Fans of Piketty, trusts, wills and other matters may relish the Productivity Commission's paper Wealth Transfers and their Economic Effects, out today.
The Commission states
Until now, little has been known about how much wealth Australians transfer while they are alive (gifts) or after they die (inheritances), let alone how those transfers affect those who receive them, or the impact on the distribution of wealth in society. This report sheds light on these questions.
Wealth transfers are large and growing — over $120 billion was passed on in 2018, more than double that in 2002. Inheritances in particular, which account for around 90 per cent of all transfers, have increased steadily in line with the growing wealth of older Australians. In 2018 19 the value of the average inheritance was $125 000 compared to $8000 for gifts.
Conventional wisdom suggests that wealth transfers make the richest Australians even better off. And in fact wealthier Australians do receive larger transfers on average. But by the time people receive an inheritance, they will be well into middle age — about 50 years old on average — already established in their careers and housing, and many will potentially be nearing retirement themselves. So while inheritances weigh on economic mobility — by increasing the likelihood that wealthy parents have wealthy children — the effect is moderated by the lateness in life at which they are received.
What about inequality?
Wealth transfers have unambiguously increased the amount of wealth held by richer Australians. However, when measured against the amount of wealth they already own — and this may surprise — the less well off get a much bigger boost from wealth transfers. That is, wealth transfers increase the share of wealth held by poorer Australians, reducing relative wealth inequality. And we are not an outlier. This finding is replicated in every other country studied around the world. That said, in Australia, the moderating effect is quite small: a one percentage point change in the rate of return to housing wealth — a fraction of the average annual historical return — would have a much larger impact on relative wealth inequality.
What does the future hold?
Older Australians are projected to hold a growing share of total wealth. They will also account for a larger share of total deaths, and consistent with falling fertility rates, they will also have fewer children to pass their wealth onto. These factors are projected to drive a four fold increase in the total value of inheritances, which could lead to a significant increase in the total value of wealth transfers when compared to lifetime earnings. Nevertheless, absent a significant change in how wealth transfers are distributed or saved in the future — for example, because the wealthiest Australians receive a much larger share of total inheritances than in the past, or save a much larger share of their inheritances compared to less wealthy people — they are unlikely to significantly worsen wealth inequality in Australia in the coming decades.
We might of course ask about mechanisms such as trusts.
The paper comments
The wealth of the average older Australian has grown remarkably since the turn of the century. It has been buoyed by strong real growth in house prices and almost three decades of growth in superannuation balances, alongside low rates of asset drawdown to fund retirement. As such, many older, retired Australians, at a time of life where one would expect them to be drawing down their wealth to fund consumption, have actually accumulated increasingly large stores of wealth (figure 1). They transfer their increased wealth while they are alive (known as inter vivos gifts — ‘gifts’ henceforth) and at death (inheritances).
Although research into wealth transfers has a relatively long history overseas, little is known in Australia. This report seeks to fill that gap by creating a wealth transfer fact base for Australia to answer basic questions, such as: how much wealth is transferred between Australians each year, when, and to whom? And how do people respond to receiving a wealth transfer — for example, by immediately consuming it, or investing it to consume later?
We also investigate the contribution of wealth transfers to wealth inequality in Australia in the past and the (simulated) future. Previous work by the Commission found that wealth inequality had likely increased in the opening decades of the 21st century. Academic work by Piketty and others has argued that wealth transfers, and inheritances in particular, might contribute to worsening wealth inequality in the future. We do not find compelling evidence for this. As is commonly believed, wealth transfers do largely go to the rich, but on some measures wealth transfers actually reduce wealth inequality.
While there are many factors at work, government policies affect the accumulation of wealth and the terms and conditions of its transfer to younger generations (through the tax and transfer system, superannuation policies and the treatment of housing over the lifecycle, among other factors). Of particular relevance is the extent to which policies may be contributing to the accumulation of large stores of wealth by many households and individuals, which are increasingly persisting until death. This has led to debate about policy settings that encourage retirement savings. These policy issues are complex and are not covered in this report (box 1).
Superannuation tax and contribution arrangements have led to higher levels of private saving than would occur in their absence. As many people draw down only the minimum allowable amount of their superannuation, larger inheritances result.
