wealth tax

Do inheritances increase wealth inequality? The Productivity Commission says yes and no

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Are inheritances increasing wealth inequality in Australia?

The Productivity Commission released a report on this question this week.

Its report found that, in the past 20 years, wealthier households have received larger inheritances, on average, than poorer households.

Those inheritances have contributed to an increase in absolute wealth inequality.

However, growth in asset prices, particularly property values, is having a much bigger impact on wealth inequality in Australia.

Let’s have a quick look.

What the report isn’t about

The PC’s report, called “Wealth transfers and their economic effects“, isn’t focused on wealth inequality as a whole.

Instead, it’s focused on a specific phenomenon that contributes to wealth inequality.

It has investigated the phenomenon of “wealth transfers”: How much wealth Australians transfer to each other while they are alive (as gifts) or after they die (as inheritances).

The PC says little was known, surprisingly, about how much wealth Australians transfer to each other.

That’s why it investigated the matter.

It wants this report to be a source of basic facts on the phenomenon.

What questions does the report ask?

The PC’s report asks basic questions about wealth transfers, such as:

  • How much wealth is transferred between Australians each year, when and to whom?
  • How do people respond when they receive a wealth transfer — do they consume it immediately, or invest it to consume later?

Its report also tries to figure out if wealth transfers contribute to absolute and relative wealth inequality in Australia.

The PC says previous work by the commission found wealth inequality had increased in the opening decades of the 21st century, and it wanted to know if wealth transfers, specifically,  were going to contribute to future wealth inequality.

What basic facts are established in report?

The PC says wealth transfers are large and growing, with their annual value having more than doubled since 2002 in real terms — which takes inflation into account — as Australians have accumulated larger amounts of wealth. (See graph below.)

More than $120 billion was transferred in 2018 alone.

To put that in perspective, that was significantly more than Australian government expenditure in 2018–19 on health ($80 billion), and it was only 30 per cent less than total spending on social security and welfare ($170 billion).

PC wealth transfers

Inheritances vs gifts

The report says close to 90 per cent of wealth transfers in 2018 — just over $100 billion — were in the form of inheritances, which are passed on following death.

About half of all inheritances immediately went to children of the deceased, with the remainder going to a surviving spouse or to other family and friends.

About 2 per cent went to charity.

The PC found people, generally, received inheritances when they were already well-established, with the average recipient of an inheritance being: 

  • around 50 years of age
  • close to peak earning capacity 
  • established in a house.

It’s a different story for gifts. Children are the key recipients of inheritances and gifts, but they tend to receive gifts much earlier in life.

The average recipient of a gift was:

  • around 20 years of age
  • at the beginning of their career
  • yet to start a family or purchase a house.
PC gift recipients

Wealth transfers have increased absolute wealth inequality, and impede social mobility

The report says that, over the past two decades, wealthier people typically received more via wealth transfers, increasing absolute wealth inequality in Australia.

“This is intuitive because wealthier parents have more wealth to transfer to their children, and their children tend to be wealthier, even in the absence of those transfers,” the report says.

Inheritances also impede social mobility among older Australians.

It says wealthier parents tend to have wealthier children, and inheritances strengthen this relationship.

Inheritances move — typically older — children closer to their parent’s position in the wealth distribution after their parents have died.

In 2018, inheritances accounted for about one third, roughly 36 per cent, of the “intergenerational wealth persistence” among Australians aged 64–74, whose parents had both died.

So, if all wealth had been unexpectedly destroyed at the time of death and there were no inheritances, intergenerational wealth persistence would have been less by about one third.

Older Australians will hold a disproportionately larger share of wealth over time

The report says older Australians are projected to hold a disproportionately larger share of wealth over time, relative to their share of the population.

Inheritances passed on to the next generation are projected to grow in line with rising wealth among older age groups.

And the total amount will increase nearly fourfold between 2020 and 2050.

Housing wealth will be a huge driver: Older age groups own more housing wealth, they draw down on housing wealth slowly, and they inherit large housing wealth when they’re older.

Falling fertility rates mean people who die will have fewer children to leave their wealth to, contributing to larger average inheritances received per person.

PC older wealth

What about gifts?

The future size of gifts is projected to fall, relative to the size of inheritances, because gifts tend to be made years before death from a relatively smaller stock of wealth than exists when people die.

What about ‘relative’ wealth inequality?

The PC report spends some time explaining that inheritances reduce relative wealth inequality.

What is it actually saying?

Well, it says the less well-off in society get a bigger relative boost — than richer Australians — when an inheritance or gift comes their way.

Why?

Because, if you have little to begin with, a small amount of extra money can make a bigger difference.

Most people would think that’s obvious.

For example, if you own nothing and you suddenly inherit $20,000, it can literally be life-changing.

However, if you’re already sitting on $200 million, would you notice an extra $20,000 showing up in one of your bank accounts?

The PC says it has modelled various scenarios and, in most scenarios, wealth transfers are projected to increase absolute wealth inequality in the future and reduce relative inequality.

Welfare payments are far more important for reducing inequality

But the PC also says that welfare payments reduce relative wealth inequality by far more than wealth transfers.

In other words, Australia’s welfare system is very important for reducing inequality.

It says that the welfare system redistributed about $970 billion over 12 years, compared to wealth transfers of about $350 billion.

Welfare payments include pensions (Age Pension, Disability Support Pensions, etc.) and allowances such as Jobseeker.

The Age Pension is the single-biggest component of the federal government’s social security and welfare expenditure.

Age Pension
According to the 2019-20 budget, the Age Pension and other income support for seniors was worth $46.7 billion in 2018-19(Source: Parliamentary Library, Budget Review 2019-20 index, Social security and welfare)

The PC says wealth transfers and the welfare system both reduce wealth inequality in the immediate term, but the reduction provided by the welfare system is much larger.

In fact, Australia’s welfare system reduces relative wealth inequality by 20 times that of wealth transfers.

And, whereas wealth transfers increase absolute wealth inequality in the immediate term,…

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