David R. Henderson  

The Perverse Death/Estate Tax

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Paul Krugman recently posted about Donald Trump's proposal for eliminating the death tax, aka the estate tax. But Paul really only scratched the surface. The death tax has a number of perverse effects, none of which Paul discusses.

You might think that I've already biased the issue by using the term "death tax," a term many conservatives have used to describe what is known formally as the estate tax. But actually what I've done is, however imperfectly, removed the bias. The estate tax is not a tax on estates. You could have a $100 million estate and pay zero taxes on it. What triggers the tax? Your death. So it's a tax on net worth that kicks in when you die. For that reason, the term "death tax" is just as accurate as the term "estate tax." Of course, death tax isn't quite right either because you don't pay a tax for dying if you don't have an estate. So the best term might be, however clunky, "the estate tax on people who die." What I'll do below is use the terms "death tax" and "estate tax" interchangeably.

I remember reading about 20 years ago in, I think, an NBER study that the estate tax costs the federal government revenue. You might think that claim must be incorrect. A quick look at the data shows, after all, that in 2014, the federal government's death/estate tax revenues were $19.3 billion, or 0.6 percent of total federal revenue. So how can I say that the tax costs the federal government revenue?

Answer: the unseen. That is, the tax causes people to make other adjustments, typically well before death, that reduce the government's tax revenues from other taxes. One standard way is to put assets in your children's name. But then your children are typically in a lower income tax bracket than you are. So the income from the assets is taxed at a lower rate than if you didn't transfer the assets and the feds raise less revenue from the income tax.

The estate tax causes the government to lose revenue in other ways too. One way is that it reduces the incentive to accumulate capital and the lower capital stock leads to lower productivity than otherwise. Lower productivity means lower total output and, with lower total output, federal corporate and income tax revenues are lower. And it's not proportional. If the growth rate falls by, say, 0.1 percentage point, federal corporate and income taxes fall by more than 0.1 percentage point: a good guess would be that they would fall by about 0.15 percentage point. Economists refer to this relationship as the elasticity of the taxes with respect to output. Why this more than proportional fall? Because the higher income that would have been taxed would have been taxed at people's marginal tax rates--and marginal tax rates substantially exceed average tax rates. A given fall percentage drop in this income, therefore, leads to a higher percentage fall in tax revenues.

This somewhat dated piece by David Block and Scott Drenkard of the Tax Foundation, "The Estate Tax: Even Worse Than Republicans Say," gives other reasons that the death tax could cost the government revenues, as well as showing other perverse results of the tax.


Comments and Sharing


CATEGORIES: Taxation




COMMENTS (41 to date)
Mike W writes:

How does one "put assets in your children's name" without paying the gift tax...which is essentially the death tax on transfers before death? Sam Walton did it but the assets had zero value at the time of transfer.

If the threat of the estate tax encourages the wealthy to set up and transfer their wealth to charitable foundations rather than pay the government is that such a bad thing?

Ben G writes:

"that it reduces the incentive to accumulate capital and the lower capital stock leads to lower productivity than otherwise."

Do you seriously believe that the (probably very minor) disincentive to accumulate more capital before death from this tax results is a big of a hit to productivity than children being showered in huge inheritances? Also, please tell me how property is productive capital? I find it hugely unlikely that individuals will reduce investment in productive capital before death as businesses are mostly exempt from estate tax, so you can invest in extra capacity for your business without 40% of it being taken away when your death comes.

The elite's children are far more likely to go into high-earning and more productive jobs than the average person but, I'd imagine that if they're given or are destined to get inheritances of millions of dollars, their incentive to work as hard, get a better education or stay in the labor force at all is diminished considerably, therefore hitting productivity.

Inheritances taxes, I fully believe, are the only taxes that have an ability to do good on a society. They are vital in ensuring equality of opportunity is preserved which leads to productivity improvements and encourages charitable giving at the time of death which does far more good than giving a huge heap of unearned money to people in the middle of their lives.

MikeP writes:

How does one "put assets in your children's name" without paying the gift tax...

