In 1945, the allies won world war 2 and the united states was left as
one of the only manufacturing centres in the world that was not reduced to rubble.
This led to one of the longest periods of sustained economic prosperity in history,
as American industry rapidly improved the lives of a new wave of middle-class workers.
This all coincided with a massive spike in birth rates, because well people had
lived through years of grueling conflict and they were ready to start families.
The generation formed by this boom in new babies needed a name,
but the jury is still out on what that will be.
Generational naming conventions aside,
these post war babies are coming up against some harsh realities.
The sad guarantees in life are death and taxes.
We will actually cover both of these here, but the important one, for now,
is that the wealthiest generation in history is starting to retire, and die.
In doing so they will be responsible for the greatest wealth transfer
in history, as they pass along a collective 30 trillion dollars
to their beneficiaries over the next few decades just in the united states alone.
That kind of capital movement is going to have some extremely significant impacts on the economy
some of which we are already starting to feel.
So what is actually been passed along?
Will all of this stuff maintain it’s value in the hands of its new owners.
Should we tax it?
And finally, how might this actually be a huge economic problem.
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Properly addressing and managing the transfer of a
generations wealth could be the make or break for an economy.
If it is not handled correctly it could genuinely see assets
and businesses go without the stewardship they relied on with their previous owners.
But to give context to this whole issue it is important to first understand
What is being passed down
The collective value of expected inheritances over the next few decades
are by some estimates approaching 100 trillion dollars worldwide.
This worldwide figure is a little less concrete and a lot harder to reliably quantify than the USA
where records tend to be a little bit more rigid.
In the US the number that we are looking at is 30 trillion dollars,
of which around 9 trillion dollars is in the form of typical liquid and semi liquid assets.
This is things like cash, cars, boats, beanie baby collections, share portfolios and houses.
All of this money changing hands is bound to give a boost to the wallets
of a younger generation which has famously been saddled with economic headwinds like
student loan debts, stagnant wages and turbulent job markets.
You might be forgiven for thinking oh this is great it is going to finally give millennials
the healthy financial boost they needed to get in to homes, or
unsaddles themselves of debt, or even just become bigger spenders.
And while there are definitely going to be some good things
that come from this transfer it may not be all good news.
But from the top
The first impact this will have is an upwards pressure on demand.
A paper published by the American economic review found that around 70% of households
who received an inheritance windfall had spent all the money within the space of 5 years.
This is obviously terrible financial management on their behalf, but for the wider economy
that frivolous spending will create jobs and business opportunities for people.
Probably people in the jetski industry.
It’s worth quickly noting that this paper and its findings are oooolllddd,
it was originally published in 1959 and then revised for 1961,
but since then consumers marginal propensity to consume has only risen
meaning that for every extra dollar people are
receiving they are spending a larger portion of it rather than saving.
also more recent but less comprehensive studies are still finding the same figures.
This is an interesting phenomenon and there are a few things to pull apart from these transfers.
For starters smaller inheritances are more likely to be squandered.
Now obviously it is easier to spend less money than it is to spend up more money,
but it more has to do with where this money goes.
An inheritance of less than $100,000 is not necessarily life-changing for most US citizens.
Don’t get me wrong, it’s alot of money, but it won’t let the average person
quit their job and it probably won’t accommodate a house purchase either.
Of course, $100,000 would be a healthy deposit for a house pretty much
anywhere in the world, but it would still be up to the recipient of the inheritance
to qualify for financing for the remainder of the purchase price.
An asset-based inheritance may give someone an injection of cash,
but it doesn’t increase their incomes or polish up their credit score,
so more often times it is difficult to deploy this capital effectively.
Of course, the relatively financially savvy viewers that make up the audience of an Economics
based youtube channel will probably point out alternative investments like the stock market.
This is not a bad plan, but in reality, most average people are pretty scared of
investing directly into shares. A 2016 Gallup pole noted that only around 25% of americans
are directly invested in shares outside of things like 401k’s and roth IRA’s.
Now considering the median inheritance in the USA is around 69,000 dollars it
is reasonable to expect alot of this money will be squandered rather than deployed into
investments that will increase the standard of living for the recipients long term.
Another important point to note is that while the median inheritance size is
$69,000 dollars, the average inheritance size is over $700,000.
Whit this means is that a large majority of this wealth transfer is coming from,
and going to wealthy households.
Now for the more regular recipients there is one other option available to handle this cash,
and that is paying off debt.
The average student loan debt in the USA
is $32,731 as of 2019 according to the federal reserve bank.
This is ignoring totally ignoring consumer debt
A financial windfall like this might motivate people to just pay out debt, which on an
individual level is probably pretty responsible, but economy-wide, it means no consumption, and no
investment, which makes GDP figures sad. Now this is all ignoring the big elephant
in the room. So far we have only looked at a poultry 9 trillion dollars worth of wealth.
Now this 9 trillion dollars comes from pretty much any asset type that you can slap a price tag on.
So it begs the question, where is the remaining 21 trillion dollars coming from?
