Monday, November 07, 2005

An argument for abolishing the death tax

American capitalism is harmed by the pervasive short-term outlook of corporate America. If only corporate America would care more about the long-run, then they would care more about reputation and thus behave responsibly and they would care more about innovations that had long-run pay-offs. Hence, they would invest more in the very important basic research.

But the estate tax shortens time-horizons of managers. Without an estate tax, managers know that any wealth they accumulate (particularly in massive stock grants in the company they manage) will be passed on generation after generation and their glory will live in the palaces their descendants inhabit. So they take measures to make sure that over the long-run their companies do well. Yet with an estate tax managers cease to care how their descendants will live off their accumulated stock wealth and so have short-time horizons.

This cribbed largely from an odd footnote in "Credit Markets and the Control of Capital" by Joseph Stiglitz (pg. 147, n48).

Update: As Tom Bozzo notes in comments, the irony fails to come off. So here is the broader context of the footnote:
Yet the return on many long-term investments will not occur until some time in the future. Keynes, in the General Theory, expressed a concern that investors in the stock market were merely concerned with short-term gains, not the long-term returns...similar allegations are brought against the managers of many of America's largest enterprises; the heads of these enterprises are financial experts, not production experts...their perspective is not unlike that of the Keynesian investor: they wish to find underpriced assets, just before those assets are discovered by others, so that they can reap a short-term capital gain. Their behavior is not suprising: what incentive do they have to be concerned about the long-term prospects of the firm or the productivity of the economy.

\begin{Footnote}: Their position should be contrasted with that of the owner-manager under primitive capitalism, whose dynastic ambitions included leaving his firm to his heirs. Such individuals were not concerned with what they might be able to sell their firm on a day-to-day basis, but with the long-term prospects of the firm. [Then Stiglitz talks about suggestive evidence for the short-run bias of managers]. /end{Footnote}

4 Comments:

Anonymous battlepanda said...

Do you really think Ken Lay would have paused in his plunderings if only there was no estate tax? I don't think so somehow.
The psychological mechanisms described in this model might indeed exist, but I have a feeling any practical effects would be swamped by the sheer volume of short-horizion dealings. Certainly, it would have to be quite a substantial effect to counteract the negative social effects of passing on inequality through the generations and the negative financial effects of depriving the government of a substantial income.

I have a feeling that if you're a Warren Buffet, you're going to invest prudently even if you know that the government is going to take a big chunk of the pie from your kids when you go -- a bigger half-pie for your kids is better than a smaller half-pie. And the imprudent investor is going to continue to be imprudent on the whole, because that's the way he thinks he'll make the most money, either for himself or his kids. Whether the gov. takes 0% or 5% or 50% of it is irrelevant.

8:27 PM  
Blogger henry said...

Consider the extreme case. What if, at death, your entire estate was nationalized? And what if there were no loopholes? I don't think that people at the top would try to make nearly as much money as they would if their children could inherit an unlimited and untaxable amount of money.

And would the disincentive effect on wealth-accumulation change much if there were just a 99% estate tax? Or 90%? Unlikely, so why would it completely disappear at 50%?

Of course, the question is how large is the effect? But I think its a really interesting argument.

9:33 AM  
Blogger Tom Bozzo said...

As Stiglitz is not a proponent of estate tax repeal (see, e.g., this PowerPoint presentation accompanying a speech he gave at Swarthmore last year), nor for that matter of totally unfettered capitalism, providing some context from the reported source material would be useful (esp. for those of us w/o JSTOR access to the JMCB). Or, some explicit irony signal might be nice.

1:43 PM  
Blogger Tom Bozzo said...

Thanks for the clarifying addition.

4:05 PM  

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