The gift tax doesn't apply to the first $28,000 per gift for a couple.

So for two kids, that's $56k per year transferred tax free. Over 18 years, that's $1M nominal and, at 4% interest, almost $1.5M in the account.

Greg G writes:

One of the first principles of tax avoidance is to defer taxes as long as you can. I would prefer paying taxes after I die to paying them while I am alive.

So then, if you are going to call estate taxes 'Death Taxes" you should be consistent and call all other taxes the "Breath Taxes."

The few estates still subject to estate taxes typically consist of huge amounts of unrealized capital gains. Less wealthy taxpayers find it a lot harder to avoid realizing capital gains and paying the tax on them.

I wouldn't call making it easiest for the richest people to avoid the capital gains taxes that many other people have to pay an advance for fairness. Nobody really wants to pay tax on anything. An unearned windfall is the thing it makes the most sense to tax. Perverse compared to what?

Glen Smith writes:

Thing that struck me in taking estate planning courses was that the estate tax is primarily about redistributing wealth from the wealthy to the uber wealthy and arguably at tool for indirectly moving wealth from the not wealthy and concentrating it even more in the top. It was not about revenue or redistribution of wealth from the haves to the have nots.

mucgoo writes:

Why not the British "inheritance tax"? That seems neutral to me.

mk writes:

[Comment removed for supplying false email address. Email the webmaster@econlib.org to request restoring your comment privileges. A valid email address is required to post comments on EconLog and EconTalk.--Econlib Ed.]

Philo writes:

You apologize for using the term 'death tax', saying it "isn't quite right either because you don't pay a tax for dying if you don't have an estate [indeed, a substantial estate]." But we talk unapologetically about 'income tax', even though if your income is small enough you pay no tax on it. Maybe we should call it "big-income income tax," and likewise "big-estate death tax," but that seems fussy and pedantic. I see no valid objection to the term 'death tax'.

Philo writes:

@ Greg G:

On the term 'breath taxes': income tax must be paid on a person's income even if he died during the year; the tax applies even if the relevant person is no longer breathing.

Stuart Buck writes:

I'd be more open to these proposals to eliminate the estate tax, if the people making the proposals seemed to be more aware of the fact that inheritances are not taxed as income. Indeed, if a rich guy bought 100,000 shares of stock at Walmart's IPO in 1970 (total cost: $1.6 million), and then died recently, the stock would be worth around $12 BILLION dollars. He could leave that stock to his heirs, and they would owe no income or capital gains tax, because their basis in the stock would be the fair market value at the time of his death. $12 billion in what is essentially income: not taxed.

Think about it: you tax what you want less of, and you exempt from tax what you want more of. Thus, we tax cigarettes and exempt charitable giving.

So why do you want a world in which we tax income that people actually earn through hard work, but in which rich heirs can get millions or billions of dollars in income, tax free, as long as they didn't earn it? Why do we want less work and more idle recipients of someone else's largess? Or to put even a finer point on it, why should a worker struggling to raise a family on $50,000 pay any taxes of various kinds, while Donald Trump's children could inherit millions or billions without paying any taxes whatsoever? How is that fair, and how does it encourage behavior that is socially desirable?

zeke5123 writes:

@ Stuart Buck

Of course, the easy retort is to eliminate the step up in basis at time of death. Instead, treat it similar to a contribution to a partnership (i.e., carry over basis). In this way, you maintain the built-in gain (aside from complex monetization techniques that the decedent could've engaged).

Stuart Buck writes:

Eliminating the step-up in basis for things like stock doesn't address the underlying fact that inheritances aren't taxed as income in any event. Bill Gates dies and leaves a relative a billion dollars in cash. That relative doesn't owe any income tax, even though the relative WOULD owe income tax from his $50k job. Why does that make sense?

David R. Henderson writes:

@Stuart Buck,
I'd be more open to these proposals to eliminate the estate tax, if the people making the proposals seemed to be more aware of the fact that inheritances are not taxed as income.
I’m not sure if you’re addressing me. If so, you need to know that I am quite aware of this. That’s why the post was on the estate/death tax, not on the income tax.

