04 February 2010

Estate Taxes

ProfessorBainbridge | The Estate Tax

I see that President Obama wants to bring back the estate tax. The GOP wants to make repeal permanent. I'm more or less in the middle.

The politics and economics of taxing death are very subtle, as Bruce Bartlett once explained:
A man-bites-dog story occurred on February 18, when a group of rich people signed an ad in the New York Times opposing elimination of the estate tax. Since the estate tax only affects those with net assets greater than $675,000, it is per se a tax only on the "rich." Thus, when those upon whom the tax is levied protest its abolition, it is news. But in reality, it is not at all surprising that some rich people support the estate tax, because they benefit from it in many ways.

The truth of the matter is that those with great wealth pay little in estate taxes now. The bulk of the tax is paid by the modestly wealthy-- small businessmen, farmers and long-term investors--who may never have had much income. They often die not even realizing that they were wealthy, but without the elaborate tax shelters of the very rich. Their assets frequently have to be sold to pay the tax collector, making it impossible to keep them in the family.

Thus one consequence of the estate tax is that it makes it very hard for small businesses to become big businesses, and for modest wealth to become great wealth. It is no coincidence that many of the richest families in the U.S.--such as the Du Ponts, Mellons and Rockefellers--are heirs to wealth first created during the 19th century, when there was no federal income or estate tax. Those with such "old money" have always disdained the "nouveau riche" and done what they could to protect their social position against upstarts. The estate tax serves this purpose extremely well. ...
Good point.

Of course, the estate tax is as morally unjustifiable as taxing any other action or transaction without negative externalities.  "You're dead, therefore the State gets to have some of the money that you legally acquired."  Where's the morality of that coming from?  But we'll put that aside for the time being.

I think the estate tax is silly because it does not account for the number of heirs of the estate being taxed. Even accepting that accumulation of wealth is something sinister that we can legitimately target, why treat the bequest of $650,000 to one heir as more favored than the bequest of $70,000 to each of ten grandchildren?

Furthermore, why does the inheritor about to go bankrupt suffer the same tax penalty as the inheritor who is already rich before the bequest?  Inheritances should be taxed as income to the receiver, based on their financial status, not based on the status of the deceased.

We could resolve this situation even easier if we moved to my proposed lifetime tax policy.  Rather than arbitrarily assessing people's income level every 365.24 days, we keep track of total lifetime income and determine your tax rate based on that.  For starters, this gets us around the sticking point that high income does not equal high wealth.  "The rich" are not the same set of people as "those with high incomes this year."  To the point at hand, a generous bequest to an heir would push them up the lifetime income scale, moving them closer towards being treated as one of "the rich" for the rest of their life rather than it acting as a  singular blip.

I haven't puzzled through all the incentives changes this would bring about.  For starters you would probably need a flat tax rate coupled with exemptions that are still on an annual basis.  Perhaps we need some blend of this lifetime earning system and current year-based policy.  Maybe we blend the approaches by taxing based on income in a rolling window of ten years or so.  It's all pipe dreams at this point anyway...


  1. I'm 100% in favor of an estate tax, if drafted properly to exclude small family farms and businesses (which by the way it does). How can anyone actually argue that it burdens farms and business when less than 2% of estates are taxed and the dollar threshold is in the seven figures? Just doesn't make sense. Also, I would think that most people (as you do) who find the income tax morally unjustified and economically inefficient would be in favor of an estate tax? It's probably the most ethical tax the federal government could impose, right? And it has a minimal impact on people's economic choices.

  2. (1) You would know much better than I, but I am under the impression that small business (including farms) are excluded only if they are still businesses. Someone who sells their business before dying could not pass on the cash to their heirs without taxation. I don't have numbers, but I have it on good authority that this is vastly more common than it used to be, as most people do not want to carry on in their parents' footsteps as much. I am not sure why we would want to treat these two situations differently besides the warm fuzzy feelings we have for "family business." What business of it is anyone else's if I give my kid a $1M company or $1M in cash?

    (2) I don't think that a tax that only applies to a few people makes it either more or less moral. If it's wrong to do to one person, it's wrong to do to 100 million people. A tax that effects so few people is certainly less of a priority, which is why this isn't a big issue for me, but I still don't like it.

    (3) The dollar threshold is high, but again, I don't see that impacting the morality. That definitely impacts whether it's pragmatically justifiable, but not morality. Congress either has the right to confiscate a portion of an estate or it doesn't. I don't see how we can say "well, it's not okay if they take anything over X, but it is okay if they take anything over 2X."

    (4) You are absolutely right that it bears relatively little impact on people's incentives, compared to other taxes. I had not considered that, and it is a mark in the estate tax's favor.

  3. Yea good points. I might be reading your comments wrong. I guess I should have asked what you meant by morally unjustified. What I'm saying is that it only applies to the accession to the decedent's wealth, and theoretically that makes sense to me for a lot of reasons. I would have to check on whether family businesses or farms or whatever actually do get screwed by this.

    Thomas Jefferson thought that a decedent's property should be transferred to the state since it was unethical for one generation to bind the next in any way. This an interesting area for nerd(s) like me (us) who likes stuff that involves both economics and law.