If you have frequented the camping grounds or motel strips of Middle America lately, you mayhave noticed graying couples driving station wagons and recreational vehicles festooned with bumperstickers that read: "We're Spending Our Children's Inheritance."
If the legend on these bumper stickers, which came on the market in the late Eighties, accuratelyreflected parental sentiment, it would imply a shocking reversal of attitude toward the institution ofinheritance. As far as we know, parents have always felt a strong obligation to transmit much of theirwealth to their children.
In truth, the people who display this slogan are not doing what they say they're doing. The bumpersticker bespeaks jocularity, not resentment or hostility toward inheritance. But it is a sign of thetimes, alerting us that ordinary people have come to sense that the patterns of inheritance are influx. If the bumper sticker were rewritten to articulate the true state of mind of the cars' owners,it would be unwieldy and unamusing. The text would read: "We Have Already Transferred to Our ChildrenDuring Our Lifetimes Most of What Would Formerly Have Been Their Inheritance from Us upon Our Deaths,and We Are Enjoying Spending Some of What's Left."
The changes in the practice of wealth transfer reflect changes in wealth itself that have occurredover the last century or so as a result of the vast technological forces that have transformed theproduction of goods and services. Whereas wealth used to take mainly tangible forms (real estate,plant and equipment, inventory, and personal artifacts), wealth in today's advanced technologicalsocieties is mostly intangible. The new wealth is of two main sorts. One category is financialassets stocks, bonds, bank deposits, mutual-fund shares, insurance contracts. The other great form ofmodern wealth is what economists call human capital the skills and knowledge that facilitate life inadvanced technological societies.
These changes in the nature of wealth, have dramatically altered the timing and the character ofinheritance. While wealth transmission from parents to children once tended to center upon major itemsof patrimony such as the family farm or the family firm, wealth for today's broad middle class ismostly transmitted as a radically different kind of asset: investment in human capital. Consequently,wealth transmission between generations now occurs while the children are growing up and the parentsare still alive, rather than upon the death of the parents.
The awesome demographic transformation of modern life has also affected the transmission of wealth.Those same parents who now make their main wealth transfers to their children during their own livesare also living much longer. The need to provide for parents in their lengthy old age has put a hugenew claim on family wealth, a claim that necessarily reduces the residuum that would otherwise havepassed to survivors. Furthermore, a new institution has arisen to help channel the process of savingand dissaving for old age: the private pension fund. The distinctive attribute of pension wealth isthat it tends to be distributed in the form of annuity payments. When wealth is annuitized, virtuallynothing is left for transfer on death.
The ever larger capital requirements of technologically advanced enterprises require modes offinancing that exceed the capabilities of the family. The corporation, as well as specializedfinancial institutions, arose to facilitate the pooling and allocation of capital. Corporations,banks, insurance companies, and other financial intermediaries displaced the family from its formerrole as the primary unit of capital accumulation. In turn, these intermediaries created new forms ofwealth in financial assets various securities, depository claims, and other contract rights.
These instruments of financial intermediation now absorb the savings that had previously been devotedto family enterprises. Because family wealth is no longer retained but rather invested externally, itnow takes the form of claims on outside enterprises. This new property, paper property, has become thecharacteristic form of transmissible wealth. As Roscoe Pound said in an arresting dictum, "Wealth in acommercial age is made up largely of promises."
The same underlying technological and economic forces have also stripped the family of much ofits role as an educational institution. The educational demands of modern economic life have becomeimmense, and so has the cost of providing children with this educational endowment. Calculationspublished in 1985 by George E. Johnson of the University of Michigan indicate that "education costssociety approximately as much as investment in nonresidential physical capital."
There is no mystery about who has been paying the bill for this vast expansion of education. Evenchildless people pay substantial sums in taxes to support the public educational establishment. Butfor present purposes, I want to focus on propertied families who are raising children. My point issimple: In striking contrast to the patterns of the last century and before, the business of educatingchildren has become the main occasion for intergenerational wealth transfer today.
Parental efforts to secure the benefits of education for their children often begin in early youth.There has been a huge increase in formal preschool education in recent decades. In the years of theirchildren's primary and secondary education, propertied parents either seek housing in suitable schooldistricts or send their children to private schools.
And then there is college. The popular press has paid much attention to the saga of ever-risinguniversity costs. A May 1987 Newsweek story supplied figures on the annual cost ofundergraduate education at Johns Hopkins. The $15,410 that Hopkins charged in 1987 for tuition, room,and board constituted 31 percent of a family income of $50,000 per year. By contrast, the $2,000 thatHopkins charged in 1960 represented only 15 percent of the inflation-adjusted equivalent family incomefor that year, which was $13,500.
