How economic inequality affects children’s outcomes

Posted on by Austin Clemens

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About the author: Ariel Kalil is a professor of public policy at the Harris School of Public Policy Studies, University of Chicago.

What happens in the home is paramount to children’s early development. Economically disadvantaged children’s limited access to cognitively enriching home environments may help drive growing gaps in cognitive and non-cognitive skills, producing a feedback cycle that leads to low socioeconomic mobility and further grows inequality. Research increasingly suggests that policy should identify new targets for programs aimed at enhancing parent-child interactions in low-income families, such as Early Head Start and Healthy Families America. All parents want to help their children flourish, but low-income parents often lack the resources to achieve their parenting goals. Parents are children’s first teachers and, to equalize the playing field, governments need to invest in parents so that they, in turn, can better invest in their children.

Background

Economic growth for much of the 20th century supported America’s promise of offering opportunities to both parents and their children. It is well known, however, that income inequality increased dramatically in the United States beginning in the 1970s.1 Greg Duncan and Richard Murnane illustrate how increasing family income inequality may affect access to high-quality child care, neighborhoods, schools, and other settings that help build children’s skills and educational attainments.2 Changes in these social contexts may in turn affect children’s skill acquisition and educational attainment directly as well as indirectly by influencing how schools operate.

Growing income inequality also increases the gap in the resources high- and low-income families can spend on enrichment goods and services for their children.3 For instance, Sabino Kornrich and Frank Furstenberg show that spending on child-enrichment goods and services jumped for families in the top quintiles but increased much less—in both absolute and relative terms—for families in bottom-income quintiles, as reflected in four large consumer expenditure surveys conducted between the early 1970s and 2005-2006. In 1972-1973, high-income families spent about $2,700 more per year on child enrichment than did low-income families. By 2005-2006, this gap had nearly tripled, to $7,500.4

As the incomes of affluent and poor American families have diverged over the past three decades, so too has the educational performance of the children in these families. Sean Reardon documents substantial growth in the income-based gap on the test scores of children born since the 1950s. Among children born around 1950, test scores of low-income (10th income percentile) children lagged behind those of their better-off (90th income percentile) peers by a little over half a standard deviation, or about 50 points on an SAT-type test. Fifty years later, this gap was twice as large. Family income is now a better predictor of children’s success in school than race.5

At age four, children from families in the poorest income quintile score on average at the 32nd percentile of the national distribution on math, the 34th percentile in a test of literacy, and at the 32nd percentile on a measure of school readiness compared with children in the richest quintile, who scored at the 69th percentile on math and literacy and at the 63rd percentile on school readiness.6 Gaps in conduct problems and attention/hyperactivity also are apparent albeit less pronounced. On measures of hyperactivity, for instance, children from families in the poorest income quintile score on average at the 55th percentile of the national distribution (in this case, higher scores indicate higher levels of behavior problems) compared with children in the richest quintile, who scored at the 44th percentile.7

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Using data from the 1979 and 1997 National Longitudinal Surveys of Youth, Martha Bailey and Susan Dynarski show that graduation rates for children born into high-income families jumped 21 percentage points (from 33 percent to 54 percent) between the early 1960s and the early 1980s. The corresponding increase for children born into low-income families was only four percentage points (from 5 percent to 9 percent). A little less than half of the gap between rich and poor in college graduation rates can be explained by differences in college enrollment rates, with the rest explained by differences in students’ persistence in completing their degrees.8 Phillipe Belley and Lance Lochner show that high family income has become a substantially more important determinant of college attendance and college quality in recent years, particularly for those youth with the lowest skills.9

Drivers of the socioeconomic
status-based gaps in child outcomes

Rising gaps in children’s skills and attainments cannot be attributed to rising income gaps alone, however.10 In fact, Reardon estimates that only about half of the rising income-based gap in test scores can be attributed to rising income inequality.11 Parents invest more than money in their children’s development. Through their time and attention parents can provide a cognitively stimulating and emotionally supportive home environment that promotes children’s early learning and behavioral adjustment. Economically advantaged parents differ from their less advantaged peers on many relevant dimensions of parenting.12

Mounting evidence suggests that socioeconomic status-based gaps in parenting and children’s early developmental outcomes have grown alongside increasing economic inequality in family conditions.13 The demography of family structure, for example, has changed in ways that favor the socioeconomically advantaged and their ability to invest parental time and resources in their children’s development. Between 1980 and 2010, the share of children living with college-educated mothers who were married remained at about 90 percent. In contrast, the share of children living with mothers who lacked a high school degree and who were married decreased from about 73 percent to about 66 percent.14 Two-biological-parent households not only enjoy greater economic well-being but also demonstrate higher levels of parental time investment in children than do single-parent households.15

Trends in maternal age at first birth also have changed in important ways that may favor the parenting environments provided by mothers with high socioecoconomic status. Comparing data on U.S. births in 1970, 1989 and 2006 by age of mother and maternal schooling reveals that the maternal age gap between children born to high school dropouts and college graduate mothers grew by nearly 3 years—from 4.3 years to 7.1 years.16 Positive parenting behaviors increase in maternal age at first birth whereas negative parenting behaviors decrease in maternal age at first birth.17

Finally, how parents think about parenting has changed dramatically over the past century. In 1900, parenting experts emphasized nutrition, medical care, and fresh air as the key inputs into child development, according to a comprehensive analysis of magazine articles containing parenting advice. By the 1980’s, intellectual stimulation and social/emotional development had replaced nutrition and fresh air as key topics of concern along with medical care.18 Yet economically advantaged parents, more so than their disadvantaged counterparts, may have responded more quickly to this advice, thus widening the parenting gap.