Stuart Buck writes:

Yes, that is a defect of the post -- if one proposes eliminating the estate/death tax without discussing why or why not inheritances should be treated as income, then it's like half of the equation is missing. One could make an argument for taxing inheritances as income to the recipient rather than taxing the estate, and that might be a very persuasive argument, but to argue against the estate tax without even mentioning the fact that this would leave massive inheritances (including step-up in basis for investments) untaxed at all even though someone is receiving money just as they would from a paycheck -- well, that won't do.

As noted above, I would argue that inheritances are less desirable than productive work, and therefore they should, if anything, be taxed at a higher rate than income is. I would be open to the argument that they should be taxed the same, if someone actually made that argument. But to imply that inheritances should be completely untaxed even while income from productive work is taxed -- that makes no sense at all.

zeke5123 writes:

Yes, that is a defect of the post -- if one proposes eliminating the estate/death tax without discussing why or why not inheritances should be treated as income, then it's like half of the equation is missing. One could make an argument for taxing inheritances as income to the recipient rather than taxing the estate, and that might be a very persuasive argument, but to argue against the estate tax without even mentioning the fact that this would leave massive inheritances (including step-up in basis for investments) untaxed at all even though someone is receiving money just as they would from a paycheck -- well, that won't do.

The estate/death tax is really an inheritance tax. It doesn't make sense to talk about eliminating an estate tax while at the same time believing that the inheritance should be subject to the income tax. That is like saying we should eliminate A but make sure we do A.

In fact, the concept that the estate tax is truly an inheritance tax explains the stepped up basis. It is seen as a transfer which (though operating under a different code section) should result in an exchange basis on section 1012.

But what I find problematic about the estate/inheritance tax is that it is a double tax. The income was taxed once within Family X, and then the inheritance tax imposes a second tax. Now, that isn't the case in the context of assets with built-in gain, so I agree with eliminating that principle.

The other final point is that the estate tax by and large is avoidable in its current form. Hire a good T&E attorney, and you won't pay a cent of tax. Of course, that is unproductive spending, so that is another argument for getting rid of the current estate tax (of course, perhaps not an argument for getting rid of all estate taxes).

Mike W writes:

He could leave that stock to his heirs, and they would owe no income or capital gains tax, because their basis in the stock would be the fair market value at the time of his death. $12 billion in what is essentially income: not taxed.

Yes, the heirs would not pay income or capital gains taxes but, the assets get that step-up basis treatment because they are included in the decedent's estate and are subject to the estate tax.

Basically, your Walmart stock owner, and his wife, pay a 40% tax on the market value of the assets passed to their heirs that exceeds about $12 million. There is an exemption for the first $11 million of joint assets and the first million after that is taxed at graduated rates (e.g.,18% on the first $10,000 increasing to 39% between $750,000 and $1 million).

Your Walmart stockholders would probably leave something to their heirs, and pay estate tax on those amounts, and, rather than paying the government, reduce their taxable estate by setting up a charitable foundation with the bulk of the estate.

Greg Jaxon writes:

In the next edition of the Bill of Rights, let's add two other fundamental rights to property and contract... namely (that Congress make no law impinging) the right of a citizen to bequeath property to heirs they choose, nor (ala the second amendment) the right to keep and bear gold or silver-- i.e. the right to hoard and to tender these in contracted exchanges.
Debating these things as matters of public policy concedes the moral high ground that powers over these matters of personal economic liberty were never enumerated and delegated to the feds.

john hare writes:

It seems to me that only one person noted the fact that the inherited money had already been taxed as income once. And nobody addressed the issue that the death tax reduces revenue through reaction to well understood incentives as noted in the article.

Jim Glass writes:

You might think that I've already biased the issue by using the term "death tax," a term many conservatives have used...

and

if you are going to call estate taxes 'Death Taxes" you should be consistent and call all other taxes the "Breath Taxes."