Now it is quite obvious that very few families can afford to pay 31 percent of family income, oranything near it, on what we would call in an accounting sense a current basis. That is especiallytrue when the family has more than one child in the educational mill at the same time. For mostfamilies, therefore, these education expenses represent capital transfers in a quite literal sense:Either the money comes from savings (that is, from the family's capital), or debt is assumed (meaningthat the money is borrowed against the family's future capital).
The same Newsweek article that discussed the costs of a Hopkins education also recounted thesaga of a parent named C.Y. Lu, who had the financial misfortune to have one son attending Princetonwhile the other was at Harvard Law School. Mr. Lu was reported to have sold off investments, taken outeducational loans, and refinanced his home mortgage by $60,000, in order to raise a total of $140,000.Mr. Lu was quoted as saying, "I've told my sons, your education is going to be your inheritance."
Back in the nineteenth century or earlier, Mr. Lu would have husbanded his wealth and left it to hissons at his death. Today, in mid-life, he cashes out and goes into debt in order to fork over hissavings to Princeton and Harvard.
Nobody forces Mr. Lu to do this. He could have told his two sons, "Boys, I'll make you a deal. I'llbuy you out of those admission letters from Princeton and Harvard. Stay away from those cauldrons ofred ink, and content yourselves with attending the community college down the road or better yet, goright to work in an accessible career like pumping gas at the corner filling station. Then, I'll have$140,000 more in family wealth that I can invest. It will compound and be available for you on mydeath."
Well, we all know that virtually no parent behaves that way. Parents understand full well whateconomists have been demonstrating with their studies of human capital. Those degrees from Princetonand Harvard are superior investments when compared with any class of financial assets, by virtue of avery conventional test: The degrees produce a far larger income stream.
Had Mr. Lu's children been daughters, his financial predicament would not have improved. One of thegreat American social achievements was to extend the opportunity for formal education to women. Thattrend was epitomized in the nineteenth century with the proliferation of women's colleges. Today, morewomen than men attend college.
From the proposition that the main wealth transfer to children now takes place during the parents'lifetime, there follows a corollary: Children of propertied parents are much less likely to expect aninheritance.
People are typically middle-aged when their remaining parent dies, and middle-aged people are far lesslikely to be financially needy. It is still the common practice within middle- and upper-middle-classfamilies for parents to leave to their children most or all of any property that remains when theparents die, but there is no longer a widespread sense of parental responsibility to abstain fromconsumption in order to transmit an inheritance. Children no longer expect an inheritance, parents nolonger feel the obligation to leave one, and thus the whimsical bumper sticker.
The changes in the timing and character of family wealth transmission mostly affect the middle andupper-middle classes. School bills make little dent in large fortunes. There are intrinsic limits tohow much education an individual can absorb, and those limits are reached long before the holders ofgreat wealth would notice. Hence the educational expenditures that loom so large for moderatelypropertied families do not significantly reduce the wealth that families of great fortune cantransfer.
Although this twentieth century inheritance revolution mainly affects the middle andupper-middle classes, there is a deeper sense in which the forces that have transformed the patternsof wealth transmission for these classes have also touched the holders of great wealth. The newpattern has become a powerful social norm that has begun to chip away at the ethos of older notions ofinheritance.
In September 1986, Fortune interviewed some extremely wealthy people who planned to leave theirchildren only token inheritances. The story led off with the views of Warren Buffett, chairman of theBerkshire Hathaway holding company, whose personal wealth was then estimated at $1.5 billion. Mr.Buffett explained why he plans to leave each of his three children only a few hundred thousanddollars; having put the children through college, he said that he expects them "to carve out their ownplace in this world...." He thought that it would be "harmful" and "antisocial" to set up his childrenwith "a lifetime supply of food stamps just because they came out of the right womb."
Mr. Buffett's millions will go to charity. So will the $50 million fortune of New York entrepreneurEugene Lang, who sent his three children to college, gave each "a nominal sum" after college, andplans to disinherit them. He explained to the Fortune reporter: "To me, inheritance dilutes themotivation that most young people have to fulfill the best that is in them. I want to give my kids thetremendous satisfaction of making it on their own."
Most people of great means prefer to leave their wealth to their descendants, hoping to educate therecipients to use the wealth responsibly. Buffett and Lang are voicing an attitude toward conventionalwealth transmission that is not only quite exceptional, but also historically recent and veryAmerican. Behind it, I think, is the assumption that wealth is largely fungible, that the family'spatrimony entails no particular sentimental attachment or social significance. Americans increasinglyexpect personal wealth to take the form of earned income; that is, we expect it to be a return onhuman capital. Buffett and Lang have taken that expectation to its limit. In their eyes, conventionalwealth transfer has lost its legitimacy. The esteem once associated with holding property now appliesonly to earned income to wealth that embodies the fruits of human capital.
John H. Langbein is a professor at the Yale University Law School. Reprinted withpermission of the author from: The Public Interest, No. 102 (Winter 1991). ©1991 by NationalAffairs, Inc.