It seems to be happening more and more these days: economists and tax experts use words that sound interesting at first glance but, on closer inspection, turn out to mean very little. Terms such as ‘unearned wealth’ and ‘windfalls’ suggest that people receive ‘free’ economic benefits or enjoy ‘increases in value’ for which no effort has been made. In this way, those who use these terms hope to create a basis for levying taxes.

Undefinable terms

The major problem with concepts of this kind is that they are difficult to define. As I previously demonstrated, it is virtually impossible to accurately determine the actual economic gain on a property. It is still possible to calculate a price increase, but as soon as we factor in maintenance, financing costs, renovations, taxes, one’s own labour and inflation, it becomes much more difficult to determine which part can actually be regarded as economic gain. Remarkably, the WSJ recently published a similar article.

Even if it were possible to calculate the actual increase in value of a property, the question remains as to how much of that should be regarded as risk compensation. After all, the buyer took a significant financial risk at a certain point and had to bear the uncertainty for years. The same applies to investment gains. These can be broadly divided into compensation for inflation and compensation for risk – neither of which are, by any means, ‘free’ gains. Analyses must be carried out, risks taken, costs incurred and periods of uncertainty endured.

Even in the case of inheritances, it is doubtful whether the term ‘unearned’ is as self-evident as is often assumed. Parents have probably deliberately built up their wealth whilst bearing the associated risks. Children have sometimes contributed directly or indirectly to that wealth, for example through a family business or other forms of support.

Moreover, there are other sensitive points of discussion when it comes to inheritances. Parents or grandparents could also have spent their wealth during their lifetimes on consumption, charitable causes, or gifts to their children. In the latter case, we are suddenly no longer talking about an inheritance, but about a gift. From an economic perspective, the distinction is less significant than is often assumed.

Furthermore, an inheritance can be seen as a form of deferred consumption. The assets could also have been spent on holidays, cars, luxury goods or other forms of consumption. The fact that this was not done means that, in economic terms, an inheritance represents the present value of consumption that never took place. From that perspective, inheritance tax can also be seen as a levy on long-term saving and deferred consumption.

What is earned?

To test the strength of a concept, logic sometimes employs a reductio ad absurdum: we take a line of reasoning to its ultimate conclusion. In this way, I could also argue that virtually everything is unearned. The entrepreneur benefits from an innate talent, the investor from market conditions or monetary policy, the employee from intelligence, health and upbringing, and the homeowner from the location where they happened to end up.

Anyone who claims that an inheritance is unearned because the recipient did not work for it would have to say the same about intelligence, health, talent, upbringing and social networks. People have not chosen or earned these things either. The concept of ‘unearned’ then becomes so broad that virtually every economic success falls under it.

Nobel Prize winner Friedrich Hayek made a similar point. According to him, the market does not reward a person’s (moral) merit, but rather what other people value at a given moment. A brilliant scientist may remain poor, whilst a pop star earns millions. That does not mean the pop star has greater merit. It merely means that consumers value their achievements more highly. The distinction between deserved and undeserved therefore turns out to be less clear-cut than is often suggested.

In this context, Nassim Taleb also emphasises the importance of chance in his acclaimed book Fooled by Randomness. Much success arises from a fortuitous combination of skill, risk and timing. We mainly see the winners who have become rich, but far fewer of the thousands of people who work just as hard and yet ‘fail’. This makes it dangerous to declare with certainty, in hindsight, exactly which wealth is earned and which is unearned.

Final thoughts

Supporters of inheritance tax will counter that it is not the deceased but the heir who acquires a new financial position. That seems a legitimate argument, but even so, the question remains as to why that financial position must automatically be labelled ‘unearned’ rather than a voluntary transfer of ownership by the testator.

Ultimately, the economically relevant question is not so much whether wealth is earned or unearned. The central question is which taxes cause the least economic distortion. As soon as terms such as ‘unearned wealth’, ‘free profit’ or ‘taxable windfall’ are introduced, the discussion shifts from economic analysis to moral judgement.

And that is precisely where the problem lies. Anyone who calls something ‘unearned’ has, in fact, already made a normative judgement. We are then no longer talking about positive economics (objectively: if x happens, then y happens), but about normative economics, which bears a strong resemblance to political philosophy. That is, of course, perfectly acceptable, but let us then also be honest about what is happening. In the book mentioned earlier, Nassim Taleb puts it in his usual incisive way: ‘Normative Economics is like religion without the aesthetics.’

This article contains a personal opinion by Harry Geels

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