No and no. Death taxes have been called "death taxes" ever since they were first conceived for the obvious reason that they apply at death. When I was in law school and MBA school there were chapters in legal and public finance textbooks routinely titled "Death Taxes", no political issue at all about it. That's simply what they were.

Then the left came up with the fanciful political rhetoric that the right had invented the term as fanciful political rhetoric -- and the right instead of calmly pointing to the truth instead defiantly embraced the slur aimed it.

I mean, one learns something about the nature of politics from watching bogus partisan political fiction become so embraced as "truth" by both sides that the massively documented actual truth is totally forgotten and ignored by everybody.

Courtesy of the Tax History Project, see this study out of FDR's Treasury Department in 1937...
~~~~

DEATH AND GIFT TAXES

1. THE DESIRABILITY OF DEATH TAXES

UNIVERSAL ACCEPTANCE: Taxation of the transfer of property at death...

PAINLESSNESS: Death taxes constitute a relatively painless method of raising revenue. The descendent is dead

2. DEATH TAXES AS A SOURCE OF FEDERAL REVENUE...

Greg G writes:

Well if you want to get technical about it, isn't it the estate rather than the death that's really being taxed? Dying is free. It's only dying with an estate that's taxed. I don't know the full history of the use of the term Jim, and I didn't claim to.

I do remember seeing Frank Luntz claim that his focus groups where were the political usefulness of the term was discovered. Of course, it's certainly possible this was just self-promotion on his part.

Stuart Buck writes:

Two people have now pointed out that an inheritance was already taxed once, when it was income to the original owner. For one thing, that is often untrue, due to the step-up in basis that we've already discussed. But more definitely, it is utterly irrelevant. If I earn income and pay income tax, and then use $1,000 to pay a contractor to do some work on my house, the contractor cannot escape income tax on the specious theory that I already paid income tax on that amount. Yes, I did, when it was income FOR ME, but now it has changed hands and become income FOR HIM.

For any income tax to work, you can't declare that money is only to be taxed "once," and then when it changes hands thereafter, it isn't taxed. Given how money circulates, that would quickly eliminate almost all income from taxation.

So Rich Guy earns income and pays income tax. Later, he leaves $10m to an heir. That heir now has $10m in income TO HIM, and should pay income tax. Alternatively, we could tax the $10m before the heir gets hold of it (in which case it's the estate tax).

But I don't hear anyone making an intellectually honest argument (or any argument at all) in favor of no taxation whatsoever. After all, why should people who acquire $10m income via inheritance should be so heavily favored by the tax code over people who got $10m income via productive work? Why would anyone want to discourage productive work?

So are we all agreed that if we do away with the estate tax, inheritances should become subject to the normal income tax rules?

Benjamin Cole writes:

I probably agree that the death tax should be abolished.

I just wish i could see such fervor about somehow reducing FICA taxes on some guy working for $15 an hour.

Why do we tax productive behavior?

If I had to choose, I would prefer to tax dying than working.

The Original CC writes:

Ben G:

Do you seriously believe that the (probably very minor) disincentive to accumulate more capital before death from this tax results is a big of a hit to productivity than children being showered in huge inheritances? Also, please tell me how property is productive capital?

To the extent that a death tax encourages spending money on frivolous things before death instead of keeping the money invested, it reduces capital available for investment and increases curent consumption. I think that's what they were arguing.

Mike W writes:

So Rich Guy earns income and pays income tax. Later, he leaves $10m to an heir. That heir now has $10m in income TO HIM, and should pay income tax. Alternatively, we could tax the $10m before the heir gets hold of it (in which case it's the estate tax).

So all we're really concerned about here is the $11 million estate tax exemption. The income (capital gains) included in the value of assets in excess of that exemption amount is currently subject to a tax, the estate tax.

Its arguable that the heirs have "income" as it is commonly understood...i.e., as value added...from the transaction. Actually all that occurred was a change in the name of the owners of the assets.

So are we all agreed that if we do away with the estate tax, inheritances should become subject to the normal income tax rules?

That would seem to replace our existing system with another merely for the sake of change with no real benefit.