Well, its coming from the vast collection of
Private companies
Private companies, those are businesses that are incorporated but are not publicly listed
make up the majority of wealth held by individuals over the age of 65.
These businesses can be anything from a family restaurant to Koch industries but
it tends to be that business owners control a larger portion of wealth.
Another quick side note is that this figure includes trust structures.
Trusts are an effective way to disperse assets to beneficiaries before
and after the deaths of the individuals that a contributing to these entities.
I will leave a link in the video description on a video that properly describes the ins
and outs of trusts, but briefly they are basically just buckets of assets with
designated managers which control the money, for the benefit of well, the beneficiaries.
These entities are particularly popular amongst wealthy individuals
because it means they can give money to their children while leaving something like a law
firm in charge of actually managing the money. This means they can set rules and limitations
about how the money is accessed and used, like they can only draw a certain amount per year,
or the beneficiary needs to get a college degree to acess the money or whatever weird and
wonderful stipulations rich people come up with to control their children from beyond the grave.
All of this is of course why wealthy children get the title trust fund baby.
Now wealth inequality argument aside, trust funds and trust fund babies are not necessarily the
problem here, it’s more so the genuine businesses that are out there functioning day to day.
Imagine an auto mechanics shop,
a majority of the value of that business will come from it’s ability to fix cars.
If this businesses gets passed along in a will there is no guarantee that the
beneficiaries of the previous proprietor will be technically proficient in auto repairs.
In this very simple example that would mean that
this businesses would loose a good portion of it’s value.
Now of course larger businesses might have employee’s in place that
can handle day to day work but loosing the owner can be very destabailising.
How many examples are there of businesses out there that have been successful run by a CEO
after they were promoted into that role from their previous position as son of the CEO?
Of course, successful handovers do happen but reputations exist for a reason.
A US census bureau study found that 2 thirds of family businesses do not
survive the transition from the first generation to the second,
of those that do survive only 50% then make it on to the third generation.
Even for people that don’t have a loverly family business coming their way
this is a real concern. Family run small to medium size enterprises
made up around 50% of the USA’s gross national product in 2019.
In many other countries around the world, this figure is even higher.
If 50% of these businesses go bust that will mean job losses,
productivity losses, and supply chain problems for the entire world.
Now of course there will be businesses that come in to replace businesses that shut down,
but this transition is not always as smooth as the perfect little economic assumptions that we make.
Structural inefficiencies are going to be a major concern during the post-boomer boom.
Now with so much at stake the logical question is how is this all been managed…
Or more specifically
How is this been taxed?
Most developed nations in the world today have some form of
estate tax that is levied on the passing down of assets.
This includes the united states where there is a federal tax of 40%
is charged for estates over 11.68 million dollars in value.
Of course given this high value, the charges don’t apply to
99.9% of inheritances but for those that it does those charges are pretty steep.
Multi million dollar estates are more likely to involve some kind
of family business which raises the question of accelerating the problems we saw earlier.
If a business is struggling through leadership transition the last thing that they will need
is for uncle sam to stick his hand out and ask for 40% of their value paid out in cash.
This may very well force the beneficiaries to just
sell the business off to cover the tax burden which will again cause business turmoil.
Now an entire industry has actually grown around this where institutions like insurance companies
will offer life insurance policies to cover the estate tax burden.
Beyond this it must be recognised that the actual valuations given to family companies can be
pretty fluid and more often than not these institutions
are valued lower than they probably should be for reporting purposes.
Even more to the point, an 11 million dollar family business would likely
have some kind of succession plan in place with pre-existing employees in executive positions.
Now the argument for an estate tax is that sure it might cause some turbulence in large institutions
during a transition phase but that can be planned for, even if it means taking on a loan,
selling some shares in the business or lets be honest. Sitting down with an
estate lawyer and jumping through some loopholes.
This tax provides strong revenue from people that can, of course,
afford it. while also reducing the tax burden on smaller businesses or
regular folks that might only get few thousand dollars in their trust fund.
A best of both worlds approach has been presented
to just tax larger businesses more during their regular operations to
avoid the massive disturbance that comes from this transition period.
Let us know what you think the best way for governments to handle the
great wealth transfer will be in the comments below and as always we will
discuss the most upvoted answer in this weeks q&A.
Until then we can rest easy knowing that an estate tax is doing exactly
what wealthy business owner want it to do. Tax them over their dead bodies.
Final thoughts
The great wealth transfer is coming and it is going to have
very significant impacts of individuals businesses and companies across the globe.
While you might not personally benefit from a nice fat trust fund it is still
worthwhile knowing that this will be a period of great opportunity.
Chaos is a ladder and the inefficiencies created by businesses changing hands,
shares been sold and inheritances squandered
will create huge opportunities for those savvy enough to take advantage of them.
Long-term the impacts are very hard to predict,
but money moving from the hands of a generation with a high propensity to horde and save wealth
to a generation with a high propensity to spend it is going to cause some kind of boom.
We just can’t be sure which type.
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