Why parents matter

Economically advantaged parents display more of the behaviors deemed supportive of children’s development across a range of parenting domains. Economically advantaged parents display more authoritative (versus authoritarian) parenting styles,19 engage in more sensitive and responsive mother-child interactions,20 use greater language stimulation,21 and use greater levels of parental management and advocacy.22 A famous example of differential parenting by socioeconomic status is the study by Betty Hart and Todd Risley, who intensively observed the language patterns of 42 families with young children. They found that in professional families, children heard an average of 2,153 words per hour, while children in working class families heard an average of 1,251 words per hour, and children in welfare-recipient families heard an average of 616 words per hour. By age four, a child from a welfare-recipient family could have heard 32 million words fewer than a classmate from a professional family.23

One of the most important parenting differences between advantaged and disadvantaged parents is in how much time the parent spends with the child. Annette Lareau’s qualitative study of family life reported that middle-class parents target their time with children toward developmentally enhancing activities. In her study, middle-class families (whose jobs, by her definition, require college-level skills) engage in a pattern of “concerted cultivation” to actively develop children’s talents and skills. By contrast, in lower-class families, Lareau identified a pattern that she calls “the accomplishment of natural growth,” wherein parents attend to children’s material and emotional needs but presume that their talents and skills will develop without concerted parental intervention.24

Numerous quantitative studies not only show large differences in the time investments of advantaged and disadvantaged parents but also that these gaps remain large even when other differences across families, such as employment hours and schedules, are accounted for.25 Work by Ariel Kalil, Rebecca Ryan, and Michael Corey further shows that highly educated mothers are more “efficient” in their parental time investments by tailoring their specific activities to children’s developmental stage. This research also shows that with respect to total childcare time, the educational gradient is most apparent in households with the youngest children, a point also made by Erik Hurst, Daniel Sacks, and Betsey Stevenson.26 Economically advantaged mothers, more so than their less advantaged counterparts, may have learned the message that parental investments in early childhood are key ingredients in children’s long-run success.27

High-income parents appear to be investing more parenting time than ever before in their children’s cognitive development and educational success.28 This increase may mean that high-skilled parents are responding to the increased returns to having high-skilled (highly educated) children.29 Work by Erik Hurst , Daniel Sacks, and Betsey Stevenson further show that all of the increase in childcare time between 1985 and 2003 has come from households with children ages 5 and younger, and Evrim Altintas shows that the growing education gap in time with young children is driven by time in educationally enriching activities.30

Increases in the parenting gap are expected to be relevant for socioeconomic status-based gaps in children’s development. Observational research suggests that the quality of the home learning environment as measured by the HOME score accounts for up to half of the relationship between socioeconomic status and disparities in children’s cognitive test scores.31 In a descriptive analysis of U.S. data from the Early Childhood Longitudinal Study-Birth Cohort, Jane Waldfogel and Elizabeth Washbrook conclude that parenting style (in particular, mothers’ sensitivity and responsiveness as well as the home learning environment) is the most important factor explaining the poorer cognitive performance of low-income children relative to middle-income children, accounting for between a quarter and a third percentage of the gaps in literacy, mathematics, and language.32

What’s the role for
public policy?

Few trends are more ominous than the increases in both the class gaps and achievement gaps between low- and high-income children in the United States. The rising income-based achievement gaps call into question whether the American Dream of intergenerational mobility is now beyond the reach of many children raised in low-income families.33

Policy approaches to addressing increasing disparities in outcomes for children from low- and high-income families can take a number of forms. Some of these will boost families’ economic security, others can help support parents’ engagement in their children’s development, and others can provide educational supports directly to children. Such approaches can be pursued simultaneously. These include policies such as the Earned Income Tax Credit that redistributes income and relies on parents to use the added income to promote their children’s development; policies such as the Nurse Family Partnership that teach high-risk parents about positive parenting practices and about the nature of early childhood development; polices such as Pell Grants that encourage would-be parents to acquire post-secondary schooling; and policies such as state pre-Kindergarten programs that provide educational services directly to young children.34

Given the importance of parental engagement in children’s development, it may be especially fruitful for policies to focus on boosting parents’ ability to provide a cognitively stimulating and emotionally supportive home environment. Gaps in children’s skills could be narrowed if less-advantaged parents adopted the parenting practices of their more-advantaged peers. Notably, a leading family intervention for low-income children—the Nurse-Family Partnership program—is being targeted for substantial expansion by the federal government from the Administration on Children and Families’ Maternal, Infant, and Early Childhood Home Visiting Program demonstration. The program provides weekly in-home visits by trained nurses from pregnancy through the child’s second birthday.

