Inheritance and Entrepreneurship Fail

Entrepreneurs are great. The fact that Dragon’s Den makes great TV and that Joseph Schumpeter thought they were great more or less confirms it.

The Other TaxPayers' Alliance, <em>our</e> TaxPayers' Alliance

The Other TaxPayers' Alliance, our TaxPayers' Alliance

Most in a society will always tend to favour a safe, pleasant life, if they can get it. So individuals who act to take risks and experiment are vital. By taking risks and attempting to innovate entrepreneurs add value to the world around them. They help create new technologies or organisational structures which change the way we live our lives. Ultimately they help unleash the storms of Creative Destruction which have helped create the tremendous wealth we see around us. Even as the price for this has been tremendous suffering. [1]

The TaxPayers’ Alliance have a new report which attempts to attack Inheritance tax from a new angle. They have proposed that our Inheritance Tax is a bar to entrepreneurship and job creation. In a recession, job creation is vital to recovery and so this tax and they argue this tax should be scrapped. This is a nonsense argument for a number of reasons.

Won’t someone please think of the Children

Firstly we will consider their argument that Inheritance Tax reduces the incentive to experiment, invest and save because it reduces the amount you can pass on to your children. This argument is dealt with well here and here. The TaxPayer’s Alliance claim that taxation on income, savings and inheritance lead to an effective tax rate of 90% and reduce the incentive to interest, start a business or innovate within an existing one.

Anyone who knows any entrepreneurs or the literature on entrepreneurship in general, will know that analysis of future inheritance tax rates rarely figure in the list of reasons businesses are started. You don’t consider your death before you have even lived.

Dropping bags of Money from Hearses

A second argument which has been proposed is that Inheritance is an effective method for providing low cost capital for business start ups. Forgive me for saying this of the TaxPayer’s Alliance (who I lampooned here and there only today) but there is a reasonable level of logic behind this argument.

It has been suggested by Dani Rodrik and James Galbraith and others that the market produces less entrepreneurs than is optimal. In other words, investment for entrepreneurs is undersupplied because, although the benefits are widespread, those who invest are not able to capitalise on all of this increase in wealth. Investors therefore do not provide as much capital as is best for society overall.

However there is no evidence or theory which suggests that allocating resources at random throughout the population, by virtue of birth alone, is a better way of stimulate entrepreneurship than a more redistributive system. The TaxPayers’ Alliance propose that creating a tiny minority of arbitrarily enriched individuals will boost entrepreneurship in the most efficient way. This is not ture.

It is, in fact, yet another reason to ask:  Who fund the TaxPayers’ Alliance? What are their links to the Tory Party? Why don’t they target corporate tax avoidance? Why are they so obsessed with Inheritance Tax when it affects only 6% of estates? And why don’t they stop pretending to represent you and I?

[1] Unfortunately, one factor which is always ignored by the pro-entrepreneur anti-redistribution right is that those employed by entrepreneurs are taking every bit as much a risk as the entrepreneur themselves. If a company fails then employees are in almost as precarious a position as the entrepreneur. Conversely, if a company is a success then they usually obtain at best a very minor share of the payout.

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8 thoughts on “Inheritance and Entrepreneurship Fail

  1. Good post.

    Though not sure why you think Entrepreneur needs a capital E.

    Sorry, I’m a serial pedant.

    1. Hmmm, a bit over zealous definitely. I’ve changed it now.

      Don’t worry, I’m a pedant too. Your not the only one who would be annoyed by this sentence.

  2. I dunno, I suspect that on the narrowest consideration, randomly giving kids a few million quid probably would raise overall levels of entrepreneurialism (probably not by making those kids entrepreneurial, but by giving them the cash to invest in their entrepreneurial peers). The argument goes that in a hypothetical egalitarian society, nobody has enough money to invest the sums needed to do ‘crazy’ innovation. The large sums of money would be controlled by institutions (possibly, but by no means necessarily state institutions) which would probably be risk-averse and would certainly be likely to oppose any innovation that could be a risk to their position, and would probably tend towards groupthink to boot (and thus if one institution can’t grasp the value of an innovation, none of them will be able to and thus the investment isn’t made). On the other hand, the existence of ‘independently wealthy’ individuals who might, actually, be a bit irrational helps to keep the ‘investment gene pool’ varied. Hayek argued something akin to this in ‘The Constitution of Liberty’.

    I don’t think that this answers everything, but it’s not a totally stupid point. That said, I suspect that the inheritance of anyone whose parents were rich enough to pay IHT at the present levels is more than enough to fund a startup or two, which rather undermines the TPA’s point. An example, perhaps, of a Laffer-esque curve that works against the TPA?

    1. I don’t think the TPA are making a serious argument here though. I hardly think it is meant to be taken seriously. They just know that some people are going to use it as ammunition in their fight for a less fair Tax system. Well, a Tax system which benefits the wealthy, call that what you want.

      ! dunno, I suspect that on the narrowest consideration, randomly giving kids a few million quid probably would raise overall levels of entrepreneurialism (probably not by making those kids entrepreneurial, but by giving them the cash to invest in their entrepreneurial peers).

