Last will and testament

What does inheritance mean?

There are positive and negative aspects to inheritance from both economic and social viewpoints. For individuals it can create opportunity – the opportunity to start a new business or to expand an existing one, the chance to acquire a good education, or the freedom to move in order to pursue a better life for oneself and one’s children. Historically it has allowed some talented people the free time to be highly creative in the arts or sciences. Inheritors have also founded or supported major charities and public projects, including hospitals, universities, museums, and art galleries. In other words, inheritance can be an important positive force.

Inheritance also has negative connotations. It is often seen as a kind of lottery resulting in lifetime prospects being linked to birth rather than to personal choices, effort, or achievement. Andrew Carnegie and others with self-made fortunes have feared that the expectation of inheritance may sap the work effort and ambition of heirs, and have established foundations or made other charitable donations as a partial alternative. These concerns may weaken the fabric of society if sufficient people consider the allocation of resources and opportunities to be unfair, or if wealthy offspring are dissolute and irresponsible. The economy may also suffer if too much of its industry or finance is in the hands of unambitious inheritors rather than dynamic self-made individuals. If a large fraction of a nation’s wealth is inherited then growth prospects may be impaired.

Concerns about the effects of inheritance have had an impact on public policy, in connection with public education, progressive taxes and death duties, for example. Those concerns also lead to a desire for information about the level and distribution of inherited wealth. Here we review some of the important recent research and new evidence on the topic. Much of the empirical evidence has been collected in Europe or North America, but patterns and trends in emerging market and developing countries are also very much of interest.

Inheritance of wealth
Inheritance is an important component of wealth. 31% of Forbes billionaires have inherited their wealth and if we exclude China, Russia and the other transition countries the figure is still 38%. More broadly, our work suggests that inherited wealth likely accounts for 30-50% of total household wealth in OECD countries. In low growth or traditional societies the share is likely to be higher. At the other extreme, very little household wealth in today’s transition economies was inherited.

Evidence on inheritance
Modern economic research on inheritance began with a study of males in the United Kingdom who left estates at death worth £10,000 or more in the 1920s. An examination of the wills of their predecessors concluded that about one-third had inherited their fortunes, one-third were self-made, and one-third were in an intermediate category. Later studies using a similar methodology discovered that inheritance became less important for top wealth holders in the United Kingdom during the next 50 years. Similar evidence of a decline in the importance of inheritance from the 1920s to the 1970s has been found in France, Sweden and the United States.

More up-to-date evidence on inheritance can be gained from the “rich lists” published in Forbes magazine and elsewhere. Each year, Forbes provides a list of the world’s billionaires and adds supplementary information, including whether the billionaire was “self-made”. Of the worldwide total of 1226 billionaires in 2012, 842 billionaires (or 69%) were reported to be self-made. This figure is inflated, however, by China, Russia, and other Eastern European countries which account for 209 billionaires, only two of whom are not self-made.

When these transition countries are excluded, only 62% of billionaires are self-made, with the implication that 38% owe their fortunes partly or wholly to inheritance. The self-made fraction varies greatly across countries – from just 35% in Germany and 40% in France, to 78% in Australia and 86% in the United Kingdom. In the United States, which has a third of the world’s billionaires, 73% are self-made.

Characteristics of inheritors
There is little to distinguish the relative wealth or age of self-made billionaires compared to those who have inherited. Excluding transition countries, inheritors average 64 years of age worldwide while the self-made average 65 years.

The average wealth of inheritors, at USD 4.2 billion, is 16% higher than that of the self-made. However, there is considerable variation in these patterns. For example, in France, Japan, and the United Kingdom the inheritors are appreciably older than the self-made; and in China and Russia the billionaires are unusually young, averaging just 51 years of age.

Large countries are sometimes representative of their regions or sub-regions, sometimes not. In continental Northern Europe, the fraction of self-made in France and Germany is similar to the Nordic countries (40% self-made, excluding Norway) and Switzerland (44%); but the four other countries in the area with billionaires (Austria, Belgium, the Netherlands and Norway), have 74% self-made (14 out of 19). The self-made fraction (60%) in Brazil is fairly close to the figure of 56% for Latin America as a whole. Japan’s fraction of self-made (75%) is high for the Asia-Pacific region, which (excluding China) has an overall figure of 58%, while India and Indonesia, at 42% and 53%, are on the low side. Finally, Africa has 11 of 16 billionaires (69%) self-made, while the Middle East (excluding Israel) is at the opposite extreme with only 25 out of 57 (44%). Israel is dissimilar from its neighbors with 9 out of 13, or 69% self-made.

