Thursday, October 14, 2010

 Greg Mankiw writes:
 I don’t want to move to a bigger house or buy that Ferrari, but I hope to put some money aside for my three children. They will never lead lives of leisure, but I hope they won’t have to struggle to find down payments to buy their own homes or to send their kids to college.
Various commentators have written about Mankiw's piece. Tyler Cowen seems to agree with the key point, as he writes:
I also see that if a person runs a successful small business, has a long time horizon, has a strong bequest motive, and can earn eight percent nominal a year (make it reinvestment in a private business if you don't buy the equity premium story), that person faces a very high marginal tax rate.  In one of Greg's examples it's about ninety percent.
But Tyler (and everybody else I've read) misses the critical factor: the ability to give money to your children, tax free, right now, means that Greg Manki (and anyone similarly situated) can avoid the estate tax portion of his calculation. As such, his marginal tax rate will not approach 90%, at least not until long, long after he has assured that his children will, indeed, live lives of leisure.

Professor Mankiw: you can give money to your children, tax free, every year. How much? $13,000 per year from you and another $13,000 per year from your wife. To each of your children. If your children are married, then that's another $26,000 you can give to their spouse. Every year

Let's say you give $26,000 per year to each of your children, starting at birth, who then invest it. Let's say they get 4% real return annually and you continue the gifts for 30 years. At the end of 30 years, each of your children will have well over $1.4 million.

The Census Bureau (2007) lists median household income for the US at just over $50,000. So if Greg's kids want to live comfortably (at the median household income) for the rest of their lives without ever working a day after their 30th birthday, they'll have to earn 3.5 percent (+/-) on their fortune.

Then once Greg dies, he can leave them another $3.5 million tax free in his estate. Say he has 3 kids, that's an extra $1.167 million per kid. Now let's say each of those kids takes that $1.167 million (which they don't need! They're already living a life of leisure without doing a day of work!) and invests it at a 4% real return annually for 40 years. That throws off $47,000 per year during their lifetimes ... which they can then turn around and give $23,500 per year to each of their two kids. Who will, in turn, never have to work a day past their 30th birthdays either. And then they can divide the $1.167 million between their kids, who can pass it on to their kids....

Never working a day after your 30th birthday: sounds like a "life of leisure" to me. Not only for your kids, but for your grandkids. And all of that on money that has not been touched by the estate tax.

Tyler Cowen writes (same piece):
I am more struck by the possibility that such marginal rates are morally wrong and I wonder if that is not his view too.
But a 90% marginal tax rate only applies to people who are trying to give money to their children beyond the point at which their children can already live lives of leisure. I don't see any moral problem with that, at all.

If you have so much money that the estate tax is going to take a bite, why not plan ahead and, I don't know, maybe give some of your money to somebody else. Don't you have any nephews or nieces you're fond of? What about friends of your children? Children of your friends? What about deserving folks you run across in other walks of your life? Former students who through no fault of their own fall on hard times? Start throwing $26,000 per year, every year, at those folks. Maybe even consider donating to some charities. Your marginal tax rate will never approach 90%, and you just might make a difference in the world that would do more good than giving your children more money than they will ever need.

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