      I have to disagree. Inheritance is a very bad way to encourage entrepreneurs, this money has no price on it, even a below market one. Therefore there is less incentive to invest it and an incentive to just consume it as income. Taxing it at 100% and dropping it at random around the population would have the same affect.

      On top of that you have to consider how usefully those funds it could be used elsewhere. For example, if used for reducing the burden on new businesses it could make those first few months less risky. Or if used to fund a tax draw-back for R&D investment. There are any number of ways it could be used more efficiently.

      I don’t think your argument on an egalitarian society are relevant here, I’m afraid. The TPA are just arguing to make a very unequal society more unequal. (And as a side note so very big and important companies do a lot of innovation and invention, google for example. Or Japanese firms in the late 20th C. Schumpeter would label certain firms R&D departments as entrepreneurial, because they can and do take risk and add value).

      1. On top of that you have to consider how usefully those funds it could be used elsewhere

        Yes, but we’re back to a situation where institutions have to hand out the cash. Tax breaks are all well and good, but we actually already have generous R&D tax credits. What I’m talking about is investment, of sums of £100k-£2million, into startup/early-stage companies – the Googles of tomorrow, as it were. In parts of the country (basically outside of London and the Home Counties) a substantial proportion of investment comes from the government and semi-governmental institutions (ignoring here the status of the banks). Where I live, this means the North-West Development Agency. They are atrocious at funding early-stage innovation because they are incredibly risk-averse. They require not just copious business planning but also, for grants/investments over a certain amount, they require you to already be turning a profit and have shown a record of successfully spending investment cash. In short, you aren’t going to get a speculative investment from them.

        It’s very tempting to say that we’d be better off if we took the cash away from the undeserving rich and gave it to institutions set up to ‘promote innovation’. But I worry about the homogenisation of the investment decision-making pool and I don’t think it’s unreasonable to be rationally in favour of having some perfectly undeserving people in charge of such funds, simply because I suspect that they’re more likely to throw the cash at a genius/madman with a good idea than the regional development agencies are.

        On the subject of innovation in big firms, I’m not sure. Most of Google’s greatest innovations came in their early stages (PageRank when they were tiny, Map/Reduce is pretty old now too, as is BigTable). Their recent innovations came from outside – Google Docs was a buyout of Writely, Google Wave came from an acquired software team, Google Chrome is basically just a layer on top of the open source WebKit browser that was originally developed as KHTML for a Linux variant, Google Voice is a buyout of GrandCentral, YouTube was bought out, Google Analytics was built on the open source Urchin software, et cetera. The myth of Google as an innovative firm is pervasive and wrong – they’re a very successful near-monopoly advertising brokerage firm with a brilliant PR department (one can see why the Tories think that Google is to be worshipped as the way of the future).

        I don’t really want to be in the position of defending the TPA, mostly because I don’t really agree with them. I think that there is some perversity at work here, in that in an unequal society with scarce resources there might be a net societal benefit in there being some of us with a few million quid to invest on the basis that it’s better than there being nobody in that position. Given where we are, the TPA might actually be ‘not totally wrong’, as it were. But in a hypothetical society where average levels of income were higher (and income taxes lower?), and investment was easier to find for businesses, they’d be dead wrong. Unfortunately, it’s easier to point out the problems with the TPA’s arguments than it is to figure out how we create a society in which the TPA are irrelevant.

        1. Yes, but we’re back to a situation where institutions have to hand out the cash… Where I live, this means the North-West Development Agency. They are atrocious at funding early-stage innovation because they are incredibly risk-averse.

          Good point, I hadn’t realised that you had some experience with these sorts of institutions. However, State sponsored entrepreneurs have worked well in other countries as they were developing. I don’t think risk aversion is something which can’t be overcome with the right incentive structure in place. Moreover, I don’t think it’s the really risky investments that the state should specialise in. It’s the investment with a really long time horizon where government can excel, because they can operate at a loss and wait for a return longer than a private entity.

          While it’s true that large institutions can be risk averse, there’s nothing inherent in inherited wealth that would make one take risks with it either. Let’s be honest, if someone has inherited something there are a lot of people who would think it irresponsible to take a risky punt with it.

          In the end, using IHT to reduce the tax burden in general (and not just ring fencing the tax collected for funding entrepreneurs), would do more to increase consumption and savings and entrepreneurship, than removing IHT altogether.

          Tax breaks are all well and good, but we actually already have generous R&D tax credits.

          They are not that generous when you consider how vital R&D is to a post-industrial economy. If you look at the current Vesta occupations you see how our Government are allowing a firm to destroy jobs for workers with the tacit knowledge good R&D funding can create.

          When you look at the technological challenges ahead of us you have to admit that the market cannot fund the R&D needed. I come back to the sort of longue dureé attitude I mentioned above, where the Government should have invest in things with a long and slow payout.

          Sadly, I don’t think the TPA are a product of a particularly poor tax regime, or of a Labour Government’s “fiscal irresponsibility,” there’s no easy way to get rid of them.

          I don’t think we will see a “society where TPA are irrelevant” soon, because there are too many wealthy individuals who need a semi-respectable attack dog to do their dirty work.

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