One mission of the Nurse-Family Partnership program is to improve children’s health and development by helping young, economically disadvantaged parents provide more competent care. Some experimental evaluations of the program show it reduces child maltreatment. In one study, mothers in the treatment group who received nurse visits during their pregnancy and the child’s infancy had 0.29 substantiated reports of child abuse and neglect at some point before the child turned 15. Mothers in the control group, in contrast, had on average 0.54 such reports.35 This is important because child maltreatment is costly for the individual affected and for society.36

The Nurse-Family Partner program also yields long-run benefits for some children. By age 19, girls in the treatment group had fewer arrests and convictions; a subset of these girls had fewer children and less Medicaid use than their comparison group counterparts.37 Although there is room for improvement in the design and delivery of this and similar intervention programs, research underscores the merit of the new federal emphasis on supporting parenting in educationally disadvantaged families.

Important new evidence also is emerging that suggests that low-cost “light-touch” efforts can be highly successful in helping low-income parents support their young children’s learning and development.38

Conclusion

The United States has made little progress toward narrowing the achievement gap between advantaged and disadvantaged children. This is in part because public policy has neglected the critical role of parenting in children’s development. Parents do more than spend money on children’s development; they also promote child development by spending time in cognitively enriching activities and by providing emotional support and consistent discipline.

All parents want the best for their children, but the “parenting divide” between economically advantaged and disadvantaged children is large and appears to be growing over time.39 The main barrier to designing and scaling up parenting interventions nationwide is the currently limited understanding of the key ingredients of successful programs. Policymakers need to become better informed on effective interventions that can motivate and support parents to engage effectively in their children’s development.

The “silver spoon” tax: how to strengthen wealth transfer taxation

Posted on by Austin Clemens
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This article is part of our series: Delivering equitable growth: strategies for the next Administration.

About the author: Lily L. Batchelder is a professor of law and public policy at New York University School of Law.

 Wealth transfer taxes are a critical policy tool for mitigating economic inequality, including inequality of opportunity. They are also relatively efficient. This essay summarizes why and how wealth transfer taxes should be strengthened. Reform options that our next President should consider include increasing the wealth transfer tax rate, broadening the base, repealing stepped-up basis, addressing talking points against wealth transfer taxes with little or no factual basis, and converting the estate and gift taxes into a direct tax on the recipients of large inheritances.

Why wealth transfer taxes should be preserved and expanded

For those concerned about economic inequality, taxing wealth transfers is a critical policy tool, mitigating inequality in ways that other taxes cannot. Inheritances represent roughly 40 percent of all wealth40 and about 4 percent of annual household income.41 Bequests alone total about $500 billion per year.42

There are two types of inequality that policymakers should care about. The first is within-generation disparities in income, wealth, or other measures of economic well-being. Both income and wealth inequality are extremely high in the United States. The top 1 percent of households receives 15 percent of all income and holds 35 percent of all wealth.43 Wealth transfers increase within-generation inequality on an absolute basis (See Figure 1), but not on a relative basis. This is because of what economists call regression to the mean.44 Someone who earns $100 million per year, for example, is likely to have a child whose income is slightly lower, even including the child’s inheritance. Conversely, someone who earns $10,000 per year is likely to have a child whose income is slightly higher than her own.

Figure 1

But equally important is a second type of inequality: inequality of economic opportunity. A child whose parents earn $100 million will, on average, be radically better off than a child whose parents earn $10,000. The United States has one of the highest levels of opportunity inequality among its competitors.45 In the United States, a father on average passes on roughly half of his economic advantage or disadvantage to his son. Among most of our competitors, the comparable figure is less than one-third, and for several it is less than one-fifth.46

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Financial inheritances worsen this inequality of life chances dramatically. Indeed, 30 percent of the correlation between parent and child incomes—and more than 50 percent of the correlation between the wealth of parents and the wealth of their children— is attributable to financial inheritances.47 This is more than the impact of IQ, personality, and schooling combined.

Increasing the progressivity of income and payroll taxes would go a long way toward addressing both of these types of inequality.48 But it would leave significant holes if not accompanied by stronger taxes on wealth transfers. Under current law, for example, if a wealthy individual bequeaths assets with $100 million in unrealized gains, neither the donor nor the heir ever has to pay income or payroll tax on that $100 million gain. In addition, the recipients of large inheritances never have to pay income or payroll tax on the value of inheritances they receive, whether attributable to unrealized gains or not.49

Some argue that any income or payroll tax previously paid by a wealthy individual on gifts and bequests they make should count as tax paid by the heir. But they are two separate people. When a wealthy individual pays his assistant’s wages out of after-tax funds, we don’t think the assistant has thereby paid tax on their own wages. In short, today the income and payroll taxes effectively tax unearned income in the form of inheritances at a zero rate.