The ability of large estates to avoid tax by contributing assets to charitable foundations would likely remain an element of the income tax system as it is currently. That would leave only the $11 million exemption amount subject to an income tax. Would the tax revenue from taxing just the income, i.e., the built-in capital gain, in that $11 million be greater or less than the revenue collected under the existing estate tax system? And, if less, what kind of response would that prompt from the government to replace that lost revenue.

It seems like a lot of wasted effort for no significant benefit (kinda like debating the terminology of a tax levied at death).

Stuart Buck writes:

Actually all that occurred was a change in the name of the owners of the assets.

That's all that occurs with ANY form of income -- money (or something valuable) changes hands. The whole point, which neither you nor anyone else has yet grappled with, is that there is no reason to refuse to tax income that is unattached to any productive work, while taxing the heck out of income that comes from productive work.

The ability of large estates to avoid tax by contributing assets to charitable foundations would likely remain an element of the income tax system as it is currently.

So what?

Would the tax revenue from taxing just the income, i.e., the built-in capital gain, in that $11 million be greater or less than the revenue collected under the existing estate tax system?

Who cares? The point I've been making has nothing to do with government revenue overall; it has to do with the distortionary effect of taxing money that changes hands due to productive work while not taxing money that changes hands where there has been zero productive work.

Mike W writes:

How would one arrive at this "distortionary effect" in order to evaluate the merits of one tax regime over another?

If capital gains are taxed more would that not result in some sort of distortionary effect? Why assume that the effect would be positive?

And the idea of "productive work" seems to be a value-laden term that fits a particular point of view that labor income is somehow more virtuous than capital gains. That's merely a self-serving argument that someone else should be taxed more.

I don't see how evaluating proposals to change the tax code on anything other than an evidence-based analysis of costs and benefits amounts to much more than an exercise in academic navel gazing or self-interest advocacy.

Steve J writes:

Stuart Buck is the only one making sense here. His argument is very simple. Income is taxed in the US. Can anyone explain why inheritance income should not be taxed?

Jim Glass writes:

"As long as an inheritance tax remains a true inheritance tax it always involves a conversion of capital into income, hence an act of economic waste which is damaging to all." — Joseph Schumpeter

That said, the estate tax is a creature of politics, not economics, so expect it to make far more logic politically than economically, which indeed it does. All the economic faults described above are true enough, but because Congress keeps the revenue effect of the tax so small they just don't really matter enough for anyone to put any pressure on Congress due to its economic results -- which is just what Congress wants.

This lets both parties continually reap political gains from it by practicing posturing over substance. The party of the Kennedys poses as being being tough on inherited wealth and inequality while letting Joe's descendants plus the families of Fords, Rockefellers, DuPonts et al, ride their inheritances for generations. Via a tax that consistently collects a lower effective rate from those richest families and a higher rates from the less rich, due to all the 'planning devices' built into it that are best used by the richest. Buffett and Gates can voice public support for the estate tax because they know they won't pay any, and so can happily support Democrats.

"I don't need Bush's tax cut. I have never worked a [bleeping] day in my life." -- Patrick Kennedy, campaigning for Howard Dean, 2003, WaPo. (No longer on the WaPo site but archived)

Republicans are at least as bad if not even more hypocritical. They had ample votes to repeal the estate tax in full in 2001 but instead pretended they couldn't because of budget rules, so instead voted to repeal it for all of one year 10 years in the future. Then they spent a decade claiming they *had* repealed it and aggressively collecting contributions needed to make the repeal "permanent" -- while the Democrats simultaneously beat the drum for contributions to "Stop the repeal of the estate tax!" Total result of all the controversy, only marginal small changes like we see in all tax laws all the time.

A faux repeal filled the campaign hoppers of both parties for a decade. What could be a better political result? Who says the two parties can't cooperate? And now it starts up again.

"All of this proves what the present state of the tax shows full well - Congress, including Republicans, wants a sick but not yet dead tax: the better to vote on." The Politics of Estate Tax Reform

