Scott Sumner  

Don't tax death

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Here's the Economist magazine, in an article advocating death taxes:

Advocates of the tax were unable to counter with anything nearly as powerful. A few pointed out that double taxation occurs on a daily basis in the form of sales taxes (people buy things with taxed income), or that it is what the person leaves behind, rather than the person, which is subject to the estate tax.
I understand the impulse that leads people to favor inheritance taxes. But death taxes are not the way to go about it. When economists complain about "double taxation", they have something very specific in mind---taxing future consumption at a higher rate than current consumption. Combining a sales tax with an income tax does not lead to the double taxation of future consumption. However an income tax alone, indeed any tax on capital income, does lead to the double taxation of future consumption.

Death taxes are not bad because a bunch of old rich people have to pay money to the government, rather they are bad because thrifty rich people are taxed at a much higher rate than profligate rich people. I have no problem with progressive taxes, which tax high rates of consumption more heavily than low rates of consumption. I do have a problem with taxing future consumption at a higher rate than current consumption.

Consider Sweden:

Sweden, which is usually seen as egalitarian, has gone one step further. In 2004 its inheritance tax was repealed, with the support of a former communist party, among others. What prompted such a radical transformation from the 1960s, when the largest estates could face an effective tax rate of 60%? By the end of the 1970s there was a growing sense that the Swedish state was bloated; a turning-point came when Astrid Lindgren, the creator of Pippi Longstocking and a national hero, revealed that she faced marginal tax rates of more than 100%. A financial crisis in the early 1990s reinforced the sense that the country needed to become more competitive.

Politicians noted the special disgust that Swedes reserved for inheritance tax. According to Swedish Enterprise, a lobby group, entrepreneurs such as Ingvar Kamprad, the founder of IKEA, were leaving the country to avoid high taxes. Stories abounded of family firms broken up to pay the bill. At first, tweaks were introduced to the Swedish system. Yet the resulting complexity met with disapproval. Sweden is a small country with high levels of social trust; people are allergic to bureaucracy, says Janerik Larsson of Timbro, a think-tank. "It was easier to get rid of it entirely." After abolition Mr Kamprad returned to Sweden. The economy has grown quickly in recent years, and anti-tax advocates claim they have been vindicated.


Sweden is not just "usually seen as egalitarian", it is fairly egalitarian. And the Swedish case shows that there is nothing inconsistent with abolishing the inheritance tax and being an egalitarian country.


Comments and Sharing






COMMENTS (23 to date)
Name writes:

If someone's son does something in exchange for the parent's money, that should be taxed as income, right? But if he is given the money in exchange for nothing, then it should not be taxed? Why reward doing nothing over doing something?

Scott Sumner writes:

Name, You said:

"If someone's son does something in exchange for the parent's money, that should be taxed as income, right?"

Why? The income tax doesn't tax "something" it taxes output. What if the "something" is "being a good person"?

If the old man gives money to his son, presumably he thinks his son deserves it. You and I may not agree, but it's the old man's money---he can spend it as he sees fit.

me writes:

But isn't that exactly what Name claims?

Inheritance should be taxed as income on the recipients side precisely because it is a return on prior work (being a good son)

Jon writes:

As an example of tax insanity...
https://www.bogleheads.org/forum/viewtopic.php?f=2&t=242166&newpost=3883130#p3883130

Most all of the states that opted to deviate from the IRS contribution rules are in the Northeast.

However, CA had a period of similar non conformity in the early 80s for IRAs:

Nondeductible Contributions Made Before 1987
If you made nondeductible contributions before 1987, none of your distribution is taxed until you have recovered your pre-1987 basis. Because there was a difference between federal and California contribution limits before 1987, there may be a difference in the California and federal taxable amounts. If there is a difference, make an adjustment to reduce your federal AGI to the correct taxable amount for California. Your adjustment is the lesser of your pre-1987 California basis or IRA distribution included in federal AGI. Use Worksheet I — Part A on page 13 to compute your pre-1987 California basis. Use Worksheet I — Part B to compute your adjustment to federal AGI and your remaining pre-1987 California basis. See Example 1 and Example 2 on page 7. Use Worksheet II on page 13, as a summary of your
California basis and its recovery. If you have more than one IRA account, combine all your IRAs to complete the worksheet. If both you and your spouse/RDP have IRAs, you each must complete a separate worksheet based on your own IRA contributions, deductions, and distributions

Thaomas writes:

There are very good arguments for tax changes that progressively tax consumption. A simple repeal of the inheritance tax (or a reduction in the corporate tax rate) unaccompanied by higher marginal tax rates on large incomes does not do that.

DougT writes:

"You get less of what you tax, and more of what you subsidize."

Do we want current consumption or future consumption? Because of political short-termism, I think most pols want consumption now, rather than consumption later. So their political interests align with the economic consequences of an inheritance tax. This only changes when the adverse consequences of the tax become prominent, as in the case of Sweden's high-profile expatriates.

Name writes:

Scott: "Why? The income tax doesn't tax "something" it taxes output. What if the "something" is "being a good person"?"

