That’s the subject of an article in Slate that leads with:
So, a Treasury secretary, a labor union leader, a hedge-fund billionaire, and an heiress walk into a conference call.
You will recall that the estate tax was temporarily repealed and it will come back in full force in 2011 unless some new legislation is passed. I have praised estate taxes before.
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July 24, 2010 at 9:46 am
Karen
The definition of fairness is this argument is unclear. It is not necessarily “unfair” that someone passes their wealth onto their children. If the society is one where there is a caste system and the same stock of wealth is essentially passed on from generation to generation and serves to keep people locked in the socio-economic class they were born into, then we can make a case that they inheritance system is unfair.
If instead the society is based more on a meritocracy system such that people are able to create new wealth/value by hard work and implementing their new ideas (entrepreneurship), then wealth creation and the ability to build a better life for oneself and one’s children actually drives economic mobility rather than hindering it.
In the latter case, is it really fair to tax that person’s wealth again when they die? Presumably the savings that went into creating the wealth were already taxed (if they were saved from past wages or dividends, or interest). If they were not fully taxed because much of it is locked in unrealized capital gains, the capital gains tax will take care of taxing it when their heirs unlock some of the capital gains through a sale.
The second issue, efficiency, needs to consider some of the enormous excess burdens of the estate tax. A great deal of resources are diverted from productive investment and spent on estate planning, tax sheltering and other means of legally avoiding the estate tax. That is for those fortunate enough to be able to do so. There are also a number of smaller family businesses who put all of their money into building their businesses. They often do not have extra funds to do adequate estate planning and are hit with a large tax liability when the owner dies. Further, these estates are not liquid, the value of the business is in its assets, intellectual property, land and other non-liquid forms. Therefore to pay the estate tax (the government doesn’t barter), the heirs must liquidate much of their business essentially destroying the value the owner had created.
Just some some additional considerations; when looking for a good mechanism to achieve particular goals, we need to understand what goal we are trying to achieve and understand the underlying environment (preferences, technology, existing institutions). Mechanisms that may work well in one environment could be very harmful in another. (Particulary it can do permanent damage to an entrepreneurial economy culture that is built on the idea of hard work and the American Dream)
July 24, 2010 at 11:00 am
twicker
Karen (et al.), to address a few of your points:
1) It sounds like you believe that, if a system is predominantly a meritocracy and, thus, wealth creation is based on meritocratic action, then *it will remain a meritocracy with wealth transfer between generations.* I am not at all sanguine about this proposition — because, after the initial creation, the subsequent generations merely need to hold onto their investments, not perform any further meritocratic behavior. They have the opportunity to become free-riders. (Further, I don’t believe that the US is as pure a meritocracy as we would like to believe, especially with much of our wealth tied up not in productivity-enhancing investments but in real estate (and dirt, by itself, doesn’t increase productivity), but that’s a different discussion.)
2) Re: capital gains: actually, no — unrealized capital gains are specifically NOT taxed when they are passed on to subsequent generations. The relevant tax information:
From the IRS: Frequently Asked Questions on Estate Taxes
“What happens if I sell property that I have inherited?”
http://www.irs.gov/businesses/small/article/0,,id=108143,00.html#13
“IRC §1014 provides that the basis of property acquired from a decedent is its fair market value at the date of death, so there is usually little or no gain to account for if the sale occurs soon after the date of death.”
So — any unrealized capital gain is, in fact, NOT taxed, because it provides the basis of the capital for the descendant (we’ll call her X), and the tax that X pays (or the tax writeoff that X realizes) is based on the difference between the capital that X received and the later gain or loss — not on the initial amount.
3) Please remember that, prior to the Bush tax cuts, small businesses/family farms/etc. had plenty of carve-outs in the tax law; those transfers haven’t been taxed in ages, and wouldn’t be taxed if the tax cuts lapse.