Wealth transfer taxes play an important role in partially addressing this inequity of excluding inherited income from the income and payroll tax bases.50 But inherited income is still taxed at less than one-quarter of the rate on income from work and savings. (See Figure 2.)

Figure 2

A fairer tax system would tax income in the form of large inheritances at a higher rate than income from work. Recipients of large inheritances are better off than people who earn the same amount of money by working. In economist-speak, they have no “opportunity cost;” they have not had to give up any leisure or earning opportunities in order to receive the inheritance. All else equal, it is therefore fairer for them to pay more taxes, not less. But all else is not equal. Heirs of large inheritances also typically have a huge leg up in earning income if they choose to work—with access to the best education, influential family friends, interest-free or low-interest loans, and a safety net if they take risks that don’t pan out. This further strengthens the case for taxing inheritances at a higher rate.

More progressive income and payroll taxes cannot address this inequity in the tax system and ensure that large inheritances are taxed at higher rates than wage income.51 The same is true of proposals to adopt a tax on wealth as opposed to wealth transfers.

Importantly, bipartisan experts agree that wealth transfer taxes are largely borne by the heirs of large estates, not their benefactors.52 As a result, it would be more accurate to call wealth transfer taxes “silver spoon” taxes, not “death” taxes as their opponents prefer.

In addition to playing a critical role in making the tax system fairer, wealth transfer taxes are relatively efficient. It is an article of faith among estate tax opponents that wealth transfer taxes harm the economy because they discourage work and saving among very wealthy individuals. But in order to have these effects, the wealthy would need place a high value on the amount their heirs will inherit after-tax when making work and saving decisions. In fact, a large body of empirical research finds this is not the case, and that the amount that the affluent accumulate for wealth transfers is relatively unresponsive to the wealth transfer tax rate.53

People with very large estates typically have saved for multiple reasons. They may enjoy being wealthy, with the prestige and power that it confers while they are alive. They may have saved to have enough for their retirement needs, including unanticipated health expenses. And they may, of course, have saved to give to their children. But the empirical evidence to date suggests the first two motivations are so strong that the wealthy do not reduce their saving by all that much if they expect their estate to be taxed at a high rate. Put differently, a lot of the reason why people save is to have wealth while they are alive, which wealth transfer taxes do not affect.

Moreover, any negative incentive effects of wealth transfer taxes on wealthy donors are at least partially offset by their positive incentive effects on the next generation. Such taxes induce heirs to work and save more because heirs do not have as large an inheritance to live off of as a result.54 Wealth transfer taxes also improve business productivity. Several studies have found that businesses run by heirs perform worse because nepotism limits labor market competition for the best manager.55

For all these reasons, wealth transfer taxes may be more efficient than comparably progressive income and wealth taxes56—in addition to playing a unique role in mitigating inequality of economic opportunity.

How to strengthen wealth transfer taxes

There are two main components of the wealth transfer tax system: the estate tax on bequests and the gift tax on wealth transfers made during life.57 In 2016, transferors are entitled to a lifetime exemption of $5.45 million ($10.9 million per couple). If their combined gifts and bequests exceed this threshold, the excess is taxed at a rate of 40 percent. Transferors also can exclude $14,000 in gifts each year to a given heir from ($28,000 per couple), meaning such gifts don’t even count toward the lifetime exemption. Currently only 0.2 percent of estates owe any estate tax.58

Option #1: raise the rate

The simplest way to strengthen wealth transfer taxes would be to raise the rate. Restoring the 2009 estate tax parameters (a $3.5 million exemption and a 45 percent rate) would raise $160 billion over 10 years.59 Also raising the rate to range from 50 percent to 65 percent to the extent that estates exceed $10 million to $1 billion would raise about $235 billion over 10 years instead.60

At a minimum, large inheritances should be taxed at the top marginal tax rate that applies to labor income—roughly 50 percent when one includes state and local income taxes.61 But a higher rate would be fairer and more efficient. The optimal tax rate on extremely large inheritances is estimated to be between 50 percent and 80 percent.62

Reducing the lifetime exemption amount also is worth considering, but it should be a lower priority. A higher rate focuses wealth transfer taxes on the wealthiest heirs and limits compliance costs.

Option #2: replace the estate and gift taxes with an inheritance tax

A more fundamental improvement would be to replace the estate and gift taxes with an inheritance tax. The lifetime exemption for the estate and gift taxes applies to the amount transferred, not the amount inherited by the heir. Suppose Richie Rich is an only child and receives $5 million in bequests from each of his parents and stepparents. Under current law, the $20 million he inherits is exempt from estate and income taxes because each bequest is under the exemption. But under an inheritance tax, the exemption would be based on how much he receives instead.