Surely if the parent employed the son and paid him that way, it should be taxed. Where is the line between that and what should not be taxed?

Michael writes:

Agree with Name. If rich parent spends money on hiring a cleaner, the cleaner pays income tax. If the child works as a cleaner, he pays income tax. Why should income be untaxed if it's the special case of receipt from estate? So by all means abolish estate tax. Just treat inheritance as income. Maybe allow smoothing over multiple years to avoid triggering penal thresholds, but I struggle ethically with the idea that you only pay tax on money you earned in the market.

Scott Sumner writes:

me, Being a good son is not output. I don't think there is a single country in the entire world that taxes "being a good son".

Jon, Good example. It's an insane system.

Name, I don't see the connection between being a good person and being an employee. One does not imply the other.

Dylan writes:

"Combining a sales tax with an income tax does not lead to the double taxation of future consumption. However an income tax alone, indeed any tax on capital income, does lead to the double taxation of future consumption."

I'm not getting this distinction. I'm living off money I made 20 years ago and paying sales tax on the consumption, how is that not taxing future consumption relative to the time I paid the income tax on it?

I also think I'm on the same page as Name and others with regards to income. What if I'm a rich person and hire a maid to clean my house and we agree on a below market wage with the understanding that I will bequeath some of my estate to them untaxed later to make up for the shortfall?

robc writes:

I think Name and Michael are providing really good examples of why we shouldn't have an income tax.

It isn't just inheritance, defining what is and isn't "income" is hard. And any rules will get gamed by those who can afford tax and estate planning.

Gifts are another example. I can give my daughter $28k per year tax free ($14k from me, $14k from my wife). But any more than that and she has to pay taxes on it.

Why is that the limit on what is a gift vs what is income? What magically makes dollar number 14001 different?

But not allowing gifts would be just as stupid.

The income tax is just a really, really bad way of raising revenue for the state. Possibly the worst of all possible tax methods.

Effem writes:

While i happen to agree with you in general, i think the best argument for an inheritance tax is that we seem to have decided that striving for "equality of opportunity" is part of our national identity. With estimates of inherited wealth as high as 30-40% that basically becomes impossible.

Matthew Waters writes:

The estate tax offsets the step-up in capital gains. I would be fine with eliminating the estate tax if there was also an elimination of capital gains step-up.

Capital gains itself is a double taxation. A hyper-rational person would theoretically change from investment to consumption based on capital gains rates. In practice, there is little elasticity. Gains realizations do have elasticity with rates, but actual capital investment has little relationship.

Many of the largest capital gains are really gains from labor. Pure single taxation at income would have Warren Buffett pay nearly zero taxes since the dissolution of his partnership in the 60's. The partnership was the last time he earned income not based on an invested principal. Clearly his investment returns have involved labor. Taxing his capital gains is tax on his labor picking investments.

Matthew Waters writes:

"Gifts are another example. I can give my daughter $28k per year tax free ($14k from me, $14k from my wife). But any more than that and she has to pay taxes on it."

As a note, this is wrong. The gift is *reportable* over $14k, per person receiving a gift. A gift above $14k does not get taxed on the giftee. Technically, neither giftees nor inheritors directly pay the tax.

Instead, all gifts above $14k by a person gets added to their estate tax. Let's say somebody is worth $6MM. If they die, the estate is taxed on what's above $4.5MM. That person cannot simply give $2MM to their children, then have an estate worth $4MM.

The $2MM gift would be reported and added to a lifetime ledger for the estate tax. On death, the same taxes from the estate would be paid.

Wealthy people do peg gifts just below $14k and do so per person. So a millionaire with a few children and several grandchildren can functionally give away most of their wealth in irrevocable trusts, outside of the estate tax.

For normal people, the gift tax is not really something to worry about. You have to report it, but the *giver* does not pay taxes on it until they go above estate tax thresholds.

Alan Goldhammer writes:

I guess it must be pile on Scott day!!! The "death tax" is a huge misnomer and it's also very complicated as I've found out following a modest inheritance I received that was part cash & securities and the 2nd part was real estate.

The big issue to me is the passing on of securities at market value irrespective of the capital gains that the decedent had accrued. This by passes what might be a significant amount of tax that is never received by the Treasury. Is this fair?

ZC writes:

@robc

"Gifts are another example. I can give my daughter $28k per year tax free ($14k from me, $14k from my wife). But any more than that and she has to pay taxes on it."

That's not an example, that's absolutely incorrect.

No, she wouldn't pay tax on it. Anything in excess of the annual gift tax exemption amount would be reportable by you to count against your future estate tax exemption. As the estate tax exemption increases to $11.2M in 2018, and you were unaware of this, I'm going to venture a guess that you won't be having an estate tax problem. Even if you gifted her more than 22.2M between you and your wife, she still wouldn't pay any tax, it's still a gift to her. Your estate would have a tax liability. Gift all you want to your daughter.

It's always amusing to me that people with a poor understanding of the tax code have no qualms about confidently boldly espousing their views on optimal taxation. Although, that is certainly an argument that the tax code is overly complicated.

