Estate Tax Takedown – Levine Defeats Mankiw

I’m a huge fan of Bloomberg’s Matt Levine,1  who is basically smarter and funnier than anyone writing about finance.

Anyway, I was annoyed to read yesterday’s Op-Ed by Gregory Mankiw (whose textbook of course we all had to have in College) Mankiw’s a Harvard professor with all the respect that comes with that, and he’s attacking a tax position I hold dearly. My view is that the Estate Tax is the best of all taxes, and Mankiw’s view in the Op-Ed is that it’s unfair, because of the different level of taxation that will hit a theoretical household of frugals vs. spendthrifts.

Mankiw’s view is that two households that generate, say, $20 million in wealth will be hit by unequal taxes, depending on how they spend, or don’t spend, their money. To complete the thought, a spendy household will end up avoiding the estate tax – currently 40% of an estate’s value above $5.45 million. Meanwhile, a thrifty household will pay those hefty taxes, when the couple dies. Humph. That did sound unfair when I read it yesterday.

Thankfully, Levine rescues my views, with an important distinction. The taxpayer is actually their heir, not the wealth-generator. The wealth-generator is dead. And when you think about what is “fair” to heirs, the calculus changes. Take it away, Matt:

Here is a curious argument from N. Gregory Mankiw that the estate tax is bad “because it violates a principle that economists call horizontal equity. The basic idea is that similar people should face similar tax burdens.” So if two couples — the Frugals and the Profligates — each start businesses, work hard, and earn the same amount of money, they should each pay the same amount of taxes, even if the Frugals save all their money and the Profligates spend theirs. They do. But Mankiw thinks they don’t:

[Levine now quoting Mankiw:] Under an income tax, the couples would pay the same, because they earned the same income. Under a consumption tax, Mr. and Mrs. Profligate would pay more because of their lavish living (though the Frugals’ descendants would also pay when they spend their inheritance). But under our current system, which combines an income tax and an estate tax, the Frugal family has the higher tax burden. To me, this does not seem right.

Ah, see, the problem here is thinking that the senior Frugals pay the estate tax. They don’t. They are dead when the estate tax is assessed. The two great inevitabilities are death and taxes, but death is in an important sense logically prior. When you pay taxes, you still (usually) prefer not to be dead. Once you are dead, you have no preferences about taxes. We could fund the government with a lovely, efficient, non-distortionary system of taxing only the dead, except — and this is another key point — the dead don’t have any money. The incidence of the estate tax can’t be on dead people. Once the Frugals die, their heirs have the money, and the estate tax taxes them. If the Frugals’ children make $30,000 a year as art gallery assistants and also inherit $20 million, and Mr. and Mrs. Justnotrich’s children make $30,000 a year as Wal-Mart employees and inherit nothing, it seems odd to say that they should pay the same taxes as a matter of horizontal equity.


So anyway, I think Levine the finance blogger wins that round against Mankiw the professor. Also, it fits my worldview, so…

Please see related posts:

The Estate Tax is the best tax

Adult conversation about taxes

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  1. And you should subscribe to his daily email. No wait, don’t, because then you’ll realize how often I’m trying to ape his style. Forget I mentinoed it.

Hello Houston

The Houston Chronicle recently started running my stuff, and I’m excited.

In honor of my introduction to Houston, I’d like to offer a personal story about my very first trip to Houston. Best of all, this anecdote has a pithy financial moral at the end.

In Spring 2001 I lived in New York City and sold emerging market bonds for Goldman Sachs. “Emerging markets” means Latin American, Asian, Eastern European, Middle Eastern and African bonds – all very volatile products. It was a super-fun job. I had recently picked up a new client – a couple of clever guys who operated a hedge fund within a successful pipeline company in Houston.

houston_chronicleI set up a visit to Houston because, of course, I already knew this company’s reputation. They dominated not only their pipeline business but had financially engineering their way into oil and gas trading, water-rights and paper-trading, and now a sophisticated, relative-value, emerging market bond hedge fund. (If the words “relative-value emerging market bond hedge fund” make perfect sense for you, then congratulations. If they don’t, then this column is for you.) Anyway, Fortune Magazine named them “America’s Most Innovative Company” for six years in a row. These guys were my kind of client.

First trip to Houston

We drank cocktails together in a fancy Houston bar while I listened to my clients describe the keys to their success.

“We just have the smartest guys in every business we tackle, and we know how to go after a business and make money off it.”

I was so convinced. I’m not kidding.

The smartest guys, with the best ideas, and all this awesome financial engineering? What could possibly go wrong? Personally, I planned to invest in the stock of that pipeline company as soon as I got my next bonus. Which, fortunately for me, was many months away.

For the next few months I spent a fair amount of my free time researching the company on my Bloomberg terminal. The amazing thing about Bloomberg terminals – for those of you who haven’t worked on Wall Street – is that I could find anything and everything about the company I could ever want or need. Historical earnings data and future projections. Analyst reports. News stories. Key executive bios. Charts and graphs and comparisons. I even personally knew key executives there! I loved my clients, and I loved this stock. And I couldn’t wait to get paid, so I could start investing in all those smart guys with all their innovative financial techniques.

enronBetter lucky than good

One of the most important lessons I learned in my Wall Street years is that it’s far better to be lucky than good. (That’s not the previously-promised pithy moral lesson, but it is true.)

Enron collapsed in the Fall of 2001 – before I got paid my bonus – so I never poured my own money down that rat hole. But boy was I eager to do it – only weeks before they collapsed.

Ever since then, whenever I hear people tell me about an individual stock they have bought, or plan to buy, and their reasons for doing so, I think of my clients at Enron.

What I learned from this Enron experience is that – not unlike Lord Commander Jon Snow – I know NOTHING when it comes to picking a good stock to buy. I thought I had access to EVERYTHING. And yet, I was completely wrong.

What I’d like you to know also – that promised pithy financial moral is right here – is that when it comes to picking individual stocks, you also know nothing.

My “I believe” speech, Bull Durham-style

annie_savoySo, I don’t believe in individual stock-picking when it comes to money matters and being smart.

“Well now,” you, as Susan Sarandon’s character Annie Savory in Bull Durham, might ask, “what do you believe in then?”

“I believe in getting wealthy,

Markets, cost discipline, the power of compounding,

Aggressive allocations, never selling, and neighborhood poker (if you like to gamble),

That Jim Cramer’s finance shows are self-indulgent, dangerous, garbage fires.

I believe Lee Harvey Oswald could not have acted alone.

bull_durhamI believe there ought to be a constitutional amendment outlawing variable annuities and the carried interest loophole.

I believe in index funds, entrepreneurship, selling investments only when you have to have the money and never for ‘timing” or ‘tax’ reasons, and long, slow, deep, soft automatic retirement-account dollar-cost averaging that lasts five decades.”

“Good night,” I whisper, as I turn and walk out the door, Crash Davis cool.

Leaving you/Annie/Susan Sarandon character breathless to say anything but:

“Oh my.”


A version of this ran in the Houston Chronicle and the San Antonio Express News.



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