I propose requiring heirs of large inheritances to pay income tax plus an inheritance surcharge on amounts they inherit above a large lifetime exemption. If the lifetime exemption were $2.1 million and the surcharge were 15 percent (roughly equal to the maximum payroll tax rate) then such an inheritance tax would raise roughly $200 billion more over 10 years than the current estate tax. Dialing the rates up or the exemption amount down could raise more revenue. (See Figure 3.)63 To state the obvious, $2.1 million is a lot of money. An individual who inherits $2.1 million at age 21 can live off her inheritance for the rest of her life without anyone in her house ever working and, on average, her annual household income will still be higher than about 7 out of 10 American families.64

Figure 3

There are several advantages of an inheritance tax relative to an estate tax. First, it would more equitably allocate wealth transfer taxes among heirs. Both types of taxes are borne by wealthy heirs and not their benefactors. But not all large inheritances come from the largest estates, and some small inheritances come from relatively large estates.

In addition, the type of inheritance tax outlined here would apply different rates to heirs based on their total income. As a result, about 30 percent of the burden of the inheritance tax in dollar terms would fall on different heirs than under a revenue-equivalent estate tax.65 While roughly one-third of heirs burdened by the estate tax have inherited less than $1 million, none would owe any inheritance tax.66

These differences should not be taken as a fundamental critique of the estate tax. It is overwhelmingly borne by the recipients of large inheritances: Less than 4 percent of the revenue comes from individuals inheriting less than $1 million. Its burdens are just allocated among the recipients of large inheritances less precisely than under an inheritance tax.

A second, and perhaps even more important, advantage of an inheritance tax is that it could better align public understanding of wealth transfer taxes with their actual economic effects. The structure of an estate tax makes it easy for opponents to characterize it as a double tax on the frugal, generous entrepreneur who just wants to take care of his family after his death. In fact, nothing could be further from the truth. The estate tax is actually the only tax that that ensures wealthy heirs pay at least some tax on their large inheritances—even if at a much lower rate than their personal assistants. But this imagery is powerful. Perhaps as a result, most countries around the world that historically had estate taxes have repealed them, while those with inheritance taxes have not.67

The structure of an inheritance tax makes the inequities of our current system clearer. It simply requires wealthy heirs to pay income tax on their large inheritances just as all American workers pay tax on their earnings. Even with a surcharge, wealthy heirs would still typically pay a lower rate of tax on their inherited income than workers pay on a similar amount of labor income because of the large exemption, which workers cannot claim on their wages.

There are ancillary advantages of an inheritance tax as well. It would be simpler because it permits a wait-and-see approach for split and contingent transfers, rather than requiring taxpayers and the Internal Revenue Service to guess upfront what portion of the transfer will ultimately go to tax-exempt individuals or charities. At the margin, it could induce the wealthy to share their estates more broadly. And it is clearly administrable. Inheritance taxes are far more common than estate taxes cross-nationally.68

Option #3: repeal stepped-up basis

Regardless of whether the estate tax is expanded or replaced with an inheritance tax, policymakers should repeal stepped-up basis.69 This is the provision that completely exempts all accrued gains on bequeathed assets from income and payroll taxes, by “stepping up” the basis of asset to its fair market value when it is transferred.

President Obama has proposed repealing stepped-up basis, subject to several carve-outs including an exemption for the first $100,000 in accrued gains ($200,000 per couple).70 Together with raising the capital gains rate to 28 percent, this proposal would raise $210 billion over 10 years and significantly more over time as it fully phases in.71 While not technically an estate or gift tax reform, repealing stepped-up basis would accomplish all the same objectives as strengthening those taxes. It is highly progressive because inheritances are distributed so unequally and accrued gains are distributed even more unequally.72

The U.S. Department of the Treasury estimates that 99 percent of the revenue raised would come from the top 1 percent and 80 percent from the top 0.1 percent.73 It helps ensure that large inheritances are taxed at a rate closer to income from working. And it is highly efficient. Indeed, repealing stepped-up basis is even more efficient than raising wealth transfer tax rates because it reduces current law’s “lock-in” incentives to hold on to underperforming assets purely for tax reasons.

If repealing stepped-up basis is not an option then the next best solution would be to apply carryover basis to bequests.74 This would allow heirs to delay paying income tax on accrued gains on their inheritances indefinitely. But heirs would at least need to pay the associated income tax when they ultimately sell the asset. As a result, it would reduce lock-in incentives, but not by nearly as much as stepped-up basis repeal. It would also raise significantly less revenue.75

Option #4: broaden the wealth transfer tax base

A number of smaller reforms to broaden the wealth transfer tax base should also be pursued. Many of these proposals, such as limiting gaming around grantor-retained annuity trusts, are in President Obama’s budget. Together, these budget proposals would raise $17 billion over 10 years.76 The next President should also finalize the current Administration’s recently issued regulation addressing loopholes using valuation discounts, and ensure that Congress does not repeal it.77