The fraction of billionaires who are self-made rises with age. Excluding the transition countries again, it is below 60% for those aged 25-44 or 45-54, but 67% or more above age 65. This reflects the fact that it takes time to build up a business or investments worth USD 1 billion or more starting from scratch. Inheritors, on the other hand, have had at least one more generation to build up their wealth, and increase in frequency with wealth. The self-made fraction falls from 67% in the Forbes bottom quintiles (i.e. bottom 20% groups by level of wealth) to 47% among the top 5%. The only exception is at the very top of the Forbes listing, where the self-made make up 8 out of the 10 wealthiest billionaires. The attention given to self-made people at the apex of the world wealth distribution may create the impression that self-made fortunes become more common among the billionaires as wealth rises, but this impression is mistaken.

Trends over time
Changes over time in the importance of inheritance at different levels of the wealth distribution have not been studied for the world as a whole, but have attracted attention in the United States, which has some of the best data for this purpose. Survey data reveals that the fraction of families that had received a wealth transfer in the form of a bequest or gift fell from 24% in 1989 to 18% in 2001 and then increased to 21% in 2007. Demography provides possible explanations for this U-shaped trend. Over this period longevity continued to rise in the United States, particularly for males, reducing the number of transfers, since the bulk occur on death. That may help to explain the decline from 1989 to 2001. The subsequent rise may be due partly to the aging of the large baby boom cohort, which brought it into “inheritance range” around the turn of the century.

Survey data also shows that wealth transfers are on average quite large, and that they rise steeply in importance with income or wealth. From 1989 to 2007, they averaged USD 84,700 or 23% of net worth for the overall sample, and USD 408,400 for just those who had received transfers. Of those with income over USD 250,000, 38% had received a transfer, with an average amount of USD 3 million for recipients. For families in the top 1% of the wealth distribution, the corresponding numbers were 44% with a transfer and an average amount of USD 5 million. Transfers were more common, and larger, for whites, the more educated, and older people. Incidence was 25% for whites, 29% for those with 16 years of schooling (generally a postsecondary education), and 29% for those aged 75 or more.

Incidence of inheritance among the Forbes 400
Another source of data is the “Forbes 400” list of the 400 wealthiest individuals/families in the United States, which currently corresponds almost exactly to the list of US billionaires. In 2012, 69% were self-made. In 2007 and some earlier years additional information was provided about the inheritors, with 39% being classified as “inherited and growing” and 61% simply stated to have inherited.

As for the world as a whole, in the United States the self-made fraction rises with age, but interestingly this fraction does not fall uniformly with wealth. While 74% of those in the bottom quintile are self-made, the figure drops to an average of 67% for the next two quintiles, then rises to 68% in the fourth quintile and 70% in the top quintile.

The rise in the incidence of the self-made in the higher ranges of the Forbes 400 has often been noted and has a popular explanation. In the United States, in each generation there are entrepreneurs and investors who amass spectacular fortunes and rise to the top of the pyramid. When these “super billionaires” die, their fortunes are not passed on intact, but are split – among widows, children and other beneficiaries. So the second-generation drops down the Forbes 400 list (or drops out altogether), the third falls further, and so on.

Being successful enough to enter the Forbes 400 list is something more easily done when the economy is growing faster, business is booming, and asset prices are rising quickly. Although the two decades before the global financial crisis were interrupted by two recessions and associated stock market crashes, overall conditions were conducive for the creation of new fortunes. So the self-made might have been expected to oust inheritors in the Forbes 400 over much of this period, as appears to have happened.

We use a sample that includes all members of the Forbes 400 in 2007, and smaller subsamples for earlier years, dropping enough of the least wealthy to keep sample size constant as a percentage of the US adult population. Figure 1 shows the fraction of the Forbes 400 who inherited their fortunes, at intervals from 1982 to 2007, both for the group as a whole and split between those above and below age 55. The greater incidence of inheritance among younger members is again evident. There is also a clear downward trend in the incidence of inheritance until the turn of the century, then an apparent rebound, as in the survey data, which could be a random event or due in part to demographics, as suggested earlier.