(BTW, this isn't the only tax with which Congress plays this game. It has been rolling over a growing collection of small tax bills known as "the extenders" every two years since the 1970s, because it is always and forever somehow subject to budget rules that stop it from making them permanent. Though Congress people themselves treat it as an open secret that the "forever temporary" nature of the extenders really serves to provide them with a bi-annual annuity from interest group contributors and lobbyists.)

Mark V Anderson writes:

I've often thought that the death tax is the best tax we could have. What tax could be less onerous than one that burdened the dead?

Although as someone pointed out, it is really a tax on the inheritors, not the person who died. But again, it seems a lot less onerous to tax money going to inheritors, who no more deserve this cash over anyone else, than it is to tax income, sales, or property of those who have earned their money. In fact, I would think this would be libertarians' favorite tax, because of their strong aversion to taxing those who earned their money. It might also result in a more equal starting point for people, the one kind of equality most libertarians favor.

However, there is one very strong argument against this tax. It is difficult to administer and thus easy to evade. The executor must find all the assets of the deceased, which can be very difficult. And the tax gives an incentive to put one's money into small mobile assets such as jewels or gold, which isn't useful for the productive economy.

I just wish it was more common for the deceased to give most of their money to charity, beyond a small token of appreciation to their heirs.

https://www.amazon.com/Simplify-Government-Mark-Anderson-ebook/dp/B01GLQACCW/ref=sr_1_1?s=books&ie=UTF8&qid=1469241098&sr=1-1&keywords=simplify+government#navbar

Jim Glass writes:

So Rich Guy earns income and pays income tax. Later, he leaves $10m to an heir. That heir now has $10m in income TO HIM, and should pay income tax.

Quick look at some issues...

(1) Practicality. It was tried decades ago, failed immediately and was quickly abandoned. The recordkeeping required is utterly impossible. Income is determined *net* of related expenses involved in creating it. When Aunt Matilda dies and her belongings are spread to heirs near and far, nobody gets the records for whatever particular item they inherited to determine net income on it. She probably didn't have them herself. So calculating net income is impossible. Now, if one argues that the value of an inheritance from her is 100% income to nephew Bernie so it should be taxed in full as income to him, then one is disregarding the definition of income and greatly increasing the family's tax bill -- which families across America will not tolerate politically.

For instance, Aunty buys a bedroom set for $1,000 and dies when it is worth $700. If she'd sold it her income would have been $0. Now, if you tax it as $700 of "income" to heir Bernie then you are really running up the family tax bill! Multiply by ... great masses of things people inherits everywhere, big and small. That's just not going to work, in either politics or economics.

(2) Economics. Gifts and other transfers in general are *not* income to recipients either to the IRS or in the national economic accounts. Why do you want to change the definition of income as to inheritances alone? Parent makes a gift of an $100,000 asset to child while living, no income to child. Parent makes same gift through a will, now this is to be income to the child. Why?

You are not proposing to "apply normal income tax rules", you are proposing to change the definition of income as to inheritances alone.

So to be clear: Applying "normal income tax rules" would be imposing a forced calculation at death of gain on every separate single item in an estate, with that gain being taxed to the heir recipient of each item -- but that is real-world utterly impossible. While, OTOH, instead taxing the gross value of transfers to heirs as income to them is very far from normal income tax rules.

(3) Double taxation revisited. The current market value of a capital asset is the present value of the income it is expected to produce in the future. E.g., bonds valued at $10 million derive that value from the income stream they are expected to provide going forward. Thus, if you tax a person who inherits the bonds as having $10 million of current income on the basis of this future income stream, and then later also tax him on that interest as he receives the income stream, then plainly you are double-taxing that interest income.

So are we all agreed that if we do away with the estate tax, inheritances should become subject to the normal income tax rules?

Not all! It is the impossibility of applying normal income tax rules to estates to calculate gain/loss and resulting tax item-by-item that is the very driving force behind the existence of an estate tax that adds up the gross value of all items in an estate into a single sum with one tax rate applied to the total. Hugely simpler, though difficult enough.