Precautionary saving (in anticipation of high aged care deposits, unknown medical expenses and concern that the money might run out given an uncertain time of death) contributes to unintended inheritances as does uncertainty about asset returns. To the extent that people have poorly-informed views about risks or are unable to manage these risks through different retirement products, some older Australians can be deprived of higher consumption and wellbeing in their retirement.
Moreover, some older people use their liquid savings to meet their current consumption needs, but not draw down on their housing wealth because of a lack of attractive financial approaches to liquidate housing wealth, such as equity withdrawal. This behaviour is likely influenced by the favourable treatment of owner-occupied housing in asset tests for access to the Age Pension.
What we do in this study
We undertake backward-looking empirical analysis over the past two decades to create a fact base on wealth transfer behaviour (chapter 1), and investigate how wealth transfers have affected the distribution of wealth over that time (chapter 2). We also undertake forward looking empirical analysis by projecting wealth outcomes to 2050 to examine the potential impact of future wealth transfers on inequality under different scenarios (chapter 3).
The data
The key data sources for this analysis are: the Melbourne Institute’s Household, Income and Labour Dynamics in Australia (HILDA) survey; two probate datasets, which provide partial information about wealth at death for a representative Australian sample in 2010 and for Victoria in 2016; and tax file return data, which provides information about wealth held in superannuation accounts.
The breadth and depth of information about the wealth transfer behaviour of individual Australians in these data sources is somewhat limited. But, as this report shows, a wide range of economic analysis is still possible and there is good evidence that the constraints imposed by the data do not undermine the robustness of the findings. Indeed many of the findings in this paper about the impact of wealth transfers in Australia are similar in nature (if not magnitude) to the research findings from other countries, including research undertaken with much more extensive datasets.
Richer insights about wealth transfers in Australia could be facilitated at relatively low cost in the future by including additional questions in the HILDA survey — the only household level dataset for analysing wealth transfers in Australia — and linking administrative datasets with probate records (as the latter are progressively digitised).
What we find
Australian wealth transfers are large and growing
More than $120 billion was transferred in 2018 alone (figure 2) — to put this sum in perspective, this is significantly more than Australian government expenditure in 2018 19 on health ($80 billion) and about 30 per cent less than total spending on social security and welfare ($170 billion).
The aggregate annual value of wealth transfers has more than doubled in real terms since 2002, as Australians have accumulated larger amounts of wealth. The cumulative impact on wealth transfers is immense, with slightly less than $1.5 trillion being transferred since 2002.
The annual value of wealth transfers has more than doubled since 2002
Most transfers are inheritances given to (adult) children and spouses of the deceased
Close to 90 per cent of transferred wealth — just over $100 billion in 2018 — was in the form of inheritances, passed on following death. And about half of all inheritances immediately went to the children of the deceased. The remainder went to a surviving spouse or to other family and friends. About 2 per cent went to charity. The vast majority of reported gifts went to children.
Gift recipients are much younger
Children are the key recipients of both inheritances and gifts, but they tend to receive them at different stages of their life. The average recipient of an inheritance was, at about 50 years old, close to peak earning capacity, established in a house, and received about $125 000 (the median was much lower, at about $45 000 in 2018 19). In contrast, the average recipient of a gift was about 20 years of age, at the beginning of their career, yet to start a family or purchase a house, and received about $8000 (again, the median was much lower, at about $1000) (figure 3).
Wealth transfers have increased absolute wealth inequality but decreased relative wealth inequality
Over the past two decades, wealthier people typically received more via wealth transfers than poorer people, increasing absolute wealth inequality (figure 4, panel a) (box 2). 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.
That wealth transfers increased absolute wealth inequality is consistent with recent work by the Grattan Institute and the Treasury, which found that inheritances increase absolute wealth inequality because ‘they are not distributed equally’ (The Treasury 2020, p. 51) and they ‘tend to go to people who are already wealthy’ (Wood, Griffiths and Emslie 2019, p. 3).
A less intuitive result, but one that is replicated in research for all other countries for which information was available (Britain, France, Germany, Italy, Spain and the United States), is that wealth transfers reduced relative wealth inequality, because wealthier people received less in wealth transfers as a share of their existing wealth than poorer people (figure 4, panel b). For example, as a share of their existing wealth, transfers boosted the wealth of the bottom 20 per cent (quintile 1) of the wealth distribution by about 30 times more than for those in the top 20 per cent (quintile 5).