Between 2000 and 2005, the number of billionaires with inherited fortunes in our Forbes 400 subsample rose by 26, of whom 17 were baby-boomers aged between 40 and 55 in just four families. While there is clearly some randomness at work, the fact that so many new inheritors were created is partly a reflection of the number of children in these families. Thus it seems that the arrival of the large baby boom cohort at “inheritance age” may have swelled the ranks of inheritors at the very top of the distribution. The fact that changes in business conditions are important, as well as demography, is indicated by the drop in the incidence of inheritance from 22% to 20% between 2005 and 2007. In that short time span, a surge of self-made billionaires, mainly in the financial sector displaced a number of inheritors in the Forbes 400 list.

What fraction of wealth is inherited?
Various attempts have been made to estimate the fraction of household wealth which is inherited. Using data on gifts and bequests received by the current generation has led one study to conclude that inheritances account for 46% of household wealth in the United States. But data on gifts and bequests are based on tax records, and may not be reliable given the strong incentives to minimize the flow of intergenerational transfers that are subject to tax, via family trusts and other mechanisms.

Another approach aims to estimate the non-inherited portion of wealth by cumulating past savings out of earnings. The results are particularly sensitive to the treatment of the interest received on inherited wealth. If all interest on inheritances is assigned to inherited wealth, then the share of inherited wealth in the United States is likely to be in the 50 60% range; but the share would be only 20-30% if the interest is allocated to lifecycle saving. A midway compromise, dividing interest 50:50 between inheritances and lifecycle saving, leads to an estimate of 35 45% for the share of inherited wealth, which is broadly consistent with the results of about half a dozen leading studies on the issue.

The share of inherited wealth in G7 countries during the late 1900s

Studies which have estimated the share of inherited wealth (I) in total wealth (W) usually refer to the United States before the turn of the century. In other contexts, predictions of the long run equilibrium value of the share of inherited wealth can be derived from a simple formula in which the inheritance share I/W is given by:I/W=π/(π+s/ρ) where π is the annual flow of new inheritances out of self accumulated wealth; s is the saving rate out of normal income; and ρ is the ratio of total wealth to total earnings (i.e. ρ = W/E, where E is total earned income).

One attractive feature of this equation is the ease with which realistic values can be offered for the three parameters. The wealth to earnings ratio is expected to be a little above the ratio of household wealth to disposable income, which averaged 4-6 in G7 countries until the mid 1980s, but has risen more recently in most G7 countries. It seems reasonable to assume ρ = 6 for advanced economies in the late 1900s, and s = 10% as representative of the savings rate in advanced economies during the same historical period. Finally, with a generation typically lasting about 30 years, around 1/30th of wealth should be inherited each year, so allowing for the fact that part of that inheritance derives from inherited rather than accumulated wealth suggests π = 2% as reasonable. This set of parameter values yields I/W = 55%, which is in the middle of the range mentioned earlier when all interest on inheritance is assigned to inherited wealth (which is implicitly assumed here).

The share of inherited wealth in other societies
Alternative sets of parameter values allow us to speculate on the share of inheritance in a variety of stylized hypothetical societies.

A: Low-growth traditional society (ρ = 7, s = 5%, π = 3%; I/W = 78%)
Pre-industrial societies before the demographic transition like pre-modern Europe or India before the 19th century are typical examples here. Low or zero population and earnings growth makes high wealth relative to income likely, since the wealthier old are relatively more important in both population and economic terms than in higher growth scenarios. Poorly developed financial institutions and poverty generate a low saving rate (s), while a high mortality rate leads to a relatively high annual rate of flow of new inherited wealth (π). The result is very high I/W, possibly reinforcing social and economic stagnation.

B: Slow-growing less-developed country (ρ = 5, s = 5%, π = 2%; I/W = 67%)
Most countries in Asia, Africa and Latin America were formerly in this mould and some (Myanmar, Ethiopia, Paraguay, Bolivia…) still are – going through the demographic transition but still having low savings and low income growth. Fast population growth makes the elderly relatively unimportant, reducing mean wealth relative to mean income and producing a lower ρ than in an advanced economy. The saving rate is still low – we assume the same as in a low-growth traditional society. The rate of flow of new inheritances is lower than formerly, due to lower mortality: we set π = 2% to illustrate. The lower I/W ratio than in the traditional society suggests some reason for optimism regarding future growth prospects, as self-accumulated wealth displaces inherited wealth to some extent.

