal wealth holdings of individuals, curious conclusions can be drawn from the statistics. For example, an administrative decision by local authorities to sell their council houses to occupants can apparently cause a reduction in the observed inequality of wealth.5
Valuation of Assets
Most valuation problems are well known and discussed at length in the literature (e.g. Revell, 1967). The starting point is usually that the best valuation for an asset is its market price. However, many business assets are more or less unique and have to be valued at cost, adjusted according to alternative accounting and other conventions for depreciation, and at replacement cost w...