An additional option worth considering is harmonizing the tax treatment of gifts and bequests. Currently gifts are often tax-advantaged because of the annual gift tax exclusion, the lack of present-value adjustments when calculating the lifetime exemption, and the fact that the top rate on very large gifts is effectively 29 percent, compared to 40 percent for bequests.78 Cutting the other way, bequests are tax-advantaged because they are eligible for stepped-up basis while gifts are not. These countervailing incentives create substantial tax planning costs, traps for the unwary, and inequities between similarly situated heirs. These problems could be largely addressed by repealing stepped-up basis, indexing the value of gifts to a market interest rate when calculating the lifetime exemption, and taxing gifts at the same rate as bequests.79

Option #5: address strawman arguments against wealth transfer taxes

Finally, policymakers should consider addressing talking points against wealth transfer taxes that resonate but have little or no basis in fact. A prime example is family farms. A principal rallying cry against the estate tax has long been that it forces families to sell their farms. But neither the American Farm Bureau nor The New York Times has been able to identify a single instance of this happening, even when the exemption was much lower.80

To counter this argument, one option is to adopt the proposal by former Senate Finance Committee Chairman Baucus (D-MT) to allow taxpayers to defer indefinitely any estate tax payments due on farm land at a market interest rate, provided the farm continues to be actively managed by the family.81 Because it is so rare for such farms and ranches to be subject to the estate tax, the proposal would only cost $5 billion over 10 years.82

To be clear, this proposal should only be considered if it is includes all the guardrails in the full Baucus proposal and interest accrues at a market interest rate. Otherwise, it could become a large loophole and reduce the number of farms owned and actively managed by families as opposed to passive investors in large corporations.

Conclusion

Wealth transfer taxes play a critical role in mitigating economic disparities, especially inequality of opportunity. The proposals offered here would soften the relative advantages of being born at the very top while leaving more than 99 percent of financial gifts and bequests unaffected.83

At the same time, these reforms options would raise a significant amount of revenue that could be used to mitigate the barriers to economic mobility that children from low- and middle-income families face. Effectively, they could fund a form of social inheritance through investments that partially make up for such families being unable to fund large financial wealth transfers to their children. The hundreds of billions of dollars raised could be used to fund universal pre-Kindergarten, expand the child tax credit for low- and middle-income working parents with young children, or increase the wage subsidy provided by the Earned Income Tax Credit for childless, frequently young adults. These proposals are estimated to significantly improve infant health, heighten academic achievement, boost labor force participation, and increase lifetime earnings for children from relatively disadvantaged backgrounds.84

President Franklin Delano Roosevelt once said “inherited economic power is as inconsistent with the ideals of this generation as inherited political power was inconsistent with the ideals of the generation which established our government.” The same could be said today. Rather than falling near the bottom among our competitors on this score, we can recommit to creating a society where one’s financial success depends relatively little on the circumstances of one’s birth. A first step is to start taxing extraordinarily large inheritances like we tax good, old hard work.

(I am grateful to Len Burman, Michael Graetz, Chye-Ching Huang, and Wojciech Kopczuk for helpful suggestions. All errors are mine.)

Must-Read: Economist: Hands off

Posted on by Brad DeLong

Must-Read: News magazines that have spent all of the current millennium so far making excuses for Britain’s Conservative and Unionist Party have been playing with fire. Now there is some sign they are aware of just how badly they and Britain are getting burned. Let us hope that it is not too late, and that they do not backslide:

Economist: Hands off the Bank of England: “Politicians who casually attack the central bank’s integrity are playing with fire…”

Buttonwood: Central banking and the press: Anatomy of a stupid rumour: “MARK Carney, the governor of the Bank of England, has upset many people in the Conservative party because of his warnings about the economic impact of Brexit…

…This political pressure on an independent central bank governor is a great mistake. On the day after the referendum vote, the prime minister resigned and Brexit campaign leaders were nowhere to be seen; it was Mark Carney who stepped forward to calm the markets. He was the only grown-up in the room. Now the stories are circulating that Mr Carney might resign, with some even suggesting that it could happen as soon as this week. But… the British press starts to chase its own tail…. This whole affair just shows how careful one must be in a world of 24-hour news and social media. A throwaway remark in one piece becomes a source in another story and then an authoritative looking statement in a national newspaper; Chinese whispers in the internet age. 

It’s not 24-hour news and social media that’s the problem: it’s Buttonwood having in interest in pretending that the tackiest of hacky hacks write for “a national newspaper” that makes things that are for no substantive reason classified by Buttonwood as “authoritative looking statement[s]…”

Must-Read: Anton Howes: Is Innovation in Human Nature?

Posted on by Brad DeLong

Anton Howes: Is Innovation in Human Nature?: “Most theories… assume that innovation is in human nature…

…I disagree. The more I study the lives of British innovators, the more convinced I am that innovation is not in human nature, but is instead received. People innovate because they are inspired to do so — it is an idea that is transmitted. And when people do not innovate, it is often simply because it never occurs to them to do so. Incentives matter too, of course. But a person needs to at least have the idea of innovation — an improving mentality — before they can choose to innovate, before they can even take the costs and benefits of innovation into account….