Stuart Buck is the only one making sense here. His argument is very simple. Income is taxed in the US. Can anyone explain why inheritance income should not be taxed?

Well, that very simple argument is wrong. Gifts and other transfers generally aren't income as per either the IRS or the national economic accounts. Why do you want to change this fact for inheritance transfers alone? Think of the chain of consequences...

Mike W writes:

And professor Henderson started all this with a simplistic academic observation about the definition of "death tax". A luxury of academics but not available to those living in the real world.

Stuart Buck writes:

"When Aunt Matilda dies and her belongings are spread to heirs near and far, nobody gets the records for whatever particular item they inherited to determine net income on it. She probably didn't have them herself. So calculating net income is impossible"

If "belongings" are at issue, fair market value can be declared, just as donations of items are currently declared for deduction purposes at fair market value. It isn't precise, but so what?

But by far, most inheritances of any substance aren't the living room couches or the bedroom nightstand. Instead, we're talking about cash, stocks, bonds, investments, etc. It is stupid to suggest that one can't determine the value of those things in order to declare them as income.

Gifts and other transfers generally aren't income as per either the IRS or the national economic accounts.

Only under narrow limits; otherwise they count towards the estate tax. The point, which you completely evade, is that if we get rid of the estate tax (and, presumably, the associated gift tax), we are left with a world in which acquiring money via productive work is heavily taxed whereas acquiring money through the complete accident of who you're related to (having done no productive work whatsoever) is NOT taxed.

I see no reason why productive work should be relatively disadvantaged compared to idle accidents, and you do not supply even the faintest glimmering of a plausible reason.

taxing the gross value of transfers to heirs as income to them is very far from normal income tax rules.

So what? The point here isn't to describe what the income tax rules are, or else we would be content with saying that there's an estate tax and that's the end of it. The whole premise of this debate is that people are somehow intellectually capable of discussing whether income tax rules would make more sense if altered in some respect.

It is the impossibility of applying normal income tax rules to estates to calculate gain/loss and resulting tax item-by-item

Again, it's not impossible. That's stupid. We could calculate taxable income with just as much precision as we do in many other cases.

Stuart Buck writes:

Sorry for using the word "stupid" -- that was unnecessary.

Mercer writes:

'Gifts and other transfers generally aren't income as per either the IRS "

Gifts over 14,000 are generally considered income by the IRS unless it is to a spouse.

I think death tax is misleading because 99% of people do not pay it at death since it starts on inheritances of over 5 million.

I think the priority the GOP gives to ending a tax that only the wealthy pay shows what is wrong with their party. There are many free market reforms that could benefit far more people like the zoning laws discussed in another post today. The effective high marginal rates in Obamacare subsidies, the restrictions on dental hygienists and nurse practitioners also harm far more people.

When GOP politicians and economists devote their time on things that only effect the wealthy they provide the opening for people like Trump to take over their party.

Mike W writes:

The point here isn't to describe what the income tax rules are, or else we would be content with saying that there's an estate tax and that's the end of it. The whole premise of this debate is that people are somehow intellectually capable of discussing whether income tax rules would make more sense if altered in some respect.

And there's your answer...there's an estate tax and that's the end of it.

The system we have evolved through negotiation and compromise...it may not be optimal but it is what was possible.

To be meaningful, "discussing whether income tax rules would make more sense if altered in some respect" would need to take into consideration why the rules we have were adopted in the first place. Merely proposing a binary choice of having an estate tax or not having an estate tax is not a meaningful discussion.

Brian Holtz writes:

Geolibertarians have the best answer here: untax all income, sales, trade, and production. Tax only the pollution, depletion, congestion, or monopolization of the commons: land, water, air, spectrum, minerals, wildlife, etc.

Mike W writes:

Actually, Miss America contestants have the best answer here: "Like, world peace."

Academics aren't much different.

Jim Glass writes:

"Gifts over 14,000 are generally considered income by the IRS unless it is to a spouse."

Not true. Gifts are not taxable income to recipients.

