FREEDOM TEMPERED BY SECURITY:

The Theorist: MIT’s Iván Werning uses theoretical models to find the best economic policies on estate taxes and unemployment insurance (Caren Chesler, November/December 2007, The American)

In his paper entitled “Inequality and Social Discounting,” written with Harvard University economist Emmanuel Farhi and published this past June in The Journal of Political Economy, Werning explores inequality and whether estate taxes should help mitigate it. If you’re born to rich parents, you’re more likely to be rich as an adult than if you are born to poor parents. Wealth gets passed on.

Previous studies have shown that the most efficient economic system causes inequality to grow. Policies that reduce inequality are believed to have a trade-off: If you punish people too much for doing well—by reducing their incentives to pass on wealth to their children—these people will reduce their effort, to the detriment of the economy as a whole. But allowing inequality to increase concentrates the world’s wealth into fewer and fewer hands.

Werning found that the models at the core of these judgments were incomplete. Allowing inequality to grow, unfettered, is economically optimal only if one looks at just the first generation. But if you take into account the children of first-generation parents, and their children’s children, then the most preferable system is not one that allows inequality to grow, but one that attempts to stabilize the distribution of wealth.

His paper shows that the transmission of wealth should be regulated to prevent an accumulation of luck—that children should essentially be insured against the family into which they are born.

In a follow-up paper, entitled “Progressive Estate Taxation,” also written with Farhi, Werning discovered that the best approach would be to encourage parents to leave bequests to their children, and that government should, through subsidies, help the poor pass on money to their heirs.

Werning and Fahri found that these subsidies to the less well-off, not taxes on the rich, were the best incentives for reducing inequality. “Current policy is definitely on the side of taxing and not subsidizing. Our model doesn’t necessarily lead you to that conclusion,” Werning

Thus the genius of the various savings accounts that the Third Way advocates--HSAs, O'Neill accounts, personalized SS, personal Unemployment Insiurance, etc.--which would be inheritable.

Posted by Orrin Judd at December 5, 2007 8:33 AM