Between his blog, his New York Times columns and his textbooks, Greg Mankiw has probably contributed more than anyone else alive to the cause of economic literacy. But his most recent column is, I think, a rare miss.
The thrust of the column is that the estate tax is a bad idea because it violates the principle of horizontal equity by imposing substantially different tax burdens on substantially similar people:
Consider the story of two couples. Both start family businesses when they are young. They work hard, and their businesses prosper beyond anything they expected. When they reach retirement age, both couples sell their businesses. After paying taxes on the sale, they are each left with a sizable nest egg of, say, $20 million, which they plan to enjoy during their golden years.
Then the stories diverge. One couple, whom I’ll call the Frugals, live modestly. Mr. and Mrs. Frugal don’t scrimp, but they watch their spending. They recognize how lucky they have been, and they want to share their success with their children, grandchildren, nephews and nieces.
The other couple, whom I’ll call the Profligates, have a different view of their wealth. They earned it, and they want to enjoy every penny of it themselves. Mr. and Mrs. Profligate eat at top restaurants, drink rare wines, drive flashy cars and maintain several homes. They spend their time sailing the Caribbean in their opulent yacht and flying their private jet from one luxury resort to the next.
So here’s the question: How should the tax burdens of the two couples compare? 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.
The problem with this argument is that it’s not an argument against the estate tax. It’s an argument against any tax (other than a pure $X-per-person-per-year head tax). Try it:
Consider the story of two couples. Both start family businesses when they are young. They work equally hard, and their businesses prosper equally well, bringing in the same $200,000 per year. The Joneses spend their money as it comes in, while the Engermans place half their earnings in interest-bearing accounts. They are both subject to the same 50% annual income tax — which means the Joneses pay $100,000 a year in taxes, but the Engermans pay more.
Note that the Joneses and the Engermans are as similar and as different as the Frugals and the Profligates. In each case, the two couples work equally hard, prosper equally well, and spend their earnings at different rates. So if horizontal equity by itself is all that matters, then the income tax is as bad as the estate tax.
Consider the story of two couples. Both start family businesses when they are young. Both businesses prosper equally, in that they each earn $10,000 a month. The Barneses operate their business twelve months a year, earn $120,000 and pay $60,000 tax. The Nobles operate their business six months a year, enjoy six months of leisure, earn $60,000 and pay $30,000 tax.
This too fails to meet the criterion of horizontal equity, because the Barneses pay twice as much as the Nobles. You might argue that the Barneses and the Nobles, unlike the Frugals and Profligates, actually earn different incomes. But that’s only because they’ve chosen different tradeoffs between leisure and income, just as the Frugals and Profligates have chosen different tradeoffs between current and future consumption. If the Frugals and Profligates count as “similar” in this discussion, then so should the Barneses and the Nobles.
Okay, then, maybe Mankiw’s argument is an argument against all taxes. But even then it won’t do as an argument against estate taxes insofar as the alternative to an estate tax is some other tax to which the argument applies equally well.
Mankiw has in fact made some pretty eloquent arguments against estate taxes in the past, and I am very sympathetic to those arguments. This is not one of them.