My favourite example is John Kay’s flying shuttle. It was an improvement to the loom, which radically increased the productivity of weaving, and which finds a place in every textbook…. Kay’s innovation was to use two wooden boxes on either side to catch the shuttle. And he attached a string, with a little handle called a picker, so that the shuttle could be jerked across the loom, at great speed…. Kay’s innovation was extraordinary in its simplicity. As the inventor Bennet Woodcroft put it, weaving with an ordinary shuttle had been “performed for upwards of five thousand years, by millions of skilled workmen, without any improvement being made to expedite the operation, until the year 1733”. All Kay added was some wood and some string. And he applied it to weaving wool, which had been England’s main industry since the middle ages….

It is illustrative of many more innovations that were low-hanging fruit, ripe for the plucking for centuries. So the usual, natural state is the state of those millions of weavers who preceded Kay, who never knew another innovator and so never even received the idea of innovating. As the agricultural innovator Arthur Young put it, the natural state is not innovation, but “that dronish, sleepy, and stupid indifference, that lazy negligence, which enchains men in the exact paths of their forefathers, without enquiry, without thought”.

Must-Read: Paul Krugman (2011): The Ricardian Equivalence Argument Against Stimulus

Posted on by Brad DeLong

Must-Read: Paul Krugman (2011): The Ricardian Equivalence Argument Against Stimulus: “There have been a lot of shockingly bad performances among macroeconomists in this crisis…

…most startling… is the way freshwater economists… demonstrated… they don’t understand… their own… Ricardian equivalence… that what determines consumption is the lifetime present value of after-tax income, and hence that, say, a temporary tax cut won’t stimulate spending…. It is… dubious… even done right…. But… it does NOT imply that government spending on… infrastructure will be met by offsetting declines in private spending….

Robert Lucas was betraying a complete misunderstanding… when he said this:

If the government builds a bridge, and then the Fed prints up some money to pay the bridge builders, that’s just a monetary policy. We don’t need the bridge to do that. We can print up the same amount of money and buy anything with it. So, the only part of the stimulus package that’s stimulating is the monetary part.…

But, if we do build the bridge by taking tax money away from somebody else, and using that to pay the bridge builder — the guys who work on the bridge — then it’s just a wash. It has no first-starter effect. There’s no reason to expect any stimulation. And, in some sense, there’s nothing to apply a multiplier to. (Laughs.) You apply a multiplier to the bridge builders, then you’ve got to apply the same multiplier with a minus sign to the people you taxed to build the bridge. And then taxing them later isn’t going to help, we know that.

This remark was followed, by the way, by a smear against Christy Romer:

Christina Romer — here’s what I think happened. It’s her first day on the job and somebody says, you’ve got to come up with a solution to this — in defense of this fiscal stimulus, which no one told her what it was going to be, and have it by Monday morning.

So she scrambled and came up with these multipliers and now they’re kind of — I don’t know. So I don’t think anyone really believes. These models have never been discussed or debated in a way that that say — Ellen McGrattan was talking about the way economists use models this morning. These are kind of schlock economics.

Maybe there is some multiplier out there that we could measure well but that’s not what that paper does. I think it’s a very naked rationalization for policies that were already, you know, decided on for other reasons.

I’ve tried to explain why Lucas and those with similar views are all wrong…. There may be an even more intuitive way…. Think about… a family buys a house with a 30-year mortgage… takes out a $100,000 home loan…. If the house is newly built, that’s $100,000 of spending…. But the family has also taken on debt, and will presumably spend less because it knows that it has to pay off that debt. But… there’s no reason to expect the family to cut its spending right now by $100,000. Its annual mortgage payment will be something like $6,000, so maybe you would expect a fall in spending by $6000; that offsets only a small fraction of the debt-financed purchase….

How could anyone who thought about this for even a minute — let alone someone with an economics training — get this wrong?… Yet… almost everyone on the freshwater side of this divide did get it wrong, and has yet to acknowledge the error.

Must-Read: Bradley A. Hansen: The Rise and Fall of American Economic Growth

Posted on by Brad DeLong

Must-Read: Bradley A. Hansen: The Rise and Fall of American Economic Growth: “Robert Gordon’s Rise and Fall of American Economic Growth… is an excellent… expansion of Lebergott’s Pursuing Happiness…

…It describes the many ways in which the material conditions of life (what they consumed, how they worked, and their health) were transformed from 1870 to 1970. Gordon argues that economic growth this period essentially created modern economic life: comfortable homes with electricity and clean water, cars parked out front, and all of this purchased with less labor hours and less onerous labor….

Gordon’s argument that current innovations in information and communication are not transforming life the way the earlier changes did and that the rate of growth is unlikely to return to the rapid pace experienced for most of the twentieth century… actually occupies a relatively small part of the book…. I do tend to disagree with Gordon and others who underplay the transformation brought about by information technology…. I agree with Gordon that attempts to make predictions about future innovations are speculative, but I tend to be somewhat more optimistic than he is. In part, my optimism stems from the dismal performance of dire predictions about the future. Read Jevon’s on the Coal Question, or Alvin Hansen on secular stagnation….