Gifts over $14,000, to the extent their lifetime total 'over' exceeds $5.45 million, are taxed to the the person who makes the gifts by reducing that person's estate tax exempt amount, increasing ultimate estate tax correspondingly. Gift tax is an extension of estate tax with the purpose of preventing people from escaping estate tax by giving everything away. It's called the "Unified Estate and Gift Tax".

For the record, reassurance if anyone reading this is worried about owing tax on a gift!

Jim Glass writes:

*taxing the gross value of transfers to heirs as income to them is very far from normal income tax rules.*

So what? The point here isn't to describe what the income tax rules are...

You said "inheritances should become subject to the normal income tax rules", now you say you don't care about the normal income tax rules. Okay.

In reality you have a strong view of social justice and economic efficiency which tells you that transfers should be taxed as income to the recipient, albeit as a totally new rule - but you can't do that just at death, you have to adopt that rule change for *all* transfers before death too. Both logically and practically. (See "purpose of gift tax").

So you are much too modest with your reform. With all transfers taxable income, when parents pay college tuition for children it is taxable income to them (there's no income tax exemption for children), and when Aunty gives you a wedding present of a bedroom set it is taxable income to you, as are all the other wedding gifts -- making the cost of the bedroom set its purchase price *plus* the tax on its full value as income (talk about double taxation, and all those 1099s filed by everyone at the wedding for all those presents - that will be politically popular!) etc., times everything. Medical bills paid for others, funds you transfer to your new corporation, funds you give your nephew to make a down payment on a house, presents and gifts of all kinds, you name 'em. If you want to argue for this new system as a reform, fine. But it should be in thread on "income tax", not "inheritances".

Getting back to "normal income tax rules"...

*It is the impossibility of applying normal income tax rules to estates to calculate gain/loss and resulting tax item-by-item*

Again, it's not impossible. That's stupid.

I always remember my young self when meeting idealistic reformers who call reality "stupid". The Income Tax Act of 1894 tried to tax estates by income tax rules. There's really a lot of historical experience with all this. Maybe someday you'll be executor of an estate and have the fun of determining just the market value of all the separate items in it for heirs -- not even bothering with the separate income tax 'imputed sale' gain or loss on each item. Until then, ask yourself, why didn't they keep taxing estates by income tax rules, if it was so easy, and better too?

Sorry for using the word "stupid"

No offense taken. I still have an asbestos suit in my closet from my days on the old usenet.

In tax policy, "ease of enforcement" and "politically supported" are absolute necessities, "economic sense" is a mere add-on and will be trumped by either in any conflict. Idealist reforms that forget this go nowhere. And idealism can be the enemy of the workable.

E.g., my whole professional career I've known neo-Georgists who tout "land tax" as an ideal non-distorting tax, which is fine as long as they remember how very difficult it is to apply. But many get intoxicated by high principles and declare it can fund the entire government, end inequality, and cure the business cycle -- and it's easy too! Oblivious to the fact when tried in actual practice it has been a disaster (see Pittsburgh). While they have no explanation for why such a great and easy idea hasn't been picked up by politicians anywhere. (No offense to Mr. Holtz.)

There are few new ideas in tax reform. Before being swayed by one, check its history.

Stuart Buck writes:

Well, I wouldn't have any problem with taxing college expenses as income to the college attendee. I supported myself in college by, among other things, a part time job at Pizza Hut, and I had to pay taxes. I have yet to hear any remotely plausible public policy reason to tax me while exempting richer classmates who got money for free from parents.

(Yes, taxing that kind of gift wouldn't be politically popular, but it wouldn't be any harder than lots of other things that we tax, and since when is political popularity amongst concentrated interest groups a good guide to policy?)

As for taxing wedding gifts and the like, perhaps we could come up with a de minimis exemption for gifts under a $5,000 amount per person per year,or something like that. No normal person gives gifts anywhere near that, so the alleged administrative burden wouldn't be very great at all. Gifts of stock and cash are easily valued, and in kind gifts can be declared at fair market value. People might underdeclare, but not sure why you're worried about that.

Brian Holtz writes:

@Jim, see the response by Prakash at your link, and Foldvary's writings elsewhere, on the practicality and phase-in of LVT.

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