Douglas S Field writes:

Do you recall this adage describing many families' experience in America? Shirt sleeves to shirt sleeves in three generations

The above highlights the all-too-frequent reality that succeeding generations not only cannot make the fortune a predecessor did, but they cannot keep one they inherit. That is a damning observation.

With considerable wealth comes considerable power. If we are unable to credit heirs with the judgment to hang on to money, why should we trust them to manage a corporation or use their deep pockets to influence political decisions?

I am all in favor of some index adjusted cap on inheritance under which all passes tax free and over which the estate tax is nearly confiscatory (as in 90%). The only caveat to that, of course, is the judgment of politicians and bureaucrats is still more flawed and they probably cannot be trusted to set that cap appropriately.

robc writes:

Matthew and ZC,

Touche.

And, yeah, I knew that at one time. I don't have any issue (at this time), but my parents might (and they have been the ones giving my daughter gifts just under the limit). At the current estate tax exemption, there won't be an issue, but it has bounced around a bunch over the years, and at times the exemption limit has been below their net worth.

But the details being wrong doesn't change the principle: somehow, 14k per year can be gifted "off the record", but go above that and it magically becomes POTENTIALLY taxable. The point is the arbitrariness of the 14k, not the exact law. Or why if we are going to tax capital gains as income, it isnt indexed to inflation. If I buy an asset for 100k this year, we have 3% inflation, and I sell it for 103k next year, there is no real capital gain.

There are tons of examples, the problem is taxing income. Look at even the 1913 income tax form, which is as simple as they come. It had only a few categories for deductions and they make sense, but could be argued were arbitrary. All interest payments were deductible. I think people would argue about that one today. And losses due to shipwreck, which seems okay.

Roger writes:

Mark Zuckerberg is worth some $66 billion. Almost all that wealth exists as an unrealized capital gain in FB stock that has never been taxed.

While one might make an argument against taxing money twice, I see no valid argument against taxing money that has never been taxed at all. Why should his kids inherit billions of dollars tax free, leaving the rest of us to pay all of the country's bills from our comparatively minuscule incomes?

Erik Carter writes:

What do you think of the idea of taxing estates at the same rate as consumption? In other words, all income would be taxed once, either when consumed or at death. You could also argue that a gift is a form of consumption as you seem to indicate here: "If the old man gives money to his son, presumably he thinks his son deserves it. You and I may not agree, but it's the old man's money---he can spend it as he sees fit"

Matthew Waters writes:

robc,

I'm not sure if you are saying we shouldn't tax income. The estate/gift tax and the $14k threshold is not a tax on income. The $14k threshold tried to balance administrative burden with the estate tax's intent. Some threshold is needed.

Today, the estate tax starts at $5MM. A $6MM estate has an overall tax rate of 5%, since the tax starts at $5MM. A $10MM estate has an overall tax of 20%.

When those very high numbers are stated outright, there is going to be little political popularity for eliminating the estate tax. Estates with FAR more than $5MM or $10MM are also the biggest lobbyists for repeal, such as the Mars family.

That said, I would be okay with estate tax elimination with the elimination of Capital Gains basis step-up. The death tax has a huge offsetting death benefit of basis step-up.

Charitable trusts should also be eliminated entirely. Charitable Lead Trusts and Charitable Remainder Trusts are the main things used for estate tax avoidance (such as the Waltons' heirs). Such trusts can avoid *any* income tax on the living donor and, with low IRS discount rates, their heirs get a substantial portion of the estate rather than the charity.

robc writes:

Matthew,

That said, I would be okay with estate tax elimination with the elimination of Capital Gains basis step-up.

I agree with that. If we are going to have a Cap Gains tax, then that needs to happen.

I would prefer we not have a death tax, a cap gains tax or an income tax. Or a sales tax. Or excise, or property. (I am an SLT guy).

I'm not sure if you are saying we shouldn't tax income. The estate/gift tax and the $14k threshold is not a tax on income. The $14k threshold tried to balance administrative burden with the estate tax's intent. Some threshold is needed.

It was the very first post of the comments that Name said that inheritance should be taxed as income. And Michael said something similar. My first post was responding to them. The concept of estate tax as a form of income tax was established as the premise of the discussion early on.

Matthew Waters writes:

I'll confess to not knowing what SLT stands for. Do you mean single taxation on consumption?

On a blackboard, a true consumption tax regime is the best possible system. With single taxation, it has no distortion between consumption and investment. It also taxes outsize investment gains.

In practice, consumption tax proposals can be extremely naive. The Fair Tax, for example, would only tax final consumption and be extremely easy to evade. A VAT is more difficult to evade, but evasion would still happen if a VAT replaced ALL tax revenue. You can see the complex VAT evasion scheme for Louis Hamilton's jet as an example:

Louis Hamilton Jet

IMO, the multiple levels of taxation in first-world countries are a feature not a bug. It creates incentives for tax reporting, such as the incentive for companies to file W-2's and 1099's and receive labor expense. The actual investment vs consumption distortion is small.

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