The chief weakness…. It tells the story strictly from an American standpoint…. Increased economic freedom and access to education in Asia have the potential to dramatically increase the pool of innovators…

Must-Read: Simon Wren-Lewis: Being Honest about Ideology in Economics

Posted on by Brad DeLong

Simon Wren-Lewis: Being Honest about Ideology in Economics: “Noah Smith… says the fundamental problem with macroeconomics is lack of data….

…That is not in my view the whole story…. Real Business Cycle (RBC) research… was only made possible because economists chose to ignore evidence about the nature of unemployment in recessions…. In the RBC model there is no problem with recessions, and no role for policy to attempt to prevent them or bring them to an end. The business cycle fluctuations in employment they generate are entirely voluntary. RBC researchers wanted to build models of business cycles that had nothing to do with sticky prices. Yet here again the evidence was quite clear…. Why would researchers try to build models of business cycles where these cycles required no policy intervention, and ignore key evidence in doing so? The obvious explanation is ideological….

I do not think this is just a problem in macroeconomics. David Card is a very well respected labour economist…. His research involved no advocacy, but was simply about examining empirical evidence. So the friends that he lost objected not to the policy position he was taking, but to him uncovering and publishing evidence. Suppressing or distorting evidence because it does not give the answer you want is almost a definition of an illegitimate science….

I suspect there is a reluctance among the majority of economists to admit that some among them may not be following the scientific method but may instead be making choices on ideological grounds. This is the essence of Romer’s critique, first in his own area of growth economics and then for business cycle analysis. Denying or marginalising the problem simply invites critics to apply to the whole profession a criticism that only applies to a minority.

Must-Reads: October 28, 2016

Posted on by Brad DeLong

Should Reads:

Weekend reading: “Flexing market power” edition

Posted on by Nick Bunker

This is a weekly post we publish on Fridays with links to articles that touch on economic inequality and growth. The first section is a round-up of what Equitable Growth published this week and the second is the work we’re highlighting from elsewhere. We won’t be the first to share these articles, but we hope by taking a look back at the whole week, we can put them in context.

Equitable Growth round-up

One of the economic selling points for mergers and acquisitions is that the new companies will be more productive. But as new research shows for the manufacturing industry, the result more often is not greater productivity, but higher prices.

Most models of the macroeconomy assume that individuals and businesses are perfectly rational. A new paper looks at how our understanding of macroeconomic policy would change in a world where people aren’t perfectly rational.

Monopsony is not a word that rolls off the tongue, but it’s increasingly a term that anyone paying attention to the U.S. labor market should understand. A new Council of Economic Advisers brief takes a look at the role of monopsony.

Links from around the web

Columnist Martin Sandbu riffs off a recent speech by Federal Reserve Chair Janet Yellen to note the return of Keynesian thinking that calls for more active management of aggregate demand through fiscal and monetary means. [ft]

The White House recently called on state governments to rein in non-compete agreements. Evan Starr of the University of Maryland who’s done research on the effects of non-competes writes on why they’ve become such a policy concern. [vox]

Inflation seems to be picking up in the United States and in other advanced economies. Should this increase be a concern? The only thing to fear, The Economist’s Ryan Avent argues, is that the Federal Reserve and other central banks won’t let inflation run stronger. [free exchange]

Advance data for gross domestic product for the third quarter of this year came out this morning. While they showed an uptick in growth, the pace of growth in recent years has been quite lackluster. Why? Alana Semuels runs through some of the theories. [the atlantic]

Before the Great Recession, some economists, led by former Federal Reserve chairman Ben Bernanke, were concerned about a global savings glut emanating from East Asia. The savings rate of East Asian economies contributing to the glut back then was about 35 percent of collective GDP. Now it’s 40 percent. The Council of Foreign Relation’s Brad Setser lays out the data on Asia’s persistent savings glut. [follow the money]

Friday figure

Figure from “Equitable Growth’s Jobs Day Graphs: September 2016 Report Edition”

Must-Reads: Robert Waldmann: Benchmark II

Posted on by Brad DeLong

Robert Waldmann: [Benchmark II][]: “Benchmark[s] which I think are dangerous…

…Macroeconomists have agreed to treat technology as exogenous. I think this particular choice helps explain Paul Romer’s extreme irritation…. Macroeconomists have agreed that long run forecasts are best made using a neoclassical model without frictions. This means that the macroeconomic discussion is about the optimal model of convergence to a given long run which is given by assumption and not analysis or evidence. This provoked Roger Farmer to be almost as harsh as Paul Romer (by the way reading that Farmer post is a much better use of your time than reading this post)…

Benchmark II]: http://rjwaldmann.blogspot.com/2016/10/benchmark-ii.html