Of Piketty and Perpetuities

For the first time since independence, in a nation founded in large part on the rejection of a fixed nobility determined by birth and perpetuated by inheritance, America is paving the way for the creation of dynastic family wealth. Abolition or evisceration of the Rule Against Perpetuities in over half the states along with the likely repeal of the federal estate tax mean that there soon will be no obstacles to creating large pools of wealth that will insure lavish incomes to lucky heirs for generations without end. The timing of these legal changes could hardly be worse. Marshaling innovative economic data extending back centuries, Thomas Picketty convincingly argues that the relatively egalitarian incomes enjoyed in developed economies from the end of World War II until around 1980 were an aberration and that we are in the process of returning to the historical norm of much greater income and wealth inequality. The driving force is the return to a world in which the rate of return to capital (r) exceeds the growth rate of national income (g) — another historical norm temporarily abrogated during the 20th century. The wealthy hold an extremely high fraction of national wealth, and when returns to that wealth exceed the growth rate of national income, their relative economic power (and all that goes with that) increases proportionally. The main contribution of this article is, unhappily, to explore reasons that this revival of unending inherited wealth is of even greater concern than previously thought. First and foremost, the savings rate to a significant degree will be set by the dead hand control of those creating perpetual dynastic trust. In order to insure that trust assets keep up with income and beneficiary class growth, settlors will need to mandate very high savings rates for trust income. In the long term excessive savings (in excess of the “golden rule” savings rate), perhaps surprisingly, can actually retard the growth of consumption. In the shorter term, in a well-known phenomenon called the “paradox of thrift,” high savings rates can cause recessions, make them more severe, and increase their duration. Second, beneficiaries of dynastic trusts lack the power to dissipate the pools of family wealth that provide their high incomes. Prodigal children’s spending of principal is a powerful force for reducing inequality and increasing socioeconomic mobility. When not barred from doing so, descendants’ ability to sell trust assets to fund even more lavish lifestyles means that they will buy copious goods and services from those with lower incomes and less wealth. Thus perpetual dynastic family wealth thus imposes real social costs. This article recommends the conventional solution to such negative externalities: calibrated taxation of the anti-social behaviors. Instead of reinstating the Rule Against Perpetuities, this article instead suggests imposing perpetuities taxes on dynastic trusts with rates set, as closely as possible, to equal the costs imposed in terms of lower growth; more frequent and sharper business cycles; higher inequality; and lower socioeconomic mobility.