Eric Rasmusen’s Weblog

Greg Mankiw has a post on a NYTimes op-ed by Austan Goolsbee on why the very rich do not spend more on consumption or donation. It is easy to see that more consumption isn’t worth the trouble. Mankiw and Goolsbee focus on bequests. Something I think might be the key is the timing of donation.

Suppose I have X that I intend to donate to charity. Should I donate it now, or at my death? Let us assume I am absolutely sure I won’t want to spend the money, so there is no precautionary motive for delay. There now are three considerations: taxes, option value, and investment policy.

Taxes are quite important, but complicated, so I won’t say much. If I donate now, I get the tax deduction now, to be sure. If I think tax rates will rise, though, because of the social security/medicare monster, maybe I’ll want to have the deduction later instead.

There is option value in waiting, because I might find a better charity than the one I’m thinking about now. In the meantime, the cash will be getting bigger, since I’ll keep it invested, so unless I think the benefit present charitable use is higher than the rate of return on investment for later charitable use, I don’t mind waiting.

Finally, and perhaps most important for the super-rich, there is the question of whether Bill Gates thinks the charity will invest the money as well as he could. Even I think it wouldn’t invest as well as I could, because I would invest in index funds whereas the charity might well be fooled by some fast-talking fund manager, or just by its own financial inexpertise. Bill Gates, however, got rich by keeping all his capital in one investment. That’s not a good way to maximize utility, but it’s the best way to get to be a billionaire, since diversification completely eliminates your chances of having all your money in the single best stock. It’s similar to the idea that a lottery ticket has a much better chance of yielding a million percent return, ex post, than investing in an index fund would. Bill Gate might either ex ante or ex post think he’s a pretty savvy investor, forgetting all his college dropout friends who *didn’t* become billionaires. Thus, he would want to keep on investing the money himself, in effect giving the charity not just the original sum, but his perceivedly expert financial advice.

The result: the super-rich spend little while alive, but leave big charitable bequests.

This entry was posted on Saturday, March 3rd, 2007 at 11:13 am and is filed under Economics, Thoughts-New. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.