That said, wealth transfers have less of an equalising effect on relative wealth inequality in Australia than in all countries studied, except for the United States. This is primarily because Australian wealth transfers are smaller as a share of the total stock of wealth. ...
Wealth transfers increased absolute wealth inequality, but reduced relative wealth inequality
Wealth inequality can be expressed in absolute or relative terms. While relative wealth inequality is the more commonly invoked concept, both are valid and useful. Absolute wealth inequality is inequality in the dollar value of wealth held by each person in society. If every person’s wealth were to increase by a fixed amount, say $5, then absolute wealth inequality would be unchanged. If wealthier people’s wealth increased by more than poorer people’s wealth, say $10 compared to $5, then absolute wealth inequality would increase.
Relative wealth inequality is inequality in the share of wealth held by each person. If every person’s wealth were to increase by the same fixed share, say 5 per cent, then relative wealth inequality would be unchanged. If wealthier people’s wealth increased by a larger share than for poorer people, say 10 per cent compared to 5 per cent, then relative wealth inequality would increase.
If changes to wealth increase relative wealth inequality, they must also increase absolute wealth inequality. But changes to wealth that decrease relative wealth inequality do not necessarily decrease absolute wealth inequality.
The moderating effect of inheritances on relative wealth inequality persists
Studies of other countries have found that the effect of inheritances on relative inequality erodes over time because poorer recipients deplete their inheritances faster than wealthier recipients. Some studies have found that wealthier recipients earn larger returns to the invested component of their inheritances, while others have suggested that wealthier recipients consume smaller shares of their inheritances. (No studies exist for gifts.)
Our results suggest that the reduction in relative wealth inequality from inheritances persists in the longer term, because both wealthy and poor tend not to deplete their inheritances.
Inheritances impede social mobility among older Australians
As noted above, wealthier parents tend to have wealthier children, even in the absence of wealth transfers. Inheritances strengthen this relationship — which means inheritances impede social mobility — because they move children closer to their respective parent’s position in the wealth distribution. This effect is conceptually different to the effect of inheritances on wealth inequality. Among older Australians whose last surviving parent died in the past two decades, about one third of the association between their position in the wealth distribution (relative to their peers) and their parents’ position in the wealth distribution (relative to their peers, and when still alive) was because of inheritances.
Future wealth transfers are projected to increase in size
Consistent with trends over the past two decades, older Australians are projected to hold a disproportionately larger share of wealth over time relative to their share of the population (figure 5, panel a). This finding is replicated across a number of reasonable scenarios for rates of return on different assets, home ownership, savings and wealth transfer behaviour, while holding current policy settings fixed (box 3). Housing wealth is a large driver of this result (figure 5, panel b) — older age groups own more housing wealth, they draw down on housing wealth slowly, and inherit large housing wealth from their partners in old age. ...
Older people are projected to hold a greater share of wealth
Inheritances passed onto the next generation are projected to grow in line with rising wealth among older age groups, with the total amount increasing nearly fourfold between 2020 and 2050. Falling fertility rates — a long term trend evident in Australia since the late 1950s — means that people who die will have fewer children to leave their wealth to, contributing to larger average inheritances received per person. Projections of the value of gifts were based on existing gifting rates estimated from survey data (which may underreport gifts received). The 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.
Wealth transfers are projected to reduce relative wealth inequality, although behavioural changes could increase it In most of the scenarios that were modelled, wealth transfers are projected to increase absolute wealth inequality but reduce relative wealth inequality. The mechanics are the same as described above: even though wealthier people receive larger wealth transfers on average, less wealthy people receive wealth transfers that are a larger share of their existing wealth.
If wealthier people are assumed to benefit more from wealth transfers in the future — for example, because they receive a much larger share of total inheritances than observed in the past, or save a much larger share of their inheritances compared to less wealthy people — then there could be an increase in relative wealth inequality.
That said, the projected effects of wealth transfers on relative wealth inequality under all modelled scenarios are small. A one percentage point change in the rate of return to housing wealth — a fraction of the average annual historical return — is projected to have a much larger impact on wealth inequality than wealth transfers