C: Miracle economy (ρ = 4, s = 20%, π = 1%; I/W = 17%)
The wealth-income ratio is low, the saving rate is high, and the annual flow of inherited wealth is low, reflecting the dominant population and economic weight of the young when both population and income grow quickly. There is a huge contrast with the traditional society or low-growth LDC. These parameter values would generate a very low I/W ratio if they persisted into a steady state. Germany and Japan, and then the Asian Tigers passed through the miracle economy phase in about three decades each – that is, very quickly. Thus, while I/W likely fell in the miracle phases of those economies, it is doubtful if it fell to the 17% region predicted here for an economy in a “permanent miracle”. On the other hand, the latest miracle economy, China, started out with I/W, at least officially, at zero since it emerged from a society without significant private property or inherited wealth. I/W has likely been rising slowly and should still be below the steady-state miracle level. If we also consider that China’s saving rate has perhaps exceeded that of the previous miracle economies, it would seem that I/W must indeed be low in China today.

D: Low-growth advanced economy (ρ = 8, s = 5%, π = 3%; I/W = 83%)
With the exception of the USA, there has been an upward trend in wealth-income ratios in most G7 countries since the mid 1980s, with values as high as 9 observed in Japan and the UK. At the same time, household saving rates have declined to levels around 5% or lower. One estimate for France suggests that the flow of inherited wealth has risen from about 5% of GDP in the 1950s to 15% today, implying a large increase in π. A similar, but smaller, increase has also been noted for the UK. A much higher steady-state level of I/W results from these changes, which could be the future for all advanced countries, although hopefully the scenario will be limited to a small number of nations.

Inequality Impacts of Inheritance
The impact of inheritance on wealth inequality has been hotly debated for a long time. Distributional effects were particularly worrisome when primogeniture – the tradition of passing the bulk of personal wealth to the eldest son – was still prevalent. Nowadays, a more equal division of estates tends to mitigate the disequalizing impact of inheritance. Nevertheless, the view that inheritance increases inequality is still widely believed and seems intuitive. In theory, this does not have to be the case. In the altruistic model of bequests, parents care about their children’s welfare and give larger transfers to their lower-earning offspring, which can lead to a reduction in lifetime income inequality. While there is some empirical support for the altruistic models, the effect seems far too weak to ensure that intergenerational transfers are equalizing overall.

Inheritance creates opportunity for some; but it is not equal opportunity and there may be other deleterious effects – on the work effort and enterprise of offspring who inherit, and on the dynamism of economies with a high ratio if inherited to total wealth. The latter aspects lead naturally to concerns about the level and distribution of inherited wealth. The evidence is that over much of the 20th century – up to the 1970s – inherited wealth became relatively less important and more equally distributed in developed countries. Looking around the world at the moment, 69% of the Forbes billionaires are self-made, and if we exclude China, Russia and the other transition countries the figure is still 62%.

In the United States the fraction of the Forbes 400 that inherited a fortune fell from 30-35% in the early 1980s to 20-22% in the mid 2000s. However, in the United States the latest evidence shows that the incidence of inheritance hit a low point at about the turn of the century and afterwards increased. The flow of inherited wealth has also risen somewhat in the United Kingdom. And there has been a large increase in the annual flow of new inheritances in France. These changes suggest that the importance of inheritance may be on the rise, a conclusion that is reinforced by the simulations we have examined that indicate the combination of lower saving and a higher wealth-income ratio seen in many advanced economies in recent years are predictors of a higher ratio of inherited to total wealth in the future.

Reasonable assumptions suggest that inherited wealth likely accounts for 30-50% of total household wealth in OECD countries. In low growth or traditional societies the share is likely to be higher. At the other extreme, very little household wealth in today’s transition economies was inherited, unless one treats those who purchased public assets at bargain prices as having “inherited” from the state.

Some academics have challenged the intuitive assumption that inheritance leads to greater inequality. Models with an altruistic bequest motive can lead to inheritances equalizing the long-run distribution of lifetime wealth, because parents give more to their lower-earning children. While the “equalizing inheritances” school of thought has some empirical support, we believe that the equalizing effect is more apparent than real. Parental transfers may be helpful in mitigating hardship for some low-earning children, but the disequalizing effect of large bequests from wealthier parents is likely to dominate the overall impact.

If inherited wealth and the associated wealth inequality are viewed with concern, there are steps other than inheritance taxation that governments, and the wealthy themselves, can take to reduce or offset the undesirable effects. For example the wealthy can be encouraged through appropriate tax deductions or credits to increase the large scale charitable donations which are already made. Governments and business leaders can strive to maintain a level playing field so that unjustified wealth inequalities are avoided in the first place. They can also work to ensure that ordinary people have the tools to accumulate assets too. Such initiatives should be broadly acceptable and can help reduce inequality in both wealth and inheritance.



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