4) Also remember that the reason the taxes are *estate* taxes is that the descendants haven’t yet realized the gain from receiving the estate; thus, to make it easy, the estate is taxed. The purpose is not to “double tax” the recently deceased (which is a canard anyway; everything is taxed multiple times, including the money you use to pay for something where you then have a sales tax on top of income taxes, and which were brought to the store by businesses who paid gas tax, etc.). The purpose is to provide a way of taxing the unearned gain the descendants receive without first making the descendants responsible for paying the tax. In other words, it’s a way of taxing those unearned gains in the easiest, least-painful way possible for the recipients — even though the Republicans have now labeled it a “death tax” (much easier to sympathize emotionally with someone who dies than with someone who gains millions or billions because they were lucky enough to be born to the right person).
5) If you really want fairness and a meritocracy, then the obvious solution is that the entire transfer be treated as unrealized income, and then taxed as income when any part is withdrawn for whatever reason. This is, in fact, what happens: the child gains $X, not because the child worked hard for those assets, or because the child carefully managed those assets, or because the child earned the assets, or for any meritocratic reason. The child gains $X simply because *the child was born lucky* (or unlucky, if $X is small). So, if the parent wants to leave $X to her/his child — great, let the parent do that. But if the child then spends any amount of that $X (including any amount above $X that then grows because it remains in growing investments), the child should be taxed on that — just as much as the janitor or doctor or other person who works for their money should be taxed. The child didn’t earn the income they receive from the estate; the parent did. Go ahead and get rid of the “estate” tax, but then tax the people who realize unearned income. That preserves the meritocratic effects (the children don’t just get gifts, and they have a reason to preserve the capital without freeriding), and allows previous generations to pass on savings and capital to subsequent generations without fear of dilution.
Heck, the child can even avoid all taxes by preserving the entire capital of the estate — they just have to, you know, get a job and be a productive member of society. Which would pretty much be the definition of a meritocracy.
Which is a long-winded way to say that, while the past-and-(seemingly)-future estate tax is a blunt instrument that should be reformed to more-accurately reflect both what is happening and what should be happening, getting rid of any estate tax harms that very meritocracy and entrepreneurial spirit you cherish.
(And, again, as a reminder: small businesses and family farms have been excluded from estate taxes for some time now — specifically, with an extra deduction of up to $1 million; the extra $1 million for businesses actually expired in 2004 under Bush (see http://www.irs.gov/businesses/small/article/0,,id=108143,00.html#8 ). Again, thinking about the problems of small businesses and family farms helps the emotional argument of the Republicans, but those had, in reality, long since been excluded. I would agree that the amounts involved might need to be increased, but those concerns were long, long ago addressed and, now, serve no real purpose since only a few people on the far left disagree, even though the Republicans like to dissemble and pretend that it’s somehow part of mainstream liberal/progressive thought — which is patently false. And again, I’m PERSONALLY in favor of making the entire asset untaxed *until sale,* at which point the entire asset *would* be taxed unless reinvested and not used as income/consumption.)
July 24, 2010 at 2:43 pm
Dan in Euroland
But the “redistribution” that the gov’t does is based on public choice principles and not some philosophical (rawlsian) redistributive scheme. So supporters of the estate tax implicitly support a fairness doctrine entailing handing outs of tax benefits to those with the most gov’t connections (say wealthy farmers). Thus the fairness rule is ultimately defeated by the institutional structure.
Leonard Nelson once quiped that “ethics is meant to be applied” (or something close.) So if a person argues in favor of a scheme on ethical grounds, then those grounds should have empirical content. By empirical content I mean that the ethic rule incorporates and anticipates the incentive structure that is created. In short the ethical rule has to be actually applied in practice.
Here the fairness rule underlying the estate taxation is not applied in practice. Those taxed have significant influence among the State. Thus all manner of avoidance mechanisms are concocted further compounding the distortionary effect and nullifying the ethic rule.
March 19, 2014 at 3:50 am
Jade
As far as I know, you don’t pay taxes on money that is borrowed. What if you took out the equtiy from your home and asked for no pre-payment penalty? You might have a bit of a higher interest rate but you would avoid paying the capital gaines.