Billionaires

The Forbes and Financial Times articles to which Becker refers present an astonishing portrait of immense personal fortunes. I shall limit my comment to the Americans on the list. Becker is correct to note that the very largest fortunes are made rather than inherited. The reason probably is that most of them are the result of recent advances in digital technology and the increased globalization of financial and other markets. At a guess (because I don't recognize all the names in the* Forbes list), more than half of the 20 largest American fortunes are due to those recent developments and so could not be the product of inheritance. As one moves down the Forbes *list, inherited wealth appears to account for an increasing number of the American fortunes.

The American fortunes are overwhelmingly due to lawful entrepreneurial efforts rather than to politics or illegality. It is true that Microsoft lost a major antitrust case (and a number of minor ones), owing to its attempt (or so the courts found) to smother Netscape. But it is highly unlikely that Microsoft's campaign against Netscape accounts for any of the Gates, Ballmer, or Allen fortunes, as in retrospect it is apparent that Netscape lacked the business acumen to mount a successful challenge to Microsoft's dominance of the personal-computer operating-system market, as Microsoft feared.

I also agree with Becker that the benefits to consumers from the entrepreneurial efforts that produced Microsoft, Google, Apple, E-Bay, Amazon.com, Wal-Mart, private-equity firms, hedge funds, and other commercial successes that have generated large personal fortunes are much larger than the personal fortunes garnered by the founders and principals of such companies.

It does not follow, however, that these billionaires "deserve" their fortunes and therefore should be as lightly taxed as they are. As the economist Sherwin Rosen showed in a famous article, in certain circumstances a very small difference in ability can translate into an enormous different in reward. The key is the reproducibility of a product or service or innovation. If one pianist is slightly better than any other, his recordings may capture the entire market for recordings of the kind of pieces he plays best because the consumer has no reason to buy his rivals' slightly inferior recordings, provided prices are comparable. As transportation costs and tariff barriers fall and foreign countries become richer, the markets for the best American products expand, increasing the profit potential for producers with the lowest quality-adjusted costs. The greater output of the superior producer confers real value, but there is only a loose relation between that value and the reward to the producer. Bill Gates is extremely able, but not a thousand times abler than pikers worth a mere $50 million.

But of course we must not kill the goose that lays the golden eggs, through a level of taxation that discourages entrepreneurship, a risky activity. We might want to clip the goose's wings if we thought that huge fortunes were politically destabilizing, but this is not a danger in the United States, however much the left rails against Richard Scaife and the right against George Soros. There may well be a legitimate concern with the influence of campaign contributions on public policy (as illustrated by the opposition of New York's Democratic establishment to taxing hedge funds more heavily), but that concern argues for placing limits on contributions rather than on huge fortunes.

Yet even without thinking these fortunes dangerous, or the product of anything more sinister that skill and luck, we might as Becker suggests see in them an attractive source of tax revenues. The ideal tax is a tax that produces large revenues but has minimal allocative effects. A uniform head tax, avoidable only by emigration, would have minimal effects on people's behavior but would generate only modest revenues, because if genuinely uniform the tax would have to be set at a level that the poorest person could pay. A highly progressive income tax, without loopholes, would produce a great deal of revenue but probably would generate significant misallocative effects by causing people to substitute leisure for work and riskless jobs and investments for risky ones.

In these respects the estate tax is somewhere in between the head tax and the highly progressive income tax. Death cannot be averted, and in that respect an estate tax resembles a head tax. But the potential revenues are much greater, especially in an era of large fortunes. Adding up the fortunes listed in the Forbes article for just the 10 wealthiest Americans yields a total of almost $600 billion. The estate tax has as many holes as a very large Swiss cheese, but they could be closed.

There are two objections, however, to a stiff estate tax on large fortunes. The first is that it would encourage the wealthy to spend rather than invest, in order to reduce their taxable estates. But this is a more serious concern for the taxation of modest or even large estates than of immense ones, simply because of the limits of personal consumption. How much of a $3 billion annual income can a person spend on consumption rather than investment? The estate tax is likely to have a significantly smaller misallocative effect than an income tax that would produce the same revenue.

The second concern with stiffening the estate tax is that it will reduce gifts to charity. It will, because one of the biggest loopholes in the estate tax is the charitable deduction, though, as Becker points out, some very wealthy people, such as Andrew Carnegie and John D. Rockefeller, made large charitable donations before there was an estate tax (first introduced in 1916). To the extent that charitable expenditures substitute for government expenditures in areas such as education and medical research (not, however, religion--the largest beneficiary of charitable expenditures--because government is not permitted to subsidize religion), a reduction in charitable deductions is tantamount to a reduction in tax revenues, but the reduction cannot be dollar for dollar--otherwise there would be no incentive to make charitable gifts to any activity that government also funds. The reduction in charitable deductions from repealing the charitable exemption might not be great, moreover, because if one person reduces his contribution to a charity, this increases the incremental effect of another person's contribution. I worry, too, about charitable gifts overseas on the scale of the Gates Foundation; my post on January 1 of this year questioned the appropriateness of compelling U.S. taxpayers to fund (through the charitable deduction from income tax as well as from estate tax) contributions to foreign nations or their populations.

So although a stiffer estate tax on large fortunes (which would not require an increase in the tax rate but merely a closing of loopholes) would probably impose some cost in loss of charitable donations, which could in turn increase demand for public spending, I believe the revenue potential of such a tax would offset the costs. The tax increase could be made revenue-neutral, enabling a less efficient tax, such as the personal or corporate income tax, to be reduced.

There were a number of interesting comments. I cannot reply to all of them, but I will reply to a few. One comment was that "wealthy private donors often take an interest in the results they are purchasing with their donations. Few would argue that government is equally demanding with its funds. Thus, an increase in government spending to replace charitable donations seems counter productive." I do not agree. The reason is that charitable foundations are perpetual, and are controlled by self-perpetuating boards of trustees. As a result, the original donors do not control a foundation. There is thus less monitoring of foundations than there is of government programs.

Another comment questions how eliminating charitable deductions from the estate tax would generate much tax revenue. "People will simply give whatever money they had otherwise intended to charity while they are still alive, noting they don't need tax deductions to do so." This might be largely true if there were no gift tax (it would not be completely true because, not knowing when they die or what their future expenses will be, people are reluctant to give away almost all their money before they die). There is and must be a gift tax to back up the estate tax.

The same commenter said that I am "radically underestimating the incentive effects of giving to one's offspring. Assume you can close all the 'loopholes' permanently and it is impossible to give one's wealth to one's children (what a hideous thought) after death or while alive, then I assure you an awful lot of our most prolific job creators would either retire or stop being workaholics and instead take time out to smell the roses." This comment conflates closing loopholes with confiscatory tax rates. Even if there were no deductions, an estate tax of less than 100 percent would allow people who accumulated an estate to pass some of the money in the estate to their children or others, including charities.

Another commenter makes the following good point in defense of the estate tax: "Most of the wealth of these billionaires is not from income and has not been taxed, e.g. Balmer has not sold and rebought his Microsoft stock on which to pay capital gains, but has held it and his wealth is from appreciation that has not been taxed. So the estate taxes, for the most part, are taxes on money as it passed to heirs that has not yet been taxed." When the heirs sell the stock, moreover, they pay income tax only on the difference between the value of the stock at the time of the donor's death and its current value, so that the appreciation in stock value during the donor's life is never taxed.

Finally, one unrelated and very strange comment: "I take great offense at your recent statements that all Muslims in America should be under surveillance." Neither recently nor ever have I made such a suggestion.